**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.20549**

**FORM 10-Q**

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

**For the quarterlyperiod ended September 30, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 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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**LIQUIDMETAL TECHNOLOGIES, INC.**

**(**Exact name of Registrant as specified in its charter**)**
| **Delaware**                     | ** ** | **33-0264467**       |
|----------------------------------|------------|----------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employer     |
| incorporation or  organization)  |       | Identification  No.) |

**25800Commercentre Drive, Suite 100**

**LakeForest, California 92630**

(address of principalexecutive office, zip code)

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

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

Yes  x    No  o

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

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

#### As of September 30, 2006, there were 44,131,268 shares of theregistrant’s common stock, $0.001 par value, outstanding.

 

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**LIQUIDMETAL TECHNOLOGIES, INC.FORM 10-QFOR THE QUARTER ENDED****SEPTEMBER30, 2006**

**FORWARD-LOOKING INFORMATION**

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

2

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

3

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### **PART I**

### **FINANCIAL INFORMATION**

**Item 1 – Financial Statements**

**LIQUIDMETAL TECHNOLOGIES, INC. ANDSUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(in thousands, except share data)**
| ** **                                                                                                                                                                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                              | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                                              | ** ** | **(Unaudited)**        | ** ** | **(Restated)**        | ** ** |
| **ASSETS**                                                                                                                                                                              | ** ** | ** **             | ** ** | ** **            | ** ** |
|                                                                                                                                                                                    |       |                   |       |                  |       |
| Current assets:                                                                                                                                                                         |       |                   |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                              |       | $                      | 563        |                  | $          | 1,392 |   |
| Trade accounts  receivables, net of allowance for doubtful accounts of $95 and $61                                                                                                      |       | 5,099                  |       | 2,360                 |       |
| Inventories                                                                                                                                                                             |       | 2,218                  |       | 1,748                 |       |
| Prepaid expenses  and other current assets                                                                                                                                              |       | 1,635                  |       | 609                   |       |
| Total current  assets                                                                                                                                                                   |       | 9,515                  |       | 6,109                 |       |
|                                                                                                                                                                                    |       |                   |       |                  |       |
| Property, plant and equipment, net                                                                                                                                                      |       | 12,467                 |       | 13,437                |       |
| Idle equipment                                                                                                                                                                          |       | 190                    |       | 193                   |       |
| Other intangibles, net                                                                                                                                                                  |       | 1,198                  |       | 1,185                 |       |
| Other assets                                                                                                                                                                            |       | 131                    |       | 639                   |       |
| Total assets                                                                                                                                                                            |       | 23,501                 |       | 21,563                |       |
|                                                                                                                                                                                    |       |                   |       |                  |       |
| **LIABILITIES AND SHAREHOLDERS’ DEFICIENCY**                                                                                                                                       | ** ** | ** **             | ** ** | ** **            | ** ** |
|                                                                                                                                                                                    |       |                   |       |                  |       |
| Current liabilities:                                                                                                                                                                    |       |                   |       |                  |       |
| Accounts payable  and accrued expenses                                                                                                                                                  |       | 8,850                  |       | 6,530                 |       |
| Settlement  payable                                                                                                                                                                     |       | —                 |       | 3,331                 |       |
| Deferred revenue                                                                                                                                                                        |       | 46                     |       | 1,275                 |       |
| Short-term debt,  net of debt discounts of $14 and $0                                                                                                                                   |       | 3,321                  |       | 550                   |       |
| Long-term debt,  current portion, net of debt discounts of $5,089 and $0                                                                                                                |       | 12,497                 |       | 1,343                 |       |
| Warrant  liabilities                                                                                                                                                                    |       | 4,225                  |       | 1,792                 |       |
| Conversion  feature liabilities                                                                                                                                                         |       | 3,690                  |       | 1,798                 |       |
| Other  liabilities, current portion                                                                                                                                                     |       | 250                    |       | 483                   |       |
| Total current  liabilities                                                                                                                                                              |       | 32,879                 |       | 17,102                |       |
| Long-term debt, net of current portion and debt  discounts of $0 and $8,259                                                                                                             |       | 550                    |       | 5,433                 |       |
| Other long-term liabilities, net of current portion                                                                                                                                     |       | 466                    |       | 348                   |       |
| Total  liabilities                                                                                                                                                                      |       | 33,895                 |       | 22,883                |       |
|                                                                                                                                                                                    |       |                   |       |                  |       |
| Shareholders’ deficiency:                                                                                                                                                          |       |                   |       |                  |       |
| Common stock,  $0.001 par value; 100,000,000 shares authorized and 44,131,268 issued and outstanding  at September 30, 2006 and 42,187,621 issued and outstanding at December 31,  2005 |       | 44                     |       | 42                    |       |
| Additional  paid-in capital                                                                                                                                                             |       | 135,461                |       | 130,893               |       |
| Accumulated  deficit                                                                                                                                                                    |       | (148,352               | )          | (134,525              | )          |
| Accumulated  other comprehensive income                                                                                                                                                 |       | 2,453                  |       | 2,270                 |       |
| Total  shareholders’ deficiency                                                                                                                                                    |       | (10,394                | )          | (1,320                | )          |
|                                                                                                                                                                                    |       |                   |       |                  |       |
| Total  liabilities and shareholders’ deficiency                                                                                                                                    |       | $                      | 23,501     |                  | $          | 21,563 |   |

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

4

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**LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIES**

### **CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS AND COMPREHENSIVE INCOME (LOSS)**

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

**(unaudited)**
| ** **                                             | ** ** | **For the Three Months Ended   September 30,** | ** ** | **For the Nine Months Ended   September 30,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                                                     | ** ** | **2005**                                                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | ** **                                                                   | ** ** | **(Restated)**                                                              | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| ** **                                             | ** ** | ** **                                                                   | ** ** | ** **                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenue                                                |       | $                                                                            | 8,040      |                                                                        | $          | 4,342 |   | $ | 21,685 |   | $ | 10,912 |   |
| Cost of sales                                          |       | 6,449                                                                        |       | 3,756                                                                       |       | 17,337 |   | 10,553 |   |
|                                                   |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Gross profit                                           |       | 1,591                                                                        |       | 586                                                                         |       | 4,348 |   | 359 |   |
|                                                   |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Operating  expenses                                    |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Selling, general, and administrative                   |       | 2,290                                                                        |       | 2,364                                                                       |       | 7,363 |   | 6,521 |   |
| Research and development                               |       | 269                                                                          |       | 196                                                                         |       | 753 |   | 806 |   |
| Impairment of long lived assets                        |       | —                                                                       |       | 833                                                                         |       | — |   | 4,227 |   |
| Total operating expenses                               |       | 2,559                                                                        |       | 3,393                                                                       |       | 8,116 |   | 11,554 |   |
| Loss from  operations                                  |       | (968                                                                         | )          | (2,807                                                                      | )          | (3,768 | ) | (11,195 | ) |
|                                                   |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Loss from  extinguishments of debt                     |       | —                                                                       |       | (1,247                                                                      | )          | — |   | (1,247 | ) |
| Change in value  of warrants, gain (loss)              |       | 1,361                                                                        |       | 1,112                                                                       |       | (1,354 | ) | 1,145 |   |
| Change in value  of conversion feature, gain (loss)    |       | 1,987                                                                        |       | 2,215                                                                       |       | (1,933 | ) | 4,497 |   |
| Other income                                           |       | —                                                                       |       | —                                                                      |       | 572 |   | — |   |
| Interest expense                                       |       | (2,302                                                                       | )          | (1,659                                                                      | )          | (7,361 | ) | (4,377 | ) |
| Interest income                                        |       | 8                                                                            |       | 7                                                                           |       | 17 |   | 14 |   |
|                                                   |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Income (loss)  from continuing operations              |       | 86                                                                           |       | (2,379                                                                      | )          | (13,827 | ) | (11,163 | ) |
|                                                   |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Net income  (loss)                                     |       | 86                                                                           |       | (2,379                                                                      | )          | (13,827 | ) | (11,163 | ) |
|                                                   |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Other  comprehensive income (loss):                    |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Foreign exchange translation gain (loss)               |       | 56                                                                           |       | (306                                                                        | )          | 183 |   | 77 |   |
| Comprehensive income (loss)                            |       | $                                                                            | 142        |                                                                        | $          | (2,685 | ) | $ | (13,644 | ) | $ | (11,086 | ) |
|                                                   |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Net income  (loss) per share basic and diluted:        |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Income (loss) per share basic and diluted              |       | $                                                                            | 0.00       |                                                                        | $          | (0.06 | ) | $ | (0.32 | ) | $ | (0.27 | ) |
|                                                   |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Number of weighted  average shares - basic and diluted |       | 44,100                                                                       |       | 41,933                                                                      |       | 43,664 |   | 41,717 |   |

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

5

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**LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OFSHAREHOLDERS’ DEFICIENCY**

###### **For the Nine months ended September 30, 2006**

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

**(unaudited)**
| ** **                                    | ** ** | **Common  Shares** | ** ** | **Common  Stock** | ** ** | **Additional   Paid-in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|-------------------|------------|----------------------------------------|------------|--------------------------|------------|-----------------------------------------------|------------|-----------|------------|
|                                          |       |               |       |              |       |                                   |       |                     |       |                                          |       |      |       |
| **Balance,  December 31, 2005 (As Restated)** |       | 42,187,621         |       | $                 | 42         |                                   | $          | 130,893                  |       | $                                             | (134,525   | )         | $          | 2,270 |   | $ | (1,320 | ) |
| Conversion of notes payable                   |       | 105,250            |       | —            |       | 146                                    |       | —                   |       | —                                        |       | 146       |       |
| Common stock issued as director's fees        |       | 109,437            |       | —            |       | 102                                    |       | —                   |       | —                                        |       | 102       |       |
| Common stock issued to Innometal              |       | 1,700,000          |       | 2                 |       | 3,448                                  |       | —                   |       | —                                        |       | 3,450     |       |
| Stock-based compensation                      |       | 28,960             |       | —            |       | 872                                    |       | —                   |       | —                                        |       | 872       |       |
| Foreign exchange translation gain             |       | —             |       | —            |       | —                                 |       | —                   |       | 183                                           |       | 183       |       |
| Net loss                                      |       | —             |       | —            |       | —                                 |       | (13,827                  | )          | —                                        |       | (13,827   | )          |
| **Balance, September 30, 2006**               |       | 44,131,268         |       | $                 | 44         |                                   | $          | 135,461                  |       | $                                             | (148,352   | )         | $          | 2,453 |   | $ | (10,394 | ) |

 

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

6

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**LIQUIDMETAL TECHNOLOGIES, INC.  AND SUBSIDIARIES**

### **CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

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

** (unaudited)**
| ** **                                                                                | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                                              | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | ** **                                                            | ** ** | **(Restated)** | ** ** |
| **Operating  activities:**                                                                | ** ** | ** **                                                            | ** ** | ** ** | ** ** |
| Net loss                                                                                  |       | $                                                                     | (13,827    | ) | $ | (11,163 | ) |
|                                                                                      |       |                                                                  |       |   |   |
| Adjustments to reconcile loss from operations to net  cash used for operating activities: |       |                                                                  |       |   |   |
| Impairment of long lived assets                                                           |       | —                                                                |       | 4,227 |   |
| Gain on disposal of asset                                                                 |       | —                                                                |       | (14 | ) |
| Depreciation and amortization                                                             |       | 2,658                                                                 |       | 2,516 |   |
| Loss on extinguishment of debt                                                            |       | —                                                                |       | 1,247 |   |
| Amortization of debt discount                                                             |       | 4,517                                                                 |       | 2,499 |   |
| Stock-based compensation                                                                  |       | 831                                                                   |       | 41 |   |
| Bad debt expense (recovery)                                                               |       | 60                                                                    |       | (21 | ) |
| Warranty expense                                                                          |       | 71                                                                    |       | 126 |   |
| Loss (gain) from change in value of warrants                                              |       | 1,354                                                                 |       | (1,145 | ) |
| Loss (gain) from change in value of conversion  feature                                   |       | 1,933                                                                 |       | (4,497 | ) |
|                                                                                      |       |                                                                  |       |   |   |
| Changes in operating assets and liabilities:                                              |       |                                                                  |       |   |   |
| Trade accounts receivable                                                                 |       | (2,799                                                                | )          | (504 | ) |
| Inventories                                                                               |       | (470                                                                  | )          | 178 |   |
| Prepaid expenses and other current assets                                                 |       | (1,026                                                                | )          | (404 | ) |
| Other assets                                                                              |       | 237                                                                   |       | (632 | ) |
| Accounts payable and accrued expenses                                                     |       | 2,381                                                                 |       | 752 |   |
| Deferred revenue                                                                          |       | (1,229                                                                | )          | (21 | ) |
| Other liabilities                                                                         |       | (178                                                                  | )          | (142 | ) |
| Net cash used for operating activities                                                    |       | (5,487                                                                | )          | (6,957 | ) |
|                                                                                      |       |                                                                  |       |   |   |
| **Investing  Activities:**                                                                | ** ** | ** **                                                            | ** ** | ** ** | ** ** |
| Purchases of property and equipment                                                       |       | (665                                                                  | )          | (153 | ) |
| Proceeds from the sale of property and equipment                                          |       | 104                                                                   |       | 69 |   |
| Investment in patents and trademarks                                                      |       | (102                                                                  | )          | (92 | ) |
| Net cash used for investing activities                                                    |       | (663                                                                  | )          | (176 | ) |
|                                                                                      |       |                                                                  |       |   |   |
| **Financing  Activities:**                                                                | ** ** | ** **                                                            | ** ** | ** ** | ** ** |
| Proceeds from borrowings                                                                  |       | 18,241                                                                |       | 16,180 |   |
| Repayment of borrowings                                                                   |       | (12,421                                                               | )          | (9,850 | ) |
| Repayment of other liabilities                                                            |       | 63                                                                    |       | (100 | ) |
| Proceeds from restricted cash                                                             |       | —                                                                |       | 754 |   |
| Net cash provided by financing activities                                                 |       | 5,883                                                                 |       | 6,984 |   |
| Effect of foreign exchange translation                                                    |       | (562                                                                  | )          | 340 |   |
| Net (decrease) increase in cash and cash equivalents                                      |       | (829                                                                  | )          | 191 |   |
|                                                                                      |       |                                                                  |       |   |   |
| Cash and cash  equivalents at beginning of period                                         |       | 1,392                                                                 |       | 742 |   |
| Cash and cash  equivalents at end of period                                               |       | $                                                                     | 563        |   | $ | 933 |   |
|                                                                                      |       |                                                                  |       |   |   |
| Supplemental  cash flow information                                                       |       |                                                                  |       |   |   |
| Interest paid                                                                             |       | $                                                                     | 1,664      |   | $ | 1,400 |   |
| Taxes paid                                                                                |       | $                                                                     | —     |   | $ | — |   |

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

7

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During the nine months endedSeptember 30, 2006, $105 of the Company’s 6% senior convertible notes due July2007 was converted into 105,250 shares of the Company’s common stock at aconversion price of $1.00 per share.

