**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe fiscal year ended December 31, 2006**

**o**                            TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

**For the transition periodfrom                  to**

**CommissionFile No. 000-31332**

**LIQUIDMETAL TECHNOLOGIES, INC.**

**(***Exact name of Registrant as specified in its charter***)**

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

 

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

 

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

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

**Securities registered pursuant to Section 12(g) of theAct:**

**Title of each Class**

CommonStock, $0.001 par value

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

Indicate by check mark if the registrant isnot required to file reports pursuant to Section 13 or Section 15(d) of theAct. Yes  o  No  x

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor at least the past 90 days.   Yes  x  No  o

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

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of theAct).

| Large accelerated filer  o |   | Accelerated  filer  x |   | Non-accelerated  filer  o |
|--------------------------------------|--------|---------------------------------|--------|-------------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Act). Yes  o  No  x

The aggregate market value of the registrant’sCommon Stock held by non-affiliates of the registrant as of June 30, 2006was approximately $69,889,521. For purposes of this calculation only,(i) shares of Common Stock are deemed to have a market value of $1.95 pershare, the closing price of the Common Stock as reported on the Nasdaq NationalMarket on June 30, 2006, and (ii) each of the executive officers,directors and persons holding more than 10% of the outstanding Common Stock asof June 30, 2006 is deemed to be an affiliate.

 

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

 

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**PART I**

**Forward-Looking Statements**

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

·                  Ourhistory of operating losses and uncertainty surrounding our ability to achieveor sustain profitability;

·                  Ourlimited history of developing, manufacturing, and selling products made fromour bulk amorphous alloys;

·                  Lengthycustomer adoption cycles and unpredictable customer adoption practices;

·                  Ourability to identify, develop, and commercialize new product applications forour technology;

·                  Competitionfrom current suppliers of incumbent materials or producers of competingproducts;

·                  Ourability to identify, consummate, and/or integrate strategic partnerships;

·                  Thepotential for manufacturing problems or delays; and

·                  Potentialdifficulties associated with protecting or expanding our intellectual propertyposition.

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

**Item 1.Business**

Inthis annual report on Form 10-K, unless the context indicates otherwise,references to “the Company”, “Liquidmetal Technologies”, “our Company”, “we”, “us”,and similar references refer to Liquidmetal Technologies, Inc. and itssubsidiaries.

**Overview**

Weare a materials technology company that develops and commercializes productsmade from amorphous alloys.  OurLiquidmetal® family of alloys consists of a variety of proprietary coatings,powders, bulk alloys, and composites that utilize the advantages offered byamorphous alloy technology. We develop, manufacture, and sell products andcomponents from bulk amorphous alloys to customers in various industries, andwe also partner with third-party licensees to develop and commercialize bulkLiquidmetal alloy products. We believe that our proprietary bulk alloys are theonly commercially viable bulk amorphous alloys currently available in themarketplace.  In addition to our bulkalloys, we market and sell a line of proprietary amorphous alloy-basedindustrial coatings under the Liquidmetal® ArmacorTM coatings brand.

Amorphousalloys are unique materials that are distinguished by their ability to retain arandom atomic structure when they solidify, in contrast to the crystallineatomic structure that forms in other metals and alloys when they solidify.Liquidmetal alloys possess a combination of performance, processing, andpotential cost advantages that we believe can make them preferable to othermaterials in a variety of applications. The amorphous atomic structure of ouralloys enables them to overcome certain performance limitations caused byinherent weaknesses in crystalline atomic structures, thus facilitatingperformance and processing characteristics superior in many ways to those oftheir crystalline counterparts. For example, our zirconium-titanium Liquidmetalalloys are approximately 250% stronger than commonly used titanium alloys suchas Ti-6Al-4V, but they also have some of the beneficial processingcharacteristics more commonly associated with plastics. We believe theseadvantages could result in Liquidmetal alloys supplanting high-performancealloys, such as titanium and stainless steel, and other incumbent materials ina wide variety of applications. Moreover, we believe these advantages couldenable the introduction of entirely new products and applications that are notpossible or commercially viable with other materials.

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**General Corporate Information**

We were originallyincorporated in California in 1987, and we reincorporated in Delaware in May2003.  Our principal executive officesare located at 25800 Commercentre Dr., Suite 100, Lake Forest, California92630. Our telephone 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.

**Subsidiaries and OtherLocations**

Wecurrently own and operate a manufacturing facility in Pyongtaek, South Korea,which became operational in the third quarter of 2002.  This Korean subsidiary handles our bulkLiquidmetal alloy business which includes market opportunities to manufactureand sell casing components for electronic devices, medical devices, sportinggoods, tooling, prototype sampling, defense applications and metal processingequipment.  We also opened a postprocessing facility in Weihai, China in the third quarter of 2004.  This Chinese subsidiary facilitates our bulkalloy manufacturing business by handling most of our post manufacturingprocesses.  Lastly, we operate adistribution warehouse division in Conroe, Texas to handle our Liquidmetalalloy industrial coatings which are used primarily as protective coatings forindustrial machinery and equipment, such as drill pipe used by the oil drillingindustry and boiler tubes used by coal burning power plants.

**Segments**

InApril 2002, we began classifying operations into two reportable segments:Liquidmetal alloy industrial coatings and bulk Liquidmetal alloys.  The Liquidmetal alloy industrial coatings areused primarily as a protective coating for industrial machinery and equipment,such as drill pipe used by the oil drilling industry and boiler tubes used bycoal burning power plants.  BulkLiquidmetal alloys include market opportunities to manufacture and sell casingcomponents for electronic devices, medical devices, sporting goods, tooling,prototype sampling, defense applications and metal processing equipment.  The expenses incurred by the bulk Liquidmetalalloy segment are manufacturing, research and development costs, and sellingexpenses associated with identifying and developing market opportunities.  Bulk Liquidmetal alloy products can be distinguishedfrom Liquidmetal alloy coatings in that the bulk Liquidmetal alloy can havesignificant thickness, up to approximately one inch, which allows for their usein a wider variety of applications other than a thin protective coating appliedto machinery and equipment.   Revenue andexpenses associated with research and development services are included in thebulk Liquidmetal alloy segment.

Resultsof segment operations and assets are included in Note 18 to the ConsolidatedFinancial Statements contained in this Form 10-K.

**Our Technology**

The performance,processing, and potential cost advantages of Liquidmetal alloys are a functionof their unique atomic structure and their proprietary material composition.

***Unique AtomicStructure***

Theatomic structure of Liquidmetal alloys is the fundamental feature thatdifferentiates them from other alloys and metals. In the molten state, theatomic particles of all alloys and metals have an amorphous atomic structure,which means that the atomic particles appear in a completely random structurewith no discernible patterns. However, when non-amorphous alloys and metals arecooled to a solid state, their atoms bond together in a repeating pattern ofregular and predictable shapes, or crystalline grains. This process is analogousto the way ice forms when water freezes and crystallizes. In non-amorphousmetals and alloys, the individual crystalline grains contain naturallyoccurring structural defects that limit the potential strength and performancecharacteristics of the material. These defects, known as dislocations, consistof discontinuities or inconsistencies in the patterned atomic structure of eachgrain. Unlike other alloys and metals, bulk Liquidmetal alloys can retain theiramorphous atomic structure throughout the solidification process and thereforedo not develop crystalline grains and the associated dislocations.Consequently, bulk Liquidmetal alloys exhibit superior strength and othersuperior performance characteristics compared to their crystalline counterparts.Our Liquidmetal alloy coatings, in contrast to our bulk alloys, have acrystalline atomic structure when initially applied, but their atomic structurebecomes amorphous as the coatings rub against surfaces under force, thusimproving their performance over time.

Prior to 1993,commercially viable amorphous alloys could be created only in thin forms, suchas coatings, films, or ribbons. However, in 1993, researchers at the CaliforniaInstitute of Technology (Caltech) developed the first commercially viableamorphous alloy in a bulk form. Today, bulk Liquidmetal alloys can be formedinto objects that

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are up to one inchthick, and we are not aware of any other commercially available amorphousalloys that can achieve this thickness. We have the exclusive right tocommercialize bulk amorphous alloy technology through a license agreement withCaltech and other patents that we own.

***ProprietaryMaterial Composition***

The constituent elementsand percentage composition of Liquidmetal alloys are critical to their abilityto solidify into 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 of LiquidmetalAlloys**

Liquidmetal alloyspossess a unique combination of performance, processing and cost advantagesthat we believe makes them superior in many ways to other commerciallyavailable materials for a variety of existing and potential future productapplications.

***PerformanceAdvantages***

Ourbulk Liquidmetal alloys provide several distinct performance advantages overother materials, and we believe that these advantages make the alloys desirablein applications that require high yield strength, strength-to-weight ratio,elasticity and hardness.

The high yield strengthof bulk Liquidmetal alloys means that a high amount of stress must be exertedto create permanent deformation. However, because the yield strength is sohigh, the yield strength of many of our bulk Liquidmetal alloy compositions isvery near their ultimate strength, which is the measure of stress at whichtotal breakage occurs. Therefore, very little additional stress may be requiredto break an object made of bulk Liquidmetal alloys once the yield strength isexceeded. Although we believe that the yield strength of many of our bulkalloys exceeds the ultimate strength of most other commonly used alloys andmetals, our bulk alloys may not be suitable for certain applications, such aspressurized tanks, in which the ability of the material to yield significantlybefore it breaks is more important than its strength advantage. Additionally,although our bulk alloys show a high resistance to crack initiation because oftheir very high strength and hardness, certain of our bulk alloys are sensitiveto crack propagation under certain long-term, cyclical loading conditions.Crack propagation is the tendency of a crack to grow after it forms. We arecurrently developing new alloy compositions that have improved materialproperties to overcome these limitations.

***ProcessingAdvantages***

Theprocessing of a material generally refers to how a material is shaped, formed,or combined with other materials to create a finished product. Bulk Liquidmetalalloys possess processing characteristics that we believe make them preferableto other materials in a wide variety of applications. In particular, our alloysare amenable to processing options that are similar in many respects to thoseassociated with plastics. For example, we believe that bulk Liquidmetal alloyshave superior net-shape casting capabilities as compared to high-strengthcrystalline metals and alloys.  “Net-shapecasting” is a type of casting that permits the creation of near-to-net shapedproducts that reduce costly post-cast processing or machining. Additionally,unlike most metals and alloys, our bulk Liquidmetal alloys are capable of beingthermoplastically molded in bulk form. Thermoplastic molding consists ofheating a solid piece of material until it is transformed into a moldablestate, although at temperatures much lower than the melting temperature, andthen introducing it into a mold to form near-to-net shaped products.  Accordingly, thermoplastic molding can bebeneficial and economical for net shape fabrication of high-strength products.

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

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Notwithstanding theforegoing advantages, our bulk Liquidmetal alloys possess certain limitationsrelative to processing. The beneficial processing features of our bulk alloysare made possible in part by the alloys’ relatively low melting temperatures.Although a lower melting temperature is a beneficial characteristic forprocessing purposes, it renders certain bulk alloy compositions unsuitable forcertain high-temperature applications, such as jet engine exhaust components.Additionally, the current one-inch thickness limitation of ourzirconium-titanium bulk alloy renders our alloys currently unsuitable for useas structural materials in large-scale applications, such as load-bearing beamsin building construction. We are currently engaged in research and developmentwith the goal of developing processing technology and new alloy compositionsthat will enable our bulk alloys to be formed into thicker objects.

***CostAdvantages***

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

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

**Our Strategy**

As a result of theexperience and knowledge that we have gained through our activities to date,and recognizing that developing and commercializing a revolutionary newtechnology is an evolutionary process, we are continually modifying ourbusiness strategy to enable us to better capitalize on our evolving corestrengths and more effectively pursue revenue growth and profitability.  The key elements of our strategy include:

      
|        | • | *Identifying and Developing New  Applications for Our Liquidmetal Alloy Technology*. We intend to continue to identify  and develop new applications that will benefit from the performance,  processing, and cost advantages of Liquidmetal alloys.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   | • | *Focusing Our Marketing and  Internal Manufacturing Activities on Select Products with Expected Higher  Gross-Margins*. We intend to focus our marketing and  internal manufacturing activities on select products with anticipated higher  gross margins. This strategy is designed to align our product development  initiatives with our manufacturing processes and manufacturing cost  structure, and to reduce our exposure to more commodity-type product  applications that are prone to unpredictable demand and fluctuating pricing.  Our focus is primarily on higher-margin products that possess design features  that take optimal advantage of our existing and developing manufacturing  technology and that command a price commensurate with the performance  advantages of our alloys. In addition to our focus on products with higher  gross margins, we will continue to engage in prototype manufacturing, both  for internally manufactured products and for products that will ultimately be  licensed to or manufactured by third parties. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   | • | *Further Developing Our  Manufacturing Processes, Capabilities, and Efficiencies for Bulk Liquidmetal  Alloys.***We intend to  improve and enhance our internal manufacturing processes, capabilities, and  efficiencies in order to maintain quality control over products made from  bulk Liquidmetal alloys, to focus on improvements to the processing of our  alloys, and to protect our intellectual property. As our alloys become more  pervasive, however, we expect to enter into additional strategic  relationships that would involve the licensing of Liquidmetal technology to  third parties for certain market segments.                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |
|   | • | *Pursuing Strategic Partnerships In  Order to More Rapidly Develop and Commercialize Products**.*We intend to actively pursue and support strategic  partnerships that will enable us to leverage the resources, strength, and  technologies of other companies in order to more rapidly develop and  commercialize products. These partnerships may include licensing transactions  in which we license full commercial rights to our technology in a specific  application area, or they may include transactions of a more limited scope in  which, for example, we outsource manufacturing activities or grant  distribution rights. We believe that utilizing such a partnering strategy  will enable us to reduce our working capital burden, better fund product  development efforts, better                                                                                                                                                                                                                                                                 |

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|        |   | understand customer adoption practices, leverage the  technical and financial resources of our partners, and more effectively  handle product design and process challenges. As this partnering strategy  evolves, a growing portion of our revenue mix may be comprised of revenue  from the provision of product development services, technical support, and  engineering services, as well as revenues from royalties on the sale of  Liquidmetal alloy**products by  our partners.                                                                                                                                                                                                                                                                                                                          |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |
|   | • | *Advancing the Liquidmetal® Brand**.*We believe that building our corporate brand will foster  continued adoption of our technology. Our goal is to position Liquidmetal  alloys as a superior substitute for materials currently used in a variety of  products across a range of industries. Furthermore, we seek to establish  Liquidmetal alloys as an enabling technology that will facilitate the  creation of a broad range of commercially viable new products. To enhance  industry awareness of our company and increase demand for Liquidmetal alloys,  we are reviewing various brand development strategies that could include  collaborative advertising and promotional campaigns with select customers, industry  conference and trade show appearances, public relations, and other means. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |

 

**Applications for LiquidmetalAlloys**

Wehave focused our commercialization efforts for Liquidmetal alloys on fiveidentified product areas.  We believethat these areas are consistent with our strategy in terms of market size,building brand recognition, and providing an opportunity to develop and refineour processing capabilities. Although we believe that strategic partneringtransactions could create valuable opportunities beyond the parameters of thesetarget markets, we anticipate continuing to pursue these markets bothinternally and in conjunction with partners.

***Components for ElectronicProducts***

We produce components for electronic devices using our bulkLiquidmetal alloys and believe that our alloys offer enhanced performance anddesign benefits for these components in certain applications.  Bulk Liquidmetal alloys can be used forvarious structural components of a cellular phone, including the shield,faceplate, hinge, hinge housings, back plate, side plates, brackets, and thecover on the phones. We initially targeted the electronic casings marketbecause of its potential for high product volumes and branding opportunities;however, unpredictable customer adoption practices, short product model lives,processing limitations, and intense pricing pressures make it very challengingto compete in this high-volume market. Accordingly, we are currently limiting our focus in this market tohigher-margin applications that have the potential to benefit from the uniqueperformance characteristics of bulk Liquidmetal alloys.  We continue to believe that the highstrength-to-weight ratio and elastic limit of bulk Liquidmetal alloys enablethe 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.

Throughour shipments to date, we have demonstrated that bulk Liquidmetal alloys can beused for structural components of cellular phones and other electronicdevices.  During 2006, 2005, and 2004, weshipped production quantities of cell phone components to Samsung ElectronicsCompany and Vertu Limited, the luxury communication products subsidiary ofNokia, for inclusion in various cellular phone models.

***Sporting Goods and Leisure Products***

Weare developing a variety of applications for Liquidmetal alloys in the sportinggoods and leisure products area.

Inthe sporting goods industry, we believe that the high strength, hardness, andelasticity of our bulk alloys have the potential to enhance performance in avariety of products, and we further believe that many sporting goods productsare conducive to our internal manufacturing strategy of focusing on high-marginproducts that meet our design criteria. Substantial opportunities also exist for our amorphous alloy coatings,powders and composites. In 2003, Rawlings Sporting Goods Company launched a newline of baseball and softball bats that utilize a Liquidmetal alloy coating,and HEAD NV Sport launched a new line of HEAD® Liquidmetal® tennis racquetsthat incorporates Liquidmetal alloy in composite form in their racquet design.In 2005, we have also launched goods that utilize Liquidmetal alloy includingskis.  Other potential applications forour alloys in this industry include golf clubs, eyewear, fishing, hunting, andother sport products.

Inthe leisure products category, we believe that bulk Liquidmetal alloys can beused to efficiently produce intricately engineered designs with high-qualityfinishes, such as premium watchcases, and we further believe that Liquidmetalalloy technology can be used to make high-quality, high-strength jewelry fromprecious metals.  We have successfullyproduced prototype rings made from an amorphous Liquidmetal platinum alloy thatis harder (and hence more scratch resistant) than conventional platinumjewelry.

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Inorder to accelerate the commercialization of Liquidmetal alloys in the jewelryand high-end luxury products market,in June 2003, the Company entered into an exclusive, ten-year license agreementwith LLPG, Inc. (“LLPG”), a corporation headed by, Jack Chitayat, a formerdirector of the Company.  Under the terms of the agreement, LLPG has theright to commercialize Liquidmetal alloys, particularly precious-metal basedcompositions, in jewelry and high-end luxury product markets.  TheCompany, in turn, will receive royalty payments over the life of the contracton all Liquidmetal products produced and sold by LLPG.  In conjunctionwith its technology licensing contract, LLPG purchased two proprietaryLiquidmetal alloy melting machines and three proprietary Liquidmetal alloycasting machines for a total purchase price of $2.0 million.  The Companyrecognized $0.1 million of revenues as minimum royalty fees under the licenseagreement during the year ended December 31, 2006.

In December 2006, the Company enteredinto an amended the license agreement with LLPG, which extends the licenseagreement to fifteen years at reduced royalty rates.  Additionally, theamended license agreement includes a $0.4 million termination fee to be paidout in quarterly installments in 2007.  The termination fee will berecognized as revenue when received in 2007.

Inorder to accelerate the commercialization of Liquidmetal alloys in the eyewearindustry, in June of 2006, we entered into a joint venture agreement with SAGA,SpA in Padova, Italy, a specialist precision part manufacturer.  The jointventure is named Liquidmetal SAGA Italy, Srl (“LSI”), and it will have anexclusive manufacturing license for the eyewear industry.  Its initialfocus will be on the development and commercialization of eyewear with SafiloSpA, a worldwide leader in luxury eyewear, supplying frames and sunglasses for mostof the luxury brands with operations in more than 120 countries worldwide.

***Medical Devices***

Weare engaged in product development efforts relating to various medical devicesthat could be made from Liquidmetal alloys. We believe that the uniqueproperties of bulk Liquidmetal alloys provide a combination of performance andcost benefits that could make them a desirable replacement to incumbentmaterials, such as stainless steel and titanium, currently used in variousmedical device applications.  Our ongoingemphasis in 2004, 2005 and 2006 has been on surgical instrument applicationsfor Liquidmetal alloys. These include, but are not limited to, specializedblades, orthopedic instruments utilized for implant surgery procedures, dentaldevices, and general surgery devices. The potential value offered by our alloysis high performance in some cases and cost reduction in others, the latterstemming from the ability of Liquidmetal alloys to be net shape cast intocomponents, thus reducing costs of secondary processing. The status of mostcomponents in the prototyping phase is subject to non-disclosure agreementswith our customers.

We believe that our future success in the medical devicemarket will be driven largely by strategically aligning ourselves withwell-established companies that are uniquely positioned to facilitate theintroduction of Liquidmetal alloys into this market, especially as it relatesto the unique processing challenges and stringent material qualificationrequirements 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.

***Industrial Coatings andPowders***

Wecontinue to market and sell amorphous alloy industrial coatings and powdersunder the Liquidmetal® ArmacorTM Coatings brand name. Liquidmetal alloycoatings are used primarily as a protective coating for industrial machineryand equipment. Since the inception of this business in the late 1980s, ourproprietary coatings have demonstrated a high degree of hardness and lowcoefficient of friction which, when combined with their strong adhesionproperties, reduce the wear and consequent failure of the machinery andequipment on which they are used. In contrast to our bulk alloys, we sellLiquidmetal coatings primarily in the form of a wire or powder feedstock thatis melted and applied to machinery or equipment through welding or thermalspray processes.

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

Liquidmetalcoatings have also been sold into the power generation industry specificallyfor the purpose of coating boiler tubes in coal-burning power plants in orderto extend the lives of these boilers. Boiler tubes are subject to high heat,erosion, and corrosion and often require costly replacement, both in terms ofreplacement parts and length of downtime for

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installation.Additionally, residue build-up in boiler tubes of coal burning power plantscreates operating inefficiencies. Historic performance and testing ofLiquidmetal coatings have demonstrated that our coatings extend the life ofthese boiler tubes meaningfully beyond their current average life depending onthe specific environment. In addition, our coatings have demonstrated theability to reduce build-up of residue on boiler tubes, helping to improve theefficiencies of the boilers. Historically, we have not concentrated salesefforts on the boiler tube market in a substantial way. However, given the sizeof the market and potential opportunities for our coatings, we have recentlydedicated greater effort to this area.

***Defense Applications***

We are working with the U.S. Department of Defense, aswell as a variety of defense-related research and development agencies andlarge defense contractors, to develop various defense-related applications forLiquidmetal alloys. For example, we are currently developing prototype kineticenergy penetrator rods for use in armor-piercing ammunition systems. Kineticenergy penetrators, or KEPs, are armor piercing munitions that are currentlymade primarily from depleted uranium or tungsten alloys. Initial ballistictests under the Liquidmetal KEP program have demonstrated that tungsten KEPsperform better whenever Liquidmetal alloy is combined with the tungsten tocreate a composite material.  In August2003, we signed a new $3.0 million research and development contract with theU.S. Army for the development of KEPs, which was later supplemented byadditional $2.7 million. Our strategy is to orient the KEP program towardfuture systems such as the Joint Strike Fighter program and the Army’s FutureCombat System.

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 can present opportunities thatwe can capitalize on the trend toward lighter but stronger weapon systems inthe U.S. military, and our strategy is to align ourselves with the largest andmost significant players in this industry. Product development programs for defense applications are currentlyunderway with several leading defense contractors, including AlliantTechsystems and General Dynamics.

**Going Concern /Liquidity**

Wehave experienced significant operating losses since our inception. Our net lossfor the fiscal years ended December 31, 2006 and 2005 was $14.5 million and$7.1 million, respectively. In the audit report on our financial statements forour fiscal years ended December 31, 2006 and 2005, our present auditorsincluded a going-concern qualification indicating that our significantoperating losses and working capital deficit cause substantial doubt about ourability to continue as a going concern. By issuing an opinion stating thatthere is substantial doubt about our ability to continue as a going concern,our auditors have indicated that they are uncertain as to whether we have thecapability to continue our operations without additional funding.  On January 3, 2007, we completed a private placementof $14.8 million in principal amount of 8% Convertible Subordinated Notes dueJanuary 2010 (the “January 2010 Notes”). The January 2010 Notes were issued foraggregate cash in the amount of $12.9 million and in payment of a total of $1.9million in principal and accrued but unpaid interest under our previouslyissued 7% Senior Secured Convertible Notes due August 2007 and our  8%Unsecured Subordinated Notes.

Weanticipate that the $12.9 million aggregate cash raised in the privateplacement will be sufficient to pursue our current operating plan onlythrough the third quarter of 2007, and we will therefore require additionalfunding at or prior to that time.  Ourneed for additional capital could also be accelerated to before the thirdquarter of 2007 because we are currently in breach of an obligation under theJanuary 2010 Notes to satisfy certain previously issued debt within five daysof the issue date of the January 2010 Notes. We are currently in discussions with the holders of the January 2010Notes in an effort to negotiate a forbearance with respect to this breach, andthe holders of the January 2010 Notes have not yet indicated a desire todeclare a default under the January 2010 Notes. However, we cannot be certain that the holders of such notes will notdeclare a default and accelerate all amounts due thereunder.

As a result of the foregoing, we areactively seeking additional sources of capital and seeking to restructureand/or modify existing indebtedness.  Theamount of funding that we seek and the timing of such fundraising efforts willdepend on the extent to which we are able to increase revenues throughobtaining additional purchase orders for our products and/or the extent towhich we can restructure or modify our debt. Because we cannot be certain that we will be able to obtain adequatefunding from debt, equity, or other traditional financing sources, we are alsoactively exploring several strategic financing options, including the possiblesale of our manufacturing plant in South Korea (which would then be replacedwith a smaller facility) and the possible sale of our Liquidmetal Coatingsbusiness.  We cannot guarantee thatadequate funds will be available when needed, and if we do not receivesufficient capital, we may be required to alter or reduce the scope of ouroperations.

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**Liquidmetal Golf**

From 1997 until September 2001, we engaged in the retailmarketing and sale of golf clubs through a majority owned subsidiary,Liquidmetal Golf. The retail business of Liquidmetal Golf was discontinued inSeptember 2001 and is now treated as a discontinued operation in ourconsolidated financial statements. Although the retail golf club business hasbeen discontinued, Liquidmetal Golf will be engaged in the business ofmanufacturing and selling golf club components to golf original equipmentmanufacturers that will integrate these components into their own clubs andthen sell them under their respective brand names. Liquidmetal Technologiesowns 79% of the outstanding common stock in Liquidmetal Golf.

Our Liquidmetal Golfsubsidiary has the exclusive right and license to utilize our Liquidmetal alloytechnology for purposes of golf equipment applications. This right and licenseis set forth in an intercompany license agreement between LiquidmetalTechnologies and Liquidmetal Golf. This license agreement provides thatLiquidmetal Golf has a perpetual and exclusive license to use Liquidmetal alloytechnology for the purpose of manufacturing, marketing, and selling golf clubcomponents and other products used in the sport of golf. In consideration ofthis license, Liquidmetal Golf has issued 4,500,000 shares of Liquidmetal Golfcommon stock to Liquidmetal Technologies.

**Our Intellectual Property**

Ourintellectual property consists of patents, trade secrets, know-how, andtrademarks. Protection of our intellectual property is a strategic priority forour business, and we intend to vigorously protect our patents and otherintellectual property. Our intellectual property portfolio includes 32 owned orlicensed U.S. patents and numerous patent applications relating to thecomposition, processing, and application of our alloys, as well as variousforeign counterpart patents and patent applications.

Ourinitial bulk amorphous alloy technology was developed by researchers at theCalifornia Institute of Technology (“Caltech”). We have purchased patent rightsthat provide us with the exclusive right to commercialize the amorphous alloyand other amorphous alloy technology acquired from Caltech through a licenseagreement (“Caltech License Agreement”) with Caltech. Under the Caltech licenseagreement, we have the exclusive worldwide right to make, use, and sellproducts from all of Caltech’s inventions, proprietary information, know-how,and other technology relating to amorphous alloys existing as of September 1,2001. We also have an exclusive worldwide license to eleven issued patents andtwo patent applications held by Caltech relating to amorphous alloy technology,as well as all related foreign counterpart patents and patent applications. Ofthe patents currently issued to Caltech and licensed by us, the earliestexpiration date is 2013 and the latest expiration date is 2021.  Furthermore, the license agreement gives usthe exclusive right to make, use, and sell products from substantially allamorphous alloy technology that was developed in Professor William Johnson’sCaltech laboratory during the period September 1, 2001 through August 31, 2005.All fees and other amounts payable by us for these rights and licenses havebeen paid in full, and no further royalties, license fees, or other amountswill be payable in the future under this license agreement.

Ourrights under the license agreement are perpetual in duration. However, Caltechhas the right to convert the license to a non-exclusive license if we fail toutilize the licensed technology for a period of 18 or more consecutive months,provided that Caltech must give us 180-days advance written notice of theconversion and we may cure the failure at any time during the 180-day noticeperiod. If we cure the failure, then the license will not be converted into anon-exclusive license.

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

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

Inaddition to the patents and patent applications that we license from Caltech,we are building a portfolio of our own patents to expand and enhance ourtechnology position. These patents and patent applications primarily relate tovarious applications of our bulk amorphous alloys, the composition of ourcoatings and powders, and the processing of our alloys. The patents relating toour coatings expire on various dates between 2006 and 2017, and the patentsrelating to our bulk amorphous alloys expire on various dates between 2013 and2021. Our policy is to seek patent protection for all technology, inventions,and improvements that are of commercial importance to the development of ourbusiness, except to the extent that we believe it is advisable to maintain suchtechnology or invention as a trade secret.

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Inorder to protect the confidentiality of our technology, including tradesecrets, know-how, and other proprietary technical and business information, werequire that all of our employees, consultants, advisors and collaboratorsenter into confidentiality agreements that prohibit the use or disclosure ofinformation that is deemed confidential. The agreements also obligate ouremployees, consultants, advisors and collaborators to assign to usdevelopments, discoveries and inventions made by such persons in connectionwith their work with us.

**Research and Development**

Weare engaged in ongoing research and development programs that are driven by thefollowing key objectives:

 
|        | • | *Enhance Material Processing and Manufacturing  Efficiencies.*We plan to continue research and development  of processes and compositions that will decrease our cost of making products  from Liquidmetal alloys.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
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|   | • | *Optimize Existing Alloys and Develop New  Compositions.*We believe that the primary technology driver  of our business will continue to be our proprietary alloy compositions. We  plan to continue research and development on new alloy compositions to  generate a broader class of amorphous alloys with a wider range of  specialized performance characteristics. During 2003 and continuing into  2006, we have successfully expanded our portfolio of bulk amorphous alloys to  include additional zirconium-titanium alloys, as well as alloys based on  other metals, such as iron, gold, and platinum. Although these various  compositions are at different stages of development and only a few are  currently suitable for commercial use, we believe that a larger alloy  portfolio will enable us to increase the attractiveness of our alloys as an  alternative to incumbent materials and, in certain cases, drive down product  costs. We also believe that our ability to optimize our existing alloy  compositions will enable us to better tailor our alloys to our customers’  specific application requirements. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   | • | *Develop New Applications.*We  will continue research and development of new applications for Liquidmetal  alloys. We believe the range of potential applications will broaden by  expanding the forms, compositions, and methods of processing of our alloys.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |

 

Weconduct our research and development programs internally and also throughstrategic relationships that we enter into with third parties. Our internalresearch and development efforts are conducted by a team of 12 scientists andengineers whom we either employ directly or engage as consultants.  Included among this team are ProfessorWilliam Johnson, who discovered our initial bulk amorphous alloy at Caltech in1993, and his graduate student at the time, Atakan Peker, who is employed asour Vice President of Technology. Professor Johnson was an employee of our company from October 2001through December 2003 and then became a consultant to our company.  Professor Johnson continues to be a member ofour board of directors.

Inaddition to our internal research and development efforts, we enter intocooperative research and development relationships with leading academicinstitutions.  We have entered intodevelopment relationships with other companies for the purpose of identifyingnew applications for our alloys and establishing customer relationships withsuch companies. Some of our product development programs are partially fundedby our customers. We are also engaged in negotiations with other potentialcustomers regarding possible product development relationships. Our researchand development expenses for the years ended December 31, 2006, 2005, and 2004,were $1.0 million, $1.1 million, and $1.5 million,  respectively.

**Manufacturing**

We currently own and operate a 166,000square foot manufacturing facility in Pyongtaek, South Korea, which becameoperational in the third quarter of 2002. We opened a 14,400 square foot facility in Weihai, China in August 2004to facilitate our bulk alloy manufacturing business.  We believe that these facilities will meetour anticipated manufacturing needs for the foreseeable future, although theseneeds may change depending upon the actual and forecasted orders we receive forour products. We currently intend to develop supplemental research anddevelopment, prototyping and manufacturing capabilities elsewhere, includingthe United States, for purposes of meeting our long-term manufacturing needsand our customers’ requirements.  InDecember 2003, we entered into a license agreement with Florida Custom Mold,Inc., a Clearwater, Florida-based company that specializes in high-quality molddesign and injection molding services, under which Florida Custom Mold iscurrently acting as a contract manufacturer to our company for purposes ofproducing prototypes of certain defense and medical products in the US.

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**Raw Materials**

Liquidmetal alloy compositions are comprised of manyelements, all of which are available commodity products. We believe that eachof 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 2006, one customer, FlextronicsManufacturing LTD, who is a direct supplier to SanDisk, accounted for 10% ormore of our revenue from continuing operations. During 2005, one customer, Samsung, accounted for 10% or more of ourrevenue from continuing operations. During 2004, four customers accounted for 10% or more of our revenue fromcontinuing operations.  Revenues fromCharm Tech and Pntel, both of which are direct suppliers to Samsung,represented 62% of revenue from continuing operations for the year ended 2004.  Also, revenues from defense related contractswith the United States of America represented 10% and Growell Metal represented12% of revenue from continuing operations for the year ended 2004.  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 or business thatmanufactures, markets, distributes, or sells bulk amorphous alloys or productsmade from bulk amorphous alloys. We believe it would be difficult to develop acompetitive bulk amorphous alloy without infringing our patents. However, ourbulk Liquidmetal alloys face competition from other materials, includingmetals, alloys, plastics and composites, which are currently used in thecommercial applications that we pursue. For example, we face significantcompetition from plastics and zinc in our electronics components business, andtitanium and composites will continue to be used widely in medical devices andsporting goods. Based on our experience with developing products for a varietyof customers, we believe that the selection of materials by potential customerswill continue to be product-specific in nature, with the decision for eachproduct being driven primarily by the performance needs of the application andsecondarily by cost considerations and design flexibility. Because of therelatively high strength of our alloys and the design flexibility of ourprocess, we are most competitive when the customer is seeking a higher strengthas well as greater design flexibility than currently available with othermaterials. However, if currently available materials, such as plastics, arestrong enough for the application, our alloys are often not competitive thoseapplications with respect to price. We also believe that our alloys aregenerally not competitive with the cost of some of the basic metals, such assteel, aluminum or copper, when such basic metals can be used in specificapplications, but our alloys are generally more competitive with price on more exoticmetals, such as titanium. Our alloys could also face competition from newmaterials that may be developed in the future, including new materials thatcould render our alloys obsolete.

Our Liquidmetal alloy coatings face competition fromindustrial 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.

We will also experience indirectcompetition from the competitors of our customers. Because we will rely on ourcustomers to market and sell finished goods that incorporate our components orproducts, our success will depend in part on the ability of our customers toeffectively market and sell their own products and compete in their respectivemarkets.

**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 

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distribution channels of our customers to facilitatethe commercialization of our alloys.  Wealso direct business development efforts toward companies who we believe couldbe viable candidates for potential partnering transactions, such as licensingrelationships, distribution arrangements, joint ventures, and the like.

**Employees**

As of December 31, 2006, we had 636 full-timeand 54 part-time employees. As of that date, 106 of our Korean operationemployees were represented by a labor union. We have not experienced any work stoppages and we consider our employeerelations to be favorable.

**Governmental Regulation**

Medical instruments incorporating our Liquidmetal alloyswill be subject to regulation in the United States by the FDA and correspondingstate and foreign regulatory agencies. Any orthopedic devices that we developwill be regulated in a similar manner. Medical device manufacturers to whom weintend to sell our products may need to obtain FDA approval before marketingtheir medical devices that incorporate our products. Medical device manufacturersmay need to obtain similar approvals before marketing these medical deviceproducts in foreign countries.

Because we intend to sell our medical device products tomedical device manufacturers, we do not believe that we will need to obtain FDAapproval or similar foreign approvals before selling products to medical devicemanufacturers.  Nonetheless, as amanufacturer of medical device components, we would be subject to qualitycontrol and record keeping requirements of FDA and other federal and state statutesand regulations, as well as similar regulations in foreign countries.

The process of obtaining and maintaining required FDA andforeign regulatory approvals for medical devices that incorporate our productscould be lengthy, expensive, and uncertain for our customers. Additionally,regulatory agencies can delay or prevent product introductions. Generally,before a medical device manufacturer can market a product incorporating one ofour products, our customer must obtain for their finished product marketingclearance through a 510(k) premarket notification or approval of a pre-marketapproval application, or PMA. The FDA will typically grant a 510(k) clearanceif the applicant can establish that the device is substantially equivalent to apredicate device. It generally takes a number of months from the date of a510(k) submission to obtain clearance, but it may take longer, particularly ifa clinical trial is required.

The FDA may find that a 510(k) is not appropriate for amedical device that incorporates our product or that substantial equivalencehas not been shown and as a result will require a PMA. A PMA application mustbe submitted if a proposed medical device does not qualify for a 510(k)pre-market clearance procedure. PMA applications must be supported by validscientific evidence to demonstrate the safety and effectiveness of the device,typically including the results of clinical trials, bench tests, and laboratoryand animal studies. The PMA process can be expensive, uncertain and lengthy, requiresdetailed and comprehensive data, and generally takes significantly longer thanthe 510(k) process. Additionally, the FDA may never approve the PMA.

Similar regulations in foreign countries vary significantlyfrom country to country and with respect to the nature of the particularmedical device. The time required to obtain these foreign approvals to marketour products may be longer or shorter than that required in the United States,and requirements for such approval may differ from FDA requirements.

**Environmental Law Compliance**

Our manufacturing operations are subject to national, state,and local environmental laws in each of China, South Korea, and the UnitedStates. We believe that we are in material compliance with all applicableenvironmental regulations. While we continue to incur costs to comply withenvironmental regulations, we do not believe that such costs will have amaterial effect on our capital expenditures, earnings, or competitive position.

**Item1A. Risk Factors**

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 

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undue reliance should not be placed on thesestatements. Liquidmetal Technologies, Inc. undertakes no obligation to updatepublicly any forward-looking statements, whether as a result of newinformation, future events or otherwise.

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

**We have incurred significantoperating losses in the past and may not be able to achieve or sustainprofitability in the future.**

We have experienced significant operating lossessince our inception.  Our net loss forthe fiscal years ended December 31, 2006, 2005, and 2004, was $14.5 million,$7.1 million, and $14.9 million, respectively. We had an accumulated deficit of approximately $149.0 million atDecember 31, 2006. Of this accumulated deficit, $44.5 million was attributableto losses generated by our discontinued equipment manufacturing and retailgolf.  We anticipate that we may continueto incur operating losses for the foreseeable future.  Consequently, it is possible that we maynever achieve positive earnings and, if we do achieve positive earnings, we maynot be able to achieve them on a sustainable basis.

**We may require additional funding, which may notbe available on favorable terms or at all.**

 

Our future capital requirements will depend on the amount ofcash generated by our operations. Our projections of cash flows from operationsand, consequently, future cash needs are subject to substantial uncertainty. Inaddition, in our audit report on our financial statements for our fiscal yearsended December 31, 2005 and 2004, our auditors included a going-concernqualification indicating that our significant operating losses and workingcapital deficit cause substantial doubt about our ability to continue as agoing concern.  By issuing an opinionstating that there is substantial doubt about our ability to continue as agoing concern, our auditors have indicated that they are uncertain as towhether we have the capability to continue our operations without additionalfunding.  On January 3, 2007, wecompleted a private placement of $14.8 million in principal amount of 8%Convertible Subordinated Notes due January 2010 (the “January 2010 Notes”). TheJanuary 2010 Notes were issued for aggregate cash in the amount of $12.9million and in payment of a total of $1.9 million in principal and accrued butunpaid interest under our previously issued 7% Senior Secured Convertible NotesDue August 2007 and our previously issued 8% Unsecured Subordinated Notes.

We anticipate that the $12.9 million aggregate cashraised in the private placement will be sufficient to pursue our currentoperating plan only through the third quarter of 2007, and we will thereforerequire additional funding at or prior to that time.  Our need for additional capital could also beaccelerated to before the third quarter of 2007 because we are currently inbreach of an obligation under the January 2010 Notes to satisfy certainpreviously issued debt within five days of the issue date of the January 2010Notes.  We are currently in discussionswith the holders of the January 2010 Notes in an effort to negotiate aforbearance with respect to this breach, and the holders of the January 2010Notes have not yet indicated a desire to declare a default under the January2010 Notes.  However, we cannot becertain that the holders of such notes will not declare a default andaccelerate all amounts due thereunder. See “Risk Factors—We are currently inbreach under convertible notes that we have issued, and the noteholders maytherefore accelerate the amounts due under such notes.”

 

As a result of the foregoing, we are actively seekingadditional sources of capital and seeking to restructure and/or modify existingindebtedness.  The amount of funding thatwe seek and the timing of such fundraising efforts will depend on the extent towhich we are able to increase revenues through obtaining additional purchaseorders for our products and/or the extent to which we can restructure or modifyour debt.  Because we cannot be certainthat we will be able to obtain adequate funding from debt, equity, or othertraditional financing sources, we are also actively exploring several strategicfinancing options, including the possible sale of our manufacturing plant inSouth Korea (which would then be replaced with a smaller facility) and thepossible sale of our Liquidmetal Coatings business.  We cannot guarantee that adequate funds willbe available when needed, and if we do not receive sufficient capital, we maybe required to alter or reduce the scope of our operations. Ifwe raise additional funds by issuing equity securities, existing stockholdersmay be diluted.  In addition, if sharesof our common stock or securities convertible into or exercisable for ourcommon stock are issued in consideration of such funds at an effective pershare price lower than the conversion and exercise prices of our currentlyoutstanding convertible notes and warrants, then anti-dilution provisions insuch convertible notes and warrants would be triggered, thus possibly causingeven greater dilution to our then-existing stockholders if the notes areconverted or the warrants are exercised. See “Risk Factors— Ourconvertible notes and warrants contain anti-dilution provisions that, iftriggered, could cause substantial dilution to our then-existing stockholders.”

** **

**We have a limited history ofdeveloping, manufacturing, and selling products made from our bulk amorphousalloys.**

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 have a relatively limitedhistory of producing bulk amorphous alloy components and products on amass-production basis.  Furthermore, ourability to produce our products in desired quantities and at commerciallyreasonable prices is uncertain and is dependent on a variety of factors thatare outside of our control, including the nature and design of the component,the customer’s specifications, and required delivery timelines.

**We rely on assumptions aboutthe markets for our products and components that, if incorrect, may adverselyaffect 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 

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

Our business is based upon the commercializationof a new and unique materials technology. Our ability to increase our revenueswill depend on our ability to successfully maintain and establish relationshipswith customers who are willing to incorporate our proprietary alloys andtechnology into their finished products. However, we believe that the size ofour company and the newness of our technology and manufacturing process maycontinue to make it challenging to maintain and establish such relationships.In addition, we rely and will continue to rely to a large extent on themanufacturing, research, and development capabilities, as well as the marketingand distribution capabilities, of our customers in order to commercialize ourproducts. Our future growth and success will depend in large part on ourability to enter into these relationships and the subsequent success of theserelationships. If our products are selected for use in a customer’s products,we still may not realize significant revenue from that customer if thatcustomer’s products are not commercially successful.

**It may take significant timeand 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 is generally affected by the amount of time it takes for us to, amongother things:

**·**      identify apotential customer and introduce the customer to Liquidmetal alloys;

**·**      work with thecustomer to select and design the parts to be fabricated from Liquidmetalalloys;

**·**      make the moldsand tooling to be used to produce the selected part;

**·**      make prototypesand samples for customer testing;

**·**      work with ourcustomers to test and analyze prototypes and samples; and

**·**      with respect tosome types of products, such as 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 a customerrelationship, it may take a significant amount of time for that customer todevelop, manufacture, and sell finished goods that incorporate our componentsand 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 a customerfrom initial testing to prototype and from prototype to final product. If weare unable to minimize these transition costs, or to recover the costs of thesetransitions from our customers, our operating results will be adverselyaffected.

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**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, 2006, revenues from onecustomer, Flextronics Manufacturing LTD, represented approximately 13% of totalrevenues from continuing operations and for the year ended December 31, 2005,revenues from one customer, Samsung, represented approximately 10% of totalrevenue from continuing operations, and for the year ended December 31, 2004,revenue from two customers represented approximately 62% of total revenue fromcontinuing operations.  Revenues fromdirect suppliers to SanDisk were approximately 22% of total revenues for theyear ended December 31, 2006.  Revenuesfrom direct suppliers to Samsung represented approximately 15%, 14% and 62% oftotal revenues from continuing operations for the year ended December 31, 2006,2005 and 2004, respectively.  Also,revenues from defense related contracts with the United States of Americarepresented 7%, 9%, and 10%, for the year ended December 31, 2006, 2005, and2004, respectively, and Growell Metal represented 0%, 0%, 12%, of revenue fromcontinuing operations for the year ended December 31, 2006, 2005, and2004.  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 sales arrangementswith these customers, they will have the ability to reduce or discontinue theirpurchases 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 typically will not have exclusive sales arrangementswith our customers, they will not be precluded from exploring and adoptingcompeting technologies. Also, products incorporating competing technologies maybe more successful for reasons unrelated to the performance of our customers’products or the marketing efforts of our customers.

