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| NEON > SEC Filings for NEON > Form 10-Q on 15-May-2012 | All Recent SEC Filings |
15-May-2012
Quarterly Report
Forward Looking Statements
This Quarterly Report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, adopted pursuant to the Private
Securities Litigation Reform Act of 1995. Statements that are not purely
historical may be forward-looking. You can identify some forward-looking
statements by the use of words such as "believes," "anticipates," "expects,"
"intends" and similar expressions. Forward- looking statements involve inherent
risks and uncertainties regarding events, conditions and financial trends that
may affect our future plans of operation, business strategy, results of
operations and financial position. A number of important factors could cause
actual results to differ materially from those included within or contemplated
by such forward-looking statements, including, but not limited to risks relating
to the uncertainty of growth in market acceptance for our technology, a history
of losses since inception, our ability to remain competitive in response to new
technologies, the costs to defend, as well as risks of losing, patents and
intellectual property rights, a reliance on our future customers' ability to
develop and sell products that incorporate our technology, the concentration of
our operations in a limited number of facilities, the uncertainty of demand for
our technology in certain markets, our ability to manage growth effectively, our
dependence on key members of our management and development team, our limited
experience in conducting operations internationally, and our ability to obtain
adequate capital to fund future operations, For a discussion of these and other
factors that could cause actual results to differ from those contemplated in the
forward-looking statements, please see the discussion under ''Risk Factors''
contained in our Annual Report on Form 10-K for the fiscal year ended December
31, 2011 and in our publicly available filings with the Securities and Exchange
Commission. Forward-looking statements reflect our analysis only as of the date
hereof. Actual events or results may differ materially from the results
discussed in or implied by the forward-looking statements. We do not undertake
any responsibility to update or revise any of these factors or to announce
publicly any revisions to forward-looking statements, whether as a result of new
information, future events or otherwise. .
The following Management's Discussion and Analysis should be read in conjunction with the condensed consolidated financial statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q and consolidated financial statements for the year ended December 31, 2011 included in our Annual Report on Form 10-K.
Overview
Neonode Inc., "we", "us", "our", the "Company", develops and licenses the next generation of MultiSensingTM user interfaces and optical multi-touch solutions for some of the world's largest consumer brands. The cornerstone of our offer to customers is our patented zForceŽ MultiSensing touch technology which provides a far more augmented and profound user experience than traditional touch. zForce MultiSensing is suited for small to midsized consumer and industrial electronic devices and supports unlimited gestures, multi-touch and sweep navigation. zForce MultiSensing applies on any surface and integrates with all types of devices. zForce MultiSensing uses infrared light with zero latency that responds with any object - like a pen, finger, brush or gloved finger (with sizes down to 1 mm), at a very high scanning speed of 1000 Hz.
Neonode licenses zForce MultiSensing to Original Equipment Manufacturers ("OEMs") and Original Design Manufacturers ("ODMs") who embed our technology into electronic devices that they develop and sell and is currently being integrated into products such as mobile phones, e-Readers, household appliances, printers and office equipment, GPS devices, automobile consoles, games and toys, and tablet devices.
Our technology licensing model allows us to focus on the development of solutions for multi-touch enabled screens, and thus we do not have to contend with the financial and logistical burden of manufacturing products, which is handled by our ODM/OEM clients. We license the right to use zForce and software which, together with standard components from partners, create a complete optical touch solution. Our licensing model provides the added benefit of allowing us to grow revenues without the need of increasing costs at anywhere near the same rate to support the revenue growth.
Critical Accounting Policies
The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The condensed consolidated financial statements for the three months ended March 31, 2012 and 2011, and as of March 31, 2012 and December 31, 2011 include the accounts of Neonode Inc. and our wholly owned subsidiary, Neonode Technologies AB. All inter-company accounts and transactions have been eliminated in consolidation.