During the nine months endedSeptember 30, 2006, the Company fulfilled its settlement payable to Innometal(formerly known as Growell Metal) of $3,450, net of foreign exchangetranslation loss, through stock issuance of 1,700,000 shares of the Company’scommon stock.

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

8

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**LIQUIDMETAL TECHNOLOGIES AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**For theNine Months Ended September 30, 2006 and 2005**

**(inthousands, 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.  Allintercompany balances and transactions have been eliminated.  Operating results for the three and ninemonths ended September 30, 2006 are not necessarily indicative of the resultsthat may be expected for any future periods or the year ending December 31,2006.  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 16, 2006, as amended by Form 10-K/A filed on March 31, 2006, April 25,2006 and July 20, 2006.  

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

The Company classifies operations into two reportablesegments: Liquidmetal alloy industrial coatings and bulk Liquidmetal alloys(see Note 10). Liquidmetal alloy industrial coatings are used primarily as aprotective coating for industrial machinery and equipment, such as drill pipeused by the oil drilling industry and boiler tubes used by coal-burning powerplants. Bulk Liquidmetal alloys include potential market opportunities tomanufacture and sell products and components for electronic devices, medicaldevices, defense applications, and sporting goods.  In addition, the bulk Liquidmetal alloyssegment includes tooling and prototype sampling.  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-basedcompensation

The Company previously appliedAccounting Principles Board (“APB”) Opinion No. 25 for options when theexercise price of options granted to employees is less than the fair value of the underlyingstock on the date of grant.  Aspermitted, the Company had previously elected to adopt provisions of Statementof Financial Accounting Standard (“SFAS”) No. 123, *Accounting for Stock-Based Compensation*for options granted to non-employees whoperform services for the Company and the disclosure-only provisions ofoptions granted to employees. 

In December 2004, the FASB issued SFASNo. 123 (revised 2004), *Share-BasedPayment* (“SFAS 123R”), which replaces SFAS No. 123, *Accounting for Stock-Based Compensation*, (“SFAS 123”)and supersedes APB Opinion No. 25, *Accountingfor Stock Issued to Employees*, (“APB 25”). SFAS 123R requiresall share-based payments to employees, including grants of employee stockoptions, to be recognized in the financial statements based on their fairvalues. Under SFAS 123R, the Company is required to measure the cost ofemployee services received in exchange for stock options and similar awardsbased on the grant-date fair value of the award and recognize this cost in theincome statement over the period during which an employee is required toprovide service in exchange for the award. The pro forma disclosures previouslypermitted under SFAS 123 are no longer an alternative to financialstatement recognition. The Company adopted SFAS 123R on January 1,2006 using the modified prospective method and recorded $296 and $831 for thethree and nine months period ended September 30, 2006, of non-cash charges forstock compensation related to amortization of the fair value of restrictedstock and unvested stock options representing an increase from the stockcompensation that would have been recorded under APB 25 and SFAS 123. Underthis method, the Company will recognize compensation cost, on a prospectivebasis, for the portion of outstanding awards for which the requisite servicehas not yet been rendered as of January 1, 2006 and any new grants, basedupon the grant-date fair value of those awards calculated under SFAS 123 forpro forma disclosure purposes. Accordingly, we have not restated prior periodamounts. The following table illustrates the pro forma effect on net income for

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periods prior to the adoption of SFAS 123R as if we hadapplied the fair value recognition provisions of SFAS 123 during such periods:

|                                    | ** **                                                                                                                                | **For the Three  Months Ended  September 30,** | ** ** | **For the Nine   Months Ended  September 30,** | ** ** |
|------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                         | ** **                                                                                                                                | **2005**                                                           | ** ** | **2005**                                                                | ** ** |
| ** **                         | ** **                                                                                                                                | **(Restated)**                                                     | ** ** | **(Restated)**                                                          | ** ** |
| ** **                         | ** **                                                                                                                                | ** **                                                         | ** ** | ** **                                                              | ** ** |
| Net loss as reported               |                                                                                                                                      | $                                                                  | (2,379     | )                                                                       | $          | (11,163 | ) |
| s                                  |                                                                                                                                      |                                                               |       |                                                                    |       |
| *Add:*                             | stock-based employee compensation expense included  in reported net loss, net of related tax effects                                      |                                                               | 41         |                                                                    | 41         |   |
|                               |                                                                                                                                      |                                                               |       |                                                                    |       |
| *Deduct:*                          | total stock-based employee compensation expense  determined under the fair value based method for all awards, net of related  tax effects |                                                               | (695       | )                                                                       | (2,237     | ) |
|                               |                                                                                                                                      |                                                               |       |                                                                    |       |
| Proforma net loss:                 |                                                                                                                                      | $                                                                  | (3,033     | )                                                                       | $          | (13,359 | ) |
| Basic and  diluted loss per share: |                                                                                                                                      |                                                               |       |                                                                    |       |
| As reported                        |                                                                                                                                      | $                                                                  | (0.06      | )                                                                       | $          | (0.27 | ) |
| Proforma                           |                                                                                                                                      | $                                                                  | (0.07      | )                                                                       | $          | (0.32 | ) |

 

The fair value ofeach option grant is estimated on the date of the grant using the Black-Scholesoption-pricing model with the following weighted-average assumptions used forgrants for the nine months ended September 30, 2006 and 2005, respectively:expected volatility of approximately 100% for all periods; dividend yield of 0%for all periods; expected option life of approximately 5 years; and arisk-free interest rate ranging from 3.64% to 4.82%.

**2.         Basis of Presentation and Recent Accounting Pronouncements**

Translation of Foreign Currency

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

Recent Accounting Pronouncements

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

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In July2006, the FASB issued FASB interpretation (FIN) No. 48, “Accounting forUncertainty in Income Taxes — an interpretation of FASB statement No. 109,”which prescribes a recognition threshold and measurement process for recordingin the financial statements, uncertain tax positions taken or expected to betaken in a tax return.  In addition, FIN48 provides guidance on the derecognizing, classification, accounting ininterim periods and disclosure requirements for uncertain tax positions.  The Company is currently evaluating theimpact, if any, that FIN 48 will have on its financial statements.

InSeptember 2006, the FASB issued SFAS No. 157, “Fair Value Measurement”*,*which defines fair value, establishes a framework formeasuring fair value and expands disclosures about fair valuemeasurements.  The effective date of SFASNo. 157 will be the first quarter of 2008. While the Company is currently evaluating the provisions of SFAS 157,the adoption is not expected to have a material impact on its consolidatedfinancial statements.

InSeptember 2006, the SEC issued SAB No. 108, “Guidance re: the Use of aCumulative Effect Adjustment to Correct Immaterial Misstatements” (“SAB 108”).Registrants are required to apply the provisions of SAB 108 no later than theannual financial statements for their first fiscal year ending after November15, 2006. The application of SAB 108 is not expected to have a material impacton the Company’s financial statements.

**3.         Liquidity**

The Company has experienced losses from continuingoperations during the last three fiscal years and has an accumulated deficit of$148,352 as of September 30, 2006.  Cashused for operations for the nine months ended September 30, 2006 was $5,487 andcash flow from operations will likely be negative throughout fiscal year2006.  As of September 30, 2006, theCompany’s principal source of liquidity are $563 of cash and $5,099 of tradeaccounts receivable.  Such conditionsraise substantial doubt that the Company will be able to continue as a goingconcern.  These operating resultsoccurred while the Company was developing and continues to develop,commercialize, and manufacture products from an entirely new and uniquetechnology.  These factors have placed asignificant strain on the financial resources of the Company.  The ability of the Company to overcome thesechallenges depends on its ability to correct its production inefficiencies, reduceits operating costs, generate higher revenue, achieve positive cash flow fromcontinuing operations and continued sources of debt and equity financing.  The consolidated financial statements do notinclude any adjustments that might result from the outcome of these uncertainties.

The Company completed a $1,000 10% subordinated promissorynote on March 17, 2006.  Also, on May 17,2006 and September 21, 2006, the Company completed a private placement of 8%unsecured subordinated notes in the aggregate principal amount of $4,125 (SeeNote 8).  Further, the Company borrowed$12,666, which was offset by repayments of $11,331, under a factoring, loan,and security agreement executed on April 21, 2005 to fund its working capitalrequirements during the nine months ended September 30, 2006.  

Capital requirements duringthe next 12 months will depend on numerous factors, including the successof existing products, the development of new applications for Liquidmetalalloys, and the resources devoted to develop and support Liquidmetal alloyproducts.  Specifically, we anticipate that we couldneed $5,000 to $10,000 over the next twelve months to pursue ourcurrent operating plan, although this amount may be lower depending on theorders we receive for our products. The amount of funding that we plan to seek and the timing of suchfundraising efforts will depend on the extent to which we are able to increaserevenues through obtaining additional purchase orders for our products,particularly components for cellular phones and flash memory drive casings andother electronic components, and our ability to continue to improve ourmanufacturing processes.  We evaluate ourworking capital needs and operating plan assumptions on a monthly basis todetermine whether any adjustment to our cash and liquidity outlook iswarranted, and we also review potential sources of financing on an ongoingbasis.  However, adequate funds may notbe available when needed, and if we raise additional funds by issuing equitysecurities, existing stockholders may be subject to dilution.  If we don’t receive sufficient funding tooperate under our current plan, we intend to reduce operations and expenses andshift our focus to the pursuit of licensing transactions and other strategictransactions that are less capital intensive. 

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**4. Inventories**

Inventories are accounted for using the moving averagebasis and at standard cost, which approximate cost on a first-in, first-outbasis and are valued at the lower of cost or market.  Inventories were comprised of the following:
|                   | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|------------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| ** **        | ** ** | **(Unaudited)**        | ** ** | **(Restated)**        | ** ** |
|              |       |                   |       |                  |       |
| Raw materials     |       | $                      | 842        |                  | $          | 565 |   |
| Work in process   |       | 931                    |       | 763                   |       |
| Finished goods    |       | 445                    |       | 420                   |       |
| Total inventories |       | $                      | 2,218      |                  | $          | 1,748 |   |

**5. Idle Equipment**

Idle equipment consists of certain equipment held bythe Company for use in expansion of bulk alloy parts manufacturing.  Whilethe equipment may be used internally to meet future capacity requirements,considering our current revenue and foreseeable production requirements, theCompany does not anticipate utilizing this equipment internally in the nearfuture.  Total amount of idle equipmentremaining was $190 as of September 30, 2006 and $193 as of December 31, 2005.

During the nine months ended September 30, 2006, theCompany disposed of $12 of its idle equipment for proceeds of $104. Theresulting gain of $92 is included in other income.

**6. Settlement Payable**

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

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

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directs theprospective customer to Growell and encourages the prospective customer topurchase the machine from Growell.  

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

As an inducementfor Innometal to enter into the Settlement Amendment, James Kang, a former directorand officer of the Company, had entered into a buy-sell agreement withInnometal whereby Mr. Kang agreed to personally purchase from Innometal, andInnometal agreed to sell to Mr. Kang, the 1,700,000 shares issued to Innometalunder the Settlement Amendment. Mr. Kang received no consideration from the Companyin connection with his entering into this buy-sell agreement, and no registrationrights with respect to the shares under the buy-sell agreement. While the termsof the buy-sell agreement may be independently re-negotiated between Mr. Kangand Innometal, all releases to the Company that are applicable under theSettlement Amendment has and will remain in full force and effect. Subsequentto September 30, 2006, Mr. Kang resigned as a director and officer and iscurrently working as a consultant for the Company (see Note 14).

**7. Product Warranty**

Managementestimates product warranties as a percentage of certain bulk alloy productsales earned during the period.  As ofSeptember 30, 2006, the Company used 5% of bulk alloy product sales as anestimate of warranties to be claimed. The percentage is based on industry averages and historicalinformation.  During the three monthsended September 30, 2006, the Company recorded $34 of net gain from expired warrantyand during the nine months ended September 30, 2006, the Company recorded $71of warranty expense.  During the threeand nine months ended September 30, 2005, the Company recorded $50 and $126,respectively, of warranty expense.  Theproduct warranty accrual balance is included in accounts payable and accruedexpenses.

