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Neonode, Inc (NASDAQ:NEON)

Q3 2013 Earnings Conference Call

November 7, 2013 10:00 AM ET

Executives

Daniel Gelbtuch - SVP, Corporate Finance and IR

Thomas Eriksson - CEO

David Brunton - CFO

Analysts

Mike Malouf - Craig-Hallum Capital

James Medvedeff - Cowen & Co

Operator

Hello everyone, thank you for standing by and welcome to Neonode’s Third Quarter 2013 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. At this time for opening remarks and introductions, I would like to turn the call over to Daniel Gelbtuch, our Senior Vice President of Corporate Finance and Investor Relations. Daniel, please go ahead and start the conference.

Daniel Gelbtuch

Thank you, welcome and thank you for joining us. On today’s call, we’ll review our third quarter 2013 financial results, and provide a corporate update. Our update will include details of our design wins, technology developments, and new customer agreements that we recently announced. The prepared remarks will be provided by Thomas Eriksson, our CEO and David Brunton, our CFO. Before turning the call over to Thomas and David, I would like to make the following remarks concerning forward-looking statements.

All statements in this conference call other than historical facts are forward-looking statements. The words anticipate, believe, estimate, expect, tend, will, guides, confidence, targets, projects, and other similar expressions typically are used to identify forward-looking statements. These forward statements do not guarantee the future performance that may involve or are subject to risks, uncertainties and other factors that may affect Neonode’s business, financial position, and other operating results, which include but are not limited to the risk factors and other qualifications contained in Neonode’s Annual Report on 10-K, quarterly reports on 10-Q and other reports filed by Neonode with the SEC to which your attention is directed.

Therefore, actual outcomes and results may differ materially from what is expected or implied by these forward-looking statements. Neonode expressly disclaims any intent or obligation to update these forward-looking statements.

At this time it’s now my pleasure to turn the call over to Thomas Eriksson, Chief Executive Officer of Neonode. Thomas, please go ahead.

Thomas Eriksson

Thank you, Daniel. Good morning everyone, and welcome to the call. To start with I'm very happy to announce that we signed license agreements with two large consumer electronics OEM in Korea. We have initiated projects with both of these customers across multiple sectors such as mobile computing, children's tablets, smartwatches and white goods. The inventory into companies of this caliber is a major milestone for us, so they can quickly drive higher volumes across many sectors that we expect this customer should be a major source of growth for Neonode in the coming year. Our Q2 GAAP revenues of $1.1 million excluded approximately $160,000 of revenues that were earned in September quarter, they reported after our auditor's reporting deadline. Our Q3 revenues included two brand new royalty streams, one from Leapfrog and other from Volvo.

Our soft comparisons were due to the weak e-reader market, as retail ASPs are still well above $100, which is increasingly uncompetitive relative to color tablets. However, on the positive side we have reengaged with major Tier One eReader OEM which should help us recapture the market share that we lost over the last year. Moreover these OEMs are particularly focused on aggressively driving down retail price points in order to transform e-readers into a compelling giveaway and promotional product which will hopefully revive unit growth in 2014. We're now engaged with numerous [indiscernible] and semiconductor OEMs and have multiple development projects ongoing. In parallel, we're working with the Operating Systems players to make sure our technology fulfills their requirement.

Not only will our solution drive notebook and large monitor touch screen dealer materials down to the single digits, but it will enable OEMs to add features like low power 2D and 3D proximity sensing, air gestures [indiscernible] while substantially reducing overall system costs in areas such as keyboards and track pads. On the print front, we're happy to announce that one our large Tier One Print OEMs is on track to ramp in December and currently in production. Moreover, our partnership for this leading global print OEM and their internal creations has expanded significantly over the last months, especially in the low cost printers. Our [indiscernible] technology makes it possible for a customer to [indiscernible] the low cost printer control panels that normally includes both keys and a display.

Currently these types of high volume printers only have buttons without any touch function, as traditional assistive or capacitive touch is way too expensive. On the children's tablet front, according to press reports, Leapfrog flagship the LeapPad Ultra has experienced robust demand and has fixed its initial firmware issues. In addition we expect a new premier Tier One customer to globally launch a children's tablet for this holiday season. Thus we expect substantial growth from the children's tablet segment here on out.

