**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C. 20549**

 

### **FORM 10-Q**

 

**ý****                                ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**

** **

**For the quarterly period ended June 30, 2005**

 

**OR**

 

**o****                                ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the transition period from                         to                       **

 

**CommissionFile No**.  **001-31332**

 

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**LIQUIDMETALTECHNOLOGIES, INC.**

**(**Exact name of Registrant as specified in itscharter**)**

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

 

**25800 Commercentre Drive, Suite 100**

**LakeForest, California 92630**

(address of principal executive office, zip code)

 

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

 

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Indicate by check mark whether the registrant (1)has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for at least the past 90 days.

 

Yes ý No o

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).

 

Yes ý No o

 

#### **As of July 11, 2005, there were 41,609,652 shares of theregistrant’s common stock, $.001 par value, outstanding.**

 

 

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**LIQUIDMETAL TECHNOLOGIES, INC.FORM 10-QFOR THE QUARTER ENDED****JUNE 30,2005**

** **

**FORWARD-LOOKING INFORMATION**

 

Statements in this reportconcerning the future sales, expenses, profitability, financial resources,product mix, market demand, product development and other statements in thisreport concerning the future results of operations, financial condition andbusiness of Liquidmetal Technologies, Inc. are “forward-looking” statements asdefined in the Securities Act of 1933 and Securities Exchange Act of 1934.Investors are cautioned that the Company’s actual results in the future may differmaterially from those projected in the forward-looking statements due to risksand uncertainties that exist in the Company’s operations and businessenvironment, including competition, need for increased acceptance of products,ability to continue to develop and extend our brand identity, ability toanticipate and adapt to a competitive market, ability to effectively managerapidly expanding operations, amount and timing of operating costs and capitalexpenditures relating to expansion of our business, operations andinfrastructure, ability to provide superior customer service, dependence uponkey personnel and the like. The Company’s most recent filings with theSecurities and Exchange Commission, including Form 10-K, contain additionalinformation concerning many of these risk factors, and copies of these filingsare available from the Company upon request and without charge.

 

2

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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 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  2 – Unregistered Sales of Equity Securities and Use of Proceeds**                                 | ** ** |
| ** **                            | ** **                                                                                                     | ** ** |
| ** **                            | **Item 3 – Defaults  Upon Senior Securities**                                                             | ** ** |
| ** **                            | ** **                                                                                                     | ** ** |
| ** **                            | **Item 6 –  Exhibits and Reports on Form 8-K**                                                            | ** ** |
| ** **                            | ** **                                                                                                     | ** ** |
| **Signatures**                        | ** **                                                                                                     |
| ** **                            | ** **                                                                                                     | ** ** |
| **Certifications**                    | ** **                                                                                                     |

 

3

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### **PART I**

### **FINANCIAL INFORMATION**

 

**Item 1 – Financial Statements**

 

**LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                        | ** ** | **(unaudited)** | ** ** | ** **       | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|------------------|------------|
| ** **                                                                                                                                        | ** ** | **June 30,**    | ** ** | **December 31,** | ** ** |
| ** **                                                                                                                                        | ** ** | **2005**        | ** ** | **2004**         | ** ** |
| **ASSETS**                                                                                                                                        | ** ** | ** **      | ** ** | ** **       | ** ** |
|                                                                                                                                              |       |            |       |             |       |
| Current Assets:                                                                                                                                   |       |            |       |             |       |
|                                                                                                                                              |       |            |       |             |       |
| Cash and cash  equivalents                                                                                                                        |       | $               | 1,256      |             | $          | 742 |   |
| Restricted Cash                                                                                                                                   |       | —          |       | 754              |       |
| Trade accounts  receivables, net of allowance for doubtful accounts of $69 and $108                                                               |       | 2,359           |       | 1,668            |       |
| Inventories                                                                                                                                       |       | 2,190           |       | 2,353            |       |
| Prepaid expenses  and other current assets                                                                                                        |       | 954             |       | 930              |       |
| Total current assets                                                                                                                              |       | 6,759           |       | 6,447            |       |
|                                                                                                                                              |       |            |       |             |       |
| Property, Plant  and Equipment, net                                                                                                               |       | 14,996          |       | 16,434           |       |
| Idle Equipment                                                                                                                                    |       | 193             |       | 1,906            |       |
| Long Term  Inventory                                                                                                                              |       | —          |       | 1,810            |       |
| Other  intangibles, net                                                                                                                           |       | 1,158           |       | 1,143            |       |
| Other assets                                                                                                                                      |       | 816             |       | 768              |       |
| Total assets                                                                                                                                      |       | $               | 23,922     |             | $          | 28,508 |   |
|                                                                                                                                              |       |            |       |             |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                    |       |            |       |             |       |
| ** **                                                                                                                                        |       |            |       |             |       |
| Current  Liabilities:                                                                                                                             |       |            |       |             |       |
|                                                                                                                                              |       |            |       |             |       |
| Accounts payable  and accrued expenses                                                                                                            |       | $               | 7,095      |             | $          | 4,969 |   |
| Settlement  Payable                                                                                                                               |       | 3,294           |       | 3,246            |       |
| Deferred revenue                                                                                                                                  |       | 934             |       | 900              |       |
| Short-term debt                                                                                                                                   |       | 493             |       | —           |       |
| Long-term debt,  current portion, net of debt discount of $1,654                                                                                  |       | 8,531           |       | 5,991            |       |
| Other  liabilities, current portion                                                                                                               |       | 752             |       | 1,032            |       |
| Warrant  liability                                                                                                                                |       | 1,677           |       | 550              |       |
| Total current  liabilities                                                                                                                        |       | 22,776          |       | 16,688           |       |
|                                                                                                                                              |       |            |       |             |       |
| Long-term debt,  net of current portion                                                                                                           |       | 2,044           |       | 2,618            |       |
| Other long-term  liabilities, net of current portion                                                                                              |       | 373             |       | 342              |       |
| Total  liabilities                                                                                                                                |       | 25,193          |       | 19,648           |       |
|                                                                                                                                              |       |            |       |             |       |
| Shareholders’  Equity (Deficiency):                                                                                                          |       |            |       |             |       |
|                                                                                                                                              |       |            |       |             |       |
| Common stock,  $0.001 par value; 100,000,000 shares authorized and 41,609,652 issued and  outstanding at June 30, 2005 and December 31, 2004 |       | 42              |       | 42               |       |
| Additional paid  in capital                                                                                                                       |       | 132,160         |       | 132,160          |       |
| Accumulated  deficit                                                                                                                              |       | (135,827        | )          | (125,313         | )          |
| Accumulated  other comprehensive income                                                                                                           |       | 2,354           |       | 1,971            |       |
| Total  shareholders’ equity (deficiency)                                                                                                     |       | (1,271          | )          | 8,860            |       |
|                                                                                                                                              |       |            |       |             |       |
| Total liabilities  and shareholders’ equity (deficiency)                                                                                     |       | $               | 23,922     |             | $          | 28,508 |   |

 

Theaccompanying notes are an integral part of the condensed consolidated financialstatements.

 

4

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**LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIES**

 

### **CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS**

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

**(unaudited)**

 
| ** **                                                             | ** ** | **For the Three**         | ** ** | **For the Six**           | ** ** |
|------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                             | ** ** | **Months Ended June 30,** | ** ** | **Months Ended June 30,** | ** ** |
| ** **                                                             | ** ** | **2005**                  | ** ** | **2004**                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                   |       |                      |       |                      |       |   |   |   |   |
| Revenue                                                                |       | $                         | 3,727      |                      | $          | 4,055 |   | $ | 6,570 |   | $ | 10,343 |   |
| Cost of sales                                                          |       | 3,962                     |       | 2,475                     |       | 6,797 |   | 6,032 |   |
|                                                                   |       |                      |       |                      |       |   |   |   |   |
| Gross (loss)  profit                                                   |       | (235                      | )          | 1,580                     |       | (227 | ) | 4,311 |   |
|                                                                   |       |                      |       |                      |       |   |   |   |   |
| Operating  Expenses:                                                   |       |                      |       |                      |       |   |   |   |   |
| Selling,  general, and administrative                                  |       | 1,567                     |       | 2,544                     |       | 4,157 |   | 5,609 |   |
| Research and  development                                              |       | 213                       |       | 345                       |       | 610 |   | 686 |   |
| Impairment of  long lived assets                                       |       | 3,394                     |       | —                    |       | 3,394 |   | — |   |
| Total expenses                                                         |       | 5,174                     |       | 2,889                     |       | 8,161 |   | 6,295 |   |
|                                                                   |       |                      |       |                      |       |   |   |   |   |
| Loss from  operations                                                  |       | (5,409                    | )          | (1,309                    | )          | (8,388 | ) | (1,984 | ) |
|                                                                   |       |                      |       |                      |       |   |   |   |   |
| Other income                                                           |       | —                    |       | 694                       |       | 133 |   | 1,280 |   |
| Other expense                                                          |       | (100                      | )          | —                    |       | (100 | ) | — |   |
| Interest expense                                                       |       | (909                      | )          | (1,166                    | )          | (2,166 | ) | (1,437 | ) |
| Interest income                                                        |       | 1                         |       | 22                        |       | 7 |   | 34 |   |
| Loss from  continuing operations                                       |       | (6,417                    | )          | (1,759                    | )          | (10,514 | ) | (2,107 | ) |
|                                                                   |       |                      |       |                      |       |   |   |   |   |
| Loss from  discontinued equipment manufacturing operations, net of tax |       | —                    |       | (356                      | )          | — |   | (749 | ) |
|                                                                   |       |                      |       |                      |       |   |   |   |   |
| Net loss                                                               |       | (6,417                    | )          | (2,115                    | )          | (10,514 | ) | (2,856 | ) |
|                                                                   |       |                      |       |                      |       |   |   |   |   |
| Other  comprehensive loss                                              |       |                      |       |                      |       |   |   |   |   |
| Foreign exchange  translation gain                                     |       | 62                        |       | 43                        |       | 383 |   | 422 |   |
| Comprehensive  loss                                                    |       | $                         | (6,355     | )                         | $          | (2,072 | ) | $ | (10,131 | ) | $ | (2,434 | ) |
|                                                                   |       |                      |       |                      |       |   |   |   |   |
| Net loss per  common share – basic and diluted:                   |       |                      |       |                      |       |   |   |   |   |
| Loss per share –  continuing operations                           |       | $                         | (0.15      | )                         | $          | (0.04 | ) | $ | (0.25 | ) | $ | (0.05 | ) |
| Loss per share –  discontinued operations                         |       | $                         | —     |                      | $          | (0.01 | ) | $ | — |   | $ | (0.02 | ) |
| Loss per share  basic and diluted                                      |       | $                         | (0.15      | )                         | $          | (0.05 | ) | $ | (0.25 | ) | $ | (0.07 | ) |
|                                                                   |       |                      |       |                      |       |   |   |   |   |
| Number of  weighted average shares – basic and diluted            |       | 41,610                    |       | 41,610                    |       | 41,610 |   | 41,610 |   |

 

Theaccompanying notes are an integral part of the condensed consolidated financialstatements.

 

5

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**LIQUIDMETAL TECHNOLOGIES,INC.  AND SUBSIDIARIES**

 

### **CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

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

**(unaudited)**

 
| ** **                                                                                    | ** ** | **For the Six Months** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                    | ** ** | **Ended June 30,**     | ** ** |
| ** **                                                                                    | ** ** | **2005**               | ** ** | **2004** | ** ** |
|                                                                                          |       |                   |       |   |   |
| **Operating  activities:**                                                                    |       |                   |       |   |   |
| Net loss                                                                                      |       | $                      | (10,514    | ) | $ | (2,856 | ) |
|                                                                                          |       |                   |       |   |   |
| Adjustments to  reconcile net loss from operations to net cash used for operating activities: |       |                   |       |   |   |
| Impairment of  long lived assets                                                              |       | 3,394                  |       | — |   |
| Loss on disposal  of asset                                                                    |       | 1                      |       | — |   |
| Depreciation and  amortization                                                                |       | 1,694                  |       | 1,823 |   |
| Amortization of  debt discount                                                                |       | 479                    |       | 1,069 |   |
| Stock-based  compensation                                                                     |       | —                 |       | 276 |   |
| Bad debt  (recovery) expense                                                                  |       | (43                    | )          | 105 |   |
| Warranty expense                                                                              |       | 76                     |       | 137 |   |
|                                                                                          |       |                   |       |   |   |
| Changes in  operating assets and liabilities:                                                 |       |                   |       |   |   |
| Accounts  receivable                                                                          |       | (648                   | )          | (521 | ) |
| Inventories                                                                                   |       | 320                    |       | (2,235 | ) |
| Prepaid expenses  and other current assets                                                    |       | (24                    | )          | 189 |   |
| Other assets                                                                                  |       | (169                   | )          | (575 | ) |
| Accounts payable  and accrued expenses                                                        |       | 2,050                  |       | 2,749 |   |
| Deferred revenue                                                                              |       | 34                     |       | (597 | ) |
| Warrant  liabilities                                                                          |       | (33                    | )          | (1,280 | ) |
| Other  liabilities                                                                            |       | (182                   | )          | (3,692 | ) |
| Net cash used  for continuing operations                                                      |       | (3,565                 | )          | (5,408 | ) |
|                                                                                          |       |                   |       |   |   |
| Net cash  provided by discontinued operations                                                 |       | —                 |       | 822 |   |
| Net cash used  for operating activities                                                       |       | (3,565                 | )          | (4,586 | ) |
|                                                                                          |       |                   |       |   |   |
| **Investing  Activities:**                                                                    |       |                   |       |   |   |
| Purchases of  property and equipment                                                          |       | (63                    | )          | — |   |
| Proceeds from  sale of property and equipment                                                 |       | 1                      |       | — |   |
| Investment in  patents and trademarks                                                         |       | (70                    | )          | (102 | ) |
| Net cash used  for investing activities                                                       |       | (132                   | )          | (102 | ) |
|                                                                                          |       |                   |       |   |   |
| **Financing  Activities:**                                                                    |       |                   |       |   |   |
| Proceeds from  borrowings                                                                     |       | 4,669                  |       | 9,924 |   |
| Repayment of  borrowings                                                                      |       | (1,613                 | )          | (1,841 | ) |
| Proceeds from  restricted cash                                                                |       | 754                    |       | (58 | ) |
| Net cash  provided by financing activities                                                    |       | 3,810                  |       | 8,025 |   |
|                                                                                          |       |                   |       |   |   |
| Effect of  foreign exchange translation                                                       |       | 401                    |       | (108 | ) |
| Net increase in  cash and cash equivalents                                                    |       | 514                    |       | 3,229 |   |
|                                                                                          |       |                   |       |   |   |
| Cash and cash  equivalents at beginning of period                                             |       | 742                    |       | 3,127 |   |
| Cash and cash  equivalents at end of period                                                   |       | $                      | 1,256      |   | $ | 6,356 |   |
|                                                                                          |       |                   |       |   |   |
| Supplemental  cash flow information:                                                          |       |                   |       |   |   |
| Interest paid                                                                                 |       | $                      | 229        |   | $ | 208 |   |
| Taxes paid                                                                                    |       | $                      | —     |   | $ | — |   |

 

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

 

6

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Duringthe six months ended June 30, 2004, the Company sold it’s 51% ownershipinterest in Dongyang to the 49% minority shareholder, which resulted in a lossof $46 from disposal of discontinued operations as of June 30, 2004.

