**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

** **

### **FORM 10-Q**

 
| **ý**                                                                                                                               | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
| ** **                                                                                                                               | ** ** | ** **                                                                                    |
| **For the quarterly period  ended March 31, 2006**                                                                                       |
|                                                                                                                                     |       |                                                                                          |
| **OR**                                                                                                                                   |
|                                                                                                                                     |       |                                                                                          |
| **o**                                                                                                                                    | ** ** | **TRANSITION  REPORT 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 ofRegistrant as specified in its charter**)**

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

 

**25800 Commercentre Drive, Suite 100**

**LakeForest, California 92630**

(addressof principal executive office, zip code)

 

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

 

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

 

Yes  ý    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. (Checkone):

| Large  accelerated filer ý |   | Accelerated  filer o |   | 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  ý

 

#### As of April 26, 2006,there were 44,056,058 shares of the registrant’s common stock, $.001 par value,outstanding.

 

 

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**LIQUIDMETAL TECHNOLOGIES, INC.FORM 10-QFOR THE QUARTER ENDED****MARCH 31, 2006**

** **

**FORWARD-LOOKING INFORMATION**

 

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

 

2

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#### **TABLE OF CONTENTS**

 
| **PART I**                                                                                                       | ** **                                                                          |
|------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------|
|                                                                                                             |                                                                                |   |
| Item 1 –   Financial Statements                                                                        |                                                                                |
|                                                                                                             | Condensed Consolidated Balance Sheets  (unaudited)                                  |   |
|                                                                                                             | Condensed Consolidated Statements of  Operations and Comprehensive Loss (unaudited) |   |
|                                                                                                             | Condensed Consolidated Statements of  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.****AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

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

 
| ** **                                                                                                                                                                         | ** ** | **(unaudited)** | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **March 31,**   | ** ** | **December 31,** | ** ** |
| ** **                                                                                                                                                                         | ** ** | **2006**        | ** ** | **2005**         | ** ** |
| **ASSETS**                                                                                                                                                                         |       |            |       |             |       |
|                                                                                                                                                                               |       |            |       |             |       |
| Current  Assets:                                                                                                                                                                   |       |            |       |             |       |
|                                                                                                                                                                               |       |            |       |             |       |
| Cash and cash equivalents                                                                                                                                                          |       | $               | 1,263      |             | $          | 1,392 |   |
| Trade accounts receivables, net of  allowance for doubtful accounts of $69 and $61                                                                                                 |       | 3,506           |       | 2,360            |       |
| Inventories                                                                                                                                                                        |       | 1,764           |       | 1,748            |       |
| Prepaid expenses and other current assets                                                                                                                                          |       | 561             |       | 609              |       |
| Total current assets                                                                                                                                                               |       | 7,094           |       | 6,109            |       |
|                                                                                                                                                                               |       |            |       |             |       |
| Property,  plant and equipment, net                                                                                                                                                |       | 13,300          |       | 13,437           |       |
| Idle  equipment                                                                                                                                                                    |       | 199             |       | 193              |       |
| Other  intangibles, net                                                                                                                                                            |       | 1,196           |       | 1,185            |       |
| Other assets                                                                                                                                                                       |       | 547             |       | 639              |       |
| Total assets                                                                                                                                                                       |       | $               | 22,336     |             | $          | 21,563 |   |
|                                                                                                                                                                               |       |            |       |             |       |
| **LIABILITIES  AND SHAREHOLDERS’ DEFICIENCY**                                                                                                                                 |       |            |       |             |       |
|                                                                                                                                                                               |       |            |       |             |       |
| Current  liabilities:                                                                                                                                                              |       |            |       |             |       |
|                                                                                                                                                                               |       |            |       |             |       |
| Accounts payable and accrued expenses                                                                                                                                              |       | 7,977           |       | $                | 6,530      |   |
| Settlement payable                                                                                                                                                                 |       | —          |       | 3,331            |       |
| Deferred revenue                                                                                                                                                                   |       | 407             |       | 1,275            |       |
| Short-term debt                                                                                                                                                                    |       | 2,286           |       | 550              |       |
| Long-term debt, current portion                                                                                                                                                    |       | 1,391           |       | 1,343            |       |
| Other liabilities, current portion                                                                                                                                                 |       | 300             |       | 483              |       |
| Warrant liabilities                                                                                                                                                                |       | 3,165           |       | 1,792            |       |
| Conversion feature liabilities                                                                                                                                                     |       | 1,940           |       | 959              |       |
| Total current liabilities                                                                                                                                                          |       | 17,466          |       | 16,263           |       |
|                                                                                                                                                                               |       |            |       |             |       |
| Long-term  debt, net of current portion and debt discount of $6,285 and $7,354                                                                                                     |       | 7,080           |       | 6,338            |       |
| Other  long-term liabilities, net of current portion                                                                                                                               |       | 391             |       | 348              |       |
| Total liabilities                                                                                                                                                                  |       | 24,937          |       | 22,949           |       |
|                                                                                                                                                                               |       |            |       |             |       |
| Shareholder’s  equity (deficiency):                                                                                                                                           |       |            |       |             |       |
| Common stock, $0.001 par value; 100,000,000  shares authorized and 43,956,621 issued and outstanding at March 31, 2006 and  42,187,621 issued and outstanding at December 31, 2005 |       | 44              |       | 42               |       |
| Additional paid-in capital                                                                                                                                                         |       | 136,607         |       | 132,861          |       |
| Accumulated deficit                                                                                                                                                                |       | (141,622        | )          | (136,559         | )          |
| Accumulated other comprehensive income                                                                                                                                             |       | 2,370           |       | 2,270            |       |
| Total shareholder’ deficiency                                                                                                                                                 |       | (2,601          | )          | (1,386           | )          |
|                                                                                                                                                                               |       |            |       |             |       |
| Total liabilities and shareholders’  deficiency                                                                                                                               |       | $               | 22,336     |             | $          | 21,563 |   |

 

The accompanying notes are an integral partof the condensed consolidated financial statements.

 

4

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**LIQUIDMETAL TECHNOLOGIES, INC.****AND SUBSIDIARIES**

** **

### **CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS AND COMPREHENSIVE LOSS**

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

**(unaudited)**

 
| ** **                                             | ** ** | **For the Three Months   Ended March 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
|                                                   |       |                                       |       |   |   |
| Revenue                                                |       | $                                          | 6,555      |   | $ | 2,843 |   |
| Cost of  sales                                         |       | 5,324                                      |       | 2,835 |   |
| Gross profit                                           |       | 1,231                                      |       | 8 |   |
|                                                   |       |                                       |       |   |   |
| Operating  expenses                                    |       |                                       |       |   |   |
| Selling, general, and administrative                   |       | 2,705                                      |       | 2,590 |   |
| Research and development                               |       | 203                                        |       | 397 |   |
| Total operating expenses                               |       | 2,908                                      |       | 2,987 |   |
| Loss from operations                                   |       | (1,677                                     | )          | (2,979 | ) |
|                                                   |       |                                       |       |   |   |
| Change in  value of warrants, (loss) gain              |       | (1,289                                     | )          | 133 |   |
| Change in  value of conversion feature, (loss)         |       | (981                                       | )          | — |   |
| Other income                                           |       | 480                                        |       | — |   |
| Interest  expense                                      |       | (1,598                                     | )          | (1,257 | ) |
| Interest  income                                       |       | 2                                          |       | 6 |   |
|                                                   |       |                                       |       |   |   |
| Loss from  continuing operations                       |       | (5,063                                     | )          | (4,097 | ) |
|                                                   |       |                                       |       |   |   |
| Net Loss                                               |       | (5,063                                     | )          | (4,097 | ) |
|                                                   |       |                                       |       |   |   |
| Other  comprehensive gain (loss):                      |       |                                       |       |   |   |
| Foreign exchange translation gain                      |       | 100                                        |       | 321 |   |
| Comprehensive loss                                     |       | $                                          | (4,963     | ) | $ | (3,776 | ) |
|                                                   |       |                                       |       |   |   |
| Per common  share basic and diluted:                   |       |                                       |       |   |   |
| Net loss per share basic and diluted                   |       | (0.12                                      | )          | (0.10 | ) |
|                                                   |       |                                       |       |   |   |
| Number of  weighted average shares - basic and diluted |       | 42,817                                     |       | 41,610 |   |

 

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

 

5

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**LIQUIDMETAL TECHNOLOGIES, INC.****AND SUBSIDIARIES**

** **

**CONDENSEDCONSOLIDATED STATEMENTS OFSHAREHOLDERS’ DEFICIENCY**

###### **For the Three Months Ended March 31, 2006**

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

**(unaudited)**

 
| ** **                                  | ** ** | **Common  Shares** | ** ** | **Common  Stock** | ** ** | **Additional   Paid-in  Capital** | ** ** | **Accumu-  lated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income (loss)** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|--------------------|------------|-------------------|------------|-----------------------------------|------------|-----------------------------|------------|------------------------------------------------------|------------|-----------|------------|
|                                        |       |               |       |              |       |                              |       |                        |       |                                                 |       |      |       |
| **Balance,  December 31, 2005**             |       | 42,187,621         |       | $                 | 42         |                              | $          | 132,861                     |       | $                                                    | (136,559   | )         | $          | 2,270 |   | $ | (1,386 | ) |
| Conversion of notes payable                 |       | 59,000             |       | —            |       | 59                                |       | —                      |       | —                                               |       | 59        |       |
| Common stock issued as director’s fees |       | 10,000             |       | —            |       | 15                                |       | —                      |       | —                                               |       | 15        |       |
| Common stock issued to Innometal            |       | 1,700,000          |       | 2                 |       | 3,448                             |       | —                      |       | —                                               |       | 3,450     |       |
| Stock-based compensation                    |       | —             |       | —            |       | 224                               |       | —                      |       | —                                               |       | 224       |       |
| Foreign exchange translation gain           |       | —             |       | —            |       | —                            |       | —                      |       | 100                                                  |       | 100       |       |
| Net loss                                    |       | —             |       | —            |       | —                            |       | (5,063                      | )          | —                                               |       | (5,063    | )          |
| **Balance,  March 31, 2006**                |       | $                  | 43,956,621 |              | $          | 44                                |       | $                           | 136,607    |                                                 | $          | (141,622  | )          | $ | 2,370 |   | $ | (2,601 | ) |
|                                             |            |                    |            |                   |            |                                   |            |                             |            |                                                      |            |           |            |  |  |  |  |  |  |

 

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

 

