**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM10-Q**

**x**                              QUARTERLY REPORT PURSUANTTO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe quarterly period ended June 30, 2006**

**OR**

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

**Forthe transition period from          to**

**CommissionFile No.  001-31332**

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**LIQUIDMETAL TECHNOLOGIES, INC.**

**(**Exact name ofRegistrant as specified in its charter**)** 

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

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

Registrant’s telephonenumber, including area code: **(949) 206-8000**

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Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for at least the past 90 days.

Yes  x    No  o

Indicateby check whether the registrant is a large accelerated filer, an acceleratedfiler, or a non-accelerated filer. See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
| Large  accelerated filer o |   | Accelerated  filer x |   | Non-accelerated  filer o |
|----------------------------|--------|----------------------|--------|--------------------------|

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b2 of the Exchange Act). Yes   o    No  x

#### As of August 4, 2006, there were 44,085,018 shares of the registrant’scommon stock, $.001 par value, outstanding.

 

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**LIQUIDMETAL TECHNOLOGIES, INC.FORM 10-QFOR THE QUARTER ENDED****JUNE 30, 2006**

**FORWARD-LOOKING INFORMATION**

Statements in this report concerning the future sales,expenses, profitability, financial resources, product mix, market demand,product development and other statements in this report concerning the futureresults of operations, financial condition and business of LiquidmetalTechnologies, Inc. are “forward-looking” statements as defined in theSecurities Act of 1933 and Securities Exchange Act of 1934. Investors arecautioned that the Company’s actual results in the future may differ materiallyfrom those projected in the forward-looking statements due to risks anduncertainties that exist in the Company’s operations and business environment,including competition, need for increased acceptance of products, ability tocontinue to develop and extend our brand identity, ability to anticipate andadapt to a competitive market, ability to effectively manage rapidly expandingoperations, amount and timing of operating costs and capital expendituresrelating to expansion of our business, operations and infrastructure, abilityto provide superior customer service, dependence upon key personnel and thelike. The Company’s most recent filings with the Securities and ExchangeCommission, including Form 10-K, contain additional information concerning manyof these risk factors, and copies of these filings are available from theCompany upon request and without charge.

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**TABLE OF CONTENTS**
| **PART I**                                                                                                 |                                                                                |       |
|------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------|------------|
| ** **                                                                                                 |                                                                                |       |
| Item 1 – Financial  Statements                                                                        | ** **                                                                          | ** ** |
|                                                                                                       | Condensed  Consolidated Balance Sheets (unaudited)                                  |       |   |
|                                                                                                       | Condensed  Consolidated Statements of Operations and Comprehensive Loss (unaudited) |       |   |
|                                                                                                       | Condensed  Consolidated Statements of Shareholders’ Deficiency (unaudited)     |       |   |
|                                                                                                       | Condensed  Consolidated Statements of Cash Flows (unaudited)                        |       |   |
|                                                                                                       | Notes to  Condensed Consolidated Financial Statements (unaudited)                   |       |   |
|                                                                                                       |                                                                                |       |   |
| Item 2 –  Management’s Discussion and Analysis of Financial Condition and Results of  Operations | ** **                                                                          | ** ** |
|                                                                                                       | ** **                                                                          | ** ** |
| Item 3 –  Quantitative and Qualitative Disclosures about Market Risk                                  | ** **                                                                          | ** ** |
|                                                                                                       | ** **                                                                          | ** ** |
| Item 4 – Controls and  Procedures                                                                     | ** **                                                                          | ** ** |
| ** **                                                                                                 | ** **                                                                          | ** ** |
| **PART II –  Other Information**                                                                      |                                                                                |       |
|                                                                                                       |                                                                                |       |
| Item 1 – Legal Proceedings                                                                            | ** **                                                                          | ** ** |
|                                                                                                       | ** **                                                                          | ** ** |
| Item 1A – Risk Factors                                                                                | ** **                                                                          | ** ** |
|                                                                                                       | ** **                                                                          | ** ** |
| Item 2 –  Unregistered Sales of Equity Securities and Use of Proceeds                                 | ** **                                                                          | ** ** |
|                                                                                                       | ** **                                                                          | ** ** |
| Item 3 – Defaults  Upon Senior Securities                                                             | ** **                                                                          | ** ** |
|                                                                                                       | ** **                                                                          | ** ** |
| Item 4 –  Submission of Matters to a Vote of Security Holders                                         | ** **                                                                          | ** ** |
|                                                                                                       | ** **                                                                          | ** ** |
| Item 5 – Other Information                                                                            | ** **                                                                          | ** ** |
|                                                                                                       | ** **                                                                          | ** ** |
| Item 6 – Exhibits                                                                                     | ** **                                                                          | ** ** |
|                                                                                                       | ** **                                                                          | ** ** |
| Signatures                                                                                                 | ** **                                                                          | ** ** |
|                                                                                                       | ** **                                                                          | ** ** |
| Certifications                                                                                             | ** **                                                                          | ** ** |

 

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### **PART IFINANCIAL INFORMATION**

**Item 1 – Financial Statements**

**LIQUIDMETALTECHNOLOGIES, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS(in thousands, except share data)**
|                                                                                                                                                                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                                         | ** ** | **(Unaudited)**   | ** ** | **(Restated)**        | ** ** |
| **ASSETS**                                                                                                                                                                         | ** ** | ** **        | ** ** | ** **            | ** ** |
| ** **                                                                                                                                                                         | ** ** | ** **        | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                                                    |       |              |       |                  |       |
| Cash  and cash equivalents                                                                                                                                                         |       | $                 | 2,225      |                  | $          | 1,392 |   |
| Trade  accounts receivables, net of allowance for doubtful accounts of $101 and $61                                                                                                |       | 4,338             |       | 2,360                 |       |
| Inventories                                                                                                                                                                        |       | 2,316             |       | 1,748                 |       |
| Prepaid  expenses and other current assets                                                                                                                                         |       | 1,255             |       | 609                   |       |
| Total current  assets                                                                                                                                                              |       | 10,134            |       | 6,109                 |       |
|                                                                                                                                                                               |       |              |       |                  |       |
| Property, plant and  equipment, net                                                                                                                                                |       | 13,061            |       | 13,437                |       |
| Idle equipment                                                                                                                                                                     |       | 191               |       | 193                   |       |
| Other intangibles, net                                                                                                                                                             |       | 1,192             |       | 1,185                 |       |
| Other assets                                                                                                                                                                       |       | 408               |       | 639                   |       |
| Total assets                                                                                                                                                                       |       | $                 | 24,986     |                  | $          | 21,563 |   |
|                                                                                                                                                                               |       |              |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’  DEFICIENCY**                                                                                                                                 | ** ** | ** **        | ** ** | ** **            | ** ** |
|                                                                                                                                                                               |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                               |       |              |       |                  |       |
| Accounts payable  and accrued expenses                                                                                                                                             |       | 9,014             |       | 6,530                 |       |
| Settlement  payable                                                                                                                                                                |       | —            |       | 3,331                 |       |
| Deferred revenue                                                                                                                                                                   |       | 474               |       | 1,275                 |       |
| Short-term debt,  net of debt discounts of $43 and $0                                                                                                                              |       | 2,830             |       | 550                   |       |
| Long-term debt,  current portion, net of debt discounts of $5,638 and $0                                                                                                           |       | 7,962             |       | 1,343                 |       |
| Warrant  liabilities                                                                                                                                                               |       | 5,497             |       | 1,792                 |       |
| Conversion  feature liabilities                                                                                                                                                    |       | 5,691             |       | 1,798                 |       |
| Other  liabilities, current portion                                                                                                                                                |       | 294               |       | 483                   |       |
| Total current  liabilities                                                                                                                                                         |       | 31,762            |       | 17,102                |       |
|                                                                                                                                                                               |       |              |       |                  |       |
| Long-term debt, net of  current portion and debt discounts of $807 and $8,259                                                                                                      |       | 3,688             |       | 5,433                 |       |
| Other long-term  liabilities, net of current portion                                                                                                                               |       | 428               |       | 348                   |       |
| Total  liabilities                                                                                                                                                                 |       | 35,878            |       | 22,883                |       |
|                                                                                                                                                                               |       |              |       |                  |       |
| Shareholder's equity  (deficiency):                                                                                                                                                |       |              |       |                  |       |
| Common stock,  $0.001 par value; 100,000,000 shares authorized and 44,085,018 issued and  outstanding at June 30, 2006 and 42,187,621 issued and outstanding at  December 31, 2005 |       | 44                |       | 42                    |       |
| Additional  paid-in capital                                                                                                                                                        |       | 135,105           |       | 130,893               |       |
| Accumulated  deficit                                                                                                                                                               |       | (148,438          | )          | (134,525              | )          |
| Accumulated  other comprehensive income                                                                                                                                            |       | 2,397             |       | 2,270                 |       |
| Total  shareholders' deficiency                                                                                                                                                    |       | (10,892           | )          | (1,320                | )          |
|                                                                                                                                                                               |       |              |       |                  |       |
| Total liabilities and  shareholders' deficiency                                                                                                                                    |       | $                 | 24,986     |                  | $          | 21,563 |   |

The accompanying notes are an integral part of the condensedconsolidated financial statements.

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**LIQUIDMETALTECHNOLOGIES, INC. AND SUBSIDIARIES****CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS****(in thousands, except per sharedata)(unaudited)**
|                                                       | ** ** | **For the Three Months** | ** ** | **For the Six Months** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                            | ** ** | **Ended June 30,**            | ** ** | **Ended June 30,**          | ** ** |
| ** **                                            | ** ** | **2006**                                | ** ** | **2005**                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                  | ** ** | ** **                              | ** ** | **(Restated)**                        | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| ** **                                            | ** ** | ** **                              | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                               |       | $                                       | 7,090      |                                  | $          | 3,727 |   | $ | 13,645 |   | $ | 6,570 |   |
| Cost of sales                                         |       | 5,564                                   |       | 3,962                                 |       | 10,888 |   | 6,797 |   |
|                                                  |       |                                    |       |                                  |       |   |   |   |   |
| Gross profit  (loss)                                  |       | 1,526                                   |       | (235                                  | )          | 2,757 |   | (227 | ) |
|                                                  |       |                                    |       |                                  |       |   |   |   |   |
| Operating expenses                                    |       |                                    |       |                                  |       |   |   |   |   |
| Selling,  general, and administrative                 |       | 2,368                                   |       | 1,567                                 |       | 5,073 |   | 4,157 |   |
| Research and  development                             |       | 281                                     |       | 213                                   |       | 484 |   | 610 |   |
| Impairment of  long lived assets                      |       | —                                  |       | 3,394                                 |       | — |   | 3,394 |   |
| Total operating  expenses                             |       | 2,649                                   |       | 5,174                                 |       | 5,557 |   | 8,161 |   |
| Loss from operations                                  |       | (1,123                                  | )          | (5,409                                | )          | (2,800 | ) | (8,388 | ) |
|                                                  |       |                                    |       |                                  |       |   |   |   |   |
| Change in value of  warrants, (loss) gain             |       | (1,426                                  | )          | (100                                  | )          | (2,715 | ) | 33 |   |
| Change in value of  conversion feature, (loss) gain   |       | (2,137                                  | )          | 1,167                                 |       | (3,920 | ) | 2,282 |   |
| Other income                                          |       | 92                                      |       | —                                |       | 572 |   | — |   |
| Interest expense                                      |       | (3,277                                  | )          | (1,181                                | )          | (5,059 | ) | (2,718 | ) |
| Interest income                                       |       | 7                                       |       | 1                                     |       | 9 |   | 7 |   |
|                                                  |       |                                    |       |                                  |       |   |   |   |   |
| Loss from continuing  operations                      |       | (7,864                                  | )          | (5,522                                | )          | (13,913 | ) | (8,784 | ) |
|                                                  |       |                                    |       |                                  |       |   |   |   |   |
| Net Loss                                              |       | (7,864                                  | )          | (5,522                                | )          | (13,913 | ) | (8,784 | ) |
|                                                  |       |                                    |       |                                  |       |   |   |   |   |
| Other comprehensive  income:                          |       |                                    |       |                                  |       |   |   |   |   |
| Foreign exchange  translation gain                    |       | 28                                      |       | 62                                    |       | 127 |   | 383 |   |
| Comprehensive  loss                                   |       | $                                       | (7,836     | )                                     | $          | (5,460 | ) | $ | (13,786 | ) | $ | (8,401 | ) |
|                                                  |       |                                    |       |                                  |       |   |   |   |   |
| Net loss per share  basic and diluted:                |       |                                    |       |                                  |       |   |   |   |   |
| Loss per share  basic and diluted                     |       | $                                       | (0.18      | )                                     | $          | (0.13 | ) | $ | (0.32 | ) | $ | (0.21 | ) |
|                                                  |       |                                    |       |                                  |       |   |   |   |   |
| Number of weighted average shares - basic and diluted |       | 44,075                                  |       | 41,610                                |       | 43,446 |   | 41,610 |   |

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

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**LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIENCYFor the Six Months Ended June 30, 2006(in thousands, except per share data)(unaudited)**
|                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **      | ** ** | **Accumulated**   | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|------------|------------|------------|------------|----------------|------------|-----------------|------------|-------------------|------------|------------|------------|
| ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **      | ** ** | **Other**         | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Common** | ** ** | **Common** | ** ** | **Paid-in**    | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **Shares** | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **Deficit**     | ** ** | **Income**        | ** ** | **Total**  | ** ** |
| ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** | **(Restated)** | ** ** | **(Restated)**  | ** ** | ** **        | ** ** | ** ** | ** ** |
|                                          | ** ** | ** ** | ** ** | ** ** | ** ** | ** **     | ** ** | ** **      | ** ** | ** **        | ** ** | ** ** | ** ** |
| **Balance, December 31, 2005 (As  Restated)** |       | 42,187,621 |       | $          | 42         |           | $          | 130,893         |       | $                 | (134,525   | )          | $          | 2,270 |   | $ | (1,320 | ) |
| Conversion of  notes payable                  |       | 59,000     |       | —     |       | 86             |       | —          |       | —            |       | 86         |       |
| Common stock  issued as director's fees       |       | 109,437    |       | —     |       | 102            |       | —          |       | —            |       | 102        |       |
| Common stock  issued to Innometal             |       | 1,700,000  |       | 2          |       | 3,448          |       | —          |       | —            |       | 3,450      |       |
| Stock-based  compensation                     |       | 28,960     |       | —     |       | 576            |       | —          |       | —            |       | 576        |       |
| Foreign exchange  translation gain            |       | 0          |       | —     |       | —         |       | —          |       | 127               |       | 127        |       |
| Net loss                                      |       | 0          |       | —     |       | —         |       | (13,913         | )          | —            |       | (13,913    | )          |
| **Balance, June 30, 2006**                    |       | 44,085,018 |       | $          | 44         |           | $          | 135,105         |       | $                 | (148,438   | )          | $          | 2,397 |   | $ | (10,892 | ) |

