**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K******

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

 

**For the transition period from                   to                   **

 

**Commission File No. 000-31332**

 

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**LIQUIDMETAL TECHNOLOGIES, INC.**

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

 

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

 

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

 

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

 

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

 

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

 

**Title of each Class**

CommonStock, .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 ý

 

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 ý

 

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

 

Indicate by check markif 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 ý |   | Non-accelerated  filer o |
|---------------------------------|--------|--------------------------------|--------|-------------------------------|

 

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

 

The aggregate marketvalue of the registrant’s Common Stock held by non-affiliates of the registrantas of June 30, 2005 was approximately $49,763,593. For purposes of thiscalculation only, (i) shares of Common Stock are deemed to have a marketvalue of $1.93 per share, the closing price of the Common Stock as reported onthe Nasdaq National Market on June 30, 2005, and (ii) each of theexecutive officers, directors and persons holding more than 10% of theoutstanding Common Stock as of June 30, 2005 is deemed to be an affiliate.

 

 

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**TABLE OF CONTENTS**

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

 

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**PART I**

 

**Forward-Looking Statements**

 

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

 

•                  Ourhistory of losses and uncertainty surrounding our ability to achieveprofitability;

•                  Ourlimited history of manufacturing products from bulk amorphous alloys;

•                  Lengthycustomer adoption cycles and unpredictable customer adoption practices;

•                  Ourability to identify, develop, and commercialize new product applications;

•                  Competitionfrom other materials;

•                  Ourability to consummate strategic partnerships in the future;

•                  Thepotential for manufacturing problems or delays;

•                  Potentialdifficulties associated with protecting or expanding our intellectual propertyposition; and

•                  Pendingshareholder litigation against our company

 

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

 

**Item 1. Business**

 

In this annualreport on Form 10-K, unless the context indicates otherwise, references to“the Company”, “Liquidmetal Technologies”, “our Company”, “we”, “us”, andsimilar references refer to Liquidmetal Technologies, Inc. and itssubsidiaries.

 

**Overview**

 

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

 

Amorphousalloys are unique materials that are distinguished by their ability to retain arandom atomic structure when they solidify, in contrast to the crystallineatomic structure that forms in other metals and alloys when they solidify.Liquidmetal alloys possess a combination of performance, processing, andpotential cost advantages that we believe will make them preferable to 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.

 

**GeneralCorporate Information**

 

We wereoriginally incorporated in California in 1987, and we reincorporated inDelaware in May 2003. Our principal executive offices are located at 25800Commercentre Dr., Suite 100, Lake Forest, California 92630. Our telephone

 

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numberat that address is (949) 206-8000. Previously, our principal executive officeswere located in Tampa, Florida. In December 2003, we consolidated allcorporate functions into our Lake Forest facility, which had previously servedas our principal research and development office. Our Internet website addressis www.liquidmetal.com and all of our filings with the Securities and ExchangeCommission are available free of charge on our website.

 

**Subsidiariesand Other Locations**

** **

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

 

**Segments**

 

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

 

Results ofsegment operations and assets are included in Note 19 to the ConsolidatedFinancial Statements contained in this Form10-K.

 

**OurTechnology**

 

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

 

***Unique Atomic Structure***

 

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

 

Prior to1993, commercially viable amorphous alloys could be created only in thin forms,such as coatings, films, or ribbons. However, in 1993, researchers at theCalifornia Institute of Technology (Caltech) developed the first

 

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commerciallyviable amorphous alloy in a bulk form. Today, bulk Liquidmetal alloys can beformed into objects that are up to one inch thick, and we are not aware of anyother commercially available amorphous alloys that can achieve this thickness.We have the exclusive right to commercialize bulk amorphous alloy technologythrough a license agreement with Caltech and other patents that we own.

 

***Proprietary Material Composition***

 

Theconstituent elements and percentage composition of Liquidmetal alloys arecritical to their ability to solidify into an amorphous atomic structure. Wehave several different alloy compositions that have different constituentelements in varying percentages. These compositions are protected by variouspatents that we own or exclusively license from third parties, includingCaltech. The raw materials that we use in Liquidmetal alloys are readilyavailable and can be purchased from multiple suppliers.

 

**Advantagesof Liquidmetal Alloys**

 

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

 

***Performance Advantages***

 

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

 

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

 

***Processing Advantages***

 

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

 

BulkLiquidmetal alloys also permit the creation of composite materials that cannotbe created with most non-amorphous metals and alloys. A composite is a materialthat is made from two or more different types of materials. In general, 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

 

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eliminate orlimit damage to the constituent materials when creating composites. In additionto composites, we believe that the processing advantages of Liquidmetal alloyswill ultimately allow for a variety of other finished forms, including acoating or a spray. Most high-strength metals and alloys cannot be processedinto these forms.

 

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

 

***Cost Advantages***

 

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

 

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

 

**OurStrategy**

 

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

 

•                  *Identifyingand Developing New Applications for Our Liquidmetal Alloy Technology.*We intend to continue to identify and develop new applications that willbenefit from the performance, processing, and cost advantages of Liquidmetalalloys.

 

•*                  Focusing OurMarketing and Internal Manufacturing Activities on Select Products withExpected Higher Gross-Margins.*We intend to focus our marketing andinternal manufacturing activities on select products with anticipated highergross margins. This strategy is designed to align our product developmentinitiatives with our manufacturing processes and manufacturing cost structure,and to reduce our exposure to more commodity-type product applications that areprone to unpredictable demand and fluctuating pricing. Our focus is primarilyon higher-margin products that possess design features that take optimal advantageof our existing and developing manufacturing technology and that command aprice commensurate with the performance advantages of our alloys. In additionto our focus on products with higher gross margins, we will continue to engagein prototype manufacturing, both for internally manufactured products and forproducts that will ultimately be licensed to or manufactured by third parties.

 

•*                  FurtherDeveloping Our Manufacturing Processes, Capabilities, and Efficiencies for BulkLiquidmetal Alloys.* We intend to improve and enhance our internalmanufacturing processes, capabilities, and efficiencies in order to maintainquality control over products made from bulk Liquidmetal alloys, to focus onimprovements to the processing of our alloys, and to protect our intellectualproperty. As our alloys become more pervasive, however, we expect to enter intoadditional strategic relationships that would involve the licensing ofLiquidmetal technology to third parties for certain market segments.

 

•*                  PursuingStrategic Partnerships In Order to More Rapidly Develop and CommercializeProducts*. We intend to

 

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actively pursue and support strategicpartnerships that will enable us to leverage the resources, strength, and technologiesof other companies in order to more rapidly develop and commercialize products.These partnerships may include licensing transactions in which we licensefull commercial rights to our technology in a specific application area, orthey may include transactions of a more limited scope in which, forexample, we outsource manufacturing activities or grant distribution rights. Webelieve that utilizing such a partnering strategy will enable us to reduce ourworking capital burden, better fund product development efforts, betterunderstand customer adoption practices, leverage the technical and financialresources of our partners, and more effectively handle product design andprocess challenges. As this partnering strategy evolves, a growing portion of ourrevenue mix may be comprised of revenue from the provision of productdevelopment services, technical support, and engineering services, as well asrevenues from royalties on the sale of Liquidmetal alloy products by ourpartners.

 

•*                  Advancing theLiquidmetal® Brand*. We believe that building our corporate brand willfoster continued adoption of our technology. Our goal is to positionLiquidmetal alloys as a superior substitute for materials currently used in avariety of products across a range of industries. Furthermore, we seek toestablish Liquidmetal alloys as an enabling technology that will facilitate thecreation of a broad range of commercially viable new products. To enhanceindustry awareness of our company and increase demand for Liquidmetal alloys,we are reviewing various brand development strategies that could includecollaborative advertising and promotional campaigns with select customers,industry conference and trade show appearances, public relations, and othermeans.

 

**Applications for Liquidmetal Alloys**

 

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

 

***Components for Electronic Products***

 

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

 

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

 

***Sporting Goods and Leisure Products***

 

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

 

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

 

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Otherpotential applications for our alloys in this industry include golf clubs,eyewear, fishing, hunting, and other sport products.

 

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

 

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

 

***Medical Devices***

 

We areengaged in product development efforts relating to various medical devices thatcould be made from Liquidmetal alloys. We believe that the unique properties ofbulk Liquidmetal alloys provide a combination of performance and cost benefitsthat could make them a desirable replacement to incumbent materials, such asstainless steel and titanium, currently used in various medical deviceapplications. Our ongoing emphasis in 2004 and 2005 has been on surgicalinstrument applications for Liquidmetal alloys. These include, but are notlimited to, specialized blades, orthopedic instruments utilized for implantsurgery procedures, dental devices, and general surgery devices. The potentialvalue offered by our alloys is high performance in some cases and costreduction in others, the latter stemming from the ability of Liquidmetal alloysto be net shape cast into components, thus reducing costs of secondaryprocessing. The status of most components in the prototyping phase is subjectto non-disclosure agreements with our customers.

 

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

 

***Industrial Coatings and Powders***

 

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

 

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

 

Liquidmetalcoatings have also been sold into the power generation industry specificallyfor the purpose of coating boiler tubes in coal-burning power plants in orderto extend the lives of these boilers. Boiler tubes are subject to high heat,erosion, and corrosion and often require costly replacement, both in terms ofreplacement parts and length of downtime for installation. Additionally,residue build-up in boiler tubes of coal burning power plants creates operatinginefficiencies. Historic performance and testing of Liquidmetal coatings havedemonstrated that our coatings extend the life of these boiler tubes meaningfullybeyond their current average life depending on the specific environment. Inaddition, our coatings have demonstrated the ability to reduce build-up ofresidue on boiler tubes, helping to improve the efficiencies of

 

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the boilers.Historically, we have not concentrated sales efforts on the boiler tube marketin a substantial way. However, given the size of the market and potentialopportunities for our coatings, we have recently dedicated greater effort tothis area.

 

***Defense Applications***

 

We are working with the U.S.Department of Defense, as well as a variety of defense-related research anddevelopment agencies and large defense contractors, to develop variousdefense-related applications for Liquidmetal alloys. For example, we arecurrently developing prototype kinetic energy penetrator rods for use inarmor-piercing ammunition systems. Kinetic energy penetrators, or KEPs, arearmor piercing munitions that are currently made primarily from depleteduranium or tungsten alloys. Initial ballistic tests under the Liquidmetal KEP programhave demonstrated that tungsten KEPs perform better whenever Liquidmetalalloy is combined with the tungsten to create a composite material. In August 2003,we signed a new $3.0 million research and development contract with the U.S.Army for thedevelopmentof KEPs. Our strategy is to orient the KEP program toward future systems suchas the Joint Strike Fighter program and the Army’s Future Combat System.

 

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

 

**GoingConcern**

** **

We haveexperienced significant operating losses since our inception. Our net loss forthe fiscal years ended December 31, 2005 and 2004 was $11.2 million and$12.7 million, respectively. In our audit reports on our financial statementsfor our fiscal years ended December 31, 2005 and 2004, our present andformer auditors have included a going-concern qualification indicating that oursignificant operating losses and working capital deficit cause substantialdoubt about our ability to continue as a going concern. By issuing an opinionstating that there is substantial doubt about our ability to continue as agoing concern, our former and current auditors have indicated that they areuncertain as to whether we have the capability to continue our operationswithout additional funding.

 

Accordingly,we anticipate that we will need additional funding during the next 12 monthsand would seek to raise such funds through public or private equity financing,bank debt financing, or from other sources. Adequate funds may not beavailable when needed, and if we raise additional funds by issuing equitysecurities, existing stockholders may be diluted.

 

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**LiquidmetalGolf**

 

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

 

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

 

**OurIntellectual Property**

 

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

 

Our initialbulk amorphous alloy technology was developed by researchers at the CaliforniaInstitute of Technology (“Caltech”). We have purchased patent rights thatprovide us with the exclusive right to commercialize the amorphous alloy andother amorphous alloy technology acquired from Caltech through a licenseagreement (“Caltech License Agreement”) with Caltech. Under the Caltech licenseagreement, we have the exclusive worldwide right to make, use, and sellproducts from all of Caltech’s inventions, proprietary information, know-how,and other technology relating to amorphous alloys existing as of September 1,2001. We also have an exclusive worldwide license to eleven issued patents and twopatent applications held by Caltech relating to amorphous alloy technology, aswell as all related foreign counterpart patents and patent applications.Of the 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 us the exclusive right to make, use, and sellproducts from substantially all amorphous alloy technology that is developed inProfessor William Johnson’s Caltech laboratory during the period September 1,2001 through August 31, 2005. All fees and other amounts payable by us forthese rights and licenses have been paid in full, and no further royalties,license fees, or other amounts will be payable in the future under this licenseagreement.

 

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

 

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

 

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

 

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

 

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

 

**Researchand Development**

 

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

 

•                  *Enhance Material Processing and ManufacturingEfficiencies.*We plan to continue research and development ofprocesses and compositions that will decrease our cost of making products fromLiquidmetal alloys.

 

•                  *OptimizeExisting Alloys and Develop New Compositions.*We believe that theprimary technology driver of our business will continue to be our proprietaryalloy compositions. We plan to continue research and development on new alloycompositions to generate a broader class of amorphous alloys with a widerrange of specialized performance characteristics. During 2003 and continuinginto 2005, we have successfully expanded our portfolio of bulk amorphous alloysto include additional zirconium-titanium alloys, as well as alloys based onother metals, such as iron, gold, and platinum. Although these variouscompositions are at different stages of development and only a few arecurrently suitable for commercial use, we believe that a larger alloy portfoliowill enable us to increase the attractiveness of our alloys as an alternativeto incumbent materials and, in certain cases, drive down product costs. We alsobelieve that our ability to optimize our existing alloy compositions willenable us to better tailor our alloys to our customers’ specific applicationrequirements.

 

•                  *DevelopNew Applications.* We will continue research and development of newapplications for Liquidmetal alloys. We believe the range of potential applicationswill broaden by expanding the forms, compositions, and methods of processing ofour alloys.

 

We conductour research and development programs internally and also through strategicrelationships that we enter into with third parties. Our internal research anddevelopment efforts are currently focused on product and process development.Our internal research and development efforts are conducted by a team of 15scientists, engineers and researchers whom we either employ directly or engageas consultants. Included among this team are Professor William Johnson, whodiscovered our initial bulk amorphous alloy at Caltech in 1993, and hisgraduate student at the time, Atakan Peker, who is employed as our VicePresident of Technology. Professor Johnson was an employee of our company from October 2001through December 2003 and then became a consultant to the Company. ProfessorJohnson continues to be a member of our board of directors.

 

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

 

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

 

**Manufacturing**

 

Wecurrently own and operate a 166,000 square foot manufacturing facility inPyongtaek, South Korea, which became operational in the third quarter of 2002. Weopened a 14,400 square foot facility in Weihai, China in August 2004 tofacilitate our bulk alloy manufacturing business. We believe that thesefacilities will meet our anticipated manufacturing needs for the foreseeablefuture, although these needs may change depending upon the actual andforecasted orders we receive for our products. We currently intend to developsupplemental research and development, prototyping and manufacturingcapabilities elsewhere, including the United States, for purposes of meetingour long-term manufacturing needs and our customers’ requirements. In December 2003,we entered into a license agreement

 

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withFlorida Custom Mold, Inc., a Clearwater, Florida-based company thatspecializes in high-quality mold design and injection molding services, underwhich Florida Custom Mold is currently acting as a contract manufacturer to ourcompany for purposes of producing prototypes of certain defense and medicalproducts in the US.

 

**RawMaterials**

 

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

 

**Customers**

 

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

 

**Competition**

 

We are notaware of any other company or business that manufactures, markets, distributes,or sells bulk amorphous alloys or products made from bulk amorphous alloys. Webelieve it would be difficult to develop a competitive bulk amorphous alloywithout infringing our patents. However, our bulk Liquidmetal alloys facecompetition from other materials, including metals, alloys, plastics andcomposites, which are currently used in the commercial applications that wepursue. For example, we face significant competition from plastics and zinc inour electronics components business, and titanium and composites will continueto be used widely in medical devices and sporting goods. Based on ourexperience with developing products for a variety of customers, we believe thatthe selection of materials by potential customers will continue to beproduct-specific in nature, with the decision for each product being drivenprimarily by the performance needs of the application and secondarily by costconsiderations and design flexibility. Because of the relatively high strengthof our alloys and the design flexibility of our process, we are mostcompetitive when the customer is seeking a higher strength as well as greaterdesign flexibility than currently available with other materials. However, ifcurrently available materials, such as plastics, are strong enough for theapplication, our alloys are often not competitive those applications withrespect to price. We also believe that our alloys are generally not competitivewith the cost of some of the basic metals, such as steel, aluminum or copper,when such basic metals can be used in specific applications, but our alloys aregenerally more competitive with price on more exotic metals, such as titanium. Ouralloys could also face competition from new materials that may bedeveloped in the future, including new materials that could render our alloysobsolete.

 

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

 

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

 

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**Backlog**

 

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

 

**Salesand Marketing**

 

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

 

**Employees**

 

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

 

**GovernmentalRegulation**

 

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

 

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

 

The processof obtaining and maintaining required FDA and foreign regulatory approvals formedical devices that incorporate our products could be lengthy, expensive, anduncertain for our customers. Additionally, regulatory agencies can delay orprevent product introductions. Generally, before a medical device manufacturercan market a product incorporating one of our products, our customer mustobtain for their finished product marketing clearance through a 510(k)premarket notification or approval of a pre-market approval application, orPMA. The FDA will typically grant a 510(k) clearance if the applicant canestablish that the device is substantially equivalent to a predicate device. Itgenerally takes a number of months from the date of a 510(k) submission toobtain clearance, but it may take longer, particularly if a clinical trialis required.

 

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

 

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

 

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**Environmental Law Compliance**

 

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

 

**Item 1A. Risk Factors**

 

This report containsforward-looking statements (within the meaning of the Private SecuritiesLitigation Reform Act of 1995) that are based on management’s currentexpectations, estimates, forecasts, and projections about the Company and itsbusiness. In addition, other written or oral statements which constituteforward-looking statements may be made from time to time by or on behalfof Liquidmetal Technologies, Inc. Any statement in this report that is nota statement of historical fact is a forward-looking statement, and in somecases, words such as “believe,” “estimate,” “project,” “expect,” “intend,” “may,”“anticipate,” “plans,” “seeks,” and similar expressions identifyforward-looking statements. Forward-looking statements involve risks anduncertainties that could cause actual outcomes and results to differ materiallyfrom the anticipated outcomes or result. These statements are not guarantees offuture performance, and undue reliance should not be placed on these statements.Liquidmetal Technologies, Inc. undertakes no obligation to update publiclyany forward-looking statements, whether as a result of new information, futureevents or otherwise.

 

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

 

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

 

We haveexperienced significant operating losses since our inception. Our net loss forthe fiscal years ended December 31, 2005, 2004, and 2003 was $11.2million, $12.7 million and $33.6 million, respectively. We had an accumulateddeficit of approximately $136.6 million at December 31, 2005. Of thisaccumulated deficit, $44.5 million was attributable to losses generated by ourdiscontinued equipment manufacturing and retail golf businesses through December 31,2005. We anticipate that we may continue to incur operating losses for theforeseeable future. Consequently, it is possible that we may never achievepositive earnings and, if we do achieve positive earnings, we may not beable to achieve them on a sustainable basis.

 

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

 

Our futurecapital requirements will depend on the amount of cash generated by ouroperations. Our projections of cash flows from operations and, consequently,future cash needs are subject to substantial uncertainty. In addition, in ouraudit report on our financial statements for our fiscal years ended December 31,2005 and 2004, our auditors included a going-concern qualification indicatingthat our significant operating losses and working capital deficit causesubstantial doubt about our ability to continue as a going concern. Ouroperating plan is based on assumptions that are uncertain or otherwise subjectto change. If our available funds and cash generated from operations areinsufficient to satisfy our liquidity requirements, we will needadditional funds in the future to support our working capital requirements andfor other purposes, and we anticipate that we will need to raise additionalfunds through public or private equity financing, bank debt financing, or fromother sources. Adequate funds may not be available when needed or may notbe available on favorable terms. If we raise additional funds by issuing equitysecurities, existing stockholders may be diluted. If funding isinsufficient at any time in the future, we may not be able to develop orenhance our products or services, take advantage of business opportunities, orrespond to competitive pressures, any of which could harm our business.

 

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

 

We havemarketed and sold industrial coatings to distributors in the coatings industrysince 1987. Prior to the third quarter of 2002, our experience selling productsmade from bulk amorphous alloys has been limited to our discontinued retailgolf business, which had a different marketing strategy than the one we arecurrently employing. Therefore, we have a relatively limited history ofproducing bulk amorphous alloy components and products on a mass-productionbasis. Furthermore, our ability to produce our products in desired quantitiesand at commercially reasonable prices is

 

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uncertainand is dependent on a variety of factors that are outside of our control,including the nature and design of the component, the customer’sspecifications, and required delivery timelines.

 

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

 

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

 

**If we cannot establish and maintain relationships with customers that incorporateour components and products into their finished goods, we will not be able toincrease our revenue and commercialize our products.**

 

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

 

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

 

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

 

•                  identify a potential customer andintroduce the customer to Liquidmetal alloys;

 

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

 

•                  make the molds and tooling to be usedto produce the selected part;

 

•                  make prototypes and samples forcustomer testing;

 

•                  work with our customers to test andanalyze prototypes and samples; and

 

•                  with respect to some types ofproducts, such as medical devices, to obtain regulatory approval.

 

Wecurrently do not have a sufficient history of selling products made from ourbulk amorphous alloys to predict accurately the length of our average salescycle. We believe that our average sales cycle from the time we deliver anactive proposal to a customer until the time our customer fully integrates ourbulk amorphous alloys into its product could be a significant period of time.Our history to date has demonstrated that the sales cycle could extendsignificantly longer than we anticipate. The time it takes to transition acustomer from limited production to full-scale production runs will depend uponthe nature of the processes and products into which our alloys are integrated. Moreover,we have found that customers often proceed very cautiously and slowly beforeincorporating a fundamentally new and unique type of material into theirproducts.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

The futuregrowth and success of our bulk amorphous alloy business will depend in part onour ability to establish and retain a technological advantage over othermaterials for our targeted applications. For many of our targeted applications,we will compete with manufacturers of similar products that use differentmaterials. These different materials may include plastics, titaniumalloys, or stainless steel, among others. For example, we have targeted thecellular phone component market as an application for bulk Liquidmetal alloys.In this market, we believe we will compete with other manufacturers of cellularphone components who use plastics or metal to construct their components. Theseother manufacturers may be able to manufacture their cellular phonecomponents, particularly those made from plastics, at significantly less costthan

 

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our alloys.In other markets, we will compete directly with suppliers of the incumbentmaterial. In addition, in each of our targeted markets, our success will dependin part on the ability of our customers to compete successfully in theirrespective markets. Thus, even if we are successful in replacing an incumbentmaterial in a finished product, we will remain subject to the risk that ourcustomer will not compete successfully in its own market.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

As a part ofour business strategy, we intend to pursue strategic partnering transactionsthat provide access to new technologies, products, markets, and manufacturingcapabilities. These transactions could include licensing agreements, jointventures, or even business combinations. We believe that these transactionswill be particularly important to our future growth and success due to the sizeand resources of our company and the newness of our technology. For example, wemay determine that we may need to license our technology to a largermanufacturer in order to penetrate a particular

 

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market. Inaddition, 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 successfullyidentify any potential strategic partnerships. Even if we do identify one ormore potentially beneficial strategic partnering, we may not be able toconsummate these transactions on favorable terms or obtain the benefits weanticipate from such a transaction.

 

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

 

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

 

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

 

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

 

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

 

•                  staffingand managing our manufacturing facility located in South Korea andpost-processing facility located in China;

 

•                  productor material transportation delays or disruption, including the availability andcosts of air and other transportation between our South Korean and Chinesefacilities and the United States;

 

•                  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 the profitability of products manufactured overseas orsold to overseas customers;

 

•                  burden of complying with complex foreignlaws and treaties, which could limit our ability to conduct our business ascontemplated in South Korea and China; and

 

•                  trade protection laws, policies, andmeasures and other regulatory requirements affecting trade and investment thatcould adversely affect the profitability of our South Korean and ChineseOperations, including loss or modification of exemptions for taxes and tariffs.

 

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

 

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

 

Ourproprietary alloy compositions are comprised of many elements, all of which areavailable commodity products. Although we believe that each of these rawmaterials is currently readily available in sufficient quantities from multiplesources on commercially acceptable terms, if the prices of these materialssubstantially increases or there is an interruption

 

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in the supplyof these materials, such increase or interruption could adversely affect ourprofitability. For example, if the price of one of the elements included in ouralloys substantially increases, we may not be able to pass the priceincrease on to our customers.

 

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

 

We expect toconduct business in various foreign currencies and will be exposed to marketrisk from changes in foreign currency exchange rates and interest rates.Fluctuations in exchange rates between the U.S. dollar and such foreigncurrencies may have a material adverse effect on our business, results ofoperations, and financial condition and could specifically result in foreignexchange gains and losses. The impact of future exchange rate fluctuations onour operations cannot be accurately predicted. To the extent that thepercentage of our non-U.S. dollar revenue derived from international salesincreases in the future, our exposure to risks associated with fluctuations inforeign exchange rates will increase further. Moreover, as a result ofoperating a manufacturing facility in South Korea, a substantial portion of ourcosts are and will continue to be denominated in the South Korean won. Adversechanges in the exchange rates of the South Korean won to the U.S. dollar willaffect our costs of goods sold and operating margins and could result inexchange losses. The average foreign exchange rates for the years ended December 31,2005, 2004, and 2003 were 1,028, 1,151, and 1,195 South Korean Won to the U.S.dollar, respectively. The fluctuations in the exchange rates resulted inforeign currency translation gains of $0.3 million, $1.7 million, and $0.2million for the years ended December 31, 2005, 2004, and 2003,respectively.

 

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

 

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

 

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

 

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

 

•                  operate our business without infringingon the intellectual property rights of third parties.

 

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

 

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

 

**Othercompanies may claim that we infringe their intellectual property rights,which could cause us to incur significant expenses or prevent us from sellingour products.**

 

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Our successdepends, in part, on our ability to operate without infringing on valid,enforceable patents or proprietary rights of third parties and not breachingany licenses that may relate to our technology and products. Futurepatents issued to third parties may contain claims that conflict with ourpatents and that compete with our products and technologies, and third partiescould assert infringement claims against us. Any litigation or interference proceedings,regardless of their outcome, may be costly and may requiresignificant 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 or using products that incorporate the challenged intellectualproperty;

 

•                  pay damages; or

 

•                  enter into licensing or royaltyagreements that may be unavailable on acceptable terms.

 

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

 

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

 

•                  $2.8 million in principal outstandingunder our Korean subsidiary’s loan from Kookmin Bank of South Korea;

 

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

 

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

 

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

 

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

 

•                  a significant portion of our cash flowfrom operations is likely to be dedicated to the payment of the principal ofand interest on our indebtedness;

 

•                  we may be unable to refinance ourindebtedness on terms acceptable to us or at all;

 

•                  our cash flow may be insufficient tomeet our required principal and interest payments; and

 

•                  we may be unable to obtainadditional loans as a result of covenants and agreements with existing debtholders.

 

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

 

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merger orsale of all or substantially all of our business assets. These covenants may curtailour ability to raise capital in the future or otherwise restrict our ability toenter into a transaction that we believe would be in the best interest of ourstockholders.

 

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

 

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

 

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

 

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

 

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

 

In general,the SEC has broad authority under the Securities Exchange Act of 1934 toinstitute investigations, to seek injunctions, to seek monetary penalties, andto otherwise pursue enforcement actions for violations of Section 13(a),including a failure to file a Form 10-K or for the omission of necessarystatements in a Form 10-K. Therefore, a violation under Section 404of SOX or Section 13(a) of the Securities Exchange Act of 1934 couldpotentially subject an issuer to these same investigations and penalties. Section 404of SOX is a relatively new legal requirement, and there is very little precedentestablishing the consequences or appropriate response to a public company’sfailure to comply with Section 404. Accordingly, although we havediscussed our Section 404 noncompliance with the SEC, we cannot predictwhat action, if any, the SEC may take against our company as a result of afailure to be compliant with our obligations under Section 404 of SOX or Section 13(a) ofthe Securities Exchange Act of 1934.

 

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

 

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

 

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

 

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

 

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

 

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

 

•                  Lack of adequate segregation of duties inour Coatings Division in Texas in order processing and invoicing.

 

•                  Lack of adequate controls anddocumentation in our South Korean operations to evidence proper customerinvoicing and revenue recognition in the proper period.

 

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

 

•                  Lack of controls over internal access toour SAP system of reporting by unauthorized users.

 

•                  Manual performance of numerous proceduresthat could be automated using current reporting systems.

 

In additionto the foregoing, after a review of our operating results for the fiscal yearended December 31, 2004 and for the quarters ended March 31, 2005, June 30,2005, and September 30, 2005, and pursuant to Rule 13a-15 under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), our ChiefExecutive Officer and our Chief Financial Officer have determined that, as ofeach such date, our disclosure controls and procedures were not effective toprovide reasonable assurance that information that we are required to disclosein reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission rules and forms. Our management reachedthis conclusion based on the above-described material weaknesses.

 

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

 

We cannot becertain that our efforts to improve the material weaknesses in our internalcontrol over financial reporting and the ineffectiveness of our disclosurecontrols and procedures will be successful or that we will be able to maintainadequate controls over our financial processes and reporting in the future. Wewill need to commit substantial resources,

 

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includingsubstantial time from our management team’s accounting personnel and fromexternal consultants, to implement and integrate into our organization improveddisclosure controls and additional procedures generally and to improve systemsto report financial information on a timely basis. Any failure or delay todevelop or maintain effective controls, or difficulties encountered in theirimplementation or in other effective improvement of our internal and disclosurecontrols could materially harm our operating results or cause us to fail tomeet our reporting obligations. Ineffective internal and disclosure controlscould also cause investors to lose confidence in our reported financialinformation, which would likely have a significant negative effect on thetrading price of our securities.

 

**Therestatement of our 2003 and 2002 consolidated financial statements has had amaterial adverse impact on us.**

 

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

 

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

 

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

 

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

 

**We arecurrently a defendant in several stockholder class-action lawsuits andderivative actions.**

 

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

 

In addition to the above, certain of our present and former officersand directors, as well as the company as a nominal defendant, havebeen named in three shareholder derivative actions. Two shareholder derivativecomplaints were filed in California state court styled*Brian Clair, Derivatively on Behalf of LiquidmetalTechnologies, Inc. v. John Kang, et*

 

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*al.*, Case No. 04CC00551,and*Joseph Durgin, Derivatively on Behalf ofLiquidmetal Technologies, Inc. v. John Kang, et al.*, Case No. 04CC00553,both commenced in the Superior Court of Orange County, California.  A third shareholder derivative complaint wasfiled in the United States District Court for the Middle District ofFlorida, Tampa Division, styled*RobertStory v. John Kang, et al.*, Case No. 8:04-CV-1587-T-23TBM. Theseshareholder derivative lawsuits allege that the defendants breached variousfiduciary duties and otherwise violated state law based primarily upon the sameunderlying facts and circumstances as alleged in the federal shareholder class action.The plaintiffs seek unspecified compensatory damages, restitution anddisgorgement of profits, equitable and/or injunctive relief as permitted by lawand other relief.

 

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

 

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

 

**Evolvingregulation of corporate governance and public disclosure may result inadditional expenses and continuing uncertainty.**

 

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

 

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

 

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

 

**The timeand cost associated with complying with government regulations to which wecould become subject could have a material adverse effect on our business.**

 

Some of theapplications that we have identified or may identify in the future may besubject to government regulations. For example, any medical devices such asprecision ophthalmic instruments and orthopedic devices made from our alloyslikely will be subject to extensive government regulation in the United Statesby the Food and Drug Administration, or FDA. Any medical device manufacturersto whom we sell Liquidmetal alloy products may need to comply with FDArequirements, including premarket approval or clearance under Section 510(k)of the Food Drug and Cosmetic Act before

 

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marketing inthe United States Liquidmetal alloy medical device products. These medicaldevice manufacturers may be required to obtain similar approvals beforemarketing these medical devices in foreign countries. Any medical devicemanufacturers with which we jointly develop and sell medical device products may notprovide significant assistance to us in obtaining required regulatoryapprovals. The process of obtaining and maintaining required FDA and foreignregulatory approvals could be lengthy, expensive, and uncertain. Additionally,regulatory agencies can delay or prevent product introductions. The failure tocomply with applicable regulatory requirements can result in substantial fines,civil and criminal penalties, stop sale orders, loss or denial of approvals,recalls of products, and product seizures.

 

In addition,the processing of beryllium, a minor constituent element of some of our alloys,can result in the release of beryllium into the workplace and the environmentand in the creation of beryllium oxide as a by-product. Beryllium is classifiedas a hazardous air pollutant, a toxic substance, a hazardous substance, and aprobable human carcinogen under environmental, safety, and health laws, andvarious acute and chronic health effects may result from exposure toberyllium. We are required to comply with certain regulatory requirements andto obtain a permit from the U.S. Environmental Protection Agency or othergovernment agencies to process beryllium. Our failure to comply with present orfuture governmental regulations related to the processing of beryllium couldresult in suspension of manufacturing operations and substantial fines orcriminal penalties.

 

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

 

**Theexistence of minority stockholders in our Liquidmetal Golf subsidiary createspotential for conflicts of interest.**

 

We directlyown 79% of the outstanding capital stock of Liquidmetal Golf, our subsidiarythat has the exclusive right to commercialize out technology in the golf market.The remaining 21% of Liquidmetal Golf stock is owned by approximately 95stockholders of record. As a result, conflicts of interest may developbetween us and the minority stockholders of Liquidmetal Golf. To the extentthat our officers and directors are also officers or directors of LiquidmetalGolf, matters may arise that place the fiduciary duties of theseindividuals in conflicting positions. John Kang, our Chairman, President, andChief Executive Officer, is also director of Liquidmetal Golf. In addition,James Kang, Founder and Director, is also a director of Liquidmetal Golf.

 

**Our stockprice has experienced volatility and may continue to experiencevolatility.**

 

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

 

•                  quarter-to-quarter variations in resultsof operations;

 

•                  loss of a major customer;

 

•                  announcements of technologicalinnovations by us or our potential competitors;

 

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

 

•                  new products offered by us or ourcompetitors;

 

•                  announcements of strategic relationshipsor strategic partnerships; or

 

•                  other events or factors that may bebeyond our control.

 

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

 

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**Ourconvertible notes and warrants contain anti-dilution provisions that, iftriggered, could cause substantial dilution to our then-existing stockholders.**

 

As ofDecember 31, 2005, we had outstanding approximately $2.4 million in aggregateprincipal amount of July 2007 Notes with a conversion price of $1.00 per shareand $9.9 million in aggregate principal amount of August 2007 Notes with aconversion price of $2.00 per share. We also had outstanding warrants topurchase up to 563,151 shares of our common stock at an exercise price of $2.73per share and warrants to purchase an aggregate of 3,777,715 shares at anexercise price of $2.00 per share. Each of these notes and warrants containweighted-average anti-dilution provisions whereby, if we issue shares in thefuture for consideration below such conversion or exercise prices, then (withcertain exceptions, including the issuance of stock options) the conversionprice for our convertible notes would automatically be reduced (allowing theholders of the notes to receive additional shares of common stock uponconversion) and the exercise price of the warrants would automatically bereduced. Further, the warrants from our outstanding convertible Notes and thebeneficial conversion features of our August 2007 Notes have been accounted foras derivatives under SFAS 133 “Accounting for Derivative Instruments andHedging Activities” and EITF 00-19 “Accounting for Derivative FinancialInstruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” Ifour available funds and cash generated from operations are insufficient tosatisfy our liquidity requirements in the future, then we may need to raisesubstantial additional funds in the future to support our working capitalrequirements and for other purposes. If shares of our common stock orsecurities convertible into or exercisable for our common stock are issued inconsideration of such funds at an effective per share price lower than theconversion and exercise prices of our convertible notes and warrants, thenthese anti-dilution provisions would be triggered, thus possibly causingsubstantial dilution to our then-existing stockholders if the notes areconverted or the warrants are exercised. Further, subsequent sales of theshares in the public market could depress the market price of our stock bycreating an excess in supply of shares for sale.

