Attached files

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EX-21.1 - LIST OF SUBSIDIARIES - Neonode, Incf10k2009ex21i_neonode.htm
EX-32.1 - CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 - Neonode, Incf10k2009ex32i_neonode.htm
EX-31.2 - CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 - Neonode, Incf10k2009ex31ii_neonode.htm
EX-31.1 - CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 - Neonode, Incf10k2009ex31i_neonode.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the fiscal year ended December 31, 2009
 
or
   
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from to


Commission File No. 0-8419

NEONODE INC.
(Exact name of Registrant as specified in its charter)

Delaware
94-1517641
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification Number)

Sweden Linnegatan 89, SE-115 23 Stockholm, Sweden
USA 651 Byrdee Way, Lafayette, CA 94549
(Address of principal executive offices and Zip Code)

Sweden + 46 8 667 17 17
USA + 1 925 768 0620
(Registrant's Telephone Numbers, including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class
Name of Each Exchange on Which Registered
Common Stock
NONE

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No ý
 
 
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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 such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 
Large accelerated filer ¨
Accelerated filer ¨
 
Non-accelerated filer ¨
Smaller reporting company ý
   
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act. Yes ¨ No ý

The approximate aggregate market value of the common stock held by non-affiliates of the registrant, based on the closing price for the registrant’s common stock on June 30, 2009 (the last business day of the second quarter of the registrant’s current fiscal year) as reported on the Nasdaq Capital Markets, was $3,861,252.

The number of shares of the registrant’s common stock outstanding as of March 24, 2010 was 426,985,185.
The number of shares of the registrant’s Series A Preferred stock outstanding as of March 24, 2010 was 68,120.
The number of shares of the registrant’s Series B Preferred stock outstanding as of March 24, 2010 was 9,875.

DOCUMENTS INCORPORATED BY REFERENCE

Exhibits incorporated by reference are referred to in Part IV.
 
 
 
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NEONODE INC.

2009 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS
 
PART I
 
Item 1.
BUSINESS
4
Item 1A.
RISK FACTORS
12
Item 1B.
UNRESOLVED STAFF COMMENTS
18
Item 2.
PROPERTIES
18
Item 3.
LEGAL PROCEEDINGS
18
Item 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
19 
     
PART II
 
Item 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
20
Item 6.
SELECTED FINANCIAL DATA
20
Item 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
20
Item 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
33
Item 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
34
Item 9.
CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
76
Item 9A.
CONTROLS AND PROCEDURES
76
Item 9B.
OTHER INFORMATION
77
     
PART III
 
Item 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
77
Item 11.
EXECUTIVE COMPENSATION
82
Item 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
87
Item 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
89
Item 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
91
     
PART IV
 
Item 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
92
     
SIGNATURES
94


 
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SPECIAL NOTE ON FORWARD LOOKING STATEMENTS

Certain statements set forth in or incorporated by reference in this Annual Report on Form 10-K constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements include, without limitation, our expectations regarding the adequacy of anticipated sources of cash, planned capital expenditures, the effect of interest rate increases, and trends or expectations regarding our operations. Words such as “may,” “will,” “should,” “believes,” “anticipates,” “expects,” “intends,” ”plans,” “estimates” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. Such statements are based on currently available operating, financial and competitive information and are subject to various risks and uncertainties. Readers are cautioned that the forward-looking statements reflect management’s estimates only as of the date hereof, and we assume no obligation to update these statements, even if new information becomes available or other events occur in the future. Actual future results, events and trends may differ materially from those expressed in or implied by such statements depending on a variety of factors, including, but not limited to those set forth under “Item 1A Risk Factors” and elsewhere in this Annual Report on Form 10-K.

PART I
 
ITEM 1.
BUSINESS

       We provide optical touchscreen solutions for handheld consumer and industrial electronic devices. We license our touchscreen technology to Original Equipment Manufacturers (OEMs) and Original Design Manufacturers (ODMs) who imbed our touchscreen technology into electronic devices that they develop and sell, such as mobile phones, e-book readers, mobile internet devices, global positioning systems (GPS), digital picture frames and micro PCs. The cornerstone of our solution is our innovative optical infrared touchscreen technology, zForce™. We believe that keyboards and keypads with moving parts will become obsolete for handheld devices and that our touchscreen solutions will be at the forefront of a new wave of finger-based and pen input technologies that will enable the user to interact and operate everything from small mobile devices to large industrial applications using a combination of touches, swipes, and hand gestures.

Our History

Neonode Inc. (the Company), formerly known as SBE, Inc., was incorporated in the State of Delaware on September 4, 1997.

On August 10, 2007, SBE, Inc. consummated a reverse merger transaction with Neonode Inc., and SBE, Inc.’s name was subsequently changed to “Neonode Inc.” on the completion of the Merger. Neonode Inc. prior to the Merger was incorporated in the State of Delaware in 2006 and was the parent of Neonode AB, a company founded in February 2004 and incorporated in Sweden. Following the closing of the Merger, the business and operations of Neonode Inc. prior to the Merger became the primary business and operations of the newly-combined company. The newly-combined company’s headquarters was located in Stockholm, Sweden.

Through our previously wholly-owned subsidiary, Neonode AB, we developed our touchscreen technology and an optical touchscreen mobile phone product, the N2.  We began shipping the N2 to our first customers in July 2007 but faced difficult circumstances in finding a viable market for our N2 mobile phone. We did not generate sufficient cash flow from the sale of N2 mobile phones to continue operations and Neonode AB filed for liquidation under the Swedish bankruptcy laws on December 9, 2008. As of that date, Neonode AB ceased to be owned and operated by Neonode Inc. Effective with Neonode AB’s bankruptcy filing on December 9, 2008, Neonode Inc. ceased to have any financial obligations related to the accounts payable or other debts of Neonode AB. The operations of Neonode AB for the period January 1, 2008 through December 9, 2008 are included in the consolidated accounts of Neonode Inc. for the year ended December 31, 2008.  
 
 
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2008 Corporate Restructuring
 
AB Cypressen AB nr 9683 (Cypressen) (subsequently renamed Neonode Technologies AB), a company incorporated in Sweden, was acquired by Neonode Inc. on December 29, 2008 and became a wholly-owned subsidiary of Neonode Inc. on that date. Neonode Inc. issued shares of its Series A Preferred stock to the stockholders of Neonode Technologies AB in exchange for all of the outstanding stock of Neonode Technologies AB. The Neonode Technologies AB stockholders were employees of the Company and/or Neonode AB and, as such, are related parties. Neonode Technologies AB did not have any operations in 2008. The Consolidated Balance Sheet of the Company as of December 31, 2008 includes the accounts of Neonode Technologies AB which is comprised of cash totaling approximately $12,000.  The acquisition of Neonode Technologies AB by Neonode Inc. does not qualify as a business combination, and accordingly the fair value of the shares of Series A Preferred Stock issued to the sellers of Neonode Technologies AB shares are accounted for as compensation.  As there is an 18 month service requirement related to the Neonode Inc. shares issued to the Neonode Technologies AB shareholders, the value of the Series A Preferred Stock is amortized over the 18 month service period beginning December 31, 2008.

In 2008, as a result of our inability to sell a sufficient number of mobile phones to support our operations, we took the following actions to restructure and refinance the Company:

·  
On October 22, 2008, Neonode Inc.’s previously wholly-owned Swedish subsidiary, Neonode AB, filed for company reorganization in compliance with the Swedish Reorganization Act (1996:764). Mr. Anders W. Bengtsson of the Stockholm-based law firm Nova was appointed to administer the process. In accordance with §16 of the Swedish Reorganization Act, a Neonode AB creditors’ meeting was held at the district court of Stockholm, Sweden on November 11, 2008;

·  
On October 22, 2008, we terminated our agreement with Distribution Management Consolidators Worldwide, LLC (DMC Worldwide) and dissolved Neonode USA, which had been created for the sole purpose of distributing the N2 in the US and China and licensing our technology worldwide;

·  
On December 1, 2008, we transferred the intellectual property of Neonode AB, including all patents, copyrights and trademarks to Neonode Inc. pursuant to an intercompany debt pledge agreement.

·  
On December 9, 2008, Neonode AB filed a petition for bankruptcy in compliance with the Swedish Bankruptcy Act (1987:672) as a direct result of the failure to reach a satisfactory settlement agreement with the creditors of Neonode AB. Mr. Hans Ödén of the Stockholm-based Ackordscentralen AB, a consultancy firm specializing in insolvency, was appointed by the district court of Stockholm to administer the process.Under Swedish bankruptcy law, effective with the bankruptcy filing we no longer have an ownership interest in Neonode AB, and, as such, we are no longer responsible for the liabilities of Neonode AB and we no longer have title or an ownership interest in the assets of Neonode AB. The Swedish bankruptcy court appointed a Swedish legal firm as receiver with the expressed duty to liquidate all the assets of Neonode AB and enter into final settlements with the creditors of Neonode AB.

·  
On December 29, 2008, we entered into a Share Exchange Agreement with Neonode Technologies AB, a Swedish engineering company, and the stockholders of Neonode Technologies AB:  Iwo Jima SARL, Wirelesstoys AB, and Athemis Ltd. (the “Neonode Technologies AB Stockholders”), pursuant to which we agreed to acquire all of the issued and outstanding shares of Neonode Technologies AB in exchange for the issuance of shares of Neonode Inc. Series A Preferred Stock to the Neonode Technologies AB Stockholders.   Pursuant to the terms of the Share Exchange Agreement, upon the closing of the transaction, Neonode Technologies AB became a wholly-owned subsidiary of the Company;

·  
On December 30, 2008, we entered into a restructuring transaction in which we converted the majority of the outstanding warrants and convertible debt that had been issued in previous financing transactions to shares of Series A and B Preferred stock, respectively, that are convertible into shares of our common stock in accordance with the Company’s Certificate of Designations filed with the Delaware Secretary of State;
 
 
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·  
On December 30, 2008, we entered into a financing transaction in which we raised approximately $1.1 million as of December 31, 2008 through the sale of shares of Series A Preferred Stock that are convertible into shares of our common stock in accordance with the Company’s Certificate of Designations filed with the Delaware Secretary of State;

2009 Corporate Financing

·  
On January 21, 2009, we entered into a settlement agreement with Alpha Capital Anstalt (Alpha) whereby we issued shares of our common stock to settle a claim that Alpha made that we had failed to issue certain stock certificates pursuant to the terms and conditions of certain prior investment subscription agreements;

·  
On January 23, 2009, we issued shares of our common stock to vendors of Neonode Inc. in settlement of approximately $53,000 in outstanding Neonode Inc. accounts payable;

·  
On September 8, 2009, we entered into a private placement financing transaction and issued $986,983 in notes with a 7% annual interest rate, due December 31, 2010, that are convertible into approximately 49.4 million shares of our common stock. We also issued warrants that, if exercised, are convertible into 24.7 million shares of our common stock at an exercise price of $0.04 per share.

We have not generated sufficient cash from the sale of our products or licensing of our technology to support our operations and have incurred significant losses. During the twelve months ended December 31, 2008 and 2009, we raised approximately $9.6 million and $1.0 million, respectively, net cash proceeds through the sale of our securities and convertible debt. Unless we are able to increase our revenues and/or decrease expenses substantially in addition to securing additional sources of financing, we will not have sufficient cash to support our operations through June 2010.
 
Touchscreen Product Solutions
          
          We develop touchscreen technologies that enrich the user’s experience in interacting with the user’s mobile computing, communications, and entertainment devices. Our innovative touchscreen technology can be engineered to accommodate many diverse platforms and our experience in human factors and usability can be utilized to improve the features and functionality of our solutions. Our extensive array of technology includes software, mechanical and electrical designs, and pattern recognition and touch sensing technologies.

          Our touchscreen solutions for our customers include sensor design, module layout, and software features for which we provide design support and device testing. This allows us to be a one-stop supplier for complete touchscreen design from the early design stage to testing and support. Through our technologies and expertise, we seek to provide our customers with solutions that address their individual design issues and that will result in high-performance, feature-rich, and reliable touchscreen interface solutions.

Technologies

Our touchscreen solutions are based on our patented zForce™ and Neno™ hardware and software technology. zForce™ is our optical infrared touchscreen technology that supports one-handed navigation, allowing the user to operate the functionality with finger gestures passing over the screen. Neno™ is our software-based user interface.

zForce™ has been patented in several countries and is patent-pending in the US. It uses infrared light that is projected as a grid over the screen. The infrared light pulses 120 times a second so that the grid is constantly being refreshed. Coordinates are produced on the screen and are then converted into mathematical algorithms when a user's fingers move across the screen. This input method is unique to Neonode and is enabled by the zForce™ technology.
 
 
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Currently, there are two dominant types of touchscreen technologies available in the market - capacitive and resistive. Capacitive technology is the technology that the Apple iPhone uses and resistive technology is what is found on most stylus-based PDAs.  Resistive technology is pressure sensitive technology. Best used for detailed work and for selection of a particular spot on a screen, resistive technology is not useful for sweeping gestures or motion, such as zooming in and out.  Capacitive technology, which is used on a laptop computer mouse pad, is very good for sweeping gestures and motion. The screen actually reacts to the finger’s tiny electric impulses. Capacitive touchscreens work only if the user has unimpeded contact between his finger and the screen.

Our zForce™ optical touchscreen technology has a number of key advantages over each of these technologies, including:

 
·
  No additional layers are added to the screen that may dilute the screen resolution and clarity. Layering technology is required to activate the capacitive and resistive technologies and can be very costly;
 
 
·
  The zForce™ grid technology is more responsive than the capacitive screen technology and, as a result, is quicker and less prone to misreads. It allows movement and sweeping motions as compared to point-sensitive, stylus-based resistive screens;
 
 
·
  zForce™, an abbreviation for zero force necessary, obviates the need to use any force to select or move items on the screen as would be the case with a stylus;
 
 
·
  zForce™ is cost-efficient due to the lower cost of materials and extremely simple manufacturing process when compared to the expensive layered capacitive and resistive screens; and
 
 
·
  zForce™ allows multiple methods of input, such as simple finger taps to hit keys, sweeps to zoom in or out, and gestures to write text or symbols directly on the screen.

zForce™ incorporates some of the best functionalities of both the capacitive and resistive touchscreen technologies. It works in all climates and, unlike the competing technologies, can be used with gloves. In addition, zForce™ allows for waterproofing of the device.

Because of its uniqueness and flexibility, we believe that our zForce™ technology presents a tremendous licensing opportunity for Neonode. The market is vast, given the current rapid increase in touchscreen-based devices such as cell phones, PCs, media players, and GPS navigation devices.

Our software user interface, Neno™, runs on Windows CE and is completely unique. Neno™ is designed to operate complex and full feature applications on a small screen. It allows for a number of input methods and is designed to deliver high precision, fast response, and ease of use on a complex device.

Neno™ includes the following features:

 
·
Media players for streaming video, movies and music that support all the standard applications, including
WMA,WMV, MP3,WAV,DivX and AVI MPEG¼;
 
·
Internet explorer 6.0 browser;
 
·
Image viewer with camera preview and capture;
 
·
Organizer with calendar and task with Microsoft Outlook synchronization;
 
·
Calendar, alarm, calculator and call list;
 
·
Telephony manager for voice calls;
 
·
Messaging manager for SMS, MMS, IM and T9;
 
·
File manager;
 
·
Task manager for switching between applications;
 
·
Notebook; and
 
·
Games.
 
