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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2009

OR

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

For the transition period from          to         

Commission File No.  001-31332

LIQUIDMETAL TECHNOLOGIES, INC.

(Exact name of Registrant as specified in its charter)

30452 Esperanza

Rancho Santa Margarita, CA 92688

(address of principal executive office, zip code)

Registrant’s telephone number, including area code: (949) 635-2100

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Act).  See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b 2 of the Exchange Act). Yes o No x

As of November 16, 2009, there were 47,583,101 shares of the registrant’s common stock, $0.001 par value, outstanding.

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LIQUIDMETAL TECHNOLOGIES, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2009

FORWARD-LOOKING INFORMATION

Statements in this report concerning the future sales, expenses, profitability, financial resources, product mix, market demand, product development and other statements in this report concerning the future results of operations, financial condition and business of Liquidmetal Technologies, Inc. are “forward-looking” statements as defined in the Securities Act of 1933 and Securities Exchange Act of 1934. Investors are cautioned that the Company’s actual results in the future may differ materially from those projected in the forward-looking statements due to risks and uncertainties that exist in the Company’s operations and business environment, including competition, need for increased acceptance of products, ability to continue to develop and extend our brand identity, ability to anticipate and adapt to a competitive market, ability to effectively manage rapidly expanding operations, amount and timing of operating costs and capital expenditures relating to expansion of our business, operations and infrastructure, ability to provide superior customer service, dependence upon key personnel and the like. The Company’s most recent filings with the Securities and Exchange Commission, including Form 10-K, contain additional information concerning many of these risk factors, and copies of these filings are available from the Company upon request and without charge.

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PART I

FINANCIAL INFORMATION

Item 1 – Financial Statements

LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

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

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LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(in thousands, except per share data)

(unaudited)

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

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LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ DEFICIENCY

For the Nine Months Ended September 30, 2009

(in thousands, except per share data)

(unaudited)

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

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LIQUIDMETAL TECHNOLOGIES, INC.  AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands, except per share data)

(unaudited)

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

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LIQUIDMETAL TECHNOLOGIES AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

1.         Basis of Presentation / Description of Business

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“generally accepted accounting principles”) for interim financial information and with the instructions to Form 10-Q.  Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included.  All intercompany balances and transactions have been eliminated.  Operating results for the nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for any future periods or the year ending December 31, 2009.  The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Form 10-K filed with the Securities and Exchange Commission on April 15, 2009.

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

The Company classifies operations into two reportable segments: Liquidmetal alloy industrial coatings and bulk Liquidmetal alloys (see Note 9). Liquidmetal alloy industrial coatings are used primarily as a protective coating for industrial machinery and equipment, such as drill pipes used by the oil drilling industry and boiler tubes used by coal-burning power plants. Bulk Liquidmetal alloys include potential market opportunities to manufacture and sell products and components for electronic devices, medical devices, defense applications, and sporting goods.  In addition, the bulk Liquidmetal alloys segment includes tooling and prototype sampling.  Furthermore, such alloys are used to generate research and development services revenue for developing uses related primarily to defense and medical applications as well as potential license fees, royalties, and other compensation from strategic partnering transactions.

In July 2007, the Company transferred substantially all of the assets of its Liquidmetal alloy industrial coatings business to a newly formed, newly capitalized subsidiary named Liquidmetal Coatings, LLC, a Delaware limited liability company (“LMC”), and LMC assumed substantially all of the assets and liabilities of the coatings business.  The transfer included the thermal spray coatings assets and liabilities acquired under a purchase agreement with Foster Wheeler Energy Services in June 2007.  The Company holds a 69.25% ownership interest in LMC.  The results of operation of LMC are consolidated and comprise our Liquidmetal alloy industrial coatings segment for financial reporting purposes.

2.         Basis of Presentation and Recent Accounting Pronouncements

Translation of Foreign Currency

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

Reclassifications

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

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LIQUIDMETAL TECHNOLOGIES AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

Recent Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (“SFAS 160”). This statement establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Minority interests will be recharacterized as noncontrolling interests and classified as a component of shareholders’ equity separate from the parent’s equity. In addition, SFAS 160 establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. This statement is effective prospectively, except for certain retrospective disclosure requirements, for fiscal years beginning after December 15, 2008. The Company has adopted SFAS 160 as of January 1, 2009.

In April 2008, the FASB issued FASB Staff Position No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”). FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets.” The intent of FSP 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of an asset under SFAS 141(R) and other U.S. generally accepted accounting principles FSP 142-3 applies to intangible assets that are acquired individually or with a group of other assets acquired in business combinations and asset acquisitions. FSP 142-3 also requires expanded disclosure related to the determination of intangible asset useful lives. FSP 142-3 is effective for fiscal years beginning after December 15, 2008. The Company has adopted FSP 142-3 as of January 1, 2009.

In May 2008, the FASB issued FASB Staff Position No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP APB 14-1”) which clarifies that convertible debt instruments that may be settled in cash or other assets upon conversion are not addressed by APB No. 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants.” Additionally, FSP APB 14-1 requires an entity to separately account for the liability and equity components of a convertible instrument to reflect an entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 also expands the disclosure requirements regarding convertible debt instrument terms and how the instrument is reflected in an entity’s financial statements. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company has adopted APB 14-1 as of January 1, 2009.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles for nongovernmental entities. SFAS 162 will become effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” The Company has adopted SFAS 162 as of January 1, 2009.

In June 2008, the FASB ratified the consensus reached on EITF Issue No. 07-5, “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock” (“EITF 07-05”). EITF 07-5 clarifies the determination of whether an instrument (or an embedded feature) is indexed to an entity’s own stock, which would qualify as a scope exception under SFAS 133, Accounting for Derivative Instruments and Hedging Activities. EITF 07-5 is effective for financial statements issued for fiscal years beginning after December 15, 2008. Early adoption for an existing instrument is not permitted. The Company has adopted EITF 07-5 as of January 1, 2009.

In June 2008, FASB issued EITF Issue No. 08-4, “Transition Guidance for Conforming Changes to Issue No. 98-5” (“EITF 08-4”). The objective of EITF 08-4 is to provide transition guidance for conforming changes made to EITF 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios”, that result from EITF 00-27 “Application of Issue No. 98-5 to Certain Convertible Instruments”, and FAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. This Issue is effective for financial statements issued for fiscal years ending after December 15, 2008. Early application is permitted. The Company has adopted EITF 08-4 as of January 1, 2009.

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LIQUIDMETAL TECHNOLOGIES AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

In April 2009, the FASB issued FASB Staff Position No. 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies” (“FSP 141(R)-1”), which amends SFAS No. 141 (Revised 2007), “Business Combinations” (“SFAS 141(R)”). FSP 141(R)-1 applies to all assets acquired and liabilities assumed in a business combination that arise from contingencies that would be within the scope of SFAS No. 5, Accounting for Contingencies, if not acquired or assumed in a business combination, except for assets or liabilities arising from contingencies that are subject to specific guidance in SFAS 141(R). The provisions of FSP 141(R)-1 that amend SFAS 141(R) are effective for the first annual reporting period beginning on or after December 15, 2008. The Company adopted FSP 141(R)-1 on January 1, 2009, and the impact of this guidance will depend upon the nature, terms, and size of the acquisitions we consummate.

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP FAS 115-2 and FAS 124-2”), which amends SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and SFAS No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations. This FSP amends the other-than-temporary guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities. The provisions of FSP FAS 115-2 and FAS 124-2 that amend SFAS 115 and SFAS 124 are effective for interim and annual reporting periods ending after June 15, 2009. The implementation of this FSP is not expected to affect the Company’s consolidated results of operations or financial condition.

In June 2009, the FASB issued SFAS 166, “Accounting for Transfers of Financial Assets,” which will be effective for us on January 1, 2010.  SFAS 166 removes the concept of a qualifying special-purpose entity (QSPE) from SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities”, and removes the exception from applying FASB Interpretation 46R, “Consolidation of Variable Interest Entities”. This statement also clarifies the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. The Company is currently evaluating the impact of adopting this standard on the consolidated financial statements.

