SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

 

LIQUIDMETAL TECHNOLOGIES, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

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 o No ý

 

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

 

Yes ý No o

 

As of December 31, 2004, there were 41,609,652 shares of the registrant’s common stock, $.001 par value, outstanding.

 

 

FORM 10-Q

 

FOR THE QUARTER ENDED

 

SEPTEMBER 30, 2004

 

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.

 

2

 

TABLE OF CONTENTS

 

PART I
Item 1 – Financial Statements
	Condensed Consolidated Balance Sheets (unaudited)
	Condensed Consolidated Statements of Operations and Comprehensive Loss (unaudited)
	Condensed Consolidated Statements of Shareholders’ Equity (unaudited)
	Condensed Consolidated Statements of Cash Flows (unaudited)
	Notes to Condensed Consolidated Financial Statements (unaudited)
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3 – Quantitative and Qualitative Disclosures about Market Risk
Item 4 – Controls and Procedures
PART II – Other Information
Item 2 – Changes in Securities and Use of Proceeds
Item 6 – Exhibits and Reports on Form 8-K
Signatures
Certifications

 

Explanatory Note

 

We have restated certain quarterly financial statements previously reported and related disclosures to correct our premature recognition of revenues from one transaction with a single customer that we originally recorded in March 2003.  We have also restated our financial statements for the fiscal year ended December 31, 2002 and related disclosures in our annual report on Form 10-K to correct two similar premature revenue recognition events with the same customer that were originally recorded in September and December 2002.  Upon analysis of the transaction terms and certain related agreements undertaken by the Company to resolve a dispute with the customer, we concluded that the transactions were contingent upon continued performance by a subsidiary of the Company, which would have precluded revenue recognition until the contingency ended. Under the terms of a Settlement Agreement reached with the customer on January 10, 2004, the Company reacquired the equipment associated with the two fiscal 2002 transactions and recognized the revenue associated with the March 2003 transaction in January 2004.  The restatement of our December 31, 2002 financial statements resulted in a $1.9 million reduction of revenue and a $1.0 million increase in net loss.  The restatement of our 2003 financial statements did not have any impact for the quarter ended September 30, 2003.  The effect of the restatement during the nine months ended September 30, 2003 is a decrease in revenues by $3.0 million and an increase in net loss by $1.4 million.

 

3

 

Item 1 – Financial Statements

 

LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

		September 30, 2004			December 31, 2003
		(unaudited)
ASSETS
Current Assets:
Cash and cash equivalents		$	1,396		$	3,127
Restricted cash		1,000			—
Trade accounts receivables, net of allowance for doubtful accounts of $203 and $127		3,590			3,748
Inventories		5,681			3,731
Prepaid expenses and other current assets		1,506			395
Assets available for sale, net		—			827
Total current assets		13,173			11,828
Property, plant and equipment, net		15,857			17,743
Other intangibles, net		1,108			984
Other assets		815			297
Total assets		$	30,953		$	30,852
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable and accrued expenses		$	8,423		$	3,683
Deferred revenue		838			1,435
Long-term debt, current portion, net of discounts of $980		5,826			1,032
Other liabilities, current portion		636			4,705
Total current liabilities		15,723			10,855
Long-term debt, net of current portion		2,650			3,015
Other long-term liabilities, net of current portion		1,245			814
Total liabilities		19,618			14,684
Commitments and Contingencies:
Minority interest		—			5
Shareholders’ Equity:
Common stock, $0.001 par value; 100,000,000 shares authorized and 41,609,652 issued and outstanding at September 30, 2004 and December 31, 2003		42			42
Paid in capital		132,160			128,581
Unamortized stock-based compensation		—			(128		)
Accumulated deficit		(121,612		)	(112,587		)
Accumulated comprehensive income		745			255
Total shareholders’ equity		11,335			16,163
Total liabilities and shareholders’ equity		$	30,953		$	30,852

 

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

 

4

 

LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except per share data)

(unaudited)

 