 
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Intellectual Property

We believe that innovation in product engineering, sales, marketing, support, and customer relations, and protection of this proprietary technology and knowledge, will impact our future success. In addition to certain patents that are pending, we rely on a combination of copyright, trademark, trade secret laws and contractual provisions to establish and protect the proprietary rights in our products.

We have applied for patent protection of our invention named “On a substrate formed or resting display arrangement” in six countries through a patent cooperation treaty (PCT) application and in 24 designated countries through an application to the European Patent Office (EPO). We applied for a patent in Sweden relating to a mobile phone and have also applied for a patent in the United States regarding software named “User Interface.”
 
We have been granted trademark protection for the word NEONODE in the European Union (EU), Sweden, Norway, and Australia. In addition, we have been granted protection for the figurative mark NEONODE in Sweden. Additional applications for the figurative trademark are still pending in Switzerland, China, Russia, and the United States.

Our “User Interface” may also be protected by copyright laws in most countries, especially Sweden and the EU (which do not grant patent protection for the software itself), if the software is new and original. Protection can be claimed from the date of creation.

Consistent with our efforts to maintain the confidentiality and ownership of our trade secrets and other confidential information, and to protect and build our intellectual property rights, we require our employees and consultants, and certain customers, manufacturers, suppliers and other persons with whom we do business or may potentially do business, to execute confidentiality and invention assignment agreements upon commencement of a relationship with us, typically extending for a period of time beyond termination of the relationship.

Distribution, Sales and Marketing

We consider both OEMs and ODMs and their contract manufacturers to be our primary customers. Both the OEMs, ODMs and their contract manufacturers may determine the design and pricing requirements and make the overall decision regarding the use of our user interface solutions in their products. The use and pricing of our interface solutions will be governed by a technology licensing agreement.

Our sales staff solicits prospective customers and our sales personnel receive substantial technical assistance and support from our internal engineering resources because of the highly technical nature of our product solutions. We expect that sales will frequently result from multi-level sales efforts that involve senior management, design engineers, and our sales personnel interacting with our potential customers’ decision-makers throughout the product development and order process.

Our sales are normally negotiated and executed in U.S. Dollars or Euros.

Our sales force and marketing operations are managed out of our corporate headquarters in Stockholm, Sweden, and our current sales force is comprised of consultants located in Stockholm, Korea and Australia.

Research and Development

We continue to invest in research and development of current and emerging technologies that we deem critical to maintaining our competitive position in the touchscreen user interface markets. Many factors are involved in determining the strategic direction of our product development focus, including trends and developments in the marketplace, competitive analyses, market demands, business conditions, and feedback from our customers and strategic partners. In fiscal years 2009 and 2008, we spent $1.0 million and $3.3 million, respectively, on research and development activities.
 
 
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We carefully monitor innovations in other technologies and are constantly seeking new areas for application of zForce™. We have developed a technology roadmap that we believe will result in a steady stream of new innovations and areas of use.  We no longer develop mobile phone products, but now focus our development efforts on our touchscreen technology.

Our research and development is predominantly in-house, but is also done in close collaboration with external partners and specialists. Our development areas can be divided into the following areas:

 
·   Software
 
·   Optical
 
·   Mechanical
 
·   Electrical

Recent Developments

During the period from August 25, 2009 through December 31, 2009, we completed a private placement of convertible notes totaling $987,000 that can be converted, at the holder’s option, into 49,349,151 shares of our common stock at a conversion price of $0.02 per share. The convertible note holders have the right to have the conversion price adjusted to equal the lower stock price if we issue stock or convertible notes at a lower conversion price than $0.02 during the period that the notes are outstanding. These convertible notes are due on December 31, 2010 and bear an annual interest rate of 7%, payable on June 30 and December 31 of each year that the convertible notes are outstanding. In addition, we issued 24,674,576 three-year warrants to the convertible note holders with an exercise price of $0.04 per share. The warrants may be exercised and converted to common stock, at the warrant holder’s option, beginning on the six-month anniversary date of issuance until the warrant expiration date. We are not obligated to register the common stock related to the convertible debt or the warrants.
 
In the three months ended March 31, 2010, we received $1.2 million proceeds related to a private placement of convertible notes and stock purchase warrants that can be converted, at the holder’s option, into 60,160,564 shares of our common stock at a conversion price of $0.02 per share and 30,080,282 stock purchase warrants that have an exercise price of $0.04 per share. The convertible note holders have the right to have the conversion price adjusted to equal the lower stock price if we issue stock or convertible notes at a lower conversion price than $0.02 during the period that the notes are outstanding. These convertible notes are due on December 31, 2010 and bear an annual interest rate of 7%, payable on June 30 and December 31 of each year that the convertible notes are outstanding. The warrants may be exercised and converted to common stock, at the warrant holder’s option, beginning on the six month anniversary date of issuance until the warrant expiration date. We are not obligate to register the common stock related to the convertible debt or the warrants. On March 21, 2010, we issued 875,000 shares of our common stock and a warrant to purchase 875,000 of our common stock an exercise price of $0.04 per share to Davisa Ltd for services provided for the private placement of convertible note and warrant in the March 2010 financing transaction.

Overview of the Touchscreen Market and Competition

Competing Touchscreen Technologies:
       
  Today there are different touchscreen technologies available in the market. all of them with different or slightly different profiles, level of maturity, and cost price:

·  
Resistive -- uses conductive and resistive layers separated by thin space;
·  
Surface acoustic wave -- uses ultrasonic waves that pass over the touchscreen panel;
·  
Capacitive and projected capacitive -- a capacitive touchscreen panel is coated with a material, typically indium tin oxide, that conducts a continuous electrical current across the sensor. When the sensor's 'normal' capacitance field (its reference state) is altered by another capacitance field, e.g., someone's finger, electronic circuits located at each corner of the panel measure the resultant 'distortion' in the sine wave characteristics to detect a touch;
 
 
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·  
Infrared -- uses infrared beams that are broken by finger or heat from the finger sensed from a camera to detect a touch;
·  
Strain gauge -- uses a spring mounted on the four corners and strain gauges are used to determine deflection when the screen is touched;
·  
Optical imaging -- uses two or more image sensors placed around the edges (mostly the corners) of the screen and a light source to create a shadow of the finger;
·  
In-cell optical touch technology -- embeds photo sensors directly into an LCD glass. By integrating the touch function directly into an LCD glass, the LCD acts like a low resolution camera to “see” the shadow of the finger;
·  
Dispersive signal technology -- uses sensors to detect the mechanical energy in the glass that occur due to a touch; and
·  
Acoustic pulse recognition -- uses more than two piezoelectric transducers located at some positions of the screen to turn the mechanical energy of a touch (vibration) into an electronic signal.

The following are the advantages and disadvantages of the most common competing touchscreen technologies:

Resistive Touchscreen Technology:

1.  
Uses conductive and resistive layers separated by a thin space.
2.  
Touch creates contact between resistive circuit layers closing a switch.
3.  
A controller layer is inserted between layers to determine touch coordinates.

Advantages:
§  
 High resolution
§  
 Low cost
§  
 Proven solution for low cost touchscreen applications
§  
 Support for large screen sizes

Disadvantages:
§  
 Not fully transparent (more backlight needed, which requires high power consumption; reflections; loss of colors)
§  
 Requires frequent recalibration to work properly
§  
 Large frame size (limited active area of the total display area and outer dimensions of the device)
§  
 Sensitive to scratches

Surface Capacitive Touchscreen Technology:

1.  
Two sides of a glass substrate are coated with uniform conductive indium tin oxide coating (ITO).  Silicon dioxide hard coating is coated on the front side of ITO coating layer. There are electrodes on the four corners for launching electric current.
2.  
Voltage is applied to the electrodes on the four corners.
3.  
A finger touches the screen and draws a minute amount of current to the point of contact.
4.  
The controller precisely calculates the proportion of the current passed through the four electrodes and calculates the X/Y coordinate of a touch point.

Advantages:
§  
 No “edge” or bezel on the top of the on the screen display
§  
 Medium to high resolution
§  
 Support for large screen sizes
 
 
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Disadvantages:
§  
 Expensive, typically three to four times the cost of a resistive touchscreen solution
§  
 Not fully transparent (more backlight needed, which requires high power consumption; reflections; loss of colors)
§  
 Cannot be used with gloves or pen. Only supports fingers
§  
 Limited temperature range for operation
§  
 Limited capturing speed (for gestures)
§  
 No multi-touch support

Projected Capacitive Touchscreen Technology:

1.  
This touch technology requires one or more etched ITO layers forming multiple horizontal (X) and vertical (Y) electrodes, which derive drive from a sensing chip
2.  
AC signals drive one axis and the response through the screen cycles back via the other electrodes.
3.  
Position detection comes by measuring the distribution of the change in signals between the X and Y electrodes. Math algorithms then determine the XY coordinates of the touch by processing signal-level changes

Advantages:
§  
 No “edge” or bezel on the top of the on the screen display
§  
 Medium to high resolution
§  
 Multi-touch support

Disadvantages:
§  
 Very expensive, typically 10 times the cost of a resistive touchscreen solution, making it suitable only for high end devices
§  
 Not fully transparent (more backlight needed, which requires high power consumption; reflections; loss of colors)
§  
 Cannot be used with gloves or pen (only support fingers)
§  
 Limited temperature range for operation (not for car navigation systems, etc.)
§  
 Limited capturing speed (no support for gestures)
§  
 Limited screen size (typical maximum 3-4 inches) due to poor signal to noise ratio (SNR)
§  
 No pen support

Neonode zForce Touchscreen Technology:

1.  
zForce uses a small frame around the display with LEDs and photoreceptors on the opposite sides, hidden behind a infrared-transparent bezel.
2.  
A controller sequentially pulses the LEDs to create a grid of infrared light beams across the display.
3.  
A touch obstructs one or more of the beams which identify the X and Y coordinates, which also gives area information.
4.  
Interpolation with analog reading and processing of the signal give multiple touch readings/high speed gesture support.

Advantages:
§  
 Multi-touch support
§  
 Fully transparent (maximum display quality)
§  
 Fast capturing of movements (support for gestures)
§  
 Support for extended temperature range
§  
 Support for large screen sizes
§  
 Low cost for high performance

Disadvantages:

§  
 Bezel height of 0.5 mm (edge around the display)
 
 
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The most inexpensive and widely used touchscreen solution on the market today is resistive touch. There are function limitations associated with resistive touch solutions, primarily that a user needs to press on a particular point on the screen and may be required to use a stylus or pen to touch the screen.  Many consumer devices that incorporate touchscreen applications use resistive touch solutions, including GPS and mobile phone products. Capacitive touch solutions provide a more robust set of functions that use a finger instead of a stylus to activate. Capacitive touch allows the user to move around the screen quickly, zoom in and out, and change screen views very easily. Capacitive touch solutions are priced much higher than resistive touch solutions and, as a result, are found mainly in higher priced devices. The product most users identify with a capacitive touch solution is the Apple iPhone. Our optical infrared touch solution provides the robust functionality of capacitive touch, can be activated with a finger or stylus, and is priced much closer to resistive touch solutions.

Touchscreen Technologies Competitors:
 
Company
Technology
           
3M
Surface Capacitive, Dispersive Signal Touch
       
Synaptics
Capacitive
             
RPO
Optical wave guide with camera
         
Nextwindow
Optical with camera
           
Zytronic
Projective Capacitive
           
Tyco Electronics
Capacitive, Resistive, Surface Wave, Surface capacitive
     
Touch International
Resistive, Projected Capacitive, Surface Capacitive
     
Mass Multimedia Inc.
All touchscreen technologies        
     
TPK
 Acoustic Recognition, Force Intuition, Wire Resistive, Digital Wire Resistive
(provide the capacitive touchscreen for the Apple iPhone)
 
 
Technology License Agreements

As of December 31, 2009, we do not have any technology license agreements with customers.

Employees

On December 31, 2009, we had ten full-time employees and one part-time employee. We augment our staff with consultants on an “as needed” basis. Our full-time and our part-time employees are located in our corporate headquarters in Stockholm, Sweden, and one employee is located in a branch office in the United States. None of our employees is represented by a labor union. We have experienced no work stoppages. We believe our employee relations are positive.
 
ITEM 1A.
RISK FACTORS
 
In addition to the other information in this Annual Report on Form 10-K, stockholders or prospective investors should carefully consider the following risk factors:

Risks Related To Our Business

We do not have sufficient cash to pay our independent registered public accounting firm for the required financial audit of our 2009 financial statements or the required reviews of our quarterly financial statements for the first three quarters of 2009.
 
 
-12-

 
 
Due to our lack of cash resources, we did not have sufficient cash to pay our independent registered public accounting firm to complete their audit of our 2009 financial statements that are included in this Annual Report on Form 10-K.  Since our Annual Report on Form 10-K for the period ending December 31, 2009 has been filed without audited financial statements and without the required audit opinion of our current independent registered public accounting firm, our Form 10-K is deficient and does not comply with the reporting requirements of the Securities Exchange Act of 1934 (the “Exchange Act”).   In addition, we did not have the cash resources to pay the past due amounts due to our previous independent registered public accounting firm that audited our 2008 financial statements included in this Annual Report on Form 10K.  As a result, the 2008 financial statements that are included in this Annual Report on Form 10K are presented without the required audit opinion of our previous independent registered public accounting firm.  Moreover, we have not had our quarterly financial statements that were presented in our Periodic Reports on Form 10-Q for the first three quarters of 2009 reviewed by our independent registered public accounting firm as required by the Securities and Exchange Commission (SEC) regulations. .

We intend to complete the required audit of our financial statements for the period ending December 31, 2009 as soon as we obtain the necessary funds.  When we complete the audits of the annual financial statements and reviews of the quarterly financial statements for 2009, we will be required to file an amended Annual Report on Form 10-K for the year 2009 and amended Periodic Reports on Form 10-Q for the quarters ended March 31, 2009, June 30, 2009, and September 30, 2009. These amended filings may include adjustments to our financial statements and results of operations as compared to the reports previously filed without audit or review procedures performed by our independent registered public accounting firm.

Our current failure to comply with the Exchange Act’s reporting requirements may result in the SEC instituting an administrative proceeding seeking revocation of the registration of our registered securities.  In addition, our failure to comply with the Exchange Act’s reporting requirements could adversely affect the value of our common stock.  Furthermore, our failure to satisfy the current public information requirement of Rule 144 means that the reduced Rule 144 holding period prior to the resale of our unregistered stock is unavailable to holders of our unregistered stock, which may adversely affect a stockholder’s ability to resell our stock and cause our share price to decline.  Similarly, our filing deficiency and failure to have the required financial statement audit and reviews requires us to use the longer and more expensive Form S-1 to register current or future unregistered shares that have or may be issued.  This may also have a negative impact on the trading price of our common stock and on our market listing on the OTC Bulletin Board, and may adversely impact our ability to obtain necessary financing.

We will require additional capital to fund our operations, which capital may not be available on commercially attractive terms or at all.

We will require sources of capital in addition to cash on hand to continue operations and to implement our business plan. We project that we have sufficient liquid assets to continue operating until the end of June 2010. We are currently evaluating different financing alternatives, including but not limited to selling shares of our common or preferred stock, or issuing notes that may be converted in shares of our common stock which could result in the issuance of additional shares.   If our operations do not become cash flow positive, we will be forced to seek credit line facilities from financial institutions, additional private equity investment, or debt arrangements. No assurances can be given that we will be successful in obtaining such additional financing on reasonable terms, or at all. If adequate funds are not available on acceptable terms, or at all, we may be unable to adequately fund our business plan, which could have a negative effect on our business, results of operations, and financial condition. In addition, if funds are available, the issuance of equity securities or securities convertible into equity could dilute the value of shares of our common stock and cause the market price to fall, and the issuance of debt securities could impose restrictive covenants that could impair our ability to engage in certain business transactions.
 