In June 2009, the FASB issued SFAS 167, “Amendments to FASB Interpretation No. 46R,” which will be effective for us on January 1, 2010. SFAS 167 requires an analysis to determine whether a variable interest gives the entity a controlling financial interest in a variable interest entity. This statement requires an ongoing reassessment and eliminates the quantitative approach previously required for determining whether an entity is the primary beneficiary. The Company does not expect a material effect from the adoption of this standard on our consolidated financial statements.

In June 2009, the FASB issued SFAS 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles — a replacement of FASB Statement No. 162,” which will be effective for us on September 30, 2009.  SFAS 168’s objective is to establish the FASB Accounting Standards Codification as the source of authoritative non-governmental accounting principles to be applied in the preparation of financial statements in conformity with US GAAP. Although SFAS 168 does not change GAAP, the adoption of SFAS 168 will impact our consolidated financial statements since all future references to authoritative accounting literature will be in accordance with SFAS 168.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA and the SEC did not or are not believed by management to have a material impact on our company’s present or future consolidated financial statements.

3.         Liquidity

The Company has experienced losses from continuing operations during the last three fiscal years and has an accumulated deficit of $159,844 as of September 30, 2009.  Cash used in operations for the nine months ended September 30, 2009 was $1,854; and cash flow from operations will likely be negative throughout fiscal year 2009.  As of September 30, 2009, the Company’s principal sources of liquidity are $121 of cash and $2,349 of trade accounts receivable.  Such conditions raise substantial doubt that the Company will be able to continue as a going concern.  These operating results occurred while the

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LIQUIDMETAL TECHNOLOGIES AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

Company was developing and continues to develop, commercialize, and manufacture products from an entirely new and unique technology.  These factors have placed a significant strain on the financial resources of the Company.  The ability of the Company to overcome these challenges depends on its ability to correct its production inefficiencies, reduce its operating costs, generate higher revenue, achieve positive cash flow from continuing operations and continued sources of debt and equity financing.  The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

On May 1, 2009, the Company completed a financing transaction (the “Transaction”) whereby aggregate cash of $2,500 and principal and accrued interest of $20,625 due under the previously issued 8% Convertible Subordinated Notes due January 2010 (the “Prior Notes”) were exchanged for 500,000 shares of convertible Series A-1 Preferred Stock with an original issue price of $5.00 per share, 2,625,002 shares Series A-2 Preferred Stock with an original issue price of $5.00 per share, and $7,500 of new 8% Senior Secured Convertible Subordinated Notes due January 2011 (the “Exchange Notes”). Of the $2,500 aggregate cash purchase price, approximately $100 remains outstanding and is included prepaid expenses and other current assets as of September 30, 2009.  The Transaction was consummated pursuant to a Securities Purchase and Exchange Agreement, dated May 1, 2009 (the “Securities Purchase Agreement”), among the exchanging note holders and investors (collectively, the “Buyers”).  The Securities Purchase Agreement gives the Buyers option to subscribe for an additional 1,000,000 shares of Series A-1 Preferred Stock at $5.00 per share at any time prior to six months from the closing date (the “Series A-1 Option”). (See Note 6)

On October 30, 2009, the Company entered into an agreement with Carlyle Liquid Holdings, LLC, a Buyer in the Transaction, to issue 180,000 shares of convertible Series A-1 Preferred Stock for $900 of cash pursuant to the Series A-1 Option (see Note 13).

The Company anticipates that it will not have sufficient funds to pursue its current operating plan beyond the fourth quarter of 2009 and will therefore require additional funding.  Because the Company cannot be certain that it will be able to obtain adequate funding from debt, equity, or other traditional financing sources, it is also actively pursuing several strategic financing options, including the intent to sell its manufacturing plant in South Korea (which would then be replaced with a smaller facility) and additional licensing and outsourcing of our manufacturing operations.

Additionally, we have approximately $291 of principal and accrued interest outstanding as of September 30, 2009, under the 8% unsecured subordinated notes (the “Bridge Notes”), which were due August 17, 2007.  We are working to repay the Bridge Notes with our noteholder.

We have $378 of outstanding loan as of September 30, 2009 under a factoring, loan, and security agreement with a financing company.  In June 2009, the Company received a formal notice of default from the financing company for repayment of the outstanding loan balance.  As of the filing of this report, the Company entered into a settlement agreement with the financing company whereby we agreed to repay approximately $100 each month until the outstanding loans and accrued fees have been repaid.  The first $100 monthly payment was made in November 2009.

We have outstanding liens and judgments on our assets by various creditors for past-due trade payables totaling $1,114 which are held by creditors in South Korea, as of September 30, 2009.  We are currently working to resolve the matter with each creditor by seeking forbearance until we are able to obtain funding to repay the amounts due, although there is no assurance that we will be able to obtain any such funding.   If we cannot repay the amounts due or obtain forbearance, the creditors may seek to foreclose on the Company’s assets.  Such a foreclosure would have material adverse effect on our operations, financial condition, and results of operations.

4.         Inventories

Inventories are accounted for using the moving average basis and at standard cost, which approximate cost on a first-in, first-out basis and are valued at the lower of cost or market.  Inventories were comprised of the following:

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LIQUIDMETAL TECHNOLOGIES AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

5.         Product Warranty

Management estimates product warranties as a percentage of certain bulk alloy product sales earned during the period.  As of September 30, 2009, the Company used 5% of bulk alloy product sales as an estimate of warranties to be claimed.  The percentage is based on industry averages and historical information.  Additionally, as of September 30, 2009 the Company used 1% of coatings applications sales as estimates of warranties to be claimed.

During the three and nine months ended September 30, 2009, the Company recorded $0 and $92 of net gain on warranty, respectively. During the three and nine months ended September 30, 2008, the Company recorded $46 and $68 of net gain on warranty, respectively. The warranty accrual balance is included in accounts payable and accrued expenses.

6.         Notes Payable

Unsecured Subordinated Notes

On May 17, 2006, September 21, 2006, and December 1, 2006, the Company issued 8% Unsecured Subordinated Notes due August 2007 in the aggregate principal amount of $4,584 (the “August 2007 Subordinated Notes”).  The August 2007 Subordinated Notes are unsecured and became due August 2007.

During 2007 and 2008, the Company retired $1,925 and $1,650 of the August 2007 Subordinated Notes, respectively.  During the second quarter of 2009, the Company retired $750 of the August 2007 Subordinated Notes.

As of September 30, 2009 and December 31, 2008, the Company’s gross outstanding loan balance of the August 2007 Subordinated Notes totaled $259 and $1,009, respectively, and is included in current portion of long-term debt.  As of September 30, 2009, the effective interest rate for the August 2007 Subordinated Notes was 8%.

Secured Convertible Subordinated Notes

On January 3, 2007 and December 28, 2007, the Company issued 8% Convertible Subordinated Notes due January 2010 in the aggregate principal amount of $17,300 (the “January 2010 Notes”).  Additionally, during 2007, 2008 and 2009, the Company issued $971, $1,315, and $723 of additional January 2010 Notes for accrued interest, respectively.   The January 2010 Notes were convertible into the Company’s common stock at $1.10 per share.

On May 1, 2009, the January 2010 Notes were retired as part of a financing transaction (see Senior Secured Convertible Notes below).

The Company’s gross outstanding loan balance of the January 2010 Notes totaled $0 and $19,113 as of September 30, 2009 and December 31, 2008, respectively.  As of September 30, 2009 and December 31, 2008, un-amortized discounts for conversion feature, warrants, and cash discount totaled $0 and $7,128, respectively, and other asset debt issuance costs totaled $0 and $655, respectively.  Interest expense for the amortization of debt issuance cost and discount on note was $0 and

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LIQUIDMETAL TECHNOLOGIES AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

$1,816 for the three and nine months ended September 30, 2009, respectively.  Interest expense for the amortization of debt issuance cost and discount on note was $1,006 and $2,563 for the three and nine months ended September 30, 2008, respectively.

Pursuant to Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” the Company is required to report a value of the conversion liability as a fair value and record the fluctuation to the fair value of the conversion feature liability to current operations.  The change in the fair value of the conversion feature liability resulted in losses of $0 and $1,137 for three and nine months ended September 30, 2009, respectively.  The change in the fair value of the conversion feature liability resulted in gains of $642 and $2,104 for three and nine months ended September 30, 2008, respectively.  The fair value of conversion feature outstanding at September 30, 2009 and December 31, 2008 was $0 and $147, respectively.