		For the Three Months Ended Sept. 30,						For the Nine Months Ended Sept. 30,
		2004			2003			2004			2003
											restated
Revenue		$	4,615		$	3,281		$	14,958		$	11,013
Cost of sales		3,241			4,595			9,273			11,401
Gross profit (loss)		1,374			(1,314		)	5,685			(388		)
Operating Expenses:
Selling, general, and administrative		3,569			3,661			9,178			12,294
Research and development		374			981			1,060			7,755
Total expenses		3,943			4,642			10,238			20,049
Loss from operations		(2,569		)	(5,956		)	(4,553		)	(20,437		)
Loss from extinguishments of debt		(1,663		)	—			(1,663		)	—
Other expense (including $427 change in warrant value)		(434		)	—			(434		)	—
Other income		302			—			1,582			—
Interest expense		(1,805		)	(106		)	(3,242		)	(281		)
Interest income		—			53			34			281
Gain on sale of marketable securities held-for-sale		—			—			—			1,178
Loss from operations before minority interest, income taxes and discontinued operations		(6,169		)	(6,009		)	(8,276		)	(19,259		)
Income taxes		—			—			—			—
Minority interest in loss (income) of consolidated subsidiary		—			(23		)	—			(26		)
Loss from continuing operations		(6,169		)	(5,986		)	(8,276		)	(19,233		)
Loss from discontinued equipment manufacturing operations, (net of tax of $8 for the nine months ended September 30, 2003)		—			(115		)	(749		)	(425		)
Net loss		(6,169		)	(6,101		)	(9,025		)	(19,658		)
Other comprehensive loss:
Foreign exchange translation gain		68			687			490			846
Net unrealized loss on marketable securities held-for-sale (including transfer of realized gain of $1,178)		—			—			—			(1,668		)
Comprehensive loss		$	(6,101	)	$	(5,414	)	$	(8,535	)	$	(20,480	)
Net loss per common share – basic and diluted:
Loss per share – continuing operations		$	(0.15	)	$	(0.14	)	$	(0.20	)	$	(0.46	)
Loss per share – discontinued operations		$	—		$	(0.01	)	$	(0.02	)	$	(0.01	)
Loss per share basic and diluted		$	(0.15	)	$	(0.15	)	$	(0.22	)	$	(0.47	)
Number of weighted average shares – basic and diluted		41,610			41,610			41,610			41,532

 

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

 

5

 

LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the Nine months Ended September 30, 2004

(in thousands, except share data)

(unaudited)

 

		Common Shares		Common Stock			Paid in Capital			Unamortized Stock-Based Compensation			Accumulated Deficit			Comprehensive Income			Total
Balance, December 31, 2003		41,609,652		$	42		$	128,581		$	(128	)	$	(112,587	)	$	255		$	16,163
Stock-based compensation		—		—			261			15			—			—			276
Unamortized stock-based compensation		—		—			(113		)	113			—			—			—
Beneficial conversion feature of convertible debt		—		—			3,424			—			—			—			3,424
Warrants cancelled		—		—			7			—			—			—			7
Foreign exchange translation gain		—		—			—			—			—			490			490
Net loss		—		—			—			—			(9,025		)	—			(9,025		)
Balance, September 30, 2004		41,609,652		$	42		$	132,160		$	—		$	(121,612	)	$	745		$	11,335

 

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

 

6

 

LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands, except share data)

(unaudited)

 

		For the Nine Months Ended Sept. 30,
		2004			2003
					restated
Operating Activities:
Net loss		$	(9,025	)	$	(19,658	)
Adjustments to reconcile loss from continuing operations to net cash provided by (used for) operating activities:
Loss on disposal of property and equipment		8			—
Gain on sale of marketable securities held-for-sale		—			(1,178		)
Depreciation and amortization		2,585			3,462
Loss on extinguishments of debt		1,663			—
Amortization of debt discount		2,692			—
Stock-based compensation		276			293
Bad debt expense		111			(134		)
Warranty expense		269			283
Changes in operating assets and liabilities:
Accounts receivable		47			1,292
Inventories		(1,950		)	(1,650		)
Prepaid expenses and other current assets		(1,111		)	1,464
Other assets		(877		)	174
Accounts payable and accrued expenses		3,887			(5,139		)
Deferred revenue		(597		)	62
Other liabilities		(4,259		)	291
Net cash used for continuing operations		(6,281		)	(20,438		)
Net cash provided by (used for) discontinued operations		822			(1,771		)
Net cash used for operating activities		(5,459		)	(22,209		)
Investing Activities:
Purchases of property and equipment		(73		)	(1,961		)
Proceeds from sale of property and equipment		11			—
Proceeds from sale of marketable securities held-for-sale		—			2,578
Investment in patents and trademarks		(202		)	(252		)
Net cash provided by (used) for investing activities		(264		)	365
Financing Activities:
Proceeds from borrowings		9,924			5,488
Repayment of borrowings		(4,898		)	—
Repayment of other liabilities		(91		)	(43		)
Stock warrants exercised		—			5
Stock options exercised		—			391
Restricted cash		(1,000		)	—
Net cash provided by financing activities		3,935			5,841
Effect of foreign exchange translation		57			(469		)
Net increase (decrease) in cash and cash equivalents		(1,731		)	(16,472		)
Cash and cash equivalents at beginning of period		3,127			25,058
Cash and cash equivalents at end of period		$	1,396		$	8,586
Supplemental cash flow information:
Interest paid		$	463		$	145
Taxes paid		$	—		$	126

 

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

 

7

 

During the nine months ended September 30, 2004, the Company sold it’s 51% ownership interest in Dongyang to the 49% minority shareholder, which resulted in a loss of $46 from disposal of discontinued operations.