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

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**LIQUIDMETAL TECHNOLOGIES, INC.  AND SUBSIDIARIESCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands, except per share data)(unaudited)**

|                                                                                           | ** ** | **For the Six Months** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                | ** ** | **Ended June 30,**          | ** ** |
| ** **                                                                                | ** ** | **2006**                              | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | ** **                            | ** ** | **(Restated)** | ** ** |
| **Operating activities:**                                                                 | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Net loss                                                                                  |       | $                                     | (13,912    | ) | $ | (8,784 | ) |
|                                                                                      |       |                                  |       |   |   |
| Adjustments to  reconcile loss from operations to net cash used for operating activities: |       |                                  |       |   |   |
| Impairment of  long lived assets                                                          |       | —                                |       | 3,394 |   |
| (Gain) loss on  disposal of asset                                                         |       | (92                                   | )          | 1 |   |
| Depreciation and  amortization                                                            |       | 1,765                                 |       | 1,694 |   |
| Amortization of  debt discount                                                            |       | 2,925                                 |       | 1,031 |   |
| Stock-based  compensation                                                                 |       | 535                                   |       | — |   |
| Bad debt expense  (recovery)                                                              |       | 60                                    |       | (43 | ) |
| Warranty expense                                                                          |       | 107                                   |       | 76 |   |
| Loss (gain) from  change in value of warrants                                             |       | 2,715                                 |       | (33 | ) |
| Loss from change  in value of conversion feature                                          |       | 3,920                                 |       | (2,282 | ) |
| Changes in  operating assets and liabilities:                                             |       |                                  |       |   |   |
| Trade accounts  receivable                                                                |       | (2,038                                | )          | (648 | ) |
| Inventories                                                                               |       | (568                                  | )          | 320 |   |
| Prepaid expenses  and other current assets                                                |       | (646                                  | )          | (24 | ) |
| Other assets                                                                              |       | 65                                    |       | (169 | ) |
| Accounts payable  and accrued expenses                                                    |       | 2,523                                 |       | 2,050 |   |
| Deferred revenue                                                                          |       | (801                                  | )          | 34 |   |
| Other  liabilities                                                                        |       | (167                                  | )          | (182 | ) |
| Net cash used  for operating activities                                                   |       | (3,609                                | )          | (3,565 | ) |
|                                                                                      |       |                                  |       |   |   |
| **Investing Activities:**                                                                 | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Purchases of  property and equipment                                                      |       | (693                                  | )          | (63 | ) |
| Proceeds from  the sale of property and equipment                                         |       | 106                                   |       | 1 |   |
| Investment in  patents and trademarks                                                     |       | (65                                   | )          | (70 | ) |
| Net cash used  for investing activities                                                   |       | (652                                  | )          | (132 | ) |
|                                                                                      |       |                                  |       |   |   |
| **Financing Activities:**                                                                 | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Proceeds from  borrowings                                                                 |       | 12,042                                |       | 4,669 |   |
| Repayment of  borrowings                                                                  |       | (6,744                                | )          | (1,613 | ) |
| Repayment of  other liabilities                                                           |       | 57                                    |       | — |   |
| Proceeds from  restricted cash                                                            |       | —                                |       | 754 |   |
| Net cash  provided by financing activities                                                |       | 5,355                                 |       | 3,810 |   |
| Effect of  foreign exchange translation                                                   |       | (261                                  | )          | 401 |   |
| Net (decrease)  in cash and cash equivalents                                              |       | 833                                   |       | 514 |   |
|                                                                                      |       |                                  |       |   |   |
| Cash and cash  equivalents at beginning of period                                         |       | 1,392                                 |       | 742 |   |
| Cash and cash  equivalents at end of period                                               |       | $                                     | 2,225      |   | $ | 1,256 |   |
|                                                                                      |       |                                  |       |   |   |
| Supplemental cash flow  information                                                       |       |                                  |       |   |   |
| Interest paid                                                                             |       | $                                     | 602        |   | $ | 229 |   |
| Taxes paid                                                                                |       | $                                     | —     |   | $ | — |   |

The accompanying notes are an integral part of the condensedconsolidated financial statements.

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During the six months ended June 30, 2006, $59 of the Company’s 6%senior convertible notes due July 2007 was converted into 59,000 shares of theCompany’s common stock at a conversion price of $1.00 per share.

During the six months ended June30, 2006, the Company fulfilled its settlement payable to Innometal (formerlyknown as Growell Metal) of $3,450, net of foreign exchange translation loss,through stock issuance of 1,700,000 shares of the Company’s common stock at aconversion price of $1.00 per share.

The accompanying notes are an integral part of the condensedconsolidated financial statements

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**LIQUIDMETALTECHNOLOGIES, INC.  AND SUBSIDIARIESNOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTSFor the Six Months Ended June 30, 2006 and 2005(in thousands, except share date)(unaudited)**

**1.             Basisof Presentation / Description of Business**

The accompanyingunaudited condensed consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (“generally accepted accounting principles”) for interim financialinformation and with the instructions to Form 10-Q.  Accordingly, they do not include all of theinformation and notes required by generally accepted accounting principles forcomplete financial statements.  In theopinion of management, all adjustments (consisting only of normal recurringaccruals) considered necessary for a fair presentation have been included.  All intercompany balances and transactionshave been eliminated.  Operating resultsfor the three and six months ended June 30, 2006 are not necessarily indicativeof the results that may be expected for any future periods or the year endingDecember 31, 2006.  The accompanyingunaudited condensed consolidated financial statements should be read inconjunction with the Company’s Form 10-K filed with the Securities and ExchangeCommission on March 16, 2006, as amended by Form 10-K/A filed on March 31,2006, April 25, 2006 and July 20, 2006.

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

The Companyclassifies operations into two reportable segments: Liquidmetal alloyindustrial coatings and bulk Liquidmetal alloys (see Note 10). Liquidmetalalloy industrial coatings are used primarily as a protective coating forindustrial machinery and equipment, such as drill pipe used by the oil drillingindustry and boiler tubes used by coal-burning power plants. Bulk Liquidmetalalloys include potential market opportunities to manufacture and sell productsand components for electronic devices, medical devices, defense applications,and sporting goods.  In addition, thebulk Liquidmetal alloys segment includes tooling and prototype sampling.  In addition, such alloys are used to generateresearch and development services revenue for developing uses related primarilyto defense and medical applications as well as potential license fees,royalties, and other compensation from strategic partnering transactions.

Stock-based compensation

The Company previously applied Accounting PrinciplesBoard (“APB”) Opinion No. 25 for options when the exercise price of optionsgranted to employees is less than the fair value of the underlying stock on thedate of grant.  As permitted, the Companyhad previously elected to adopt provisions of Statement of Financial AccountingStandard (“SFAS”) No. 123, *Accounting for Stock-BasedCompensation* for options granted to non-employees who performservices for the Company and the disclosure-only provisions of options grantedto employees.

In December 2004, the FASB issued SFASNo. 123 (revised 2004), *Share-BasedPayment* (“SFAS 123R”), which replaces SFAS No. 123, *Accounting for Stock-Based Compensation*, (“SFAS 123”)and supersedes APB Opinion No. 25, *Accountingfor Stock Issued to Employees*, (“APB 25”). SFAS 123R requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the financial statements based on their fairvalues. Under SFAS 123R, the Company is required to measure the cost ofemployee services received in exchange for stock options and similar awardsbased on the grant-date fair value of the award and recognize this cost in theincome statement over the period during which an employee is required toprovide service in exchange for the award. The pro forma disclosures previouslypermitted under SFAS 123 are no longer an alternative to financialstatement recognition. The Company adopted SFAS 123R on January 1,2006 using the modified prospective method and recorded $311 and $535 for thethree and six months period ended June 30, 2006, of non-cash charges for stockcompensation related to amortization of the fair value of restricted stock andunvested stock options representing an increase from the stock compensationthat would have been recorded under APB 25 and SFAS 123. Under this method, theCompany will recognize compensation cost, on a prospective basis, for theportion of outstanding awards for which the requisite service has not yet beenrendered as of January 1, 2006 and any new grants, based upon thegrant-date fair value of those awards calculated under SFAS 123 for pro formadisclosure purposes. Accordingly, we have not restated prior period amounts.The following table illustrates the pro forma effect on net income for periodsprior to the adoption of SFAS 123R as if we had applied the fair valuerecognition provisions of SFAS 123 during such periods:

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|                                    | ** **                                                                                                                                | **For the Three**  | ** ** | **For the Six**    | ** ** |
|------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------------------------|------------|------------------------------|------------|
| ** **                         | ** **                                                                                                                                | **Months**                   | ** ** | **Months**                   | ** ** |
| ** **                         | ** **                                                                                                                                | **Ended June 30,** | ** ** | **Ended June 30,** | ** ** |
| ** **                         | ** **                                                                                                                                | **2005**                     | ** ** | **2005**                     | ** ** |
|                               | ** **                                                                                                                                | **(Restated)**               | ** ** | **(Restated)**               | ** ** |
|                               |                                                                                                                                      |                         |       |                         |       |
| Net loss as  reported              |                                                                                                                                      | $                            | (5,522     | )                            | $          | (8,784 | ) |
|                               |                                                                                                                                      |                         |       |                         |       |
| *Add:*                             | stock-based employee compensation expense included  in reported net loss, net of related tax effects                                      |                         | —     |                         | —     |   |
|                               |                                                                                                                                      |                         |       |                         |       |
| *Deduct:*                          | total stock-based employee compensation expense  determined under the fair value based method for all awards, net of related  tax effects |                         | (736       | )                            | (1,519     | ) |
|                               |                                                                                                                                      |                         |       |                         |       |
| Proforma net loss:                 |                                                                                                                                      | $                            | (6,258     | )                            | $          | (10,303 | ) |
| Basic and  diluted loss per share: |                                                                                                                                      |                         |       |                         |       |
| As reported                        |                                                                                                                                      | $                            | (0.13      | )                            | $          | (0.21 | ) |
| Proforma                           |                                                                                                                                      | $                            | (0.15      | )                            | $          | (0.25 | ) |

The fair value of each option grant is estimated onthe date of the grant using the Black-Scholes option-pricing model with thefollowing weighted-average assumptions used for grants for the six months endedJune 30, 2006 and 2005, respectively: expected volatility of approximately 100%for all periods; dividend yield of 0.0% for all periods; expected option lifeof approximately 5 years; and a risk-free interest rate ranging from 3.64%to 4.82%.

**2.             Basis of Presentation and RecentAccounting Pronouncements**

Translationof Foreign Currency

The Companyapplies **FASB No.52, Foreign Currency Translation**, for translating foreigncurrency into US dollars in our consolidation of the financialstatements.  Upon consolidation of the Company’s foreign subsidiaries intothe Company’s consolidated financial statements, any balances with thesubsidiaries denominated in the foreign currency are translated at the exchangerate at year-end. The financial statements of Liquidmetal Korea have beentranslated based upon Korean Won as the functional currency. Liquidmetal Korea’sassets and liabilities were translated using the exchange rate at period endand income and expense items were translated at the average exchange rate forthe reporting period. The resulting translation adjustment was included inother comprehensive income (loss).

RecentAccounting Pronouncements

InFebruary 2006, the FASB issued SFAS No. 155, (“SFAS No. 155”),“Accounting for Certain Hybrid Instruments,” which amendsSFAS No. 133, “Accounting for Derivative Instruments and HedgingActivities,” and SFAS No. 140, “Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities.”SFAS No. 155 allows financial instruments that have embeddedderivatives to be accounted for as a whole (eliminating the need to bifurcatethe derivative from its host) if the holder elects to account for the wholeinstrument on a fair value basis. SFAS No. 155 also clarifies andamends certain other provisions of SFAS No. 133 andSFAS No. 140. This statement is effective for all financialinstruments acquired or issued in fiscal years beginning afterSeptember 15, 2006. The Company does not expect the adoption of this newstandard to have a material impact on its financial position, results ofoperations or cash flows.

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**3.             Liquidity**

The Company has experienced losses from continuingoperations during the last three fiscal years and has an accumulated deficit of$148,438 as of June 30, 2006.  Cash usedfor operations for the six months ended June 30, 2006 was $3,609 and cash flowfrom operations will likely be negative throughout fiscal year 2006.  As of June 30, 2006, the Company’s principalsource of liquidity is $2,225 of cash and $4,338 of trade accountsreceivable.  Such conditions raisesubstantial doubt that the Company will be able to continue as a goingconcern.  These operating resultsoccurred while the Company was developing and continues to develop,commercialize, and manufacture products from an entirely new and uniquetechnology.  These factors have placed asignificant strain on the financial resources of the Company.  The ability of the Company to overcome thesechallenges depends on its ability to correct its production inefficiencies,continues to reduce its operating costs, generate higher revenue, and achievepositive cash flow from continuing operations and profitability and continuedsources of debt and equity financing. The consolidated financial statements do not include any adjustmentsthat might result from the outcome of the uncertainty.

The Company completed a $1,000 10%subordinated promissory note on March 17, 2006. Also, on May 17, 2006 theCompany completed a private placement of 8% unsecured subordinated notes in theaggregate principal amount of $3,625. (See Note 8) Further, the Companyborrowed $7,417, offset by repayments of $6,092, under a factoring, loan, andsecurity agreement executed on April 21, 2005 to fund our working capitalrequirements.

Capital requirements during the next 12 monthswill depend on numerous factors, including the success of existing products,the development of new applications for Liquidmetal alloys, and the resourcesdevoted to develop and support Liquidmetal alloy products.  Specifically, we anticipate thatwe could need $1,000 to $5,000 over the next twelvemonths to pursue our current operating plan, although this amount maybe lower depending on the orders we receive for our products.  The amount of funding that we plan to seekand the timing of such fundraising efforts will depend on the extent to whichwe are able to increase revenues through obtaining additional purchase ordersfor our products, particularly components for cellular phones and flash memorydrive casings and other electronic components, and our ability to continue toimprove our manufacturing processes.  Weevaluate our working capital needs and operating plan assumptions on a monthlybasis to determine whether any adjustment to our cash and liquidity outlook iswarranted, and we also review potential sources of financing on an ongoingbasis.  However, adequate funds may notbe available when needed, and if we raise additional funds by issuing equitysecurities, existing stockholders may be subject to dilution.  If we don’t receive sufficient funding tooperate under our current plan, we intend to reduce operations and expenses andshift our focus to the pursuit of licensing transactions and other strategictransactions that are less capital intensive.

**4. Inventories**

Inventories are accounted for using the moving averagebasis and at standard cost, which approximate cost on a first-in, first-outbasis and are valued at the lower of cost or market.  Inventories were comprised of the following:
|                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------|------------|-------------------|------------|-----------------------|------------|
| ** **         | ** ** | **2006**          | ** ** | **2005**              | ** ** |
| ** **         | ** ** | **(Unaudited)**   | ** ** | **(Restated)**        | ** ** |
|               |       |              |       |                  |       |
| Raw materials      |       | $                 | 948        |                  | $          | 565 |   |
| Work in process    |       | 951               |       | 763                   |       |
| Finished goods     |       | 417               |       | 420                   |       |
| Total  inventories |       | $                 | 2,316      |                  | $          | 1,748 |   |

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**5. Idle Equipment**

Idle equipment consists of certain equipment held bythe Company for use in expansion of bulk alloy parts manufacturing.  Whilethe equipment may be used internally to meet future capacity requirements,considering our current revenue and foreseeable production requirements, theCompany does not anticipate utilizing this equipment internally in the nearfuture.  Total amount of idle equipmentremaining was $191 and $193 as of June 30, 2006 and December 31, 2005,respectively.

In June 2006, the Company disposed of $12 of its idleequipment for proceeds of $104.  Theresulting gain of $92 is included in other income.