Senior Secured Convertible Notes

On May 1, 2009, the Company completed a financing transaction (the “Transaction”) whereby aggregate cash of $2,500 and principal and accrued interest of $20,625 due under the previously issued 8% Convertible Subordinated Notes due January 2010 (the “January 2010 Notes”) were exchanged for 500,000 shares of convertible Series A-1 Preferred Stock with an original issue price of $5.00 per share, 2,625,002 shares Series A-2 Preferred Stock with an original issue price of $5.00 per share, and $7,500 of new 8% Senior Secured Convertible Notes due January 2011 (the “January 2011 Notes”).   Of the $2,500 aggregate cash purchase price, approximately $100 remains outstanding and is included prepaid expenses and other current assets as of September 30, 2009.  Transaction was consummated pursuant to a Securities Purchase and Exchange Agreement, dated May 1, 2009 (the “Securities Purchase Agreement”), among the exchanging note holders and investors (collectively, the “Buyers”).  The Securities Purchase Agreement gives the Buyers option to subscribe for an additional 1,000,000 shares of preferred stock at $5.00 per share at any time prior to six months from the closing date.  Additionally, 8,138,352 of previously issued warrants to purchase common shares held by holders of the January 2010 Notes have been cancelled in the Transaction.

The January 2011 Notes are due January 3, 2011 and bear annual interest rate of 8% with interest payable in October and April in cash or, at the Company’s option, in the form of additional notes (in which case the interest rate will be 10%).  The preferred stocks accrue cumulative dividends at an annual rate of 8%, which is payable semi-annually. Beginning on the second anniversary of the initial issuance, the dividend will increase to 10%.  The dividends are payable in cash or in kind by the issuance of the Company of additional preferred stock, only when and as declared by the Company’s Board of Directors.

The Series A-1 Preferred Stock, Series A-2 Preferred Stock, and January 2011 Notes are convertible into the Company’s common stock at conversion price of $0.10, $0.22, and $0.60 per common share, respectively.  The Company issued warrants to purchase 3,125,007 shares and 42,329,407 shares of the Company’s common stock at an exercise of $0.60 and $0.50 per share to the buyers of the January 2011 Notes and preferred stocks, respectively.  The warrants will expire on January 3, 2012.  The conversion prices and the number of common stock issuable under the preferred stocks, January 2011 Notes and warrants are subject to adjustments for anti-dilution purposes.

In connection with the Transaction, the Company and the Buyers entered into a Registration Rights Agreement under which the Company is required, upon the written request of the holders of more than fifty percent (50%) of the securities underlying the January 2011 Notes, warrants, and preferred stocks, on or before 180 days after the closing of the Transaction, to file a registration statement with the SEC covering the resale of the shares of Company’s common stock issuable pursuant to the January 2011 Notes, the warrants and the preferred stocks and to use its best efforts to have the registration declared effective at the earliest date (but in no event later than 60 days after filing if there is no SEC review of the registration statement, or 120 days if there is an SEC review).   The Company may be required to pay liquidated damages as set forth in the Registration Rights Agreement, if the registration statement is not filed or does not become effective on a timely basis.

The redemption of the previously issued January 2010 Notes was treated as an extinguishment of debt in accordance with Emerging Issues Task Force No. 96-19, “Debtors Accounting for a Modification or Exchange of Debt Instruments.”  The Transaction resulted in a $2,029 loss from extinguishment of debt, which consisted of write down of $503 other asset deferred

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LIQUIDMETAL TECHNOLOGIES AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

issue costs, $5,487 debt discount, $1,306 decrease in conversion feature liability of the extinguished notes, $2,347 decrease in warrant liability from the warrants redeemed from holders of the January 2011 Notes, and $308 write off of accrued fees.

Pursuant to Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” EITF 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments,” and EITF 05-2 “The Meaning of ‘Conventional Convertible Debt Instrument’ in EITF Issue No. 00-19,” the original fair value of the embedded conversion feature of $3,367 have been recorded as conversion feature liability as the debt is considered nonconventional convertible debt. The original fair value was computed using the Black-Scholes model under the following assumptions: (1) expected life of 1.68 years; (2) volatility of 176%; (3) risk free interest of 0.92% and dividend rate of 0%. In addition, the Company is required to report a value of the conversion liability as a fair value and record the fluctuation to the fair value of the conversion feature liability to current operations.

The change in the fair value of the conversion feature liability resulted in gains of $474 and $2,572 for the three and nine months ended September 30, 2009, respectively.  The fair value of conversion feature outstanding at September 30, 2009 was $795.   The fair value of conversion feature outstanding at September 30, 2009 was computed using the Black-Scholes model under the following assumptions: (1) expected life of 1.26 years; (2) volatility of 174%, (3) risk free interest of 0.4% and dividend rate of 0%.

Pursuant to EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”, the original fair values of the warrants of $14,773 have been recorded as warrant liability, which was computed using the Black-Scholes pricing model under the following assumptions: (1) expected life of 2.67 years; (2) volatility of 176%; (3) risk free interest of 1.39% and (4) dividend rate of 0%.

The original fair value of the embedded conversion feature of $3,367 was recorded as discounts on the convertible notes and the original fair value of the warrants issued to buyers of the January 2011 Notes of $999 was recorded as discounts of the convertible notes. The original fair value of warrants issued to buyers of preferred stocks of $13,774 was recorded as reduction of additional paid-in capital. In addition, the Company incurred $440 of direct costs relating to the Transaction, of which $143 of was recorded as debt issuance cost in other assets relating to issuance of the convertible notes and $297 was recorded as reduction of additional paid-in capital relating to the issuance of the preferred stocks.

The Company’s gross outstanding loan balance of the January 2011 Notes totaled $7,500 as of September 30, 2009.  As of September 30, 2009, un-amortized discounts for conversion feature and warrants totaled $3,691, and other asset debt issuance costs totaled $121.  Interest expense for the amortization of debt issuance cost and discount on note was $441 and $696 for the three and nine months ended September 30, 2009, respectively.  The effective interest rate of the January 2011 Notes was 70% as of September 30, 2009.

Factoring Agreement

The Company entered into a Factoring, Loan, and Security Agreement (the “Agreement”) with a financing company on April 21, 2005.  All borrowings are secured by outstanding receivables specifically assigned to the financing company.  Further, pursuant to a Continuing Guaranty Agreement, dated January 5, 2009, the outstanding borrowings are personally guaranteed by John Kang, the Company’s Chairman. Assigned receivables are considered “Approved” or “Non-Approved” by the financing company.  Borrowings made against non-approved receivables assigned are limited to $1,000 and total borrowings made on approved and non-approved receivables assigned are limited to $5,000.

Payments on assigned receivables are received directly by the financing company, and applied to outstanding advances.  All outstanding advances and uncollected assigned receivables are subject to fees and interest charges ranging from 0.55% to 1.5% plus prime rate as published by the Wall Street Journal, with a minimum annual fee of $30. All receivables assigned and advances made are subject to return and recall by the financing company, respectively.  As such, the advances have been classified as short-term secured borrowings in accordance with SFAS No. 140 “Accounting for Transfer and Servicing of Financial Assets and Extinguishments of Liabilities.”

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

For the nine months ended September 30, 2009, the Company borrowed $38 and repaid $239 under the Agreement.  The total outstanding advance made under the agreement is $378 and $580 as of September 30, 2009 and December 31, 2008, respectively, which is presented as short-term debt.  The weighted average rate of interest for borrowings made under the Agreement was 7.96% and 6.95% for the nine months ended September 30, 2009 and 2008, respectively.   In June 2009, the Company received a formal notice of default from the financing company for repayment of the outstanding loan balance.  As of the filing of this report, the Company entered into a settlement agreement with the financing company whereby the Company agreed to repay approximately $100 each month until the outstanding loans and accrued fees have been repaid.  The first $100 monthly payment was made in November 2009.

Kookmin Note

On February 4, 2003, the Company’s Korean subsidiary received 6,500,000 in South Korean Won, or approximately $5,488, under a loan from Kookmin Bank of South Korea.  This loan is collateralized by the plant facilities and certain equipment in South Korea.