6

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**LIQUIDMETAL TECHNOLOGIES,INC. ****AND SUBSIDIARIES**

** **

### **CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

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

**(unaudited)**

** **
| ** **                                                                                | ** ** | **For the Three Months   Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
| **Operating  activities:**                                                                |       |                                       |       |   |   |
| Net loss                                                                                  |       | $                                          | (5,063     | ) | (4,097 | ) |
|                                                                                      |       |                                       |       |   |   |
| Adjustments to reconcile loss from  operations to net cash used for operating activities: |       |                                       |       |   |   |
| (Gain) on disposal of asset                                                               |       | —                                     |       | (1 | ) |
| Depreciation and amortization                                                             |       | 782                                        |       | 843 |   |
| Amortization of debt discount                                                             |       | 1,229                                      |       | 197 |   |
| Stock-based compensation                                                                  |       | 224                                        |       | — |   |
| Bad debt expense (recovery)                                                               |       | 28                                         |       | (20 | ) |
| Warranty expense                                                                          |       | 74                                         |       | 42 |   |
| Loss (gain) from change in value of  warrants                                             |       | 1,289                                      |       | (133 | ) |
| Loss from change in value of beneficial  conversion feature                               |       | 981                                        |       | — |   |
|                                                                                      |       |                                       |       |   |   |
| Changes in  operating assets and liabilities:                                             |       |                                       |       |   |   |
| Trade accounts receivable                                                                 |       | (1,174                                     | )          | (97 | ) |
| Inventories                                                                               |       | (16                                        | )          | 198 |   |
| Prepaid expenses and other current assets                                                 |       | 48                                         |       | 496 |   |
| Other assets                                                                              |       | 17                                         |       | 16 |   |
| Accounts payable and accrued expenses                                                     |       | 1,388                                      |       | 1,546 |   |
| Deferred revenue                                                                          |       | (868                                       | )          | (20 | ) |
| Other liabilities                                                                         |       | (107                                       | )          | (81 | ) |
| Net cash used for operating activities                                                    |       | (1,168                                     | )          | (1,111 | ) |
|                                                                                      |       |                                       |       |   |   |
| **Investing  Activities:**                                                                |       |                                       |       |   |   |
| Purchases of property and equipment                                                       |       | (145                                       | )          | — |   |
| Investment in patents and trademarks                                                      |       | (39                                        | )          | (45 | ) |
| Net cash used for investing activities                                                    |       | (184                                       | )          | (45 | ) |
|                                                                                      |       |                                       |       |   |   |
| **Financing  Activities:**                                                                |       |                                       |       |   |   |
| Proceeds from borrowings                                                                  |       | 3,995                                      |       | 158 |   |
| Repayment of borrowings                                                                   |       | (2,581                                     | )          | (308 | ) |
| Repayment of other liabilities                                                            |       | (33                                        | )          | (33 | ) |
| Proceeds from restricted cash                                                             |       | —                                     |       | 754 |   |
| Net cash provided by financing activities                                                 |       | 1,381                                      |       | 571 |   |
| Effect of foreign exchange translation                                                    |       | (158                                       | )          | 184 |   |
| Net (decrease) in cash and cash equivalents                                               |       | (129                                       | )          | (401 | ) |
|                                                                                      |       |                                       |       |   |   |
| Cash and  cash equivalents at beginning of period                                         |       | 1,392                                      |       | 742 |   |
| Cash and  cash equivalents at end of period                                               |       | 1,263                                      |       | 341 |   |
|                                                                                      |       |                                       |       |   |   |
| Supplemental  cash flow information                                                       |       |                                       |       |   |   |
| Interest paid                                                                             |       | $                                          | 293        |   | $ | 88 |   |
| Taxes paid                                                                                |       | $                                          | —     |   | $ | — |   |

 

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

 

7

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During the three months ended March 31, 2006, the $59 of the Company’s6% senior convertible notes due July 2007 was converted into 59,000 shares ofthe Company’s common stock at a conversion price of $1.00 per share.

 

During the three months ended March 31, 2006, the Company fulfilled itssettlement payable to Innometal (formerly known as Growell Metal) of $3,450,net of foreign exchange translation loss, through stock issuance of 1,700,000shares of the Company’s common stock at a conversion price of $1.00 per share.

 

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

 

8

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**LIQUIDMETAL TECHNOLOGIES AND SUBSIDIARIES**

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**For the Three Months Ended March 31, 2006 and 2005**

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

**(unaudited)**

 

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

 

Theaccompanying unaudited condensed consolidated financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America (“generally accepted accounting principles”) forinterim financial information and with the instructions to Form 10-Q.  Accordingly, they do not include all of theinformation and notes required by generally accepted accounting principles forcomplete financial statements.  In the opinionof management, all adjustments (consisting only of normal recurring accruals)considered necessary for a fair presentation have been included.  All intercompany balances and transactionshave been eliminated.  In addition,certain reclassifications have been made for consistent presentation.  Operating results for the three months endedMarch 31, 2006 are not necessarily indicative of the results that may beexpected for any future periods or the year ending December 31, 2006.  The accompanying unaudited condensedconsolidated financial statements should be read in conjunction with theCompany’s Form 10-K filed with the Securities and Exchange Commission on March16, 2006, as amended by Form 10-K/A filed on April 25, 2006.

 

Liquidmetal Technologies, Inc. (“Liquidmetal Technologies”) and itssubsidiaries (collectively “the Company”) are in the business of developing,manufacturing, and marketing products made from amorphous alloys. LiquidmetalTechnologies markets and sells Liquidmetal® alloy industrial coatings and alsomanufactures, markets and sells products and components from bulk Liquidmetalalloys that can be incorporated into the finished goods of its customers acrossa variety of industries.   The Companyalso partners with third-party licensees and distributors to develop andcommercialize Liquidmetal alloy products.

 

TheCompany classifies operations into two reportable segments: Liquidmetal alloyindustrial coatings and bulk Liquidmetal alloys. Liquidmetal alloy industrialcoatings are used primarily as a protective coating for industrial machineryand equipment, such as drill pipe used by the oil drilling industry and boilertubes used by coal-burning power plants. Bulk Liquidmetal alloys includepotential market opportunities to manufacture and sell products and componentsfor electronic devices, medical devices, defense applications, and sportinggoods.  In addition, the bulk Liquidmetalalloys segment includes tooling and prototype sampling, and the manufacture andsale of die casting equipment (see Note 10). In addition, such alloys are used to generate research and developmentservices revenue for developing uses related primarily to defense and medicalapplications as well as potential license fees, royalties, and othercompensation from strategic partnering transactions.

 

Stock-based compensation

 

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

 

InDecember 2004, the FASB issued SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123R”), whichreplaces SFAS No. 123, *Accounting forStock-Based Compensation*, (“SFAS 123”) and supersedes APBOpinion No. 25, *Accounting for StockIssued to Employees*, (“APB 25”). SFAS 123R requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the financial statements based on their fair values. UnderSFAS 123R, the Company is required to measure the cost of employee servicesreceived in exchange for stock options and similar awards based on thegrant-date fair value of the award and recognize this cost in the income statementover the period during which an employee is required to provide service inexchange for the award. The pro forma disclosures previously permitted underSFAS 123 are no longer an alternative to financial statement recognition.The Company adopted SFAS 123R on January 1, 2006 using the modifiedprospective method and recorded $224 of non-cash charges for stock compensationrelated to amortization of the fair value of restricted stock and unvestedstock options representing a $224 increase from the stock compensation thatwould have been recorded under APB 25 and SFAS 123. Under this method, theCompany will recognize compensation cost, on a prospective basis, for theportion of outstanding awards for which the requisite service has not yet beenrendered as of January 1, 2006 and any new grants, based upon thegrant-date fair value of those awards calculated under SFAS 123 for pro formadisclosure purposes. Accordingly, we have not restated prior period amounts.The following

 

9

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tableillustrates the pro forma effect on net income for periods prior to theadoption of SFAS 123R as if we had applied the fair value recognitionprovisions of SFAS 123 during such periods:

 
| ** **                         | ** **                                                                                                                                | **For the Three**          | ** ** |
|------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------|----------------------------|------------|
| ** **                         | ** **                                                                                                                                | **Months Ended March 31,** | ** ** |
| ** **                         | ** **                                                                                                                                | **2005**                   | ** ** |
|                               |                                                                                                                                      |                       |       |
| Net loss as  reported              |                                                                                                                                      | $                          | (4,097     | ) |
|                               |                                                                                                                                      |                       |       |
| *Add:*                             | stock-based employee compensation expense included in reported net  loss, net of related tax effects                                      |                       | —     |   |
|                               |                                                                                                                                      |                       |       |
| *Deduct:*                          | total  stock-based employee compensation expense determined under the fair value  based method for all awards, net of related tax effects |                       | (783       | ) |
|                               |                                                                                                                                      |                       |       |
| Proforma net loss:                 |                                                                                                                                      | $                          | (4,880     | ) |
| Basic and  diluted loss per share: |                                                                                                                                      |                       |       |
| As reported                        |                                                                                                                                      | $                          | (0.10      | ) |
| Proforma                           |                                                                                                                                      | $                          | (0.12      | ) |

 

Thefair value of each option grant is estimated on the date of the grant using theBlack-Scholes option-pricing model with the following weighted-averageassumptions used for grants for the three months ended March 31, 2006 and 2005,respectively: expected volatility of approximately 100% for all periods;dividend yield of 0.0% for all periods; expected option life of approximately5 years; and a risk-free interest rate ranging from 3.6% to 4.3%.

** **

**2.         Basisof Presentation and Recent Accounting Pronouncements**

** **

Translationof Foreign Currency

 

The Companyapplies *FASB No. 52, Foreign CurrencyTranslation*, for translating foreign currency into USdollars in our consolidation of the financial statements.  Uponconsolidation of the Company’s foreign subsidiaries into the Company’sconsolidated financial statements, any balances with the subsidiariesdenominated in the foreign currency are translated at the exchange rate atyear-end. The financial statements of Liquidmetal Korea have been translatedbased upon Korean Won as the functional currency. Liquidmetal Korea’s assetsand liabilities were translated using the exchange rate at period end andincome and expense items were translated at the average exchange rate for thereporting period. The resulting translation adjustment was included in othercomprehensive income (loss).

 

Reclassifications

 

Certainamounts from the prior year have been reclassified to conform to current year’spresentation.

 

RecentAccounting Pronouncements

 

InFebruary 2006, the FASB issued SFAS No. 155,(“SFAS No. 155”), “Accounting for Certain Hybrid Instruments,” whichamends SFAS No. 133, “Accounting for Derivative Instruments andHedging Activities,” and SFAS No. 140, “Accounting for Transfers andServicing of Financial Assets and Extinguishments of Liabilities.” SFAS No. 155allows financial instruments that have embedded derivatives to be accounted foras a whole (eliminating the need to bifurcate the derivative from its host) ifthe holder elects to account for the whole instrument on a fair value basis.SFAS No. 155 also clarifies and amends certain other provisions ofSFAS No. 133 and SFAS No. 140. This statement is effectivefor all financial instruments acquired or issued in fiscal years beginningafter September 15, 2006. The Company does not expect the adoption of thisnew standard to have a material impact on its financial position, results ofoperations or cash flows.

 

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**3.         Liquidity**

 

TheCompany has experienced losses from continuing operations during the last threefiscal years and has an accumulated deficit of $141,622 as of March 31,2006.  Cash used for operations for thethree months ended March 31, 2006 was $1,168 and cash flow from operations willlikely be negative throughout fiscal year 2006. As of March 31, 2006, the Company’s principal source of liquidity is$1,263 of cash and $3,506 of trade accounts receivable.  Such conditions raise substantial doubt thatthe Company will be able to continue as a going concern.  These operating results occurred while theCompany was developing and continues to develop and to commercialize andmanufacture products from an entirely new and unique technology.  These factors have placed a significantstrain on the financial resources of the Company.  The ability of the Company to overcome thesechallenges depends on its ability to correct its production inefficiencies,continues to reduce its operating costs, generate higher revenue, and achievepositive cash flow from continuing operations and profitability and continuedsources of debt and equity financing. The consolidated financial statements do not include any adjustmentsthat might result from the outcome of the uncertainty.

 

TheCompany completed a $1,000 10% subordinated promissory note on March 17, 2006for $1,000 aggregate cash received.  Further,the Company borrowed $2,995, offset by repayments of $2,259, under a factoring,loan, and security agreement executed on April 21, 2005 during the three monthsended March 31, 2006 to fund our working capital requirements. (See Note 8)

 

Capitalrequirements during the next 12 months will depend on numerous factors,including the success of existing products, the development of new applicationsfor Liquidmetal alloys, the resources devoted to develop and supportLiquidmetal alloy products.  Specifically,we anticipate that we could need $1,000 to $5,000 over the nexttwelve months to pursue our current operating plan, although thisamount may be lower depending on the orders we receive for our products.  The amount of funding that we plan to seekand the timing of such fundraising efforts will depend on the extent to whichwe are able to increase revenues through obtaining additional purchase ordersfor our products, particularly components for cellular phones and flash memorydrive casings, and our ability to continue to improve our manufacturingprocesses.  We evaluate our workingcapital needs and operating plan assumptions on a monthly basis to determinewhether any adjustment to our cash and liquidity outlook is warranted, and wealso review potential sources of financing on an ongoing basis.  However, adequate funds may not be availablewhen needed, and if we raise additional funds by issuing equity securities,existing stockholders may be diluted.  Ifwe don’t receive sufficient funding to operate under our current plan, weintend to reduce operations and expenses and shift our focus to the pursuit oflicensing transactions and other strategic transactions that are less capitalintensive.