Accounts Receivable and Allowance for Doubtful Accounts
Our accounts receivable are stated at net realizable value. Our policy is to maintain allowances for estimated losses resulting from the inability of our customers to make required payments. Credit limits are established through a process of reviewing the financial history and stability of each customer. Where appropriate, we obtain credit rating reports and financial statements of the customer when determining or modifying its credit limits. We regularly evaluate the collectibility of our trade receivable balances based on a combination of factors. When a customer's account balance becomes past due, we initiate dialogue with the customer to determine the cause. If it is determined that the customer will be unable to meet its financial obligation, such as in the case of a bankruptcy filing, deterioration in the customer's operating results or financial position or other material events impacting its business, we record a specific allowance to reduce the related receivable to the amount we expect to recover. Should all efforts fail to recover the related receivable, we will write-off the account. We also record an allowance for all customers based on certain other factors including the length of time the receivables are past due and historical collection experience with customers. We determined that an allowance for doubtful accounts was not necessary at March 31, 2012 and December 31, 2011.
Long-lived Assets
We assess any impairment by estimating the future cash flow from the associated asset in accordance with relevant accounting guidance. If the estimated undiscounted future cash flow related to these assets decreases or the useful life is shorter than originally estimated, we may incur charges for impairment of these assets. At March 31, 2012, we believe there is no impairment of our long-lived assets. There can be no assurance, however, that market conditions will not change or sufficient commercial demand for our products and services will materialize, which could result in impairment of long-lived assets in the future.
Liability for Warrants and Embedded Derivatives
We do not enter into derivative contracts for purposes of risk management or speculation. However, from time to time, we enter into contracts that are not considered derivative financial instruments in their entirety but that include embedded derivative features, such as conversion features. Such embedded derivatives are assessed at inception of the contract and every reporting period, depending on their characteristics, are accounted for as separate derivative financial instruments pursuant to accounting guidance, if such embedded conversion features, if freestanding, would meet the classification of a liability. Accounting guidance requires that we analyze all material contracts and determine whether or not they contain embedded derivatives. Any such embedded conversion features that meet the above criteria are then bifurcated from their host contract and recorded on the consolidated balance sheet at fair value and the changes in the fair value of these derivatives are recorded each period in the consolidated statements of operations as an increase or decrease to non-cash charges for conversion features and warrants.
Similarly, if warrants meet the criteria in accordance with accounting guidance to be classified as liabilities, then the fair value of the warrants are recorded on the consolidated balance sheet at their fair values, and any changes in such fair values are recorded each period in the consolidated statements of operations as an increase or decrease to non-cash charges for conversion features.
Concentration of Credit and Business Risks
In the short term, we anticipate that we will depend on a limited number of customers for substantially all of our future revenue. Failure to anticipate or respond adequately to technological developments in our industry, changes in customer or supplier requirements or changes in regulatory requirements or industry standards, or any significant delays in the development or introduction of products or services, could have a material adverse effect on our business, operating results and cash flows.
Our accounts receivable as of March 31, 2012 was due from eight customers, two of which accounted for 76% of our accounts receivable as of March 31, 2012. Our net revenues for the three months ended March 31, 2012 was earned from ten customers. Our customers are located in the U.S., Europe and Asia. Customers which accounted for 10% or more of our net revenues during the three months ended March 31, 2012 are as follows:
ˇ Amazon accounted for 55%
ˇ Sony Corporation accounted for 16%
Our accounts receivable as of December 31, 2011 was due from five customers, two of which accounted for 87% of our accounts receivable as of December 31, 2011. Our net revenues for the three months ended March 31, 2011 was earned from two customers, of which Sony Corporation accounted for approximately 97% of our net revenues for the three months ended March 31, 2011.
Revenue Recognition
Engineering Services:
We may sell engineering consulting services to our customers on a flat rate or hourly rate basis. We recognize revenue from these services when all of the following conditions are met: (1) evidence existed of an arrangement with the customer, typically consisting of a purchase order or contract; (2) our services were performed and risk of loss passed to the customer; (3) we completed all of the necessary terms of the contract; (4) the amount of revenue to which we were entitled was fixed or determinable; and (5) we believed it was probable that we would be able to collect the amount due from the customer. To the extent that one or more of these conditions has not been satisfied, we defer recognition of revenue. Generally, we recognize revenue as the engineering services stipulated under the contact are completed and accepted by our customers.