 

**We havenever paid dividends on our common stock, and we do not anticipate paying anycash dividends in the foreseeable future.**

 

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

 

**Antitakeoverprovisions of our certificate of incorporation and bylaws and provisions ofapplicable corporate law could delay or prevent a change of control that youmay favor.**

 

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

 

•                  authorize our board of directors, 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 meetingof our stockholders;

 

•                  provide for a classified board of directors; and

 

•                  establish advance notice requirements to nominatedirectors for election to our board of directors or to propose matters that canbe acted on by stockholders at stockholder meetings.

 

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

 

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##### **Item1B. Unresolved Staff Comments**

 

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

 

Form l0-K/A for the fiscal year ended December 31, 2004

 

General

 

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

#  

Item 9A. Controls and Procedures, page 3

 

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

#  

# 3.               We note the conclusions of your certifyingofficers in the second paragraph that your disclosure controls and proceduresare not effective. The description of your disclosure controls and proceduresappears to be based on the definition set forth in Rule 13a-15(e) under theExchange Act. As described, however, the description does not fully conform tothat definition. Please revise accordingly. Alternatively, you may state thatyour certifying officers concluded that your disclosure controls andprocedures, as of the end of the period covered by the report, were noteffective.

#  

# 4.               We note the conclusions of your managementregarding the effectiveness of your internal control over financial reporting. Pleasereconcile with the disclosure indicating that your management has not completedits assessment of your internal control over financial reporting.

#  

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

#  

•                  Please disclose when the material weaknesses began.

 

•                  Please disclose in greater detail the material weaknesses and theirimpact on your financial statements.

 

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

 

•                  Please disclose the identity of the independent consulting firm youhave retained and disclose the findings of this consultant.

 

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

 

Exhibits 31.3 and 31.4

 

# 7.               Amend your December 31, 2004 certifications toinclude the missing two sections relating to internal control over financialreporting required for accelerated filers. Also please note that the certifyingofficers should not include their positions in the first line of the certification.Also amend your 2005 10-Q certifications to reflect the missing sections of thecertifications relating to internal control over financial reporting. See Item601(b)(31) of Regulation S-K.

 

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Form 10-Q for the fiscal quarter ended September 30, 2005

 

Item 4. Controls and Procedures. page 34

 

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

#  

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

#  

As of the filing of this Form 10-K for the fiscalyear ended December 31, 2005, the Company addressed the foregoing comments inAmendment No. 2 to the Form l0-K for the fiscal year ended December 31, 2004 and Forms 10-Q/Afor the fiscal quarters ended March 31, 2005, June 30, 2005 and September 30,2005, all of which were filed on March 16, 2006.

 

**Item 2. Properties**

 

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

 

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

 

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

 

On August2004, we entered into a 3 year lease for a post-processing facility located inWeihai, China, which consists of approximately 14,400 square feet, tofacilitate our bulk alloy manufacturing.

 

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

 

**Item 3. LegalProceedings**

 

We and certain of our present and former officers and directors werenamed as defendants in nine purported class action complaints filed in theUnited States District Court for the Middle District of Florida, TampaDivision, and the Central District of California, Southern Division, allegingviolations of Sections 11 and 15 of the Securities Act of 1933 and Sections10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5promulgated thereunder. In August 2004, four complaints were consolidated inthe Middle District of Florida under the caption*Primavera Investors v. Liquidmetal Technologies, Inc., et al.*,Case No. 8:04-CV-919-T-23EAJ. John Lee, Chris Cowley, Dwight Mamanteo, ScottPurcell and Mark Rabold were appointed co-lead plaintiffs (the “Lead Plaintiffs”),but Mr. Mamanteo later withdrew. In September 2004, the five complaints filedin the Central District of California were transferred to the Middle Districtof Florida for consolidation with the*Primavera Investors* action. The Lead Plaintiffs served theirConsolidated Amended Class Action Complaint on January 12, 2005. The AmendedComplaint alleges that the Prospectus issued in connection with our initialpublic offering in May 2002 contained material misrepresentations and omissionsregarding our historical financial condition and regarding a personal stocktransaction by our former chief executive officer. The Lead Plaintiffsfurther generally allege that during the proposed Class Period of May 21, 2002,through May 13, 2004, the defendants engaged in improper revenue recognitionwith respect to certain of our business transactions, failed to maintainadequate internal controls, and knowingly disclosed unrealistic but favorableinformation about market demand for and commercial viability of our products toartificially inflate the value of our stock. The Amended Complaint seeksunspecified compensatory damages and other relief. We, along with otherdefendants, filed a Motion to Dismiss Plaintiffs’ Consolidated Amended ClassAction Complaint in March 2005.  The Motion to Dismisswas denied in December 2005, and the defendants served their Answer andAffirmative Defenses to the Consolidated Amended Class Action Complaint onDecember 16, 2005.  The Lead Plaintiffs Motion for Class Certificationis presently due April 2006.  Weintend to vigorously defend against the class action. We cannot currentlypredict the impact or resolution of this litigation or reasonably estimate arange of

 

28

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possible loss, which could be material. The resolution of this lawsuitmay harm our business and have a material adverse impact on our financialcondition.

 

In addition to the above, certain of our present and former officersand directors, as well as the company as a nominal defendant, havebeen named in three shareholder derivative actions. Two shareholder derivativecomplaints were filed in California state court styled*Brian Clair, Derivatively on Behalf of LiquidmetalTechnologies, Inc. v. John Kang, et al.*, Case No. 04CC00551, and*Joseph Durgin, Derivatively on Behalf of LiquidmetalTechnologies, Inc. v. John Kang, et al.*, Case No. 04CC00553, bothcommenced in the Superior Court of Orange County, California.   Athird shareholder derivative complaint was filed in the United StatesDistrict Court for the Middle District of Florida, Tampa Division, styled*Robert Story v. John Kang, et al.*, CaseNo. 8:04-CV-1587-T-23TBM. These shareholder derivative lawsuits allege that thedefendants breached various fiduciary duties and otherwise violated state lawbased primarily upon the same underlying facts and circumstances as alleged inthe federal shareholder class action. The plaintiffs seek unspecifiedcompensatory damages, restitution and disgorgement of profits, equitable and/orinjunctive relief as permitted by law and other relief.

 

The two shareholder derivative complaints in California state courthave been consolidated. We, along with other defendants, have thrice succeededin having the Plaintiffs’ complaints dismissed for their failure to adequatelyplead demand futility.  Most recently, on September 15, 2005, we,along with other defendants, filed a demurrer to the Plaintiffs’Consolidated Second Amended Shareholder Derivative Complaint dated August16, 2005.  In hearings on October 19, 2005, and January 20,2006, the presiding judge sustained the demurrer, dismissing the second amendedcomplaint but giving the plaintiffs until February 3, 2006, within whichto serve a third amended complaint. The plaintiffs filed their Consolidated Third Amended ShareholderDerivative Complaint on February 3, 2006. We anticipate filing a demurer,seeking dismissal of the third amended complaint.

 

In the Florida derivative action, the Plaintiff filed a First AmendedShareholder Derivative Complaint on November 22, 2004.  We, alongwith other defendants, filed a Motion to Dismiss inDecember 2004, to which the Plaintiff responded in opposition inFebruary 2005.  On January 20, 2006, the presiding judge granted ourMotion to Dismiss, dismissing the complaint based upon the plaintiff’s failureto adequately plead futility.  On February 17,2006, the plaintiff filed its Notice of Appeal of the Court’s Order grantingthe Motion to Dismiss.  We intend to vigorously defend against thederivative actions. We cannot currently predict the impact or resolution ofthis litigation or reasonably estimate a range of possible loss, which could bematerial. The resolution of this lawsuit may harm our business and have amaterial adverse impact on our financial condition.

 

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

 

No matters were submitted to a vote of oursecurity holders during the fourth quarter of 2005.

 

29

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**PART II**

 

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

 

Our common stockis currently quoted on the Nasdaq OTC Bulletin Board under the symbol “LQMT.OB.”  From the period July 16, 2004 through June14, 2005, we were delisted from the Nasdaq Stock Market and our common stockwas quoted on the “pink sheets”. We were admitted for quotation on the Nasdaq’sOTC Bulletin Board on June 15, 2005. On March 16, 2006, the last reported salesprice of our common stock was $1.45 per share. As of March 16, 2006, we had 247record holders of our common stock.

 

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

 

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

 

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

 

 We have never paid a cash dividend on ourcommon stock. We do not anticipate paying any cash dividends on our commonstock in the foreseeable future, and we plan to retain our earnings to financefuture growth.

 

**Item 6. SelectedConsolidated Financial Data**

 

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

 

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

 

30

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| ** **                                                                                                                   | ** ** | **For the  Years Ended December 31,**     | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                                                   | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                                                                   | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| ** **                                                                                                                   | ** ** | **(in thousands, except per share data)** | ** ** |
|                                                                                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| **Consolidated Statement of Operations Data:**                                                                               | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                                                                                      |       | 16,365                                    |       | $ | 17,429 |   | $ | 13,658 |   | $ | 9,138 |   | $ | 3,882 |   |
| Cost of sales                                                                                                                |       | 15,129                                    |       | 12,168 |   | 18,162 |   | 5,656 |   | 1,924 |   |
| Gross Profit                                                                                                                 |       | 1,236                                     |       | (5,261 | ) | (4,504 | ) | 3,482 |   | 1,958 |   |
|                                                                                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Operating expenses:                                                                                                          |       |                                      |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative                                                                                          |       | 8,534                                     |       | 11,591 |   | 17,729 |   | 13,099 |   | 5,239 |   |
| Research and development                                                                                                     |       | 1,120                                     |       | 1,467 |   | 8,780 |   | 11,825 |   | 1,726 |   |
| Impairment of goodwill                                                                                                       |       | —                                    |       | — |   | 184 |   | — |   | — |   |
| Impairment of long lived assets                                                                                              |       | 4,487                                     |       | — |   | 2,684 |   | — |   | — |   |
| Total operating expenses                                                                                                     |       | 14,141                                    |       | 13,058 |   | 29,377 |   | 24,924 |   | 6,965 |   |
|                                                                                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Income (loss) before interest, other  income, income taxes, minority interest and discontinued operations                    |       | (12,905                                   | )          | (7,797 | ) | (33,881 | ) | (21,442 | ) | (5,007 | ) |
| Loss from extinguishments of debt                                                                                            |       | (1,247                                    | )          | (1,663 | ) | — |   | — |   | — |   |
| Change in value of warrants, net                                                                                             |       | 3,985                                     |       | 747 |   | — |   | — |   | — |   |
| Change in value of beneficial conversion  feature                                                                            |       | 3,849                                     |       | — |   | — |   | — |   | — |   |
| Other income                                                                                                                 |       | —                                    |       | 302 |   | — |   | — |   | — |   |
| Interest expense, net                                                                                                        |       | (4,928                                    | )          | (3,566 | ) | (86 | ) | (603 | ) | (1,095 | ) |
| Gain on sale of marketable securities  held-for-sale                                                                         |       | —                                    |       | — |   | 1,178 |   | 832 |   | — |   |
|                                                                                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Income (loss) before income taxes, minority  interest and discontinued operations                                            |       | (11,246                                   | )          | (11,977 | ) | (32,789 | ) | (21,213 | ) | (6,102 | ) |
| Income taxes                                                                                                                 |       | —                                    |       | — |   | — |   | — |   | — |   |
| Minority interest in loss of consolidated  subsidiary                                                                        |       | —                                    |       | — |   | 21 |   | 118 |   | — |   |
|                                                                                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Income (loss) from continuing operations                                                                                     |       | (11,246                                   | )          | (11,977 | ) | (32,768 | ) | (21,095 | ) | (6,102 | ) |
| Income (loss) from operations of  discontinued operations, net                                                               |       | —                                    |       | (749 | ) | (964 | ) | 83 |   | (5,973 | ) |
| Gain (loss) from disposal of discontinued  operations, net                                                                   |       | —                                    |       | — |   | 127 |   | 1,556 |   | (11,949 | ) |
|                                                                                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Net loss                                                                                                                     |       | $                                         | (11,246    | ) | $ | (12,726 | ) | $ | (33,605 | ) | $ | (19,456 | ) | $ | (24,024 | ) |
|                                                                                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Income (loss) per share from continuing  operations – basic and diluted                                                 |       | $                                         | (0.27      | ) | $ | (0.29 | ) | $ | (0.79 | ) | $ | (0.54 | ) | $ | (0.18 | ) |
|                                                                                                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Weighted average common shares used to  compute income (loss) per share from continuing operations – basic and  diluted |       | 41,833                                    |       | 41,610 |   | 41505 |   | 38,714 |   | 33,323 |   |

 

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| ** **                                                  | ** ** | **As of December 31,**                    | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                  | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | **(restated)** | ** ** | **(restated)** | ** ** |
| ** **                                                  | ** ** | **(in thousands, except per share data)** | ** ** |
| ** **                                                  | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Consolidated Balance Sheet Data:**                        |       |                                      |       |   |   |   |   |   |   |   |   |
|                                                        |       |                                      |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                   |       | $                                         | 1,392      |   | $ | 742 |   | $ | 3,127 |   | $ | 25,058 |   | $ | 2,230 |   |
| Working capital (deficiency)                                |       | (10,154                                   | )          | (10,241 | ) | (698 | ) | 25,812 |   | (9,573 | ) |
| Total assets                                                |       | 21,563                                    |       | 28,508 |   | 30,852 |   | 24,845 |   | 6,680 |   |
| Long-term debt, including current portion,  net of discount |       | 7,681                                     |       | 8,609 |   | 4,047 |   | — |   | 2,988 |   |
| Shareholders’ equity (deficiency)                      |       | (1,386                                    | )          | 8,860 |   | 16,163 |   | 50,599 |   | (7,504 | ) |
|                                                             |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

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

 

*This management’s discussion and analysis, as well as othersections of this report on Form 10-K, may contain “forward-lookingstatements” that involve risks and uncertainties, including statementsregarding our plans, future events, objectives, expectations, forecasts, orassumptions. Any statement that is not a statement of historical fact is 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. These statements involve risks anduncertainties that could cause actual outcomes and results to differ materiallyfrom the anticipated outcomes or results, and undue reliance should not beplaced on these statements. These risks and uncertainties include, but are notlimited to, the matters discussed under the caption “Risk Factors” inItem 1A of this report and other risks and uncertainties discussed infilings made with the Securities and Exchange Commission (including risksdescribed in subsequent reports on Form 10-Q, Form 10-K,Form 8-K, and other filings). Liquidmetal Technologies, Inc. disclaims anyintention or obligation to update or revise any forward-looking statements,whether as a result of new information, future events, or otherwise.*

 

##### **OVERVIEW**

 

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

 

Amorphous alloys are unique materials that are distinguished by theirability to retain a random atomic structure when they solidify, in contrast tothe crystalline atomic structure that forms in other metals and alloys whenthey solidify. Liquidmetal alloys possess a combination of performance,processing, and potential cost advantages that we believe will make thempreferable 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 believethese advantages could enable the introduction of entirely new products andapplications that are not possible or commercially viable with other materials.

 

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

 

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

 

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

 

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Research anddevelopment expenses represent salaries, related benefits expense, stock-basedcompensation, depreciation of research equipment, consulting and contractservices, expenses incurred for the design and testing of new processingmethods, expenses for the development of sample and prototype products, andother expenses related to the research and development of Liquidmetal alloys.Costs associated with research and development activities are expensed asincurred. We plan to enhance our competitive position by improving our existingtechnologies and developing advances in amorphous alloy technologies. Webelieve that our research and development efforts will focus on the discovery ofnew alloy compositions, the development of improved processing technology, andthe identification of new applications for our alloys.

 

We maintaincertain of our raw material inventories in amounts in excess of our operatingcycle of one year due to the nature of our manufacturing process, productionlead time, and the recyclability of our raw material. These inventories wereclassified as long-term inventory as of December 31, 2004. We 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 $2.7 millionduring the fiscal year 2005.

 

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

 

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

 

Inconjunction with the divestiture of our Dongyang and Taesung subsidiaries inMarch and June 2004, respectively, we decided to discontinue our equipmentmanufacturing business in order to conform our operations to our broadercorporate business strategy. Pursuant to Accounting Principles Board OpinionNo. 30, Reporting the Results of Operations — Reporting the Effects ofDisposal of a Segment of a Business, and Extraordinary, Unusual andInfrequently Occurring Events and Transactions, we reclassified ourconsolidated financial statements to reflect the discontinuation of ourequipment manufacturing operations. The revenue, costs and expenses, assets andliabilities, and cash flows of the equipment manufacturing business weresegregated in our financial statements.

 

Impairment ofgoodwill represents the write-down of the goodwill balance of Dongyang Yudoro (“Dongyang”),our 51% owned subsidiary in South Korea. During 2003, Dongyang experienced netlosses as a result of a continuing economic downturn in markets for itsmachinery products. These events, along with Dongyang’s operating cash flowlosses and uncertainty surrounding its future cash flows, led us to evaluateour investment for recoverability as of December 31, 2003. As a result, wedetermined that the carrying value of our investment in Dongyang exceeded itsfair value as of December 31, 2003 in the amount of $0.2 million. In March2004, we sold our 51% investment in Dongyang to the 49% minority stockholder.

 

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

 

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

 

34

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

 

***Results of Operations***

 

***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 offsetby a $0.4 million increase in bulk alloy parts primarily to increased sales tosporting goods manufacturers and $1.9 million increase from sale of ourcoatings products from increased demand for drill pipe coatings during 2005.

 

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

 

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

 

*Research and Development Expenses*. Research and development expenses decreasedto $1.1 million, or 7% of revenue, in the twelve months endedDecember 31, 2005 from $1.5 million, or 8% of revenue, in the twelvemonths ended December 31, 2004. The decrease was primarily a resultof decreases in salaries, wages and related expenses by $0.3 million anddecrease in laboratory and prototyping expenses 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 our costs. TheCompany continues to perform research and development efforts on newLiquidmetal alloys and related processing capabilities, develop newmanufacturing techniques, and contract with consultants and provide researchgrants to various institutions to advance the development of Liquidmetalalloys.

 

*Impairment of Long Lived Assets*.Impairment of long lived assets increased to $4.5 million, or 27% of revenue,for the twelve months ended December 31, 2005 from $0 for the twelve monthsended December 31, 2004. Impairment expense represents primarily write-down of$2.7 million of raw materials considered to be long term inventory and $1.7million of idle equipment. While we may use the excess raw materials beyond oneyear to fulfill future customer order, we have determined that our currentcapacity was not significant enough to warrant holding this inventory as a longterm asset. Further, while we have actively marketed the idle equipment forultimate sale since early 2004, we were unable to sell this equipment. Inaddition, while the equipment may be used internally to meet future capacityrequirements, considering our current revenue, we do not anticipate utilizingthis equipment internally in the near future. As such, we have reduced thecarrying values of the excess raw material and idle equipment.

 

*Loss from Extinguishments of Debt.*Lossfrom extinguishments of debt decreased to $1.2 million, or 8% of revenue, forthe twelve months ended December 31, 2005 from $1.7 million, or 10% of revenue,for the twelve months ended December 31, 2004. The $1.2 million loss fromextinguishments of debt was recognized from the exchange of our 6%

 

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Convertible Notes due 2006 in August 2005. The $1.7 million loss fromextinguishments of debt was recognized from exchange of our 6% SeniorConvertible Notes due March 2007 in August 2004.

 

*Change in value of warrants, net.*Changein value of warrants was a net gain of $4.0 million, or 24% of revenue, duringthe twelve months ended December 31, 2005 from the change in value of warrantsissued from the senior convertible debt funded in March 2004 and exchanged inAugust 2004, convertible debt funded in June 2005, and senior convertible debtfunded in August 2005 primarily as a result of fluctuations in our stock price.

 

*Change in value of beneficial conversionfeature.*Change in value of beneficial conversionfeature was a gain of $3.8 million, or 24% of revenue, during the twelve monthsended December 31, 2005 from the change in value of beneficial conversionfeature liability from the senior convertible debt funded in August 2005primarily as a result of fluctuations in our stock price. There were no amountsrecorded as change in value of beneficial conversion feature for the twelvemonths ended December 31, 2004.

 

*Other Income.*Otherincome was $0.3 million, or 2% of revenue, during the twelve months endedDecember 31, 2004 from certain stock transactions with John Kang, our Chairman,President, and Chief Executive Officer during 2002 (see Note 23). There were noamounts recorded as other income for the twelve months ended December 31, 2005.

 

*Interest Expense*.Interest expense was $4.9 million, or 30% of revenue, for the twelve monthsended December 31, 2005 and was $3.6 million, or 21% of revenue, for the twelvemonths ended December 31, 2004. During each of the twelve months ended December31, 2005 and 2004, the interest expense was primarily due to the interestaccrued on the Kookmin Bank loan funded on February 4, 2003, senior convertibledebt funded on March 3, 2004 and exchanged in August 2004, convertible debtfunded on June 13, 2005, and senior convertible debt funded in August 9, 2005, aswell as amortization of debt issuance costs and discount on the convertibledebt. 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 interest and late registration penalty were paidas of December 31, 2005.

 

*Interest Income.*Interestincome was $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.

 

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

 

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

 

*Cost of Sales*. Cost of sales decreased to $12.2 million, or 70% of revenue,during the twelve months ended December 31, 2004 from $18.2 million,or 133% of revenue, in the twelve months ended December 31, 2003. Thisdecrease was a result of the continued maturing of our manufacturing processand represents the Company’s efforts to manage costs and focus on our corebusiness while continuing to build production pipeline and manufacturinginfrastructure required to prepare for and support the anticipated growth ofour bulk Liquidmetal alloy business. The cost of sales for the products sold bythe coatings business segment is generally consistent from year to year becausethe Liquidmetal coatings products are produced by third parties and soldwholesale to various industries.

 

*Selling, General, and Administrative Expenses*. Selling, general, and administrativeexpenses decreased to $11.6 million, or 66% of revenue, in the twelvemonths ended December 31, 2004 from $17.7 million, or 130% ofrevenue, in the twelve months ended December 31, 2003. Thisdecrease was primarily a result of decrease in wages and related expense by$5.0 million, decreases in travel and communication expenses by $0.8million, decreases in rent by $0.8 million, decrease in relocation expenses by$0.7 million, offset by an increase in professional fees, consultant fees, andcontract services by $0.8 million, and an increase in insurance costs by$0.4 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.

 

36

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*Research and Development Expenses*. Research and development expenses decreasedto $1.5 million, or 8% of revenue, in the twelve months endedDecember 31, 2004 from $8.8 million, or 64% of revenue, in the twelvemonths ended December 31, 2003. The decrease was primarily a resultof decreases in salaries, wages and the related expenses by $3.0 million,decrease in laboratory and prototyping expenses by $2.0 million, decreasein depreciation expense by $0.7 million, decrease in professional fees,consultant fees, and contract services by $0.6 million, decrease in researchgrants by $0.3 million, and decrease in travel related expenses by $0.2 million.The decreases were a result of the Company focusing primarily on our corebusiness associated with our bulk Liquidmetal alloy business while managing ourcosts. The Company continues to perform research and development efforts on newLiquidmetal alloys and related processing capabilities, develop newmanufacturing techniques, and contract with consultants and provide researchgrants to various institutions to advance the development of Liquidmetalalloys.

 

*Impairment of Goodwill*. Impairment of goodwill was $0.2million, or 1% of revenue, in the twelvemonths ended December 31, 2003. Impairmentof goodwill represents the write-down of the goodwill balance of DongyangYudoro (“Dongyang”), our 51% owned subsidiary in South Korea. During2003, Dongyang experienced net losses as a result of a continuing economicdownturn in the market for its machinery products. These events along withDongyang’s operating, and cash flow losses, and uncertainty surrounding itsfuture cash flows, led us to evaluate our investment for recoverability as ofDecember 31, 2003. As a result, we determined that the carrying value of ourinvestment in Dongyang exceeded its fair value as of December 31, 2003 in theamount of $0.2 million. In March 2004, we sold our 51% investment in Dongyangto the 49% minority shareholder (see Note 17). There was no impairment chargeto goodwill in the twelve months endedDecember 31, 2004.

 

*Impairment of Long Lived Assets*. Impairment of long lived assets was $2.7million, or 20% of revenue, in the twelve months ended December 31, 2003. Impairmentexpense represents a write-down of the building of our manufacturing facilityin South Korea. Due to the decreased production and usage of our Pyongtaekmanufacturing operation, we decided to obtain independent appraisals as to thefair value of this building. Accordingly, the fair value of the building asdetermined by the average of the two independent appraisals was less than thecarrying value of the building as of December 31, 2003. There was no impairmentcharge to long lived assets in the twelve months ended December 31, 2004.

 

*Loss from Extinguishment of Debt.*Lossfrom extinguishment of debt was $1.7 million, or 10% of revenue, during thetwelve months ended December 31, 2004 due to the extinguishment of our MarchNotes as it relates to the exchange in August 2004. There was no such lossrecorded during twelve months ended December 31, 2003.

 

*Change in value of warrants, net.*Changein value of warrants was a net gain of $0.7 million, or 4% of revenue, duringthe twelve months ended December 31, 2004 from the change in valuation of warrant payable issued related to thesenior convertible debt funded in March 2004, which was exchanged in August2004 (see note 14). There were no such amounts recorded for the twelve monthsended December 31, 2003.

 

*Other Income.*Otherincome was $0.3 million, or 2% of revenue, during the twelve months endedDecember 31, 2004 from certain stock transactions with John Kang, our Chairman,President, and Chief Executive Officer during 2002 (see Note 23). There were noamounts recorded as other income for the twelve months ended December 31, 2003.

 

*Interest Expense*. Interest expense was $3.6 million, or 21% of revenue, in thetwelve months ended December 31, 2004 and was $0.4 million, or 3% ofrevenue, in the twelve months ended December 31, 2003. During thetwelve months ended December 31, 2004, the interest expense was primarily dueto the interest accrued, amortization of debt discount and deferred issuancecosts on new senior convertible debt originally sold on March 3, 2004 andexchanged in August 2004, and interest accrued on Kookmin Bank loan funded onFebruary 4, 2003. During the twelvemonths ended December 31, 2003, interest expense was primarily due tointerest accrued on the Kookmin Bank loan to our South Korean subsidiary madeon February 4, 2003.

 

*Interest Income.* Interest income was $37 thousand for the twelve months endedDecember 31, 2004 for interest earned on certificate of deposits. Interestincome was $0.3 million or 2% of revenue for the twelve months ended December31, 2003 for interest earned on short-term, investment grade, interest-bearingsecurities.

 

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

 

37

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##### **QUARTERLYRESULTS**

 

The following information presents our unaudited quarterlyoperating results for 2005 and 2004. The data has been prepared by LiquidmetalTechnologies, Inc. on a basis consistent with the Consolidated FinancialStatements included elsewhere in this Form 10-K, and includes alladjustments, consisting of normal recurring accruals, that we considernecessary for a fair presentation thereof. These operating results are notnecessarily indicative of our future performance.

 

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

 

We haveamended our third quarter financial statements originally filed on form 10-Q onDecember 1, 2005, to properly account for the beneficial conversion feature of the senior convertiblenotes issued in August 2005. Accounting for this feature resulted in a benefitof $1.0 million in our earnings from the change in value of beneficial conversionfeature and an increase to interest expense of $0.1 million from additionalamortization of debt discounts related to the revaluation of the beneficialconversion feature of the senior convertible debt issued in August 2005. In addition, the company wrote-down $0.8million of primarily raw material inventory considered to be long term as thecarrying value of the inventory held as an impairment charge. While we may use the excess raw materials beyond one yearto fulfill future demand, we did not foresee use of this inventory in theforeseeable future.

 

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

 

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

 

These statements should be read in conjunction withrestatement footnote 2 in the notes toconsolidated financial statements in the fiscal 2003 annual report on Form 10-Kfiled on November 10, 2004, which reflects the restatements of prior yeartransactions.

 

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| ** **                                             | ** ** | **For the Three Months Ended**            | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                             | ** ** | ** **                                | ** ** | **Amended** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Consolidated Statements of Operations Data:**        | ** ** | **12/31/05**                              | ** ** | **9/30/05** | ** ** | **6/30/05** | ** ** | **3/31/05** | ** ** |
| ** **                                             | ** ** | **(In thousands, except per share data)** | ** ** |
| ** **                                             | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                |       | $                                         | 5,453      |   | $ | 4,342 |   | $ | 3,727 |   | $ | 2,843 |   |
| Cost of sales                                          |       | 4,576                                     |       | 3,756 |   | 3,962 |   | 2,835 |   |
|                                                   |       |                                      |       |   |   |   |   |   |   |
| Gross (loss) profit                                    |       | 877                                       |       | 586 |   | (235 | ) | 8 |   |
|                                                   |       |                                      |       |   |   |   |   |   |   |
| Operating expenses                                     |       |                                      |       |   |   |   |   |   |   |
| Selling, general, and administrative                   |       | 2,013                                     |       | 2,364 |   | 1,567 |   | 2,590 |   |
| Research and development                               |       | 314                                       |       | 196 |   | 213 |   | 397 |   |
| Impairment of long lived assets                        |       | 260                                       |       | 833 |   | 3,394 |   | — |   |
| Total expenses                                         |       | 2,587                                     |       | 3,393 |   | 5,174 |   | 2,987 |   |
|                                                   |       |                                      |       |   |   |   |   |   |   |
| Loss from operations                                   |       | (1,710                                    | )          | (2,807 | ) | (5,409 | ) | (2,979 | ) |
|                                                   |       |                                      |       |   |   |   |   |   |   |
| Loss from exinguishments of debt                       |       | —                                    |       | (1,247 | ) | — |   | — |   |
| Change in value of warrants, net                       |       | 2,840                                     |       | 1,112 |   | (100 | ) | 133 |   |
| Change in value of beneficial conversion  feature      |       | 2,867                                     |       | 982 |   | — |   | — |   |
| Interest expense                                       |       | (1,489                                    | )          | (1,290 | ) | (909 | ) | (1,257 | ) |
| Interest income                                        |       | 3                                         |       | 7 |   | 1 |   | 6 |   |
| Gain (loss) from continuing operations                 |       | 2,511                                     |       | (3,243 | ) | (6,417 | ) | (4,097 | ) |
|                                                   |       |                                      |       |   |   |   |   |   |   |
| Net loss                                               |       | $                                         | 2,511      |   | $ | (3,243 | ) | $ | (6,417 | ) | $ | (4,097 | ) |
|                                                   |       |                                      |       |   |   |   |   |   |   |
| Other comprehensive loss                               |       |                                      |       |   |   |   |   |   |   |
| Foreign exchange translation gain (loss)               |       | 222                                       |       | (306 | ) | 62 |   | 321 |   |
| Comprehensive gain (loss)                              |       | 2,733                                     |       | (3,549 | ) | (6,355 | ) | (3,776 | ) |
|                                                   |       |                                      |       |   |   |   |   |   |   |
| Net loss per commoon share - basic and  diluted:       |       |                                      |       |   |   |   |   |   |   |
| Gain (loss) per share basic and diluted                |       | $                                         | 0.06       |   | $ | (0.06 | ) | $ | (0.15 | ) | $ | (0.10 | ) |
|                                                   |       |                                      |       |   |   |   |   |   |   |
| Number of weighted average shares - basic  and diluted |       | 42,180                                    |       | 41,933 |   | 41,610 |   | 41,610 |   |

 

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| ** **                                                                                                         | ** ** | **For the Three Months Ended**            | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| **Consolidated Statements of Operations Data:**                                                                    | ** ** | **12/31/04**                              | ** ** | **9/30/04** | ** ** | **6/30/04** | ** ** | **3/31/04** | ** ** |
| ** **                                                                                                         | ** ** | **(In thousands, except per share data)** | ** ** |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Revenue                                                                                                            |       | $                                         | 2,471      |   | $ | 4,615 |   | $ | 4,055 |   | $ | 6,288 |   |
| Cost of sales                                                                                                      |       | 2,895                                     |       | 3,241 |   | 2,475 |   | 3,557 |   |
| Gross profit (loss)                                                                                                |       | (424                                      | )          | 1,374 |   | 1,580 |   | 2,731 |   |
| Operating expense:                                                                                                 |       |                                      |       |   |   |   |   |   |   |
| Selling, general, and administrative                                                                               |       | 2,413                                     |       | 3,569 |   | 2,544 |   | 3,065 |   |
| Research and development                                                                                           |       | 407                                       |       | 374 |   | 345 |   | 341 |   |
| Total operating expenses                                                                                           |       | 2,820                                     |       | 3,943 |   | 2,889 |   | 3,406 |   |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Loss from operations                                                                                               |       | (3,244                                    | )          | (2,569 | ) | (1,309 | ) | (675 | ) |
| Loss on extinguishments of debt                                                                                    |       | —                                    |       | (1,663 | ) |   |   |   |   |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Change in value of warrants, net                                                                                   |       | (99                                       | )          | (434 | ) | 694 |   | 586 |   |
| Other income (expense), net                                                                                        |       | —                                    |       | 302 |   | — |   | — |   |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Interest income (expense), net                                                                                     |       | (358                                      | )          | (1,805 | ) | (1,144 | ) | (259 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Loss from operation before income taxes and  discontinued operations                                               |       | (3,701                                    | )          | (6,169 | ) | (1,759 | ) | (348 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Income taxes                                                                                                       |       | —                                    |       | — |   | — |   | — |   |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Loss from continuing operations                                                                               |       | (3,701                                    | )          | (6,169 | ) | (1,759 | ) | (348 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Loss from discontinued operations, net of  tax                                                                     |       | —                                    |       | — |   | (356 | ) | (393 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Net loss                                                                                                           |       | $                                         | (3,701     | ) | $ | (6,169 | ) | $ | (2,115 | ) | $ | (741 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Loss per share from continuing operations –  basic and diluted                                                |       | $                                         | (0.09      | ) | $ | (0.15 | ) | $ | (0.04 | ) | $ | (0.01 | ) |
|                                                                                                               |       |                                      |       |   |   |   |   |   |   |
| Weighted average common shares used to  compute loss per share from continuing operations – basic and diluted |       | 41,610                                    |       | 41,610 |   | 41,610 |   | 41,610 |   |

 

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

 

Our cash used for operating activities was$6.5 million for the year ended December 31, 2005. Our cash used foroperating activities, including our discontinued equipment manufacturingoperations, was $6.3 million for the year ended December 31, 2004. Our workingdeficit remained unchanged at $(10.2) million at December 31, 2005 and 2004 asour current assets and liabilities decreased by approximately $0.4 million. TheCompany’s current asset and liability decrease of approximately $0.4 millionwas primarily attributable to increase in cash and cash equivalents of $0.7million, increase in trade accounts receivable of $0.7 million, decrease incurrent portion of long term debt of $4.6 million, decrease in current portionof other liabilities of $0.6 million, offset by an decrease in restricted cashof $0.8 million, decrease in inventories of $0.6 million, decrease in prepaidexpenses and other current assets of $0.3 million, increase in accounts payableand accrued liability of $1.6 million, increase in settlement payable of $0.1million, increase in deferred revenue of $0.4 million, increase in short-termdebt of $0.6 million, increase in warrant liabilities of $1.2 million, andincrease in beneficial conversion feature liabilities of $1.0 million.