 

**4. Inventories**

 

Inventoriesare accounted for using the moving average basis and at standard cost, whichapproximate cost on a first-in, first-out basis and are valued at the lower ofcost or market.  Inventories werecomprised of the following:

 
| ** **        | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|---------------|------------|------------------|------------|
| ** **        | ** ** | **2006**      | ** ** | **2005**         | ** ** |
| ** **        | ** ** | ** **    | ** ** | ** **       | ** ** |
| Raw  materials    |       | $             | 659        |             | $          | 565 |   |
| Work in  process  |       | 587           |       | 763              |       |
| Finished  goods   |       | 518           |       | 420              |       |
| Total inventories |       | $             | 1,764      |             | $          | 1,748 |   |

 

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**5. Idle Equipment**

 

Idleequipment consists of certain equipment held by the Company for use inexpansion of bulk alloy parts manufacturing.  While the equipment may beused internally to meet future capacity requirements, considering our currentrevenue and foreseeable production requirements, the Company does notanticipate utilizing this equipment internally in the near future. Total amountof idle equipment remaining was $199 and $193 as of March 31, 2006 and December31, 2005, respectively.

 

**6. Settlement Payable**

 

The settlement payable balance consists of payables to Growell Metal Co., Ltd. (“Growell”), aSouth Korean metals processing company, as a result of a settlement agreementexecuted in January 2004. Under terms of the January 2004 settlement of thedispute over certain sales transactions from 2003 and 2002 between LiquidmetalKorea and Growell, LiquidmetalKorea agreed to pay Growell$4,895 to purchase Growell’sinvestment in alloy inventories, proprietary alloying equipment purchased fromLiquidmetal Korea, and supporting equipment purchased from other suppliers.Also as part of the settlement, Growellsatisfied in full a balance of $2,058 owed to Liquidmetal Korea for the diecasting machines 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. ****Theremaining settlement payable of $2,837 was to be paid to****Growell****(in cash or stock at the Company’s discretion) byDecember 31, 2004. As of December 31, 2005, the settlement payable was not paidto****Growell****due to****Growell****’s breach of warranty on equipment repurchased byLiquidmetal Korea. The outstanding balance of payables to****Growell****from the settlement was $3,331 as of December 31,2005, net of foreign exchange translation loss.****

 

Under the settlement agreement between the parties, the Company andGrowell granted to the other party (and the other party’s affiliates) a releaseof all known and unknown claims of any nature arising between the partiesthrough the date of settlement, as well as a release against future claimsunder agreements between the parties that were terminated as a part of thesettlement. The settlement agreement provided that all agreements of any naturebetween the parties and their respective affiliates were terminated as of thedate of settlement, with the exception of certain confidentiality agreements, aLiquidmetal coatings distribution agreement, and future rights under the diecasting agreement pursuant to which Growell purchased the die casting machinesand obtained a license to make auto parts from Liquidmetal alloys. Thesettlement agreement also includes, as an accommodation to Growell, if theCompany becomes aware of any prospective customer that desires to purchase aproprietary Company casting machine at a time when Growell desires to sell anyof its Liquidmetal die casting machines, then the Company will not sell suchdie casting machine to the prospective customer unless the Company firstdirects the prospective customer to Growell and encourages the prospectivecustomer to purchase 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 toSettlement Agreement (the “Settlement Amendment”) with Innometal Co., Ltd.(“Innometal”). Under the Settlement Amendment, Innometal and the Company haveagreed that the Company’s obligation of $3,331 under the Settlement Agreementwill be fully satisfied through the issuance to Innometal of 1,700,000 sharesof our common stock. The Company issued 1,700,000 shares to Innometal on March22, 2006. The shares were issued to Innometal in a private placement exemptfrom registration under the Securities Act of 1933, as amended (the “SecuritiesAct”). Specifically, the shares were issued by virtue of Section 4(2) of theSecurities Act in that the issuance did not involve a public offering,Innometal has adequate access to information about the company, and appropriaterestrictive legends were affixed to all certificates representing the shares issuedto Innometal. The shares received by Innometal under the Settlement Amendmentare “restricted securities” within the meaning of Rule 144 under the SecuritiesAct, and Innometal has not been granted any registration rights by the companywith respect to such shares.

 

As an inducement for Innometal to enter into the Settlement Amendment,James Kang, a director and founder of the Company, has entered into a buy-sellagreement with Innometal whereby Mr. Kang has agreed to personally purchasefrom Innometal, and Innometal has agreed to sell to Mr. Kang, the 1,700,000shares issued to Innometal under the Settlement Amendment, with such purchaseand sale to take place on October 31, 2006. The aggregate purchase price forthe shares payable by Mr. Kang under this buy-sell agreement will beapproximately $2,800. In order to secure his obligations under the buy-sellagreement, Mr. Kang has pledged to Innometal 500,000 shares of the company’scommon stock currently held by him. Mr. Kang will receive no consideration fromus in connection with his entering into this buy-sell agreement, and Mr. Kangwill not have any registration rights with respect to the shares purchasedunder the buy-sell agreement.

 

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**7. Product Warranty**

 

Management estimates product warranties as a percentage of bulk alloyproduct sales earned during the period. As of March 31, 2006, the Company used5% of bulk alloy product sales as an estimate of warranties to be claimed. Thepercentage is based on industry averages and historical information. During thethree months ended March 31, 2006 and 2005, the Company recorded $74 and $42,respectively, of warranty expense. The product warranty accrual balance isincluded in accounts payable and accrued expenses.

 

**8. Notes Payable**

 

Senior Convertible Note

 

OnMarch 3, 2004, the Company issued $9,924 of 6.0% senior convertible notes due2007 (the “March Notes”) to investor groups in a transaction led by MichiganVenture Capital Co., Ltd, a South Korea-based institutional investment firm,and IndiGo Ventures LLC, a New York-based investment firm (the “PlacementAgents”) that served as a financial advisor to the Company for the transaction.The notes were collateralized by the patents held by the Company and secondpriority mortgage interest in plant facilities and certain equipment in SouthKorea. The notes were convertible at any time into common stock at a price of$3.00 per share. Investors in the private placement and the Placement Agentsreceived warrants to purchase an aggregate amount of up to approximately 1.2million shares of common stock, exercisable at $3.00 per share for varyingperiods but no later than 100 days following the effectiveness of aregistration statement covering the resale of shares issuable upon exercise ofthe warrants. In addition, the investors had the right to call for repayment ofthe notes prior to maturity at any time after the second anniversary of theclosing of the transaction.

 

Thefair value of the 1.2 million warrants totaled $1,883 and was computed usingthe Black-Scholes pricing model under the following assumptions: (1) expectedlife of 3 years; (2) volatility of 82%, (3) risk free interest of 0.95% anddividend rate of 0%. In addition, since this debt is convertible into equity atthe option of the note holder at beneficial conversion rates, an embeddedbeneficial conversion feature was recorded as a debt discount and will beamortized using the effective interest rate method over the life of the debt inaccordance with Emerging Issues Task Force No. 00-27, “Application of Issue No.98-5 to Certain Convertible Instruments.” In March 2004, total cost of beneficial conversion feature of $3,395 andthe fair value of the 0.6 million warrants issued to investors of $584 wererecorded as discounts of the convertible note. In addition, $718 relating tothe fair value of the 0.6 million warrants issued to the Placement Agents and$581 direct costs incurred relating to issuance of the convertible note wererecorded as debt issuance cost as a contra liability account in warrantliability and other assets, respectively.

 

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

 

OnAugust 19, 2004, the Company completed a private exchange offer for its MarchNotes with the remaining holders after the redemption. Under terms of theexchange offer, approximately $5,460 in aggregate principal amount of the MarchNotes have been exchanged for an aggregate of (i) $2,730 of 6% Senior SecuredNotes Due 2007 (the “July 2007 Notes”) and (ii) $2,730 of 10% Senior SecuredNotes Due 2005 (the “July 2005 Notes”), collectively referred to as “ExchangeNotes”. The Exchange Notes are collateralized by certain patents owned by theCompany and second priority mortgage interest in plant facilities and certainequipment at our South Korea plant. 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 Noteshave been exchanged and redeemed subsequent to the close of the second quarterof 2005 (see 2005 Senior Convertible Notes below). The July 2007 Notes have amaturity date of July 29, 2007, and a conversion price of $1.00 per 

 

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share.Further, the exchange notes are convertible into Common Stock, at the option ofthe Company, if at any time after the issuance of the notes, the closing pershare price of the Common Stock exceeds $4.00 (as adjusted for stock splits,reverse splits, stock dividends, and recapitalizations) for 30 consecutivetrading days, and further provided that there has been effective registrationduring such period. Holders of the July 2007 Notes also have the right to callfor repayment of the July 2007 Notes prior to maturity at any time after thesecond anniversary of the closing of the exchange offer. The July 2007 Noteshave been amended subsequent to the close of the second quarter of 2005 toprovide for an Amended Registration Rights Agreement, and Amended and RestatedSecurity Agreement (see 2005 Senior Convertible Notes below).

 

Atotal of 563,151 warrants to purchase our common stock at an exercise price of$3.00 per share—all of which were previously issued in connection with thepurchase of the March Notes—have been amended to provide for an extendedexpiration 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 of registrationof shares issuable under the warrants and senior convertible debt. The warrantexercise price is subject to price adjustment for anti-dilution purposes. As ofMarch 31, 2006, there were 149,894 warrants outstanding and the exercise priceof the warrants was $2.73 per share.

 

Theexchange offer was treated as an extinguishment of the March Notes inaccordance with Emerging Issues Task Force No. 96-19, “Debtors Accounting for aModification or Exchange of Debt Instruments.” The exchange resulted in a $1,663 loss from extinguishment of the MarchNotes, write down of $352 of deferred issue costs in other assets, $189 ofcontra liability deferred issuance costs, and $1,122 of debt discount as aresult of the change in carrying value of exchanged notes.

 

Inconnection with the private exchange offer, the Company issued $250 of privateplacement notes to certain Placement Agents as issuance costs. Of the $250notes issued, $125 was paid in the form of long-term notes which is due in 2007with interest rate of 6% per annum (July 2007 Notes) and $125 was paid in theform of short-term notes which is due in 2005 with interest rate of 10% perannum (July 2005 Notes). The Short-Term and July 2007 Notes are convertibleinto Common Stock at $2.00 and $1.00, respectively, and have the same terms asthe Exchange Notes issued to the investors. Further, a beneficial conversionfeature was recorded from the $125 July 2007 Notes issued to Placement Agentsof $29 during August 2004.

 

TheCompany was obligated, pursuant to a Registration Rights Agreement, as amendedby the Exchange Notes, between the Company, the Placement Agents and the noteholders to file a registration statement with the Securities and ExchangeCommission (“SEC”) to register the shares of Common Stock issuable uponconversion of the notes payable and the related warrants within 90 daysfollowing the effective closing date of the exchange notes (July 29, 2004), andto use best efforts to cause such registration statement to become effectivewithin 60 days following the SEC’s first written comments on the registration statement.Further, if the Company is not in compliance with the registration or listingrequirements, the holders have rights to late registration payments equal tobetween 2% and 3% of the purchase price paid for the unconverted notes for thefirst 30 business days of late registration, and 1% and 3% for each 30 businessdays thereafter, but no more than 18% of the purchase price of the unconvertednote balance. Late registration fee of $856 has been accrued as interestexpense as of March 31, 2005.