Now over to an update on our latest research and new technology development. First, regarding our multifinger touch solution. During the last few months our engineering team has been working intensively to complete the solution of our notebook OEM customers. What we were happy about is that we managed to create a hybrid between our traditional low cost, low power touch for dual fingers and our new multifinger technology. This is a very important breakthrough because now we can dynamically switch between these modes, to still support ultra low power, ultra fast report rates (Ph) for dual fingers and the other modes have enough speed to meet operating system requirements for multifinger touch. During the development of this new technology, we've also worked extensively filing new IP both for naked window solution and flash glass design.

We also made some breakthrough in large screen sizes for monitors for example, in response to the increased demand resuming for low cost touch, particularly in the printing monitor market which exceeds 120 million units annually, our engineering team has successfully expanded a [indiscernible] range for a top solution to support displays from 17 to 27 inches. For example, we can drive a 21 inch monitor with a single controller chip which enables monitor customer to add touch functionality for less than $10. Even with one controller we can achieve a report rate of 300 frames per second. Regarding our new single side sensor, which we announced are $1 single side sensor technology which creates a two dimensional touch sensor on any surface, we've been serving proven technology in terms of better resolution, improved linearity and increased yield. We've also been working with our vendors to perfect the solution to insure optimal performance at the lowest bill of materials, we have also improved mechanic architecture on the single side sensor so it easily can be integrated into very small displays such as mobile phones and round watches. This technology will also be made [indiscernible] so it can be integrated into different products without doing a full custom design.

And now over to our IP developments, on the IP front we have been extremely active, we have intensified for a touch and user interface solution to further expand and bolster our patent portfolio, to date we have 20 patent issued and have 80 patent pending up from 16 and 78 last quarter and now over to David who will talk about the financials.

David Brunton

Thanks Thomas. Earlier today we filed our form 10-Q with the SEC as well as released our third quarter financial results and a press release. Both of these are available for download from the investor section of our website at neonode.com. For the third quarter ended September 30, 2013 revenues decreased 35% to $1.1 million compared to $1.7 million for the same period in 2012. Our revenues for the three months ended September 30 2013 included $900,000 from license fees plus $200,000 of non recurring engineering or NRE fees for the engineering services, design services, compared to $1.6 million of license fees plus $100,000 of NRE fees in the same quarter of the prior year.

For the nine months ended September 30, 2013, revenues decreased 44% to $2.7 million compared to $4.8 million for the same period in 2012. Our revenue for the nine months ended September 30 2013, included $2.1 million from license fees plus $600,000 of NRE fees compared to $4.1 million of license fees plus $700,000 of NRE fees in the prior year. Although our total revenue was lower in 2013 compared to 2012, we did see a continued diversification of our customer base. We had 12 customers shipping products incorporating our license technology during the nine months ended September 30 2013, compared to six in the same period of 2012.

Several of the customers products just started ramping in the last month of the third quarter of 2013 and we expect them to continue to ramp over the next couple of months and beyond. The decrease in overall revenue for the three and nine months ended September 30, 2013 compared with the same period in 2012 is primarily due to a decrease in license fees from Amazon. Amazon contributed approximately 46% of our total revenues during the nine months ended September 30 2012, compared to less than 1% in the nine months just ended.

The decrease of revenues earned from Amazon was partially offset by an increase in revenues earned from Leapfrog Enterprises and Netronics Inc. Cost of revenues for the three months ended September 30, 2013, increased 167% to $800,000 compared to $300,000 in the same period of 2012. Our cost of revenues for the nine months ended September 30, 2013 increased 30% to $1.4 million compared to $1.1 million for the same period of 2012.

These costs represent the cost of customer to product design activities that have been completed. We should begin to see some of these products go into production as early as the end of the fourth quarter this year and others during 2014. As of September 30, 2013 we recorded $600,000 of costs associated with engineering design services to our work in process account that is included in prepaid assets on the balance sheet. The engineering design service costs will be expensed as a cost of revenue when the customer project is completed and the corresponding NRE that is included in deferred revenue is recognized.

We have currently have $3.4 million of deferred revenue included as a liability on our balance sheet. $2.5 million of this is prepaid license fees from three customers, the deferred license fees will be recognized as revenue when the customer products are manufactured and shipped. In addition, $900,000 of the deferred revenue is NRE fees from 17 customers that has been deferred until the corresponding projects have been completed. The total operating expenses for the third quarter of 2013 increased slightly by 4% to $3.6 million compared to $3.5 million for the third quarter of 2012, total operating expense for the nine months ended September 30, 2013 increased 3% to $11.2 million compared to $10.8 million for the same period in 2012. This increase is primarily due to an increase in the engineering department staffing.