 

Our cash used in investing activities was$0.3 million for the year ended December 31, 2005 for the acquisition ofproperty and equipment and investments in patents and trademarks.

 

Our cash provided by financing activities was$7.1 million for the year ended December 31, 2005, which consists of $0.8million in proceeds from restricted cash, $13.1 million in proceeds fromconvertible debt funded in June 2005 and senior convertible debt funded inAugust 2005, $0.2 million in proceeds from borrowings from our short term debtexecuted in March 2005, $4.4 million in proceeds from factoring agreementexecuted in April 2005, offset by $11.5 million on repayment of borrowings.

 

We anticipate that our capital expenditureswill be approximately less than $0.5 million for the full year 2006 for theacquisition of furniture, fixtures, and other business equipment. This amountis subject to change, however, depending upon the nature and the amount of theproduct orders that we actually receive from customers.

 

Our capital requirements during the nexttwelve months will depend on numerous factors, including the success ofexisting products either in manufacturing or development, the development ofnew applications for Liquidmetal alloys, the resources we devote to develop andsupport our Liquidmetal alloy products, the success of pursuing strategiclicensing and funded product development relationships with external partners. Duringthe next twelve months, based on our current business plan, we expect tohave sufficient resources to continue to devote limited capital to our researchand development activities, to further develop and strengthen our manufacturingtechnology, and to provide for working capital and other general corporatepurposes. However, based on our historical operating results and the continueddevelopment of our manufacturing capabilities and alloy compositions, thereexists the possibility that these resources will not be adequate to operate atthe proposed business plan levels. These expenses and capital expenditurescould consume a material amount of our cash resources, but the amount of theserequirements will depend on the nature and amount of orders we receive for thepurchase of our bulk Liquidmetal alloy products.

 

We have experienced significant operatinglosses since our inception. Our net loss for the fiscal years ended December31, 2005 and 2004 was $11.2 million and $12.7 million, respectively. In theaudit report on our financial statements for our fiscal years ended December31, 2005 and 2004, our auditors included a going-concern qualificationindicating that our significant operating losses and working capital deficitcause substantial doubt about our ability to continue as a going concern. Byissuing an opinion stating that there is substantial doubt about our ability tocontinue as a going concern, our auditors have indicated that they areuncertain as to whether we have the capability to continue our operationswithout additional funding. Accordingly, we anticipate that we will needadditional funding during the next 12 months and 

 

41

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would seek to raise such funds through public or private equityfinancing, bank debt financing, or from other sources. Adequate funds may notbe available when needed, and if we raise additional funds by issuing equitysecurities, existing stockholders may be diluted.

 

In March 1996, we entered into a distribution agreementwhereby we granted to a third party exclusive rights to market and sell golfproducts incorporating Liquidmetal technology to certain Japanese sportingequipment companies. The third party paid us a $1.0 million distributionfee as part of this agreement, of which a portion was refundable according to aformula based on the gross profit earned by the third party. The remainingunearned distribution fee of $0.8 million has not been refunded as ofDecember 31, 2005, and we do not believe the third party is entitled to arefund. On March 28, 2003, the distribution agreement was terminated andwe entered into a new agreement to pay to the same third party a commission onthe net sales price of all Liquidmetal golf equipment that is shipped by ourCompany or its affiliates to Japanese golf companies for sale into the Japaneseend-market. This commission will apply to golf equipment shipped by our Companyor its affiliates during the period beginning on March 28, 2003 and endingon March 28, 2006. If, by March 28, 2006, we have not paid$0.4 million in commission payments, the balance between commissions paidand $0.4 million will be paid by April 30, 2006, thereby guaranteeingthe third party a $0.4 million minimum payment during the term of theagreement. We will recognize the unearned distribution fee of $0.8 millionas revenue proportionately with the payment of commissions under the letteragreement.

 

##### **USEOF PROCEEDS**

 

Pursuant toour Registration 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 ofDecember 31, 2003, we used $70.7 million of net proceeds from theOffering. In 2002, we used approximately $7.8 million of the net proceedsfrom the Offering to repay all outstanding promissory notes and accruedinterest, $11.1 million to fund the construction of our manufacturingfacility in South Korea, $14.3 million to purchase equipment used tomanufacture Liquidmetal parts, $0.4 million to purchase assets related toproduction and sale of equipment used in the production process of Liquidmetalalloy products, and $0.3 million to purchase the 51% interest in ourmajority owned Dongyang subsidiary. During the third quarter of 2002, we used$2.0 million to invest in the common stock of Growell Metal, whichsupplied a portion of the Liquidmetal alloy ingots used in our manufacturingoperations in Korea. We have since sold such stock, realizing a gain on thesale. We used the remaining proceeds of $32.7 million for working capitalin 2002 and 2003, excluding $2.1 million paid to Paul Azinger in 2002 and2003 for amounts due under the terms of his terminated endorsement agreementwith our discontinued retail golf operations.

 

**PrivatePlacements**

 

On March 3,2004, we sold $9.9 million of 6.0% senior convertible notes due 2007 (the “MarchNotes”) to investor groups in a transaction led by Michigan Venture CapitalCo., Ltd, a South Korea-based institutional investment firm, and IndiGoVentures LLC, a New York-based investment firm that served as a financialadvisor to our company for the transaction. The notes were convertible at anytime into our common stock at a price of $3.00 per share. Investors in theprivate placement received warrants to purchase an aggregate amount of up toapproximately 1.2 million shares of common stock, originally exercisable at$3.00 per share for varying periods but no later than 100 days following theeffectiveness of a registration statement covering the resale of sharesissuable upon exercise of the warrants. In addition, the investors had theright to call for repayment of the notes prior to maturity at any time afterthe second anniversary of the closing of the transaction.

 

On August 19,2004, we completed a private exchange offer for our March Notes. Under terms ofthe exchange offer, approximately $5.5 million in aggregate principal amount ofthe March Notes were exchanged for an aggregate of (i) $2.75 million of 6%Senior Secured Notes Due 2007 (the “July 2007 Notes”) and (ii) $2.75 million of10% Senior Secured Notes Due 2005 (the “July 2005 Notes”), collectivelyreferred to as “Exchange Notes”. In addition, we redeemed approximately $4.5

 

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million ofthe March Notes in cash. The Exchange Notes were collateralized by certainpatents owned by our company and a second priority mortgage interest in plantfacilities and certain equipment at our plant in South Korea. The July 2005Notes had a maturity date of July 29, 2005, and a conversion price of $2.00 pershare (compared to a conversion price of $3.00 per share under the March Notes).The July 2007 Notes have a maturity date of July 29, 2007, and a conversionprice of $1.00 per share. Further, the exchange notes are convertible intoCommon Stock, at the option of our company, if at any time after the issuanceof the notes, the closing per share price of the Common Stock exceeded $4.00(as adjusted for stock splits, reverse splits, stock dividends, andrecapitalizations) for 30 consecutive trading days, and further provided thatthere has been effective registration during such period. Holders of the July2007 Notes also have the right to call for repayment of the July 2007 Notesprior to maturity at any time after the second anniversary of the completion ofthe exchange offer. A total of 563,151 warrants to purchase our common stock atan exercise price of $3.00 per share—all of which were previously issued inconnection with the purchase of the March Notes—were amended to provide for anextended expiration date of March 1, 2006. The warrant exercise price issubject to price adjustment for anti-dilution purposes. As of October 1, 2005,the warrant price was determined to be exercisable at $2.73.

 

OnJune 13, 2005, we completed a private placement (the “June 2005 PrivatePlacement”) of 10% Convertible Unsecured Notes Due June 13, 2006 in theaggregate principal amount of $3,250 (the “June 2006 Notes”), together withwarrants to purchase up to an aggregate of 893,750 shares of our company’scommon stock (the “Warrants”). The June 2006 Notes were unsecured and were dueon the earlier of June 13, 2006 or the consummation of a follow-on equityor debt offering or restructuring transaction pursuant to which our companyreceives gross proceeds of at least $4,000.  Prior to maturity, the June2006 Notes were interest-only, with interest payments due quarterly, at therate of 10% per year.  If, within 120 days following the issue date of theJune 2006 Notes, our company either failed to redeem the notes for theprincipal amount and accrued interest thereon or failed to close a “QualifiedFinancing,” then the June 2006 Notes would have been convertible at aconversion price equal to seventy five percent (75%) of the closing price ofour company’s common stock on the first trading day immediately preceding theconversion date.  A “Qualified Financing “ was defined in the June 2006Notes as any debt or equity financing of our company resulting in aggregategross proceeds to our company of at least $5,000 and in which the holders of atleast sixty percent (60%) of the aggregate principal amount of our company’sLong-Term Notes either (i) agree that the equity or debt securities to beissued in such financing shall be pari passu in order of payment to the July2007 Notes held by them or (ii) exchange their July 2007 Notes for newsecurities in the financing transaction. We successfully completed a QualifiedFinancing on August 9, 2005, and the June 2006 Notes never became convertible.

 

On August 9,2005, we completed a private placement (the “August 2005 Private Placement”) of$9,878 in principal amount of new 7% Convertible Secured Promissory Notes dueAugust 2007 (the “Senior Notes”). The issuance consisted of $5,000 cash,exchange of $1,284 in principal amount of the July 2005 Notes, the exchange of$2,996 in principal amount of the June 2006 Notes, satisfaction of accruedinterest and late registration fees in the amount of $589 on the July 2005Notes, and satisfaction of accrued interest of $9 on the previously issued June2006 Notes. The Senior Notes were issued pursuant to a Securities PurchaseAgreement dated effective as of August 2, 2005 among the our company, thepurchasers of the Senior Notes, and the holders of previously issued July 2005Notes and June 2006 Notes. Interest payments on the Senior Notes are duequarterly, and failure to make timely interest payments will result in increasein interest rates to 14% per annum on the Senior Notes (“Default Rates”). As ofSeptember 30, 2005, we have made timely interest payments. The Senior Notes areconvertible into shares of our common stock at $2.00 per share Pursuant to anAmended and Restated Security Agreement. The Senior Notes are secured bysubstantially all of our assets and rank senior to all other obligations of ourcompany, other than the our loan with Kookmin Bank of South Korea (or anyrefinancing of such loan), the July 2007 Notes, purchase-money asset financing,trade creditors in the ordinary course of business, and any inventory orreceivables-based credit facility that we may obtain in the future, providedthat the amount of the credit facility does not exceed 50% of eligibleinventory and 80% of eligible receivables. The Senior Notes will automaticallyconvert into shares of our common stock if the common stock has an averageclosing price of more than $5.00 per share during 30 consecutive trading days. Wealso issued warrants to the purchasers of the Senior Notes and placement agentsgiving them the right to purchase up to 2,469,470 and 414,495 shares of ourcommon stock, respectively, with an exercise price of $2.00 per share. Thewarrants will expire on August 2, 2010.

 

In connectionwith the August 2005 Private Placement, we entered into an amended and restatedregistration rights agreement with the holders of the July 2007 Notes, theholders of the August 2007 Notes, and the holders of the above-describedoutstanding warrants. This amended and restated registration rights agreementreplaced all other registration rights agreements previously entered into by usin connection with the private sale by us of convertible notes and warrants. Underthe amended and restated registration rights agreement, we are required to filea resale registration statement for the shares underlying all of ouroutstanding convertible notes and warrants, as described above, by October 31,2005, to enable the resale of such shares by the selling stockholders on adelayed or continuous basis under Rule 415 of the Securities Act. We are thenrequired to cause such registration statement to become effective within 60days after we receive the first written comments on the registration statementfrom the SEC, or if the SEC notifies us that it will not review theregistration statement, within five days after such notification. We will besubject to certain monetary penalties, as set forth in the registration rightsagreement, if the registration statement is not filed or does not becomeeffective on a timely basis. Specifically, if we do not file the registrationstatement on

 

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a timelybasis, 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 payable for each period of 30 business days thatthe filing of the registration statement is made past the required filing date,and the payments will be due 10 business days following the end of each 30-dayperiod. If the registration statement has not been declared effective by therequired effective date, we 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 the foregoing, the late filing fees and lateregistration fees will not exceed 18% of the aggregate warrant exercise pricesand aggregate note principal amounts.

 

Ourconvertible notes and related documents contain restrictive covenants pursuantto which we generally may not (i) incur any indebtedness that would be seniorto, or on the same rank as, the convertible notes with respect to payment orsecurity, (ii) grant any liens or security interests in any of our assets whichserve as collateral for the convertible notes (which collateral consists ofsubstantially all of our assets), (iii) with certain exceptions, sell any ofthe assets that constitute collateral for the notes, (iv) become a guarantorfor a third-party’s obligation (other than guarantees in the ordinary course ofbusiness not in excess of $500,000 in the aggregate), (v) acquire any shares orsecurities of any other person or entity in excess of an aggregate of $1.0million over any rolling 12-month period, (vi) purchase or otherwise acquireany assets in excess of an aggregate of $3.0 million over any rolling 12-monthperiod, (vii) engage in any transaction resulting in the issuance to any personof more than 40% of the equity of our company, or (viii) engage in any mergeror sale of all or substantially all of our business assets. These covenants maycurtail our ability to raise capital in the future or otherwise restrict ourability to enter into a transaction that we believe would be in the bestinterest of our stockholders. We believe that we are currently in compliancewith all such covenants. While there can be no assurances that we will be ableto maintain compliance with these restrictive covenants in the future, if weviolate these covenants and do not cure such violations within 30 days ofwritten notice from the noteholders, the noteholders may demand payment in fullour convertible notes, collect penalty interest, and exercise other remediesthat are available under notes.

 

On December6, 2005, we received a letter from a representative of the holders of theAugust 2007 Notes demanding the payment of a late filing fee by us for theperiod following October 31, 2005, but under the terms of the amended andrestated registration rights agreement, we do not believe that we are obligatedto pay any late filing fees unless and until we fail to file the registrationstatement by December 13, 2005, which is the last day of the first 30-businessday period following October 31, 2005. The letter also stated that the letterwas serving as a notice of default under the Senior Notes as a result of ourfailure to file a registration statement by October 31, 2005, although underthe terms of the Senior Notes, we have thirty days after delivery of the letterin which to cure such default. On December 9, 2005, we filed the registrationstatement and have cured the default notice received on December 6, 2005.

 

**OFF-BALANCE SHEET ARRANGEMENTS**

 

An off-balance sheet arrangement is any transaction,agreement or other contractual arrangement involving an unconsolidated entityunder which a company has (1) made guarantees, (2) a retained or a contingentinterest in transferred assets, (3) an obligation under derivative instrumentsclassified as equity, or (4) any obligation arising out of a material variableinterest in an unconsolidated entity that provides financing, liquidity, marketrisk or credit risk support to the company, or that engages in leasing,hedging, or research and development arrangements with the company.

 

We have made no arrangements of the types described in any of thecategories that may have a material current or future effect on our financialcondition, liquidity or results of operations. See Note 12 to the ConsolidatedFinancial Statements contained in this Annual Report on Form 10-K.

 

##### **CONTRACTUALOBLIGATIONS**

 

The following table summarizes our company’s obligationsand commitments as of December 31, 2005:

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

 

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(1)          Contractual cashobligations include Long-Term Debt comprised of $2,369 of Senior ConvertibleNotes issued in 2004, $9,878 of Convertible Notes issued in 2005, and $2,790 ofKookmin Notes, Short-Term Debt comprised of $550 advances received underfactoring, loan, and security agreement, and future minimum lease paymentsunder capital and operating leases, liabilities incurred from settlement with aformer customer (Growell) and divesture of our equipment manufacturingbusiness, and purchase commitments from a consultant.

(2)          Does not includeinterest payments of $1,623, un-amortized discounts for beneficial conversionfeature and warrants, deferred issuance costs of $6,493 of our convertiblenotes.

(3)          Does not include minimuminterest and fee payments of $30.

(4)          Includes imputedinterest of $3.

(5)          In January 2005 Growellwas acquired by a third party, and we****are currently in negotiations to settle thisbalance with the third party.****

 

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

 

The preparation of consolidated financial statements inconformity with accounting principles generally accepted in the United Statesrequires us to make estimates and assumptions that affect reported amounts ofassets and liabilities and disclosure of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenues andexpenses during the reporting period. These estimates and assumptions are basedon historical experience and various other factors that are believed to bereasonable under the circumstances. Actual results could differ materially fromthese estimates under different assumptions or conditions.

 

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

 

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

 

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

 

•                                 We record an allowance for doubtful accountsas a contra-asset to our trade receivables for estimated uncollectibleaccounts. Management estimates the amount of potentially uncollectible accountsby reviewing significantly past due customer balances relative to historicalinformation available for those customers. In the event, in future periods,actual uncollectible accounts exceed the estimate for uncollectible accounts, anadjustment 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,

 

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anadjustment would be made and income would increase in the period of suchdetermination. 

 

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

 

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

 

##### **COMPLIANCEWITH SECTION 404 OF THE SARBANES-OXLEY ACT OF 2002**

 

As directedby Section 404 of the Sarbanes-Oxley Act of 2002, or SOX, the SEC has adoptedrules requiring public companies to include a report of management on thecompany’s internal controls over financial reporting in their annual reports onForm 10-K. In addition, the public accounting firm auditing a public company’sfinancial statements must attest to and report on management’s assessment ofthe effectiveness of the company’s internal controls over financial reporting.Although these requirements were first applicable to our annual report on Form10-K for our fiscal year ending December 31, 2004, we were unable to complywith these requirements for such fiscal year. As disclosed in our amended Form10-K filed with the SEC on May 10, 2005, the time and resources necessary to completethe restatement of prior periods’ financial statements delayed our ability tocomplete the internal documentation, assessment and evaluation of internalcontrol over financial reporting, all of which are required to be undertaken tocomply with Section 404 of SOX. This delay prevented our independent auditorfrom being able to satisfactorily complete a timely audit of our internalcontrol over financial reporting as of December 31, 2004.

 

Due to thesedelays, we and our independent auditor determined that it would not be possibleto complete the management’s assessment and auditor’s audit of our internalcontrols over financial reporting as of December 31, 2004, and accordingly ourindependent auditor has issued a disclaimer of opinion with respect to ourinternal control over financial reporting as of December 31, 2004, and suchdisclaimer was filed with our amended Form 10-K filed on May 10, 2005. Thefiling of this disclaimer does not comply with the SEC’s rules and regulationsunder Section 404, and this noncompliance has resulted in us being in violationof Section 13(a) under the Securities Exchange Act of 1934. Section 13(a)establishes the general requirement that public companies must file with theSEC, in accordance with such rules and regulations as the SEC may prescribe,such information, documents, and reports as the SEC may from time to timerequire for the protection of investors, including Form 10-Ks and 10-Qs.

 

In general,the SEC has broad authority under the Securities Exchange Act of 1934 toinstitute investigations, to seek injunctions, to seek monetary penalties, andto otherwise pursue enforcement actions for violations of Section 13(a),including a failure to file a Form 10-K or for the omission of necessarystatements in a Form 10-K. Therefore, a violation under Section 404 of SOX orSection 13(a) of the Securities Exchange Act of 1934 could potentially subjectan issuer to these same investigations and penalties. Section 404 of SOX is arelatively new legal requirement, and there is very little precedentestablishing the consequences or appropriate response to a public company’sfailure to comply with Section 404. Accordingly, although we have discussed ourSection 404 noncompliance with the SEC, we cannot predict what action, if any,the SEC may take against our company as a result of a failure to be compliantwith our obligations under Section 404 of SOX or Section 13(a) of theSecurities Exchange Act of 1934.

 

EffectiveDecember 27, 2005, the SEC announced final rulings on revisions to acceleratedfiler definition and deadlines for periodic reports. The ruling revised thedefinition of the term “accelerated filer” to permit an accelerated filer thathas voting and non-voting common equity held by non-affiliates of less than $50million to exit accelerated filer status at the end of the

 

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fiscal yearin which its equity falls below $50 million and to file its annual report forthat year and subsequent periodic reports on a non-accelerated basis. As of thefiscal year ended December 31, 2005, we are considered an accelerated filer andare required to comply with SOX 404 requirements for the 2005 fiscal year.

 

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

 

****The Company has devotedsignificant amount of financial and internal resources during 2005 and earlypart of 2006 to ensure compliance with SOX 404, and on January 16, 2006,Company’s management believes that the Company has substantially completed itsdocumentation, assessment and evaluation of its internal controls overfinancial reporting as of December 31, 2005. However, our independent auditors,Stonefield Josephson Inc., resigned on December 1, 2005, and on January 20,2006, the Company hired Choi, Kim & Park LLP (“CKP”) as its new independentregistered public accounting firm. While the Company has advised CKP of theforegoing weaknesses in internal controls, due to the untimeliness of theforegoing events, CKP was unable to satisfactorily complete their audit of theCompany’s internal control over financial reporting pursuant to SOX 404, andthus, have issued a disclaimer of an opinion on the company’s internal controlover financial reporting as of December 31, 2005. The Company’s management willcontinue to monitor potential changes in the legal and regulatory requirementsof SOX 404, particularly the requirements for small public companies.****

 

##### **RECENTACCOUNTING PRONOUNCEMENTS**

 

In June 2005,the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 05-2 “TheMeaning of ‘Conventional Convertible Debt Instrument’ in EITF Issue No. 00-19, ‘Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock.’” Issuers of convertible debt are required by Statement133 to evaluate whether it is necessary to separate the “embedded” conversionfeature from the debt contract and account for the conversion feature as if itwere a separate derivative instrument. If the issuer determines that theembedded conversion feature would be classified in equity if it were afreestanding instrument, the conversion feature is not separated from the debtcontract. EITF 00-19’s criteria must be applied to determine whether aconversion feature qualifies for equity classification, but it exempts aconversion feature embedded in a “conventional convertible debt instrument”from some of the criteria. EITF 05-2 requires convertible instruments that maybe settled in a combination of cash or shares, e.g., those referred to as “InstrumentC” in EITF 90-19, and instruments that may be convertible into a variablenumber of shares are not “conventional.” As a result, nonconventional instruments would need to satisfy allrequirements of EITF 00-19 to support a conclusion that the conversion featuredoes not require accounting separate from that for the debt contract. Theadoption of this Issue resulted in recognition of the beneficial conversionfeature from the senior convertible notes issued in August 2005 as liabilitiesof $1.0 million as of December 31, 2005 and a gain of $3.8 million from thechange in fair value of beneficial conversion feature liabilities for the yearended December 31, 2005.

 

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

 

In September2005, the EITF reached a consensus on Issue 05-7 “Accounting for Modificationsto Conversion Options Embedded in Debt Instruments and Related Issues,” whichrequires that a change in the fair value of a conversion option brought aboutby modifying the debt agreement be included in analyzing in accordance withEITF 96-19 “Debtor’s Accounting for a Modification or Exchange of DebtInstruments” whether a debt instrument is considered extinguished. Under EITF96-19’s requirements, an issuer who modifies a debt instrument must compare thepresent value of the original debt instrument’s cash flows to the present valueof the cash flows of the modified debt. If the present value of those cashflows varies by more than 10 percent, the modification is consideredsignificant and extinguishments accounting is applied to the original debt. Ifthe change in the present value of the cash flows is less than 10 percent, thedebt is considered to be modified and is subject to EITF 96-19’s modificationaccounting. EITF 05-7’s Consensus requires that in applying the 10 percent testthe change in the fair value of the conversion option be treated in the samemanner as a current period cash flow. The Consensus also requires that, if amodification does not result in an extinguishment, the change in fair value ofthe conversion option be accounted for as an adjustment to interest expenseover the remaining term of the debt. The issuer should not recognize abeneficial conversion feature or reassess an existing beneficial conversionfeature upon modification of the conversion option of a debt instrument thatdoes not result in an extinguishment. EITF 05-7 is effective for modificationsof debt instruments beginning in the first interim

 

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or annualreporting period beginning after December 15, 2005. The Company does not expectthe adoption of the EITF to have material impact on the Company’s financialstatements.

 

In September2005, the EITF reached a consensus on Issue No. 05-8, “Income Tax Consequencesof Issuing Convertible Debt with a Beneficial Conversion Feature.”  Under EITF 05-8, the issuance of convertibledebt with a beneficial conversion feature results in a temporary difference forpurposes of applying Statement 109. The deferred taxes recognized for thetemporary difference should be recorded as an adjustment to paid-in capital.EITF 98-5 “Accounting for Convertible Securities with Beneficial ConversionFeatures or Contingently Adjustable Conversion Ratios” and EITF 00-27  “Application of Issue No. 98-5 to CertainConvertible Instruments” require that the nondetachable conversion feature of aconvertible debt security be accounted for separately if it is a beneficialconversion feature. A beneficial conversion feature is recognized and measuredby allocating to additional paid-in capital a portion of the proceeds equal tothe conversion feature’s intrinsic value. A discount on the convertible debt isrecognized for the amount that is allocated to additional paid-in capital. Thedebt discount is accreted from the date of issuance to the stated redemptiondate of the convertible instrument or through the earliest conversion date ifthe instrument does not have a stated redemption date. The U.S. Federal IncomeTax Code includes the entire amount of proceeds received at issuance as the taxbasis of the convertible debt security. The EITF 05-8 Consensus should beapplied retrospectively to all instruments with a beneficial conversion featureaccounted for under EITF 98-5 and EITF 00-27 for periods beginning afterDecember 15, 2005. The Company does not expect the adoption of the EITF to havematerial impact on the Company’s financial statements.

 

In May 2005,the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections — areplacement of APB Opinion No. 20 and FASB Statement No. 3.”  SFAS No. 154replaces APB Opinion No. 20, “Accounting Changes,” and FASB Statement No. 3, “ReportingAccounting Changes in Interim Financial Statements” and changes therequirements for the accounting for and reporting of a change in accounting principle. This statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in theunusual instance that the pronouncement does not include specific transitionprovisions.  When a pronouncement includes specific transition provisions,those provisions should be followed.  SFAS No. 154 is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 31, 2005.   We do notbelieve the adoption of SFAS No. 154 will have a material effect on itsconsolidated financial position, results of operations or cash flows.

 

On March 29,2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107) regarding theStaff’s interpretation of SFAS 123(R). This interpretation expresses the viewsof the staff regarding the interaction between SFAS 123(R) and certain SECrules and regulations and provides the staff’s views regarding the valuation ofshare-based payment arrangements for public companies. In particular, this SABprovides guidance related to share-based payment transactions with noemployees, the transition from nonpublic to public entity status, valuationmethods, the accounting for certain redeemable financial instruments issuedunder share-based payment arrangements, the classification of compensationexpense, non-GAAP financial measures, first-time adoption of SFAS 123(R) in aninterim period, capitalization of compensation cost related to share-basedpayment arrangements, the accounting for income tax effects of share-basedpayment arrangements upon adoption of SFAS 123(R), the modification of employeeshare options prior to adoption of Statement 123(R) and disclosures inManagement’s Discussion and Analysis subsequent to adoption of SFAS 123(R). Ourcompany will adopt SAB 107 in connection with its adoption of SFAS 123(R).

 

In December2004, the FASB issued SFAS No. 123R, “Share-Based Payment”, which replaces SFASNo. 123. SFAS No. 123R requires public companies to recognize an expense forshare-based payment arrangements including stock options and employee stockpurchase plans. The statement eliminates a company’s ability to account forshare-based compensation transactions using APB 25, and generally requiresinstead that such transactions be accounted for using a fair value basedmethod. SFAS No. 123R requires an entity to measure the cost of employeeservices received in exchange for an award of equity instruments based on thefair value of the award on the date of grant, and to recognize the cost overthe period during which the employee is required to provide service in exchangefor the award. In April 2005, the SEC amended the compliance dates for SFAS123(R), to allow companies to implement the standard at the beginning of theirnext fiscal year, instead of the next reporting period beginning after June 15,2005. SFAS No. 123R is effective for our company in the quarter ending March31, 2006. Upon adoption of SFAS 123R, companies are allowed to select one ofthree alternative transition methods, each of which has different financialreporting implications. We are currently evaluating the transition methods,valuation methodologies and other assumptions for employee stock options inlight of SFAS No. 123R. Current estimates of option values using theBlack-Scholes method may not be indicative of results from valuationmethodologies ultimately implemented by our company upon adoption of SFAS No.123R. Although we have not yet fully quantified the impact this standard willhave on our financial statements, it is likely that the adoption of SFAS No.123R will have a material impact on our company’s financial position andresults of operations. Stock-based Compensation under Consolidated FinancialStatements provides the pro forma net income and earnings per share as if theCompany had used a fair-value-based method similar to the methods requiredunder SFAS 123(R) to measure the compensation expense for employee stock awardsduring the year ended December 31, 2005 and 2004.

 

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In December2004 the Financial Accounting Standards Board issued two FASB StaffPositions—FSP FAS 109-1, *Application ofFASB Statement 109 “Accounting for Income Taxes” to the Tax Deduction onQualified Production Activities*Provided*by the American Jobs Creation Act of 2004, and FSP FAS 109-2Accounting and Disclosure Guidance for the Foreign Earnings RepatriationProvision within the American Jobs Creation Act of 2004.* Neither ofthese affected the Company as it does not participate in the relatedactivities.

 

In December2004, the FASB issued SFAS No.153, “Exchanges of Nonmonetary Assets, anamendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions.” Theamendments made by Statement 153 are based on the principle that exchanges ofnonmonetary assets should be measured based on the fair value of the assetsexchanged. Further, the amendments eliminate the narrow exception fornonmonetary exchanges of similar productive assets and replace it with abroader exception for exchanges of nonmonetary assets that do not havecommercial substance. Previously, Opinion 29 required that the accounting foran exchange of a productive asset for a similar productive asset or anequivalent interest in the same or similar productive asset should be based onthe recorded amount of the asset relinquished. Opinion 29 provided an exceptionto its basic measurement principle (fair value) for exchanges of similarproductive assets. The Board believes that exception required that some nonmonetaryexchanges, although commercially substantive, be recorded on a carryover basis.By focusing the exception on exchanges that lack commercial substance, theBoard believes this Statement produces financial reporting that more faithfullyrepresents the economics of the transactions. The Statement is effective fornonmonetary asset exchanges occurring in fiscal periods beginning after June15, 2005. Earlier application is permitted for nonmonetary asset exchangesoccurring in fiscal periods beginning after the date of issuance. Theprovisions of this Statement shall be applied prospectively. We have evaluatedthe impact of the adoption of SFAS 153, and do not believe the impact will besignificant to our company’s overall results of operations or financialposition.

 

In November2004, the FASB issued SFAS No. 151 “Inventory Costs, an amendment of ARB No.43, Chapter 4. The amendments made by Statement 151 clarify that abnormalamounts of idle facility expense, freight, handling costs, and wasted materials(spoilage) should be recognized as current-period charges and require theallocation of fixed production overheads to inventory based on the normalcapacity of the production facilities. The guidance is effective for inventorycosts incurred during fiscal years beginning after June 15, 2005. Earlierapplication is permitted for inventory costs incurred during fiscal yearsbeginning after November 23, 2004. We have evaluated the impact of the adoptionof SFAS 151, and do not believe the impact will be significant to our company’soverall results of operations or financial position.

 

In March2004, the FASB approved the consensus reached on the Emerging Issues Task Force(EITF) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and ItsApplication to Certain Investments.” The objective of this Issue is to provideguidance for identifying impaired investments. EITF 03-1 also provides newdisclosure requirements for investments that are deemed to be temporarilyimpaired. In September 2004, the FASB issued a FASB Staff Position (FSP) EITF03-1-1 that delays the effective date of the measurement and recognitionguidance in EITF 03-1 until after further deliberations by the FASB. Thedisclosure requirements are effective only for annual periods ending after June15, 2004. We have evaluated the impact of the adoption of the disclosurerequirements of EITF 03-1 and do not believe the impact will be significant toour company’s overall results of operations or financial position. Once theFASB reaches a final decision on the measurement and recognition provisions, wewill evaluate the impact of the adoption of EITF 03-1.

 

In December2003, the Securities and Exchange Commission (“SEC”) issued Staff AccountingBulletin (“SAB”) No. 104, “Revenue Recognition.” SAB 104 supersedes SAB 101, “RevenueRecognition in Financial Statements.” SAB 104’s primary purpose is to rescindaccounting guidance contained in SAB 101 related to multiple element revenuearrangements, superseded as a result of the issuance of EITF 00-21, “Accountingfor Revenue Arrangements with Multiple Deliverables.” Additionally, SAB 104rescinds the SEC’s Revenue Recognition in Financial Statements Frequently AskedQuestions and Answers (“the FAQ”) issued with SAB 101 that had been codified inSEC Topic 13, Revenue Recognition. Selected portions of the FAQ have beenincorporated into SAB 104. While the wording of SAB 104 has changed to reflectthe issuance of EITF 00-21, the revenue recognition principles of SAB 101remain largely unchanged by the issuance of SAB 104, which was effective uponissuance. The adoption of SAB 104 did not impact the consolidated financialstatements.

 

Other recentaccounting pronouncements issued by the FASB (including its Emerging IssuesTask Force), the AICPA and the SEC did not or are not believed by management tohave a material impact on our company’s present or future consolidatedfinancial statements.

 

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

 

We are exposed to various market risks in conductingthe business of the company, and we anticipate that this exposure will increaseas a result of our planned growth. In an effort to mitigate losses associatedwith these risks, we may at times enter

 

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into derivative financial instruments, althoughwe have not historically done so. These may take the form of forward salescontracts, option contracts, foreign currency exchange contracts, and interestrate swaps. We have not, and do not intend to, engage in the practice oftrading derivative securities for profit.

 

*Interest Rates.*Weare exposed to market risks relating to changes in interest rates. Although wedo not currently have any borrowings with variable interest rates, fluctuationsin interest rates may have a negative impact to any future borrowings.

 

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

 

*Foreign Exchange Rates.*As a result of our manufacturing presencein South Korea, a substantial portion of our costs will be denominated in SouthKorean won. Consequently, fluctuations in the exchange rates of the SouthKorean won to the U.S. dollar will affect our costs of goods sold and operatingmargins and could result in exchange losses. Although we do not currently enterinto foreign exchange hedge transactions, we may do so in the future as ourbusiness grows. Fluctuations in exchange rates resulted inforeign currency translation gains of $0.3 million, $1.7 million, and $0.2million for the years ended December 31, 2005, 2004, and 2003, respectively.

 

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**Item 8. FinancialStatements and Supplementary Data**

 

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

 

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

 

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

 

Deloitte was engaged by the Company to serve as the Company’s independentauditors for the fiscal year ended December 31, 2003. The reports of Deloittewith respect to the Company’s financial statements for the fiscal years endedDecember 31, 2002 and 2001 contained no adverse opinion or disclaimer ofopinion and were not qualified or modified as to uncertainty, audit scope oraccounting principles. During the fiscal years ended December 31, 2003 and 2002and the period from December 31, 2003 through the date of Deloitte’sresignation, there were no disagreements between the Company and Deloitte onany matter of accounting principles or practices, financial statementdisclosure, or auditing scope or procedure, which disagreements, if notresolved to the satisfaction of Deloitte, would have caused Deloitte to makereference to the subject matter of the disagreements in connection with itsreport on the Company’s financial statements for such year.