 

Interestpayments are due quarterly, and failure to make timely interest payments willresult in increase in interest rate to 10% and 14% on the 6% and 10% seniorconvertible notes (“Default Rates”). The Default Rates became effective onApril 1, 2005 from non-payment of a scheduled interest payment. The Companybecame compliant with timely interest payments during the third quarter offiscal year 2006, and as of March 31, 2006, the Company has complied with allscheduled interest payments.

 

OnAugust 9, 2005, the July 2005 Notes, accrued interest and late registrationfees were redeemed in cash and exchanged for 7% Convertible Secured PromissoryNotes due August 2007  (see 2005 SeniorConvertible Notes below).

 

Duringthe year end December 31, 2005, $485 of the July 2007 Notes were converted into485,750 of the Company’s common stock at a conversion price of $1.00 per share.Additionally, during the three months ended March 31, 2006, $59 of the July2007 Notes were converted into 59,000 of the Company’s common stock at aconversion price of $1.00 per share.

 

TheCompany’s gross outstanding loan balance of the July 2007 Notes totaled $2,310and $2,369 as of March 31, 2006 and December 31, 2005, respectively. Asof March 31, 2006 and December 31, 2005, un-amortized discounts for beneficial conversion feature and warrantstotaled $272 and $303, and otherasset debt issuance costs totaled $35 and $43, respectively. Interest expense for the amortization of debt issuancecost and discount on note was $39 and $197, respectively,  for the three months ended March 31, 2006 and2005. As of March 31, 2006, the effective interest rate for the July 2007 Noteswas 32%.

 

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Pursuant to EITF 00-19, “Accounting for Derivative FinancialInstruments Indexed to, and Potentially Settled in, a Company’s Own Stock”, theoriginal relative fair values of the warrants of $1,302 have been recorded aswarrant liability as the Company has not yet filed the registration statement.In addition, the Company is required to report a value of the warrant as a fairvalue and record the fluctuation to the fair value of the warrant liability tocurrent operations. The change in the fair value of the warrants resulted in aloss of $3 and a gain of $133 for the three months ended March 31, 2006 and2005, respectively.  The fair value ofwarrants outstanding was $3 and $0 as of March 31, 2006 and December 31, 2005,respectively.  The fair value of warrantsoutstanding as of March 31, 2006 was computed using the Black-Scholes modelunder the following assumptions: (1) expected life of 0.27 years; (2)volatility of 82%, (3) risk free interest of 4.63%and dividend rate of 0%.

 

Convertible Notes

 

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

 

The June 2006 Notes issued by the Company in the June 2005 PrivatePlacement are unsecured and was due on the earlier of June 13, 2006 or theconsummation of a follow-on equity or debt offering or restructuringtransaction pursuant to which the Company receives gross proceeds of at least$4,000.  Prior to maturity, the June 2006 Notes are interest-only, withinterest payments due quarterly, at the rate of 10% per year.  The June2006 Notes can be prepaid by the Company at any time without penalty.  If,within 120 days following the issue date of the June 2006 Notes, the Companyeither fails to redeem the notes for the principal amount and accrued interestthereon or fails to close a “Qualified Financing,” then the June 2006 Noteswill thereafter be convertible at a conversion price equal to seventy fivepercent (75%) of the closing price of the Company’s common stock on the firsttrading day immediately preceding the conversion date.  A “QualifiedFinancing “ is defined in the June 2006 Notes as any debt or equity financingof the Company resulting in aggregate gross proceeds to the Company of at least$5,000 and in which the holders of at least sixty percent (60%) of theaggregate principal amount of the Company’s Long Term Notes due July 2007either (i) agree that the equity or debt securities to be issued in suchfinancing shall be*pari passu* inorder of payment to the 2007 Notes held by them or (ii) exchange their2007 Notes for new securities in the financing transaction. On August 9, 2005,the Company successfully completed Qualified Financing, which resulted inexchange and redemption of the Convertible Notes (see 2005 Senior ConvertibleDebt). As a result, the Notes never became convertible.

 

As a part of the June 2005 Private Placement, the Company issuedwarrants to the purchasers of the Notes giving them the right to purchase up toan aggregate of 812,500 shares of the Company’s common stock.  Inaddition, warrants to purchase 81,250 shares of the Company’s common stock wereissued to the placement agent in the transaction.  The warrants have anexercise price of $2.00 per share, provided that upon the consummation of thefirst ensuing public or private equity or debt offering or restructuringtransaction in which the Company receives gross proceeds of at least $3,250(including without limitation any restructuring of the Company’s previouslyissued 10% Senior Secured Notes Due July 29, 2005), the exercise pricewill be automatically adjusted downward (but not upward) as of the closing dateof such offering or restructuring transaction so that it is equal to the lowesteffective common stock purchase price paid for any securities issued by theCompany to the investors in such offering or restructuring transaction. The warrants will expire on June 13, 2010 and are subject to exerciseprice adjustment for anti-dilution purposes. The exercise price of the warrantsremained unchanged at $2.00 per share as of March 31, 2006.

 

The fairvalue of the 893,750 warrants totaled $1,160 and was computed using theBlack-Scholes pricing model under the following assumptions: (1) expected lifeof 5 years; (2) volatility of 118%, (3) risk free interest of 3.87% anddividend rate of 0%. In accordance with Emerging Issues Task Force No. 00-27,“Application of Issue No. 98-5 to Certain Convertible Instruments” the embeddedbeneficial conversion feature of the debt was not recorded as the debt isconsidered contingently convertible at the time of issuance, and as a result ofthe completion of the Qualified Financing the debt subsequent to the close ofthe second quarter, the debt was determined to be not convertible. In June2005, 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 thefair value of the 81,250 warrants issued to the Placement Agents and $278direct costs incurred relating to issuance of the convertible note wererecorded as debt issuance cost as a contra liability account in debt discountand other assets, respectively, and will be amortized using the effectiveinterest rate method over the life of the loan.

 

On August 9,2005, the Notes were redeemed in cash and exchanged for 7% Convertible SecuredPromissory Notes due August 

 

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2007 (see2005 Senior Convertible Notes below). The exchange offer was treated as anextinguishment of the Notes in accordance with Emerging Issues Task Force No.96-19, “Debtors Accounting for a Modification or Exchange of Debt Instruments.”  The exchange resulted in a $1,247 loss fromextinguishment of the Notes which consists of write down of $240 of deferredissue costs in other assets, $92 of contra liability deferred issuance costs,and $915 of debt discount as a result of the change in carrying value ofexchanged notes.

 

Pursuantto EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company’s Own Stock”, the original fair values of thewarrants of $1,160 have been recorded as warrant liability as the Company hasnot yet filed the registration statement. In addition, the Company is requiredto report a value of the warrant as a fair value and record the fluctuation tothe fair value of the warrant liability to current operations. The change inthe fair value of the warrants resulted in a loss of $302 and $0 for the threemonths ended March 31, 2006 and 2005. The fair value of warrants outstanding atMarch 31, 2006 of $719 was computed using the Black-Scholes model under the followingassumptions: (1) expected life of 4.20 years; (2) volatility of 82%, (3) riskfree interest of 4.82%and dividend rate of 0%.

 

2005 Senior Convertible Debt

 

On August 9, 2005, the Company completed a private placement (the“August 2005 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 amountof previously issued 10% Senior Secured Notes Due July 29, 2005 (the “July 2005Notes”), the exchange of $2,996 in principal amount of previously issued 10%Convertible Unsecured Notes Due June 2006 (the “June 2006 Notes”), satisfactionof accrued interest and late registration fees in the amount of $589 on thepreviously issued July 2005 Notes, and satisfaction of accrued interest of $9previously issued June 2006 Notes. The August 2007 Notes were issued pursuantto a Securities Purchase Agreement dated effective as of August 2, 2005 amongthe Company, the purchasers of the August 2007 Notes, and the holders ofpreviously issued July 2005 Notes and June 2006 Notes of the Company due June2006.

 

Interest payments are due quarterly, and failure to make timelyinterest payments will result in increase in interest rates to 14% per annum onthe August 2007 Notes (“Default Rates”). As of March 31, 2006, the Company hasmade timely interest payments.

 

The August 2007 Notes are convertible into shares of the Company’scommon stock at $2.00 per share pursuant to an Amended and Restated SecurityAgreement. The convertible price of the August 2007 Notes is subject to priceadjustment for anti-dilution purposes. As of March 31, 2006, the convertibleprice of the August 2007 Notes remained unchanged at $2.00 per share.

 

Further, pursuant to Statement of Financial Accounting Standards No.133, “Accounting for Derivative Instruments and Hedging Activities,” EITF00-19, “Accounting for Derivative Financial Instruments Indexed to, andPotentially Settled in, a Company’s Own Stock,” EITF 00-27, “Application ofIssue No. 98-5 to Certain Convertible Instruments,” and EITF 05-2 “The Meaningof ‘Conventional Convertible Debt Instrument’ in EITF Issue No. 00-19,” theoriginal fair value of the embedded conversion feature of $4,808 have beenrecorded as conversion feature liability as the debt is considerednonconventional convertible debt. The original fair value was computed usingthe Black-Scholes model under the following assumptions: (1) expected life of 2years; (2) volatility of 93%; (3) risk free interest of 4.06% and dividend rateof 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 fairvalue of the conversion feature liability resulted in a loss of $981 for thethree months ended March 31, 2006. The fair value of the conversion featuresoutstanding as of March 31, 2006 of $1,940 was computed using the Black-Scholesmodel under the following assumptions: (1) 1.34 years; (2) volatility of82%, (3) risk free interest of 4.82% and dividend rate of 0%. The fair value ofconversion features outstanding at December 31, 2005 of $959 was computed usingthe Black-Scholes model under the following assumptions: (1) 1.59 years; (2)volatility of 88%, (3) risk free interest of 4.41%and dividend rate of 0%.

 

TheAugust 2007 Notes are secured by substantially all assets of the Company andrank senior to all other obligations of the Company, other than the Company’sloan with Kookmin Bank of South Korea (or any refinancing of such loan), theJuly 2007 Notes, purchase money asset financing, trade creditors in theordinary course of business, and any inventory or receivables-based creditfacility that the Company may obtain in the future, provided that the amount ofthe credit facility 

 

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doesnot exceed 50% of eligible inventory and 80% of eligible receivables. TheAugust 2007 Notes will automatically convert into common stock if the Company’scommon stock has an average closing price of more than $5.00 per share during30 consecutive trading days.

 

TheCompany also issued warrants to the purchasers of the August 2007 Notes and placementagents giving them the right to purchase up to 2,469,470 and 414,495 shares ofCompany common stock, respectively, with an exercise price of $2.00 per share,which is subject to price adjustment for anti-dilution purposes. As of March31, 2006, the convertible price of the August 2007 Notes remained unchanged at$2.00 per share. The warrants will expire on 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 liabilityas the Company has not yet filed the registration statement, which was computedusing the Black-Scholes pricing model under the following assumptions: (1) expectedlife of 5 years; (2) volatility of 93%; (3) risk free interest of 4.17% anddividend rate of 0%. In addition, the Company is required to report a value ofthe warrant as a fair value and record the fluctuation to the fair value of thewarrant liability to current operations. The change in the fair value of thewarrants resulted in a net loss of $985 for the three months ended March 31,2006. The fair value of warrants outstanding was $2,359 as of March 31, 2006,which was computed using the Black-Scholes model under the followingassumptions: (1) expected life of 4.34 years; (2) volatility of 82%, (3) riskfree interest of 4.82% and dividend rate of 0%. The fair value of warrantsoutstanding at December 31, 2005 of $1,375 was computed using the Black-Scholesmodel under the following assumptions: (1) expected life of 4.59 years; (2)volatility of 88%, (3) risk free interest of 4.35% and dividend rate of 0%.