On the customer front, we signed nine license agreements with new customers in 2013, and now have license agreements with 33 customers. In addition, we have several additional license agreements with new customers in the final review phase. For the three and nine months ended September 30, 2013, our net loss was $3.3 million or $0.09 per share and $10 million or $0.29 per share respectively compared to a net loss of $2.1 million or $0.06 per share and $7.2 million or $0.22 per share in the same period last year.

On September 16, 2013, we issued approximately 1.2 million shares of our common stock to investors who completed an equity financing transaction in which we raise $7.7 million and received $6.9 million in cash net of $800,000 of direct selling costs that included legal, audit and other regulatory costs. Our current cash balance is expected to provide sufficient cash to achieve our future business objectives.

As of September 30, 2013, we had cash of approximately $10.6 million along with $1.1 million of accounts receivable and working capital of $8.1 million. Our cash used in operations increased to $6.5 million for the nine months ended September 30, 2013 compared to $1.6 million used for the same nine month period in the previous year. Our currently monthly cash burn rate net of revenue is approximately $700,000 per month.

Our shareholder equity is $8.3 million as of September 30, 2013 and there are 37.9 million shares of common stock outstanding. Common shares outstanding plus shares underlying stock based awards preferred stock and outstanding warrants to purchase common stock totaled 40.3 million shares on September 30, 2013 compared to 39.8 million shares at December 31, 2012.

Now I would like to turn the call back over to Thomas for some closing comments.

Thomas Eriksson

Thank you, David. To recap Neonode continues to add key partnerships and customers, gain seeing momentum, improve visibility and develop the touch solution, all of which will allow the company to accelerate growth in the coming years. We’re not only securing new design wins and premier licensees, but we are aggressively investing in our business to meet customer demand and remaining on the leading edge of touch solutions. I would like to take this opportunity to thank all of our customers, partners, investors and our very talented and dedicated employees for the trust and support.

This concludes the prepared remarks and we’ll open the call for questions. Thank you very much.

Question-And-Answer-Session

Operator

(Operator Instructions). Our first question comes from the line of Mike Malouf of Craig-Hallum Capital.

Mike Malouf - Craig-Hallum Capital

Thanks for taking my question. I wanted to talk a little bit about the PC market. How do you see this playing out with regards to OEMs looking at your prototypes with both on the notebook side and on the monitors? For instance how long does it take for them to take a look at the prototype and understand if that’s what they want? Have you gotten any feedback yet? And is there a chance that we could see Windows 8 certification on your products or maybe you’ve already done that? Thank you.

Daniel Gelbtuch

This is Daniel, we can’t really comment on exactly the time tables for our customers. We’re in the , it's a constant give and take; it’s a very iterative process. We deliver prototypes for their specifications. There is always some feedback that goes back and forth. The feedback to-date has been extremely positive. The OEMs that we delivered, who are very excited or very bullish about the prospects for our touch solutions in both monitors and in laptops.

In terms of Windows 8 testing, that is something that we believe will take place in the near term. But that is not something that we necessarily control. So it’s something that we expect to happen relatively soon. We’re very confident that we will pass those tests or customers will pass those tests with their products. And we will get to you as soon as that takes place. But right now we’re in advanced stages of engagement. The customers are very, perspective customers are and major OEMs on both the semiconductor side and the PC semiconductor side and on the OEM side on the PC OEM side and all them are very engaged, very excited and the feedback has been excellent to-date.

Mike Malouf - Craig-Hallum Capital

Well, that’s great to hear. Maybe Thomas I could ask you this question; with regards to the actual PC notebook solution and I guess for the monitor solution, the price difference between a competing product is obviously very dramatic. What is the trade off that an OEM has to take on? What’s the downside with taking on your technology versus either the traditional ITO technology which is obviously more expensive or even some of the new metal mesh or silver nanowire technologies that are out there?

Thomas Eriksson

We don’t know any things that makes this worse, and that’s the notion. We both support a naked window solution which means there is no front glass and we support solution with the glass. And using our solution, you get 100% transparent window compared to like a capacity solution with a metal-mesh or ITO, that matter is not fully transparent. So our customer can use added solution depending on the application.