**8. Notes Payable**

Senior Convertible Note

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

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

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

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

During 2004, the Company redeemed $4,465 of theoutstanding note balance in cash.  Theredemption resulted in a write down of debt issuance costs and debt discount of$3,571 to interest expense and a reduction in conversion feature liabilities of$914 from cancellation of the embedded conversion feature of the redeemed notesto additional paid in capital during the year ended December 31, 2004.  Further, 500,000 of warrants originallyissued to a financial advisor for the transaction expired during June 2004 and163,748 of unexercised warrants originally issued to investors were cancelledas a result of the Company’s redemption of the note balances during the yearended December 31, 2004.  The 663,748total expired and canceled warrants immediately prior to the expiration andcancellation resulted in a reduction of warrant liability of $7 and $279 toadditional paid in capital and change in value of warrants, respectively,during the year ended December 31, 2004.

On August 19, 2004, the Company completed a privateexchange offer for its March Notes with the remaining holders after theredemption.  Under terms of the exchangeoffer, approximately $5,460 in aggregate principal amount of the March Noteshave been exchanged for an aggregate of (i) $2,730 of 6% Senior Secured NotesDue 2007 (the “July 2007 Notes”) and (ii) $2,730 of 10% Senior Secured NotesDue 2005 (the “July 2005 Notes”), 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 July 2005 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 July 2005 Notes have been exchanged andredeemed subsequent to the close of the second quarter of 2005 (see 2005 SeniorConvertible Notes below). The July 2007 Notes have a maturity date of July 29,2007, and a conversion price of $1.00 per share.   Further, the Exchange Notes are convertibleinto Common Stock, at the option of the Company, if at any time after theissuance of the notes, the closing per share price of the Common Stock exceeds$4.00 (as adjusted for stock splits, reverse splits, stock dividends, andrecapitalizations) for 30 consecutive trading days, and further provided thatthere has been effective registration during such period.  The convertible price of the Exchange Notesis subject to price adjustment for anti-dilution purposes.  As of September 30, 2006, the convertibleprice of the July 2007 Notes remained unchanged at $1.00 per share.  Holders of the July 2007 Notes also have theright to call for repayment of the July 2007 Notes prior to maturity at anytime after the second anniversary of the closing of the exchange offer.   

A total of 563,151 warrants to purchase our commonstock at an exercise price of $3.00 per share—all of which were previouslyissued in connection with the purchase of the March Notes—have been amended toprovide for an extended expiration date of March 1, 2006.  The warrants issued to placement agents areto expire the later of March 1, 2006 or 100 days after the effectiveness ofregistration of shares issuable under the warrants and senior convertibledebt.  The warrant exercise price issubject to price adjustment for anti-dilution purposes.  There were 165,324 warrants outstanding and theexercise price of the warrants was $2.72 per share as of September 30,2006.   

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The exchange offer was treated as an extinguishment ofthe March Notes in accordance with EITF No. 96-19, “Debtors Accounting for aModification or Exchange of Debt Instruments.” The exchange resulted in a $2,941 loss from extinguishment of the MarchNotes, which consisted of write down of $352 of deferred issue costs in otherassets, $670 of debt discount, and an increase of $1,919 in conversion featureliability as a result of the change in carrying value of exchanged notes.

In connection with the private exchange offer, theCompany issued $250 of private placement notes to certain Placement Agents asissuance costs.  Of the $250 notesissued, $125 was paid in the form of long-term notes which is due in 2007 withinterest rate of 6% per annum (July 2007 Notes) and $125 was paid in the formof short-term notes which is due in 2005 with interest rate of 10% per annum(July 2005 Notes).  The July 2005 andJuly 2007 Notes are convertible into common stock at $2.00 and $1.00,respectively, and have the same terms as the Exchange Notes issued to theinvestors.  Further, $143 of originalfair value of the embedded conversion feature from the $250 notes issued to PlacementAgents was recorded as conversion feature liabilities during August 2004.

The Company was obligated, pursuant to a RegistrationRights Agreement, as amended by the Exchange Notes, between the Company, thePlacement Agents and the note holders to file a registration statement with theSecurities and Exchange Commission (“SEC”) to register the shares of common stockissueable upon conversion of the notes payable and the related warrants within90 days following the effective closing date of the exchange notes (July 29,2004), and to use best efforts to cause such registration statement to becomeeffective within 60 days following the SEC’s first written comments on theregistration statement.  Further, if theCompany is not in compliance with the registration or listing requirements, theholders have rights to late registration payments equal to between 2% and 3% ofthe purchase price paid for the unconverted notes for the first 30 businessdays of late registration, and 1% and 3% for each 30 business days thereafter,but no more than 18% of the purchase price of the unconverted notebalance.  Late registration fee of $1,028has been accrued as interest expense as of September 30, 2005. 

Interest payments are due quarterly, and failure tomake timely interest payments will result in increase in interest rate to 10%and 14% on the 6% and 10% senior convertible notes (“Default Rates”).  The Default Rates became effective on April1, 2005 from non-payment of a scheduled interest payment.  The Company became compliant with timelyinterest payments during the third quarter of fiscal year 2005, and as ofSeptember 30, 2006, the Company has complied with all scheduled interestpayments.

On August 9, 2005, the July 2005 Notes, accruedinterest and late registration fees were redeemed in cash and exchanged for 7%Convertible Secured Promissory Notes due August 2007.  Further, the July 2007 Notes have beenamended subsequent to the close of the second quarter of 2005 to provide for anamended and restated registration rights agreement and an amended and restatedsecurity agreement.  During the three andnine months ended September 30, 2006, the Company accrued $31 and $217,respectively, in interest expense as a result of receiving a demand letter froma note holder under the amended and restated registration rights agreement forfailure to timely file a registration statement and register the sharesissuable under notes and warrants (see 2005 Senior Convertible Notesbelow).  The Company paid $55 of the latefiling and registration fees and the remaining $162 is included in accountspayable and accrued liabilities as of September 30, 2006.  Further, the July 2007 Notes and its relateddebt discount and deferred issuance cost are presented as current liabilitiesand current assets, respectively, as of September 30, 2006.

During the year ended December 31, 2005, $485 of theJuly 2007 Notes were converted into 485,750 of the Company’s common stock at aconversion price of $1.00 per share. Additionally, during the nine months ended September 30, 2006, $105 ofthe July 2007 Notes were converted into 105,250 of the Company’s common stockat a conversion price of $1.00 per share. The conversion resulted in reduction of conversion feature liabilitiesof $541 and $41 to additional paid in capital for the year ended December 31,2005 and for the nine months ended September 30, 2006, respectively.

The Company’s gross outstanding loan balance of theJuly 2007 Notes totaled $2,264 and $2,369 as of September 30, 2006 and December31, 2005, respectively.   As ofSeptember 30, 2006 and December 31, 2005, un-amortized discounts for conversion feature andwarrants totaled $607 and $1,207, respectively, and other asset debt issuance coststotaled $22 and $43, respectively. Interest expense for the amortization of debt issuance cost and discounton note was $190 and $606, for the three months and nine months ended September30, 2006, respectively, and $594 and $1,554 for the three and nine months 

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ended September 30, 2005, respectively.  As of September 30, 2006, the effectiveinterest rate for the July 2007 Notes was 33%. 

Pursuant toStatement of Financial Accounting Standards No. 133, “Accounting for Derivativeinstruments and Hedging Activities,” the Company is required to report a valueof the conversion liability as a fair value and record the fluctuation to thefair value of the conversion feature liability to current operations.  The change in the fair value of theconversion feature liability resulted in a gain of $676 and a loss of $1,072for the three and nine months ended September 30, 2006, respectively, and again of $1,233 and $3,515 for the three and nine months ended September 30,2005, respectively.  The fair value ofconversion feature liability was $1,871 and $840 as of September 30, 2006 andDecember 31, 2005, respectively.  Thefair value of conversion liability outstanding at September 30, 2006 wascomputed using the Black-Scholes model under the following assumptions: (1)0.83 years; (2) volatility of 73%, (3) risk free interest of 4.91% and dividendrate of 0%. The fair value of conversion feature liability outstanding atDecember 31, 2005 was computed using the Black-Scholes model under thefollowing assumptions: (1) 1.57 years; (2) volatility of 88%, (3) risk freeinterest of 4.41% and dividend rate of 0%.

Pursuant to EITF00-19, “Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company’s Own Stock”. In addition, the Company is required to report a value of the warrant asa fair value and record the fluctuation to the fair value of the warrantliability to current operations.  Thechange in the fair value of the warrants resulted in a gain of $11 and a lossof $7 for the three and nine months ended September 30, 2006, respectively, anda gain of $170 and $457 for the three and nine months ended September 30, 2005,respectively.  The fair value of warrantsoutstanding was $7 and $0 as of September 30, 2006 and December 31, 2005,respectively.  The fair value of warrantsoutstanding at September 30, 2006 was computed using the Black-Scholes modelunder the following assumptions: (1) expected life of 0.27 years; (2)volatility of 73%, (3) risk free interest of 4.89%and dividend rate of 0%. Thefair value of warrants outstanding at December 31, 2005 was computed using theBlack-Scholes model under the following assumptions: (1) expected life of 0.16years; (2) volatility of 88%, (3) risk free interest of 4.08% and dividend rateof 0%.

Convertible Notes

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

The June 2006Notes issued by the Company in the June 2005 Private Placement are unsecuredand was due on the earlier of June 13, 2006 or the consummation of afollow-on equity or debt offering or restructuring transaction pursuant towhich the Company receives gross proceeds of at least $4,000.  Prior tomaturity, the June 2006 Notes are interest-only, with interest payments duequarterly, at a rate of 10% per year.  The June 2006 Notes can be prepaidby the Company at any time without penalty.  If, within 120 days followingthe issue date of the June 2006 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 June 2006 Notes will thereafter be convertibleat a conversion price equal to seventy five percent (75%) of the closing priceof the Company’s common stock on the first trading day immediately precedingthe conversion date.  A “Qualified Financing “ is defined in the June 2006Notes as any debt or equity financing of the Company resulting in aggregategross proceeds to the Company of at least $5,000 and in which the holders of atleast sixty percent (60%) of the aggregate principal amount of the Company’sLong Term Notes due July 2007 either (i) agree that the equity ordebt securities to be issued in such financing shall be*pari passu* in order of payment to the2007 Notes held by them or (ii) exchange their 2007 Notes for newsecurities in the financing transaction. On August 9, 2005, the Company successfully completed QualifiedFinancing, which resulted in exchange and redemption of the Convertible Notes(see 2005 Senior Convertible Debt).  As aresult, the Notes never became convertible.  

As a part of theJune 2005 Private Placement, the Company issued warrants to the purchasers ofthe Notes giving them the right to purchase up to an aggregate of 812,500shares of the Company’s common stock.  In addition, warrants to purchase81,250 shares of the Company’s common stock were issued to the placement agentin the transaction.  The warrants have an exercise price of $2.00 pershare, containing a one-time provision that upon the consummation of the firstensuing public or private equity or debt offering or restructuring transactionin 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, 

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2005), for theJune 2005 Private Placement only, the exercise price will be automaticallyadjusted downward (but not upward) as of the closing date of such offering orrestructuring transaction so that it is equal to the lowest effective commonstock purchase price paid for any securities issued by the Company to theinvestors in such offering or restructuring transaction.  The warrantswill expire on June 13, 2010 and are subject to exercise price adjustmentfor anti-dilution purposes.  As set forthin the July 2005 Notes below, the Company successfully exchanged the Notes for$9,878 and thus, the exercise price of the warrants remained unchanged at $2.00per share.

The fair value of the 893,750 warrants totaled$1,160 and was computed using the Black-Scholes pricing model under thefollowing assumptions: (1) expected life of 5 years; (2) volatility of 118%,(3) risk free interest of 3.87% and dividend rate of 0%.  In accordance with EITF No. 00-27, “Applicationof Issue No. 98-5 to Certain Convertible Instruments” the embedded beneficialconversion feature of the debt was not recorded as the debt is consideredcontingently convertible at the time of issuance, and as a result of thecompletion of the Qualified Financing the debt subsequent to the close of thesecond quarter, the debt was determined to be not convertible. In June 2005,the fair value of the 812,500 warrants issued to investors of $1,055 wasrecorded as discounts of the convertible note. In addition $105 relating to the fair value of the 81,250 warrantsissued to the Placement Agents and $278 direct costs incurred relating toissuance of the convertible note were recorded as debt issuance cost as acontra liability account in debt discount and other assets, respectively, andwas amortized using the effective interest rate method over the life of the loan.

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

On August 9, 2005,the Company entered into an amended and restated registration rights agreementwith the holders of the warrants in connection with the August 2005 PrivatePlacement.  During the three and ninemonths ended September 30, 2006, the Company accrued $20 and $140,respectively, in interest expense as a result of receiving a demand letter inMay 2006 from a note holder under the amended and restated registration rightsagreement for failure to file timely a registration statement and registeringthe shares issuable under the warrants (see 2005 Senior Convertible notesbelow).  The Company paid $107 of thelate filing and registration fees and the remaining $33 is included in accountspayable and accrued liabilites as of September 30, 2006.