**Our growth depends on ourability 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 bulk amorphous alloybusiness will depend in part on our ability to establish and retain atechnological advantage over other materials for our targeted applications. Formany of our targeted applications, we will compete with manufacturers ofsimilar products that use different materials. These different materials mayinclude plastics, titanium alloys, or stainless steel, among others. Forexample, we have targeted the cellular phone component market as an applicationfor bulk Liquidmetal alloys. In this market, we believe we will compete withother manufacturers of cellular phone components who use plastics or metal toconstruct their components. These other manufacturers may be able tomanufacture their cellular phone components, particularly those made fromplastics, at significantly less cost than our alloys. In other markets, we willcompete directly with suppliers of the incumbent material. In addition, in eachof our targeted markets, our success will depend in part on the ability of ourcustomers to compete successfully in their respective markets. Thus, even if weare successful in replacing an incumbent material in a finished product, wewill remain subject to the risk that our customer will not compete successfullyin its own market.

**Our bulkamorphous alloy technology is still at an early stage of commercializationrelative 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 

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continue expanding and improving our technology platform by,among other things, constantly refining and improving our manufacturingprocesses, optimizing our existing amorphous alloy compositions for variousapplications, and developing and improving new bulk amorphous alloycompositions.  Our failure to furtherexpand our technology base could limit our growth opportunities and hamper ourcommercialization efforts.

**Future advances in materials science could renderLiquidmetal alloys obsolete.**

** **

Academic institutions and business enterprises frequentlyengage in the research and testing of new materials, including alloys andplastics. Advances in materials science could lead to new materials that have amore favorable combination of performance, processing, and cost characteristicsthan our alloys. The future development of any such new materials could render ouralloys obsolete and unmarketable or may impair our ability to competeeffectively.

**Our growth depends upon our ability to retain andattract a sufficient number of qualified employees.**

** **

Our business is based upon the commercialization of a newand unique materials technology. Our future growth and success will depend inpart on our ability to retain key members of our management and scientificstaff, who are familiar with this technology and the potential applications andmarkets for it. For example, as a result of their experience and knowledge ofour alloy technology, we believe that our future growth and success will dependin large part on the efforts of Larry Buffington, our President and ChiefExecutive Officer, and Dr. Atakan Peker, our Vice President of Technology. Wedo not have “key man” or similar insurance on any of these individuals. If welose their services or the services of other key personnel, our financialresults or business prospects may be harmed. Additionally, our future growthand success will depend in part on our ability to attract, train, and retainscientific engineering, manufacturing, sales, marketing, and managementpersonnel. We cannot be certain that we will be able to attract and retain thepersonnel necessary to manage our operations effectively. Competition forexperienced executives and scientists from numerous companies and academic andother research institutions may limit our ability to hire or retain personnelon acceptable terms. In addition, many of the companies with which we competefor experienced personnel have greater financial and other resources than wedo. Moreover, the employment of non-citizens may be restricted by applicableimmigration laws.

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

** **

As a part of our business strategy, we intend to pursuestrategic partnering transactions that provide access to new technologies,products, markets, and manufacturing capabilities. These transactions couldinclude licensing agreements, joint ventures, or even business combinations. Webelieve that these transactions will be particularly important to our futuregrowth and success due to the size and resources of our company and the newnessof our technology. For example, we may determine that we may need to licenseour technology to a larger manufacturer in order to penetrate a particularmarket. In addition, we may pursue transactions that will give us access to newtechnologies that are useful in connection with the composition, processing, orapplication of Liquidmetal alloys. We may not be able to successfully identifyany potential strategic partnerships. Even if we do identify one or morepotentially beneficial strategic partnering, we may not be able to consummatethese transactions on favorable terms or obtain the benefits we anticipate fromsuch a transaction.

**We may encounter manufacturing problems or delaysor may be unable to produce high-quality products at acceptable costs.**

** **

We have relatively limited experience in manufacturing ourproducts and may be required to manufacture a range of products in high volumeswhile ensuring high quality and consistency. Although we currently own andoperate a 166,000 square feet and a 14,400 square feet manufacturing facilitiesin South Korea and China, respectively, we cannot guarantee that thesefacilities will be able to produce the intended products with productionyields, quality controls, and production costs that provide us with acceptablemargins or profitability or satisfy the requirements of our customers.

**We expect to derive a substantial portion of ourrevenue from sales outside the United States, and problems associated withinternational business operations could affect our ability to manufacture andsell our products.**

** **

We expect that we will continue to manufacture a substantialportion of our initial bulk Liquidmetal alloy products in our South Koreanfacility and derive a material portion of our revenues from customers in SouthKorea.  For our fiscal years ended December31, 2006, 2005, and 2004, approximately 12%, 31%, and 54%, of our revenues camefrom customers located in South Korea, respectively.  As a result, our manufacturing operations andfinancial results are subject to risks of political instability, including therisk of conflict between North Korea and South Korea and tensions between theUnited States and North Korea. In addition, we anticipate that the trend offoreign customers accounting for a significant portion of our total revenuesmay continue. Specifically, we expect to continue to derive a significantamount of revenue from sales to customers located in Asia. A downturn in theeconomies of Asian countries where our products will be sold, particularlySouth Korea’s economy, could materially harm our business.

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Consequently, our operations and revenue likely will besubject 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 transportationdelays or disruption, including the availability and costs of air and othertransportation between our South Korean and Chinese facilities and the UnitedStates;

**·**                  political and economic instability,including instability involving China and North Korea that may disrupt ouroperations in China and South Korea;

**·**                  potentially adverse tax consequences, which may reduce theprofitability of products manufactured overseas or sold to overseas customers;

**·**                  burden of complying with complex foreign laws and treaties,which could limit our ability to conduct our business as contemplated in SouthKorea and China; and

**·**                  trade protection laws, policies, and measures and otherregulatory requirements affecting trade and investment that could adverselyaffect the profitability of our South Korean and Chinese Operations, includingloss or modification of exemptions for taxes and tariffs.

Moreover, customers may sell finished goods that incorporateour components and products outside of the United States, which exposes usindirectly to additional foreign commerce risks.

**A substantial increase in the price orinterruption in the supply of raw materials for our alloys could have anadverse effect on our profitability.**

** **

Our proprietary alloy compositions are comprised of manyelements, all of which are available commodity products. Although we believethat each of these raw materials is currently readily available in sufficientquantities from multiple sources on commercially acceptable terms, if theprices of these materials substantially increases or there is an interruptionin the supply of these materials, such increase or interruption could adverselyaffect our profitability. For example, if the price of one of the elementsincluded in our alloys substantially increases, we may not be able to pass theprice increase on to our customers.

**Our business is subject to the potential adverseconsequences of exchange rate fluctuations.**

** **

We expect to conduct business in various foreign currenciesand will be exposed to market risk from changes in foreign currency exchangerates and interest rates. Fluctuations in exchange rates between the U.S.dollar and such foreign currencies may have a material adverse effect on ourbusiness, results of operations, and financial condition and could specificallyresult in foreign exchange gains and losses. The impact of future exchange ratefluctuations on our operations cannot be accurately predicted. To the extentthat the percentage of our non-U.S. dollar revenue derived from internationalsales increases in the future, our exposure to risks associated withfluctuations in foreign exchange rates will increase further. Moreover, as aresult 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. The average foreign exchange rates for theyears ended December 31, 2006, 2005, and 2004 were 967, 1,028, and 1,151 SouthKorean Won to the U.S. dollar, respectively. The fluctuations in the exchangerates resulted in foreign currency translation gains of $0.3 million, $0.3million, and $1.7 million, for the years ended December 31, 2006, 2005, and2004, respectively.

**Our inability to protect our licenses, patents,and proprietary rights in the United States and foreign countries could harmour business because third parties may take advantage of our research anddevelopment efforts.**

** **

We have an exclusive license from the California Instituteof Technology, or Caltech, to several patents and patent applications relatingto amorphous alloy technology, and we have obtained several of our ownpatents.  Our success depends in part onour ability to obtain and maintain patent and other proprietary rightprotection for our technologies and products in the United States and othercountries. If we are unable to obtain or maintain these protections, we may notbe able to prevent third parties from using our proprietary rights.Specifically, we must:

**·**      protect andenforce our owned and licensed patents and intellectual property;

 

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**·**      exploit ourpatented technology (owned and licensed); and

**·**      operate ourbusiness without infringing on the intellectual property rights of thirdparties.

Our licensed technology comprises several issued UnitedStates patents covering the composition and method of manufacturing of the familyof Liquidmetal 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 have various expiration datesuntil 2022, and those relating to our bulk amorphous alloys have expirationdates between 2013 and 2025. Patents covering the sale of our ArmacoreTMcoatings material expired during 2005. We continue to hold other coatings related patents; however, if we areunable to protect our proprietary rights prior to the expiration of thesepatents, we may lose the advantage we have established as being the first tomarket bulk amorphous alloy products. In addition, the laws of some foreigncountries do not protect proprietary rights to the same extent as the laws ofthe United States, and we may encounter significant problems and costs inprotecting our proprietary rights in these foreign countries.

Patent law is still evolving relative to the scope andenforceability of claims in the fields in which we operate. Our patentprotection involves complex legal and technical questions. Our patents andthose 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 may claim that we infringe theirintellectual property rights, which could cause us to incur significantexpenses or prevent us from selling our products.**

** **

Our success depends, in part, on our ability to operatewithout infringing on valid, enforceable patents or proprietary rights of thirdparties and not breaching any licenses that may relate to our technology andproducts. Future patents issued to third parties may contain claims thatconflict with our patents and that compete with our products and technologies,and third parties could assert infringement claims against us. Any litigationor interference proceedings, regardless of their outcome, may be costly and mayrequire significant time and attention of our management and technical personnel.Litigation or interference proceedings could also force us to:

**·**                  stop or delay using our technology;

**·**                  stop or delay our customers from selling, manufacturing orusing products that incorporate the challenged intellectual property;

**·**                  pay damages; or

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

**Our level of indebtedness reduces our financialflexibility and could impede our ability to operate.**

** **

As of December 31, 2006, our long-term debt was $14.7 million,including the current portion of such debt. Our long-term debt (including the current portion) includes thefollowing:

**·**                  $1.8 million in principal outstanding under our Koreansubsidiary’s loan from Kookmin Bank of South Korea;

**·**                  $2.1 million in principal outstanding under the 6% SeniorSecured Notes due July 2007 (the “July 2007 Notes”) issued in our August 19,2004  private exchange; and

**·**                  $9.9 million in principal outstanding under the 7% SeniorSecured Convertible Notes due August 2007 (the “August 2007 Notes”) issued inour August 2, 2005 private placement.

**·**                  $4.6 million in principal outstanding under the 8%Unsecured Subordinated Notes issued in May 2006, September 2006, and December2006 private placements.

Under our loan from Kookmin Bank, we are obligated to makeequal monthly payments of principal and interest of $0.11 million each throughthe period ending in February 2008. Under our July 2007 Notes and August 2007 Notes, we are required to makecash interest payments to the noteholders of $0.21 million per quarter untilsuch notes are converted or 

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paid.  Unless suchnotes are converted, the $2.1 million in aggregate principal amount under ourJuly 2007 Notes will become due in July 2007, provided that the holders of suchnotes may demand payment thereunder at any time after July 2006.  The $9.9 million in aggregate principalamount under our August 2007 Notes will become due in August 2007 while the$4.6 million in aggregate principal amount under the 8% Unsecured SubordinatedNotes will become due in August 2007.

As of December 31, 2006, our short-term debt was $2.7million.  Our short-term debt includedthe following:

**·**                  $1.7 million in outstanding advances received under afactoring, loan, and security agreement executed in April 2005 with a financingcompany; and

**·**                  $1.0 million in principal outstanding under unsecuredsubordinated promissory notes issued in a March 17, 2006 private placement.

In January 2007, we completed a privateplacement of Convertible Subordinated Notes Due January 2010 in the aggregateprincipal amount of $14.8 million plus warrants to purchase approximately4,774,049 shares of our common stock at an exercise price of $1.93 pershare.  The notes issued in the privateplacement have an initial conversion price of $1.55 per share.  In February 2007, we entered into conversionagreements with the holders of our August 2007 Notes totaling $1.9 million ofprincipal providing for the conversion of such notes at a reduced conversionprice of $1.25 per share. We issued 1,520,000 shares of common stock under theagreement.

Our level of debt affects our operations inseveral important ways, including the following:

**·**                  a significant portion of our cash flow from operations islikely to be dedicated to the payment of the principal of and interest on ourindebtedness;

**·**                  we may be unable to refinance our indebtedness on termsacceptable to us or at all;

**·**                  our cash flow may be insufficient to meet our requiredprincipal and interest payments; and

**·**                  we may be unable to obtain additional loans as a result ofcovenants and agreements with existing debt holders.

In addition, our convertible notes and related documentscontain restrictive covenants pursuant to which we generally may not (i) incurany indebtedness that would be senior to, or on the same rank as, theconvertible notes with respect to payment or security, (ii) grant any liens orsecurity interests in any of our assets which serve as collateral for theconvertible notes (which collateral consists of substantially all of our assets),(iii) with certain exceptions, sell any of the assets that constitutecollateral for the notes, (iv) become a guarantor for a third-party’sobligation (other than guarantees in the ordinary course of business not inexcess of $500,000 in the aggregate), (v) acquire any shares or securities ofany other person or entity in excess of an aggregate of $1.0 million over anyrolling 12-month period, (vi) purchase or otherwise acquire any assets inexcess of an aggregate of $3.0 million over any rolling 12-month period, (vii)engage in any transaction resulting in the issuance to any person of more than40% of the equity of our company, or (viii) engage in any merger or sale of allor substantially all of our business assets. These covenants may curtail our abilityto raise capital in the future or otherwise restrict our ability to enter intoa transaction that we believe would be in the best interest of ourstockholders.

**We are currently in breach under convertible notesthat we have issued, and the noteholders may therefore accelerate the amountsdue under such notes.**

** **

Our January 2010 Notes wereissued pursuant to a Securities Purchase Agreement, dated January 3, 2007,between our company and the purchasers of the January 2010 Notes (the “JanuaryPurchase Agreement”).  Under the terms ofthe January Purchase Agreement, we agreed to satisfy, within 5 days after theclosing of the private placement, through either repayment or conversion,approximately $15.5 million of our outstanding debt under previously issued promissorynotes (including the August 2007 Notes). We originally agreed to this covenant based on assurances that asubstantial number of holders of the August 2007 Notes would elect to converttheir August 2007 Notes at a reduced conversion price following the privateplacement under a note conversion agreement proposed by us, but most of suchholders have elected not to proceed with such conversion.  Accordingly, in an effort to preserve funds,we have not yet repaid the indebtedness as required by the January Purchase Agreement and are therefore in breach of the January 2010Notes.  We are currently in discussionswith the holders of the January 2010 Notes in an effort to negotiate aforbearance with respect to this breach, and the holders of the January 2010have not yet indicated a desire to declare a default under the January 2010Notes.  However, if such holders declarea default , they may elect to accelerate the maturity of the January 2010 Notesif we do not cure the breach within ten days, and we would likely not be ableto cure such breach at such time.  Also,because we repaid $1.8 million in principal and interest in January andFebruary 2007 under certain subordinated bridge notes without 

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first repaying the August 2007Notes and July 2007 Notes, we may also be deemed to be in breach of the August2007 Notes and July 2007 Notes, which case they would also have the right toaccelerate such notes and foreclose on their security interest if the breach isnot cured within thirty days of notice of default.  The August 2007 Notes and July 2007 Notes aresecured by substantially all of the assets of our company.

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

Changing laws, regulations and standards relating tocorporate governance and public disclosure, including the Sarbanes-Oxley Act of2002 and new SEC regulations, are creating uncertainty for public companies. Asa result of these new rules and the size and limited resources of our company,we will incur additional costs associated with our public company reportingrequirements, and we may not be able to comply with some of these new rules.For example, we were not able to comply with Section 404 of the Sarbanes-OxleyAct of 2002 for our 2005 and 2004 fiscal years. In addition, these new rulescould make it more difficult or more costly for us to obtain certain types ofinsurance, including director and officer liability insurance, and this couldmake it difficult for us to attract and retain qualified persons to serve onour board of directors.

We are presently evaluating and monitoring developments withrespect to new and proposed rules and cannot predict or estimate the amount ofthe additional costs we may incur or the timing of such costs. These new orchanged laws, regulations, and standards are subject to varyinginterpretations, in many cases due to their lack of specificity, and as aresult, their application in practice may evolve over time as new guidance is providedby regulatory and governing bodies. This could result in continuing uncertaintyregarding compliance matters and higher costs necessitated by ongoing revisionsto disclosure and governance practices.

We are committed to maintaining high standards of corporategovernance and public disclosure. As a result, we intend to invest resources tocomply with evolving laws, regulations, and standards, and this investment mayresult in increased general and administrative expenses and a diversion ofmanagement time and attention from revenue-generating activities to complianceactivities. If our efforts to comply with new or changed laws, regulations, andstandards differ from the activities intended by regulatory or governing bodiesdue to ambiguities related to practice, regulatory authorities may initiatelegal proceedings against us and we may be harmed.

**The time and cost associated with complying withgovernment regulations to which we could become subject could have a materialadverse effect on our business.**

** **

Some of the applications that we have identified or mayidentify in the future may be subject to government regulations. For example,any medical devices such as precision ophthalmic instruments and orthopedicdevices made from our alloys likely will be subject to extensive governmentregulation in the United States by the Food and Drug Administration, or FDA.Any medical device manufacturers to whom we sell Liquidmetal alloy products mayneed to comply with FDA requirements, including premarket approval or clearanceunder Section 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, a minorconstituent element of some of our alloys, can result in the release of berylliuminto the workplace and the environment and in the creation of beryllium oxideas a by-product. Beryllium is classified as a hazardous air pollutant, a toxicsubstance, a hazardous substance, and a probable human carcinogen underenvironmental, safety, and health laws, and various acute and chronic healtheffects may result from exposure to beryllium. We are required to comply withcertain regulatory requirements and to obtain a permit from the U.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 the potential for dualuse, such as military and non-military applications, they may be subject toimport and export restrictions of the U.S. government, as well as othercountries. The process of obtaining any required U.S. or foreign licenses orapprovals could be time-consuming, costly, and uncertain. Failure to complywith import and export regulatory requirements can lead to substantial fines,civil and criminal penalties, and the loss of government contracting and exportprivileges.

 

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**The existence of minoritystockholders in our Liquidmetal Golf subsidiary creates potential for conflictsof interest.**

We directly own 79% of the outstanding capital stock ofLiquidmetal Golf, our subsidiary that has the exclusive right to commercializeout technology in the golf market.  Theremaining 21% of Liquidmetal Golf stock is owned by approximately 95stockholders of record. As a result, conflicts of interest may develop betweenus and the minority stockholders of Liquidmetal Golf. To the extent that ourofficers and directors are also officers or directors of Liquidmetal Golf,matters may arise that place the fiduciary duties of these individuals inconflicting positions.  John Kang, ourChairman, President, and Chief Executive Officer, is also director ofLiquidmetal Golf.  In addition, JamesKang, Founder and Director, is also a director of Liquidmetal Golf.

**Our stock price has experiencedvolatility and may continue to experience volatility.**

During 2006, the highest bid price for our common stock was$2.34 per share, while the lowest bid price during that period was $0.87 pershare.  The trading price of our commonstock could continue to fluctuate widely due to:

**·**      quarter-to-quarter variations in resultsof operations;

**·**      loss of a major customer;

**·**      announcements of technological innovationsby us or our potential competitors;

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

**·**      new products offered by us or ourcompetitors;

**·**      announcements of strategic relationshipsor strategic partnerships; or

**·**      other events or factors that may be beyondour 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 havefluctuated broadly, often for reasons unrelated to the operating performance ofthe specific 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.

**Our convertible notes andwarrants contain anti-dilution provisions that, if triggered, could causesubstantial dilution to our then-existing stockholders.**

The convertible notes and warrants issued in our January2007 private placement contain “full-ratchet” anti-dilution rights.  As a result of these anti-dilution rights,under our January 2010 Notes, if we issue or grant in the future any rights topurchase any of our common stock, or other security convertible into our commonstock, for an effective per share price less than the conversion price then ineffect, the conversion price of all unconverted January 2010 Notes will bedecreased to equal such lower price. With regard to the warrants issued in connection with the January 2010Notes, if we, in the future, issue or grant any rights to purchase any of ourcommon stock, or other security convertible into our common stock, for a pershare price less than the conversion price of the January 2010 Notes then ineffect, the exercise price of the warrants will be reduced to equal such lowerprice and the number of shares of our common stock for which the warrants maybe exercised will be increased so that the total aggregate exercise priceremains constant.  The foregoing adjustmentsto the conversion price of the notes and the exercise price of the warrantswill not apply to certain exempt issuances, including issuances pursuant toemployee stock option plans and strategic transactions.

In addition to the above-described full-ratchetanti-dilution rights, certain other notes and warrants previously issued by uscontain “weighted-average” anti-dilution provisions.  As of December 31, 2006, we had outstanding$2.1 million in aggregate principal amount of 6% Senior Convertible Notes DueJuly 2007 with a conversion price of $1.00 per share, $9.9 million in aggregateprincipal amount of 7% Senior Convertible Notes Due August 2007 with aconversion price of $2.00 per share, warrants to purchase 973,064 shares at anexercise price of $2.58 per share, and warrants to purchase 3,902,714 shares atan exercise price of $2.00 per share, each of which notes and warrants containweighted-average anti-dilution provisions. Under these provisions, if we issue shares in the future forconsideration below the conversion or exercise prices then in effect, then(with certain exceptions, including the issuance of stock options) theconversion price for our convertible notes would automatically be reduced(allowing the holders of the notes to receive additional shares of 

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common stock upon conversion) and the exercise price of thewarrants would automatically be reduced (with a corresponding increase in thenumber of shares issuable pursuant to such warrants).  It is also possible that a future triggeringof the full-ratchet anti-dilution rights in our January 2010 Notes could resultin a corresponding triggering of the above-described weighted-averageanti-dilution provisions in the other notes and warrants.

If our available funds and cash generated from operationsare insufficient to satisfy our liquidity requirements in the future, then wemay need to raise substantial additional funds in the future to support ourworking capital requirements and for other purposes. If shares of our commonstock or securities convertible into or exercisable for our common stock areissued in consideration of such funds at an effective per share price lowerthan the conversion and exercise prices of our convertible notes and warrants,then these anti-dilution provisions would be triggered, thus possibly causingsubstantial dilution to our then-existing stockholders if the notes areconverted or the warrants are exercised. Further, subsequent sales of theshares in the public market could depress the market price of our stock bycreating an excess in supply of shares for sale.

**We have never paid dividends onour common stock, and we do not anticipate paying any cash dividends in theforeseeable future.**

We have paid no cash dividends on our common stock to date.We currently intend to retain our future earnings, if any, to fund thedevelopment and growth of our businesses, and upon the completion of thisoffering, we do not anticipate paying any cash dividends on our capital stockfor the foreseeable future. In addition, the terms of existing or any futuredebts may preclude us from paying dividends on our stock. As a result, capitalappreciation, if any, of our common stock will be your sole source of gain forthe foreseeable future.

**Anti-takeover provisions of ourcertificate of incorporation and bylaws and provisions of applicable corporatelaw 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 to acquire us,even if doing so would be beneficial to our stockholders. These provisionscould discourage potential takeover attempts and could adversely affect themarket price of our shares. Because of these provisions, you might not be ableto receive a premium on your investment. These provisions:

**·**                  authorize our board of directors, without stockholderapproval, to issue up to 10,000,000 shares of “blank check” preferred stockthat could be issued by our board of directors to increase the number ofoutstanding shares and prevent a takeover attempt;

**·**                  limit stockholders’ ability to call a special meeting ofour stockholders;

**·**                  provide for a classified board of directors; and

**·**                  establish advance notice requirements to nominate directorsfor election to our board of directors or to propose matters that can be actedon by stockholders at stockholder meetings.

The provisions describedabove could delay or make more difficult transactions involving a change incontrol of us or our management.

**An ongoing investigation by the Department of Justice couldhave a material adverse impact on our company.**

In August 2006, wereceived a federal grand jury subpoena for the production of documents relatedto the period from January 1, 1999 though the present.  The documentsbeing sought include accounting records, documents relating to our relationshipwith Growell Metal of Korea, and documents and records relating to transactionsin company stock by officers and directors.  The subpoena was issued inconnection with a grand jury investigation being conducted by the U.S.Department of Justice, Criminal0020Division, in the Middle District of Floridaconcerning alleged accounting improprieties involving our company, among otherthings.  We have been, and intend to continue to be, fully cooperativewith the authorities in connection with the Department of Justice’s subpoenaand investigation.  However, in the event that current or former membersof our senior management were to be implicated in any wrongdoing, it could havea material adverse impact on our capital resources and business focus.

**Item 1B.Unresolved Staff Comments**

None.

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**Item 2.Properties**

Our principal executive offices and principal research anddevelopment offices are located in Lake Forest, California and consist ofapproximately 30,000 square feet. This facility is occupied pursuant to a leaseagreement that expires in June 2007.

In Conroe, Texas, we lease an office and warehouse for ourcoatings business segment. This facility, which is approximately 10,000 squarefeet, is leased through September 2007.

Our principal prototyping and manufacturing facility is inPyongtaek, South Korea, and consists of approximately 166,000 square feet. Welease the land on which this facility is located, although we own thebuildings, fixtures, and all personal property located on the land. The parcelof land consists of approximately four acres and is leased through 2022.

On August 2004, we entered into a 3 year lease for apost-processing facility located in Weihai, China, which consists ofapproximately 14,400 square feet, to facilitate our bulk alloy manufacturing.

We currently expect that the foregoingfacilities will meet our anticipated internal manufacturing, research,warehousing, and administrative needs for the foreseeable future.

**Item 3.Material Legal Proceedings**

In April 2006, we reachedagreements-in-principle to settle our previously-disclosed consolidatedsecurities class action and shareholder derivative actions for a total of $7.5million; $7.0 million for the class action and $0.5 million for the derivativeactions.  In addition, we will commit tomaintain or implement various corporate governance measures in connection withthe settlement of the derivative actions.

The consolidated classaction arose from a number of lawsuits filed in 2004 against our company andcertain of our former and current directors and officers on behalf of personswho purchased our common stock between May 21, 2002 and May 13,2004.  These actions, which were brought under the federal securitieslaws, alleged that the Prospectus issued in connection with our initial publicoffering in May 2002 contained material misrepresentations and omissionsregarding our historical financial condition and regarding a personal stocktransaction by our former chief executive officer.  They also alleged thatour company and certain of our present and former officers and directorsengaged in improper revenue recognition with respect to certain of our businesstransactions, failed to maintain adequate internal controls, and knowinglydisclosed unrealistic but favorable information about market demand for andcommercial viability of our products to artificially inflate the value of ourstock.  On October 19, 2006, thepresiding judge entered an Order giving final approval of the class action settlement.  In connection with the settlement, ourdirectors and officers’ liability insurers contributed $7.0 million to asettlement fund, from which approved claims of eligible class members will bepaid in accordance with a court-approved plan of allocation.  Taking into account the insurancecontribution, the net cost of the settlement to our company is approximately$0.5 million, which is the insurance deductible we paid over several quartersending in the third quarter of 2005, and which was previously recorded as acharge.

In addition, inMay 2004, two shareholder derivative actions were filed in the SuperiorCourt of Orange County, California and later consolidated.  Shortlythereafter, one additional shareholder derivative action was filed in the UnitedStates District Court for the Middle District of Florida, Tampa Division. These derivative actions were brought by certain shareholders against certainof our present and former officers and directors as well as our company (as anominal defendant).  The suits alleged that the defendants breachedvarious fiduciary duties and otherwise violated state law based primarily uponthe same facts and circumstances underlying thefederal securities class action.  On August 2, 2006, plaintiffs’counsel in the California derivative action filed a Notice of Settlement in theSuperior Court.  The action is presentlystayed while the parties’ counsel negotiate and prepare formal settlementdocuments.  Final documentation andapproval of the settlement of the derivative actions remains outstanding.

Finally, in August 2006,the United States Department of Justice (“DOJ”) instituted a grand juryproceeding in the Middle District of Florida to investigate, among otherthings, alleged accounting improprieties in relation to certain of our businesstransactions and a personal stock transaction by our former chief executiveofficer.  The grand jury proceeding isbased primarily upon the same underlying facts and circumstances as alleged inthe federal class action and shareholder derivative actions.  To date, subpoenas for the production ofdocuments and/or grand jury testimony have been issued to our company andseveral present and former officers and directors.  We are cooperating with the DOJ in itsinvestigation.

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

No matters were submitted to a vote of oursecurity holders during the fourth quarter of 2006.

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**PART II**

**Item 5.Market For Registrant’s CommonEquity and Related Stockholder Matters**

Our common stock is currently quoted on the OTC BulletinBoard under the symbol “LQMT.”  OnFebruary 28, 2007, the last reported sales price of our common stock was $1.32per share.  As of February 28, 2007, wehad 256 record holders of our common stock.

The following table sets forth, on a per share basis, therange of high and low bid information for the shares of our common stock foreach full quarterly period within the two most recent fiscal years and anysubsequent interim period for which financial statements are included.  These quotations reflect inter-dealer prices,without retail mark-up, mark-down or commission and may not necessarilyrepresent actual transactions.
| **2006**       | ** ** | **High** | ** ** | **Low** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| Fourth Quarter |       |     | $          | 1.80    |       |   |   | $ | 1.42 |   |   |
| Third Quarter  |       |     | $          | 2.01    |       |   |   | $ | 1.31 |   |   |
| Second Quarter |       |     | $          | 2.34    |       |   |   | $ | 1.31 |   |   |
| First Quarter  |       |     | $          | 1.75    |       |   |   | $ | 0.87 |   |   |

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

 

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.Selected Consolidated FinancialData**

The following table shows our selected consolidatedfinancial data as of and for the years ended December 31, 2002 through2006.

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| ** **                                                     | ** ** | ** ** | ** ** | **For the Years Ended December 31,**      | ** ** | ** **     | ** ** |
|----------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------|------------|----------------|------------|
| ** **                                                     | ** ** | ** ** | ** ** | ** **                                                         | ** ** | ** **     | ** ** |
| ** **                                                     | ** ** | **2006**   | ** ** | **2005**                                                           | ** ** | **2004**       | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                     | ** ** | ** ** | ** ** | **(Restated)**                                                     | ** ** | **(Restated)** | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| ** **                                                     | ** ** | ** ** | ** ** | **(in thousands, except per share data)** | ** ** | ** **     | ** ** |
| **Consolidated  Statement of Operations Data:**                |       |       |       |                                                               |       |           |       |   |   |   |   |
| Revenue                                                        |       | $          | 27,669     |                                                               | $          | 16,365         |       | $ | 17,429 |   | $ | 13,658 |   | $ | 9,138 |   |
| Cost of sales                                                  |       | 22,418     |       | 15,129                                                             |       | 12,168         |       | 18,162 |   | 5,656 |   |
| Gross profit (loss)                                            |       | 5,251      |       | 1,236                                                              |       | 5,261          |       | (4,504 | ) | 3,482 |   |
|                                                           |       |       |       |                                                               |       |           |       |   |   |   |   |
| Operating  expenses:                                           |       |       |       |                                                               |       |           |       |   |   |   |   |
| Selling, general and administrative expenses                   |       | 9,962      |       | 8,534                                                              |       | 11,591         |       | 17,729 |   | 13,099 |   |
| Research and development expenses                              |       | 950        |       | 1,120                                                              |       | 1,467          |       | 8,780 |   | 11,825 |   |
| Impairment of goodwill                                         |       | —     |       | —                                                             |       | —         |       | 184 |   | — |   |
| Impairment of long lived assets                                |       | —     |       | 4,487                                                              |       | —         |       | 2,684 |   | — |   |
| Total operating expenses                                       |       | 10,912     |       | 14,141                                                             |       | 13,058         |       | 29,377 |   | 24,924 |   |
|                                                           |       |       |       |                                                               |       |           |       |   |   |   |   |
| Loss before  interest, other income, income taxes,             |       |       |       |                                                               |       |           |       |   |   |   |   |
| minority  interest and discontined operations                  |       | (5,661     | )          | (12,905                                                            | )          | (7,797         | )          | (33,881 | ) | (21,442 | ) |
| Loss from extinguishments of debt                              |       | —     |       | (1,247                                                             | )          | (2,941         | )          | — |   | — |   |
| Change in value of warrants, gain                              |       | 279        |       | 3,985                                                              |       | 747            |       | — |   | — |   |
| Change in value of conversion feature, (loss) gain             |       | (226       | )          | 9,118                                                              |       | 2,093          |       | — |   | — |   |
| Other income                                                   |       | 572        |       | —                                                             |       | 302            |       | — |   | — |   |
| Interest expense                                               |       | (9,509     | )          | (6,021                                                             | )          | (6,577         | )          | (390 | ) | (1,109 | ) |
| Interest income                                                |       | 23         |       | 17                                                                 |       | 37             |       | 304 |   | 506 |   |
| Gain on sale of marketable securities held-for-sale            |       | —     |       | —                                                             |       | —         |       | 1,178 |   | 832 |   |
|                                                           |       |       |       |                                                               |       |           |       |   |   |   |   |
| Loss before  income taxes, minority interest and               |       |       |       |                                                               |       |           |       |   |   |   |   |
| discontinued operations                                        |       | (14,522    | )          | (7,053                                                             | )          | (14,136        | )          | (32,789 | ) | (21,213 | ) |
| Income taxes                                                   |       | —     |       | —                                                             |       | —         |       | — |   | — |   |
| Minority interest in loss of consolidated subsidiary           |       | —     |       | —                                                             |       | —         |       | 21 |   | 118 |   |
|                                                           |       |       |       |                                                               |       |           |       |   |   |   |   |
| Loss from  continuing operations                               |       | (14,522    | )          | (7,053                                                             | )          | (14,136        | )          | (32,768 | ) | (21,095 | ) |
| Income (loss) from operations of discontinued

operations, net |       | —     |       | —                                                             |       | (749           | )          | (964 | ) | 83 |   |
| Gain (loss) from disposal of discontinued

operations, net     |       | —     |       | —                                                             |       | —         |       | 127 |   | 1,556 |   |
|                                                           |       |       |       |                                                               |       |           |       |   |   |   |   |
| Net loss                                                       |       | $          | (14,522    | )                                                                  | $          | (7,053         | )          | $ | (14,885 | ) | $ | (33,605 | ) | $ | (19,456 | ) |
|                                                           |       |       |       |                                                               |       |           |       |   |   |   |   |
| Loss per share  from continuing                                |       |       |       |                                                               |       |           |       |   |   |   |   |
| operations -  basic and diluted                                |       | $          | (0.33      | )                                                                  | $          | (0.17          | )          | $ | (0.34 | ) | $ | (0.79 | ) | $ | (0.54 | ) |
| Income (loss)  per share from discontinued operations          |       | $          | —     |                                                               | $          | —         |       | $ | (0.02 | ) | $ | (0.02 | ) | $ | 0.00 |   |
| Net loss per  share                                            |       | $          | (0.33      | )                                                                  | $          | (0.17          | )          | $ | (0.36 | ) | $ | (0.81 | ) | $ | (0.54 | ) |
|                                                           |       |       |       |                                                               |       |           |       |   |   |   |   |
| Weighted average common  shares - basic and diluted            |       | 43,809     |       | 41,833                                                             |       | 41,610         |       | 41,505 |   | 38,714 |   |

 

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| ** **                                                    | ** ** | ** ** | ** ** | **As of December 31,** | ** ** | ** **     | ** ** |
|---------------------------------------------------------------|------------|------------|------------|---------------------------------------|------------|----------------|------------|
| ** **                                                    | ** ** | ** ** | ** ** | ** **                            | ** ** | ** **     | ** ** |
| ** **                                                    | ** ** | **2006**   | ** ** | **2005**                              | ** ** | **2004**       | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                    | ** ** | ** ** | ** ** | **(Restated)**                        | ** ** | **(Restated)** | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| ** **                                                    | ** ** | ** ** | ** ** | **(in thousands)**               | ** ** | ** **     | ** ** |
| **Consolidated  Balance Sheet Data:**                         |       |       |       |                                  |       |           |       |   |   |   |   |
| Cash and cash  equivalents                                    |       | $          | 144        |                                  | $          | 1,392          |       | $ | 742 |   | $ | 3,127 |   | $ | 25,058 |   |
| Working capital  (deficiency)                                 |       | (23,157    | )          | (10,993                               | )          | (14,910        | )          | (698 | ) | 25,812 |   |
| Total assets                                                  |       | 22,244     |       | 21,563                                |       | 28,508         |       | 30,852 |   | 24,845 |   |
| Long-term debt,  including current portion, net   of discount |       | 14,705     |       | 6,776                                 |       | 6,628          |       | 4,047 |   | — |   |
| Shareholders’ equity  (deficiency)                       |       | (10,363    | )          | (1,320                                | )          | 4,191          |       | 16,163 |   | 50,599 |   |
|                                                               |            |            |            |                                       |            |                |            |  |  |  |  |  |  |  |  |  |

 

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**Item 7. Management’s Discussion and Analysis of Financial Conditionand 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 relianceshould not be placed on these statements. These risks and uncertaintiesinclude, but are not limited to, the matters discussed under the caption “RiskFactors” in Item 1A of this report and other risks and uncertaintiesdiscussed in filings made with the Securities and Exchange Commission(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 anyforward-looking statements, whether as a result of new information, futureevents, or otherwise.*

##### **OVERVIEW**

We are a materials technology company that develops andcommercializes 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 licenseesto develop and commercialize bulk Liquidmetal alloy products. We believe thatour proprietary bulk alloys are the only commercially viable bulk amorphousalloys currently available in the marketplace. In addition to our bulk alloys, we market and sell a line of proprietaryamorphous alloy-based industrial coatings under the Liquidmetal® ArmacorTM coatings brand.

Amorphous alloys are unique materials that are distinguishedby their ability to retain a random atomic structure when they solidify, incontrast to the crystalline atomic structure that forms in other metals andalloys when they solidify. Liquidmetal alloys possess a combination ofperformance, processing, and potential cost advantages that we believe can makethem 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 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 believe theseadvantages could 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. Bulk Liquidmetal alloy segment revenueincludes sales of parts or components of electronic devices, medical products,and sports and leisure goods; tooling and prototype parts (includingdemonstration parts and test samples) for customers with products indevelopment, product licensing and arrangements, and research and developmentrevenue relating primarily to defense and medical applications.  We expect that these sources of revenue willcontinue to significantly change the character of our revenue mix.

The cost of sales for our Liquidmetal coatings segmentconsists primarily of the costs of outsourcing our manufacturing to thirdparties. Consistent with our expectations, our cost of sales has beenincreasing over historical results as we further build our bulk Liquidmetalalloy business. Although we plan to continue outsourcing the manufacturing ofour coatings, we will internally manufacture many products derived from ourbulk 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.

Research and development expenses represent salaries,related benefits expense, stock-based compensation, depreciation of researchequipment, consulting and contract services, expenses incurred for the designand testing of new processing methods, expenses for the development of sampleand prototype products, and other expenses related to the research anddevelopment of Liquidmetal alloys. Costs associated with research anddevelopment activities are expensed as incurred. 

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We plan to enhance our competitive position by improving ourexisting technologies and developing advances in amorphous alloy technologies.We believe that our research and development efforts will focus on thediscovery of new alloy compositions, the development of improved processingtechnology, and the identification of new applications for our alloys.

We maintain certain of our raw material inventories inamounts in excess of our operating cycle of one year due to the nature of ourmanufacturing process, production lead time, and the recyclability of our rawmaterial. These inventories were classified as long-term inventory as ofDecember 31, 2004.  We have determinedthat its current and projected raw material requirements are not sufficientenough to warrant the use of such raw materials in the foreseeable future. As aresult, we determined that the carrying value of raw materials held by itssubsidiary, Liquidmetal Korea, exceeded its fair value in the amount of $2.7million during the fiscal year 2005.

Idle equipment consists of certain equipment held by theCompany for use in expansion of bulk alloy parts manufacturing.  Due toexcess manufacturing capacity, the Company classified the equipmentas idle equipment as of December 31, 2005 and 2004.  While the equipmentmay be used internally to meet future capacity requirements, considering ourcurrent revenue and foreseeable production requirements, we do not anticipateutilizing this equipment internally in the near future. As a result, wedetermined that the carrying value of idle equipment held by its subsidiary,Liquidmetal Korea, exceeded its fair value in the amount of $1.7 million duringthe second quarter of fiscal year 2005.

Impairment of Long-Lived Assets consists of a write-down of$2.5 million of raw materials considered to be long term inventory and $1.7 millionof idle equipment.  During 2005, while wemay use the excess raw materials beyond one year to fulfill future customerorder, we determined that our capacity was not significant enough to warrantholding this inventory as a long term asset. Further, while we have actively marketed the idle equipment for ultimatesale since early 2004, we were unable to sell this equipment. In addition,while the equipment may be used internally to meet future capacityrequirements, considering the revenues during 2005, we did not anticipateutilizing this equipment internally in the near future.  As such, during 2005 we have reduced thecarrying values of the excess raw material and idle equipment.

Change in Value of Warrantsconsists of changes to the fair value of warrants outstanding at eachperiod.  The warrants have been accountedfor as a liability in accordance with Emerging Issues Task Force Issue No.00-19, “Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company’s Own Stock,” with the change in fair valuesreported in earnings. The fair values are determined using a Black-Scholespricing model and fluctuations in our stock price have had the greatest impacton the valuation of outstanding warrants.

Change in Value of ConversionFeature consists of changes to the fair value of the embedded conversionfeature of our senior convertible notes. The embedded conversion feature has been accounted for as a separatederivative instrument in accordance with SFAS 133 with a change in fair valuesreported in earnings.  The change in fairvalues are determined using a Black-Scholes pricing model and fluctuations inour stock price have had the greatest impact on the valuation of outstandingconversion features.

On May 21, 2003, we completed a reincorporation bytransitioning from a California corporation to a Delaware corporation. Thereincorporation was effected through the merger of the former California entityinto a newly created wholly owned Delaware subsidiary. The reincorporationchanged the legal domicile of our company but did not result in any change toour business, management, employees, fiscal year, assets or liabilities, orlocation of facilities. As part of the reincorporation, each share of theCalifornia corporation was automatically converted into one share of theDelaware corporation.  In addition, totalauthorized shares decreased from 200,000,000 shares to 100,000,000 shares.

In conjunction with the divestiture of our Dongyang andTaesung subsidiaries in March and June 2004, respectively, we decided todiscontinue our equipment manufacturing business in order to conform ouroperations to our broader corporate business strategy.  Pursuant to Accounting Principles BoardOpinion No. 30, Reporting the Results of Operations — Reporting theEffects of Disposal of a Segment of a Business, and Extraordinary, Unusual andInfrequently Occurring Events and Transactions, we reclassified ourconsolidated financial statements to reflect the discontinuation of our equipmentmanufacturing operations. The revenue, costs and expenses, assets andliabilities, and cash flows of the equipment manufacturing business weresegregated in our financial statements.

On August 4, 2004, we established a post-processing plant inthe city of Weihai in Shandong province of China under Weihai LiquidmetalCompany Limited, which is 100 percent owned by Liquidmetal Korea, to facilitateour bulk alloy manufacturing business. Weihai Liquidmetal is consolidated into Liquidmetal Technologies withall intercompany transactions eliminated.

On June 26, 2006, we entered into a joint venture agreementwith SAGA, SpA in Padova, Italy, (‘SAGA”) a specialist precision partsmanufacturer.  The joint venture is namedLiquidmetal SAGA Italy, Srl (“LSI”).  Wealso entered into an exclusive manufacturing license agreement for the eyewearindustry with LSI.  Under the jointventure agreement, we have the option to buy ownership interest in LSI,initially, of 19.9% to up to 50%.  InDecember 2006, we have purchased 19.9% interest in the joint venture.

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***Results of Operations***

***Comparison of the years endedDecember 31, 2006 and 2005***

*Revenue*. Revenue increased to $27.7 million in the twelve months endedDecember 31, 2006 from $16.4 million in the twelve months endedDecember 31, 2005. The increase included a $7.3 million increase in sales andprototyping of parts manufactured from bulk Liquidmetal alloys to consumerelectronics customers as a result of increased demand in electronic casingsapplications, and increase of $3.5 million in sale of our coatings products asa result of increased demand in oil drilling applications, and an increase of$0.5 million in research and development services as a result of  increased research and development servicesprimarily from defense applications.