 

In connectionwith the August 2005 Private Placement, the Company entered into an amended andrestated registration rights agreement with the holders of the July 2007 Notes,the holders of the August 2007 Notes, and the holders of the above-describedoutstanding warrants. This amended and restated registration rights agreementreplaced all other registration rights agreements previously entered into by usin connection with the private sale by us of convertible notes and warrants.Under the amended and restated registration rights agreement, the Company isrequired to file a resale registration statement for the shares underlying allof our outstanding convertible notes and warrants, as described above, byOctober 31, 2005, to enable the resale of such shares by the sellingstockholders on a delayed or continuous basis under Rule 415 of the SecuritiesAct. The Company is then required to cause such registration statement tobecome effective within 60 days after we receive the first written comments onthe registration statement from the SEC, or if the SEC notifies us that it willnot review the registration statement, within five days after suchnotification. The Company will be subject to certain monetary penalties, as setforth in the registration rights agreement, if the registration statement isnot filed or does not become effective on a timely basis. Specifically, if theCompany does not file the registration statement on a timely basis, we will beobligated to pay a late filing fee to the selling stockholders in the amount of3% of the warrant exercise price on each of the warrants held by them plus 3%of the principal amount of the outstanding notes held by them. This fee will bepayable for each period of 30 business days that the filing of the registrationstatement is made past the required filing date, and the payments will be due10 business days following the end of each 30-day period. If the registrationstatement has not been declared effective by the required effective date, theCompany will be obligated to pay a monthly late registration fee to the sellingstockholders in the amount of 2% of the aggregate warrant exercise prices andaggregate note principal amounts for the first 30 business days after therequired effective date, and 1% for each 30-business day period thereafteruntil the registration statement is declared effective. Notwithstanding 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 December6, 2005, the Company received a letter from a representative of the holders ofthe August 2007 Notes demanding the payment of a late filing fee by us for theperiod following October 31, 2005, but under the terms of the amended andrestated registration rights agreement, the Company does not believe that it isobligated to pay any late filing fees unless and until the Company fails tofile the registration statement by December 13, 2005, which is the last day ofthe first 30-business day period following October 31, 2005. The letter alsostated that the letter was serving as a notice of default under the SeniorNotes as a result of our failure to file a registration statement by October31, 2005, although under the terms of the Senior Notes, the Company has thirtydays after delivery of the letter in which to cure such default. On December 9,2005 the Company filed the registration statement, which was within the 30-dayperiod and has cured the default notice.

 

TheCompany has received first written comments in January 2006. However, theregistration statement has not been made effective within the 60 day periodcalled for by the registration rights agreement and the Company may be subjectto default 

 

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noticesby the holders of the convertible notes and warrants. As of the filing of thisreport, the Company’s management is not aware of any outstanding defaultnotices.

 

Ourgross outstanding loan balance of the August 2007 Notes totaled $9,878 as ofMarch 31, 2006 and December 31, 2005. As of March 31, 2006 and December 31,2005, un-amortized discounts for beneficial conversion feature and warrantstotaled $5,551 and $6,587, and other asset debt issuance costs totaled $316 and$384, and contra liability debt issuance cost totaled $391 and $464,respectively. Interest expense for the amortization of debt issuance cost anddiscount on note was $1,177 for the three months ended March 31, 2006. As ofMarch 31, 2006, the effective interest rate for the August 2007 Notes was 54%.

 

SubordinatedPromissory Note

 

On March 17,2006, the Company issued a $1,000 10% subordinated promissory note due October16, 2006 (the “October 2006 Note”) to Atlantic Realty Group, Inc., a companycontrolled by Jack Chitayat, a former director of the Company.  TheOctober 2006 Note is unsecured and subordinated to all prior indebtedness ofthe Company.  All accrued interest and unpaid principal under the notewill be due October 16, 2006.  The proceeds from the October 2006 Note isto be used solely for working capital purposes.  In connection with theOctober 2006 Note, the Company issued warrants to purchase an aggregate amountof up to 125,000 shares of common stock, exercisable at $2.00 per share. The warrants will expire on March 17, 2009, and include price adjustmentprovisions for anti-dilution purposes.  As of March 31, 2006, the exerciseprice of the warrants remained unchanged at $2.00 per share. There are noregistration rights of the shares issuable from the exercise of thewarrants.  Further, cashless exercise of the warrants is permitted.

 

Pursuant toEITF 00-19, “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 warrant 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 net gain of $1 which is recorded aschange in value of warrants for the three months ended March 31, 2006. The fair value of warrants outstanding at March 31, 2006 of $83 was computedusing the Black-Scholes model under the following assumptions: (1) expectedlife of 2.96 years; (2) volatility of 82%, (3) risk free interest of 4.83%anddividend rate of 0%.

 

Ourgross outstanding loan balance of the October 2006 Note totaled $1,000 as ofMarch 31, 2006. As of March 31, 2006, un-amortized discounts for warrantstotaled $71. Interest expense for the amortization of discount on the note was$13 for the three months ended March 31, 2006. As of March 31, 2006, theeffective interest rate for the October 2006 Note was 22%.

 

Factoring Agreement

 

The Company entered into a Factoring, Loan, and Security Agreement (the“Agreement”) with a financing company on April 21, 2005, which allows forborrowings of up to $1,500. The Agreement expires on April 21, 2006, andautomatically renews annually thereafter. All borrowings are secured byoutstanding receivables specifically 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 amendedwhereas advances are made on 85% of Approved receivables assigned and 50% ofNon-Approved receivables assigned. Payments on assigned receivables arereceived directly by the financing company, and applied to outstandingadvances. All outstanding advances and uncollected assigned receivables aresubject to fees and interest charges ranging from 0.55% to 1.5% plus prime rateas published by the Wall Street Journal, with a minimum annual fee of $30. Allreceivables assigned and advances made are subject to return and recall by thefinancing company, respectively. 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 ofLiabilities.”  As of March 31, 2006, theCompany has borrowed $2,995 and repaid $2,259 during the three months endedMarch 31, 2006. The total outstanding advance made under the agreement is$1,286 and $550 as of March 31, 2006 and December 31, 2005, which is presentedas short-term debt. The weighted average rate of interest for borrowings madeunder the Agreement was 9% for the three months ended March 31, 2006. TheCompany has $214 available for future borrowings under the Agreement as ofMarch 31, 2006, which is contingent on approval of eligible receivables by thefinancing company.

 

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Kookmin Note

 

On February 4, 2003, ourKorean subsidiary received 6,500,000 in South Korean Won, or approximately$5,488, under a loan from Kookmin Bank of South Korea. The loan bears interestat an annual rate of 7.1%. In the event of delayed repayment, the interestincreases to a maximum of 21%, depending on the length of time the repayment isdelayed. As of March 31, 2006, the interest rate was increased to 9.2% fromdelayed interest payments made. This loan is collateralized by the plantfacilities and certain equipment in South Korea. During the first eighteenmonths from the origination date, interest was payable on a monthly basis. InOctober 2003, the Company paid $873 of principal at the request of Kookmin Bankdue to the sale of machines that had been part of the collateral on the loan. Subsequentto October 31, 2003, Kookmin Bank requested that the Company pay an additional$866 of principal by February 2004 due to the Company’s current credit rating. TheCompany made two payments on the requested additional loan pay down in Novemberand December 2003 of $320 and $205, respectively. The remaining payment of $341was subsequently made in February 2004. Beginning in September 2004, theCompany is required to make equal monthly installments of principal andinterest to repay the remaining balance of the loan over a 36-month period. Principalpayments made to Kookmin Bank totaled $221 for the three months ended March 31,2006, which includes $100 of foreign exchange translation loss. The outstandingloan balance totaled $2,568 and $2,790, of which $1,391 and $1,343 is includedin current portion of long-term debt, as of March 31, 2006 and December 31,2005, respectively.

 

**9. Stock Compensation Plan**

 

During the three months ended March 31, 2006, under the Company’s 2002Non-employee Director Stock Option Plan which provides for the grant of stockoptions to non-employee directors, the Company granted 60,000 common shares ofthe Company for an average exercise price of $0.77. Further, all optionsgranted under this plan had exercise prices that were equal to the fair marketvalue on the date of grant.

 

In March 2006, one of the former non-employeedirectors of our company were given the opportunity to receive shares of stockunder the plan in lieu of past-due director and committee fees that were due tohim for periods through December 31, 2005. Such shares were issuable to him atan average price of $1.50 per share. As of March 31, 2006, a total of 10,000shares were issued to non-employee directors in lieu of these past-due fees.

 

The Company canceled 423,032 options during the three months ended March31, 2006, for terminated employees and directors.

 

**10. SegmentReporting and Geographic Information**

 

SFAS No. 131,*Disclosures aboutSegments of an Enterprise and Related Information,*requirescompanies to provide certain information about their operating segments. InApril 2002, the Company began classifying operations into two reportablesegments: Liquidmetal alloy industrial coatings and bulk Liquidmetal alloys. TheLiquidmetal alloy industrial coatings are used primarily as a protectivecoating for industrial machinery and equipment, such as drill pipe used by theoil drilling industry and boiler tubes used by coal burning power plants. BulkLiquidmetal alloys include market opportunities to manufacture and sell casingcomponents for electronic devices, medical devices, sporting goods, tooling,prototype sampling, defense applications and metal processing equipment. Primarily,the expenses incurred by the bulk Liquidmetal alloy segment are research anddevelopment costs and selling expenses associated with identifying anddeveloping 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 expensesassociated with research and development services and product licensingarrangements are included in the bulk Liquidmetal alloy segment. The accountingpolicies of the reportable segments are the same as those described in Note 3to the consolidated financial statements included in the Company’s Form 10-Kfiled with the Securities and Exchange Commission on March 16, 2006, as amendedby Form 10-K/A filed on April 25, 2006.

 

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Summarized financial information concerning the Company’s reportablesegments is shown in the following tables:

 
| ** **                                                         | ** ** | **Coatings** | ** ** | **Bulk Alloy** | ** ** | **Segment Totals** | ** ** |
|--------------------------------------------------------------------|------------|--------------|------------|---------------------|------------|-------------------------|------------|
| Three months  ended March 31, 2006                                 |       |         |       |                |       |                    |       |
| Revenue to  external customers                                     |       | $            | 2,384      |                | $          | 4,171                   |       | $ | 6,555 |   |
| Gross profit                                                       |       | 990          |       | 241                 |       | 1,231                   |       |
| Total segment  income                                              |       | 805          |       | (385                | )          | 419                     |       |
| Total  identifiable assets at end of period                        |       | 878          |       | 17,488              |       | 18,366                  |       |
|                                                               |       |         |       |                |       |                    |       |
| Three months  ended March 31, 2005                                 |       |         |       |                |       |                    |       |
| Revenue to  external customers                                     |       | $            | 1,049      |                | $          | 1,794                   |       | $ | 2,843 |   |
| Gross profit  (loss)                                               |       | 568          |       | (560                | )          | 8                       |       |
| Income (loss)  before interest expense and discontinued operations |       | 327          |       | (1,149              | )          | (822                    | )          |
| Total  identifiable assets at end of period                        |       | 701          |       | 22,054              |       | 22,755                  |       |

 

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

 
| ** **                                                                        | ** ** | **For the Three Months  Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                        | ** ** | **2006**                                                           | ** ** | **2005** | ** ** |
|                                                                              |       |                                                               |       |   |   |
| Total segment  income (loss) before minority interest, interest expense           |       | $                                                                  | 419        |   | $ | (822 | ) |
| General and  administrative expenses, excluded                                    |       | (1,616                                                             | )          | (2,157 | ) |
|                                                                              |       |                                                               |       |   |   |
| Consolidated  loss before interest, other income, income taxes, minority interest |       | (1,197                                                             | )          | (2,979 | ) |
| Change in value  of warrants, net                                                 |       | (1,289                                                             | )          | 133 |   |
| Change in value  of conversion feature                                            |       | (981                                                               | )          | — |   |
| Interest expense                                                                  |       | (1,598                                                             | )          | (1,257 | ) |
| Interest income                                                                   |       | 2                                                                  |       | 6 |   |
| Consolidated net  loss                                                            |       | $                                                                  | (5,063     | ) | $ | (4,097 | ) |

 

Included in bulk alloysegment net income for the three months ended March 31, 2006 is $480 of otherincome recognized from termination of a distribution agreement in March 2006(see Note 12).