On September 16, 2009, the Company retired the loan and paid $219 in outstanding principal and interest.

The outstanding loan balance totaled $0 and $151, as of September 30, 2009 and December 31, 2008, respectively, and are included in current portion of long-term debt.

Debt of Majority Owned Subsidiary

On July 24, 2007, the Company completed an $11,500 financing transaction (the “Transaction”) that provided funding to repay convertible notes previously issued by us that were scheduled to become due in July and August 2007.  In the Transaction, the Company transferred substantially all of the assets of the Company’s Liquidmetal Coatings division to a newly formed, newly capitalized subsidiary named Liquidmetal Coatings, LLC, a Delaware limited liability company (“LMC”), and LMC assumed substantially all of the liabilities of the division.

LMC was capitalized through a $6,500 subordinated debt and equity investment by C3 Capital Partners (“C3”) and a $5,000 senior credit facility with Bank Midwest, N.A.  This debt and equity resulted in cash proceeds of $11,102 after related debt issuance costs of $398, which proceeds LMC used to purchase all of the assets and liabilities from the Company.  The Company incurred an additional $459 in issuance costs directly related to the debt issuance.  As a result, $857 was recorded as deferred debt issuance costs to be amortized over the life of the debt.  Interest expense for the amortization of debt issuance cost was $42 and $121 for the three and nine months ended September 30, 2009, respectively.  Interest expense for the amortization of debt issuance cost was $41 and $142 for the three and nine months ended September 30, 2008, respectively.

The Company retains a 69.25% ownership interest in LMC, C3 holds a 19% ownership interest, Larry Buffington, the Company’s President and CEO, (who also serves as the President and CEO of LMC) holds a 10% ownership interest, and CRESO Capital Partners (“CRESO”), the Company’s financial advisor in the Transaction, holds a 1.75% ownership interest.  The equity interests acquired by C3 and issued to CRESO were not considered a discount to debt, as the unconsolidated net assets of LMC were deemed to have an initial value of $0 upon closing of the Transaction for financial accounting purposes.  Further, LMC is fully responsible for the repayment of debt obligations.

Midwest Debt

In connection with the Transaction, LMC entered into a Loan Agreement (the “Loan Agreement”), dated July 24, 2007, with Bank Midwest, N.A. (“Midwest”).  Following the Transaction, the Loan Agreement has been amended to renew and modify certain terms. The Loan Agreement, as amended, provides for total loan availability of $5,350, consisting of a $4,000 term loan with an annual interest rate of 8.48% and a revolving loan of up to $1,350 with a variable interest equal to prime rate as published in the Wall Street Journal with a minimum interest rate of 6.5%.  Interest payments are due monthly.  The term loan has a maturity date of July 20, 2011.  The revolving loan has a maturity date of September 24, 2009, which was extended through June 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

30, 2010 as of the filing of this report (see Note 13).  Borrowing availability under the revolving loan is based in a percentage of LMC’s eligible receivables and eligible inventory, and the initial advance under the revolving loan was $1,000 on July 24, 2007.

LMC’s obligations under the Loan Agreement are secured by a blanket security interest in all of LMC’s assets and the Company’s equity interest in LMC, and pursuant to an intercreditor agreement between the C3 and Midwest.  Midwest’s security interest in the assets is senior to C3’s security interest in the same assets.

LMC is required to make monthly principal payments under the term loan of: $63 during months 1 through 12, $83 during months 13 through 36, and $104 during months 37 through 48.  All remaining principal is due and payable on July 20, 2011.  If the term loan is prepaid within the first twenty-four (24) months after July 24, 2007, LMC will pay a prepayment penalty of 1% of the outstanding principal balance, together with accrued interest.  After the twenty-four month period has lapsed, LMC will have the right to prepay the term loan without penalty.

As of September 30, 2009 and December 31, 2008, the gross outstanding loan balance under the term loan totaled $1,979 and $2,729, respectively, and the gross outstanding loan balance under the revolving loan totaled $600 and $597, respectively. The loans are presented as long-term debt and short-term debt on the Company’s consolidated balance sheet, respectively.  Interest expense incurred under the term loan and revolving loan totaled $54 and $177 for the three and nine months ended September 30, 2009, respectively.   Interest expense incurred under the term loan and revolving loan totaled $63 and $243 for the three and nine months ended September 30, 2008, respectively.

Additionally, LMC entered into Promissory Notes, dated August 29, 2007 and October 21, 2008 (the “Capital Loan”), with Midwest to provide for $45 and $105 to be used towards the purchase of a company truck and HVOF spray equipment with annual interest rates of 7.43% and 8.25%, respectively.  The Capital Loan has maturity dates of September 1, 2012 and November 1, 2013.  LMC is required to make monthly principal and interest payments of $3 per month.  As of September 30, 2009 and December 31, 2008, the gross outstanding loan balance under the Capital Loan totaled $109 and $129, respectively, which is presented as long-term debt on the Company’s consolidated balance sheet.  Interest expense incurred under the Capital Loan totaled $2 and $7 for the three and nine months ended September 30, 2009, respectively.  Interest expense incurred under the Capital Loan totaled $1 and $2 for the three and nine months ended September 30, 2008, respectively.

C3 Debt

In the Transaction, LMC also entered into a Securities Purchase Agreement, dated July 24, 2007 (the “Securities Purchase Agreement”), with C3 Capital Partners, L.P. (“C3”), C3 Capital Partners II, L.P. (“C3 II”, and with C3, the “C3 entities”), and Liquidmetal Coatings Solutions, LLC, a wholly owned subsidiary of LMC that will operate the thermal spray coatings business (“LMCS”).  Pursuant to the Securities Purchase Agreement, LMC issued to the C3 entities subordinated promissory notes in the aggregate principal amount of $6,500 (the “Subordinated Notes”). Under the Securities Purchase Agreement, the C3 entities have the right, beginning on the July 24, 2012 (or, if earlier, upon a default by LMC under the Subordinated Notes or Securities Purchase Agreement) to require LMC to purchase the C3 entities’ membership interests in LMC for a purchase price equal to their pro rata portion of the greater of (i) the appraised fair market value of LMC or (ii) six times LMC’s trailing 12-month earnings before interest, taxes, depreciation, and amortization, less funded debt.

The Subordinated Notes have a maturity date of July 20, 2012 with no required principal payments before maturity other than upon specified triggering events, such as a change in control of LMC.  Interest accrues at an annual rate of 14%, with 12% interest being payable monthly beginning September 2007 and the remaining 2% interest being payable at maturity.  In connection with the Securities Purchase Agreement and the Subordinated Notes, the Company and LMC entered into pledge agreements with the C3 entities in which the Company pledged its membership interest in LMC to secure the obligations under the notes and LMC pledged its membership interests in LMCS to secure its obligations under the notes.  LMC and LMCS also granted to C3 a blanket security interest in all of their assets to secure their obligations under the Subordinated Notes.

The gross outstanding loan balance including accrued interest payable upon maturity of the Subordinated Note totaled $6,791 and $6,690 as of September 30, 2009 and December 31, 2008, respectively.  Interest expense incurred under the Subordinated Notes totaled $203 and $606 for the three and nine months ended September 30, 2009, respectively.  Interest expense incurred under the Subordinated Notes totaled $199 and $594 for the three and nine months ended September 30, 2008, respectively.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

7.         Stock Compensation Plan

During the nine months ended September 30, 2009, under the Company’s 2002 Non-employee Director Stock Option Plan which provides for the grant of stock options to non-employee directors, the Company granted options to purchase 120,000 of the Company’s common shares for an average exercise price of $0.21.  Further, all options granted under this plan had exercise prices that were equal to the fair market value on the date of grant.

During the nine months ended September 30, 2009, under the Company’s 2002 Equity Incentive Plan which provides for the grant of stock options to officers, employees, consultants and directors of the Company its subsidiaries, the Company granted options to purchase 233,010 of the Company’s common shares for an average exercise price of $0.21.    Further, all options granted under this plan had exercise prices that were equal to the fair market value on the date of grant.

The Company cancelled 701,308 options during the nine months ended September 30, 2009, for terminated employees and options expired.