 

 

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

 

7

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**LIQUIDMETAL TECHNOLOGIES ANDSUBSIDIARIES**

** **

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**For the Six Months Ended June 30,2005 and 2004**

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

**(unaudited)**

 

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

 

The accompanying unaudited condensed consolidatedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America (“generallyaccepted accounting principles”) for interim financial information and with theinstructions to Form 10-Q.  Accordingly,they do not include all of the information and notes required by generallyaccepted accounting principles for complete financial statements.  In the opinion of management, all adjustments(consisting only of normal recurring accruals) considered necessary for a fairpresentation have been included.  Inaddition, certain reclassifications have been made for consistentpresentation.  Operating results for thethree and six months ended June 30, 2005 are not necessarily indicative of theresults that may be expected for any future periods or the year ending December31, 2005.  The accompanying unauditedcondensed consolidated financial statements should be read in conjunction withthe Company’s Form 10-K filed with the Securities and Exchange Commission onMarch 30, 2005.

 

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

 

The Company classifies operations into two reportablesegments: Liquidmetal alloy industrial coatings and bulk Liquidmetal alloys.Liquidmetal alloy industrial coatings are used primarily as a protectivecoating for industrial machinery and equipment, such as drill pipe used by theoil drilling industry and boiler tubes used by coal-burning power plants. BulkLiquidmetal alloys include potential market opportunities to manufacture andsell products and components for electronic devices, medical devices, defenseapplications, and sporting goods.  Inaddition, the bulk Liquidmetal alloys segment includes tooling and prototype sampling,and the manufacture and sale of die casting equipment (see Note 7).  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 applies Accounting Principles Board (“APB”) OpinionNo. 25 for options when the exercise price of options granted to employees is less than thefair value of the underlying stock on the date of grant.  The Company applies Statement of Financial Accounting Standards (“SFAS”)No. 123 for options granted to non-employees who perform services for theCompany.

 

Had the Companydetermined compensation cost based on the fair value at the grant date forstock options consistent with the method of SFAS No. 123, the Company’sloss from continuing operations and basic and diluted loss per sharefrom continuing operations would have been as follows:

 

8

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| ** **                         | ** **                                                                                                                                | **For the Three**         | ** ** | **For the Six**           | ** ** |
|------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------|---------------------------|------------|---------------------------|------------|
| ** **                         | ** **                                                                                                                                | **Months Ended June 30,** | ** ** | **Months Ended June 30,** | ** ** |
| ** **                         | ** **                                                                                                                                | **2005**                  | ** ** | **2004**                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                         | ** **                                                                                                                                | ** **                | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss as  reported              |                                                                                                                                      | $                         | (6,417     | )                         | $          | (2,115 | ) | $ | (10,514 | ) | $ | (2,856 | ) |
|                               |                                                                                                                                      |                      |       |                      |       |   |   |   |   |
| *Add:*                             | stock-based employee compensation expense included  in reported net loss, net of related tax effects                                      |                      | —     |                      | 7          |   | — |   | 276 |   |
|                               |                                                                                                                                      |                      |       |                      |       |   |   |   |   |
| *Deduct:*                          | total stock-based employee compensation expense  determined under the fair value based method for all awards, net of related  tax effects |                      | (736       | )                         | (1,338     | ) | (1,519 | ) | (2,809 | ) |
|                               |                                                                                                                                      |                      |       |                      |       |   |   |   |   |
| Proforma net  loss:                |                                                                                                                                      | $                         | (7,153     | )                         | $          | (3,208 | ) | $ | (12,033 | ) | $ | (5,389 | ) |
|                               |                                                                                                                                      |                      |       |                      |       |   |   |   |   |
| Basic and  diluted loss per share: |                                                                                                                                      |                      |       |                      |       |   |   |   |   |
| As reported                        |                                                                                                                                      | $                         | (0.15      | )                         | $          | (0.05 | ) | $ | (0.25 | ) | $ | (0.07 | ) |
| Proforma                           |                                                                                                                                      | $                         | (0.17      | )                         | $          | (0.08 | ) | $ | (0.29 | ) | $ | (0.13 | ) |

 

The fair value of each option grant is estimated on the date of thegrant using the Black-Scholes option-pricing model with the followingweighted-average assumptions used for grants for the six months ended June 30,2005 and 2004, respectively: expected volatility of approximately 100% for allperiods; dividend yield of 0.0% for all periods; expected option life ofapproximately 5 years; and a risk-free interest rate ranging from 2.9% to4.2%.

 

**2.****         Basis of Presentation and Recent AccountingPronouncements**

 

Translation of Foreign Currency

 

The Company applies **FASB No. 52, Foreign Currency Translation**,for translating foreign currency into US dollars in ourconsolidation of the financial statements.  Upon consolidation of theCompany’s foreign subsidiaries into the Company’s consolidated financialstatements, any balances with the subsidiaries denominated in the foreigncurrency are translated at the exchange rate at year-end. The financialstatements of Liquidmetal Korea have been translated based upon Korean Won asthe functional currency. Liquidmetal Korea’s assets and liabilities weretranslated using the exchange rate at period end and income and expense itemswere translated at the average exchange rate for the reporting period. Theresulting translation adjustment was included in other comprehensive income(loss).

 

Reclassifications

 

Certain amounts from the prior year have been reclassified to conformto current year’s presentation.

 

Recent Accounting Pronouncements

 

In March 2004, the EITF reached a consensus on recognition andmeasurement guidance previously discussed under EITF 03-01 The consensusclarifies the meaning of other-than-temporary impairment and its application toinvestments classified as either available-for-sale or held-to-maturity underFASB Statement No. 115, “Accounting for Certain Investments in Debt and EquitySecurities,” and other investments accounted for under the cost method. Therecognition and measurement guidance for which the consensus was reached inMarch 2004 is to be applied to other-than-temporary impairment evaluations inreporting periods beginning after June 15, 2004. In September 2004, the FASBissued a final FASB Staff Position that delays the effective date for themeasurement and recognition guidance for all investments within the scope ofEITF Issue No. 03-01; however, the disclosure requirements remain effective forannual periods ending after June 15, 2004. The Company does not believe thatthe adoption of this statement will have a material effect on the Company’sresults of operation and financial position.

 

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In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment”,which replaces SFAS No. 123. SFAS No. 123R requires public companies torecognize an expense for share-based payment arrangements including stockoptions and employee stock purchase plans. The statement eliminates a company’sability to account for share-based compensation transactions using APB 25, andgenerally requires instead that such transactions be accounted for using a fairvalue based method. SFAS No. 123R requires an entity to measure the cost ofemployee services received in exchange for an award of equity instruments basedon the fair value of the award on the date of grant, and to recognize the costover the period during which the employee is required to provide service inexchange for the award. In April 2005, the SEC amended the compliance dates forSFAS 123(R), to allow companies to implement the standard at the beginning oftheir next fiscal year, instead of the next reporting period beginning afterJune 15, 2005. SFAS No. 123R is effective for the Company in the quarter endingMarch 31, 2006. Upon adoption of SFAS 123R, companies are allowed to select oneof three alternative transition methods, each of which has different financialreporting implications. The Company is currently evaluating the transitionmethods, valuation methodologies and other assumptions for employee stockoptions in light of SFAS No. 123R. Current estimates of option values using theBlack-Scholes method may not be indicative of results from valuationmethodologies ultimately implemented by the Company upon adoption of SFAS No.123R. Although the Company has not yet fully quantified the impact thisstandard will have on its financial statements, it is likely that the adoptionof SFAS No. 123R will have a material impact on the Company’s financialposition and results of operations. Stock-based Compensation under Note 1 included in these CondensedConsolidated Financial Statements provides the pro forma net income andearnings per share as if the Company had used a fair-value-based method similarto the methods required under SFAS 123(R) to measure the compensation expensefor employee stock awards during the three and six months ended June 30, 2005and 2004.

 

On March 29, 2005, the SEC issued Staff Accounting Bulletin No. 107(SAB 107) regarding the Staff’s interpretation of SFAS 123(R). Thisinterpretation expresses the views of the staff regarding the interactionbetween SFAS 123(R) and certain SEC rules and regulations and provides thestaff’s views regarding the valuation of share-based payment arrangements forpublic companies. In particular, this SAB provides guidance related to share-basedpayment transactions with nonemployees, the transition from nonpublic to publicentity status, valuation methods, the accounting for certain redeemablefinancial instruments issued under share-based payment arrangements, theclassification of compensation expense, non-GAAP financial measures, first-timeadoption of SFAS 123(R) in an interim period, capitalization of compensationcost related to share-based payment arrangements, the accounting for income taxeffects of share-based payment arrangements upon adoption of SFAS 123(R), themodification of employee share options prior to adoption of Statement 123(R)and disclosures in Management’s Discussion and Analysis subsequent to adoptionof SFAS 123(R). The Company will adopt SAB 107 in connection with its adoptionof SFAS 123(R).

 

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes andError Corrections — a replacement of APB Opinion No. 20 and FASB Statement No.3.”  SFAS No. 154 replaces APB Opinion No. 20, “Accounting Changes,” andFASB Statement No. 3, “Reporting Accounting Changes in Interim FinancialStatements” and changes the requirements for the accounting for and reportingof a change in accounting principle.  This statement applies to allvoluntary changes in accounting principle.  It also applies to changesrequired by an accounting pronouncement in the unusual instance that thepronouncement does not include specific transition provisions.  When apronouncement includes specific transition provisions, those provisions shouldbe followed.  SFAS No. 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 31,2005.  The Company does not believe the adoption of SFAS No. 154 will havea material effect on its consolidated financial position, results of operationsor cash flows.

 

Other recent accounting pronouncements issued by the FASB (includingits Emerging Issues Task Force), the AICPA and the SEC did not or are notbelieved by management to have a material impact on the Company’s present orfuture consolidated financial statements.

 

**3.****        ****Liquidity**

 

The Company hasexperienced losses from continuing operations during the last two fiscal yearsand has an accumulated deficit of $135,827 as of June 30, 2005.  Cash used for continuing operations for thesix months ended June 30, 2005 was $3,565 and cash flow from continuingoperations may be negative throughout fiscal year 2005.  As of June 30, 2005, the Company’s principalsource of liquidity is $1,256 of cash and trade accounts receivable of$2,359.  Such conditions raise 

 

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substantial doubt thatthe Company will be able to continue as a going concern for a reasonable periodof time.  These operating resultsoccurred while the Company was developing and attempting to commercialize andmanufacture products from an entirely new and unique technology.  This business plan required significantspending related to start-up costs and capital expenditures.  These factors have placed a significantstrain on the financial resources of the Company.  The ultimate success of the Company dependson its ability to continue reducing operating costs, generate higher revenue,and achieve positive cash flow from continuing operations andprofitability.  The consolidatedfinancial statements do not include any adjustments that might result from theoutcome of the uncertainty.

 

Additionally, the Company is not in compliance withcertain covenant requirements of the senior convertible debt as of June 30, 2005.  Although there has been no formal notice ofdefault received from the note holders, as the note holders have the right tocall for repayment of the outstanding balance of the senior convertible debt,the total outstanding debt balance of $5,709 have been included as currentliabilities as of June 30, 2005 (see Note 8).

 

The Company completed $3,250 private placement of 10%convertible debt on June 13, 2005 and Factoring, Loan, and Security Agreement (“FactoringAgreement”) on April 21, 2005, which allows for borrowing up to $1,500, to meetworking capital needs of the Company (see Note 8).  Borrowings made under the Factoring Agreementare secured by the Company’s trade receivables. Such borrowings totaled $1,222, which was offset by $729 of repayments madeas June 30, 2005.

 

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, the resourcesdevoted to develop and support Liquidmetal alloy products, and the cost ofsuccessful implementation of Section 404 of the Sarbanes-Oxley Act of2002.  If the available funds and cashgenerated from operations are insufficient to satisfy liquidity requirements,the Company may need additional funds in the future to support working capitalrequirements and for other purposes, and may need to raise additional fundsthrough public or private equity financing, bank debt financing, or from othersources. Subsequent to the close of the second quarter of 2005, the Companycompleted a private placement of $9,877 of 7% convertible debt in considerationfor $5,000 aggregate cash received, $4,280 exchange of previously issued notes,and satisfaction of accrued interest and fees of $597 from the previouslyissued notes (see Note 14). Adequate funds may not be available when needed ormay not be available on favorable terms. However, the Company anticipatescapital expenditures in the next 12 months will be less than $0.5 million. TheCompany expects to continue to devote limited capital to our research anddevelopment activities, to further develop and strengthen our manufacturingcapabilities, and for working capital and other general corporate purposes.