Licensing Revenues:
We also derive revenue from the licensing of internally developed intellectual
property ("IP"). We enter into IP licensing agreements that generally provide
licensees the right to incorporate our IP components in their products with
terms and conditions that vary by licensee. The IP licensing agreements
generally include a nonexclusive license for the underlying IP. Fees under these
agreements may include license fees relating to our IP and royalties payable
following the sale by our licensees of products incorporating the licensed
technology. The license for our IP has standalone value and can be used by the
licensee without maintenance and support. As of September 30, 2011, Neonode
meets all the accounting requirements for revenue recognition as per unit
royalty products are distributed or licensed by the Company's customers. For
technology license arrangements that do not require significant modification or
customization of the underlying technology, we recognize new technology license
revenue when: (1) we enter into a legally binding arrangement with a customer
for the license of technology; (2) customer distributes or license the products;
(3) customer payment is deemed fixed or determinable and free of contingencies
or significant uncertainties; and (4) collection is reasonably assured.
Prior to September 30, 2011, we deferred the technology license fee revenue until such time as the warranty period stipulated in the license agreement expired because we did not have sufficient historical experience in estimating potential warranty costs. From June 2010 to December 31, 2011, we entered into 12 technology license contracts with customers. During that time there were no warranty related costs incurred for any customer products after they have been released to market. During the quarter ended September 30, 2011, the Company performed an analysis and determined that it had sufficient historical evidence regarding estimated warranty costs and therefore began recognizing technology license fee revenues, net of warranty costs, if any, as the products incorporating the Neonode technology are distributed or licensed by our customers, assuming all other revenue recognition criteria has been met. Our customers report to us the quantities of products distributed by them after the end of the reporting period stipulated in the contract, generally 30 to 45 days after the end of the month or quarter.
Explicit return rights are not offered to customers. There have been no returns through March 31, 2012.
We may from time-to-time develop custom hardware products for our customers that incorporate our touchscreen technology. Our policy is to recognize revenue from hardware product sales when title transfers and risk of loss has passed to the customer, which is generally upon shipment of our hardware products to our customers. We will estimate expected sales returns and record the amount as a reduction of revenue and cost of hardware and other revenue at the time of shipment. To date, we have not sold any hardware products.
Software Products:
We may derive revenues from software licensing sales. We will account for the licensing of software in accordance with accounting guidance and such guidance requires judgment, including whether a software arrangement includes multiple elements, and if so, whether vendor-specific objective evidence ("VSOE") of fair value exists for those elements.
For software license arrangements that do not require significant modification or customization of the underlying software, we will recognize new software license revenue when: (1) we enter into a legally binding arrangement with a customer for the license of software; (2) we deliver the products; (3) customer payment is deemed fixed or determinable and free of contingencies or significant uncertainties; and (4) collection is reasonably assured.
On January 1, 2011, we adopted new authoritative guidance on a prospective basis
for revenue arrangements containing multiple deliverables. This guidance
requires us to allocate revenues to all deliverables based on their relative
selling price using a specific hierarchy. The hierarchy is as follows:
vendor-specific objective evidence ("VSOE"), third-party evidence of selling
price ("TPE") or best estimate of selling price ("BESP").
When a sale involves multiple elements, we will allocate the entire fee from the arrangement to each respective element based on VSOE of fair value and recognize revenue when each element's revenue recognition criteria are met. VSOE of fair value for each element is established based on the price charged when the same element is sold separately. We have established VSOE for our software licenses based on historical stand-alone sales to third parties or from the stated renewal rates contained in the customer contracts. Maintenance service revenue is recognized on a straight-line basis over the support period.
We have not yet demonstrated VSOE for the professional services that are rendered in conjunction with our software license sales. In accordance with the hierarchy we would attempt to establish the selling price of professional services using TPE. Our product contains significant differentiation such that the comparable pricing of products with similar functionality cannot be obtained. We are typically not able to obtain TPE for professional services.
When we are unable to establish selling prices using VSOE or TPE, we use BESP. The objective of BESP is to determine the price at which we would transact a sale if professional services were sold on a stand-alone basis. BESP is generally used for offerings that are not typically sold on a stand-alone basis or for highly customized offerings.