8.         Preferred Units of Subsidiary

On February 22, 2008, LMC completed a transaction under which it issued and sold $2,500 in preferred membership units to two minority members of LMC (the “Preferred Units Transaction”).  Immediately following the sale of the preferred membership units, the subscription proceeds (after a 1% transaction fee) were distributed to LMC’s common unit members, and as a result of such distribution, the Company received approximately $1,714 in the distribution.  The preferred units issued by LMC have an accruing priority return of 14% per year that are priority over any distribution made by LMC and may be redeemed at any time within four years of issuance through cash payment or distribution in excess of the 14% priority return.  If LMC fails to redeem the preferred units on or before the second anniversary of the issue date, the preferred units will receive an additional 200 common membership units (equal to 2% of the currently outstanding common units) per quarter until the preferred units are redeemed in full.

As of September 30, 2009, LMC has redeemed $236 of its preferred units and distributed $290 in priority return to the preferred unit holders.  The total preferred units outstanding are $2,264 as of September 30, 2009.

9.         Segment Reporting and Geographic Information

SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, requires companies to provide certain information about their operating segments.  In April 2002, the Company began classifying operations into two reportable segments: Liquidmetal alloy industrial coatings and bulk Liquidmetal alloys.  The Liquidmetal alloy industrial coatings are used primarily as a protective coating for industrial machinery and equipment, such as drill pipe used by the oil drilling industry and boiler tubes used by coal burning power plants.  Bulk Liquidmetal alloys include market opportunities to manufacture and sell casing components 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 and development costs and selling expenses associated with identifying and developing market opportunities.  Bulk Liquidmetal alloys products can be distinguished from Liquidmetal alloy coatings in that the bulk Liquidmetal alloy can have significant thickness, up to approximately one inch, which allows for their use in a wider variety of applications other than a thin protective coating applied to machinery and equipment.   Revenue and expenses associated with research and development services and product licensing arrangements are included in the bulk Liquidmetal alloy segment.  The accounting policies of the reportable segments are the same as those described in Note 3 to the consolidated financial statements included in the Company’s Form 10-K filed with the Securities and Exchange Commission on April 15, 2009.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

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

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

Included in bulk alloy segment income for the nine months ended September 30, 2008 is $247 of other income and $17 of other expense. Excluded general and administrative expenses are attributable to the Company’s corporate headquarters.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

These expenses primarily include corporate salaries, consulting, professional fees and facility costs.  Research and development expenses are included in the operating costs of the segment that performed the research and development.

Revenues from sales to companies in the United States were $1,983 and $3,038 during the three months ended September 30, 2009 and 2008, respectively.  The revenue related to the United States of America was earned under defense-related research and development contracts, sales of coatings products, and sales of Liquidmetal bulk alloy products.

During the three months ended September 30, 2009, the Company had revenue from sales to companies outside of the United States of $2,226 of which $1,404 represented sales to companies located in South Korea.  During the three months ended September 30, 2008, the Company had revenues from companies outside of the United States of $2,003 of which $131 represented sales to companies located in South Korea.  The revenue related to sales to companies outside of the United States was from bulk alloy products.

Long-lived assets include net property, plant, and equipment, and net intangible assets. The Company had long-lived assets of $1,985 and $1,813 located in the United States at September 30, 2009 and December 31, 2008, respectively. The Company had long-lived assets of $6,380 and $6,277 located in South Korea at September 30, 2009 and December 31, 2008, respectively.

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

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

10.      Income (Loss) Per Common Share

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

Options to purchase 7,627,484 shares of common stock at prices ranging from $0.09 to $15.00 per share were outstanding at September 30, 2009, but were not included in the computation of diluted EPS for the same period as the inclusion would have been antidilutive.  Warrants to purchase 55,428,242 shares of common stock with prices ranging from $0.50 to $1.55 per share outstanding at September 30, 2009, were not included in the computation of diluted EPS for the same period as the inclusion would have been antidilutive. 12,500,000 shares of common stock issuable upon conversion of the Company’s convertible notes with conversion prices of $0.60 per share outstanding at September 30, 2009 were not included in the computation of diluted EPS for the same period because the inclusion would have been antidilutive.  Additionally, 82,752,841 shares of common stock issuable upon conversion of the Company’s convertible preferred stocks with conversion prices ranging from $0.10 and $0.22 per share outstanding at September 30, 2009 were not included in the computation of diluted EPS for the same period because the inclusion would have been antidilutive.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

Pursuant to EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”, the Company is required to report a value of the warrant as a fair value and record the fluctuation to the fair value of the warrant liability to current operations.  The change in the fair value of the warrants resulted in gains of $2,015 and $8,138 for the three and nine months ended September 30, 2009, respectively, and gains of $989 and $2,385 for the three and nine months ended September 30, 2008, respectively. The fair value of warrants outstanding at September 30, 2009 of $4,981 was computed using the Black-Scholes model under the following assumptions: (1) expected life of 0.70 to 3.24 years; (2) volatility of 174%, (3) risk free interest of 0.40% to 1.45%, and dividend rate of 0%.  The fair value of warrants outstanding at December 31, 2008 of $692 was computed using the Black-Scholes model under the following assumptions: (1) expected life of 0.21 to 3.99 years; (2) volatility of 113%, (3) risk free interest of 0.11% to 1.55%, and dividend rate of 0%.

11.      Commitments and Contingencies

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

On June 26, 2006, the Company entered into a joint venture agreement with SAGA, SpA in Padova, Italy, (“SAGA”) a specialist precision parts manufacturer.  The joint venture is named Liquidmetal SAGA Italy, Srl (“LSI”).  The Company also entered into an exclusive manufacturing license agreement for the eyewear industry with LSI.  Under the joint venture agreement, the Company has option to buy ownership interest in LSI, initially, of 19.9% to up to 50%.  In December 2006, the Company exercised the 19.9% interest in LSI and will have two years to purchase the additional interest at a nominal price. In January 2007 and June 2007, the Company contributed additional $217 and $86, respectively, into LSI as additional investment.  The contribution did not change the Company’s 19.9% interest in LSI.  Under the licensing agreement, at any time following 18 months after the effective date of the agreement, LSI may exercise its option to sell to the Company certain business assets including manufacturing equipment acquired under the joint venture.  During 2008, 2007 and 2006, the Company recognized revenues of $0, $103 and $702, respectively, of Liquidmetal alloys sold to LSI for use in the joint venture.   There were no alloys sold to LSI during the three and nine months ended September 30, 2009.

We have outstanding liens and judgments on our assets by various creditors for past-due trade payables totaling $1,114 which are held by creditors in South Korea, as of September 30, 2009.  We are currently working to resolve the matter with each creditor by seeking forbearance until we are able to obtain funding to repay the amounts due, although there is no assurance that we will be able to obtain any such funding.   If we cannot repay the amounts due or obtain forbearance, the creditors may seek to foreclose on the Company’s assets.  Such a foreclosure would have material adverse effect on our operations, financial condition, and results of operations.

12.      Related Party Transactions

Soo Buchanan, the sister of John Kang, the Company’s Chairman, provides services to the Company as a consultant.  During the three and nine months ended September 30, 2009, the Company incurred $0 for her services as a consultant.  During the three and nine months ended September 30, 2008, the Company incurred $10 and $70, respectively, for her services as a consultant. Additionally, Otis Buchanan, the husband of Ms. Buchanan, was employed by the Company and was paid aggregate compensation of approximately $27 and $82 during each of the three and nine months ended September 30, 2009 and 2008, respectively.

John Kang, Chairman of the Company, advanced the Company $250 during the three and nine months ended September 30, 2009 to fund working capital needs.  The Company repaid $85 of the advance and has $165 outstanding as of September 30, 2009, which is included in short-term debt.  Further, Mr. Kang entered into a Continuing Guarantee Agreement, dated January 5, 2009, to personally guarantee repayment of the Company’s outstanding borrowings made under a Factoring Agreement (see Note 6).