The current worldwide financial and credit markets are difficult to access.
 
The continuing crisis in the worldwide financial and credit markets make it extremely difficult to access sources of capital or borrowings.   Credit line facilities from financial institutions, additional private equity investment, and debt arrangements may not be available to us for some time in the future.  No assurances can be given that we will be successful in obtaining such additional financing on reasonable terms, or at all. If adequate funds are not available on acceptable terms, or at all, we may be unable to adequately fund our business plans, which could have a negative effect on our business, results of operations, and financial condition.
 
 
-13-

 
 
Our former wholly-owned Swedish subsidiary, Neonode AB, has been liquidated under the Swedish bankruptcy laws

Neonode AB, our former wholly-owned Swedish subsidiary, filed a petition to liquidate under the Swedish bankruptcy laws on December 9, 2008. Neonode AB was our operating company that developed and marketed our touchscreen mobile phone, the N2. We no longer manufacture or sell mobile phone products and have implemented a new strategy for our business.  While we have acquired Neonode Technologies AB, we may not be successful in our transition from the manufacturing and selling of mobile phone products to the licensing of our touchscreen technologies to other companies.

We have never been profitable and we anticipate significant additional losses in the future.

Neonode Inc. was formed in 1997 and reconstituted in 2006 as a holding company, owning and operating Neonode AB, which had been formed in 2004. We had been primarily engaged in the business of developing and selling mobile phones. Following the liquidation of Neonode AB, we have implemented a new strategy for our business.  We have a limited operating history on which to base an evaluation of our business and prospects. Our prospects must be considered in light of the risks and uncertainties encountered by companies in the early stages of development, particularly companies in new and rapidly evolving markets. We were not successful in selling mobile phones and have refocused our business on licensing our touchscreen technology. Although we secured one technology license agreement in July 2005, it was not the main focus of our business. We may not be successful in entering the technology licensing business. Our success will depend on many factors, including, but not limited to:

 
·   the growth of touchscreen interface usage;
 
·   the efforts and success of our OEM and other customers;
 
·   the level of competition faced by us; and
 
·   our ability to meet customer demand for engineering support, new technology and ongoing service.

In addition, we have experienced substantial net losses in each fiscal period since our inception. These net losses resulted from a lack of substantial revenues and the significant costs incurred in the development of our products and infrastructure. Our ability to continue as a going concern is dependent on our ability to raise additional funds and implement our business plan.

Our limited operating history and the emerging nature of our market, together with the other risk factors set forth in this report, make prediction of our future operating results difficult. There can also be no assurance that we will ever achieve significant revenues or profitability or, if significant revenues and profitability are achieved, that they could be sustained.

If we fail to develop and introduce new products and services successfully and in a cost effective and timely manner, we will not be able to compete effectively and our ability to generate revenues will suffer.

We operate in a highly competitive, rapidly evolving environment, and our success depends on our ability to develop and introduce new products, technology, and services that our customers and end users choose to buy. If we are unsuccessful at developing and introducing new products, technology, and services that are appealing to our customers and end users with acceptable quality, prices and terms, we will not be able to compete effectively and our ability to generate revenues will suffer.

The development of new products, technology, and services is very difficult and requires high levels of innovation. The development process is also lengthy and costly. If we fail to anticipate our end users’ needs or technological trends accurately or if we are unable to complete the development of products and services in a cost effective and timely fashion, we will be unable to introduce new products and services into the market or successfully compete with other providers.
 
 
-14-

 
 
As we introduce new or enhanced products or integrate new technology into new or existing products, we face risks including, among other things, disruption in customers’ ordering patterns, excessive levels of older product inventories, inability to deliver sufficient supplies of new products to meet customers’ demand, possible product and technology defects, and potentially unfamiliar sales and support environments. Premature announcements or leaks of new products, features, or technologies may exacerbate some of these risks. Our failure to manage the transition to newer products or the integration of newer technology into new or existing products could adversely affect our business, results of operations, and financial condition.

We are dependent on the ability of our customers to design, manufacture and sell their products that incorporate our touchscreen technologies.

Our products and technologies are licensed to other companies which must be successful in designing, manufacturing and selling the products that incorporate our technologies. If our customers are not able to design, manufacture or sell their products, or are delayed in producing their products, our revenues, profitability, and liquidity, as well as our brand image, may be adversely affected.

We must significantly enhance our sales and product development organizations.

We will need to improve the effectiveness and breadth of our sales operations in order to increase market awareness and sales of our technologies, especially as we expand into new market segments. Competition for qualified sales personnel is intense, and we may not be able to hire the kind and number of sales personnel we are targeting. Likewise, our efforts to improve and refine our products require skilled engineers and programmers. Competition for professionals capable of expanding our research and development organization is intense due to the limited number of people available with the necessary technical skills. If we are unable to identify, hire, or retain qualified sales, marketing, and technical personnel, our ability to achieve future revenue may be adversely affected.

We are dependent on the services of our key personnel.

We are dependent on our current management for the foreseeable future. The loss of the services of any member of management could have a materially adverse effect on our operations and prospects.

If third parties infringe our intellectual property or if we are unable to secure and protect our intellectual property, we may expend significant resources enforcing our rights or suffer competitive injury.

Our success depends in large part on our proprietary technology and other intellectual property rights. We rely on a combination of patents, copyrights, trademarks and trade secrets, confidentiality provisions, and licensing arrangements to establish and protect our proprietary rights. Our intellectual property, particularly our patents, may not provide us with a significant competitive advantage. If we fail to protect or to enforce our intellectual property rights successfully, our competitive position could suffer, which could harm our results of operations.

Our pending patent and trademark applications for registration may not be allowed, or others may challenge the validity or scope of our patents or trademarks, including patent or trademark applications or registrations. Even if our patents or trademark registrations are issued and maintained, these patents or trademarks may not be of adequate scope or benefit to us or may be held invalid and unenforceable against third parties.

We may be required to spend significant resources to monitor and police our intellectual property rights. Effective policing of the unauthorized use of our products or intellectual property is difficult and litigation may be necessary in the future to enforce our intellectual property rights. Intellectual property litigation is not only expensive, but time-consuming, regardless of the merits of any claim, and could divert attention of our management from operating the business. Despite our efforts, we may not be able to detect infringement and may lose competitive position in the market before they do so. In addition, competitors may design around our technology or develop competing technologies. Intellectual property rights may also be unavailable or limited in some foreign countries, which could make it easier for competitors to capture market share.
 
 
-15-

 
 
Despite our efforts to protect our proprietary rights, existing laws, contractual provisions and remedies afford only limited protection. Intellectual property lawsuits are subject to inherent uncertainties due to, among other things, the complexity of the technical issues involved, and we cannot assure you that we will be successful in asserting our intellectual property rights. Attempts may be made to copy or reverse engineer aspects of our products or to obtain and use information that we regard as proprietary. Accordingly, we cannot assure you that we will be able to protect our proprietary rights against unauthorized third party copying or use. The unauthorized use of our technology or of our proprietary information by competitors could have an adverse effect on our ability to sell our products.

We have an international presence in countries whose laws may not provide protection of our intellectual property rights to the same extent as the laws of the United States, which may make it more difficult for us to protect our intellectual property.
 
As part of our business strategy, we target customers and relationships with suppliers and original equipment manufacturers in countries with large populations and propensities for adopting new technologies. However, many of these countries do not address misappropriation of intellectual property nor deter others from developing similar, competing technologies or intellectual property. Effective protection of patents, copyrights, trademarks, trade secrets and other intellectual property may be unavailable or limited in some foreign countries. In particular, the laws of some foreign countries in which we do business may not protect our intellectual property rights to the same extent as the laws of the United States. As a result, we may not be able to effectively prevent competitors in these regions from infringing our intellectual property rights, which could reduce our competitive advantage and ability to compete in those regions and negatively impact our business.

If we are unable to obtain key technologies from third parties on a timely basis, free from errors or defects, we may have to delay or cancel the release of certain products or features in our products or incur increased costs.

We license third-party software for use in our products, including the operating systems. Our ability to release and sell our products, as well as our reputation, could be harmed if the third-party technologies are not delivered to customers in a timely manner, on acceptable business terms, or if they contain errors or defects that are not discovered and fixed prior to release of our products and we are unable to obtain alternative technologies on a timely and cost effective basis to use in our products. As a result, our product shipments could be delayed, our offering of features could be reduced, or we may need to divert our development resources from other business objectives, any of which could adversely affect our reputation, business and results of operations.

Changes in financial accounting standards or practices may cause unexpected fluctuations in and adversely affect our reported results of operations.
 
Any change in financial accounting standards or practices that cause a change in the methodology or procedures by which we track, calculate, record and report our results of operations or financial condition or both could cause fluctuations in, and adversely affect, our reported results of operations and cause our historical financial information not to be reliable as an indicator of future results.

Wars, terrorist attacks or other threats beyond our control could negatively impact consumer confidence, which could harm our operating results.

Wars, terrorist attacks or other threats beyond our control could have an adverse impact on the United States, Europe and the world economy in general, and consumer confidence and spending in particular, which could harm our business, results of operations and financial condition.
 
 
-16-

 
 
Risks Related to Owning Our Stock

During the 2009 fiscal year, due to our lack of cash resources, we were unable to obtain a review of our interim financial statements by our registered independent accountants in accordance with Rule 10-01(d) of the Securities and Exchange Commission Regulation S-X.

During the 2009 fiscal year, due to our lack of cash resources, we were unable to obtain a review of our interim financial statements by our registered independent accountants in accordance with Rule 10-01(d) of the Securities and Exchange Commission Regulation S-X.  Our failure to comply with these SEC requirements could adversely affect the value of our common stock.  In addition, our failure to satisfy the current public information requirement of Rule 144 means that the reduced Rule 144 holding period prior to the resale of our unregistered stock is unavailable to holders of our unregistered stock.  This may adversely affect a stockholder’s ability to resell our stock and cause our share price to decline.

If we continue to experience losses, we could experience difficulty meeting our business plan and our stock price could be negatively affected.

If we are unable to gain market acceptance of our touchscreen technologies, we will experience continuing operating losses and negative cash flow from our operations. Any failure to achieve or maintain profitability could negatively impact the market price of our common stock. We anticipate that we will continue to incur product development, sales and marketing and administrative expenses. As a result, we will need to generate significant quarterly revenues if we are to achieve and maintain profitability. A substantial failure to achieve profitability could make it difficult or impossible for us to grow our business. Our business strategy may not be successful, and we may not generate significant revenues or achieve profitability. Any failure to significantly increase revenues would also harm our ability to achieve and maintain profitability. If we do achieve profitability in the future, we may not be able to sustain or increase profitability on a quarterly or annual basis.

Our certificate of incorporation and bylaws and the Delaware General Corporation Law contain provisions that could delay or prevent a change in control.

Our board of directors has the authority to issue up to 2,000,000 shares of Preferred stock and to determine the price, rights, preferences and privileges of those shares without any further vote or action by the stockholders. The rights of the holders of common stock will be subject to, and may be materially adversely affected by, the rights of the holders of any Preferred stock that may be issued in the future. The issuance of Preferred stock could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. Furthermore, certain other provisions of our certificate of incorporation and bylaws may have the effect of delaying or preventing changes in control or management, which could adversely affect the market price of our common stock. In addition, we are subject to the provisions of Section 203 of the Delaware General Corporation Law, an anti-takeover law.

Our stock price has been volatile, and your investment in our common stock could suffer a decline in value.

There has been significant volatility in the market price and trading volume of equity securities, which is unrelated to the financial performance of the companies issuing the securities. These broad market fluctuations may negatively affect the market price of our common stock. You may not be able to resell your shares at or above the price you pay for those shares due to fluctuations in the market price of our common stock caused by changes in our operating performance or prospects, and other factors.

Some specific factors that may have a significant effect on our common stock market price include:
 
·
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.
 
 
-17-

 

Future sales of our common stock could adversely affect its price and our future capital-raising activities could involve the issuance of equity securities, which would dilute your investment and could result in a decline in the trading price of our common stock.

We may sell securities in the public or private equity markets if and when conditions are favorable, even if we do not have an immediate need for additional capital at that time. Sales of substantial amounts of common stock, or the perception that such sales could occur, could adversely affect the prevailing market price of our common stock and our ability to raise capital. We may issue additional common stock in future financing transactions or as incentive compensation for our executive management and other key personnel, consultants and advisors. Issuing any equity securities would be dilutive to the equity interests represented by our then-outstanding shares of common stock. The market price for our common stock could decrease as the market takes into account the dilutive effect of any of these issuances. Furthermore, we may enter into financing transactions at prices that represent a substantial discount to the market price of our common stock. A negative reaction by investors and securities analysts to any discounted sale of our equity securities could result in a decline in the trading price of our common stock.

       Our common stock is currently traded on the OTC Bulletin Board Market. Our stock price and liquidity may continue to be impacted.

Our common stock is traded on the OTC Bulletin Board market, which is generally considered a less efficient and less prestigious market than other markets, such as the Nasdaq Capital Market. The price and liquidity of our stock may continue to be adversely affected as a result of our common stock trading on the OTC Bulletin Board Market.

ITEM 1B.
UNRESOLVED STAFF COMMENTS

N one.
 
ITEM 2.
PROPERTIES

On January 12, 2009, our subsidiary, Neonode Technologies AB, entered into a 12 month lease with Vasakronan Fastigheter AB for approximately 2,000 square feet of office space located at Linnegatan 89, Stockholm, Sweden for approximately $5,000 per month. The annual payment for this space equates to approximately $60,000. This lease was extended through July 1, 2010 with a provision for additional automatic three month extensions at our discretion.

In addition, we lease office space located in Lafayette, California that is provided by our Chief Financial Officer on a rent-free basis.
 
ITEM 3.
LEGAL PROCEEDINGS
 
On September 4, 2008, we received a summons to appear in the United States District Court for the Southern District of New York because one of our investors in previous private placements transactions, Alpha Capital Anstalt (Alpha), alleged that we failed to issue certain stock certificates pursuant to the terms and conditions of the September 2007 investment subscription agreements. Alpha was asking the court to award it $734,650 in damages plus attorneys fees. Although we believed the claim had no merit, we signed a definitive settlement agreement on January 21, 2009, and issued Alpha 1,096,997 shares of our common stock as settlement in full. On February 13, 2009, a notice was sent to the Court by Alpha’s legal counsel dismissing the action.
 
 
-18-

 
 
On December 9, 2008, Empire Asset Management (Empire), a broker dealer that acted as the Company’s financial advisor and exclusive placement agent in previous private placement transactions, initiated a lawsuit against the Company in the Supreme Court of the State of New York alleging that the Corporation misrepresented the success of its business with the purpose of inducing Empire’s customers to invest in the Company.  Empire is seeking compensatory damages in an unspecified amount for the harm allegedly suffered.  The Company intends to defend vigorously against the action.
 
   On May 11, 2009, Mr. David Berman initiated a lawsuit against the Company in the Supreme Court of the State of New York alleging that the Corporation misrepresented the success of its business to induce Mr. Berman to invest in the Company.  Mr. Berman, who was a client of Empire, invested $549,860.00 in the Company’s private placement offerings on March 4, 2008 and May 16, 2008, and purchased an additional 162,900 shares totaling $251,081.69 in the after-market. The Company believes that the action has no merit and intends to defend vigorously against the action.
 