**6.  Settlement Payable**

The settlementpayable balance consists of payables to Growell Metal Co., Ltd. (“Growell”), a SouthKorean metals processing company, as a result of a Settlement Agreementexecuted in January 2004.  Under terms ofthe January 2004 settlement of the dispute over certain sales transactions from2003 and 2002 between Liquidmetal Korea and Growell, Liquidmetal Korea agreed to pay Growell $4,895 topurchase Growell’sinvestment in alloy inventories, proprietary alloying equipment purchased fromLiquidmetal Korea, and supporting equipment purchased from othersuppliers.  Also as part of thesettlement, Growellsatisfied in full a balance of $2,058 owed to Liquidmetal Korea for the diecasting machines Growellpurchased from Liquidmetal Korea in the first quarter of 2003 as part of alicense agreement to manufacture Liquidmetal alloy parts for the South Koreanautomotive industry.  ****The remainingsettlement payable of $2,837 was to be paid to****Growell****(in cash or stock atthe Company’s discretion) by December 31, 2004. As of December 31, 2005, the settlement payable was not paid to****Growell****due to****Growell****’s breach of warrantyon equipment repurchased by Liquidmetal Korea. The outstanding balance of payables to****Growell****from the settlementwas $3,331 as of December 31, 2005, net of foreign exchange translation loss.****

Under theforegoing settlement agreement between the parties, the Company and Growellgranted to the other party (and the other party’s affiliates) a release of allknown and unknown claims of any nature arising between the parties through thedate of settlement, as well as a release against future claims under agreementsbetween the parties that were terminated as a part of the settlement.  The settlement agreement provided that allagreements of any nature between the parties and their respective affiliateswere terminated as of the date of settlement, with the exception of certainconfidentiality agreements, a Liquidmetal coatings distribution agreement, andfuture rights under the die casting agreement pursuant to which Growellpurchased the die casting machines and obtained a license to make auto partsfrom Liquidmetal alloys.  The settlementagreement also includes, as an accommodation to Growell, if the Company becomesaware of any prospective customer that desires to purchase a proprietaryCompany casting machine at a time when Growell desires to sell any of itsLiquidmetal die casting machines, then the Company will not sell such diecasting machine to the prospective customer unless the Company first directsthe prospective customer to Growell and encourages the prospective customer topurchase the machine from Growell.

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

As an inducementfor Innometal to enter into the Settlement Amendment, James Kang, a directorand founder of the Company, has entered into a buy-sell agreement with Innometalwhereby Mr. Kang has agreed to personally purchase from Innometal, andInnometal has agreed to sell to Mr. Kang, the 1,700,000 shares issued toInnometal under the Settlement Amendment, with such purchase and sale to takeplace on October 31, 2006. The aggregate purchase price for the shares 

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payable by Mr.Kang under this buy-sell agreement will be approximately $2,800. In order tosecure his obligations under the buy-sell agreement, Mr. Kang has pledged toInnometal 500,000 shares of the company’s common stock currently held by him.Mr. Kang will receive no consideration from us in connection with his enteringinto this buy-sell agreement, and Mr. Kang will not have any registrationrights with respect to the shares purchased under the buy-sell agreement.

**7.  Product Warranty**

Managementestimates product warranties as a percentage of bulk alloy product sales earnedduring the period.  As of June 30, 2006,the Company used 5% of bulk alloy product sales as an estimate of warranties tobe claimed.  The percentage is based onindustry averages and historical information. During the three and six months ended June 30, 2006, the Companyrecorded $32 and $106, respectively, of warranty expense.  During the three and six months ended June30, 2005, the Company recorded $34 and $76, respectively, of warrantyexpense.  The product warranty accrualbalance is included in accounts payable and accrued expenses.

**8.  Notes Payable**

Senior Convertible Note

On March 3, 2004, the Company issued $9,924 of 6%senior convertible notes due 2007 (the “March Notes”) to investor groups in atransaction led by Michigan Venture Capital Co., Ltd, a South Korea-basedinstitutional investment firm, and IndiGo Ventures LLC, a New York-basedinvestment firm (the “Placement Agents”) that served as a financial advisor tothe Company for the transaction.  Thenotes 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 anytime into common stock at a price of $3.00 per share.  Investors in the private placement and thePlacement Agents received warrants to purchase an aggregate amount of up toapproximately 1.2 million shares of common stock, exercisable at $3.00 pershare for varying periods but no later than 100 days following theeffectiveness of a registration statement covering the resale of sharesissuable upon exercise of the warrants. In addition, the investors had the right to call for repayment of thenotes prior to maturity at any time after the second anniversary of the closingof the transaction.

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

Pursuant to EITF 00-19, “Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock”, the original fair value of the 1.2 million warrants of $1,302 has beenrecorded as warrant liabilities.  Theoriginal fair value was computed using the Black-Scholes pricing model underthe following assumptions: (1) expected life of 3 years; (2) volatility of 82%,(3) risk free interest of 0.95% and dividend rate of 0%.

In March 2004, the original fair value of the embeddedconversion feature of $7,595, the original fair value of the 0.6 millionwarrants issued to investors of $584, and the original fair value of 0.6million warrants issued to Placement Agents of $718 were recorded as discountsof the convertible note.  In addition,$581 direct costs incurred relating to issuance of the convertible note wererecorded as debt issuance cost in other assets.

During 2004, the Companyredeemed $4,465 of the outstanding note balance in cash.  The redemption resulted in a write down ofdebt issuance costs and debt discount of $3,571 to interest expense and areduction in conversion feature liabilities of $914 from cancellation of theembedded conversion feature of the redeemed notes to additional paid in capitalduring the year

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ended December 31,2004.  Further, 500,000 of warrantsoriginally issued to a financial advisor for the transaction expired duringJune 2004 and 163,748 of unexercised warrants originally issued to investorswere cancelled as a result of the Company’s redemption of the note balancesduring the year ended December 31, 2004. The 663,748 total expired and canceled warrants immediately prior to theexpiration and cancellation resulted in a reduction of warrant liability of $7and $279 to additional paid in capital and change in value of warrants,respectively, during the year ended December 31, 2004.

On August 19, 2004,the Company completed a private exchange offer for its March Notes with theremaining holders after the redemption. Under terms of the exchange offer, approximately $5,460 in aggregateprincipal amount of the March Notes have been exchanged for an aggregate of (i)$2,730 of 6% Senior Secured Notes Due 2007 (the “July 2007 Notes”) and (ii)$2,730 of 10% Senior Secured Notes Due 2005 (the “July 2005 Notes”),collectively referred to as “Exchange Notes”. The Exchange Notes are collateralized by certain patents owned by theCompany and second priority mortgage interest in plant facilities and certainequipment at our South Korea plant.  TheJuly 2005 Notes have a maturity date of July 29, 2005, and a conversion priceof $2.00 per share (compared to a conversion price of $3.00 per share under theMarch Notes).  The July 2005 Notes havebeen exchanged and redeemed subsequent to the close of the second quarter of2005 (see 2005 Senior Convertible Notes below). The July 2007 Notes have amaturity date of July 29, 2007, and a conversion price of $1.00 per share.   Further, the Exchange Notes are convertibleinto Common Stock, at the option of the Company, if at any time after theissuance of the notes, the closing per share price of the Common Stock exceeds$4.00 (as adjusted for stock splits, reverse splits, stock dividends, andrecapitalizations) for 30 consecutive trading days, and further provided thatthere has been effective registration during such period.  The convertible price of the Exchange Notesis subject to price adjustment for anti-dilution purposes.  As of June 30, 2006, the convertible price ofthe July 2007 Notes remained unchanged at $1.00 per share.  Holders of the July 2007 Notes also have theright to call for repayment of the July 2007 Notes prior to maturity at anytime after the second anniversary of the closing of the exchange offer.

A total of 563,151warrants to purchase our common stock at an exercise price of $3.00 pershare—all of which were previously issued in connection with the purchase ofthe March Notes—have been amended to provide for an extended expiration date ofMarch 1, 2006.  The warrants issued toplacement agents are to expire the later of March 1, 2006 or 100 days after theeffectiveness of registration of shares issuable under the warrants and seniorconvertible debt.  The warrant exerciseprice is subject to price adjustment for anti-dilution purposes.  There were 165,324 warrants outstanding andthe exercise price of the warrants was $2.72 per share as of June 30,2006.   

The exchange offerwas treated as an extinguishment of the March Notes in accordance with EITF No.96-19, "Debtors Accounting for a Modification or Exchange of DebtInstruments.”  The exchange resulted in a$2,941 loss from extinguishment of the March Notes, which consisted of writedown of $352 of deferred issue costs in other assets, $670 of debt discount,and an increase of $1,919 in conversion feature liability as a result of thechange in carrying value of exchanged notes.

In connection withthe private exchange offer, the Company issued $250 of private placement notesto certain Placement Agents as issuance costs. Of the $250 notes issued, $125 was paid in the form of long-term noteswhich is due in 2007 with interest rate of 6% per annum (July 2007 Notes) and$125 was paid in the form of short-term notes which is due in 2005 withinterest rate of 10% per annum (July 2005 Notes).  The July 2005 and July 2007 Notes areconvertible into Common Stock at $2.00 and $1.00, respectively, and have thesame terms as the Exchange Notes issued to the investors.  Further, $143 of original fair value of theembedded conversion feature from the $250 notes issued to Placement Agents wasrecorded as conversion feature liabilities during August 2004.

The Company was obligated, pursuant to a RegistrationRights Agreement, as amended by the Exchange Notes, between the Company, thePlacement Agents and the note holders to file a registration statement with theSecurities and Exchange Commission (“SEC”) to register the shares of CommonStock issuable upon conversion of the notes payable and the related warrantswithin 90 days following the effective closing date of the exchange notes (July29, 2004), and to use best efforts to cause such registration statement tobecome effective within 60 days following the SEC’s first written comments onthe registration statement.  Further, ifthe Company is not in compliance with the registration or listing requirements,the holders have rights to late registration payments equal to between 2% and3% of the purchase price paid for the unconverted notes for the first 30business days of late registration, and 1% and 3% for each 30 business daysthereafter, but no more than 18% of the purchase price of the unconverted notebalance.  Late registration fee of $1,028has been accrued as interest expense as of June 30, 2005.

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Interest payments are due quarterly, and failure tomake timely interest payments will result in increase in interest rate to 10%and 14% on the 6% and 10% senior convertible notes (“Default Rates”).  The Default Rates became effective on April1, 2005 from non-payment of a scheduled interest payment.  The Company became compliant with timelyinterest payments during the third quarter of fiscal year 2005, and as of June30, 2006, the Company has complied with all scheduled interest payments.

On August 9, 2005, the July 2005 Notes, accruedinterest and late registration fees were redeemed in cash and exchanged for 7%Convertible Secured Promissory Notes due August 2007.  Further, the July 2007 Notes have been amendedsubsequent to the close of the second quarter of 2005 to provide for an amendedand restated registration rights agreement, and amended and restated securityagreement.  During the three months endedJune 30, 2006, the Company accrued $186 in interest expense as a result ofreceiving a demand letter from a note holder under the amended and restatedregistration rights agreement for failure to timely file a registrationstatement and register the shares issuable under notes and warrants (see 2005Senior Convertible Notes below). Further, the July 2007 Notes and its related debt discount and deferredissuance cost are presented as current liability and current asset,respectively, as of June 30, 2006.

During the year ended December 31, 2005, $485 of theJuly 2007 Notes were converted into 485,750 of the Company’s common stock at aconversion price of $1.00 per share. Additionally, during the three months ended March 31, 2006, $59 of theJuly 2007 Notes were converted into 59,000 of the Company’s common stock at aconversion price of $1.00 per share.  Theconversion resulted in reduction of conversion feature liabilities of $541 and$27 to additional paid in capital for the year ended December 31, 2005 and forthe six months ended June 30, 2006, respectively.

The Company’s gross outstanding loan balance of theJuly 2007 Notes totaled $2,310 and $2,369 as of June 30, 2006 and December 31,2005, respectively.   As of June30, 2006 and December 31, 2005, un-amortized discounts for conversion feature andwarrants totaled $806 and $1,207, respectively, and other asset debt issuance coststotaled $29 and $43, respectively. Interest expense for the amortization of debt issuance cost and discounton note was $193 and $416, for the three months and six months ended June 30,2006, respectively, and $483 and $960 for the three and six months ended June30, 2005, respectively.  As of June 30,2006, the effective interest rate for the July 2007 Notes was 42%.

Pursuant toStatement of Financial Accounting Standards No. 133, “Accounting for Derivativeinstruments and Hedging Activities,” the Company is required to report a valueof the conversion liability as a fair value and record the fluctuation to thefair value of the conversion feature liability to current operations.  The change in the fair value of the conversionfeature liability resulted in a loss of $947 and $1,748 for the three and sixmonths ended June 30, 2006, respectively, and a gain of $1,167 and $2,282 forthe three and six months ended June 30, 2005, respectively.  The fair value of conversion feature liabilitywas $2,561 and $840 as of June 30, 2006 and December 31, 2005,respectively.  The fair value ofconversion liability outstanding at June 30, 2006 was computed using theBlack-Scholes model the following assumptions: (1) 1.08 years; (2) volatilityof 78%, (3) risk free interest of 5.21% and dividend rate of 0%. The fair valueof conversion feature liability outstanding at December 31, 2005 was computedusing the Black-Scholes model under the following assumptions: (1) 1.57 years;(2) volatility of 88%, (3) risk free interest of 4.41%and dividend rate of 0%.

Pursuant to EITF00-19, “Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company’s Own Stock”, the original relative fairvalues of the warrants of $1,302 have been recorded as warrant liability.  In addition, the Company is required toreport a value of the warrant as a fair value and record the fluctuation to thefair value of the warrant liability to current operations.  The change in the fair value of the warrantsresulted in a loss of $15 and $18 for the three and six months ended June 30,2006, respectively, and a gain of $154 and $287 for the three and six monthsended 2005, respectively.  The fair valueof warrants outstanding was $­19 and $0 as of June 30, 2006 and December 31,2005, respectively.  The fair value ofwarrants outstanding at June 30, 2006 was computed using the Black-Scholesmodel under the following assumptions: (1) expected life of 0.27 years; (2)volatility of 78%, (3) risk free interest of 5.01%and dividend rate of 0%. Thefair value of warrants outstanding at December 31, 2005 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%.

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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 2006Notes issued by the Company in the June 2005 Private Placement are unsecuredand was due on the earlier of June 13, 2006 or the consummation of afollow-on equity or debt offering or restructuring transaction pursuant towhich the Company receives gross proceeds of at least $4,000.  Prior tomaturity, the June 2006 Notes are interest-only, with interest payments duequarterly, at the rate of 10% per year.  The June 2006 Notes can beprepaid by the Company at any time without penalty.  If, within 120 daysfollowing the issue date of the June 2006 Notes, the Company either fails toredeem the notes for the principal amount and accrued interest thereon or failsto close a “Qualified Financing,” then the June 2006 Notes will thereafter beconvertible at a conversion price equal to seventy five percent (75%) of theclosing price of the Company’s common stock on the first trading dayimmediately preceding the conversion date.  A “Qualified Financing “ isdefined in the June 2006 Notes as any debt or equity financing of the Companyresulting in aggregate gross proceeds to the Company of at least $5,000 and inwhich the holders of at least sixty percent (60%) of the aggregate principalamount of the Company’s Long Term Notes due July 2007 either(i) agree that the equity or debt securities to be issued in suchfinancing shall be*pari passu* inorder of payment to the 2007 Notes held by them or (ii) exchange their2007 Notes for new securities in the financing transaction.  On August 9, 2005, the Company successfullycompleted Qualified Financing, which resulted in exchange and redemption of theConvertible Notes (see 2005 Senior Convertible Debt).  As a result, the Notes never becameconvertible.