*Cost of Sales*. Cost of sales increased to $22.4 million, or 81% of revenue, duringthe twelve months ended December 31, 2006 from $15.1 million, or 92% ofrevenue, in the twelve months ended December 31, 2005. The increase was aresult of increases in bulk Liquidmetal alloy business and coatingsbusiness.  Cost of sales as a percentageof revenue has decreased as a result of continued maturing of our manufacturingprocess, which represents the Company’s efforts to manage costs and focus onour core business, and an increase in revenues generated from our higher margincoatings products.  We believe thathigher manufacturing volumes and greater mix of higher-margin products in thefuture will cause the gross profit to improve over time.  The cost to manufacture parts from our bulkLiquidmetal alloys is variable and differs based on the unique design of eachproduct.  However, cost of sales for theproducts sold by the coatings business segment is generally consistent becausethe Liquidmetal coatings products are produced by third parties and soldwholesale to various industries.

*Selling, General, and Administrative Expenses*. Selling, general, and administrativeexpenses increased to $10.0 million, or 36% of revenue, in the twelve months endedDecember 31, 2006 from $8.5 million, or 52% of revenue, in the twelvemonths ended December 31, 2005.  Thisincrease was primarily a result of increase in wages and expenses of $1.4million, increase in professional and contracted services of $0.4 million,increase in travel expenses of $0.3 million, and increase in advertising andpromotions expense of $0.2 million offset by a decrease in insurance expense of$0.7 million and decrease in rent expense of $0.1 million.  The decrease in selling, general andadministrative expenses as a percentage of revenue represent the Company’sefforts to manage costs and focus on our core business while continuing tobuild our corporate infrastructure required to prepare for and support theanticipated growth of our bulk Liquidmetal alloy business.

*Research and Development Expenses*. Research and development expenses decreasesto $1.0 million, or 3% of revenue, in the twelve months ended December 31,2006 from $1.1 million, or 7% of revenue, in the twelve months ended December 31,2005.  The decrease was a resultof the Company focusing primarily on our core business associated with our bulkLiquidmetal 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.

*Impairmentof Long Lived Assets*. Impairment of long lived assetsdecreased to $0, in the twelve months ended December 31, 2006 from $4.5million, or 27% of revenue, in the twelve months ended December 31, 2005.  Impairment expense during 2005 representprimarily write-down of $2.7 million of raw materials considered to be longterm inventory and $1.7 million of idle equipment which were written down dueto our projected capacity for 2006 as not being significant enough to warrantholding this inventory as a long term asset. Further, while we have actively marketed the idle equipment for ultimatesale since early 2004, we were unable to sell this equipment.  While the equipment may be used internally tomeet future capacity requirements we did not anticipate utilizing thisequipment internally in the near future. As such, we reduced the carrying values of the excess raw material andidle equipment in 2005.  No suchreductions were needed in 2006.

*Lossfrom Extinguishments of Debt.* Loss from extinguishments of debt decreased to $0 in the twelve monthsended December 31, 2006 from $1.2 million, or 8% of revenue, in the twelvemonths ended December 31, 2005.  The $1.2million loss from extinguishments of debt was recognized from the exchange ofour 6% Convertible Notes due 2006 in August 2005.

*Changein Value of Warrants.*Change in value of warrants was a gainof $0.3 million, or 1% of revenue during the twelve months ended December 31,2006, and $4.0 million, or 24% of revenue, during the twelve months endedDecember 31, 2005, from the change in value of warrants issued primarily as aresult of fluctuations in our stock price.

*Changein Value of Conversion Feature.*Change in the value of ourconversion feature liability from our senior convertible debt funded in March2004 and exchanged in August 2004 and August 2005 resulted in a change in valueof conversion feature loss of $0.2 million, or 1% of revenue, in the twelvemonths ended December 31, 2006, and a gain of $9.1 million, or 56% of revenue,in the twelve months ended December 31, 2005, primarily due to fluctuations inour stock price.

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*OtherIncome.*Other income was $0.6 million, or 2% of revenue, inthe twelve months ended December 31, 2006 from $0.1 million of  gain recognized from disposal of idleequipment and  $0.5 million gain recognizedfrom termination of a distribution agreement with a Japanese sporting goodsdistributor originally enetered into in March 1996.  There were no amounts recognized as otherincome in the twelve months ended December 31, 2005.

*InterestExpense*. Interest expense was $9.5 million or 34% of revenue,in the twelve months ended December 31, 2006 and was $6.0 million, or 37% ofrevenue, in the twelve months ended December 31, 2005.  Interest expense consists primarily of interestaccrued on the Kookmin Bank loan funded in 2003, convertible debt funded in2004 and 2005, subordinated notes funded in 2006, fees charged from short-termborrowings under the 2005 factoring, loan, and security agreement, as well asamortization of debt issuance costs and discount on the convertible debt.  The increase in interest expense wasprimarily due to costs accrued for late registration penalties of $1.6 million,higher debt balances and increased debt discount amortization during the twelvemonths ended December 31, 2006.

*InterestIncome.* Interestincome was $23 thousand and $17 thousand for the twelve months ended December31, 2006 and 2005, respectively, from interest earned on cash deposits.

***Comparison of the years endedDecember 31, 2005 and 2004***

*Revenue*. Revenue decreased to $16.4 million in the twelve months endedDecember 31, 2005 from $17.4 million in the twelve months endedDecember 31, 2004. The decrease included a $2.6 million decrease fromrestatement of revenues from 2003 to 2004 as part of our 2003 financialstatement restatement which resulted in one-time recognition of revenues duringthe first quarter of 2004, and $0.9 million decrease from our research anddevelopment services related primarily to reduced activity from defense,leisure, and luxury goods applications during 2005.  The decreases were offset by a $0.4 millionincrease in bulk alloy parts primarily to increased sales to sporting goodsmanufacturers and $1.9 million increase from sale of our coatings products fromincreased demand for drill pipe coatings during 2005.

*Cost of Sales*. Cost of sales increased to $15.1 million, or 92% of revenue, duringthe twelve months ended December 31, 2005 from $12.2 million, or 70%of revenue, in the twelve months ended December 31, 2004. The increase wasa result of decreases in bulk Liquidmetal alloy business.  Cost of sales as a percentage of revenue hasincreased as a result of ramp up of lower margin electronic casing andprototypes during the year.   Further,significant portion of our manufacturing costs continue to remain fixed.  We believe that higher manufacturing volumesand greater mix of higher margin products in the future will cause the grossprofit to improve over time.  The cost tomanufacture parts from our bulk Liquidmetal alloys is variable and differsbased on the unique design of each product. However, the cost of sales for the products sold by the coatingsbusiness segment is generally consistent because the Liquidmetal coatingsproducts are produced by third parties and sold wholesale to various industries.

*Selling, General, and Administrative Expenses*. Selling, general, and administrativeexpenses decreased to $8.5 million, or 52% of revenue, in the twelvemonths ended December 31, 2005 from $11.6 million, or 67% of revenue,in the twelve months ended December 31, 2004.  This decrease was primarily a resultof decrease in professional and contracted services of $1.8 million, decreasein advertising and promotions expense of $0.2 million, decrease in bad debtexpenses of $0.1 million, decrease in product warranty expense of $0.2 million,decrease in insurance costs of $0.6 million, and decrease in amortization anddepreciation costs of $0.2 million. These and other decreases in selling, general and administrativeexpenses represent the Company’s efforts to manage costs and focus on our corebusiness while continuing to build our corporate infrastructure required toprepare for and support the anticipated growth of our bulk Liquidmetal alloybusiness.

*Research and Development Expenses*. Research and development expenses decreasedto $1.1 million, or 7% of revenue, in the twelve months endedDecember 31, 2005 from $1.5 million, or 8% of revenue, in the twelvemonths ended December 31, 2004.  Thedecrease was primarily a result of decreases in salaries, wages and relatedexpenses by $0.3 million and decrease in laboratory and prototypingexpenses by $0.1 million.  Thedecreases were a result of the Company focusing primarily on our core businessassociated with our bulk Liquidmetal alloy business while managing ourcosts.  The Company continues to performresearch and development efforts on new Liquidmetal alloys and relatedprocessing capabilities, develop new manufacturing techniques, and contractwith consultants and provide research grants to various institutions to advancethe development of Liquidmetal alloys.

*Impairmentof Long Lived Assets*. Impairment of long lived assetsincreased to $4.5 million, or 27% of revenue, for the twelve months endedDecember 31, 2005 from $0 for the twelve months ended December 31, 2004.  Impairment expense represents primarilywrite-down of $2.7 million of raw materials considered to be long terminventory and $1.7 million of idle equipment. While we may use the excess raw materials beyond one year to fulfillfuture customer order, we have determined that our current capacity was notsignificant enough to warrant holding this inventory as a long term asset.  Further, while we have actively marketed theidle equipment for ultimate sale since early 2004, we 

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were unable to sell thisequipment. In addition, while the equipment may be used internally to meetfuture capacity requirements, considering our current revenue, we do notanticipate utilizing this equipment internally in the near future.  As such, we have reduced the carrying valuesof the excess raw material and idle equipment.

*Lossfrom Extinguishments of Debt.* Loss from extinguishments of debt decreased to $1.2 million, or 8% ofrevenue, for the twelve months ended December 31, 2005 from $2.9 million, or17% of revenue, for the twelve months ended December 31, 2004.  The $1.2 million loss from extinguishments ofdebt was recognized from the exchange of our 6% Convertible Notes due 2006 inAugust 2005.  The $2.9 million loss fromextinguishments of debt was recognized from exchange of our 6% SeniorConvertible Notes due March 2007 in August 2004.

*Changein Value of Warrants.*Change in value of warrants was a netgain of $4.0 million, or 24% of revenue, and $0.7 million, or 4.3% of revenue,during the twelve months ended December 31, 2005 and 2004, respectively fromthe change in value of warrants issued from the senior convertible debt fundedin March 2004 and exchanged in August 2004, convertible debt funded in June2005, and senior convertible debt funded in August 2005 primarily as a resultof fluctuations in our stock price.

*Changein Value of Conversion Feature.*Change in the value of ourconversion feature liability from our senior convertible debt funded in March2004 and exchanged in August 2004 and August 2005 resulted in a Change in valueof conversion feature gain of $9.1 million, or 56% of revenue, and a gain of$2.1 million, or 12% of revenue, for the twelve months ended December 31, 2005and 2004, respectively, primarily due to fluctuations in our stock price.

*OtherIncome.*Other income was $0.3 million, or 2% of revenue,during the twelve months ended December 31, 2004 from certain stocktransactions with John Kang, our Chairman, President, and Chief ExecutiveOfficer during 2002.  There were noamounts recorded as other income for the twelve months ended December 31, 2005(see Item 13 Certain Relationships and Related Transactions, Part III).

*InterestExpense*. Interest expense was $6.0 million, or 37% of revenue, for the twelve months ended December31, 2005 and was $6.6 million, or 38% of revenue, for the twelve months endedDecember 31, 2004.  During each of thetwelve months ended December 31, 2005 and 2004, the interest expense wasprimarily due to the interest accrued on the Kookmin Bank loan funded on February4, 2003, senior convertible debt funded on March 3, 2004 and exchanged inAugust 2004, convertible debt funded on June 13, 2005, and senior convertibledebt funded in August 9, 2005, as well as amortization of debt issuance costsand discount on the convertible debt. During 2005, $0.1 million of interest expense was accrued from defaultinterest rates applied to the senior convertible notes effective April 1, 2005from non-payment of quarterly scheduled interest payments and $1.0 million oflate registration penalty fee of our senior convertible debt was accrued asinterest expense.  The default interestand late registration penalty were paid as of December 31, 2005.

Interest Income.  Interest incomewas $17 thousand for the twelve months ended December 31, 2005, and $37thousand for the twelve months ended December 31, 2004 from interest earned oncash deposits.

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**QUARTERLY RESULTS**

Thefollowing information presents our unaudited quarterly operating results for2006 and 2005. The data has been prepared by Liquidmetal Technologies, Inc. ona basis consistent with the Consolidated Financial Statements included elsewherein this Form 10-K, and includes all adjustments, consisting of normalrecurring accruals, that we consider necessary for a fair presentation thereof.These operating results are not necessarily indicative of our futureperformance.
| ** **                                                                                                    | ** ** | **For the Three Months Ended**                 | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                    | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Consolidated Statements of Operations Data:**                                           | ** ** | **12/31/06**                                                       | ** ** | **09/30/06** | ** ** | **06/30/06** | ** ** | **03/31/06** | ** ** |
| ** **                                                                                                    | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| ** **                                                                                                    | ** ** | **(In thousands, except per share data)** | ** ** |
| ** **                                                                                                    | ** ** | **(Unaudited)**                                                    | ** ** |
| Revenue                                                                                                       |       | $                                                                  | 5,984      |   | $ | 8,040 |   | $ | 7,090 |   | $ | 6,555 |   |
| Cost of sales                                                                                                 |       | 5,081                                                              |       | 6,449 |   | 5,564 |   | 5,324 |   |
| Gross profit                                                                                                  |       | 903                                                                |       | 1,591 |   | 1,526 |   | 1,231 |   |
|                                                                                                          |       |                                                               |       |   |   |   |   |   |   |
| Operating expenses                                                                                            |       |                                                               |       |   |   |   |   |   |   |
| Selling,  general, and administrative                                                                         |       | 2,599                                                              |       | 2,290 |   | 2,368 |   | 2,705 |   |
| Research and  development                                                                                     |       | 197                                                                |       | 269 |   | 281 |   | 203 |   |
| Total operating  expenses                                                                                     |       | 2,796                                                              |       | 2,559 |   | 2,649 |   | 2,908 |   |
| Loss from operations                                                                                          |       | (1,893                                                             | )          | (968 | ) | (1,123 | ) | (1,677 | ) |
| Loss from  extinguishments of debt                                                                            |       | —                                                             |       | — |   | — |   | — |   |
| Change in value  of warrants, gain (loss)                                                                     |       | 1,633                                                              |       | 1,361 |   | (1,426 | ) | (1,289 | ) |
| Change in value  of conversion feature, gain (loss)                                                           |       | 1,707                                                              |       | 1,987 |   | (2,137 | ) | (1,783 | ) |
| Other income                                                                                                  |       | —                                                             |       | — |   | 92 |   | 480 |   |
| Interest expense                                                                                              |       | (2,148                                                             | )          | (2,302 | ) | (3,277 | ) | (1,782 | ) |
| Interest income                                                                                               |       | 6                                                                  |       | 8 |   | 7 |   | 2 |   |
|                                                                                                          |       |                                                               |       |   |   |   |   |   |   |
| Income (loss) from  operations before income taxes and discontinued operations                                |       | (695                                                               | )          | 86 |   | (7,864 | ) | (6,049 | ) |
| Income taxes                                                                                                  |       | —                                                             |       | — |   | — |   | — |   |
|                                                                                                          |       |                                                               |       |   |   |   |   |   |   |
| Net income (loss)                                                                                             |       | (695                                                               | )          | 86 |   | (7,864 | ) | (6,049 | ) |
|                                                                                                          |       |                                                               |       |   |   |   |   |   |   |
| Net income (loss) per  share from continuing operations - basic and diluted                                   |       | $                                                             | (0.02      | ) | $  | 0.00 |   | $  | (0.18 | ) | $  | (0.14 | ) |
|                                                                                                          |       |                                                               |       |   |   |   |   |   |   |
| Weighted average common shares used to compute loss per share from  continuing operations - basic and diluted |       | 44,245                                                             |       | 44,100 |   | 44,075 |   | 42,817 |   |

 

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| ** **                                                                                                              | ** ** | **For the Three Months Ended**                 | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                              | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Consolidated Statements of Operations Data:**                                                     | ** ** | **12/31/05**                                                       | ** ** | **09/30/05** | ** ** | **06/30/05** | ** ** | **03/31/05** | ** ** |
| ** **                                                                                                              | ** ** | **(Restated)**                                                     | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| ** **                                                                                                              | ** ** | **(In thousands, except per share data)** | ** ** |
| ** **                                                                                                              | ** ** | **(Unaudited)**                                                    | ** ** |
|                                                                                                                    |       |                                                               |       |   |   |   |   |   |   |
| Revenue                                                                                                                 |       | $                                                                  | 5,453      |   | $ | 4,342 |   | $ | 3,727 |   | $ | 2,843 |   |
| Cost of sales                                                                                                           |       | 4,576                                                              |       | 3,756 |   | 3,962 |   | 2,835 |   |
| Gross profit                                                                                                            |       | 877                                                                |       | 586 |   | (235 | ) | 8 |   |
|                                                                                                                    |       |                                                               |       |   |   |   |   |   |   |
| Operating  expenses                                                                                                     |       |                                                               |       |   |   |   |   |   |   |
| Selling, general, and administrative                                                                                    |       | 2,013                                                              |       | 2,364 |   | 1,567 |   | 2,590 |   |
| Research and development                                                                                                |       | 314                                                                |       | 196 |   | 213 |   | 397 |   |
| Impairment of long lived assets                                                                                         |       | 260                                                                |       | 833 |   | 3,394 |   |   |   |
| Total operating expenses                                                                                                |       | 2,587                                                              |       | 3,393 |   | 5,174 |   | 2,987 |   |
|                                                                                                                    |       |                                                               |       |   |   |   |   |   |   |
| Loss from  operations                                                                                                   |       | (1,710                                                             | )          | (2,807 | ) | (5,409 | ) | (2,979 | ) |
| Loss from extinguishments of debt                                                                                       |       | —                                                             |       | (1,247 | ) | — |   | — |   |
| Change in value of warrants, gain (loss)                                                                                |       | 2,840                                                              |       | 1,112 |   | (100 | ) | 133 |   |
| Change in value of conversion feature, gain (loss)                                                                      |       | 4,621                                                              |       | 2,215 |   | 1,167 |   | 1,115 |   |
| Other income                                                                                                            |       | —                                                             |       | — |   | — |   | — |   |
| Interest expense                                                                                                        |       | (1,644                                                             | )          | (1,659 | ) | (1,181 | ) | (1,537 | ) |
| Interest income                                                                                                         |       | 3                                                                  |       | 7 |   | 1 |   | 6 |   |
|                                                                                                                    |       |                                                               |       |   |   |   |   |   |   |
| Income (loss)  from operations before income taxes and discontinued operations                                          |       | 4,110                                                              |       | (2,379 | ) | (5,522 | ) | (3,262 | ) |
| Income taxes                                                                                                            |       | —                                                             |       | — |   | — |   | — |   |
|                                                                                                                    |       |                                                               |       |   |   |   |   |   |   |
| Net income  (loss)                                                                                                      |       | 4,110                                                              |       | (2,379 | ) | (5,522 | ) | (3,262 | ) |
|                                                                                                                    |       |                                                               |       |   |   |   |   |   |   |
| Income (loss)  per share from continuing operations - basic and diluted                                                 |       | $                                                             | 0.10       |   | $  | (0.06 | ) | $  | (0.13 | ) | $  | (0.08 | ) |
|                                                                                                                    |       |                                                               |       |   |   |   |   |   |   |
| Weighted average common  shares used to compute income (loss) per share from continuing opertaions - basic  and diluted |       | 42,180                                                             |       | 41,933 |   | 41,610 |   | 41,610 |   |

 

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**LIQUIDITY AND CAPITAL RESOURCES**

Since our inception, wehave funded our operations through the sale of equity securities in privateplacements and our initial public offering, the sale of convertible notes andwarrants in private placements, debt financing, and cash generated fromoperations.

Our cash used foroperating activities was $5.3 million and $6.5 million for the year endedDecember 31, 2006 and 2005, respectively. Our working deficit increased to $23.2 million from $11.0 million atDecember 31, 2006 and 2005, respectively. The increase of approximately $12.2 million in working deficit wasprimarily attributable to the decrease in cash of $1.2 million, increase inshort-term debt of 2.1 million, and increase of current portion of long-termdebt of $13.1 million, offset by increase in prepaid expenses of $0.2 million,decrease in settlement payable of $3.3 million, and decrease in deferredrevenue of $1.1 million.

Our cash used ininvesting activities was $0.9 million for the year ended December 31, 2006primarily for the acquisition of property and equipment and investments inpatents and trademarks.

Our cash provided byfinancing activities was $5.6 million for the year ended December 31, 2006,which consists of $1.0 million in proceeds from borrowings from oursubordinated promissory notes executed in March 2006 and 4.6 million inproceeds from borrowings from private placement of 8% unsecured subordinatednotes executed in May, September, and December 2006.  Further, the Company received net $1.1million in borrowings from factoring agreement executed in April 2005.  The proceeds from borrowings have been usedto meet working capital requirements.  OnNovember 10, 2006, the Company’s factoring agreement was amended to allow forborrowings of up to $5.0 million based on receivable assigned.  The Company has $3.3 million available forfuture borrowings under the Factoring Agreement as of December 31, 2006, whichis contingent on approval of eligible receivables by the financingcompany.  The proceeds from borrowingshave been used to meet working capital requirements.

Our capital requirementsduring the next twelve months will depend on numerous factors, includingthe success of existing products either in manufacturing or development, thedevelopment of new applications for Liquidmetal alloys, and the resources wedevote to develop and support our Liquidmetal alloy products, the success ofpursuing strategic licensing and funded product development relationships withexternal partners.

We haveexperienced significant operating losses since our inception. Our net loss forthe fiscal years ended December 31, 2006 and 2005 was $14.5 million and $7.1million, respectively. In the audit report on our financial statements for ourfiscal years ended December 31, 2006 and 2005, our auditors included agoing-concern qualification indicating that our significant operating lossesand working capital deficit cause substantial doubt about our ability tocontinue as a going concern. By issuing an opinion stating that there issubstantial doubt about our ability to continue as a going concern, ourauditors have indicated that they are uncertain as to whether we have thecapability to continue our operations without additional funding.  On January 3, 2007, we completed a privateplacement of $14.8 million in principal amount of 8% Convertible SubordinatedNotes due January 2010 (the “January 2010 Notes”). The January 2010 Notes wereissued for aggregate cash in the amount of $12.9 million and in payment of atotal of $1.9 million in principal and accrued but unpaid interest under ourpreviously issued 7% Senior Secured Convertible Notes Due August 2007 and our8% Unsecured Subordinated Notes.

We anticipate that the$12.9 million aggregate cash raised in the January 2007 private placement willbe sufficient to pursue our current operating plan only through the third quarterof 2007, and we will therefore require additional funding at or prior to thattime.  Our need for additional capitalcould also be accelerated to before the third quarter of 2007 because we arecurrently in breach of an obligation under the January 2010 Notes to satisfycertain previously issued debt within five days of the issue date of theJanuary 2010 Notes.  We are currently indiscussions with the holders of the January 2010 Notes in an effort to negotiatea forbearance with respect to this breach, and the holders of the January 2010Notes have not yet indicated a desire to declare a default under the January2010 Notes.  However, we cannot becertain that the holders of such notes will not declare a default andaccelerate all amounts due thereunder.

Asa result of the foregoing, we are actively seeking additional sources ofcapital and seeking to restructure and/or modify existing indebtedness.  The amount of funding that we seek and thetiming of such fundraising efforts will depend on the extent to which we areable to increase revenues through obtaining additional purchase orders for ourproducts and/or the extent to which we can restructure or modify our debt.  Because we cannot be certain that we will beable to obtain adequate funding from debt, equity, or other traditionalfinancing sources, we are also actively exploring several strategic financingoptions, including the possible sale of our manufacturing plant in South Korea(which would then be replaced with a smaller facility) and the possible sale ofour Liquidmetal Coatings business.  Wecannot guarantee that adequate funds will be available when needed, and if wedo not receive sufficient capital, we may be required to alter or reduce thescope of our operations.

As of December 31,2006, we had accrued $1.6 million and paid $0.7 million of the late filing andregistration fees as a result of the late fee provisions of a restatedregistration rights agreement, dated August 2, 2005.  We are currently innegotiations with the holders to settle the outstanding late filing andregistration fees.   However, we cannot predict the outcome of thenegotiations, and the resolution of this issue may harm our business and have amaterial adverse impact on our financial condition.

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**InitialPublic Offering Proceeds**

Pursuant to ourRegistration Statement on Form S-1 (Registration No. 333-73716), asamended, initially filed with the Securities and Exchange Commission onNovember 20, 2001 and declared effective May 21, 2002, we closed aninitial public offering of 5,000,000 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 aggregate cash proceedsduring the second quarter 2002 of $78.4 million. The net proceeds were$70.7 million after deducting underwriting commissions of$5.5 million and other transaction fees of $2.2 million. The managingunderwriters for the Offering were Merrill Lynch & Co., UBS Warburg, andRobert W. Baird & Co.

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

**Private Placements of ConvertibleNotes and Bridge Notes**

On March 3, 2004, we sold$9.9 million of 6.0% Senior Convertible Notes due 2007 (the “Initial Notes”)and warrants to purchase approximately 1.2 million shares of our common stockto accredited investors in a private placement. The notes were convertible at any time into our common stock at a priceof $3.00 per share, and the warrants granted in this transaction expired onvarious dates through March 1, 2006.

On August 19, 2004, wecompleted a private placement in which the investors in the March 2004 privateplacement exchanged approximately $5.46 million in aggregate principal amountof the Initial Notes for an aggregate of (i) $2.73 million of new 6% SeniorSecured Notes Due 2007 (the “July 2007 Notes”) and (ii) $2.73 million of new10% Senior Secured Notes Due 2005 (the “July 2005 Notes”).  The remaining Initial Notes were redeemed forcash in connection with the transaction. The July 2007 Notes and July 2005 Notes were secured by certain patentsowned by our company and a second priority mortgage interest in plantfacilities and certain equipment at our plant in South Korea.  The July 2005 Notes had a maturity date ofJuly 29, 2005, and a conversion price of $2.00 per share.  The July 2007 Notes had a maturity date ofJuly 29, 2007, and a conversion price of $1.00 per share.

OnJune 13, 2005, we completed a private placement of 10% ConvertibleUnsecured Notes Due June 13, 2006 in the aggregate principal amount of $3.25million (the “June 2006 Bridge Notes”), together with warrants to purchase upto an aggregate of 893,750 shares of our company’s common stock.  The June 2006 Bridge Notes were unsecured andwere due on the earlier of June 13, 2006 or the consummation of afollow-on equity or debt offering or restructuring transaction pursuant towhich our company receives gross proceeds of at least $4.0 million.

On August 9, 2005, wecompleted a private placement of $9.9 million in principal amount of new 7%Senior Secured Convertible Notes due August 2007 (the “August 2007 Notes”).  The August 2007 Notes were issued inconsideration of $5.0 million in cash, the exchange of $1.3 million inprincipal amount of the July 2005 Notes, the exchange of $3.0 million inprincipal amount of the June 2006 Bridge Notes (resulting in the fullsatisfaction of the June 2006 Bridge Notes), satisfaction of accrued interestand late registration fees in the amount of $0.6 million on the July 2005Notes, and satisfaction of accrued interest of $9 thousand on the June 2006Bridge Notes.  Interest of 7% per annumon the August 2007 Notes was due quarterly. The August 2007 Notes were convertible into shares of our common stockat $2.00 per share and were secured by substantially all of our assets.  We also issued warrants to the purchasers ofthe August 2007 Notes and placement agents giving them the right to purchase upto 2,469,470 and 414,495 shares of our common stock, respectively, with anexercise price of  $2.00 per share.  The warrants will expire on August 2, 2010.

On March 17, 2006, inexchange for a $1.0 million loan, we issued a $1.0 million 10% subordinatedpromissory note due October 16, 2006 (the “Atlantic Note”) to Atlantic RealtyGroup, Inc., a company controlled by Jack Chitayat, a former director of ourcompany.  The Atlantic Note was unsecuredand subordinated to all prior indebtedness of our company.  All accrued interest and unpaid principal wasdue on October 16, 2006.  In connectionwith the March 2006 Note, we issued warrants to Atlantic Realty to purchase anaggregate amount of up to 125,000 shares of common stock exercisable at $2.00per share.  The warrants will expire onMarch 17, 2009.

On May 17, 2006,September 21, 2006, and December 1, 2006, we completed a private placement of8% Unsecured Subordinated Notes in the aggregate principal amount of $4.6million (the “New Bridge Notes”), together with warrants to purchase up to anaggregate of 973,064 shares of our common stock.  The New Bridge Notes were unsecured and werescheduled 

36

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to become due onthe earlier of August 17, 2007 or the consummation of a follow-on equity ordebt offering pursuant to which we receive gross proceeds of at least $6.0million. Interest on the New Bridge Notes accrued at the rate of 8% perannum.  The New Bridge Notes weresubordinate in right of payment and in all other respects to the previouslyissued July 2007 Notes and August 2007 Notes. As a part of the private placement of the New Bridge Notes, we issuedwarrants to the purchasers of the New Bridge Notes giving them the right topurchase up to an aggregate of 892,249 shares of our common stock, and warrantsto purchase 80,717 shares of our common stock were issued to the placementagent in the transaction. The warrants have an exercise price of $2.58 pershare and will expire on May 17, 2011.

As of December 31,2006, $9.9 million in aggregate principal amount of August 2007 Notes werestill outstanding with accrued but unpaid interest in the amount ofapproximately $173 thousand, and $2.1 million in aggregate principal amount ofJuly 2007 Notes were also outstanding with accrued but unpaid interest in theamount of approximately $32 thousand.

On January 3, 2007, we completed a private placement of $14.8 million inprincipal amount of new 8% Convertible Subordinated Notes due January 2010 (the“January 2010 Notes”).  The January 2010Notes were issued for aggregate cash in the amount of $12.9 million and inpayment of a total of $1.9 million in principal and accrued but unpaid interestunder the August 2007 Notes and New Bridge Notes.  When we originally announced this privateplacement in a Form 8-K filed on January 4, 2007, we announced that the privateplacement resulted in the issuance of $19.8 million in principal amount ofJanuary 2010 Notes, $12.9 million of which resulted from the investment of newcash and $6.9 million of which resulted from the exchange of notes previouslyissued by us.  However, subsequent to ourannouncement, certain holders of previously issued notes have elected not toproceed with the exchange of their notes for January 2010 Notes as anticipated,and therefore the amount of January 2010 Notes issued in the private placementultimately amounted to $14.8 million, $12.9 million of which resulted from theinvestment of new cash and $1.9 million of which resulted from the exchange ofpreviously issued notes.  We alsooriginally announced that the January 2010 Notes had a maturity date ofDecember 31, 2006, but upon the actual issuance of such notes, it was agreedwith the noteholders that the maturity date would be January 3, 2010.

The January 2010 Notes were issued pursuant to a Securities PurchaseAgreement, dated January 3, 2007, between our company and the purchasers of theJanuary 2010 Notes (the “January Purchase Agreement”).  Under the terms of the January PurchaseAgreement, we agreed to repay, within 5 days after the closing of the privateplacement, approximately $15.5 million of our outstanding debt under previouslyissued promissory notes (including the August 2007 Notes, the Atlantic Note,and New Bridge Notes).  We originallyagreed to this covenant based on assurances that a substantial number ofholders of the August 2007 Notes would elect to convert their August 2007 Notesat a reduced conversion price following the private placement under a noteconversion agreement proposed by us, but most of such holders have elected notto proceed with such conversion. Accordingly, in an effort to preserve funds, we have not yet repaid theindebtedness as required by the January Purchase Agreement and are in breach ofthe January 2010 Notes.  We are currentlyin discussions with the holders of the January 2010 Notes in an effort tonegotiate a forbearance with respect to this breach, and the holders of theJanuary 2010 have not yet indicated a desire to declare a default under theJanuary 2010 Notes.  Also, because werepaid $1.8 million of principal and interest under the Atlantic Note and NewBridge Notes in January and February 2007 without first repaying the August2007 Notes and July 2007 Notes, we may also be in breach of the August 2007Notes and July 2007 Notes.  In February2007, we did enter into conversion agreements with the holders of the August2007 Notes holding $1.9 million of principal providing for the conversion ofsuch notes at a reduced conversion price of $1.25 per share and issued1,520,000 shares of our common stock.

The January 2010Notes are convertible at any time at the option of the holder into shares ofour common stock at a conversion price of $1.55 per share, subject toadjustment for anti-dilution. The January 2010 Notes bear interest at 8% perannum with interest payable quarterly in arrears in cash, or, at our option, inthe form of additional January 2010 Notes (in which case the interest rate willbe 10% per annum). Our ability to pay interest with additional January 2010Notes is subject to specified conditions, including the existence of aneffective registration statement covering the resale of the shares issued inpayment of interest and certain minimum trading volumes in the stock to beissued. From and after an event of default under the January 2010 Notes and forso long as the event of default is continuing, the January 2010 Notes will beardefault interest at a rate of 12% per annum (or 15% per annum if we elect topay interest with additional January 2010 Notes).

Beginning July 31,2008 and at the end of each month thereafter, we will be required to redeem1/36th of the principal amount of the January 2010 Notes in cash or, at ourelection, with shares of our common stock. Our ability to pay the redemptionamounts with shares of our common stock will be subject to specifiedconditions, including the existence of an effective registration statementcovering the resale of the shares issued in payment of the redemption amountand certain minimum trading volumes in the stock to be issued. Any unconvertedJanuary 2010 Notes will become due on December 31, 2009, although we will havethe right at any time after 18 months following the issuance of the January2010 Notes to redeem the January 2010 Notes in whole or in part for a cash redemptionprice of 105% of the portion of the principal amount being redeemed plus allaccrued and unpaid interest thereon. The January 2010 Notes are unsecured andare subordinate to our July 2007 Notes and to certain secured financing from commercial lenders incurred by usin the future.  The terms of the 2010Notes also provide that we will be required to maintain a sufficient bankbalance to provide for the timely repayment of our July 2007 Notes.

As a part of theJanuary 2007 private placement, we issued warrants to the purchasers of theJanuary 2010 Notes giving them the right to purchase up to an aggregate of4,774,049 shares of our common stock at an exercise price of $1.93 per share.In connection with the private placement, we also issued to the placement agentfor the transaction warrants to purchase an 

37

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aggregate of248,710 shares of our common stock at an exercise price of $1.55 pershare.  All of the warrants (includingthe warrants granted to the placement agent in the transaction) are immediatelyexercisable and will expire in January 2012.

In connection withthe January 2007 private placement, we entered into a Registration RightsAgreement with the purchasers of the January 2010 Notes under which we arerequired, on or before 45 days after the closing of the private placement, tofile a registration statement with the SEC covering the resale of the shares ofour common stock issuable pursuant to the January 2010 Notes and warrants andto use our best efforts to have the registration declared effective at theearliest date (but in no event later than 90 days after filing if there is noSEC review of the registration statement, or 120 days if there is an SECreview).  We will be subject to certain monetary penalties, as setforth in the Registration Rights Agreement, up to a maximum amount of 18% ofthe aggregate amount of Notes sold in the Private Placement if the registrationstatement is not filed or does not become effective on a timely basis. Themonetary penalties will accrue at the rate of 1% per month of thethen-outstanding principal amount of the January 2010 Notes. In the event thatwe are unable to include in the registration statement all shares of our commonstock issuable pursuant to the January 2010 Notes and warrants, then we will berequired to file up to two additional registration statements to register theresale of any shares excluded from the originally filed registration statementand to pay the foregoing monetary penalties on the January 2010 Notesconvertible into the excluded shares until the resale of such excluded sharesis covered by an effective registration statement or until such shares can besold under SEC Rule 144.

**Loan from Kookmin Bank**

Our LiquidmetalKorea Co., Ltd. subsidiary has an outstanding loan from Kookmin Bank in theRepublic of Korea.  As of December 31,2006, the outstanding balance under this loan was $1.8 million.  The loan is payable in monthly installmentsof $0.11 million per month through February 2008.

**OFF-BALANCESHEET ARRANGEMENTS**

An off-balance sheetarrangement is any transaction, agreement or other contractual arrangementinvolving an unconsolidated entity under which a company has (1) madeguarantees, (2) a retained or a contingent interest in transferred assets, (3)an obligation under derivative instruments classified as equity, or (4) anyobligation arising out of a material variable interest in an unconsolidatedentity that provides financing, liquidity, market risk or credit risk supportto our company, or that engages in leasing, hedging, or research anddevelopment arrangements with our company.

On June 26, 2006, we entered into a joint venture agreement with SAGA,SpA in Padova, Italy, (‘SAGA”) a specialist precision parts manufacturer.  The joint venture is named Liquidmetal SAGAItaly, Srl (“LSI”).  We also entered intoan exclusive manufacturing license agreement for the eyewear industry withLSI.  Under the joint venture agreement,we have the option to buy ownership interest in LSI, initially, of 19.9% to upto 50%.  In December 2006, we havepurchased 19.9% interest in the joint venture. Underthe licensing agreement, at any time following 18 months after the effectivedate of the agreement, LSI may exercise its option to sell us certain businessassets including manufacturing equipment acquired under the joint venture.  During year ended December 31, 2006, werecognized revenues of $0.7 million of Liquidmetal alloys sold to SAGA for usein the joint venture. We anticipate the alloys to be fully utilized by thejoint venture prior to the 18 month period.

 

**CONTRACTUALOBLIGATIONS**

Thefollowing table summarizes our company’s obligations and commitments as ofDecember 31, 2006:
| ** **                                          | ** ** | **Payments Due by Period (in thousands)** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                          | ** ** | ** **                                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                          | ** ** | ** **                                                         | ** ** | **Less Than** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Contractual Cash Obligations (1)** | ** ** | **Total**                                                          | ** ** | **1 Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **After 5 Years** | ** ** |
|                                                |       |                                                               |       |   |   |   |   |   |   |   |   |
| Long-term debt  (2)                                 |       | $                                                                  | 18,341     |   | $ | 18,116 |   | $ | 225 |   | $ | — |   | $ | — |   |
| Short-term debt  (3)                                |       | 2,669                                                              |       | 2,669 |   | — |   | — |   | — |   |
| Capital lease  obligation                           |       | 6                                                                  |       | 6 |   | — |   | — |   | — |   |
| Operating leases  and rents                         |       | 799                                                                |       | — |   | 798 |   | 1 |   | — |   |
| Consulting  services payable                        |       | 136                                                                |       | 136 |   | — |   | — |   | — |   |
| Dongyang                                            |       | 12                                                                 |       | 12 |   | — |   | — |   | — |   |
| Nichimen                                            |       | 350                                                                |       | 350 |   | — |   | — |   | — |   |
|                                                |       | $                                                                  | 22,313     |   | $ | 21,289 |   | $ | 1,023 |   | $ | 1 |   | $ | — |   |

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(1)             Contractual cashobligations include Long-Term Debt comprised of $2,083 of Senior ConvertibleNotes issued in 2004, $9,878 of Convertible Notes issued in 2005, $4,584 ofUnsecured Subordinated Notes issued in 2006, and $1,796 of Kookmin Notes,Short-Term Debt comprised of $1,669 advances received under factoring, loan,and security agreement, and $1,000 of Unsecured Subordinated Promissory Noteissued in 2006, future minimum lease payments under capital and operatingleases, purchase commitments from consultants, payments due from ourdiscontinued equipment manufacturing business (Dongyang), and minimum paymentsdue under a distribution agreement (Nichimen).

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(2)             Does not includeinterest payments of $1,970, un-amortized discounts for conversion feature andwarrants of $3,636 of our convertible notes.

(3)             Does not includeminimum interest and fee payments of $30.

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

The preparation ofconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States requires us to make estimates andassumptions that affect reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. These estimates and assumptions are based on historicalexperience and various other factors that are believed to be reasonable underthe circumstances. Actual results could differ materially from these estimatesunder different assumptions or conditions.

We believe that thefollowing accounting policies are the most critical to our consolidatedfinancial statements since these policies require significant judgment orinvolve complex estimates that are important to the portrayal of our financialcondition 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, Korea and China, are translated into U.S. dollars. As exchange ratesvary, those results, when translated, may vary from expectations and adverselyimpact overall expected profitability. The cumulative translation effects forsubsidiaries using functional currencies other than the U.S. dollar areincluded in accumulated foreign exchange translation in stockholders’ 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.

·                  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 accounts as acontra-asset to our trade receivables for estimated uncollectible accounts.Management estimates the amount of potentially uncollectible accounts byreviewing 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.

·                  We value our assets at lower of cost or fairmarket value. Management has determined fair market to be equal to the sellingprice of the assets to be sold less the cost of disposal. In the event, infuture periods, actual selling prices are lower than the estimate for sellingprices, an adjustment would be made and income would decrease in the period ofsuch determination.

·                  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 income increasedin the period of such determination. Likewise, in the event we determine wewould not be able to realize all or part of our deferred tax assets in thefuture, an adjustment would be made and charged to income in the period of suchdetermination.

·                  We account for the warrants and the embeddedconversion feature of our senior convertible notes as derivatives 

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in accordance with Statement of FinancialAccounting Standards No. 133, Accounting for Derivative Instrumentsand Hedging Activities, and Emerging Issues Task Force Issue No. 00-19,Accounting for Derivative Financial Instruments Indexed to, and PotentiallySettled in, a Company’s Own Stock.  Fairvalues of warrants and embedded conversion features are measured at each periodend using Black-Scholes pricing models and changes in fair value during theperiod arereported in our earnings

·                  We adopted Statement of Financial AccountingStandards No. 123, Share-Based Payment (“SFAS 123R”), onJanuary 1, 2006. This new standard requires companies to expense the fairvalue of employee stock options and similar awards. We adopted SFAS 123R usingthe modified prospective transition method. Therefore, stock based compensationexpense measured in accordance with SFAS 123R was recorded starting with thefirst quarter of 2006, but the prior year consolidated statement of income wasnot restated. The adoption of SFAS 123R resulted in incremental expense of $1.1million for the year ended December 31, 2006.

**RECENTACCOUNTING PRONOUNCEMENTS**

In February 2006, theFASB issued SFAS No. 155, (“SFAS No. 155”), “Accounting forCertain Hybrid Instruments,” which amends SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” and SFAS No. 140,“Accounting for Transfers and Servicing of Financial Assets and Extinguishmentsof Liabilities.” SFAS No. 155 allows financial instruments that haveembedded derivatives to be accounted for as a whole (eliminating the need tobifurcate the derivative from its host) if the holder elects to account for thewhole instrument on a fair value basis. SFAS No. 155 also clarifiesand amends certain other provisions of SFAS No. 133 andSFAS No. 140. This statement is effective for all financialinstruments acquired or issued in fiscal years beginning afterSeptember 15, 2006. The Company does not expect the adoption of this newstandard to have a material impact on its financial position, results ofoperations or cash flows.

In July 2006, the FASBissued FASB interpretation (FIN) No. 48, “Accounting for Uncertainty in IncomeTaxes — an interpretation of FASB statement No. 109,” which prescribes arecognition threshold and measurement process for recording in the financialstatements, uncertain tax positions taken or expected to be taken in a taxreturn.  In addition, FIN 48 providesguidance on the derecognizing, classification, accounting in interim periodsand disclosure requirements for uncertain tax positions.  The Company is currently evaluating theimpact, if any, that FIN 48 will have on its financial statements.

In September 2006, theFASB issued SFAS No. 157, “Fair Value Measurement”*,*whichdefines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements.  The effective date of SFAS No. 157 will bethe first quarter of 2008.  While theCompany is currently evaluating the provisions of SFAS 157, the adoption is notexpected to have a material impact on its consolidated financial statements.

In September 2006, theSEC issued SAB No. 108, “Guidance re: the Use of a Cumulative Effect Adjustmentto Correct Immaterial Misstatements” (“SAB 108”). Registrants are required toapply the provisions of SAB 108 no later than the annual financial statementsfor their first fiscal year ending after November 15, 2006. The application ofSAB 108 is not expected to have a material impact on the Company’s financialstatements.

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

**Item 7A. Quantitative and Qualitative Disclosures About MarketRisks**

We are exposed tovarious market risks in conducting the business of the company, and we anticipatethat this exposure will increase as a result of our planned growth. In aneffort to mitigate losses associated with these risks, we may at times enterinto derivative financial instruments, although we have not historically doneso. These may take the form of forward sales contracts, option contracts,foreign currency exchange contracts, and interest rate swaps. We have not, anddo not intend to, engage in the practice of trading derivative securities forprofit.

*InterestRates.*We are exposed to market risks relating to changes ininterest rates.  Although we do notcurrently have any borrowings with variable interest rates, fluctuations ininterest rates may have a negative impact to any future borrowings.

*CommodityPrices.*We are exposed to price risk related to anticipatedpurchases of certain commodities used as raw materials by our businesses,including titanium and zirconium. Although we do not currently enter intocommodity future, forward, and option contracts to manage the fluctuations in pricesof anticipated purchases, we may enter into such contacts in the future as ourbusiness grows and as our purchases of these raw materials increases.

*ForeignExchange 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. Fluctuations in exchange rates resulted in foreign currencytranslation gains of $0.3 million, $0.3 million, and $1.7 million,for the yearsended December 31, 2006, 2005, and 2004, respectively.

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**Item 8.Financial Statements andSupplementary Data**

The financial statementsrequired by this item are located in Consolidated Financial Statements in Item15 of this report. The supplementary financial information required by thisitem is located under the caption “QUARTERLY RESULTS” in Item 7 of thisreport.

**Item 9.Changes in and Disagreements withAccountants on Accounting and Financial Disclosures**

On November 23, 2005,Stonefield Josephson, Inc. (“Stonefield”), the Company’s independent registeredpublic accounting firm, notified the Company that Stonefield would resign asthe Company’s independent registered public accounting firm upon the completionof Stonefield’s review of the Company’s interim unaudited financial statementsas of and for the three and nine month periods ended September 30, 2005. The Company’s interim unaudited financial statements as of and for thethree and nine month periods ended September 30, 2005 were included in the Company’sreport on Form 10-Q for the third quarter ended September 30, 2005 filed withthe SEC on December 1, 2005, and the Company’s relationship with Stonefield wastherefore effectively terminated as of December 1, 2005.