 

Ourcash flow projections from operations and, consequently, future cash needs aresubject to uncertainty.  If our availablefunds and cash generated from operations are insufficient to satisfy ourliquidity requirements, we may need to raise additional capital to fund ouroperations and capital expenditure requirements.  We cannot be certain that additional capital,whether through selling additional debt or equity securities or obtaining aline of credit or other loan, will be available to us or, if available, will beon terms acceptable to us.  If we issueadditional securities to raise funds, these securities may have rights,preferences, or privileges senior to those of the rights of our common stockand our stockholders may experience additional dilution.

 

**4.Inventories**

 

The Company maintainscertain of its raw material inventories in amounts in excess of our operatingcycle of one year due to the nature of our manufacturing process, productionlead time, and the recyclability of our raw material. These inventories wereclassified as long-term inventory as of December 31, 2004. The Companydetermined that its current and projected raw material requirements are notsufficient enough to warrant the use of such raw materials in the foreseeablefuture. Accordingly, the Company reduced the carrying value of raw materialsheld by its subsidiary, Liquidmetal Korea, by the amounts considered to beexcessive. The write-down amounted to $1,653 is included in “Impairment of longlived assets” in the accompanying Condensed Consolidated Statement ofOperations and Comprehensive Loss for the three and six months ended June 30,2005. The total amount of long term inventory was $0 and $1,810 as of June 30,2005 and December 31, 2004, respectively.

 

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| ** **                 | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------|------------|--------------|------------|------------------|------------|
| ** **                 | ** ** | **2004**     | ** ** | **2004**         | ** ** |
|                       |       |         |       |             |       |
| Raw materials              |       | $            | 1,515      |             | $          | 1,688 |   |
| Work in process            |       | 412          |       | 352              |       |
| Finished goods             |       | 263          |       | 313              |       |
| Total current  inventories |       | 2,190        |       | 2,353            |       |
| Long-term  inventories     |       | —       |       | 1,810            |       |
| Total  inventories         |       | $            | 2,190      |             | $          | 4,163 |   |

 

**5.Idle Equipment**

 

Idle equipment consistsof certain equipment held by the Company for use in expansion of bulk alloyparts manufacturing.  Due to excess manufacturing capacity, theCompany classified the equipment as idle equipment at December 31, 2004. While the equipment may be used internally to meet future capacityrequirements, considering our current revenue and foreseeable productionrequirements, the Company does not anticipate utilizing this equipmentinternally in the near future. For these reasons, during the quarter ended June30, 2005, the Company determined to write down the carrying value of the idleequipment held by its subsidiary, Liquidmetal Korea, to its net realizablevalue. The write-down amounted to $1,741 and is included in operating expensesas “Impairment of long lived assets” in the accompanying Condensed ConsolidatedStatement of Operations and Comprehensive Loss for the three and six monthsended June 30, 2005. Total amount of idle equipment remaining was $194 and$1,906 as of June 30, 2005 and December 31, 2004, respectively.

 

**6.****        ****Discontinued Operations**

 

*Dongyang*

 

On June 28, 2002, the Company acquired a 51%interest in Chusik Hoesa Dongyang Yudoro (“Dongyang”).  In March 2004, the Company soldits 51% investment in Dongyang to the 49% minority shareholder.  The selling price of the Company’s 51%interest in Dongyang was $80, which was equal to the Company’s net carryingvalue for the 51% ownership held. Further, the Company agreed to pay Dongyang $155 for the purchase of areceivable balance from Growell.  Thetransaction resulted in net payable to Dongyang of $75 and a loss of $46 fromtransfer of the Company’s interest in Donyang to the minority shareholder.  The loss from operations for the six monthsended June, 2004 totaled $50 and is included in the loss from discontinuedequipment manufacturing operations for the period.  The net payable balance of $75 is to be paidin quarterly installments throughout 2004, with $25 to be paid subsequent to2004.  The outstanding amount payable toDongyang is $11 and $25 as of June 30, 2005 and December 31, 2004,respectively, and is included in accounts payable and accrued liabilities.

 

Summarizedoperating results of Dongyang’s discontinued operations are as follows.

 
| ** **                                                             | ** ** | **For the Three months  Ended June 30,** | ** ** | **For the Six months  Ended June 30,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                             | ** ** | **2005**                                 | ** ** | **2004**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                   |       |                                     |       |                                   |       |   |   |   |   |
| Revenue                                                                |       | $                                        | —     |                                   | $          | — |   | $ | — |   | $ | 22 |   |
| Loss from  discontinued equipment manufacturing operations, net of tax |       | —                                   |       | —                                 |       | — |   | (96 | ) |
|                                                                        |            |                                          |            |                                        |            |  |  |  |  |  |  |  |  |

 

*Taesung*

 

OnJune 14, 2004, the Company entered into an Asset Purchase Agreement whereby allthe assets and liabilities of its Taesung equipment manufacturing division inKorea were sold to a third party for $345 which is payable by the third partyin four equal installments with the last installment being due on June 30,2005.  As of March 31, 2004, managementdetermined that no impairment was anticipated on the divestiture of its Taesungdivision.  Ultimately, the sale resultedin a loss of 

 

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approximately$184.  The loss from operations for thethree and six months ended June 30, 2004 totaled $179 and $469 and is includedin the loss from discontinued equipment manufacturing operations for theperiod.

 

Summarizedoperating results of Taesung’s operations are as follows:

 
| ** **                                                             | ** ** | **For the Three months  Ended June 30,** | ** ** | **For the Six months  Ended June 30,** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                             | ** ** | **2005**                                 | ** ** | **2004**                               | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                   |       |                                     |       |                                   |       |   |   |   |   |
| Revenue                                                                |       | $                                        | —     |                                   | $          | 72 |   | $ | — |   | $ | 172 |   |
| Loss from  discontinued equipment manufacturing operations, net of tax |       | —                                   |       | (356                                   | )          | — |   | (653 | ) |
|                                                                        |            |                                          |            |                                        |            |  |  |  |  |  |  |  |  |

 

**7.****        ****Product Warranty**

 

Due to the lack ofhistorical information for warranty expense related to bulk alloy products,management estimates product warranties as a percentage of bulk alloy productsales earned during the period.  During thethree and six months ended June 30, 2005, the Company recorded $34­ and $76,respectively, of warranty expense. During the three and six months ended June 30, 2004, the Companyrecorded $­79 and $137, respectively, of warranty expense.  The product warranty accrual balance isincluded in accounts payable and accrued expenses.

 

**8.****        ****Notes Payable**

 

Senior ConvertibleNote

 

On March 3, 2004, theCompany issued $9.9 million of 6.0% senior convertible notes due 2007 (the “MarchNotes”) to investor groups in a transaction led by Michigan Venture CapitalCo., Ltd, a South Korea-based institutional investment firm, and IndiGoVentures LLC, a New York-based investment firm (the “Placement Agents”) thatserved as a financial advisor to the Company for the transaction.  The notes were collateralized by the patentsheld by the Company and second priority mortgage interest in plant facilitiesand certain equipment in South Korea. The notes were convertible at any time into common stock at a price of$3.00 per share.  Investors in theprivate placement and the Placement Agents received warrants to purchase anaggregate amount of up to approximately 1.2 million shares of common stock,exercisable at $3.00 per share for varying periods but no later than 100 daysfollowing the effectiveness of a registration statement covering the resale ofshares issuable 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.

 

The fair value of the 1.2million warrants totaled $1,883 and was computed using the Black-Scholespricing model under the following assumptions: (1) expected life of 3 years;(2) volatility of 82%, (3) risk free interest of 0.95% and dividend rate of0%.  In addition, since this debt isconvertible into equity at the option of the note holder at beneficialconversion rates, an embedded beneficial conversion feature was recorded as a debtdiscount and will be amortized using the effective interest rate method overthe life of the debt in accordance with Emerging Issues Task Force No. 00-27, “Applicationof Issue No. 98-5 to Certain Convertible Instruments.”  In March 2004, total cost of beneficialconversion feature of $3,395 and the fair value of the 0.6 million warrantsissued to investors of $584 were recorded as discounts of the convertiblenote.  In addition, $718 relating to thefair value of the 0.6 million warrants issued to the Placement Agents and $581direct costs incurred relating to issuance of the convertible note wererecorded as debt issuance cost as a contra liability account in warrantliability and other assets, respectively.

 

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 $2,071 to interest expense during theyear ended December 31, 2004.  Further,500,000 of warrants originally issued to a financial advisor for thetransaction expired during June 2004 and 163,748 of unexercised warrantsoriginally issued to investors were cancelled as a result of the Company’sredemption of the note balances during the year ended December 31, 2004.  The 663,748 total expired and canceledwarrants immediately prior to the expiration and cancellation resulted in areduction of warrant liability of $7 and $279 to paid in capital and change invalue of warrants, respectively, during the year ended December 31, 2004.

 

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On August 19, 2004, theCompany completed a private exchange offer for its March Notes with theremaining holders after the redemption. Under terms of the exchange offer, approximately $5.5 million inaggregate principal amount of the March Notes have been exchanged for anaggregate of (i) $2.75 million of 6% Senior Secured Notes Due 2007 (the “Long-TermNotes”) and (ii) $2.75 million of 10% Senior Secured Notes Due 2005 (the “Short-TermNotes”), collectively referred to as “Exchange Notes”.  The Exchange Notes are collateralized bycertain patents owned by the Company and second priority mortgage interest inplant facilities and certain equipment at our South Korea plant.  The Short-Term Notes have a maturity date ofJuly 29, 2005, and a conversion price of $2.00 per share (compared to aconversion price of $3.00 per share under the March Notes).  The Short-Term Notes have been exchanged andredeemed subsequent to the close of the second quarter of 2005 (see Note 14).The Long-Term Notes have a maturity date of July 29, 2007, and a conversionprice of $1.00 per share.  Further, theexchange notes are convertible into Common Stock, at the option of the Company,if at any time after the issuance of the notes, the closing per share price ofthe Common Stock exceeds $4.00 (as adjusted for stock splits, reverse splits,stock dividends, and recapitalizations) for 30 consecutive trading days, andfurther provided that there has been effective registration during suchperiod.  Holders of the Long-Term Notesalso have the right to call for repayment of the Long-Term Notes prior tomaturity at any time after the second anniversary of the closing of theexchange offer.  The Long-Term Notes havebeen amended subsequent to the close of the second quarter of 2005 to providefor an Amended Registration Rights Agreement, and Amended and Restated SecurityAgreement (see Note 14).

 

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 exchange offer wastreated as an extinguishment of the March Notes in accordance with EmergingIssues Task Force No. 96-19, “Debtors Accounting for a Modification or Exchangeof Debt Instruments.”  The exchangeresulted in a $1,663 loss from extinguishment of the March Notes, write down of$352 of deferred issue costs in other assets, $189 of contra liability deferredissuance costs, and $1,122 of debt discount as a result of the change incarrying value of exchanged notes.

 

In connection with theprivate exchange offer, the Company issued $250 of private placement notes tocertain 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 (Long-Term Notes) and$125 was paid in the form of short-term notes which is due in 2005 withinterest rate of 10% per annum (Short-Term Notes).  The Short-Term and Long-Term Notes areconvertible into Common Stock at $2.00 and $1.00, respectively, and have thesame terms as the Exchange Notes issued to the investors.  Further, a beneficial conversion feature wasrecorded from the $125 Long-Term Notes issued to Placement Agents of $29 duringAugust 2004.

 

The Company wasobligated, pursuant to a Registration Rights Agreement, as amended by theExchange Notes, between the Company, the Placement Agents and the note holdersto file a registration statement with the Securities and Exchange Commission (“SEC”)to register the shares of Common Stock issuable upon conversion of the notespayable and the related warrants within 90 days following the effective closingdate of the exchange notes (July 29, 2004), and to use best efforts to causesuch registration statement to become effective within 60 days following theSEC’s first written comments on the registration statement.  Further, if the Company is not in compliancewith the registration or listing requirements, the holders have rights to lateregistration payments equal to between 2 and 3 percent of the purchase pricepaid for the unconverted notes for the first 30 business days of lateregistration, and 1 and 3 percent for each 30 business days thereafter, but nomore than 18 percent of the purchase price of the unconverted notebalance.  Late registration fee of $1,028has been accrued as interest expense, and is included in accounts payable andaccrued liabilities as of June 30, 2005. The $5,709 balance of the note and un-amortized discounts for beneficialconversion feature and warrants of $551 is presented as short-term liability asof June 30, 2005 as the note holders have the right to call for payment ondemand as the registration statement has not been filed in accordance with theamended Registration Rights Agreement. As of the filing of this report, the Company has not received anydemands for payment from the note holders.

 

Interest payments are duequarterly, and failure to make timely interest payments will result in increasein interest rate to 10% and 14% on the 6% and 10% senior convertible notes (“DefaultRates”).  The Default Rates becameeffective on April 1, 2005 from non-payment of a scheduled interestpayment.  As such, the Company accrued$171 of additional interest from the default rates applied to the loan balanceas of June 30, 2005, which is included in accounts payable and accruedliabilities.

 

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As of June 30, 2005 andDecember 31, 2004, our gross outstanding loan balance of the Short-Term andLong-Term Notes totaled $5,709, un-amortized discounts for beneficial conversionfeature and warrants totaled $551 and $851, and other asset debt issuance coststotaled $75 and $183, respectively. Interest expense for the amortization of debt issuance cost and discounton note was $211 and $408 for the three and six months ended June 30, 2005, and$271 and $335 for the three and six months ended June 30, 2004,respectively.  As of June 30, 2005, theeffective interest rates for the Short-Term and Long-Term Notes were 22% and32%, respectively.

 

Pursuant to EITF 00-19, “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock”, the original relative fair values of the warrants of$1,302 have been recorded as other liability as the Company has not yet filedthe registration statement.  In addition,the Company is required to report a value of the warrant as a fair value andrecord the fluctuation to the fair value of the warrant liability to currentoperations.  The change in the fair valueof the warrants resulted in a net gain of $154 and $287 for the three and sixmonths ended June 30, 2005, and a net gain of $694 and $1,280 for the three andsix months ended June 30, 2004.  The fairvalue of warrants outstanding at June 30, 2005 of $263 was computed using theBlack-Scholes model under the following assumptions: (1) expected life of 0.67years; (2) volatility of 117%, (3) risk free interest of 3.45%and dividend rateof 0%.