As a part of theJune 2005 Private Placement, the Company issued warrants to the purchasers ofthe Notes giving them the right to purchase up to an aggregate of 812,500shares of the Company’s common stock.  In addition, warrants to purchase81,250 shares of the Company’s common stock were issued to the placement agentin the transaction.  The warrants have an exercise price of $2.00 pershare, provided that upon the consummation of the first ensuing public orprivate equity or debt offering or restructuring transaction in which theCompany receives gross proceeds of at least $3,250 (including withoutlimitation any restructuring of the Company’s previously issued 10% SeniorSecured Notes Due July 29, 2005), the exercise price will be automaticallyadjusted downward (but not upward) as of the closing date of such offering orrestructuring transaction so that it is equal to the lowest effective commonstock purchase price paid for any securities issued by the Company to theinvestors in such offering or restructuring transaction.  The warrantswill expire on June 13, 2010 and are subject to exercise price adjustmentfor anti-dilution purposes.  The exerciseprice of the warrants remained unchanged at $2.00 per share as of June 30,2006.

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

On August 9, 2005, the Notes were redeemed in cash and exchanged for 7%Convertible Secured Promissory Notes due August 2007 (see 2005 SeniorConvertible Notes below).  The exchangeoffer was treated as an extinguishment of the Notes in accordance with EITF No.96-19, “Debtors Accounting for a Modification or Exchange of Debt Instruments.”  The exchange resulted in a $1,247 loss fromextinguishment of the Notes which consists of write down of $240 of deferredissue costs in other assets, $92 of contra liability deferred issuance costs, and$915 of debt discount  as a result of thechange in carrying value of exchanged notes.

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On August 9, 2005, the Company entered into an amended and restatedregistration rights agreement with the holders of the warrants in connectionwith the August 2005 Private Placement. During the three months ended June 30, 2006, the Company accrued $120 ininterest expense as a result of receiving a demand letter in May 2006 from anoteholder under the amended and restated registration rights agreement forfailure to file timely a registration statement and registering the sharesissuable under the warrants (see 2005 Senior Convertible notes below).

Pursuant to EITF 00-19, “Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock”, the original fair values of the warrants of $1,160 have been recordedas warrant liability as the Company has not yet filed the registrationstatement.  In addition, the Company isrequired to report a value of the warrant as a fair value and record thefluctuation to the fair value of the warrant liability to currentoperations.  The change in the fair valueof the warrants resulted in a loss of $321 and $623 for the three and sixmonths ended June 30, 2006, respectively, and a loss of $254 for the three andsix months ended June 30, 2005.  The fairvalue of the warrants outstanding was $1,041, and $418 at June 30, 2006 andDecember 31, 2005, respectively.  Thefair value of warrants outstanding at June 30, 2006 was computed using the Black-Scholesmodel under the following assumptions: (1) expected life of 3.95 years; (2)volatility of 78%, (3) risk free interest of 5.10%and dividend rate of 0%. Thefair value of warrants outstanding at December 31, 2005 was computed using theBlack-Scholes model under the following assumptions: (1) expected life of 4.45years; (2) volatility of 88%, (3) risk free interest of 4.35%and dividend rateof 0%.

2005 Senior Convertible Debt

On August 9, 2005, theCompany completed a private placement of $9,878 in principal amount of new 7%Convertible Secured Promissory Notes due August 2007 (the “August 2007 Notes”).  The issuance consisted of $5,000 cash,exchange of $1,284 in principal amount of previously issued 10% Senior SecuredNotes Due July 29, 2005 (the “July 2005 Notes”), the exchange of $2,996 inprincipal amount of previously issued 10% Convertible Unsecured Notes Due June2006 (the “June 2006 Notes”), satisfaction of accrued interest and lateregistration fees in the amount of $589 on the previously issued July 2005Notes, and satisfaction of accrued interest of $9 previously issued June 2006Notes.  The August 2007 Notes were issuedpursuant to a Securities Purchase Agreement dated effective as of August 2,2005 among the Company, the purchasers of the August 2007 Notes, and theholders of previously issued July 2005 Notes and June 2006 Notes of the Companydue June 2006.

Interest payments are duequarterly, and failure to make timely interest payments will result in increasein interest rates to 14% per annum on the August 2007 Notes (“Default Rates”).  As of June 30, 2006, the Company has madetimely interest payments.

The August 2007 Notes areconvertible into shares of the Company’s common stock at $2.00 per sharepursuant to an Amended and Restated Security Agreement.  The convertible price of the August 2007Notes is subject to price adjustment for anti-dilution purposes.  As of June 30, 2006, the convertible price ofthe August 2007 Notes remained unchanged at $2.00 per share.

Further, pursuant to Statementof Financial Accounting Standards No. 133, “Accounting for DerivativeInstruments and Hedging Activities,” EITF 00-19, “Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock,” EITF 00-27, “Application of Issue No. 98-5 to Certain ConvertibleInstruments,” and EITF 05-2 “The Meaning of ‘Conventional Convertible DebtInstrument’ in EITF Issue No. 00-19,” the original fair value of the embeddedconversion feature of $4,808 have been recorded as conversion feature liabilityas the debt is considered nonconventional convertible debt. The original fairvalue was computed using the Black-Scholes model under the followingassumptions: (1) expected life of 2 years; (2) volatility of 93%; (3) risk freeinterest of 4.06% and dividend rate of 0%. In addition, the Company is required to report a value of the conversionliability as a fair value and record the fluctuation to the fair value of theconversion feature liability to current operations.  The change in the fair value of theconversion feature liability resulted in a loss of $1,190 and $2,171 for thethree and six months ended June 30, 2006. The fair value of the conversion features outstanding as of June 30,2006 of $3,130 was computed using the Black-Scholes model under the followingassumptions: (1) 1.09years; (2) volatility of 78%, (3) risk free interest of 5.21% and dividend rateof 0%.  The fair value of conversionfeatures outstanding at December 31, 2005 of $959 was computed using the Black-Scholesmodel under the following assumptions: (1) 1.59 years; (2) volatility of 88%,(3) risk free interest of 4.41%and dividend rate of 0%.

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The August 2007 Notes are secured by substantially allassets of the Company and rank senior to all other obligations of the Company,other than the Company’s 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 the Company may obtain in the future,provided that the amount of the credit facility does not exceed 50% of eligibleinventory and 80% of eligible receivables. The August 2007 Notes willautomatically convert into common stock if the Company’s common stock has anaverage closing price of more than $5.00 per share during 30 consecutivetrading days.

The Company also issued warrants to the purchasers ofthe August 2007 Notes and placement agents giving them the right to purchase upto 2,469,470 and 414,495 shares of Company common stock, respectively, with anexercise price of  $2.00 per share, whichis subject to price adjustment for anti-dilution purposes.  As of June 30, 2006, the exercise price ofthe warrants remained unchanged at $2.00 per share. The warrants will expire onAugust 2, 2010.

Pursuant to EITF 00-19, “Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock”, the originalfair values of the warrants of $4,068 have been recorded as warrant liabilityas the Company has not yet filed the registration statement, which was computedusing the Black-Scholes pricing model under the following assumptions: (1)expected life of 5 years; (2) volatility of 93%; (3) risk free interest of4.17% and dividend rate of 0%.  Inaddition, the Company is required to report a value of the warrant as a fairvalue and record the fluctuation to the fair value of the warrant liability tocurrent operations.  The change in thefair value of the warrants resulted in a net loss of $1,047 and $2,032 for thethree and six months ended June 30, 2006, respectively.  The fair value of warrants outstanding was$3,406 as of June 30, 2006, which was computed using the Black-Scholes modelunder the following assumptions: (1) expected life of 4.09 years; (2)volatility of 78%, (3) risk free interest of 5.10% and dividend rate of0%.  The fair value of warrantsoutstanding at December 31, 2005 of $1,375 was computed using the Black-Scholesmodel under the following assumptions: (1) expected life of 4.59 years; (2)volatility of 88%, (3) risk free interest of 4.35% and dividend rate of 0%.

In connection with theAugust 2005 Private Placement, the Company 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 andrestated registration rights agreement replaced all other registration rightsagreements previously entered into by us in connection with the private sale byus of convertible notes and warrants. Under the amended and restated registration rights agreement, theCompany is required to file a resale registration statement for the shares underlyingall of our outstanding convertible notes and warrants, as described above, byOctober 31, 2005, to enable the resale of such shares by the sellingstockholders on a delayed or continuous basis under Rule 415 of the SecuritiesAct.  The Company is then required tocause such registration statement to become effective within 60 days after wereceive the first written comments on the registration statement from the SEC,or if the SEC notifies us that it will not review the registration statement,within five days after such notification. The Company will be subject to certain monetary penalties, as set forthin the registration rights agreement, if the registration statement is notfiled or does not become effective on a timely basis.  Specifically, if the Company does not filethe registration statement on a timely basis, we will be obligated to pay alate filing fee to the selling stockholders in the amount of 3% of the warrantexercise price on each of the warrants held by them plus 3% of the principalamount of the outstanding notes held by them. This fee will be payable for each period of 30 business days that thefiling of the registration statement is made past the required filing date, andthe payments will be due 10 business days following the end of each 30-dayperiod.  If the registration statementhas not been declared effective by the required effective date, the Companywill be obligated to pay a monthly late registration fee to the sellingstockholders in the amount of 2% of the aggregate warrant exercise prices andaggregate note principal amounts for the first 30 business days after therequired effective date, and 1% for each 30-business day period thereafteruntil the registration statement is declared effective.  Notwithstanding the foregoing, the latefiling fees and late registration fees will not exceed 18% of the aggregatewarrant exercise prices and aggregate note principal amounts.

On December 6, 2005, theCompany received a letter from a representative of the holders of the August2007 Notes demanding the payment of a late filing fee by us for the periodfollowing October 31, 2005, but under the terms of the amended and restatedregistration rights agreement, the Company did not believe that it wasobligated to pay any late filing fees unless and until the Company failed tofile the registration statement by December 13, 2005, which was the last day ofthe first 30-business day period following October 31, 2005.  On December 9, 2005 the Company filed theregistration statement, which was within the 30-day period and believed it hadcured the default notice.

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On May 12, 2006, the Company received a letter from one holder holding$500 of the August 2007 Notes demanding immediate payment of late filing feesand late registration fees for the period following October 31, 2005 throughMay 2, 2006.  As a result of the late feeprovisions of the restated registration rights agreement, we are obligated topay late filing and late registration fees accrued through June 30, 2006 of upto $1,048 to all of the holders of the August 2007 Notes.   In addition, the letter purported toconstitute a notice of default under the August 2007 Notes and July 2007 Notes(the “Notes”) as a result of our failure to the late filing and lateregistration fees.   The Company accrued$1,354 of outstanding late filing and late registration fees to holders of theCompany’s convertible debt as interest expense as of June 30, 2006.  Under the terms of the Notes, if a default isnot cured by us within thirty (30) days of notice thereof, the holder has theright to accelerate all principal and interest due under the Notes.  As of June 30, 2006, the Company has not paidany amounts under the demand letter and the Company currently is innegotiations with the holder regarding the matters set forth in the letter withthe goal of preventing any acceleration of amounts due under the Notes (SeeNote 14).  Further, the Notes and itsrelated debt discount and debt issuance cost is presented as current liabilityand current asset, respectively, as of June 30, 2006.

Our gross outstanding loan balance of the August 2007Notes totaled $9,878 as of June 30, 2006 and December 31, 2005.  As of June 30, 2006 and December 31, 2005,un-amortized discounts for conversion feature and warrants totaled $4,514 and$6,587, and other asset debt issuance costs totaled $257 and $384, and contraliability debt issuance cost totaled $318 and $464, respectively.  Interest expense for the amortization of debtissuance cost and discount on note was $1,036 and $2,214 for the three andsix  months ended June 30, 2006.  As of June 30, 2006, the effective interestrate for the August 2007 Notes was 54%.

Subordinated PromissoryNote

On March 17, 2006, theCompany issued a $1,000 10% subordinated promissory note due October 16, 2006(the “October 2006 Note”) to Atlantic Realty Group, Inc., a company controlledby Jack Chitayat, a former director of the Company.  The October 2006 Noteis unsecured and subordinated to all prior indebtedness of the Company. All accrued interest and unpaid principal under the note will be due October16, 2006.  The proceeds from the October 2006 Note is to be used solelyfor working capital purposes.  In connection with the October 2006 Note,the Company issued warrants to purchase an aggregate amount of up to 125,000shares of common stock, exercisable at $2.00 per share.  The warrants willexpire on March 17, 2009, and include price adjustment provisions foranti-dilution purposes.  As of June 30, 2006, the exercise price of thewarrants remained unchanged at $2.00 per share. There are no registrationrights of the shares issuable from the exercise of the warrants.  Further,cashless exercise of the warrants is permitted.

Pursuant to EITF 00-19, “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock,” the original fair value of the warrants of $84 have beenrecorded as warrant liability as the warrant holders can elect to settle thewarrants in cash, which was computed using Black-Scholes pricing model underthe following assumptions: (1) expected life of 2.96 years; (2) volatility of84%; (3) risk free interest of 4.64% and dividend rate of 0%.  Inaddition, the Company is required to report a value of the warrant as a fairvalue and record the fluctuation to the fair value of the warrant liability tocurrent operations.  The change in the fair value of the warrants resultedin a net loss of $40 for the three and six months ended June 30, 2006 and isrecorded as change in value of warrants.  The fair value of warrantsoutstanding at June 30, 2006 of $123 was computed using the Black-Scholes modelunder the following assumptions: (1) expected life of 2.71 years; (2) volatilityof 78%, (3) risk free interest of 5.13%and dividend rate of 0%.

Our gross outstanding loan balance of the October 2006Note totaled $1,000 as of June 30, 2006 and is included in short-term debt.  As of June 30, 2006, un-amortized discountsfor warrants totaled $43.  Interestexpense for the amortization of discount on the note was $28 and $41 for thethree and six months ended June 30, 2006. As of June 30, 2006, the effective interest rate for the October 2006Note was 22%. 

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Unsecured Subordinated Notes

On May 17, 2006, the Companycompleted a private placement of 8% unsecured subordinated notes (the “May 2006Private Placement”) in the aggregate principal amount of $3,625 (the “August2007 Subordinated Notes”), together with warrants to purchase up to an aggregateof 705,233 shares of the Company’s common stock.  The May 2006 Private Placement, was madesolely to “accredited investors” including Ricardo A. Salas, the Company’sPresident and CEO.  Mr Salas holds $100of the August 2007 Subordinated Notes.

The August 2007 SubordinatedNotes are unsecured and will become due on the earlier of August 17, 2007 orthe consummation of a follow-on equity or debt offering pursuant to which theCompany receives gross proceeds of at least $6,000 to be used for working capitalpurposes and repayment of debt, but excluding financings for the purpose ofpurchasing capital assets (a “Follow-On Financing”).  Interest on the unpaid principal balance ofeach August 2007 Subordinated Note accrues at the rate of 8% per annum from May17, 2006 until maturity date.  The August2007 Subordinated Notes can be prepaid by the Company at any time withoutpenalty.

The August 2007 SubordinatedNotes is subordinate in right of payment and in all other respects to the July2007 Notes, the August 2007 Notes, and any other notes that may be issued bythe Company after May 17, 2006 in exchange for or in satisfaction of any July2007 Notes or August 2007 Notes (collectively, the “Senior Notes”).  Notwithstanding the maturity date of theAugust 2007 Subordinated Notes, the Company will not make any payments ofprincipal, interest or otherwise under the August 2007 Subordinated Notes untilall amounts due and payable under the Senior Notes have been satisfied in full(whether through cash payments or conversion).