Pursuant to EITF 00-19, “Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock”, the original fair values of the warrants of $1,160 have been recordedas warrant liability.  In addition, theCompany is required to report a value of the warrant as a fair value and recordthe fluctuation to the fair value of the warrant liability to currentoperations.  The change in the fair valueof the warrants resulted in a gain of $257 and a loss of $366 for the three andnine months ended September 30, 2006, respectively, and a gain of $349 and $95for the three and nine months ended September 30, 2005.  The fair value of the warrants outstandingwas $784, and $418 at September 30, 2006 and December 31, 2005,respectively.  The fair value of warrantsoutstanding at September 30, 2006 was computed using the Black-Scholes modelunder the following assumptions: (1) expected life of 3.70 years; (2)volatility of 73%, (3) risk free interest of 4.59%and dividend rate of 0%. Thefair value of warrants outstanding at December 31, 2005 was computed using theBlack-Scholes model under the following assumptions: (1) expected life of 4.45years; (2) volatility of 88%, (3) risk free interest of 4.35%and dividend rateof 0%.

2005 Senior Convertible Notes

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

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of the August 2007 Notes,and the holders of previously issued July 2005 Notes and June 2006 Notes of theCompany due June 2006.  

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

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

Further, pursuant toStatement of Financial Accounting Standards No. 133, “Accounting for DerivativeInstruments and Hedging Activities,” EITF 00-19, “Accounting for DerivativeFinancial Instruments Indexed to, and Potentially Settled in, a Company’s OwnStock,” EITF 00-27, “Application of Issue No. 98-5 to Certain ConvertibleInstruments,” and EITF 05-2 “The Meaning of ‘Conventional Convertible DebtInstrument’ in EITF Issue No. 00-19,” the original fair value of the embeddedconversion feature of $4,808 have been recorded as conversion feature liabilityas the debt is considered nonconventional convertible debt. The original fairvalue was computed using the Black-Scholes model under the followingassumptions: (1) expected life of 2 years; (2) volatility of 93%; (3) risk freeinterest of 4.06% and dividend rate of 0%. In addition, the Company is required to report a value of the conversionliability as a fair value and record the fluctuation to the fair value of theconversion feature liability to current operations.  The change in the fair value of theconversion feature liability resulted in a gain of $1,311 and a loss of $860for the three and nine months ended September 30, 2006 and a net gain of $982for the three and nine months ended September 30, 2005.  The fair value of the conversion featuresoutstanding as of September 30, 2006 of $1,819 was computed using theBlack-Scholes model under the following assumptions: (1) 0.84 years; (2) volatility of 73%, (3)risk free interest of 4.91% and dividend rate of 0%.  The fair value of conversion featuresoutstanding at December 31, 2005 of $959 was computed using the Black-Scholesmodel under the following assumptions: (1) 1.59 years; (2) volatility of 88%,(3) risk free interest of 4.41%and dividend rate of 0%.

The August 2007 Notes are secured by substantially allassets of the Company and rank senior to all other obligations of the Company,other than the Company’s loan with Kookmin Bank of South Korea (or anyrefinancing of such loan), the July 2007 Notes, purchase money asset financing,trade creditors in the ordinary course of business, and any inventory orreceivables-based credit facility that the Company may obtain in the future,provided that the amount of the credit facility does not exceed 50% of eligibleinventory and 80% of eligible receivables. The August 2007 Notes willautomatically convert into common stock if the Company’s common stock has anaverage closing price of more than $5.00 per share during 30 consecutivetrading days. 

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

Pursuant to EITF 00-19, “Accounting for Derivative Financial InstrumentsIndexed to, and Potentially Settled in, a Company’s Own Stock”, the originalfair values of the warrants of $4,068 have been recorded as warrant liability,which was computed using the Black-Scholes pricing model under the followingassumptions: (1) expected life of 5 years; (2) volatility of 93%; (3) risk freeinterest of 4.17% and dividend rate of 0%. In addition, the Company is required to report a value of the warrant asa fair value and record the fluctuation to the fair value of the warrant liabilityto current operations.  The change in thefair value of the warrants resulted in a gain of $830 and $1,202 for the threeand nine months ended September 30, 2006, respectively, and a gain of $593 forthe three and nine months ended September 30, 2005.  The fair value of warrants outstanding was$2,576 as of September 30, 2006, which was computed using the Black-Scholesmodel under the following assumptions: (1) expected life of 3.84 years; (2)volatility of 73%, (3) risk free interest of 4.59% and dividend rate of 0%.  The fair value of warrants outstanding atDecember 31, 2005 of $1,375 was computed using the Black-Scholes model underthe following assumptions: (1) expected life of 4.59 years; (2) volatility of88%, (3) risk free interest of 4.35% and dividend rate of 0%.

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In connection withthe August 2005 Private Placement, the Company entered into an amended andrestated registration rights agreement with the holders of the July 2007 Notes,the holders of the August 2007 Notes, and the holders of the above-describedoutstanding warrants.  This amended andrestated registration rights agreement replaced all other registration rightsagreements previously entered into by us in connection with the private sale byus of convertible notes and warrants.  Underthe amended and restated registration rights agreement, the Company is requiredto file a resale registration statement for the shares underlying all of ouroutstanding convertible notes and warrants, as described above, by October 31,2005, to enable the resale of such shares by the selling stockholders on adelayed or continuous basis under Rule 415 of the Securities Act.  The Company is then required to cause suchregistration statement to become effective within 60 days after we receive thefirst written comments on the registration statement from the SEC, or if theSEC notifies us that it will not review the registration statement, within fivedays after such notification.  TheCompany will be subject to certain monetary penalties, as set forth in theregistration rights agreement, if the registration statement is not filed ordoes not become effective on a timely basis. Specifically, if the Company does not file the registration statement ona timely basis, we will be obligated to pay a late filing fee to the sellingstockholders in the amount of 3% of the warrant exercise price on each of thewarrants held by them plus 3% of the principal amount of the outstanding notesheld by them.  This fee will be payablefor each period of 30 business days that the filing of the registration statementis made past the required filing date, and the payments will be due 10 businessdays following the end of each 30-day period. If the registration statement has not been declared effective by therequired effective date, the Company will be obligated to pay a monthly lateregistration fee to the selling stockholders in the amount of 2% of theaggregate warrant exercise prices and aggregate note principal amounts for thefirst 30 business days after the required effective date, and 1% for each30-business day period thereafter until the registration statement is declaredeffective.  Notwithstanding theforegoing, the late filing fees and late registration fees will not exceed 18%of the aggregate warrant exercise prices and aggregate note principal amounts.  

On December 6,2005, the Company received a letter from a representative of the holders of theAugust 2007 Notes demanding the payment of a late filing fee by us for theperiod following October 31, 2005, but under the terms of the amended andrestated registration rights agreement, the Company did not believe that it wasobligated to pay any late filing fees unless and until the Company failed tofile the registration statement by December 13, 2005, which was the last day ofthe first 30-business day period following October 31, 2005.  On December 9, 2005 the Company filed theregistration statement, which was within the 30-day period and believed it hadcured the default notice.  

On May 12, 2006, the Company received a letter fromone holder holding $500 of the August 2007 Notes demanding immediate payment oflate filing fees and late registration fees for the period following October31, 2005 through May 2, 2006.  As aresult of the late fee provisions of the restated registration rightsagreement, we are obligated to pay late filing and late registration fees toall of the holders of the August 2007 Notes for failure to timely file aregistration statement and register the shares issuable under notes andwarrants.   In addition, the letterpurported to constitute a notice of default under the August 2007 Notes andJuly 2007 Notes (the “Notes”) as a result of our failure to the late filing andlate registration fees.   During thethree and nine months ended September 30, 2006, the Company accrued $173 and$1,221, respectively, of outstanding late filing and late registration fees toholders of the Company’s convertible debt as interest expense.  The Company’s registration statement becameeffective on August 7, 2006.  The Companypaid $569 of the late filing and registration fees and the remaining $653 isincluded in accounts payable and accrued liabilities as of September 30,2006.  The Company is currently innegotiations with the holder regarding the matters set forth in the letter withthe goal of preventing any acceleration of amounts due under the Notes (SeeNote 14).  

Our gross outstanding loan balance of the August 2007Notes totaled $9,878 as of September 30, 2006 and December 31, 2005.  As of September 30, 2006 and December 31,2005, un-amortized discounts for conversion feature and warrants totaled $3,478and $6,587, and other asset debt issuance costs totaled $198 and $384, andcontra liability debt issuance cost totaled $245 and $464, respectively.  Interest expense for the amortization of debtissuance cost and discount on note was $1,036 and $3,250 for the three and ninemonths ended September 30, 2006.  As ofSeptember 30, 2006, the effective interest rate for the August 2007 Notes was54%. 

SubordinatedPromissory Note

On March 17, 2006,the Company issued a $1,000 10% subordinated promissory note due October 16,2006 (the “October 2006 Note”) to Atlantic Realty Group, Inc., a companycontrolled by Jack Chitayat, a former director of the Company.  OnSeptember 30, 2006, the October 2006 Note was amended to mature on November 1,2006.  The October 2006 Note is unsecuredand 

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subordinated toall prior indebtedness of the Company.  All accrued interest and unpaidprincipal under the note will be due November 15, 2006.  The proceeds fromthe October 2006 Note is to be used solely for working capital purposes. In connection with the October 2006 Note, the Company issued warrants topurchase an aggregate amount of up to 125,000 shares of common stock,exercisable at $2.00 per share.  The warrants will expire on March 17,2009, and include price adjustment provisions for anti-dilution purposes. As of September 30, 2006, the exercise price of the warrants remained unchangedat $2.00 per share. There are no registration rights of the shares issuable fromthe exercise of the warrants.  Further, cashless exercise of the warrantsis permitted.  

Pursuant to EITF00-19, “Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company’s Own Stock,” the original fair value of thewarrants of $84 have been recorded as warrant liability as the warrant holderscan elect to settle the warrants in cash, which was computed usingBlack-Scholes pricing model under the following assumptions: (1) expected lifeof 2.96 years; (2) volatility of 84%; (3) risk free interest of 4.64% anddividend rate of 0%.  In addition, the Company is required to report avalue of the warrants as a fair value and record the fluctuation to the fairvalue of the warrant liability to current operations.  The change in thefair value of the warrants resulted in a gain of $35 and a loss of $5 for thethree and nine months ended September 30, 2006.  The fair value ofwarrants outstanding at September 30, 2006 of $89 was computed using theBlack-Scholes model under the following assumptions: (1) expected life of 2.46years; (2) volatility of 73%, (3) risk free interest of 4.62% and dividend rate of 0%.

Our gross outstanding loan balance of the October 2006Note totaled $1,000 as of September 30, 2006 and is included in short-termdebt.  As of September 30, 2006,un-amortized discounts for warrants totaled $14.  Interest expense for the amortization ofdiscount on the note was $29 and $69 for the three and nine months endedSeptember 30, 2006.  As of September 30,2006, the effective interest rate for the October 2006 Note was 22%. 

Unsecured Subordinated Notes

On May 17, 2006, the Companycompleted a private placement of 8% unsecured subordinated notes (the “May 2006Private Placement”) in the aggregate principal amount of $3,625 (the “August2007 Subordinated Notes”), together with warrants to purchase up to anaggregate of 705,233 shares of the Company’s common stock.  The May 2006 Private Placement, was madesolely to “accredited investors” including Ricardo A. Salas, the Company’sPresident and CEO.  Mr. Salas holds $100of the August 2007 Subordinated Notes. On September 21, 2006, the Company completed an additional privateplacement under the terms of the May 2006 Private Placement in the aggregateprincipal amount of $500 together with warrants to purchase up to an aggregateof 96,900 shares of the Company’s common stock. Subsequent to September 30, 2006, Mr. Salas has resigned as an officerand director of the Company (see Note 14).

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

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

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

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As part of the August 2007Private Placement, the Company issued warrants to the purchasers of the Notesgiving them right to purchase up to an aggregate of 802,133 shares of theCompany’s common stock.  In addition, warrantsto purchase 68,508 shares of the Company’s common stock were issued to theplacement agent in the transaction.  Thewarrants have an exercise price of $2.58 per share, which is subject to priceadjustment for anti-dilution purposes. The exercise price of the warrants remained unchanged at $2.58 per shareas of September 30, 2006.  The warrantswill expire on May 17, 2011.

Pursuant to EITF 00-19, “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock,” the original fair value of the warrants of $905 for theMay 17, 2006 placement have been recorded as warrant liability, as the warrantholders can elect to settle the warrants in cash, which was computed usingBlack-Scholes pricing model under the following assumptions: (1) expected lifeof 5.00 years; (2) volatility of 80%; (3) risk free interest of 5.03% anddividend rate of 0%.  The original fairvalue of the warrants of $89 for the September 21, 2006 placement have beenrecorded as warrant liability, as the warrant holders can elect to settle thewarrants in cash, which was computed using Black-Scholes pricing model underthe following assumptions: (1) expected life of 4.65 years; (2) volatility of76%; (3) risk free interest of 4.60% and dividend rate of 0%.

In addition, the Company isrequired to report a value of the warrant as a fair value and record thefluctuation to the fair value of the warrant liability to currentoperations.  The change in the fair valueof the warrants resulted in a gain of $228 and $226 for the three and ninemonths ended September 30, 2006.  Thefair value of the warrants outstanding at September 30, 2006 of $768 wascomputed using the Black-Scholes model under the following assumptions: (1)expected life of 4.63 years; (2) volatility of 73%; (3) risk free interest of4.59% and dividend rate of 0%.

Our gross outstanding loanbalance of the August 2007 Subordinated Notes totaled $4,125 as of September30, 2006.  As of September 30, 2006,un-amortized discounts for warrants totaled $747.  Interest expense for the amortization ofdiscount on the note was $150 and $248 for the three and nine months endedSeptember 30, 2006.  As of September 30,2006, the effective interest rate for the August 2007 Subordinated Notes was37%.