We will also continue to defer revenues that represent undelivered post-delivery engineering support until the engineering support has been completed and the software product is accepted. To date, we have not sold any software products.
The adoption of this guidance did not have a material effect on our consolidated financial statements.
Product Research and Development
Research and development ("R&D") costs are expensed as incurred. R&D costs consist mainly of personnel related costs in addition to some external consultancy costs such as testing, certifying and measurements.
Stock-Based Compensation Expense
We measure the cost of employee services received in exchange for an award of equity instruments, including share options, based on the fair value of the award on the grant date, and recognize the value as compensation expense over the period the employee is required to provide services in exchange for the award, usually the vesting period, net of estimated forfeitures.
We account for equity instruments issued to non-employees at their fair value and the unvested portion is re-measured each reporting period as long as the instrument requires variable accounting.
When determining stock-based compensation expense involving options and warrants, we determine the estimated fair value of options and warrants using the Black-Scholes option pricing model.
Accounting for Debt Issued with Detachable Stock Purchase Warrants and Beneficial Conversion Features
We account for debt issued with stock purchase warrants by allocating the proceeds of the debt between the debt and the detachable warrants based on the relative fair values of the debt security without the warrants and the warrants themselves, if the warrants are equity instruments. The relative fair value of the warrants are recorded as a debt discount and amortized to expense over the life of the related debt using the effective interest method. At each balance sheet date, we make a determination if these warrant instruments should be classified as liabilities or equity, and reclassify them if the circumstances dictate.
In certain instances, the Company enters into convertible notes that provide for an effective or actual rate of conversion that is below market value, and the embedded conversion feature does not qualify for derivative treatment (a "BCF"). In these instances, we account for the value of the BCF as a debt discount, which is then amortized to expense over the life of the related debt using the straight-line method which approximates the effective interest method.
Results of Operations
Net Revenues
Net revenues for the three months ended March 31, 2012 and 2011 was $1.2 million and $539,000, respectively. Our net revenues for the three months ended March 31, 2012 included $896,000 from license fees related to the shipment of eReaders plus $268,000 in fees for engineering design services related to our touch screen solution for another customer. Our net revenues for the three months ended March 31, 2011 included $521,000 from license fees related to the shipment of eReaders by Sony Corporation (Sony) plus $18,000 in fees for engineering design services related to our touch screen solution for another customer.
On June 18, 2010, in conjunction with the signing of the technology license agreement with Sony, they issued an initial purchase order for $475,000 of touchscreen licenses. We recorded the $475,000 pre-payment as deferred revenue until the initial warranty period expired. Sony began shipping its first eReader product on September 1, 2010. During the three months ended March 31, 2011, we recognized the $475,000 of deferred revenue related to the Sony initial purchase order plus $46,000 related to additional licenses purchased during the three months ended March 31, 2011.
As of March 31, 2012, we have signed sixteen technology license agreements with global OEMs and customers. We signed one new license agreement with a global OEM subsequent to March 31, 2012. In addition, we are currently developing prototype products and are engaged in product engineering design discussions with numerous global OEMs who are in the process of qualifying our touchscreen technology for incorporation in various products such as printer products, GPS devices, e-Readers, tablets, touch panels for automobiles, household appliances, mobile phones and games and toys. The development and product release cycle for these products typically takes six to eighteen months.
Drivers of the touch screen market include mobile phones, printers, laptops, tablets, eReaders, navigation screens, etc. The proliferation and mass market acceptance of touch screens have prompted new applications and uses for existing and new offerings, thus making the production and utilization of these modules one of the fastest growing tech segments. The typical sales cycle is 9-18 months with new customers while existing customer lead times are typically 6-9 months. During the initial cycle, there are three phases: evaluation, design, and commercial. In the evaluation phase, prospects validate the Neonode technology using a Neonode evaluation kit and may produce short runs. During the design phase, true product development begins, with solution definition occurring as well. This phase tends to be the longest and it should be noted that this phase is where delays typically occur, drawing out the term of the overall cycle. In the final phase, commercialization, the customer enters into full production mode, and Neonode earns license revenue.