The August 2007 SubordinatedNotes also gives the investors the opportunity to participate in a Follow-OnFinancing at a discounted rate.  If aholder of the August 2007 Notes elects to participate in a Follow-On Financing,the holder of the Note will be entitled to purchase the securities beingoffered in the Follow-On Financing at a discount of 7% of the gross per sharepurchase price (in the case of an offering of common stock or preferred stock)or 7% of the face amount of the security being sold (in the case of an offeringof debt securities).

As part of the August 2007Private Placement, the Company issued warrants to the purchasers of the Notesgiving them right to purchase up to an aggregate of 705,233 shares of theCompany’s common stock.  In addition,warrants to purchase 68,508 shares of the Company’s common stock were issued tothe placement agent in the transaction. The warrants have an exercise price of $2.58 per share, which is subjectto price adjustment for anti-dilution purposes. The exercise price of the warrants remained unchanged at $2.58 pershare.  The warrants will expire on May17, 2011.

Pursuant to EITF 00-19, “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock,” the original fair value of the warrants of $905 have beenrecorded as warrant liability as the warrant holders can elect to settle thewarrants in cash, which was computed using Black-Scholes pricing model underthe following assumptions: (1) expected life of 5.00 years; (2) volatility of80%; (3) risk free interest of 5.03% and dividend rate of 0%.  In addition, the Company is required toreport a value of the warrant as a fair value and record the fluctuation to thefair value of the warrant liability to current operations.  The change in the fair value of the warrantsresulted in a net loss of $2 for the three and six months ended June 30, 2006,which is recorded as change in value of warrants.  The fair value of the warrants outstanding atJune 30, 2006 of $907 was computed using the Black-Scholes model under thefollowing assumptions: (1) expected life of 4.88 years; (2) volatility of 78%;(3) risk free interest of 5.10% and dividend rate of 0%.

Our gross outstanding loanbalance of the August 2007 Subordinated Notes totaled $3,625 as of June 30,2006.  As of June 30, 2006, un-amortizeddiscounts for warrants totaled $807. Interest expense for the amortization of discount on the note was $98for the three and six months ended June 30, 2006.  As of June 30, 2006, the effective interestrate for the August 2007 Subordinated Notes was 38%.

Factoring Agreement

The Companyentered into a Factoring, Loan, and Security Agreement (the “Agreement”) with afinancing company on April 21, 2005, which allows for borrowings of up to$1,500, however, the financing company may, from time to time, allow for additionalborrowings at its discretion.  TheAgreement expires on April 21, 2006, and automatically renews annuallythereafter. All borrowings are secured by outstanding receivables specificallyassigned to the financing company. Assigned receivables are considered “Approved” or “Non-Approved” by thefinancing company.  On January 27, 2006,the terms of the

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agreement wereamended whereas advances are made on 85% of Approved receivables assigned and50% of Non-Approved receivables assigned. Payments on assigned receivables are received directly by the financingcompany, and applied to outstanding advances. All outstanding advances and uncollected assigned receivables aresubject to fees and interest charges ranging from 0.55% to 1.5% plus prime rateas published by the Wall Street Journal, with a minimum annual fee of $30. Allreceivables assigned and advances made are subject to return and recall by thefinancing company, respectively.  Assuch, the advances have been classified as short-term secured borrowings inaccordance with SFAS 140 “Accounting for Transfer and Servicing of FinancialAssets and Extinguishments of Liabilities.” As of June 30, 2006, the Company has borrowed $7,417 and repaid $6,092.The total outstanding advance made under the agreement is $1,873 and $550 as ofJune 30, 2006 and December 31, 2005, respectively, which is presented asshort-term debt.   The weighted averagerate of interest for borrowings made under the Agreement was 9.27% for the sixmonths ended June 30, 2006.  As of June30, 2006, the Company’s availability for future borrowing under the agreementis based on the discretion of the financing company, which is contingent onapproval of eligible receivables by the financing company.  

Kookmin Note

On February 4, 2003, our Korean subsidiary received6,500,000 in South Korean Won, or approximately $5,488, under a loan fromKookmin Bank of South Korea.  The loanbears interest at an annual rate of 7.1%. In the event of delayed repayment, the interest rate increases to amaximum of 21%, depending on the length of time the repayment is delayed.  As of June 30, 2006, the interest rate wasincreased to 9.2% from delayed interest payments made.  This loan is collateralized by the plantfacilities and certain equipment in South Korea.  During the first eighteen months from theorigination date, interest was payable on a monthly basis.  In October 2003, the Company paid $873 ofprincipal at the request of Kookmin Bank due to the sale of machines that hadbeen part of the collateral on the loan. Subsequent to October 31, 2003, Kookmin Bank requested that the Companypay an additional $866 of principal by February 2004 due to the Company’scurrent credit rating.  The Company madetwo payments on the requested additional loan pay down in November and December2003 of $320 and $205, respectively.  Theremaining payment of $341 was subsequently made in February 2004.  Beginning in September 2004, the Company isrequired to make equal monthly installments of principal and interest to repaythe remaining balance of the loan over a 36-month period.  Principal payments made to Kookmin Banktotaled $508 for the six months ended June 30, 2006, which includes $243 offoreign exchange translation loss.  Theoutstanding loan balance totaled $2,282 and $2,790, of which $1,413 and $1,343is included in current portion of long-term debt, as of June 30, 2006 andDecember 31, 2005, respectively.

**9.         Stock CompensationPlan**

During each of the three and six months ended June 30, 2006, under theCompany’s 2002 Non-employee Director Stock Option Plan which provides for thegrant of stock options to non-employee directors, the Company  granted options to purchase 60,000 of theCompany’s common shares for an average exercise price of $0.77.  Further, all options granted under this planhad exercise prices that were equal to the fair market value on the date ofgrant.

During each of thethree and six months ended June 30, 2006, under the Company’s 2002 EquityIncentive Plan which provides for the grant of stock options to officers,employees, consultants and directors of the Company and its subsidiaries, theCompany granted options to purchase 862,500 of the Company’s common shares for anaverage exercise price of $1.44. Further, all options granted under this plan had exercise prices thatwere equal to the fair market value on the date of grant.

In March 2006, one of the former non-employee directors of our companywas given the opportunity to receive shares of stock under the plan in lieu ofpast-due director and committee fees that were due to him for periods throughDecember 31, 2005.  Such shares were issuable to him at an average priceof $1.50 per share.

In April 2006, two of the non-employee directors ofour company were given the opportunity to receive shares of stock under the 2002Equity Incentive Plan in lieu of the director and committee fees that were dueto them for periods through December 31, 2006. Such shares were issuable to them at an average price of $0.88 pershare.  As of June 30, 2006, a total of109,437 shares were issued to non-employee directors in lieu of these past-duefees.

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In May 2006, the Company’s Chief Executive Officer was given the opportunityto receive shares of stock under the 2002 Equity Incentive Plan in lieu ofpast-due consulting fees that were due him for periods through December 31,2005.  A total of 28,960 shares wereissued to him at an average price of $1.41 per share.

The Company canceled 10,000 and 433,032 options during the three and sixmonths ended June 30, 2006, respectively, for terminated employees anddirectors.

**10.      Segment Reporting and GeographicInformation**

SFAS No. 131,*Disclosures about Segments of an Enterprise andRelated Information,*requires companies to provide certaininformation about their operating segments. In April 2002, the Company began classifying operations into tworeportable segments: Liquidmetal alloy industrial coatings and bulk Liquidmetalalloys.  The Liquidmetal alloy industrialcoatings are used primarily as a protective coating for industrial machineryand equipment, such as drill pipe used by the oil drilling industry and boilertubes used by coal burning power plants. Bulk Liquidmetal alloys include market opportunities to manufacture andsell casing components for electronic devices, medical devices, sporting goods,tooling, prototype sampling, defense applications and metal processingequipment.  Primarily, the expensesincurred by the bulk Liquidmetal alloy segment are research and developmentcosts and selling expenses associated with identifying and developing marketopportunities.  Bulk Liquidmetal alloysproducts can be distinguished from Liquidmetal alloy coatings in that the bulkLiquidmetal alloy can have significant thickness, up to approximately one inch,which allows for their use in a wider variety of applications other than a thinprotective coating applied to machinery and equipment.   Revenue and expenses associated with researchand development services and product licensing arrangements are included in thebulk Liquidmetal alloy segment.  Theaccounting policies of the reportable segments are the same as those describedin Note 4 to the consolidated financial statements included in the Company’sForm 10-K filed with the Securities and Exchange Commission on March 16, 2006,as amended by Form 10-K/A filed on March 31, 2006, April 25, 2006, and July 20,2006.

Summarizedfinancial information concerning the Company’s reportable segments is shown inthe following tables:
| ** **                                                         | ** ** | **Coatings** | ** ** | **Bulk Alloy** | ** ** | **Segment Totals** | ** ** |
|--------------------------------------------------------------------|------------|--------------|------------|---------------------|------------|-------------------------|------------|
| Three months  ended June 30, 2006                                  |       |         |       |                |       |                    |       |
| Revenue to external customers                                      |       | $            | 1,743      |                | $          | 5,347                   |       | $ | 7,090 |   |
| Gross profit                                                       |       | 674          |       | 852                 |       | 1,526                   |       |
| Income (loss) before interest expense and  discontinued operations |       | 477          |       | 31                  |       | 508                     |       |
| Total identifiable assets at end of period                         |       | 1,002        |       | 19,584              |       | 20,586                  |       |
|                                                               |       |         |       |                |       |                    |       |
| Three months  ended June 30, 2005                                  |       |         |       |                |       |                    |       |
| Revenue to external customers                                      |       | $            | 1,332      |                | $          | 2,395                   |       | $ | 3,727 |   |
| Gross profit (loss)                                                |       | 574          |       | (809                | )          | (235                    | )          |
| Income (loss) before interest expense and  discontinued operations |       | 435          |       | (4,691              | )          | (4,256                  | )          |
| Total identifiable assets at end of period                         |       | 1,170        |       | 17,228              |       | 18,398                  |       |
|                                                               |       |         |       |                |       |                    |       |
| Six months ended  June 30, 2006                                    |       |         |       |                |       |                    |       |
| Revenue to external customers                                      |       | $            | 4,127      |                | $          | 9,518                   |       | $ | 13,645 |   |
| Gross profit                                                       |       | 1,664        |       | 1,094               |       | 2,758                   |       |
| Income (loss) before interest expense and  discontinued operations |       | 1,282        |       | (355                | )          | 927                     |       |
| Total identifiable assets at end of period                         |       | 1,002        |       | 19,584              |       | 20,586                  |       |
|                                                               |       |         |       |                |       |                    |       |
| Six months ended  June 30, 2005                                    |       |         |       |                |       |                    |       |
| Revenue to external customers                                      |       | $            | 2,381      |                | $          | 4,189                   |       | $ | 6,570 |   |
| Gross profit (loss)                                                |       | 1,056        |       | (1,283              | )          | (227                    | )          |
| Income (loss) before interest expense and  discontinued operations |       | 762          |       | (5,840              | )          | (5,078                  | )          |
| Total  identifiable assets at end of period                        |       | 1,170        |       | 17,228              |       | 18,398                  |       |

 

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Reconciling information between reportable segments and the Company’sconsolidated totals is shown in the following table:
| ** **                                                                   | ** ** | **For the Three Months** | ** ** | **For the Six Months** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                   | ** ** | **Ended June 30,**            | ** ** | **Ended June 30,**          | ** ** |
| ** **                                                                   | ** ** | **2006**                                | ** ** | **2005**                              | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                   | ** ** | **(Restated)**                          | ** ** | **(Restated)**                        | ** ** |
|                                                                         |       |                                    |       |                                  |       |   |   |   |   |
| Total segment  income (loss) before minority interest, interest expense      |       | $                                       | 508        |                                  | $          | (4,256 | ) | $ | 927 |   | $ | (5,078 | ) |
| General and administrative expenses, excluded                                |       | 1,539                                   |       | 1,153                                 |       | 3,155 |   | 3,310 |   |
|                                                                         |       |                                    |       |                                  |       |   |   |   |   |
| Consolidated  loss before interest, other income, income taxes, minority int |       | (1,031                                  | )          | (5,409                                | )          | (2,228 | ) | (8,388 | ) |
| Change in value of warrants, net                                             |       | (1,426                                  | )          | (100                                  | )          | (2,715 | ) | 33 |   |
| Change in value of conversion feature                                        |       | (2,137                                  | )          | 1,167                                 |       | (3,920 | ) | 2,282 |   |
| Interest expense                                                             |       | (3,277                                  | )          | (1,181                                | )          | (5,059 | ) | (2,718 | ) |
| Interest income                                                              |       | 7                                       |       | 1                                     |       | 9 |   | 7 |   |
| Consolidated net loss                                                        |       | $                                       | (7,864     | )                                     | $          | (5,522 | ) | $ | (13,913 | ) | $ | (8,784 | ) |

Included in bulkalloy segment income for the three and six months ended June 30, 2006 is $92and $572 of other income, respectively, recognized from $92 gain on disposal ofidle equipment (see Note 5) and $480 gain on termination of a distributionagreement in March 2006 (see Note 12)

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

Revenues from sales to companies in the United Stateswere $3,150 and $1,925 during the three months ended June 30, 2006 and 2005,respectively.  The revenue related to theUnited States of America was earned under defense-related research anddevelopment contracts, sales of coatings products, and sales of Liquidmetalbulk alloy products.

As of December 31, 2005, one customer represented 12%,or $288, of the total outstanding trade accounts receivable.  As of June 30, 2006, one customer represented23%, or $997, of the total outstanding trade accounts receivable.  One customer represented 10%, or $1,306 oftotal sales for the six months ended June 30, 2006.   Two customers represented 23%, or $1,535, oftotal sales for the six months ended of June 30, 2005.

During the three months ended June 30, 2006, theCompany had revenues from companies outside of the United States of $3,940 ofwhich $1,043 represented sales to companies located in South Korea.  During the three months ended June 30, 2005,the Company had revenue from sales to companies outside of the United States of$1,802 of which $971 represented sales to companies located in SouthKorea.  The revenue related to sales tocompanies outside of the United States was from bulk alloy products.

Long-lived assetsinclude net property, plant, and equipment, and net intangible assets. TheCompany had long-lived assets of $1,754 and $2,107 located in the United Statesat June 30, 2006 and December 31, 2005, respectively. The Company hadlong-lived assets of $12,665 and $12,846 located in South Korea at June 30,2006 and December 31, 2005, respectively.

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Reconcilinginformation between reportable segments and the Company’s consolidated totalsis shown in the following table:
|                                            | ** ** | **June 30,** | ** ** |
|--------------------------------------------|------------|-------------------|------------|
| ** **                                 | ** ** | **2006**          | ** ** |
|                                       |       |              |       |
| Total segment assets                       |       | $                 | 20,586     |   |
| Cash and cash  equivalents                 |       | 1,912             |       |
| Prepaid expenses  and other current assets |       | 401               |       |
| Other property,  plant and equipment       |       | 353               |       |
| Intangibles, net                           |       | 1,192             |       |
| Other assets                               |       | 542               |       |
| Total consolidated assets                  |       | $                 | 24,986     |   |

Assets excludedfrom segment assets include assets attributable to the Company’s corporate headquarters.  The Company’s largest assets consist of cashand intangible assets, which consist primarily of the Company’s patents andtrademarks.

