Neonode Inc. - Quarter Report: 2008 March (Form 10-Q)

		March 31, 2008			December 31, 2007
Parts and materials		$	1,007		$	247
Finished goods held at customer locations			5,124			1,243
Finished goods held at manufacturing partner			5,322			5,120
Total inventories		$	11,453		$	6,610

Parts and materials consist of components purchased by us in order to reduce the production lead time of our products. Finished goods held at manufacturing partner locations consist of N2 phones and accessories located at our manufacturing partner or with our web sales partner. Inventory at our manufacturing partner is being modified under our voluntary recall program. Finished goods held at customer locations consists of N2 phones that have been shipped to distributors but remain in their inventories at the end of the period for which revenue has been deferred.

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4.   Convertible Debt and Notes Payable

Our convertible debt and notes payable consists of the following (in thousands):

 

		March 31,			December 31,
		2008			2007
Senior Convertible Secured August Bridge Notes (face value $2,800)		$	2,635		$	2,634
Senior Convertible Secured Notes September 2007 (face value $3,053 at March 31, 2008 and $3,058 at December 31, 2007)			1,100			1,112
Loan - Almi Företagspartner			103			120
Capital leases – office copying machines			97			72
Total			3,935			3,938
Unamortized debt discount			3,716			3,746
Total debt, net of debt discount			219			192
Less: short-term portion of long-term debt			119			132
Long-term debt		$	100		$	60

 

Future maturities of notes payable (in thousands):

 

Year ended December 31,		Future Maturity of Notes Payable
2008 remaining		$	2,874
2009			24
2010			3,058
Thereafter			-
Total principal payments		$	5,956

Senior Convertible Secured August Bridge Notes

On August 8, 2007, we made an offering of convertible notes pursuant to a Note Purchase Agreement (August Bridge Notes or Bridge Notes), dated as of July 31, 2007, amended August 1, 2007 and September 26, 2007. The August Bridge Notes are convertible into the units offered in the September 26, 2007 financing agreement described below. We received $3,250,000 from the Bridge Note offering and issued an option to invest $750,000, at the same terms and conditions as the Bridge Notes, to one of the Bridge Note investors/financial advisor as part of a longer range financing plan. The August Bridge Notes originally matured on December 31, 2007, however the maturity of these notes was extended to June 30, 2008 in conjunction with the September 2007 financing described below. The option to invest $750,000 had an expiration date of December 31, 2007 when issued, however, this option was extended on December 31, 2007 to March 31, 2008 and subsequently extended on March 24, 2008 to June 30, 2008.

		Weighted Average Number of Shares			Exercise Price Per Share			Weighted Average Exercise Price
Outstanding at December 31, 2007			2,434,732		$	1.42 - $ 27.50		$	2.58
Granted			410,000			3.45 - $ 3.45			3.45
Cancelled or expired			(40,000	)		3.45 - $ 3.45			3.45
Exercised			—			—			—
Outstanding at March 31, 2008			2,804,732		$	1.42 - $ 27.50		$	2.69

The 1996 Plan terminated effective January 17, 2006 and although we can no longer issue stock options out of the plan, the outstanding options at the date of termination will remain outstanding and vest in accordance with their terms. Options granted under the Director Plan vest over a one to four-year period, expire five to seven years after the date of grant and have exercise prices reflecting market value of the shares of our common stock on the date of grant. Stock options granted under the 1996, 1998 and 2006 and are exercisable over a maximum term of ten years from the date of grant, vest in various installments over a one to four-year period and have exercise prices reflecting the market value of the shares of common stock on the date of grant.

The Neonode Plan has been designed for participants (i) who are subject to Swedish income taxation (each, a “Swedish Participant”) and (ii) who are not subject to Swedish income taxation (each, a “Non-Swedish Participant”). We will not grant any additional equity awards out of the Neonode Plan. The options issued under the plan to the Non-Swedish Participant are five year options with 25% vesting immediately and the remaining vesting over a three year period. The options issued to Swedish participants are vested immediately upon issuance.

		Three months ended March 31, 2007			Three months ended March 31, 2008			Remaining unamortized expense at March 31, 2008
Stock based compensation		$	163		$	890		$	1,430

The remaining unamortized expense related to stock options will be recognized on a straight line basis monthly as compensation expense over the remaining vesting period which approximates 3 years.

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

 

Options granted in three months ended March 31		2008			2007
Expected life (in years)			2.11			4.57
Risk-free interest rate			3.32	%		5.75	%
Volatility			163.66	%		119.53	%
Dividend yield			0.00	%		0.00	%

The weighted average grant-date fair value of options granted during the three months ended March 31,2008 and 2007 was $2.67 and $1.51, respectively. There were no stock options exercised during the three months ending March 31, 2008. The total intrinsic value of options exercised during the three months ended March 31, 2007 was $35,754.

The fair value of stock-based awards to employees is calculated using the Black-Scholes option pricing model, even though this model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which differ significantly from our stock options. The Black-Scholes model also requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term and forfeiture rate of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior, as well as expected behavior on outstanding options. The risk-free rate is based on the U.S. Treasury rates in effect during the corresponding period of grant. The expected volatility is based on the historical volatility of our stock price. These factors could change in the future, which would affect fair values of stock options granted in such future periods, and could cause volatility in the total amount of the stock-based compensation expense reported in future periods.