 

The Company previously announced that it expected to restate revenues andresults of operations for the third and fourth quarters of 2002 and the firstquarter of 2003 in connection with the Company’s sales of alloy melting andcasting equipment during such quarters to Growell Metal Co., Ltd., a SouthKorea metals processing company (“Growell”). The Company’s Audit Committeeconducted an internal inquiry at the request of Deloitte into the Company’stransactions with Growell and found that the original revenue recognition onthe Growell equipment sales did not take into account all relevantdocumentation relating to the transactions. The Company announced in January2004 that it entered into a dispute settlement agreement with Growell toresolve various outstanding claims between the parties relating to the Company’stransactions with Growell.

 

In connection with the Audit Committee’s inquiry into the Growellequipment sales and dispute settlement, the Audit Committee also reviewed thefacts and circumstances relating to a personal stock transaction between theCompany’s CEO and Growell. In this transaction, as reported by the CEO, the CEOundertook a private sale of personal shares of the Company’s common stock toGrowell in February 2002, prior to the Company’s initial public offering. Aspart of the inquiry, the CEO reported that this sale included a previouslyundisclosed personal agreement to ensure that the purchase price of the stockpurchased by Growell would be at a thirty percent discount to the Company’sinitial public offering price, and he also provided information regarding hisfulfillment of this personal agreement.

 

As of May 6, 2004, certain details of the foregoing transactions had notbeen resolved to Deloitte’s satisfaction. As a result of the expectedrestatements and these unresolved issues, the Company’s previously issuedfinancial statements for the year ended December 31, 2002 and Deloitte’s auditreport thereon, as well as the Company’s quarterly financial statements for thethird quarter of 2002 and the first, second, and third quarters of 2003 (andDeloitte’s related review reports thereon), should no longer be relied upon.

 

Deloitte communicated to the Company that it was unwilling to continue torely on the representations of the Company’s CEO. Deloitte had also previouslycommunicated to the Company that, in light of the facts and circumstancessurrounding the expected restatement, there were material weaknesses in theCompany’s internal accounting controls relating to the execution,administration, and accounting for contracts, particularly in the Company’sSouth Korean operations. The Company has taken and is continuing to take stepsto improve these internal controls.

 

Other than the foregoing, none of the reportable events described underItem 304(a)(1)(v) of Regulation S-K occurred within the two most recent fiscalyears of the Company ended December 31, 2003 and 2002 or within the subsequentinterim period through the date of Deloitte’s resignation.

 

The Company’s Audit Committee discussed with Deloitte the mattersdisclosed above regarding Deloitte’s resignation. The Company authorizedDeloitte to respond fully to the inquiries of the Company’s successoraccountant concerning the matters disclosed above.

 

On May 21, 2004, the Company’s Audit Committee appointed StonefieldJosephson, Inc. (“Stonefield”) as the Company’s independent auditors. Duringthe two fiscal years prior to the engagement of Stonefield and through the dateof the commencement of their engagement, the Company did not consult Stonefieldregarding (i) the application of accounting 

 

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principles to a specific transaction, either completed or proposed, or thetype of audit opinion that may be rendered on the Company’s financialstatements, and neither a written report nor oral advice was provided to theCompany that Stonefield Josephson concluded was an important factor consideredby the Company in reaching a decision as to any accounting, auditing orfinancial reporting issue; or (ii) any matter that was either the subject of a “disagreement”(as defined in Item 304(a)(1)(iv) of Regulation S-K and the relatedinstructions thereto) or a “reportable event” (as defined in Item 304(a)(1)(v)of Regulation S-K).  On November 23,2005, Stonefield, the Company’s independent registered public accounting firm,notified the Company that Stonefield would resign as the Company’s independentregistered public accounting firm upon the completion of Stonefield’s review ofthe Company’s interim unaudited financial statements as of and for the threeand nine month periods ended September 30, 2005.  The Company’sinterim unaudited financial statements as of and for the three and nine monthperiods ended September 30, 2005 were included in the Company’s report onForm 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 Stonefield with respect to the Company’s financialstatements for the fiscal years ended December 31, 2003 and 2004 containedno adverse opinion or disclaimer of opinion and were not qualified or modifiedas to uncertainty, audit scope, or accounting principles, except for anexplanatory paragraph regarding the Company’s ability to continue as a goingconcern contained in Stonefield’s report on the Company’s financial statementsand for a disclaimer of opinion made by Stonefield with respect to the Company’sinternal controls over financial reporting and the Company’s assessment ofthose controls as of December 31, 2004.

 

From May 21, 2004, the date Stonefield was appointed as the Company’sindependent auditors, through the date of Stonefield’s resignation, there wereno disagreements between the Company and Stonefield on any matter of accountingprinciples or practices, financial statement disclosure, or auditing scope orprocedure, which disagreements, if not resolved to the satisfaction ofStonefield, would have caused Stonefield to make reference to the subjectmatter of the disagreements in connection with its report on the Company’sfinancial statements for such years.

 

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

 

Stonefield has advised the Company that there are material weaknesses inits internal controls, mainly related to internal controls of its South Koreanoperations.  Therefore, Stonefield has expanded the scope of its review ofthe interim unaudited financial statements as of and for the three and ninemonth periods ended September 30, 2005.  The material deficiencies inthe Company’s internal controls over financial reporting include the following:

 

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

 

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

 

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

 

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

 

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

 

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

 

In connection with the foregoing, Stonefield has also advised the Companythat it believes that the Company has made insufficient progress indocumenting, assessing, and evaluating the Company’s internal controls overfinancial reporting for purposes of timely complying with Section 404 ofthe Sarbanes-Oxley Act of 2002.

 

The Company’s Audit Committee has discussed with Stonefield the mattersdisclosed above regarding Stonefield’s resignation.  The Company hasauthorized Stonefield to respond fully to the inquiries of the Company’ssuccessor accountant concerning the matters disclosed above.

 

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

 

**Item 9A. Controls and Procedures**

 

Evaluation ofdisclosure controls and procedures. During the course of the re-audit of our financial statements of LiquidmetalTechnologies, Inc. (the “Company”) for the fiscal years ended December 31,2001, 2002, and 2003, it was determined that revenues from certain salesmade by the Company to various customers were either not recognizedin the proper periods or should not have been recognized as revenue. It ****was also determinedthat compensation expense related to certain stock options granted in 2001 and2002 were not calculated in accordance with generally accepted accountingprinciples under APB Opinion No. 25, SFAS No. 123, and EITF 00-23.** **These determinations and the associated restatement of previouslyissued financial statements in the Form 10-K for the year ended December 31,2003, filed on November 10, 2004, suggest that, at the time of the subjecttransactions and the preparation of our financial statements for the relevantperiods, the Company’s disclosure controls and procedures (as definedin Rule 13a-15 under the Securities Exchange Act of 1934) were ineffectiveas of the end of the period covered by such Form 10-K.

 

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

 

The Company carried out an evaluation underthe supervision and with the participation of the Company’s management,including the Company’s Chief Executive Officer and Chief Financial Officer, ofthe effectiveness, as of December 31, 2005, of the design and operation of theCompany’s disclosure controls and procedures pursuant to Rule 13a-15 under theSecurities Exchange Act of 1934, as amended. Based on that evaluation, theChief Executive Officer and Chief Financial Officer have concluded that thesedisclosure controls and procedures, as of December 31, 2005, were noteffective.  This determination was basedprimarily on the material weaknesses in internal controls over financialreporting identified below.

 

****Updateon Management’s Assessment of Internal Control Over Financial Reporting********.The time********and resources committed tothe restatement of prior periods’ financial statements as aforementioneddelayed management in commencing and completing its documentation, assessmentand evaluation of internal control over financial reporting. Due to the issuesdescribed in the foregoing paragraph, as well as limitation on financial andinternal resources, management’s assessment of the effectiveness of ourinternal control over financial reporting had been substantially delayed, whichin turn prohibited the Company’s former independent registered publicaccounting firm, Stonefield Josephson, Inc., in performing its audit ofmanagement’s assessment of the effectiveness of internal control over financialreporting pursuant to SOX 404 as of December 31, 2004.****

 

****TheCompany has been advised by the SEC that the filing of the above mentioneddisclaimer does not comply with the SEC’s rules and regulations under Section404, and the SEC has further advised us that this noncompliance has resulted inthe Company being in violation of Section 13(a) under the Securities ExchangeAct of 1934 Section 13(a) establishes the general requirement that publiccompanies must file with the SEC, in accordance with such rules and regulationsas the SEC may prescribe, such information, documents, and reports as the SECmay from time to time require for the protection of investors, including Form10-Ks and 10-Qs.****

 

****During2005, the Company has taken steps to comply with Section 404, including hiringindependent consulting firms, Assurance Consulting 3 in January 2005 and LoginFinancial in July 2005, to assist the Company with its Section 404 complianceand to identify and propose remedial actions to address and mitigatedeficiencies in internal controls over financial reporting. In addition,beginning July 2005 the Company has devoted additional internal resourcesincluding having an executive manager lead the SOX 404 compliance effort on afull time basis. Also, beginning August 2005, management allocated a consultantfrom Login Financial to our South Korean operations and re-evaluated ourcontrols as well as implemented additional control procedures. The Company’sevaluation included revising our documentation, re-performing walkthroughs andre-testing our internal controls. In addition, on****

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****November14, 2005 management hired an additional “Big 4” third party consultant who isexperienced in the SOX 404 effort for companies operating in South Korea toaddress and mitigate material deficiencies during the fourth quarter of 2005and into 2006. Even though the Company devoted these resources, considering the********nature of the Company’s operations having substantial presence in South Koreain addition to the Company’s US operations in Texas and California as well asthe amount of time, financial resources, complexity associated with Section 404compliance, limited financial resources of the Company and management’s latestart in identifying and documenting it’s internal controls, the Company’sauditors advised the Company and the Audit Committee of the Board of Directorsthat they believed it was highly unlikely that the Company’s management wouldbe able to finish its testing and assessment of the Company’s internal controlsin time for Stonefield to begin its testing of management’s assertions overinternal controls by the end of fiscal year 2005 in accordance with thestandards of Section 404.****

 

****In the ongoing process of making our assessment of internal controlover financial reporting, management used the criteria established in “InternalControl - Integrated Framework” issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Of the various controlprocedures that we have documented, performed walkthroughs, and tested as of December31, 2005, management has identified several control deficiencies, some of whichhave been determined to be material weaknesses in internal control overfinancial reporting as follows.****

 

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

 

****This deficiency resulted from the fact that the processesutilized at the Company’s  Korean Operationswere designed to meet certain Korean business practices whereby invoices arecreated once a month, the invoices are confirmed by the customer prior to beingsent to and received by the customer, and payments of invoices are done onlythrough wire transfers.  As part of theseKorean business practices,, “tax invoices” are generated by sellers of goodsand are issued to customers as formal documents required by the Koreangovernment to immediately document and report sales for income tax purposes.****

 

****Previously, these processes were handled by the accountingand sales departments in the Korean Operations, and to mitigate the risk offraud or error, the Company relied on the fact that all invoices were confirmedwith the customer prior to recognizing revenue, all cash receipts were receivedvia wire transfer, and revenue accounts were reconciled by accounting on amonthly basis. Nevertheless, the Company’s former auditor has informed theCompany that these processes lacked certain formal documentation and segregationof duties.  To remediate theseweaknesses, the Company implemented the following changes in its KoreanOperations during November 2005****

 

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

 

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

 

****•********     ********AdditionalResources:  In November 2005, theCompany began devoting additional internal resources to the Korean accountingdepartment to segregate****

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****duties further. This included having (1) the sales accountant create all taxinvoices as mentioned under “Segregation of Duties” above, (2) theAssistant Sales Manager reconcile the delivery requisitions maintained in theProduction Department, and (3) the Accounting Department control vendorcreation in the purchasing module of our SAP reporting system.  In addition, the Company is currentlyconducting a search for an accountant for the Korean operations to furtheraugment control procedures.****

 

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

 

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

 

****Despite these measures, the Company’s former auditorconcluded that the lack of segregation of duties in the Coatings Businessconstituted a material weakness in the Company’s internal controls overfinancial reporting.  As a result, in September 2005,the Company instituted additional internal control procedures in its CoatingsBusiness, including the following: (1) requiring that all orders besupported by a written purchase order containing the customer’s letterhead andaddress, the part number and description, and the signature of the purchaserwith terms and conditions, (2) requiring that all 3rd party vendor “dropshipments” be supported by shipping documents faxed or mailed to the Company bythe vendor, (3) periodically performing on-site audits of the accountingprocedures at the Coating Business by the Company’s central corporateaccounting group, the first of which has been performed in December 2005and (4) hiring an additional Accounting Manager in December 2005 inthe Corporate Accounting Group to further monitor the Coatings Business andother accounting functions.****

 

****3.********    ********Lack of adequate controls and documentationin the Company’s South Korean Operations to evidence proper customer invoicingand revenue recognition in the proper period:****

 

****The measures taken to remedy the deficiency described innumber 1 above also served to remediate this deficiency.****

 

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

 

****The Company’s overall assessment of its internal controls,including documentation, walkthroughs, and testwork, commenced in February of2005.  Management believes that theCompany’s assessment of its controls in its U.S. operations has beensubstantially completed in December 2005, although due to limitedfinancial resources, the Company was unable to begin its assessment of itsKorean Operations until mid-to late 2005. The Company identified and, beginning in August of 2005, retained abi-lingual consultant from Login Financial to work in the Company’s KoreanOperations on a full time basis to help with the SOX 404 complianceeffort.  In addition, to expedite theimplementation process, the Company hired, in November 2005, an consultantfrom Price Waterhouse Coopers-Korea who is familiar with SOX 404 implementationfor Korean companies.  Nevertheless, theCompany’s former auditor informed the Company that they believed that progressat the Korean Operations on the SOX 404 process has not been sufficient toenable the Company to complete the process in time for compliance.  Although the disclosure in this paragraph maynot be characterized as a material weakness in internal controls per se (butinstead constitutes an update on the Company’s efforts regarding SOX 404compliance), the Company has disclosed this information based on former auditor’srecommendation.****

 

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

 

****SAP is the Company’s global enterprise resource planning(ERP) software that handles the Company’s financial reporting on a real-timebasis.  Historically, access to SAP wascontrolled on an ad hoc basis by the Controller and the Vice President ofOperations of the Company, and formal IT procedures for SAP administration werelacking.  During September 2005, theCompany hired an independent IT consultant specializing in SOX implementationsspecifically for the Company’s global IT cycle. The Company has substantially completed its assessment of IT systemcontrols, including improving the Company’s internal access controls to its SAPsystem.****

 

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

 

****Current manual procedures include (1) creating excel spreadsheetinvoices to bill customers; (2) performing manual currency translations (“FXTranslation”) for financial reporting in U.S. dollars; and (3) using amanual purchase requisition system. While these procedures may be automated through modules in the SAPsystem, due to the significant financial investment necessary to automate theseprocedures in SAP, the Company is not able to automate these procedures at thistime.  However, beginning in August 2005,the Company implemented control procedures to mitigate risks associated withmanual procedures including****

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****(1) requiring additional authorizations fro all purchases, journalentries, and requisitions and (2) creating checklists for month end,customer/vendor creation, human resource filing, and revenue support to ensurepropriety and completeness of the Company’s accounting records.****

 

****The Company has devoted a significant amount of financial and internalresources during 2005 and early part of 2006 to pursue compliance with SOX 404,and on January 16, 2006, Company’s management believes that the Company hadsubstantially completed its documentation, assessment and evaluation of itsinternal controls over financial reporting as of December 31, 2005. However,our independent auditors, Stonefield Josephson Inc., resigned on December 1,2005, and on January 20, 2006, the Company hired Choi, Kim & Park LLP (“CKP”)as its new independent registered public accounting firm. While the Company hasadvised CKP of the foregoing weaknesses in internal controls, due to theuntimeliness of the foregoing events, CKP was unable to satisfactorily completetheir audit of the Company’s internal control over financial reporting pursuantto SOX 404, and thus, have issued a disclaimer of an opinion on the company’sinternal control over financial reporting as of December 31, 2005. The Company’smanagement will continue to monitor potential changes in the legal andregulatory requirements of SOX 404, particularly the requirements for smallpublic companies.****

 

****Ingeneral, the SEC has broad authority under the Securities Exchange Act of 1934to institute investigations, to seek injunctions, to seek monetary penalties,and to otherwise pursue enforcement actions for violations of Section 13(a),including a failure to file a Form 10-K or for the omission of necessarystatements in a Form 10-K. Therefore, a violation under Section 404 couldpotentially subject a company to these same investigations and penalties.Section 404 is a relatively new legal requirement, and there is very littleprecedent establishing the consequences or appropriate response to a publiccompany’s failure to comply with Section 404. Accordingly, although the Companyhas discussed its Section 404 noncompliance for 2004 and 2005 with the SEC, theCompany cannot predict what action, if any, the SEC may take against theCompany as a result of a failure to be compliant with its obligations underSection 404.****

 

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

 

57

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

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

 

We were engaged to audit management’s assessment included in theaccompanying Management’s Report on Internal Control Over Financial Reporting,that Liquidmetal Technologies, Inc. (the “Company”) maintained effectiveinternal control over financial reporting as of December 31, 2005, basedon criteria established in Internal Control - Integrated Framework issued bythe Committee of Sponsoring Organizations of the Treadway Commission (COSO). Liquidmetal Technologies, Inc.’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reporting.

 

A material weakness is a significant deficiency, or combination ofsignificant deficiencies, that results in more than a remote likelihood that amaterial misstatement of the annual or interim financial statements will not beprevented or detected.  Management has not completed its assessment ofinternal control over financial reporting, which has prevented us from beingable to satisfactorily complete an audit of the Company’s internal control overfinancial reporting.   However, management has identified thefollowing material weaknesses during their assessment:  lack of adequatesegregation of duties in accounts receivable involving cash receipts, shipping,delivery of products, and invoice reconciliations, as well as in orderprocessing and invoicing; lack of documentation of authorization oftransactions; manual performance of numerous procedures that could be automatedusing current reporting systems; material adjustments to the accounting recordsand financial statements as of and for the year ended December 31, 2005that were not initially identified by the Company’s internal control overfinancial reporting; and the Company had inadequate controls related to timelyperformance of its assessment of internal control over financial reporting.  The existence of one or more material weaknesses as of December 31,2005 would preclude a conclusion that the Company’s internal control overfinancial reporting was effective as of that date.  These materialweaknesses were considered in determining the nature, timing and extent ofaudit tests applied in our audit of the 2005 consolidated financial statements,and our disclaimer of opinion regarding the effectiveness of the Company’sinternal control over financial reporting does not affect our opinion on thoseconsolidated financial statements.

 

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

 

Because of its inherent limitations, internal control over financialreporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk thatcontrols may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate.

 

Since management has not completed all the steps necessary to enable usto satisfactorily complete an audit of their internal control over financialreporting, and we were unable to apply other procedures to satisfy ourselves asto the effectiveness of the company’s internal control over financialreporting, the scope of our work was not sufficient to enable us to express,and we do not express, an opinion either on management’s assessment or on theeffectiveness of the company’s internal control over financial reporting.

 

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

 

 
| /s/ Choi, Kim & Park, LLP                      |   |
|---------------------------------------------------------|--------|
|                                                    |   |
| Choi, Kim & Park, LLP  Los Angeles, California |
| March 14, 2006                                     |

 

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

 

****None.****

**** ****

****58****

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**** ****

**PART III**

 

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

 

Set forth below is a table identifying our current directors andexecutive officers as of December 31, 2005:

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

 

*John Kang* was re-elected as Chairman of ourBoard of Directors in August 2003. Mr. Kang**hasbeen a director of our Company since 1994. From December 1994 to June 2001, heserved as Chairman of our Board of Directors in various capacities. From June2001 until December 30, 2005, Mr. Kang had served variously as our ChiefExecutive Officer and President. From July 1996 to September 2000, Mr. Kangserved variously as Chief Executive Officer, President, and a director ofMedical Manager Corporation, a public company traded on the Nasdaq NationalMarket until its sale in September 2000 to WebMD Corporation. From 1988 to1995, he was Chairman of the board of directors of Clayton Group, Inc., aprivate company engaged in the distribution of waterworks equipment. Mr. 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 thatwere made 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 isunrelated to Mr. Kang’s service as a director and officer of our company. Mr.Kang resigned as our President and Chief Executive Officer on December 30,2005, although he continues to serves as Chairman of the Board of our companyand continues to work for our company on a full-time basis.

 

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

 

*James Kang*hasserved as a director since December 1994 and as executive Founder of ourcompany since August 2003. From December 1994 to June 2001, he served variouslyas our Chief Executive Officer, President, and Chairman. Mr. Kang received aB.A. degree in Marketing from the University of Illinois in 1983, and an M.B.A.degree from the Kellogg School 

 

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of Management at Northwestern University in 1985. Mr. Kang is thebrother of John Kang, our Chairman of the Board of Directors, who was also ourChief Executive Officer and President during 2004.

 

*William Johnson, Ph.D*.*,*has served as a director since June 2000. From October2001 to September 2003, he was employed as our executive Vice Chairman ofTechnology. Since 1997, Professor Johnson has been the Mettler Professor ofEngineering and Applied Physics at Caltech. He held a Visiting Professorappointment at the Metal Physics Institute in Gottingen, Germany (1983) andreceived a Von Humbolt Distinguished Scientist Fellowship in Gottingen (1988). Heis the 1995 recipient of the TMS/AIME Hume Rothery Award for his experimentalwork. 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 ResearchCenter (1975-1977). At Caltech, Professor Johnson directed the research thatled to the discovery of our bulk Liquidmetal alloy. Professor Johnson iscurrently a consultant to the Company.

 

*Dean Tanella* waselected 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 of Safe Harbor Capital,LLC and, since 2003, as President of HarborLight Capital, LLC, both of whichare private investment firms. Mr. Tanella received his bachelors degree fromPrinceton University and his MBA from the Harvard Graduate School of BusinessAdministration. In December 2004, Mr. Tanella was also named Executive VicePresident – Capital Markets Group and a member of the Board of Directors atGunnAllen Financial Inc., a leading independent brokerage firm headquartered inTampa, Florida.

 

*Robert Biehl* hasserved as a director since January 2005. Mr. Biehl founded the MasterplanningGroup International and as President, personally consulted over 400 clients andmentored over 2,500 executives and world leaders. Prior to startingMasterplanning Group, Mr. Biehl was an executive staff of World VisionInternational where he designed and developed the Love Loaf Program, which hasraised millions of dollars worldwide. He has also published many books in thearea of personal and organizational development. Mr. Biehl received his B.A.degree in psychology and a Masters Degree in Counseling from Michigan StateUniversity.

 

*CK Cho* was electedas a director in January 2005. Mr. 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 as CEO and President of Winvest VenturePartners Inc. and is currently serving as President and CEO of ATIC, an ITVenture Capital Company based in Korea. Mr. Cho received his bachelors degreemajoring in Business Administration and Material Sciences from the KoreaUniversity of Seoul.

 

*Young Ham* has been our ChiefFinancial Officer since April 2005, prior to which he served as the CFO of theAsian operation in 2004. Prior to joining Liquidmetal, he served as Presidentand Chief Consultant of Dime Financial Advisory based in Seoul, Korea fromNovember 1999 through July 2003. In addition, Mr. Ham was a founding partnerfor Hanmi Accounting Corporation in South Korea since July 2003 where heprovided accounting and consulting services to multi-national corporations. Mr.Ham was also the Chief Internal Auditor and Financial Advisor to AnswerInternational Asia Inc. and Director of Dongyang Economy Research Institute. Financialadvisory and management consulting clients have included, Nextel Co., Ltd,Korea Masterbuilders, Korea Spoland Co., 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.

 

**Change in Principal FinancialOfficer**

 

On April 15, 2005, Tony Chung resigned as our VicePresident of Finance and ceased to be our principal financial officer. On thesame day, our board elected Young Ham to serve as our Chief Financial Officerand become our company’s principal financial officer. Mr. Chung continues toserve our company as Vice President of Legal and Administration. Additionalinformation regarding Mr. Ham is set forth above in this Item 10.

 

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

###### ** **

**Terms of Directors**

 

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

 

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**directorswhose term is scheduled to expire at the 2005 annual meeting of stockholders:John Kang, William Johnson, and Robert Biehl. CLASS II currently consists ofthe following directors whose term is scheduled to expire at the 2006 annualmeeting of stockholders:  Dean Tanellaand CK Cho. CLASS III currently consists of the following directors whose termwill expire at the 2007 annual meeting of stockholders:  James Kang and Rick Salas.**

** **

**Audit Committee**

 

Our board ofdirectors has an Audit Committee that is currently comprised of Mr. Tanella,who has assumed the role of Audit Committee Chairman since Mr. Addonisio’sresignation, and Mr. Biehl.  The Audit Committee is responsible forreviewing the independence, qualifications, and activities of our independentcertified accountants 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 of1934. The Audit Committee is governed by a written charter approved by theboard of directors.

 

**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 and Nominating Committee**

** **

A CorporateGovernance and Nominating Committee (“the Committee”) was formed onFebruary 18, 2003, and is comprised of Mr. Tanella and Mr. Biehl. All members of the Committee are “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 Governance Committee’s principal functions include:

 

•                 developing and maintaining ourcorporate governance policy guidelines;

 

•                 developing and maintaining our codes ofconduct and ethics;

 

•                 overseeing the interpretation andenforcement of our Code of Conduct and our Code of Ethics for Chief ExecutiveOfficer and Senior Financial and Accounting Officers; and

 

•                 evaluating the performance of ourboard, its committees, and committee chairmen and our directors.

** **

•                 selecting and recommending a slate ofdirector nominees for election at each of the Company’s annual meeting of theshareholders and recommending to the Board director nominees to fill vacanciesor new positions on the Board or its committees that may occur from time totime.

 

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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 isattached as Exhibit 14 to our Annual Report on Form 10-K filed on November 10,2004. In addition, we intend to promptly disclose (1) the nature of anyamendment to our Code that applies to our principal executive officer,principal financial officer, principal accounting officer or controller, orpersons performing similar functions and (2) the nature of any waiver,including an implicit waiver, from a provision of our Code that is granted toone of these specified officers, the name of such person who is granted thewaiver and the date of the waiver on our website in the future. You may alsorequest a copy of the Code by sending the request to information@liquidmetal.com.

 

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

###### ** **

During the years ended December 31, 2004 and2005, our executive officers and directors filed with the Securities andExchange Commission on a timely basis all required reports relating to transactionsinvolving shares of our common stock beneficially owned by them, except thatJohn Kang, Chairman, disposed of 188,700 shares during various dates in 2004and 207,520 during various dates in 2005 as gifts to various individuals andorganizations and James Kang, Director and Founder, disposed of 67,320 shareson January 5, 2004 and 200,000 shares on November 23, 2005 as gifts to variousindividuals and organization. These disposals were reported in John Kang’s Form5 filed of February 17, 2005 and February 14, 2006 and James Kang’s Form 4filed on January 28, 2005 and Form 5 filed on February 17, 2006.

 

**Item 11. ExecutiveCompensation**

 

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

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

 

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**(1)**          As of August 22, 2003, JohnKang was named Chairman of our board of directors. Mr. Kang resigned from hisposition as President and Chief Executive Officer of our company on December30, 2005. However, he will continue to serve as Chairman of the board and willcontinue to work for the Company on a full-time basis.

** **

**(2)**          On December 30, 2005, RicardoSalas was named Chief Executive Officer and President of the Company. Previouslyduring 2005, Mr. Salas served as a consultant, and has accrued $20,000 inunpaid service fees as of December 31, 2005.

** **

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

 

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(4)          On April 15, 2005, Young Ham became the Chief Financial Officer of theCompany. Previously during 2005 and 2004, Mr. Ham Served as the Chief FinancialOfficer at Liquidmetal Korea.

 

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

 

**AggregateOption Exercises in Last Year and Year-End Values**

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

** **

----

**(1)**          Represents the difference betweenthe fair market value of the underlying shares at the time of exercise and theexercise price of the options exercised.

** **

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

** **

**EMPLOYMENT AGREEMENTS**

 

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

 

We haveentered into the following employment agreements with the executive officersidentified above. Ricardo Salas, who was elected as our President and ChiefExecutive Officer on December 30, 2005, will receive an initial base salary of$250,000 for serving as President and Chief Executive Officer of our company.We and Mr. Salas have not yet entered into an employment agreement relating toMr. Salas’ 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 Kang that, as amended,provides for his employment as our Chief Executive Officer and President, andon August 22, 2003, Mr. Kang was named Chairman of our Board of Directors. OnDecember 30, 2005, Mr. Kang ceased to serve as our President and ChiefExecutive Officer, and Mr. Kang’s employment agreement has an expiration dateof December 31, 2005, although the agreement automatically renews on ayear-to-year basis until Mr. Kang resigns or his employment is terminated by uswith or without cause. Mr. Kang receives an annual base salary equal to$200,000 per year, and his employment will terminate upon the earlier of hisdeath, resignation, disability, or termination by the board of directors forany reason. If we terminate Mr. Kang’s employment without cause, or if Mr. Kangterminates his own employment upon a change of control of our company or forother good reason, as defined in the agreement, we are responsible for payingMr. Kang a lump-sum cash payment equal to 200% of Mr. Kang’s annual base salaryplus the average cash bonus during the two full fiscal years immediatelypreceding the termination. Pursuant to the agreement, Mr. Kang was issuedoptions to purchase 1,612,904 shares of our common stock at an exercise priceof $4.65 per share. The options expire on December 31, 2010 and vestedimmediately upon grant. In addition, Mr. Kang is prohibited, during hisemployment with us and for one year after he is no longer employed by us, fromsoliciting any of our employees or competing with us in any manner. Starting inMay 2003, Mr. Kang and other members of senior management took a 10% voluntarydecrease in their base salary and returned to full salary in June 2004.

 

*James Kang.*On May1, 2001, we entered into an employment agreement with James Kang that, asamended, provides for his employment as the named executive Founder of ourcompany. Mr. Kang’s employment agreement expires on May 1, 2006. Mr. Kangreceives an annual base salary equal to $300,000 per year, and his employmentwill terminate upon the earlier of his death, resignation, disability, ortermination by the board of directors for any reason. If we terminate Mr. Kang’semployment without cause, or if Mr. Kang terminates his own employment upon achange of control of our company or for other good reason, as defined in theagreement, we are responsible for paying Mr. Kang a severance benefit equal toa lump-sum cash payment equal to 200% of Mr. Kang’s annual base salary plus theaverage cash bonus during the two full fiscal years immediately preceding thetermination. Pursuant to the agreement, Mr. Kang was issued options to 

 

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purchase 2,580,646 shares of our common stock at an exercise price of$6.20 per share. The options expire on April 30, 2011 and vest at a rate of 33%per year for three years, with the first 33% vesting on May 21, 2002 and anadditional 33% on May 21, 2003 and 2004. In addition, Mr. Kang is prohibited,during his employment with us and for two years after he is no longer employedby us, from soliciting any of our employees or customers. Starting in May 2003,Mr. Kang and other members of senior management took a 10% voluntary decreasein their base salary and returned to full salary in June 2004.

 

*Young Ham.*On April15, 2005, we entered into an employment agreement with Young Ham, whichprovides for his employment as the named Chief Financial Officer. Mr. Ham’s employmentagreement expires April 15, 2008, and his term may continue subsequent to theexpiration date on a month-to-month basis at the same salary. His annual salaryis $150,000, and he received 50,000 stock options as part of the employmentagreement.

 

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

###### ** **

**General**

 

The Compensation Committee of our Board of Directors wasestablished in 2002 and currently consists of CK Cho and Robert Biehl. TheCompensation Committee is comprised entirely of non-employee directors and isresponsible for establishing the compensation of our senior management,including salaries, bonuses, termination arrangements, and other executiveofficer benefits. The Compensation Committee also administers our equityincentive plans. The Compensation Committee also annually reviews and approvesthe compensation of Ricardo Salas, our Chief Executive Officer and President.

 

**Compensation Philosophy**

 

**TheCompensation Committee’s goal is to establish and maintain compensationpolicies that will enable us to attract, motivate, and retain high-qualityexecutives and to ensure that their individual interests are aligned with ourlong-term interests and our stockholders. The committee places heavy emphasison paying for performance and believes that a significant portion of anexecutive’s total compensation opportunity should be at risk and tied tocompany performance. Our compensation package consists of three principalcomponents:**

** **

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

 

•                  Annual incentivebonus eligibility; and

 

•                  Stock optiongrants and other forms of equity-based compensation.

 

**Base Salary***.*Base salary is the largest portion of the cashcompensation package received by each of our executive officers. The basesalary of each of our executive officers is governed by employment agreementsthat were entered into during 2000 through 2005. Subject to the minimum amountsset forth in their respective employment agreements, we generally establish thebase salary of each executive officer based, among other factors, on theCompensation Committee’s assessment of that executive officer’s position,responsibilities, experience, and performance. Our philosophy is to pay basesalaries sufficient to attract and retain highly qualified executives. Anexecutive officer’s level of responsibility is the primary factor used indetermining base salary. Individual performance also is considered indetermining any salary adjustment.

 

The Compensation Committee reviews and approves allexecutive officer salary adjustments as recommended by the Chief ExecutiveOfficer and determines whether to increase the base salary above the amount setforth in their employment agreements. The Compensation Committee reviewsannually the performance of the Chief Executive Officer and establishes hisbase salary, subject to the minimum $250,000 annual base salary. In 2005 and2004, the Compensation Committee did not increase the base salary of any of theexecutive officers.

 

**AnnualBonus***.*Our executiveofficers are eligible for an annual cash bonus under our Performance BonusPlan.

 

The plan is designed to:

 

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

 

•                  be aligned withour mission, values and culture;

 

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

 

•                  be externally competitive bymatching or leading competitors; and

 

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

 

Awards of incentive bonuses generally are based onachieving corporate goals and a subjective evaluation of the contributions ofindividual executives toward the achievement of our business goals. Eligibilityfor the bonus will be contingent upon the Company meeting or exceedingcompany-wide financial goals and successful attainment of individual goals forthe position. Both elements must be successfully met in order to be eligiblefor the bonus. None of our executive officers received bonuses for 2004 and2005 because the company-wide financial goals were not satisfied.

 

**Equity-Based Compensation***.*

** **

**Ourequity-based awards to our executive officers consist principally of stockoptions granted from time to time under our 2002 Equity Incentive Plan and our1996 Stock Option Plan. Stock option grants are based on various factors,including the executive officer’s position, responsibility and tenure, eachexecutive officer’s ability to contribute to our future success, and the otherelements 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 2005, the Compensation Committeeapproved awards of options to executive officers and certain members of seniormanagement, with the sizes of the awards determined with reference to the scopeof the position and the employees’ relative contributions to the Company. Inaddition, three of our executive officers, John Kang, our Chairman of theBoard, James Kang, our executive Founder, and William Johnson, our Director,own a significant amount of our common stock.**

** **

**CEO Compensation**

 

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

 

Prior to John Kang’s resignation as our President and Chief ExecutiveOfficer on December 30, 2005, Mr. Kang’s base salary was $200,000. Mr. Kang’scompensation reflects his status as a significant stockholder of the Company. Accordingly,his base salary is lower than the base salary of CEOs of comparable companies. Mr.Kang voluntarily waived his base salary from January 2004 through May 2004 in supportof the Company’s strategic cash objectives. In June 2004, Mr. Kang returned tohis base salary of $200,000 and received his differential retroactive pay inequal installments over the remaining months of 2004. As a significantstockholder in the Company, his overall compensation is tied directly tosustained increases in the Company’s value. During 2005, Mr. Kang participatedin a voluntary salary deferral plan, which resulted in 50% deferral of his basesalary from January through June 2005, which was applied to his Section 16(b)liability from 2002 stock transactions with Growell Metal Co., Ltd. In June2005, Mr. Kang returned to his base salary of $200,000.