 

During the nine months ended September 30, 2004, the Company sold assets and liabilities of its Taesung equipment manufacturing division in Korea to a third party which resulted in a loss of approximately $184.

 

During the nine months ended September 30, 2004, the change in the foreign exchange between the U.S. Dollar and the South Korean Won resulted in a $574 gain related to property, plant and equipment, net and loss of $133 from notes payable.

 

During the nine months ended September 30, 2004, the Company completed a private exchange offer for its Senior debt.  Under terms of the exchange offer, approximately $5.5 million in aggregate principal amount of the notes have been exchanged for an aggregate of (i) $2.75 million of 6% Senior Secured Notes Due 2007 (the “Long-Term Notes”) and (ii) $2.75 million of 10% Senior Secured Notes Due 2005 (the “Short-Term Notes”), collectively referred to as “Exchange Notes” (see Note 7).

 

During the nine months ended September 30, 2003, the change in the foreign exchange between the U.S. Dollar and the South Korean Won resulted in a $166 loss related to the note payable, a $1,249 gain related to property, plant and equipment and a $6 loss related to minority interest in consolidated subsidiary.

 

During the nine months ended September 30, 2003, an option holder surrendered 93,758 shares of the Company’s common stock in-lieu of cash payment for the option exercise price of $250 and income taxes payable by the option holder of $403.  The Company immediately canceled the common shares received in lieu of cash payment upon receipt of the shares.

 

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

 

8

 

LIQUIDMETAL TECHNOLOGIES, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the Nine Months Ended September 30, 2004 and 2003

(in thousands, except share data)

(unaudited)

 

1.                                      Basis of Presentation and Recent Accounting Pronouncements

 

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.  In addition, certain reclassifications have been made for consistent presentation.  Operating results for the nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for any future periods or the year ending December 31, 2004.  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 November 10, 2004.

 

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. 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 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, and the manufacture and sale of die casting equipment (see Note 5 for disclosure regarding the disposal of this segment). In addition, 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.

 

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

 

Stock-based compensation

 

The Company applies Accounting Principles Board (“APB”) Opinion No. 25 for options when the exercise price of options granted to employees is less than the fair value of the underlying stock on the date of grant. The Company applies Statement of Financial Accounting Standards (“SFAS”) No. 123 for options granted to non-employees who perform services for the Company.

 

Had the Company determined stock-based compensation cost based on the fair value at the grant date for stock options consistent with the method of SFAS No. 123, the Company’s loss from continuing operations and basic and diluted loss per share from continuing operations would have been as follows:

 

			For the Three Months Ended Sept. 30,						For the Nine Months Ended Sept. 30,
			2004			2003			2004			2003
												Restated
Net loss as reported			$	(6,169	)	$	(6,101	)	$	(9,025	)	$	(19,658		)
Add:	stock-based employee compensation expense included in reported net loss, net of related tax effects		—			5			276			188
Deduct:	total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects		(910		)	(990		)	(3,720		)	(4,344			)
Proforma loss			$	(7,079	)	$	(7,086	)	$	(12,469	)	$	(23,814		)
Basic and diluted loss per share:
As reported			$	(0.15	)	$	(0.15	)	$	(0.22	)	$	(0.47		)
Proforma			(0.17		)	(0.17		)	(0.30		)	(0.57			)

 

9

 

2.                                      Restatement

 

The Company has restated certain quarterly financial statements previously reported and related disclosures to correct our premature recognition of revenues from one transaction with a single customer that we originally recorded in March 2003.  We have also restated our financial statements for the fiscal year ended December 31, 2002 and related disclosures in our annual report on Form 10-K to correct two similar premature revenue recognition events with the same customer that were originally recorded in September and December 2002.  Upon analysis of the transaction terms and certain related agreements undertaken by the Company to resolve a dispute with the customer, we concluded that the transactions were contingent upon continued performance by a subsidiary of the Company, which would have precluded revenue recognition until the contingency ended. Under the terms of a Settlement Agreement reached with the customer on January 10, 2004, the Company reacquired the equipment associated with the two fiscal 2002 transactions and recognized the revenue associated with the March 2003 transaction in January 2004.  The restatement of our December 31, 2002 financial statements resulted in a $1.9 million reduction of revenue and a $1.0 million increase in net loss.  The restatement of our 2003 financial statements did not have any impact for the quarter ended September 30, 2003.  The effect of the restatement during the nine months ended September 30, 2003 is a decrease in revenues by $3.0 million and an increase in net loss by $1.4 million.