 

Convertible Notes

 

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

 

The Notes issued by the Company in the Private Placement are unsecuredand will become due on the earlier of June 13, 2006 or the consummation ofa follow-on equity or debt offering or restructuring transaction pursuant towhich the Company receives gross proceeds of at least $4,000.  Prior tomaturity, the Notes will be interest-only, with interest payments duequarterly, at the rate of 10% per year.  The Notes can be prepaid by theCompany at any time without penalty.  If, within 120 days following theissue date of the Notes, the Company either fails to redeem the notes for theprincipal amount and accrued interest thereon or fails to close a “QualifiedFinancing,” then the Notes will thereafter be convertible at a conversion priceequal to seventy five percent (75%) of the closing price of the Company’scommon stock on the first trading day immediately preceding the conversiondate.  A “Qualified Financing “ is defined in the Notes as any debt orequity financing of the Company resulting in aggregate gross proceeds to theCompany of at least $5,000 and in which the holders of at least sixty percent(60%) of the aggregate principal amount of the Company’s Long Term Notes dueJuly 2007 either (i) agree that the equity or debt securities to beissued in such financing shall be*pari passu*in order of payment to the 2007 Notes held by them or (ii) exchange their2007 Notes for new securities in the financing transaction.  Subsequent to the close of the second quarterof 2005, the Company successfully completed Qualified Financing, which resultedin exchange and redemption of the Convertible Notes (see Note 14).  As a result, the Notes never become convertible.

 

The holders of the Notes will have the right to call for earlyrepayment of the Notes if, on the date that is 180 days of the issue date ofthe Notes (i) the Company is not then compliant with its SEC reportingobligations, or (ii) the Company’s common stock is not then listed or quoted onthe OTC Bulletin Board, Nasdaq Stock Market, New York Stock Exchange, orAmerican Stock Exchange.

 

As a part of the Private Placement, the Company issued Warrants to thepurchasers of the Notes giving them the right to purchase up to an aggregate of812,500 shares of the Company’s common stock.  In addition, Warrants topurchase 81,250 shares of the Company’s common stock were issued to theplacement agent in the transaction.  The Warrants have an exercise priceof $2.00 per share, provided that upon the consummation of the first ensuingpublic or private equity or debt offering or restructuring transaction in whichthe Company receives gross proceeds of at least $3,250 (including withoutlimitation any restructuring of the Company’s 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.

 

The fair value of the 893,750 warrants totaled$1,160 and was computed using the Black-Scholes pricing model under the 

 

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following assumptions: (1) expected life of 5 years;(2) volatility of 118%, (3) risk free interest of 3.87% and dividend rate of0%.  In accordance with Emerging IssuesTask Force No. 00-27, “Application of Issue No. 98-5 to Certain ConvertibleInstruments” the embedded beneficial conversion feature of the debt was notrecorded as the debt is considered contingently convertible at the time ofissuance, and as a result of the completion of the Qualified Financing the debtsubsequent to the close of the second quarter, the debt was determined to benot convertible. In June 2005, the fair value of the 812,500 warrants issued toinvestors of $1,055 was recorded as discounts of the convertible note.  In addition $105 relating to the fair valueof the 81,250 warrants issued to the Placement Agents and $278 direct costsincurred relating to issuance of the convertible note were recorded as debtissuance cost as a contra liability account in debt discount and other assets,respectively, and will be amortized using the effective interest rate methodover the life of the loan. As of June 30, 2005, the gross outstandingloan balance of the Notes totaled $3,250, un-amortized discounts for warrantstotaled $1,003, and other asset debt issuance costs totaled $264, and contraliability debt issuance cost totaled $100. Interest expense for the amortization of debt issuance cost and discounton note was $71 for the three months ended June 30, 2005.  As of June 30, 2005, the effective interestrates for Notes was 54%.

 

Under a registration rights agreement entered into between the Companyand the purchasers of the Notes, the Company is required, within 90 days of thedate of the issuance of the Notes, to file a registration statement with theSEC covering the resale of the shares of Company common stock into which theNotes are convertible and for which the Warrants are exercisable.  TheCompany is required to cause this registration statement to become effectivewithin 60 days after the Company receives the first written comments on theregistration statement from the SEC, or if the SEC notifies the Company that itwill not review the registration statement, within five days after suchnotification.  The Company will be subject to certain monetary penalties,as set forth in the registration rights agreement, if the registrationstatement is not filed or does not become effective on a timely basis.  As the Company was unable to complete thedocumentation, assessment and evaluation of internal control over financialreporting, which are required to be undertaken to comply with Section 404of the Sarbanes-Oxley Act of 2002 (“SOX 404”) as of December 31, 2004, the Companycannot determine the impact of the non-compliance as of December 31, 2004 onthe registration statement and cannot ensure that the registration statementswill be completed in a timely manner. The Company has taken steps to ensurecompliance with SOX 404 requirements as of December 31, 2005. There can be noassurance, however, that the Company will be in compliance with Section 404 asof December 31, 2005 and 2004 and/or that the Company will have theRegistration statement declared effective by the SEC prior to such compliance.

 

Pursuant to EITF 00-19, “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock”, the original relative fair values of the warrants of$1,160 have been recorded as other liability as the Company has not yet filedthe registration statement.  In addition,the Company is required to report a value of the warrant as a fair value andrecord the fluctuation to the fair value of the warrant liability to currentoperations.  The change in the fair valueof the warrants resulted in a net loss of $254 for the three months ended June30, 2005.  The fair value of warrantsoutstanding at June 30, 2005 of $1,414 was computed using the Black-Scholes modelunder the following assumptions: (1) expected life of 4.96 years; (2)volatility of 117%, (3) risk free interest of 3.72%and dividend rate of 0%.

 

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.  The Agreement expires on April21, 2006, and automatically renews annually thereafter. All borrowings aresecured by outstanding receivables specifically assigned to the financingcompany.  Assigned receivables areconsidered “Approved” or “Non-Approved” by the financing company.  Advances are made on 80% of Approvedreceivables assigned and 30% of receivables assigned.  Payments on assigned receivables are receiveddirectly by the financing company, and applied to outstanding advances.  All outstanding advances and uncollectedassigned receivables are subject to fees and interest charges ranging from 0.65percent to 2 percent plus prime rate as published by the Wall Street Journal,with a minimum annual fee of $30. All receivables assigned and advances madeare subject to return and recall by the financing company, respectively.  As such, the advances have been classified asshort-term secured borrowings in accordance with FAS 140 “Accounting forTransfer and Servicing of Financial Assets and Extinguishments of Liabilities.”  As of June 30, 2005, the Company has borrowed$1,222 and repaid $729.  The totaloutstanding advance made under the agreement is $493 as of June 30, 2005, whichis presented as short-term debt.

 

Kookmin Note

 

On February 4, 2003, ourKorean subsidiary received 6,500,000 in South Korean Won, or approximately$5,488, under a loan from Kookmin Bank of South Korea.  The loan bears interest at an annual rate of7.1%.  In the event of delayed repayment,the interest increases to a maximum of 21%, depending on the length of time therepayment is delayed.  This loan iscollateralized by the plant facilities and certain equipment in 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, 

 

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2003, Kookmin Bankrequested that the Company pay an additional $866 of principal by February 2004due to the Company’s current credit rating. The Company made two payments on the requested additional loan pay downin November and December 2003 of $320 and $205, respectively.  The remaining payment of $341 wassubsequently made in February 2004. Beginning in September 2004, the Company is required to make equalmonthly installments of principal and interest to repay the remaining balanceof the loan over a 36-month period. Principal payments made to Kookmin Bank totaled $621 for the six monthsended June 2005, which includes $65 of foreign exchange translation loss.  The outstanding loan balance totaled $3,270,of which $1,226 is included in current portion of long-term debt, as of June30, 2005.

 

**9.     StockCompensation Plan**

 

During the three and six months ended June 30,2005, under the Company’s 2002 Equity Incentive Plan which provides for thegrant of stock options to officers, employees, consultants and directors, theCompany granted options to purchase 7,500 and 891,165 common shares of theCompany for an average exercise price of $1.63 and $2.21, respectively, whichequaled the fair market value on the date of grant

 

During the three months ended June 30, 2005, underthe Company’s 2002 Non-employee Director Stock Option Plan which provides forthe grant of stock options to non-employee directors, the Company did not grantany options.  During the six months endedJune 30, 2005, the Company granted 180,000 common shares of the Company for anaverage exercise price of $2.33 under this plan.  Further, all options granted under this planhad exercise prices that were equal to the fair market value on the date ofgrant.

 

The Company canceled 84,582 and 244,184 optionsduring the three and six months ended June 30, 2005, respectively, forterminated employees and directors.

 

**10.****      Segment Reporting and GeographicInformation**

 

SFAS No. 131,*Disclosures about Segments of an Enterprise and Related Information,*requirescompanies to provide certain information about their operating segments.  In April 2002, the Company began classifyingoperations into two reportable segments: Liquidmetal alloy industrial coatingsand bulk Liquidmetal alloys.  TheLiquidmetal alloy industrial coatings are used primarily as a protectivecoating for industrial machinery and equipment, such as drill pipe used by theoil drilling industry and boiler tubes used by coal burning power plants.  Bulk Liquidmetal alloys include marketopportunities to manufacture and sell casing components for electronic devices,medical devices, sporting goods, tooling, prototype sampling, defenseapplications and metal processing equipment. Primarily, the expenses incurred by the bulk Liquidmetal alloy segmentare research and development costs and selling expenses associated withidentifying and developing market opportunities.  Bulk Liquidmetal alloys products can bedistinguished from Liquidmetal alloy coatings in that the bulk Liquidmetalalloy can have significant thickness, up to approximately one inch, whichallows for their use in a wider variety of applications other than a thinprotective coating applied to machinery and equipment.  Revenue and expenses associated 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 3 to the consolidated financial statements included in the Company’sForm 10-K filed with the Securities and Exchange Commission on March 30, 2005.

 

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

 
| ** **                                                            | ** ** | ** **   | ** ** | ** **     | ** ** | **Segment** | ** ** |
|-----------------------------------------------------------------------|------------|--------------|------------|----------------|------------|-------------|------------|
| ** **                                                            | ** ** | **Coatings** | ** ** | **Bulk Alloy** | ** ** | **Totals**  | ** ** |
|                                                                  |       |         |       |           |       |        |       |
| 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      |       |
|                                                                  |       |         |       |           |       |        |       |
| Three months ended June 30, 2004:                                     |       |         |       |           |       |        |       |
| Revenue to external customers                                         |       | $            | 706        |           | $          | 3,349       |       | $ | 4,055 |   |
| Gross profit                                                          |       | 327          |       | 1,253          |       | 1,580       |       |
| Income before interest expense,  discontinued operations, and general |       | 192          |       | 619            |       | 811         |       |
| Total identifiable assets at end of period                            |       | 821          |       | 24,702         |       | 25,523      |       |
|                                                                  |       |         |       |           |       |        |       |
| Six months ended June 30, 2005:                                       |       |         |       |           |       |        |       |
| Revenue to external customers                                         |       | $            | 2,381      |           | $          | 4,189       |       | $ | 6,570 |   |
| Gross profit                                                          |       | 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      |       |
|                                                                  |       |         |       |           |       |        |       |
| Three months ended June 30, 2004:                                     |       |         |       |           |       |        |       |
| Revenue to external customers                                         |       | $            | 1,722      |           | $          | 8,621       |       | $ | 10,343 |   |
| Gross profit                                                          |       | 795          |       | 3,516          |       | 4,311       |       |
| Income before interest expense and  discontinued operations           |       | 540          |       | 2,100          |       | 2,640       |       |
| Total identifiable assets at end of period                            |       | 821          |       | 24,702         |       | 25,523      |       |

 

Reconciling information between reportable segments and the Company’sconsolidated totals is shown in the following table:

 
| ** **                                                                                            | ** ** | **For the Three**         | ** ** | **For the Six**           | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                                            | ** ** | **Months Ended June 30,** | ** ** | **Months Ended June 30,** | ** ** |
| ** **                                                                                            | ** ** | **2005**                  | ** ** | **2004**                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                  |       |                      |       |                      |       |   |   |   |   |
| Total operating income (loss) before  minority interest, interest expense and discontinued operations |       | $                         | (4,256     | )                         | $          | 811 |   | $ | (5,078 | ) | $ | 2,640 |   |
| General and administrative expenses not  allocated to segments                                        |       | 1,153                     |       | (2,120                    | )          | 3,310 |   | (4,624 | ) |
| Loss before interest, other income, income  taxes, minority interest and discontinued operations      |       | (5,409                    | )          | (1,309                    | )          | (8,388 | ) | (1,984 | ) |
| Other income                                                                                          |       | —                    |       | 694                       |       | 133 |   | 1,280 |   |
| Other expense                                                                                         |       | (100                      | )          | —                    |       | (100 | ) | — |   |
| Interest expense                                                                                      |       | (909                      | )          | (1,166                    | )          | (2,166 | ) | (1,437 | ) |
| Interest income                                                                                       |       | 1                         |       | 22                        |       | 7 |   | 34 |   |
| Loss from discontinued operations, net                                                                |       | —                    |       | (356                      | )          | — |   | (749 | ) |
| Loss from disposal of discontinued  operations, net                                                   |       | —                    |       | (356                      | )          | — |   | (749 | ) |
| Consolidated net loss                                                                                 |       | $                         | (6,417     | )                         | $          | (2,115 | ) | $ | (10,514 | ) | $ | (2,856 | ) |

 

Excluded general and administrative expensesare attributable to the Company’s corporate headquarters.  These expenses primarily include corporatesalaries, consulting, professional fees and facility costs.  Research and development expenses areincluded in the operating costs of the segment that performed the research anddevelopment.