The reports of Stonefieldwith respect to the Company’s financial statements for the fiscal years endedDecember 31, 2003 and 2004 contained no adverse opinion or disclaimer ofopinion and were not qualified or modified as to uncertainty, audit scope, oraccounting principles, except for an explanatory paragraph regarding theCompany’s ability to continue as a going concern contained in Stonefield’sreport on the Company’s financial statements and for a disclaimer of opinionmade by Stonefield with respect to the Company’s internal controls overfinancial reporting and the Company’s assessment of those controls as ofDecember 31, 2004.

From May 21, 2004, thedate Stonefield was appointed as the Company’s independent auditors, through the date of Stonefield’s resignation, there were no disagreementsbetween the Company and Stonefield on any matter of accounting principles orpractices, financial statement disclosure, or auditing scope or procedure,which disagreements, if not resolved to the satisfaction of Stonefield, wouldhave caused Stonefield to make reference to the subject matter of thedisagreements in connection with its report on the Company’s financialstatements for such years.

There were no “reportableevents” as described under Item 304(a)(1)(v) of Regulation S-K occurring withinthe two most recent fiscal years of the Company ended December 31, 2004 and2003 or within the subsequent interim period through the date of Stonefield’sresignation, except as follows:

Stonefield has advisedthe Company that there are material weaknesses in its internal controls, mainlyrelated to internal controls of its South Korean operations.  Therefore,Stonefield has expanded the scope of its review of the interim unauditedfinancial statements as of and for the three and nine month periods ended September30, 2005.  The material deficiencies in the Company’s internal controlsover financial reporting include the following:

a)              Lackof adequate segregation of duties in the Company’s South Korean operations inaccounts receivable, involving cash receipts, shipping, delivery of products,and customer invoice reconciliations;

b)             Lackof adequate segregation of duties in the Company’s Coatings Division in Texasin order processing and invoicing;

c)              Lackof adequate controls and documentation in the Company’s South Korean operationsto evidence proper customer invoicing and revenue recognition in the properperiod;

d)             Lackof progress in documenting, assessing and evaluating the Company’s internalcontrols in our South Korean Operations evidenced by aforementioneddeficiencies of which remediations will need to be completed as of December 31,2005.

e)              Lackof sufficient controls over internal access to the Company’s SAP system ofreporting by unauthorized users; and

f)                Themanual performance of numerous procedures that could be automated using currentreporting systems;

In connection with theforegoing, Stonefield has also advised the Company that it believes that theCompany has made insufficient progress in documenting, assessing, andevaluating the Company’s internal controls over financial reporting forpurposes of timely complying with Section 404 of the Sarbanes-Oxley Act of2002.

The Company’s AuditCommittee has discussed with Stonefield the matters disclosed above regardingStonefield’s resignation.  The Company has authorized Stonefield torespond fully to the inquiries of the Company’s successor accountant concerningthe matters disclosed above.

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Upon Stonefield’sresignation, the Company’s Audit Committee commenced an immediate search and onJanuary 20, 2006, hired Choi Kim & Park LLP (“CKP”) as its new registeredindependent public accounting firm.

As of December 31, 2006,the Company has completed its documentation, assessment, and evaluation of theCompany’s internal controls over financial reporting and has complied withSection 404 of the Sarbanes-Oxley Act of 2002. See Item 9A “Controls and Procedures.”

**Item9A. Controls and Procedures**

Evaluation of DisclosureControls and Procedures.  Based on an evaluation ofour disclosure controls and procedures (as defined in Rule 13a-15(e) underthe Exchange Act) as of December 31, 2006, the end of the period coveredby this report, our Chief Executive Officer and Chief Financial Officer haveconcluded that the disclosure controls and procedures were effective.

Changes in InternalControls.  During the quarter endedDecember 31, 2006, there was no change in our internal control overfinancial reporting (as defined in Rule 13a-15(f) under the Exchange Act)that has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

Management’s Report on Internal Control over FinancialReporting.  Thecompany’s management is responsible for establishing and maintaining adequateinternal control over financial reporting. Internal control over financialreporting is a process designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsin accordance with generally accepted accounting principles and includes thosepolicies and procedures that (1) pertain to the maintenance of recordsthat, in reasonable detail, accurately and fairly reflect the transactions anddispositions of the company’s assets, (2) provide reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat the company’s receipts and expenditures are being made only in accordancewith authorizations of the company’s management and directors, and(3) provide reasonable assurance regarding prevention or timely detectionof unauthorized acquisition, use, or disposition of the company’s assets thatcould have a material effect on the financial statements.

As required by Section 404 of the Sarbanes-Oxley Actof 2002 and the related rule of the SEC, management assessed the effectivenessof the company’s internal control over financial reporting using the InternalControl-Integrated Framework developed by the Committee of SponsoringOrganizations of the Treadway Commission.

Based on this assessment, management concluded that thecompany’s internal control over financial reporting was effective as ofDecember 31, 2006. Management has not identified any material weaknessesin the company’s internal control over financial reporting as ofDecember 31, 2006.

Our independent auditors, Choi, Kim & Park, LLP (“CKP”),who have audited and reported on our financial statements, issued anattestation report on our management’s assessment of the company’s internalcontrol over financial reporting. CKP’s reports are included in this annualreport on Form 10-K.

 

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

The Boardof Directors and Shareholders of Liquidmetal Technologies Inc.

We have audited management’s assessment, included in theaccompanying Management’s Report on Internal Control over Financial Reporting,that Liquidmetal Technologies Inc. and subsidiaries (the “Company”) maintainedeffective internal control over financial reporting as of December 31,2006, based on criteria established in Internal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission.The Company’s management is responsible for maintaining effective internalcontrol over financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting. Our responsibility is to express anopinion on management’s assessment and an opinion on the effectiveness of theCompany’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards ofthe Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether effective internal control over financial reporting was maintained inall material respects. Our audit included obtaining an understanding ofinternal control over financial reporting, evaluating management’s assessment,testing and evaluating the design and operating effectiveness of internalcontrol, and performing such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinions.

A company’s internal control over financial reporting is aprocess designed by, or under the supervision of, the company’s principalexecutive and principal financial officers, or persons performing similarfunctions, and effected by the company’s board of directors, management, andother personnel to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect the transactions and dispositions of theassets of the company; (2) provide reasonable assurance that transactionsare recorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (3) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

Because of the inherent limitations of internal controlover financial reporting, including the possibility of collusion or impropermanagement override of controls, material misstatements due to error or fraudmay not be prevented or detected on a timely basis. Also, projections of anyevaluation of the effectiveness of the internal control over financial reportingto future periods are subject to the risk that the controls may becomeinadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate.

In our opinion, management’s assessment that the Companymaintained effective internal control over financial reporting as ofDecember 31, 2006, is fairly stated, in all material respects, based onthe criteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission. Also in ouropinion, the Company maintained, in all material respects, effective internalcontrol over financial reporting as of December 31, 2006, based on thecriteria established in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards ofthe Public Company Accounting Oversight Board (United States), the consolidatedfinancial statements as of and for the year ended December 31, 2006 of theCompany and our report dated February 15, 2007 and July 17, 2006 expressesan unqualified opinion on those financial statements and includes explanatoryparagraphs referring to the Company’s ability to continue as a going concern.

 

/s/ Choi, Kim & Park LLP

Los Angeles, CaliforniaCertified Public Accountants

February 14, 2007

**** ****

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

****None.****

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**PART III**

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

Set forth below is atable identifying our directors and executive officers as of December 31, 2006:

 

| Name                    | ** ** | **Age** | ** ** | **Position**                          |
|-------------------------|------------|---------|------------|---------------------------------------|
|                    |       |    |       |                                  |
| Larry Buffington        |       | 59      |       | President and Chief Executive Officer |
|                    |       |    |       |                                  |
| Young Ham               |       | 37      |       | Chief Financial Officer               |
|                    |       |    |       |                                  |
| John Kang               |       | 43      |       | Chairman of the Board                 |
|                    |       |    |       |                                  |
| Dean Tanella            |       | 46      |       | Director                              |
|                    |       |    |       |                                  |
| William Johnson,  Ph.D. |       | 57      |       | Director                              |
|                    |       |    |       |                                  |
| Robert Biehl            |       | 62      |       | Director                              |
|                    |       |    |       |                                  |
| CK Cho                  |       | 51      |       | Director                              |
|                    |       |    |       |                                  |
| Patrick Caruana         |       | 67      |       | Director                              |

 

*LarryBuffington* was elected by the Company’s Board of Director toserve as the President and Chief Executive Officer of the Company in October2006.  Mr. Buffington has been serving asfull-time consultant to the Company since July 2006.  He is also the president of Buffington Consulting,a consulting firm that Mr. Buffington started in 1997 focusing on theassessment and turnaround of manufacturing operations.  Prior to starting Buffington Consulting, Mr.Buffington was the General Manager of the Communications Products Business Unitof Augat, Inc., a public company with worldwide manufacturing operations incommunication, automotive and electronic products.  Mr. Buffington received a bachelors degree inIndustrial Engineering from Pennsylvania State University in 1969.

*Young Ham* has been ourChief Financial Officer since April 2005, prior to which he served as the CFOof the Asian operation in 2004.  Prior tojoining Liquidmetal, he served as President and Chief Consultant of DimeFinancial Advisory based in Seoul, Korea from November 1999 through July2003.  In addition, Mr. Ham was afounding partner for Hanmi Accounting Corporation in South Korea since July2003 where he provided accounting and consulting services to multi-nationalcorporations.  Mr. Ham was also the ChiefInternal Auditor and Financial Advisor to Answer International Asia Inc. andDirector of Dongyang Economy Research Institute.  Financial advisory and management consultingclients have included, Nextel Co., Ltd, Korea Masterbuilders, Korea SpolandCo., Ltd..  Tax and legal service clientsrange from Hyundai Merchant Marine to the Korea National Oil Company. An M.B.A.graduate student of Seoul National University in 1994, Young Ham is a CPA inboth the United States and Seoul, South Korea.

*John Kang*was re-elected as Chairman of our Board of Directors in August 2003.   Mr. Kang**hasbeen a director of our Company since 1994. From December 1994 to June 2001, he served as Chairman of our Board ofDirectors in various capacities.  FromJune 2001 until December 30, 2005, Mr. Kang had served variously as our ChiefExecutive Officer and President.  FromJuly 1996 to September 2000, Mr. Kang served variously as Chief ExecutiveOfficer, President, and a director of Medical Manager Corporation, a publiccompany traded on the Nasdaq National Market until its sale in September 2000to WebMD Corporation. From 1988 to 1995, he was Chairman of the board ofdirectors of Clayton Group, Inc., a private company engaged in the distributionof waterworks equipment.  Mr. Kangreceived a B.A. degree in Economics from Harvard College in 1985. Mr. Kang isthe brother of James Kang, one of our directors. On December 15, 2005, anindictment naming as defendants ten former officers and directs of MedicalManager Corporation, including Mr. Kang, was filed in the United StatesDistrict Court for the District of South Carolina (Beaufort Division). Theindictment includes counts for conspiracy, conspiracy to launder moneyinstruments, and money laundering relating to a series of acquisitions that weremade by Medical Manager during the years the years 1996 through 2003, theaccounting practices of Medical Manager during that time frame, and the filingof various financial statements during that time frame.  The indictment is unrelated to Mr. Kang’sservice as a director and officer of our company.  Mr. Kang resigned as our President and ChiefExecutive Officer on December 30, 2005, although he continues to serves asChairman of the Board of our company and continues to work for our company on afull-time basis.

*DeanTanella* was elected as a director in February 2004.  Mr. Tanella is a 20-year veteran of theinstitutional investment business and has worked for such leading firms asRaymond James & Associates, CS First Boston Corp., Adams Harkness &Hill, Drexel Burnham Lanbert, Inc., Kidder Peabody & Co. and the VanguardGroup.  Since  1999, Mr. Tanella has served as President ofSafe Harbor Capital, LLC and, since 2003, as President of HarborLight Capital,LLC, both of which are private 

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investment firms.  Mr. Tanella received his bachelors degreefrom Princeton University and his MBA from the Harvard Graduate School ofBusiness Administration.  In December2004, Mr. Tanella was also named Executive Vice President — Capital MarketsGroup and a member of the Board of Directors at GunnAllen Financial Inc., aleading independent brokerage firm headquartered in Tampa, Florida.

*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 consultantto the Company.

*RobertBiehl* has served as a director since January 2005.  Mr. Biehl founded the Masterplanning GroupInternational and as President, personally consulted over 400 clients andmentored over 2,500 executives and world leaders.  Prior to starting Masterplanning Group, Mr. Biehlwas an executive staff of World Vision International where he designed anddeveloped the Love Loaf Program, which has raised millions of dollarsworldwide.  He has also published manybooks in the area of personal and organizational development.  Mr. Biehl received his B.A. degree inpsychology and a Masters Degree in Counseling from Michigan State University.

*CKCho* was elected as a director in January 2005.  Mr. Cho has over 18 years of experience withSamsung Electronics and managed over $700 million annual procurement budgetresponsible for semi-conductor and telecommunication equipment and otherelectronic components.  He also served asCEO and President of Winvest Venture Partners Inc. and is currently serving asPresident and CEO of ATIC, an IT Venture Capital Company based in Korea.  Mr. Cho received his bachelors degreemajoring in Business Administration and Material Sciences from the KoreaUniversity of Seoul.

*Patrick Caruana*was elected as a director in October2006.  Mr. Caruana is a retired UnitedStates Air Force General and a recently retired vice president for NorthropGrumman Space Technology.  From 2002through February 2005, he had served as Vice President of Northrop GrummanSpace Technology and was the Corporate lead for Missile and Defense businessdevelopment in the Asia market.  Mr.Caruana served as Vice President and Program Manager for TRW Space &Electronics from August 1999 until the Company was acquired by Northrup Grummanin 2002.  Prior to joining TRW, Mr.Caruana served 36 years in the U.S. Air Force, retiring the grade of LieutenantGeneral.  Mr. Caruana is a graduate ofthe U.S. Air Force Academy, where he earned a bachelor’s degree inengineering.  In 1972, Mr. Caruanareceived a Master of Science degree in Mathematics from Texas A&MUniversity.

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

**Terms ofDirectors**

**Ourboard of directors is divided into three classes (designated “CLASS I,” “CLASSII,” and “CLASS III”), as nearly equal in number as possible, with each classserving three-year terms expiring at the third annual meeting of stockholdersafter their elections or until their respective successors have been electedand qualified.  CLASS I currently consistof the following directors whose term is scheduled to expire at the 2006 annualmeeting of stockholders or the first annual meeting thereafter: John Kang,William Johnson, and Robert Biehl.  CLASSII currently consists of the following directors whose term is scheduled toexpire at the 2007 annual meeting of stockholders:  Dean Tanella and CK Cho.  CLASS III currently consists of the followingdirectors whose term will expire at the 2008 annual meeting ofstockholders:  Patrick Caruana.**

**AuditCommittee**

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

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**CompensationCommittee**

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

**Corporate Governance andNominating Committee**

ACorporate Governance 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 “independent directors,” as defined by therules applicable to members of the Committee. The Committee is generallyresponsible for adopting policies, procedures, and practices designed to helpensure that our corporate governance policies, procedures, and practicescontinue to assist the board and our management in effectively and efficientlypromoting the best interests of our stockholders. The Committee is alsoresponsible for selecting and recommending for approval by the Board and theCompany’s stockholders a slate of director nominees for election at each of theCompany’s annual meetings of stockholders, and otherwise for determining theBoard committee members and chairmen, subject to Board ratification, as well asrecommending to the Board director nominees to fill vacancies or new positionson the Board or its committees that may occur or be created from time to time,all in accordance with the Company’s Bylaws and applicable law.

The Corporate GovernanceCommittee’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 andSenior Financial and Accounting Officers; 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.

 

**Compensation Committee Interlocksand Insider Participation**

None of the members of ourcompensation committee serves, or has at any time served, as an officer oremployee of us or any of our subsidiaries. None of our executive officers hasserved as a member of the compensation committee, or other committee serving anequivalent function, of any other entity, one of whose executive officersserved as a member of our compensation committee.

**Limitation of Liability andIndemnification of Officers and Directors**

Our by-laws provide that ourdirectors, officers and employees shall be indemnified by us to the fullestextent authorized by Delaware law, as it now exists or may in the future beamended, against all expense, liability and loss reasonably incurred orsuffered by them in connection with their service for or on behalf of us. In addition, we have entered into separate indemnification agreements with ourdirectors and executive officers. We believe that these provisions andagreements are necessary to attract and retain qualified persons as directorsand executive officers. These indemnification agreements may require us toindemnify our directors and executive officers for related expenses, includingattorneys’ fees, judgments, fines and amounts paid in settlement that were actuallyand reasonably incurred or suffered by a director or executive officer in anaction or proceeding arising out of his or her service as one of our directorsor executive officers.  In order to cover the foregoing potential expensesand liablity, we have obtained insurance that insures our directors andofficers against specified losses.

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**Code of Ethics**

Our board ofdirectors has adopted a Code of Ethics that is applicable to its principalexecutive officer, principal financial officer, principal accounting officer orcontroller, and persons performing similar functions.  The Code of Ethics is attached as Exhibit 14to our Annual Report on Form 10-K filed on November 10, 2004.  In addition, we intend to promptly disclose(1) the nature of any amendment to our Code that applies to our principalexecutive officer, principal financial officer, principal accounting officer orcontroller, or persons performing similar functions and (2) the nature ofany waiver, including an implicit waiver, from a provision of our Code that isgranted to one of these specified officers, the name of such person who isgranted the waiver and the date of the waiver on our website in the future. Youmay also request a copy of the Code by sending the request to information@liquidmetal.com.

**Item 11. Executive Compensation**

**COMPENSATION DISCUSSION AND ANALYSIS**

This compensation discussiondescribes the material elements of compensation awarded to, earned by, or paidto each of our executive officers who served as named executive officers duringthe last completed fiscal year. This compensation discussion focuses on theinformation contained in the following tables and related footnotes andnarrative for primarily the last completed fiscal year, but we also describecompensation actions taken before or after the last completed fiscal year tothe extent it enhances the understanding of our executive compensationdisclosure.

The compensation committeecurrently oversees the design and administration of our executive compensationprogram.

The principal elements of ourexecutive compensation program are base salary, annual cash incentives,long-term equity incentives in the form of stock options, other benefits andperquisites, post-termination severance and acceleration of stock option vestingfor certain named executive officers upon termination and/or a change incontrol. Our other benefits and perquisites consist of reimbursement forcertain automobile payments and health insurance benefits. Our philosophy is toposition the aggregate of these elements at a level that is commensurate withour size and sustained performance.

**Compensation Program Objectives and Philosophy**

The objectives of ourcompensation programs are to:

·                  attract, motivate and retain talented anddedicated executive officers;

·                  provide our executive officers with both cash andequity incentives to further the interests of us and our stockholders; and

·                  provide employees with long-term incentives so wecan retain them and provide stability during our growth stage

Generally, the compensation ofour executive officers is composed of a base salary, an annual incentivecompensation award and equity awards in the form of stock options. In settingbase salaries, the compensation committee reviewed the individual contributionsof the particular executive. The management incentive program for 2006 is adiscretionary award determined by the compensation committee based on companyperformance. In addition, stock options are granted to provide the opportunityfor long-term compensation based upon the performance of our common stock overtime.

For each of our named executiveofficers, the compensation committee reviews and approves all elements ofcompensation taking into consideration recommendations from our principalexecutive officer (for compensation other than his own), as well as competitivemarket guidance provided at the request of the compensation committee.

We have designed our managementincentive program so that bonuses paid thereunder will qualify asperformance-based compensation under Section 162(m) of the Internal RevenueCode of 1986, as amended (the Code). Given the compensation cost to us ofawarding stock options under recent accounting pronouncements, we will considerthe size and frequency of any future stock option awards under our long-termequity incentive program.

**Base Salaries**

We provide the opportunity forour named executive officers and other executives to earn a competitive annualbase salary. We provide this opportunity to attract and retain an appropriatecaliber of talent for the position, and to provide a base wage that is notsubject to our performance risk. We review base salaries for our namedexecutive officers annually in January and increases are based on ourperformance and individual performance. The salary of our principal executiveofficer is set by our compensation committee.

**CashIncentives**

We provide the opportunity forour named executive officers and other executives to earn cash incentive award.We provide this opportunity to attract and retain an appropriate caliber oftalent for the position and to motivate executives to achieve our annualbusiness goals. We plan to review cash incentive awards for our named executiveofficers and other executives annually in March to determine award payments forthe last completed fiscal year, as well as to establish award opportunities forthe current fiscal year.

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Awards are subject to thecompensation committee’s discretion and may take into account corporateperformance measures, including, but not limited to, revenues, EBITDA and netincome. The compensation committee establishes award criteria, generally, as apercentage of annual growth.

For the year ended December 31,2006, John Kang, our chairman of the board and Young Ham, our chief financialofficer, are eligible to receive cash awards under the 2006 managementincentive program based on revenue and profit growth over 2005.  Mr. Kang is eligible for cash awards of 5% ofrevenues that exceed annual revenues in 2005. Mr. Ham is eligible for cash awards of 1% of profit that exceed profitsin 2005.  The awards are subject to finalapproval by the compensation committee based on overall performance of thecompany.   There were no such awardsdeclared or paid to our named executive officers during 2006.

In setting the target bonus amounts, our Boardtook into consideration that our named executive officers have significantequity interests in us through direct ownership of shares or prior optiongrants, which already provide them with performance incentives.

**Equity-Based Compensation***.*

Our equity-based awards to our executive officers consist principally ofstock options granted from time to time under our 2002 Equity Incentive Planand our 1996 Stock Option Plan.  Stock option grants are based on variousfactors, including the executive officer’s position, responsibility and tenure,each executive officer’s ability to contribute to our future success, and theother elements of such executive officer’s compensation. Generally, we useequity-based compensation to better align the interests of our executiveofficers with those of our stockholders.

For our named executive officers,our stock option program is based on grants that are individually negotiated inconnection with employment agreements and other grants to our executives. Wehave traditionally used stock options as its form of equity compensationbecause stock options provide a relatively straightforward incentive for ourexecutives, result in less immediate dilution of existing shareholders’interests and, prior to our adoption of FAS 123(R), resulted in lesscompensation expense for us relative to other types of equity awards. During2006, all grants of stock options to our employees were granted with exerciseprices equal to or greater than the fair market value of our common stock onthe respective grant dates. For a discussion of the determination of the fairmarket value of these grants, see Item 7 “Management’s Discussion and Analysisof Financial Condition and Results of Operations—Critical Accounting Policies”.

We do not time stock optiongrants to executives in coordination with the release of material non-publicinformation. Our stock options have a 10-year contractual exercise term or5-year contractual term if the optionee owns more than 10% of voting power ofthe company. In general, the option grants are also subject to the followingpost-termination and change in control provisions:

 

| Event                                                                         | ** ** | **Award Vesting**           | ** ** | **Exercise Term**                     |
|-------------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------------|
| Termination by  Us Reason Other than     Cause, Disability or Death |       | Forfeit Unvested (1)        |       | 3 months from Date of Termination (1) |
| Disability or  Death                                                          |       | Forfeit Unvested            |       | 12 months from Date of Termination    |
| Termination for  Cause                                                        |       | Forfeit Vested and Unvested |       | —                                |
| Other  Termination                                                            |       | Forfeit Unvested            |       | 90 days from Date of Termination      |
| Change in  Control                                                            |       | Accelerated (2)             |       | Accelerated (2)                       |

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(1)             Optionsgranted under the 2002 Non-employee Director Option Plan will continue to vestand be exercisable for 12 months following the termination.

(2)             TheBoard of Directors may, at its discretion, may amend vesting rights includingadditional grant additional shares in case of mergers or reorganizations foranti-dilution purposes.

The vesting of certain of our named executiveofficers’ stock options may be accelerated pursuant to the terms of theiremployment agreements in certain termination and/or change in control events.These terms are more fully described in “—Employment Agreements” and “—PotentialPayments upon Termination or Change in Control.”

**ExecutiveBenefits and Perquisites**

We provide the opportunity forour named executive officers and other executives to receive certainperquisites and general health and welfare benefits. We also offerparticipation in our defined contribution 401(k) savings plan. We do not matchemployee contributions under our 401(k) plan. Participation in general healthand welfare benefits and the 401(k) plan are voluntary and are 

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available to all eligibleemployees of the company.  We providethese benefits to provide an additional incentive for our executives and toremain competitive in the general marketplace for executive talent. For thelast completed fiscal year, perquisites other than general health and welfarebenefits consisted of car payment reimbursements provided to John Kang, ourchairman of the board, and CK Cho, our director.

Set forth below is informationregarding compensation earned by or paid or awarded to the following executiveofficers of the company during the year ended December 31, 2006: (i) LarryBuffington, our president and chief executive officer; (ii) Young Ham, ourchief financial officer; and (iii) John Kang, who is our chairman of the board,James Kang, who is a former founder and director of the board, and  Ricardo Salas, who is a former president andchief executive officer, which persons are the three most highly compensatedexecutives whose total compensation exceeded $200,000, other than Messrs.Buffington and Ham, who were serving as executive officers at December 31,2006.  The identification of such namedexecutive officers is determined based on the individual’s total compensationfor the year ended December 31, 2006, as reported below in the SummaryCompensation Table.

**Summary Compensation Table**

Thefollowing table sets forth for each of the named executive officers: (i) thedollar value of base salary and bonus earned during the year ended December 31,2006; (ii) the aggregate grant date fair value of stock and option awardsgranted during the year, computed in accordance with SFAS 123 (R); (iii) thedollar value of earnings for services pursuant to awards granted during theyear under non-equity incentive plans; (iv) the change in pension value andnon-qualified deferred compensation earnings during the year; (v) all othercompensation for the year; and, finally, (vi) the dollar value of totalcompensation for the year.

 
| ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **              | ** ** | **Change in**     | ** ** | ** **         | ** ** | ** ** | ** ** |
|-------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|---------------------|------------|-------------------------|------------|------------------------|------------|--------------------|------------|------------|------------|
| ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **              | ** ** | **Pension Value** | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **              | ** ** | **and**                | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | ** **              | ** ** | **Nonqualified**       | ** ** | ** **         | ** ** | ** ** | ** ** |
| **Name and**                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **          | ** ** | **Non-Equity**          | ** ** | **Deferred**           | ** ** | ** **         | ** ** | ** ** | ** ** |
| **Principal**                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **Stock**  | ** ** | **Option**          | ** ** | **Incentive Plan** | ** ** | **Compensation**       | ** ** | **All Other** | ** ** | ** ** | ** ** |
| **Position**                        | ** ** | **Year**   | ** ** | **Salary** | ** ** | **Bonus**  | ** ** | **Awards** | ** ** | **Awards (1)** | ** ** | **Compensation**        | ** ** | **Earnings**           | ** ** | **Compensation**   | ** ** | **Total**  | ** ** |
| Larry 

   Buffington (2) |       | 2006       |       | $          | 41,667     |       | —     |       | —     |                | —     |                    | —     |                   | —     |               | —     |       | $          | 41,667 |   |
| Young Ham                           |       | 2006       |       | $          | 153,438    |       | —     |       | —     |                | $          | 25,526                  |       | —                 |       | —             |       | —     |       | $ | 178,964 |   |
| John Kang                           |       | 2006       |       | $          | 213,750    |       | —     |       | —     |                | —     |                    | —     |                   | —     |               | $     | 11,752     | (3)        | $ | 225,502 |   |
| James Kang                          |       | 2006       |       | $          | 250,000    |       | —     |       | —     |                | —     |                    | —     |                   | —     |               | —     |       | $          | 250,000 |   |
| Ricardo Salas (4)                   |       | 2006       |       | $          | 222,418    |       | —     |       | —     |                | $          | 51,052                  |       | —                 |       | —             |       | —     |       | $ | 273,470 |   |
|                                     |            |            |            |            |            |            |            |            |            |                     |            |                         |            |                        |            |                    |            |            |            |  |  |  |  |

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(1)             Amountrepresent the expensed fair value of stock options granted in 2006 under SFAS123(R) as discussed in Note 17, “Stock Compensation Plan” to our financialstatement included elsewhere in this annual report on Form 10-K.

(2)             Mr.Buffington commenced employment in October 2006 at an initial annual salary of$200,000, which was subsequently adjusted to $250,000 in January 2007.

(3)             Amountrepresents automobile lease payments.

(4)             Mr.Salas resigned as our president and chief executive officer of the company inOctober 2006.

For a description of the material terms of employmentagreements with our named executive officers, see “—Employment Agreements.”

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**Grants of Plan–based Awards**

Thefollowing table sets forth information regarding all incentive plan awards thatwere made to the named executive officers during 2006, including incentive planawards (equity-based and non-equity based) and other planned-based awards.  Disclosure on a separate line item isprovided for each grant of an award made to a named executive officer duringthe year.  The information supplementsthe dollar value disclosure of stock, option and non-stock awards in theSummary Compensation Table by providing additional details about such awards.  Equity incentive-based awards are subject toa performance condition or a market condition as those terms are defined bySFAS 123(R).  Non-equity incentive planawards are awards that are not subject to SFAS 123(R) and are intended to serveas an incentive for performance to occur over a specified period.

 
|                  |       |      |   |                                     |       |                                   |       |               |       |               |       |              |       |        |   | **All Other** |   | **All Other** |   |       |   |
|------------------|------------|-----------|--------|------------------------------------------|------------|----------------------------------------|------------|--------------------|------------|--------------------|------------|-------------------|------------|-------------|--------|--------------------|--------|--------------------|--------|------------|--------|
|             |       |      |   |                                     |       |                                   |       |               |       |               |       |              |       |        |   | **Stock**          |   | **Option**         |   |       |   |
|             |       |      |   | ** **                               | ** ** | ** **                             |       | **Awards:**        |       | **Awards:**        |       | **Exercise**      |       |
|             |       |      |   | **Estimated Future Payouts**   | ** ** | **Estimated Future Payouts** |       | **Number**         |       | **Number of** |       | **or Base**  |       |
|             |       |      |   | **Under Non–Equity Incentive** | ** ** | **Under Equity Incentive**        |       | **of Shares** |       | **Securities**     |       | **Price of** |       |
| ** **       | ** ** | **Grant** |   | **Plan Awards**                     | ** ** | **Plan Awards**                        |       | **of Stock**  |       | **Underlying**     |       | **Option**        |       |
| **Name**         | ** ** | **Date**  |   | **Threshold**                            | ** ** | **Target**                             | ** ** | **Maximum**        | ** ** | **Threshold**      | ** ** | **Target**        | ** ** | **Maximum** |   | **or Units**  |   | **Options**        |   | **Awards** |   |
| Larry Buffington |       | —    |   | —                                   |       | —                                 |       | —             |       | —             |       | —            |       | —      |   | —             |   | —             |   | —     |   |
| Young Ham        |       | 4/1/06    |   | —                                   |       | —                                 |       | —             |       | —             |       | —            |       | —      |   | —             |   | 25,000             |   | $          | 1.44   |   |
| John Kang        |       | —    |   | —                                   |       | —                                 |       | —             |       | —             |       | —            |       | —      |   | —             |   | —             |   | —     |   |
| James Kang       |       | —    |   | —                                   |       | —                                 |       | —             |       | —             |       | —            |       | —      |   | —             |   | —             |   | —     |   |
| Ricardo Salas    |       | 4/1/06    |   | —                                   |       | —                                 |       | —             |       | —             |       | —            |       | —      |   | —             |   | 500,000            |   | $          | 1.44   |   |
|                  |            |           |        |                                          |            |                                        |            |                    |            |                    |            |                   |            |             |        |                    |        |                    |        |            |        |  |  |  |  |

 

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**Outstanding Equity Awardsat Fiscal Year-End**

Thefollowing table sets forth information on outstanding option and stock awardsheld by the named executive officers at December 31, 2006, including the numberof shares underlying both exercisable and unexercisable portions of each stockoption as well as the exercise price and expiration date of each outstandingoption.

 
| ** **       | ** ** | ** **                                                                     | ** ** | **Stock Awards**                                                              |
|------------------|------------|--------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|
| ** **       | ** ** | **Option Awards**                                                              | ** ** | ** **                                                                    | ** ** | ** ** | ** ** | **Equity  Incentive  Plan** | ** ** | **Equity  Incentive  Plan** |
| **Name**         | ** ** | **Number of  Securities  Underlying  Unexer-  cised  Options  Exercis-  able** | ** ** | **Number of  Securities  Underlying  Unexercised  Options  Unexer-  cisable** | ** ** | **Equity  Incentive  Plan  Awards  Number of  Securities  Underlying  Unexer-  cised  Unearned  Options** | ** ** | **Option  Exercise  Price** | ** ** | **Option  Expiration  Date** | ** ** | **Vesting  Commence-  ment Date** | ** ** | **Number  of Shares  or Units  of Stock  That  Have Not  Vested** | ** ** | **Market  Value of  Shares or  Units of  Stock  That  Have Not  Vested** | ** ** | **Awards:  Number  of  Unearned  Shares,  Units or  Other  Rights  That  Have Not  Vested** | ** ** | **Awards:  Market or  Payout  Value of  Unearned  Shares,  Units or  Other  Rights  That Have  Not Vested** |
| Larry Buffington |       | —                                                                         |       | —                                                                        |   | — |   | — |   | — |   | — |   | — |   | — |   | — |   | — |
| Young Ham        |       | 20,000 

7,500 

10,000 

—                                               |       | 30,000 

30,000 

40,000 

25,000                                             |   | — 

— 

— 

— |   | $1.42 

$2.33 

$1.69 

$1.44 |   | 7/14/2014 12/31/2014  2/28/2015 3/31/2016 |   | 7/15/2005(1)1/1/2006(1) 3/1/2006(1)  4/1/2007(1) |   | — |   | — |   | — |   | — |
| John Kang        |       | 21,505 

1,591,399 

10,000                                                    |       | — 

— 

40,000                                                      |   | — 

— 

— |   | $4.65 

$4.65 

$2.33 |   | 12/30/2010 12/30/2010  12/31/2014 |   | 12/31/2000(2)  12/31/2000(2)1/1/2006(1) |   | — |   | — |   | — |   | — |
| James Kang       |       | 43,010 

253,764 

2,532,259 

48,387                                          |       | — 

— 

— 

—                                             |   | — 

— 

— 

— |   | $2.33 

$2.33 

$6.20 

$6.20 |   | 4/7/2008 

4/7/2008 

5/20/2011 5/20/2011 |   | 4/8/1999(3) 4/8/1999(3)5/21/2002(4)5/21/2002(4) |   | — |   | — |   | — |   | — |
| Ricardo Salas    |       | — 

—                                                                |       | 153,260 346,740                                                               |   | — 

— |   | $1.44 

$1.44 |   | 3/31/2016 3/31/2016 |   | 4/1/2007(1) 4/1/2007(1) |   | — |   | — |   | — |   | — |

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(1)             The shares underlying thisoption vest 20% per year starting with the vesting commencement date andthereafter.

(2)             The shares underlying thisoption vest 100% immediately on grant date.

(3)             The shares underlying thisoption vest 25% per year starting with the vesting commencement date andthereafter.

(4)             The shares underlying thisoption vest 33% per year starting with the vesting commencement date andthereafter.

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**Option Exercises and Stock Vested**

Therewere no exercise of stock options and vesting of restricted stock during 2006.

**Employment Agreements**

Wehave entered into the following employment agreements with the executiveofficers identified above. Larry Buffington, who was elected as our Presidentand Chief Executive Officer on October 8, 2006, received an initial base salaryof $200,000 for serving as President and Chief Executive Officer of ourcompany.  Effective January 1, 2007, theCompensation Committee approved an increase in the base salary to $250,000.  We and Mr. Buffington have not yet enteredinto an employment agreement relating to Mr. Buffington’s employment with us,but we may determine to do so in the future.

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

***Young Ham.*** On April 15, 2005, we entered into anemployment agreement with Young Ham, which provides for his employment as thenamed Chief Financial Officer.  Mr. Ham’semployment agreement expires April 15, 2008, and his term may continuesubsequent to the expiration date on a month-to-month basis at the samesalary.  His annual salary is $150,000,and he received 50,000 stock options as part of the employment agreement withan exercise price of $1.42 per share. The options expire on July 14, 2014 and vest at a rate of 20% per yearfor five years. If we terminate Mr. Ham’s employment without cause, we areresponsible for paying Mr. Ham a severance benefit of Mr. Ham’s monthly basesalary for three-month period immediately following the effective date of thetermination.

**401(k) Savings Plan**

 

Wehave adopted a tax-qualified employee savings and retirement plan, or 401(k)plan, that covers all of our employees. Pursuant to our 401(k) plan,participants may elect to reduce their current compensation, on a pre-taxbasis, 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 us, in oursole discretion, to make additional employer contributions to the 401(k) plan.However, we do not currently make employer contributions to the 401(k) plan andmay not do so in the future. As such, contributions by employees or by us tothe 401(k) plan, and the income earned on plan contributions, are not taxableto employees until withdrawn from the 401(k) plan, and we can deduct ourcontributions, if any, at the time they are made.

**PensionBenefits**

We do not sponsor any qualified or non-qualifieddefined benefit plans.

**Nonqualified Deferred Compensation**

We do not maintain anynon-qualified defined contribution or deferred compensation plans. Thecompensation committee, which is comprised solely of “outside directors” asdefined for purposes of Section 162(m) of the Code, may elect to provideour officers and other employees with non-qualified defined contribution ordeferred compensation benefits if the compensation committee determines thatdoing so is in our best interests. We sponsor a tax qualified definedcontribution 401(k) savings plan.

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**Disclosure Regarding Termination andChange Control Provisions**

Potentialpayments payable to our executive officers upon termination of employmentfollowing a change in control of us is discussed under “—Employment Agreements”.The compensation committee of our board of directors may, at their discretion,amend or add benefits to these arrangements as they deem advisable.

 

**Director Compensation**

The following table sets forth information regarding the compensationreceived by each of our directors during the year ended December 31, 2006;
| ** **      | ** ** | ** **                 | ** ** | ** **      | ** ** | ** **       | ** ** | ** **              | ** ** | **Change in**     | ** ** | ** **         | ** ** | ** ** | ** ** |
|-----------------|------------|----------------------------|------------|-----------------|------------|------------------|------------|-------------------------|------------|------------------------|------------|--------------------|------------|------------|------------|
| ** **      | ** ** | ** **                 | ** ** | ** **      | ** ** | ** **       | ** ** | ** **              | ** ** | **Pension Value** | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **      | ** ** | ** **                 | ** ** | ** **      | ** ** | ** **       | ** ** | ** **              | ** ** | **and**                | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **      | ** ** | ** **                 | ** ** | ** **      | ** ** | ** **       | ** ** | ** **              | ** ** | **Nonqualified**       | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **      | ** ** | **Fees Earned ** | ** ** | ** **      | ** ** | ** **       | ** ** | **Non-Equity**          | ** ** | **Deferred**           | ** ** | ** **         | ** ** | ** ** | ** ** |
| ** **      | ** ** | **orPaid**                 | ** ** | **Stock ** | ** ** | **Option ** | ** ** | **Incentive Plan** | ** ** | **Compensation**       | ** ** | **All Other** | ** ** | ** ** | ** ** |
| **Name**        | ** ** | ** in Cash**     | ** ** | **Awards**      | ** ** | **Awards(1)**    | ** ** | **Compensation**        | ** ** | **Earnings**           | ** ** | **Compensation**   | ** ** | **Total**  | ** ** |
| John Kang       |       | —                     |       | —          |       | —           | (2)        | —                  |       | —                 |       | —             |       | —     |       |
| William Johnson |       | —                     |       | —          |       | $                | 5,469      | (3)                     | —     |                   | —     |               | —     |       | $          | 5,469 |   |
| Dean Tanella    |       | $                          | 75,000     |            | —     |             | $          | 16,388                  | (4)        | —                 |       | —             |       | —     |       | $ | 91,388 |   |
| Robert Biehl    |       | —                     |       | —          |       | $                | 5,469      | (5)                     | —     |                   | —     |               | $          | 47,500     | (8)        | $ | 52,969 |   |
| CK Cho          |       | —                     |       | —          |       | $                | 5,469      | (6)                     | —     |                   | —     |               | $          | 76,365     | (9)        | $ | 81,834 |   |
| Patrick Caruana |       | $                          | 1,667      |            | —     |             | $          | 60,867                  | (7)        | —                 |       | —             |       | —     |       | $ | 62,534 |   |

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(1)             Amountsrepresent the expensed fair value of stock options granted in 2006 under SFAS123(R) as discussed in Note 15, “Stock Compensation Plan”, to our consolidatedfinancial statements included elsewhere in this report on Form 10K.

(2)             1,662,904shares of options were outstanding as of December 31, 2006.

(3)             70,000shares of options were outstanding as of December 31, 2006.

(4)             90,000shares of options were outstanding as of December 31, 2006.

(5)             60,000shares of options were outstanding as of December 31, 2006.

(6)             60,000shares of options were outstanding as of December 31, 2006.

(7)             50,000shares of options were outstanding as of December 31, 2006.

(8)             Amountrepresents shares of stock issued in lieu of cash payment.

(9)    Amountrepresents $20,639 of automobile lease payments, $15,726 of purchases madeusing company credit card, and $40,000shares of stock issued in lieu of cash payment.

 

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

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

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

**Compensation Committee Report**

The compensation committee of the board of directors hasreviewed and discussed the above Compensation Discussion & Analysis withmanagement and, based on such review and discussion, has recommended to theboard of directors that the Compensation Discussion & Analysis be includedin the company’s Annual Report on Form 10-K statement.

CK Cho

RobertBiehl

December31, 2006

CompensationCommittee of the Board of Directors

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 1993 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.

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

Thefollowing table sets forth certain information regarding the beneficialownership of our common stock as of February 1, 2007 by:

**·**                  each person known by us to be a beneficial owner of morethan 5.0% of our outstanding common stock;

**·**                  each of our directors;

**·**                  each of our named executive officers; and

**·**                  all directors and executive officers as a group.

Thenumber and percentage of shares beneficially owned is determined under rules ofthe SEC and the information is not necessarily indicative of beneficialownership for any other purpose. Under such rules, beneficial ownershipincludes any shares as to which the individual has sole or shared voting poweror investment power and also any shares which the individual has the right toacquire beneficial ownership of within 60 days of February 1, 2007 through theexercise of any stock option or other right. Unless otherwise indicated in thefootnotes, each person has sole voting and investment power with respect to theshares shown as beneficially owned. A total of 44,311,768 shares of our commonstock were issued and outstanding as of February 1,

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2007.  Unless otherwise indicated, the address ofall directors and named executive officers is 25800 Commercentre Drive, Suite100, Lake Forest, CA 92630.

| Name of Beneficial Owner                                              | ** ** | **Shares** | ** ** | **Percent of Class** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------|------------|--------------------------------|------------|
| **5%  Stockholders**                                                                 |       |       |       |                           |       |
| Tjoa Thian  Song(1)  16 Raffles Quay #B1-14A  Hong Leong Building  Singapore 0101    |       | 4,008,523  |       | 9                              | %          |
|                                                                                 |       |       |       |                           |       |
| Jack Chitayat(2)  1133 Park Avenue, Suite 1W  New York, NY 10128                     |       | 2,669,289  |       | 6                              | %          |
|                                                                                 |       |       |       |                           |       |
| James Kang(3)  Hyundai Hyperion Apt. 101-403  Youngsan-Gu, Hannam-Dong  Seoul, Korea |       | 6,149,991  |       | 14                             | %          |
|                                                                                 |       |       |       |                           |       |
| **Directors  and Named Executive Officers**                                          |       |       |       |                           |       |
| John Kang(4)                                                                         |       | 5,084,973  |       | 12                             | %          |
|                                                                                 |       |       |       |                           |       |
| William  Johnson(5)                                                                  |       | 1,176,650  |       | 3                              | %          |
|                                                                                 |       |       |       |                           |       |
| Dean Tanella(6)                                                                      |       | 67,620     |       | *                              |       |
|                                                                                 |       |       |       |                           |       |
| Robert Biehl(7)                                                                      |       | 116,059    |       | *                              |       |
|                                                                                 |       |       |       |                           |       |
| CK Cho(8)                                                                            |       | 1,213,452  |       | 3                              | %          |
|                                                                                 |       |       |       |                           |       |
| Patrick  Caruana(9)                                                                  |       | —     |       | —                         |       |
|                                                                                 |       |       |       |                           |       |
| Young Ham(10)                                                                        |       | 60,000     |       | *                              |       |
|                                                                                 |       |       |       |                           |       |
| All directors and  executive officers as a group (7 persons)                    |       | 7,718,754  |       | 18                             | %          |

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*  Less than one percent.

(1)           3,874,585 of these shares are held ofrecord by a revocable grantor trust established by Mr. Tjoa for himself and hisfamily members.  Mr. Tjoa continues tobeneficially own all such shares.