       The Company’s D&O insurance provider has extended coverage and will cover the costs of legal representation, subject to the payment by the Company of the retention amount of $150,000.
 
         On October 2, 2009, Xerox Corporation (“Xerox”) initiated a law suit against the Company in the Superior Court of California alleging that the Company breached an equipment lease agreement with Xerox and demanding payment of $108,592.81 plus interest, late payment charges, and legal costs.  On December 14, 2009, Xerox obtained an entry of default against the Company without prior warning to the Company.  The Company has filed a motion to set aside the entry of default and a hearing on this motion is set for June 2, 2010.  The Company intends to defend vigorously against the action.
 
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
Our annual meeting of stockholders was held on Friday, December 11, 2009, at our corporate headquarters located at Linnegatan 89, SE 115 23 Stockholm, Sweden.

The stockholders approved the following two items:
 
 (i)
 
The election of Per Bystedt and Thomas Eriksson as directors of the Company, each for a term of three years or until his successor is elected:
 
  For Against Withheld
       
  263,662,570  - -
 
(ii)       The ratification of the appointment of KMJ Corbin and Company as our independent auditors for the fiscal year 2009.
 
  For Against Withheld
       
  263,662,570  - -
 
 
-19-

 
 
PART II

ITEM 5.
MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Effective January 2, 2009, our common stock was quoted on the Pink Sheets under the symbol NEON.PK and effective January 26, 2009, our common stock has been quoted on the Over the Counter Bulletin Board Market (OTCBB) under the symbol NEON.OB.

In 2008, our stock was traded on the Nasdaq Capital Market under the symbol NEON. The following table presents quarterly information on the price range of our common stock, indicating the high and low bid prices reported by the Nasdaq Capital Market. These prices do not include retail markups, markdowns or commissions. As of December 31, 2009, there were approximately 2,634 holders of record of our common stock.  

Fiscal Quarter Ended
 
March 31
June 30
September 30
December 31
Fiscal 2009
       
High
$0.06
$0.05
$0.05
$0.04
Low
$0.02
$0.02
0.02
$0.02
Fiscal 2008
       
High
$3.70
$3.09
$0.49
$0.19
Low
$1.74
$0.35
$0.10
$0.03

There are no restrictions on our ability to pay dividends; however, it is currently the intention of our Board of Directors to retain all earnings, if any, for use in our business and we do not anticipate paying cash dividends in the foreseeable future. Any future determination as to the payment of dividends will depend, among other factors, upon our earnings, capital requirements, operating results and financial condition.

ITEM 6.
SELECTED FINANCIAL DATA
  
Not applicable.

ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Words such as “believes,” “anticipates,” “expects,” “intends” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. Readers are cautioned that the forward-looking statements reflect our analysis only as of the date hereof, and we do not assume any obligation to update these statements. Actual events or results may differ materially from the results discussed in or implied by the forward-looking statements. The following discussion should be read in conjunction with the company’s financial statements for the years ended December 31, 2009 and 2008 and the related notes included therein.

Overview

        We specialize in user-friendly touchscreen solutions for hand-held devices, based on our innovative optical technology, which we refer to as zForce™.  Our mission is to make the easiest (to use and integrate), best (functionality and design) and cheapest touchscreen solution for handheld devices.
 
 
-20-

 
 
Through our formerly wholly-owned subsidiary, Neonode AB, we developed our touchscreen technology and an optical touchscreen mobile phone product, the Neonode N2. On December 1, 2008, we transferred the Neonode AB intellectual property including patents, copyrights and trademarks from Neonode AB to Neonode Inc. pursuant to an intercompany debt pledge agreement. On December 9, 2008, Neonode AB filed for liquidation under the Swedish bankruptcy laws.  Effective with Neonode AB’s bankruptcy filing on December 9, 2008, Neonode Inc. was no longer in the mobile phone business and was relieved of any financial obligations related to the accounts payable or other debts of Neonode AB.

           We have not generated sufficient cash from the sale of our products or licensing of our technology to support our operations and have incurred significant losses. During the twelve months ended December 31, 2008 and 2009, we raised approximately $9.6 million and $1.0 million, respectively, net cash proceeds though the sale of our securities and convertible debt. We raised an additional $1.2 million in the three months ended March 31, 2010 through the sale of our securities. Unless we are able to increase our revenues and/or decrease expenses substantially in addition to securing additional sources of financing, we will not have sufficient cash to support our operations through June 2010.

On December 30, 2008, we commenced certain refinancing and capital raising transactions to enable us to continue to develop our technology. A description of the actions we took to restructure and refinance the company and a description of our new business are included above in Item 1 “Business.”

We have incurred net operating losses and negative operating cash flows since inception. As of December 31, 2009, we had an accumulated deficit of $76.9 million. We expect to incur additional losses and may have negative operating cash flows through the end of 2010. We did not have sufficient cash to pay our independent registered public accounting firm to complete the audit of our 2009 financial statements included in this Annual Report on Form 10K and to pay past due amounts to our previous independent registered public accounting firm who audited our 2008 financial statements included in this Annual Report on Form 10K. As a result, the 2008 and 2009 financial statements that are included in this Annual Report on Form 10K are presented without the required audit opinions of or current and previous independent registered public accounting firms. Although we have been able to fund our operations to date, there is no assurance that our capital raising efforts will be able to attract the additional capital or other funds needed to sustain our operations.

Our success is dependent on our obtaining sufficient capital or operating cash flows to fund our operations and to development of our technology and products, and on our bringing such technology and products to the worldwide market. To achieve these objectives, we may be required to raise additional capital through public or private financings or other arrangements. It cannot be assured that such financings will be available on terms attractive to us, if at all. Such financings may be dilutive to stockholders and may contain restrictive covenants.
 
In addition to the immediate risks relating to our ability to continue as a going concern and to obtain funding under the current market conditions, we are subject to certain risks common to technology-based companies in similar stages of development. See “Risk Factors” above. Principal risks include 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.
 
 
-21-

 
 
Critical Accounting Policies and Estimates

The preparation of our financial statements are in conformity with generally accepted accounting principles in the United States of America (GAAP) and include the accounts of Neonode Inc. and its former wholly-owned subsidiary based in Sweden, Neonode AB, through December 9, 2008, the date Neonode AB filed for bankruptcy. The balance sheet as of December 31, 2008, includes the accounts of our new wholly owned subsidiary based in Sweden, Neonode Technologies AB. Operating results for Neonode Technologies AB from date of acquisition to December 31, 2008, have been insignificant.  For 2009, the audited consolidated statements of operations and cash flows appearing elsewhere in this Annual Report on Form 10-K and the discussion of our financial condition and results of operations for the twelve months ended December 31, 2009 appearing below include the results of operations of our new wholly-owned subsidiary, Neonode Technologies AB, which Neonode Inc. purchased on December 29, 2008.  The audited consolidated balance sheet as of December 31, 2009 includes the accounts of Neonode Inc. and Neonode Technologies AB.

All inter-company accounts and transactions have been eliminated in consolidation. Our accounting policies affecting our financial condition and results of operations are more fully described in Note 2 to our consolidated financial statements. Certain of our accounting policies require the application of judgment by management in selecting appropriate assumptions for calculating financial estimates, which inherently contain some degree of uncertainty. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances. The historical experience and assumptions form the basis for making judgments about the reported carrying values of assets and liabilities and the reported amounts of revenue and expenses that may not be readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following are some of the more critical accounting policies and related judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

Neonode AB Mobile Phone Business and Licensing of Our Intellectual Property:

We recognize revenue from product sales when title transfers and risk of loss has passed to the customer, which is generally upon shipment of products to our customers. We estimate expected sales returns and record the amount as a reduction of revenues and cost of sales at the time of shipment. Our policy complies with the accounting guidance issued by the Securities and Exchange Commission (SEC). We recognized revenue from the sale of our mobile phones when all of the following conditions were met: (1) evidence existed of an arrangement with the customer, typically consisting of a purchase order or contract; (2) our products were delivered 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 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 deferred recognition of revenue. Judgments were required in evaluating the credit worthiness of our customers. Credit was not extended to customers and revenue was not recognized until we determined that collectibility was reasonably assured.

In 2008, our revenues generated by the sale of Neonode AB’s mobile phones consisted primarily of sales to distributors. From time to time, we allowed certain distributors price protection subsequent to the initial product shipment. Price protection may have allowed the distributor a credit (either in cash or as a discount on future purchases) if there was a price decrease during a specified period of time or until the distributor resold the goods. Future price adjustments were difficult to estimate since we do not have a sufficient history of making price adjustments. Therefore, we deferred recognition of revenue derived from sales to these customers until they resold our products to their customers. Although revenue recognition and related cost of sales were deferred, we recorded an accounts receivable at the time of initial product shipment. As standard terms were generally FOB shipping point, payment terms were enforced from the shipment date, and legal title and risk of inventory loss passed to the distributor upon shipment.
 
For products sold to distributors with agreements allowing for price protection and product returns, we recognized revenue based on our best estimate of when the distributor sold the product to its end customer. Our estimate of such distributor sell-through was based on information received from our distributors. Revenue was not recognized upon shipment since, due to various forms of price concessions; the sales price was not substantially fixed or determinable at that time.
 
 
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Revenue from products sold directly to end-users though our web sales channels were generally recognized when title and risk of loss passed to the buyer, which typically occurred upon shipment. Reserves for sales returns were estimated based primarily on historical experience and were provided at the time of shipment.

Generally, our customers were responsible for the payment of all shipping and handling charges directly with the freight carriers.

Neonode AB derived revenue from the licensing of our internally developed intellectual property (IP). We entered into IP licensing agreements that generally provided licensees the right to incorporate our IP components in their products with terms and conditions that varied by licensee. The IP licensing agreements generally included a nonexclusive license for the underlying IP. Fees under these agreements may have included 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. On December 1, 2008, we transferred the Neonode AB intellectual property including patents, copyrights and trademarks to Neonode inc. pursuant to an intercompany debt pledge agreement.

Hardware Products:
 
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 defer and recognize service revenue over the contractual period or as services are rendered. We 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. Our policy complies with the accounting guidance provided by the SEC. Judgments are required in evaluating the credit worthiness of our customers. Credit is not extended to customers and revenue is not recognized until we have determined that collectibility is reasonably assured. Our sales transactions are denominated in U.S. dollars or Euros. The software component of our hardware products is considered incidental.  Therefore, we do not recognize software revenue related to our hardware products separately from the hardware product sale. To date, we have not sold any hardware products.

When selling hardware, we expect our agreements with OEMs and ODMs to incorporate clauses reflecting the following understandings:

-  
all prices are fixed and determinable at the time of sale;
-  
title and risk of loss pass at the time of shipment (FOB shipping point);
-  
collectibility of the sales price is probable (the customer is creditworthy, the customer is obligated to pay, and such obligation is not contingent on the ultimate sale of the customer’s integrated solution);
-  
the customer’s obligation to us will not be changed in the event of theft or physical destruction or damage of the product;
-  
we do not have significant obligations for future performance to directly assist in the resale of the product by the OEMs; and
-  
there is no contractual right of return other than for defective products.
 
Software Products:
 
We may derive revenues from the following sources: (1) software, which includes our Neno™ software licenses and (2) engineering services, which include consulting. We account for the licensing of software in accordance with accounting guidance that 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. These documents include post delivery support, upgrades, and similar services. To date, we have not sold any software products.
 
 
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For software license arrangements that do not require significant modification or customization of the underlying software, we 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. We initially defer all revenue related to the software license and maintenance fees until such time that we are able to establish VSOE for these elements of our software products.  Revenue deferred under these arrangements is recognized to revenue over the expected contract term. 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.

Engineering Services:

We may sell engineering consulting services to our customers on a flat rate or hourly rate basis. We recognize revenue as the engineering services stipulated under the contact are completed and accepted by our customers.  On December 29, 2009, we signed an engineering services agreement with an OEM to provide engineering services over a three month period in 2010 related to the development of a touchscreen application for a mobile phone product. The value of this agreement is approximately $100,000.

Allowance for Doubtful Accounts  

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 our customers when determining or modifying their 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 our historical collection experience with customers. We do not have any accounts receivable at December 31, 2009 and 2008, respectively.

Warranty Reserves

Our mobile phone products were generally warranted against defects for 12 months following the sale. We had a 12 month warranty from the manufacturer of the mobile phones. Reserves for potential warranty claims not covered by the manufacturer were provided at the time of revenue recognition and were based on several factors, including current sales levels and our estimate of repair costs. Shipping and handling charges were expensed as incurred. Upon filing for bankruptcy on December 9, 2008, the warranty obligations related to Neonode AB’s previous sales of mobile phone products were transferred to the Swedish bankruptcy court along with all the assets and liabilities of Neonode AB.

We do not anticipate that our technology products will have any warranty obligations associated with licenses related to these technologies.

Research and Development
 
Research and Development (R&D) costs are expensed as incurred. R&D costs are accounted for in accordance with accounting guidance. Research and development costs consists mainly of personnel related costs in addition to some external consultancy costs such as testing, certifying, and measurements.
 
 
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Long-lived Assets

We assess any impairment by estimating the future cash flow from the associated asset in accordance with accounting guidance. If the estimated undiscounted cash flow related to these assets decreases in the future or the useful life is shorter than originally estimated, we may incur charges for impairment of these assets. The impairment is based on the estimated discounted cash flow associated with the asset.

Stock Based Compensation Expense

We account for stock-based employee compensation arrangements in accordance with accounting guidance. We account for equity instruments issued to non-employees in accordance with accounting guidance, which requires that such equity instruments be recorded at their fair value and the unvested portion be re-measured each reporting period. 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 Stock Purchase Warrants

We account for debt issued with stock purchase warrants in accordance with accounting guidance if they meet equity classification. We allocate 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. The warrants were classified as a liability pursuant to the accounting guidance. The warrants were recorded among “Liability for warrants to purchase common stock” and are valued at fair valued at the end of each reporting period using the Black-Scholes option pricing model.

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 embedded derivatives are assessed at inception of the contract and every reporting period and, depending on their characteristics, are accounted for as separate derivative financial instruments pursuant to the 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 classification of liabilities in accordance with accounting guidance, 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 and warrants.

Income taxes

We account for income taxes in accordance with accounting guidance. Accounting guidance requires recognition of deferred tax liabilities and assets for the expected future tax consequences of items that have been included in the financial statements or tax returns. We estimate income taxes based on rates in effect in each of the jurisdictions in which we operate. Deferred income tax assets and liabilities are determined based upon differences between the financial statement and income tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The realization of deferred tax assets is based on historical tax positions and expectations about future taxable income. Valuation allowances are recorded against net deferred tax assets where, in our opinion, realization is uncertain based on the “not more likely than not” criteria of the accounting guidance.
 
 
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Based on the uncertainty of future pre-tax income, we fully reserved our net deferred tax assets as of December 31, 2009 and 2008. In the event we were to determine that we would be able to realize our deferred tax assets in the future, an adjustment to the deferred tax asset would increase income in the period such a determination was made. The provision for income taxes represents the net change in deferred tax amounts, plus income taxes payable for the current period.

Effective January 1, 2007, we adopted the provisions of the accounting, which provisions included a two-step approach to recognizing, de-recognizing and measuring uncertain tax positions accounted for in accordance with the accounting guidance. As a result of the implementation of the accounting guidance, we recognized no increase in the liability for unrecognized tax benefits and a decrease in the related reserve of the same amount. Therefore, upon implementation of the applicable accounting guidance, we recognized no material adjustment to the January 1, 2007 balance of retained earnings. As of December 31, 2009, we had no unrecognized tax benefits.
 