 

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

 

Revenues from sales tocompanies in the United States were $2,266 and $1,401 during the three monthsended March 31, 2006 and 2005, respectively. The revenue related to the UnitedStates of America was earned under defense-related research and developmentcontracts and sales of coatings products.

 

As of December 31, 2005, onecustomer represented 12%, or $288, of the total outstanding trade accountsreceivable. There are no customers with greater than 10% of accounts receivableas of March 31, 2006. One customer represented 13%, or $845 of total sales forthe three months ended March 31, 2006. Three customers represented 80%, or $2,266,of total sales for the three months ended of March 31, 2005.

 

During the three monthsended March 31, 2006, the Company had revenues from companies outside of theUnited States of $4,289 of which $3,087 represented sales to companies locatedin South Korea. During the three months ended March 31, 

 

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2005, the Company hadrevenue from sales to companies outside of the United States of $1,442 of which$934 represented sales to companies located in South Korea. The revenue relatedto sales to companies outside of the United States was from bulk alloyproducts.

 

Long-lived assets includenet property, plant, and equipment, and net intangible assets. The Company hadlong-lived assets of $1,604 and $2,107 located in the United States at March31, 2006 and December 31, 2005, respectively. The Company had long-lived assetsof $12,678 and $12,846 located in South Korea at March 31, 2006 andDecember 31, 2005, respectively.

 

Reconciling informationbetween reportable segments and the Company’s consolidated totals is shown inthe following table:

 
| ** **                                 | ** ** | **March 31,** | ** ** |
|--------------------------------------------|------------|--------------------|------------|
| ** **                                 | ** ** | **2006**           | ** ** |
|                                       |       |               |       |
| Total segment  assets                      |       | $                  | 18,366     |   |
| Cash and cash  equivalents                 |       | 1,263              |       |
| Prepaid expenses  and other current assets |       | 561                |       |
| Other property,  plant and equipment       |       | 403                |       |
| Intangibles, net                           |       | 1,196              |       |
| Other assets                               |       | 547                |       |
| Total  Consolidated Assets                 |       | $                  | 22,336     |   |

 

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

 

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

 

Basicearnings per share (“EPS”) is computed by dividing earnings (loss) attributableto common shareholders by the weighted average number of common sharesoutstanding for the periods. Diluted EPS reflects the potential dilution ofsecurities that could share in the earnings.

 

Optionsto purchase 7,630,723 shares of common stock at prices ranging from $0.77 to$15.00 per share were outstanding at March 31, 2006, but were not included inthe computation of diluted EPS for the same period because the inclusion wouldhave been antidilutive. Warrants to purchase 3,777,715 shares of common stockat $2.00 per share outstanding at March 31, 2006 were not included in thecomputation of diluted EPS for the same period because the inclusion would havebeen antidilutive. 7,248,685 of convertible shares from the senior convertibledebt were not included in the computation of diluted EPS for the same periodbecause the inclusion would have been antidilutive.

 

**12.          Commitmentsand Contingencies**

 

TheCompany is from time to time a party to certain legal proceedings arising inthe ordinary course of business. Although outcomes cannot be predicted withcertainty, the Company does not believe that any legal proceeding to which itis a party will have a material adverse effect on the Company’s financialposition, results of operations, and cash flows.

 

The Company and certain of the present and former officers anddirectors were named as defendants in nine purported class action complaintsfiled in the United States District Court for the Middle District of Florida,Tampa Division, and the Central District of California, Southern Division,alleging violations of Sections 11 and 15 of the Securities Act of 1933 andSections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5promulgated thereunder. In August 2004, four complaints were consolidated inthe Middle District of Florida under the caption*Primavera Investors v. Liquidmetal Technologies, Inc., et al.*,Case No. 8:04-CV-919-T-23EAJ. John Lee, Chris Cowley, Dwight Mamanteo, ScottPurcell and Mark Rabold were appointed co-lead plaintiffs (the “Lead Plaintiffs”),but Mr. Mamanteo later withdrew. In September 2004, the five complaints filedin the Central District of California were transferred to the Middle Districtof Florida for 

 

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consolidation with the*PrimaveraInvestors* action. The Lead Plaintiffs served their ConsolidatedAmended Class Action Complaint on January 12, 2005. The Amended Complaintalleges that the Prospectus issued in connection with our initial publicoffering in May 2002 contained material misrepresentations and omissionsregarding our historical financial condition and regarding a personal stocktransaction by our former chief executive officer. The Lead Plaintiffsfurther generally allege that during the proposed Class Period of May 21, 2002,through May 13, 2004, the defendants engaged in improper revenue recognitionwith respect to certain of our business transactions, failed to maintainadequate internal controls, and knowingly disclosed unrealistic but favorableinformation about market demand for and commercial viability of our products toartificially inflate the value of our stock. The Amended Complaint seeksunspecified compensatory damages and other relief. The Company, along withother defendants, filed a Motion to Dismiss Plaintiffs’ Consolidated AmendedClass Action Complaint in March 2005.  The Motion toDismiss was denied in December 2005, and the defendants served theirAnswer and Affirmative Defenses to the Consolidated Amended Class ActionComplaint on December 16, 2005.  The Lead Plaintiffs Motion for ClassCertification was presently due in April 2006.

 

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

 

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

 

In the Florida derivative action, the Plaintiff filed a First AmendedShareholder Derivative Complaint on November 22, 2004.  The Company,along with other defendants, filed a Motion to Dismiss inDecember 2004, to which the Plaintiff responded in opposition inFebruary 2005.  On January 20, 2006, the presiding judge granted ourMotion to Dismiss, dismissing the complaint based upon the plaintiff’s failureto adequately plead futility. On February 17, 2006, the plaintiff filed itsNotice of Appeal of the Court’s Order granting the Motion toDismiss.  The plaintiff’s initial brief is presently due on April 4,2006.

 

In April 2006, the Company reached agreements in principal to settlethe Company’s consolidated securities class action and shareholder derivativeactions (see Note 14).

 

In March 1996, theCompany entered into a distribution agreement whereby it granted to a thirdparty exclusive rights to market and sell golf products incorporatingLiquidmetal Technology to certain Japanese sporting equipment companies. Thethird party paid the Company a $1,000 distribution fee as part of thisagreement, of which a portion was refundable according to a formula based onthe gross profit earned by the third party. The remaining unearned distributionfee of $830 has not been refunded. On March 28, 2003, the distributionagreement was terminated and the Company entered into a new agreement to pay tothe same third 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 beapplied to golf equipment shipped by the Company or its affiliates during theperiod beginning on March 28, 2003 and ending on March 28, 2006. If, by March28, 2006, the Company has not paid $350 in commission payments, the balancebetween commission paid and $350 will be paid by April 30, 2006, therebyguaranteeing the third party a $350 minimum payment during the term of theagreement. As of December 31, 2005, the unearned distribution fee remainedunchanged at $830. As 

 

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of March 31, 2006, theCompany has not paid the minimum commission and accrued $350 from the unearneddistribution fee for minimum payments due in accounts payable and accruedliabilities. Further, the Company recognized net balance of the unearneddistribution fee of $480 as other income during the three months ended March31, 2006. The Company is currently is in the process of renegotiating thedistribution agreement with the same third party to settle the balance.

 

**13.          Related Party Transactions**

 

InJune 2003, the Company entered into an exclusive, ten-year license agreementwith LLPG, Inc. (“LLPG”), a corporation headed by, Jack Chitayat, a formerdirector of the Company. Under the terms of the agreement, LLPG has the rightto commercialize Liquidmetal alloys, particularly precious-metal basedcompositions, in jewelry and high-end luxury product markets. The Company, inturn, will receive royalty payments over the life of the contract on allLiquidmetal products produced and sold by LLPG.

 

We are a party to a consulting agreement withChitnis Consulting, Inc., which is owned 100% by Shekhar Chitnis, a formerdirector and executive officer of our company. Under this agreement, we haveengaged Chitnis Consulting to provide consulting services on an as-needed basisthrough December 31, 2005. On January 1, 2006, the term of the agreement wasextended to December 31, 2006. During the three months ended March 31, 2006 and2005, we incurred $0 and $13 in consulting fees from Chitnis Consulting.

 

We are a party to a consulting agreement with William Johnson, a boardmember. Under this agreement, Mr. Johnson provides consulting services on anas-needed basis through 2004 as it relates to marketing and developmentLiquidmetal alloy. In April 2006, the Company entered into an agreement withMr. Johnson effective from January 1, 2006 through December 31, 2006. Duringthe three months ended March 31, 2006 and 2005, we incurred $15 and $15 inconsulting fees from Mr. Johnson, respectively.

 

In November 2004, we entered intoan agreement with John Kang, our Chairman, President, and Chief Executive Officer,in which Mr. Kang agreed that certain stock transactions by him in 2002involving our common stock should have resulted in a liability under Section16(b) of the Securities Exchange Act of 1934, as amended (“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’ssubsequent indirect purchase and disposition of Liquidmetal Technologies commonstock in order to satisfy a personal agreement Mr. Kang made to Growell Metalin February 2002 regarding the guaranteed minimum value of the stock purchasedby Growell Metal in February 2002 (the purchases and dispositions incident tothis agreement occurred in August and November 2002, respectively). Lastly, thetransactions include open-market purchases of an aggregate of 89,300 shares ofour common stock made by Mr. Kang in August 2002.

 

The Audit Committee ofour Board of Directors conducted an independent inquiry into theabove-described transactions with the aid of independent legal counsel and, asa result of such inquiry, the Audit Committee concluded that the transactionsshould have resulted in a liability to the Company under Section 16(b) in theamount of $302. Mr. Kang has acknowledged this liability, and in an agreementnegotiated between Mr. Kang and the Audit Committee and approved by the fullBoard, Mr. Kang will pay this liability through periodic installments in 2005and 2006. As a result, the Company accrued for the $302 receivable in otherassets and other income as of December 31, 2004. The above-describedtransactions involving Growell Metal was reported on a new Form 4filed by Mr. Kang on November 15, 2004, and the open-market purchases werepreviously reported on a timely basis in August 2002. As of December 31, 2005,the outstanding amount of the receivable was $235, which is included in otherassets, and has remained unchanged as of March 31, 2006.

 

** 14. Subsequent Events**

 

In April 2006, theCompany has reached agreements in principle to settle the Company’spreviously-disclosed consolidated securities class action and shareholderderivative actions (see Note 12).

 

If approved by thecourts, the agreements would settle the consolidated class action litigation *entitled Primavera Investors v. Liquidmetal Technologies, Inc., et al.*,the consolidated shareholder derivative actions entitled *Brian Clair,Derivatively on*

 

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*Behalf ofLiquidmetal Technologies, Inc. v. John Kang, et al*. and *Joseph Durgin, Derivatively on Behalf of Liquidmetal Technologies, Inc.v. John Kang, et al*., and the shareholder derivative action entitled*Robert Story v. John Kang, et al.,* pendingin the United States District Court for the Middle District of Florida, TampaDivision, the Superior Court of Orange County, California, and the UnitedStates District Court for the Middle District of Florida, Tampa Division,respectively. The consolidated class action arose from a number of lawsuitsfiled in 2004 under the federal securities laws against Liquidmetal and certainof its former and current directors and officers. The derivative actions alsoarose from lawsuits originally filed in 2004 and was based upon the same factsand circumstances underlying the class action.

 

As part of theagreements, Liquidmetal’s directors’ and officers’ liability insurance carrierswill contribute a total of $7,500 to settle all of the actions: $7,025 for theconsolidated class action and $475 for the two derivative actions. The fundspaid to settle the consolidated class action will be principally paid into anescrow account within a specified period of time after the federal court grantspreliminary approval of the settlement. The funds will be disbursed to certainpurchasers of Liquidmetal securities according to a distribution plan to bedevised and approved by the federal court. In addition, Liquidmetal will committo maintaining or implementing various corporate governance measures inconnection with the settlement of the derivative actions.