 

3.                                      Basis of Presentation and Recent Accounting Pronouncements

 

Translation of Foreign Currency

 

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 Korea have been translated based upon Korean Won as the functional currency. Liquidmetal 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).

 

10

 

New Accounting Pronouncements

 

In October 2004, the Emerging Issues Task Force of the Financial Accounting Standards Board issued its consensus opinion on EITF Issue No. 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings Per Share (EITF No. 04-8). The Task Force reached a consensus that contingently convertible debt instruments with embedded conversion features that are contingent upon market price triggers should be included in diluted earnings per share computations, if dilutive, regardless of whether the contingency has been met. The Company currently does not have any contingently convertible debt under the scope of EITF Issue No. 04-8.

 

In November 2004, the FASB issued SFAS No. 151 “Inventory Costs, an amendment of ARB No. 43, Chapter 4. The amendments made by Statement 151 clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges and require the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. The guidance is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal years beginning after November 23, 2004. The Company has evaluated the impact of the adoption of SFAS 151, and does not believe the impact will be significant to the Company’s overall results of operations or financial position.

 

In December 2004, the FASB issued SFAS No.153, “Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions.”The amendments made by Statement 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, Opinion 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. Opinion 29 provided an exception to its basic measurement principle (fair value) for exchanges of similar productive assets. The Board believes that exception required that some nonmonetary exchanges, although commercially substantive, be recorded on a carryover basis. By focusing the exception on exchanges that lack commercial substance, the Board believes this Statement produces financial reporting that more faithfully represents the economics of the transactions. The Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date of issuance. The provisions of this Statement shall be applied prospectively. The Company has evaluated the impact of the adoption of SFAS 153, and does not believe the impact will be significant to the Company’s overall results of operations or financial position.

 

In December 2004, the FASB issued SFAS No.123 (revised 2004), “Share-Based Payment”. Statement 123(R) will provide investors and other users of financial statements with more complete and neutral financial information by requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. Statement 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. Statement 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. Statement 123, as originally issued in 1995, established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25, as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair-value-based method been used. Public entities (other than those filing as small business issuers) will be required to apply Statement 123(R) as of the first interim or annual reporting period that begins after June 15, 2005. The Company has evaluated the impact of the adoption of SFAS 123(R), and does not believe the impact will be significant to the Company’s overall results of operations or financial position.

 

11

 

4.                                      Liquidity

 

The Company has experienced losses from continuing operations during the last two fiscal years and has an accumulated deficit of $121,612 as of September 30, 2004.  Cash used for continuing operations for the nine months ended September 30, 2004 was $6.3 million and cash flow from continuing operations may be negative throughout the remaining fiscal year 2004.  Such conditions raise substantial doubt that the Company will be able to continue as a going concern for a reasonable period of time.  These operating results occurred while the Company was developing and attempting to commercialize and manufacture products from an entirely new and unique technology.  This business plan required significant spending related to start-up costs and capital expenditures.  These factors have placed a significant strain on the financial resources of the Company.  The ultimate success of the Company depends on its ability to continue reducing operating costs, generate higher revenue, and achieve positive cash flow from continuing operations and profitability.  The consolidated financial statements do not include any adjustments that might result from the outcome of the uncertainty.

 

Our capital requirements during the next 12 months will depend on numerous factors, including the success of our existing products, the development of new applications for Liquidmetal alloys, and the resources we devote to develop and support our Liquidmetal alloy products.  However, we anticipate our capital expenditures in the next 12 months will be less than $0.5 million.  We expect to continue to devote limited capital to our research and development activities, to further develop and strengthen our manufacturing capabilities, and for working capital and other general corporate purposes.

 

We believe that our current cash and cash equivalents together with anticipated cash flow from operations will be sufficient to fund our working capital and capital expenditure requirements for at least the next 12 months.  Our cash flow projections from operations and, consequently, future cash needs are subject to uncertainty.  If our available funds and cash generated from operations are insufficient to satisfy our liquidity requirements, we may need to raise additional capital to fund our operations and capital expenditure requirements.  We cannot be certain that additional capital, whether through selling additional debt or equity securities or obtaining a line of credit or other loan, will be available to us or, if available, will be on terms acceptable to us.  If we issue additional securities to raise funds, these securities may have rights, preferences, or privileges senior to those of the rights of our common stock and our stockholders may experience additional dilution.