Factoring Agreement

The Companyentered into a Factoring, Loan, and Security Agreement (the “Agreement”) with afinancing company on April 21, 2005, which allows for borrowings of up to$1,500, however, the financing company may, from time to time, allow foradditional borrowings at its discretion. The Agreement expires on April 21, 2006, and automatically renewsannually thereafter. All borrowings are secured by outstanding receivablesspecifically assigned to the financing company. Assigned receivables are considered “Approved” or “Non-Approved” by thefinancing company.  On January 27, 2006,the terms of the agreement were amended whereas advances are made on 85% ofApproved receivables assigned and 50% of Non-Approved 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 from0.55% to 1.5% plus prime rate as published by the Wall Street Journal, with aminimum annual fee of $30. All receivables assigned and advances made aresubject to return and recall by the financing company, respectively.  As such, the advances have been classified asshort-term secured borrowings in accordance with SFAS 140 “Accounting forTransfer and Servicing of Financial Assets and Extinguishments of Liabilities.”  As of September 30, 2006, the Company hasborrowed $12,666 and repaid $11,331.  Thetotal outstanding advance made under the agreement is $1,885 and $550 as ofSeptember 30, 2006 and December 31, 2005, respectively, which is presented asshort-term debt.   The weighted averagerate of interest for borrowings made under the Agreement was 9.53% for the ninemonths ended September 30, 2006.  As ofSeptember 30, 2006, the Company’s availability for future borrowing under theagreement is based on the discretion of the financing company, which iscontingent on approval of eligible receivables by the financing company.  

Kookmin Note

On February 4, 2003, our Korean subsidiary received 6,500,000 in SouthKorean Won, or approximately $5,488, under a loan from Kookmin Bank of SouthKorea.  The loan bears interest at anannual rate of 7.1%.  In the event ofdelayed repayment, the interest rate increases to a maximum of 21%, dependingon the length of time the repayment is delayed. As of September 30, 2006, the interest rate was increased to 9.2% fromdelayed interest payments made.  Thisloan is collateralized by the plant facilities and certain equipment in SouthKorea.  During the first eighteen monthsfrom the origination date, interest was payable on a monthly basis.  In October 2003, the Company paid $873 ofprincipal at the request of Kookmin Bank due to the 

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sale of machines that had been part of the collateral on the loan.  Subsequent to October 31, 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 $1,090 for the ninemonths ended September 30, 2006, which includes $170 of foreign exchangetranslation loss.  The outstanding loanbalance totaled $1,870 and $2,790, of which $1,320 and $1,343 is included incurrent portion of long-term debt, as of September 30, 2006 and December 31,2005, respectively.  

**9.     Stock Compensation Plan**

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

During the threeand nine months ended September 30, 2006, under the Company’s 2002 EquityIncentive Plan which provides for the grant of stock options to officers,employees, consultants and directors of the Company and its subsidiaries, theCompany granted options to purchase 20,000 and 882,500 of the Company’s commonshares for an average exercise price of $1.63 and $1.40, respectively.  Further, all options granted under this planhad exercise prices that were equal to the fair market value on the date ofgrant.

In March 2006, one of the former non-employee directors of our companywas given the opportunity to receive shares of stock under the 2002 EquityIncentive Plan in lieu of past-due director and committee fees that were due tohim for periods through December 31, 2005.  Such shares were issuable tohim at an average price of $1.50 per share.  In April 2006, two of the non-employee directors ofour company were given the opportunity to receive shares of stock under the2002 Equity Incentive Plan in lieu of the director and committee fees that weredue to them for periods through December 31, 2006.  Such shares were issuable to them at anaverage price of $0.88 per share.  As ofSeptember 30, 2006, a total of 109,437 shares were issued to non-employee directorsin lieu of these past-due fees.  

In May 2006, theCompany’s Chief Executive Officer was given the opportunity to receive sharesof stock under the 2002 Equity Incentive Plan in lieu of past-due consultingfees that were due him for periods through December 31, 2005.  A total of 28,960 shares were issued to himat an average price of $1.41 per share.  

The Company canceled 0 and 433,032 options during the three and ninemonths ended September 30, 2006, respectively, for terminated employees anddirectors.

**10.      Segment Reporting and Geographic Information**

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 withresearch and development services and product licensing arrangements areincluded in the bulk Liquidmetal alloy segment. The accounting policies of the reportable 

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segments are the same as those described in Note 4 tothe consolidated financial statements included in the Company’s Form 10-K filedwith the Securities and Exchange Commission on March 16, 2006, as amended byForm 10-K/A filed on March 31, 2006, April 25, 2006, and July 20, 2006.   

Summarized financial information concerning theCompany’s reportable segments is shown in the following tables:
|                                                                    | ** ** | **Coatings** | ** ** | **Bulk Alloy** | ** ** | **Segment Totals** | ** ** |
|--------------------------------------------------------------------|------------|--------------|------------|---------------------|------------|-------------------------|------------|
| Three Months  Ended September 30, 2006                             |       |         |       |                |       |                    |       |
| Revenue to external customers                                      |       | $            | 2,589      |                | $          | 5,451                   |       | $ | 8,040 |   |
| Gross profit                                                       |       | 1,110        |       | 481                 |       | 1,591                   |       |
| Income (loss) before interest expense and  discontinued operations |       | 905          |       | (506                | )          | 399                     |       |
| Total identifiable assets at end of period                         |       | 1,515        |       | 18,971              |       | 20,486                  |       |
|                                                               |       |         |       |                |       |                    |       |
| Three Months  Ended September 30, 2005 (Restated)                  |       |         |       |                |       |                    |       |
| Revenue to external customers                                      |       | $            | 1,549      |                | $          | 2,793                   |       | $ | 4,342 |   |
| Gross profit (loss)                                                |       | 635          |       | (49                 | )          | 586                     |       |
| Income (loss) before interest expense and  discontinued operations |       | 420          |       | (1,429              | )          | (1,009                  | )          |
| Total identifiable assets at end of period                         |       | 772          |       | 16,414              |       | 17,186                  |       |
|                                                               |       |         |       |                |       |                    |       |
| Nine Months  Ended September 30, 2006                              |       |         |       |                |       |                    |       |
| Revenue to external customers                                      |       | $            | 6,716      |                | $          | 14,969                  |       | $ | 21,685 |   |
| Gross profit                                                       |       | 2,774        |       | 1,574               |       | 4,348                   |       |
| Income (loss) before interest expense and  discontinued operations |       | 2,187        |       | (860                | )          | 1,327                   |       |
| Total identifiable assets at end of period                         |       | 1,515        |       | 18,971              |       | 20,486                  |       |
|                                                               |       |         |       |                |       |                    |       |
| Nine Months  Ended September 30, 2005 (Restated)                   |       |         |       |                |       |                    |       |
| Revenue to external customers                                      |       | $            | 3,930      |                | $          | 6,982                   |       | $ | 10,912 |   |
| Gross profit (loss)                                                |       | 1,691        |       | (1,332              | )          | 359                     |       |
| Income (loss) before interest expense and discontinued  operations |       | 1,182        |       | (7,270              | )          | (6,088                  | )          |
| Total  identifiable assets at end of period                        |       | 772          |       | 16,414              |       | 17,186                  |       |

 

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Reconciling information between reportable segments and the Company’sconsolidated totals is shown in the following table:
| ** **                                                                        | ** ** | **For the Three Months Ended   September 30,** | ** ** | **For the Nine Months Ended   September 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2006**                                                                     | ** ** | **2005**                                                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                        | ** ** | ** **                                                                   | ** ** | **(Restated)**                                                              | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
| ** **                                                                        | ** ** | ** **                                                                   | ** ** | ** **                                                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total segment  income (loss) before minority interest, interest expense           |       | $                                                                            | 399        |                                                                        | $          | (1,009 | ) | $ | 1,327 |   | $ | (6,088 | ) |
| General and administrative expenses, excluded                                     |       | (1,367                                                                       | )          | (1,798                                                                      | )          | (4,523 | ) | (5,107 | ) |
|                                                                              |       |                                                                         |       |                                                                        |       |   |   |   |   |
| Consolidated  loss before interest, other income, income taxes, minority interest |       | (968                                                                         | )          | (2,807                                                                      | )          | (3,196 | ) | (11,195 | ) |
| Loss from extinguishments of debt                                                 |       | —                                                                       |       | (1,247                                                                      | )          | — |   | (1,247 | ) |
| Change in value of warrants, net                                                  |       | 1,361                                                                        |       | 1,112                                                                       |       | (1,354 | ) | 1,145 |   |
| Change in value of conversion feature                                             |       | 1,987                                                                        |       | 2,215                                                                       |       | (1,933 | ) | 4,497 |   |
| Interest expense                                                                  |       | (2,302                                                                       | )          | (1,659                                                                      | )          | (7,361 | ) | (4,377 | ) |
| Interest income                                                                   |       | 8                                                                            |       | 7                                                                           |       | 17 |   | 14 |   |
| Consolidated net income  (loss)                                                   |       | $                                                                            | 86         |                                                                        | $          | (2,379 | ) | $ | (13,827 | ) | $ | (11,163 | ) |

Included in bulkalloy segment income for the three and nine months ended September 30, 2006 is$0 and $572 of other income, respectively, recognized from $480 gain ontermination of a distribution agreement in March 2006 (see Note 12) and $92gain on disposal of idle equipment in June 2006 (see Note 5).

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

Revenues from sales to companies in the United Stateswere $3,212 and $2,234 during the three months ended September 30, 2006 and2005, respectively.  The revenue relatedto the United States of America was earned under defense-related research anddevelopment contracts, sales of coatings products, and sales of Liquidmetal bulkalloy products.

As of December 31, 2005, one customer represented 12%,or $288, of the total outstanding trade accounts receivable.  As of September 30, 2006, three customersrepresented 56%, or $2,856, of the total outstanding trade accounts receivable.  One customer represented 12% and 11% of totalsales for the nine months ended September 30, 2006 and 2005, respectively.   

During the three months ended September 30, 2006, theCompany had revenues from companies outside of the United States of $4,828 ofwhich $362 represented sales to companies located in South Korea.  During the three months ended September 30,2005, the Company had revenue from sales to companies outside of the UnitedStates of $2,108 of which $1,665 represented sales to companies located inSouth Korea.  The revenue related tosales to companies outside of the United States was from bulk alloy products.

Long-lived assetsinclude net property, plant, and equipment, and net intangible assets. TheCompany had long-lived assets of $1,539 and $2,107 located in the United Statesat September 30, 2006 and December 31, 2005, respectively. The Company hadlong-lived assets of $12,118 and $12,848 located in South Korea at September30, 2006 and December 31, 2005, respectively.  

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Reconciling informationbetween reportable segments and the Company’s consolidated totals is shown inthe following table:
|                                            | ** ** | **September 30,** | ** ** |
|--------------------------------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **2006**               | ** ** |
|                                       |       |                   |       |
| Total segment  assets                      |       | $                      | 20,486     |   |
| Cash and cash  equivalents                 |       | 516                    |       |
| Prepaid expenses  and other current assets |       | 963                    |       |
| Other property,  plant and equipment       |       | 309                    |       |
| Intangibles, net                           |       | 1,198                  |       |
| Other assets                               |       | 29                     |       |
| Total consolidated  assets                 |       | $                      | 23,501     |   |

Assets excludedfrom segment assets include assets attributable to the Company’s corporateheadquarters.  The Company’s largestassets consist of prepaid expenses and other current assets and intangibleassets, which consist primarily of the Company’s patents and trademarks.  

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

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

Options to purchase 8,503,223shares of common stock at prices ranging from $0.77 to $15.00 per share wereoutstanding at September 30, 2006 and options to purchase 8,090,973 shares ofcommon stock at prices ranging from $1.16 to $15.00 per share were outstandingat September 30, 2005, but were not included in the computation of diluted EPSfor the respective periods as the inclusion would have been antidilutive.  Warrants to purchase 4,938,680 shares ofcommon stock at prices ranging from $2.00 to $2.72 per share outstanding at September30, 2006 and warrants to purchase 4,340,866 shares of common stock at pricesranging from $2.00 to $3.00, were not included in the computation of dilutedEPS for the respective periods as the inclusion would have been antidilutive. 7,202,437 and 11,672,051 of convertible shares fromthe senior convertible debt at September 30, 2006 and 2005, respectively, werenot included in the computation of diluted EPS for the respective periods as theinclusion would have been antidilutive.

**12.      Commitmentsand Contingencies**

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

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

The consolidated class action arose from a number oflawsuits filed in 2004 against the Company and certain of its former andcurrent directors and officers on behalf of persons who purchased the Company’scommon stock between May 21, 2002 and May 13, 2004.  Theseactions, which were brought under the federal securities laws, allegedthat the Prospectus issued in connection with the Company’s initial publicoffering in May 2002 contained material misrepresentations and omissionsregarding the Company’s historical financial condition and regarding a personalstock transaction by the Company’s former chief executive officer.  Theyalso alleged that the Company and certain of its present and former officersand directors engaged in improper revenue recognition with respect to certainof the Company’s business transactions, failed to maintain adequate internalcontrols, and knowingly disclosed unrealistic but favorable information aboutmarket demand for and commercial viability of the Company’s products toartificially inflate the value of the Company’ stock. 