 

Taking intoaccount the insurance contribution, the net cost of the settlement to thecompany should be approximately $500, which is the insurance deductible thecompany paid over several quarters ending in the third quarter of 2005, andwhich the Company previously recorded as a charge.

 

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**Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

** **

*This management’s discussion andanalysis should be read in conjunction with the condensed consolidatedfinancial statements and notes included elsewhere in this report onForm 10-Q.*

 

*This management’s discussion andanalysis, as well as other sections of this report on Form 10-Q, maycontain “forward-looking statements” that involve risks and uncertainties,including statements regarding our plans, future events, objectives,expectations, forecasts, or assumptions. Any statement that is not a statementof historical fact is a forward-looking statement, and in some cases, wordssuch as “believe,” “estimate,” “ project,” “expect,” “intend,” “may,” “anticipate,”“plans,” “seeks,” and similar expressions identify forward-looking statements.These statements involve risks and uncertainties that could cause actualoutcomes and results to differ materially from the anticipated outcomes orresults, and undue reliance should not be placed on these statements. Theserisks and uncertainties include, but are not limited to, the matters discussedunder the caption “Factors Affecting Future Results” in our Annual Report onForm 10-K for the fiscal year ended December 31, 2005 and other risks anduncertainties discussed in filings made with the Securities and ExchangeCommission (including risks described in subsequent reports on Form 10-Q,Form 10-K, Form 8-K, and other filings). Liquidmetal Technologiesdisclaims any intention or obligation to update or revise any forward-lookingstatements, whether as a result of new information, future events, orotherwise.*

 

**Overview**

 

We are a materials technology company thatdevelops and commercializes products 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, and sell products and components from bulkamorphous alloys that are incorporated into the finished goods of ourcustomers, and we also market and sell amorphous alloy industrial coatings. Wealso partner with third-party licensees and distributors to develop andcommercialize Liquidmetal alloy products. We have the exclusive right todevelop, manufacture, and sell what we believe are the only commercially viablebulk amorphous alloys.

 

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

 

Ourrevenues are derived from two principal operating segments: Liquidmetal alloyindustrial coatings and bulk Liquidmetal alloy products. Liquidmetal alloyindustrial coatings are used primarily as a protective coating for industrialmachinery and equipment, such as drill pipe used by the oil drilling industryand boiler tubes used in coal-burning power plants. The historical operatinginformation for fiscal year 2001 is based substantially on sales of Liquidmetalalloy coatings. In the second half of 2002, we began producing bulk Liquidmetalalloy components and products for incorporation into our customers’ finishedgoods. Bulk Liquidmetal alloy segment revenue includes sales of parts orcomponents 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. We expect that these sources of revenue willcontinue to significantly change the character of our revenue mix.

 

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

 

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

 

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

 

On August 4, 2004, the Company established aplant in the city of Weihai in Shandong province of China under WeihaiLiquidmetal Company Limited, which is 100% owned by Liquidmetal Korea, tofacilitate our bulk alloy manufacturing business. Weihai Liquidmetal isconsolidated into Liquidmetal Technologies with all intercompany transactionseliminated.

 

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

 

**CriticalAccounting Policies and Estimates**

** **

The preparation of condensed consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States requires us to make estimates and assumptionsthat affect reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period. Theseestimates and assumptions are based on historical experience and various otherfactors that are believed to be reasonable under the circumstances. Actualresults could differ materially from these estimates under differentassumptions or conditions.

 

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

 

•                  Exchange rate fluctuations

•                  Warranty accrual

•                  Allowance for doubtful accounts

•                  Inventories at lower of cost or net realizablevalue

•                  Deferred tax assets

 

Our Annual Report on Form 10-K for theyear ended December 31, 2005,containsfurther discussions on our critical accounting policies and estimates.

 

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

 

**Results of Operations**

 

Comparison of the threemonths ended March 31, 2006 and 2005

 

*Revenue*. Revenueincreased $3.8 million to $6.6 million for the three months ended March 31,2006 from $2.8 million for the three months ended March 31, 2005. Theincrease consisted of an increase of $2.1 million from the sales andprototyping of parts manufactured from bulk Liquidmetal alloys to consumerelectronics customers as a result of increased demand from electronic casingsapplications, an increase of $0.3 million from our research and developmentcontracts, and an increase of 

 

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$1.3 million from sales of our coatings products as a result ofincrease in demand from oil drilling applications.

 

*Cost of Sales*.Cost of sales increased to $5.3 million, or 81% of revenue, for the threemonths ended March 31, 2006 from $2.8 million, or 100% of revenue, for thethree months ended March 31, 2005. The decrease in cost of sales as apercentage of revenue was 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. Significant portions of our manufacturing costs continue toremain fixed. We believe that higher manufacturing volumes and greater mix ofhigher-margin products in the future will cause the gross profit to improveover time. The cost to manufacture parts from our bulk Liquidmetal alloys isvariable and differs based on the unique design of each product. However, thecost of sales for the products sold by the coatings business segment isgenerally consistent because the Liquidmetal coatings products are produced bythird parties and sold wholesale to various industries.

 

*Selling, General, and AdministrativeExpenses*. Selling, general, and administrative expensesdecreased to $2.7 million, or 41% of revenue, for the three months endedMarch 31, 2006 from $2.6 million, or 91% of revenue, for the three monthsended March 31, 2005. This increase was primarily a result of increase wagesand compensation of $0.7 million primarily from recognition of stock basedcompensation expense during the quarter and increases in employees, advertisingand promotions costs of $0.1 million primarily from higher commissions costs,travel expenses of $0.1 million, offset by decreases in professional servicesby $0.2 million, decrease in insurance costs of $0.4 million, and decrease indepreciation expenses of $0.1 million.

 

*Research and Development Expenses*.Research and development expenses decreased to $0.2 million, or 3% of revenue,for the three months ended March 31, 2006 from $0.4 million, or 14% ofrevenue, for the three months ended March 31, 2005. The Company continues toperform research and development of new Liquidmetal alloys and relatedprocessing capabilities, develop new manufacturing techniques, and contractwith consultants to advance the development of Liquidmetal alloys. The decreasewas primarily due to decreases in salaries, wages and related costs of$0.2 million

 

*Change in Value of Warrants.*Change in value of warrants decreased to anet loss of $1.3 million, or 20% of revenue, for the three months ended March31, 2006 from a net gain of $0.1 million, or 5% of revenue, for the threemonths ended March 31, 2005. The change in value of warrant consisted of warrantsissued from the senior convertible debt funded in March 2004 and exchanged inAugust 2004, convertible debt funded in June 2005, senior convertible debtfunded in August 2005, and subordinated promissory note funded in March 2006primarily as a result of fluctuations in our stock price.

 

*Change in Value of Conversion Feature.*Change in value ofconversion feature was a net loss of $1.0 million, or 15% of revenue, duringthe three months ended March 31, 2006 from the change in value of conversionfeature liability from the senior convertible debt funded in August 2005primarily as a result of fluctuations in our stock price. There were no amountsrecorded as change in value of conversion feature for the three months endedMarch 31, 2005.

 

*Other Income.*Otherincome was $480, or 7% of revenue, for the three months ended March 31, 2006from net gain recognized from termination of a distribution agreement with aJapanese sporting goods distributor originally entered into in March 1996. Therewere no amounts recognized as other income during the three months ended March31, 2005.

 

*Interest Expense*.Interest expense was $1.6 million, or 24% of revenue, for the three monthsended March 31, 2006 and was $1.3 million, or 44% of revenue, for the threemonths ended March 31, 2005. Interest expense consists primarily of interestaccrued on the Kookmin Bank loan funded in February 2003, senior convertibledebt funded in March 2004 and exchanged in August 2004, senior convertible debtfunded in August 2005, subordinated promissory note funded in March 2006, feescharged from short-term borrowings under the April 2005 factoring, loan, andsecurity agreement, as well as amortization of debt issuance costs and discounton the convertible debt. The increase was primarily due to additionalamortization of debt issuance costs and discount on debt funded in June 2005and August 2005 as well as fees from borrowings made under the April 2005factoring, loan, and security agreement.

 

*Interest Income.*Interestincome was $2 thousand for the three months ended March 31, 2006 and was $6thousand for the three months ended March 31, 2005 from interest earned on cashdeposits.

 

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**Liquidityand Capital Resources**

 

Our cash used foroperating activities was $1.2 million for the three months ended March 31,2006 and $1.1 million for the three months ended March 31, 2005. Ourworking deficit increased from $10.2 million at December 31, 2005 to $10.4million at March 31, 2006. The Company’s working deficit increase of $0.2million was primarily attributable to increase in accounts payable and accruedliability of $1.4 million, increase in short term debt of $1.7 million,increase in warrant liabilities of $1.4 million, increase in conversion featureliability of $1.0 million, offset by increase in trade accounts receivable of$1.1 million, decrease in settlement payable of $3.3 million, and decrease indeferred revenue of $0.9 million.

 

Our cash used ininvesting activities was $0.2 million for the three months ended March 31, 2006for the acquisition of property and equipment and investments in patents andtrademarks.

 

Our cash provided byfinancing activities was $1.4 million for the three months ended March 31,2006, which consists of $1.0 million in proceeds from borrowings from oursubordinated promissory note executed in March 2006 and $3.0 million inproceeds from factoring agreement executed in April 2005, offset by $2.6million on repayment of borrowings. The proceeds from borrowings have been usedto meet working capital requirements.

 

Our capital requirementsduring the next twelve months will depend on numerous factors, includingthe success of existing products either in manufacturing or development, thedevelopment of new applications for Liquidmetal alloys, the resources we devoteto develop and support our Liquidmetal alloy products, the success of pursuingstrategic licensing and funded product development relationships with externalpartners.

 

We have experiencedsignificant operating losses since our inception. Our net loss for the threemonths ended March 31, 2006 and 2005 was $5.1 million and $4.1 million,respectively. In the audit report on our financial statements for our fiscalyears ended December 31, 2005 and 2004, our auditors included a going-concernqualification indicating that our significant operating losses and workingcapital deficit cause substantial doubt about our ability to continue as agoing concern. By issuing an opinion stating that there is substantial doubt aboutour ability to continue as a going concern, our auditors have indicated thatthey are uncertain as to whether we have the capability to continue ouroperations without additional funding. Accordingly, we anticipate that we willneed additional funding during the next 12 months, and we plan to seek to raisesuch funds through public or private equity financing, bank debt financing, orfrom other sources. Specifically, we anticipate that we could need $1to $5 million over the next twelve months to pursue our currentoperating plan, although this amount may be lower depending on theorders we receive for our products. The amount of funding that we plan toseek and the timing of such fundraising efforts will depend on the extent towhich we are able to increase revenues through obtaining additional purchaseorders for our products, particularly components for cellular phones and flashmemory drive casings, and our ability to continue to improve our manufacturingprocesses. We evaluate our working capital needs and operating plan assumptionson a monthly basis to determine whether any adjustment to our cash andliquidity outlook is warranted, and we also review potential sources offinancing on an ongoing basis. However, adequate funds may not be available whenneeded, and if we raise additional funds by issuing equity securities, existingstockholders may be diluted. If we don’t receive sufficient funding to operateunder our current plan, we intend to reduce operations and expenses and shiftour focus to the pursuit of licensing transactions and other strategictransactions that are less capital intensive.