 

5.                                      Discontinued Operations

 

Dongyang

 

On June 28, 2002, the Company acquired a 51% interest in Chusik Hoesa Dongyang Yudoro (“Dongyang”).   During 2003, Dongyang experienced net losses as a result of a continuing economic downturn in markets for its machinery products. These events, along with Dongyang’s operating loss, cash flow losses and uncertainty surrounding its future cash flows, led the Company to evaluate its investment for recoverability as of December 31, 2003.  As a result, the Company determined that the carrying value of its investment in Dongyang exceeded its fair value as of December 31, 2003 in the amount of $184.  This impairment loss was recorded in operating expenses for the year ended December 31, 2003.

 

In March 2004, the Company sold its 51% investment in Dongyang to the 49% minority shareholder.  The selling price of the Company’s 51% interest in Dongyang was $80, which was equal to the Company’s net carrying value for the 51% ownership held.  Further, the Company agreed to pay Dongyang $155 for the purchase of a receivable balance from Growell.  The transaction resulted in net payable to Dongyang of $75 and a loss of $46 from transfer of the Company’s interest in Donyang to the minority shareholder.  The loss from operations for the three months ended March 31, 2004 totaled $50 and was included in the loss from discontinued equipment manufacturing operations for that period.  The net payable balance of $75 is to be paid in quarterly installments throughout 2004.  The outstanding amount payable to Dongyang is $25 as of September 30, 2004 and is included in accounts payable and accrued liabilities.

 

12

 

The Company has adopted SFAS 144 and as a result the 2003 balances have been restated in order to conform with the presentation of 2004 financial statements.  Dongyang is reported as part of the assets available for sale on the balance sheet for 2003.

 

As Donyang was sold prior to March 31, 2004, there are no assets or liabilities of Dongyang as of March 31, 2004.  The following is a listing of the major classes of assets and liabilities of Dongyang as of December 31, 2003.

 

		December 31, 2003
Current Assets:
Cash and cash equivalents		$	1
Accounts receivable, net		181
Inventories		1,572
Prepaid expenses and other current assets		56
Total current assets		1,810
Property, plant and equipment, net		$	58
Other Assets		29
Total assets		$	1,897
Current Liabilities:
Accounts payable and accrued expenses		$	233
Deferred revenue		1,583
Total current liabilities		$	1,816

 

Summarized operating results of Dongyang’s discontinued operations are as follows.

 

		For the Three months Ended September 30,						For the Nine months Ended September 30,
		2004			2003			2004			2003
											(restated)
Revenue		$	—		$	212		$	22		$	859
Loss from discontinued equipment manufacturing operations, net of tax		—			(59		)	(96		)	(251		)

 

Taesung

 

On June 14, 2004, the Company entered into an Asset Purchase Agreement whereby all the assets and liabilities of its Taesung equipment manufacturing division in Korea were sold to a third party for $345 which is payable by the third party in four equal installments with the last installment being due on June 30, 2005.  The sale resulted in a loss of $184 and is included in the loss from discontinued equipment manufacturing operations at September 30, 2004.  The loss from operations for the nine months ended September 30, 2004 totaled $749 and is included in the loss from discontinued equipment manufacturing operations for the period.

 

The Company has adopted SFAS 144 and as a result the 2003 balances have been restated in order to conform with the presentation of 2004 financial statements.  Taesung is reported as part of the discontinued business operations as of March 31, 2004 as the Company’s plans for divesture of Taesung was determined during the three months ended March 31, 2004.

 

As Taesung was sold during the period ended June 30, 2004, there are no assets and liabilities of Taesung as of September 30, 2004.  The following is a listing of the major classes of assets and liabilities of Taesung as of December 31, 2003.

 

		December 31, 2003
Current Assets:
Cash and cash equivalents		$	1
Accounts receivable, net		256
Inventories		477
Prepaid expenses and other current assets		113
Total current assets		847
Property, plant and equipment, net		$	157
Other Assets		100
Total assets		$	1,104
Current Liabilities:
Accounts payable and accrued expenses		$	358

 

Summarized operating results of Taesung’s operations are as follows.

 

		For the Three months Ended September 30,						For the Nine months Ended September 30,
		2004			2003			2004			2003
											(restated)
Revenue		$	—		$	31		$	172		$	1,667
Loss from discontinued equipment manufacturing operations, net of tax		—			(56		)	(653		)	(174		)

 

 

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6.                                      Product Warranty

 

Due to the lack of historical information for warranty expense related to bulk alloy products, management estimates product warranties as a percentage of bulk alloy product sales earned during the period.  During the three and nine months ended September 30, 2004, the Company recorded $131 and $269 of warranty expense, respectively.  The product warranty accrual balance is included in accounts payable and accrued expenses and the warranty expense is included in selling, general, and administrative expenses.

 

7.                                      Long-term Debt

 

Senior Convertible Note

 

On March 3, 2004, the Company issued $9.9 million of 6.0% senior convertible notes due 2007 (the “March Notes”) to investor groups in a transaction led by Michigan Venture Capital Co., Ltd, a South Korea-based institutional investment firm, and IndiGo Ventures LLC, a New York-based investment firm (the “Placement Agents”) that served as a financial advisor to the Company for the transaction.  The notes were collateralized by the patents held by the Company and second priority mortgage interest in plant facilities and certain equipment in South Korea.  The notes were convertible at any time into common stock at a price of $3.00 per share.  Investors in the private placement and the Placement Agents received warrants to purchase an aggregate amount of up to approximately 1.2 million shares of common stock, exercisable at $3.00 per share for varying periods but no later than 100 days following the effectiveness of a registration statement covering the resale of shares issuable upon exercise of the warrants.  In addition, the investors had the right to call for repayment of the notes prior to maturity at any time after the second anniversary of the closing of the transaction.

 

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

 

From June through August 2004, the Company redeemed $4,465 of the outstanding note balance in cash.  The redemption resulted in a write down of debt issuance costs and debt discount of $1,407 and $2,071 to interest expense during the three and nine months ended September 30, 2004, respectively.  Further, 500,000 of warrants originally issued to a financial advisor for the transaction expired during June 2004 and 163,748 of unexercised warrants originally issued to investors were cancelled as a result of the Company’s redemption of the note balances during the quarter ended September 30, 2004.  The 663,748 total expired and canceled warrants immediately prior to the expiration and cancellation resulted in a reduction of warrant liability of $7 and $279 to paid in capital and other income, respectively, during the three and nine months ended September 30, 2004.

 

On August 20, 2004, the Company completed a private exchange offer for its March Notes with the remaining holders after the redemption.  Under terms of the exchange offer, approximately $5.5 million in aggregate principal amount of the March Notes have been exchanged for an aggregate of (i) $2.75 million of 6% Senior Secured Notes Due 2007 (the “Long-Term Notes”) and (ii) $2.75 million of 10% Senior Secured Notes Due 2005 (the “Short-Term Notes”), collectively referred to as “Exchange Notes”.  The Exchange Notes are collateralized by the patents held by the Company and second priority mortgage interest in plant facilities and certain equipment in South Korea.  The Short-Term Notes have a maturity date of July 29, 2005, and a conversion price of $2.00 per share (compared to a conversion price of $3.00 per share under the March Notes).  The Long-Term Notes have a maturity date of July 29, 2007, and a conversion price of $1.00 per share.   Further, the exchange notes are convertible into Common Stock, at the option of the Company, if at any time after the issuance of the notes, the closing per share price of the Common Stock exceeds $4.00 (as adjusted for stock splits, reverse splits, stock dividends, and recapitalizations) for 30 consecutive trading days, and further provided that there has been effective registration during such period.  Holders of the Long-Term Notes also have the right to call for repayment of the Long-Term Notes prior to maturity at any time after the second anniversary of the closing of the exchange offer.

 

In addition, holders of both the Long-Term Notes and Short-Term Notes have the right to call for repayment of the notes if the Company does not, within 120 days of the deemed closing date of the exchange (July 29, 2004), become compliant with its SEC reporting obligations and become listed or quoted on the OTC Bulletin Board, the Nasdaq Stock Market, or a national securities exchange.  A total of 562,151 warrants to purchase our common stock at an exercise price of $3.00 per share—all of which were previously issued in connection with the purchase of the March Notes—have been amended to provide for an extended expiration date of March 1, 2006.

 

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

 

In connection with the private exchange offer, the Company issued $250 of private placement notes to certain Placement Agents as issuance costs.  Of the $250 notes issued, $125 was paid in the form of long-term notes which is due in 2007 with interest rate of 6% per annum (Long-Term Notes) and $125 was paid in the form of short-term notes which is due in 2005 with interest rate of 10% per annum (Short-Term Notes).  The Short-Term and Long-Term Notes are convertible into

 

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Common Stock at $2.00 and $1.00, respectively, and have the same terms as the Exchange Notes issued to the investors.  Further, a beneficial conversion feature was recorded from the $125 Long-Term Notes issued to Placement Agents of $29 during August 2004.

 

As of September 30, 2004, our gross outstanding loan balance totaled $5,709, un-amortized discounts for beneficial conversion feature and warrants totaled $980 and other asset debt issuance costs totaled $221.  Interest expense for the amortization of debt issuance cost and discount on note was $217 and $622 for the three and nine months ended September 30, 2004.

 

The Company was obligated, pursuant to a Registration Rights Agreement, as amended by the Exchange Notes, between the Company, the Placement Agents and the note holders to file a registration statement with the Securities and Exchange Commission (“SEC”) to register the shares of Common Stock issuable upon conversion of the notes payable and the related warrants within 90 days following the effective closing date of the exchange notes (July 29, 2004), and to use best efforts to cause such registration statement to become effective within 60 days following the SEC’s first written comments on the registration statement.  Further, if the Company is not in compliance with the registration or listing requirements, the holders have rights to late registration payments equal to 2 percent of the purchase price paid for the unconverted notes for the first 30 business days of late registration, and 1 percent for each 30 business days thereafter, but no more than 10 percent of the purchase price of the unconverted note balance.  The $5,709 balance of the note and un-amortized discounts for beneficial conversion feature and warrants of $980 is presented as short-term liability as of September 30, 2004 as the note holders have the right to call for payment on demand as the registration statement has not been filed in accordance with the amended Registration Rights Agreement.  As of December 2004, the Company has not received any demands for payment from the note holders.

 

Pursuant to EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”, the relative fair values of the warrants of $1,302 have been recorded as other liability during March 2004 as the Company has not yet filed the registration statement.  In addition, the Company is required to report a value of the warrant as a fair value and record the fluctuation to the fair value of the warrant liability to current operations.  The change in the relative fair value of the warrants resulted in a loss of $434, which is included in other expense, and a net gain of $846, which is recorded as net other income, for the three and nine months ended September 30, 2004, respectively.  The fair value of warrants outstanding at September 30, 2004 of $449 was computed using the Black-Scholes model under the following assumptions: (1) expected life of 1.42 years; (2) volatility of 124%, (3) risk free interest of 2.63% and dividend rate of 0%.

 

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.  The loan bears interest at an annual rate of 7.1%.  In the event of delayed repayment, the interest increases to a maximum of 21%, depending on the length of time the repayment is delayed.  This loan is collateralized by the plant facilities and certain equipment in South Korea.  During the first eighteen months from the origination date, interest was payable on a monthly basis.  In October 2003, the Company paid $873 of principal at the request of Kookmin Bank due to the sale of machines that had been part of the collateral on the loan.  Subsequent to October 31, 2003, Kookmin Bank requested that the Company pay an additional $866 of principal by February 2004 due to the Company’s current credit rating.  The Company made two payments on the requested additional loan paydown in November and December 2003 of $320 and $205, respectively.  The remaining payment of $341 was made in February 2004.  Beginning in September 2004, the Company will be required to make equal monthly installments of principal and interest to repay the remaining balance of the loan over a 36-month period.

 

Because this note payable is denominated in South Korea Won, the balance will fluctuate with the exchange rate between the U.S. Dollar and the South Korean Won, resulting in the recognition of foreign exchange gains or losses that are included in other comprehensive loss.  At September 30, 2004, the balance of the note was $3,747 resulting in the recognition of a cumulative foreign exchange loss of $133, which is included in other comprehensive loss during the nine months ended September 30, 2004.

 

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8.                                      Stock Compensation Plan

 

During the quarter ended September 30, 2004, under the Company’s 2002 Equity Incentive Plan which provides for the grant of stock options to officers, employees, consultants and directors, the Company granted options to purchase 385,359 common shares of the Company for an average exercise price of $1.38.  All options granted under this plan had exercise prices that were equal to the fair market value on the date of grant.

 

During the quarter ended September 30, 2004, 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 20,000 common shares of the Company for an average exercise price of $1.42.  All options granted under this plan had exercise prices that were equal to the fair market value on the date of grant.

 

Further, 4,808 options were forfeited during the quarter ended September 30, 2004 by terminated employees and directors.

 

9.                                      Segment Reporting

 

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 alloy 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 are included in the bulk Liquidmetal alloy segment.  The accounting policies of the reportable segments are the same as those described in Note 18 to the consolidated financial statements included in the Company’s Form 10-K filed with the Securities and Exchange Commission on November 10, 2004.