 

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Revenues from sales tocompanies in the United States were $1,925 and $1,328 during the three monthsended June 30, 2005 and 2004, respectively. The revenue related to the United States of America was earned under threedefense-related research and development contracts and sales of coatingsproducts.

 

As of June 30, 2005, onecustomer represented 11%, or $263, of the total outstanding trade accountsreceivable.  As of December 31, 2004, twocustomers represented 30%, or $497, of the total outstanding trade accountsreceivable.  Two customers represented23%, or $1,535, of total sales for the six months ended June 30, 2005.  Three customers represented 55%, or $5,692,of total sales for the six months ended of June 30, 2004.

 

During the three monthsended June 30, 2005, the Company had revenues from companies outside ofthe United States of $1,802 of which $971 represented sales to companieslocated in South Korea.  During the threemonths ended June 30, 2004, the Company had revenue from sales to companiesoutside of the United States of $2,799 of which $2,006 represented sales tocompanies located in South Korea.  Of thesales in South Korea, $72 was from our discontinued equipment manufacturingbusiness.  The revenue related to salesto companies outside of the United States was from bulk alloy productsincluding equipment sales.

 

Long-lived assets include net property,plant, and equipment, and net intangible assets. The Company had long-livedassets of $1,874 and $1,594 located in the United States at June 30, 2005 andDecember 31, 2004, respectively. The Company had long-lived assets of $14,279and $15,422 located in South Korea at June 30, 2005 and December 31, 2004,respectively.

 

Reconciling information between reportablesegments and the Company’s consolidated totals is shown in the following table:

 
| ** **                                | ** ** | **June 30,** | ** ** |
|-------------------------------------------|------------|--------------|------------|
| ** **                                | ** ** | **2005**     | ** ** |
|                                      |       |         |       |
| Total segment assets                      |       | $            | 18,398     |   |
| Cash and cash equivalents                 |       | 1,256        |       |
| Prepaid expenses and other current assets |       | 954          |       |
| Other property, plant and equipment, net  |       | 710          |       |
| Intangibles, net                          |       | 1,158        |       |
| Other assets                              |       | 816          |       |
| Total consolidated assets                 |       | $            | 23,292     |   |

 

Assets excludedfrom segment assets include assets attributable to the Company’s corporateheadquarters.  The largest assetrepresents the Company’s intangible assets, consisting primarily of theCompany’s patents and trademarks.

 

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

 

Basicearnings per share (“EPS”) is computed by dividing earnings (loss) attributableto common shareholders by the weighted average number of common shares outstandingfor the periods. Diluted EPS reflects the potential dilution of securities thatcould share in the earnings.  Commonstock equivalents consist of 9,828,208 and 8,308,922 equity instruments and6,973,877 and 3,457,894 senior equity convertible debt instruments at June 30,2005 and 2004, respectively, and have not been included in the EPS calculationat June 30, 2005 and 2004 as the amounts are anti-dilutive.

 

**12.****      Commitmentsand Contingencies**

 

In September 2004, as part of a security agreement to finance a certaininsurance policy, the Company used certificates of deposits with maturities ofless than one year as collateral.  The$754 held in certificates of deposits is presented as restricted cash atDecember 31, 2004.  During the quarterended March 31, 2005, the certificate of deposits was liquidated and theproceeds were used to paydown the balance of the financing on the insurancepolicy.

 

In August 2004, the Company entered into a consulting agreement wherebythe Company was to receive services from a third party to improve the Company’sbulk alloy manufacturing process.  Theservice is to be provided from August 2004 through 

 

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October 2005.  The total amountof service fees is $172, of which $15 was included in trade accounts payable asof June 30, 2005.  As of December 31,2004, the total amount of outstanding balance included in trade accountspayable was $15.

 

The Company is from time to time a party tocertain legal proceedings arising in the ordinary course of business. Althoughoutcomes cannot be predicted with certainty, the Company does not believe thatany legal proceeding to which it is a party will have a material adverse effecton the Company’s financial position, results of operations, and cash flows.

 

Liquidmetal Technologies and certain of its present and former officersand directors were named as defendants in nine purported class actioncomplaints filed in the United States District Courts for the Middle Districtof Florida, Tampa Division, and the Central District of California, SouthernDivision, alleging violations of Sections 11 and 15 of the Securities Act of1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 andRule 10b-5 promulgated thereunder. In August 2004, four complaints wereconsolidated in the United States District Court for the Middle District ofFlorida under the caption *Primavera Investors v.Liquidmetal Technologies, Inc., et al.*, Case No.8:04-CV-919-T-23EAJ.  John Lee, ChrisCowley, Dwight Mamanteo, Scott Purcell and Mark Rabold, were appointed co-leadplaintiffs (the “Lead Plaintiffs”).  InSeptember 2004, the other five complaints filed in the Central District ofCalifornia were transferred to the Middle District of Florida for consolidationwith the *Primavera Investors* action.  The Lead Plaintiffs served their ConsolidatedAmended Class Action Complaint on January 12, 2005.  The Amended Complaint alleges that theProspectus issued in connection with the Company’s initial public offering in May2002 contained material misrepresentations and omissions regarding theCompany’s historical financial condition and regarding a personal stocktransaction by the Company’s chief executive officer.  The Lead Plaintiffs further generally allegethat during the proposed Class Period of May 21, 2002, through May 13, 2004,the defendants engaged in improper revenue recognition with respect to certainof 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’s stock.  The Amended Complaint seeks unspecified compensatorydamages and other relief.  We filed aMotion to Dismiss on March 29, 2005. Plaintiffs’ response to our Motion to Dismiss was filed on June 3,2005.  The Company cannot anticipate whenthe Court will rule on the Motion to Dismiss. The Company intends to vigorously defend against the class action.  The Company cannot currently predict the impact or resolution of thislitigation or reasonably estimate a range of possible loss, which could bematerial.

 

In addition to the above,certain present and former officers and directors of Liquidmetal Technologies,as well as Liquidmetal Technologies as a nominal defendant, have been named inthree shareholder derivative actions. Two shareholder derivative complaints were filed in California statecourt styled Brian Clair, Derivatively on Behalf of Liquidmetal Technologies,Inc. v. John Kang, et al., Case No. 04CC00551, and Joseph Durgin, Derivativelyon Behalf of Liquidmetal Technologies, Inc. v. John Kang, et al., Case No. 04CC00553, both commenced in the SuperiorCourt of Orange County, California.  Athird shareholder derivative complaint was filed in Florida federal courtstyled Robert Story v. John Kang, et al., Case No. 8:04-CV-1587-T23TBM,commenced in the Middle District of Florida, Tampa Division.  These shareholder derivative lawsuits allegethat the defendants breached various fiduciary duties and otherwise violatedstate law based primarily upon the same underlying facts and circumstances asalleged in the federal shareholder class action. The plaintiffs seekunspecified compensatory damages, restitution and disgorgement of profits,equitable and/or injunctive relief as permitted by law and other relief.  The two shareholder derivative complaints inCalifornia state court have been consolidated. Plaintiffs served a Consolidated Shareholder Derivative Complaint onOctober 12, 2004.  The defendants serveda Demurrer to the Consolidated Shareholder Derivative Complaint on November 22,2004, seeking dismissal of that complaint. At a hearing on February 10, 2005, the court sustained the demurrer,dismissing the Consolidated Shareholder Derivative Complaint but giving theplaintiffs 45 days within which to amend the complaint.  Plaintiffs filed their Consolidated AmendedShareholder Derivative Complaint on March 28, 2005.  The Company, along with other defendants,filed a Demurrer on May 17, 2005.  TheCourt sustained the demurrer at a hearing on July 7, 2005, again dismissing thecomplaint but giving the plaintiffs 40 days within which to further amend thecomplaint.  Separately, the plaintiffsmoved to compel the Company to respond to certain written discovery on March 7,2005.  The Motion to Compel was grantedon April 28, 2005.  The class actiondefendants subsequently filed a Motion to Stay Discovery in Related StateAction on June 9, 2005.  The plaintiffsfiled a Memorandum of Law in Opposition to the Defendants’ Motion to Stay onJune 20, 2005.  The Motion to Stay ispending.  By stipulation, if the Motionto Stay is denied, the Company will be required to respond to the writtendiscovery and produce documents within 10 days of the court’s ruling on theMotion. In the Florida derivative action, the Plaintiff filed a First AmendedShareholder Derivative Complaint on November 22, 2004.  The Company’s Motion to Dismiss, which wasfiled on 

 

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December 20, 2004, is fullybriefed.  The Company cannot anticipatewhen the Court will rule on the Motion to Dismiss.  The Company intends to vigorously defendagainst the derivative actions.  Wecannot currently predict the impact or resolution of this litigation orreasonably estimate a range of possible loss, which could be material.

 

As of June 30, 2005, theCompany has accrued $626 as receivables from insurance companies from excesslegal costs incurred to defend against the class action and derivativelawsuits.  The amount is included inprepaid expenses and other current assets.

 

In March 1996, theCompany entered into a distribution agreement whereby it granted to a thirdparty exclusive rights to market and sell golf products incorporatingLiquidmetal Technology to certain Japanese sporting equipment companies.  The third party paid the Company a $1.0million distribution fee as part of this agreement, of which a portion wasrefundable according to a formula based on the gross profit earned by the thirdparty.  On March 28, 2003, thedistribution agreement was terminated and the Company entered into a newagreement to pay to the same third party a commission on the net sales price ofall Liquidmetal golf equipment that is shipped by the Company or its affiliatesto Japanese golf companies for sale into the Japanese end-market.  This commission will apply to golf equipmentshipped by the Company or its affiliates during the period beginning on March28, 2003 and ending on March 28, 2006. If, by March 28, 2006, the Company has not paid $350 in commissionpayments, the balance between commission paid and $350 will be paid by April30, 2006, thereby guaranteeing the third party a $350 minimum payment duringthe term of the agreement.  The Companywill recognize the unearned distribution fee of $830 as revenue proportionatelywith the payment of commissions under the new agreement.  As of June 30, 2005 and December 31, 2004,the unearned distribution fee remained unchanged at $830.

 

Under terms of the January 2004settlement of the dispute over certain sales transactions from 2003 and 2002between Liquidmetal Korea and Growell Metal Co., Ltd., a South Korean metalsprocessing company (“Growell”), Liquidmetal Korea agreed to pay Growell $4,895to purchase Growell’s investment in alloy inventories, proprietary alloyingequipment purchased from Liquidmetal Korea, and supporting equipment purchasedfrom other suppliers.  Also as part ofthe settlement, Growell satisfied in full a balance of $2,058 owed toLiquidmetal Korea for the die casting machines Growell purchased from LiquidmetalKorea in the first quarter of 2003 as part of a license agreement tomanufacture Liquidmetal alloy parts for the South Korean automotiveindustry.  The remaining settlementpayable of $2,837 and trade accounts payable of $14 were to be paid to Growell(in cash or stock at the Company’s discretion) by December 31, 2004.  As of December 31, 2004, the settlementpayable of $3,246, net of foreign exchange translation loss, was not paid toGrowell due to Growell’s breach of warranty on equipment repurchased byLiquidmetal Korea.  In January 2005,Growell was acquired by a third party. As of June 30, 2005, the outstanding settlement payable to the thirdparty of $3,294, net of foreign exchange translation loss, was not paid, andthe Company is currently in negotiations to settle this balance with the thirdparty.

 

**13.****    Related Party Transactions**

 

 In June 2003, the Company entered into an exclusive,ten-year license agreement with LLPG, Inc. (“LLPG”), a corporation headed by aformer director of the Company.  Underthe terms of the agreement, LLPG has the right to commercialize Liquidmetalalloys, particularly precious-metal based compositions, in jewelry and high-endluxury product markets.  The Company, inturn, will receive royalty payments over the life of the contract on allLiquidmetal products produced and sold by LLPG. In conjunction with its technology licensing contract, LLPG purchasedtwo proprietary Liquidmetal alloy melting machines and three proprietaryLiquidmetal alloy casting machines for a total purchase price of $2,000.  At December 31, 2003, the Company had aremaining receivable balance of $500 due from LLPG, which was subsequently paidin full in March 2004.

 

We are a party to a consulting agreement withChitnis Consulting, Inc., which is owned 100% by Shekhar Chitnis, a formerdirector and executive officer of our company. Under this agreement, we have engaged Chitnis Consulting to provideconsulting services on an as-needed basis through December 31, 2005.  During each of the three and six months endedJune 30, 2005 and 2004, we incurred $13 and $25, respectively, in consultingfees from Chitnis Consulting.

 

We are a party to a consultingagreement with William Johnson, a board member. Under this agreement, Mr. Johnson provides consulting services on anas-needed basis through 2004 as it relates to marketing and developmentLiquidmetal alloy.  During the three andsix months ended June30, 2005, we incurred $5 and $10 in consulting fees fromMr. Johnson, respectively.  During thethree and six months ended June30, 2004, we incurred $14 in consulting feesfrom Mr. Johnson, respectively.

 

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In November 2004, we entered intoan agreement with John Kang, our Chairman, President, and Chief ExecutiveOfficer, in which Mr. Kang agreed that certain stock transactions by him in2002 involving our common stock should have resulted in a liability underSection 16(b) of the Securities Exchange Act of 1934, as amended (“Section16(b)”).  These transactions include Mr.Kang’s private sale of 285,715 shares of his personal Liquidmetal Technologiescommon stock to Growell Metal Co., Ltd. in February 2002, prior to our initialpublic offering.  They also include Mr.Kang’s subsequent indirect purchase and disposition of Liquidmetal Technologiescommon stock in order to satisfy a personal agreement Mr. Kang made to GrowellMetal in February 2002 regarding the guaranteed minimum value of the stockpurchased by Growell Metal in February 2002 (the purchases and dispositionsincident to this agreement occurred in August and November 2002,respectively).  Lastly, the transactionsinclude open-market purchases of an aggregate of 89,300 shares of our commonstock made by Mr. Kang in August 2002.

 

The Audit Committee ofour Board of Directors conducted an independent inquiry into theabove-described transactions with the aid of independent legal counsel and, asa result of such inquiry, the Audit Committee concluded that the transactionsshould have resulted in a liability to the Company under Section 16(b) in theamount of $302.  Mr. Kang hasacknowledged this liability, and in an agreement negotiated between Mr. Kangand the Audit Committee and approved by the full Board, Mr. Kang will pay thisliability through periodic installments in 2005 and 2006.  As a result, the Company accrued for the $302receivable in other assets and other income as of December 31, 2004.  The above-described transactions involvingGrowell Metal was reported on a new Form 4 filed by Mr. Kang onNovember 15, 2004, and the open-market purchases were previously reported on atimely basis in August 2002.  As of June30, 2005, the outstanding amount of the receivable was $235, which is includedin other assets.  Mr. Kang has paidapproximately $67 as of June 30, 2005 and will make monthly installments ofapproximately $12 to pay down the outstanding balance.

 

During the period endedJune 30, 2005, the Company borrowed approximately $198 from CK Cho, a member ofour Board of Directors for working capital purposes. The note was due and paidin full as of June 30, 2005.  The notehas an annual rate of interest of 6% resulting in the Company payingapproximately $2 in interest.  Mr. Choalso is a Chief Executive Officer of Winvest Venture PartnersInc., who holds $500 of Senior Convertible Notes as of June 30, 2005 (see Note8).

 

**14.Subsequent Events**

 

OnAugust 9, 2005, the Company completed a private placement (the “PrivatePlacement”) of $9,877 in principal amount of new 7% Convertible SecuredPromissory Notes due August 2007 (the “Notes”). The issuance consisted of $5,000 cash, exchange of $1,284 in principalamount of previously issued 10% Senior Secured Notes Due July 29, 2005 (the“July 2005 Notes”), the exchange of $2,996 in principal amount of previouslyissued 10% Convertible Unsecured Notes Due June 2006 (the “June 2006 Notes”),and satisfaction of accrued interest and late registration fees in the amountof $597 on the previously issued notes by the Company.  The Notes were issued pursuant to aSecurities Purchase Agreement dated effective as of August 2, 2005 among theCompany, the purchasers of the Notes, and the holders of previously issuedSenior Convertible Notes and Convertible Notes of the Company (see Note8).  The Notes are convertible intoshares of the Company’s common stock at $2.00 per share Pursuant to an Amendedand Restated Security Agreement.  TheNotes are secured by substantially all assets of the Company and rank senior toall other obligations of the Company, other than the Company’s loan withKookmin Bank of South Korea (or any refinancing of such loan), the 6% SeniorConvertible Notes due July 2007, and the receivable based financingarrangement.  The Company also issuedWarrants to the purchasers of the Notes and placement agents giving them theright to purchase up to 2,469,175 and 384,808 shares of Company common stock,respectively, with an exercise price of $2.00 per share.  The Warrants will expire on August 2,2010.  The fair value of the warrantsissued totaled $4,024 as of effective date of the Notes, and was computed usingthe Black-Scholes pricing model under the following assumptions: (1) expectedlife of 5 years; (2) volatility of 93%; (3) risk free interest of 4.12% anddividend rate of 0% . Further, the beneficial conversion feature of the Notesapproximated $3,185 as of the effective date of the Note.  As of the date of the report, the Company hasnot yet completed the analysis for the accounting treatment of the Notes on itsfinancial statements.  The Company estimates write-downs and netloss in regards to this transaction to be approximately $1,500 to $2,000.

 

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

 

*This management’s discussion and analysis should be read in conjunctionwith the condensed consolidated financial statements and notes included elsewherein this report on Form 10-Q.*

 

*This management’s discussion and analysis, as well as other sections ofthis report on Form 10-Q, may contain “forward-looking statements” thatinvolve risks and uncertainties, including statements regarding our plans,future events, objectives, expectations, forecasts, or assumptions. Anystatement that is not a statement of historical fact is a forward-lookingstatement, and in some cases, words such as “believe,” “estimate,” “ project,”“expect,” “intend,” “may,” “anticipate,” “plans,” “seeks,” and similarexpressions identify forward-looking statements. These statements involve risksand uncertainties that could cause actual outcomes and results to differmaterially from the anticipated outcomes or results, and undue reliance shouldnot be placed on these statements. These risks and uncertainties include, butare not limited to, the matters discussed under the caption “Factors AffectingFuture Results” in our Annual Report on Form 10-K for the fiscal year ended December31, 2004 and other risks and uncertainties discussed in filings made with theSecurities 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 thatdevelops and commercializes products made from amorphous alloys.  Our Liquidmetal® family of alloys consists ofa variety of coatings, powders, bulk alloys, and composites that utilize theadvantages offered by amorphous alloy technology.  We develop, manufacture, and sell productsand components from bulk amorphous alloys that are incorporated into thefinished goods of our customers, and we also market and sell amorphous alloyindustrial coatings.  We also partnerwith third-party licensees and distributors to develop and commercializeLiquidmetal alloy products.  We have theexclusive right to develop, manufacture, and sell what we believe are the onlycommercially viable bulk amorphous alloys.

 

Amorphousalloys are unique materials that are distinguished by their ability to retain arandom atomic structure when they solidify, in contrast to the crystallineatomic structure that forms in ordinary metals and alloys when they solidify.Liquidmetal alloys possess a combination of performance, processing, and costadvantages that we believe makes them preferable to other materials in avariety of applications. The amorphous atomic structure of our alloys enablesthem to overcome certain performance limitations caused by inherent weaknessesin crystalline atomic structures, thus facilitating performance and processingcharacteristics superior in many ways to those of their crystallinecounterparts. For example, our zirconium-titanium Liquidmetal alloys areapproximately 250% stronger than commonly used titanium alloys, such asTi-6Al-4V, but they have processing characteristics similar in many respects toplastics. We believe these advantages could result in Liquidmetal alloyssupplanting other incumbent materials in a wide variety of applications.Moreover, we believe these advantages will enable the introduction of entirelynew products and applications that are not possible or commercially viable withother materials.

 

Ourrevenues are derived from two principal operating segments: Liquidmetal alloyindustrial coatings and bulk Liquidmetal alloy products.  Liquidmetal alloy industrial coatings areused primarily as a protective coating for industrial machinery and equipment,such as drill pipe used by the oil drilling industry and boiler tubes used incoal-burning power plants. The historical operating information for fiscal year2001 is based substantially on sales of Liquidmetal alloy coatings. In thesecond half of 2002, we began producing bulk Liquidmetal alloy components andproducts for incorporation into our customers’ finished goods. Bulk Liquidmetalalloy segment revenue includes sales of parts or components of electronicdevices, medical products, and sports and leisure goods; tooling and prototypeparts (including demonstration parts and test samples) for customers withproducts in development, product licensing and arrangements, and research anddevelopment revenue relating primarily to defense and medicalapplications.  We expect that thesesources of revenue will continue to significantly change the character of ourrevenue mix.

 

The cost of sales for our Liquidmetal coatingssegment consists primarily of the costs of outsourcing our manufacturing tothird parties. Consistent with our expectations, our cost of sales has beenincreasing over historical results as we further build our bulk Liquidmetal alloybusiness. Although we plan to continue outsourcing the manufacturing of ourcoatings, we will internally manufacture many products derived from our bulkLiquidmetal alloys.

 

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Selling, general, and administrative expensescurrently consist primarily of salaries and related benefits, severance costs,travel, consulting and professional fees, depreciation and amortization,insurance, office and administrative expenses, and other expenses related toour operations.

 

Research and development expenses representsalaries, related benefits expense, stock-based compensation, depreciation ofresearch equipment, consulting and contract services, expenses incurred for thedesign and testing of new processing methods, expenses for the development ofsample and prototype products, and other expenses related to the research anddevelopment of Liquidmetal alloys. Costs associated with research anddevelopment activities are expensed as incurred. We plan to enhance our competitiveposition by improving our existing technologies and developing advances inamorphous alloy technologies. We believe that our research and developmentefforts will focus on the discovery of new alloy compositions, the developmentof improved processing technology, and the identification of new applicationsfor our alloys.

 

On August 4, 2004, the Company established aplant in the city of Weihai in Shandong province of China under WeihaiLiquidmetal Company Limited, which is 100 percent owned by Liquidmetal Korea,to facilitate our bulk alloy manufacturing business.  Weihai Liquidmetal is consolidated intoLiquidmetal Technologies with all intercompany transactions eliminated.

 

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

 

**CriticalAccounting Policies and Estimates**

 

The preparation of condensed consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States requires us to make estimates and assumptionsthat affect reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.  These estimates and assumptions are based onhistorical experience and various other factors that are believed to bereasonable under the circumstances. Actual results could differ materially from these estimates under differentassumptions 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:

 

•                  Exchange rate fluctuations 

•      Warranty accrual

•      Allowance for doubtful accounts

•      Inventories at lower of cost or net realizablevalue

•      Deferred tax assets

 

Our 10-K Report as of December 31, 2004contains further discussions on our critical accounting policies and estimates.

 

**Resultsof Operations**

 

Comparison of the threemonths ended June 30, 2005 and 2004

 

*Revenue*. Revenuedecreased $0.3 million to $3.7 million for the three months ended June 30, 2005from $4.0 million for the three months ended June 30, 2004.  The decrease consisted of a decrease of $0.6million from the sales and prototyping of parts manufactured from bulkLiquidmetal alloys to consumer electronics customers as a result of decreaseddemand for conventional hinge components used in certain cellular phone models,and a decrease of $0.2 million from decreased activity from research anddevelopment services related primarily to defense applications, offset by anincrease of $0.6 million from sales of our coatings products.

 

*Cost of Sales*. Cost of sales increased to $4.0million, or 106% of revenue, for the three months ended June 30, 2005 from$2.5 million, or 61% of revenue, for the three months ended June 30,2004.  The increase was a result ofdecreases in bulk Liquidmetal alloy business. Cost of sales as a percentage of revenue has increased as a result oflower business volumes generated from our bulk Liquidmetal alloys.  Significant portion of our manufacturingcosts continue to remain fixed.  Webelieve that higher manufacturing volumes and greater mix of higher-marginproducts in the future will cause the gross profit 

 

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to improve over time. The costto manufacture parts from our bulk Liquidmetal alloys is variable and differsbased on the unique design of each product. However, the cost of sales for the products sold by the coatingsbusiness segment is generally consistent because the Liquidmetal coatingsproducts are produced by third parties and sold wholesale to variousindustries.

 

*Selling, General, and Administrative Expenses*.Selling, general, and administrative expenses decreased to $1.6 million,or 42% of revenue, for the three months ended June 30, 2005 from$2.5 million, or 63% of revenue, for the three months ended June 30, 2004.This decrease was primarily a result of decrease professional services by $0.8million, decrease in bad debt expense of $0.1 million, and decrease indepreciation, travel expenses, and product warranty costs of $0.1 million,offset by an increase in insurance costs by $0.1 million.  These and other decreases in selling, generaland administrative expenses represent the Company’s efforts to manage costs andfocus on our core business while continuing to build our corporateinfrastructure required to prepare for and support the anticipated growth ofour bulk Liquidmetal alloy business.

 

*Research and Development Expenses*. Researchand development expenses decreased to $0.2 million, or 6% of revenue, forthe three months ended June 30, 2005 from $0.3 million, or 9% of revenue,for the three months ended June 30, 2004. The Company continues to performresearch and development of new Liquidmetal alloys and related processingcapabilities, develop new manufacturing techniques, and contract withconsultants to advance the development of Liquidmetal alloys.  The decrease was primarily due to decreasesin salaries, wages and the related costs by $0.1 million.

 

*Impairment of Long Lived Assets*. Impairment oflong lived assets increased to $3,394, or 91% of revenue, for the three monthsended June 30, 2005 from $0 for the three months ended June 30, 2004.  Impairment expense represents write-down of$1,653 of raw materials considered to be long term inventory and $1,741 of idleequipment.  While we may use the excessraw materials beyond one year to fulfill future demand, we cannot currentlyforesee use of this inventory in the foreseeable future.  Further, while we have marketed the idleequipment for ultimate sale since early 2004, we were unable to sell thisequipment. In addition, while the equipment may be used internally to meetfuture capacity requirements, considering our current revenue, we do notanticipate utilizing this equipment internally in the near future.  As such, we have reduced the carrying valuesof the excess raw material and idle equipment.

 

*Other Income*. Other income decreased to $0,for the three months ended June 30, 2005 from $0.7 million, or 17% of revenue,for the three months ended June 30, 2004. Other income consists of change in value of warrants issued from thesenior convertible debt funded in March 2004 and exchanged in August 2004primarily as a result of fluctuations in our stock price.

 

*Other Expense*. Other expense increased to $0.1million, or 3% of revenue, for the three months ended June 30, 2005 from $0 forthe three months ended June 30, 2004. Other expense consists of change in value of warrants issued from thesenior convertible debt funded in March 2004 and exchanged in August 2004primarily as a result of fluctuations in our stock price.

 

*Interest Expense*. Interest expense was $0.9million, or 24% of revenue, for the three months ended June 30, 2005 and was$1.2 million, or 29% of revenue, for the three months ended June 30, 2004.  During each of the three months ended June30, 2005 and 2004, the interest expense was primarily due to the interestaccrued on the Kookmin Bank loan funded on February 4, 2003, senior convertibledebt funded on March 3, 2004 and exchanged in August 2004, and convertible debtfunded on June 13, 2005, as well as amortization of debt issuance costs anddiscount on the senior convertible debt funded in March 2004 and exchanged inAugust 2004 and convertible debt funded on June 13, 2005.  The decrease was primarily due toacceleration of amortization of debt issuance costs and discount on debt duringthe three months ended June 30, 2004 from principal payments made.  During the three months ended June 30, 2005,$0.2 million of interest expense was accrued from default interest ratesapplied to the senior convertible notes effective April 1, 2005 from nonpayment of quarterly scheduled interest payments (see Item 3 Defaults UponSenior Securities, Part II).