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

Basic earnings per share (“EPS”)is computed by dividing earnings (loss) attributable to common shareholders bythe weighted average number of common shares outstanding for the periods.Diluted EPS reflects the potential dilution of securities that could share inthe earnings.

Options to purchase 8,483,223shares of common stock at prices ranging from $0.77 to $15.00 per share wereoutstanding at June 30, 2006, but were not included in the computation ofdiluted EPS for the same period as the inclusion would have beenantidilutive.  Warrants to purchase 4,841,780 shares of common stock at prices rangingfrom $2.00 to $2.72 per share outstanding at June 30, 2006, were not includedin the computation of diluted EPS for the same period as the inclusion wouldhave been antidilutive.  7,248,685 and 6,973,877 of convertibleshares from the senior convertible debt at June 30, 2006 and 2005,respectively, were not included in the computation of diluted EPS for the sameperiod because the inclusion would have been antidilutive.

**12.      Commitmentsand Contingencies**

The Company is from time to time a party to certainlegal proceedings arising in the ordinary course of business. Although outcomescannot be predicted with certainty, the Company does not believe that any legalproceeding to which it is a party will have a material adverse effect on theCompany’s financial position, results of operations, and cash flows.

In April 2006, the Company reached agreements inprinciple to settle our previously-disclosed consolidated securities classaction and shareholder derivative actions.

The settlement covers a series of nine securitiesclass action lawsuits that were filed against the Company beginning inApril 2004 on behalf of persons who purchased the Company’s common stockbetween May 21, 2002 and May 13, 2004, in connection with the Company’sinitial public offering in May 2002.  These actions, which werebrought under the federal securities laws against the Company and certainof its former and current directors and officers, were consolidated in theUnited States District Court for the Middle District of Florida, TampaDivision.  These cases alleged that the Prospectus issued in connectionwith the initial public offering in May 2002 contained materialmisrepresentations and omissions regarding the Company’s historical financialcondition and regarding a personal stock transaction by the Company’s formerchief executive officer.  They also alleged that the Company and certainof its present and former officers and directors engaged in improper revenuerecognition with respect to certain of the Company’s business transactions,failed to maintain adequate internal controls, and knowingly disclosedunrealistic but favorable information about market demand for and commercialviability of the Company’s products to artificially inflate the value of theCompany’ stock.

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In addition to the securities class actions, inMay 2004, two shareholder derivative actions were filed in the SuperiorCourt of Orange County, California.  Shortly thereafter, one additionalshareholder derivative action was filed in the United States District Court forthe Middle District of Florida, Tampa Division.  These derivative actionswere brought by certain shareholders against certain of the Company’s presentand former officers and directors as well as the Company (as a nominal defendant). The suits alleged that the defendants breached various fiduciary duties andotherwise violated state law based primarily upon the same underlying facts andcircumstances as alleged in the federal securities classaction.  The settlement also covers these derivative actions.

If approved by the courts, the agreements would settlethe consolidated class action litigation entitled *Primavera Investors v. Liquidmetal Technologies, Inc., et al.*,the consolidated shareholder derivative actions entitled *Brian Clair, Derivatively on Behalf of LiquidmetalTechnologies, Inc. v. John Kang, et al*. and *Joseph Durgin, Derivatively on Behalf of LiquidmetalTechnologies, Inc. v. John Kang, et al*., and the shareholderderivative action entitled *Robert Story v.John Kang, et al.,* pending in the United States District Court forthe Middle District of Florida, Tampa Division, the Superior Court of OrangeCounty, California, and the United States District Court for the MiddleDistrict of Florida, Tampa Division, respectively.

As part of the agreements, the Company’s directors’and officers’ liability insurance carriers will contribute a total of $7,500 tosettle all of the actions: $7,025 for the consolidated class action and $475for the two derivative actions. The funds paid to settle the consolidated classaction will be principally paid into an escrow account within a specifiedperiod of time after the federal court grants preliminary approval of thesettlement. The funds will be disbursed to certain purchasers of the Company’ssecurities according to a distribution plan to be devised and approved by thefederal court. In addition, the Company will commit to maintaining orimplementing various corporate governance measures in connection with thesettlement of the derivative actions.

Taking into account the insurance contribution, thenet cost of the settlement to the Company should be approximately $500, whichis the insurance deductible the Company paid over several quarters ending inthe third quarter of 2005, and which was previously recorded as a charge.

In March 1996, the Company entered into a distributionagreement whereby it granted to a third party exclusive rights to market andsell golf products incorporating Liquidmetal Technology to certain Japanesesporting equipment companies.  The thirdparty paid the Company a $1,000 distribution fee as part of this agreement, ofwhich a portion was refundable according to a formula based on the gross profitearned by the third party.  The remainingunearned distribution fee of $830 has not been refunded.  On March 28, 2003, the distribution agreementwas terminated and the Company entered into a new agreement to pay to the samethird party a commission on the net sales price of all Liquidmetal golfequipment that is shipped by the Company or its affiliates to Japanese golfcompanies for sale into the Japanese end-market.  This commission was to be applied to golfequipment shipped by the Company or its affiliates during the period beginningon March 28, 2003 and ending on March 28, 2006. If, by March 28, 2006, the Company has not paid $350 in commissionpayments, the balance between commission paid and $350 will be paid by April30, 2006, thereby guaranteeing the third party a $350 minimum payment duringthe term of the agreement.  As ofDecember 31, 2005, the unearned distribution fee remained unchanged at$830.  As of June 30, 2006, the Companyhas not paid the minimum commission and accrued $350 from the unearneddistribution fee for minimum payments due in accounts payable and accruedliabilities.  Further, the Companyrecognized net balance of the unearned distribution fee of $480 as other incomeduring the six months ended June 30, 2006. The Company is currently is in theprocess of renegotiating the distribution agreement with the same third partyto settle the balance.

On June 26, 2006, theCompany entered into a joint venture agreement with SAGA, SpA in Padova, Italy,(“SAGA”) a specialist precision parts manufacturer.  The joint venture isnamed Liquidmetal SAGA Italy, Srl (“LSI”).  The Company also entered intoan exclusive manufacturing license agreement for the eyewear industry withLSI.  Under the joint venture agreement, the Company has option to buyownership interest in LSI, initially, of 19.9% to up to 50%.  The Companyhas until September 30, 2006 to exercise the 19.9% interest in LSI and willhave two years to purchase the additional interest at a nominal price.  Ifthe Company does not purchase the additional interest during the first twoyears of the agreement, the Company will be able to purchase the additionalinterest at a price equal to 30.1% of LSI’s then outstanding net equity. As of June 30, 2006 and as of the filing of this Form 10Q, the Company has notpurchased any interest in the joint venture.

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Under the licensingagreement, at any time following 18 months after the effective date of theagreement, LSI may exercise its option to sell to the Company certain businessassets including manufacturing equipment acquired under the joint venture.  During the three months ended June 30, 2006,the Company recognized revenues of $236 of Liquidmetal alloys sold to SAGA foruse in the joint venture. The Company anticipates the alloys to be fullyutilized by the joint venture prior to the 18 month period.

**13.    RelatedParty Transactions**

In June 2003, the Companyentered into an exclusive, ten-year license agreement with LLPG, Inc. (“LLPG”),a corporation headed by, Jack Chitayat, a former director of the Company.  Under the terms of the agreement, LLPG hasthe right to commercialize Liquidmetal alloys, particularly precious-metalbased compositions, in jewelry and high-end luxury product markets.  The Company, in turn, will receive royaltypayments over the life of the contract on all Liquidmetal products produced andsold by LLPG.

The Company is a party to a consulting agreementwith Chitnis Consulting, Inc., which is owned 100% by Shekhar Chitnis, a formerdirector and executive officer of the Company. Under this agreement, the Company engaged Chitnis Consulting to provideconsulting services on an as-needed basis through December 31, 2005.  On January 1, 2006, the term of the agreementwas extended to December 31, 2006. During each of the three and six months ended June 30, 2006, the Companyincurred $0 in consulting fees from Chitnis Consulting, respectively.  During each of the three and six months endedJune 30, 2005, the Company incurred $13 and $25 in consulting fees from ChitnisConsulting, respectively.

The Company is aparty to a consulting agreement with William 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. In April 2006, the Company entered into an agreement with Mr. Johnsoneffective from January 1, 2006 through December 31, 2006.  During each of the three and six months endedJune 30, 2006, we incurred $15 and $15 in consulting fees from Mr. Johnson,respectively. During the three and six months ended June30, 2005, we incurred$5 and $10 in consulting fees from Mr. Johnson, respectively.

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

The Audit Committee of the Company’s Board ofDirectors conducted an independent inquiry into the above-describedtransactions with the aid of independent legal counsel and, as a result of suchinquiry, the Audit Committee concluded that the transactions should haveresulted in a liability to the Company under Section 16(b) in the amount of$302.  Mr. Kang has acknowledged thisliability, and in an agreement negotiated between Mr. Kang and the AuditCommittee and approved by the full Board, Mr. Kang will pay this liabilitythrough periodic installments in 2005 and 2006. As a result, the Company accrued for the $302 receivable in other assetsand other income as of December 31, 2004. The above-described transactions involving GrowellMetal was reported on a new Form 4 filed by Mr. Kang on November15, 2004, and the open-market purchases were previously reported on a timelybasis in August 2002.  As of December 31,2005, the outstanding amount of the receivable was $235, which is included inother assets, and has remained unchanged as of June 30, 2006.

During the six months ended 2005, the Company executeda $198 promissory note with CK Cho, member of our Board of Directors, forworking capital purposes. The note was due and paid in full as of June 30,2005. The note had an annual rate of interest of 6% which resulted in theCompany paying approximately $2 in interest. Mr. Cho also held $620 of SeniorConvertible Notes and held 92,584 exercisable warrants as of December 31,2005 and June 30, 2006. Further, during 2005, Mr. Cho advancedapproximately $1,260 to cover short-term liquidity needs. The advances weremade without interest and were repaid as of December 31, 2005.  There were no such advances during the sixmonths ended June 30, 2006.

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During the six months ended June 30, 2006, RicardoSalas, our President and Chief Executive Officer advanced the Company $100 tocover short-term liquidity needs. The advance was made without interest andwere repaid during the quarter ended March 31, 2006. During 2005, RicardoSalas, our President and Chief Executive Officer, and Young Ham, our ChiefFinancial Officer, advanced the company $75 and $133 to cover short-termliquidity needs, respectively. The advances were made without interest and wererepaid as of December 31, 2005. Mr. Salas held $310 of senior convertiblenotes and held 46,292 warrants as of December 31, 2005. As of June 30,2006, Mr. Salas held $310 million of senior convertible Notes and $100 ofour 8% unsecured subordinated notes and 65,672 warrants.

** 14. Subsequent Events**

The Company filed itsRegistration Statement Amendment No. 3 on August 4, 2006 in connection with theamended registration rights agreement with the holders of the July 2007 Notesand the holders of the August 2007 Notes (the “Notes).  On August 7, 2006, the registration statementbecame effective.  Late filing and lateregistration fees pursuant to the amended registration rights agreement were$1,509 as of August 7, 2006.  The Companyhas not paid the late filing and registration fees and is currently innegotiations with the noteholders to either reduce or delay the payment of thefees and to prevent any acceleration of the amounts due under the Notes.

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

*Thismanagement’s discussion and analysis should be read in conjunction with thecondensed consolidated financial statements and notes included elsewhere in thisreport on Form 10-Q.*

*Thismanagement’s discussion and analysis, as well as other sections of this reporton Form 10-Q, may contain “forward-looking statements” that involve risksand uncertainties, including statements regarding our plans, future events,objectives, expectations, forecasts, or assumptions. Any statement 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. These statements involve risks and uncertaintiesthat could cause actual outcomes and results to differ materially from theanticipated outcomes or results, and undue reliance should not be placed onthese statements. These risks and uncertainties include, but are not limitedto, the matters discussed under the caption “Factors Affecting Future Results”in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005,as amended, and other risks and uncertainties discussed in filings made withthe Securities and Exchange Commission (including risks described in subsequentreports on Form 10-Q, Form 10-K, Form 8-K, and other filings).Liquidmetal Technologies disclaims any intention or obligation to update orrevise any forward-looking statements, whether as a result of new information,future events, or otherwise.*

**Overview**

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

Amorphous alloys are uniquematerials that are distinguished by their ability to retain a random atomicstructure when they solidify, in contrast to the crystalline atomic structurethat forms in ordinary metals and alloys when they solidify. Liquidmetal alloyspossess a combination of performance, processing, and cost advantages that webelieve makes them preferable to other materials in a variety of applications.The amorphous atomic structure of our alloys enables them to overcome certainperformance limitations caused by inherent weaknesses in crystalline atomicstructures, thus facilitating performance and processing characteristicssuperior in many ways to those of their crystalline counterparts. For example,our zirconium-titanium Liquidmetal alloys are approximately 250% stronger thancommonly used titanium alloys, such as Ti-6Al-4V, but they have processing characteristicssimilar in many respects to plastics. We believe these advantages could resultin Liquidmetal alloys supplanting other incumbent materials in a wide varietyof applications. Moreover, we believe these advantages will enable theintroduction of entirely new products and applications that are not possible orcommercially viable with other materials.

Our revenues are derived from twoprincipal operating segments: Liquidmetal alloy industrial coatings and bulkLiquidmetal alloy products.  Liquidmetalalloy industrial coatings are used primarily as a protective coating forindustrial machinery and equipment, such as drill pipe used by the oil drillingindustry and boiler tubes used in coal-burning power plants. The historicaloperating information for fiscal year 2001 is based substantially on sales ofLiquidmetal alloy coatings. In the second half of 2002, we began producing bulkLiquidmetal alloy components and products for incorporation into our customers’finished goods. Bulk Liquidmetal alloy segment revenue includes sales of partsor components of electronic devices, medical products, and sports and leisuregoods; tooling and prototype parts (including demonstration parts and testsamples) for customers with products in development, product licensing andarrangements, and research and development revenue relating primarily todefense and medical applications.  Weexpect that these sources of revenue will continue to significantly change thecharacter of our revenue mix.

The cost of sales for our Liquidmetal coatings segment consistsprimarily of the costs of outsourcing our manufacturing to third parties.Consistent with our expectations, our cost of sales has been increasing overhistorical results as we further build our bulk Liquidmetal alloy business.Although we plan to continue outsourcing the manufacturing of our coatings, wewill internally manufacture many products derived from our bulk Liquidmetalalloys.

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Selling, general, and administrative expenses currently consistprimarily of salaries and related benefits, stock-based compensation, severancecosts, travel, consulting and professional fees, depreciation and amortization,insurance, office and administrative expenses, and other expenses related toour operations.

Research and development expenses represent salaries, related benefitsexpense, depreciation of research equipment, consulting and contract services,expenses incurred for the design and testing of new processing methods,expenses for the development of sample and prototype products, and otherexpenses related to the research and development of Liquidmetal alloys. Costsassociated with research and development activities are expensed as incurred.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 discoveryof new alloy compositions, the development of improved processing technology,and the identification of new applications for our alloys.

On August 4, 2004, the Company established a plant in the city of Weihaiin Shandong province of China under Weihai Liquidmetal Company Limited, whichis 100% owned by Liquidmetal Korea, to facilitate our bulk alloy manufacturingbusiness.  Weihai Liquidmetal isconsolidated into Liquidmetal Technologies with all intercompany transactionseliminated.

The following discussion and analysis of our financial condition andresults of operations focuses on the historical results of our continuing operations.