New Accounting Pronouncements

The following are the expected effects of recent accounting pronouncements. We are required to analyze these pronouncements and determine the effect, if any, the adoption of these pronouncements would have on our results of operations or financial position.

          In May 2009, the Financial Accounting Standards Board (FASB) issued accounting guidance which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date, but before financial statements are issued, and specifically requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. The accounting guidance is effective for interim and annual periods ending after June 15, 2009, or for our quarter ended September 30, 2009, and will be applied prospectively.

         In June 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification TM and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162 (“SFAS 168”) (the “Codification”). The Codification, which was launched on July 1, 2009, became the single source of authoritative nongovernmental U.S. GAAP, superseding existing FASB, American Institute of Certified Public Accountants (AICPA), Emerging Issues Task Force (EITF) and related literature. The Codification eliminates the GAAP hierarchy contained in SFAS No. 162 and establishes one level of authoritative GAAP. All other literature is considered non-authoritative. SFAS 168 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. We will adopt the Codification for our quarter ending December 31, 2009. There will be no change to our consolidated financial statements due to the implementation of the Codification.

Results of Operations

Effective January 2, 2009, our common stock was quoted on the Pink Sheets under the symbol NEON.PK and effective January 26, 2009, our common stock has been quoted on the Over the Counter Bulletin Board Market (OTCBB) under the symbol NEON.OB. In 2008, our stock was traded on the Nasdaq Capital Market under the symbol NEON.

2008 Financial Statements

On December 9, 2008, our formerly wholly-owned Swedish subsidiary, Neonode AB, filed for liquidation under the bankruptcy laws of Sweden. Pursuant to the Swedish bankruptcy laws, we were no longer responsible for the debt and liabilities nor do we have any ownership interest in the assets of Neonode AB as of December 9, 2008, the effective date of the bankruptcy filing,. The audited consolidated statements of operations and cash flows appearing elsewhere in this Annual Report on Form 10-K and the discussion of our financial condition and results of operations for the year ended December 31, 2008 appearing below include the results of operations of our former wholly-owned subsidiary, Neonode AB, only from January 1, 2008 through December 9, 2008, the date Neonode AB filed for bankruptcy. Accounting guidance precludes consolidation of a majority-owned subsidiary where control does not rest with the majority owners, for instance, where the subsidiary is in bankruptcy.  Accordingly, we deconsolidated Neonode AB from our consolidated financial statements on the date it filed for bankruptcy, December 9, 2008.
 
 
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        On December 29, 2008, we entered into a Share Exchange Agreement with Neonode Technologies AB, a Swedish engineering company, and the stockholders of Neonode Technologies AB:  Iwo Jima SARL, Wirelesstoys AB, and Athemis Ltd. (the Neonode Technologies AB Stockholders), pursuant to which we agreed to acquire all of the issued and outstanding shares of Neonode Technologies AB in exchange for the issuance of 495,000 shares of Neonode Inc. Series A Preferred Stock to the Neonode Technologies AB Stockholders.   The 495,000 shares of our Series A Preferred Stock were converted to 237,911,185 shares of our common stock in 2009.  Pursuant to the terms of the Share Exchange Agreement, upon the closing of the transaction, Neonode Technologies AB became our wholly-owned subsidiary. Neonode’s consolidated balance sheets as of December 31, 2008 include the accounts of Neonode Inc. and its new wholly-owned subsidiary, Neonode Technologies AB. Neonode Technologies AB did not have any operations prior to its acquisition by us on December 29, 2008; therefore, the acquisition of Neonode Technologies AB has no accounting impact on the consolidated statements of operations for the year ended December 31, 2008.

2009 Financial Statements

For 2009, the audited consolidated statements of operations and cash flows appearing elsewhere in this Annual Report on Form 10-K and the discussion of our financial condition and results of operations for the twelve months ended December 31, 2009 appearing below include the results of operations of our new wholly owned subsidiary, Neonode Technologies AB, which Neonode Inc. purchased on December 29, 2008.  The audited consolidated balance sheet as of December 31, 2009, includes the accounts of Neonode Inc. and Neonode Technologies AB.

The following table sets forth, as a percentage of net sales, certain statements of operations data for the twelve months ended December 31, 2008. We did not have any sales in 2009, so no percentages of net sales are presented for the twelve months ended December 31, 2009.  These operating results are not necessarily indicative of our operating results for any future period.
 

   
2008
 
Net sales
    100 %
Cost of sales
    212 %
        Gross margin
    (112 %)
Operating expenses:
       
Research and development
    45 %
Sales and marketing
    54 %
General and administrative
    82 %
Total operating expenses
    181 %
Operating loss
    (293 %)
Other income (expense):
       
Interest and other income
    --  
Interest and other expense
    (5 %)
Foreign currency exchange rate loss
    (12 %)
Write off of receivable from Neonode AB
    (39 %)
Gain on debt forgiveness of Neonode AB
    135 %
Gain on troubled debt restructuring
    46 %
Non-cash items related to debt discounts and
 deferred financing fees and the valuation of
 conversion features and warrants
    86 %
Total interest and other expense
    212 %
Net loss
    (81 %)
 
 
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Net Sales

We did not have any net sales for the year ended December 31, 2009. Net sales for the year ended December 31, 2008 were $7.3 million. Revenue for the year ended December 31, 2008 included $6.9 million from the sale of our N2 mobile phones by our formerly wholly-owned subsidiary, Neonode AB. A significant portion of our net sales in 2008 is primarily attributable to the sale of the inventory of approximately 28,000 N2 mobile phones held by our manufacturing partner in the fourth quarter of 2008. Our manufacturing partner applied the cash proceeds from the sale of the inventory of N2s to our outstanding accounts payable balance with them.

                On December 9, 2008, our formerly wholly-owned subsidiary, Neonode AB, filed for liquidation under the Swedish bankruptcy laws. Effective with Neonode AB’s bankruptcy filing on December 9, 2008, Neonode Inc. was no longer in the mobile phone business and no longer has any known financial obligations related to the accounts payable or other debts of Neonode AB. The intellectual property of Neonode AB was transferred to Neonode Inc. prior to filing for bankruptcy and Neonode Inc. will continue to pursue technology sales and licensing opportunities through its newly-acquired subsidiary, Neonode Technologies AB.

We restructured and recapitalized our business on December 31, 2008 to focus our business on the development of our zForce touchscreen solutions that enable people to interact more easily and intuitively with a wide variety of mobile computing, communications, entertainment, and other electronic devices. Our sales are targeted at OEM’s and ODM’s which produce handheld devices for the digital lifestyle consumer products market, including portable digital music and video players, e-books, digital cameras, mobile phones, and other electronic devices which may utilize our customized touchscreen solutions.

We do not have any customers for our touchscreen technology and currently believe that we will depend on a limited number of OEM and ODM customers for substantially all 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.

Gross Margin

        Gross margin as a percentage of net sales was (112)% in the year ended December 31, 2008. Our cost of sales includes the direct cost of production of the phone plus the cost of our internal production department and accrued estimated warranty costs. In the year ended December 31, 2008, our cost of sales includes an inventory write-down charge of $10.2 million. We experienced limited success in selling our N2 mobile phone since introduction in 2007 and reevaluated our selling efforts and the potential markets for the N2 in 2008. Based upon this reevaluation, we decided that it was probable that in 2008 we would have to reduce the selling price of our N2 phones and/or offer our customers substantial incentives in order to sell the N2. As a result of our revaluation, we recorded a write-down reducing the value of our inventory to the estimated realizable value of our inventory prior to Neonode AB filing for bankruptcy on December 9, 2008.

Product Research and Development

Product research and development (R&D) expenses for the year ended December 31, 2009 were $1.0 million, a 70% decrease compared to $3.3 million for the same period ending December 31, 2008.
 
 
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       The main factors that contributed to the decrease in R&D costs are a decrease in the headcount of our engineering department from 14 to eight, primarily at the end of 2008, along with a cessation in external development costs associated with the development of the N2 and a decrease related to corporate overhead, rent and travel-related costs. On October 22, 2008, our formerly wholly-owned Swedish subsidiary, Neonode AB, filed for company reorganization in compliance with the Swedish Reorganization Act (1996:764). In conjunction with the reorganization, we reduced our staffing levels across the company and cancelled all outside contractors and consultants, and stopped all R&D projects related to development and improvement of our mobile phone products. Under the Swedish Reorganization Act, the Swedish government assumed responsibility for payment of salaries and benefits to Neonode AB’s employees on the day the Swedish court approved Neonode AB’s petition for reorganization.

We are not currently planning to continue to pursue any expenditure on R&D projects related to developing or update our current or future mobile phone products. As part of our corporate reorganization, we will continue to pursue R&D expenditures on the development of our touchscreen and other technologies. We have a development roadmap based on our touchscreen and other technologies. As of December 31, 2009, we have 10 full-time employees and one part-time employee, of which eight full-time are part of our engineering department.

Sales and Marketing

Sales and marketing expenses for the year ended December 31, 2009 were $0.3 million, compared to $3.9 million for the same period in 2008, a decrease of 92%.

         The decrease in the year ended December 31, 2009 over the same period in 2008 is primarily related to a wind down in product marketing activities related to our N2 mobile phone handset. On October 22, 2008, our Swedish subsidiary, Neonode AB, filed for company reorganization in compliance with the Swedish Reorganization Act (1996:764). In conjunction with the reorganization, we reduced our staffing levels across the company and cancelled all sales and promotional activities. Under the Swedish Reorganization Act, the Swedish government assumed responsibility for payment of salaries and benefits to Neonode AB’s employees on the day the Swedish court approved Neonode AB’s petition for reorganization.

Our sales activities after our corporate reorganization now focuses primarily on OEM and ODM customers who will integrate our touchscreen technology into their products, and the OEM and ODM customers will sell and market their products to their customers. As of December 31, 2009, we have retained two consultants in our sales and marketing department.
 
General and Administrative

General and administrative (G&A) expenses for the year ended December 31, 2009 were $2.4 million, a 60% decrease from $6.0 million for the same period in 2008.

        The decrease in 2009 as compared to 2008 is related to a decrease in headcount in our G&A department from eight employees to two employees and one consultant. In addition there has been a significant decrease related to legal, accounting, facilities and travel costs. The year ended December 31, 2008 also includes $225,000 in expense related to the termination of the Neonode USA agreement. On October 22, 2008, our Swedish subsidiary, Neonode AB, filed for company reorganization in compliance with the Swedish Reorganization Act (1996:764). In conjunction with the reorganization, we reduced our staffing levels across the company and cancelled all sales and promotional activities. Under the Swedish Reorganization Act, the Swedish government assumed responsibility for payment of salaries and benefits to Neonode AB’s employees on the day the Swedish court approved Neonode AB’s petition for reorganization.

      As of December 31, 2009, we have two employees and one consultant in our G&A department fulfilling management and accounting responsibilities.
 
 
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Interest Expense and Other Expense

Interest expense for the twelve months ended December 31, 2009 was $30,000, as compared to $368,000 for the twelve months ended December 31, 2008. The $338,000 decrease is due to a decrease in interest bearing debt outstanding at December 31, 2008 when we converted $6.2 million of convertible debt to equity as part of a corporate reorganization.

Foreign Exchange Loss

Foreign exchange loss for the twelve months ended December 31, 2009 was $92,000, as compared to $848,000 for the twelve months ended December 31, 2008. The $756,000 decrease is due to a reduction in the total, expenses, assets and cash balances combined with changes in the exchange rate in the US Dollar as compared to the Swedish Krona in 2009 compared to 2008.

Write-off of Accounts Receivable from Subsidiary

              On December 9, 2008, our formerly wholly-owned Swedish subsidiary, Neonode AB, filed a petition for liquidation in compliance with the Swedish Bankruptcy Act (1987:672). Mr. Hans Ödén of the Stockholm-based Ackordscentralen AB, a consultancy firm specializing in insolvency, was appointed by the district court of Stockholm to administer the process. We wrote off our $2.8 million receivable from Neonode AB on December 9, 2008, the date Neonode AB filed for bankruptcy.

         Gain on debt forgiveness of Neonode AB
 
For the twelve months ended December 31, 2008, we recorded again on the forgiveness of debt of Neonode AB in bankruptcy totaling $9.8 million pursuant to the applicable accounting guidance.

Non-cash Items Related to Debt Discounts and Deferred Financing Fees and the Valuation of Conversion Features and Warrants

Non-cash items related to debt discounts and deferred financing fees and the valuation of conversion features and warrants interest for the year ended December 31, 2009 amounted to a loss of $1.8 million. The change is the direct result of exchanging the outstanding debt and a majority of the outstanding warrants to equity (preferred stock A and B), which resulted in a troubled debt restructuring loss of $2.7 million in 2009 combined with an overall decrease in the Company’s common stock price that reduced the fair value of the conversion features and warrants during 2009. This resulted in marked-to-market non-cash income of $900,000 in 2009.

Non-cash items related to debt discounts and deferred financing fees and the valuation of conversion features and warrants interest for the year ended December 31, 2008 amounted to a gain of $9.6 million. The change is the direct result of exchanging the outstanding debt and a majority of the outstanding warrants to equity (preferred stock A and B), which resulted in a troubled debt restructuring gain of $3.4 million in 2008 combined with an overall decrease in the Company’s common stock price that reduced the fair value of the conversion features and warrants during 2008. This resulted in marked-to-market non-cash income of $6.3 million in 2008.

On December 29, 2008, we entered into Note Conversion Agreements with the holders of convertible notes and promissory notes of the Company in the aggregate amount of up to $6,341,611, for the issuance of up to 250,014 shares of Series A Preferred Stock in exchange for the surrender of the Convertible Notes by the note holders.  A total of 24 out of 27 note holders agreed to the surrender of notes and accrued interest on such notes in the aggregate amount of $6,195,805 in consideration for the issuance of 244,265.56 shares of Series A Preferred Stock on December 31, 2008.  The fair value of the convertible notes and promissory notes and related embedded conversion features amounted to $3.1 million immediately prior to conversion, using the Black-Scholes option pricing model. The assumptions used when calculating the fair value of the common stock anti-dilution feature were a term of 0.23 years, volatility of 357.2%, and a risk-free interest rate of 1.1%. The fair value of the Series A Preferred stock on the date of conversion was $10 per share, as the Company also raised $1.2 million in cash from both inside and outside investors, with outside investors comprising approximately 51%.  Accordingly, the Company believes that the $10 per share for the Series A shares is at an arm’s length price.  This conversion resulted in troubled debt restructuring accounting in accordance with accounting guidance, and we recorded a non-cash gain on conversion of $3.4 million.
 
 
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On March 31, 2009, our shareholders approved a resolution to increase the conversion ratio to 480.63 shares of common stock for each share of Series A Preferred Stock and 132.07 for each share of Series B Preferred Stock. The fair value of the conversion of the 244,265.56 shares of Series A Preferred shares issued to the investors in the private placement transaction that will be converted to a total of 117,401,356 shares of our common stock was $4.7 million based on our stock price on March 31, 2009, the date our shareholders approved the conversion ratio.  On March 31, 2009, we recorded the $2.3 million increase in the fair value as an increase in Common Stock Additional Paid In Capital on the Condensed Consolidated Balance Sheets and as a Loss on Troubled Debt Restructuring on our Consolidated Statements of Operations for the twelve months ended December 31, 2009.