 

*Interest Income.* Interest income was $1 thousand for the threemonths ended June 30, 2005, and $22 thousand for the three months ended June30, 2004 from interest earned on cash deposits. The decrease was primarily due to decrease in deposits held.

 

Comparison of the sixmonths ended June 30, 2005 and 2004

 

*Revenue*. Revenuedecreased $3.8 million to $6.6 million for the six months ended June 30, 2005from $10.3 million for the six months ended June 30, 2004.  The decrease included a $2.6 million decreasefrom restatement of revenues from 2003 to 2004 as a part of our 2003 financialstatement restatement which resulted in one-time recognition of revenues duringthe first 

 

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quarter of2004, a decrease of $1.2 million from the sales and prototyping of partsmanufactured from bulk Liquidmetal alloys to consumer electronics customers asa result of decreased demand for conventional hinge components used in certaincellular phone models, and a decrease of $0.6 million from decreased activityfrom research and development services related primarily to defenseapplications, offset by an increase of $0.6 million from sale of our coatingsproducts.

 

*Cost of Sales*. Costof sales increased to $6.8 million, or 103% of revenue, for the six monthsended June 30, 2005 from $6.0 million, or 58% of revenue, for the sixmonths ended June 30, 2004.  The increasewas a result of decreases in bulk Liquidmetal alloy business.  Cost of sales as a percentage of revenue hasincreased as a result of lower business volumes generated from our bulkLiquidmetal alloys.  Significant portionof our manufacturing costs continue to remain fixed.  We believe that higher manufacturing volumesand greater mix of higher-margin products in the future will cause the grossprofit to improve over time. The cost 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, and administrative expenses decreased to $4.2 million,or 63% of revenue, for the six months ended June 30, 2005 from$5.6 million, or 54% of revenue, for the six months ended June 30, 2004.This decrease was primarily a result of decrease in wages and related expenseby $0.2 million, decrease in bad debt expenses by $0.1 million, decreasein professional and contracted services of $0.7 million, decrease inadvertising and promotions expense by $0.2 million, and decrease intelephone and communication expense by $0.1 million, offset by an increase ininsurance costs by $0.2 million.  Theseand other decreases in selling, general and administrative expenses representthe Company’s efforts to manage costs and focus on our core business whilecontinuing to build our corporate infrastructure required to prepare for andsupport the anticipated growth of our bulk Liquidmetal alloy business.

 

*Research and Development Expenses*. Researchand development expenses decreased to $0.6 million, or 9% of revenue, forthe six months ended June 30, 2005 from $0.7 million, or 7% of revenue,for the six months ended June 30, 2004. The Company continues to performresearch and development of new Liquidmetal alloys and related processingcapabilities, develop new manufacturing techniques, and contract withconsultants to advance the development of Liquidmetal alloys.  The decrease was primarily due to decrease inlaboratory and prototype supplies used by $0.1 million.

 

*Impairment of Long Lived Assets*. Impairment oflong lived assets increased to $3,394, or 91% of revenue, for the six monthsended June 30, 2005 from $0 for the six months ended June 30, 2004.  Impairment expense represents write-down of$1,653 of raw materials considered to be long term inventory and $1,741 of idleequipment.  While we may use the excessraw materials beyond one year to fulfill future customer order, we havedetermined that our current capacity was not significant enough to warrantholding this inventory as a long term asset. Further, while we have actively marketed the idle equipment for ultimatesale since early 2004, we were unable to sell this equipment. In addition,while the equipment may be used internally to meet future capacityrequirements, considering our current revenue, we do not anticipate utilizingthis equipment internally in the near future. As such, we have reduced the carrying values of the excess raw materialand idle equipment.

 

*Other Income*. Other income decreased to $0.1million, or 2% of revenue, for the six months ended June 30, 2005 from $1.3million, or 12% of revenue, for the six months ended June 30, 2004.  Other income consists of change in value ofwarrants issued from the senior convertible debt funded in March 2004 andexchanged in August 2004 primarily as a result of fluctuations in our stockprice.

 

*Other Expense*. Other expense increased to $0.1million, or 2% of revenue, for the six months ended June 30, 2005 from $0 forthe six months ended June 30, 2004. Other expense consists of change in value of warrants issued from thesenior convertible debt funded in March 2004 and exchanged in August 2004primarily as a result of fluctuations in our stock price.

 

*Interest Expense*. Interest expense was $2.2million, or 33% of revenue, for the six months ended June 30, 2005 and was $1.4million, or 14% of revenue, for the six months ended June 30, 2004.  During each of the six months ended June 30,2005 and 2004, the interest expense was primarily due to the interest accruedon the Kookmin Bank loan funded on February 4, 2003, senior convertible debtfunded on March 3, 2004 and exchanged in August 2004, and convertible debtfunded on June 13, 2005, as well as amortization of debt issuance costs anddiscount on the senior convertible debt funded in March 2004 and exchanged inAugust 2004, and convertible debt funded on June 13, 2005.  As of June 30, 2005, $0.2 million of interestexpense was accrued from default interest rates applied to the seniorconvertible notes effective April 1, 2005 from non payment of quarterlyscheduled interest payments and $1.0 million of late registration penalty feeof our senior convertible debt was accrued as interest expense (see Item 3 Defaults Upon Senior Securities, PartII).  The increase in interest expense 

 

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was primarily due to increasescosts accrued for penalties during the six months ended June 30, 2005.

 

*Interest Income.* Interest income was $7 thousand for the sixmonths ended June 30, 2005, and $34 thousand for the six months ended June 30,2004 from interest earned on cash deposits. The decrease was primarily due to decrease in deposits held.

 

**Liquidityand Capital Resources**

 

Our cash used inoperating activities was $3.6 million for the six months ended June 30,2005 and $4.6 million, which includes cash used in our discontinuedequipment manufacturing business of $0.8 million, for the six months ended June30, 2004.  Our working deficit increasedfrom $(10.2) million at December 31, 2004 to $(16.0) million at June 30,2005.  The Company’s working deficitincrease of $5.8 million was primarily attributable to decrease in restrictedcash of $0.8 million, decrease in current inventories of $0.2 million, increasein accounts payable and accrued liability of $2.1 million, increase in currentportion of long term debt of $2.5 million, increase in short-term debt of $0.5million, increase in warrant liabilities of $1.1 million, and increase indeferred revenues and settlement payable of $0.1 million, offset by increase incash of $0.5 million, increase accounts receivable of $0.7 million, anddecrease in decrease in current portion of other liability of $0.3.

 

Our cash used ininvesting activities was $0.1 million for the six months ended June 30, 2005for the acquisition of property and equipment and investments in patents andtrademarks.

 

Our cash provided byfinancing activities was $3.8 million for the six months ended June 30, 2005,which consists of $0.8 million in proceeds from restricted cash and $3.2million in proceeds from convertible debt funded on June 13, 2005, $1.2 millionin proceeds from factoring agreement executed in April 2005, and $0.2 millionin proceeds from borrowings from our short term debt executed in March 2005,offset by $1.6 million on repayment of borrowings.

 

We anticipate that our capitalexpenditures will be approximately less than $0.5 million for the full year2005 for the acquisition of furniture, fixtures, and other business equipment.This amount is subject to change, however, depending upon the nature and theamount of the product orders that we actually receive from customers.

 

Our capital requirements duringthe next twelve months will depend on numerous factors, including thesuccess of existing products either in manufacturing or development, thedevelopment of new applications for Liquidmetal alloys, the resources we devoteto develop and support our Liquidmetal alloy products, the success of pursuingstrategic licensing and funded product development relationships with externalpartners, and the cost of successful implementation of Section 404 of theSarbanes-Oxley Act of 2002. During the next twelve months, based on ourcurrent business plan, we expect to have sufficient resources to continue todevote limited capital to our research and development activities, to furtherdevelop and strengthen our manufacturing technology, and to provide for workingcapital and other general corporate purposes. However, based on our historical operating results and the continueddevelopment of our manufacturing capabilities and alloy compositions, thereexists the possibility that these resources will not be adequate to operate atthe proposed business plan levels.  Theseexpenses and capital expenditures could consume a material amount of our cashresources, but the amount of these requirements will depend on the nature andamount of orders we receive for the purchase of our bulk Liquidmetal alloyproducts.

 

Our business is based oncommercializing an entirely new and unique technology, and our current businessplan contains a variety of assumptions and expectations that are subject touncertainty, including assumptions and expectations about order flow, unitvolumes, manufacturing efficiencies, product cost and pricing, continuingtechnology improvements, customer adoption practices, strategic licensingrelationships and other relevant matters. These assumptions take into accountrecent significant cost reductions, as well as recent improvements to ourmanufacturing processes. We have experienced losses from continuing operationsduring the last two fiscal years and have an accumulated deficit of $135.8million as of June 30, 2005. At June 30, 2005, our principal source ofliquidity was $1.3 million of cash and cash equivalents and trade accountsreceivables of $2.4 million.  Suchconditions raise substantial doubt that our Company will be able to continue asa going concern for a reasonable period of time without receiving additionalfunding.  These operating resultsoccurred while we were developing and attempting to commercialize andmanufacture products from an entirely new and unique technology. This businessplan required significant spending related to start-up costs and capitalexpenditures. These factors have placed a significant strain on our financialresources. The ultimate success of the Company depends on our ability tocontinue to reduce operating costs, generate higher revenue, achieve positivecash flow from continuing operations and achieve profitability.

 

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Additionally, the Companyis not in compliance with certain covenant requirements of our seniorconvertible debt as of June 30, 2005. Although there has been no formal notice of default received from thenote holders, as the note holders have the right to call for repayment of theoutstanding balance of the senior convertible debt, the total outstanding debtbalance of $5,709 have been included as current liabilities as of June 30,2005.  Further, $0.2 million ofinterest expense was accrued from default interest rates applied to the seniorconvertible notes effective April 1, 2005 from non-payment of quarterlyscheduled interest payments as of June 30, 2005.  (See Item 3 Defaults Upon Senior Securities, Part II)

 

Our future successdepends on our ability to continue reducing operating costs and ultimately togenerate higher revenue and attain profitability. We cannot be certain thatadditional capital, whether through selling additional debt or equitysecurities or obtaining a line of credit or other loan, will be available to usor, if available, will be on terms acceptable to us. If we issue additionalsecurities to raise funds, these securities may have rights, preferences, orprivileges senior to those of our common stock, and our current stockholdersmay experience dilution.

 

**ContractualObligations**

 

The following table summarizesthe Company’s obligations and commitments as of June 30, 2005:

 
| ** **                            | ** ** | **Payments Due by Period (in thousands)** | ** ** |
|---------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Cash Obligations  (1)** | ** ** | **Total**                                 | ** ** | **Less Than 1  Year** | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **After 5 Years** | ** ** |
|                                  |       |                                      |       |   |   |   |   |   |   |   |   |
| Long-term debt (2)                    |       | $                                         | 12,229     |   | $ | 10,185 |   | $ | 2,044 |   | $ | — |   | $ | — |   |
| Short-term debt (3)                   |       | 493                                       |       | 493 |   | — |   | — |   |   |   |
| Capital lease obligation (3)          |       | 142                                       |       | 67 |   | 75 |   | — |   | — |   |
| Operating leases and rents            |       | 1,180                                     |       | 239 |   | 762 |   | 178 |   | 1 |   |
| Growell settlement payable (4)        |       | 3,294                                     |       | 3,294 |   | — |   | — |   | — |   |
| Consulting services payable           |       | 60                                        |       | 60 |   | — |   | — |   | — |   |
| Dongyang payable                      |       | 11                                        |       | 11 |   | — |   | — |   | — |   |
|                                  |       | $                                         | 17,409     |   | $ | 14,349 |   | $ | 2,881 |   | $ | 178 |   | $ | 1 |   |

 

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| (1) | Contractual  cash obligations include Long-Term Debt comprised of $5,709 of Senior  Convertible Notes issued in 2004, $3,250 of Convertible Notes issued in 2005,  and $3,270 of Kookmin Notes, Short-Term Debt comprised of $493 advances  received under factoring, loan, and security agreement, and future minimum  lease payments under capital and operating leases, liabilities incurred from  settlement with a former customer (Growell) and divesture of our equipment  manufacturing business, and purchase commitments from a consultant. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Does not  include interest payments of $1,369, un-amortized discounts for beneficial  conversion feature and warrants, deferred issuance costs of $1,983 of our  convertible notes.                                                                                                                                                                                                                                                                                                                                                                   |
| (3) | Does not  include minimum interest and fee payments of $30.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| (4) | Includes  imputed interest of $7.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| (5) | In January  2005 Growell was acquired by a third party, and we****are currently in  negotiations to settle this balance with the third party.****                                                                                                                                                                                                                                                                                                                                                                                                     |

 

#### **Off Balance Sheet Arrangements**

 

Anoff-balance sheet arrangement is any transaction, agreement or othercontractual arrangement involving an unconsolidated entity under which a companyhas (1) made guarantees, (2) a retained or a contingent interest in transferredassets, (3) an obligation under derivative instruments classified as equity, or(4) any obligation arising out of a material variable interest in anunconsolidated entity that provides financing, liquidity, market risk or creditrisk support to the company, or that engages in leasing, hedging, or researchand development arrangements with the company.

 

We have made no arrangements of the types describedin any of the categories that may have a material current or future effect onour financial condition, liquidity or results of operations.