Daniel Gelbtuch

Basically to your point about, your question about is there any trade off or any, are we giving up any or are customers giving up anything in terms of quality or performance by using us? Absolutely not. Our speech are better than the capacitive solutions out there. We shine particularly in PC space, particularly because these are large environments where projected capacitor is challenged in terms of performance, especially at larger sizes. We have no size challenges whatsoever and we have said in our prepared remarks we are easily going up to 27 in sizes with full performance and full speed and all the requirements for Windows 8. In addition we do not have any issues in terms of having a cover glass, there are no glare issues.

PC OEMs for the most part do want, do request some sort of bezel, so that fits perfectly into our current solutions. And as Thomas just mentioned down the road we will have our Flush solution ready towards the end of this year or early next. And we're offering everything to the PC customers at this point. Again they are very excited, the feedback has been excellent, the performance of our solutions is excellent. And I think we're going to really disrupt the market. I think this is going to be our sweet spot.

Mike Malouf - Craig-Hallum Capital

That's great. One of things I didn't hear a lot of and I am wondering if you could give us a little color is on the auto side. What's been the progress with regards to the auto side and particularly you are getting into anything else besides the standard counsel?

Thomas Eriksson

As we said previously we have multiple projects with numerous top 10 automotive customers both on the OEM side and on the system OEM side. While we rolling out mobile BYD this NEON and Alpine by name we have more than two dozen projects with many eCORP systems in automotive OEMs. In terms of new markets, or new opportunities beyond the center stack, we're now engaged with one of the largest global suppliers of door handles.

As you might have seen already many auto OEMs are quickly integrating sensors into door handles to enhance the keyless entry features of the car. Car solutions use capacitive sensors which are at least three to four times more expensive than our optical solutions and are extremely limited in terms of features and performance. For example capacitive sensors have a very difficult time using gloved hands and also are not optimized for extreme environments, extreme cold or extreme heat.

So this is an area that we’re really excelling and we could do it for a much, much, much lower price. And remember the car door handle is roughly three to four times bigger than the overall auto market which is expected to be 80 million units. In addition, we have also, as we display back in CES, we have also developed a steering wheel, a touch steering wheel that uses proximity sensing for heads up displays and we have more than a few very high end automobile OEMs that are evaluating this product as we speak.

And then finally the last, I guess the fourth or fifth opportunity in the car is the knobs, the circular touch sensor which we developed can be integrated into things like BMW iDrive where we have the steering, we control the telematics, gets controlled by a round knob right below the center stack. And we can add sort of a mouse feature to it.

Operator

Our next question comes from the line of James Medvedeff from Cowen.

James Medvedeff - Cowen & Co

I wanted to see if you might be able to provide any more color on the ramp of the printer OEM? You said they are producing now and expect to deliver units in December. Do you have any sense of the volumes that you might see?

Thomas Eriksson

This is something that we really have to be careful; we can’t really talk about the printer OEM per se and their size, but we do expect that this is going to be definitely into millions on an annual basis, well on millions in annual basis and should proceed up into the double digits or the tens of millions going forward over time. We expect this large tier 1 printer licensee to ramp during the end of this quarter and we have confirmed that they are currently in production.

So we expect to generate some revenue from this segment in the fourth quarter and we expect that there will be linear ramps of the many, many projects that has been won and has been manufactured and has been tested already to start rolling out over the next three to four quarters.

James Medvedeff - Cowen & Co

And just on revenue recognition for that, if they shift in December do you get revenue in December or do you get that in arrears?

Thomas Eriksson

We get it in, we recognize it in the quarter that it is shifting; however we do have a 15 day after quarter cut off for revenue recognition. So this customer, any customer in our customer base, in order for it to be recognized during the quarter, has been, has to report their revenues, has to produce their report for royalties within 15 days of the quarter end. I will let Dave answer, give you more color on it.

David Brunton

With this particular customer actually the fourth quarter revenue will be recognized in the first quarter, because they report 45 days after the end of quarter. And I am not going to be able to budge them into reporting [indiscernible] days, I just want to put that out there. We'll definitely be able to announce the numbers on the next conference call, but the revenue recognition will take place in the first quarter, just don't want to have any false pretenses on that.

James Medvedeff - Cowen & Co

And then on the P&L sales and marketing came in down significantly quarter-over-quarter and below what we were expecting. How should we think about that going forward? Is this a new run rate or it’s something, sorry.

David Brunton

Yes. That will be the new run rate. We actually looked at the sales team around the world and decided through an analysis to move some of the sales functions on consolidated. So we cut some of the sales functional.

Thomas Eriksson

And at the same time we also moved some up into R&D; that’s something like a judgment call.