 

No bonus payments were made to Mr. Kang for 2004 and 2005because the Compensation Committee determined not to pay any bonuses to any ofour executive officers due to the Company missing its financial goals. During2005, Mr. Kang was granted 50,000 shares of stock options. No options weregranted to Mr. Kang in 2004. As of December 31, 2005, Mr. Kang held options andwarrants to purchase 1,985,485 shares of our common stock, of which 1,945,485were fully vested.

 

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

** **

Compensation Committee of the Board of Directors

 

CK Cho

Robert BiehlDecember 31, 2005

 

**The report ofthe Compensation Committee shall not be deemed incorporated by reference by anygeneral statement incorporating by reference this Annual Report on Form 10-Kinto any filing under the Securities Act of 1933 or under the**

 

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**SecuritiesExchange Act of 1934, except to the extent that we specifically incorporatethis information by reference, and shall not otherwise be deemed filed undersuch acts.**

** **

**DIRECTORCOMPENSATION**

 

Ournon-employee directors receive an annual fee of $10,000 for their service toour board and are reimbursed for expenses incurred in attending board andcommittee meetings. Non-employee directors are also entitled to receive a$10,000 annual cash stipend for each standing board committee (excluding theAudit Committee) on which the director serves. For Audit Committee service, theAudit Committee chairman is entitled to a $35,000 annual stipend, and the othermembers of the Audit Committee are entitled to a $27,500 annual stipend. Inaddition to the annual stipends, each non-employee director is entitled toreceive a per-meeting fee of $1,000 for each meeting of the board of directorsor any board committee attended in person. Effective December 30, 2005, DeanTanella was elected as the lead independent director of the Company. The leadindependent director is entitled to a $30,000 annual stipend.

 

We also have a 2002 Non-employee Director Stock Option Plan pursuant towhich our non-employee directors are entitled to receive stock options. Underthis plan, when a director is first elected or appointed to our board ofdirectors, the non-employee director is entitled to receive an initial stockoption grant to purchase 50,000 shares of our 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 grantedunder the plan have an exercise price equal to the fair market value of ourcommon stock on the date of the grant. These stock options have a 10-year term,vest, and are exercisable pursuant to an equal 5-year vesting schedule, andremain exercisable for certain periods of time after a person is no longer adirector.

 

No directorwho is an employee will receive separate compensation for services rendered asa director. However, our employee directors are eligible to participate in our2002 Equity Incentive Plan

 

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

 

The followingtable sets forth certain information regarding the beneficial ownership of ourcommon stock as of January 13, 2006 by:

 

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

 

each of our directors;

 

each of our namedexecutive officers; and

 

all directors andexecutive officers as a group.

 

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

 

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

 

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*  Less than one percent.

 

(1)           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 will continue to serve as Chairman of the board and will continue to workfor the Company on a full-time basis. The beneficial shares include:

 

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

 

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

 

(2)           Includes 2,861,291 shares issuablepursuant to outstanding stock options that are exercisable currently or within60 days of January 13, 2006. Also includes 969 shares held by James Kang’sminor children. Does not include 16,129 shares issuable pursuant to outstandingstock options that are not exercisable currently or within 60 days of January13, 2006.

 

(3)           Includes 12,000 shares issuablepursuant to outstanding stock options that are exercisable currently or within60 days of January 13, 2006. Does not include 58,000 shares that are issuablepursuant to outstanding stock options that are not exercisable within 60 days.

 

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

 

(5)           Does not include 10,000 sharesissuable pursuant to outstanding stock options that are exercisable currentlywithin 60 days of January 13, 2006. Does not include 50,000 shares that areissuable pursuant to outstanding stock options that are not exercisable within60 days of January 13, 2006.

 

(6)           Includes 92,584 shares issuablepursuant to currently exercisable warrants and 435,167 shares issuable pursuantto currently convertible notes. Also, includes 10,000 shares issuable pursuantto outstanding stock options that are exercisable currently or within 60 daysof January 13, 2006. Does not include 50,000 shares that are issuable pursuantto outstanding stock options that are not exercisable within 60 days of January13, 2006.

 

(7)           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 to beneficially own all such shares.

 

(8)           Includes 17,500 shares issuablepursuant to outstanding stock options exercisable currently or within 60 daysof January 13, 2006. Does not include 120,000 shares that are issuable pursuantto outstanding stock options that are not exercisable within 60 days of January13, 2006.

 

(9)           Includes 67,126 shares issuablepursuant to currently exercisable warrants and 217,584 shares issuable pursuantto currently convertible notes.

 

(10)         91,792 of these shares are held of record by a trustestablished by Mr. Chitayat for his family members.  Mr. Chitayat continues to beneficially ownall such shares.

 

**Equity IncentivePlans/Equity Compensation Plans**

** **

Securitiesauthorized for issuance under equity compensation plans as of December 31, 2005were as follows:

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

 

Equitycompensation plans not approved by stockholders consist of:

 

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

 

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

 

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

 

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

 

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

 

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

 

The number ofsecurities and type of plans available for future issuance of stock options asof December 31, 2005 were as follows:

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

 

***1996 Stock Option Plan***

 

Our 1996Stock 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.

 

As ofDecember 31, 2005, options to purchase 3,386,297 shares of common stock wereoutstanding and exercisable at a weighted average price of $6.14 per shareunder the 1996 Stock Option Plan. As of December 31, 2005, 1,974,365 shares hadbeen issued upon exercise of options under the plan.

 

***2002 Equity Incentive Plan***

 

Our 2002Equity Incentive Plan, which was adopted by our board of directors and approvedby our stockholders in April 2002, provides for the grant of stock options toofficers, employees, consultants, and directors of our company and itssubsidiaries. 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 stockholders. 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 

 

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options. Inaddition, the plan permits the granting of stock appreciation rights, or SARs,with or independently of options, as well as stock bonuses and rights topurchase restricted stock. A total of ten million shares of our common stockmay be granted under the plan.

 

The plan isadministered by our board of directors or a committee appointed by our board ofdirectors. All members of such a committee must be a non-employee director andan outside director, as defined in the plan. Subject to the limitations setforth in the plan, the administrator has the authority to select the persons towhom grants are to be made, to designate the number of shares to be covered byeach stock award, to determine whether an option is to be an incentive stockoption or a nonstatutory stock option, to establish vesting schedules, tospecify the option exercise price and the type of consideration to be paid uponexercise, and, subject to some restrictions, to specify other terms of stockawards.

 

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.

 

Any incentivestock options granted to an optionee which, when combined with all otherincentive stock options becoming exercisable for the first time in any calendaryear that are held by that person, would have an aggregate fair market value inexcess of $100,000, shall automatically be treated as nonstatutory stockoptions.

 

The plan maybe amended, altered, suspended or terminated by our board of directors at anytime, 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 April 2012. As of December 31, 2005, there were 2,151,950outstanding options or stock awards at a weighted average price of $2.66 underthe plan.

 

In September 2005, 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 periods through September 30, 2005.  Such shares were issuable to such directorsat an average price of $1.89 per share. As of December 31, 2005, a total of 92,219 shares were issued to non-employeedirectors in lieu of these past-due fees.

 

***2002 Non-employee DirectorStock Option Plan***

 

Our 2002Non-employee Director Stock Option Plan was adopted by our board of directorsand by our stockholders in April 2002. We have reserved a total of one millionshares of our common stock for issuance under the plan. The option grants underthe plan are automatic and nondiscretionary, and the exercise price of theoptions is equal to 100% of the fair market value of our common stock on thegrant 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.

 

The term ofthe options granted under the plan is 10 years, but the options expire 12months 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.

 

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

 

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The plan willterminate in March 2012, unless our board of directors terminates it sooner.

 

**Item 13. CertainRelationships and Related Transactions**

 

In June 2003,we entered into an exclusive, ten-year license agreement with LLPG, Inc. (“LLPG”),a corporation primarily owned and led by Jack Chitayat, a former director ofour 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.  In turn, wewill receive royalty payments over the life of the contract on all Liquidmetalproducts produced and sold by LLPG.  In conjunction with its technologylicensing contract, LLPG purchased two proprietary Liquidmetal alloy meltingmachines and three proprietary Liquidmetal alloy casting machines for a totalpurchase price of $2,000,000. We have not received any royalties to date underthis agreement.

 

We are aparty to 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 our board of directors, is a professor at Caltech, and substantiallyall of the amorphous alloy technology licensed to us under the Caltech licenseagreement was developed in Professor Johnson’s Caltech laboratory.  Additionally, we reimburse Caltech for laboratory expenses incurred byProfessor Johnson’s Caltech laboratory, which during the years ended December31, 2005 and 2004, amounted to $20,000 and $0, respectively.

 

We are a party to a consulting agreement with WilliamJohnson, a board member. Under this agreement, Mr. Johnson provides consultingservices on an as-needed basis through 2004 as it relates to marketing anddevelopment Liquidmetal alloy. The agreement currently continues on amonth-to-month basis. During the years ended December 31, 2005 and 2004, weincurred approximately $15,000 and approximately $90,000 in consulting feesfrom Mr. Johnson, respectively.

 

We are aparty to a consulting agreement with Chitnis Consulting, Inc., which is owned100% by Shekhar Chitnis, a former director and executive officer of ourcompany.  Under this agreement, we have engaged Chitnis Consulting toprovide consulting services on an as-needed basis through December 31,2005.  During the years ended December 31, 2005 and 2004, we incurredapproximately $53,000 and $54,000 in consulting fees from Chitnis Consulting,respectively.

 

Soo Buchanan,the sister of John Kang and James Kang, was employed by our company and waspaid aggregate compensation of approximately $104,000 and $43,000 as ofDecember 31, 2005 and 2004.  Effective, July 31, 2005, our Ms. Buchananwas terminated as an employee and began providing services to the company as aconsultant. During 2005, the company incurred $18,000 for her services as aconsultant. Additionally, Otis Buchanan, the husband of Ms. Buchanan, wasemployed by the Company and was paid aggregate compensation of approximately$103,000 and $54,000 as of December 31, 2005 and 2004, respectively.

 

In November 2004, we entered into an agreement with John Kang, ourChairman, President, and Chief Executive Officer, in which Mr. Kang agreed thatcertain stock transactions by him in 2002 involving our common stock shouldhave resulted in a liability under Section 16(b) of the Securities Exchange Actof 1934, as amended (“Section 16(b)”). These transactions include Mr. Kang’sprivate sale of 285,715 shares of his personal Liquidmetal Technologies commonstock to Growell Metal Co., Ltd. in February 2002, prior to our initial publicoffering. They also include Mr. Kang’s subsequent indirect purchase anddisposition of Liquidmetal Technologies common stock in order to satisfy apersonal agreement Mr. Kang made to Growell Metal in February 2002 regardingthe guaranteed minimum value of the stock purchased by Growell Metal inFebruary 2002 (the purchases and dispositions incident to this agreementoccurred in August and November 2002, respectively). Lastly, the transactionsinclude open-market purchases of an aggregate of 89,300 shares of our commonstock made by Mr. Kang in August 2002.

 

The AuditCommittee of our Board of Directors conducted an independent inquiry into theabove-described transactions with the aid of independent legal counsel and, asa result of such inquiry, the Audit Committee concluded that the transactionsshould have resulted in a liability to the Company under Section 16(b) in theamount of $0.3 million. Mr. Kang has acknowledged this liability, and in anagreement negotiated between Mr. Kang and the Audit Committee and approved bythe full Board, Mr. Kang will pay this liability through periodic installmentsin 2005 and 2006. As a result, the Company accrued for the $0.3 millionreceivable in other assets and other income as of December 31, 2004. Theabove-described transactions involving Growell Metal was reported ona new Form 4 filed by Mr. Kang on November 15, 2004, and the open-marketpurchases were previously reported on a timely basis in August 2002. As ofDecember 31, 2005, the outstanding amount of the receivable was $0.2 million,which is included in other assets. Mr. Kang has paid $0.1 million during 2005. TheCompany has agreed to defer 

 

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Mr. Kang’spayment schedule until 2006 as Mr. Kang has agreed accept reduced compensationfor the remainder of 2005. The remaining outstanding balance of $0.2 millionwill be due before the end of 2006.

 

During theyear ended December 31, 2005, the Company executed a $0.2 million promissorynote with CK Cho, member of our Board of Directors, for working capitalpurposes. The note was due and paid in full as of June 30, 2005. The note hasan annual rate of interest of 6% resulting in the Company paying approximately$2 thousand in interest. Mr. Cho also holds $0.6 million of Senior ConvertibleNotes and holds 92,584 exercisable warrants as of December 31, 2005. Further,during the year ended December 31, 2005, Mr. Cho advanced approximately $1.3million to cover short-term liquidity needs. The advances were made withoutinterest and were repaid as of December 31, 2005.

 

During theyear ended December 31, 2005, Ricardo Salas, our President and Chief ExecutiveOfficer, and Young Ham, our Chief Financial Officer, each advanced the companyapproximately $0.1 million to cover short-term liquidity needs. The advanceswere made without interest and were repaid as of December 31, 2005.

 

We believethat each of the foregoing transactions was consummated on terms at least asfavorable to us as we would expect to negotiate with unrelated third parties.

 

**Item 14. Principal AccountingFees and Services**

 

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

 

Choi, Kim & Park, LLP

 

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

 

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

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

 

----

(1)*Audit Fees.*Fees for audit services billed in 2005 consisted of audit of theCompany’s annual financial statements for 2005;

 

Stonefield Josephson, Inc.

 

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

 

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

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

 

----

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

 

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

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

 

Fees for audit services billed in 2005 consisted of:

•                  Review of theCompany’s quarterly financial statements for 2005;

•                  Review of theCompany’s internal controls in accordance with Section 404 of theSarbanes-Oxley Act of 2002 for 2005.

 

73

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

 

**PART IV**

 

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

 

(a)          Thefollowing 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 onthe Exhibit Index, which appears at the end of this Item 15, arefiled as part of, or     incorporated by reference into,this report.

 

(c)                   *Financial Statement Schedules*.See Item 15(a)(2) above.

 

 

74

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**EXHIBIT INDEX**

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

 

75

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| 10.14* |   | — |   | Employment Agreement, dated November 3, 2004, between Liquidmetal  Technologies, Inc. and Tony Chung. (incorporated by reference to Exhibit  10.14 to the Form 10-K filed on November 10, 2004)                                                                                                                                                                                          |
|--------|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.15* |   | — |   | Employment  Agreement, dated December 31, 2000, between Liquidmetal Technologies,  Inc. and T. Scott Wiggins (incorporated by reference to Exhibit 10.11 to  the Registration Statement on Form S-1 filed on November 20, 2001  (Registration No. 333-73716)).                                                                                                  |
| 10.16* |   | — |   | Employment  Agreement, dated May 21, 2001, between Liquidmetal Technologies, Inc.  and Brian McDougall (incorporated by reference to Exhibit 10.12 to the  Registration Statement on Form S-1 filed on November 20, 2001  (Registration No. 333-73716)).                                                                                                        |
| 10.17* |   | — |   | Employment  Separation Agreement, dated December 31, 2003, between Liquidmetal  Technologies, Inc. and Brian McDougall. (incorporated by reference to  Exhibit 10.17 to the Form 10-K filed on November 10, 2004)                                                                                                                                                                        |
| 10.18* |   | — |   | Letter Agreement, dated February 26, 2004, between Brian McDougall  and Liquidmetal Technologies, Inc. (incorporated by reference to Exhibit 10.18  to the Form 10-K filed on November 10, 2004)                                                                                                                                                                                         |
| 10.19* |   | — |   | Employment  Agreement, December 1, 2002, between Liquidmetal Technologies, Inc. and  Thomas Trotter. (incorporated by reference to Exhibit 10.19 to the  Form 10-K filed on November 10, 2004)                                                                                                                                                                                           |
| 10.20* |   | — |   | Employment  Separation Agreement, dated November 6, 2003, between Liquidmetal  Technologies, Inc. and Thomas Trotter. (incorporated by reference to  Exhibit 10.20 to the Form 10-K filed on November 10, 2004)                                                                                                                                                                          |
| 10.21* |   | — |   | Separation  and Consulting Agreement, dated November 15, 2001, between Liquidmetal  Technologies, Inc. and Shekhar Chitnis, together with Consulting Agreement  attached as Exhibit A (incorporated by reference to Exhibit 10.14  to the Registration Statement on Form S-1 (Amendment No. 2) filed on  April 5, 2002 (Registration No. 333-73716)). |
| 10.22  |   | — |   | Warrant  for Purchase of Shares of Common Stock, dated February 21, 2001, granted  by Liquidmetal Technologies, Inc. to John Kang and Ricardo Salas  (incorporated by reference to Exhibit 10.18 to the Registration Statement on  Form S-1 filed on November 20, 2001 (Registration No. 333-73716)).                                                                     |
| 10.23  |   | — |   | Warrant  for Purchase of Shares of Common Stock, dated February 21, 2001, granted  by Liquidmetal Technologies, Inc. to Tjoa Thian Song (incorporated by reference  to Exhibit 10.19 to the Registration Statement on Form S-1 filed on  November 20, 2001 (Registration No. 333-73716)).                                                                            |
| 10.24  |   | — |   | Non-Qualified  Stock Option Agreement, dated January 1, 2001, between Liquidmetal  Technologies, Inc. and Paul Azinger (incorporated by reference to  Exhibit 10.19 to the Registration Statement on Form S-1 filed on  November 20, 2001 (Registration No. 333-73716)).                                                                                        |
| 10.25  |   | — |   | Foreign  Corporation Lease Zone Occupancy (Lease) Agreement, dated March 5, 2002,  between Kyonggi Local Corporation and Liquidmetal Korea Co., Ltd.  (incorporated by reference to Exhibit 10.22 to the Registration  Statement on Form S-1 (Amendment No. 2) filed by Liquidmetal  Technologies on April 5, 2002 (Registration No. 333-73716)).          |
| 10.26  |   | — |   | Credit  Service Agreement, dated February 2003, between Liquidmetal Korea Co., Ltd.  and Kookmin Bank (incorporated by reference to Exhibit 10.20 to the Form 10-K  filed on March 31, 2003).                                                                                                                                                                                            |
| 10.27  |   | — |   | Agreement  for Rent dated February, 2003, between Liquidmetal Korea Co., Ltd. and Dong  Myung Seo Bank (incorporated by reference to Exhibit 10.21 to the Form 10-K  filed on March 31, 2003).                                                                                                                                                                                           |
| 10.28  |   | — |   | Share  Transfer Agreement, dated February 28, 2004, among Liquidmetal Korea Co.  Ltd., Sun Joo Ho, and Dongyang Induction Co. Ltd. (incorporated by  reference to Exhibit 10.28 to the Form 10-K filed on November 10, 2004)                                                                                                                                                             |
| 10.29  |   | — |   | Settlement  Agreement, dated January 10, 2004, between Liquidmetal Korea Co., Ltd. and  Growell Metal Co., Ltd. (incorporated by reference to Exhibit 10.29 to  the Form 10-K filed on November 10, 2004)                                                                                                                                                                                |
| 10.30  |   | — |   | Amended  and Restated Securities Purchase Agreement, dated March 1, 2004, among  Liquidmetal Technologies, Inc., Michigan Venture Capital Co., Ltd., and the  investors identified as “Purchasers” therein (incorporated by reference to  Exhibit 10.1 to the Form 8-K filed on July 2, 2004).                                                                                 |
| 10.31  |   | — |   | Form  of 6% Senior Convertible Note issued under Amended and Restated Securities  Purchase Agreement (incorporated by reference to Exhibit 10.2 to the Form 8-K  filed on July 2, 2004).                                                                                                                                                                                                 |

 

76

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| 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 Security Note Due 2007 of Liquidmetal Technologies, Inc. issued  pursuant to Note Exchange Agreement filed as Exhibit 10.3 hereto (incorporated by reference to Exhibit 10.3  to the Form 8-K filed on August 20, 2004).                                            |
| 10.44 |   | — |   | Note  Exchange Agreement, dated July 29, 2004, among Liquidmetal Technologies, Inc  and Winvest Venture Partners Inc. (incorporated by reference to Exhibit 10.4 to the Form 8-K filed on  August 20, 2004).                                                                           |
| 10.45 |   | — |   | 10%  Senior Secured Notes Due 2005 of Liquidmetal Technologies, Inc. issued to  Winvest Venture Partners Inc. (incorporated by reference to Exhibit 10.5 to the Form 8-K filed on  August 20, 2004).                                                                                   |
| 10.46 |   | — |   | Form  of 6% Senior Security Note Due 2007 of Liquidmetal Technologies, Inc. issued  to Winvest Venture Partners Inc. (incorporated by reference to Exhibit 10.6 to the Form 8-K filed on  August 20, 2004).                                                                            |
| 10.47 |   | — |   | Employment  Agreement, dated January 14, 2005, between Liquidmetal Technologies, Inc. and  John Thorne (incorporated by reference to Exhibit 10.47 to the Form 10-K  filed on March 30, 2005).                                                                                         |
| 10.48 |   |   |   | Securities  Purchase Agreement dated August 2, 2005, among Liquidmetal Technologies, Inc.  and the parties identified as “Purchasers” therein (incorporated by reference  from Exhibit 10.1 of the Registrant’s 10-Q/A filed on August 30, 3005)                        |
| 10.49 |   |   |   | Form  of 7% Senior Secured Convertible Note of Liquidmetal Technologies, Inc.,  dated August 2, 2005 (incorporated by reference from Exhibit 10.2 of the  Registrant’s 10-Q/A filed on August 30, 3005)                                                                           |
| 10.50 |   |   |   | Form  of Common Stock Purchase Warrant, dated August 2, 2005 (incorporated by  reference from Exhibit 10.3 of the Registrant’s 10-Q/A filed on August 30,  3005)                                                                                                                  |
| 10.51 |   |   |   | Amended  and Restated Registration Rights Agreement, dated August 2, 2005, among  Liquidmetal Technologies, Inc. and the parties identified as “Purchasers”  therein (incorporated by reference from Exhibit 10.4 of the Registrant’s  10-Q/A filed on August 30, 3005) |
| 10.52 |   |   |   | Amended  and Restated Security Agreement, dated August 2, 2005, among Liquidmetal  Technologies, Inc. and the parties identified as the “Secured Parties”  therein (incorporated                                                                                             |

 

77

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|   |   |   |   | by  reference from Exhibit 10.5 of Registrant’s 10-Q/A filed on August 30, 3005)                                                                                                                                                                                      |
|--------|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.53* |   |   |   | Employment  Separation Agreement, dated September 30, 2005, between Liquidmetal  Technologies, Inc. and David G. Binnie (incorporated by reference from  Exhibit 10.53 of the Registration Statement on Form S-1 filed on December 9,  2005 (Registration No.333-130251)). |
| 10.54  |   |   |   | Securities  Purchase Agreement, dated June 13, 2005, among Liquidmetal Technologies, Inc.  and the parties identified as “Purchasers” therein (incorporated by reference  from Exhibit 99.1 of the Registrant’s 8-K filed on 06/16/05)                      |
| 10.55  |   |   |   | Form  of 10% Convertible Unsecured Note of Liquidmetal Technologies, Inc. due June  2006 (incorporated by reference from Exhibit 99.2 of the Registrant’s 8-K  filed on 06/16/05)                                                                                     |
| 10.56  |   |   |   | Form  of Common Stock Purchase Warrant, dated June 13, 2005 (incorporated by  reference 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).                                                                                                                                       |
| 10.59  |   |   |   | Form  of Indemnity Agreement between Liquidmetal Technologies, Inc. and directors  and executive officers.                                                                                                                                                                 |
| 10.60  |   |   |   | Factoring,  Loan, and Security Agreement, dated April 21, 2005, between Liquidmetal  Technologies, Inc. and Hana Financial, Inc.                                                                                                                                           |
| 14     |   | — |   | Code  of Ethics for Chief Executive Officer and Senior Financial and Accounting  Officers. (incorporated by reference to Exhibit 14 to the Form 10-K  filed on November 10, 2004)                                                                                          |
| 21     |   | — |   | Subsidiaries  of the Registrant. (incorporated by reference to Exhibit 21 to the  Form 10-K filed on November 10, 2004)                                                                                                                                                    |
| 23.1   |   | — |   | Consent  of Choi, Kim & Park, LLP                                                                                                                                                                                                                                      |
| 23.2   |   | — |   | Consent  of Stonefield Josephson, Inc.                                                                                                                                                                                                                                     |
| 24.1   |   | — |   | Power  of Attorney relating to subsequent amendments (included on the signature  page(s) of this report).                                                                                                                                                                  |
| 31.1   |   | — |   | Certification  of Principal Executive Officer pursuant to Rule 13a-15(e) or 15d-15(e) of the  Securities Exchange Act of 1934, as amended.                                                                                                                                 |
| 31.2   |   | — |   | Certification  of Principal Financial Officer pursuant to Rule 13a-15(e) or 15d-15(e) of the  Securities Exchange Act of 1934, as amended.                                                                                                                                 |
| 32.1   |   | — |   | Certification  of Chief Executive Officer pursuant to 18 U.S.C. 1350.                                                                                                                                                                                                      |
| 32.2   |   | — |   | Certification  of Principal Financial Officer pursuant to 18 U.S.C. 1350.                                                                                                                                                                                                  |

 

----

*            Denotes amanagement contract or compensatory plan or arrangement required to be filed asan exhibit this Form 10-K. 

 

78

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**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/  Ricardo Salas                                |   |
|                  |   | Ricardo  Salas   President and Chief Executive Officer |   |
|                  |   |                                                   |   |
| Date:  March 16, 2006 |   |                                                   |   |   |
|                  |   |                                                   |   |   |
|                  | By:    | /s/  Young Ham                                    |   |
|                  |   | Young  Ham  Chief Financial Officer               |   |
|                  |   |                                                   |   |
| Date:  March 16, 2006 |   |                                                   |   |   |

 

79

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**POWER OF ATTORNEY**

 

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

 

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

 
| **Signature**              |   | **Title**                    |   | **Date**        |   |
|----------------------------|--------|------------------------------|--------|-----------------|--------|
| /s/  John Kang        |   | Chairman  of the Board  |   | March  16, 2006 |   |
| John  Kang                 |   | and  Director                |   |            |   |
|                       |   |                         |   |            |   |
| /s/  James Kang       |   | Founder  and Director        |   | March  16, 2006 |   |
| James  Kang                |   |                         |   |            |   |
|                       |   |                         |   |            |   |
| /s/  William Johnson  |   | Director                     |   | March  16, 2006 |   |
| William  Johnson           |   |                         |   |            |   |
|                       |   |                         |   |            |   |
| /s/  Robert Biehl     |   | Director                     |   | March  16, 2006 |   |
| Robert  Biehl              |   |                         |   |            |   |
|                       |   |                         |   |            |   |
| /s/ Dean Tanella      |   | Director                     |   | March  16, 2006 |   |
| Dean Tanella               |   |                         |   |            |   |
|                       |   |                         |   |            |   |
| /s/ CK Cho            |   | Director                     |   | March  16, 2006 |   |
| CK Cho                     |   |                         |   |            |   |

 

 

Certificationsprovided as Exhibits.

 

80

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**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

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

 

81

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

** **

To the Board of Directors and Shareholders of

Liquidmetal Technologies, Inc.

 

We have audited the accompanying consolidated balance sheet ofLiquidmetal Technologies, Inc. and subsidiaries (the “Company”) as of December 31,2005, and the related consolidated statements of operations and comprehensiveloss, shareholders’ equity (deficiency), and cash flows for the year ended December 31,2005. Our audit also included the financial statement schedule listed atindex in Item 15(a) as of and for the year ended December 31, 2005. Ourresponsibility is to express an opinion on the financial statements andfinancial statement schedule based on our audit.

 

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

 

In our opinion, such consolidated financial statements present fairly,in all material respects, the financial position of Liquidmetal Technologies, Inc.and subsidiaries as of December 31, 2005, and the results of theiroperations and cash flows for the year ended December 31, 2005, inconformity with accounting principles generally accepted in the United Statesof America. Also, in our opinion, such financial statement schedule, whenconsidered in relation to the basic consolidated financial statements taken asa whole, presents fairly in all material respects the information set forththerein.

 

Theaccompanying consolidated financial statements have been prepared assuming thatthe Company will continue as a going concern. As discussed in Note 2 tothe consolidated financial statements, the Company’s significant operatinglosses and working capital deficit raise substantial doubt about its ability tocontinue as a going concern. Management’s plans regarding those matters alsoare described in Note 2. The consolidated financial statements do not includeany adjustments that might result from the outcome of this uncertainty.

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

 

February 23, 2006

 

82

----

 

To the Board of Directors andShareholders of Liquidmetal Technologies, Inc.

 

We have audited the accompanyingconsolidated balance sheet of Liquidmetal Technologies, Inc. andsubsidiaries (the “Company”) as of December 31, 2004 , and the relatedconsolidated statements of operations and comprehensive loss, shareholders’equity (deficiency), and cash flows for each of the two years in the periodended December 31, 2004 . Our audit also included the financial statement schedule listedat index in Item 15(a) as of and for the years ended December 31,2004 and 2003. Our responsibility is to express an opinion on the financialstatements and financial statement schedule based on our audits.

 

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(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, such consolidatedfinancial statements present fairly, in all material respects, the financialposition of Liquidmetal Technologies, Inc. and subsidiaries as of December 31,2004, and the results of their operations and cash flows for each of the twoyears in the period ended December 31, 2004, in conformity with accountingprinciples generally accepted in the United States of America. Also, in ouropinion, such financial statement schedule, when considered in relation to thebasic consolidated financial statements taken as a whole, presents fairly inall material respects the information set forth therein.

 

The accompanying consolidatedfinancial statements have been prepared assuming that the Company will continueas a going concern. As discussed in Note 2 to the consolidated financialstatements, the Company’s significant operating losses and working capitaldeficit raise substantial doubt about its ability to continue as a goingconcern. Management’s plans regarding those matters also are described in Note2. The consolidated financial statements do not include any adjustments thatmight result from the outcome of this uncertainty.

 
| Stonefield Josephson, Inc.     |
|--------------------------------|
|                           |
| /s/ Stonefield Josephson, Inc. |   |

Irvine, California

Certified Public Accountants

 

March 3,2005

 

83

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**LIQUIDMETAL TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**(inthousands, except share data)**

 
| ** **                                                                                                                                                             | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                             | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                                                                             |       |                  |       |   |   |
|                                                                                                                                                                   |       |                  |       |   |   |
| Current  Assets:                                                                                                                                                       |       |                  |       |   |   |
|                                                                                                                                                                   |       |                  |       |   |   |
| Cash and  cash equivalents                                                                                                                                             |       | $                     | 1,392      |   | $ | 742 |   |
| Restricted  cash                                                                                                                                                       |       | —                |       | 754 |   |
| Trade  accounts receivables, net of allowance for doubful accounts of $61 and $108                                                                                     |       | 2,360                 |       | 1,668 |   |
| Inventories                                                                                                                                                            |       | 1,748                 |       | 2,353 |   |
| Prepaid  expenses and other current assets                                                                                                                             |       | 609                   |       | 930 |   |
| Total  current assets                                                                                                                                                  |       | 6,109                 |       | 6,447 |   |
|                                                                                                                                                                   |       |                  |       |   |   |
| Property,  plant and equipment, net                                                                                                                                    |       | 13,437                |       | 16,434 |   |
| Idle  equipment                                                                                                                                                        |       | 193                   |       | 1,906 |   |
| Long-term  inventory                                                                                                                                                   |       | —                |       | 1,810 |   |
| Other  intangibles, net                                                                                                                                                |       | 1,185                 |       | 1,143 |   |
| Other assets                                                                                                                                                           |       | 639                   |       | 768 |   |
| Total assets                                                                                                                                                           |       | $                     | 21,563     |   | $ | 28,508 |   |
|                                                                                                                                                                   |       |                  |       |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                         |       |                  |       |   |   |
|                                                                                                                                                                   |       |                  |       |   |   |
| Curernt  liabilities:                                                                                                                                                  |       |                  |       |   |   |
|                                                                                                                                                                   |       |                  |       |   |   |
| Accounts  payable and accrued expenses                                                                                                                                 |       | $                     | 6,530      |   | $ | 4,969 |   |
| Settlement  payable                                                                                                                                                    |       | 3,331                 |       | 3,246 |   |
| Deferred  revenue                                                                                                                                                      |       | 1,275                 |       | 900 |   |
| Short-term  debt                                                                                                                                                       |       | 550                   |       | — |   |
| Long-term  debt, current portion, net of debt discount of $0 and $851                                                                                                  |       | 1,343                 |       | 5,991 |   |
| Other  liabilities, current portion                                                                                                                                    |       | 483                   |       | 1,032 |   |
| Warrant  liabilities                                                                                                                                                   |       | 1,792                 |       | 550 |   |
| Beneficial  conversion feature liabilities                                                                                                                             |       | 959                   |       | — |   |
| Total  current liabilities                                                                                                                                             |       | 16,263                |       | 16,688 |   |
|                                                                                                                                                                   |       |                  |       |   |   |
| Long-term  debt, net of current portion and debt discount of $7,354 and $0                                                                                             |       | 6,338                 |       | 2,618 |   |
| Other  long-term liabilities, net of current portion                                                                                                                   |       | 348                   |       | 342 |   |
| Total  liabilities                                                                                                                                                     |       | 22,949                |       | 19,648 |   |
|                                                                                                                                                                   |       |                  |       |   |   |
| Shareholder’s  equity (deficiency):                                                                                                                               |       |                  |       |   |   |
| Common  stock, $0.001 par value; 100,000,000 shares authorized and 42,187,621 and  41,609,652 issued and outstanding at December 31, 2005 and 2004,  respectively |       | 42                    |       | 42 |   |
| Additional  paid in capital                                                                                                                                            |       | 132,861               |       | 132,160 |   |
| Accumulated  deficit                                                                                                                                                   |       | (136,559              | )          | (125,313 | ) |
| Accumulated  other comprehensive income                                                                                                                                |       | 2,270                 |       | 1,971 |   |
| Total  shareholder’ equity (deficiency)                                                                                                                           |       | (1,386                | )          | 8,860 |   |
|                                                                                                                                                                   |       |                  |       |   |   |
| Total  liabilities and shareholders’ equity (deficiency)                                                                                                          |       | $                     | 21,563     |   | $ | 28,508 |   |

 

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

 

84

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**LIQUIDMETAL TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS ANDCOMPREHENSIVE LOSS**