On December 29, 2008, the Company commenced entering into Warrant Conversion Agreements with the holders of warrants for the purchase of shares, notes, and/or additional warrants of the Company, for the issuance of up to 108,850 shares of Series B Preferred Stock in exchange for the surrender of the warrants by the warrant holders.  The Company has entered into Warrant Conversion Agreements with 92 out of 129 warrant holders for the issuance of 92,795.23 shares of Series B Preferred Stock on December 31, 2008. The fair value of the converted warrants which were recorded as liabilities amounted to $159,000 immediately prior to conversion, using the Black-Scholes option pricing model. The assumptions used when calculating the fair value of the warrants prior to conversion were a term of 4.4 years, volatility of 152.3%, and a risk-free interest rate of 1.37%. The fair value of the Series B Preferred stock on the date of conversion was $0.022 per share, which is based upon a fully diluted price per share using the Company’s market capitalization on that date. This conversion resulted in troubled debt restructuring accounting in accordance with accounting guidance, and we recorded a non-cash gain on conversion of $157,000.

The fair value of the conversion of the 97,795.23 shares of Series B Preferred shares issued to the investors in the private placement transaction that will be converted to a total of 12,255,466 shares of our common stock was $488,000 based on our stock price on March 31, 2009, the date our shareholders approved the conversion ratio.  On March 31, 2009, we recorded the $488,000 increase in the fair value as an increase in Common Stock Additional Paid In Capital on the Condensed Consolidated Balance Sheets and as a Loss on Troubled Debt Restructuring on our Consolidated Statements of Operations for the twelve months ended December 31, 2009.

Deemed Dividend to Preferred Shareholders

On December 31, 2008, we issued 112,190.40 shares of Series A Preferred stock that at the date of issuance had a conversion rate of one share of common stock for each share of Series A Preferred stock to investors in a private placement transaction that raised $1.1million.  On March 31, 2009, our shareholders approved a resolution to increase the conversion ratio to 480.63 shares of common stock for each share of Series A Preferred Stock. The fair value of the conversion of the 112,190.40 shares of Series A Preferred shares issued to the investors in the private placement transaction that will be converted to a total of 53,922,072 shares of our common stock was $1.0 million based on our stock price on March 31, 2009, the date our shareholders approved the conversion ratio.  On December 31, 2008, the $2.4 million fair value of the Series A preferred issued prior to the shareholder approval is included in Series A Preferred stock in the Shareholders’ Equity on the Condensed Consolidated Balance Sheets. On March 31, 2009, we recorded the $1.0 million increase in the fair value as an increase in Common Stock Additional Paid In Capital on the Condensed Consolidated Balance Sheets and as a deemed dividend to Preferred Shareholders on our Condensed Consolidated Statements of Operations for the twelve months ended December 31, 2009.

Income Taxes

Our effective tax rate was 0% in the year ended December 31, 2009 and 2008, respectively. We recorded valuation allowances in 2009 and 2008 for deferred tax assets related to net operating losses due to the uncertainty of realization. As of December 31, 2008, due to the bankruptcy of Neonode AB, we no longer have any significant amounts of net operating loss carryforwards and hence no significant amounts of deferred tax assets.
 
 
-31-

 
 
Net Loss
 
As a result of the factors discussed above, we recorded a net loss of $12.3 million for the year ended December 31, 2009 compared to a net loss of $5.9 million in the comparable period in 2008.      

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:

 
·   actual versus anticipated licensing of our technology;
 
·   our actual versus anticipated operating expenses;
 
·   the timing of our OEM customer product shipments;
 
·   the timing of payment for our technology licensing agreements;
 
·   our actual versus anticipated gross profit margin;
 
·   our ability to raise additional capital, if necessary; and
 
·   our ability to secure credit facilities, if necessary.

The consolidated financial statements included herein have been prepared on a going concern basis, which contemplates continuity of operations and the realization of assets and repayment of liabilities in the ordinary course of business. Due to our lack of cash resources, we did not have sufficient cash to pay our independent registered public accounting firm to complete their audit of our 2009 financial statements that are included in this Annual Report on Form 10-K.  Since our Annual Report on Form 10-K for the period ending December 31, 2009 has been filed without audited financial statements and without the required audit opinion of our current independent registered public accounting firm, our Form 10-K is deficient and does not comply with the reporting requirements of the Securities Exchange Act of 1934 (the “Exchange Act”). Although we have been able to fund our operations to date, there is no assurance that cash flow from our operations or our capital raising efforts will be able to attract the additional capital or other funds needed to sustain our operations. The lack of a completed audit may make it more difficult for us to raise funds. If we are unable to obtain additional funding for operations, we may not be able to continue operations as proposed, requiring us to modify our business plan, curtail various aspects of our operations, or cease operations. In such event, investors may lose a portion or all of their investment.

On December 31, 2008, we completed certain refinancing and capital raising transactions, acquired Neonode Technologies AB, and began operations with a primary focus on licensing our touchscreen technology to third party OEM customers. We do not have any current active customers for our touchscreen technology. In most circumstances, our target customers will have to successfully integrate our technology into their products and then sell those products to their customers before we will receive any cash from technology license agreements.

Our cash is subject to interest rate risk. We invest primarily on a short-term basis. Our financial instrument holdings at December 31, 2009 were analyzed to determine their sensitivity to interest rate changes. The fair values of these instruments were determined by net present values. In our sensitivity analysis, the same change in interest rate was used for all maturities and all other factors were held constant. If interest rates increased by 10%, the expected effect on net loss related to our financial instruments would be immaterial. The functional currency of our foreign subsidiary is the applicable local currency, the Swedish Krona, and is subject to foreign currency exchange rate risk. Any increase or decrease in the exchange rate of the U.S. Dollar compared to the Swedish Krona will impact Neonode’s future operating results.

At December 31, 2009, we had cash and cash equivalents of $28,000, as compared to $17,000 at December 31, 2008. In the twelve month period ended December 31, 2009, $1.8 million of cash was used in operating activities, primarily as a result of our net loss increased by the following non-cash items (in thousands):
 
 
-32-

 
 
Depreciation and amortization
 
$
9
 
Stock-based compensation expense
   
6,789
 
Loss on retirement of fixed assets
   
30
 
Gain on conversion of accounts payable to equity
   
(55)
 
Loss on troubled debt restructuring
   
2,741
 
Deemed dividend to preferred stockholders
   
1,035
 
Change in fair value of embedded derivatives and warrants recorded as a liability
   
(922)
 
 Total net non-cash items included in cash used in our operations
 
$
9,627
 

Adjusted working capital deficit (current assets less current liabilities not including non-cash liabilities related to warrants and embedded derivatives) was $1.8 million at December 31, 2009, compared to an adjusted working capital deficit of $962,000 at December 31, 2008.

In the twelve months ended December 31, 2009, we purchased $27,000 of fixed assets, consisting primarily of computers and engineering equipment.

In December 2008, we completed a private placement of equity securities for cash totaling $10.7 million. On December 31, 2008, $1.0 million was included as a stock subscription receivable and the cash proceeds were received in January and February 2009.
 
During the period from August 25, 2009 through December 31, 2009, we completed a private placement of convertible notes totaling $987,000 that can be converted, at the holder’s option, into 49,349,151 shares of our common stock at a conversion price of $0.02 per share. The convertible note holders have the right to have the conversion price adjusted to equal the lower stock price if we issue stock or convertible notes at a lower conversion price than $0.02 during the period that the notes are outstanding. These convertible notes are due on December 31, 2010 and bear an annual interest rate of 7%, payable on June 30 and December 31 of each year that the convertible notes are outstanding. In addition we issued 24,674,576 three-year warrants to the convertible note holders with an exercise price of $0.04 per share. The warrants may be exercised and converted to common stock, at the warrant holder’s option, beginning on the six-month anniversary date of issuance until the warrant expiration date. We are not obligated to register the common stock related to the convertible debt or the warrants.
 
In the three months ended March 31, 2010, we received $1.2 million proceeds related to a private placement of convertible notes and stock purchase warrants that can be converted, at the holder’s option, into 60,160,564 shares of our common stock at a conversion price of $0.02 per share and 30,080,282 stock purchase warrants that have an exercise price of $0.04 per share. The convertible note holders have the right to have the conversion price adjusted to equal the lower stock price if we issue stock or convertible notes at a lower conversion price than $0.02 during the period that the notes are outstanding. These convertible notes are due on December 31, 2010 and bear an annual interest rate of 7%, payable on June 30 and December 31 of each year that the convertible notes are outstanding. The warrants may be exercised and converted to common stock, at the warrant holder’s option, beginning on the six month anniversary date of issuance until the warrant expiration date. We are not obligate to register the common stock related to the convertible debt or the warrants. On March 21, 2010, we issued 875,000 shares of our common stock and a warrant to purchase 875,000 of our common stock an exercise price of $0.04 per share to Davisa Ltd for services provided for the private placement of convertible note and warrant in the March 2010 financing transaction.

         The majority of our cash has been provided by borrowings from senior secured notes and bridge notes that have been, or are, convertible into shares of our common stock or from the sale of our common stock and common stock purchase warrants to private investors. We will require sources of capital in addition to cash on hand to continue operations and to implement our strategy. Our operations are not cash flow positive and we may be forced to seek credit line facilities from financial institutions, additional private equity investment, or debt arrangements. No assurances can be given that we will be successful in obtaining such additional financing on reasonable terms, or at all. If adequate funds are not available on acceptable terms, or at all, we may be unable to adequately fund our business plans and it could have a negative effect on our business, results of operations and financial condition. In addition, if funds are available, the issuance of equity securities or securities convertible into equity could dilute the value of shares of our common stock and cause the market price to fall, and the issuance of debt securities could impose restrictive covenants that could impair our ability to engage in certain business transactions.

ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable .
 
 
-33-

 
 
The following Financial Statements have not been audited and no auditor’s report is filed herewith.
 
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to the Financial Statements
Page
   
Financial Statements
 
   
Consolidated Balance Sheets at December 31, 2009 and 2008
  34
   
Consolidated Statements of Operations for the years ended December 31, 2009 and 2008
  35
   
Consolidated Statements of Stockholders’ Deficit for the years ended December 31, 2009 and 2008
  36
   
Consolidated Statements of Cash Flows for the years ended December 31, 2009 and 2008
  38
   
Notes to Consolidated Financial Statements
  40
   
 

 
-34-

 
 
NEONODE INC
CONSOLIDATED BALANCE SHEETS
(In thousands)
 
   
December 31,
   
December 31,
 
      2009       2008  
ASSETS
               
Current assets:
               
  Cash and cash equivalents
  $ 28     $ 17  
  Prepaid expense
    58       46  
  Other
    47       --  
    Total current assets
    133       63  
                 
Property, plant and equipment, net
    20       116  
    Total assets
  $ 153     $ 179  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities:
               
  Current portion of convertible long term debt and leases
  $ 307     $ 17  
  Accounts payable
    719       688  
  Accrued expenses
    947       320  
  Embedded derivatives of convertible debt and warrants
    2,858       --  
    Total current liabilities
    4,831       1,025  
                 
Long term convertible debt and leases
    --       207  
    Total liabilities
    4,831       1,232  
                 
Commitments and contingencies (note 19)
               
                 
Stockholders' deficit:
               
      Series A Preferred Stock, 899,081 shares authorized with par value $0.001
               
          at December 31, 2009 and 2008. 86,142 and 855,522 shares issued and outstanding
               
          at December 31, 2009 and 2008, respectively . (In the event of dissolution,
               
          each share of Series A Preferred Stock has a liquidation preference equal to
               
          par value of  $0.001 over the shares of Common Stock)
    880       3,531  
      Series B Preferred Stock, 108,850 shares authorized with par
               
          value $0.001at December 31, 2009 and 2008 17,265 and 92,796 shares
               
          issued and outstanding at December 31, 2009 and 2008, respectively.
               
         (In the event of dissolution, each share of Series B Preferred Stock has a
               
          liquidation preference equal to par value of  $0.001 over the shares of
               
          Common Stock)
    --       2  
  Common stock, 75,000,000 shares authorized with par value $0.001                
          at December 31, 2009 and 2008, respectively; 416,472,328 and
               
          35,058,011 shares issued and outstanding at December 31, 2009
               
          and 2008, respectively
    416       35  
  Common stock additional paid in capital
    70,968       61,016  
  Accumulated other comprehensive income (expense)
    (92     --  
  Stock subscription receivable
    --       (1,035
  Accumulated deficit
    (76,850     (64,602
    Total stockholders' deficit
    (4,678     (1,053 )
    Total liabilities and stockholders' deficit
  $ 153     $ 179  
 
The accompanying notes are an integral part of these Consolidated Financial Statements.
 
-35-

 
 
NEONODE INC
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
 
   
Year ended
 
   
December 31,
 
   
2009
   
2008
 
             
Net revenue
  $ -     $ 7,282  
Cost of sales
    -       15,459  
Gross margin
    -       (8,177 )
                 
Operating expenses
               
Product research and development
    999       3,288  
Sales and marketing
    346       3,943  
General and administrative
    1,697       5,957  
Amortization of fair value of stock issued to
               
    related parties for purchase of Neonode
               
   Technologies AB
    6,337       --  
    Total operating expenses
    9,379       13,188  
                 
Operating loss
    (9,379 )     (21,365 )
                 
Interest and other income
    --       16  
Interest and other expense
    (70 )     (368 )
Foreign currency exchange rate loss
    --       (848 )
Gain on conversion and forgiveness of
               
accounts payable
    55       --  
Write-off of receivable from Neonode AB
    --       (2,828 )
Gain on forgiveness of Neonode AB’s
               
 net liabilities
    --       9,820  
Gain (loss) on troubled debt restructuring
    (2,741 )     3,360  
Non-cash items related to debt discounts and
               
 deferred financing fees and the valuation of
               
 conversion features and warrants
    922       6,278  
Total interest and other expense
    (1,834 )     15,430  
                 
Net loss from operations
    (11,213 )     (5,934
                 
Other comprehensive loss
               
Foreign currency exchange rate loss
    (92     --  
Comprehensive loss
  $ (92 )   $ --  
                 
Deemed dividend to Preferred Stockholders
    (1,035 )     --  
Net loss attributable to common stockholders
  $ (12,340 )   $ (5,934 )
                 
Loss attributable to common stockholders per common share:
         
                 
Basic and diluted loss per share
  $ (0.05 )   $ (0.21 )
Basic and diluted – weighted average
               
shares used in per share computations
    247,551       28,164  
 
The accompanying notes are an integral part of these Consolidated Financial Statements.
 
