On the back of Neonode's (NEON) recent project-oriented money raise (which was reputedly extremely oversubscribed), which included insider sales that were (and are still) misunderstood, there have been a number of negative issues raised, which have pressured NEON shares and have considerably increased the short position (which is now a whopping and record-high 8.86M shares, or about 28% of the float, which equates to 15.4 days-to-cover ratio).
While most of the complaints seem superficially plausible, it would behoove investors to dig a bit deeper (into the filings, conference calls, investor presentations, industry practices, etc) in order to gain proper perspective and context, which can then intuitively explain all.
Lets analyze the main complaints/issues:
Short Issue #1: Neonode management indicated on its 2Q earnings call that Neonode's balance sheet was sufficient to carry NEON to breakeven. So why did Neonode raise money a month later?
Explanation: Management crisply stated on the 2Q earnings call, that Neonode did not need to raise money to achieve breakeven, BUT would raise money (i.e. sell the ~1M shares off the shelf) ONLY if there was a major project (i.e. Windows 8 laptops) that required immediate investment.
Along these lines, it seems (and management has confirmed publicly) that Neonode's embryonic and industry's lowest-cost PC solution, which was first demonstrated in late June 2013 (and is in the prototyping stage), is gaining an overabundance of attention/demand from the "big boys". According to management, Neonode's optical-touch PC solution has a total system cost that is below $10 (and has a substantial cost reduction road map to the low single digits), versus the closest metal mesh competitor, Uni-Pixel's (UNXL), whose elusive UniBoss has a total system cost of ~$25, and has a yet-to-be-proven supply chain (while Neonode's licensees have shipped over 15M units to date, with ~100% yields and zero returns). The basis of this conclusion (i.e. that NEON needs to invest quickly/aggressively, in order to adequately address its burgeoning PC opportunity) is based upon the flurry of recent PC-centric announcements from Neonode:
- Neonode stated in its 1Q earnings release that the company "entered into partnership with a Tier One PC Semiconductor OEM to jointly develop a PC reference and automotive platform" On Neonode's 2Q earnings call management explicitly confirmed that NVIDIA (NVDA), the #1 supplier of PC GPUs, and a leading supplier of application processors (Tegra), is the previously announced/unnamed Tier One PC Semiconductor partner.
- On August 6th Neonode announced a design win with an unnamed Tier One PC OEM, who I believe is Hewlett Packard (HPQ). My belief is rooted in the fact that a new license was not announced (in conjunction with the win), which means this Tier One customer likely has a license already. Hewlett Packard is #1 in printers (~40% market share) and #2 in laptops (16.5% market share in 2Q13 according to IDC) - and is likely the "huge" printer OEM that licensed Neonode's technology in 1H12, and will commence volume shipments at the end of 2013.
- On 7/23 Neonode announced a license agreement with its first Tier One Global Consumer Electronics OEM in South Korea, and then announced the second Korean OEM on 9/5. Since there are only two Tier One Global Consumer Electronics OEMs in South Korea, it is clear that Neonode has landed both LG (LG) and Samsung (GM:SSNLF). According to IDC, Samsung was #6 in the 2Q13 laptop market with a 7.3% market share.
- Neonode management has mentioned repeatedly over the last two months that they are working with more than a few top-tier PC OEMs, and are developing platform solutions for Advanced Micro Devices (AMD) and Intel (INTC).
- Moreover, the reason why Neonode stated unequivocally (on the 2Q CC) that the company did not need to raise money to achieve cash-flow break-even, is because of the imminent ramps of:
- Printers in December (printer revenues should easily eclipse $10M in 2014),
- Childrens Tablets - LeapFrog's (LF) flagship LeapPad Ultra (build/revenues commenced in June, ahead of its retail launch in July)
- A second Tier-One children's tablet in 4Q
- Volvo (VOLVAF) started shipping and generating revenues in June,
- Chinese smartphones in 4Q
- and perhaps (according to management) a massive Chinese automotive system OEM in 4Q/1Q
These 5-6 near-term revenue ramps should put Neonode into the black within a few quarters. In addition, these ramps and prospects could be further augmented by likely 1H14 revenues from NVIDIA's (NVDA) PC reference designs (for Chromebook and Windows), along with potential NRE fees from Tier One PC OEMs.
Moreover, Neonode should be cash flow positive within the next quarter or two (management explicitly said it was possible on the 2Q conference call), in light of the aforementioned ramps, positive eReader seasonality, and likely cash inflows from NRE and license prepayments over the next 2 quarters (i.e. cash is collected but first get accounted as "deferred revenues" on the balance sheet).