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

In May 2009, the Company completed a transaction in which (i) the holders of our 8% Convertible Subordinated Notes exchanged such notes for a combination of new 8% Senior Secured Convertible Notes and shares of a new series of convertible preferred stock designated “Series A-2 Preferred Stock”, together with warrants thereon, and (ii) certain investors purchased, for an aggregate purchase price of $2,500, shares of a new series of convertible preferred stock designated as “Series A-1 Preferred Stock” (see Note 6).   The lead investors in this transaction were Carlyle Liquid, LLC and Carlyle Liquid Holdings, LLC (the “Carlyle Entities”), which are two investor entities organized by Abdi Mahemedi and Jack Chitayat.  Mr. Mahemedi became a director and greater-than-5% beneficial owner of our company by reason of the May 2009 transaction, and Jack Chitayat is a former director of our company who became a greater-than-5% beneficial owner of our company by reason of the May 2009 transaction.  Mr. Mahemedi and Mr. Chitayat have shared voting and investment control over the shares held by the Carlyle Entities due to the fact that other entities owned by them are the managing members of these two Carlyle entities.  Additionally, Mr. Iraj Azarm, a director of our company, is a passive investor in the Carlyle Entities, and James Kang, a greater-than-5% beneficial owner of our company and the brother of our Chairman John Kang, is also an indirect passive investor in the Carlyle Entities.

The Company has an exclusive license agreement with LLPG, Inc. (“LLPG”), a corporation headed by Mr. Chitayat.  Under the terms of the agreement, LLPG has the right to commercialize Liquidmetal alloys, particularly precious-metal based compositions, in jewelry and high-end luxury product markets.  The Company, in turn, will receive royalty payments over the life of the contract on all Liquidmetal products produced and sold by LLPG.    The Company recognized revenues from product sales and licensing fees of $0 and $203 from LLPG during the three and nine months ended September 30, 2009 and $119 and $290 of revenues during the three and nine months ended September 30, 2008, respectively.  Approximately, $52 and $30 is included in accounts receivables as of September 30, 2009 and December 31, 2008, respectively, for outstanding trade receivables due from LLPG.

As of September 30, 2009 and December 31, 2008, Ricardo Salas, the Company’s Executive Vice President, held $0 and $381 of the convertible unsecured subordinated notes, respectively, and $259 of the unsecured subordinated notes for both periods.  Mr. Salas advanced the Company $75 during the three and nine months ended September 30, 2009 to meet working capital needs and are included in short-term debt.  The $75 advance accrues interest at an annual rate of 10%.

On June 1, 2007, the Company entered into a transaction with Grace Metal (currently Liquidmetal Korea Co., Ltd. “LMK”), under which (i) LMK agreed to purchase various equipments (including die casting machines and vacuum induction melters) used in the Company’s bulk amorphous alloy business segment and (ii) the Company granted LMK a 10-year exclusive license to manufacture products made from bulk Liquidmetal alloys for customers whose principal headquarters or whose major operations are located in South Korea.  LMK was formed by an investor group that includes the former director and officer of the Company, James Kang, who is also the brother of John Kang, Chairman of our company.  Under an equipment purchase agreement between the Company and LMK, LMK agreed to buy the purchased equipment for a total purchase price of $2,000.  The equipment purchase agreement provides that delivery of the equipment can be delayed to accommodate the Company’s continuing manufacturing needs, and it also provides that the Company will retain a security interest in the purchased equipment until full payment of the purchase price.

In consideration of the license agreement with LMK, the Company will be entitled to royalty of 10% of LMK’s net sales of licensed products (unless LMK’s margin on the products falls below specified levels, in which case a new royalty will be negotiated in good faith).  Effective June 1, 2008, the royalty rate was adjusted to 5%.  The agreement provides that the Company may convert the license to a non-exclusive in the event that the net sales in the second year of the contract or thereafter are not sufficient to result in royalties of $500 or more per year.  The agreement also provides that LMK will be required to purchase all alloy feedstock from the Company, and the Company will have the right to continue to manufacture Liquidmetal alloy products for South Korean customers until all purchased equipment has been commissioned.

The Company purchased production supplies and outsourced production of certain bulk alloy production with LMK. In June 2008, the Company began sharing the use of its manufacturing facility and production equipment in Pyongtaek, South Korea, with LMK as the Company began significant outsourcing of its bulk alloy parts production. The Company incurred expenses for purchase of production supplies and outsourcing fees of $698 and $1,135 during the three and nine months ended September 30, 2009, respectively, and $830 and $1,213 during the three and nine months ended September 30, 2008,

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2009 and 2008

(in thousands, except share data)

(unaudited)

respectively.  Approximately, $29 and $0 is included in accounts payable and accrued expenses as of September 30, 2009 and December 31, 2008, respectively, for outstanding trade payables due to LMK.  The Company recognized revenue from sales of raw materials and royalties for a total of $1,652 and $3,775 during the three and nine months ended September 30, 2009, respectively, and $296 and $1,628 during the three and nine months ended September 30, 2008, respectively.  Approximately, $942 and $212 is included in accounts receivables as of September 30, 2009 and December 31, 2008, respectively, for outstanding trade receivables due from LMK.

In November 2009, John Kang, the Company’s Chairman, Tony Chung, the Company’s Chief Financial Officer, and Ricardo Salas, the Company’s Executive Vice President, acquired 100,000 shares of the Company’s Series A-1 Preferred Stock and warrants to purchase 2,500,000 of common stock held by Carlyle Liquid Holdings, LLC for an aggregate cash price of $500.  The Series A-1 Preferred Stock are convertible into the Company’s common stock at a conversion price of $0.10 per common share.  Further, the warrants are issuable into the Company common stock at an exercise price of $0.50 per share and expire on October 30, 2014.

13.      Subsequent Events

On October 6, 2009, Liquidmetal Coatings, LLC entered into an agreement with Bank Midwest, N.A. to amend the terms of a senior credit facility and promissory notes originally funded between July 2007 and October 2008 (the “Loan Modification Amendment”).  The Loan Modification Agreement adjusts, among other terms, the interest rate of all outstanding loans to a fixed rate of 9%, certain financial covenants under the term loan, maturity date of the revolving loan through June 30, 2010, and requires an immediate repayment of $325 of the term note and $325 of the revolving loan.  The members of the Liquidmetal Coatings, LLC (the “Members”) are required to contribute $1,000 in equity to repay the amounts due under the Loan Modification Amendment (the “Capital Call”).  On October 6, 2009 the Members contributed $650 to pay down the loans.  As a result of the payment, the monthly amortization payments due under the term loan were reduced to $47 and the maturity date was extended to September 30, 2012.  Additionally, the Members are required to contribute an additional $350 on or before December 15, 2009 to repay the term loan and revolving loan if certain financial convents are not met.

In connection with the Loan Modification Agreement, the Company borrowed $450 from C3 Capital Partners (“C3”) to contribute its share of the Capital Call pursuant to a bridge loan agreement with C3.  The bridge loan was paid by the Company as of the filing of this report.

On October 30, 2009, the Company entered into an agreement with Carlyle Liquid Holdings, LLC, to issue 180,000 shares of convertible Series A-1 Preferred Stock for $900 of cash.  The Series A-1 Preferred Stock are convertible into the Company’s common stock at a conversion price of $0.10 per common share.  Further, the Company issued warrants to purchase 4,500,000 shares of common stock at an exercise price of $0.50 per share with an expiration date of October 30, 2014.

On November 1, 2009, the Company issued $378 of new 8% Senior Secured Convertible Notes Due January 2011 (the “New Notes”).  The New Notes were issued in satisfaction of accrued interest due under the original 8% Senior Secured Convertible Notes issued by the Company in May 2009 (the “Original Notes”) The Original Notes and New Notes all become due in January 2011.  The New Notes bear interest at 8% per annum with interest payable semi annually in arrears and are subordinate to certain secured financing from commercial lenders incurred by us in the future.