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In addition to the consolidated securities classaction, in May 2004, two shareholder derivative actions were filed in theSuperior Court of Orange County, California and later consolidated. Shortly thereafter, one additional shareholder derivative action was filed inthe United States District Court for the Middle District of Florida, TampaDivision.  These derivative actions were brought by certain shareholdersagainst certain of the Company’s present and former officers and directors aswell as the Company (as a nominal defendant).  The suits alleged that thedefendants breached various fiduciary duties and otherwise violated state lawbased primarily upon the same underlying facts and circumstances underlying thefederal securities class action.  

The class action settlement is part of apreviously-disclosed agreement to settle the class action and the two pendingderivative actions for a total of $7,500: $7,025 for the consolidated classaction and $475 for the two derivative actions. In addition, the Company willcommit to maintaining or implementing various corporate governance measures inconnection with the settlement of the derivative actions. Final documentationand approval of the settlement of the derivative actions remains outstanding.

Subsequent to September 30, 2006, the company receiveda court order approving the settlement of the consolidated class actionlitigation.  In connection with thesettlement, the Company’s directors and officers’ liability insurerscontributed $7,025 to a settlement fund, from which approved claims of eligibleclass members will be paid in accordance with a court-approved plan ofallocation.  Taking into account theinsurance contribution, the net cost of the settlement to the Company isapproximately $500, which is the insurance deductible the Company paid overseveral quarters ending in the third quarter of 2005, and which was previouslyrecorded as a charge. 

In August 2006, the Company received a federal grandjury subpoena for the production of certain documents related to the periodJanuary 1, 1999 though the present.  Thedocuments being sought include accounting records, documents relating to theCompany’s relationship with Growell Metal of Korea, and documents and recordsrelating to transactions in company stock by officers and directors.  The Company has been advised that thematerials sought are pertinent to a grand jury investigation recently initiatedin the Middle District of Florida by the U.S. Department of Justice, CriminalDivision, Fraud Section concerning alleged accounting improprieties by theCompany, among other things.  The Companybelieves the subject matter of the investigation is largely similar to thesubject matter of the previously disclosed consolidated securities class actionand shareholder derivative actions that the Company reached agreements inprinciple to settle subsequent to September 30, 2006.  The Company will fully cooperate with theauthorities in connection with this subpoena and investigation.

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

On June 26, 2006,the Company entered into a joint venture agreement with SAGA, SpA in Padova,Italy, (“SAGA”) a specialist precision parts manufacturer.  The jointventure is named Liquidmetal SAGA Italy, Srl (“LSI”).  The Company alsoentered into an exclusive manufacturing license agreement for the eyewearindustry with LSI.  Under the joint venture agreement, the Company hasoption to buy ownership interest in LSI, initially, of 19.9% to up to50%.  The Company initially has until September 30, 2006 to exercise the19.9% interest in LSI and will have two years to purchase the additionalinterest at a nominal 

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price. However, as of September 30, 2006, the exercise date of the agreement has beenextended to November 15, 2006.  If theCompany does not purchase the additional interest during the first two years ofthe agreement, the Company will be able to purchase the additional interest ata price equal to 30.1% of LSI’s then outstanding net equity.  As ofSeptember 30, 2006 and as of the filing of this Form 10Q, the Company has notpurchased any interest in the joint venture.  

Under thelicensing agreement, at any time following 18 months after the effective dateof the agreement, LSI may exercise its option to sell to the Company certainbusiness assets including manufacturing equipment acquired under the jointventure.  During the three and ninemonths ended September 30, 2006, the Company recognized revenues of $312 and$561, respectively, of Liquidmetal alloys sold to SAGA for use in the jointventure. The Company anticipates the alloys to be fully utilized by the jointventure prior to the 18 month period.

**13.    RelatedParty Transactions**

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

The Company is a party to a consulting agreementwith Chitnis Consulting, Inc., which is owned 100% by Shekhar Chitnis, a formerdirector and executive officer of the Company. Under this agreement, the Company engaged Chitnis Consulting to provideconsulting services on an as-needed basis through December 31, 2005.  On January 1, 2006, the term of the agreementwas extended to December 31, 2006. During each of the three and nine months ended September 30, 2006, theCompany incurred $0 in consulting fees from Chitnis Consulting,.  During the three and nine months endedSeptember 30, 2005, the Company incurred $14 and $39 in consulting fees fromChitnis Consulting, respectively.  

The Company is aparty to a consulting agreement with William Johnson, a board member.  Under this agreement, Mr. Johnson providesconsulting services on an as-needed basis through 2004 as it relates to marketingand development Liquidmetal alloy.  InApril 2006, the Company entered into an agreement with Mr. Johnson effectivefrom January 1, 2006 through December 31, 2006. During the three and nine months ended September 30, 2006, we incurred$15 and $45 in consulting fees from Mr. Johnson, respectively. During the threeand nine months ended September 30, 2005, we incurred $15 and $25 in consultingfees from Mr. Johnson, respectively. 

In November 2004, the Company entered into an agreementwith John Kang, our Chairman, in which Mr. Kang agreed that certain stocktransactions by him in 2002 involving our common stock should have resulted ina liability under Section 16(b) of the Securities Exchange Act of 1934, asamended (“Section 16(b)”).  Thesetransactions include Mr. Kang’s private sale of 285,715 shares of his personalLiquidmetal Technologies common stock to Growell Metal Co., Ltd. in February2002, prior to our initial public offering. They also include Mr. Kang’s subsequent indirect purchase and dispositionof Liquidmetal Technologies common stock in order to satisfy a personalagreement Mr. Kang made to Growell Metal in February 2002 regarding theguaranteed minimum value of the stock purchased by Growell Metal in February2002 (the purchases and dispositions incident to this agreement occurred inAugust and November 2002, respectively). Lastly, the transactions include open-market purchases of an aggregateof 89,300 shares of our common stock made by Mr. Kang in August 2002.

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

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During the nine months ended 2005, the Companyexecuted a $198 promissory note with CK Cho, member of our Board of Directors,for working capital purposes. The note was due and paid in full as of September30, 2005. The note had an annual rate of interest of 6% which resulted in theCompany paying approximately $2 in interest. Mr. Cho also held $620 ofSenior Convertible Notes and held 92,584 exercisable warrants as ofDecember 31, 2005 and September 30, 2006. Further, during 2005,Mr. Cho advanced approximately $1,260 to cover short-term liquidity needs.The advances were made without interest and were repaid as of December 31,2005.  There were no such advances duringthe nine months ended September 30, 2006.

During the three and nine months ended September 30,2006, Ricardo Salas, our President and Chief Executive Officer advanced theCompany $450 and $550, respectively, to cover short-term liquidity need.  As of September 30, 2006, $450 of the advanceis outstanding and accrues a monthly interest of 7.75%.  During 2005, Ricardo Salas, and Young Ham,our Chief Financial Officer, advanced the company $75 and $133 to covershort-term liquidity needs, respectively. The advances were made withoutinterest and were repaid as of December 31, 2005. Mr. Salas also held $310of senior convertible notes and $100 of the August 2007 Subordinated Notes andheld a total of 65,672 and 46,292warrants as of September 30, 2006 andDecember 31, 2005, respectively.  Subsequent toSeptember 30, 2006, Mr. Salas has resigned as an officer and director of theCompany (see Note 14).

**14. Subsequent Events**

On October 8, 2006, Ricardo Salas, the President andChief Executive Officer of the Company resigned as an officer and director ofthe Company.  Consecutively, on October8, 2006, the Board of Directors of the Company elected Larry E. Buffington toserve as the President and Chief Executive Officer of the Company.

On October 19, 2006, the Company received a courtorder approving the settlement of the consolidated class action litigationentitled *Primavera Investors v. Liquidmetal Technologies,Inc. et al*. pending in the United States District Court for theMiddle District of Florida, Tampa Division (see Note 12).  In connection with the settlement, theCompany’s directors’ and officers’ liability insurers contributed $7,025 to asettlement fund, from which approved claims of eligible class members will bepaid in accordance with a  court-approvedplan of allocation.  Taking into accountthe insurance contribution, the net cost of the settlement to the Company isapproximately $500, which is the insurance deductible the Company paid overseveral quarters ending in the third quarter of 2005, and which was previouslyrecorded as a charge. 

On October 20, 2006, James Kang resigned as a directorof the Company and Patrick Caruana was elected to the Company’s Board ofDirectors to fill the vacancy created by Mr. Kang’s resignation.  In connection with the resignation, Mr. Kanghas also agreed to resign as an officer and employee of the Company and toterminate his Employment Agreement with the Company.  In consideration of Mr. Kang’s agreementto resign and in lieu of any severance payment, he has entered into aconsulting agreement with the Company whereby he will be paid a consulting feeof $200 per year for a period of three years. 

On November 10, 2006,the Company’s factoring agreement was amended to allow for borrowings of up to$5,000 based on receivable assigned.

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

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

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

**Overview**

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

Amorphous alloys are uniquematerials that are distinguished by their ability to retain a random atomic structurewhen they solidify, in contrast to the crystalline atomic structure that formsin ordinary metals and alloys when they solidify. Liquidmetal alloys possess acombination of performance, processing, and cost advantages that we believemakes them preferable to other materials in a variety of applications. Theamorphous atomic structure of our alloys enables them to overcome certainperformance limitations caused by inherent weaknesses in crystalline atomicstructures, thus facilitating performance and processing characteristicssuperior in many ways to those of their crystalline counterparts. For example,our zirconium-titanium Liquidmetal alloys are approximately 250% stronger thancommonly used titanium alloys, such as Ti-6Al-4V, but they have processingcharacteristics similar in many respects to plastics. We believe theseadvantages could result in Liquidmetal alloys supplanting other incumbentmaterials in a wide variety of applications. Moreover, we believe theseadvantages will enable the introduction of entirely new products andapplications that are not possible or commercially viable with other materials.

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

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

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

Research and development expenses represent salaries, related benefitsexpense, depreciation of research equipment, consulting and contract services,expenses incurred for the design and testing of new processing methods,expenses for the development of sample and prototype products, and otherexpenses related to the research and development of Liquidmetal alloys. Costsassociated with research and development activities are expensed as incurred.We plan to enhance our competitive position by improving our existing technologiesand developing advances in amorphous alloy technologies. We believe that ourresearch and development efforts will focus on the discovery of new alloycompositions, the development of improved processing technology, and theidentification of new applications for our alloys.

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

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

**Critical Accounting Policies and Estimates**

The preparation of condensed consolidated financial statements inconformity with accounting principles generally accepted in the United Statesrequires us to make estimates and assumptions that affect reported amounts ofassets and liabilities and disclosure of contingent assets and liabilities atthe date of the financial statements and the reported amounts of revenues andexpenses during the reporting period. These estimates and assumptions are based on historical experience andvarious other factors that are believed to be reasonable under thecircumstances.  Actual results coulddiffer materially from these estimates under different assumptions orconditions.

We believe that the followingaccounting policies are the most critical to our condensed consolidatedfinancial statements since these policies require significant judgment orinvolve complex estimates that are important to the portrayal of our financialcondition and operating results:

·                  Exchangerate fluctuations

·                  Warrantyaccrual

·                  Allowancefor doubtful accounts

·                  Inventoriesat lower of cost or net realizable value

·                  Deferredtax assets

·                  Valuationof derivatives of warrants and embedded conversion features

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

The company adopted Statement of Financial AccountingStandards No. 123, Share-Based Payment (“SFAS 123R”), onJanuary 1, 2006. This new standard requires companies to expense the fairvalue of employee stock options and similar awards. The company adopted SFAS123R using the modified prospective transition method. Therefore, stock basedcompensation expense measured in accordance with SFAS 123R was recorded duringthe first quarter of 2006, but the prior year consolidated statement of incomewas not restated. The adoption of SFAS 123R resulted in incremental expense of$0.3 million and $0.8 million for the three and nine months ended September 30,2005.  See Note 1 for furtherinformation. 

**Resultsof Operations**

Comparison of the three months endedSeptember 30, 2006 and 2005

*Revenue*. Revenue increased $3.7 million to$8.0 million for the three months ended September 30, 2006 from$4.3 million for the three months ended September 30, 2005.  The increase consisted of an increase of $2.7million from the sales and prototyping of parts manufactured from bulkLiquidmetal alloys to consumer electronics customers as a result of increased 

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demandfrom electronic casings applications and an increase of $1 million from salesof our coatings products as a result of increase in demand from oil drillingapplications.  

*Costof Sales*. Cost of sales increased to $6.4 million, or 80% ofrevenue, for the three months ended September 30, 2006 from $3.8 million,or 87% of revenue, for the three months ended September 30, 2005.  The increase was a result of increases inbulk Liquidmetal alloy business and coatings business.  The decrease in cost of sales as a percentageof revenue was a result of continued maturing of our manufacturing process,which represents the Company’s efforts to manage costs and focus on our corebusiness, and an increase in revenues generated from our higher margin coatingsproducts. Significant portions of our manufacturing costs continue to remainfixed.  We believe that highermanufacturing volumes and greater mix of higher-margin products in the futurewill cause the gross profit to improve over time.  The cost to manufacture parts from our bulkLiquidmetal alloys is variable and differs based on the unique design of eachproduct.  However, the cost of sales forthe products sold by the coatings business segment is generally consistentbecause the Liquidmetal coatings products are produced by third parties andsold wholesale to various industries. 

*Selling,General, and Administrative Expenses*. Selling, general, andadministrative expenses decreased to $2.3 million, or 28% of revenue, forthe three months ended September 30, 2006 from $2.4 million, or 54% ofrevenue, for the three months ended September 30, 2005. This decrease wasprimarily a result of increases in wages and compensation of $0.1 millionprimarily from recognition of stock based compensation expense during the quarterand increases in employees offset by decrease in product warranty of $0.1million and a decrease in depreciation of $0.1 million. 