Operator

(Operator Instructions). Our next question comes from the line of [indiscernible].

Unidentified Analyst

You raised $7 million in the last round. Insiders increased their selling of their own shares. How would we be breakeven before year end? You’re saying in the last call that you didn’t need to raise capital. So you raise the 7 million, and my numbers show you went higher 3 million going into the fourth quarter and insiders increased their selling to such a dramatic level, bubble was supposedly being used for tax purposes. And I haven’t seen any insider buyers expect of one Board member.

Thomas Eriksson

First of all, as we mentioned in last call, we said that we’ll only raise money for specific projects with high ROI and that major project that we’re focused on is PC, that’s number one. And that’s the reason why we raised money. The second point which is what we said last quarter is that we have new projects, new customers like printer, like children’s tablet, like [indiscernible] which are layering on and those themselves should get us through breakeven. They’ve started to layer on and they will continue to ramp up, and those projects themselves on their own get us through breakeven.

Unidentified Analyst

Do they, because we heard about mobile a year ago, and we heard about printers a year ago and so it’s every, the story sense where we keep hearing about new projects but yet we haven’t seen anything from the projects we heard about a year ago.

Thomas Eriksson

The projects that was somewhat a year ago, some of them.

Unidentified Analyst

With mobile.

Thomas Eriksson

Some of the projects got delayed or fell off; that’s number one. Again that’s, those are designed, not every design will make it to market. However the markets that we discussed about and we’re talking about now that get us to breakeven are printer, which is in production now. That will have to be an act of god for it to not to happen, that’s number one.

Unidentified Analyst

That will make you breakeven for the fourth quarter in its own way?

Thomas Eriksson

We do not talk about the fourth quarter, it’s on right in last quarter we mentioned that we could breakeven over the next few quarters. That is still very much possible. We do not predict and cannot predict the exact amount of pre ramp and initial ramp of new customers. The new customers like in the children’s tablet space, ramp up this quarter, will continue to ramp next quarter and over the next three quarters will continue to ramp. And in the case of order, we cannot control the end market results. However, these customers have ramped, they said they’re going to ramp and they are ramping. So there is proof of the customer.

And then in terms of printer which is probably going to be one of our biggest customers and will be the one that probably helps us breakeven, that product, that customer, that very large customer is in significant production right now, as we speak, has already build and anticipation of ramping and going to market and is expected to ramp this quarter, end of this quarter.

So all of those three markets, we are not talking about handsets getting us through profitability; we’re not talking about even PC getting us the profitability. The three key markets that we’re talking about, these new markets plus the eReader resurgence hopefully, our goal next year will get us to profitability. And at the same time we have again these new markets which we are getting into like PC which are looking, look like they are about to burst in a very good way in terms of the monitor market where we have a disruptive solution, very disruptive solution with almost no competition, or no viable competition at our price point, and addition to the laptop markets which are also starting to gain significant momentum and those are what we are going to be leading us to profitability over the next year.

Now, in terms of and I know you mentioned that reduced side are stronger put place. As it relates to the insider selling we had expiring three year warrants which had to be converted by mid October. As a result they were selling away both net exercising and corresponding income tax consequences. Moreover, there were extra share sales to cover outstanding personal loans, compensation deployments and cost equities that the insiders took on behalf of Neonode over the last three years. On insider selling I would agree, it’s typically not viewed positively. We strongly believe our sales were extremely justified or our [indiscernible] extremely considerable. The current insider ownership is 70% of shares outstanding, and Neonode’s management and board is extremely invested and confident in Neonode’s long term prospects.

So, again, you could talk to we can have Dave gave some more color about this. We’ve been over this road a lot. When people take out second on mortgages or take out large 7 figurer loans that they pay interest on and they get warrants in return for those layouts, or those out ways, selling those loans and then selling the share, converting those loans and selling the corresponding shares is something that again might not look good to everyone, but is certainly justifiable and understandable. I’d like to put this issue to that.

Unidentified Analyst

Okay. I appreciate the answer. I don’t agree with that answer on the selling of the shareholders over the last few years, but that’s fine. I appreciate the answer thank you very much.

Operator

At this time there are no further questions. I would now like to turn the floor back over to management for any closing remarks.

Daniel Gelbtuch

Want to thank you for joining on the call and I would keep you posted on our progress in 2013 and the future. Have a very good day. Thank you.

Operator

Thank you. This concludes today Neonode’s third quarter 2013 earnings conference call. You may now disconnect.

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