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Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

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

This management’s discussion and analysis, as well as other sections of this report on Form 10-Q, may contain “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 statement of historical fact is a forward-looking statement, and in some cases, words such 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 actual outcomes and results to differ materially from the anticipated outcomes or results, and undue reliance should not be placed on these statements. These risks and uncertainties include, but are not limited to, the matters discussed under the caption “Factors Affecting Future Results” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 and other risks and uncertainties discussed in filings made with the Securities and Exchange Commission (including risks described in subsequent reports on Form 10-Q, Form 10-K, Form 8-K, and other filings). Liquidmetal Technologies disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

Overview

We are a materials technology company that develops and commercializes products made from amorphous alloys.  Our Liquidmetal® family of alloys consists of a variety of coatings, powders, bulk alloys, and composites that utilize the advantages offered by amorphous alloy technology.  We develop, manufacture, and sell products and components from bulk amorphous alloys that are incorporated into the finished goods of our customers, and we also market and sell amorphous alloy industrial coatings.  We also partner with third-party licensees and distributors to develop and commercialize Liquidmetal alloy products.  We have the exclusive right to develop, manufacture, and sell what we believe are the only commercially viable bulk amorphous alloys.

Amorphous alloys are unique materials that are distinguished by their ability to retain a random atomic structure when they solidify, in contrast to the crystalline atomic structure that forms in ordinary metals and alloys when they solidify. Liquidmetal alloys possess a combination of performance, processing, and cost advantages that we believe makes them preferable to other materials in a variety of applications. The amorphous atomic structure of our alloys enables them to overcome certain performance limitations caused by inherent weaknesses in crystalline atomic structures, thus facilitating performance and processing characteristics superior in many ways to those of their crystalline counterparts. For example, our zirconium-titanium Liquidmetal alloys are approximately 250% stronger than commonly used titanium alloys, such as Ti-6Al-4V, but they have processing characteristics similar in many respects to plastics. We believe these advantages could result in Liquidmetal alloys supplanting other incumbent materials in a wide variety of applications. Moreover, we believe these advantages will enable the introduction of entirely new products and applications that are not possible or commercially viable with other materials.

Our revenues are derived from three principal operating segments: Liquidmetal alloy industrial coatings, Liquidmetal coatings application, and bulk Liquidmetal alloy products.  Liquidmetal alloy industrial coatings are used primarily as a protective coating for industrial machinery and equipment, such as drill pipe used by the oil drilling industry and boiler tubes used in coal-burning power plants. Liquidmetal coatings application is the service provided for applying Liquidmetal products as a protective coating.  Bulk Liquidmetal alloy segment revenue includes sales of parts or components of electronic devices, medical products, and sports and leisure goods, tooling and prototype parts (including demonstration parts and test samples) for customers with products in development, product licensing and arrangements, and research and development revenue relating primarily to defense and medical applications.  We expect that these sources of revenue will continue to significantly change the character of our revenue mix.

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

Selling, general, and administrative expenses currently consist primarily of salaries and related benefits, stock-based

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compensation, travel, consulting and professional fees, depreciation and amortization, insurance, office and administrative expenses, and other expenses related to our operations.

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

On July 24, 2007, we transferred substantially all of the assets of our Liquidmetal alloy industrial coatings business to a newly formed, newly capitalized subsidiary named Liquidmetal Coatings, LLC, a Delaware limited liability company (“LMC”), and LMC assumed substantially all of the liabilities of the coatings business.   The transfer included the thermal spray coatings assets and liabilities acquired under a purchase agreement with Foster Wheeler Energy Services in June 2007.  We hold a 69.25% ownership interest in LMC.  The results of operation of LMC are consolidated and comprise our Liquidmetal alloy industrial coatings segment for financial reporting purposes.

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

Critical Accounting Policies and Estimates

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  These estimates and assumptions are based on historical experience and various other factors that are believed to be reasonable under the circumstances.  Actual results could differ materially from these estimates under different assumptions or conditions.

We believe that the following accounting policies are the most critical to our condensed consolidated financial statements since these policies require significant judgment or involve complex estimates that are important to the portrayal of our financial condition and operating results:

·                  Exchange rate fluctuations

·                  Warranty accrual

·                  Allowance for doubtful accounts

·                  Inventories at lower of cost or net realizable value

·                  Deferred tax assets

·                  Valuation of derivatives of warrants and embedded conversion features

Our Annual Report on Form 10-K for the year ended December 31, 2008, contains further discussions on our critical accounting policies and estimates.

Results of Operations

Comparison of the three months ended September 30, 2009 and 2008

Revenue. Revenue decreased $0.8 million to $4.2 million for the three months ended September 30, 2009 from $5.0 million for the three months ended September 30, 2008.  The decrease consisted of $0.7 million from the sales of our coating products as a result decrease in demand in oil drilling applications, a decrease of $0.2 million from our research and development contracts, which were offset by a $0.1 million increase in sales and prototyping of parts manufactured from bulk Liquidmetal alloys to consumer electronics customers as a result of increase in demand in electronic casings applications.

Cost of Sales. Cost of sales decreased to $2.9 million, or 69% of revenue, for the three months ended September 30, 2009 from $3.8 million, or 75% of revenue, for the three months ended September 30, 2008.  The decrease was a result of a

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continued change in revenue mix during the three months ended September 30, 2009. The cost to manufacture parts from our bulk Liquidmetal alloys is variable and differs based on the unique design of each product.  However, the cost of sales for the products sold by the coatings business segment is generally consistent because the Liquidmetal coatings products are produced by third parties and sold wholesale to various industries.

Selling, General, and Administrative Expenses. Selling, general, and administrative expenses decreased to $1.3 million, or 32% of revenue, for the three months ended September 30, 2009 from $1.4 million, or 28% of revenue, for the three months ended September 30, 2008. The decrease was primarily a result of a decrease in salaries and related benefits expense of $0.1 million.

Research and Development Expenses. Research and development expenses were $0.3 million, or 8% of revenue, for the three months ended September 30, 2009 and $0.3 million, or 6% of revenue, for the three months ended September 30, 2008.  We continue to perform research and development of new Liquidmetal alloys and related processing capabilities, develop new manufacturing techniques, and contract with consultants to advance the development of Liquidmetal alloys.

Change in Value of Warrants.  Change in value of warrants increased to a gain of $2.0 million, or 48% of revenue, for the three months ended September 30, 2009 from a gain of $1.0 million, or 20% of revenue, for the three months ended September 30, 2008.  The change in value of warrants consisted of warrants issued from convertible and subordinated notes and convertible preferred stocks issued between 2004 and 2009 primarily as a result of fluctuations in our stock price.

Change in Value of Conversion Feature. Change in the value of conversion feature liability from our convertible notes resulted in a gain of $0.5 million, or 11% of revenue, during the three months ended September 30, 2009 from a gain of $0.6 million, or 13% of revenue, for the three months ended September 30, 2008, primarily as a result of fluctuations in our stock price.

Interest Expense. Interest expense was $1.1 million, or 25% of revenue, for the three months ended September 30, 2009 and was $1.9 million, or 37% of revenue, for the three months ended September 30, 2008. Interest expense consists primarily of debt discount amortization and interest accrued on outstanding convertible and subordinated notes, borrowings under a factoring, loan, and security agreement, a revolving loan agreement, and the Kookmin loan.  The decrease was due to certain of our convertible and subordinated notes retired during the second quarter of 2009.

Comparison of the nine months ended September 30, 2009 and 2008

Revenue. Revenue decreased $6.2 million to $11.3 million for the nine months ended September 30, 2009 from $17.5 million for the nine months ended September 30, 2008.  The decrease consisted of $2.6 million decrease in sales and prototyping of parts manufactured from bulk Liquidmetal alloys to consumer electronics customers as a result of decrease in demand in electronic casings applications, a decrease of $2.8 million from the sales of our coating products as a result decrease in demand in oil drilling applications, and a decrease of $0.8 million from our research and development contracts.

Cost of Sales. Cost of sales decreased to $6.9 million, or 61% of revenue, for the nine months ended September 30, 2009 from $13.3 million, or 76% of revenue, for the nine months ended September 30, 2008.  The decrease was a result of a continued change in revenue mix during the nine months ended September 30, 2009. The cost to manufacture parts from our bulk Liquidmetal alloys is variable and differs based on the unique design of each product.  However, the cost of sales for the products sold by the coatings business segment is generally consistent because the Liquidmetal coatings products are produced by third parties and sold wholesale to various industries.

Selling, General, and Administrative Expenses. Selling, general, and administrative expenses decreased to $4.3 million, or 38% of revenue, for the nine months ended September 30, 2009 from $4.6 million, or 26% of revenue, for the nine months ended September 30, 2008. The decrease was primarily a result of decreases in salaries and related benefits expenses of $0.2 million and professional services expenses of $0.2 million.