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

 
| ** **                                                                                         | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                         | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                               |       |                                        |       |   |   |   |   |
| Revenue                                                                                            |       | $                                           | 16,365     |   | $ | 17,429 |   | $ | 13,658 |   |
| Cost of  sales                                                                                     |       | 15,129                                      |       | 12,168 |   | 18,162 |   |
|                                                                                               |       |                                        |       |   |   |   |   |
| Gross (loss)  profit                                                                               |       | 1,236                                       |       | 5,261 |   | (4,504 | ) |
|                                                                                               |       |                                        |       |   |   |   |   |
| Operating  expenses                                                                                |       |                                        |       |   |   |   |   |
| Selling,  general, and administrative                                                              |       | 8,534                                       |       | 11,591 |   | 17,729 |   |
| Research and  development                                                                          |       | 1,120                                       |       | 1,467 |   | 8,780 |   |
| Impairment  of goodwill                                                                            |       | —                                      |       | — |   | 184 |   |
| Impairment  of long lived assets                                                                   |       | 4,487                                       |       | — |   | 2,684 |   |
| Total  operating expenses                                                                          |       | 14,141                                      |       | 13,058 |   | 29,377 |   |
|                                                                                               |       |                                        |       |   |   |   |   |
| Loss before  interest, other income, income taxes, minority interest, and discontinued  operations |       | (12,905                                     | )          | (7,797 | ) | (33,881 | ) |
| Loss from  exinguishments of debt                                                                  |       | (1,247                                      | )          | (1,663 | ) | — |   |
| Change in  value of warrants, net                                                                  |       | 3,985                                       |       | 747 |   | — |   |
| Change in  value of beneficial conversion feature                                                  |       | 3,849                                       |       | — |   | — |   |
| Other income                                                                                       |       | —                                      |       | 302 |   | — |   |
| Interest  expense                                                                                  |       | (4,945                                      | )          | (3,603 | ) | (390 | ) |
| Interest  income                                                                                   |       | 17                                          |       | 37 |   | 304 |   |
| Gain on sale  of marketable securities held-for-sale                                               |       | —                                      |       | — |   | 1,178 |   |
| Loss before  income taxes, minority interest and discontinued operations                           |       | (11,246                                     |  )    | (11,977 |  ) | (32,789 |  ) |
|                                                                                               |       |                                        |       |   |   |   |   |
| Income taxes                                                                                       |       | —                                      |       | — |   | — |   |
|                                                                                               |       |                                        |       |   |   |   |   |
| Loss before  minority interest and discontinued operations                                         |       | (11,246                                     | )          | (11,977 | ) | (32,789 | ) |
|                                                                                               |       |                                        |       |   |   |   |   |
| Minority  interest in loss of consolidated subsidiary                                              |       | —                                      |       | — |   | 21 |   |
|                                                                                               |       |                                        |       |   |   |   |   |
| Loss from  continuing operations                                                                   |       | (11,246                                     | )          | (11,977 | ) | (32,768 | ) |
|                                                                                               |       |                                        |       |   |   |   |   |
| Discontinued  operations:                                                                          |       |                                        |       |   |   |   |   |
| Income  (loss) from operations of discontinued operations, net                                     |       | —                                      |       | (749 | ) | (964 | ) |
| Gain (loss)  from disposal of discontinued operations, net                                         |       | —                                      |       | — |   | 127 |   |
| Net Loss                                                                                           |       | (11,246                                     | )          | (12,726 | ) | (33,605 | ) |
| Other  comprehensive gain (loss):                                                                  |       |                                        |       |   |   |   |   |
| Foreign  exchange translation gain (loss) during the period                                        |       | 299                                         |       | 1,716 |   | 211 |   |
| Net  unrealized gain (loss) on marketable securities available-for-sale                            |       | —                                      |       | — |   | (1,668 | ) |
| Comprehensive  loss                                                                                |       | $                                           | (10,947    | ) | $ | (11,010 | ) | $ | (35,062 | ) |
|                                                                                               |       |                                        |       |   |   |   |   |
| Per common  share basic and diluted:                                                               |       |                                        |       |   |   |   |   |
| Loss per  share - continuing operations                                                            |       | (0.27                                       | )          | (0.29 | ) | (0.79 | ) |
| Loss per  share - discontinuing operations                                                         |       | —                                      |       | (0.02 | ) | (0.02 | ) |
| Loss per  share basic and diluted                                                                  |       | (0.27                                       | )          | (0.31 | ) | (0.81 | ) |
|                                                                                               |       |                                        |       |   |   |   |   |
| Number of  weighted average shares - basic and diluted                                             |       | 41,833                                      |       | 41,610 |   | 41,505 |   |

 

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

 

85

----

 

**LIQUIDMETAL TECHNOLOGIES, INC. ANDSUBSIDIARIES**

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

**(inthousands, except share data)**

 
| ** **                                        | ** ** | **Common  Shares** | ** ** | **Common  Stock** | ** ** | **Additional  Paid in  Capital** | ** ** | **Unamortized  Stock-based  Compensation** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Compre-hensive  Income (loss)** | ** ** | **Total**  | ** ** |
|---------------------------------------------------|------------|--------------------|------------|-------------------|------------|---------------------------------------|------------|--------------------------------------------|------------|--------------------------|------------|------------------------------------------------------------|------------|------------|------------|
| ** **                                        | ** ** | ** **         | ** ** | ** **        | ** ** | **(restated)**                        | ** ** | **(restated)**                             | ** ** | **(restated)**           | ** ** | ** **                                                 | ** ** | ** ** | ** ** |
|                                              |       |               |       |              |       |                                  |       |                                       |       |                     |       |                                                       |       |       |       |
| **Balance, December 31, 2002 (as restated)** |       | 41,009,245         |       | $                 | 106,554    |                                  | $          | 21,575                                     |       | $                        | (260       | )                                                          | $          | (78,982    | )          | $ | 1,712 |   | $ | 50,599 |   |
|                                              |       |               |       |              |       |                                  |       |                                       |       |                     |       |                                                       |       |       |       |
| Stock options exercised                           |       | 684,165            |       | 1,149             |       | —                                |       | —                                     |       | —                   |       | —                                                     |       | 1,149      |       |
| Repurchase of shares                              |       | (93,758            | )          | (653              | )          | —                                |       | —                                     |       | —                   |       | —                                                     |       | (653       | )          |
| Change in par value due to reincorporation        |       | —             |       | (107,008          | )          | 107,008                               |       | —                                     |       | —                   |       | —                                                     |       | —     |       |
| Stock-based compensation                          |       | 10,000             |       | —            |       | 100                                   |       | 25                                         |       | —                   |       | —                                                     |       | 125        |       |
| Unamortized stock option-based compensation       |       | —             |       | —            |       | (107                                  | )          | 107                                        |       | —                   |       | —                                                     |       | —     |       |
| Purchase of common stock of subsidiaries          |       | —             |       | —            |       | 5                                     |       | —                                     |       | —                   |       | —                                                     |       | 5          |       |
| Foreign exchange translation gain                 |       | —             |       | —            |       | —                                |       | —                                     |       | —                   |       | 211                                                        |       | 211        |       |
| Reclassification for net realized gain            |       | —             |       | —            |       | —                                |       | —                                     |       | —                   |       | (1,668                                                     | )          | (1,668     | )          |
| Net loss                                          |       | —             |       | —            |       | —                                |       | —                                     |       | (33,605                  | )          | —                                                     |       | (33,605    | )          |
|                                              |       |               |       |              |       |                                  |       |                                       |       |                     |       |                                                       |       |       |       |
| **Balance December 31, 2003**                |       | 41,609,652         |       | $                 | 42         |                                  | $          | 128,581                                    |       | $                        | (128       | )                                                          | $          | (112,587   | )          | $ | 255 |   | $ | 16,163 |   |
|                                              |       |               |       |              |       |                                  |       |                                       |       |                     |       |                                                       |       |       |       |
| Stock-based compensation                          |       | —             |       | —            |       | 261                                   |       | 15                                         |       | —                   |       | —                                                     |       | 276        |       |
| Unamortized stock option-based compensation       |       | —             |       | —            |       | (113                                  | )          | 113                                        |       | —                   |       | —                                                     |       | —     |       |
| Beneficial conversion feature                     |       | —             |       | —            |       | 3,424                                 |       | —                                     |       | —                   |       | —                                                     |       | 3,424      |       |
| Warrants cancelled                                |       | —             |       | —            |       | 7                                     |       | —                                     |       | —                   |       | —                                                     |       | 7          |       |
| Foreign exchange translation gain                 |       | —             |       | —            |       | —                                |       | —                                     |       | —                   |       | 1,716                                                      |       | 1,716      |       |
| Net loss                                          |       | —             |       | —            |       | —                                |       | —                                     |       | (12,726                  | )          | —                                                     |       | (12,726    | )          |
|                                              |       |               |       |              |       |                                  |       |                                       |       |                     |       |                                                       |       |       |       |
| **Balance, December 31, 2004**               |       | 41,609,652         |       | $                 | 42         |                                  | $          | 132,160                                    |       | $                        | —     |                                                       | $          | (125,313   | )          | $ | 1,971 |   | $ | 8,860 |   |
|                                              |       |               |       |              |       |                                  |       |                                       |       |                     |       |                                                       |       |       |       |
| Stock based compensation                          |       | —             |       | —            |       | 41                                    |       | —                                     |       | —                   |       | —                                                     |       | 41         |       |
| Conversion of notes payable                       |       | 485,750            |       | —            |       | 485                                   |       | —                                     |       | —                   |       | —                                                     |       | 485        |       |
| Common stock issued as director’s fees       |       | 92,219             |       | —            |       | 175                                   |       | —                                     |       | —                   |       | —                                                     |       | 175        |       |
| Foreign exchange translation gain                 |       | —             |       | —            |       | —                                |       | —                                     |       | —                   |       | 299                                                        |       | 299        |       |
| Net loss                                          |       | —             |       | —            |       | —                                |       | —                                     |       | (11,246                  | )          | —                                                     |       | (11,246    | )          |
|                                              |       |               |       |              |       |                                  |       |                                       |       |                     |       |                                                       |       |       |       |
| **Balance, December 31, 2005**               |       | 42,187,621         |       | $                 | 42         |                                  | $          | 132,861                                    |       | $                        | —     |                                                       | $          | (136,559   | )          | $ | 2,270 |   | $ | (1,386 | ) |

 

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

 

86

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**LIQUIDMETAL TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands, exceptshare data)**

 
| ** **                                                                                     | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Operating activities:**                                                                      |       |                                        |       |   |   |   |   |
| Net loss                                                                                       |       | $                                           | (11,246    | ) | (12,726 | ) | (33,605 | ) |
| Add (gain)  loss from operations and loss on disposition of discontinued operations            |       | —                                      |       | 749 |   | 837 |   |
|                                                                                           |       | (11,246                                     | )          | (11,977 | ) | (32,768 | ) |
| Adjustments  to reconcile net loss from operations to net cash used for operating  activities: |       |                                        |       |   |   |   |   |
| Impairment  of long lived assets                                                               |       | 4,307                                       |       | — |   | 2,684 |   |
| Impairment  of goodwill                                                                        |       | —                                      |       | — |   | 184 |   |
| Loss from  growell settlement                                                                  |       | —                                      |       | — |   | 2,765 |   |
| Gain on sale  of marketable securities held-for-sale                                           |       | —                                      |       | — |   | (1,178 | ) |
| (Gain) loss  on disposal of asset                                                              |       | (14                                         | )          | 4 |   | — |   |
| Depreciation  and amortization                                                                 |       | 3,401                                       |       | 3,444 |   | 4,354 |   |
| Loss on  extinguishments of debt                                                               |       | 1,247                                       |       | 1,663 |   | — |   |
| Amortization  of debt discount                                                                 |       | 2,793                                       |       | 2,860 |   | — |   |
| Stock-based  compensation                                                                      |       | 41                                          |       | 276 |   | 123 |   |
| Bad debt  (recovery) expense                                                                   |       | (6                                          | )          | 84 |   | (28 | ) |
| Warranty  expense                                                                              |       | 101                                         |       | 288 |   | (297 | ) |
| Minority  interest                                                                             |       | —                                      |       | — |   | (21 | ) |
| (Gain) loss  from change in value of warrants                                                  |       | (3,986                                      | )          | 747 |   | — |   |
| (Gain) loss  from change in value of beneficial conversion feature                             |       | (3,849                                      | )          | — |   | — |   |
| Changes in  operating assets and liabilities:                                                  |       |                                        |       |   |   |   |   |
| Trace  accounts receivable                                                                     |       | (686                                        | )          | 1,996 |   | 1,660 |   |
| Inventories                                                                                    |       | (151                                        | )          | (2,103 | ) | (100 | ) |
| Prepaid  expenses and other current assets                                                     |       | 350                                         |       | (535 | ) | 1,689 |   |
| Other assets                                                                                   |       | (378                                        | )          | (869 | ) | 83 |   |
| Accounts  payable and accrued expenses                                                         |       | 1,606                                       |       | 414 |   | (5,969 | ) |
| Deferred revenue                                                                               |       | 375                                         |       | (535 | ) | 38 |   |
| Other  liatbilities                                                                            |       | (410                                        | )          | (2,154 | ) | 2,661 |   |
| Net cash  used for continuing operations                                                       |       | (6,505                                      | )          | (6,397 | ) | (24,120 | ) |
|                                                                                           |       |                                        |       |   |   |   |   |
| Net cash  provided by (used for) discontinued operations                                       |       | —                                      |       | 73 |   | (2,429 | ) |
| Net cash  used for operating activities                                                        |       | (6,505                                      | )          | (6,324 | ) | (26,549 | ) |
| **Investing  Activies:**                                                                       |       |                                        |       |   |   |   |   |
| Purchases of  property and equipment                                                           |       | (169                                        | )          | (73 | ) | (2,329 | ) |
| Proceeds  from sale of property and equipment                                                  |       | 69                                          |       | 38 |   | — |   |
| Proceeds  from sale of marketable securities held-for-sale                                     |       | —                                      |       | — |   | 2,578 |   |
| Investment  in patents and trademarks                                                          |       | (159                                        | )          | (273 | ) | (298 | ) |
| Net cash  used for investing activities                                                        |       | (259                                        | )          | (308 | ) | (49 | ) |
| **Financing  Activities:**                                                                     |       |                                        |       |   |   |   |   |
| Proceeds  from borrowings                                                                      |       | 17,774                                      |       | 9,924 |   | 5,488 |   |
| Repayment of  borrowings                                                                       |       | (11,333                                     | )          | (5,184 | ) | (1,441 | ) |
| Repayment of  other liabilities                                                                |       | (133                                        | )          | (135 | ) | (72 | ) |
| Proceeds  from restricted cash                                                                 |       | 754                                         |       | (754 | ) | — |   |
| Stock  options excercised                                                                      |       | —                                      |       | — |   | 899 |   |
|                                                                                           |       |                                        |       |   |   |   |   |
| Proceeds  from issuance of common stock by subsidiaries, net                                   |       | —                                      |       | — |   | 5 |   |
| Net cash  provided by financing activities                                                     |       | 7,062                                       |       | 3,851 |   | 4,879 |   |
| Effect of  foreign exchange translation                                                        |       | 353                                         |       | 396 |   | (212 | ) |
| Net increase  (decrease) in cash and cash equivalents                                          |       | 651                                         |       | (2,385 | ) | (21,931 | ) |
|                                                                                           |       |                                        |       |   |   |   |   |
| Cash and  cash equivalents at beginning of period                                              |       | 742                                         |       | 3,127 |   | 25,058 |   |
| Cash and  cash equivalents at end of period                                                    |       | 1,393                                       |       | 742 |   | 3,127 |   |
|                                                                                           |       |                                        |       |   |   |   |   |
| Supplemental  cash flow information                                                            |       |                                        |       |   |   |   |   |
| Interest  paid                                                                                 |       | $                                           | 1,472      |   | $ | 640 |   | $ | 443 |   |
| Taxes paid                                                                                     |       | $                                           | —     |   | $ | — |   | $ | — |   |

 

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

 

87

----

 

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

 

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

 

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

 

In 2003, an optionholder surrendered 93,758 shares of the Company’s common stock in lieu of cashpayment for the option exercise price of $250 and income taxes payable by theoption holder of $403. The Company immediately canceled the common sharesreceived in lieu of cash payment upon receipt of the shares.

 

In 2003 the Companyreclassified $1,477 of machines from property, plant and equipment to machinesheld by customer.

 

In 2003, the Companyentered into a lease agreement for $291 of laboratory equipment that wasrecorded as a capital lease obligation.

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

88

----

 

**LIQUIDMETALTECHNOLOGIES, INC AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**For theYears Ended December 31, 2005, 2004, and 2003**

**(inthousands, except share data)**

 

**1.Description of Business**

 

LiquidmetalTechnologies, Inc. (“Liquidmetal Technologies”) and its subsidiaries(collectively “the Company”) are in the business of developing, manufacturing,and marketing products made from amorphous alloys. Liquidmetal Technologiesmarkets and sells Liquidmetal® alloy industrial coatings and also manufactures,markets and sells products and components from bulk Liquidmetal alloys that canbe incorporated into the finished goods of its customers across a variety ofindustries. The Company also partners with third-party licensees anddistributors to develop and commercialize Liquidmetal alloy products.

 

The Company classifiesoperations into two reportable segments: Liquidmetal alloy industrial coatingsand bulk Liquidmetal alloys. Liquidmetal alloy industrial coatings are usedprimarily as a protective coating for industrial machinery and equipment, suchas drill pipe used by the oil drilling industry and boiler tubes used bycoal-burning power plants. Bulk Liquidmetal alloys include potential marketopportunities to manufacture and sell products and components for electronicdevices, medical devices, defense applications, and sporting goods. Inaddition, the bulk Liquidmetal alloys segment includes tooling and prototypesampling, and the manufacture and sale of die casting and VIM equipment (seeNote 3 for disclosure regarding the disposal of this segment). In addition,such alloys are used to generate research and development services revenue fordeveloping uses related primarily to defense and medical applications as wellas potential license fees, royalties, and other compensation from strategicpartnering transactions.

 

On August 4,2004, the Company established a post-processing plant in the city of Weihai inShandong province of China under Weihai Liquidmetal Company Limited, which is100 percent owned by Liquidmetal Korea, to facilitate our bulk alloymanufacturing business. Weihai Liquidmetal is consolidated into LiquidmetalTechnologies with all intercompany transactions eliminated.

 

**2.Liquidity**

 

The Company hasexperienced losses from continuing operations during the last two fiscal yearsand has an accumulated deficit of $136,559 as of December 31, 2005. Cashused for continuing operations for the year ended December 31, 2005 was$6,505. At December 31, 2005, working deficit was $10,154. As of December 31,2005, the Company’s principal source of liquidity is $1,392 of cash and $2,360of trade accounts receivable. Such conditions raise substantial doubt that theCompany will be able to continue as a going concern. These operating resultsoccurred while the Company was developing and continues to develop and tocommercialize and manufacture products from an entirely new and uniquetechnology. These factors have placed a significant strain on the financial resourcesof the Company. The ability of the Company to overcome these challenges dependson its ability to correct its production inefficiencies, continue to reduce itsoperating costs, generate higher revenue, and achieve positive cash flow fromcontinuing operations and profitability and continued sources of debt andequity financing. The consolidated financial statements do not include anyadjustments that might result from the outcome of the uncertainty.

 

Capital requirementsduring the next 12 months will depend on numerous factors, including thesuccess of existing products, the development of new applications forLiquidmetal alloys, the resources devoted to develop and support Liquidmetalalloy products. If the available funds and cash generated from operations areinsufficient to satisfy liquidity requirements, the Company will needadditional funds in the future to support working capital requirements and forother purposes, and will need to raise additional funds through public orprivate equity financing, bank debt financing, or from other sources. Subsequentto the close of the second quarter of 2005, the Company completed a privateplacement of $9,878 of 7% convertible debt in consideration for $5,000aggregate cash received, $4,280 exchange of previously issued notes, andsatisfaction of accrued interest and fees of $598 from the previously issuednotes (see Note 14). Adequate funds may not be available when needed or may notbe available on favorable terms. The Company expects to continue to devotelimited capital to our research and development activities, to further developand strengthen our manufacturing capabilities, and for working capital andother general corporate purposes.

 

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

 

EffectiveDecember 27, 2005, the SEC announced final rulings on revisions toaccelerated filer definition and deadlines for periodic reports. The rulingrevised the definition of the term “accelerated filer” to permit an acceleratedfiler that has voting and non-voting

 

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commonequity held by non-affiliates of less than $50 million to exit acceleratedfiler status at the end of the fiscal year in which its equity falls below $50million and to file its annual report for that year and subsequent periodicreports on a non-accelerated basis. As of the fiscal year ended December 31,2005, we are considered an accelerated filer and are required to comply withSOX 404 requirements for the 2005 fiscal year.

 

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

 

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

 

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

 

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

 

**3.Summary of Significant Accounting Policies**

 

*Principlesof 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 minority shareholder. In June 2004,the Company sold assets and liability of its Taesung equipment manufacturingdivision in Korea to a third party. Accordingly,the results of Dongyang and Taesung’s operations have been reclassified in theconsolidated financial statements as discontinued operations (see Note 17). Previously,the results of Donyang and Taesung’s operations have been included in theconsolidated financial statements from the acquisition date. All intercompanybalances and transactions have been eliminated. A minority interest inLiquidmetal Golf is included in the consolidated financial statements as acomponent of the loss from operations of the discontinued retail golf segment(see Note 17). Effective in 2003, management closed the Japan operations andthe Seoul office, which did not result in a significant impact on the financialposition or results of operations for any of the periods presented. Also,effective in December 2003, management closed the Tampa office (see Note12). In August 2004, the Companyestablished a post-processing plant in the city of Weihai in Shandong provinceof China under Weihai Liquidmetal Company Limited, which is 100 percent ownedby Liquidmetal Korea, to facilitate our bulk alloy manufacturing business.

 

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

 

*RevenueRecognition.*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 provides guidance on revenuerecognition issues in the absence of authoritative literature addressing aspecific arrangement or a specific industry. The Company’s revenue recognitionpolicy complies with the requirements of SAB 101 and SAB 104. Revenue isrecognized at the time the Company ships its products, as this is when titlepasses to the customer and all other incidences of a sale have occurred.Revenue is deferred and included in liabilities when the Company receives cashin advance for services not yet performed or goods not yet delivered.

 

The Company appliesthe percentage of completion method to recognize revenue earned from governmentcontracts that have cost-plus-fixed-fee arrangements. These arrangementsprovide the Company with full reimbursement on the actual cost incurred, plus afixed fee that the Company is entitled to. These arrangements are covered bythe American Institute of Certified Public Accountants Statement of Position81-1, *Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts* (SOP 81-1)and Accounting Research Bulletin No. 45, *Long-termConstruction-Type Contracts* (ARB 45). In addition, cost-reimbursablecontracts are also specifically covered by Accounting Research Bulletin No. 43,Chapter 11, Section A, *GovernmentContracts, Cost-Plus-Fixed Fee Contracts*(ARB 43). Substantially allof our cost-reimbursable and time and material contracts are with the U.S.Government, primarily with the Department of Defense. Revenues recognized undercost-plus-fixed fee are consistent with percentage of completion method and areconsistent with ARB 43.

 

Saleson cost-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 those costs. Theestimated profit on a cost-reimbursable contract is generally fixed or variablebased on the contract fee arrangement.

 

*Cashand 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 Company considers all cash and cashequivalents held under restrictive accounts as restricted cash.

 

*MarketableSecurities.*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.”

 

*TradeAccounts 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 December 31, 2005, one customer represented12%, or $288, of the total outstanding trade accounts receivable. Two customersrepresent 30%, or $497, of total outstanding trade accounts receivable as of December 31,2004.

 

The allowance fordoubtful accounts reflects management’s best estimate of probable lossesinherent in the trade accounts receivable. Management primarily determines theallowance based on the aging of accounts receivable balances, historicalwrite-off experience, customer concentrations, customer creditworthiness andcurrent industry and economic trends. The Company’s provisions foruncollectible receivables are included in selling, general and administrativeexpense in the accompanying consolidated statements of operations andcomprehensive loss.

 

*Inventories.*Inventories are accounted for using themoving average basis and reported at the lower of cost or market. Inventoriesconsist of raw materials, work in process, and finished goods. The Companyrecords write-offs for inventory obsolescence when it is deemed that there isimpairment of the value of the inventories on hand.

 

*Property,Plant and Equipment.*Property, plantand equipment are stated at cost less accumulated depreciation andamortization. Additions and major renewals are capitalized. Repairs andmaintenance are charged to expense as incurred. Upon disposal, the related costand accumulated depreciation are removed from the accounts, with the resultinggain or loss included in operating

 

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income. Depreciationis provided principally on the straight-line method over the estimated usefullives of the assets, which range from two to twenty years.

 

Leased propertymeeting certain criteria is capitalized and the present value of the relatedlease payments is recorded as a liability. Amortization of capitalized leasedassets is provided on the straight-line method over the estimated useful livesof the assets, which is five years.

 

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

 

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

 

*Impairmentof Long-lived Assets.*The Companyreviews long-lived assets to be held and used in operations for impairmentwhenever events or changes in circumstances indicate that the carrying value ofan asset may be impaired. An impairment loss is recognized when theestimated fair value of the assets is less than the carrying value of theassets. The Company recognized an impairment of long-lived assets in the amountof $4,512 during the year ended December 31, 2005 (see Notes 6 and 8), $0during the year ended December 31, 2004, and $2,684 during the year ended December 31,  2003 (see Note 7).

 

*FairValue of Financial Instruments.*The estimatedfair value of amounts reported in the consolidated financial statements havebeen determined using available market information and valuation methodologies,as applicable. The carrying amount of cash and cash equivalents, accountsreceivable, accounts payable, and all other current assets and liabilitiesapproximate their fair value because of their short term maturities at December 31,2005 and 2004, unless otherwise stated. The fair value of non-current assetsand liabilities approximate their carrying value unless otherwise stated. Thefair value of the Company’s long-term debt is based on interest rates thatwould be available to the Company for the issuance of debt with similar terms.

 

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

 

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

 

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

 

*Stock-BasedCompensation.*The Companyapplies Accounting Principles Board (“APB”) Opinion No. 25 for optionswhen the exercise price of options granted to employees is less than the fairvalue of the underlying stock on the date of grant. The Company appliesStatement of Financial Accounting Standards (“SFAS”) No. 123 for optionsgranted to non-employees who perform services for the Company.

 

Had the Companydetermined employee stock-based compensation cost based on the fair value atthe grant date for stock options consistent with the method of SFAS No. 123,the Company’s net loss and basic and diluted net loss per share would have beenas follows:

 

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| ** **                                    | ** **                                                                                                                        | **For the years ended December 31,** | ** ** |
|-----------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------|------------|
| ** **                                    | ** **                                                                                                                        | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net loss  from Continuing Operations:         |                                                                                                                              |                                                          |       |   |   |   |   |
| As reported                                   |                                                                                                                              | $                                                             | (11,246    | ) | $ | (11,977 | ) | $ | (32,768 | ) |
| Add:                                          | stock-based employee compensation expense  included included in reported net loss, net of related tax effects                     |                                                          | 41         |   | 276 |   | 123 |   |
| Deduct:                                       | total stock-based employee compensation  expense determined under the fair value based method for all awards, net of  related tax |                                                          | (2,861     | ) | (4,201 | ) | (5,427 | ) |
| Proforma net  loss from continuing oeprations |                                                                                                                              | $                                                             | (14,066    | ) | $ | (15,902 | ) | $ | (38,072 | ) |
|                                          |                                                                                                                              |                                                          |       |   |   |   |   |
| Basic and  diluted net loss per share:        |                                                                                                                              |                                                          |       |   |   |   |   |
| As reported                                   |                                                                                                                              | (0.27                                                         | )          | (0.29 | ) | (0.79 | ) |
| Proforma                                      |                                                                                                                              | (0.34                                                         | )          | (0.38 | ) | (0.92 | ) |

 

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

 

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

 

The Company applies **FASB No. 52,Foreign Currency Translation**, for translating foreigncurrency into US dollars in our consolidation of the financialstatements. Due to our restatement of 2002 financial statements, certainfootnote disclosures and previously reported financial statements were adjustedto conform to retroactive applications of FASB No. 52. Theseadjustments did not have a material impact in the financial statements. See Note 2in the notes to consolidated financial statements in the fiscal 2003 annualreport on Form 10-K filed on November 10, 2004, which reflects therestatements of prior year transactions.

 

*EarningsPer Share.*Basic earningsper share (“EPS”) is computed by dividing earnings (losses) attributableto common shareholders by the weighted average number of common sharesoutstanding for the periods. Diluted EPS reflects the potential dilution thatcould occur if securities or other contracts to issue common stock wereexercised or converted into common stock.

 

*Useof Estimates.*The preparationof financial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosures of contingent assets and liabilities at the date of the financial statementsand the reported amounts of revenue and expenses during the reported periods.Actual results could differ from those estimates. These management estimatesare primarily related to impairment of long-lived assets, inventory valuation,product warranty, and the allowance for bad debt account balances.

 

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

 

*NewAccounting Pronouncements.*

 

In June 2005,the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 05-2“The Meaning of ‘Conventional Convertible Debt Instrument’ in EITF Issue No. 00-19,‘Accounting for Derivative Financial Instruments Indexed to, and PotentiallySettled in, a Company’s Own Stock.’” Issuers of convertible debt are requiredby Statement 133 to evaluate whether it is necessary to separate the “embedded”conversion feature from the debt contract and account for the conversionfeature as if it were a separate

 

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derivativeinstrument. If the issuer determines that the embedded conversion feature wouldbe classified in equity if it were a freestanding instrument, the conversionfeature is not separated from the debt contract. EITF 00-19’s criteria must beapplied to determine whether a conversion feature qualifies for equityclassification, but it exempts a conversion feature embedded in a “conventionalconvertible debt instrument” from some of the criteria. EITF 05-2 requiresconvertible instruments that may be settled in a combination of cash orshares, e.g., those referred to as “Instrument C” in EITF 90-19, andinstruments that may be convertible into a variable number of shares arenot “conventional.”  As a result,nonconventional instruments would need to satisfy all requirements of EITF00-19 to support a conclusion that the conversion feature does not requireaccounting separate from that for the debt contract. The adoption of this Issueresulted in recognition of the beneficial conversion feature from the seniorconvertible notes issued in August 2005 as liabilities of $959 as of December 31,2005 and a gain of $3,849 from the change in fair value of beneficialconversion feature liabilities for the year ended December 31, 2005 (seeNote 14).

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

In December 2003,the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin(“SAB”) No. 104, “Revenue Recognition.” SAB 104 supersedes SAB 101, “RevenueRecognition in Financial Statements.” SAB 104’s primary purpose is to rescindaccounting guidance contained in SAB 101 related to multiple element revenuearrangements, superseded as a result of the issuance of EITF 00-21, “Accountingfor Revenue Arrangements with Multiple Deliverables.” Additionally, SAB 104rescinds the SEC’s Revenue Recognition in Financial Statements Frequently AskedQuestions and Answers (“the FAQ”) issued with SAB 101 that had been codified inSEC Topic 13, Revenue Recognition. Selected portions of the FAQ have beenincorporated into SAB 104. While the wording of SAB 104 has changed to reflectthe issuance of EITF 00-21, the revenue recognition principles of SAB 101remain largely unchanged by the issuance of SAB 104, which was effective uponissuance. The adoption of SAB 104 did not impact the consolidated financialstatements.

 

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

 

**4.Marketable Securities**

 

On July 29, 2002,the Company invested $2,000 in Growell Metal, Inc. (“Growell”), a metalsprocessing company located in South Korea and publicly traded on South Korea’sKOSDAQ stock market. The Company acquired 891,100 shares (or approximately5%) of Growell’s outstanding common stock in this transaction. During thefourth quarter of 2002, Growell’s spin-off of its electronics division resultedin the creation of a new company named Growell Electronics, Inc. (“GrowellElectronics”). As a result of the spin-off, 30% of the Company’s 891,100 commonshares of Growell were exchanged for an equal number of shares in the common stockof Growell Electronics. During the year ended December 31, 2002, theCompany sold its shares in Growell Electronics for approximately $1,432, whichwas based on the market price of the stock on the KOSDAQ stock market on thedate of sale. This sale resulted in a realized gain of $832. At December 31,2002, the change in fair value of the remaining investment in Growell resultedin an unrealized gain of $1,668, which is reported as other comprehensiveincome in the accompanying consolidated financial statements. In April 2003,the Company sold the stock owned in Growell, which resulted in a realized gainof $1,178. A reclassification adjustment of ($1,668) for net realized gainsincluded in net loss is included in “Other comprehensive loss” on the accompanyingStatement of Operations and Comprehensive Loss for the year ended December 31,2003.

 

96

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**5.Trade accounts receivable**

 

Trade accountsreceivables from continuing operations were comprised of the following:

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

 

**6.Inventories**

 

Inventories werecomprised of the following:

 

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

 

The Company maintains certain of its rawmaterial inventories in amounts in excess of our operating cycle of one yeardue to the nature of our manufacturing process, production lead time, and therecyclability of our raw material. These inventories were classified aslong-term inventory as of December 31, 2005, 2004 and 2003. The Companydetermined that its current and projected raw material requirements are 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 considered to beexcessive 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” inthe accompanying Consolidated Statement of Operations and Comprehensive Lossfor the year ended December 31, 2005. The total amount of long terminventory was $0, and $1,810 as of December 31, 2005 and 2004,respectively.

 

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

 

Machines held by customer represent machines conditionally sold toGrowell in 2002 and 2003. These machines are subject to put options wherebyGrowell has the right to require the Company to buy back the machines ifcertain conditions are not met. The Company recorded a write-down of $2,765 ofraw material and machine inventory associated with the settlement of a disputewith Growell in December 2003 (see Note 11). These amounts are included in“Cost of Sales” in the accompanying Statement of Operations and ComprehensiveLoss for the years ended December 31, 2003 and 2002.

 

**7.Property, Plant and Equipment**

 

Property, plant andequipment consists of the following:

 

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

 

Depreciation expenseis classified as follows:

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

 

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

 

**8.Idle Equipment**

 

Idle equipmentconsists of certain equipment held by the Company for use in expansion of bulkalloy parts manufacturing. 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$1,741 and is included in operating expenses as “Impairment of long livedassets” in the accompanying Consolidated Statement of Operations andComprehensive Loss for the year ended December 31, 2005. Total amount ofidle equipment remaining was $193, and $1,906 as of December 31, 2005 and2004 respectively.

 

**9.Other Intangible Assets**

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

 

98

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Amortization expensewas $117, $113, and $100, for the years ended December 31, 2005, 2004, and2003, respectively. The estimated aggregate amortization expense for each ofthe five succeeding years is as follows:

 
| **December 31,** | ** ** | **Aggregate Amortization Expense** | ** ** |
|-----------------------|------------|----------------------------------------------|------------|
| 2006                  |       | $                                            | 114        |   |
| 2007                  |       | 112                                          |       |
| 2008                  |       | 110                                          |       |
| 2009                  |       | 108                                          |       |
| 2010                  |       | 106                                          |       |
|                       |            |                                              |            |  |

 

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

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

 

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

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

 

Purchased patentrights represent the exclusive right to commercialize the bulk amorphous alloyand other amorphous alloy technology acquired from California Institute ofTechnology (“Caltech”), a shareholder, through a license agreement with Caltech(“License Agreement”). Under the License Agreement, the Company has theexclusive right to make, use, and sell products from all of Caltech’sinventions, proprietary information, know-how, and other technology relating toamorphous alloys in existence as of September 1, 2001. The Company alsohas an exclusive license to eleven issued patents and two patent applicationsheld by Caltech relating to amorphous alloy technology, as well as all relatedforeign counterpart patents and patent applications. Of the patentscurrently issued to Caltech and licensed by the Company, the earliestexpiration date is 2013 and the latest expiration date is 2021. Furthermore,the license agreement gives the Company the exclusive right to make, use, andsell products from substantially all amorphous alloy technology that isdeveloped in Professor William Johnson’s Caltech laboratory during the period September 1,2001 through August 31, 2005. All fees and other amounts payable by theCompany for these rights and licenses have been paid or accrued in full, and nofurther royalties, license fees or other amounts will be payable in the futureunder the License Agreements.

 

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

 

**10.Goodwill**

 

During2002, the Company completed an impairment review and did not recognize anyimpairment of goodwill. Accordingly, for 2002, the Company has forgone allrelated goodwill amortization expense. During 2003, Dongyang experiencednet losses as a result of a continuing economic downturn in markets for itsmachinery products. These events, along with Dongyang’s operating loss, cashflow losses and uncertainty surrounding its future cash flows, led the Companyto evaluate its investment for recoverability as of December 31, 2003. Asa result, the Company determined that the carrying value of its investment inDongyang exceeded its fair value as of December 31, 2003 in the amount of$184. This impairment loss is recorded in operating expenses as “Impairment ofGoodwill” in the accompanying Statement of Operations and Comprehensive Lossfor the year ended December 31, 2003.