 
-36-

 
 
NEONODE INC
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT
 
(Amounts in thousands, except per share amounts)
 
Amounts in thousands
 
Common stock shares issued (1)
   
Par value of common stock
   
Additional paid-in- capital on common stock
   
Series A Preferred stock shares issued
   
Series A Preferred stock
   
Series B Preferred stock shares issued
   
Series B Preferred stock
   
Stock subscription receivable
 
   
Accumulated Comprehensive loss
   
Accumulated deficit
   
Stock-holders' equity (deficit)
       
Balances, December 31, 2007
    23,781       23       55,406       -       -       -       -       -       354       (58,668 )     (2,885 )      
Employee stock options exercised for cash
    21       -       38       -       -       -       -       -       -       -       38        
Common stock issued related to employee liabilities
    657       -       54       -       -       -       -       -       -       -       54        
Employee stock option compensation expense
    -       -       1,163       -       -       -       -       -       -       -       1,163        
Conversion of debt to common stock and warrants
    10       -       15       -       -       -       -       -       -       -       15        
Shares of common stock issued pursuant to private placement  and warrant repricing financing transactions net of $1,137,000 cash and $5,385,000 non-cash  issuance costs
    10,589       11       4,274       -       -       -       -       -       -       -       4,285        
Conversion of warrant liability to equity
    -       -       67       -       -       -       -       -       -       -       67        
Issuance of Series A Preferred stock in financing transaction, net of accrued issuance costs of $46,000
    -       -       -       112       1,076       -       -       -       -       -       1,076        
 
Issuance of Series A Preferred stock in debt conversion transaction, net of stock given in lieu of cash issuance costs of $41,000
    -       -       -       248       2,443       -       -       -       -       -       2,443        
Issuance of Series A Preferred stock in acquisition of Neonode Technologies AB
    -       -       -       495       12       -       -       -       -       -       12        
Stock subscription receivable associated with financing transaction on December 31, 2008
    -       -       -       -       -       -       -       (1,035 )     -       -       (1,035 )      
 
 
-37-

 
 
 
Issuance of Series B Preferred stock in warrant conversion
    -       -       -                       93       2       -       -       -       2        
Foreign currency translation adjustment
    -       -       -       -       -       -       -       -       (354 )     -       (354 )      
Net loss
    -       -       -       -       -       -       -       -       -       (5,934 )     (5,934 )     354  
Comprehensive loss
    -       -       -       -       -       -       -       -       -       -       -       (5,934 )
Balances, December 31, 2008
    35,058     $ 35     $ 61,016       855     $ 3,531       93     $ 2     $ (1,035 )   $ -     $ (64,602 )   $ (1,053 )     (5,580 )
                                                                                                 
Employee stock option compensation expense
    -       -       147       -       -       -       -       -       -       -       147          
Employee Warrant Expense
    -       -       305       -       -       -       -       -       -       -       305          
Amortization of fair value of stock issued to
 related parties for purchase of Neonode Technologies AB
    -               6,337       -       -       -       -       -       -       -       6,337          
Reversal of conversion of warrant liability to equity
    -       -       (67 )     -       -       -       -       -       -       -       (67 )        
Common stock issued to settle accounts payable
    763       1       20       -       -       -       -       -       -       -       21          
 
Common stock issued to settle lawsuit
    1,189       1       54       -       -       -       -       -       -       -       55          
Exchange of Series A Preferred Stock for common stock
    369,488       369       2,282       (769 )     (2,651 )     -       -       -       -       -       -          
Exchange of Series B Preferred Stock for common stock
    9,974       10       (8 )     -       -       (76 )     (2 )     -       -       -       -          
Loss on troubled debt restructuring related to the market value of  preferred stock issued
    -       -       2,741                       -       -       -       -       -       2,741          
Fair value of warrants recorded on January 1, 2009
    -       -       (2,894 )     -       -       -       -       -       -       -       (2,894 )        
Deemed dividend to preferred stockholders
    -       -       1,035       -       -       -       -       -       -       -       1,035          
Proceeds received from subscription receivable
    -       -       -       -       -       -       -       1,035       -       -       1,035          
                                                                                                 
Foreign currency translation adjustment
    -       -       -       -       -       -       -       -       (92 )     -       (92 )        
Net loss
    -       -       -       -       -       -       -       -       -       (12,248 )     (12,248 )     (92 )
Comprehensive loss
    -       -       -       -       -       -       -       -       -       -       -       (12,248 )
Balances, December 31, 2009
    416,475     $ 416     $ 70,968       86     $ 880       17     $ -     $ -     $       $ (76,850 )   $ (4,678 )     (12,340 )
                                                                                                 
The accompanying notes are an integral part of these Consolidated Financial Statements.
 
 
-38-

 
 
 
NEONODE INC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
             
   
Twelve months ended
   
December 31,
 
   
2009
   
2008
 
Cash flows from operating activities:
           
Net loss
  $ (12,248 )     (5,934 )
Adjustments to reconcile net loss to net cash used by operating activities:
               
Stock based compensation expense
    6,789       1,163  
Depreciation and amortization
    9       339  
Loss on sale of property and equipment
    30       16  
Gain on conversion of accounts payable to equity
    (55     --  
Write-down of inventory to net realizable value
    ---       10,155  
Write-off of receivable from Neonode AB
    ---       2,828  
Gain on forgiveness of Neonode AB’s net liabilities
    ---       (9,820
Loss (Gain) on troubled debt restructuring
    2,741       (3,360 )
Deemed dividend to preferred stockholders
    1,035       --  
Debt discounts and deferred financing fees and the valuation of conversion features and warrants
    (922 )     (6,278 )
Changes in operating assets and liabilities:
               
Cumulative effect of the foreign exchange translation rates on the assets and liabilities of Neonode AB for the period January 1, 2008 through December 9, 2008, the date of bankruptcy
    ---        5,223   
Accounts receivable and other assets
    (47 )     870  
Inventories
    ---       (3,089 )
Prepaid expenses
    (12     1,035  
Accounts payable and other accrued expense
    863       (5,474  
Deferred revenue
    ---       (2,979 )
Net cash used in operating activities
    (1,817 )     -15,305  
                 
Cash flows from investing activities:
               
Proceeds from sale of property and equipment
    --       32  
Purchase of property, plant and equipment
    (27 )    
(205
)
Net cash used in investing activities
    (27     (173 )
                 
Cash flows from financing activities:
               
Proceeds from issuance of convertible debt
    958       --  
Proceeds from purchase of employee stock options
    ---       38  
 Cash increase resulting from merger and acquisition
               
   transactions and sale of software business
    ---       12  
Proceeds from issuance of common stock,
               
  warrant repricing and preferred stock
    1,035       9,733  
Equity issuance costs
    (46 )     (1,137
Restricted cash
    ---       5,702  
Net cash provided by financing activities
    1,947       14,348  
Effect of exchange rates on cash and cash equivalents
    (92     --  
                 
Net increase (decrease) in cash and cash equivalents
    11       (1,130
Cash and cash equivalents at beginning of period
    17       1,147  
Cash and cash equivalents at end of period
  $ 28     $ 17  
                 
 
 
 
-39-

 
 
 
 
Supplemental disclosure of cash flow information:
           
Interest paid
  $ 32     $ 121  
Supplemental disclosure of non-cash transactions:
               
Fair value of warrants issued in repricing
  $ --     $ 13,786  
Fair value of warrants and Series A Preferred stock issued
               
           to financial advisors and Bridge Note holders for financing and restructuring transaction costs
  $ --     $ 5,472  
Conversion of September convertible notes
  $ --     $ 35  
Fair value of August note surrendered towards the exercise of re-priced warrants
  $ --     $ 375  
Fair value of Series A and B Preferred stock issued to convert convertible notes and warrants  to equity
  $ --     $ 2,445  
    Fair Value of stock issued to employees in settlement of employee related vacation and severance liabilities
  $ --     $ 54  
Fair value of warrant liability converted to equity
  $ --     $ 67  
Fair value of 495,000 shares of Series A Preferred stock issued
               
           to related parties for 100% of Neonode Technologies AB
  $ --     $ 4,950  
Preferred Stock Series A Subscription Receivable
  $ --     $ 1,035  
Fair value of conversion to common stock of Series A and B
               
               Preferred stock issued to note and warrant holders related to
               
               corporate restructuring  in excess of amounts recorded in equity at December 31, 2008
  $ 2,741     $ --  
Deemed dividend to investors who received Series A Preferred
               
               stock issued related to corporate restructuring at December 31,
         
               2008 based on the fair value of the conversion to common stock at March 31, 2009
  $ 1,035     $ --  
Fair value of warrants with price protection
  $ 2,158     $ --  
Fair value of warrants issued to employees
  $ 305     $ --  
Fair value of embedded conversion feature of convertible debt issued in September 2009 financing transaction
  $ 700     $ --  
Fair value of 762,912 shares of common stock issued to convert accounts payable to equity
  $ 23       --  
    Fair value of convertible debt issued to convert accounts payable to equity
  $ 28       --  
Fair value of conversion to common stock of 495,000 shares of Series A Preferred stock issued to related parties for
               
              100% of Neonode Technologies AB recorded as compensation expense
  $ 6,337     $ --  
              
               
     
               
                 
 
The accompanying notes are an integral part of these Consolidated Financial Statements.
 
 
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NEONODE INC

Notes to the Consolidated Financial Statements

1.     Nature of the business and operations

Neonode Inc. (the Company) was incorporated in the State of Delaware in 2006 as the parent of Neonode AB, a company founded in February 2004 and incorporated in Sweden. On December 29, 2008, we entered into a Share Exchange Agreement with AB Cypressen nr 9683 (Cypressen) (renamed Neonode Technologies AB), a Swedish engineering company, and Neonode Technologies AB became our wholly-owned subsidiary.

On December 9, 2008, our formerly wholly-owned subsidiary, Neonode AB, filed for liquidation under the Swedish bankruptcy laws. Effective with Neonode AB’s bankruptcy filing on December 9, 2008, Neonode Inc. is no longer in the mobile phone business and there are no known financial obligations related to the accounts payable or other debts of Neonode AB for which Neonode Inc. has responsibility. The Consolidated Statements of Operations and Consolidated Statements of Cash Flows include the accounts of Neonode AB for the period January 1, 2008 through December 9, 2008, the date Neonode AB filed for bankruptcy.

On December 29, 2008, we entered into a Share Exchange Agreement with Neonode Technologies AB and the stockholders of Neonode Technologies AB:  Iwo Jima SARL, Wirelesstoys AB, and Athemis Ltd (the Neonode Technologies AB Stockholders), pursuant to which we agreed to acquire all of the issued and outstanding shares of Neonode Technologies AB in exchange for the issuance of shares of Neonode Inc. Series A Preferred Stock to the Neonode Technologies AB Stockholders.   Pursuant to the terms of the Share Exchange Agreement, upon the closing of the transaction, Neonode Technologies AB became a wholly-owned subsidiary of the Company.   The Neonode Technologies AB Stockholders are or where our employees and/or Neonode AB, and as such are related parties. Neonode Technologies AB did not have any operations in 2008. Our Consolidated Balance Sheet as of December 31, 2008 includes the accounts of Neonode Technologies AB which is comprised of cash totaling approximately $12,000. The acquisition of Neonode Technologies AB by us did not qualify as a business combination merger of entities under common control; accordingly the assets of Neonode Technologies AB are recorded at their historical cost basis of $12,000. The remaining fair value of the Preferred Stock Series A shares issued to the sellers of Neonode Technologies AB shares are accounted for as compensation.  Pursuant to the Share Exchange Agreement, the Neonode Technologies AB stockholders are required to work for us for 18 months for the shares of stock they received to fully vest. If they discontinue to work for us prior to the 18 month vesting period the unvested shares will be forfeited back to us. The $9.5 million fair value of the common stock (as converted from Series A Preferred Stock) issued under the Share Exchange Agreement is amortized to compensation expense over the 18 month at the rate of $528,000 per month period beginning December 31, 2008.

        We provide optical touchscreen solutions for handheld consumer and industrial electronic devices. We license our touchscreen technology to Original Equipment Manufacturers (OEMs) and Original Design Manufacturers (ODMs) who imbed our touchscreen technology into electronic devices that they develop and sell such as mobile phones, e-book readers, mobile internet devices, global positioning systems (GPS), digital picture frames and micro PCs. The cornerstone of our solution is our innovative optical infrared touchscreen technology, zForce™. We believe that keyboards and keypads with moving parts will become obsolete for handheld devices and that our touchscreen solutions will be at the forefront of a new wave of finger-based and pen input technologies that will enable the user to interact and operate everything from small mobile devices to large industrial applications using a combination of touches, swipes, and hand gestures.
 
 
 
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Liquidity

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the ordinary course of business. We did not have sufficient cash to pay our independent registered public accounting firm to complete the audit of our 2009 financial statements included in this Annual Report on Form 10K and to pay past due amounts to our previous independent registered public accounting firm who audited our 2008 financial statements included in this Annual Report on Form 10K. As a result, the 2008 and 2009 financial statements that are included in this Annual Report on Form 10K are presented without the required audit opinions of or current and previous independent registered public accounting firms. We have incurred net operating losses and negative operating cash flows since inception. As of December 31, 2009, we had an accumulated deficit of $76.9 million and working capital deficit (current assets less current liabilities, not including non-cash warrant liability) of $1.9 million. Our operations are subject to certain risks and uncertainties frequently encountered by companies in the early stages of operations. Such risks and uncertainties include, but are not limited to, technical and quality problems in new products, ability to raise additional funds, credit risks and costs for developing new products. Our ability to generate revenues in the future will depend substantially on our ability to enter into customer contracts with customers and to raise additional funds through debt or equity. During the period from August 25, 2009 through December 31, 2009, we completed a private placement of convertible notes and stock purchase warrants totaling $987,000.  In the three months ended March 31, 2010, we completed a private placement of convertible notes and stock purchase warrants totaling $1.2 million.

There is no assurance that we will be successful in obtaining sufficient funding on acceptable terms, if at all. If we are unable to secure additional funding and/or our stockholders, if required, do not approve such financing, we would have to curtail certain expenditures which we consider necessary for optimizing the probability of success of developing new products and executing our business plan. If we are unable to obtain additional funding for operations, we may not be able to continue operations as proposed, requiring us to modify our business plan, curtail various aspects of our operations or cease operations. The financial statements do not include any adjustments related to the recovery of assets and classification of liabilities that might be necessary should we be unable to continue as a going concern.

September 2009 Convertible Debt Financing Transaction

During the period from August 25, 2009 through December 31, 2009, we completed a private placement of convertible notes totaling $987,000 that can be converted, at the holder’s option, into 49,349,151 shares of our common stock at a conversion price of $0.02 per share. The convertible note holders have the right to have the conversion price adjusted to equal the lower stock price if we issue stock or convertible notes at a lower conversion price than $0.02 during the period that the notes are outstanding. These convertible notes are due on December 31, 2010 and bear an annual interest rate of 7%, payable on June 30 and December 31 of each year that the convertible notes are outstanding. In addition, we issued 24,674,576 three-year warrants to the convertible note holders with an exercise price of $0.04 per share. The warrants may be exercised and converted to common stock, at the warrant holder’s option, beginning on the six-month anniversary date of issuance until the warrant expiration date. We are not obligated to register the common stock related to the convertible debt or the warrants.

Neonode AB Bankruptcy

On December 9, 2008, Neonode AB, our formerly wholly owned subsidiary located in Sweden, filed for liquidation under the bankruptcy laws in Sweden. Under Swedish bankruptcy law, effective with the bankruptcy filing, we no longer have an ownership interest in Neonode AB, and, as such, we are no longer responsible for the liabilities of Neonode AB and we no longer have title or an ownership interest in the assets of Neonode AB. The Swedish bankruptcy court appointed a Swedish legal firm as receiver with the expressed duty to liquidate all the assets of Neonode AB and enter into final settlements with the creditors of Neonode AB.

We account for our investment in Neonode AB in accordance with accounting guidance   Relevant accounting guidance precludes consolidation of a majority-owned subsidiary where control does not rest with the majority owners, for instance, where the subsidiary is in bankruptcy.  Accordingly, we deconsolidated Neonode AB from our consolidated financial statements on the date it filed for bankruptcy, December 9, 2008.
 
 
 
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Our Consolidated Statements of Operations and Consolidated Statements of Cash Flows include the accounts of Neonode AB for the period January 1, 2008 through December 9, 2008, the date Neonode AB filed for bankruptcy. Since we no longer have an ownership interest in Neonode AB, we recorded a write-off of our receivable from Neonode AB totaling $2.8 million on the date Neonode AB filed for bankruptcy. We also recorded a gain on debt forgiveness of Neonode AB in bankruptcy totaling $9.8 million pursuant to the requirements of relevant accounting guidance.