(2)           Includes 125,000 shares issuablepursuant to currently exercisable warrants held by Atlantic Realty Group, Inc.,a company controlled by Mr. Chitayat, and 91,792 shares held of record by atrust established by Mr. Chitayat for his family members.  Mr. Chitayat continues to beneficially ownall such shares.

(3)           Includes 67,829 shares issuable pursuantto currently exercisable warrants. Also includes 2,877,420 shares issuablepursuant to outstanding stock options that are exercisable currently or within60 days of January 9, 2007 and includes 969 shares held by James Kang’s minorchildren.  Does not include the 1,700,000shares that Mr. Kang has agreed to personally purchase on October 31, 2006 fromInnometal Co., Ltd. as an inducement for Innometal to enter into a SettlementAgreement with us.  Innometal agreed toaccept these shares in full satisfaction of all of our obligations to themunder January 2004 settlement agreement.

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(4)           As of August 22, 2003, John Kang wasnamed Chairman of our board of directors. Mr. Kang resigned from his positionas President and Chief Executive Officer of our company on December 30,2005.  However, he continues to serve asChairman of the Board and continues to work for our company on a full-timebasis.** **The beneficial shares include:

(a)       1,632,904shares issuable pursuant to outstanding stock options that are exercisablecurrently or within 60 days of February 1, 2007.  Does not include 30,000 shares that areissuable pursuant to outstanding stock options that are not exercisablecurrently or within 60 days of February 1, 2007; and

(b)       152,400shares held by Mr. Kang’s minor children.

(5)           Includes 26,000 shares issuablepursuant to outstanding stock options that are exercisable currently or within60 days of February 1, 2007.  Does notinclude 54,000 shares that are issuable pursuant to outstanding stock optionsthat are not exercisable currently or within 60 days of February 1, 2007.

(6)           Includes 16,130 shares held by Mr.Tanella’s investment firm, HarborLight Diversified Fund, LP.  Also, includes 2,890 shares held by Mr.Tanella’s family.  Includes 40,000 sharesissuable pursuant to outstanding stock options that are exercisable currentlyor within 60 days of February 1, 2007. Does not include 80,000 shares that areissuable pursuant to outstanding stock options that are not exercisablecurrently or within 60 days of February 1, 2007.

(7)           Includes 22,000 shares issuablepursuant to outstanding stock options that are exercisable currently or within60 days of February 1, 2007. Does not include 48,000 shares that are issuablepursuant to outstanding stock options that are not exercisable currently orwithin 60 days of February 1, 2007.

(8)           Includes 233,285 shares issuablepursuant to currently exercisable warrants and 716,569 shares issuable pursuantto currently convertible notes.  Also,includes 22,000 shares issuable pursuant to outstanding stock options that areexercisable currently or within 60 days of February 1, 2007.  Does not include 48,000 shares that areissuable pursuant to outstanding stock options that are not exercisablecurrently or within 60 days of February 1, 2007.

(9)           Mr. Caruana holds 60,000 sharesissuable pursuant to outstanding stock options, none of which are exercisablecurrently or within 60 days of February 1, 2007.

 (10)        Includes60,000 shares issuable pursuant to outstanding stock options exercisablecurrently or within 60 days of February 1, 2007.  Does not include 102,500 shares that areissuable pursuant to outstanding stock options that are not exercisablecurrently or within 60 days of February 1, 2007.

**Equity Incentive / EquityCompensation Plans**

Ourexecutive officers, directors, and all of our employees are allowed toparticipate in our equity incentive plans. We believe that providing them with the ability to participate in suchplans provides them with a further incentive towards ensuring our success andaccomplishing our corporate goals.

Securities authorized forissuance under equity compensation plans as of December 31, 2006 were asfollows:
| **Plan Category**                                  | ** ** | **Number of securities  to be issued upon  exercise of  outstanding options,  warrants, and rights  [a]** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants, and rights  [b]** | ** ** | **Number of securities  remaining available for  future issuance under equity  compensation plans  (excluding securities  reflected in column [a])  [c]** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by stockholders     |       | 7,792,591                                                                                                                                              |       | $                                                                                                                 | 4.35       |                                                                                                                                                                                                                  | 8,653,923  |   |
| Equity  compensation plans not approved by stockholders |       | 5,252,123                                                                                                                                              |       | $                                                                                                                 | 2.77       |                                                                                                                                                                                                                  | —     |   |
| Total                                                   |       | 13,044,714                                                                                                                                             |       |                                                                                                              |       | 8,653,923                                                                                                                                                                                                             |       |

 

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Equitycompensation plans not approved by stockholders consist of:

**·**                  Warrants to purchase up to 893,750 shares issued on June13, 2005 with an exercise price of $2.00 per share and an expiration date ofJune 13, 2010;

**·**                  Warrants to purchase up to 2,883,965 shares issued onAugust 2, 2005 with an exercise price of $2.00 per share and an expiration dateof August 2, 2010;

**·**                  Warrants to purchase up to 125,000 shares issued on March17, 2006 with an exercise price of $2.00 per share and an expiration date ofMarch 17, 2009;

**·**                  Warrants to purchase up to 973,064 shares issued betweenMay 17, 2006 and December 1, 2006 with an exercise price of $2,58 per share andan expiration date of May 17, 2011; and

**·**                  Warrants to purchase up to 376,345 shares issued to PaulAzinger on January 1, 2001 with an exercise price of $1.16 per share and anexpiration date of January 1, 2008.

Thenumber of securities and type of plans available for future issuance of stockoptions as of December 31, 2006 were as follows:
| **Plan Name**                            | ** ** | **Options and Warrants for Common Shares** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                    | ** ** | **Authorized**                                                      | ** ** | **Exercised** | ** ** | **Outstanding** | ** ** | **Available** | ** ** |
| 1996 Stock  Option Plan                       |       | 12,903,226                                                          |       | 1,974,365 |   | 3,225,006 |   | — |   |
| 2002 Equity  Incentive Plan                   |       | 10,000,000                                                          |       | — |   | 2,016,077 |   | 7,983,923 |   |
| 2002  Non-employee Director Stock Option Plan |       | 1,000,000                                                           |       | — |   | 330,000 |   | 670,000 |   |
| Total Stock Options                           |       | 23,903,226                                                          |       | 1,974,365 |   | 5,601,083 |   | 8,653,923 |   |

 

**1996 Stock Option Plan**

Our1996 Stock Option Plan provides for the grant of stock options to employees,directors, and consultants of our company and its affiliates. The purpose ofthe plan is to retain the services of existing employees, directors, andconsultants; to secure and retain the services of new employees, directors, andconsultants; and to provide incentives for such persons to exert maximumefforts for our success. The plan provides for the granting to employees ofincentive stock options within the meaning of Section 422 of the InternalRevenue Code of 1986, as amended, and for the granting to employees andconsultants of nonstatutory stock options. Our board of directors terminatedthe 1996 Stock Option Plan on April 4, 2002. The termination will not affectany outstanding options under the plan, and all such options will continue toremain outstanding and be governed by the plan.

Optionsgranted under the 1996 Stock Option Plan are generally not transferable by theoptionee except by will or the laws of descent and distribution, and eachoption is exercisable, during the lifetime of the optionee, only by theoptionee. Options generally must be exercised within 90 days after the optionee’stermination for cause, three months following the end of the optionee’s statusas an employee or consultant, other than for cause or for death or disability,or within six months after the optionee’s termination by disability or twelvemonths following the optionee’s termination by death. However, in no event mayan option be exercised later than the earlier of the expiration of the term ofthe option or ten years from the date of the grant of the option or, where anoptionee owns stock representing more than 10% of the voting power, five yearsfrom the date of the grant of the option in the case of incentive stockoptions.

Asof December 31, 2006, options to purchase 3,225,006 shares of common stock wereoutstanding at a weighted average price of $6.14 per share under the 1996 StockOption Plan. As of December 31, 2006, options to purchase 1,974,365 shares hadbeen issued upon exercise of options under the plan. There were 3,223,069options exercisable under the 1996 Stock Option Plan as of December 31, 2006.

**2002 Equity****Incentive Plan**

Our2002 Equity Incentive Plan, which was adopted by our board of directors andapproved by our stockholders in April 2002, provides for the grant of stockoptions to officers, employees, consultants, and directors of our company andits subsidiaries. The purpose of the plan is to advance the interests of ourstockholders by enhancing our ability to attract, retain, and motivate personswho make or are expected to make important contributions to our company and itssubsidiaries by providing such persons with equity ownership opportunities andperformance-based incentives, thereby better aligning their interests withthose of our

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stockholders.The plan provides for the granting to employees of incentive stock optionswithin the meaning of Section 422 of the Internal Revenue Code of 1986, asamended, and for the granting to employees and consultants of nonstatutorystock options. In addition, the plan permits the granting of stock appreciationrights, or SARs, with or independently of options, as well as stock bonuses andrights to purchase restricted stock. A total of ten million shares of ourcommon stock may be granted under the plan.

Theplan is administered by our board of directors or a committee appointed by ourboard of directors. All members of such a committee must be a non-employeedirector and an outside director, as defined in the plan. Subject to thelimitations set forth in the plan, the administrator has the authority toselect the persons to whom grants are to be made, to designate the number ofshares to be covered by each stock award, to determine whether an option is tobe an incentive stock option or a nonstatutory stock option, to establishvesting schedules, to specify the option exercise price and the type ofconsideration to be paid upon exercise, and, subject to some restrictions, tospecify other terms of stock awards.

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

Optionsgranted under the plan are generally not transferable by the optionee except bywill or the laws of descent and distribution, and to certain relatedindividuals with the consent of the administrator. Options generally must beexercised within three months after the optionee’s termination of employmentfor any reason other than disability or death, or within 12 months after theoptionee’s termination by disability. Options granted under the plan vest atthe rate specified in the option agreement. However, in no event may an optionbe exercised later than the earlier of the expiration of the term of the optionor 10 years from the date of the grant of the option, or when an optionee ownsstock representing more than 10% of the voting power, five years from the dateof the grant of the option in the case of incentive stock options.

Anyincentive stock options granted to an optionee which, when combined with allother incentive stock options becoming exercisable for the first time in anycalendar year that are held by that person, would have an aggregate fair marketvalue in excess of $0.1 million, shall automatically be treated as nonstatutorystock options.

Theplan may be amended, altered, suspended or terminated by our board of directorsat any time, but no such amendment, alteration, suspension or termination mayadversely affect the terms of any option previously granted without the consentof the affected optionee. Unless terminated sooner, the plan will terminateautomatically in September 2012.  As ofDecember 31, 2006, there were 2,016,077 outstanding options or stock awards ata weighted average price of $2.46 under the plan.  There were 854,093 options exercisable underthe 2002 Equity Incentive Plan as of December 31, 2006.

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

InFebruary 2006, the non-employee directors of our company were given theopportunity to receive shares of stock under the plan in lieu of director andcommittee fees that were due for fiscal year 2006.  Such shares were issuable to such directorsat an average price of $0.88 per share, the effective closing price of ourstock on January 1, 2006 when the fees became due.  In April 2006, we issued a total of 99,432shares to non-employee directors in lieu of these fees.

InMarch 2006, one of the former non-employee directors of our company, VincentAddonisio, was given the opportunity to receive shares of stock under the planin lieu of past-due director and committee fees that were due to him forperiods through December 31, 2005 at an average price of $1.50.  We issued a total of 10,000 shares at anaverage price of $1.50 in March 2006.

In April 2006, thenon-employee directors of our company were given the opportunity to receiveshares of stock under the plan in lieu of past-due director and committee feesthat were due to them for director fees for fiscal year 2006 due to them as ofJanuary 1, 2006.  Such shares wereissuable to such directors at an average price of $0.88 per share.  In April 2006, a total of 109,437 shares wereissued to non-employee directors in lieu of these past-due fees.

InMay 2006, our former President and Chief Operating Officer, Ricardo Salas, wasgiven the opportunity to receive shares of stock under the plan in lieu ofpast-due salaries and fees that were due to him for services rendered throughMarch 31, 2006.  Such shares wereissuable to Mr. Salas at an average price of $1.41 per share.  In May 2006, a total of 28,960 shares wereissued to Mr. Salas in lieu of these past-due salaries and fees.

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**2002 Non-employee Director StockOption Plan**

Our2002 Non-employee Director Stock Option Plan was adopted by our board ofdirectors and by our stockholders in April 2002. We have reserved a total ofone million shares of our common stock for issuance under the plan. The optiongrants under the plan are automatic and nondiscretionary, and the exerciseprice of the options is equal to 100% of the fair market value of our commonstock on the grant date.

Onlynon-employee directors are eligible for grants under the plan. The plan willprovide for an initial grant to a new non-employee director of an option topurchase 50,000 shares of our common stock. Subsequent to the initial grants,each non-employee director will be automatically granted on the first businessday of January commencing January 1, 2003, an option to purchase 10,000 sharesof our common stock.

Theterm of the options granted under the plan is 10 years, but the options expire12 months after the termination of the optionee’s status as a director or threemonths if the termination is due to the voluntary resignation of the optionee.The option grants will vest and become exercisable as to one-fifth of theshares on the date that is one year after the date of grant and an additionalone-fifth of the shares subject to the option on a cumulative basis will vestand become exercisable annually thereafter.

Asof December 31, 2006, options to purchase 330,000 shares of common stock wereoutstanding at a weighted average price of $2.16 per share under the 2002Non-employee Director Stock Option Plan. There were 54,000 options exercisableunder the 002 Non-employee Director Stock Option Plan as of December 31, 2006.

Theplan will terminate in October 2012, unless our board of directors terminatesit sooner.

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

InJune 2003, the Company entered into an exclusive, ten-year license agreementwith LLPG, Inc. (“LLPG”), a corporation headed by, Jack Chitayat, a former directorof the Company.  Under the terms of the agreement, LLPG has the right tocommercialize Liquidmetal alloys, particularly precious-metal basedcompositions, in jewelry and high-end luxury product markets.  TheCompany, in turn, will receive royalty payments over the life of the contracton all Liquidmetal products produced and sold by LLPG.  In conjunctionwith its technology licensing contract, LLPG purchased two proprietaryLiquidmetal alloy melting machines and three proprietary Liquidmetal alloy castingmachines for a total purchase price of $2.0 million.  The Companyrecognized $0.1 million of revenues as minimum royalty fees under the licenseagreement during the year ended December 31, 2006.

InDecember 2006, the Company entered into an amended the license agreement withLLPG, which extends the license agreement to fifteen years at reduced royaltyrates.  Additionally, the amended license agreement includes a $0.4million termination fee to be paid out in quarterly installments in 2007.  Thetermination fee will be recognized as revenue when received in 2007.

TheCompany has a license agreement with California Institute of Technology (“Caltech”)under which we exclusively license from Caltech certain inventions andtechnology relating to amorphous alloys.  Professor William Johnson, amember of the Company’s board of directors, is a professor at Caltech, andsubstantially all of the amorphous alloy technology licensed to us under theCaltech license agreement was developed in Professor Johnson’s Caltechlaboratory.   Additionally, the Company reimburses Caltech forlaboratory expenses incurred by Professor Johnson’s Caltech laboratory, whichduring the years ended December 31, 2006 and 2005, amounted to $0.1 million and$20 thousand, respectively.

Additionally, the Company is a party to a consultingagreement with Mr. Johnson.  Under thisagreement, Mr. Johnson provides consulting services on an as-needed basisthrough 2004 as it relates to marketing and development Liquidmetal alloy.  During 2005, the agreement continued on amonth to month basis.  In April 2006, theCompany entered into an agreement with Mr. Johnson effective from January 1,2006 through December 31, 2006.  During the years ended December 31, 2006and 2005, the Company incurred $0.1 million and $15 thousand in consulting feesfrom Mr. Johnson, respectively.

The Company is a party to a consulting agreement withChitnis Consulting, Inc., which is owned 100% by Shekhar Chitnis, a formerdirector and executive officer of the Company. Under this agreement, the Company engaged Chitnis Consulting to provideconsulting services on an as-needed basis through December 31, 2005.  On January 1, 2006, the term of the agreementwas extended to December 31, 2006 and on January 1, 2007, the term of theagreement was once again extended to December 31, 2007.  During theyears ended December 31, 2006 and 2005, the Company incurred $0 and $0.1million in consulting fees from Chitnis Consulting, respectively.

SooBuchanan, the sister of John Kang and James Kang, was employed by the Companyand was paid aggregate compensation of approximately $0 and $0.1 million as ofDecember 31, 2006 and 2005, respectively.  Effective, July 31, 2005, Ms.Buchanan was terminated as an employee and began providing services to theCompany as a consultant.  During 2006 and2005, the Company incurred $0.1 million and $24 thousand, respectively, for herservices as a consultant. Additionally, Otis Buchanan, the husband of Ms.Buchanan, was employed by the Company and was paid aggregate compensation ofapproximately $0.1 million as of December 31, 2006 and 2005.

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In November 2004, the Company enteredinto an agreement with John Kang, our Chairman of the Board, in which Mr. Kangagreed that certain stock transactions by him in 2002 involving the Company’scommon stock should have resulted in a liability under Section 16(b) of theSecurities Exchange Act of 1934, as amended (“Section 16(b)”).  These transactions include Mr. Kang’s privatesale of 285,715 shares of his personal Liquidmetal Technologies common stock toGrowell Metal Co., Ltd. in February 2002, prior to our initial publicoffering.  They also include Mr. Kang’ssubsequent indirect purchase and disposition of Liquidmetal Technologies commonstock in order to satisfy a personal agreement Mr. Kang made to Growell Metalin February 2002 regarding the guaranteed minimum value of the stock purchasedby Growell Metal in February 2002 (the purchases and dispositions incident tothis agreement occurred in August and November 2002, respectively).  Lastly, the transactions include open-marketpurchases of an aggregate of 89,300 shares of the Company’s common stock madeby Mr. Kang in August 2002.

TheAudit Committee of our Board of Directors conducted an independent inquiry intothe above-described transactions with the aid of independent legal counsel and,as a result of such inquiry, the Audit Committee concluded that thetransactions should have resulted in a liability to the Company under Section16(b) in the amount of $0.3 million.  Mr.Kang has acknowledged this liability, and in an agreement negotiated betweenMr. Kang and the Audit Committee and approved by the full Board, Mr. Kang willpay this liability through periodic installments in 2005 and 2006.  As a result, the Company accrued for the $0.3million receivable in other assets and other income as of December 31,2004.  The above-described transactionsinvolving Growell Metal was reported on a new Form 4 filed by Mr.Kang on November 15, 2004, and the open-market purchases were previouslyreported on a timely basis in August 2002. As of December 31, 2006, the outstanding amount of the receivable was$0.2 million, which is included in other assets.  Mr. Kang has paid $0 during 2006 and iscurrently in negotiation with the Board of Directors on a payment plan for theremaining liability.

Duringthe year ended December 31, 2005, the Company executed a $0.2 millionpromissory note with CK Cho, member of our Board of Directors, for workingcapital purposes.  The note was due andpaid in full as of June 20, 2005.  Thenote had an annual rate of interest of 6% resulting in the Company payingapproximately $2 thousand in interest. Further, during the year ended December 31, 2005 Mr. Cho advancedapproximately $1.3 million to cover short-term liquidity needs.  The advance were made without interest andwere repaid as of December 31, 2005.  Asof both, December 31 2006 and 2005, Mr. Cho holds $0.6 million of SeniorConvertible Notes and holds 92,584 exercisable warrants.

Duringthe year ended December 31, 2005, Ricardo Salas, the Company’s former Presidentand Chief Executive Officer, and Young Ham, our Chief Financial Officer,advanced the Company $0.1 million and $0.1 million to cover short-termliquidity needs, respectively.  The advanceswere made without interest and were repaid as of December 31, 2005.  During the year ended December 31, 2006,Ricardo Salas, the Company’s former President and Chief Executive Officeradvanced the Company $0.6 million to cover short-term liquidity need.  The Company paid $0.1 million to Mr. Salasusing 7.75% interest rate and on December 1 2006, the remaining balance of $0.5million and its accrued interest of $9 thousand was converted into the 8%Unsecured Subordinated Notes.  Mr. Salasalso held $0.3 million of senior convertible notes and $0.6 million of theAugust 2007 Subordinated Notes and held a total of 154,529 warrants as ofDecember 31, 2006.

During2006, the Company purchased production supplies and molds from Grace Metal,Lead Metal, and SDM, which are controlled by James Kang, a former director andofficer of the Company.  The Companypurchased a total of $0.5 million for the year ended December 31, 2006, ofwhich, $10 thousand is included in accounts payable and accrued liabilities atDecember 31, 2006.

Webelieve that each of the foregoing transactions was consummated on terms atleast as favorable to us as we would expect to negotiate with unrelated thirdparties.

**Item14. Principal Accounting Fees and Services**

Prior toJanuary 2006, Stonefield Josephson, Inc. was our independent public accountant;however, effective December 1 2005, Stonefield Josephson, Inc. resigned as ourindependent accountant.  LiquidmetalTechnologies subsequently engaged Choi, Kim & Park, LLP on January 20,2006.  The following includes principalaccounting fees and services from our auditors.

Choi, Kim & Park, LLP

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

| Fees           | ** ** | **2006** | ** ** |
|----------------|------------|----------|------------|
| Audit Fees (1) |       | $        | 540,000    |   |
|                |            |          |            |  |

----

(1)*Audit Fees.*Fees for audit services billed in 2006 consisted of:

·                  Auditof the Company’s financial statements for 2005;

·                  Reviewof the Company’s quarterly financial statements for 2006;

·                  Review of the Company’s internalcontrols in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 for2006;

60

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·                  Reviewof the Company’s restatements of all quarterly and annual financial statementsfor 2004 and 2005 and the first quarterly financial statement for 2006;

·                  Reviewof the Company’s S-1 filing for 2006.

Stonefield Josephson,Inc.

StonefieldJosephson, Inc. was engaged in May 2004 and has served as our independentpublic accountants during the year ended December 31, 2003 and 2004, andthrough December 1, 2005.

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

| Fees           | ** ** | **2004** | ** ** | **2005** | ** ** | **2006** | ** ** |
|----------------|------------|----------|------------|----------|------------|----------|------------|
| Audit Fees (1) |       | $        | 150,000    |     | $          | 420,000  |       | $ | 132,000 |   |
|                |            |          |            |          |            |          |            |  |  |  |

----

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

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

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

Fees for audit services billed in 2005 consisted of:

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

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

Fees for services billed in 2006 consisted of:

·                  Reviewof the Company’s 2004 and 2005 numbers as included in the Company’s annual andquarterly financial statements for 2005 and 2006, respectively.

The AuditCommittee pre-approves all audit and permissible non-audit services provided bythe independent directors on a case-by-case basis.  The Audit Committee approved 100% of theservices performed by Choi, Kim & Park, LLP and Stonefield Josephson, Inc.in 2006, 2005, and 2004 as identified above.

**PART IV**

**Item 15.Exhibits and Financial Statement Schedules**
|     | (a)  The following  documents are filed as a part of this report:    |
|----------|---------------------------------------------------------------------------|
|     |                                                                      |
| * * | * *                                                                  | *1. Financial Statements.* |
| * * | * *                                                                  | * * |
| * * | * *                                                                  | *2. Financial  Statement Schedules.* See the last page of Consolidated  Financial Statements. |
| * * | * *                                                                  | * * |
| * * | * *                                                                  | *3. Exhibits.*  See Item 15(c) below. |
| * * | * *                                                                  |
| * * | *(b)   Exhibits.*                                                    | The exhibits  listed on the Exhibit Index, which appears at the end of this  Item 15, are filed as part of, or incorporated by reference into, this  report. |
| * * | * *                                                                  | * * |
|     | (c)  *Financial Statement  Schedules.* See Item 15(a)(2) above. |
|          |                                                                           |  |  |

 

61

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**EXHIBITINDEX**
| Exhibit  Number | ** ** | **Document Description**                                                                                                                                                                                                                                                                                                                                                              |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                                                                                                                                                  |
| 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).*                                                                                                                                                              |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.5            |       | 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).*                                                                                                                                                                       |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.22           |       | 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).*                                                                                                                                                                                        |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                  |
| 10.29           |       | 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).*                                                                              |

62

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| Exhibit  Number | ** ** | **Document Description**                                                                                                                                                                                                                                                        |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                                            |
| 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 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 Secured 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 Secured 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).*                                                                      |
|            | * *   | * *                                                                                                                                                                                                                                                                        |
| 10.48           |       | Securities Purchase Agreement dated August 2, 2005,  among Liquidmetal Technologies, Inc. and the parties identified as  “Purchasers” therein*(incorporated by reference from Exhibit  10.1 of the Registrant’s 10-Q/A filed on 08/30/05)*                       |
|            | * *   | * *                                                                                                                                                                                                                                                                        |
| 10.49           |       | Form of 7% Senior Secured Convertible Note of  Liquidmetal Technologies, Inc., dated August 2, 2005*(incorporated by reference from Exhibit  10.2 of the Registrant’s 10-Q/A filed on 08/30/05)*                                                                           |
|            | * *   | * *                                                                                                                                                                                                                                                                        |
| 10.50           |       | Form of Common Stock Purchase Warrant, dated August  2, 2005*(incorporated by reference from Exhibit 10.3 of  the Registrant’s 10-Q/A filed on 08/30/05)*                                                                                                                  |
|            | * *   | * *                                                                                                                                                                                                                                                                        |
| 10.51           |       | Amended and Restated Registration Rights Agreement,  dated August 2, 2005, among Liquidmetal Technologies, Inc. and the parties  identified as “Purchasers” therein*(incorporated by reference from Exhibit  10.4 of the Registrant’s 10-Q/A filed on 08/30/05)* |
|            | * *   | * *                                                                                                                                                                                                                                                                        |
| 10.52           |       | Amended and Restated Security Agreement, dated  August 2, 2005, among Liquidmetal Technologies, Inc. and the parties  identified as the “Secured Parties” therein*(incorporated by reference from Exhibit  10.5 of Registrant’s 10-Q/A filed on 08/30/05)*       |

 

63

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| Exhibit  Number | ** ** | **Document Description**                                                                                                                                                                                                                                                                                                                                                                                                                                               |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.54           |       | Securities Purchase Agreement, dated June 13, 2005,  among Liquidmetal Technologies, Inc. and the parties identified as  “Purchasers” therein*(incorporated by reference from Exhibit  99.1 of the Registrant’s 8-K filed on 06/16/05)*                                                                                                                                                                                                                 |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.55           |       | Form of 10% Convertible Unsecured Note of  Liquidmetal Technologies, Inc. due June 2006 *(incorporated by reference from Exhibit  99.2 of the Registrant’s 8-K filed on 06/16/05)*                                                                                                                                                                                                                                                                                |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.56           |       | Form of Common Stock Purchase Warrant, dated June  13, 2005 *(incorporated by reference from Exhibit 99.3 of  the Registrant’s 8-K filed on 06/16/05)*                                                                                                                                                                                                                                                                                                            |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.57           |       | Registration Rights Agreement, dated June 13, 2005,  among Liquidmetal Technologies, Inc. and the parties identified as  “Purchasers” therein *(incorporated by reference from Exhibit  99.4 of the Registrant’s 8-K filed on 06/16/05)*                                                                                                                                                                                                                |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.58           |       | Agreement, dated November 3, 2004, between  Liquidmetal Technologies, Inc. and John Kang relating to liability under  Section 16(b)*(incorporated by reference  from Exhibit 10.58 to the Form 10-K filed on March 16, 2006).*                                                                                                                                                                                                                                         |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.59           |       | Form of Indemnity Agreement between Liquidmetal  Technologies, Inc. and directors and executive officers*(incorporated by reference from Exhibit 10.59 to  the Form 10-K filed on March 16, 2006).*                                                                                                                                                                                                                                                                    |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.60           |       | Factoring, Loan, and Security Agreement, dated April  21, 2005, between Liquidmetal Technologies, Inc. and Hana Financial, Inc. and  Amendment No. 1 to Factoring, Loan, and Security Agreement, dated January 27,  2006, between Liquidmetal Technologies, Inc. and Hana Financial, Inc.*(incorporated by  reference to Exhibit 10.60 to the Registration Statement on  Form S-1 (Amendment No. 1) filed on 04/20/06 (Registration  No. 333-130251)).* |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.61           |       | 10% Subordinated Promissory Note Due October 16,  2006 of Liquidmetal Technologies, Inc., dated March 17, 2006, issued to  Atlantic Realty Group, Inc.*(incorporated by reference to  Exhibit 10.61 to the Registration Statement on Form S-1 (Amendment  No. 1) filed on 04/20/06 (Registration No. 333-130251)).*                                                                                                                                     |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.62           |       | Warrant for Purchase of Shares of Common Stock,  dated March 17, 2006, granted by Liquidmetal Technologies, Inc. to Atlantic  Realty Group, Inc.*(incorporated by  reference to Exhibit 10.62 to the Registration Statement on  Form S-1 (Amendment No. 1) filed on 04/20/06 (Registration  No. 333-130251)).*                                                                                                                                          |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.63           |       | Amendment to Settlement Agreement, dated March 21,  2006, between Liquidmetal Technologies, Inc. and Innometal Co., Ltd.*(incorporated by reference to Exhibit 10.63 to the Registration  Statement on Form S-1 (Amendment No. 1) filed on 04/20/06 (Registration  No. 333-130251)).*                                                                                                                                                                   |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.64           |       | Employment Agreement, dated April 19, 2006, between  Liquidmetal Technologies, Inc. and Ricardo Salas*(incorporated by reference to Exhibit 10.64 to the Registration  Statement on Form S-1 (Amendment No. 1) filed on 04/20/06 (Registration  No. 333-130251)).*                                                                                                                                                                                      |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.65           |       | Consulting Agreement, dated April 12, 2006, between  Liquidmetal Technologies, Inc. and William Johnson *(incorporated  by reference to Exhibit 10.65 to the Registration Statement on  Form S-1 (Amendment No. 1) filed on 04/20/06 (Registration  No. 333-130251)).*                                                                                                                                                                                  |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.66           |       | Securities Purchase Agreement, dated May 17, 2006,  among Liquidmetal Technologies, Inc. and the parties identified as  “Purchasers” therein*(incorporated by reference to  Exhibit 10.66 to the Registration Statement on Form S-1 (Amendment  No. 2) filed on 07/20/06 (Registration No. 333-130251)).*                                                                                                                                     |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.67           |       | Form of 8% Unsecured Subordinated Note due August  2007 *(incorporated by reference to Exhibit 10.67  to the Registration Statement on Form S-1 (Amendment No. 2) filed on  07/20/06 (Registration No. 333-130251)).*                                                                                                                                                                                                                                   |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.68           |       | Form of Common Stock Purchase Warrant, dated May 17,  2006*(incorporated by reference to Exhibit 10.68  to the Registration Statement on Form S-1 (Amendment No. 2) filed on  07/20/06 (Registration No. 333-130251)).*                                                                                                                                                                                                                                 |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.69           |       | Registration Rights Agreement, dated May 17, 2006,  among Liquidmetal Technologies, Inc. and the parties identified as  “Purchasers” therein*(incorporated by reference to  Exhibit 10.69 to the Registration Statement on Form S-1 (Amendment  No. 2) filed on 07/20/06 (Registration No. 333-130251)).*                                                                                                                                     |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.70           |       | Consulting Agreement, dated October 20, 2006,  between Liquidmetal Technologies, Inc. and James Kang*(incorporated by reference from Exhibit  10.1 to the Form 8-K filed on 10/24/06).*                                                                                                                                                                                                                                                                                |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.71           |       | Amendment of Stock Option Agreements and Consulting Agreement, dated  November 13, 2006, between Liquidmetal Technologies, Inc. and James Kang *(incorporated by reference from Exhibit 10.1 to the  Form 10-Q filed on 11/14/06).*                                                                                                                                                                                                                                    |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.72           |       | Securities Purchase Agreement, dated January 3, 2007*(the  “Securities Purchase Agreement”)*, among Liquidmetal Technologies,  Inc. *(the “Company”)*and the investors  listed on the Schedule of Buyers attached thereto *(the  “Buyers”)**(incorporated  by reference from Exhibit 10.1 to the Form 8-K filed on 01/04/07).*                                                                                                           |
|            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.73           |       | Form of Convertible Subordinated Note issued pursuant to Securities  Purchase Agreement***(incorporated by reference from Exhibit 10.2 to the  Form 8-K filed on 01/04/07).*                                                                                                                                                                                                                                                                                           |

64

----

 
| 10.74  |   | Form of Common Stock Purchase Warrant issued  pursuant to Securities Purchase Agreement *(incorporated  by reference from Exhibit 10.3 to the Form 8-K filed on 01/04/07).*       |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                              |
| 10.75  |   | Registration Rights Agreement, dated January 3,  2007, among the Company and the Buyers*(incorporated by reference from Exhibit  10.4 to the Form 8-K filed on 01/04/07).*        |
|   |   |                                                                                                                                                                              |
| 10.76  |   | Amendment No. 2 to Factoring, Loan & Security  Agreement, dated January 23, 2007, between Liquidmetal Technologies Inc. and  Hana Financial, Inc.                             |
|   |   |                                                                                                                                                                              |
| 14     |   | Code of Ethics for Chief Executive Officer and  Senior Financial and Accounting Officers*(incorporated by  reference to Exhibit 14 to the Form 10-K filed on November 10, 2004).* |
|   |   |                                                                                                                                                                              |
| 21     |   | Subsidiaries of the Registrant.*(incorporated by reference from Exhibit 21 to the Form 10-K filed on November  10, 2004).*                                                        |
|   |   |                                                                                                                                                                              |
| 23.1   |   | Consent of Registered Independent Public Accounting  Firm, Choi, Kim & Park, LLP.                                                                                             |
|   |   |                                                                                                                                                                              |
| 23.2   |   | Consent of Registered Independent Public Accounting  Firm, Stonefield Josephson, Inc.                                                                                             |
|   |   |                                                                                                                                                                              |
| 24.1   |   | Power of Attorney relating to subsequent amendments  (included on the signature page(s) of this report)                                                                           |
|   |   |                                                                                                                                                                              |
| 31.1   |   | Certification of Principal Executive Officer  pursuant to Rule 13a-15(e) or 15d-15(e) of the Securities Exchange Act of  1934, as amended.                                        |
|   |   |                                                                                                                                                                              |
| 31.2   |   | Certification of Principal Financial Officer  pursuant to Rule 13a-15(e) or 15d-15(e) of the Securities Exchange Act of  1934, as amended.                                        |
|   |   |                                                                                                                                                                              |
| 32.1   |   | Certification pursuant to 18 U.S.C. 1350.                                                                                                                                         |

----

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

 

65

----

**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/ Larry Buffington |
|                                                    |
| Larry Buffington  President and Chief Executive Officer |
|                                                    |                           |                 |
| Date: March 16, 2007                                    |                           |                 |
|                                                    |                           |                 |
|                                                    | By:                            | /s/ Young Ham        |
|                                                    |
| Young Ham  Chief Financial Officer                      |
|                                                    |                           |                 |
| Date: March 16, 2007                                    |                           |                 |

 

66

----

**POWEROF ATTORNEY**

KNOW ALL THESE PERSONSBY THESE PRESENTS, that each person whose signature appears below constitutesand appoints Larry Buffingtonand Young Ham and each of them, jointlyand severally, his attorneys-in-fact, each with full power of substitution, forhim in any and all capacities, to sign any and all amendments to this Report onForm 10-K, and to file the same, with exhibits thereto and other documentsin connection therewith, with the Securities and Exchange Commission, herebyratifying and confirming all that each said attorneys-in-fact or his substituteor substitutes, may do or cause to be done by virtue hereof.

Pursuant to therequirements of the Securities Exchange Act of 1934, this Report onForm 10-K has been signed below by the following persons on behalf of theRegistrant and in the capacities and on the dates indicated: 
| Signature           | ** ** | **Title**                          | ** ** | **Date**       |
|---------------------|------------|------------------------------------|------------|----------------|
| ** **          | ** ** | ** **                         | ** ** | ** **     |
| /s/ John Kang       |       | Chairman of the Board and Director |       | March 16, 2007 |
|                |       |                               |       |           |
| John Kang           |       |                               |       |           |
|                |       |                               |       |           |
| /s/ William Johnson |       | Director                           |       | March 16, 2007 |
|                |       |                               |       |           |
| William Johnson     |       |                               |       |           |
|                |       |                               |       |           |
| /s/ Robert Biehl    |       | Director                           |       | March 16, 2007 |
|                |       |                               |       |           |
| Robert Biehl        |       |                               |       |           |
|                |       |                               |       |           |
| /s/ Dean Tanella    |       | Director                           |       | March 16, 2007 |
|                |       |                               |       |           |
| Dean Tanella        |       |                               |       |           |
|                |       |                               |       |           |
| /s/ CK Cho          |       | Director                           |       | March 16, 2007 |
|                |       |                               |       |           |
| CK Cho              |       |                               |       |           |
|                |       |                               |       |           |
| /s/ Patrick Caruana |       | Director                           |       | March 16, 2007 |
|                |       |                               |       |           |
| Patrick Caruana     |       |                               |       |           |

 

Certificationsprovided as Exhibits.

67

----

**INDEXTO CONSOLIDATED FINANCIAL STATEMENTS**
|                                                                    | ** ** | ** ** |
|--------------------------------------------------------------------|------------|------------|
|                                                               | ** ** | **Page**   |
|                                                               |       |       |
| Report  of Independent Registered Public Accounting Firm           |       | 69         |
| Consolidated  Financial Statements:                                |       |       |
| Consolidated  Balance Sheet                                        |       | 71         |
| Consolidated Statements of Operations and  Comprehensive Loss      |       | 72         |
| Consolidated Statements of Shareholders’ Equity  (Deficiency) |       | 73         |
| Consolidated Statements of Cash Flows                              |       | 74         |
| Notes  to Consolidated Financial Statements                        |       | 76         |

 

68

----

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directorsand Shareholders of Liquidmetal Technologies, Inc.

We have audited theaccompanying consolidated balance sheet of Liquidmetal Technologies, Inc. andsubsidiaries (the “Company”) as of December 31, 2006 and 2005, and the relatedconsolidated statements of operations and comprehensive loss, shareholders’equity (deficiency), and cash flows for the years ended December 31, 2006 and2005 as well as the effects of the adjustments for the correction of the errordescribed in Note 2 as of and for the year ended December 31, 2004. Our auditsalso included the financial statement schedule listed at index in Item 15(a) asof and for the years ended December 31, 2006 and 2005. Our responsibility is toexpress an opinion on the financial statements and financial statement schedulebased on our audits.

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of Liquidmetal Technologies, Inc. and subsidiaries as ofDecember 31, 2006 and 2005, and the results of their operations and cash flowsfor the years ended December 31, 2006 and 2005, as well as the effects of theadjustments for the correction of the error described in Note 2 as of and forthe year ended December 31, 2004, in conformity with accounting principlesgenerally accepted in the United States of America. Also, in our opinion, suchfinancial statement schedule, when considered in relation to the basicconsolidated financial statements taken as a whole, presents fairly in allmaterial respects the information set forth therein.

The accompanyingconsolidated financial statements have been prepared assuming that the Companywill continue as a going concern. As discussed in Note 3 to the consolidatedfinancial statements, the Company’s significant operating losses and workingcapital deficit raise substantial doubt about its ability to continue as agoing concern. Management’s plans regarding those matters also are described inNote 3. The consolidated financial statements do not include any adjustmentsthat might result from the outcome of this uncertainty.
| /s/ Choi, Kim & Park LLP |   |
|------------------------------|--------|
|                         |
| Los Angeles, California      |
| Certified Public Accountants |

 

February 15, 2007, exceptfor Note 2, as to which the date is July 17, 2006

69

----

**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

To the Board of Directorsand Shareholders of Liquidmetal Technologies, Inc.

We have audited, beforethe effects of the adjustments for the correction of the error described inNote 2, the consolidated statements of operations and comprehensive loss,shareholders’ equity (deficiency), and cash flows of Liquidmetal Technologies,Inc. and subsidiaries (the “Company”) for the year ended December 31, 2004 (the2004 financial statements before the effects of the adjustments discussed inNote 2 are not presented herein). Our audit also included the financialstatement schedule listed at index in Item 15(a), except for the correction ofthe error described in Note 2, as of and for the year ended December 31, 2004. Ourresponsibility is to express an opinion on the financial statements andfinancial statement schedule based on our audits.

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

In our opinion, exceptfor the error described in Note 2, such consolidated financial statementspresent fairly, in all material respects, the financial position of LiquidmetalTechnologies, Inc. and subsidiaries as of December 31, 2004, and the results oftheir operations and cash flows for each of the two 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 statementschedule, except for the error described in Note 2, when considered in relationto the basic consolidated financial statements taken as a whole, presentsfairly in all material respects the information set forth therein.

We were not engaged toaudit, review, or apply any procedures to the adjustments for the correction ofthe error described in Note 2, and accordingly, we do not express an opinion orany other form of assurance about whether such adjustments are appropriate andhave been properly applied. Those adjustments were audited by Choi, Kim &Park LLP.