**CriticalAccounting Policies and Estimates**

The preparation of condensed 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.  Theseestimates and assumptions are based on historical experience and various otherfactors that are believed to be reasonable under the circumstances.  Actual results could differ materially fromthese estimates under different assumptions or conditions.

We believe that thefollowing accounting policies are the most critical to our condensedconsolidated financial statements since these policies require significantjudgment or involve complex estimates that are important to the portrayal ofour financial condition and operating results:

·       Exchangerate fluctuations

·       Warrantyaccrual

·       Allowancefor doubtful accounts

·       Inventoriesat lower of cost or net realizable value

·       Deferredtax assets

·       Valuationof derivatives of warrants and embedded conversion features

Our Annual Report onForm 10-K for the year ended December 31, 2005, contains further discussions on our criticalaccounting policies and estimates.

The company adopted Statement of Financial AccountingStandards No. 123, Share-Based Payment (“SFAS 123R”), onJanuary 1, 2006. This new standard requires companies to expense the fairvalue of employee stock options and similar awards. The company adopted SFAS123R using the modified prospective transition method. Therefore, stock basedcompensation expense measured in accordance with SFAS 123R was recorded duringthe first quarter of 2006, but the prior year consolidated statement of incomewas not restated. The adoption of SFAS 123R resulted in incremental expense inthe first quarter of 2006 of $0.2 million. See Note 1 for further information.

**Resultsof Operations**

Comparison of the three months ended June 30, 2006 and 2005

*Revenue*. Revenue increased $3.4 million to$7.1 million for the three months ended June 30, 2006 from $3.7 millionfor the three months ended June 30, 2005. The increase consisted of an increase of $2.9 million from the sales andprototyping of parts manufactured from bulk Liquidmetal alloys to consumerelectronics customers as a result of increased demand from electronic casingsapplications, an increase of $0.1 million from our research and developmentcontracts, and an increase of $0.4 million from sales of our coatings productsas a result of increase in demand from oil drilling applications.

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*Cost of Sales*. Cost of sales increased to$5.6 million, or 78% of revenue, for the three months ended June 30, 2006 from$4.0 million, or 106% of revenue, for the three months ended June 30,2005.  The increase was a result ofincreases in bulk Liquidmetal alloy business and coatings business.  The decrease in cost of sales as a percentageof revenue was a result of continued maturing of our manufacturing process,which represents the Company’s efforts to manage costs and focus on our corebusiness, and an increase in revenues generated from our higher margin coatingsproducts. Significant portions of our manufacturing costs continue to remainfixed.  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 parts from our bulkLiquidmetal alloys is variable and differs based on the unique design of eachproduct.  However, the cost of sales forthe products sold by the coatings business segment is generally consistentbecause the Liquidmetal coatings products are produced by third parties andsold wholesale to various industries.

*Selling,General, and Administrative Expenses*. Selling, general, andadministrative expenses increased to $2.4 million, or 33% of revenue, forthe three months ended June 30, 2006 from $1.6 million, or 42% of revenue,for the three months ended June 30, 2005. This increase was primarily a resultof increases in wages and compensation of $0.5 million primarily fromrecognition of stock based compensation expense during the quarter and increasesin employees, travel cost of $0.1 million, professional services of $0.2million, bad debt expense of $0.1 million, and franchise and property taxes of$0.1 million, offset by decrease in insurance expense of $0.2 million.

*Researchand Development Expenses*. Research and development expenses increasedto $0.3 million, or 4% of revenue, for the three months ended June 30,2006 from $0.2 million, or 3% of revenue, for the three months ended June30, 2005. The Company continues to perform research and development of newLiquidmetal alloys and related processing capabilities, develop newmanufacturing techniques, and contract with consultants to advance thedevelopment of Liquidmetal alloys.  The increasewas primarily due to increases in wages and compensation, and prototyping costs.

*Impairmentof Long Lived Assets*. Impairment of long lived assetsdecreased to $0, for the three months ended June 30, 2006 from $3.4 million or91% of revenue, for the three months ended June 30, 2005.  Impairment expense represents write-down of$1,653 of raw materials considered to be long term inventory and $1,741 of idleequipment.  During 2005, while we may usethe excess raw materials beyond one year to fulfill future customer order, wedetermined that our capacity was not significant enough to warrant holding thisinventory as a long term asset.  Further,while we have actively marketed the idle equipment for ultimate sale sinceearly 2004, we were unable to sell this equipment. In addition, while theequipment may be used internally to meet future capacity requirements,considering the revenues during 2005, we did not anticipate utilizing thisequipment internally in the near future. As such, during 2005 we have reduced the carrying values of the excessraw material and idle equipment.

*Changein Value of Warrants. *Change in value of warrants decreased to anet loss of $1.4 million, or 20% of revenue, for the three months ended June 30,2006 from a net loss of $0.1 million, or 3% of revenue, for the three monthsended June 30, 2005.  The change in valueof warrant consisted of warrants issued from the senior convertible debt fundedin March 2004 and exchanged in August 2004, convertible debt funded in June2005, senior convertible debt funded in August 2005, subordinated promissorynote funded in March 2006, and unsecured subordinated notes funded in May 2006 primarilyas a result of fluctuations in our stock price.

*Changein Value of Conversion Feature.*Change in the value of our conversion feature liability from our seniorconvertible debt funded in March 2004 and exchanged in August 2004 and August2005 resulted in a change in value of conversion feature loss of $2.1 million,or 30% of revenue, during the three months ended June 30, 2006 from a gain of$1.2 million or 31% of revenue, for the three months ended June 30, 2005, primarilyas a result of fluctuations in our stock price.

*OtherIncome.*  Other income was $0.1 million, or 1% ofrevenue, for the three months ended June 30, 2006 from gain recognized fromdisposal of idle equipment. There were no amounts recognized as other incomeduring the three months ended June 30, 2005.

*InterestExpense*. Interest expense was $3.3 million, or 46% ofrevenue, for the three months ended June 30, 2006 and was $1.2 million, or 32%of revenue, for the three months ended June 30, 2005.  Interest expense consists primarily ofinterest accrued on the Kookmin Bank loan funded in 2003, convertible debtsfunded in 2004 and 2005, subordinated notes funded in

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March and May 2006,fees charged from short-term borrowings under the April 2005 factoring, loan,and security agreement, as well as amortization of debt issuance costs anddiscount on the convertible debt.  Theincrease was primarily due to additional amortization of debt issuance costsand discount on debt funded in August 2005, increases in fees from borrowingsmade under the April 2005 factoring, loan, and security agreement fromadditional amounts borrowed in 2006, and interest costs accrued for late registration and late filing fee penaltiesduring the three months ended June 30, 2006 (see Item 3 Defaults Upon SeniorSecurities, Part II).

*Interest Income.* Interest income was $7 thousand for the threemonths ended June 30, 2006 and was $1 thousand for the three months ended June30, 2005 from interest earned on cash deposits.

Comparison of the six months ended June 30, 2006 and 2005

*Revenue*. Revenue increased $7.1 million to$13.6 million for the six months ended June 30, 2006 from $6.6 million forthe six months ended June 30, 2005.  The increaseincluded $5.0 million increase in sales and prototyping of parts manufacturedfrom bulk Liquidmetal alloys to consumer electronics customers from increaseddemand from electronic casings applications, an increase of $1.7 million insale of our coatings products, and an of $0.3 million increase in research anddevelopment services from increased research and development services primarilyfrom defense applications.

*Cost of Sales*. Cost of sales increased to$10.9 million, or 80% of revenue, for the six months ended June 30, 2006from $6.8 million, or 103% of revenue, for the six months ended June 30,2005.  The increase was a result of increasesin bulk Liquidmetal alloy business and coatings business.  Cost of sales as a percentage of revenue has decreasedas a result of continued maturing of our manufacturing process, whichrepresents the Company’s efforts to manage costs and focus on our corebusiness, and an increase in revenues generated from our higher margin coatingsproducts.  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, thecost of sales for the products sold by the coatings business segment isgenerally consistent because the Liquidmetal coatings products are produced bythird parties and sold wholesale to various industries.

*Selling,General, and Administrative Expenses*. Selling, general, andadministrative expenses increased to $5.1 million, or 37% of revenue, forthe six months ended June 30, 2006 from $4.2 million, or 63% of revenue,for the six months ended June 30, 2005. This increase was primarily a result ofincrease in wages and compensation of $1.0 million primarily fromrecognition of stock based compensation expense during the quarter andincreases in employees, increase in travel costs of $0.2 million, increase inbad debt expense of $0.1 million, and increase in property and franchise taxes of$0.1 million, offset by decrease in insurance expense of $0.7 million.

*Researchand Development Expenses*. Research and development expensesdecreased to $0.5 million, or 4% of revenue, for the six months ended June30, 2006 from $0.6 million, or 9% of revenue, for the six months endedJune 30, 2005. The Company continues to perform research and development of newLiquidmetal alloys and related processing capabilities, develop newmanufacturing techniques, and contract with consultants to advance thedevelopment of Liquidmetal alloys.  Thedecrease was primarily due to decrease in wages and compensation.

*Impairmentof Long Lived Assets*. Impairment of long lived assets decreasedto $0, for the six months ended June 30, 2006 from $3.4 million or 52% ofrevenue, for the six months ended June 30, 2005.  Impairment expense represents write-down of$1,653 of raw materials considered to be long term inventory and $1,741 of idleequipment.  During 2005, while we may usethe excess raw materials beyond one year to fulfill future customer order, wedetermined that our capacity was not significant enough to warrant holding thisinventory as a long term asset.  Further,while we have actively marketed the idle equipment for ultimate sale sinceearly 2004, we were unable to sell this equipment. In addition, while theequipment may be used internally to meet future capacity requirements,considering the revenues during 2005, we did not anticipate utilizing thisequipment internally in the near future. As such, during 2005 we have reduced the carrying values of the excessraw material and idle equipment.

*Change inValue of Warrants.* Change in value of warrants decreased to a net loss of $2.7 million, or 20%of revenue, during the six months ended June 30, 2006 from a net gain of $0.03million, or 1% of revenue, for the six months ended June 30, 2005.  The change in value of warrant consisted ofwarrants issued from the senior convertible debt funded in March 2004 andexchanged in August 2004, convertible debt funded in June 2005, seniorconvertible debt funded in August 2005, subordinated promissory notes funded inMarch 2006, and unsecured subordinatednotes funded in May 2006 primarily as a result of fluctuations in our stockprice.

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*Change inValue of Conversion Feature*. Change in the value of our conversion feature liability from our seniorconvertible debt funded in March 2004 and exchanged in August 2004 and August2005 resulted in a change in value of conversion feature loss of $3.9 million,or 29% of revenue, during the six months ended June 30, 2006 from a gain of $2.3million, or 35% of revenue, during the six months ended June 30, 2005,primarily as a result of fluctuation in our stock prices.

*OtherIncome.*  Other income was $0.6 million, or 4% ofrevenue, for the six months ended June 30, 2006 from $0.1 million  gain recognized from disposal of idleequipment and $0.5 million gain recognized from termination of a distributionagreement with a Japanese sporting goods distributor originally entered into inMarch 1996.  There were no amountsrecognized as other income during the six months ended June 30, 2005.

*InterestExpense*. Interest expense was $5.1 million, or 37% ofrevenue, for the six months ended June 30, 2006 and was $2.7 million, or 41% ofrevenue, for the six months ended June 30, 2005.  Interest expense consists primarily ofinterest accrued on the Kookmin Bank loan funded in 2003, convertible debtsfunded in 2004 and 2005, subordinated notes funded in March and May 2006, feescharged from short-term borrowings under the April 2005 factoring, loan, andsecurity agreement, as well as amortization of debt issuance costs and discounton the convertible debt, fees charged from short-term borrowings under the April2005 factoring, loan, and security agreement, as well as amortization of debtissuance costs and discount on the convertible debt.  The increase in interest expense wasprimarily due to costs accrued for late registration and late filing fee penaltiesduring the six months ended June 30, 2006 (see Item 3 Defaults Upon Senior Securities, Part II).

*Interest Income.* Interest income was $9 thousand for the sixmonths ended June 30, 2006, and $7 thousand for the six months ended June 30,2005 from interest earned on cash deposits.

**Liquidityand Capital Resources**

Our cash used for operating activities was $3.6 millionfor the six months ended June 30, 2006 and $3.6 million for the six monthsended June 30, 2005.  Our working deficitincreased from $11.0 million at December 31, 2005 to $21.6 million at June 30,2006.  The Company’s working deficitincrease of $10.6 million was primarily attributable to increase in accountspayable and accrued liability of $2.4 million, increase in short term debt of $2.3million, increase in current portion of long-term debt of $6.6 million,increase in warrant liabilities of $3.7 million, increase in conversion featureliability of $3.9 million, offset by increase in cash and cash equivalents of$0.8 million, increase in trade accounts receivable of $2.0 million, increasein inventories by $0.6 million, increase in prepaid expenses and other currentassets by $0.6 million, decrease in settlement payable of $3.3 million,decrease in deferred revenue of $0.8 million, and decrease in other currentliabilities of $0.2 million.

Our cash used in investing activities was $0.7 millionfor the six months ended June 30, 2006 for the acquisition of property andequipment and investments in patents and trademarks.

Our cash provided by financing activities was $5.4million for the six months ended June 30, 2006, which consists of $1.0 millionin proceeds from borrowings from our subordinated promissory notes executed inMarch 2006 and $3.6 million in proceeds from borrowings from private placementof 8% unsecured subordinated notes executed in May 2006. Further, the Company received a net of $1.3 million in borrowings fromfactoring agreement executed in April 2005. The proceeds from borrowings have beenused to meet working capital requirements.

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, and the resources we devote to developand support our Liquidmetal alloy products, the success of pursuing strategiclicensing and funded product development relationships with external partners.

We have experienced significant operating losses sinceour inception. Our net loss for the six months ended June 30, 2006 and 2005 was$13.9 million and $8.8 million, respectively. In the audit report on ourfinancial statements for our fiscal years ended December 31, 2005 and 2004, ourauditors included a going-concern qualification indicating that our significantoperating losses and working capital deficit cause substantial doubt about ourability to continue as a going concern. By issuing an opinion stating thatthere is substantial doubt about our ability to continue as a going concern,our auditors have indicated that they are uncertain as to whether we have thecapability to continue our operations without additional funding.

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Accordingly, we anticipate that we will needadditional funding during the next 12 months, and we plan to seek to raise suchfunds through public or private equity financing, bank debt financing, or fromother sources.  Specifically, weanticipate that we could need $1 to $5 million over the next twelvemonths to pursue our current operating plan, although this amount maybe lower depending on the orders we receive for our products.  The amount of funding that we plan to seekand the timing of such fundraising efforts will depend on the extent to whichwe are able to increase revenues through obtaining additional purchase ordersfor our products, particularly components for cellular phones and flash memorydrive casings, and our ability to continue to improve our manufacturingprocesses.  We evaluate our working capitalneeds and operating plan assumptions on a monthly basis to determine whetherany adjustment to our cash and liquidity outlook is warranted, and wealso review potential sources of financing on an ongoing basis.  However, adequate funds may not be availablewhen needed, and if we raise additional funds by issuing equity securities,existing stockholders may be diluted.  Ifwe don’t receive sufficient funding to operate under our current plan, weintend to reduce operations and expenses and shift our focus to the pursuit oflicensing transactions and other strategic transactions that are less capitalintensive.