Research and Development Expenses. Research and development expenses were $0.9 million, or 8% of revenue, for the nine months ended September 30, 2009 and $0.8 million, or 5% of revenue for the nine months ended September 30, 2008.  The increase was primarily a result of an increase in salaries and related benefits expenses of $0.1 million.  We continue to perform research and development of new Liquidmetal alloys and related processing capabilities, develop new manufacturing techniques, and contract with consultants to advance the development of Liquidmetal alloys.

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Loss from Extinguishment of Debt.  Loss from extinguishment of debt increased to $1.5 million, or 13% of revenue, for the nine months ended September 30, 2009 from $0 for the nine months ended September 30, 2008.  The $1.5 million loss was recognized from extinguishment of certain of our convertible and subordinated notes during the second quarter of 2009.

Change in Value of Warrants.  Change in value of warrants increased to a gain of $8.1 million, or 72% of revenue, for the nine months ended September 30, 2009 from a gain of $2.4 million, or 14% of revenue, for the nine months ended September 30, 2008.  The change in value of warrants consisted of warrants issued from convertible and subordinated notes and convertible preferred stocks issued between 2004 and 2009 primarily as a result of fluctuations in our stock price.

Change in Value of Conversion Feature. Change in the value of conversion feature liability from our convertible notes resulted in a gain of $1.4 million, or 13% of revenue, during the nine months ended September 30, 2009 from a gain of $2.1 million, or 12% of revenue, for the nine months ended September 30, 2008, primarily as a result of fluctuations in our stock price.

Other Expense.  Other expense was $17 thousand for the nine months ended September 30, 2008 from costs of issuing shares of preferred units of our subsidiary.   There was no other expense for the nine months ended September 30, 2009.

Other Income.  Other income was $0.2 million, or 1% of revenue, for the nine months ended September 30, 2008 from write off of accounts payables.   There was no other income for the nine months ended September 30, 2009.

Interest Expense. Interest expense was $4.8 million, or 42% of revenue, for the nine months ended September 30, 2009 and was $5.3 million, or 30% of revenue, for the nine months ended September 30, 2008. Interest expense consists primarily of debt discount amortization and interest accrued on outstanding convertible and subordinated notes, borrowings under a factoring, loan, and security agreement, a revolving loan agreement, and the Kookmin loan.  The decrease was due to extinguishment of certain of our convertible and subordinated notes during the second quarter of 2009.

Interest Income.  Interest income was $3 thousand for the nine months ended September 30, 2008 from interest earned on cash deposits.  There was no interest income for the nine months ended September 30, 2009.

Liquidity and Capital Resources

Our cash used in operating activities was $1.9 million for the nine months ended September 30, 2009 and our cash provided by operating activities was $0.3 million for the nine months ended September 30, 2008.  Our working capital deficit decreased from $20.8 million at December 31, 2008 to $13.4 million at September 30, 2009.  The working capital deficit decrease of $7.4 million was primarily attributable to an increase of accounts receivables of $0.1 million, increase of inventories of $0.3 million, decrease of long-term debt, current portion, net of discounts of $12.8 million, offset by decrease of prepaid expenses and other current assts of $0.3 million, increase of accounts payable and accrued expenses of $0.6 million, increase of warrant liabilities of $4.3 million, and increase of conversion feature liabilities of $0.6 million.

Our cash used in investing activities was $0.7 million for the nine months ended September 30, 2009 for the acquisition of property and equipment and investments in patents and trademarks.

Our cash provided by financing activities was $2.5 million for the nine months ended September 30, 2009.  We paid net $12.8 million in borrowings from a factoring agreement executed in April 2005, a revolving and term loan agreement executed in July 2007, and convertible and subordinated notes, which were offset by $15.3 million proceeds from issuance of convertible preferred stocks.

On May 1, 2009, we completed a financing transaction (the “Transaction”) whereby aggregate cash of $2.5 million and principal and accrued interest of $20.6 million due under the previously issued 8% Convertible Subordinated Notes due January 2010 (the “Prior Notes”) were exchanged for 500,000 shares of convertible Series A-1 Preferred Stock with an original issue price of $5.00 per share, 2,625,002 shares Series A-2 Preferred Stock with an original issue price of $5.00 per share, and $7.5 million of new 8% Senior Secured Convertible Subordinated Notes due January 2011 (the “Exchange Notes”). Of the $2.5 million aggregate cash purchase price, approximately $0.1 million remains outstanding and is included prepaid expenses and other current assets in the condensed consolidated balance sheet as of September 30, 2009.  The Transaction was consummated pursuant to a Securities Purchase and Exchange Agreement, dated May 1, 2009 (the “Securities

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Purchase Agreement”), among the exchanging note holders and investors (collectively, the “Buyers”).  The Securities Purchase Agreement gives the Buyers option to subscribe for an additional 1,000,000 shares of Series A-1 Preferred Stock at $5.00 per share at any time prior to six months from the closing date (the “Series A-1 Option”).

The Exchange Notes are due January 3, 2011 and bear annual interest rate of 8% with interest payable in October and April in cash or, at our company’s option, in the form of additional notes (in which case the interest rate will be 10%).  The preferred stocks accrue cumulative dividends at an annual rate of 8%, which is payable semi-annually. Beginning on the second anniversary of the initial issuance, the dividend will increase to 10%.  The dividends are payable in cash or in kind by the issuance of the company of additional preferred stock, only when and as declared by our Board of Directors.

The Series A-1 Preferred Stock, Series A-2 Preferred Stock, and Exchange Notes are convertible into the company’s common stock at conversion price of $0.10, $0.22, and $0.60 per common share, respectively.  We issued warrants to purchase 3,125,007 shares and 42,329,407 shares of our company’s common stock at an exercise of $0.60 and $0.50 per share to the buyers of the Exchange Notes and preferred stocks, respectively.  The warrants will expire in January 2012.  The conversion prices and the number of common stock issuable under the preferred stocks, Exchange Notes and warrants are subject to adjustments for anti-dilution purposes.

On October 30, 2009, we entered into an agreement with Carlyle Liquid Holdings, LLC, a Buyer in the Transaction, to issue 180,000 shares of convertible Series A-1 Preferred Stock for $0.9 million of cash pursuant to the Series A-1 Option.  Further, we issued warrants to purchase 2,500,000 shares of common stock at an exercise price of $0.50 per share with an expiration date of October 30, 2014.

We anticipate that we will not have sufficient funds to pursue our current operating plan beyond the fourth quarter of 2009 and we will therefore require additional funding.  Because we cannot be certain that we will be able to obtain adequate funding from debt, equity, or other traditional financing sources, we are also actively exploring several strategic financing options, including the possible sale of our manufacturing plant in South Korea (which would then be replaced with a smaller facility) and additional licensing and outsourcing of our manufacturing operations.

Additionally, we have approximately $0.3 million of principal and accrued interest outstanding as of September 30, 2009, under the 8% unsecured subordinated notes (the “Bridge Notes”), which were due August 17, 2007. We are working to repay the Bridge Notes with our noteholder.

We have $0.4 million of outstanding loan as of September 30, 2009 under a factoring, loan, and security agreement with a financing company.  In June 2009, we received a formal notice of default from the financing company for repayment of the outstanding loan balance.  As of the filing of this report, we entered into a settlement agreement with the financing company whereby the agreed to repay approximately $0.1 million each month until the outstanding loans and accrued fees have been repaid.  The first $0.1 million monthly payment was made in November 2009.

We have outstanding liens and judgments on our assets by various creditors for past-due trade payables totaling $1.1 million, which are held by creditors in South Korea, as of September 30, 2009.  We are currently working to resolve the matter with each creditor by seeking forbearance until we are able to obtain funding to repay the amounts due, although there is no assurance that we will be able to obtain any such funding.   If we cannot repay the amounts due or obtain forbearance, the creditors may seek to foreclose on the Company’s assets.  Such a foreclosure would have material adverse effect on our operations, financial condition, and results of operations.

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Contractual Obligations

The following table summarizes the Company’s obligations and commitments as of September 30, 2009: