This management's discussion and analysis should be read in conjunction with the consolidated financial statements and notes included elsewhere in this Quarterly Report on Form 10-Q. All amounts described in this section are in thousands, except percentages, periods of time, and share and per share data. This management's discussion and analysis, as well as other sections of this Quarterly Report on Form 10-Q, may contain "forward-looking statements" that involve risks and uncertainties, including statements regarding our plans, future events, objectives, expectations, estimates, forecasts, assumptions, or projections. 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," "plan," "seek," and similar words or 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 in Part II herein, under the heading "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 and other risks and uncertainties discussed in other filings made with theSecurities and Exchange Commission (including risks described in subsequent reports on Form 10-Q and Form 8-K and other filings). We disclaim any intention or obligation, other than as required by applicable law, 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 proprietary bulk alloys and composites that utilize the advantages offered by amorphous alloy technology. We design, develop, and sell custom products and parts from bulk amorphous alloys to customers in various industries. We also partner with third-party manufacturers and licensees to develop and commercializeLiquidmetal alloy products. Amorphous alloys are, in general, 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 other metals and alloys when they solidify.Liquidmetal alloys are proprietary amorphous alloys that possess a combination of performance, processing, and potential cost advantages that we believe will make them preferable to other materials in a variety of applications. The amorphous atomic structure of bulk 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. We believe the alloys and the molding technologies we employ can result in components for many applications that exhibit exceptional dimensional control and repeatability that rivals precision machining, excellent corrosion resistance, brilliant surface finish, high strength, high hardness, high elastic limit, alloys that are non-magnetic, and the ability to form complex shapes common to the injection molding of plastics. All of these characteristics are achievable from the molding process, so design engineers often do not have to select specific alloys to achieve one or more of the characteristics as is the case with crystalline materials. We believe these advantages could result inLiquidmetal alloys supplanting high-performance alloys, such as titanium and stainless steel, and other incumbent materials in a wide variety of applications. Moreover, we believe these advantages could enable the introduction of entirely new products and applications that are not possible or commercially viable with other materials. Our revenues are derived from i) selling our bulk amorphous alloy custom products and parts for applications which include, but are not limited to, non-consumer electronic devices, medical products, automotive components, and sports and leisure goods? ii) selling tooling and prototype parts such as demonstration parts and test samples for customers with products in development? and iii) product licensing and royalty revenue. Our cost of sales consists primarily of the costs of manufacturing, which include raw alloy and direct labor costs. Selling, general, and administrative expenses currently consist primarily of salaries and related benefits, 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 expenses, 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 ofLiquidmetal bulk 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. InJuly 2019 , the Company adopted the 2019 Restructuring Plan pursuant to which the Company elected to wind down its prior manufacturing operations at the Company'sLake Forest, CA facility and seek to outsource the manufacture of parts utilizing the Company's technology through domestic and international manufacturing partners. In connection with the 2019 Restructuring Plan, the Company shifted its business strategy from internal manufacture of parts and products for customers toward the use and reliance of outsourced manufacturers, which will initially be Yihao, aChina -based company that is an affiliate of our largest beneficial stockholder our CEO and Chairman,Professor Li . 19
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Table of Contents Licensing Transactions Eontec License Agreement OnMarch 10, 2016 , in connection with the 2016 Purchase Agreement, we entered into the License Agreement with Eontec pursuant to which we each entered into a cross-license of our respective technologies. The License Agreement provides for the cross-license of certain patents, technical information, and trademarks between us and Eontec. In particular, we granted to Eontec a paid-up, royalty-free, perpetual license to our patents and related technical information to make, have made, use, offer to sell, sell, export, and import products in certain geographic areas outside ofNorth America andEurope , and Eontec granted to us a paid-up, royalty-free, perpetual license to Eontec's patents and related technical information to make, have made, use, offer to sell, sell, export, and import products in certain geographic areas outside of specified countries inAsia . The license granted by us to Eontec is exclusive (including to the exclusion of us) in the countries ofBrunei ,Cambodia ,China (P.R.C and R.O.C.),East Timor ,Indonesia ,Japan ,Laos ,Malaysia ,Myanmar ,Philippines ,Singapore ,South Korea ,Thailand , andVietnam . The license granted by Eontec to us is exclusive (including to the exclusion of Eontec) inNorth America andEurope . The cross-licenses are non-exclusive in geographic areas outside of the foregoing exclusive territories.
Beyond the License Agreement, we collaborate with Eontec to accelerate the commercialization of amorphous alloy technology. This includes but is not limited to developing technologies to reduce the cost of amorphous alloys, working on die cast machine technology platforms to pursue broader markets, sharing knowledge to broaden our intellectual property portfolio, and utilizing Eontec's volume production capabilities as a third party contract manufacturer.
Apple License Transaction OnAugust 5, 2010 , we entered into a license transaction with Apple pursuant to which (i) we contributed substantially all of our intellectual property assets to a newly organized special-purpose, wholly-owned subsidiary, called CIP, (ii) CIP granted to Apple a perpetual, worldwide, fully-paid, exclusive license to commercialize such intellectual property in the field of consumer electronic products, as defined in the license agreement, in exchange for a license fee, and (iii) CIP granted back to us a perpetual, worldwide, fully-paid, exclusive license to commercialize such intellectual property in all other fields of use. Under the agreements relating to the license transaction with Apple, we were obligated to contribute, to CIP, all intellectual property that we developed throughFebruary 2012 . Subsequently, this obligation was extended to apply to all intellectual property developed throughFebruary 2016 . We are also obligated to maintain certain limited liability company formalities with respect to CIP at all times after the closing of the license transaction. Other License Transactions OnJanuary 31, 2012 , we entered into a Supply and License Agreement for a five year term with Engel whereby Engel was granted a non-exclusive license to manufacture and sell injection molding machines to our licensees. Since that time, we and Engel have agreed on an injection molding machine configuration that can be commercially supplied and supported by Engel. OnDecember 6, 2013 , the companies entered into an Exclusivity Agreement for a ten year term whereby we agreed, with certain exceptions and limitations, that we and our licensees would purchase amorphous alloy injection molding machines exclusively from Engel in exchange for certain royalties to be paid by Engel to us based on a percentage of the net sales price of such injection molding machines. Our Liquidmetal Golf subsidiary has the exclusive right and license to utilize ourLiquidmetal alloy technology for purposes of golf equipment applications. This right and license is set forth in an intercompany license agreement betweenLiquidmetal Technologies and Liquidmetal Golf. This license agreement provides that Liquidmetal Golf has a perpetual and exclusive license to useLiquidmetal alloy technology for the purpose of manufacturing, marketing, and selling golf club components and other products used in the sport of golf. We own 79% of the outstanding common stock of Liquidmetal Golf. InMarch 2009 , we entered into a license agreement with Swatch under which Swatch was granted a non-exclusive license to our technology to produce and market watches and certain other luxury products. InMarch 2011 , this license agreement was amended to grant Swatch exclusive rights as to watches and all third parties (including us), but non-exclusive as to Apple. We will receive royalty payments over the life of the contract on allLiquidmetal products produced and sold by Swatch. The license agreement with Swatch will expire on the expiration date of the last licensed patent. OnJanuary 31, 2020 , we entered into the Agreement with Eutectix, which provides for collaboration, joint development efforts, and the manufacturing of products based on the Company's proprietary amorphous metal alloys. Under the Agreement, the Company has licensed to Eutectix specified equipment owned by the Company, including two injection molding machines, two diecasting machines, and other machines and equipment, all of which will be used to make product for Company customers and Eutectix customers. The licensed machines and equipment represent substantially all of the machinery and equipment then held by the Company. The Company has also licensed to Eutectix various patents and technical information related to the Company's proprietary technology. Under the Agreement, Eutectix will pay the Company a royalty of six percent (6%) of the net sales price of licensed products sold by Eutectix, and Eutectix will also manufacture for the Company product ordered by the Company. The Agreement has a term of five years, subject to renewal provisions and the ability of either party to terminate earlier upon specified circumstances. 20
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Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted inthe 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 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: • Revenue recognition • Investments in debt securities • Impairment of long-lived assets and definite-lived intangibles • Deferred tax assets • Share based compensation • Valuation of inventory • Leases Our Annual Report on Form 10-K for the year endedDecember 31, 2019 (the "2019 Annual Report") contains further discussions on our critical accounting policies and estimates. 21
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Table of Contents Results of Operations
Comparison of the three and nine months ended
For the three months ended September 30, For the nine months ended September 30, 2020 2019 2020 2019 in 000's % of Revenue in 000's % of Revenue in 000's % of Revenue in 000's % of Revenue Revenue: Products$ 288 $ 373 $ 367 $ 728 Licensing and royalties 39 48 64 48 Total revenue 327 421 431 776 Cost of sales 171 52% 284 67% 242 56% 566 73% Gross profit 156 48% 137 33% 189 44% 210 27% Selling, marketing, general and administrative 1,096 335% 1,380 328% 2,953 685% 4,088 527% Research and development 30 9% 284 67% 86 20% 1,179 152% Impairment of long-lived assets - 0% - 0% - 0% 1,676 216% Gain on disposal of long-lived assets - 0% (7 ) -2% (35 ) -8% (2 ) 0% Total operating expense 1,126 1,657 3,004 6,941 Operating loss (970 ) (1,520 ) (2,815 ) (6,731 ) Lease income 132 - 352 - Interest and investment income 61 125 297 344 Net loss$ (777 ) $ (1,395 ) $ (2,166 ) $ (6,387 )
Revenue and operating expenses
Revenue. Total revenue decreased to$327 for the three months endedSeptember 30, 2020 from$421 for the three months endedSeptember 30, 2019 . Total revenue decreased to$431 for the nine months endedSeptember 30, 2020 from$776 for the nine months endedSeptember 30, 2019 . The decrease was attributable to lower product sale volumes associated with the Company's continued transition from internal manufacturing to outsourced manufacturing. During the three months endedSeptember 30, 2020 , the Company began making routine deliveries under production orders, which will continue through at least the first half of 2021. In the event the Company can continue to deliver under these orders, through outsourced manufacturing supply chains, and add additional orders, revenue streams are expected to increase, stabilize and become more predictable. Cost of sales. Cost of sales was$171 , or 52% of total revenue, for the three months endedSeptember 30, 2020 , a decrease from$284 , or 67% of total revenue, for the three months endedSeptember 30, 2019 . Cost of sales was$242 , or 56% of total revenue, for the nine months endedSeptember 30, 2020 , a decrease from$566 , or 73% of products revenue, for the nine months endedSeptember 30, 2019 . The decrease in our cost of sales as a percentage of products revenue for the three and nine months endedSeptember 30, 2020 was primarily attributable to more predictable costs associated with established volume manufacturers. If we are able to sustain and increase shipments of routine, commercial products and parts through third party contract manufacturers, we expect our cost of sales percentages to decrease, stabilize, and be more predictable. Gross profit. Our gross profit increased to$156 for the three month period endedSeptember 30, 2020 from$137 for the three month period endedSeptember 30, 2019 . Our gross profit as a percentage of total revenue, increased to 48% for the three month period endedSeptember 30, 2020 from 33% for the three month period endedSeptember 30, 2019 . Our gross profit decreased to$189 for the nine month period endedSeptember 30, 2020 from$210 for the nine month period endedSeptember 30, 2019 . Our gross profit as a percentage of total revenue, increased to 44% for the nine month period endedSeptember 30, 2020 from 27% for the nine month period endedSeptember 30, 2019 . Our gross profit percentages have fluctuated and may continue to fluctuate based on production volumes and quoted production prices per unit and may not be representative of our future business. If we are able to sustain and increase shipments of routine, commercial products and parts through future orders to third party contract manufacturers, we expect our gross profit percentages to stabilize, increase, and be more predictable. 22
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Selling, marketing, general and administrative. Selling, marketing, general, and administrative expenses were$1,096 and$2,953 for the three and nine months endedSeptember 30, 2020 , respectively, compared to$1,380 and$4,088 for the three and nine months endedSeptember 30, 2019 , respectively. The decrease in expenses was attributable to overall lower costs for employee compensation due to headcount reductions associated with the 2019 Restructuring Plan. These decreases were off-set by an increase in bad debt expense. Research and development. Research and development expenses were$30 and$86 for the three and nine months endedSeptember 30, 2020 , respectively, compared to$284 and$1,179 for