 

99

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

 

**11.Settlement Payable**

 

Thesettlement payable balance consists of payables to Growell Metal Co.,Ltd., a South Korean metals processing company (“Growell”), as a result of a settlement agreementexecuted in January 2004. Under terms of the January 2004settlement of the dispute over certain sales transactions from 2003 and 2002between Liquidmetal Korea and Growell, Liquidmetal Korea agreed to pay Growell$4,895 to purchase Growell’s investment in alloy inventories, proprietaryalloying equipment purchased from Liquidmetal Korea, and supporting equipmentpurchased from other suppliers. Also as part of the settlement, Growellsatisfied in full a balance of $2,058 owed to Liquidmetal Korea for the diecasting machines Growell purchased from Liquidmetal Korea in the first quarterof 2003 as part of a license agreement to manufacture Liquidmetal alloyparts for the South Korean automotive industry. ****The remaining settlementpayable of $2,837 were to be paid to Growell (in cash or stock at the Company’sdiscretion) by December 31, 2004. As 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 payablesto Growell from the settlement was $3,331 and $3,246 as of December 31,2005 and 2004, respectively, net of foreign exchange translation loss. In January 2005,Growell was acquired by a third party and the Company is currently innegotiations to settle this balance with the third party.****

 

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

** **

**12.Other Liabilities**

 

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

 

100

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

 

During2003, the Company initiated activities to substantially reduce the number ofemployees and consolidate manufacturing and administrative facilities toimprove operational effectiveness and efficiency and reduce expenses. Duringthe year ended December 31, 2003, there was a total of 225 employeesterminated. The total amount of severance granted to the terminated employeesis $2,718 which is included in Cost of Sales in the amount of $199, Selling,general and administrative in the amount of $2,253, and Research andDevelopment in the amount of $266 in the accompanying Consolidated Statement ofOperations for the year ended December 31, 2003. The amount of severancepaid was $174 and $1,104 as of December 31, 2005 and 2004, respectively. Theremaining severance owed to the terminated employees is $550 and $579 as of December 31,2005 and 2004, respectively. The total severance granted to terminatedemployees of $2,718 is separated into the following reportable segments as of December 31,2003: Coatings at $75 and Bulk alloy at $2,643. The categories of employeesthat were 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 were other relocation expenses associated withrelocating the Tampa, Florida office to Lake Forest, California totaling $759,which included the accrual of all remaining facility and telecommunicationlease payments for the Tampa, Florida office. Total liability accrued from therelocation and terminations in 2003, including the severance and leaseaccruals, were $276 and $1,175 as of December 31, 2005 and 2004,respectively. The Company has substantially concluded all cost reduction andrestructuring activities as of March 31, 2004. The remaining portion ofthe 2003 termination and relocation liability, all classified as currentliability, is $416 at December 31, 2005. At December 31, 2004, thecurrent portion of the 2003 termination and relocation liability was $909 andthe long-term portion of the liability was $266.

 

All leases with aninitial term greater than one year are accounted for under SFAS No. 13 *Accounting for Leases.*These leases areclassified as either capital leases or operating leases, as appropriate. Assetsunder capital leases are capitalized using interest rates appropriate at theinception of each lease. At December 31, 2005, the cost recorded for theoffice furniture and furnishings, the SEM Microscope and the JSM 6360 ElectronMicroscope under the capital lease was $107, $47 and $289, respectively, and theaccumulated amortization was $79, $27 and $147, respectively. At December 31,2004, the cost recorded for the office furniture and furnishings, the SEMMicroscope and the JSM 6360 Electron Microscope under the capital lease was$107, $47 and $289, respectively and the accumulated amortization $57, $22 and$89, respectively. Future minimum lease payments for the above assets undercapital leases during subsequent years are as follows:

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

 

101

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**13.Product Warranty**

 

Management estimatesproduct warranties as a percentage of bulk alloy product revenues. As of December 31,2005 and 2004, the Company used five percent of bulk alloy product sales as anestimate of warranties to be claimed. During the years ended December 31,2004 and 2005, the Company’s product warranty accrual balance had the followingactivity:

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

 

The product warrantyaccrual balance was included in accounts payable and accrued expenses at December 31,2005 and December 31, 2004.

 

**14.Notes Payable**

 

Senior ConvertibleNote

 

On March 3,2004, the Company issued $9.9 million of 6% senior convertible notes due 2007(the “March Notes”) to investor groups in a transaction led by MichiganVenture Capital Co., Ltd, a South Korea-based institutional investment firm,and IndiGo Ventures LLC, a New York-based investment firm (the “PlacementAgents”) that served as a financial advisor to the Company for the transaction.The notes were collateralized by the patents held by the Company and secondpriority mortgage interest in plant facilities and certain equipment in SouthKorea. The notes were convertible at any time into common stock at a price of$3.00 per share. Investors in the private placement and the Placement Agentsreceived warrants to purchase an aggregate amount of up to approximately 1.2million shares of common stock, exercisable at $3.00 per share for varyingperiods but no later than 100 days following the effectiveness of aregistration statement covering the resale of shares issuable upon exercise ofthe warrants. The conversion and warrant exercise price are subject to priceadjustments for anti-dilution purposes. In addition, the investors had theright to call for repayment of the notes prior to maturity at any time afterthe second anniversary of the closing of the transaction.

 

The fairvalue of the 1.2 million warrants totaled $1,883 and was computed using theBlack-Scholes pricing model under the following assumptions: (1) expectedlife of 3 years; (2) volatility of 82%, (3) risk free interest of0.95% and dividend rate of 0%. In addition, since this debt is convertible intoequity at the option of the note holder at beneficial conversion rates, anembedded beneficial conversion feature was recorded as a debt discount and willbe amortized using the effective interest rate method over the life of the debtin accordance with Emerging Issues Task Force No. 00-27, “Application ofIssue No. 98-5 to Certain Convertible Instruments.”  In March 2004, total cost of beneficialconversion feature of $3,395 and the fair value of the 0.6 million warrantsissued to investors of $584 were recorded as discounts of the convertible note.In addition, $718 relating to the fair value of the 0.6 million warrants issuedto the Placement Agents and $581 direct costs incurred relating to issuance ofthe convertible note were recorded as debt issuance cost as a contra liabilityaccount in warrant liability and other assets, respectively.

 

During2004, the Company redeemed $4,465 of the outstanding note balance in cash. Theredemption resulted in a write down of debt issuance costs and debt discount of$2,071 to interest expense during the year ended December 31, 2004. Further,500,000 of warrants originally issued to a financial advisor for thetransaction expired during June 2004 and 163,748 of unexercised warrantsoriginally issued to investors were cancelled as a result of the Company’sredemption of the note balances during the year ended December 31, 2004. The663,748 total expired and canceled warrants immediately prior to the expirationand cancellation resulted in a reduction of warrant liability of $7 and $279 topaid in capital and change in value of warrants, respectively, during the yearended December 31, 2004.

 

On August 19,2004, the Company completed a private exchange offer for its March Noteswith the remaining holders after the redemption. Under terms of the exchangeoffer, approximately $5.5 million in aggregate principal amount of the March Noteshave been exchanged for an aggregate of (i) $2.75 million of 6% SeniorSecured Notes Due 2007 (the “July 2007 Notes”) and (ii) $2.75

 

102

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millionof 10% Senior Secured Notes Due 2005 (the “July 2005 Notes”), collectivelyreferred to as “Exchange Notes”. The Exchange Notes are collateralized bycertain patents owned by the Company and second priority mortgage interest inplant facilities and certain equipment at our South Korea plant. The July 2005Notes had a maturity 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 and redeemed subsequent to theclose of the second quarter of 2005 (see 2005 Senior Convertible Notes below).The July 2007 Notes have a maturity date of July 29, 2007, and aconversion price of $1.00 per share. The conversion prices of the July 2007Notes and July 2005 Notes are subject to price adjustments foranti-dilution purposes. Further, the exchange notes are convertible into CommonStock, at the option of the Company, if at any time after the issuance of thenotes, the closing per share price of the Common Stock exceeds $4.00 (asadjusted for stock splits, reverse splits, stock dividends, andrecapitalizations) for 30 consecutive trading days, and further provided thatthere has been effective registration during such period. Holders of the July 2007Notes also have the right to call for repayment of the July 2007 Notesprior to maturity at any time after the second anniversary of the closing ofthe exchange offer. The July 2007 Notes have been amended subsequent tothe close of the second quarter of 2005 to provide for an Amended RegistrationRights Agreement, and Amended and Restated Security Agreement (see 2005 SeniorConvertible Notes below).

 

A totalof 563,151 warrants to purchase our common stock at an exercise price of $3.00per share—all of which were previously issued in connection with the purchaseof the March Notes—have been amended to provide for an extended expirationdate of March 1, 2006. The warrant exercise price is subject to priceadjustment for anti-dilution purposes. As of December 31, 2005, thewarrant price was determined to be exercisable at $2.73.

 

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

 

Inconnection with the private exchange offer, the Company issued $250 of privateplacement notes to certain Placement Agents as issuance costs. Of the $250notes issued, $125 was paid in the form of long-term notes which is due in2007 with interest rate of 6% per annum (July 2007 Notes) and $125 waspaid in the form of short-term notes which is due in 2005 with interestrate of 10% per annum (July 2005 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, abeneficial conversion feature was recorded from the $125 July 2007 Notesissued to Placement Agents of $29 during August 2004.

 

TheCompany was obligated, pursuant to a Registration Rights Agreement, as amendedby the Exchange Notes, between the Company, the Placement Agents and the noteholders to file a registration statement with the Securities and ExchangeCommission (“SEC”) to register the shares of Common Stock issuable uponconversion of the notes payable and the related warrants within 90 daysfollowing the effective closing date of the exchange notes (July 29,2004), and to use best efforts to cause such registration statement to becomeeffective within 60 days following the SEC’s first written comments on theregistration statement. Further, if the Company is not in compliance with theregistration or listing requirements, the holders have rights to lateregistration payments equal to between 2 and 3 percent of the purchase pricepaid for the unconverted notes for the first 30 business days of lateregistration, and 1 and 3 percent for each 30 business days thereafter, but nomore than 18 percent of the purchase price of the unconverted note balance. Lateregistration fee of $1,028 has been recorded as interest expense during theyear ended December 31, 2005.

 

Interestpayments are due quarterly, and failure to make timely interest payments willresult in increase in interest rate to 10% and 14% on the 6% and 10% seniorconvertible notes (“Default Rates”). The Default Rates became effective on April 1,2005 from non-payment of a scheduled interest payment. As of December 31,2005, the Company has complied with all scheduled interest payments.

 

On August 9,2005, the July 2005 Notes, accrued interest and late registration feeswere redeemed in cash and exchanged for 7% Convertible Secured Promissory Notesdue August 2007  (see 2005 SeniorConvertible Notes below).

 

Duringthe year ended December 31, 2005, $485 of the Long-Term Notes wereconverted into 485,750 of the Company’s common stock at a conversion price of$1.00 per share.

 

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As of December 31, 2005 our gross outstandingloan balance of the July 2005 and July 2007 Notes totaled $0 and $2,369,respectively. As of December 31, 2004, our gross outstanding loan balance ofthe July 2005 and July 2007 Notes totaled $2,854 and $2,855, respectively. Asof December 31, 2005 and December 31, 2004, un-amortized discounts forbeneficial conversion feature and warrants totaled $303 and $851, and otherasset debt issuance costs totaled $43 and $183, respectively. Interest expensefor the amortization of debt issuance cost and discount on note was $689 and$789 for the year ended December 31, 2005 and 2004, respectively. As ofDecember 31, 2005, the effective interest rates for the July 2007 Notes were32%. As of December 31, 2004, the effective interest rates for the July 2005and July 2007 Notes were 22% and 32% respectively.

 

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 other liability as the Company has not yet filedthe registration statement. In addition, the Company is required to report avalue of the warrant as a fair value and record the fluctuation to the fair valueof the warrant liability to current operations. The change in the fair value ofthe warrants resulted in a net gain of $550 and $747 for the year endedDecember 31, 2005 and 2004, respectively. The fair value of warrantsoutstanding was $0 at December 31, 2005. The fair value was computed using theBlack-Scholes model under the following assumptions: (1) expected life of 0.16years; (2) volatility of 88%, (3) risk free interest of 4.08%and dividend rateof 0%.

 

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

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

 

Convertible Notes

 

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

 

The June 2006 Notesissued by the Company in the June 2005 Private Placement are unsecured and wasdue on the earlier of June 13, 2006 or the consummation of a follow-onequity or debt offering or restructuring transaction pursuant to which theCompany receives gross proceeds of at least $4,000.  Prior to maturity,the June 2006 Notes are interest-only, with interest payments due quarterly, atthe rate of 10% per year.  The June 2006 Notes can be prepaid by theCompany at any time without penalty.  If, within 120 days following theissue date of the June 2006 Notes, the Company either fails to redeem the notesfor the principal amount and accrued interest thereon or fails to close a “QualifiedFinancing,” then the June 2006 Notes will thereafter be convertible at aconversion price equal to seventy five percent (75%) of the closing price ofthe Company’s common stock on the first trading day immediately preceding theconversion date.  A “Qualified Financing “ is defined in the June 2006Notes as any debt or equity financing of the Company resulting in aggregategross proceeds to the Company of at least $5,000 and in which the holders of atleast sixty percent (60%) of the aggregate principal amount of the Company’sJuly 2007 Notes either (i) agree that the equity or debt securities to beissued in such 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. OnAugust 9, 2005, the 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 becameconvertible.

 

As a part of theJune 2005 Private Placement, the Company issued warrants to the purchasers ofthe June 2006 Notes giving them the right to purchase up to an aggregate of812,500 shares of the Company’s common stock.  In addition, warrants topurchase 81,250 shares of the Company’s common stock were issued to theplacement agent in the transaction.  The warrants have an exercise priceof $2.00 per share, provided that upon the consummation of the first ensuingpublic or private equity or debt offering or restructuring transaction in whichthe Company receives gross proceeds of at least $3,250 (including withoutlimitation any restructuring of the Company’s July 2005 Notes), the exerciseprice will be automatically adjusted downward (but not upward) as of theclosing date of such offering or restructuring transaction so that it is equalto the lowest effective common stock purchase price paid for any 

 

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securities issuedby the Company to the investors in such offering or restructuringtransaction.  The warrants will expire on June 13, 2010 and aresubject to exercise price adjustment for anti-dilution purposes.

 

**The fair value of the 893,750 warrantstotaled $1,160 and was computed using the Black-Scholes pricing model under thefollowing assumptions: (1) expected life of 5 years; (2) volatility of 118%,(3) risk free interest of 3.87% and dividend rate of 0%. In accordance 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 the debtsubsequent to the close of the second quarter, the debt was determined to benot convertible. In June 2005, the fair value of the 812,500 warrants issued toinvestors of $1,055 was recorded as discounts of the convertible note. Inaddition $105 relating to the fair value of the 81,250 warrants issued to thePlacement Agents and $278 direct costs incurred relating to issuance of theconvertible note were recorded as debt issuance cost as a contra liabilityaccount in debt discount and other assets, respectively, and will be amortizedusing the effective interest rate method over the life of the loan.**

** **

**On August 9, 2005, the June 2006 Noteswere redeemed in cash and exchanged for 7% Convertible Secured Promissory Notesdue August 2007 (see 2005 Senior Convertible Notes below). The exchange offerwas treated as an extinguishment of the June 2006 Notes in accordance withEmerging Issues Task Force No. 96-19, “Debtors Accounting for a Modification orExchange of Debt Instruments.”  Theexchange resulted in a $1,247 loss from extinguishment of the June 2006 Notesas of December 31, 2005, which consists of write down of $240 of deferred issuecosts in other assets, $92 of contra liability deferred issuance costs, and$915 of debt discount as a result of the change in carrying value of exchangednotes.**

** **

Pursuant to EITF00-19, “Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company’s Own Stock”, the original fair values of thewarrants of $1,160 have been recorded as other liability as the Company has notyet filed the registration statement. 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 thefair value of the warrants resulted in a net gain of $743 for the year endedDecember 31, 2005. The fair value of warrants outstanding at December 31, 2005of $418 was computed using the Black-Scholes model under the followingassumptions: (1) expected life of 4.45 years; (2) volatility of 88%, (3) riskfree interest of 4.35%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 inprincipal amount of the July 2005 Notes, the exchange of $2,996 in principalamount of the June 2006 Notes, satisfaction of accrued interest and lateregistration fees in the amount of $589 on the July 2005 Notes, andsatisfaction of accrued interest of $9 on the June 2006 Notes. The August 2007Notes were issued pursuant to a Securities Purchase Agreement dated effectiveas of August 2, 2005 among the Company, the purchasers of the August 2007Notes, and the holders of July 2005 Notes and June 2006 Notes of the Company.

 

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

 

The August 2007 Notes are convertible intoshares of the Company’s common stock at $2.00 per share Pursuant to an Amendedand Restated Security Agreement. The convertible price of the August 2007 Notesis subject price adjustment for anti-dilution purposes. As of December 31,2005, 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 beneficialconversion feature of $4,808 have been recorded as beneficial conversionfeature liability as the debt is considered nonconventional convertible debt.The original fair value was computed using the Black-Scholes model under thefollowing assumptions: (1) expected life of 2 years; (2) volatility of 93%; (3)risk free interest of 4.06% and dividend rate of 0%. In addition, the Companyis required to report a value of the beneficial conversion liability as a fairvalue and record the fluctuation to the fair value of the beneficial conversionfeature liability to current operations. The change in the fair value of thebeneficial conversion feature liability resulted in a gain of 

 

105

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$3,849 for the year ended December 31, 2005. Thefair value of beneficial conversion features outstanding at December 31, 2005of $959 was computed using the Black-Scholes model under the followingassumptions: (1) 1.59 years; (2) volatility of 88%, (3) risk free interest of4.41%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 30 consecutivetrading days.

 

**TheCompany also issued warrants to the purchasers of the August 2007 Notes andplacement agents giving them the right to purchase up to 2,469,470 and 414,495shares of Company common stock, respectively, with an exercise price of  $2.00 per share, which is subject to priceadjustment for anti-dilution purposes . The warrants will expire on August 2,2010.**

** **

**Pursuantto EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company’s Own Stock”, the original fair values of thewarrants of $4,068 have been recorded as warrant liability as the Company hasnot yet filed the registration statement, which was computed using theBlack-Scholes pricing model under the following assumptions: (1) expected lifeof 5 years; (2) volatility of 93%; (3) risk free interest of 4.17% and dividendrate of 0%. In addition, the Company is required to report a value of thewarrant as a fair value and record the fluctuation to the fair value of thewarrant liability to current operations. The change in the fair value of thewarrants resulted in a net gain of $2,693 for the year ended December 31, 2005.The fair value of warrants outstanding at December 31, 2005 of $1,375 wascomputed using the Black-Scholes model under the following assumptions: (1)expected life of 4.59 years; (2) volatility of 88%, (3) risk free interest of4.35% and dividend rate of 0%.**

** **

In connectionwith the August 2005 Private Placement, the Company entered into an amended andrestated registration rights agreement with the holders of the July 2007 Notes,the holders of the August 2007 Notes, and the holders of the above-describedoutstanding warrants. This amended and restated registration rights agreementreplaced all other registration rights agreements previously entered into by usin connection with the private sale by us of convertible notes and warrants. Underthe amended and restated registration rights agreement, the Company is requiredto file a resale registration statement for the shares underlying all of ouroutstanding convertible notes and warrants, as described above, by October 31,2005, to enable the resale of such shares by the selling stockholders on adelayed or continuous basis under Rule 415 of the Securities Act. The Companyis then required to cause such registration statement to become effectivewithin 60 days after we receive the first written comments on the registrationstatement from the SEC, or if the SEC notifies us that it will not review theregistration statement, within five days after such notification. The Companywill be subject to certain monetary penalties, as set forth in the registrationrights agreement, if the registration statement is not filed or does not becomeeffective on a timely basis. Specifically, if the Company does not file theregistration statement on a timely basis, we will be obligated to pay a latefiling fee to the selling stockholders in the amount of 3% of the warrantexercise price on each of the warrants held by them plus 3% of the principalamount of the outstanding notes held by them. This fee will be payable for eachperiod of 30 business days that the filing of the registration statement ismade past the required filing date, and the payments will be due 10 businessdays following the end of each 30-day period. If the registration statement hasnot been declared effective by the required effective date, the Company will beobligated to pay a monthly late registration fee to the selling stockholders inthe amount of 2% of the aggregate warrant exercise prices and aggregate noteprincipal amounts for the first 30 business days after the required effectivedate, and 1% for each 30-business day period thereafter until the registrationstatement is declared effective. Notwithstanding the foregoing, the late filingfees and late registration fees will not exceed 18% of the aggregate warrantexercise prices and aggregate note principal amounts.

 

On December6, 2005, the Company received a letter from a representative of the holders ofthe August 2007 Notes demanding the payment of a late filing fee by us for theperiod following October 31, 2005, but under the terms of the amended andrestated registration rights agreement, the Company does not believe that it isobligated to pay any late filing fees unless and until the Company fails tofile the registration statement by December 13, 2005, which is the last day ofthe first 30-business day period following October 31, 2005. The letter alsostated that the letter was serving as a notice of default under the SeniorNotes as a result of our failure to file a registration statement by October31, 2005, although under the terms of the Senior Notes, the Company has thirtydays after delivery of the letter in which to cure such default. On December 9,2005 the Company filed the registration statement, which was within the 30-dayperiod and has cured the default notice.

 

The Company has received firstwritten comments in January 2006. However, the registration statement has not been made effective withinthe 60 day period called for by the registration rights agreement and theCompany may be subject to default notices by the holders of the convertiblenotes and warrants.  As of the filing ofthis report, the Company’s management is not aware of any outstanding defaultnotices

 

As of December 31, 2005, our grossoutstanding loan balance of the August 2007 Notes totaled $9,878. As ofDecember 31, 2005, un-amortized discounts for beneficial conversion feature andwarrants totaled $5,663, and other asset debt issuance costs totaled $384, andcontra liability debt issuance cost totaled $464. Interest expense for theamortization of debt issuance cost and discount on 

 

106

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note was $1,913 and for the year endedDecember 31, 2005. As of December 31, 2005, the effective interest rate for theAugust 2007 Notes was 54%.

 

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

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

 

Factoring Agreement

 

The Company enteredinto a Factoring, Loan, and Security Agreement (the “Agreement”) with afinancing company on April 21, 2005, which allows for borrowings of up to$1,500. The Agreement expires on April 21, 2006, and automatically renewsannually thereafter. All borrowings are secured by outstanding receivablesspecifically assigned to the financing company. Assigned receivables are considered“Approved” or “Non-Approved” by the financing company. Advances are made on 80%of Approved receivables assigned and 30% of Non-Approved receivables assigned. Paymentson assigned receivables are received directly by the financing company, andapplied to outstanding advances. All outstanding advances and uncollectedassigned receivables are subject to fees and interest charges ranging from 0.65percent to 2 percent plus prime rate as published by the Wall Street Journal,with a minimum annual fee of $30. All receivables assigned and advances madeare subject to return and recall by the financing company, respectively. Assuch, the advances have been classified as short-term secured borrowings inaccordance with FAS 140 “Accounting for Transfer and Servicing of FinancialAssets and Extinguishments of Liabilities.” As of December 31, 2005, the Company has borrowed $4,449 and repaid$3,899. The total outstanding advance made under the agreement is $550 as ofDecember 31, 2005, which is presented as short-term debt. The weighted averagerate of interest for borrowings made under the Agreement was 8.5% for the yearended December 31, 2005. The Company has $950 available for future borrowingsunder the Agreement as of December 31, 2005, which is contingent on approval ofeligible receivables 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. The loan bears interest at an annual rate of7.1%. In the event of delayed repayment, the interest increases to a maximum of21%, depending on the length of time the repayment is delayed. As of December31, 2005, the interest rate was increased to 9.2% from delayed interest paymentsmade. This loan is collateralized by the plant facilities and certain equipmentin South Korea. During the first eighteen months from the origination date,interest was payable on a monthly basis. In October 2003, the Company paid $873of principal at the request of Kookmin Bank due to the sale of machines thathad been part of the collateral on the loan. Subsequent to October 31, 2003,Kookmin Bank requested that the Company pay an additional $866 of principal byFebruary 2004 due to the Company’s current credit rating. The Company made twopayments on the requested additional loan pay down in November and December2003 of $320 and $205, respectively. The remaining payment of $341 wassubsequently made in February 2004. Beginning in September 2004, the Company isrequired to make equal monthly installments of principal and interest to repaythe remaining balance of the loan over a 36-month period. For the year endedDecember 31, 2004, principal payments made to Kookmin Bank totaled $296, whichincludes $422 of foreign exchange translation loss. Principal payments made toKookmin Bank totaled $1,036 for the year ended December 31, 2005, whichincludes $95 of foreign exchange translation gain. The outstanding loan balancetotaled $2,790, of which $1,343 is included in current portion of long-termdebt, as of December 31, 2005.

 

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

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

 

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

 

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

 

*Initial PublicOffering.*Pursuant to theCompany’s Registration Statement (Registration No. 333-73716) onForm S-1, as amended, initially filed with the Securities and ExchangeCommission on November 20, 2001 and declared effective May 21, 2002,the Company closed an initial public offering of 5,000,000 registered shares ofcommon stock on May 28, 2002, plus an additional 229,000 shares onJune 10, 2002 pursuant to an over allotment option, at a price of $15.00per share (which sale is referred to herein as the “Offering”). The Offeringgenerated net cash proceeds for the Company during the second quarter 2002 ofapproximately $70,721, net of underwriting commissions of $5,490 and 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 a reincorporation by transitioningfrom a California corporation to a Delaware corporation. The reincorporationwas effected though the merger of the former California entity into its newlycreated wholly owned Delaware subsidiary. In connection with thereincorporation, the number of authorized common shares was reduced from200,000,000 to 100,000,000. Additionally, the par value of the common stock waschanged from no par value common stock to common stock with a par value of$0.001 per share. For purposes of these notes, the term “Company” refers to theformer California entity with respect to periods prior to May 21, 2003.

 

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

 

Warrants

 

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

 
| **Number of Shares** | ** ** | **Exercise Price** | ** ** | **Expiration Date** | ** **         |
|--------------------------------|------------|-------------------------|------------|--------------------------|--------------------|
|                           |       |                    |       |                     |               |
| 645,162                        |       | $                       | 4.65       |                     | December 31,  2005 |   |
| 563,151                        |       | 2.73                    |       | March 1,  2006           |               |
| 893,750                        |       | 2.00                    |       | June 13,  2010           |               |
| 2,883,965                      |       | 2.00                    |       | August 2,  2010          |               |
| 4,986,028                      |       |                    |       |                     |               |
|                                |            |                         |            |                          |                    |  |

 

**16. Stock CompensationPlan**

 

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

 

On April 4, 2002, our shareholders andboard of directors adopted the 2002 Equity Incentive Plan (“2002 Equity Plan”).The 2002 Equity Plan provides for the grant of stock options to officers,employees, consultants and directors of the Company and its subsidiaries. Inaddition, the plan permits the granting of stock appreciation rights with, orindependently of, options, as well as stock 

 

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bonuses and rights to purchase restricted stock.A total of 10,000,000 shares of our common stock may be granted under the 2002Equity Plan. As of December 31, 2005, there are 2,151,950 options outstandingunder the 2002 Equity Plan.

 

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

 

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

 

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

 

Additionally, the Company has 2,221,508 optionsoutstanding at December 31, 2004 which were granted outside the 1996 CompanyPlan, 2002 Equity Plan and 2002 Director Plan.

 

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

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

 

Stock-based compensation expense was recognizedas follows for the year ended December 31, 2004:

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

 

Stock-based compensation expense was recognizedas follows for the year ended December 31, 2003:

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

 

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

 

The following table summarizes the Company’sstock option transactions for the three years ended December 31, 2005:

 
| ** **                               | ** ** | **Number of   Shares** | ** ** | **Weighted   Average   Exercise   Price** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|----------------------------------------------------------|------------|
| Options outstanding at December 31, 2002 |       | 8,317,187                        |       | $                                                        | 5.33       |   |
| Granted                                  |       | 1,810,920                        |       | 3.07                                                     |       |
| Exercised                                |       | (684,165                         | )          | 1.68                                                     |       |
| Forfeited                                |       | (1,272,481                       | )          | 5.43                                                     |       |
| Options outstanding at December 31, 2003 |       | 8,171,461                        |       | 5.11                                                     |       |
| Granted                                  |       | 795,843                          |       | 1.89                                                     |       |
| Exercised                                |       | —                           |       | —                                                   |       |
| Forfeited                                |       | (1,591,795                       | )          | 5.34                                                     |       |
| Options outstanding at December 31, 2004 |       | 7,375,509                        |       | 4.72                                                     |       |
| Granted                                  |       | 1,048,165                        |       | 2.18                                                     |       |
| Exercised                                |       | —                           |       | —                                                   |       |
| Forfeited                                |       | (429,919                         | )          | 3.43                                                     |       |
| Options outstanding at December 31, 2005 |       | 7,993,755                        |       | $                                                        | 4.45       |   |

 

The weighted average fair value of optionsgranted during the years ended December 31, 2005, 2004, and 2003 was$1.74, $1.29, and $2.41, respectively. There were 6,451,364 options with aweighted average exercise price of $4.87 exercisable at December 31, 2005,5,752,412 options with a weighted average exercise price of $5.22 exercisableat December 31, 2004, and 5,080,557 options with a weighted average exerciseprice of $5.12 exercisable at December 31, 2003.

 

Includedin the above tables are certain options granted where their exercise priceswere below the fair market value of the common stock at the grant date(measurement date). Such options totaled 358,582 with a weighted average fairvalue of $11.22 were outstanding at December 31, 2005 and December 31, 2004;and 1,327,314 with a weighted average fair value of $4.96 were outstanding atDecember 31, 2003.

 

The following table summarizes theCompany’s stock options outstanding and exercisable by ranges of option pricesas of December 31, 2005:

 

110

----

 
| **Options Outstanding**            | ** ** | **Options Exercisable**                          | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Numbers of   options   Outstanding** | ** ** | **Weighted Average   Remaining Contractual  Life (Years)** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Number of   Options   Exercisable** | ** ** | **Weighted   Average   Exercise Price** | ** ** |
|                                    |       |                                                  |       |   |   |   |   |   |   |   |   |
| $0.00 -                                 | $1.55      |                                                  |       | 711,575 |   | 6.70 |   | $ | 1.26 |   | 456,095 |   | $ | 1.19 |   |
| 1.56 -                                  | 3.10       |                                                  |       | 2,542,943 |   | 5.80 |   | 2.41 |   | 1,401,856 |   | 2.53 |   |
| 3.11 -                                  | 4.65       |                                                  |       | 1,843,195 |   | 4.80 |   | 4.61 |   | 1,781,195 |   | 4.64 |   |
| 4.66 -                                  | 6.20       |                                                  |       | 2,581,519 |   | 5.40 |   | 6.20 |   | 2,564,866 |   | 6.20 |   |
| 6.21 -                                  | 7.75       |                                                  |       | — |   | 0.00 |   | — |   | — |   | — |   |
| 7.76 -                                  | 9.30       |                                                  |       | 10,000 |   | 7.00 |   | 8.95 |   | 6,000 |   | 8.95 |   |
| 9.31 -                                  | 10.85      |                                                  |       | 10,000 |   | 7.00 |   | 9.81 |   | 4,000 |   | 9.81 |   |
| 10.86 -                                 | 12.40      |                                                  |       | 222,585 |   | 5.60 |   | 12.40 |   | 194,193 |   | 12.40 |   |
| 12.41 -                                 | 13.95      |                                                  |       | — |   | 0.00 |   | — |   | — |   | — |   |
| 13.96 -                                 | 15.50      |                                                  |       | 71,938 |   | 6.30 |   | 15.00 |   | 43,159 |   | 15.00 |   |
| Total                                   |       | 7,993,755                                             |       |   |   |   |   | 6,451,364 |   |   |   |
|                                         |            |                                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

111

----

 

**17. DiscontinuedOperations**

 

*Dongyang*

 

On June 28, 2002, the Company acquired a51% interest in Chusik Hoesa Dongyang Yudoro (“Dongyang”). During 2003,Dongyang experienced net losses as a result of a continuing economic downturnin markets for its machinery products. These events, along with Dongyang’soperating loss, cash flow losses and uncertainty surrounding its future cashflows, led the Company to evaluate its investment for recoverability as ofDecember 31, 2003. As a result, the Company determined that the carrying valueof its investment in Dongyang exceeded its fair value as of December 31, 2003in the amount of $184. This impairment loss was recorded in operating expensesfor the year ended December 31, 2003.

 

In March 2004, the Company sold its 51%investment in Dongyang to the 49% minority shareholder. The selling price ofthe Company’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 topay Dongyang $155 for the purchase of a receivable 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. Thenet payable balance of $75 is to be paid in quarterly installments throughout2004, with  $25 to be paid subsequent to2004. The outstanding amount payable to Dongyang is $25 as of December 31, 2004and is included in accounts payable and accrued liabilities.

 

The Company has adopted SFAS 144 and as a resultthe 2003 balances have been reclassified in order to conform with the presentationof 2004 financial statements.

 

Summarized operating results of Dongyang’sdiscontinued operations are as follows.

 
| ** **                                                             | ** ** | **Year Ended   December 31,** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                             | ** ** | **2005**                                     | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                   |       |                                         |       |   |   |   |   |
| Revenue                                                                |       | —                                       |       | $ | 22 |   | $ | 1,019 |   |
| Loss from discontinued equipment manufacturing  operations, net of tax |       | —                                       |       | (96 | ) | (268 | ) |
|                                                                        |            |                                              |            |  |  |  |  |  |  |

 

*Taesung*

 

On June 14, 2004, the Company entered into anAsset Purchase Agreement whereby all the assets and liabilities of its Taesungequipment manufacturing division in Korea were sold to a third party for $345which is payable by the third party in four equal installments with the lastinstallment being due on June 30, 2005. The sale resulted in a loss of $184 andis included in the loss from discontinued equipment manufacturing operations asof December 31, 2004. The loss from operations for the year ended December 31,2004 totaled $653 and is included in the loss from discontinued equipmentmanufacturing operations for the period.

 

The Company has adopted SFAS 144 and as a resultthe 2003 balances have been reclassified in order to conform with thepresentation of 2004 financial statements.

 

Summarized operating results of Taesung’s operations are as follows.

 
| ** **                                                             | ** ** | **Year Ended  Ended December,** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                             | ** ** | **2005**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                   |       |                                      |       |   |   |   |   |
| Revenue                                                                |       | —                                    |       | $ | 172 |   | $ | 2,177 |   |
| Loss from discontinued equipment  manufacturing operations, net of tax |       | —                                    |       | (653 | ) | (696 | ) |
|                                                                        |            |                                           |            |  |  |  |  |  |  |

 

*Liquidmetal Golf*

 

On April 30, 2002, management terminatedthe operations of the retail golf segment by means of liquidating substantiallyall of the retail golf assets and liabilities. The disposition of the retailgolf operations represents the disposal of a business segment. 

 

112

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Accordingly, the accompanying consolidatedfinancial statements reflect the retail golf segment as a discontinuedoperation for all periods presented.

 

For the year ended December 31, 2003, there wasa net gain of $127 in the estimate of expenses associated with the disposal ofthe discontinued retail golf operations. The change resulted from reducing thenet liabilities of the discontinued operations to $0 as there are no additionalexpenditures associated with the discontinued retail golf operations. Therewere no assets associated with discontinued retail golf operations at December31, 2004 and 2005.