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**ContractualObligations**

The following table summarizes the Company’s obligations andcommitments as of June 30, 2006:
| ** **                                          | ** ** | ** ** | ** ** | **Less Than** | ** ** | **Payments Due by Period (in thousands)** | ** ** | ** **         | ** ** |
|-----------------------------------------------------|------------|------------|------------|--------------------|------------|--------------------------------------------------------------------|------------|--------------------|------------|
| **Contractual Cash Obligations (1)** | ** ** | **Total**  | ** ** | **1 Year**    | ** ** | **1-3 Years**                                                 | ** ** | **3-5 Years** | ** ** | **After 5 Years** | ** ** |
|                                                |       |       |       |               |       |                                                               |       |               |       |   |   |
| Long-term debt (2)                                  |       | $          | 18,094     |               | $          | 13,600                                                             |       | $                  | 4,494      |   | $ | — |   | $ | — |   |
| Short-term debt (3)                                 |       | 2,873      |       | 2,873              |       | —                                                             |       | —             |       | — |   |
| Capital lease  obligation (4)                       |       | 18         |       | 18                 |       | —                                                             |       | —             |       | — |   |
| Operating leases and  rents                         |       | 1,006      |       | 489                |       | 439                                                                |       | 78                 |       | — |   |
| Consulting services  payable                        |       | 77         |       | 77                 |       | —                                                             |       | —             |       | — |   |
| Dongyang                                            |       | 11         |       | 11                 |       | —                                                             |       | —             |       | — |   |
| Nichimen                                            |       | 350        |       | 350                |       | —                                                             |       | —             |       | — |   |
|                                                |       | $          | 22,429     |               | $          | 17,418                                                             |       | $                  | 4,933      |   | $ | 78 |   | $ | — |   |

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(1)Contractual cash obligations include Long-Term Debt comprised of $2,310 ofSenior Convertible Notes issued in 2004 and $9,878 of Senior Convertible Notesissued in 2005, $3,625 of Unsecured Subordinated Notes issued in May 2006, and $2,281of Kookmin Bank Loan, Short-Term Debt comprised of $1,873 outstanding advancesreceived under factoring, loan, and security agreement, $1,000 of Unsecured SubordinatedPromissory Note issued in 2006, future minimum lease payments under capital andoperating leases, and purchase commitments from consultants, payments due fromour discontinued equipment manufacturing business (Dongyang), and minimum paymentsdue under a distribution agreement (Nichimen).

(2)Does not include interest payments of $1,281; and un-amortized discounts forconversion feature and warrants of $6,445 of our convertible notes.

(3)Does not include minimum interest and fee payments of $30 and un-amortizeddiscounts for warrants of $43.

(4) Includes imputedinterest of $1.

**OffBalance Sheet Arrangements**

An off-balance sheet arrangementis any transaction, agreement or other contractual arrangement involving anunconsolidated entity under which a company has (1) made guarantees, (2) aretained or a contingent interest in transferred assets, (3) an obligationunder derivative instruments classified as equity, or (4) any obligationarising out of a material variable interest in an unconsolidated entity thatprovides financing, liquidity, market risk or credit risk support to thecompany, or that engages in leasing, hedging, or research and developmentarrangements with the company.

On June 26, 2006, the Company entered into a jointventure agreement with SAGA, SpA in Padova, Italy, (“SAGA”) a specialistprecision parts manufacturer.  The joint venture is named Liquidmetal SAGAItaly, Srl (“LSI”).  The Company also entered into an exclusivemanufacturing license agreement for the eyewear industry with LSI.  Underthe joint venture agreement, the Company has option to buy ownership interestin LSI, initially, of 19.9% to up to 50%.  The Company has until September30, 2006 to exercise the 19.9% interest in LSI and will have two years topurchase the additional interest at a nominal price.  If the Company doesnot purchase the additional interest during the first two years of theagreement, the Company will be able to purchase the additional interest at aprice equal to 30.1% of LSI’s then outstanding net equity.  As of June 30,2006 and as of the filing of this Form 10Q, the Company has not purchased anyinterest in the joint venture.  

 

Under the licensingagreement, at any time following 18 months after the effective date of theagreement, LSI may exercise its option to sell to the Company certain businessassets including manufacturing equipment acquired under the joint venture.  During the three months ended June 30, 2006,the Company recognized revenues of $0.2 million of Liquidmetal alloys sold toSAGA for use in the joint venture. The Company anticipates the alloys to befully utilized by the joint venture prior to the 18 month period.

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**Item 3 –Quantitative and Qualitative Disclosures about Market Risk**

We are exposed to various markets risks inconducting the business of the Company, and we anticipate that this exposurewill increase as a result of our planned growth.  In an effort to mitigate losses associatedwith these risks, we may at times enter into derivative financial instruments,although we have not historically done so. These may take the form of forward sales contracts, option contracts,foreign currency exchange contracts, and interest rate swaps.  We have not, and do not intend to, engage inthe practice of trading derivative securities for profit.

*Interest Rates.*  We are exposed to market risks relating tochanges in interest rates.  Some of theproceeds of our initial public offering are invested in short-term,interest-bearing, investment grade securities. The value of these securities will be subject to interest rate risk andcould fall in value if interest rates rise.

*Commodity Prices. *We are exposed to pricerisk related to anticipated purchases of certain commodities used as rawmaterials by our businesses, including titanium and zirconium.  Although we do not currently enter intocommodity future, forward, and option contracts to manage the fluctuations inprices of anticipated purchases, we may enter into such contacts in the futureas our business grows and as our purchases of these raw materials increase.

*Foreign Exchange Rates.*  As a result of our operation of amanufacturing facility in South Korea, a substantial portion of our costs willbe denominated in the South Korean won. Consequently, fluctuations in the exchange rates of the South Korean wonto the U.S. dollar will affect our costs of goods sold and operating marginsand could result in exchange losses. Although we do not currently enter into foreign exchange hedgetransactions, we may do so in the future as our business grows.

**Item 4 –Controls and Procedures**

Evaluation of disclosure controlsand procedures**.**  As of the end of the period covered bythis report, an evaluation was carried out under the supervision and with theparticipation of the company’s management, including its Chief ExecutiveOfficer and Chief Financial Officer, of its disclosure controls and procedures(as defined by Rules 13a — 15(e) and 15d-15(e) under theSecurities Exchange Act of 1934). Based upon that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that the design andoperation of these disclosure controls and procedures were effective as of theend of the period covered by this report.

Changes in internal controls.** **There has been no change in theregistrant’s internal control over financial reporting that occurred during theregistrant’s most recent fiscal quarter that has materially affected, or isreasonably likely to materially affect, the registrant’s internal control overfinancial reporting.

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**PART II**

**OTHERINFORMATION**

**Item1 – Legal Proceedings**

In April 2006, we reached agreements in principleto settle our previously-disclosed consolidated securities class action andshareholder derivative actions.  In early July, we jointly filed aStipulation and Agreement of Settlement in the securities class action, whichhas been preliminarily approved and for which a settlement fairness hearing isset for October 18, 2006.  In early August, the derivative plaintiffs’counsel filed a Notice of Settlement with the Court, and the parties’ counselsare working to prepare formal settlement documents.

The settlement covers a series of nine securities classaction lawsuits that were filed against the company beginning inApril 2004 on behalf of persons who purchased our common stock betweenMay 21, 2002 and May 13, 2004, in connection with our initial publicoffering in May 2002.  These actions, which were brought underthe federal securities laws against the company and certain of our formerand current directors and officers, were consolidated in the United StatesDistrict Court for the Middle District of Florida, Tampa Division.  Thesecases alleged that the Prospectus issued in connection with the initial publicoffering in May 2002 contained material misrepresentations and omissionsregarding the company’s historical financial condition and regarding a personalstock transaction by the company’s former chief executive officer.  Theyalso alleged that our company and certain of its present and former officersand directors engaged in improper revenue recognition with respect to certainof the company’s business transactions, failed to maintain adequate internalcontrols, and knowingly disclosed unrealistic but favorable information aboutmarket demand for and commercial viability of the company’s products toartificially inflate the value of the company’ stock.

In addition to the securities class actions, inMay 2004, two shareholder derivative actions were filed in the SuperiorCourt of Orange County, California.  Shortly thereafter, one additionalshareholder derivative action was filed in the United States District Court forthe Middle District of Florida, Tampa Division.  These derivative actionswere brought by certain shareholders against certain of our present and formerofficers and directors as well as our company (as a nominal defendant). The suits alleged that the defendants breached various fiduciary duties andotherwise violated state law based primarily upon the same underlying facts andcircumstances as alleged in the federal securities classaction.  The settlement also covers these derivative actions.

If approved by the courts, the agreements would settlethe consolidated class action litigation entitled *Primavera Investors v. Liquidmetal Technologies, Inc., et al.*,the consolidated shareholder derivative actions entitled *Brian Clair, Derivatively on Behalf of LiquidmetalTechnologies, Inc. v. John Kang, et al*. and *Joseph Durgin, Derivatively on Behalf of LiquidmetalTechnologies, Inc. v. John Kang, et al*., and the shareholderderivative action entitled *Robert Story v.John Kang, et al.,* pending in the United States District Court forthe Middle District of Florida, Tampa Division, the Superior Court of OrangeCounty, California, and the United States District Court for the MiddleDistrict of Florida, Tampa Division, respectively.

As part of the agreements, our directors’ and officers’liability insurance carriers will contribute a total of $7.5 million to settleall of the actions: $7.025 million for the consolidated class action and $0.475million for the two derivative actions. The funds paid to settle theconsolidated class action will be principally paid into an escrow accountwithin a specified period of time after the federal court grants preliminaryapproval of the settlement. The funds will be disbursed to certain purchasersof our securities according to a distribution plan to be devised and approvedby the federal court. In addition, we will commit to maintaining orimplementing various corporate governance measures in connection with thesettlement of the derivative actions.

Taking into account the insurance contribution, thenet cost of the settlement to us should be approximately $0.5 million, which isthe insurance deductible we paid over several quarters ending in the thirdquarter of 2005, and which we previously recorded as a charge.

**Item 1A –Risk Factors**

There have been no materialchanges to the risk factors that are included in our Annual Report on Form 10-Kfor the year ended December 31, 2005, as amended, that could affect ourbusiness, results of operations or financial condition.

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**Item 2 –Unregistered Sales of Equity Securities and Use of Proceeds**

On May 17, 2006, the Company completed a private placement of 8%Unsecured Subordinated Notes for an aggregate principal of $3.6 million.  The notes are due on the earlier of August17, 2007 or the consummation of a follow-on equity or debt offering pursuant towhich the Company receives gross proceeds of at least $6.0 million to be usedfor working capital purposes and repayment of debt, but excluding financingsfor the purpose of purchasing capital assets. As part of this private placement, the Company issued warrants to thepurchasers of the notes giving them the right to purchase up to an aggregate of705,233 shares of the Company’s common stock. In addition, warrants to purchase 68,508 shares of the Company’s commonstock were issued to the placement agent in the transaction. The warrants havean exercise price of $2.58 per share and will expire on May 17, 2011. Thenotes and warrants were issued pursuant to an exemption from registration underthe Securities Act of 1933, as amended (the “Securities Act”), by virtue ofSection 4(2) of the Securities Act and by virtue of Rule 506 of Regulation Dunder the Securities Act. Such sale and issuance did not involve any publicoffering, was made without general solicitation or advertising, and theinvestors in the notes and warrants represented to the Company that they areaccredited investors with access to all relevant information necessary toevaluate the investment in the notes and warrants and that the notes, warrants,and underlying shares were being acquired for investment purposes only.

**Item 3 -Defaults Upon Senior Securities**

As of June 30, 2006, we had approximately $12.2million in principal amount of convertible notes outstanding. Approximately$2.3 million in principal amount of convertible notes will become due in July2007, with the balance becoming due in August 2007. Interest on our convertiblenotes is payable quarterly in cash. These notes are secured by substantiallyall of the assets of our company. We will be deemed to be in default underthese notes if we fail to pay any principal or interest when it becomes due,and we will also be deemed to be in default if we breach any other materialprovision of our other agreements with the noteholders and we fail to cure suchbreach within thirty days of notice of default. Upon a default under thesenotes, the noteholders have the right to accelerate the maturity date of thenotes and demand that they be immediately repaid by us. If we fail to pay suchnotes, either at maturity or upon acceleration, then the noteholders may electto foreclose upon the assets securing the notes.

On May 12, 2006, we received a letter from one holderholding $0.5 million of the August 2007 Notes demanding immediate payment oflate filing fees and late registration fees for the period following October31, 2005 through May 3, 2006. As a result of the late fee provisions of therestated registration rights agreement, we are obligated to pay late filing andlate registration fees accrued through June 30, 2006 of up to $1.4 million toall of the noteholders. In addition, the letter purported to constitute anotice of default under the August 2007 Notes and July 2007 Notes (“Notes”) asa result of our failure to pay the late filing and late registration fees.Under the terms of Notes, if a default is not cured by us within thirty (30)days of notice thereof, the holder has the right to accelerate all principaland interest due under the Notes. The Company filed itsRegistration Statement Amendment No. 3 on August 4, 2006 and on August 7, 2006,the registration statement became effective. Late filing and late registration fees were $1.5 million as of August 7,2006.  The Company has not paid the latefiling and registration fees and is currently in negotiations with thenoteholders to either reduce or delay the payment of the fees and to preventany acceleration of the amounts due under the Notes.

As of June 30, 2006, $9.9 million in aggregateprincipal amount of August 2007 Notes was still outstanding with accrued butunpaid interest in the amount of approximately $175 thousand. In addition, $2.3million in aggregate principal amount of  July 2007 Notes was alsooutstanding with accrued but unpaid interest in the amount of approximately $35thousand. As a result, the outstanding balance of the Notes are presented ascurrent portion of long term debt on the condensed consolidated balance sheetas of June 30, 2006.

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

None

**Item 5 –Other Information**

There were no mattersrequired to be disclosed in a current report on Form 8-K during the fiscalquarter covered by this report that were not so disclosed.

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**Item 6 –Exhibits**

The following documentsare filed as an exhibit to this Report:
| Exhibit    | ** ** | ** **                                                                                                                                                             |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number** | ** ** | **Description of Document**                                                                                                                                            |
|       |       |                                                                                                                                                                   |
| 31.1       |       | Certification of the President and Chief Executive  Officer, Ricardo A. Salas, as required by Section 302 of Sarbanes-Oxley Act  of 2002                               |
|       |       |                                                                                                                                                                   |
| 31.2       |       | Certification of Chief Financial Officer, Young Ham,  as required by Section 302 of Sarbanes-Oxley Act of 2002                                                         |
|       |       |                                                                                                                                                                   |
| 32.1       |       | Certification of Principal Executive Officer,  Ricardo A. Salas, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of Sarbanes-Oxley Act of 2002 |
|       |       |                                                                                                                                                                   |
| 32.2       |       | Certification of Chief Financial Officer, Young Ham,  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of  Sarbanes-Oxley Act of 2002            |

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned hereunto dulyauthorized.
|                 |   | LIQUIDMETAL TECHNOLOGIES                      |
|----------------------|--------|-----------------------------------------------|
|                 |   | (Registrant)                                  |
|                 |   |                                          |
| Date: August 9, 2006 |   | /s/ Ricardo A. Salas                          |   |
|                 |   | Ricardo A. Salas                              |
|                 |   | President and  Chief Executive Officer        |
|                 |   | (Principal  Executive Officer)                |
|                 |   |                                          |
| Date: August 9, 2006 |   | /s/ Young Ham                                 |   |
|                 |   | Young Ham                                     |
|                 |   | Chief Financial  Officer                      |
|                 |   | (Principal  Financial and Accounting Officer) |

 

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