The accompanyingconsolidated financial statements have been prepared assuming that the Companywill continue as a going concern. As discussed in Note 3 to the consolidatedfinancial statements, the Company’s significant operating losses and workingcapital deficit raise substantial doubt about its ability to continue as agoing concern. Management’s plans regarding those matters also are described inNote 3. The consolidated financial statements do not include any adjustmentsthat might result from the outcome of this uncertainty.
| /s/ Stonefield Josephson, Inc. |   |
|--------------------------------|--------|
|                           |
| Irvine, California             |
| Certified Public Accountants   |

 

March 3, 2005

 

70

----

**LIQUIDMETALTECHNOLOGIES, INC. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(in thousands, except share data)**
| ** **                                                                         | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                         | ** ** | **2006**              | ** ** | **2005** | ** ** |
| ** **                                                                         | ** ** | ** **            | ** ** | **(Restated)** | ** ** |
| **Assets**                                                                         |       |                  |       |   |   |
|                                                                               |       |                  |       |   |   |
| Current assets:                                                                    |       |                  |       |   |   |
| Cash and cash  equivalents                                                         |       | $                     | 144        |   | $ | 1,392 |   |
| Trade accounts  receivables, net of allowance for doubtful accounts of $82 and $61 |       | 3,934                 |       | 2,360 |   |
| Inventories                                                                        |       | 3,765                 |       | 1,748 |   |
| Prepaid expenses  and other current assets                                         |       | 830                   |       | 609 |   |
| Total current  assets                                                              |       | 8,673                 |       | 6,109 |   |
|                                                                               |       |                  |       |   |   |
| Property, plant and  equipment, net                                                |       | 12,095                |       | 13,437 |   |
| Idle equipment                                                                     |       | 194                   |       | 193 |   |
| Other intangibles, net                                                             |       | 1,170                 |       | 1,185 |   |
| Investment in joint  venture                                                       |       | 3                     |       | — |   |
| Other assets                                                                       |       | 109                   |       | 639 |   |
| Total assets                                                                       |       | $                     | 22,244     |   | $ | 21,563 |   |
|                                                                               |       |                  |       |   |   |
| **Liabilities and Shareholders’ Deficiency**                                  |       |                  |       |   |   |
|                                                                               |       |                  |       |   |   |
| Current liabilities:                                                               |       |                  |       |   |   |
| Accounts payable  and accrued expenses                                             |       | 9,802                 |       | 6,530 |   |
| Settlement  payable                                                                |       | —                |       | 3,331 |   |
| Deferred revenue                                                                   |       | 202                   |       | 1,275 |   |
| Short-term debt                                                                    |       | 2,669                 |       | 550 |   |
| Long-term debt,  current portion, net of debt discounts of $3,636 and $0           |       | 14,480                |       | 1,343 |   |
| Warrant  liabilities                                                               |       | 2,662                 |       | 1,792 |   |
| Conversion  feature liabilities                                                    |       | 1,838                 |       | 1,798 |   |
| Other  liabilities, current portion                                                |       | 177                   |       | 483 |   |
| Total current  liabilities                                                         |       | 31,830                |       | 17,102 |   |
|                                                                               |       |                  |       |   |   |
| Long-term debt, net of  current portion and debt discounts of $0 and $8,259        |       | 225                   |       | 5,433 |   |
| Other long-term  liabilities, net of current portion                               |       | 552                   |       | 348 |   |
| Total  liabilities                                                                 |       | 32,607                |       | 22,883 |   |
|                                                                               |       |                  |       |   |   |
| Shareholders’  deficiency:                                                    |       |                  |       |   |   |
| Common stock,  $0.001 par value; 100,000,000 shares authorized and 44,311,768 and  |       |                  |       |   |   |
| 42,187,621  issued and outstanding at December 31, 2006 and 2005, respectively     |       | 44                    |       | 42 |   |
| Additional  paid-in capital                                                        |       | 136,031               |       | 130,893 |   |
| Accumulated  deficit                                                               |       | (149,047              | )          | (134,525 | ) |
| Accumulated  other comprehensive income                                            |       | 2,609                 |       | 2,270 |   |
| Total  shareholders’ deficiency                                               |       | (10,363               | )          | (1,320 | ) |
|                                                                               |       |                  |       |   |   |
| Total liabilities and  shareholders’ deficiency                               |       | $                     | 22,244     |   | $ | 21,563 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

71

----

**LIQUIDMETAL TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS**

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

** **
| ** **                                                                     | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                     | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                     | ** ** | ** **                                  | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
|                                                                           |       |                                        |       |   |   |   |   |
|                                                                           |       |                                        |       |   |   |   |   |
| Revenue                                                                        |       | $                                           | 27,669     |   | $ | 16,365 |   | $ | 17,429 |   |
| Cost of sales                                                                  |       | 22,418                                      |       | 15,129 |   | 12,168 |   |
|                                                                           |       |                                        |       |   |   |   |   |
| Gross profit                                                                   |       | 5,251                                       |       | 1,236 |   | 5,261 |   |
|                                                                           |       |                                        |       |   |   |   |   |
| Operating  expenses                                                            |       |                                        |       |   |   |   |   |
| Selling, general, and administrative                                           |       | 9,962                                       |       | 8,534 |   | 11,591 |   |
| Research and development                                                       |       | 950                                         |       | 1,120 |   | 1,467 |   |
| Impairment of long lived assets                                                |       | —                                      |       | 4,487 |   | — |   |
| Total operating expenses                                                       |       | 10,912                                      |       | 14,141 |   | 13,058 |   |
|                                                                           |       |                                        |       |   |   |   |   |
| Loss before  interest, other income, income taxes, and discontinued operations |       | (5,661                                      | )          | (12,905 | ) | (7,797 | ) |
|                                                                           |       |                                        |       |   |   |   |   |
| Loss from extinguishments of debt                                              |       | —                                      |       | (1,247 | ) | (2,941 | ) |
| Change in value of warrants, gain                                              |       | 279                                         |       | 3,985 |   | 747 |   |
| Change in value of conversion feature, (loss) gain                             |       | (226                                        | )          | 9,118 |   | 2,093 |   |
| Other income                                                                   |       | 572                                         |       | — |   | 302 |   |
| Interest expense                                                               |       | (9,509                                      | )          | (6,021 | ) | (6,577 | ) |
| Interest income                                                                |       | 23                                          |       | 17 |   | 37 |   |
|                                                                           |       |                                        |       |   |   |   |   |
| Loss before income taxes and discontinued operations                           |       | (14,522                                     | )          | (7,053 | ) | (14,136 | ) |
|                                                                           |       |                                        |       |   |   |   |   |
| Income Taxes                                                                   |       | —                                      |       | — |   | — |   |
|                                                                           |       |                                        |       |   |   |   |   |
| Loss from continuing operations                                                |       | (14,522                                     | )          | (7,053 | ) | (14,136 | ) |
|                                                                           |       |                                        |       |   |   |   |   |
| Discontinued  operations:                                                      |       |                                        |       |   |   |   |   |
| Loss from operations of discontinued operations, net                           |       | —                                      |       | — |   | (749 | ) |
|                                                                           |       |                                        |       |   |   |   |   |
| Net loss                                                                       |       | (14,522                                     | )          | (7,053 | ) | (14,885 | ) |
|                                                                           |       |                                        |       |   |   |   |   |
| Other  comprehensive loss:                                                     |       |                                        |       |   |   |   |   |
| Foreign exchange translation gain during the period                            |       | 339                                         |       | 299 |   | 1,716 |   |
| Comprehensive loss                                                             |       | $                                           | (14,183    | ) | $ | (6,754 | ) | $ | (13,169 | ) |
|                                                                           |       |                                        |       |   |   |   |   |
|                                                                           |       |                                        |       |   |   |   |   |
| Per common share  basic and diluted:                                           |       |                                        |       |   |   |   |   |
| Loss per share - continuing operations                                         |       | $                                           | (0.33      | ) | $ | (0.17 | ) | $ | (0.34 | ) |
| Loss per share - discontinued operations                                       |       | $                                           | —     |   | $ | — |   | $ | (0.02 | ) |
| Loss per share basic and diluted                                               |       | $                                           | (0.33      | ) | $ | (0.17 | ) | $ | (0.36 | ) |
|                                                                           |       |                                        |       |   |   |   |   |
|                                                                           |       |                                        |       |   |   |   |   |
| Number of weighted  average shares - basic and diluted                         |       | 43,809                                      |       | 41,833 |   | 41,610 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

72

----

**LIQUIDMETALTECHNOLOGIES, INC. AND SUBSIDIARIES**

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

**(in thousands, except share data)**
| ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | **Unamortized** | ** ** | ** **     | ** ** | ** **             | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|-----------------|------------|----------------|------------|------------------------|------------|------------|------------|
| ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | **Stock-**      | ** ** | ** **     | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | **based**       | ** ** | **Accumu-**    | ** ** | **Other**              | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Common** | ** ** | **Common** | ** ** | **Paid-in**    | ** ** | **Compen-**     | ** ** | **lated**      | ** ** | **Compre-hensive**     | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Shares** | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **sation**      | ** ** | **Deficit**    | ** ** | **Income (loss)** | ** ** | **Total**  | ** ** |
| ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | **(Restated)** | ** ** | **(Restated)**  | ** ** | **(Restated)** | ** ** | ** **             | ** ** | ** ** | ** ** |
|                                          |       |       |       |       |       |           |       |            |       |           |       |                   |       |       |       |
| **Balance  December 31, 2003**                |       | 41,609,652 |       | $          | 42         |           | $          | 128,581         |       | $              | (128       | )                      | $          | (112,587   | )          | $ | 255 |   | $ | 16,163 |   |
|                                          |       |       |       |       |       |           |       |            |       |           |       |                   |       |       |       |
| Stock-based compensation                      |       | —     |       | —     |       | 261            |       | 15              |       | —         |       | —                 |       | 276        |       |
| Unamortized stock option-based compensation   |       | —     |       | —     |       | (113           | )          | 113             |       | —         |       | —                 |       | —     |       |
| Redemption of convertible notes payable       |       | —     |       | —     |       | 914            |       | —          |       | —         |       | —                 |       | 914        |       |
| Warrants cancelled                            |       | —     |       | —     |       | 7              |       | —          |       | —         |       | —                 |       | 7          |       |
| Foreign exchange translation gain             |       | —     |       | —     |       | —         |       | —          |       | —         |       | 1,716                  |       | 1,716      |       |
| Net loss                                      |       | —     |       | —     |       | —         |       | —          |       | (14,885        | )          | —                 |       | (14,885    | )          |
|                                          |       |       |       |       |       |           |       |            |       |           |       |                   |       |       |       |
| **Balance,  December 31, 2004 (As Restated)** |       | 41,609,652 |       | $          | 42         |           | $          | 129,650         |       | $              | —     |                   | $          | (127,472   | )          | $ | 1,971 |   | $ | 4,191 |   |
|                                          |       |       |       |       |       |           |       |            |       |           |       |                   |       |       |       |
| Stock-based compensation                      |       | —     |       | —     |       | 41             |       | —          |       | —         |       | —                 |       | 41         |       |
| Conversion of notes payable                   |       | 485,750    |       | —     |       | 1,026          |       | —          |       | —         |       | —                 |       | 1,026      |       |
| Redemption of convertible notes payable       |       | —     |       | —     |       | 1              |       | —          |       | —         |       | —                 |       | 1          |       |
| Common stock issued as director’s fees   |       | 92,219     |       | —     |       | 175            |       | —          |       | —         |       | —                 |       | 175        |       |
| Foreign exchange translation gain             |       | —     |       | —     |       | —         |       | —          |       | —         |       | 299                    |       | 299        |       |
| Net loss                                      |       | —     |       | —     |       | —         |       | —          |       | (7,053         | )          | —                 |       | (7,053     | )          |
|                                          |       |       |       |       |       |           |       |            |       |           |       |                   |       |       |       |
| **Balance,  December 31, 2005 (As Restated)** |       | 42,187,621 |       | $          | 42         |           | $          | 130,893         |       | $              | —     |                   | $          | (134,525   | )          | $ | 2,270 |   | $ | (1,320 | ) |
| Conversion of notes payable                   |       | 285,750    |       | —     |       | 471            |       | —          |       | —         |       | —                 |       | 471        |       |
| Common stock issued as director’s fees   |       | 109,437    |       | —     |       | 102            |       | —          |       | —         |       | —                 |       | 102        |       |
| Common stock issued to Innometal              |       | 1,700,000  |       | 2          |       | 3,448          |       | —          |       | —         |       | —                 |       | 3,450      |       |
| Stock-based compensation                      |       | 28,960     |       | —     |       | 1,117          |       | —          |       | —         |       | —                 |       | 1,117      |       |
| Foreign exchange translation gain             |       | —     |       | —     |       | —         |       | —          |       | —         |       | 339                    |       | 339        |       |
| Net loss                                      |       | —     |       | —     |       | —         |       | —          |       | (14,522        | )          | —                 |       | (14,522    | )          |
|                                          |       |       |       |       |       |           |       |            |       |           |       |                   |       |       |       |
| **Balance, December 31, 2006**                |       | 44,311,768 |       | $          | 44         |           | $          | 136,031         |       | $              | —     |                   | $          | (149,047   | )          | $ | 2,609 |   | $ | (10,363 | ) |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

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**LIQUIDMETALTECHNOLOGIES, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands, except share data)**
| ** **                                                                                | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                | ** ** | ** **                                  | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| **Operating  activities:**                                                                |       |                                        |       |   |   |   |   |
| Net loss                                                                                  |       | $                                           | (14,522    | ) | $ | (7,053 | ) | $ | (14,885 | ) |
| Add loss from operations and loss on disposition of  discontinued operations              |       | —                                      |       | — |   | 749 |   |
|                                                                                      |       | (14,522                                     | )          | (7,053 | ) | (14,136 | ) |
|                                                                                      |       |                                        |       |   |   |   |   |
| Adjustments to reconcile loss from operations to net  cash used for operating activities: |       |                                        |       |   |   |   |   |
| Impairment of long lived assets                                                           |       | —                                      |       | 4,307 |   | — |   |
| (Gain) loss on disposal of asset                                                          |       | —                                      |       | (14 | ) | 4 |   |
| Depreciation and amortization                                                             |       | 3,574                                       |       | 3,401 |   | 3,444 |   |
| Loss on extinguishment of debt                                                            |       | —                                      |       | 1,247 |   | 2,941 |   |
| Amortization of debt discount                                                             |       | 6,158                                       |       | 3,869 |   | 5,834 |   |
| Stock-based compensation                                                                  |       | 1,075                                       |       | 41 |   | 276 |   |
| Bad debt expense (recovery)                                                               |       | 47                                          |       | (6 | ) | 84 |   |
| Warranty expense                                                                          |       | 46                                          |       | 101 |   | 288 |   |
| Loss (gain) from change in value of warrants                                              |       | (279                                        | )          | (3,985 | ) | (747 | ) |
| Loss (gain) from change in value of conversion  feature                                   |       | 225                                         |       | (9,118 | ) | (2,093 | ) |
| Changes in operating assets and liabilities:                                              |       |                                        |       |   |   |   |   |
| Trade accounts receivable                                                                 |       | (1,621                                      | )          | (686 | ) | 1,996 |   |
| Inventories                                                                               |       | (2,017                                      | )          | (151 | ) | (2,103 | ) |
| Prepaid expenses and other current assets                                                 |       | (221                                        | )          | 350 |   | (535 | ) |
| Other assets                                                                              |       | 142                                         |       | (378 | ) | (869 | ) |
| Accounts payable and accrued expenses                                                     |       | 3,371                                       |       | 1,606 |   | 998 |   |
| Deferred revenue                                                                          |       | (1,073                                      | )          | 375 |   | (535 | ) |
| Other liabilities                                                                         |       | (171                                        | )          | (412 | ) | (1,244 | ) |
| Net cash used for continuing activities                                                   |       | (5,266                                      | )          | (6,506 | ) | (6,397 | ) |
|                                                                                      |       |                                        |       |   |   |   |   |
| Net cash provided by discontinued operations                                              |       | —                                      |       | — |   | 73 |   |
| Net cash used for operating activities                                                    |       | (5,266                                      | )          | (6,506 | ) | (6,324 | ) |
|                                                                                      |       |                                        |       |   |   |   |   |
| **Investing  Activities:**                                                                |       |                                        |       |   |   |   |   |
| Purchases of property and equipment                                                       |       | (932                                        | )          | (169 | ) | (73 | ) |
| Proceeds from the sale of property and equipment                                          |       | 104                                         |       | 69 |   | 38 |   |
| Investment in patents and trademarks                                                      |       | (104                                        | )          | (159 | ) | (273 | ) |
| Investment in joint venture                                                               |       | (3                                          | )          | — |   | — |   |
| Net cash used for investing activities                                                    |       | (935                                        | )          | (259 | ) | (308 | ) |
|                                                                                      |       |                                        |       |   |   |   |   |
| **Financing  Activities:**                                                                |       |                                        |       |   |   |   |   |
| Proceeds from borrowings                                                                  |       | 23,620                                      |       | 17,774 |   | 9,924 |   |
| Repayment of borrowings                                                                   |       | (18,117                                     | )          | (11,333 | ) | (5,184 | ) |
| Repayment of other liabilities                                                            |       | 69                                          |       | (133 | ) | (135 | ) |
| Proceeds from restricted cash                                                             |       | —                                      |       | 754 |   | (754 | ) |
| Net cash provided by financing activities                                                 |       | 5,572                                       |       | 7,062 |   | 3,851 |   |
| Effect of foreign exchange translation                                                    |       | (619                                        | )          | 353 |   | 396 |   |
| Net (decrease) increase in cash and cash equivalents                                      |       | (1,248                                      | )          | 650 |   | (2,385 | ) |
| Cash and cash  equivalents at beginning of period                                         |       | 1,392                                       |       | 742 |   | 3,127 |   |
| Cash and cash  equivalents at end of period                                               |       | $                                           | 144        |   | $ | 1,392 |   | $ | 742 |   |
| Supplemental  cash flow information                                                       |       |                                        |       |   |   |   |   |
| Interest paid                                                                             |       | $                                           | 1,970      |   | $ | 1,472 |   | $ | 640 |   |
| Taxes paid                                                                                |       | $                                           | —     |   | $ | — |   | $ | — |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

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**LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS — (Continued)(in thousands, except share data)**

In 2006, $286 of the Company’s 6% seniorconvertible notes due July 2007 was converted into 285,750 shares of theCompany’s common stock at a conversion price of $1.00 per share.

In 2006, the Company fulfilledits settlement payable to Innometal (formerly known as Growell Metal) of$3,450, net of foreign exchange translation loss, through stock issuance of1,700,000 shares of the company’s common stock.

In 2005, the Company’s 6% seniorconvertible notes due July 2007 was converted into 485,750 of the Company’scommon stock at a conversion price of $1.00 per share.

In 2004, the Company sold its51% ownership interest in Dongyang to the 49% minority shareholder, whichresulted in a loss of $46 from disposal of discontinued operations.

In 2004, the Company sold assets and liability of itsTaesung equipment manufacturing division in Korea to a third party whichresulted in a loss of approximately $184.

.

The accompanying notesare an integral part of the consolidated financial statements.

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**LIQUIDMETALTECHNOLOGIES, INC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**For theYears Ended December 31, 2006, 2005, and 2004**

**(inthousands, except share data)**

** **

**1. Description of Business**

 

Liquidmetal Technologies, Inc. (“LiquidmetalTechnologies”) and its subsidiaries (collectively “the Company”) are in thebusiness of developing, manufacturing, and marketing products made from amorphousalloys. 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 4 for disclosure regarding thedisposal of this segment). In addition, such alloys are used to generateresearch and development services revenue for developing uses related primarilyto defense and medical applications as well as potential license fees,royalties, and other compensation from strategic partnering transactions.

On August 4, 2004, the Company established apost-processing plant in the city of Weihai in Shandong province of China underWeihai Liquidmetal Company Limited, which is 100%  owned by Liquidmetal Korea, to facilitate ourbulk alloy manufacturing business. Weihai Liquidmetal is consolidated into Liquidmetal Technologies with allintercompany transactions eliminated.

**2. Restatement**

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

TheCompany previously had incorrectly accounted for the conversion feature ofsenior convertible notes during 2004 and 2005 in additional paid in capital forthe beneficial conversion feature of the notes under Emerging Issues Task Force(EITF) 00-19, “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock”,  and EITF 00-27  “Application of Issue No. 98-5, ‘Accountingfor Convertible Securities with Beneficial Conversion Features or ContingentlyAdjustable Conversion Ratios,’ to Certain Convertible Instruments.”  The Company had failed to identify andaccount for the conversion feature as an embedded derivative in accordance withSFAS 133.

Thecorrection of the error to properly state the fair value of the embeddedconversion feature of senior convertible notes in accordance with SFAS 133resulted in recognition of $7,595 as a conversion feature liability as of theissuance of the senior convertible note in March 2004 as the convertible notesare considered non-conventional convertible debt instrument.  The correction resulted in recognition of thechange in fair value of the embedded conversion feature in the Company’searnings as a gain of $2,093 and $5,269 for the years ended December 31, 2004and 2005, respectively, as well as adjustments to amortization of debt discountas interest expense of $2,974 and $1,076 for the years ended December 31, 2004and 2005, respectively, and an additional loss on extinguishment of debt of$1,278 for the year ended December 31, 2004. Additionally, the Companyrecognized $542 in additional paid in capital from redemption and conversion ofconvertible notes as of December 31, 2005 (see Note 13).   As part of the restatement,reclassifications to prior period consolidated financial statements have beenmade for consistent presentation of our warrant liabilities, settlementpayable, and change in value of warrant liabilities.

76

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Theeffects of the restatements are as follows:
| ** **                                                                                                                 | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                 | ** ** | **2005**              | ** ** | **2005** | ** ** |
| ** **                                                                                                                 | ** ** | **Previously**        | ** ** | **Restated** | ** ** |
| ** **                                                                                                                 | ** ** | **Reported**          | ** ** | ** ** | ** ** |
| **ASSETS**                                                                                                                 |       |                  |       |   |   |
| Current Assets:                                                                                                            |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                  |       | $                     | 1,392      |   | $ | 1,392 |   |
| Restricted cash                                                                                                            |       | —                |       | — |   |
| Trade accounts receivables, net of allowance for  doubtful accounts                                                        |       | 2,360                 |       | 2,360 |   |
| Inventories                                                                                                                |       | 1,748                 |       | 1,748 |   |
| Prepaid expenses and other current assets                                                                                  |       | 609                   |       | 609 |   |
| Total current assets                                                                                                       |       | 6,109                 |       | 6,109 |   |
|                                                                                                                       |       |                  |       |   |   |
| Property, plant  and equipment, net                                                                                        |       | 13,437                |       | 13,437 |   |
| Idle equipment                                                                                                             |       | 193                   |       | 193 |   |
| Long-term  inventory                                                                                                       |       | —                |       | — |   |
| Other  intangibles, net                                                                                                    |       | 1,185                 |       | 1,185 |   |
| Other assets                                                                                                               |       | 639                   |       | 639 |   |
| Total assets                                                                                                               |       | $                     | 21,563     |   | $ | 21,563 |   |
|                                                                                                                       |       |                  |       |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                             |       |                  |       |   |   |
| Current  liabilities:                                                                                                      |       |                  |       |   |   |
| Accounts payable and accrued expenses                                                                                      |       | $                     | 6,530      |   | $ | 6,530 |   |
| Settlement payable                                                                                                         |       | 3,331                 |       | 3,331 |   |
| Deferred revenue                                                                                                           |       | 1,275                 |       | 1,275 |   |
| Short-term debt                                                                                                            |       | 550                   |       | 550 |   |
| Long-term debt, current portion, net of debt  discount                                                                     |       | 1,343                 |       | 1,343 |   |
| Other liabilities, current portion                                                                                         |       | 483                   |       | 483 |   |
| Warrant liabilities                                                                                                        |       | 1,792                 |       | 1,792 |   |
| Conversion feature liabilities                                                                                             |       | 959                   |       | 1,798 |   |
| Total current liabilities                                                                                                  |       | 16,263                |       | 17,102 |   |
|                                                                                                                       |       |                  |       |   |   |
| Long-term debt,  net of current portion and debt discount                                                                  |       | 6,338                 |       | 5,433 |   |
| Other long-term  liabilities, net of current portion                                                                       |       | 348                   |       | 348 |   |
| Total liabilities                                                                                                          |       | 22,949                |       | 22,883 |   |
|                                                                                                                       |       |                  |       |   |   |
| Shareholders’  equity (deficiency):                                                                                   |       |                  |       |   |   |
| Common stock, $0.001 par value; 100,000,000 shares  authorized  and 42,187,62 issued and outstanding at  December 31, 2005 |       | 42                    |       | 42 |   |
| Additional paid-in capital                                                                                                 |       | 132,861               |       | 130,893 |   |
| Accumulated deficit                                                                                                        |       | (136,559              | )          | (134,525 | ) |
| Accumulated other comprehensive income                                                                                     |       | 2,270                 |       | 2,270 |   |
| Total shareholder’ equity (deficiency)                                                                                |       | (1,386                | )          | (1,320 | ) |
| Total  liabilities and shareholders’ equity (deficiency)                                                              |       | $                     | 21,563     |   | $ | 21,563 |   |

 

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| ** **                                                                                          | ** ** | ** **     | ** ** | **Years Ended December 31,** | ** ** | ** **     | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------|------------|---------------------------------------------|------------|----------------|------------|
| ** **                                                                                          | ** ** | **2005**       | ** ** | **2005**                                    | ** ** | **2004**       | ** ** | **2004** | ** ** |
| ** **                                                                                          | ** ** | **Previously** | ** ** | **Restated**                                | ** ** | **Previously** | ** ** | **Restated** | ** ** |
| ** **                                                                                          | ** ** | **Reported**   | ** ** | ** **                                  | ** ** | **Reported**   | ** ** | ** ** | ** ** |
| ** **                                                                                          | ** ** | ** **     | ** ** | ** **                                  | ** ** | ** **     | ** ** | ** ** | ** ** |
| ** **                                                                                          | ** ** | ** **     | ** ** | ** **                                  | ** ** | ** **     | ** ** | ** ** | ** ** |
| Revenue                                                                                             |       | $              | 16,365     |                                        | $          | 16,365         |       | $ | 17,429 |   | $ | 17,429 |   |
| Cost of sales                                                                                       |       | 15,129         |       | 15,129                                      |       | 12,168         |       | 12,168 |   |
|                                                                                                |       |           |       |                                        |       |           |       |   |   |
| Gross (loss) profit                                                                                 |       | 1,236          |       | 1,236                                       |       | 5,261          |       | 5,261 |   |
|                                                                                                |       |           |       |                                        |       |           |       |   |   |
| Operating  expenses                                                                                 |       |           |       |                                        |       |           |       |   |   |
| Selling, general, and administrative                                                                |       | 8,534          |       | 8,534                                       |       | 11,591         |       | 11,591 |   |
| Research and development                                                                            |       | 1,120          |       | 1,120                                       |       | 1,467          |       | 1,467 |   |
| Impairment of goodwill                                                                              |       | —         |       | —                                      |       | —         |       | — |   |
| Impairment of long lived assets                                                                     |       | 4,487          |       | 4,487                                       |       | —         |       | — |   |
| Total operating expenses                                                                            |       | 14,141         |       | 14,141                                      |       | 13,058         |       | 13,058 |   |
|                                                                                                |       |           |       |                                        |       |           |       |   |   |
| Loss before  interest, other income, income taxes, 

minority interest, and discontinued operations |       | (12,905        | )          | (12,905                                     | )          | (7,797         | )          | (7,797 | ) |
| Loss from extinguishments of debt                                                                   |       | (1,247         | )          | (1,247                                      | )          | (1,663         | )          | (2,941 | ) |
| Change in value of warrants, (loss) gain                                                            |       | 3,985          |       | 3,985                                       |       | 747            |       | 747 |   |
| Change in value of conversion feature, (loss) gain                                                  |       | 3,849          |       | 9,118                                       |       | —         |       | 2,093 |   |
| Other income                                                                                        |       | —         |       | —                                      |       | 302            |       | 302 |   |
| Interest expense                                                                                    |       | (4,945         | )          | (6,021                                      | )          | (3,603         | )          | (6,577 | ) |
| Interest income                                                                                     |       | 17             |       | 17                                          |       | 37             |       | 37 |   |
| Gain on sale of marketable securities held-for-sale                                                 |       | —         |       | —                                      |       | —         |       | — |   |
| Loss before income taxes, minority interest and  discontinued operations                            |       | (11,246        | )          | (7,053                                      | )          | (11,977        | )          | (14,136 | ) |
|                                                                                                |       |           |       |                                        |       |           |       |   |   |
| Income taxes                                                                                        |       | —         |       | —                                      |       | —         |       | — |   |
|                                                                                                |       |           |       |                                        |       |           |       |   |   |
| Loss before minority interest and discontinued operations                                           |       | (11,246        | )          | (7,053                                      | )          | (11,977        | )          | (14,136 | ) |
|                                                                                                |       |           |       |                                        |       |           |       |   |   |
| Minority  interest in loss of consolidated subsidiary                                               |       | —         |       | —                                      |       | —         |       | — |   |
|                                                                                                |       |           |       |                                        |       |           |       |   |   |
| Loss from continuing operations                                                                     |       | (11,246        | )          | (7,053                                      | )          | (11,977        | )          | (14,136 | ) |
|                                                                                                |       |           |       |                                        |       |           |       |   |   |
| Discontinued  operations:                                                                           |       |           |       |                                        |       |           |       |   |   |
| Income (loss) from operations of discontinued  operations, net                                      |       | —         |       | —                                      |       | (749           | )          | (749 | ) |
| Gain (loss) from disposal of discontinued  operations, net                                          |       | —         |       | —                                      |       | —         |       | — |   |
| Net Loss                                                                                            |       | (11,246        | )          | (7,053                                      | )          | (12,726        | )          | (14,885 | ) |
| Other  comprehensive gain (loss):                                                                   |       |           |       |                                        |       |           |       |   |   |
| Foreign exchange translation gain during the period                                                 |       | 299            |       | 299                                         |       | 1,716          |       | 1,716 |   |
| Net unrealized gain (loss) on marketable securities  available-for-sale                             |       | —         |       | —                                      |       | —         |       | — |   |
| Comprehensive loss                                                                                  |       | $              | (10,947    | )                                           | $          | (6,754         | )          | $ | (11,010 | ) | $ | (13,169 | ) |
|                                                                                                |       |           |       |                                        |       |           |       |   |   |
| Per common share  basic and diluted:                                                                |       |           |       |                                        |       |           |       |   |   |
| Loss per share - continuing operations                                                              |       | (0.27          | )          | (0.17                                       | )          | (0.29          | )          | (0.34 | ) |
| Loss per share - discontinuing operations                                                           |       | —         |       | —                                      |       | (0.02          | )          | (0.02 | ) |
| Loss per share basic and diluted                                                                    |       | (0.27          | )          | (0.17                                       | )          | (0.31          | )          | (0.36 | ) |
|                                                                                                |       |           |       |                                        |       |           |       |   |   |
| Number of weighted  average shares - basic and diluted                                              |       | 41,833         |       | 41,833                                      |       | 41,610         |       | 41,610 |   |

 

78

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**3. Liquidity**

The Company has experienced losses fromcontinuing operations during the last three fiscal years and has an accumulateddeficit of $149,047 as of December 31, 2006. Net cash used for continuing operations for the year ended December 31,2006 was $5,266.  At December 31, 2006,working deficit was $23,157.  As ofDecember 31, 2006, the Company’s principal source of liquidity is $144 of cashand $3,934 of trade accounts receivable. Such conditions raise substantial doubt that the Company will be able tocontinue as a going concern.  Theseoperating results occurred while the Company was developing and continues todevelop, commercialize, and manufacture products from an entirely new andunique technology.  These factors haveplaced a significant strain on the financial resources of the Company.  The ability of the Company to overcome thesechallenges depends on its ability to correct its production inefficiencies,continue to reduce its operating costs, generate higher revenue, and achievepositive cash flow from continuing operations and profitability and continuedsources of debt and equity financing. The consolidated financial statements do not include any adjustmentsthat might result from the outcome of the uncertainty.

The Company completed a $1,000 10% subordinatedpromissory note on March 17, 2006.  Also,on May 17, 2006, September 21, 2006, and December 1, 2006, the Companycompleted a private placement of 8% unsecured subordinated notes in theaggregate principal amount of $4,584 (see Note 13). Adequate funds may not beavailable when needed or may not be available on favorable terms.

On January 3, 2007, we completed a private placement of$14,800 in principal amount of 8% Convertible Subordinated Notes due January2010 (the “January 2010 Notes”). The January 2010 Notes were issued foraggregate cash in the amount of $12,850 and in payment of a total of $1,877 inprincipal and accrued but unpaid interest under our previously issued 7% SeniorSecured Convertible Notes due August 2007 and our  8% UnsecuredSubordinated Notes (see Note 23).

We anticipate that the $12,850 aggregate cash raised in theprivate placement will be sufficient to pursue our current operating planonly through the third quarter of 2007, and we will therefore requireadditional funding at or prior to that time. Our need for additional capital could also be accelerated to before thethird quarter of 2007 because we are currently in breach of an obligation underthe January 2010 Notes to satisfy certain previously issued debt within fivedays of the issue date of the January 2010 Notes.  We are currently in discussions with theholders of the January 2010 Notes in an effort to negotiate a forbearance withrespect to this breach, and the holders of the January 2010 Notes have not yetindicated a desire to declare a default under the January 2010 Notes.  However, we cannot be certain that theholders of such notes will not declare a default and accelerate all amounts duethereunder.

As a result of the foregoing, we are actively seekingadditional sources of capital and seeking to restructure and/or modify existingindebtedness.  The amount of funding that we seek and the timing of suchfundraising efforts will depend on the extent to which we are able to increaserevenues through obtaining additional purchase orders for our products and/orthe extent to which we can restructure or modify our debt.  Because we cannot be certain that we will beable to obtain adequate funding from debt, equity, or other traditionalfinancing sources, we are also actively exploring several strategic financingoptions, including the possible sale of our manufacturing plant in South Korea(which would then be replaced with a smaller facility) and the possible sale ofour Liquidmetal Coatings business.  Wecannot guarantee that adequate funds will be available when needed, and if wedo not receive sufficient capital, we may be required to alter or reduce thescope of our operations.

**4. Summary of SignificantAccounting Policies**

*Principles of Consolidation.*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 minorityshareholder.  In June 2004, the Company sold assets and liability of itsTaesung equipment manufacturing division in Korea to a third party.Accordingly, the results of Dongyang and Taesung’s operations have beenreclassified in the consolidated financial statements as discontinuedoperations (see Note 16).  Previously,the results of Donyang and Taesung’s operations have been included in theconsolidated financial statements from the acquisition date.  All intercompany balances and transactionshave been eliminated. A minority interest in Liquidmetal Golf is included inthe consolidated financial statements as a component of the loss fromoperations of the discontinued retail golf segment (see Note 16).   Effective in 2003, management closed theJapan operations and the Seoul office, which did not result in a significantimpact on the financial position or results of operations for any of theperiods presented.   Also, effective inDecember 2003, management closed the Tampa office (see Note 11).  In August 2004,the Company established a post-processing plant in the city 

79

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of Weihai in Shandongprovince of China under Weihai Liquidmetal Company Limited, which is 100% ownedby Liquidmetal Korea, to facilitate our bulk alloy manufacturing business.

*Revenue Recognition.*Revenue isrecognized pursuant to applicable accounting standards including Securities andExchange 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 provide 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.

The Company applies the percentage of completionmethod to recognize revenue earned from government contracts that havecost-plus-fixed-fee arrangements.  Thesearrangements provide the Company with full reimbursement on the actual costincurred, plus a fixed fee that the Company is entitled to.  These arrangements are covered by theAmerican Institute of Certified Public Accountants Statement of Position 81-1, *Accounting for Performance of Construction-Type andCertain Production-Type Contracts* (SOP 81-1) and Accounting ResearchBulletin No. 45, *Long-term Construction-TypeContracts* (ARB 45). In addition, cost-reimbursable contracts arealso specifically covered by Accounting Research Bulletin No. 43, Chapter 11,Section A, *Government Contracts,Cost-Plus-Fixed Fee Contracts*(ARB 43). Substantially all of ourcost-reimbursable and time and material contracts are with the U.S. Government,primarily with the Department of Defense. Revenues recognized under cost-plus-fixed fee are consistent withpercentage of completion method and are consistent with ARB 43.

Sales oncost-reimbursable plus fixed fee type contracts are recognized as allowablecosts are incurred on the contract and become billable to the customer, at anamount equal to the allowable costs plus the estimated profit on thosecosts.  The estimated profit on acost-reimbursable contract is generally fixed or variable based on the contractfee arrangement.

*Cash and Cash Equivalents.*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.*The Companyfollows 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 Accounts Receivables.*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, 2006, four customers represented 52%, or $2,057, of the total outstandingtrade accounts receivable.  One customerrepresented 12%, or $288, of the total outstanding trade accounts receivable asof December 31, 2005.

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 and Equipment.*Property,plant and 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.

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

*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 ten to seventeen years.

*Goodwill. *Beginning January 1,2002, the Company adopted Statement of Financial Accounting Standards (“SFAS”)No. 142, *Goodwill and Other IntangibleAssets*(See “New Accounting Pronouncements”). According to thisstatement, goodwill and other intangible assets are no longer subject toamortization, but instead must be reviewed annually for impairment by applyinga fair value-based test.

*Impairment of Long-livedAssets.*The Company reviews long-lived assets to be held and used inoperations for impairment whenever events or changes in circumstances indicatethat the carrying value of an asset may be impaired. An impairment loss isrecognized when the estimated fair value of the assets is less than thecarrying value of the assets.  TheCompany recognized $0, $4,487, and $0 during the year ended December 31, 2006,2005, and 2004, respectively, for impairment of long-lived assets (see Notes 6and 8).

*Fair Value of FinancialInstruments.*The estimated fair value of amountsreported in the consolidated financial statements have been determined usingavailable market information and valuation methodologies, as applicable. Thecarrying amount of cash and cash equivalents, accounts receivable, accountspayable, and all other current assets and liabilities approximate their fairvalue because of their short term maturities at December 31, 2006 and2005, unless otherwise stated. The fair value of non-current assets andliabilities approximate their carrying value unless otherwise stated.  The fair value of the Company’s long-termdebt is based on interest rates that would be available to the Company for theissuance of debt with similar terms.

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

 *Advertisingand Promotion Expenses.*Advertising and promotion expenses areexpensed when incurred. Advertising and promotion expenses were $10, $2, and$239, for the years ended December 31, 2006, 2005, and 2004 respectively.

*Debt Discount Amortization.*Debtdiscounts for notes payable are amortized to interest expense, using a methodthat approximates the interest method over the term of the related debtinstruments.

*Stock-Based Compensation*. TheCompany previously applied Accounting Principles Board (“APB”) OpinionNo. 25 for options when the exercise price of options granted to employeesis less than the fair value of the underlying stock on the date of grant.  As permitted, the Company had previouslyelected to adopt provisions of Statement of Financial Accounting Standard (“SFAS”)No. 123, Accounting for Stock-Based Compensation for options granted tonon-employees who perform services for the Company and the disclosure-onlyprovisions of options granted to employees.

In December 2004, the FASB issued SFASNo. 123 (revised 2004), *Share-Based Payment (“SFAS123R”), which replaces SFAS No. 123, Accounting for Stock-BasedCompensation, (“SFAS 123”)* and supersedes APB OpinionNo. 25, Accounting for Stock Issued to Employees, (“APB 25”).SFAS 123R requires all share-based payments to employees, including grantsof employee stock options, to be recognized in the financial statements basedon their fair values. Under SFAS 123R, the Company is required to measure thecost of employee services received in exchange for stock options and similarawards based on the grant-date fair value of the award and recognize this costin the income statement over the period during which an employee is required toprovide service in exchange for the award. The pro forma disclosures previouslypermitted under SFAS 123 are no longer an alternative to financialstatement recognition. The Company adopted SFAS 123R on January 1,2006 using the modified prospective method and recorded $1,075 for the yearended December 31, 2006, of non-cash charges for stock compensation related toamortization of the fair value of restricted stock and unvested stock optionsrepresenting an increase from the stock compensation that would have beenrecorded under APB 25 and SFAS 123. Under this method, the Company willrecognize compensation cost, on a prospective basis, for the portion ofoutstanding awards for which the requisite service has not yet been rendered asof January 1, 2006 and any new grants, based upon the grant-date fairvalue of those awards calculated under SFAS 123 for pro forma disclosurepurposes. Accordingly, we have not restated prior period amounts. The followingtable illustrates the pro forma effect on net income for periods prior to theadoption of SFAS 123R as if we had applied the fair value recognitionprovisions of SFAS 123 during such periods:

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| ** **                         | ** **                                                                                                                                     | ** ** | ** ** | **For the years ended December 31,** | ** ** |
|------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|---------------------------------------------------------------|------------|
| ** **                         | ** **                                                                                                                                     | ** ** | ** ** | **2005**                                                      | ** ** | **2004** | ** ** |
| ** **                         | ** **                                                                                                                                     | ** ** | ** ** | **(Restated)**                                                | ** ** | **(Restated)** | ** ** |
|                               |                                                                                                                                           |       |       |                                                          |       |   |   |
| Net loss as  reported              |                                                                                                                                           |       |       | $                                                             | (7,053     | ) | $ | (14,136 | ) |
| *Add:*                             | stock-based  employee compensation expense 

included  in reported net loss, net of related tax effects                                        |       | 41         |                                                          | 276        |   |
| * *                           |                                                                                                                                           |       |       |                                                          |       |   |   |
| *Deduct:*                          | total  stock-based employee compensation expense 

determined  under the fair value based method for all 

awards,  net of related tax effects |       | (2,861     | )                                                             | (4,201     | ) |
|                               |                                                                                                                                           |       |       |                                                          |       |   |   |
| Proforma net loss:                 |                                                                                                                                           |       |       | $                                                             | (9,873     | ) | $ | (18,061 | ) |
| Basic and  diluted loss per share: |                                                                                                                                           |       |       |                                                          |       |   |   |
| As reported                        |                                                                                                                                           |       |       | $                                                             | (0.17      | ) | $ | (0.34 | ) |
| Proforma                           |                                                                                                                                           |       |       | $                                                             | (0.24      | ) | $ | (0.43 | ) |
|                                    |                                                                                                                                                |            |            |                                                               |            |  |  |  |  |  |

 

Thefair value of each option grant is estimated on the date of the grant using theBlack-Scholes option-pricing model with the following weighted-averageassumptions used for grants for the years ended December 31, 2006, 2005, and2004: expected volatility of approximately 100% for all periods; dividend yieldof 0.0% for all periods; expected option life of approximately 5 years;and a risk-free interest rate ranging from 2.9% to 4.8%.

*Income Taxes.*Income taxesare 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 statementcarrying amounts and the tax basis of existing assets and liabilities. Theeffect of a tax rate change on deferred taxes is recognized in operations inthe period that the change in the rate is enacted. Valuation allowances areestablished when necessary to reduce net deferred tax assets to the amountexpected to be realized.

*Translationof Foreign Currency*. The Company applies *FASB No. 52, Foreign Currency Translation*, fortranslating foreign currency into US dollars in ourconsolidation of the financial statements. Upon consolidation of the Company’s foreign subsidiaries into theCompany’s consolidated 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 Korea’s assets and liabilities were translated using the exchangerate at period end and income and expense items were translated at the averageexchange rate for the periods reported. The resulting translation adjustmentwas included in other comprehensive income (loss).

*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.

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*New Accounting Pronouncements.*

In February 2006, theFASB issued SFAS No. 155, (“SFAS No. 155”), “Accounting forCertain Hybrid Instruments,” which amends SFAS No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” and SFAS No. 140,“Accounting for Transfers and Servicing of Financial Assets and Extinguishmentsof Liabilities.” SFAS No. 155 allows financial instruments that haveembedded derivatives to be accounted for as a whole (eliminating the need tobifurcate the derivative from its host) if the holder elects to account for thewhole instrument on a fair value basis. SFAS No. 155 also clarifiesand amends certain other provisions of SFAS No. 133 andSFAS No. 140. This statement is effective for all financialinstruments acquired or issued in fiscal years beginning afterSeptember 15, 2006. The Company does not expect the adoption of this newstandard to have a material impact on its financial position, results ofoperations or cash flows.

In July 2006, the FASBissued FASB interpretation (FIN) No. 48, “Accounting for Uncertainty in IncomeTaxes — an interpretation of FASB statement No. 109,” which prescribes arecognition threshold and measurement process for recording in the financialstatements, uncertain tax positions taken or expected to be taken in a taxreturn.  In addition, FIN 48 providesguidance on the derecognizing, classification, accounting in interim periodsand disclosure requirements for uncertain tax positions.  The Company is currently evaluating theimpact, if any, that FIN 48 will have on its financial statements.

In September 2006, theFASB issued SFAS No. 157, “Fair Value Measurement”*,*whichdefines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements.  The effective date of SFAS No. 157 will bethe first quarter of 2008.  While theCompany is currently evaluating the provisions of SFAS 157, the adoption is notexpected to have a material impact on its consolidated financial statements.

In September 2006, the SEC issued SAB No. 108, “Guidancere: the Use of a Cumulative Effect Adjustment to Correct ImmaterialMisstatements” (“SAB 108”). Registrants are required to apply the provisions ofSAB 108 no later than the annual financial statements for their first fiscalyear ending after November 15, 2006. The application of SAB 108 is not expectedto have a material impact on the Company’s financial statements.

**5. Trade accounts receivable**

Trade accounts receivables from continuingoperations were comprised of the following:

|                                        | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Trade accounts  receivable             |       | $                     | 4,016      |   | $ | 2,421 |   |
| Less: Allowance  for doubtful accounts |       | (82                   | )          | (61 | ) |
| Trade accounts receivable, net         |       | $                     | 3,934      |   | $ | 2,360 |   |

 

**6. Inventories**

Inventories were comprised of the following:

|                    | ** ** | **December 31,** | ** ** |
|--------------------|------------|-----------------------|------------|
| ** **         | ** ** | **2006**              | ** ** | **2005** | ** ** |
|               |       |                  |       |   |   |
| Raw materials      |       | $                     | 966        |   | $ | 565 |   |
| Work in process    |       | 1,729                 |       | 763 |   |
| Finished goods     |       | 1,070                 |       | 420 |   |
| Total  inventories |       | $                     | 3,765      |   | $ | 1,748 |   |

 

TheCompany maintained certain of its raw material inventories in amounts in excessof our operating cycle of one year due to the nature of our manufacturingprocess, production lead time, and the recyclability of our raw material. Theseinventories were classified as long-term inventory as of December 31,2004.  During 2005, the Companydetermined that its current and projected raw material requirements were notsufficient enough to warrant the use of such raw materials in the foreseeablefuture. Accordingly, the Company reduced the carrying value of raw materialsheld by its subsidiary, Liquidmetal Korea, by the amounts 

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consideredto be excessive during the year ended 2005. The write-down during the year ended December 31, 2005 amounted to$2,746 and is included in “Impairment of long lived assets” in the accompanyingConsolidated Statement of Operations and Comprehensive Loss for the year endedDecember 31, 2005. The total amount of long term inventory was $0 as of bothDecember 31, 2006 and 2005.

The Company analyzesinventory held for any excess or obsolescence issues.  Any amounts considered excess or obsolete arewritten off.  Further, as significantamount of sales of Liquidmetal bulk alloy parts are used primarily in consumerelectronics components, our inventory is subject to fluctuations in demand forthose consumer electronics goods. Accordingly, the Company reduces the carryingvalue of raw materials held by its subsidiary, Liquidmetal Korea, by theamounts considered to be excess or obsolete. As of December 31, 2005, the write-downs included in “Cost of Sales” inthe accompanying Consolidated Statement of Operations and Comprehensive Lossamounted to $1,644.  There were no suchwrite downs as of December 31, 2006.

**7. Property, Plant andEquipment**

Property, plant and equipment consists of thefollowing:

|                                                  | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2006**              | ** ** | **2005** | ** ** |
|                                             |       |                  |       |   |   |
| Machinery and  equipment                         |       | $                     | 12,699     |   | $ | 11,365 |   |
| Computer  equipment                              |       | 1,354                 |       | 1,354 |   |
| Office  equipment, furnishings, and improvements |       | 1,553                 |       | 1,824 |   |
| Buildings                                        |       | 13,959                |       | 11,892 |   |
| Construction in  progress                        |       | —                |       | 6 |   |
| Total                                            |       | 29,565                |       | 26,441 |   |
| Accumulated  depreciation                        |       | (17,470               | )          | (13,004 | ) |
| Total property, plant and equipment, net         |       | $                     | 12,095     |   | $ | 13,437 |   |

 

Depreciation expense is classified as follows:

 

|                                      | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|
| ** **                           | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                 |       |                                        |       |   |   |   |   |
| Cost of Sales                        |       | $                                           | 3,229      |   | $ | 2,744 |   | $ | 2,623 |   |
| Selling, general  and administrative |       | 225                                         |       | 542 |   | 700 |   |
| Research and  development            |       | —                                      |       | — |   | 8 |   |
| Total depreciation  expense          |       | $                                           | 3,454      |   | $ | 3,286 |   | $ | 3,331 |   |

 

**8. Idle Equipment**

Idle equipment consists of certain equipmentheld by the Company for use in expansion of bulk alloy partsmanufacturing.  Due to excess manufacturing capacity, theCompany classified the equipment as idle equipment at December 31,2004.  While the equipment may be used internally to meet future capacityrequirements, considering our current revenue and foreseeable productionrequirements, the Company does not anticipate utilizing this equipmentinternally in the near future. For these reasons, during the second quarter of2005, the Company determined to write down the carrying value of the idleequipment held by its subsidiary, Liquidmetal Korea, to its net realizablevalue. The write-down during the quarter ended June 30, 2005 amounted to $1,741and is included in operating expenses as “Impairment of long lived assets” inthe accompanying Consolidated Statement of Operations and Comprehensive Lossfor the year ended December 31, 2005.  In2006, the company disposed of $12 of its idle equipment for proceeds of$104.  The resulting gain of $92 isincluded in other income.  Total amountof idle equipment remaining was $194, and $193 as of December 31, 2006 and2005, respectively.