*Researchand Development Expenses*. Research and development expensesincreased to $0.3 million, or 3% of revenue, for the three months endedSeptember 30, 2006 from $0.2 million, or 5% of revenue, for the threemonths ended September 30, 2005. The Company continues to perform research anddevelopment of new Liquidmetal alloys and related processing capabilities, developnew manufacturing techniques, and contract with consultants to advance thedevelopment of Liquidmetal alloys.  Theincrease was primarily due to increases in wages and compensation, andprototyping costs.

*Impairmentof Long Lived Assets*. Impairment of long lived assetsdecreased to $0 for the three months ended September 30, 2006 from $0.8 millionor 19% of revenue, for the three months ended September 30, 2005.  Impairment expense represents write-down of$0.8 million of raw materials considered to be long term inventory.  During 2005, while we may use the excess rawmaterials beyond one year to fulfill future customer order, we determined thatour capacity was not significant enough to warrant holding this inventory as along term asset.  Further, while we haveactively marketed the idle equipment for ultimate sale since early 2004, wewere unable to sell this equipment. In addition, while the equipment may beused internally to meet future capacity requirements, considering the revenuesduring 2005, we did not anticipate utilizing this equipment internally in thenear future.  As such, during 2005 wehave reduced the carrying values of the excess raw material and idle equipment.

*Lossfrom Extinguishments of Debt. *Loss from extinguishments of debt decreasedto $0 for the three months ended September 30, 2006 from $1.2 million, or 29%of revenue, for the three months ended September 30, 2005.  The $1.2 million loss from extinguishment ofdebt was recognized from the exchange of our 6% Convertible Notes due 2006 inAugust 2005. 

*Changein Value of Warrants. *Change in value of warrants increased to anet gain of $1.4 million, or 17% of revenue, for the three months endedSeptember 30, 2006 from a net gain of $1.1 million, or 26% of revenue, for thethree months ended September 30, 2005. The change in value of warrants consisted of warrants issued from thesenior convertible debt funded in March 2004 and exchanged in August 2004,convertible debt funded in June 2005, senior convertible debt funded in August2005, subordinated promissory note funded in March 2006, and unsecuredsubordinated notes funded in May and September 2006 primarily as a result offluctuations in our stock price.* *

*Changein Value of Conversion Feature.*Change in the value of our conversion feature liability from our seniorconvertible debt funded in March 2004 and exchanged in August 2004 and August2005 resulted in a change in value of conversion feature gain of $2.0 million,or 25% of revenue, during the three months ended September 30, 2006 from a gainof $2.2 million or 51% of revenue, for the three months ended September 30,2005, primarily as a result of fluctuations in our stock price.* *

*InterestExpense*. Interest expense was $2.3 million, or 29% ofrevenue, for the three months ended September 30, 2006 and was $1.7 million, or38% of revenue, for the three months ended September 30, 2005.  Interest expense consists primarily ofinterest accrued on the Kookmin Bank loan funded in 2003, convertible debtsfunded in 2004 and 2005, subordinated notes funded in March, May, and September2006, fees charged from short-term borrowings under the April 2005 factoring,loan, 

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and securityagreement, as well as amortization of debt issuance costs and discount on theconvertible debt.  The increase wasprimarily due to additional amortization of debt issuance costs and discount ondebt funded in August 2005, increases in fees from borrowings made under theApril 2005 factoring, loan, and security agreement, and  interest costs accrued for late registrationand late filing fee penalties during the three months ended September 30, 2006(see Item 3 Defaults Upon Senior Securities, Part II).   

*Interest Income.* Interest income was $8 thousand for the threemonths ended September 30, 2006 and was $7 thousand for the three months endedSeptember 30, 2005 from interest earned on cash deposits.  

Comparison of the nine months ended September30, 2006 and 2005

*Revenue*. Revenue increased $10.8 millionto $21.7 million for the nine months ended September 30, 2006 from $10.9million for the nine months ended September 30, 2005.  The increase included $7.7 million increasein sales and prototyping of parts manufactured from bulk Liquidmetal alloys toconsumer electronics customers from increased demand from electronic casingsapplications, an increase of $2.8 million in sale of our coatings products as aresult of increase in demand from oil drilling applications, and an increase of$0.3 million in research and development services from increased research anddevelopment services primarily from defense applications.  

*Cost of Sales*. Cost of sales increased to$17.3 million, or 80% of revenue, for the nine months ended September 30,2006 from $10.6 million, or 97% of revenue, for the nine months endedSeptember 30, 2005.  The increase was aresult of increases in bulk Liquidmetal alloy business and coatingsbusiness.  Cost of sales as a percentageof revenue has decreased as a result of continued maturing of our manufacturingprocess, which represents the Company’s efforts to manage costs and focus onour core business, and an increase in revenues generated from our higher margincoatings products.  We believe thathigher manufacturing volumes and greater mix of higher-margin products in thefuture will cause the gross profit to improve over time. The cost tomanufacture parts from our bulk Liquidmetal alloys is variable and differsbased on the unique design of each product. However, the cost of sales for the products sold by the coatingsbusiness segment is generally consistent because the Liquidmetal coatingsproducts are produced by third parties and sold wholesale to variousindustries. 

*Selling,General, and Administrative Expenses*. Selling, general, andadministrative expenses increased to $7.4 million, or 34% of revenue, forthe nine months ended September 30, 2006 from $6.5 million, or 60% ofrevenue, for the nine months ended September 30, 2005. This increase wasprimarily a result of increase in wages and compensation of $1.1 millionprimarily from recognition of stock based compensation expense during thequarter and increases in employees, increase in travel costs of $0.2 million,increase in bad debt expense of $0.1 million, and increase in advertising &promotion expense of $0.2 million, offset by decrease in insurance expense of$0.7 million.   

*Researchand Development Expenses*. Research and development expensesremained unchanged at $0.8 million, or 3% of revenue, for the nine monthsended September 30, 2006 and $0.8 million, or 7% of revenue, for the ninemonths ended September 30, 2005. The Company continues to perform research anddevelopment of new Liquidmetal alloys and related processing capabilities,develop new manufacturing techniques, and contract with consultants to advancethe development of Liquidmetal alloys.  

*Impairmentof Long Lived Assets*. Impairment of long lived assetsdecreased to $0, for the nine months ended September 30, 2006 from $4.2 millionor 39% of revenue, for the nine months ended September 30, 2005.  Impairment expense represents write-down of$2.5 million of raw materials considered to be long term inventory and $1.7 ofidle equipment.  During 2005, while wemay use the excess raw materials beyond one year to fulfill future customerorder, we determined that our capacity was not significant enough to warrantholding this inventory as a long term asset. Further, while we have actively marketed the idle equipment for ultimatesale since early 2004, we were unable to sell this equipment. In addition,while the equipment may be used internally to meet future capacityrequirements, considering the revenues during 2005, we did not anticipateutilizing this equipment internally in the near future.  As such, during 2005 we have reduced thecarrying values of the excess raw material and idle equipment.  

*Loss fromExtinguishments of Debt.* Loss from extinguishments of debt decreased to $0 for the nine monthsended September 30, 2006 from $1.2 million, or 11% of revenue, for the ninemonths ended September 30, 2005.  The$1.2 million loss from extinguishments of debt was recognized from the exchangeof our 6% Convertible Notes due 2006 in August 2005.

*Change inValue of Warrants.* Change in value of warrants decreased to a net loss of $ 1.4 million, or6% of revenue, during 

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the nine monthsended September 30, 2006 from a net gain of $1.1 million, or 10% of revenue,for the nine months ended September 30, 2005. The change in value of warrant consisted of warrants issued from thesenior convertible debt funded in March 2004 and exchanged in August 2004,convertible debt funded in June 2005, senior convertible debt funded in August2005, subordinated promissory notes funded in March 2006, and unsecured subordinated notes funded in Mayand September 2006 primarily as a result of fluctuations in our stockprice. 

*Change inValue of Conversion Feature*. Change in the value of our conversion feature liability from our seniorconvertible debt funded in March 2004 and exchanged in August 2004 and August2005 resulted in a change in value of conversion feature loss of $1.9 million,or 9% of revenue, during the nine months ended September 30, 2006 from a gainof $4.5 million, or 41% of revenue, during the nine months ended September 30,2005, primarily as a result of fluctuation in our stock prices. 

*OtherIncome.*  Other income was $0.6 million, or 3% ofrevenue, for the nine months ended September 30, 2006, $0.1 million from gainrecognized from disposal of idle equipment and $0.5 million gain recognizedfrom termination of a distribution agreement with a Japanese sporting goodsdistributor originally entered into in March 1996.  There were no amounts recognized as otherincome during the nine months ended September 30, 2005.

*InterestExpense*. Interest expense was $7.4 million, or 34% ofrevenue, for the nine months ended September 30, 2006 and was $4.4 million, or40% of revenue, for the nine months ended September 30, 2005.  Interest expense consists primarily ofinterest accrued on the Kookmin Bank loan funded in 2003, convertible debtsfunded in 2004 and 2005, subordinated notes funded in March, May, and September2006, fees charged from short-term borrowings under the April 2005 factoring,loan, and security agreement, as well as amortization of debt issuance costsand discount on the convertible debt. The increase in interest expense was primarily due to costs accrued forlate registration and late filing fee penalties during the nine months endedSeptember 30, 2006 (see Item 3 DefaultsUpon Senior Securities, Part II).

*Interest Income.* Interest income was $17 thousand for the ninemonths ended September 30, 2006, and $14 thousand for the nine months endedSeptember 30, 2005 from interest earned on cash deposits.  

**Liquidity and Capital Resources**

Our cash used for operating activities was $5.5 millionfor the nine months ended September 30, 2006 and $7.0 million for the ninemonths ended September 30, 2005.  Ourworking deficit increased from $11.0 million at December 31, 2005 to $23.4million at September 30, 2006.  TheCompany’s working deficit increase of $12.4 million was primarily attributableto increase in accounts payable and accrued liability of $2.3 million, increasein short term debt of $2.8 million, increase in current portion of long-termdebt of $11.2 million, increase in warrant liabilities of $2.4 million,increase in conversion feature liability of $1.9 million, offset by increase intrade accounts receivable of $2.7 million, increase in prepaid expenses andother current assets by $1.0 million, decrease in settlement payable of $3.3million, decrease in deferred revenue of $1.2 million.

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

Our cash provided by financing activities was $5.9million for the nine months ended September 30, 2006, which consists of $1.0million in proceeds from borrowings from our subordinated promissory notesexecuted in March 2006 and $4.1 million in proceeds from borrowings fromprivate placement of 8% unsecured subordinated notes executed in May 2006 andSeptember 2006.  The Company alsoreceived net $0.5 million in borrowings from Ricardo Salas, Chief ExecutiveOfficer and President of the Company, who, subsequent to September 30, 2006,has resigned as an officer and director of the Company (see Note 14).  Further, the Company received net $1.3million in borrowings from factoring agreement executed in April 2005. Theproceeds from borrowings have been used to meet working capitalrequirements.  On November 10, 2006, theCompany’s factoring agreement was amended to allow for borrowings of up to $5.0million based on receivable assigned. The Company has $2.6 million availablefor future borrowings under the Factoring Agreement as of November 10, 2006,which is contingent on approval of eligible receivables by the financingcompany.

Our capital requirements during the nexttwelve months will depend on numerous factors, including the success ofexisting products either in manufacturing or development, the development ofnew applications for Liquidmetal alloys, and the 

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resources we devote to develop and support ourLiquidmetal alloy products, the success of pursuing strategic licensing andfunded product development relationships with external partners.  

We have experienced significant operating losses sinceour inception. Our net loss for the nine months ended September 30, 2006 and2005 was $13.8 million and $11.1 million, respectively. In the audit report onour financial statements for our fiscal years ended December 31, 2005 and 2004,our auditors included a going-concern qualification indicating that oursignificant operating losses and working capital deficit cause substantialdoubt about our ability to continue as a going concern. By issuing an opinionstating that there is substantial doubt about our ability to continue as agoing concern, our auditors have indicated that they are uncertain as towhether we have the capability to continue our operations without additionalfunding.  Accordingly, we anticipate thatwe will need additional funding during the next 12 months, and we plan to seekto raise such funds through public or private equity financing, bank debtfinancing, or from other sources. Specifically, we anticipate that we could need $5 to $10million over the next twelve months to pursue our current operatingplan, although this amount may be lower depending on the orders we receivefor our products.  The amount of fundingthat we plan to seek and the timing of such fundraising efforts will depend onthe extent to which we are able to increase revenues through obtainingadditional purchase orders for our products, particularly components forcellular phones and flash memory drive casings, and our ability to continue toimprove our manufacturing processes.  Weevaluate our working capital needs and operating plan assumptions on a monthlybasis to determine whether any adjustment to our cash and liquidity outlook iswarranted, and we also review potential sources of financing on an ongoingbasis.  However, adequate funds may notbe available when needed, and if we raise additional funds by issuing equitysecurities, existing stockholders may be diluted.  If we don’t receive sufficient funding tooperate under our current plan, we intend to reduce operations and expenses andshift our focus to the pursuit of licensing transactions and other strategictransactions that are less capital intensive. 