 

The results of operations for all periodspresented have been restated for discontinued operations. The operating resultsof the discontinued operations are as follows:

 
| ** **                                                  | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                        |       |                                        |       |   |   |   |   |
| Net gain (loss) on disposal                                 |       | $                                           | —     |   | $ | — |   | $ | 127 |   |
| Foreign exchange translation gain (loss)  during the period |       | —                                      |       | — |   | — |   |
| Comprehensive gain (loss)                                   |       | $                                           | —     |   | $ | — |   | $ | 127 |   |

 

*Stock CompensationPlan.*Historically, Liquidmetal Golf grantedits own options to employees, directors and consultants under a stock optionplan (“1997 Golf Plan”) approved by Liquidmetal Golf’s Board of Directorspursuant to which Liquidmetal Golf could have granted stock options exercisableover a period determined by the Board of Directors to purchase up to 500,000shares of common stock of Liquidmetal Golf. In connection with the Company’splan to discontinue the retail golf operations, the Company does not intend toissue additional options under the 1997 Golf Plan.

 

Liquidmetal Golf applies APB Opinion No. 25and related interpretations in accounting for its plans. Accordingly,Liquidmetal Golf recognized compensation when the exercise price of the optionswas less than the fair value of the underlying stock on the date of grant. Therewas no compensation expense recorded during the years ended December 31,2005, 2004, and 2003.

 

Had compensation cost been determined based onthe fair value at the grant dates for awards under those plans consistent withthe method of SFAS No. 123, Liquidmetal Golf’s net loss would havebeen as follows:

 
| ** **  | ** ** | **Years e****nded December 31,** | ** ** |
|-------------|------------|-------------------------------------------------|------------|
| ** **  | ** ** | **2005**                                        | ** ** | **2004** | ** ** | **2003** | ** ** |
|        |       |                                            |       |   |   |   |   |
| As reported |       | $                                               | —     |   | $ | — |   | $ | 127 |   |
| Pro forma   |       | $                                               | —     |   | $ | — |   | $ | 15 |   |

 

The fair value of each option grant is estimatedon the date of the grant using the Black-Scholes option-pricing model with thefollowing weighted-average assumptions used for grants for the fiscal yearsended December 31, 2005, 2004, and 2003: expected volatility of 100% forall periods; dividend yield of 0.0% for all periods; expected option life ofapproximately 5 years; and a risk-free interest rate ranging from 5.2% to 6.2%,as appropriate.

 

The following table summarizes Liquidmetal Golf’sstock option transactions for the three years ended December 31, 2005:

 
| ** **                               | ** ** | ** **         | ** ** | **Weighted** | ** ** |
|------------------------------------------|------------|--------------------|------------|--------------|------------|
| ** **                               | ** ** | **Number of** | ** ** | **Average**  | ** ** |
| ** **                               | ** ** | **Shares**         | ** ** | **Price**    | ** ** |
|                                     |       |               |       |         |       |
| Options outstanding at December 31, 2002 |       | 115,500            |       | $            | 8.31       |   |
| Granted                                  |       | —             |       | —       |       |
| Exercised                                |       | (300               | )          | 16.00        |       |
| Forfeited                                |       | (16,500            | )          | 5.73         |       |
| Options outstanding at December 31, 2003 |       | 98,700             |       | 8.72         |       |
| Granted                                  |       | —             |       | —       |       |
| Exercised                                |       | —             |       | —       |       |
| Forfeited                                |       | (10,000            | )          | 8.00         |       |
| Options outstanding at December 31, 2004 |       | 88,700             |       | 8.80         |       |
| Granted                                  |       | —             |       | —       |       |
| Exercised                                |       | —             |       | —       |       |
| Forfeited                                |       | (10,500            | )          | 13.71        |       |
| Options outstanding at December 31, 2005 |       | 78,200             |       | $            | 8.14       |   |

 

113

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There were 78,200 options with a weightedaverage exercise price of $8.14 exercisable at December 31, 2005. There were88,700 options with a weighted average exercise price of $8.80 exercisable atDecember 31, 2004 and there were 98,700 options with a weighted averageexercise price of $8.72 exercisable at December 31, 2003.

 

Included in the above tables are certain optionsgranted where their exercise prices were below the fair market value of thecommon stock at the grant date. Such options totaled 10,000, 10,000, and131,250 with weighted average fair values of $5.74, $5.74 and $5.74 wereoutstanding at December 31, 2005, 2004 and 2003, respectively.

 

The following summarizes Liquidmetal Golf’sstock options outstanding and exercisable by the different exercise prices atDecember 31, 2005:

 

 
| ** **              | ** ** | ** **                      | **Number of Options** | ** **            | **Weighted Average**   | ** **                      | **Number of Options** | ** ** |
|-------------------------|------------|---------------------------------|---------------------------------|-----------------------|-----------------------------|---------------------------------|---------------------------------|------------|
| ** **              | ** ** | ** **                      | **Outstanding at**         | ** **            | **Remaining Contract** | ** **                      | **Exercisable at**         | ** ** |
| **Exercise Price** | ** ** | **December 31, 2005** | ** **                      | **Life (Years)** | ** **                  | **December 31, 2005** | ** **                      |
| $0.50                   |       |                            | 10,000                          |                  | 1.33                        |                            | 10,000                          |       |
| $8.00                   |       |                            | 60,000                          |                  | 3.83                        |                            | 60,000                          |       |
| $16.00                  |       |                            | 5,700                           |                  | 2.33                        |                            | 5,700                           |       |
| $24.00                  |       |                            | 2,500                           |                  | 2.58                        |                            | 2,500                           |       |
|                    |       |                            | 88,700                          |                  |                        |                            | 78,200                          |       |
|                         |            |                                 |                                 |                       |                             |                                 |                                 |            |  |

 

**18. Income Taxes**

 

For all financial statement periods presented,there was no provision for domestic income taxes. However, there wasapproximately $8 of tax expense during the twelve months ended December 31,2003, related to foreign taxes incurred by Dongyang, a 51% owned subsidiary,which is included as part of loss from discontinued operations on theconsolidated statements of operations and comprehensive loss (see Note 17).

 

The significant components of deferred taxassets were as follows:

 
| ** **                      | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------|------------|---------------------------------------------|------------|
| ** **                      | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                            |       |                                        |       |   |   |   |   |
| Non-employee stock compensation |       | $                                           | —     |   | $ | 109 |   | $ | 51 |   |
| Allowance for bad debt          |       | 9                                           |       | 37 |   | 44 |   |
| Loss carry forwards             |       | 32,428                                      |       | 31,403 |   | 27,202 |   |
| Other                           |       | 1,139                                       |       | 1,244 |   | 1,569 |   |
| Total deferred tax asset        |       | 33,576                                      |       | 32,793 |   | 28,866 |   |
| Valuation allowance             |       | (33,576                                     | )          | (32,793 | ) | (28,866 | ) |
| Total deferred tax asset, net   |       | $                                           | —     |   | $ | — |   | $ | — |   |

 

The following table accounts for the differencesbetween the actual tax provision and the amounts obtained by applying thestatutory U.S. Federal income tax rate of 34% to income (loss) beforeincome taxes:

 
| ** **                               | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------|------------|---------------------------------------------|------------|
| ** **                               | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                     |       |                                        |       |   |   |   |   |
| Federal tax expense                      |       | (34.00                                      | )%         | (34.00 | )% | (34.00 | )% |
|                                     |       |                                        |       |   |   |   |   |
| State tax expense, net                   |       | (1.74                                       | )%         | (4.79 | )% | (1.62 | )% |
|                                     |       |                                        |       |   |   |   |   |
| Foreign income not subject to income tax |       | 22.09                                       | %          | 4.96 | % | 24.16 | % |
|                                     |       |                                        |       |   |   |   |   |
| Other                                    |       | 0.09                                        | %          | 0.79 | % | 0.36 | % |
| Increase in valuation allowance          |       | 13.56                                       | %          | 33.04 | % | 11.13 | % |
|                                     |       |                                        |       |   |   |   |   |
| Total tax provision                      |       | 0.0                                         | %          | 0.00 | % | 0.03 | % |

 

114

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As of December 31, 2005, the Company hadapproximately $90,000 of net operating loss (“NOL”) carry forwards for U.S.federal income tax purposes expiring in 2006 through 2025. In addition, theCompany has state NOL carryforwards of approximately $34,000 expiring in 2010through 2015. The Company and Liquidmetal Golf filed on a separate companybasis for federal income tax purposes. Accordingly, the federal NOLcarryforwards of one legal entity are not available to offset federal taxableincome of the other. As of December 31, 2005, Liquidmetal Technologies,Inc. had approximately $52,000 in federal NOL carryforwards, expiring in 2006through 2025 and approximately $25,000 in state NOL carryforwards, expiring in2011 through 2015. Liquidmetal Golf, Inc. had approximately $38,000 of federalNOL carryforwards, expiring in 2012 through 2025 and approximately $9,000 instate NOL carryforwards expiring in 2010 through 2015.

 

As of December 31, 2005, the Company hadapproximately $199 of Research & Development (“R&D”) creditcarryforwards for U.S. federal income tax purposes expiring in 2021 through2025. In addition, the Company has California R&D credit carryforwards ofapproximately $269, which do not expire under current California law.

 

Section 382 of the Internal Revenue Code (“IRC”)imposes limitations on the use of NOL’s and credits following changes inownership as defined in the IRC. The limitation could reduce the amount ofbenefits that would be available to offset future taxable income each year,starting with the year of an ownership change. The Company has not completedthe complex analysis required by the IRC to determine if an ownership changehas occurred.

 

The ability to realize the tax benefitsassociated with deferred tax assets, which includes benefits related to NOL’s,is principally dependent upon the Company’s ability to generate future taxableincome from operations. The Company has provided a full valuation allowance forits net deferred tax assets due to the Company’s net operating losses.

 

**19. Segment Reportingand Geographic Information**

 

SFAS No. 131,*Disclosures about Segments of an Enterprise and Related Information,*requirescompanies to provide certain information about their operating segments. InApril 2002, the Company began classifying operations into two reportablesegments: Liquidmetal alloy industrial coatings and bulk Liquidmetal alloys. TheLiquidmetal alloy industrial coatings are used primarily as a protectivecoating for industrial machinery and equipment, such as drill pipe used by theoil drilling industry and boiler tubes used by coal burning power plants. 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. Theexpenses incurred by the bulk Liquidmetal alloy segment are manufacturing,research and development costs, and selling expenses associated withidentifying and developing market opportunities. 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 expensesassociated with research and development services are included in the bulkLiquidmetal alloy segment. The accounting policies of the reportable segmentsare the same as those described in Note 3 above.

 

Summarized financial information concerning theCompany’s reportable segments is shown in the following tables:

 

115

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| ** **                                 | ** ** | **Coatings** | ** ** | **Bulk Alloy** | ** ** | **Segment Totals** | ** ** |
|--------------------------------------------|------------|--------------|------------|---------------------|------------|-------------------------|------------|
| Year ended December 31, 2005:              |       |         |       |                |       |                    |       |
| Revenue to external customers              |       | $            | 5,894      |                | $          | 10,471                  |       | $ | 16,365 |   |
| Gross profit                               |       | 2,505        |       | (1,270              | )          | 1,236                   |       |
| Total segment income                       |       | 1,746        |       | (7,747              | )          | (6,002                  | )          |
| Total identifiable assets at end of period |       | 1,199        |       | 16,473              |       | 17,672                  |       |
|                                       |       |         |       |                |       |                    |       |
| Year ended December 31, 2004:              |       |         |       |                |       |                    |       |
| Revenue to external customers              |       | $            | 3,956      |                | $          | 13,473                  |       | $ | 17,429 |   |
| Gross profit                               |       | 1,807        |       | 3,454               |       | 5,261                   |       |
| Total segment income                       |       | 1,227        |       | 2,330               |       | 3,557                   |       |
| Total identifiable assets at end of period |       | 842          |       | 22,635              |       | 23,477                  |       |
|                                       |       |         |       |                |       |                    |       |
| Year ended December 31, 2003:              |       |         |       |                |       |                    |       |
| Revenue to external customers              |       | $            | 2,997      |                | $          | 10,661                  |       | $ | 13,658 |   |
| Gross profit                               |       | 1,466        |       | (5,970              | )          | (4,504                  | )          |
| Total segment income                       |       | 369          |       | (21,140             | )          | (20,771                 | )          |
| Total identifiable assets at end of period |       | 959          |       | 23,832              |       | 24,791                  |       |

 

116

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Reconciling information for the statements ofoperations between reportable segments and the Company’s consolidated totals isshown in the following table:

 
| ** **                                                                                                    | ** ** | **For the Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                                    | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                    | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total segment income (loss) before minority  interest, interest expense and discontinued operations           |       | $                                                             | (6,002     | ) | $ | 3,557 |   | $ | (20,771 | ) |
| General and administrative expneses,  excluded                                                                |       | (6,904                                                        | )          | (11,354 | ) | (13,110 | ) |
| Consolidated loss before interest, other  income, income taxes, minority interest and discontinued operations |       | (12,905                                                       | )          | (7,797 | ) | (33,881 | ) |
| Loss from extinguishment of debt                                                                              |       | (1,247                                                        | )          | (1,663 | ) | — |   |
| Change in value of warrants, net                                                                              |       | 3,985                                                         |       | 747 |   | — |   |
| Change in value of beneficial conversion  feature                                                             |       | 3,849                                                         |       | — |   | — |   |
| Other income                                                                                                  |       | —                                                        |       | 302 |   | — |   |
| Interest expense                                                                                              |       | (4,945                                                        | )          | (3,603 | ) | (390 | ) |
| Interest income                                                                                               |       | 17                                                            |       | 37 |   | 304 |   |
| Gain on sale of marketable securities  held-for-sale                                                          |       | —                                                        |       | — |   | 1,178 |   |
| Income taxes                                                                                                  |       | —                                                        |       | — |   | — |   |
| Minority interest in loss of consolidated  subsidiary                                                         |       | —                                                        |       | — |   | 21 |   |
| Gain (loss) from discontinued oeprations,  net                                                                |       | —                                                        |       | (749 | ) | -837 |   |
| Consolidated net loss                                                                                         |       | $                                                             | (11,246    | ) | $ | (12,726 | ) | $ | (33,605 | ) |

 

Excluded general and administrative expensesare attributable to the Company’s corporate headquarters. These expensesprimarily include corporate salaries, consulting, professional fees andfacility costs. Research and development expenses are included in the operatingcosts of the segment that performed the research and development.

 

Included in our bulk alloy revenue to externalcustomers are equipment sales from our Dongyang subsidiary and Taesungequipment division in Korea, both of which were divested in March and June 2004respectively. External revenue from our discontinued equipment manufacturingoperations includes  $0.2 million for theyears ended December 31, 2004.

 

Reconciling information for the balance sheetsbetween reportable segments and the Company’s consolidated totals is shown inthe following table:

 
| ** **                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2005**              | ** ** | **2004** | ** ** |
|                                      |       |                  |       |   |   |
| Total segment assets                      |       | $                     | 17,672     |   | $ | 23,477 |   |
| Cash and cash equivalents                 |       | 1,392                 |       | 742 |   |
| Restricted cash                           |       | —                |       | 754 |   |
| Prepaid expenses and other current assets |       | 340                   |       | 801 |   |
| Other property, plant and equipment       |       | 473                   |       | 975 |   |
| Intangibles, net                          |       | 1,186                 |       | 1,143 |   |
| Other assets                              |       | 500                   |       | 616 |   |
| Total Consolidated Assets                 |       | $                     | 21,563     |   | $ | 28,508 |   |

 

Assets excluded from segments include assetsattributable to the Company’s corporate headquarters. The largest assetrepresents the Company’s intangible assets, consisting primarily of the Company’spatents and trademarks.

 

117

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

 
| ** **               | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------|------------|--------------------------------------------|------------|
| ** **               | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|                     |       |                                       |       |   |   |   |   |
| Samsung                  |       | 10                                         | %          | 5 | % | 10 | % |
| Charm Tech               |       | —                                     |       | 32 | % | — |   |
| Pntel                    |       | 8                                          | %          | 30 | % | 2 | % |
| United States Government |       | 9                                          | %          | 10 | % | 16 | % |
| Growell Metal            |       | —                                     |       | 12 | % | — |   |
| LLPG                     |       | —                                     |       | — |   | 12 | % |

 

Revenues from sales to companies in the UnitedStates of America were $8,523, $5,546 and $6,050 during the years endedDecember 31, 2005, 2004 and 2003, respectively. The revenue related to theUnited States of America was earned under three defense-related research anddevelopment contracts and sales of coatings products.

 

During the year ended December 31, 2005,the Company had revenue on sales to companies outside of the United States of$7,829 of which $5,047 represented sales to companies located in South Korea. Duringthe year ended December 31, 2004, the Company had revenue on sales to outsideof the United States of $11,883 of which $9,545 represented sales to companieslocated in South Korea. During the year ended December 31, 2003, theCompany had revenue on sales to companies outside of the United States of$7,608, of which $4,559 represented sales to companies located in South Korea.

 

Long-lived assets include net property, plant,and equipment and net intangible assets. The Company had long-lived assets of$2,107 and $1,594 located in the United States at December 31, 2005 and2004, respectively. The Company had long-lived assets of  $12,846 and $15,422 located in South Korea atDecember 31, 2005 and December 31, 2004, respectively. Further, the Companyhas long lived assets located in China of $ 106 and $47 at December 31, 2005and 2004 respectively, as a result of a new plant that opened during August2004 (see Note 1).

 

**20. Income (Loss) PerCommon Share**

 

Basic EPS is computed by dividing earnings(loss) attributable to common shareholders by the weighted average numberof common shares outstanding for the periods. Diluted EPS reflects thepotential dilution of securities that could share in the earnings. Areconciliation of the number of common shares used in calculation of basic anddiluted EPS is presented below:

 
| ** **                      | ** ** | **For the Years ended December 31,** | ** ** |
|---------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                      | ** ** | **2005**                                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                      | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted average basic shares   |       | 41,833,058                                                    |       | 41,609,652 |   | 41,505,218 |   |
| Effect of dilutive securities:  |       |                                                          |       |   |   |   |   |
| Stock options                   |       | —                                                        |       | — |   | — |   |
| Conversion of notes payable     |       | —                                                        |       | — |   | — |   |
| Weighted average diluted shares |       | 41,833,058                                                    |       | 41,609,652 |   | 41,505,218 |   |

 

Options to purchase 7,993,755 shares of commonstock at prices ranging from $0.88to $15.00 per share were outstanding atDecember 31, 2005, but were not included in the computation of diluted EPSfor the same period because the inclusion would have been antidilutive. Optionsto purchase approximately 6,899,164 shares of common stock at prices rangingfrom $1.18 to $15.00 per share were outstanding at December 31, 2004, butwere not included in the computation of diluted EPS for the same period becausethe inclusion would have been antidilutive. Options to purchase approximately8,171,461 shares of common stock at prices ranging from $1.16 to $15.50 pershare were outstanding at December 31, 2003, but were not included in thecomputation of diluted EPS for the same period because the inclusion would havebeen antidilutive.

 

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Warrants to purchase 4,986,028 shares of commonstock between $2.00 and $4.65 per share outstanding at December 31, 2005 werenot included in the computation of diluted EPS for the same period because theinclusion would have been antidilutive. Warrants to purchase 1,208,313 sharesof common 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 because the inclusion would have been antidilutive. Warrantsto purchase 645,162 shares of common stock at $4.65 per share were outstandingat December 31, 2003.

 

**21. Commitments andContingencies**

 

The Company is from time to time a party tocertain legal proceedings arising in the ordinary course of business. Althoughoutcomes cannot be predicted with certainty, the Company does not believe thatany legal proceeding to which it is a party will have a material adverse effecton the Company’s financial position, results of operations, and cash flows.

 

The Company and certain of the present and former officers anddirectors were named as defendants in nine purported class action complaintsfiled in the United States District Court for the Middle District of Florida,Tampa Division, and the Central District of California, Southern Division,alleging violations of Sections 11 and 15 of the Securities Act of 1933 andSections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5promulgated thereunder. In August 2004, four complaints were consolidated inthe Middle District of Florida under the caption*Primavera Investors v. Liquidmetal Technologies, Inc., et al.*,Case No. 8:04-CV-919-T-23EAJ. John Lee, Chris Cowley, Dwight Mamanteo, ScottPurcell and Mark Rabold were appointed co-lead plaintiffs (the “Lead Plaintiffs”),but Mr. Mamanteo later withdrew. In September 2004, the five complaints filedin the Central District of California were transferred to the Middle Districtof Florida for consolidation with the*Primavera Investors* action. The Lead Plaintiffs served theirConsolidated Amended Class Action Complaint on January 12, 2005. The AmendedComplaint alleges that the Prospectus issued in connection with our initialpublic offering in May 2002 contained material misrepresentations and omissionsregarding our historical financial condition and regarding a personal stocktransaction by our former chief executive officer. The Lead Plaintiffsfurther generally allege that during the proposed Class Period of May 21, 2002,through May 13, 2004, the defendants engaged in improper revenue recognitionwith respect to certain of our business transactions, failed to maintainadequate internal controls, and knowingly disclosed unrealistic but favorableinformation about market demand for and commercial viability of our products toartificially inflate the value of our stock. The Amended Complaint seeks unspecifiedcompensatory damages and other relief. The Company, along with otherdefendants, filed a Motion to Dismiss Plaintiffs’ Consolidated Amended ClassAction Complaint in March 2005.  The Motion to Dismisswas denied in December 2005, and the defendants served their Answer andAffirmative Defenses to the Consolidated Amended Class Action Complaint onDecember 16, 2005.  The Lead Plaintiffs Motion for ClassCertification is presently due in April 2006. The Company intends to vigorously defend against the class action. TheCompany cannot currently predict the impact or resolution of this litigation orreasonably estimate a range of possible loss, which could be material. Theresolution of this lawsuit may harm the Company’s business and have a materialadverse impact on the Company’s financial condition.

 

In addition to the above, certain of present and former officers anddirectors, as well as the Company as a nominal defendant, have beennamed in three shareholder derivative actions. Two shareholder derivativecomplaints were filed in California state court styled*Brian Clair, Derivatively on Behalf of LiquidmetalTechnologies, Inc. v. John Kang, et al.*, Case No. 04CC00551, and*Joseph Durgin, Derivatively on Behalf of LiquidmetalTechnologies, Inc. v. John Kang, et al.*, Case No. 04CC00553, bothcommenced in the Superior Court of Orange County, California.   Athird shareholder derivative complaint was filed in the United StatesDistrict Court for the Middle District of Florida, Tampa Division, styled*Robert Story v. John Kang, et al.*, CaseNo. 8:04-CV-1587-T-23TBM. These shareholder derivative lawsuits allege that thedefendants breached various fiduciary duties and otherwise violated state lawbased primarily upon the same underlying facts and circumstances as alleged inthe federal shareholder class action. The plaintiffs seek unspecifiedcompensatory damages, restitution and disgorgement of profits, equitable and/orinjunctive relief as permitted by law and other relief.

 

The two shareholder derivative complaints in California state courthave been consolidated. The Company, along with other defendants, have thricesucceeded in having the Plaintiffs’ complaints dismissed for their failure toadequately plead demand futility.  Most recently, on September 15,2005, we, along with other defendants, filed a demurrer to the Plaintiffs’Consolidated Second Amended Shareholder Derivative Complaint dated August16, 2005.  In hearings on October 19, 2005, and January 20,2006, the presiding judge sustained the demurrer, dismissing the second amendedcomplaint but giving the plaintiffs until February 3, 2006, within whichto serve a third amended complaint. The plaintiffs filed their Consolidated Third Amended ShareholderDerivative Complaint on February 3, 2006. The Company anticipates filing a demurer, seeking dismissal of the thirdamended complaint.

 

In the Florida derivative action, the Plaintiff filed a First AmendedShareholder Derivative Complaint on November 22, 2004.  The Company,along with other defendants, filed a Motion to Dismiss inDecember 2004, to which the Plaintiff responded in opposition 

 

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in February 2005.  On January 20, 2006, the presiding judgegranted our Motion to Dismiss, dismissing the complaint based upon theplaintiff’s failure to adequately plead futility.  On February 17, 2006, the plaintiff filed itsNotice of Appeal of the Court’s Order granting the Motion to Dismiss.  The plaintiff’s initial brief is presentlydue  on April 4, 2006.  A mediation of the class and derivativeactions is scheduled for early April 2006.  We intend to vigorously defendagainst the derivative actions. The Company cannot currently predict the impactor resolution of this litigation or reasonably estimate a range of possibleloss, which could be material. The resolution of this lawsuit may harm theCompany’s business and have a material adverse impact on our financialcondition.

 

In March 1996, the Company entered into adistribution agreement whereby it granted to a third party exclusive rights tomarket and sell golf products incorporating Liquidmetal Technology to certainJapanese sporting equipment companies. The third party paid the Company a $1.0million distribution fee as part of this agreement, of which a portion wasrefundable according to a formula based on the gross profit earned by the thirdparty. The remaining unearned distribution fee of $830 has not been refunded asof December 31, 2004. On March 28, 2003, the distribution agreement was terminatedand the Company 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. This commission will apply to golf equipmentshipped by the Company or its affiliates during the period beginning on March28, 2003 and ending on March 28, 2006. If, by March 28, 2006, the Company hasnot paid $350 in commission payments, the balance between commission paid and$350 will be paid by April 30, 2006, thereby guaranteeing the third party a$350 minimum payment during the term of the agreement. The Company willrecognize the unearned distribution fee of $830 as revenue proportionately withthe payment of commissions under the new agreement. As of December 31, 2005,the unearned distribution fee remained unchanged at $830.

 

In August 2004, the Company entered into aconsulting agreement whereby the Company was to receive services from a thirdparty to improve the Company’s bulk alloy manufacturing process. The service isto be provided from 2004 through February 2006. The total amount of servicefees is $172, of which $78 and $15 was included in trade accounts payable as ofDecember 31, 2005 and 2004, respectively.

 

***OperatingLeases***

 

The Company leases its offices and warehousefacilities under various lease agreements, certain of which are subject toescalations based upon increases in specified operating expenses or increasesin the Consumer Price Index. Future minimum lease payments under non-cancelableoperating leases during subsequent years are as follows:

 
| ** **            | ** ** | **Minimum**  | ** ** |
|-----------------------|------------|--------------|------------|
| **December 31,** | ** ** | **Payments** | ** ** |
|                  |       |         |       |
| 2006                  |       | $            | 706        |   |
| 2007                  |       | 322          |       |
| 2008                  |       | 117          |       |
| 2009                  |       | 77           |       |
| 2010                  |       | 1            |       |
| Total                 |       | $            | 1,223      |   |

 

Rent expense was $508, $479, and $1,419 for theyears ended December 31, 2005, 2004, and 2003, respectively.

 

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

 

The Company has a tax-qualified employee savingsand retirement plan, or 401(k) plan, which covers all of its United States-based employees. Our Korean employees are covered under a government sponsoredpension program and do not participate in the U.S. based 401(k) program.

 

Under the U.S. based 401 (k) plan, participantsmay elect to reduce their current compensation, on a pre-tax basis, by up to15% of their taxable compensation or of the statutorily prescribed annuallimit, whichever is lower, and have the amount of the reduction contributed tothe 401(k) plan. The 401(k) plan permits the Company, in its sole discretion,to make additional employer contributions to the 401(k) plan. However, theCompany did not make employer contributions to the 401(k) plan during any ofthe periods presented in the accompanying consolidated financial statements.

 

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**23. Related PartyTransactions**

 

In June 2003,the Company entered into an exclusive, ten-year license agreement with LLPG,Inc. (“LLPG”), a corporation primarily owned and led by Jack Chitayat, a formerdirector.  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.  In turn,the Company will receive royalty payments over the life of the contract on allLiquidmetal products produced and sold by LLPG.  In conjunction with itstechnology licensing contract, LLPG purchased two proprietary Liquidmetal alloymelting machines and three proprietary Liquidmetal alloy casting machines for atotal purchase price of $2,000. No royalty payments were received to date underthis agreement.

 

The Companyhas 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, 2005 and 2004, amounted to $20 and $0,respectively.

 

The Company is a party to a consulting agreement withWilliam Johnson, a board member. Under this agreement, Mr. Johnson providesconsulting services on an as-needed basis through 2004 as it relates tomarketing and development Liquidmetal alloy. The agreement currently continueson a month-to-month basis. During the years ended December 31, 2005 and 2004,the Company incurred 15 and $90 in consulting fees from Mr. Johnson,respectively.

 

The Companyis a party to a consulting agreement with Chitnis Consulting, Inc., which isowned 100% by Shekhar Chitnis, a former director and executive officer of theCompany.  Under this agreement, Chitnis Consulting has been engaged toprovide consulting services on an as-needed basis through December 31,2005.  During the years ended December 31, 2005 and 2004, the Companyincurred $53 and $54 in consulting fees from Chitnis Consulting, respectively.

 

Soo Buchanan,the sister of John Kang and James Kang, was employed by the Company and waspaid aggregate compensation of approximately $104 and $43 as of December 31,2005 and 2004.  Effective, July 31, 2005, Ms. Buchanan was terminated asan employee and began providing services to the Company as a consultant. During2005, the Company incurred $24 for her services as a consultant. Additionally,Otis Buchanan, the husband of Ms. Buchanan, was employed by the Company and waspaid aggregate compensation of approximately $103 and $54 as of December 31,2005 and 2004, respectively.

 

In November 2004, the Company entered into an agreement with John Kang,our Chairman, President, and Chief Executive Officer, in which Mr. Kang agreedthat certain stock transactions by him in 2002 involving the Company’s commonstock should have resulted in a liability under Section 16(b) of the SecuritiesExchange Act of 1934, as amended (“Section 16(b)”). These transactions includeMr. Kang’s private sale of 285,715 shares of his personal LiquidmetalTechnologies common stock to Growell Metal Co., Ltd. in February 2002, prior toour initial public offering. They also include Mr. Kang’s subsequent indirectpurchase and disposition of Liquidmetal Technologies common stock in order tosatisfy a personal agreement Mr. Kang made to Growell Metal in February 2002regarding the guaranteed minimum value of the stock purchased by Growell Metalin February 2002 (the purchases and dispositions incident to this agreementoccurred in August and November 2002, respectively). Lastly, the transactionsinclude open-market purchases of an aggregate of 89,300 shares of the Company’scommon stock made by Mr. Kang in August 2002.

 

The AuditCommittee of our Board of Directors conducted an independent inquiry into theabove-described transactions with the aid of independent legal counsel and, asa result of such inquiry, the Audit Committee concluded that the transactionsshould have resulted in a liability to the Company under Section 16(b) in theamount of $302. Mr. Kang has acknowledged this liability, and in an agreementnegotiated between Mr. Kang and the Audit Committee and approved by the fullBoard, Mr. Kang will pay this liability through periodic installments in 2005and 2006. As a result, the Company accrued for the $302 receivable in otherassets and other income as of December 31, 2004. The above-describedtransactions involving Growell Metal was reported on a new Form 4filed by Mr. Kang on November 15, 2004, and the open-market purchases werepreviously reported on a timely basis in August 2002. As of December 31, 2005,the outstanding amount of the receivable was $235, which is included in otherassets. Mr. Kang has paid $67 during 2005. The Company has agreed to defer Mr.Kang’s payment schedule until 2006 as Mr. Kang has agreed accept reducedcompensation for the remainder of 2005. The remaining outstanding balance of$235 will be due before the end of 2006.

 

During theyear ended December 31, 2005, the Company executed a $198 promissory note withCK Cho, member of our Board of Directors, for working capital purposes. Thenote was due and paid in full as of June 30, 2005. The note has an annual rateof interest of 6% resulting in the Company paying approximately $2 in interest.Mr. Cho also holds $620 of Senior Convertible Notes and holds 92,584exercisable warrants as of December 31, 2005. Further, during the year endedDecember 31, 2005, Mr. Cho advanced 

 

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approximately$1,260 to cover short-term liquidity needs. The advances were made withoutinterest and were repaid as of December 31, 2005.

 

During theyear ended December 31, 2005, Ricardo Salas, our President and Chief ExecutiveOfficer, and Young Ham, our Chief Financial Officer, advanced the company $75and $133 to cover short-term liquidity needs, respectively. The advances weremade without interest and were repaid as of December 31, 2005.

 

**24. Fourth QuarterAdjustments and Transactions**

 

During the fourth quarter of 2005, the Company wrote-down$260 of primarily raw material inventory considered to be long term as thecarrying value of the inventory held as an “Impairment of long-lived assets” inthe accompanying Statement of Operations and Comprehensive Loss. While wemay use the excess raw materials beyond one year to fulfill future demand, wedid not foresee use of this inventory in the foreseeable future as of December31, 2005 (see Note 6).

 

Further, the Company amended its thirdquarter financial statements originally filed on form 10-Q on December 1, 2005,to properly account for the beneficialconversion feature of the senior convertible notes issued in August 2005. Accountingfor this feature resulted in a gain of $982 from the change in value ofbeneficial conversion feature and an increase to interest expense of $130 fromadditional amortization of debt discounts related to the revaluation of thebeneficial conversion feature of the senior convertible debt issued in August2005. In addition, the company wrote-down $833of primarily raw material inventory considered to be long term as the carryingvalue of the inventory held as an impairment charge. While wemay use the excess raw materials beyond one year to fulfill future demand, wedid not foresee use of this inventory in the foreseeable future.

 

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**Schedule II – Valuation and Qualifying Accounts**

 
| ** **                               | ** ** | **Balance at   Beginning of   Period** | ** ** | **Additions   Charged to   Expenses** | ** ** | **Write-offs   and   Payements** | ** ** | **Balance at   End of   Period** | ** ** |
|------------------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------------------|------------|
| Allowance for doubful accounts           |       |                                                       |       |                                                 |       |                                       |       |                                                 |       |
| Year ended December 31, 2005             |       | $                                                          | 108        |                                                 | $          | (6                                         | )          | $                                                    | (41        | ) | $ | 61 |   |
| Year ended December 31, 2004             |       | 127                                                        |       | 84                                                   |       | (103                                       | )          | 108                                                  |       |
| Year ended December 31, 2003             |       | 450                                                        |       | (28                                                  | )          | (295                                       | )          | 127                                                  |       |
|                                     |       |                                                       |       |                                                 |       |                                       |       |                                                 |       |
| Product warranty accrual                 |       |                                                       |       |                                                 |       |                                       |       |                                                 |       |
| Year ended December 31, 2005             |       | $                                                          | 519        |                                                 | $          | 101                                        |       | $                                                    | 14         |   | $ | 634 |   |
| Year ended December 31, 2004             |       | 303                                                        |       | 288                                                  |       | (72                                        | )          | 519                                                  |       |
| Year ended December 31, 2003             |       | 237                                                        |       | (297                                                 | )          | 363                                        |       | 303                                                  |       |
|                                     |       |                                                       |       |                                                 |       |                                       |       |                                                 |       |
| Deferred tax asset valuation allowance * |       |                                                       |       |                                                 |       |                                       |       |                                                 |       |
| Year ended December 31, 2005             |       | $                                                          | 32,793     |                                                 | $          | 783                                        |       | $                                                    | —     |   | $ | 33,576 |   |
| Year ended December 31, 2004             |       | 28,866                                                     |       | 3,927                                                |       | —                                     |       | 32,793                                               |       |
| Year ended December 31, 2003             |       | 25,401                                                     |       | 3,465                                                |       | —                                     |       | 28,866                                               |       |

 

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*     The deferred taxasset valuation allowance represents a 100% reserve against the deferred taxasset accounts at December 31, 2005, 2004, and 2003, respectively.

 

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