 

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**9. Other Intangible Assets**

Intangible assets consist ofthe following:

|                                       | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2006**              | ** ** | **2005** | ** ** |
|                                  |       |                  |       |   |   |
| Purchased and licensed  patent rights |       | $                     | 566        |   | $ | 559 |   |
| Internally developed  patents         |       | 1,309                 |       | 1,212 |   |
| Trademarks                            |       | 85                    |       | 85 |   |
| Total                                 |       | 1,960                 |       | 1,856 |   |
| Accumulated  amortization             |       | (790                  | )          | (671 | ) |
| Total intangible  assets, net         |       | $                     | 1,170      |   | $ | 1,185 |   |

 

Amortization expense was $119, $117, and $113,for the years ended December 31, 2006, 2005, and 2004, respectively.   The estimated aggregate amortization expensefor each of the five succeeding years is as follows:

| December 31, | ** ** | **Aggregate Amortization Expense** | ** ** |
|-------------------|------------|----------------------------------------------|------------|
| 2007              |       | $                                            | 118        |   |
| 2008              |       | 117                                          |       |
| 2009              |       | 114                                          |       |
| 2010              |       | 112                                          |       |
| 2011              |       | 109                                          |       |
|                   |            |                                              |            |  |

 

Accumulated Amortization forthe years ended December 31, 2006 and 2005 is as follows:

|                                       | ** ** | **December 31,** | ** ** |
|---------------------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **2006**              | ** ** | **2005** | ** ** |
|                                  |       |                  |       |   |   |
|                                  |       |                  |       |   |   |
| Purchased and licensed  patent rights |       | $                     | (251       | ) | $ | (211 | ) |
| Internally developed  patents         |       | (502                  | )          | (430 | ) |
| Trademarks                            |       | (37                   | )          | (30 | ) |
| Total                                 |       | $                     | (790       | ) | $ | (671 | ) |

 

The weighted average amortization periods foreach of the years ended December 31, 2006, 2005, and 2004 is as follows:

 

|                                      | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                 |       |                  |       |   |   |   |   |
|                                 |       |                  |       |   |   |   |   |
| 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 |   |

 

Purchased patent rights represent the exclusiveright to commercialize the bulk amorphous alloy and other amorphous alloytechnology acquired from California Institute of Technology (“Caltech”), ashareholder, through a license agreement with Caltech (“License Agreement”).Under the License Agreement, the Company has the exclusive right to make, use,and sell products from all of Caltech’s inventions, proprietary information,know-how, and other technology relating to amorphous alloys in existence as ofSeptember 1, 2001. The Company also has an exclusive worldwide license toeleven issued patents and two patent applications held by Caltech relating toamorphous alloy technology, as well as all related foreign counterpart patentsand patent applications. Of the patents currently issued to Caltech andlicensed by the Company, the earliest expiration date is 2013 and the latestexpiration date is 2021. Furthermore, the license agreement gives the Companythe exclusive right to make, use, 

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and sell products from substantially allamorphous alloy technology that is developed in Professor William Johnson’sCaltech laboratory during the period September 1, 2001 throughAugust 31, 2005. All fees and other amounts payable by the Company forthese 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 the patents and patentapplications under the License Agreement with Caltech, the Company hasinternally developed patents. Internally developed patents include legal andregistration costs incurred to obtain the respective patents. The Companycurrently holds various patents and numerous pending patent applications in theUnited States, as well as numerous foreign counterparts to these patentsoutside of the United States.

**10. Settlement Payable**

The settlement payablebalance consists of payables to Growell Metal Co., Ltd., a South Korean metalsprocessing company (“Growell”), as a result of a settlement agreement executedin January 2004.  Under the terms of theJanuary 2004 settlement of the dispute over certain sales transactions from2003 and 2002 between Liquidmetal Korea and Growell, Liquidmetal Korea agreedto pay Growell $4,895 to purchase Growell’s investment in alloy inventories,proprietary alloying equipment purchased from Liquidmetal Korea, and supportingequipment purchased from other suppliers. Also as part of the settlement, Growell satisfied in full a balance of$2,058 owed to Liquidmetal Korea for the die casting machines Growell purchasedfrom Liquidmetal Korea in the first quarter of 2003 as part of a licenseagreement to manufacture Liquidmetal alloy parts for the South Koreanautomotive industry.  The remainingsettlement payable of $2,837 and trade payables of $14 were to be paid toGrowell (in cash or stock at the Company’s discretion) by December 31,2004.  As of December 31, 2005, thesettlement payable was not paid to Growell due to Growell’s breach of warrantyon equipment repurchased by Liquidmetal Korea. The outstanding balance of payables to Growell from the settlement was$3,331 and $3,246 as of December 31, 2005 and 2004, respectively, net offoreign exchange translation loss.

**The Company recorded a loss on the settlement at December31, 2003 of $2,765 which is included in “Cost of Sales” in the December 31,2003 Consolidated Statements of Operations and Comprehensive Loss.  The loss on settlement reflects thewrite-down of the assets received in the settlement to their fair marketvalue.  The sale of the die castingmachines to Growell 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 naturearising between the parties through the date of settlement, as well as arelease against future claims under agreements between the parties that wereterminated as a part of the settlement. The settlement agreement provided that all agreements of any naturebetween the parties and their respective affiliates were terminated as of thedate of settlement, 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 anaccommodation to Growell, if the Company becomes aware of any prospectivecustomer that desires to purchase a proprietary Company casting machine at atime when Growell desires to sell any of its Liquidmetal die casting machines,then the Company will not sell such die casting machine to the prospectivecustomer unless the Company first directs the prospective customer to Growelland encourages the prospective customer to purchase the machine from Growell**.

InJanuary 2005, Growell was acquired by a third party, Innometal Co., Ltd., andon March 21, 2006, the Company entered into an Amendment to SettlementAgreement (the “Settlement Amendment”) with Innometal Co., Ltd. (“Innometal”).  Under the Settlement Amendment, Innometal andthe Company have agreed that the Company’s obligation of $3,331 under theSettlement Agreement will be fully satisfied through the issuance to Innometalof 1,700,000 shares of our common stock. The Company issued 1,700,000 shares to Innometal on March 22, 2006. Theshares were issued to Innometal in a private placement exempt from registrationunder the Securities Act of 1933, as amended (the “Securities Act”).Specifically, the shares were issued by virtue of Section 4(2) of theSecurities Act in that the issuance did not involve a public offering,Innometal has adequate access to information about the Company, and appropriaterestrictive legends were affixed to all certificates representing the shares issuedto Innometal. The shares received by Innometal under the Settlement Amendmentare “restricted securities” within the meaning of Rule 144 under the SecuritiesAct, and Innometal has not been granted any registration rights by the Companywith respect to such shares.

Asan inducement for Innometal to enter into the Settlement Amendment, James Kang,a former director and officer of the Company, had entered into a buy-sellagreement with Innometal whereby Mr. Kang agreed to personally purchase fromInnometal, and Innometal had agreed to sell to Mr. Kang, the 1,700,000 sharesissued to Innometal under the Settlement Amendment.  Mr. Kang received noconsideration from the Company in connection with his entering into thisbuy-sell agreement and no registration rights with respect to the shares underthe buy-sell agreement.  While the terms of the buy-sell agreement may 

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beindependently re-negotiated between Mr. Kang and Innometal, all releases to theCompany that are applicable under the Settlement Amendment has and will remainin full force and effect.

**11. Other Liabilities**

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

|                                                    | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Accrued severance                                  |       | $                     | 558        |   | $ | 550 |   |
| Accrued operating lease  costs                     |       | 165                   |       | 215 |   |
| Accrued capital lease  costs                       |       | 6                     |       | 69 |   |
| Total                                              |       | 729                   |       | 834 |   |
|                                               |       |                  |       |   |   |
| Imputed interest                                   |       | —                |       | (3 | ) |
| Total                                              |       | 729                   |       | 831 |   |
| Less current portion                               |       | (177                  | )          | (483 | ) |
| Other long term  liabilities, less current portion |       | $                     | 552        |   | $ | 348 |   |

 

During 2003, the Companyinitiated activities to substantially reduce the number of employees andconsolidate manufacturing and administrative facilities to improve operationaleffectiveness and efficiency and reduce expenses.  During the year ended December 31, 2003,there were a total of 225 employees terminated. The total amount of severance granted to the terminated employees is$2,718.  The categories of employees thatwere eliminated include the following: Product management positions at various levels, including VicePresident; entry level technicians; accounting and finance positions from entrylevel through executive; marketing mid to senior level positions; engineeringmid to senior levels positions; information technology support; administrative,legal and executive support; senior internal legal counsel; human resources andsenior executives.  Also, there wereother relocation expenses associated with relocating the Tampa, Florida officeto Lake Forest, California totaling $759, which included the accrual of allremaining facility and telecommunication lease payments for the Tampa, Floridaoffice.  Total liability accrued from therelocation and terminations in 2003, including the severance and leaseaccruals, were $165 and $276 as of December 31, 2006 and 2005,respectively.  The Company hassubstantially concluded all cost reduction and restructuring activities as ofMarch 31, 2004.

All leases with an initial term greater than oneyear are accounted for under SFAS No. 13 *Accountingfor Leases.*These leases are classified as either capital leases oroperating leases, as appropriate.  Assetsunder capital leases are capitalized using interest rates appropriate at theinception of each lease. At December 31, 2006, the cost recorded for the officefurniture and furnishings, the SEM Microscope and the JSM 6360 ElectronMicroscope under the capital lease was $107, $47 and $289, respectively, andthe accumulated amortization was $100, $32 and $205, respectively.  At December 31, 2005, the cost recordedfor the office furniture and furnishings, the SEM Microscope and the JSM 6360Electron Microscope under the capital lease was $107, $47 and $289,respectively and the accumulated amortization $79, $27 and $147, respectively.  Future minimum lease payments for the aboveassets under capital leases is $6 for 2007.

**12. Product Warranty**

Management estimates product warranties as apercentage of certain bulk alloy product sales earned during the period. As ofDecember 31, 2006 and 2005, the Company used 5%of bulk alloy product sales asan estimate of warranties to be claimed. During the years ended December 31, 2005 and 2006, the Company’sproduct warranty accrual balance had the following activity:

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| Balance, December 31, 2004  |   | $   | 519    |   |
|-----------------------------|--------|-----|--------|--------|
| Expense accrual             |   | 101 |   |
| Warranty charges            |   | 14  |   |
| Balance, December 31,  2005 |   | $   | 634    |   |
| Expense accrual             |   | 46  |   |
| Warranty charges            |   | 58  |   |
| Balance, December 31, 2006  |   | $   | 738    |   |

 

The product warranty accrual balance wasincluded in accounts payable and accrued expenses at December 31, 2006 andDecember 31, 2005.

**13. Notes Payable**

Senior Convertible Note

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

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

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

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

During 2004, the Company redeemed $4,465 of theoutstanding note balance in cash.  Theredemption resulted in a write down of debt issuance costs and debt discount of$3,571 to interest expense and a reduction in conversion feature liabilities of$914 from cancellation of the embedded conversion feature of the redeemed notesto additional paid in capital during the year ended December 31, 2004.  Further, 500,000 of warrants originallyissued to a financial advisor for the transaction expired during June 2004 and163,748 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.  The 663,748total expired and canceled warrants immediately 

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prior to the expiration and cancellationresulted in a reduction of warrant liability of $7 and $279 to additional paidin capital and change in value of warrants, respectively, during the year endedDecember 31, 2004.

On August 19, 2004, the Company completed aprivate exchange offer for its March Notes with the remaining holders after theredemption.  Under terms of the exchangeoffer, approximately $5.5 million in aggregate principal amount of the MarchNotes have been exchanged for an aggregate of (i) $2.75 million of 6% SeniorSecured Notes Due 2007 (the “July 2007 Notes”) and (ii) $2.75 million of 10%Senior Secured Notes Due 2005 (the “July 2005 Notes”), collectively referred toas “Exchange Notes”.  The Exchange Notesare collateralized by certain patents owned by the Company and second prioritymortgage interest in plant facilities and certain equipment at our South Koreaplant.  The July 2005 Notes had amaturity date of July 29, 2005, and a conversion price of $2.00 per share(compared to a conversion price of $3.00 per share under the March Notes).  The July 2005 Notes have been exchanged andredeemed subsequent to the close of the second quarter of 2005 (see 2005 SeniorConvertible Notes below). The July 2007 Notes have a maturity date of July 29,2007, and a conversion price of $1.00 per share.   The conversion prices of the July 2007 Notesand July 2005 Notes are subject to price adjustments for anti-dilutionpurposes.  Further, the exchange notesare convertible into Common Stock, at the option of the Company, if at any timeafter the issuance of the notes, the closing per share price of the CommonStock exceeds $4.00 (as adjusted for stock splits, reverse splits, stockdividends, and recapitalizations) for 30 consecutive trading days, and furtherprovided that there has been effective registration during such period.  The convertible price of the Exchange Notesis subject to price adjustment for anti-dilution purposes.  As of December 31, 2006, the convertibleprice of the July 2007 Notes remained unchanged at $1.00 per share.  Holders of the July 2007 Notes also have theright to call for repayment of the July 2007 Notes prior to maturity at anytime after the second anniversary of the closing of the exchange offer.  The July 2007 Notes have been amendedsubsequent to the close of the second quarter of 2005 to provide for an AmendedRegistration Rights Agreement, and Amended and Restated Security Agreement (see2005 Senior Convertible Notes below).

A total of 563,151 warrants to purchase our commonstock at an exercise price of $3.00 per share—all of which were previouslyissued in connection with the purchase of the March Notes—have been amended toprovide for an extended expiration date of March 1, 2006.  There are no outstanding warrants at December31, 2006.

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

In connection with the private exchange offer,the Company issued $250 of private placement notes to certain Placement Agentsas issuance costs.  Of the $250 notesissued, $125 was paid in the form of long-term notes which is due in 2007 with interestrate of 6% per annum (July 2007 Notes) and $125 was paid in the form ofshort-term notes which is due in 2005 with interest rate of 10% per annum (July2005 Notes).  The July 2005 and July 2007Notes are convertible into Common Stock at $2.00 and $1.00, respectively, andhave the same terms as the Exchange Notes issued to the investors.  Further, $143 of original fair value of theembedded conversion feature of $250 notes issued to Placement Agents was recordedas conversion feature liabilities during August 2004.

The Company was obligated, pursuant to aRegistration Rights Agreement, as amended by the Exchange Notes, between theCompany, the Placement Agents and the note holders to file a registrationstatement with the Securities and Exchange Commission (“SEC”) to register theshares of Common Stock issuable upon conversion of the notes payable and therelated warrants within 90 days following the effective closing date of theexchange notes (July 29, 2004), and to use best efforts to cause such registrationstatement to become effective within 60 days following the SEC’s first writtencomments on the registration statement. Further, if the Company is not in compliance with the registration orlisting requirements, the holders have rights to late registration paymentsequal to between 2 and 3 percent of the purchase price paid for the unconvertednotes for the first 30 business days of late registration, and 1 and 3 percentfor each 30 business days thereafter, but no more than 18 percent of the purchaseprice of the unconverted note balance. Late registration fee of $1,028 has been recorded as interest expenseduring the year ended December 31, 2005.

Interest payments are due quarterly, and failureto make timely interest payments will result in increase in interest rate to10% and 14% on the 6% and 10% senior convertible notes (“Default Rates”).  The Default Rates became effective on April1, 2005 from non-payment of a scheduled interest payment.  As of December 31, 2006, the Company hascomplied with all scheduled interest payments.

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

During the year ended December 31, 2006 and2005, $286 and $485 of the July 2007 Notes were converted into 285,750 and485,750, respectively, of the Company’s common stock at a conversion price of$1.00 per share.  Theconversion resulted in reduction of conversion feature liabilities of $186 and$541 to additional paid in capital for the year ended December 31, 2006 and2005, respectively.

The Company’s gross outstanding loan balance ofthe July 2007 Notes totaled $2,083 and $2,369, as of December 31, 2006 and2005, respectively.  As of December 31,2006 and December 31, 2005, un-amortized discounts for conversion feature andwarrants totaled $391 and $1,207, respectively, and other asset debt issuancecosts totaled $14 and $43, respectively. Interest expense for the amortization of debt issuance cost and discounton note was $750 and $1,765 for the year ended December 31, 2006 and 2005,respectively.  As of December 31, 2006and 2005, the effective interest rate of the July 2007 Notes was 35% and 37%,respectively.

Pursuant to Statement of Financial AccountingStandards No. 133, “Accounting for Derivative Instruments and HedgingActivities,” the Company is required to report a value of the conversion liabilityas a fair value and record the fluctuation to the fair value of the conversionfeature liability to current operations. The change in the fair value of the conversionfeature liability resulted in a loss of $564 and a gain of $5,269 for the yearended December 31, 2006 and 2005, respectively. The fair value of conversion features outstanding at December 31, 2006of $1,218 was computed using the Black-Scholes model under the followingassumptions: (1) 0.57 years; (2) volatility of 55%, (3) risk free interest of5.00% and dividend rate of 0%.  The fairvalue of conversion features of outstanding at December 31, 2005 of $840 wascomputed using the Black-Scholes model under the following assumptions: (1)1.57 years; (2) volatility of 88%; (3) risk free interest of 4.41% and dividendrate of 0%.

Pursuant to EITF 00-19, “Accounting forDerivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock”, the original relative fair values of the warrants of$1,302 have been recorded as warrant liability. In addition, the Company is required to report a value of the warrant asa fair value and record the fluctuation to the fair value of the warrantliability to current operations.  Thechange in fair value of warrants resulted in a gain of $0 and $550 for the yearended December 31, 2006 and 2005, respectively. The warrant has expired as of December 31, 2006.

The following is arepayment schedule of the July 2007 Notes based on maturity date of the notes:
| **July 2007 Notes** | ** ** | ** **   | ** ** |
|-------------------------------|------------|--------------|------------|
| **Repayment Schedule**   | ** ** | **Minimum**  | ** ** |
| **December 31,**         | ** ** | **Payments** | ** ** |
|                          |       |         |       |
| 2007                          |       | 2,083        |       |
| Total                         |       | $            | 2,083      |   |
|                               |            |              |            |  |

 

Convertible Notes

On June 13, 2005, the Company completed a privateplacement (the “June 2005 Private Placement”) of 10% Convertible UnsecuredNotes Due June 13, 2006 in the aggregate principal amount of $3,250 (the “June2006 Notes”), together with warrants to purchase up to an aggregate of 893,750shares of the Company’s common stock (the “Warrants”).

The June 2006 Notes issued by the Company in the June 2005Private Placement are unsecured and was due on the earlier of June 13,2006 or the consummation of a follow-on equity or debt offering orrestructuring transaction pursuant to which the Company receives gross proceedsof at least $4,000.  Prior to maturity, the June 2006 Notes areinterest-only, with interest payments due quarterly, at the rate of 10% peryear.  The June 2006 Notes can be prepaid by the Company at any timewithout penalty.  If, within 120 days following the issue date of the June2006 Notes, the Company either fails to redeem the notes for the principalamount and accrued interest thereon or fails to close a “Qualified Financing,”then the June 2006 Notes will thereafter be convertible at a conversion priceequal to seventy five percent (75%) of the closing price of the Company’scommon stock on the first trading day immediately preceding the conversiondate.  A “Qualified Financing “ is defined in the June 2006 Notes as anydebt or equity financing of the Company resulting in aggregate gross proceedsto the Company of at least $5,000 and in which the holders of at least sixtypercent (60%) of the aggregate principal amount of the Company’s July 2007Notes either (i) agree that the equity or debt securities to be issued insuch financing shall be *pari passu* inorder of payment to the July 2007 Notes held by them or (ii) exchangetheir July 2007 Notes for new securities in the financing transaction.  On August 9, 2005, the 

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Company successfully completed Qualified Financing, whichresulted in exchange and redemption of the Convertible Notes (see 2005 SeniorConvertible Notes below).  As a result,the June 2006 Notes never became convertible.

 As a part of the June 2005 Private Placement, theCompany issued warrants to the purchasers of the June 2006 Notes giving themthe right to purchase up to an aggregate of 812,500 shares of the Company’scommon stock.  In addition, warrants to purchase 81,250 shares of theCompany’s common stock were issued to the placement agent in thetransaction.  The warrants have an exercise price of $2.00 per share,provided that upon the consummation of the first ensuing public or privateequity or debt offering or restructuring transaction in which the Companyreceives gross proceeds of at least $3,250 (including without limitation anyrestructuring of the Company’s July 2005 Notes), the exercise price will beautomatically adjusted downward (but not upward) as of the closing date of suchoffering or restructuring transaction so that it is equal to the lowesteffective common stock purchase price paid for any securities issued by theCompany to the investors in such offering or restructuring transaction. The warrants will expire on June 13, 2010 and are subject to exerciseprice adjustment for anti-dilution purposes.  The exercise price of the warrants remainedunchanged at $2.00 per share as of December 31, 2006.

**Thefair value of the 893,750 warrants totaled $1,160 and was computed using theBlack-Scholes pricing model under the following assumptions: (1) expected lifeof 5 years; (2) volatility of 118%, (3) risk free interest of 3.87% anddividend rate of 0%.  In accordance withEmerging Issues Task Force No. 00-27, “Application of Issue No. 98-5 to CertainConvertible Instruments” the embedded beneficial conversion feature of the debtwas not recorded as the debt is considered contingently convertible at the timeof issuance, and as a result of the completion of the Qualified Financing thedebt subsequent to the close of the second quarter, the debt was determined tobe not convertible. In June 2005, the fair value of the 812,500 warrants issuedto investors of $1,055 was recorded as discounts of the convertible note.  In addition $105 relating to the fair valueof the 81,250 warrants issued to the Placement Agents and $278 direct costs incurredrelating to issuance of the convertible note were recorded as debt issuancecost as a contra liability account in debt discount and other assets,respectively, and will be amortized using the effective interest rate methodover the life of the loan.**

**OnAugust 9, 2005, the June 2006 Notes were redeemed in cash and exchanged for 7%Convertible Secured Promissory Notes due August 2007 (see 2005 SeniorConvertible Notes below).  The exchangeoffer was treated as an extinguishment of the June 2006 Notes in accordancewith Emerging Issues Task Force No. 96-19, “Debtors Accounting for aModification or Exchange of Debt Instruments.” The exchange resulted in a $1,247 loss from extinguishment of the June2006 Notes as of December 31, 2005, which consists of write down of $240 ofdeferred issue costs in other assets, $92 of contra liability deferred issuancecosts, and $915 of debt discount as a result of the change in carrying value ofexchanged notes.**

Pursuant to EITF 00-19, “Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock”, the original fair values of the warrants of $1,160 have been recordedas warrant liability.  In addition, theCompany is required to report a value of the warrant as a fair value and recordthe fluctuation to the fair value of the warrant liability to currentoperations.  The change in the fair valueof the warrants resulted in a loss of $69 and a gain $743 for the year ended December 31, 2006 and 2005,respectively.  The fair value of warrantsoutstanding at December 31, 2006 of $487 was computed using the Black-Scholesmodel under the following assumptions: (1) expected life of 3.45 years; (2)volatility of 55%, (3) risk free interest of 4.70% and dividend rate of0%.   The fair value of warrantsoutstanding at December 31, 2005 of $418 was computed using the Black-Scholesmodel under the following assumptions: (1) expected life of 4.45 years; (2)volatility of 88%; (3) risk free interest of 4.355% and dividend rate of 0%.

2005 Senior Convertible Notes

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

Interest payments are due quarterly, and failureto make timely interest payments will result in increase in interest rates to14% per annum on the August 2007 Notes (“Default Rates”).  As of December 31, 2006, the Company has madetimely interest payments.

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The August 2007 Notes are convertible intoshares of the Company’s common stock at $2.00 per share Pursuant to an Amendedand Restated Security Agreement.  Theconvertible price of the August 2007 Notes is subject price adjustment foranti-dilution purposes.  As of December31, 2006, the convertible price of the August 2007 Notes remained unchanged at$2.00 per share.

Further, pursuant to Statement of FinancialAccounting Standards No. 133, “Accounting for Derivative Instruments andHedging Activities,” EITF 00-19, “Accounting for Derivative FinancialInstruments Indexed to, and Potentially Settled in, a Company’s Own Stock,”EITF 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments,”and EITF 05-2 “The Meaning of ‘Conventional Convertible Debt Instrument’ inEITF Issue No. 00-19,” the original fair value of the embedded conversionfeature of $4,808 have been recorded as conversion feature liability as thedebt is considered nonconventional convertible debt. The original fair valuewas computed using the Black-Scholes model under the following assumptions: (1)expected life of 2 years; (2) volatility of 93%; (3) risk free interest of4.06% and dividend rate of 0%.  In addition,the Company is required to report a value of the conversion liability as a fairvalue and record the fluctuation to the fair value of the conversion featureliability to current operations.  Thechange in the fair value of the conversion feature liability resulted in a gainof $339 and $3,849 for the year ended December 31, 2006 and 2005,respectively.  The fair value ofconversion feature outstanding at December 31, 2006 of $619 was computed usingthe Black-Scholes model under the following assumptions: (1) 0.59 year; (2)volatility of 55%, (3) risk free interest of 5.00% and dividend rate of0%.  The fair value of conversionfeatures outstanding at December 31, 2005 of $959 was computed using theBlack-Scholes model under the following assumptions: (1) 1.59 years; (2)volatility of 88%, (3) risk free interest of 4.41%and dividend rate of 0%.

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

**The Company also issued warrants to the purchasersof the August 2007 Notes and placement agents giving them the right to purchaseup to 2,469,470 and 414,495 shares of Company common stock, respectively, withan exercise price of  $2.00 per share,which is subject to price adjustment for anti-dilution purposes .  As of December 31, 2006, the exercise priceof the warrants remained unchanged at $2.00 per share.  The warrants will expire on August 2, 2010.**

**Pursuant to EITF 00-19, “Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock”, the original fair values of the warrants of $4,068 have been recordedas warrant liability as the Company has not yet filed the registrationstatement, which was computed using the Black-Scholes pricing model under thefollowing assumptions: (1) expected life of 5 years; (2) volatility of 93%; (3)risk free interest of 4.17% and dividend rate of 0%.  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 fair value of the warrantsresulted in a loss of $237 and a gain of $2,693 for the year ended December 31,2006 and 2005.  The fair value of thewarrants outstanding at December 31, 2006 of $1,612 was computed using theBlack-Scholes model under the following assumptions: (1) expected life of 3.59years; (2) volatility of 55%; (3) risk free interest of 4.70% and dividend rateof 0%.  The fair value of warrantsoutstanding at December 31, 2005 of $1,375 was computed using the Black-Scholesmodel under the following assumptions: (1) expected life of 4.59 years; (2)volatility of 88%, (3) risk free interest of 4.35% and dividend rate of 0%.**

In connection with the August 2005 Private Placement, theCompany entered into an amended and restated registration rights agreement withthe holders of the July 2007 Notes, the holders of the August 2007 Notes, andthe holders of the above-described outstanding warrants.  This amended and restated registration rightsagreement replaced all other registration rights agreements previously enteredinto by us in connection with the private sale by us of convertible notes andwarrants.  Under the amended and restatedregistration rights agreement, the Company is required to file a resaleregistration statement for the shares underlying all of our outstandingconvertible notes and warrants, as described above, by October 31, 2005, toenable the resale of such shares by the selling stockholders on a delayed orcontinuous basis under Rule 415 of the Securities Act.  The Company is then required to cause suchregistration statement to become effective within 60 days after we receive thefirst written comments on the registration statement from the SEC, or if theSEC notifies us that it will not review the registration statement, within fivedays after such notification.  TheCompany will be subject to certain monetary penalties, as set forth in theregistration rights agreement, if the registration statement is not filed ordoes not become effective on a timely basis. Specifically, if the Company does not file the registration statement ona timely basis, we will be obligated to pay a late filing fee to the sellingstockholders in the amount of 3% of the warrant exercise price on each of thewarrants held by them plus 3% of the principal amount of the outstanding notesheld by them.  This fee will be payablefor each period of 30 business days that the filing of the registrationstatement is made past the required filing date, and the payments will be due10 business days following the end of each 30-day period.  If the registration 

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statement has not been declared effective by the requiredeffective date, the Company will be obligated to pay a monthly lateregistration fee to the selling stockholders in the amount of 2% of theaggregate warrant exercise prices and aggregate note principal amounts for thefirst 30 business days after the required effective date, and 1% for each30-business day period thereafter until the registration statement is declaredeffective.  Notwithstanding theforegoing, the late filing fees and late registration fees will not exceed 18%of the aggregate warrant exercise prices and aggregate note principal amounts.

The Company filed its Registration Statement onDecember 9, 2005 and on August 7, 2006, the registration statement becameeffective.  As of December 31, 2006, theCompany has accrued $1,609 and paid $731 of the late filing and registrationfees and the remaining $878 is included in accounts payable and accruedliabilities.

As of December 31, 2006and 2005, our gross outstanding loan balance of the August 2007 Notes totaled $$9,878.  As of December 31, 2006 and2005, un-amortized discounts for beneficial conversion feature and warrantstotaled $2,441 and $5,663, respectively, and other asset debt issuance coststotaled $139 and $384, respectively, and contra liability debt issuance costtotaled $172 and $464, respectively. Interest expense for the amortization of debt issuance cost and discounton note was $4,078 and $1,913 for the year ended December 31, 2006 and 2005,respectively.  As of December 31, 2006and 2005, the effective interest rate for the August 2007 Notes was 54%.

The following is a repayment schedule of the August2007 Notes based on maturity date of the notes:
| **August 2007 Notes** | ** ** | ** **   | ** ** |
|---------------------------------|------------|--------------|------------|
| **Repayment Schedule**     | ** ** | **Minimum**  | ** ** |
| **December 31,**           | ** ** | **Payments** | ** ** |
|                            |       |         |       |
| 2007                            |       | 9,878        |       |
| Total                           |       | $            | 9,878      |   |
|                                 |            |              |            |  |

 

Subordinated Promissory Note

On March 17, 2006, the Company issued a $1,000 10%subordinated promissory note due October 16, 2006 (the “October 2006 Note”) toAtlantic Realty Group, Inc., a company controlled by Jack Chitayat, a formerdirector of the Company.  On September30, 2006, the October 2006 Note was amended to mature on November 15, 2006 andwas subsequently amended again to mature on November 30, 2006.  TheOctober 2006 Note is unsecured and subordinated to all prior indebtedness ofthe Company.  All accrued interest and unpaid principal under the notewere due November 30, 2006.  The proceeds from the October 2006 Note is tobe used solely for working capital purposes.  In connection with theOctober 2006 Note, the Company issued warrants to purchase an aggregate amountof up to 125,000 shares of common stock, exercisable at $2.00 per share. The warrants will expire on March 17, 2009, and include price adjustmentprovisions for anti-dilution purposes.  As of December 31, 2006, theexercise price of the warrants remained unchanged at $2.00 per share. There areno registration rights of the shares issuable from the exercise of thewarrants.  Further, cashless exercise of the warrants is permitted.

Pursuant to EITF 00-19, “Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock,” the original fair value of the warrants of $84 have been recorded aswarrant liability as the warrant holders can elect to settle the warrants incash, which was computed using Black-Scholes pricing model under the followingassumptions: (1) expected life of 2.96 years; (2) volatility of 84%; (3) riskfree interest of 4.64% and dividend rate of 0%.  In addition, the Companyis required to report a value of the warrants as a fair value and record thefluctuation to the fair value of the warrant liability to currentoperations.  The change in the fair value of the warrants resulted in again of $33 for the year ended December 31,206.  The fair value ofwarrants outstanding at December 31, 2006 of $50 was computed using theBlack-Scholes model under the following assumptions: (1) expected life of 2.21years; (2) volatility of 55%, (3) risk free interest of 4.82% and dividend rateof 0%.

Our gross outstanding loan balance of theOctober 2006 Note totaled $1,000 as of December 31, 2006 and is included inshort-term debt.  As of December 31,2006, there are no un-amortized discounts for the warrants.  Interest expense for the amortization ofdiscount on the note was $84 for the year ended December 31, 2006.  As of December 31, 2006, the Company accruedinterest at the default rate of 15% as the notes have not been paid uponmaturity.

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Unsecured Subordinated Notes

On May 17, 2006, the Company completed a privateplacement of 8% unsecured subordinated notes (the “May 2006 Private Placement”)in the aggregate principal amount of $3,625 (the “August 2007 SubordinatedNotes”), together with warrants to purchase up to an aggregate of 705,233shares of the Company’s common stock.  OnSeptember 21, 2006, and December 1, 2006 the Company completed an additionalprivate placement under the terms of the May 2006 Private Placement in theaggregate principal amount of $500 and $459, respectively, together withwarrants to purchase up to an aggregate of 96,900 and 88,857 shares of theCompany’s common stock, respectively. The May 2006 Private Placement, was made solely to “accredited investors”including Ricardo A. Salas, the Company’s former President and Chief ExecutiveOfficer.  Mr. Salas holds $559 of theAugust 2007 Subordinated Notes.

The August 2007 Subordinated Notes are unsecuredand will become due on the earlier of August 17, 2007 or the consummation of afollow-on equity or debt offering pursuant to which the Company receives grossproceeds of at least $6,000 to be used for working capital purposes andrepayment of debt, but excluding financings for the purpose of purchasingcapital assets (a “Follow-On Financing”). Interest on the unpaid principal balance of each August 2007Subordinated Note accrues at the rate of 8% per annum from May 17, 2006 untilmaturity date.  The August 2007Subordinated Notes can be prepaid by the Company at any time without penalty.

The August 2007 Subordinated Notes issubordinate in right of payment and in all other respects to the July 2007Notes, the August 2007 Notes, and any other notes that may be issued by theCompany after May 17, 2006 in exchange for or in satisfaction of any July 2007Notes or August 2007 Notes (collectively, the “Senior Notes”).  Notwithstanding the maturity date of theAugust 2007 Subordinated Notes, the Company will not make any payments ofprincipal, interest or otherwise under the August 2007 Subordinated Notes untilall amounts due and payable under the Senior Notes have been satisfied in full(whether through cash payments or conversion).

The August 2007 Subordinated Notes also givesthe investors the opportunity to participate in a Follow-On Financing at adiscounted rate.  If a holder of theAugust 2007 Notes elects to participate in a Follow-On Financing, the holder ofthe Note will be entitled to purchase the securities being offered in theFollow-On Financing at a discount of 7% of the gross per share purchase price(in the case of an offering of common stock or preferred stock) or 7% of theface amount of the security being sold (in the case of an offering of debtsecurities).

As part of the August 2007 Private Placement,the Company issued warrants to the purchasers of the Notes giving them right topurchase up to an aggregate of 892,247 shares of the Company’s commonstock.  In addition, warrants to purchase80,717 shares of the Company’s common stock were issued to the placement agentin the transaction.  The warrants have anexercise price of $2.58 per share, which is subject to price adjustment foranti-dilution purposes.  The exerciseprice of the warrants remained unchanged at $2.58 per share as of December 31,2006.  The warrants will expire on May17, 2011.

Pursuant to EITF 00-19, “Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock,” the original fair value of the warrants of $905 for the May 17, 2006placement have been recorded as warrant liability, as the warrant holders canelect to settle the warrants in cash, which was computed using Black-Scholespricing model under the following assumptions: (1) expected life of 5.00 years;(2) volatility of 80%; (3) risk free interest of 5.03% and dividend rate of0%.  The original fair value of the warrantsof $89 for the September 21, 2006 placement have been recorded as warrantliability, as the warrant holders can elect to settle the warrants in cash,which was computed using Black-Scholes pricing model under the followingassumptions: (1) expected life of 4.65 years; (2) volatility of 76%; (3) riskfree interest of 4.60% and dividend rate of 0%. The original fair value of the warrants of $59 for the December 1, 2006placement have been recorded as warrant liability, as the warrant holders canelect to settle the warrants in cash, which was computed using Black-Scholespricing model under the following assumptions: (1) expected life of 4.46 years;(2) volatility of 67%; (3) risk free interest of 4.39% and dividend rate of 0%.

In addition, the Company is required to report avalue of the warrant as a fair value and record the fluctuation to the fairvalue of the warrant liability to current operations.  The change in the fair value of the warrantsresulted in a gain of $551 for the year ended December 31, 2006.  The fairvalue of the warrants outstanding at December 31, 2006 of $513 was computedusing the Black-Scholes model under the following assumptions: (1) expectedlife of 4.38 years; (2) volatility of 55%; (3) risk free interest of 4.70% anddividend rate of 0%.

Our gross outstanding loan balance of the August2007 Subordinated Notes totaled $4,584 as of December 31, 2006.  As of December 31, 2006, un-amortizeddiscounts for warrants totaled $631. Interest expense for the amortization of discount on the 

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note was $434 for year ended December 31,2006.  As of December 31, 2006, theeffective interest rate for the August 2007 Subordinated Notes was 33%.

Factoring Agreement

The Company entered into a Factoring, Loan, and Security Agreement (the “Agreement”)with a financing company on April 21, 2005, which allows for borrowings of upto $1,500.  The Agreement expires onApril 21, 2006, and automatically renews annually thereafter. All borrowingsare secured by outstanding receivables specifically assigned to the financingcompany.  Assigned receivables areconsidered “Approved” or “Non-Approved” by the financing company.  On January 27, 2006, the terms of theagreement were amended whereas advances are made on 85% of Approved receivablesassigned and 50% of Non-Approved receivables assigned and on November 10, 2006,the agreement was again amended to allow for borrowing of up to $5,000 based onthe receivable assigned.  Payments onassigned receivables are received directly by the financing company, andapplied to outstanding advances.  Alloutstanding advances and uncollected assigned receivables are subject to feesand interest charges ranging from 0.55% to 1.5% plus prime rate as published bythe Wall Street Journal, with a minimum annual fee of $30. All receivablesassigned and advances made are subject to return and recall by the financingcompany, respectively.  As such, theadvances have been classified as short-term secured borrowings in accordancewith SFAS No. 140 “Accounting for Transfer and Servicing of Financial Assetsand Extinguishments of Liabilities.”  Forthe year ended December 31, 2006, the Company borrowed $18,036 and repaid$16,917 under the Agreement.  For theyear ended December 31, 2005, the Company borrowed $4,449 and repaid $3,899under the Agreement.  The totaloutstanding advance made under the agreement is $1,669 and $550 as of December31, 2006 and 2005, respectively, which is presented as short-term debt.   The weighted average rate of interest forborrowings made under the Agreement was 9.61% and 8.5% for the year endedDecember 31, 2006 and 2005, respectively. As of December 31, 2006, the Company’s availability for future borrowingunder the agreement is $3,331, which is contingent on approval of eligiblereceivables by the financing company.  

Kookmin Note

On February 4, 2003, our Korean subsidiaryreceived 6,500,000 in South Korean Won, or approximately $5,488, under a loanfrom Kookmin Bank of South Korea.  Theloan bears interest at an annual rate of 7.1%. In the event of delayed repayment, the interest increases to a maximumof 21%, depending on the length of time the repayment is delayed.  As of December 31, 2005, the interest ratewas increased to 9.2% from delayed interest payments made.  This loan is collateralized by the plantfacilities and certain equipment in South Korea.  During the first eighteen months from theorigination date, interest was payable on a monthly basis.  In October 2003, the Company paid $873 ofprincipal at the request of Kookmin Bank due to the sale of machines that hadbeen part of the collateral on the loan. Subsequent to October 31, 2003, Kookmin Bank requested that the Companypay an additional $866 of principal by February 2004 due to the Company’scurrent credit rating.  The Company madetwo payments on the requested additional loan pay down in November and December2003 of $320 and $205, respectively.  Theremaining payment of $341 was subsequently made in February 2004.  Beginning in September 2004, the Company isrequired to make equal monthly installments of principal and interest to repaythe remaining balance through February 2008. Principal payments made to Kookmin Bank totaled $994 and $1,036 for theyear ended December 31, 2006 and 2005, respectively, which includes $207 offoreign exchange translation loss for the year ended December 31, 2006 and $95of foreign exchange translation loss for the year ended December 31, 2005.  The outstanding loan balance totaled $1,796and $2,790, of which $225 and $1,343 is included in current portion oflong-term debt, as of December 31, 2006 and 2005, respectively.

The notes payable from Kookmin Loan as ofDecember 31, 2006 and 2005 and the activity for the year ended December 31,2006 is shown in the following table:

 
| ** **                           | ** ** | **December 31,** | ** ** | ** **     | ** ** | ** **     | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|----------------|------------|----------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2005**              | ** ** | **Borrowings** | ** ** | **Repayments** | ** ** | **2006**              | ** ** |
| Kookmin Loan 9.2%,  principal $5,488 |       | $                     | 2,790      |           | $          | —         |       | $                     | (994       | ) | $ | 1,796 |   |
|                                      |            |                       |            |                |            |                |            |                       |            |  |  |  |  |

 
| **Kookmin Repayment Schedule** | ** ** | **Minimum**  | ** ** |
|------------------------------------------|------------|--------------|------------|
| **December 31,**                    | ** ** | **Payments** | ** ** |
|                                     |       |         |       |
| 2007                                     |       | 1,571        |       |
| 2008                                     |       | 225          |       |
| Total                                    |       | $            | 1,796      |   |
|                                          |            |              |            |  |

 

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

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

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

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

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

Warrants

As of December 31, 2006, outstanding warrants toacquire shares of the Company’s common stock are as follows:

| Number of Shares | ** ** | **Exercise Price** | ** ** | **Expiration Date** | ** **    |
|----------------------------|------------|-------------------------|------------|--------------------------|---------------|
|                       |       |                    |       |                     |          |
| 893,750                    |       | $                       | 2.00       |                     | June 13, 2010 |   |
| 125,000                    |       | 2.00                    |       | March 17, 2009           |          |
| 2,883,964                  |       | 2.00                    |       | August 2, 2010           |          |
| 973,064                    |       | 2.58                    |       | May 17, 2011             |          |
| 4,875,778                  |       |                    |       |                     |          |
|                            |            |                         |            |                          |               |  |

 

 

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**15. Stock Compensation Plan**

Under the Company’s 1996Stock Option Plan (“1996 Company Plan”) the Company could grant to employees,directors or consultants options to purchase up to 12,903,226 shares of commonstock 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, 2006, there are 2,016,077options outstanding under the 2002 Equity Plan.

In 2006, certain of ourcurrent and former non-employee directors and our former Chief ExecutiveOfficer were given the opportunity to receive 138,397 shares of stock at pricesranging from $0.88 to $1.50 per share under the 2002 Equity Plan in lieu ofpast-due director and consulting fees that were due to them for fiscal year2006 and 2005.

In 2005, certain of ournon-employee directors were given the opportunity to receive 92,219 shares ofstock at an average price of $1.89 per share under the 2002 Equity Plan in lieuof past-due director fees that were due to them.

Prior to the approval ofthe 2002 Equity Plan, options were primarily granted under the Company’s 1996Stock Option Plan (“1996 Company Plan”). On April 4, 2002, our board ofdirectors terminated the 1996 Company Plan. The termination will not affect anyoutstanding 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 31,2006, there were 3,225,006 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 330,000 options outstanding under the 2002 Director Plan as ofDecember 31, 2006.

Additionally, theCompany has 2,221,508 options outstanding at December 31, 2006 which weregranted outside the 1996 Company Plan, 2002 Equity Plan and 2002 Director Plan.

The Company previouslyapplied Accounting Principles Board (“APB”) Opinion No. 25 for optionswhen the exercise price of options granted to employees is less than the fairvalue of the underlying stock on the date of grant.  As permitted, the Company had previouslyelected to adopt provisions of Statement of Financial Accounting Standard (“SFAS”)No. 123, Accounting for Stock-Based Compensation for options granted tonon-employees who perform services for the Company and the disclosure-onlyprovisions of options granted to employees.

In December 2004,the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS123R”), which replaces SFAS No. 123, Accounting for Stock-BasedCompensation, (“SFAS 123”) and supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees, (“APB 25”). SFAS 123R requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the financial statements based on their fairvalues. Under SFAS 123R, the Company is required to measure the cost ofemployee services received in exchange for stock options and similar awardsbased on the grant-date fair value of the award and recognize this cost in theincome statement over the period during which an employee is required toprovide service in exchange for the award. The pro forma disclosures previouslypermitted under SFAS 123 are no longer an alternative to financialstatement recognition.  The Companyadopted SFAS 123R on January 1, 2006 using the modified prospectivemethod and recorded $1,075 for the year ended December 31, 2006 of non-cashcharges for stock compensation related to amortization of the fair value ofrestricted stock and unvested stock options representing a $1,075, or $0.02 pershare, increase from the stock compensation that would have been recorded underAPB 25 and SFAS 123. Under this method, the Company will recognize compensationcost, on a prospective basis, for the portion of outstanding awards for whichthe requisite service has not yet been rendered as of January 1, 2006 andany new grants, based upon the grant-date fair value of those awards calculatedunder SFAS 123 for pro forma disclosure purposes.  Accordingly, we have not restated priorperiod amounts.