 

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**Item 3 – Quantitativeand 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 toprice risk 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 andProcedures**

 

Evaluation ofdisclosure controls and procedures.  During the course of the audit of ourfinancial statements for the fiscal years ended December 31, 2001, 2002, and 2003, it wasdetermined that revenues from certain equipment sales made by theCompany to Growell Metal Co., Ltd. in the third and fourth quarters of2002 and the first quarter of 2003 should not have been recognized inthose periods.  It was also determined that certain amounts relatingto sales made to Samsung in December 2002, to JS Technologies in September2002, and AM Corporation in December 2002 should not have been recognized.  It also was determined that compensationexpense related to certain stock options granted in 2001 and 2002 were notcalculated in accordance with generally accepted accounting principles underAPB Opinion No. 25, SFAS No. 123, and EITF 00-23.** **These determinations and the associated restatement ofpreviously issued financial statements, as described more fully elsewhere inthe Form 10-K for the year ended December 31, 2003, filed on November 10, 2004,suggest that, at the time of the subject transactions and the preparation ofour financial statements for the relevant periods, the Company’s disclosurecontrols and procedures (as defined in Rule 13a-15 under the SecuritiesExchange Act of 1934) were ineffective as of the period covered by theForm 10-K filed on November 10, 2004 for purposes of ensuring that allinformation required to be disclosed by the Company was adequatelyaccumulated and communicated to the Company’s management at suchtime.

 

Within the 90 days priorto the date of this quarterly report, Liquidmetal Technologies (the “Company”)carried out an evaluation, under the supervision and with the participation ofthe Company’s management, including the Company’s Chief Executive Officer andChief Financial Officer, of the effectiveness as of March 31, 2005 of thedesign and operation of the Company’s disclosure controls and procedurespursuant to Rule 13a-15 under the Securities Exchange Act of 1934, asamended.  Based on that evaluation, theChief Executive Officer and Chief Financial Officer have concluded that thesedisclosure controls and procedures were ineffective by reason of the materialweaknesses mentioned in more detail below in timely alerting them to materialinformation relating to the Company, including its consolidated subsidiaries,required to be included in this quarterly report on Form 10-Q.

 

Update on Management’s Assessment of Internal Control Over FinancialReporting.****Updateon Management’s Assessment of Internal Control Over Financial Reporting********. The time********andresources committed to the restatement of prior periods’ financial statementsas aforementioned delayed our internal timetable with respect to ourdocumentation, assessment and evaluation of internal control over financialreporting, which are required to be undertaken to comply with Section 404 ofthe Sarbanes-Oxley Act of 2002 (“SOX 404”). Due in part to the issues describedin the foregoing paragraph, management’s assessment of the effectiveness of ourinternal control over financial reporting has been substantially delayed and isnot complete, which in turn has prevented the Company’s independent registeredpublic accounting firm, Stonefield Josephson, from being able to****

**** ****

****29****

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**** ****

****satisfactorily complete an audit of the Company’s internalcontrol over financial reporting pursuant to SOX 404.  Based on the foregoing, Stonefield Josephsonhas disclaimed an opinion on the Company’s internal control over financialreporting.****

 

****In making our assessment ofinternal control over financial reporting, management used the criteriaestablished in “Internal Control - Integrated Framework” issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO).Although our work was incomplete, management has identified several controldeficiencies, some of which have been determined to be material weaknesses ininternal control over financial reporting. As a result of the material weaknesses identified below, management hasconcluded that it did not maintain effective internal control over financialreporting as of December 31, 2004, based on the criteria established in COSO.****

 

****We have identified the followingmaterial weaknesses in connection with our ongoing assessment of internalcontrols as follows:****

 

****1. Lack of adequate segregation of duties in accountspayable and accounts receivable involving cash receipts and deposits, bankreconciliations, cash disbursements, purchasing, and accounts receivablereconciliations;****

 

****2. Lack of adequatecontrols and monitoring of payroll and payroll processing, currently outsourcedto a third party provider; and****

 

****3.Lack of documentation to evidence reviews of certain reconciliations; lack ofdocumentation of authorization of transactions; manual performance of numerousprocedures that could be automated using current reporting systems.****

 

****4. D********ueto the lack of adequate segregation of duties and documentation to evidencereviews of certain reconciliations, authorization of transactions and manualperformance of numerous procedures, led to significant adjustments at year endto the accounting records and financial reports.****

 

****5. Managements’ documentation of the Company’s internal controls wasnot sufficient.****

 

****6. The independent third party engaged to help document and assess theCompany’s internal controls, has identified numerous and significantdeficiencies which management has not completed evaluating whether they wouldrise to the level of a material weakness in accordance to the PCAOB AuditStandard No. 2.****

 

****Management believes that it hastaken appropriate steps to address these material deficiencies subsequent toMarch 31, 2005, including hiring an independent consulting firm to identify andpropose remedial actions to address and mitigate the deficiencies.  We cannot assure you that we will notdiscover additional material weaknesses in the future; however management willcontinue to work with the independent consulting firm and work towardscompliance with SOX 404 as of December 31, 2005.****

 

Changes in internal controls. There were no changes in the Company’sinternal controls over financial reporting that occurred during the quarterended June 30, 2005.  The Company iscurrently in the process of re-evaluating its internal controls pursuant to SOX404 (see Item 4 Controls and Procedures, Evaluations of disclosure controls andprocedures).

 

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### **PART II**

### ** **

**OTHERINFORMATION**

 

**Item1 – Legal Proceedings**

 

There were no materialdevelopments in our legal proceedings during the current quarter.

 

**Item2 – Unregistered Sales of Equity Securities and Use of Proceeds**

 

On June 13, 2005, we completeda private placement (the “Private Placement”) of 10% Convertible UnsecuredNotes Due June 13, 2006 in the aggregate principal amount of $3,250 (the“Notes”), together with warrants to purchase up to an aggregate of 893,750shares of the Company’s common stock (the “Warrants”).  The net proceeds were $3.0 million afterdeducting transaction fees and expenses of $0.25 million.

 

The Notes issued in the PrivatePlacement are unsecured and will become due on the earlier of June 13,2006 or the consummation of a follow-on equity or debt offering orrestructuring transaction pursuant to which the Company receives gross proceedsof at least $4,000.  Prior to maturity, the Notes will be interest-only,with interest payments due quarterly, at the rate of 10% per year.  TheNotes can be prepaid at any time without penalty.  If, within 120 daysfollowing the issue date of the Notes, the Company either fails to redeem thenotes for the principal amount and accrued interest thereon or fails to close a“Qualified Financing,” then the Notes will thereafter be convertible at aconversion price equal to seventy five percent (75%) of the closing price ofour common stock on the first trading day immediately preceding the conversiondate.  A “Qualified Financing “ is defined in the Notes as any debt orequity financing of the Company resulting in aggregate gross proceeds to theCompany of at least $5,000 and in which the holders of at least sixty percent(60%) of the aggregate principal amount of the Company’s 6% Senior SecuredNotes due July 2007 Notes either (i) agree that the equity or debtsecurities to be issued in such financing shall be*pari passu* in order of payment to the 2007 Notes held bythem or (ii) exchange their 2007 Notes for new securities in the financingtransaction.

 

The Notes rank senior to allother debt, except for indebtedness in existence on the issue date of the Notes(including the convertible notes issued in July 2004), purchase money loans forfuture acquired assets, trade debt incurred in the ordinary course of business,and loans used to refinance indebtedness with Kookmin Bank.  Theholders of the Notes will have the right to call for early repayment of theNotes if, on the date that is 180 days of the issue date of the Notes (i) the weare not then compliant with its SEC reporting obligations, or (ii) our commonstock is not then listed or quoted on the OTC Bulletin Board, Nasdaq StockMarket, New York Stock Exchange, or American Stock Exchange.

 

As a part of the PrivatePlacement, we issued Warrants to the purchasers of the Notes giving them theright to purchase up to an aggregate of 812,500 shares of the Company’s commonstock.  In addition, Warrants to purchase 81,250 shares of our commonstock were issued to the placement agent in the transaction.  The Warrantshave an exercise price of $2.00 per share, provided that upon the consummationof the first ensuing public or private equity or debt offering or restructuringtransaction in which the Company receives gross proceeds of at least $3,250 (includingwithout limitation any restructuring of the Company’s previously issued 10%Senior Secured Notes Due July 29, 2005), the exercise price will beautomatically adjusted downward (but not upward) as of the closing date of suchoffering or restructuring transaction so that it is equal to the lowesteffective common stock purchase price paid for any securities issued by theCompany to the investors in such offering or restructuring transaction. The Warrants will expire on June 13, 2010.

 

As of June 30, 2005, we haveused $1.7 million of the net proceeds from the Private Placement for workingcapital uses.

 

**Item3 – Defaults Upon Senior Securities**

 

On March3, 2004, we sold $9.9 million of 6.0% senior convertible notes due 2007 (the“March Notes”) to investor groups in a transaction led by Michigan VentureCapital Co., Ltd, a South Korea-based institutional investment firm, and IndiGoVentures LLC, a New York-based investment firm that served as a financialadvisor to the Company for the transaction. The notes were convertible at any time into our common stock at a priceof $3.00 per share.  Investors in theprivate placement received warrants to purchase an aggregate amount of up toapproximately 1.2 million shares of common stock, exercisable at $3.00 pershare for varying periods but no later than 100 days following theeffectiveness of a registration statement covering the resale of sharesissuable upon exercise of the warrants. In addition, the investors had the right to call for repayment of the 

 

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notesprior to maturity at any time after the second anniversary of the closing ofthe transaction.

 

On August 19, 2004, the Company completed aprivate exchange offer for its March Notes.  Under terms of the exchange offer,approximately $5.5 million in aggregate principal amount of the March Noteshave been exchanged for an aggregate of (i) $2.75 million of 6% Senior SecuredNotes Due 2007 (the “Long-Term Notes”) and (ii) $2.75 million of 10% Senior SecuredNotes Due 2005 (the “Short-Term Notes”), collectively referred to as “ExchangeNotes”.  In addition, the Company redeemed approximately $4.5 million of theMarch Notes in cash.  The ExchangeNotes are collateralized by certain patents owned by the Company and secondpriority mortgage interest in plant facilities and certain equipment at ourplant in South Korea.

 

In connection with the privateexchange offer, the Company issued $250 thousand of private placement notes tocertain Placement Agents as issuance costs. Of the $250 thousand notes issued, $125 thousand was paid in the form oflong-term notes which is due in 2007 with interest rate of 6% per annum(Long-Term Notes) and $125 thousand was paid in the form of short-term noteswhich is due in 2005 with interest rate of 10% per annum (Short-Term Notes).

 

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.  The default interests rates became effectiveon April 1, 2005 from non-payment of a scheduled interest payment.  As such, the Company accrued $171 ofadditional interest from the default rates applied to the loan balance as ofJune 30, 2005, which is included in accounts payable and accrued liabilities.

 

The Short-Term Notes have a maturity date of July29, 2005, and a conversion price of $2.00 per share (compared to a conversionprice of $3.00 per share under the March Notes).  The Long-Term Notes have a maturity date of July29, 2007, and a conversion price of $1.00 per share.  Further, the exchange notes are convertibleinto Common Stock, at the option of the Company, if at any time after theissuance of the notes, the closing per share price of the Common Stock exceeds $4.00(as adjusted for stock splits, reverse splits, stock dividends, andrecapitalizations) for 30 consecutive trading days, and further provided thatthere has been effective registration during such period.  Holders of the Long-Term Notes also have the rightto call for repayment of the Long-Term Notes prior to maturity at any timeafter the second anniversary of the completion of the exchange offer.  A total of 563,151 warrants to purchase ourcommon stock at an exercise price of $3.00 per share—all of which werepreviously issued in connection with the purchase of the March Notes—have beenamended to provide for an extended expiration date of March 1, 2006.  As of June 30, 2005, we were in breach ofa covenant in the Note Exchange Agreement requiring us to becomecurrent in our SEC filings, as well as file a registration statement withthe SEC for the shares into which the notes are convertible, within 90days of the issue date of the new notes.  Late registration fee of $1.0million has been accrued as interest expense, and is included in accountspayable and accrued liabilities as of June 30, 2005. If written notice ofdefault is delivered to us for breach of this covenant, then we will havea period of 30 days to cure the breach before it becomes an event ofdefault under the notes, and if the breach is not cured during such timeperiod, the holders of the notes will become entitled toaccelerate the remaining balance of their respective notes and declarethem immediately due and payable.  Further, As of the date of thefiling of this Form 10-Q, we have not received a notice fordemand for payment as a result of not meeting the registration and listingrequirements.

 

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**Item 6 – Exhibits and Reports on Form 8-K.**

 

(a)           Exhibits

 

The following documents arefiled as an exhibit to this Report:

 
| **Exhibit** | ** ** | ** **                                                                                                                        |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------|
| **Number**  | ** ** | **Description of Document**                                                                                                       |
|        |       |                                                                                                                              |
| 31.1        |       | Certification  of the President and Chief Executive Officer, John Kang, as required by  Section 3.02 of Sarbane-Oxley Act of 2002 |
|        |       |                                                                                                                              |
| 31.2        |       | Certification  of Chief Financial Officer, Young Ham, as required by Section 3.02 of  Sarbane-Oxley Act of 2002                   |
|        |       |                                                                                                                              |
| 32.1        |       | Certification  of Principal Executive Officer, John Kang, as required by Section 9.06 of  Sarbane-Oxley Act of 2002               |
|        |       |                                                                                                                              |
| 32.2        |       | Certification  of Chief Financial Officer, Young Ham, as required by Section 9.06 of  Sarbane-Oxley Act of 2002                   |

 
| (b) |   | Reports on  Form 8-K |
|-----|--------|----------------------|

 

•Filed April 15, 2005

•Filed May 10, 2005

•Filed June 16, 2005

•Filed August 9, 2005

 

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**SIGNATURES**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned hereunto duly authorized.

 
|   |                   | LIQUIDMETAL TECHNOLOGIES                         |
|--------|------------------------|--------------------------------------------------|
|   |                   | (Registrant)                                     |
|   |                   |                                             |
|   | Date: August  12, 2005 | /s/ John  Kang                                   |   |
|   |                   | John Kang                                        |
|   |                   | Chairman,  President and Chief Executive Officer |
|   |                   | (Principal  Executive Officer)                   |
|   |                   |                                             |
|   |                   |                                             |
|   | Date: August  12, 2005 | /s/ Young  Ham                                   |   |
|   |                   | Young Ham                                        |
|   |                   | Chief  Financial Officer                         |
|   |                   | (Principal  Financial and Accounting Officer)    |

 

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