Gross Margin
Gross margin was $915,000 and $384,000 for the three months ended March 31, 2012 and 2011, respectively. Our cost of revenues includes the direct cost of production of the components plus the costs of Company employed engineering personnel plus engineering consultants to complete the engineering design contract.
Product Research and Development
Product research and development expenses for the three month period ending March 31, 2012 were $687,000 compared to $276,000 for the same period in 2011. R&D costs mainly consist of personnel related costs in addition to some external consultancy costs such as testing, certifying and measurements. Factors that contributed to the increase in R&D costs include an increase in the amount of time our engineering department spends engaged in the R&D activities. These other costs related to customer specific activities are included in our cost of revenue. R&D costs increased to $249,000 for the three months ended March 31, 2012 compared to $155,000 for the same period in 2011.
Sales and Marketing
Sales and marketing expenses for the three month period ended March 31, 2012 were $799,000 compared to $352,000 for the same period in 2011. This increase in 2012 as compared to 2011 is primarily related to an increase in sales and marketing staff, marketing activities and travel related costs.
General and Administrative
General and administrative expenses for the three months ended March 31, 2012 were $995,000 compared to $864,000 for the same period in 2011. This increase in 2012 as compared to 2011 is primarily related to salary expense, legal expenses related to patent filings, corporate and SEC compliance and customer contracts.
Interest Expense
Interest expense for the three month period ended March 31, 2011 was $54,000. We did not have any interest expense for the three month period ended March 31, 2012 . We had $3.9 million of convertible debt outstanding at March 31, 2011. All the convertible debt and accrued interest was converted to shares of our common stock on December 14, 2011.
Non-cash items related to debt discounts, deferred financing fees and the valuation of conversion features and warrants
In connection with the March 2011 financing transaction the Company determined that the embedded conversion feature to the notes meet the definition of a derivative liability, and as of the date of issuance was valued at $4.1 million. In accordance with relevant accounting guidance, the Company recorded a full debt discount up to the face amount of the notes ($3.7 million), recorded the derivative liability for the embedded conversion feature of $4.1 million and recorded the excess value of $1.2 million on the issuance as non-cash interest expense.
During the three months ended March 31, 2011, the Company recorded an aggregate loss of $7.4 million as a change in fair value of derivative liabilities.
On December 14, 2011, all of the outstanding convertible debt and accrued interest was paid or converted into shares of the Company's common stock. As of December 31, 2011, the fair value of the embedded conversion features was $0.
Income Taxes
Our tax provision for the three months ended March 31, 2012 and 2011 represents income taxes withheld by one of our foreign customers. We recorded valuation allowances for the three month periods ending March 31, 2012 and 2011 for deferred tax assets related to net operating losses due to the uncertainty of realization. In the event of future taxable income, our effective income tax rate in future periods could be lower than the statutory rate as such tax assets are realized.
Net Loss
As a result of the factors discussed above, we recorded a net loss of $1.6 million for the three month period ended March 31, 2012, compared to a net loss of $9.7 million in the comparable period in 2011.
Off-Balance Sheet Arrangements
We do not have any transactions, arrangements, or other relationships with unconsolidated entities that are reasonably likely to affect our liquidity or capital resources other than the operating leases noted above. We have no special purpose or limited purpose entities that provide off-balance sheet financing, liquidity, or market or credit risk support; or engage in leasing, hedging, research and development services, or other relationships that expose us to liability that is not reflected on the face of the financial statements.
Liquidity and Capital Resources
Our liquidity is dependent on many factors, including sales volume, operating profit and the efficiency of asset use and turnover. Our future liquidity will be affected by, among other things:
ˇ actual versus anticipated licensing of our technology;
ˇ our actual versus anticipated operating expenses;
ˇ the timing of our OEM customer product shipments;
ˇ the timing of payment for our technology licensing agreements;
ˇ our actual versus anticipated gross profit margin;
ˇ our ability to raise additional capital, if necessary; and
ˇ our ability to secure credit facilities, if necessary.
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