 

 

 

 

 

 

 

 

 

 

	·	We implemented corporate governance policies, including an employee code of conduct and whistleblower provisions, so that employees of our operating subsidiary would be aware of our compliance duties and responsibilities; and
	·	We purchased new management reporting system software, and retained a consultant to oversee its implementation, to better enable us to consolidate our accounting and budgeting systems across different international locations and functional currencies.

	·	adding personnel to our financial department, consultants, or other resources (including those with public company reporting experience) to enhance our policies and procedures, including those related to revenue recognition;
	·	exploring the suitability of further upgrades to our accounting system to complement the new management reporting system software described above;
	·	modifying the documentation and testing programs SBE was developing prior to the merger to appropriately apply to the new Neonode; and
	·	engaging a qualified consultant in 2008 to perform an assessment of the effectiveness of our internal control over financial reporting and assist us in implementing appropriate internal controls on weaknesses determined, if any, documenting, and then testing the effectiveness of those controls.

 

 

ITEM 1A.

RISK FACTORS

 

	·	testing of our products on wireless carriers’ networks;
	·	quality and coverage area of wireless voice and data services offered by the wireless carriers;
	·	the degree to which wireless carriers facilitate the introduction of and actively market, advertise, promote, distribute and resell our multimedia phone products;
	·	the extent to which wireless carriers require specific hardware and software features on our multimedia phone to be used on their networks;
	·	timely build out of advanced wireless carrier networks that enhance the user experience for data centric services through higher speed and other functionality;
	·	contractual terms and conditions imposed on them by wireless carriers that, in some circumstances, could limit our ability to make similar products available through competitive carriers in some market segments;
	·	wireless carriers’ pricing requirements and subsidy programs; and
	·	pricing and other terms and conditions of voice and data rate plans that the wireless carriers offer for use with our multimedia phone products.

 

 

	·	changes in foreign currency exchange rates;
	·	the impact of recessions in the global economy or in specific sub economies;
	·	changes in a specific country’s or region’s political or economic conditions, particularly in emerging markets;
	·	changes in international relations;
	·	trade protection measures and import or export licensing requirements;
	·	changes in tax laws;
	·	compliance with a wide variety of laws and regulations which may have civil and/or criminal consequences for them and our officers and directors who they indemnify;
	·	difficulty in managing widespread sales operations; and
	·	difficulty in managing a geographically dispersed workforce in compliance with diverse local laws and customs.

 

 

 

 

 

 

 

	·	actual or anticipated fluctuations in our operating results or future prospects;
	·	our announcements or our competitors’ announcements of new products;

	·	the public’s reaction to our press releases, our other public announcements and our filings with the SEC;
	·	strategic actions by us or our competitors, such as acquisitions or restructurings;
	·	new laws or regulations or new interpretations of existing laws or regulations applicable to our business;
	·	changes in accounting standards, policies, guidance, interpretations or principles;
	·	changes in our growth rates or our competitors’ growth rates;
	·	developments regarding our patents or proprietary rights or those of our competitors;
	·	our inability to raise additional capital as needed;
	·	concern as to the efficacy of our products;
	·	changes in financial markets or general economic conditions;
	·	sales of common stock by us or members of our management team; and
	·	changes in stock market analyst recommendations or earnings estimates regarding our common stock, other comparable companies or our industry generally.

 

Exhibit #		Description
2.1		Agreement and Plan of Merger and Reorganization between SBE, Inc. and Neonode Inc., dated January 19, 2007 (incorporated by reference to Exhibit 2.1 of our Current Report on Form 8-K filed on January 22, 2007 ) ( In accordance with Commission rules, we supplementally will furnish a copy of any omitted schedule to the Commission upon request )
2.2		Amendment No. 1 to the Agreement and Plan of Merger and Reorganization between SBE, Inc. and Neonode Inc., dated May 18, 2007, effective May 25, 2007 ( incorporated by reference to Exhibit 2.1 of our Current Report on Form 8-K filed on May 29, 2007 )
3.1		Amended and Restated Certificate of Incorporation, dated December 20, 2007, effective December 21, 2007
3.2		Bylaws, as amended through December 5, 2007
10.1		Note Purchase Agreement, dated February 28, 2006
10.2		Senior Secured Note issued to AIGH Investment Partners LLC, dated February 28, 2006
10.3		Senior Secured Note issued to Hirshcel Berkowitz, dated February 28, 2006
10.4		Senior Secured Note issued to Joshua Hirsch, dated February 28, 2006
10.5		Security Agreement, dated February 28, 2006
10.6		Stockholder Pledge and Security Agreement (form of), dated February 28, 2006
10.7		Intercreditor Agreement, dated February 28, 2006
10.8		Note Purchase Agreement, dated November 20, 2006
10.9		Senior Secured Note issued to AIGH Investment Partners LLC, dated November 20, 2006
10.10		Senior Secured Note issued to Hirshcel Berkowitz, dated November 20, 2006
10.11		Senior Secured Note issued to Joshua Hirsch, dated November 20, 2006
10.12		Amendment to Security Agreement, dated November 20, 2006
10.13		Amendment to Stockholder Pledge and Security Agreement, dated November 20, 2006
10.14		Amendment to Security Agreement, dated January 22, 2007