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**Contractual Obligations**

The following table summarizes the Company’s obligations andcommitments as of September 30, 2006:
| ** **                                          | ** ** | ** ** | ** ** | **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)                                 |       | $          | 18,137     |                                      | $          | 17,587 |   | $ | 550 |   | $ | — |   | $ | — |   |
| Short-term debt  (3)                                |       | 3,335      |       | 3,335                                     |       | — |   | — |   | — |   |
| Capital lease  obligation                           |       | 13         |       | 13                                        |       | — |   | — |   | — |   |
| Operating leases  and rents                         |       | 639        |       | 122                                       |       | 439 |   | 78 |   | — |   |
| Consulting  services payable                        |       | 71         |       | 71                                        |       | — |   | — |   | — |   |
| Dongyang                                            |       | 11         |       | 11                                        |       | — |   | — |   | — |   |
| Nichimen                                            |       | 350        |       | 350                                       |       | — |   | — |   | — |   |
|                                                |       | $          | 22,556     |                                      | $          | 21,489 |   | $ | 989 |   | $ | 78 |   | $ | — |   |

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(1)    Contractual cash obligationsinclude Long-Term Debt comprised of $2,264 of Senior Convertible Notes issuedin 2004 and $9,878 of Senior Convertible Notes issued in 2005, $4,125 ofUnsecured Subordinated Notes issued in May 2006 and September 2006, and $1,870of Kookmin Bank Loan, Short-Term Debt comprised of $1,885 outstanding advancesreceived under factoring, loan, and security agreement, $1,000 of UnsecuredSubordinated Promissory Note issued in 2006, $450 advance from Ricardo Salas,our President and Chief Executive Officer, who, subsequent to September 30,2006 has resigned as an officer and director of the Company (see Note 14),future minimum lease payments under capital and operating leases, and purchase commitmentsfrom consultants, payments due from our discontinued equipment manufacturingbusiness (Dongyang), and minimum payments due under a distribution agreement(Nichimen).

(2)    Does not include interestpayments of $1,049; and un-amortized discounts for conversion feature andwarrants of $5,505 of our convertible notes.

(3)    Does not include minimuminterest and fee payments of $48 and un-amortized discounts for warrants of $14

**OffBalance Sheet Arrangements**

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

On June 26, 2006,the Company entered into a joint venture agreement with SAGA, SpA in Padova,Italy, (“SAGA”) a specialist precision parts manufacturer.  The jointventure is named Liquidmetal SAGA Italy, Srl (“LSI”).  The Company alsoentered into an exclusive manufacturing license agreement for the eyewearindustry with LSI.  Under the joint venture agreement, the Company hasoption to buy ownership interest in LSI, initially, of 19.9% to up to50%.  The Company initially has until September 30, 2006 to exercise the19.9% interest in LSI and will have two years to purchase the additionalinterest at a nominal price.  However, as of September 30, 2006, theexercise date of the agreement has been extended to November 15, 2006.  If the Company does not purchase theadditional interest during the first two years of the agreement, the Companywill be able to purchase the additional interest at a price equal to 30.0% ofLSI’s then outstanding net equity.  As of September 30, 2006 and as of thefiling of this Form 10Q, the Company has not purchased any interest in thejoint venture.  

Under thelicensing agreement, at any time following 18 months after the effective dateof the agreement, LSI may exercise its option to sell to the Company certainbusiness assets including manufacturing equipment acquired under the jointventure.  During the three and ninemonths ended September 30, 2006, the Company recognized revenues of $0.3 and$0.5 million, respectively, of Liquidmetal alloys sold to SAGA for use in thejoint venture. The Company anticipates the alloys to be fully utilized by thejoint venture prior to the 18 month period.

**Item 3 – Quantitative and Qualitative Disclosures aboutMarket Risk**

We are exposed to various market risks in conductingthe business of the Company, and we anticipate that this exposure will 

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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 as our borrowings are subject to the volatility ofinterest rate risk.

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

*Foreign Exchange Rates.*  As a result of our operation of amanufacturing facility in South Korea, a substantial portion of our costs will bedenominated 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.

**Item4 – Controls and Procedures**

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

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

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**PART II**

**OTHERINFORMATION**

**Item1 – Legal Proceedings**

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

The consolidated class action arose from a number oflawsuits filed in 2004 against the Company and certain of its former andcurrent directors and officers on behalf of persons who purchased the Company’scommon stock between May 21, 2002 and May 13, 2004.  Theseactions, which were brought under the federal securities laws, allegedthat the Prospectus issued in connection with the Company’s initial publicoffering in May 2002 contained material misrepresentations and omissionsregarding the Company’s historical financial condition and regarding a personalstock transaction by the Company’s former chief executive officer.  Theyalso alleged that the Company and certain of its present and former officersand directors engaged in improper revenue recognition with respect to certainof the Company’s business transactions, failed to maintain adequate internalcontrols, and knowingly disclosed unrealistic but favorable information aboutmarket demand for and commercial viability of the Company’s products toartificially inflate the value of the Company’ stock. 

In addition to the consolidated securities classaction, in May 2004, two shareholder derivative actions were filed in theSuperior Court of Orange County, California and later consolidated. Shortly thereafter, one additional shareholder derivative action was filed inthe United States District Court for the Middle District of Florida, TampaDivision.  These derivative actions were brought by certain shareholdersagainst certain of the Company’s present and former officers and directors aswell as the Company (as a nominal defendant).  The suits alleged that thedefendants breached various fiduciary duties and otherwise violated state lawbased primarily upon the same underlying facts and circumstances underlying thefederal securities class action.  

The class action settlement is part of apreviously-disclosed agreement to settle the class action and the two pendingderivative actions for a total of $7,500: $7,025 for the consolidated classaction and $475 for the two derivative actions. In addition, the Company willcommit to maintaining or implementing various corporate governance measures inconnection with the settlement of the derivative actions. Final documentationand approval of the settlement of the derivative actions remains outstanding. 

Subsequent to September 30, 2006, the company receiveda court order approving the settlement of the consolidated class actionlitigation.  In connection with thesettlement, the Company’s directors and officers’ liability insurerscontributed $7,025 to a settlement fund, from which approved claims of eligibleclass members will be paid in accordance with a court-approved plan ofallocation.  Taking into account theinsurance contribution, the net cost of the settlement to the Company isapproximately $500, which is the insurance deductible the Company paid overseveral quarters ending in the third quarter of 2005, and which was previouslyrecorded as a charge. 

In August 2006, the Company received a federal grandjury subpoena for the production of certain documents related to the periodJanuary 1, 1999 though the present.  Thedocuments being sought include accounting records, documents relating to theCompany’s relationship with Growell Metal of Korea, and documents and recordsrelating to transactions in company stock by officers and directors.  The Company has been advised that thematerials sought are pertinent to a grand jury investigation recently initiatedin the Middle District of Florida by the U.S. Department of Justice, CriminalDivision, Fraud Section concerning alleged accounting improprieties by theCompany, among other things.  The Companybelieves the subject matter of the investigation is largely similar to the subjectmatter of the previously disclosed consolidated securities class action andshareholder derivative actions that the Company reached agreements in principleto settle subsequent to September 30, 2006. The Company will fully cooperate with the authorities in connection withthis subpoena and investigation.

**Item 1A –Risk Factors**

There have been nomaterial changes to the risk factors that are included in our Annual Report onForm 10-K for the year ended December 31, 2005, as amended, except for thefollowing.

**Anongoing investigation by the Department of Justice could have a materialadverse impact on our company.**

In August 2006, wereceived a federal grand jury subpoena for the production of documents relatedto certain transactions between our company and Growell Metal of South Korea,as well as certain documents relating to transactions in our common stock byofficers and directors. The subpoena was issued in connection with a grand juryinvestigation being conducted by the U.S. Department of Justice, CriminalDivision, in the Middle District of Florida concerning alleged accountingimproprieties involving our company, among other things. We have been, andintend to continue to be, fully cooperative with the authorities in connectionwith the Department of Justice’s subpoena and investigation. However, in theevent that current or former members of our senior management were to beimplicated in any wrongdoing, it could have a material adverse impact on our capitalresources and business focus.

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

On September 21, 2006, the Company completed a private placement of 8%Unsecured Subordinated Notes for an aggregate principal of $0.5 million.  The notes are due on the earlier of August17, 2007 or the consummation of a follow-on equity or debt offering pursuant towhich the Company receives gross proceeds of at least $6.0 million to be usedfor working capital purposes and repayment of debt, but excluding financingsfor the purpose of purchasing capital assets. As part of this private placement, the Company issued warrants to thepurchasers of the notes giving them the right to purchase up to an aggregate of96,900 shares of the Company’s common stock. The warrants have an exercise price of $2.58 per share and will expireon May 17, 2011. The notes and warrants were issued pursuant to anexemption from registration under the Securities Act of 1933, as amended (the “SecuritiesAct”), by virtue of Section 4(2) of the Securities Act and by virtue of Rule506 of Regulation D under the Securities Act. Such sale and issuance did notinvolve any public offering, was made without general solicitation oradvertising, and the investors in the notes and warrants represented to theCompany that they are accredited investors with access to all relevantinformation necessary to evaluate the investment in the notes and warrants andthat the notes, warrants, and underlying shares were being acquired forinvestment purposes only.

**Item 3 -Defaults Upon Senior Securities**

As of September 30, 2006, we had approximately $12.1million in principal amount of convertible notes outstanding. Approximately$2.3 million in principal amount of convertible notes will become due in July2007, with the balance becoming due in August 2007. Interest on our convertiblenotes is payable quarterly in cash. These notes are secured by substantiallyall of the assets of our company. We will be deemed to be in default underthese notes if we fail to pay any principal or interest when it becomes due,and we will also be deemed to be in default if we breach any other materialprovision of our other agreements with the note holders and we fail to curesuch breach within thirty days of notice of default. Upon a default under thesenotes, the note holders have the right to accelerate the maturity date of thenotes and demand that they be immediately repaid by us. If we fail to pay suchnotes, either at maturity or upon acceleration, then the note holders may electto foreclose upon the assets securing the notes.

On May 12, 2006, we received a letter from one holderholding $0.5 million of the August 2007 Notes demanding immediate payment oflate filing fees and late registration fees for the period following October31, 2005 through May 3, 2006. As a result of the late fee provisions of therestated registration rights agreement, we are obligated to pay late filing andlate registration fees accrued through September 30, 2006 of up to $1.6 millionto all of the note holders. In addition, the letter purported to constitute anotice of default under the August 2007 Notes and July 2007 Notes (“Notes”) asa result of our failure to pay the late filing and late registration fees.Under the terms of Notes, if a default is not cured by us within thirty (30)days of notice thereof, the holder has the right to accelerate all principaland interest due under the Notes. The Company filed itsRegistration Statement on August 4, 2006 and on August 7, 2006, theregistration statement became effective. Late filing and late registration fees accrued were $0.8 million as ofSeptember 30, 2006.  During the three andnine months ended September 30, 2006, the Company has accrued $0.2 million and$1.6 million and paid $0.7 million of the late filing and registration fees inSeptember 2006.  The Company is currentlyin negotiations with the note holders to either reduce or delay the payment ofthe remaining fees and to prevent any acceleration of the amounts due under theNotes.  

As of September 30, 2006, approximately $9.9 millionin aggregate principal amount of August 2007 Notes was still outstanding withaccrued but unpaid interest in the amount of approximately $173 thousand. Inaddition, $2.3 million in aggregate principal amount of July 2007 Notes wasalso outstanding with accrued but unpaid interest in the amount ofapproximately $34 thousand.  Theoutstanding balance of the Notes is presented as current portion of long termdebt on the condensed consolidated balance sheet as of September 30,2006.  As of the filing of this quarterly report, the Company has paid allaccrued but unpaid interest related to the outstanding balance of the Notes.

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

     None

**Item 5 –Other Information**

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

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**Item 6 – Exhibits**

The following documentsare filed as an exhibit to this Report: 
| Exhibit   Number | ** ** | **Description of Document**                                                                                                                                            |
|------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |       |                                                                                                                                                                   |
| 10.1             |       | Amendment of Stock Option Agreements and Consulting Agreement,  dated November 13, 2006, between Liquidmetal Technologies, Inc. and James  Kang                        |
|             |       |                                                                                                                                                                   |
| 31.1             |       | Certification of the President and Chief Executive  Officer, Larry Buffington, as required by Section 302 of Sarbanes-Oxley Act  of 2002                               |
|             |       |                                                                                                                                                                   |
| 31.2             |       | Certification of Chief Financial Officer, Young Ham,  as required by Section 302 of Sarbanes-Oxley Act of 2002                                                         |
|             |       |                                                                                                                                                                   |
| 32.1             |       | Certification of Principal Executive Officer, Larry  Buffington, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of Sarbanes-Oxley Act of 2002 |
|             |       |                                                                                                                                                                   |
| 32.2             |       | Certification of Chief Financial Officer, Young Ham,  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of  Sarbanes-Oxley Act of 2002            |

 

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned hereunto dulyauthorized.
|                         | LIQUIDMETAL  TECHNOLOGIES                     |   |
|-------------------------|-----------------------------------------------|--------|
|                    | (Registrant)                                  |   |
|                    |                                          |   |
| Date: November 14, 2006 | /s/ Larry Buffington                          |   |
|                    | Larry Buffington                              |   |
|                    | President and  Chief Executive Officer        |   |
|                    | (Principal  Executive Officer)                |   |
|                    |                                          |   |
|                    |                                          |   |
| Date: November 14, 2006 | /s/ Young Ham                                 |   |
|                    | Young Ham                                     |   |
|                    | Chief Financial  Officer                      |   |
|                    | (Principal  Financial and Accounting Officer) |   |

 

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