 

**ContractualObligations**

** **

The following table summarizes the Company’sobligations and commitments as of March 31, 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)                                 |       | 14,756     |       | 1,391                                                              |       | 13,365 |   | — |   | — |   |
| Short-term debt  (3)                                |       | 2,286      |       | 2,286                                                              |       | — |   | — |   | — |   |
| Capital lease  obligation (4)                       |       | 42         |       | 42                                                                 |       | — |   | — |   | — |   |
| Operating leases  and rents                         |       | 1,009      |       | 492                                                                |       | 516 |   | 1 |   | — |   |
| Consulting  services payable                        |       | 86         |       | 86                                                                 |       | — |   | — |   | — |   |
| Dongyang                                            |       | 11         |       | 11                                                                 |       | — |   | — |   | — |   |
| Nichimen                                            |       | 350        |       | 350                                                                |       | — |   | — |   | — |   |
|                                                |       | 18,540     |       | 4,658                                                              |       | 13,881 |   | 1 |   | — |   |

 

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(1) Contractual cashobligations include Long-Term Debt comprised of $2,310 of Senior ConvertibleNotes issued in 2004 and $9,878 of Convertible Notes issued in 2005, Short-TermDebt comprised of $1,286 advances received under factoring, loan, and securityagreement, $1,000 of unsecured subordinated promissory note issued in 2006,future minimum lease payments under capital and operating leases, and purchasecommitments from consultants, payments due from our discontinued equipmentmanufacturing business (Dongyang), and minimum payments due under adistribution agreement (Nichimen).

(2) Does not includeinterest payments of $1,342; and un-amortized discounts for beneficialconversion feature and warrants of $6,285 of our convertible notes.

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

(4) Includes imputedinterest of $1.

 

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**Off Balance Sheet Arrangements**

 

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

 

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

 

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

 

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

 

*InterestRates.*We are exposed to market risks relating to changes ininterest rates. Some of the proceeds of our initial public offering areinvested in short-term, interest-bearing, investment grade securities. Thevalue of these securities will be subject to interest rate risk and could fallin value if interest rates rise.

 

*CommodityPrices.*We are exposed to price risk related to anticipatedpurchases of certain commodities used as raw materials by our businesses,including titanium and zirconium. Although we do not currently enter intocommodity future, forward, and option contracts to manage the fluctuations 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.

 

*ForeignExchange Rates.*As a result of our operation of amanufacturing facility in South Korea, a substantial portion of our costs willbe denominated in the South Korean won. Consequently, fluctuations in theexchange rates of the South Korean won to the U.S. dollar will affect our costsof goods sold and operating margins and could result in exchange losses.Although we do not currently enter into foreign exchange hedge transactions, wemay do so in the future as our business grows.

 

**Item4 – Controls and Procedures**

** **

Evaluation of disclosure controls and procedures**.******As directed by Section 404 of theSarbanes-Oxley Act of 2002, or SOX, the SEC has adopted rules requiring publiccompanies to include a report of management on the company’s internal controlsover financial reporting in their annual reports on Form 10-K. In addition, thepublic accounting firm auditing a public company’s financial statements mustattest to and report on management’s assessment of the effectiveness of thecompany’s internal controls over financial reporting. Although theserequirements were first applicable to our annual report on Form 10-K for ourfiscal year ending December 31, 2004, we were unable to comply with theserequirements for such fiscal year. As disclosed in our amended Form 10-K filedwith the SEC on May 10, 2005, the time and resources necessary to complete therestatement of prior periods’ financial statements delayed our ability tocomplete the internal documentation, assessment and evaluation of internalcontrol over financial reporting, all of which are required to be undertaken tocomply with Section 404 of SOX. This delay prevented our independent auditor frombeing able to satisfactorily complete a timely audit of our internal controlover financial reporting as of December 31, 2004.

 

Due to these delays, we and our independent auditordetermined that it would not be possible to complete the management’s assessmentand auditor’s audit of our internal controls over financial reporting as ofDecember 31, 2004, and accordingly our independent auditor has issued adisclaimer of opinion with respect to our internal control over financialreporting as of December 31, 2004, and such disclaimer was filed with ouramended Form 10-K filed on May 10, 2005. The filing of this disclaimer does notcomply with the SEC’s rules and regulations under Section 404, and thisnoncompliance has resulted in us being in violation of Section 13(a) under theSecurities Exchange Act of 1934. Section 13(a) establishes the generalrequirement that public companies must file with the SEC, in accordance withsuch rules and regulations as the SEC may prescribe, such information,

 

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documents, and reports as the SEC may from time totime require for the protection of investors, including Form 10-Ks and 10-Qs.

 

In general, the SEC has broad authority under theSecurities Exchange Act of 1934 to institute investigations, to seekinjunctions, to seek monetary penalties, and to otherwise pursue enforcementactions for violations of Section 13(a), including a failure to file a Form10-K or for the omission of necessary statements in a Form 10-K. Therefore, aviolation under Section 404 of SOX or Section 13(a) of the Securities ExchangeAct of 1934 could potentially subject an issuer to these same investigationsand penalties. Section 404 of SOX is a relatively new legal requirement, andthere is very little precedent establishing the consequences or appropriateresponse to a public company’s failure to comply with Section 404. Accordingly,although we have discussed our Section 404 noncompliance with the SEC, wecannot predict what action, if any, the SEC may take against our company as aresult of a failure to be compliant with our obligations under Section 404 ofSOX or Section 13(a) of the Securities Exchange Act of 1934.

 

Effective December 27, 2005, the SEC announced finalrulings on revisions to accelerated filer definition and deadlines for periodicreports. The ruling revised the definition of the term “accelerated filer” topermit an accelerated filer that has voting and non-voting common equity heldby non-affiliates of less than $50 million to exit accelerated filer status atthe end of the fiscal year in which its equity falls below $50 million and tofile its annual report for that year and subsequent periodic reports on anon-accelerated basis. As of the fiscal year ended December 31, 2005, we areconsidered an accelerated filer and are required to comply with SOX 404requirements for the 2005 fiscal year.

 

In addition to the foregoing, although our commonstock was admitted to the OTC Bulletin Board for quotation on June 15, 2005, asa result of our noncompliance with Section 404 for our 2005 fiscal year, it maynot have been appropriate for the OTC Bulletin Board to admit our common stockfor quotation on June 15, 2005. Consequently, there is no assurance that ourcommon stock will remain eligible for quotation on the OTC Bulletin Board.

 

****On January 16, 2006, ourmanagement completed and concluded its documentation, assessment and evaluationof its internal controls over financial reporting as of December 31, 2005.During the course of its assessment, management identified the controldeficiencies described in Item 9A of our Form 10-K for the 2005 fiscal year.However, our independent auditors, Stonefield Josephson Inc., resigned onDecember 1, 2005, and on January 20, 2006, we engaged Choi, Kim & Park LLP(“CKP”) as our new independent registered public accounting firm. While we haveadvised CKP of the foregoing weaknesses in internal controls, due to theuntimeliness of the foregoing events, CKP was unable to conduct an audit of ourinternal control over financial reporting pursuant to Section 404 of SOX, andthus, have issued a disclaimer of an opinion on the company’s internal controlover financial reporting as of December 31, 2005.****

 

Update on Management’s Assessment of Internal Control Over FinancialReporting.

 

****Changes in internal controls.************Asof the end of the period covered by this report, an evaluation was carried outunder the supervision and with the participation of the company’s management,including its Chief Executive Officer and Chief Financial Officer, of itsdisclosure controls and procedures (as defined by Rules 13a –15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Basedupon that evaluation, the Chief Executive Officer and Chief Financial Officerconcluded that the design and operation of these disclosure controls andprocedures were effective. There has been no change in the registrant’sinternal control over financial reporting that occurred during the registrant’smost recent fiscal quarter that has materially affected, or is reasonablylikely to materially affect, the registrant’s internal control over financialreporting.

 

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**PART II**

**OTHERINFORMATION**

 

**Item 1 – Legal Proceedings**

 

In April 2006, theCompany reached agreements in principle to settle the Company’spreviously-disclosed consolidated securities class action and shareholderderivative actions.

 

If approved by thecourts, the agreements would settle the consolidated class action litigation *entitled Primavera Investors v. Liquidmetal Technologies, Inc., et al.*,the consolidated shareholder derivative actions entitled *Brian Clair,Derivatively on Behalf of Liquidmetal Technologies, Inc. v. John Kang, et al*.and *Joseph Durgin, Derivatively on Behalf of LiquidmetalTechnologies, Inc. v. John Kang, et al*., and the shareholderderivative action entitled *Robert Story v. John Kang,et al.,* pending in the United States District Court for the MiddleDistrict of Florida, Tampa Division, the Superior Court of Orange County,California, and the United States District Court for the Middle District ofFlorida, Tampa Division, respectively. The consolidated class action arose froma number of lawsuits filed in 2004 under the federal securities laws against theCompany and certain of its former and current directors and officers. Thederivative actions also arose from lawsuits originally filed in 2004 and wasbased upon the same facts and circumstances underlying the class action.

 

As part of theagreements, the Company’s directors’ and officers’ liability insurance carrierswill contribute a total of $7.5 million to settle all of the actions: $7.0million for the consolidated class action and $0.5 million for the twoderivative actions. The funds paid to settle the consolidated class action willbe principally paid into an escrow account within a specified period of timeafter the federal court grants preliminary approval of the settlement. Thefunds will be disbursed to certain purchasers of the Company securitiesaccording to a distribution plan to be devised and approved by the federalcourt. In addition, the Company will commit to maintaining or implementingvarious corporate governance measures in connection with the settlement of thederivative actions.

 

Taking into accountthe insurance contribution, the net cost of the settlement to the companyshould be approximately $0.5 million, which is the insurance deductible thecompany paid over several quarters ending in the third quarter of 2005, andwhich the company previously recorded as a charge.

 

**Item 1A – Risk Factors**

 

There have been no material changes to the riskfactors that are included in our Annual Report on Form 10-K for the year endedDecember 31, 2005 that could affect our business, results of operations orfinancial condition.

 

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

 

On March 17, 2006, in exchange for a $1.0 millionloan, we issued a $1.0 million 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 our company. The October 2006Note is unsecured and subordinated to all prior indebtedness of the company.All accrued interest and unpaid principal are due October 16, 2006. Theproceeds from the October 2006 Note were used for working capital purposes. Inconnection with the October 2006 Note, we issued warrants to Atlantic Realty topurchase an aggregate amount of up to 125,000 shares of common stockexercisable at $2.00 per share. The warrants will expire on March 17, 2009 andinclude price adjustment provisions for anti-dilution purposes. There are noregistration rights of the shares issuable from the exercise of the warrants.Further, cashless exercise of the warrants is permitted. We claimed exemptionfrom registration for this transaction under the Securities Act of 1933, asamended (the “Securities Act”), by virtue of Section 4(2) of the SecuritiesAct. The grant of this Note and the accompanying warrant (and the offer of theshares issuable upon exercise of the warrant) did not involve any publicoffering, was made without general solicitation or advertising, and AtlanticRealty is an accredited investor with access to all relevant informationnecessary to evaluate the investment and represented to us that the Note,warrant, and underlying shares were being acquired for investment.

 

**Item 3 - Defaults Upon SeniorSecurities**

 

None

 

**Item 4 - Submission of Matters toa Vote of Security Holders**

 

None

 

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**Item 5 –Other Information**

 

There were nomatters required to be disclosed in a current report on Form 8-K during thefiscal quarter covered by this report that were not so disclosed.

 

**Item 6 –Exhibits**

 

The following documents are filed as an exhibit to this Report:

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

 

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**SIGNATURES**

 

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

 
|               | LIQUIDMETAL TECHNOLOGIES                     |
|--------------------|----------------------------------------------|
|               | (Registrant)                                 |
|               |                                         |
| Date: May 10, 2006 | /s/ Ricardo A. Salas                         |   |
|               | Ricardo A. Salas                             |
|               | President and Chief Executive Officer        |
|               | (Principal Executive Officer)                |
|               |                                         |
|               |                                         |
| Date: May 10, 2006 | /s/ Young Ham                                |   |
|               | Young Ham                                    |
|               | Chief Financial Officer                      |
|               | (Principal Financial and Accounting Officer) |

 

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