the three and nine months endedSeptember 30, 2019 , respectively. The decrease in expense was mainly due to reductions in employee compensation, and associated development initiatives, due to headcount reductions associated with the 2019 Restructuring Plan. Going forward, we will continue to perform research and development of newLiquidmetal alloys and related processing capabilities, albeit on a reduced basis in comparison with prior periods. Gain on disposal of fixed assets. During the three and nine months endedSeptember 30, 2020 , the Company recorded gains on the disposal of fixed assets of$0 and$35 , respectively. This compares to gains on disposal of fixed assets of$7 and$2 during the three and nine months endedSeptember 30, 2019 . Operating loss. Operating loss was$970 and$2,815 for the three and nine months endedSeptember 30, 2020 , respectively. This compares to$1,520 and$6,731 for the three and nine months endedSeptember 30, 2019 , respectively. Fluctuations in our operating loss are primarily attributable to variations in operating expenses, as discussed above. We continue to invest in our technology infrastructure to expedite the adoption of our technology, but we have experienced long sales lead times for customer adoption of our technology. Until that time when we can either (i) increase our revenues with shipments of routine, commercial products and parts through third party contract manufacturers or (ii) obtain significant licensing revenues, we expect to continue to have operating losses for the foreseeable future. Other income and expenses
Lease income. Lease income relates to straight-line rental income received under
the Facility Lease. Such amounts were
Interest and investment income. Interest and investment income relates to interest earned from our cash deposits and investments in debt securities for the respective periods. Interest and investment income was$61 and$297 for the three and nine months endedSeptember 30, 2020 , respectively. This compares to interest and investment income of$125 and$344 during the three and nine months endedSeptember 30, 2019 , respectively.
Liquidity and Capital Resources
Cash used in operating activities
Cash used in operating activities totaled$1,785 and$3,666 for the nine months endedSeptember 30, 2020 and 2019, respectively. The cash was primarily used to fund operating expenses related to our business and product development efforts. Following the completion of the 2019 Restructuring Plan, cash used in operating activities for the nine months endedSeptember 30, 2020 are expected to be reflective of cash usages going forward.
Cash used in investing activities
Cash used in investing activities totaled$12,320 and$358 for the nine months endedSeptember 30, 2020 and 2019, respectively. Investing inflows primarily consist of proceeds from the sale of debt securities and proceeds from the sale of fixed assets. Investing outflows primarily consist of purchases of debt securities and capital expenditures for additional production equipment and building improvements.
Cash provided by financing activities
Cash provided by financing activities totaled$0 and$14 for the nine months endedSeptember 30, 2020 and 2019, respectively. Cash provided by financing activities is comprised of cash received for the issuance of shares following the exercise of stock options.
Financing arrangements and outlook
During 2016, we raised a total of$62,700 through the issuance of 405,000,000 shares of our common stock in multiple closings under the 2016 Purchase Agreement. The Company has a relatively limited history of selling bulk amorphous alloy products and components on a mass-production scale. Furthermore, the ability of future contract manufacturers to produce the Company's products in desired quantities and at commercially reasonable prices is uncertain and is dependent on a variety of factors that are outside of the Company's control, including the nature and design of the component, the customer's specifications, and required delivery timelines. These factors have previously required that the Company engage in equity sales under various stock purchase agreements to support its operations and strategic initiatives. As a result of the funding under the 2016 Purchase Agreement, the Company anticipates that its current capital resources, when considering expected losses from operations, will be sufficient to fund the Company's operations for the foreseeable future. 23
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As ofSeptember 30, 2020 , the Company had recorded$5,443 in cash and restricted cash, as well as$23,845 in investments in debt securities. The Company views the total of this as readily available sources of liquidity in the event needed to advance the Company's existing strategy, and/or pursue an alternative strategy.
Off Balance Sheet Arrangements
As of
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