Our Consolidated Balance Sheet does not include the accounts of Neonode AB at December 31, 2008.

2.     Summary of significant accounting policies

Principles of Consolidation

The preparation of our financial statements are in conformity with generally accepted accounting principles in the United States of America (GAAP) and include the accounts of Neonode Inc. and its former wholly-owned subsidiary based in Sweden, Neonode AB, through December 9, 2008, the date Neonode AB filed for bankruptcy. The balance sheet as of December 31, 2008 includes the accounts of our new wholly-owned subsidiary based in Sweden, Neonode Technologies AB. Operating results for Neonode Technologies AB from date of acquisition to December 31, 2008 were insignificant.  For 2009, the audited consolidated statements of operations and cash flows include the results of operations of our new wholly-owned subsidiary, Neonode Technologies AB, which we purchased on December 29, 2008.  The audited consolidated balance sheet as of December 31, 2009 includes the accounts of Neonode Inc. and Neonode Technologies AB.

All inter-company accounts and transactions have been eliminated in consolidation. Our accounting policies affecting our financial condition and results of operations are more fully described in Note 2 to our consolidated financial statements. Certain of our accounting policies require the application of judgment by management in selecting appropriate assumptions for calculating financial estimates, which inherently contain some degree of uncertainty. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, The historical experience and assumptions form the basis for making judgments about the reported carrying values of assets and liabilities and the reported amounts of revenue and expenses that may not be readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following are some of the more critical accounting policies and related judgments and estimates used in the preparation of our consolidated financial statements.

Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires making estimates and assumptions that affect, at the date of the financial statements, the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenue and expenses. Actual results could differ from these estimates. Significant estimates include, but are not limited to, collectibility of accounts receivable, carrying value of inventory, estimated useful lives of long-lived assets, recoverable amounts and fair values of intangible assets, and the fair value of securities such as options and warrants issued for stock-based compensation and in certain financing transactions.
 
Cash

We have not had any liquid investments other than normal cash deposits with bank institutions to date.
 
 
 
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Accounts Receivable and Allowance for Doubtful Accounts  

Our net 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.

Machinery and Equipment

Machinery and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method based upon estimated useful lives of the assets ranging from one to five years as follows:

Estimated useful lives
   
Tooling
1 year
Computer equipment
3 years
Furniture and fixtures
5 years

Equipment purchased under capital leases is amortized on a straight-line basis over the estimated useful life of the asset.

Upon retirement or sale of property and equipment, cost and accumulated depreciation are removed from the accounts and any gains or losses are reflected in the statement of operations. Maintenance and repairs are charged to expense as incurred.
 
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. The impairment is based on the estimated discounted cash flow associated with the asset.

Foreign Currency Translation

The functional currency of our foreign subsidiary is the applicable local currency, the Swedish Krona. The translation from Swedish Krona to U.S. Dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for income statement accounts using a weighted average exchange rate during the period. Gains or losses resulting from translation are included as a separate component of accumulated other comprehensive loss. Gains or losses resulting from foreign currency transactions are included in other income (expense). In addition, as Neonode AB entered into bankruptcy and we no longer control that entity, the foreign currency translation adjustment account relating to Neonode AB was written off into our statement of operations during the year ended 2008.  Foreign currency transaction losses included in other income and (expense) were $92,000 and $848,000 during the years ended December 31, 2009 and 2008, respectively.
 
 
 
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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 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 classification of liabilities in accordance with accounting guidance, 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 and warrants.

       Concentration of Credit and Business Risks
 
We will depend on a limited number of customers for substantially all revenue to date. 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.

Revenue Recognition

Neonode AB Mobile Phone Business and Licensing of Our Intellectual Property:

We recognize revenue from product sales when title transfers and risk of loss has passed to the customer, which is generally upon shipment of products to our customers. We estimate expected sales returns and record the amount as a reduction of revenues and cost of sales at the time of shipment. Our policy complies with the accounting guidance. We recognized revenue from the sale of our mobile phones when all of the following conditions were met: (1) evidence existed of an arrangement with the customer, typically consisting of a purchase order or contract; (2) our products were delivered 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 was not been satisfied, we deferred recognition of revenue. Judgments were required in evaluating the credit worthiness of our customers. Credit was not extended to customers and revenue was not recognized until we determined that collectibility was reasonably assured.

In 2008, our revenues generated by the sale of Neonode AB’s mobile phones consisted primarily by sales to distributors. From time to time, we allowed certain distributors price protection subsequent to the initial product shipment. Price protection may allow the distributor a credit (either in cash or as a discount on future purchases) if there is a price decrease during a specified period of time or until the distributor resells the goods. Future price adjustments are difficult to estimate since we do not have a sufficient history of making price adjustments. Therefore, we deferred recognition of revenue derived from sales to these customers until they resold our products to their customers. Although revenue recognition and related cost of sales were deferred, we recorded an accounts receivable at the time of initial product shipment. As standard terms were generally FOB shipping point, payment terms were enforced from the shipment date, and legal title and risk of inventory loss passed to the distributor upon shipment.
 
For products sold to distributors with agreements allowing for price protection and product returns, we recognized revenue based on our best estimate of when the distributor sold the product to its end customer. Our estimate of such distributor sell-through was based on information received from our distributors. Revenue was not recognized upon shipment since, due to various forms of price concessions; the sales price was not substantially fixed or determinable at that time.
 
 
 
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Revenue from products sold directly to end-users though our web sales channels were generally recognized when title and risk of loss has passed to the buyer, which typically occurs upon shipment. Reserves for sales returns were estimated based primarily on historical experience and were provided at the time of shipment.

Generally, our customers were responsible for the payment of all shipping and handling charges directly with the freight carriers.

Neonode AB derived revenue from the licensing of our internally developed intellectual property (IP). We entered into IP licensing agreements that generally provided licensees the right to incorporate our IP components in their products with terms and conditions that varied by licensee. The IP licensing agreements generally included a nonexclusive license for the underlying IP. Fees under these agreements may have included 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. On December 1, 2008, we transferred the Neonode AB intellectual property including patents, copyrights and trademarks to Neonode inc. pursuant to an intercompany debt pledge agreement.

Hardware Products:

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 defer and recognize service revenue over the contractual period or as services are rendered. We 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. Our policy complies with the accounting guidance. Judgments are required in evaluating the creditworthiness of our customers. Credit is not extended to customers and revenue is not recognized until we have determined that collectibility is reasonably assured. Our sales transactions are denominated in U.S. dollars or Euros. The software component of our hardware products is considered incidental.  Therefore, we do not recognize software revenue related to our hardware products separately from the hardware product sale. To date, we have not sold any hardware products.

When selling hardware, we expect our agreements with OEMs and ODMs to incorporate clauses reflecting the following understandings:

-  
all prices are fixed and determinable at the time of sale;
-  
title and risk of loss pass at the time of shipment (FOB shipping point);
-  
collectibility of the sales price is probable (the customer is creditworthy, the customer is obligated to pay and such obligation is not contingent on the ultimate sale of the customer’s integrated solution);
-  
the customer’s obligation to us will not be changed in the event of theft or physical destruction or damage of the product;
-  
we do not have significant obligations for future performance to directly assist in the resale of the product by the OEMs; and
-  
there is no contractual right of return other than for defective products.
 
Software Products:

We may derive revenues from the following sources: (1) software, which includes our Neno™ software licenses and (2) engineering services, which include consulting. We 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. These documents include post delivery support, upgrades, and similar services. To date, we have not sold any software products.
 
 
 
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For software license arrangements that do not require significant modification or customization of the underlying software, we 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. We initially defer all revenue related to the software license and maintenance fees until such time that we are able to establish VSOE for these elements of our software products.  Revenue deferred under these arrangements is recognized to revenue over the expected contract term. 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.

Engineering Services:

We may sell engineering consulting services to our customers on a flat rate or hourly rate basis. We recognize revenue as the engineering services stipulated under the contact are completed and accepted by our customers.  On December 29, 2009, we signed an engineering services agreement with an OEM to provide engineering services over a three month period in 2010 related to the development of a touchscreen application for a mobile phone product. The value of this agreement is approximately $100,000.

Warranty Reserves

Our mobile phone products were generally warranted against defects for 12 months following the sale. We have a 12 month warranty from the manufacturer of the mobile phones. Reserves for potential warranty claims not covered by the manufacturer were provided at the time of revenue recognition and were based on several factors, including current sales levels and our estimate of repair costs. Shipping and handling charges were expensed as incurred. Upon filing for bankruptcy on December 9, 2008, the warranty obligations related to Neonode AB’s previous sales of mobile phone products were transferred to the Swedish bankruptcy court along with all the assets and liabilities of Neonode AB.

We do not anticipate that our technology products will have any warranty obligations associated with licenses related to these technologies.

Advertising

Advertising costs are expensed as incurred. External advertising costs amounted to $0 and $442,000 for the years ending December 31, 2009 and 2008, respectively.

Research and Development

Research and Development (R&D) costs are expensed as incurred. R&D costs are accounted for in accordance with accounting guidance. Research and development costs consist mainly of personnel related costs in addition to some external consultancy costs such as testing, certifying and measurements.

Concentration of Risk

Financial instruments which potentially subject us to concentrations of credit risk consist principally of accounts receivable with customers. Since we are in the process of getting our technology to market, our first customers will comprise over 15 percent of revenue and we will need to rely on a smaller customer base as we grow. We maintain allowances for potential credit losses, if necessary.
 
 
 
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Risk and Uncertainties

Our long-term success is dependent on our obtaining sufficient capital to fund our operations and to develop our products, and on our bringing such products to the worldwide market and obtaining sufficient sales volume to be profitable. To achieve these objectives, we will be required to raise additional capital through public or private financings or other arrangements. It cannot be assured that such financings will be available on terms attractive to us, if at all. Such financings may be dilutive to our stockholders and may contain restrictive covenants.

We are subject to certain risks common to technology-based companies in similar stages of development. Principal risks include risks relating to the uncertainty of market acceptance for our products, 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 a limited number of suppliers, the concentration of our operations in a limited number of facilities, the uncertainty of demand for our products 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.

We are exposed to a number of economic and industry factors that could result in portions of our technology becoming obsolete or not gaining market acceptance. These factors include, but are not limited to, technological changes in our markets, our ability to meet changing customer requirements, competitive pressures in products and prices, and the ability of our customers to manufacture and sell their products that incorporate our technology.

A significant portion of our business is conducted in currencies other than the U.S. dollar (the currency in which its financial statements are reported), primarily the Swedish Krona and, to a lesser extent, the Euro. We incur a significant portion of our expenses in Swedish kronor, including a significant portion of our product development expense and a substantial portion of our general and administrative expenses. As a result, appreciation of the value of the Swedish Krona relative to the other currencies, particularly the U.S. dollar, could adversely affect operating results. We do not currently undertake hedging transactions to cover our currency exposure, but we may choose to hedge a portion of our currency exposure in the future as it deems appropriate.

Our future success depends on market acceptance of our technology as well as our ability to introduce new versions of our technology to meet the evolving needs of our customers.

Stock Based Compensation Expense

We follow the accounting guidance, which establishes standards for the accounting of transactions in which an entity exchanges our equity instruments for goods or services, primarily focusing on accounting for transactions where an entity obtains employee services in share-based payment transactions. Accounting guidance requires a public entity to 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 to recognize it as compensation expense over the period the employee is required to provide service in exchange for the award, usually the vesting period.
 
We account for equity instruments issued to non-employees in accordance with accounting guidance, which require that such equity instruments be recorded at their fair value and the unvested portion is re-measured each reporting period. 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

We account for debt issued with stock purchase warrants in accordance with accounting guidance, if the warrants meet equity classification. We allocate 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. At each balance sheet date, we make a determination if these warrants instruments should be classified as liabilities or equity.  The warrants were classified as a liability pursuant to the accounting guidance. The warrants were recorded among “Liability for warrants to purchase common stock” and are valued at fair value at the end of each reporting period, using the Black-Scholes option pricing model.
 
 
 
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Income Taxes

We account for income taxes in accordance with accounting guidance. Accounting guidance requires recognition of deferred tax liabilities and assets for the expected future tax consequences of items that have been included in the financial statements or tax returns. We estimate income taxes based on rates in effect in each of the jurisdictions in which it operates. Deferred income tax assets and liabilities are determined based upon differences between the financial statement and income tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The realization of deferred tax assets is based on historical tax positions and expectations about future taxable income. Valuation allowances are recorded against net deferred tax assets where, in our opinion, realization is uncertain based on the “not more likely than not” criteria of the accounting guidance.

Based on the uncertainty of future pre-tax income, we fully reserved our net deferred tax assets as of December 31, 2009 and 2008. In the event we were to determine that we would be able to realize our deferred tax assets in the future, an adjustment to the deferred tax asset would increase income in the period such a determination was made. The provision for income taxes represents the net change in deferred tax amounts, plus income taxes payable for the current period.

Effective January 1, 2007, we adopted the relevant accounting guidance, which provisions included a two-step approach to recognizing, de-recognizing and measuring uncertain tax positions accounted for in accordance with the relevant accounting guidance. As a result, we recognized no increase in the liability for unrecognized tax benefits. Therefore, upon implementation of the accounting guidance, we recognized no material adjustment to the January 1, 2007 balance of retained earnings. As of December 31, 2009, we had no unrecognized tax benefits.

Net Loss Per Share

Net loss per share amounts has been computed in accordance with accounting guidance. For each of the periods presented, basic loss per share amounts were computed based on the weighted average number of shares of common stock outstanding during the period. Net loss per share, assuming dilution amounts from common stock equivalents, is computed based on the weighted average number of shares of common stock and potential common stock equivalents outstanding during the period. The weighted average numbers of shares of common stock and potential common stock equivalents used in computing the net loss per share for the twelve month periods ending December 31, 2009 and 2008 exclude the potential common stock equivalents, as the effect would be anti-dilutive.

Comprehensive Loss

We apply the provisions of relevant accounting guidance, which establishes standards for reporting and displaying all changes in equity other than transaction with owners in their capacity as owners. Our comprehensive loss includes foreign currency translation gains and losses reflected in equity. We have reported the components of comprehensive loss in our Consolidated Statements of Stockholders' Deficit.

Cash Flow Information

Cash flows in foreign currencies have been converted to U.S. dollars at an approximate weighted average exchange rate for the respective reporting periods. The weighted average exchange rate for the Consolidated Statements of Operations was 7.65 and 6.58 Swedish Kronor to one U.S. Dollar for the year ended December 31, 2009 and 2008, respectively. The weighted average exchange rate for the Consolidated Balance Sheets was 7.21 and 7.84 Swedish Kronor to one U.S. Dollar as of December 31, 2009 and 2008, respectively.
 
 
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Fair Value of Financial Instruments

We disclose the estimated fair values for all financial instruments for which it is practicable to estimate fair value. Financial instruments including cash and cash equivalents, receivables and payables and current portions of long-term debt are deemed to approximate fair value due to their short maturities. The carrying amounts of long-term debt and capitalized lease obligations are also deemed to approximate their fair values. Since no quoted market prices exist for certain of our financial instruments, the fair values of such instruments have been derived based on our assumptions, the estimated amount and timing of future cash flows and estimated discount rates. Different assumptions could significantly affect these estimates.

New Accounting Pronouncements

The following are expected effects of recent accounting pronouncements. We are required to analyze these pronouncements and determine the effect, if any, the adoption of these pronouncements would have on our results of operations or financial position.

        In May 2009, the Financial Accounting Standards Board issued accounting guidance which establishe