Neonode Inc. — Q2 2011 Form 10-Q
Business context and period. The filing covers the quarter and six months ended June 30, 2011. Neonode licenses its zForce optical infrared touchscreen technology and provides related engineering services to device makers; it does not manufacture hardware products. Per-share figures reflect the 25-for-1 reverse stock split effective March 28, 2011.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $283,000 | $123,000 | $822,000 | $269,000 |
| Gross profit | $45,000 | $19,000 | $429,000 | $103,000 |
| Gross margin | 15.9% | 15.4% | 52.2% | 38.3% |
| Operating loss | $1.621 million | $2.204 million | $2.729 million | $4.485 million |
| Net loss | $2.722 million | $13.799 million | $12.443 million | $16.043 million |
| Basic and diluted loss per share | $0.10 | $0.80 | $0.50 | $0.94 |
Revenue included $56,000 of Sony license fees in Q2 and $577,000 for the six-month period, plus engineering fees of $214,000 and $233,000, respectively. Management said four customers were shipping products by quarter-end; additional launches were anticipated in the second half of 2011 and first half of 2012.
Cash used in operating activities was $3.048 million for the first half, compared with $1.435 million in 2010. Investing activities used $25,000; financing activities provided $4.718 million. Cash increased to $2.559 million from $911,000 at year-end 2010.
At June 30, total assets were $5.990 million and total liabilities were $9.995 million, including $6.190 million of derivative liabilities. Stockholders’ deficit was $4.005 million. The company reported $4.228 million principal outstanding on 2011 convertible notes, but the debt’s $4.228 million discount reduced its net carrying value to zero. Working capital was approximately $2.1 million when excluding the noncash embedded derivative liability; including all current liabilities, current assets were below current liabilities.
Changes versus prior comparable periods
- Revenue rose 130% in Q2 and 206% in the first half year over year. Six-month gross margin improved to 52.2% from 38.3%.
- Net losses narrowed, but remained substantial. The comparisons were affected by noncash financing-related fair-value charges and, in 2010, $3.168 million of first-half amortization of stock issued to related parties in connection with the acquisition of Neonode Technologies AB.
- Operating expenses rose in several areas: first-half sales and marketing was $715,000 versus $87,000, and general and administrative expense was $1.785 million versus $703,000. Management cited increased staffing, travel, stock warrants, and legal costs.
- Common shares outstanding increased from 21.8 million at December 31, 2010 to 27.9 million at June 30, 2011, reflecting conversions, warrant exercises, and other issuances. All stated share figures reflect the reverse split.
Outlook, risks and notable items
- Funding and going concern: The company had a $125 million accumulated deficit and a history of operating losses and negative operating cash flow. Its 2010 auditor’s report included a going-concern paragraph. Management said cash and expected customer receipts should support operations for the remainder of 2011 and expected sufficient customer license-agreement cash for the next twelve months, while warning that additional funding may be needed and is not assured.
- Customer prepayment: One customer committed to pre-purchase $3.0 million of technology licenses when product shipments began. Neonode invoiced the amount in June and reported receiving the first $1.0 million payment in July 2011. Deferred revenue was $3.075 million at June 30.
- Debt and dilution: The 2011 notes carry 7% interest, mature March 1, 2014, and are convertible at $2.50 per share. Automatic conversion provisions apply if the share-price or financing thresholds specified in the notes are met. The financing also generated warrants and a substantial derivative liability; fair-value movements contributed materially to reported losses.
- Concentration and execution: Four customers generated about 99% of Q2 revenue; one customer generated about 71% of first-half revenue. Revenue depends on customers completing product development and shipping products. Management described typical customer sales cycles of nine to eighteen months and product release cycles of six to eighteen months.
- Other risks: Risks include technology acceptance and obsolescence, competition, intellectual-property protection, reliance on key personnel and limited suppliers, foreign-exchange exposure—particularly the Swedish krona—and the ability to raise capital. The company reported no material legal proceedings.
- Controls: Management concluded disclosure controls were not effective because internal-control policies and procedures were not formally documented, citing the small accounting department. Planned remediation included adding finance resources, assessing controls, and documenting and testing them.
- The filing provides no formal revenue, earnings, or cash-flow guidance. Management’s operating and funding statements are forward-looking and subject to uncertainty.
Important facts for investors to verify
- Whether the customer’s $3.0 million license pre-purchase is collected in full, and how and when the related deferred revenue is recognized.
- Cash burn, available funding, and the assumptions behind management’s stated liquidity runway, given the going-concern warning and operating cash outflow.
- The terms, conversion triggers, dilution potential, and future cash obligations of the 2011 notes and associated warrants.
- Customer concentration, product shipment progress, and whether expected OEM launches translate into recurring license or royalty revenue.
- The effect of Level 3 derivative valuations on reported losses; the filing identifies significant unobservable valuation inputs, including expected volatility of 110%–263%.
- Progress in addressing the disclosed material weakness in internal controls.