 

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

 

		Coatings			Bulk Alloy Products			Segment Totals
Three months ended September 30, 2004:
Revenue from external customers		$	988		$	3,627		$	4,615
Gross profit		466			908			1,374
Total segment income		264			129			393
Total identifiable assets at end of period		814			23,202			24,016
Three months ended September 30, 2003:
Revenue from external customers		$	894		$	2,387		$	3,281
Gross profit (loss)		435			(1,749		)	(1,314		)
Total segment income (loss)		275			(3,669		)	(3,394		)
Total identifiable assets at end of period		865			28,329			29,194
Nine months ended September 30, 2004:
Revenue from external customers		$	2,710		$	12,248		$	14,958
Gross profit		1,260			4,425			5,685
Total segment income		804			2,237			3,041
Total identifiable assets at end of period		814			23,202			24,016
Nine months ended September 30, 2003 (restated):
Revenue from external customers		$	2,374		$	8,639		$	11,013
Gross profit (loss)		1,151			(1,539		)	(388		)
Total segment income (loss)		293			(11,955		)	(11,662		)
Total identifiable assets at end of period		865			28,329			29,194

 

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

 

		For the Three Months Ended Sept. 30,						For the Nine Months Ended Sept. 30,
		2004			2003			2004			2003
											(restated)
Total segment income (loss)		$	393		$	(3,394	)	$	3,041		$	(11,662	)
General and administrative expenses not allocated to segments		(2,962		)	(2,562		)	(7,594		)	(8,775		)
Loss before interest, other income, income taxes, minority interest and discontinued operations		(2,569		)	(5,956		)	(4,553		)	(20,437		)
Loss on extinguishments of debt		(1,663		)	—			(1,663		)	—
Other expense		(434		)	—			(434		)	—
Other income		302			—			1,582			—
Interest expense		(1,805		)	(106		)	(3,242		)	(281		)
Interest income		—			53			34			281
Gain on sale of marketable securities held-for-sale		—			—			—			1,178
Income taxes		—			—			—			—
Minority interest in loss of consolidated subsidiary		—			23			—			26
Loss from discontinued operations, net		—			(115		)	(749		)	(425		)
Net Loss		$	(6,169	)	$	(6,101	)	$	(9,025	)	$	(19,658	)

 

Excluded general and administrative expenses are attributable to the Company’s corporate headquarters.  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 of America were $1,215 and $2,006 during the three months ended September 30, 2004 and 2003, respectively.  The revenue related to the United States of America was earned under three defense-related research and development contracts and sales of coatings products.

 

During the three months ended September 30, 2004, the Company had revenue from sales to companies outside of the United States of $3,400 of which $2,895 represented sales to companies located in South Korea.  During the three months ended September 30, 2003, the Company had revenues from companies outside of the United States of $1,518 of which $1,108 represented sales to companies located in South Korea.  Of the $1,108 sales in South Korea, $243 was from our discontinued equipment manufacturing business for the three months ended September 30, 2003.  The revenue related to sales to companies outside of the United States was from bulk alloy products including equipment sales.

 

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Long-lived assets include net property, plant, and equipment and net intangible assets. The Company had long-lived assets of $2,225 and $2,547 located in the United States at September 30, 2004 and December 31, 2003, respectively. The Company had long-lived assets of $14,695 and $16,395 located in South Korea at September 30, 2004 and December 31, 2003, respectively.  Of the assets located in South Korea at December 31, 2003, $215 was from long-lived assets of our discontinued equipment manufacturing business.   Further, the Company has long lived assets of $45 at September 30, 2004 located in China as a result of a new sub-assembly plant opened during August 2004 (See note 1).

 

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

 

		September 30, 2004
Total segment assets		$	24,016
Cash and cash equivalents		1,396
Restricted cash		1,000
Prepaid expenses and other current assets		1,506
Other property, plant and equipment, net		1,112
Other intangible assets, net		1,108
Other assets		815
Total consolidated assets		$	30,953

 

Assets excluded from segment assets include assets attributable to the Company’s corporate headquarters.  The largest asset represents the Company’s cash balances, primarily generated from the Company’s proceeds from the senior convertible notes and Kookmin loan (See note 7).

 

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.  Common stock equivalents consist of 8,526,068 and 6,875,601 equity instruments at September 30, 2004 and 2003, respectively, and have not been included in the EPS calculation at September 30, 2004 and 2003 as the amounts are anti-dilutive.

 

11.                               Commitments and Contingencies

 

As of September 30, 2004 and December 31, 2003, the Company has contingent obligations of $164 and $132, respectively, for notes receivables sold with recourse.

 

During September 2004, as part of a security agreement to finance certain insurance policy, the Company used certificate of deposits with maturities of less than one year of $1,000 as collateral.  The $1,000 of certificate of deposit is presented as restricted cash at September 30, 2004.

 

Two separate lawsuits were filed in July and September 2004 by two former employees of our Pyongtaek manufacturing facility in South Korea.  The suits are based on a claim of wrongful termination and breach of employment contract.  In November 2004, the Company entered into a settlement agreement with the employees whereby the Company would pay $243 to the employees in exchange for all claims being dismissed.  The payable amount is included in accounts payable and accrued expenses as of September 30, 2004 financial statement.

 

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