The fair value of each option grant is estimated on thedate of the grant using the Black-Scholes option-pricing model with the  assumptions noted in the followingtable.  Expected volatilities are basedon historical volatility expected over the expected life of the options.  The Company uses historical data to estimateoption exercise and employee termination within the valuation model. Theexpected term of options granted is derived from vesting period of each optiongrant, which represents the period of 

 

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time that options granted are expected to beoutstanding.  Actual forfeitures wereused for years ended December 31, 2006, 2005, and 2004.  The risk free rate for period within theexpected life of the options is based on U.S. Treasury rates in effect at thetime of grant.

|                           | ** ** | **December 31,** | ** ** |
|---------------------------|------------|-----------------------|------------|
| ** **                | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** |
| Expected  volatility      |       | 100                   | %          | 100 | % | 100 | % |
| Expected  dividends       |       | —                |       | — |   | — |   |
| Expected term  (in years) |       | 5                     |       | 5 |   | 5 |   |
| Risk-free rate            |       | 4.3% - 4.8            | 2%         | 3.6% - 4. | 3% | 2.9% - 3. | 6% |

 

Stock-based compensation expense was recognizedas follows for the year ended December 31, 2006:

|                             | ** ** | **In accordance with**        | ** ** |
|-----------------------------|------------|-----------------------------------------|------------|
| ** **                  | ** ** | **APB Opinion  No. 25 ** | ** ** | **SFAS  No. 123 R** | ** ** | **Total ** | ** ** |
| General and  administrative |       | $                                       | —     |   | $ | 1,075 |   | $ | 1,075 |   |
| Research and  development   |       | —                                  |       | — |   | — |   |
| Total                       |       | $                                       | —     |   | $ | 1,075 |   | $ | 1,075 |   |

 

Stock-based compensation expense was recognizedas follows for the year ended December 31, 2005:

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

 

Stock-based compensation expense was recognizedas 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 |   |

 

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, 2006, 2005, and 2004: expectedvolatility of 100% for all periods; dividend yield of 0.0% for all periods;expected option life of approximately 5 years; and  risk-free interest rate ranging from 2.87% and4.82%, as appropriate.

The following table summarizesthe Company’s stock option transactions for the three years endedDecember 31, 2006:

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| ** **                                               | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|----------------------------------------------------------|------------|----------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                               | ** ** | ** **                 | ** ** | ** **                                 | ** ** | ** **                                          | ** ** | **(in thousands)**             | ** ** |
| Options  outstanding at December 31, 2003                |       | 8,171,461                  |       | $                                          | 5.11       |                                                |       |                                |       |   |
| Granted                                                  |       | 795,843                    |       | 1.89                                       |       |                                                |       |                                |       |
| Exercised                                                |       | —                     |       | —                                     |       |                                                |       |                                |       |
| Forfeited                                                |       | (1,591,795                 | )          | 5.34                                       |       |                                                |       |                                |       |
| Options  outstanding at December 31, 2004                |       | 7,375,509                  |       | 4.72                                       |       |                                                |       |                                |       |
| Granted                                                  |       | 1,048,165                  |       | 2.18                                       |       |                                                |       |                                |       |
| Exercised                                                |       | —                     |       | —                                     |       |                                                |       |                                |       |
| Forfeited                                                |       | (429,919                   | )          | 3.43                                       |       |                                                |       |                                |       |
| Options  outstanding at December 31, 2005                |       | 7,993,755                  |       | 4.45                                       |       |                                                |       |                                |       |
| Granted                                                  |       | 992,500                    |       | 1.42                                       |       |                                                |       |                                |       |
| Exercised                                                |       | —                     |       | —                                     |       |                                                |       |                                |       |
| Forfeited                                                |       | (1,193,664                 | )          | 2.56                                       |       |                                                |       |                                |       |
| Options  outstanding at December 31, 2006                |       | 7,792,591                  |       | $                                          | 4.35       |                                                | 5.2        |                                | $          | — |   |
| Options vested  or expected to vest at December 31, 2006 |       | 7,660,589                  |       | $                                          | 4.94       |                                                | 5.3        |                                | $          | — |   |
| Options exercisable at  December 31, 2006                |       | 6,352,670                  |       | $                                          | 4.88       |                                                | 4.1        |                                | $          | — |   |

 

The Company has restated the number ofoutstanding options as of December 31, 2004 to properly reflect the optionsgranted and outstanding.

The weighted averagefair value of options granted during the years ended December 31, 2006,2005, and 2004 was $1.10, $1.74, and $1.29, respectively. There were 6,352,670options with a weighted average exercise price of $4.88 exercisable at December31, 2006, 6,451,364 options with a weighted average exercise price of $4.87exercisable at December 31, 2005, and 5,752,412 options with a weighted averageexercise price of $5.22 exercisable at December 31, 2004.

Included in theabove tables are certain options granted where their exercise prices were belowthe fair market value of the common stock at the grant date (measurementdate).  Such options totaled 734,927 witha weighted average fair value of $7.56 were outstanding at December 31, 2006and 2005.

 

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The following table summarizes the Company’s stock optionsoutstanding and exercisable by ranges of option prices as of December 31,2006:
| **Options Outstanding**            | ** ** | ** **                                | ** ** |
|-----------------------------------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | ** **                                | ** ** | **Weighted  Average** | ** ** | ** ** | ** ** | **Options Exercisable** | ** ** |
| **Range of  Exercise Prices** | ** ** | **Numbers of  options  Outstanding** | ** ** | **Remaining  Contractual  Life (Years)** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number of  Options  Exercisable** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| $0.00 - $1.55                           |       | 1,110,075                                 |       | 7.00 |   | $ | 1.29 |   | 503,115 |   | $ | 1.21 |   |
| 1.56 - 3.10                             |       | 2,115,443                                 |       | 6.10 |   | 2.38 |   | 1,346,873 |   | 2.50 |   |
| 3.11 - 4.65                             |       | 1,714,163                                 |       | 4.10 |   | 4.60 |   | 1,668,163 |   | 4.63 |   |
| 4.66 - 6.20                             |       | 2,580,646                                 |       | 4.40 |   | 6.20 |   | 2,580,646 |   | 6.20 |   |
| 6.21 - 7.75                             |       | —                                    |       | — |   | — |   | — |   | — |   |
| 7.76 - 9.30                             |       | —                                    |       | — |   | — |   | — |   | — |   |
| 9.31 - 10.85                            |       | 10,000                                    |       | 6.00 |   | 9.81 |   | 6,000 |   | 9.81 |   |
| 10.86 - 12.40                           |       | 190,326                                   |       | 4.60 |   | 12.40 |   | 190,326 |   | 12.40 |   |
| 12.41 - 13.95                           |       | —                                    |       | 0.00 |   | 0.00 |   | — |   | 0.00 |   |
| 13.96 - 15.50                           |       | 71,938                                    |       | 5.30 |   | 15.00 |   | 57,547 |   | 15.00 |   |
| Total                                   |       | 7,792,591                                 |       |   |   |   |   | 6,352,670 |   |   |   |
|                                         |            |                                           |            |  |  |  |  |  |  |  |  |  |  |

 

**16. Discontinued Operations**

*Dongyang*

OnJune 28, 2002, the Company acquired a 51% interest in Chusik HoesaDongyang Yudoro (“Dongyang”).  During 2003, Dongyang experienced net losses as a result of a continuingeconomic downturn in markets for its machinery products.

InMarch 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 $12 as of December 31,2006 and was included in accounts payable and accrued liabilities.

Therewere no assets or liabilities associated with discontinued operations fromDongyang as of December 31, 2006 and 2005.

Summarizedoperating results of Dongyang’s discontinued operations are as follows.
| ** **                                                             | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                             | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue                                                                |       | —                                      |       | — |   | $ | 22 |   |
| Loss from discontinued  equipment manufacturing operations, net of tax |       | —                                      |       | — |   | (96 | ) |
|                                                                        |            |                                             |            |  |  |  |  |  |

 

*Taesung*

On June 14, 2004, theCompany entered into an Asset Purchase Agreement whereby all the assets andliabilities of its Taesung equipment manufacturing division in Korea were soldto a third party for $345 which is payable by the third party in four equalinstallments with the last installment being due on June 30, 2005.  The sale resulted in a loss of $184 and isincluded in the loss from discontinued equipment manufacturing operations as ofDecember 31, 2004.  The loss fromoperations for the year ended December 31, 2004 totaled $653 and is included inthe loss from discontinued equipment manufacturing operations for the period.

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Summarizedoperating results of Taesung’s operations are as follows.
| ** **                                                             | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                             | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Revenue                                                                |       | —                                      |       | — |   | $ | 172 |   |
| Loss from discontinued  equipment manufacturing operations, net of tax |       | —                                      |       | — |   | (653 | ) |
|                                                                        |            |                                             |            |  |  |  |  |  |

 

*Liquidmetal Golf*

On April 30, 2002,management terminated the operations of the retail golf segment by means ofliquidating 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.

There were no assetsassociated with discontinued retail golf operations at December 31, 2004 and2005, and there were no gain or loss resulted from the discontinued operationsfor the years ended December 31, 2006, 2005, and 2004.

*Stock Compensation Plan*.Historically, Liquidmetal Golf granted its own options to employees, directorsand consultants 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 golf operations,the Company does not intend to issue additional options under the 1997 GolfPlan.

Liquidmetal Golfpreviously applied Accounting Principles Board (“APB”) Opinion No. 25 foroptions when the exercise price of options granted to employees is less than thefair value of the underlying stock on the date of grant.  As permitted, the Company had previouslyelected to adopt provisions of Statement of Financial Accounting Standard (“SFAS”)No. 123, Accounting for Stock-Based Compensation for options granted tonon-employees who perform services for the Company and the disclosure-onlyprovisions of options granted to employees. There was no compensation expenserecorded during the years ended December 31, 2006, 2005, and 2004.

In December 2004,the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS123R”), which replaces SFAS No. 123, Accounting for Stock-BasedCompensation, (“SFAS 123”) and supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees, (“APB 25”). SFAS 123R requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the financial statements based on their fairvalues. Under SFAS 123R, the Company is required to measure the cost ofemployee services received in exchange for stock options and similar awardsbased on the grant-date fair value of the award and recognize this cost in theincome statement over the period during which an employee is required toprovide service in exchange for the award. The pro forma disclosures previouslypermitted under SFAS 123 are no longer an alternative to financialstatement recognition. The Company adopted SFAS 123R on January 1,2006 using the modified prospective method for outstanding option.  Under this method, the Company would recognizecompensation cost, on a prospective basis, for the portion of outstandingawards for which the requisite service has not yet been rendered as ofJanuary 1, 2006 and any new grants, based upon the grant-date fair valueof those awards calculated under SFAS 123 for pro forma disclosure purposes.Accordingly, we have not restated prior period amounts.  There were no charges for stock compensationrelated to amortization of the fair value of restricted stock as theoutstanding options were fully vested as of December 31, 2005 and no new grantswere made during the year ended December 31, 2006

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The following tablesummarizes Liquidmetal Golf’s stock option transactions for the three yearsended December 31, 2006:
| ** **                                               | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|----------------------------------------------------------|------------|----------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                               | ** ** | ** **                 | ** ** | ** **                                 | ** ** | ** **                                          | ** ** | **(in thousands)**             | ** ** |
| Options  outstanding at December 31, 2003                |       | 98,700                     |       | $                                          | 8.72       |                                                |       |                                |       |   |
| Granted                                                  |       | —                     |       | —                                     |       |                                                |       |                                |       |
| Exercised                                                |       | —                     |       | —                                     |       |                                                |       |                                |       |
| Forfeited                                                |       | (10,000                    | )          | 8.00                                       |       |                                                |       |                                |       |
| Options  outstanding at December 31, 2004                |       | 88,700                     |       | 8.80                                       |       |                                                |       |                                |       |
| Granted                                                  |       | —                     |       | —                                     |       |                                                |       |                                |       |
| Exercised                                                |       | —                     |       | —                                     |       |                                                |       |                                |       |
| Forfeited                                                |       | (10,500                    | )          | 13.71                                      |       |                                                |       |                                |       |
| Options  outstanding at December 31, 2005                |       | 78,200                     |       | 8.14                                       |       |                                                |       |                                |       |
| Granted                                                  |       | —                     |       | —                                     |       |                                                |       |                                |       |
| Exercised                                                |       | —                     |       | —                                     |       |                                                |       |                                |       |
| Forfeited                                                |       | (78,200                    | )          | 8.14                                       |       |                                                |       |                                |       |
| Options  outstanding at December 31, 2006                |       | —                     |       | $                                          | —     |                                                | —     |                                | $          | — |   |
| Options vested  or expected to vest at December 31, 2006 |       | —                     |       | $                                          | —     |                                                | —     |                                | $          | — |   |
| Options exercisable at  December 31, 2006                |       | —                     |       | $                                          | —     |                                                | —     |                                | $          | — |   |

 

There were no optionsexercisable at December 31, 2006.  Therewere 78,200 options with a weighted average exercise price of $8.14 exercisableat December 31, 2005 and there were 88,700 options with a weighted averageexercise price of $8.80 exercisable at December 31, 2004.

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 with weighted average fair values of $5.74, were outstanding at bothDecember 31, 2005 and 2004.

**17. Income Taxes**

The Company hasrestated certain previously issued financial statements relating to the Company’saccounting for embedded convertible feature of senior convertible notes (seeNote 2).

Significant components of deferred tax assetsare as follows: 
| ** **                     | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------|------------|---------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| ** **                     | ** ** | ** **                                  | ** ** | **(Restated)** | ** ** |
| Loss carry  forwards           |       | $                                           | 40,862     |   | $ | 31,623 |   |
|                           |       |                                        |       |   |   |
| Other                          |       | 2,272                                       |       | 1,148 |   |
| Total deferred tax asset       |       | 43,134                                      |       | 32,771 |   |
|                           |       |                                        |       |   |   |
| Valuation allowance            |       | (43,134                                     | )          | (32,771 | ) |
| Total deferred  tax asset, net |       | $                                           | —     |   | $ | — |   |

 

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The following tableaccounts for the differences between the expected federal tax benefit (based onthe statutory U.S. federal income tax rate of 34%) and the actual taxprovision: 
| ** **                                              | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                              | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                              | ** ** | ** **                                  | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Expected federal tax benefit                            |       | (34.00                                      | )%         | (34.00 | )% | (34.00 | )% |
|                                                    |       |                                        |       |   |   |   |   |
| State tax expense, net of expected federal tax  benefit |       | (4.34                                       | )%         | 0.00 | % | (4.91 | )% |
| Foreign loss not subject to U.S. federal income tax     |       | 6.71                                        | %          | 42.27 | % | 4.24 | % |
| Other                                                   |       | (38.25                                      | )%         | 0.17 | % | 0.68 | % |
| Increase (decrease) in valuation allowance              |       | 69.88                                       | %          | (8.44 | )% | 33.99 | % |
|                                                    |       |                                        |       |   |   |   |   |
| Total tax provision                                     |       | 0.00                                        | %          | 0.00 | % | 0.00 | % |

 

As of December 31,2006, the Company had approximately $110,000 of net operating loss (“NOL”)carryforwards for U.S. federal income tax purposes expiring in 2007 through2027. In addition, the Company has California state NOL carryforwards of approximately$65,000 expiring in 2007 through 2017. The Company and Liquidmetal Golf filedon a separate company basis for federal income tax purposes. Accordingly, thefederal NOL carryforwards of one legal entity are not available to offsetfederal taxable income of the other. As of December 31, 2006, LiquidmetalTechnologies, Inc. had approximately $72,000 in federal NOL carryforwards,expiring in 2007 through 2027 and Liquidmetal Golf, Inc. had approximately$38,000 in federal NOL carryforwards, expiring in 2013 through 2027.

As of December 31, 2006,the Company had approximately $186 of Research & Development (“R&D”)credit carryforwards for U.S. federal income tax purposes expiring in 2022through 2027.  In addition, the Companyhas California R&D credit carryforwards of approximately $253, which do notexpire under current California law.

Section 382 of theInternal 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 realize the tax benefitsassociated with deferred tax assets, which includes benefits related to NOL’s,is principally dependent upon the Company’s ability to generate future taxableincome from operations.  The Company hasprovided a full valuation allowance for its net deferred tax assets due to theCompany’s net operating losses.

**18. Segment Reporting andGeographic 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 4 above.

The Company has restated certain previously issued financial statementsfor due to an error related to the Company’s accounting for embeddedconvertible feature of senior convertible notes (see Note 2).

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The following tablesummarizes Liquidmetal Golf’s stock option transactions for the three yearsended December 31, 2006:
| ** **                                  | ** ** | **Coatings** | ** ** | **Bulk Alloy** | ** ** | **Segment Totals** | ** ** |
|---------------------------------------------|------------|--------------|------------|---------------------|------------|-------------------------|------------|
| Year ended  December 31, 2006:              |       |         |       |                |       |                    |       |
| Revenue to external customers               |       | $            | 9,419      |                | $          | 18,250                  |       | $ | 27,669 |   |
| Gross profit (loss)                         |       | 3,879        |       | 1,372               |       | 5,251                   |       |
| Total segment income (loss)                 |       | 3,075        |       | (1,815              | )          | 1,260                   |       |
| Total identifiable assets at end of period  |       | 1,281        |       | 19,005              |       | 20,286                  |       |
|                                        |       |         |       |                |       |                    |       |
| Year ended  December 31, 2005:              |       |         |       |                |       |                    |       |
| Revenue to external customers               |       | $            | 5,894      |                | $          | 10,471                  |       | $ | 16,365 |   |
| Gross profit (loss)                         |       | 2,505        |       | (1,269              | )          | 1,236                   |       |
| Total segment income (loss)                 |       | 1,746        |       | (7,747              | )          | (6,001                  | )          |
| Total identifiable assets at end of period  |       | 1,199        |       | 16,474              |       | 17,673                  |       |
|                                        |       |         |       |                |       |                    |       |
| 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                  |       |

 

Reconciling information for the statements ofoperations between reportable segments and the Company’s consolidated totals isshown in the following table:
| ** **                                                                                  | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                  | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                  | ** ** | ** **                                  | ** ** | **(Restated)** | ** ** | **(Restated)** | ** ** |
| Total segment  income (loss) before interest expense and discontinued operations            |       | $                                      | 1,260      |   | $  | (6,001 | ) | $  | 3,557 |   |
| General and administrative expenses, excluded                                               |       | (6,349                                      | )          | (6,904 | ) | (11,354 | ) |
| Consolidated  loss before interest, other income, income taxes, and discontinued operations |       | (5,089                                      | )          | (12,905 | ) | (7,797 | ) |
| Loss from extinguishment of debt                                                            |       | —                                      |       | (1,247 | ) | (2,941 | ) |
| Change in value of warrants, gain                                                           |       | 279                                         |       | 3,985 |   | 747 |   |
| Change in value of conversion feature, (loss) gain                                          |       | (226                                        | )          | 9,118 |   | 2,093 |   |
| Other income                                                                                |       | —                                      |       | — |   | 302 |   |
| Interest expense                                                                            |       | (9,509                                      | )          | (6,021 | ) | (6,577 | ) |
| Interest income                                                                             |       | 23                                          |       | 17 |   | 37 |   |
| Gain (loss) from discontinued operations, net                                               |       | —                                      |       | — |   | (749 | ) |
| Consolidated net loss                                                                       |       | $                                           | (14,522    | ) | $ | (7,053 | ) | $ | (14,885 | ) |

 

Includedin bulk alloy segment net income for the year ended December 31, 2006 is $572of other income recognized from $480 gain on termination of a distributionagreement in March 2006 (see Note 20) and $92 gain on disposal of idleequipment in June 2006 (See Note 8).

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 $194 for the year ended December 31, 2004.

 

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Reconciling information for the balance sheetsbetween reportable segments and the Company’s consolidated totals is shown inthe following table: 
| ** **                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Total segment  assets                     |       | $                     | 20,286     |   | $ | 17,673 |   |
| Cash and cash equivalents                 |       | 118                   |       | 1,392 |   |
| Prepaid expenses and other current assets |       | 375                   |       | 340 |   |
| Other property, plant and equipment       |       | 266                   |       | 473 |   |
| Intangibles, net                          |       | 1,170                 |       | 1,185 |   |
| Other assets                              |       | 29                    |       | 500 |   |
| Total consolidated  assets                |       | $                     | 22,244     |   | $ | 21,563 |   |

 

Assets excluded from segments include assets attributable to the Company’scorporate headquarters. The largest asset represents the Company’s intangibleassets, consisting primarily of the Company’s patents and trademarks.

Certain customers accounted for more than 10% ofrevenues from continuing operations as follows: 

|                                 | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------|------------|---------------------------------------------|------------|
| ** **                      | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| Samsung                         |       | 5                                           | %          | 10 | % | 5 | % |
| Charm Tech                      |       | —                                      |       | — |   | 32 | % |
| Pntel                           |       | 1                                           | %          | 8 | % | 30 | % |
| United States  Government       |       | 7                                           | %          | 9 | % | 10 | % |
| Growell Metal                   |       | —                                      |       | — |   | 12 | % |
| Flextronics  Manufacturing, LTD |       | 13                                          | %          | — |   | — |   |

 

Revenues from sales to companies in the United States were$12,142, $8,536 and $5,546 during the years ended December 31, 2006, 2005 and2004, respectively.  The revenue relatedto the United States of America was earned under defense-related research anddevelopment contracts, sales of coatings products, and sales of Liquidmetalbulk alloy products.

During the year endedDecember 31, 2006, the Company had revenue on sales to companies outsideof the United States of $15,527 of which $3,211 represented sales to companieslocated in South Korea.  During the yearended December 31, 2005, the Company had revenue on sales to outside of theUnited States of $7,829 of which $5,047 represented sales to companies locatedin South Korea.  During the year endedDecember 31, 2004, the Company had revenue on sales to companies outsideof the United States of $11,883, of which $9,545 represented sales to companieslocated in South Korea.

Long-lived assetsinclude net property, plant, and equipment and net intangible assets. TheCompany had long-lived assets of $1,439 and $1,670 located in the United Statesat December 31, 2006 and 2005, respectively. The Company had long-livedassets of $11,799 and $12,846 located in South Korea at December 31, 2006and December 31, 2005, respectively.  Further, the Company has long lived assets located in China of $221 and$106 at December 31, 2006 and 2005 respectively, as a result of a post-processingplant opened August 2004 (see Note 1).

**19. Income (Loss) Per CommonShare**

Basic EPS is computed bydividing 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 calculationof basic and diluted EPS is presented below:

 

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|                                  | ** ** | **For the Years Ended December 31,** | ** ** |
|----------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                       | ** ** | **2006**                                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| Weighted average  basic shares   |       | 43,809,339                                                    |       | 41,833,058 |   | 41,609,652 |   |
| Effect of  dilutive securities:  |       |                                                          |       |   |   |   |   |
| Stock options                    |       | —                                                        |       | — |   | — |   |
| Conversion of notes payable      |       | —                                                        |       | — |   | — |   |
| Weighted average  diluted shares |       | 43,809,339                                                    |       | 41,833,058 |   | 41,609,652 |   |

 

Options to purchase7,792,591 shares of common stock at prices ranging from $0.77 to $15.00 pershare were outstanding at December 31, 2006, but were not included in thecomputation of diluted EPS for the same period as the inclusion would have beenantidilutive. Options to purchase approximately 7,993,755 shares of commonstock at prices ranging from $0.88 to $15.00 per share were outstanding atDecember 31, 2005, but were not included in the computation of diluted EPSfor the same period as the inclusion would have been antidilutive.  Options to purchase approximately 7,375,509shares of common stock at prices ranging from $1.16 to $15.00 per share wereoutstanding at December 31, 2004, but were not included in the computationof diluted EPS for the same period as the inclusion would have been antidilutive.

Warrants to purchase4,875,778 shares of common stock between $2.00 and $2.58 per share outstandingat December 31, 2006 were not included in the computation of diluted EPS forthe same period as the inclusion would have been antidilutive. Warrants topurchase 4,986,028 shares of common stock between $2.00 and $4.65 per shareoutstanding at December 31, 2005 were not included in the computation ofdiluted EPS for the same period as the inclusion would have been antidilutive.   Warrants to purchase 1,208,313 shares ofcommon stock between $3.00 and $4.65 per share were outstanding atDecember 31, 2004 but were not included in the computation of diluted EPSfor the same period as the inclusion would have been antidilutive.

7,021,935 shares of commonstock issuable upon conversion of the Company’s senior convertible notes withconversion prices between $1.00 and $2.00 per share outstanding at December 31,2006 were not included in the computation of diluted EPS for the period as theinclusion would have been antidilutive.  7,308,685 shares of common stock issuable upon conversion of the Company’ssenior convertible notes with conversion prices between $1.00 and $2.00 pershare outstanding at December 31, 2005 were not included in the computation of dilutedEPS for the period as the inclusion would have been antidilutive.  4,281,752 shares of common stock issuableupon conversion of the Company’s senior convertible notes with conversionprices between $1.00 and $2.00 per share outstanding at December 31, 2004 werenot included in the computation of diluted EPS for the period as the inclusionwould have been antidilutive.

**20. Commitments andContingencies**

The Company is from timeto time a party to certain legal proceedings arising in the ordinary course ofbusiness. Although outcomes cannot be predicted with certainty, the Companydoes not believe that any legal proceeding to which it is a party will have amaterial adverse effect on the Company’s financial position, results ofoperations, and cash flows.

In April 2006, theCompany reached agreements in principle to settle our previously-disclosedconsolidated securities class action and shareholder derivative actions.

The consolidated classaction arose from a number of lawsuits filed in 2004 against the Company andcertain of its former and current directors and officers on behalf of personswho purchased our common stock between May 21, 2002 and May 13,2004.  These actions, which were brought under the federal securitieslaws, alleged that the Prospectus issued in connection with the initial publicoffering in May 2002 contained material misrepresentations and omissionsregarding historical financial condition and regarding a personal stocktransaction by the Company’s former chief executive officer.  They alsoalleged that the company and certain of its present and former officers anddirectors engaged in improper revenue recognition with respect to certainbusiness transactions, failed to maintain adequate internal controls, andknowingly disclosed unrealistic but favorable information about market demandfor and commercial viability of its products to artificially inflate the valueof its stock.  On October 19, 2006, thepresiding judge entered an Order giving final approval of the class actionsettlement.  In connection with thesettlement, our directors and officers’ liability insurers contributed $7.0million to a settlement fund, from which approved claims of eligible classmembers will be paid in accordance with a court-approved plan of allocation.  Taking into account the insurance 

 

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contribution, the netcost of the settlement to our company is approximately $0.5 million, which isthe insurance deductible we paid over several quarters ending in the thirdquarter of 2005, and which was previously recorded as a charge.

In addition to theconsolidated securities class action, in May 2004, two shareholderderivative actions were filed in the Superior Court of Orange County,California and later consolidated.  Shortly thereafter, one additionalshareholder derivative action was filed in the United States District Court forthe Middle District of Florida, Tampa Division.  These derivative actionswere brought by certain shareholders against certain of the Company’s presentand former officers and directors as well as the Company (as a nominaldefendant).  The suits alleged that the defendants breached variousfiduciary duties and otherwise violated state law based primarily upon the sameunderlying facts and circumstances underlying the federal securities classaction.  On August 2, 2006, plaintiffs’ counsel in the Californiaderivative action filed a Notice of Settlement in the Superior Court.  The action is presently stayed while theparties’ counsel negotiates and prepares formal settlement documents.  Final documentation and approval of thesettlement of the derivative actions remains outstanding.

In August 2006, theCompany received a federal grand jury subpoena for the production of certaindocuments related to the period January 1, 1999 though the present.  The documents being sought include accountingrecords, documents relating to the Company’s relationship with Growell Metal ofKorea, and documents and records relating to transactions in company stock byofficers and directors.  The Company hasbeen advised that the materials sought are pertinent to a grand juryinvestigation recently initiated in the Middle District of Florida by the U.S.Department of Justice, Criminal Division, Fraud Section concerning allegedaccounting improprieties by the Company, among other things.  The Company believes the subject matter ofthe investigation is largely similar to the subject matter of the previouslydisclosed consolidated securities class action and shareholder derivativeactions that the Company reached agreements in principle to settle on October19, 2006.  The Company will fullycooperate with the authorities in connection with this subpoena andinvestigation.

In March 1996, theCompany entered into a distribution agreement whereby it granted to a third partyexclusive rights to market and sell golf products incorporating LiquidmetalTechnology to certain Japanese sporting equipment companies.  The third party paid the Company a $1,000distribution fee as part of this agreement, of which a portion was refundableaccording to a formula based on the gross profit earned by the thirdparty.  The remaining unearneddistribution fee of $830 had not been refunded. On March 28, 2003, the distribution agreement was terminated and theCompany entered into a new agreement to pay to the same third party acommission on the net sales price of all Liquidmetal golf equipment that isshipped by the Company or its affiliates to Japanese golf companies for saleinto the Japanese end-market.  Thiscommission was to be applied to golf equipment shipped by the Company or itsaffiliates during the period beginning on March 28, 2003 and ending on March28, 2006.  If, by March 28, 2006, theCompany has not paid $350 in commission payments, the balance betweencommission paid and $350 were to be paid by April 30, 2006, therebyguaranteeing the third party a $350 minimum payment during the term of theagreement.  As of December 31, 2006 theCompany has not paid the minimum commission and accrued $350 from the unearneddistribution fee for minimum payments due in accounts payable and accruedliabilities.  Further, the Companyrecognized net balance of the unearned distribution fee of $480 as other incomeduring the year ended December 31, 2006. The Company is currently is in theprocess of renegotiating the distribution agreement with the same third partyto settle the balance.

On June 26, 2006, the Company entered into a joint ventureagreement with SAGA, SpA in Padova, Italy, (“SAGA”) a specialist precisionparts manufacturer.  The joint venture is named Liquidmetal SAGA Italy,Srl (“LSI”).  The Company also entered into an exclusive manufacturinglicense agreement for the eyewear industry with LSI.  Under the jointventure agreement, the Company has option to buy ownership interest in LSI,initially, of 19.9% to up to 50%.  In December 2006, the Company exercisedthe 19.9% interest in LSI and will have two years to purchase the additionalinterest at a nominal price. Under the licensing agreement, at any timefollowing 18 months after the effective date of the agreement, LSI may exerciseits option to sell to the Company certain business assets includingmanufacturing equipment acquired under the joint venture.  During year ended December 31, 2006, theCompany recognized revenues of $702 of Liquidmetal alloys sold to SAGA for usein the joint venture. The Company anticipates the alloys to be fully utilizedby the joint venture prior to the 18 month period.

***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:

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** **
| ** **            | ** ** | **Minimum**  | ** ** |
|-----------------------|------------|--------------|------------|
| **December 31,** | ** ** | **Payments** | ** ** |
|                  |       |         |       |
| 2007                  |       | 522          |       |
| 2008                  |       | 198          |       |
| 2009                  |       | 77           |       |
| 2010                  |       | 1            |       |
| Total                 |       | $            | 798        |   |
|                       |            |              |            |  |

 

Rent expense was $449, $508, and $479 for theyears ended December 31, 2006, 2005, and 2004, respectively.

**21.   401(k) Savings Plan**

 

The Company has a tax-qualifiedemployee savings and retirement plan, or 401(k) plan, which covers all of itsUnited States-based employees. Our Korean employees are covered under agovernment sponsored pension program and do not participate in the U.S. based401(k) program.

Under the U.S. based 401(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 the reductioncontributed to the 401(k) plan. The 401(k) plan permits the Company, in itssole discretion, to make additional employer contributions to the 401(k) plan.However, the Company did not make employer contributions to the 401(k) planduring any of the periods presented in the accompanying consolidated financialstatements.

**22.   Related Party Transactions**

 

InJune 2003, the Company entered into an exclusive, ten-year license agreementwith LLPG, Inc. (“LLPG”), a corporation headed by, Jack Chitayat, a formerdirector of the Company.  Under the terms of the agreement, LLPG has theright to commercialize Liquidmetal alloys, particularly precious-metal basedcompositions, in jewelry and high-end luxury product markets.  TheCompany, in turn, will receive royalty payments over the life of the contracton all Liquidmetal products produced and sold by LLPG.  In conjunctionwith its technology licensing contract, LLPG purchased two proprietaryLiquidmetal alloy melting machines and three proprietary Liquidmetal alloycasting machines for a total purchase price of $2,000.  The Companyrecognized $125 of revenues as minimum royalty fees under the license agreementduring the year ended December 31, 2006.

InDecember 2006, the Company entered into an amended the license agreement withLLPG, which extends the license agreement to fifteen years at reduced royaltyrates.  Additionally, the amended license agreement includes a $400termination fee to be paid out in quarterly installments in 2007.  Thetermination fee will be recognized as revenue when received in 2007.

TheCompany has a license agreement with California Institute of Technology (“Caltech”)under which we exclusively license from Caltech certain inventions andtechnology relating to amorphous alloys.  Professor William Johnson, amember of the Company’s board of directors, is a professor at Caltech, andsubstantially all of the amorphous alloy technology licensed to us under theCaltech license agreement was developed in Professor Johnson’s Caltechlaboratory.   Additionally, the Company reimburses Caltech forlaboratory expenses incurred by Professor Johnson’s Caltech laboratory, whichduring the years ended December 31, 2006 and 2005, amounted to $50 and $20,respectively.

Additionally, the Company is a party to a consultingagreement with Mr. Johnson.  Under thisagreement, Mr. Johnson provides consulting services on an as-needed basisthrough 2004 as it relates to marketing and development Liquidmetal alloy.  During 2005, the agreement continued on amonth to month basis.  In April 2006, theCompany entered into an agreement with Mr. Johnson effective from January 1,2006 through December 31, 2006.  During the years ended December 31, 2006and 2005, the Company incurred $60 and $15 in consulting fees from Mr. Johnson,respectively.

The Company is a party to a consulting agreement withChitnis Consulting, Inc., which is owned 100% by Shekhar Chitnis, a formerdirector and executive officer of the Company. Under this agreement, the Company engaged Chitnis Consulting to provideconsulting services on an as-needed basis through December 31, 2005.  On January 1, 2006, the term of the agreementwas extended to December 31, 2006 and on January 1, 2007, the term of theagreement was once again extended to December 31, 2007.  During theyears ended December 31, 2006 and 2005, the Company incurred $0 and $53 inconsulting fees from Chitnis Consulting, respectively.

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SooBuchanan, the sister of John Kang and James Kang, was employed by the Companyand was paid aggregate compensation of approximately $0 and $104 as of December31, 2006 and 2005, respectively.  Effective, July 31, 2005, Ms. Buchananwas terminated as an employee and began providing services to the Company as aconsultant.  During 2006 and 2005, theCompany incurred $116 and $24, respectively, for her services as a consultant.Additionally, Otis Buchanan, the husband of Ms. Buchanan, was employed by theCompany and was paid aggregate compensation of approximately $110 and $103 asof December 31, 2006 and 2005, respectively.

In November 2004, the Company enteredinto an agreement with John Kang, our Chairman of the Board, in which Mr. Kangagreed that certain stock transactions by him in 2002 involving the Company’scommon stock should have resulted in a liability under Section 16(b) of theSecurities Exchange Act of 1934, as amended (“Section 16(b)”).  These transactions include Mr. Kang’s privatesale of 285,715 shares of his personal Liquidmetal Technologies common stock toGrowell Metal Co., Ltd. in February 2002, prior to our initial publicoffering.  They also include Mr. Kang’ssubsequent indirect purchase and disposition of Liquidmetal Technologies commonstock in order to satisfy a personal agreement Mr. Kang made to Growell Metalin February 2002 regarding the guaranteed minimum value of the stock purchasedby Growell Metal in February 2002 (the purchases and dispositions incident tothis agreement occurred in August and November 2002, respectively).  Lastly, the transactions include open-marketpurchases of an aggregate of 89,300 shares of the Company’s common stock madeby Mr. Kang in August 2002.

TheAudit Committee of our Board of Directors conducted an independent inquiry intothe above-described transactions with the aid of independent legal counsel and,as a result of such inquiry, the Audit Committee concluded that thetransactions should have resulted in a liability to the Company under Section16(b) in the amount of $302.  Mr. Kanghas acknowledged this liability, and in an agreement negotiated between Mr.Kang and 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 reported on atimely basis in August 2002.  As ofDecember 31, 2006, the outstanding amount of the receivable was $235, which isincluded in other assets.  Mr. Kang haspaid $0 and $67 during 2006 and 2005, respectively, and is currently innegotiation with the Board of Directors on a payment plan for the remainingliability.

Duringthe year ended December 31, 2005, the Company executed a $198 promissory notewith CK Cho, member of our Board of Directors, for working capitalpurposes.  The note was due and paid infull as of June 20, 2005.  The note hadan annual rate of interest of 6% resulting in the Company paying approximately$2 in interest.  Further, during the yearended December 31, 2005 Mr. Cho advanced approximately $1,260 to covershort-term liquidity needs.  The advancewere made without interest and were repaid as of December 31, 2005.  Additionally, Mr. Cho held $620 of SeniorConvertible Notes and held 92,584 exercisable warrants as of December 31, 2006and 2005.

Duringthe year ended December 31, 2005, Ricardo Salas, the Company’s former Presidentand Chief Executive Officer, and Young Ham, our Chief Financial Officer,advanced the Company $75 and $133 to cover short-term liquidity needs,respectively.  The advances were madewithout interest and were repaid as of December 31, 2005.  During the year ended December 31, 2006, Mr.Salas, advanced the Company $550 to cover short-term liquidity needs.  The Company paid $100 to Mr. Salas using7.75% interest rate and on December 1 2006, the remaining balance of $450 andaccrued interest of $9 was converted into the 8% Unsecured Subordinated Notes(see Note 13).  Mr. Salas also held $310of senior convertible notes and $559 of the August 2007 Subordinated Notes andheld a total of 154,529 warrants as of December 31, 2006.

During2006, the Company purchased production supplies and molds from Grace Metal,Lead Metal, and SDM, which are controlled by James Kang, a former director andofficer of the Company.  The Companypurchased a total of $466 for the year ended December 31, 2006, of which $10 isincluded in accounts payable and accrued liabilities at December 31, 2006.

**23.   Subsequent Event**

 

In January 2007, the Company contributed $217 to intoLiquidmetal SAGA Italy, Srl (“LSI”), a joint venture with SAGA, SpA in Padova,Italy, (“SAGA”) a specialist precision parts manufacturer, as additionalinvestment.  The contribution did not change the Company’s 19.9% interestin LSI (See Note 20).

InJanuary 2007, the Company completed a private placement of approximately$14,800 in principal amount of 8% Convertible Subordinated Notes due January2010 (the “January 2010 Notes”).  TheJanuary 2010 Notes were issued for aggregate cash in the amount of $12,850 andin payment of a total of $1,877 in principal and accrued but unpaid interestunder our previously issued 7% Senior Secured Convertible notes due August 2007(“August 2007 Notes”) and our 8% Unsecured Subordinated notes.  The January 2010 Notes are convertible intothe Company’s common stock at a $1.55 per share.  As part of the private placement offer, theCompany issued warrants to the purchasers of the January 2010 Notes giving themthe right to purchase up to an aggregate of 4,774,049 shares of the Company’scommon stock at an exercise price of $1.93 per share.  Additionally, the Company issued warrants toplacement agents in the private placement the right to purchase 248,710 sharesof common stock at $1.55 per share. The warrants will expire on 

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January3, 2012 and are subject to exercise price adjustment for anti-dilutionpurposes.  The Company is required to setaside $2,083 of the proceeds from the private placement for payment of the 6%Senior Secured Convertible notes due July 2007 (“July 2007 Notes”).

InFebruary 2007, as part the private placement offer, the Company entered intoconversion agreements with the holders of previously issued August 2007 Notestotaling $1,900 of principal providing for the conversion of such notes at areduced conversion price of $1.25 per share. The Company issued 1,520,000 shares of common stock under the conversionagreement.

Our January 2010 Notes were issuedpursuant to a Securities Purchase Agreement, dated January 3, 2007, between theCompany and the purchasers of the January 2010 Notes (the “January PurchaseAgreement”).  Under the terms of theJanuary Purchase Agreement, we agreed to satisfy, within 5 days after theclosing of the private placement, through either repayment or conversion,approximately $15,461 of our outstanding debt under previously issuedpromissory notes (including the August 2007 Notes).  We originally agreed to this covenant basedon assurances that a substantial number of holders of the August 2007 Noteswould elect to convert their August 2007 Notes at a reduced conversion pricefollowing the private placement under a note conversion agreement proposed byus, but most of such holders have elected not to proceed with suchconversion.  Accordingly, in an effort topreserve funds, we have not yet repaid the indebtedness as required by theJanuary PurchaseAgreement and are therefore in breach of the January 2010 Notes.  We are currently in discussions with theholders of the January 2010 Notes in an effort to negotiate a forbearance withrespect to this breach, and the holders of the January 2010 have not yetindicated a desire to declare a default under the January 2010 Notes.  However, if such holders declare a default,they may elect to accelerate the maturity of the January 2010 Notes if we donot cure the breach within ten days, and we would likely not be able to curesuch breach at such time.  Also, becausewe repaid $1,763 in principal and interest in January and February 2007 undercertain subordinated bridge notes without first repaying the August 2007 Notesand July 2007 Notes, we may also be deemed to be in breach of the August 2007Notes and July 2007 Notes, which case they would also have the right toaccelerate such notes and foreclose on their security interest if the breach isnot cured within thirty days of notice of default.  The August 2007 Notes and July 2007 Notes aresecured by substantially all of the assets of our company.

In January 2007, theCompany entered into a second amendment to the Factoring, Loan, and SecurityAgreement with a financing company.  Theamendment provides for increased borrowings against non-approved receivables assignedof 80%.  Borrowings made againstnon-approved receivables assigned are limited to $1,000 and total borrowingsmade on approved and non-approved receivables assigned are limited to$5,000.  Further, the amendment providesfor interest charges of 0.5% plus prime rate of interest on outstandingborrowings.  The factoring agreement willcontinue until February 1, 2008 and will renew annually year thereafter.

Additionally, inFebruary 2007, the Company entered into an agreement to deposit cash of $2,083with a rate of prime rate of interest less 2%. The agreement is effective until July 27, 2007.   The cash deposit will be used to pay downprincipal amount of July 2007 Notes.

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**Schedule II — Valuation and Qualifying Accounts**
| ** **                                                                        | ** ** | **Balance at**   | ** ** | **Additions**       | ** ** | **Write-offs** | ** ** | **Balance at** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------|------------|---------------------|------------|----------------|------------|---------------------|------------|
| ** **                                                                        | ** ** | **Beginning of** | ** ** | **Charged to** | ** ** | **and**        | ** ** | **End of**     | ** ** |
| **Schedule II - Valuation and Qualifying Accounts** | ** ** | **Period**            | ** ** | **Expenses**        | ** ** | **Payments**   | ** ** | **Period**          | ** ** |
|                                                                              |       |                  |       |                |       |           |       |                |       |
| Allowance for  doubful accounts                                                   |       |                  |       |                |       |           |       |                |       |
| Year ended December 31, 2006                                                      |       | $                     | 61         |                | $          | 47             |       | $                   | (26        | ) | $ | 82 |   |
| Year ended December 31, 2005                                                      |       | 108                   |       | (6                  | )          | (41            | )          | 61                  |       |
| Year ended December 31, 2004                                                      |       | 127                   |       | 84                  |       | (103           | )          | 108                 |       |
|                                                                              |       |                  |       |                |       |           |       |                |       |
| Product warranty  accrual                                                         |       |                  |       |                |       |           |       |                |       |
| Year ended December 31, 2006                                                      |       | $                     | 634        |                | $          | 46             |       | $                   | 58         |   | $ | 738 |   |
| Year ended December 31, 2005                                                      |       | 519                   |       | 101                 |       | 14             |       | 634                 |       |
| Year ended December 31, 2004                                                      |       | 303                   |       | 288                 |       | (72            | )          | 519                 |       |
|                                                                              |       |                  |       |                |       |           |       |                |       |
| Deferred tax  asset valuation allowance *                                         |       |                  |       |                |       |           |       |                |       |
| Year ended December 31, 2006                                                      |       | $                     | 32,771     |                | $          | 10,363         |       | $                   | —     |   | $ | 43,134 |   |
| Year ended December 31, 2005                                                      |       | 33,477                |       | —              |       | (706           | )          | 32,771              |       |
| Year ended  December 31, 2004                                                     |       | 28,866                |       | 4,611               |       | —         |       | 33,477              |       |

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*       The deferred tax asset valuation allowance represents a 100%reserve against the deferred tax asset accounts at December 31, 2006,2005, and 2004, respectively.

 

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