Thus, in actuality, the company did PRECISELY what management said/telegraphed i.e. Neonode would only/certainly raise money if it was for a major project (i.e. Tier One PC with at least one major OEM, along with NVIDIA), with a compelling ROI (i.e. too amazing of an opportunity for NEON to pass up or delay).
For example, in order to adequately service in a Tier One PC OEM like Lenovo (OTCPK:LNVGF), Neonode would likely have to open a local office in Beijing, with a team of salesmen, field application engineers (FAEs), and mechanical/software engineers. A full blown Lenovo effort would require a capital and human-resources investment, which could not be covered by working capital (and/or the 2Q balance sheet). This critical, compelling, and timely investment requires/required a money raise.
Bottom Line: The fact that Neonode waited until now to sell their paltry 1.1M shares, which were collecting dust on the shelf since December 2011 (they could have easily executed an ATM anonymously at any point), should indicate that Neonode has MAJOR PC deals, which are either imminent or already in the hopper.
Short Issue #2: Neonode insiders (except for one Director) sold into the deal (more than the 1.1M primary shares that NEON sold), are rampant sellers, and therefore the insiders must not believe in NEON's future.
Explanation: As explained clearly by management (e.g. at the recent Craig Hallum conference and Rhino Trading investor call), and evidenced in NEON filings going back a few years, the selling insiders were forced to convert expiring 3-year warrants (expire October 2013) into shares, which required both net-exercise related selling in August (rather than coming up with loads of cash to purchase the shares at $1.38 each, they pragmatically and understandably sold shares to cover the strike price), and subsequent income-tax related selling (Swedish short-term capital gains tax rates are well above 50%).
Moreover, as clearly explained by management, back in 2009, when Neonode had just re-emerged from bankruptcy and was operating on fumes, the selling insiders funded Neonode personally, took major compensation sacrifices (e.g. substandard C-Level salaries, and cashless warrant compensations for directors), and took out massive personal loans which they were paying interest on until now.
For example, as can be seen in Neonode's 2010 proxy filing (7/15/2010), CFO David Brunton was paid a ridiculously-substandard salary of $85K in 2009 (which was down from $165K in 2008), and received warrants in lieu of cash (and even so, his overall comp was down more than 50% YoY).
Thus, these expiring warrants were issued as compensation for the insiders' sacrifices, personal layouts, and loans, and thus, the aggregate selling (~80% of the warrants) should be viewed as if these insiders were cashing an expenses check, rather than sinister insider dumping (which Richard Pearson and the shorts would shamelessly have you believe). Just look at the insider holdings … they are still extremely substantial.
The insiders currently own a whopping 17% of Neonode's fully diluted ~40M shares (~37.8M shares outstanding) after this deal, which clearly demonstrates that NEON's management still has plenty of skin in the game (the CEO and Executive Chairman own ~13% of NEON).
Contrary to what the shorts may contend, the insider selling is neither ominous (for management's skin is still a whopping 17%) or rampant (net exercising of warrants in 1Q and August just do not count qualitatively), and this deal's insider selling is more than reasonable, understandable, and acceptable i.e. nothing sinister could possibly be read into it.
Short Issue #3: Neonode keeps on announcing design wins (70+ in 2012) and licenses, but have no new revenues to show for it. Revenues and estimates have only gone down over the last two years, as Amazon (AMZN) left in September 2012 for capacitive. The negative implications are that the Neonode's announcements of design wins and licenses are either meaningless or fraudulent, while their optical touch technology must be inferior (if there are no non-eReader products on the market yet).
Explanation: This contention, while plausible on its face, clearly indicates that there is erroneous understanding of product design/testing cycles for electronics hardware. Moreover, the contention that Neonode's technology is substandard and inferior to capacitive, totally ignores all the recent big name licensing deals i.e. there is no way that world class companies like Samsung, LG, NVIDIA, Sony (SNE), HP, Texas Instruments (TXN), Alpine (GM:AELEF), Volvo, and LeapFrog are wasting their time on, paying NREs to, and signing licenses (LG and Samsung - just recently) with, a supplier of sub-par/inferior technology. Moreover, it is incredibly implausible that little old Neonode is passing the wool over ALL Tier-One companies.
While it can be frustrating to wait for product and testing design cycles to complete and yield revenue, everyone knows that the average electronics design period (from win to production) takes at least 12-18 months (on average).
Ask any company in the tech hardware world, and all will independent confirm that a multi-function printer design cycle is 18 months (~8 months to design and ~10 months to test - due to all the moving parts). A laptop design cycle ranges from 7 months (for an entry level ODM model) to 16 months (for a premier Tier-One SKU). A children's tablet design cycle is 12-15 months, while an auto cycle is 2-3 years. The only cycles that are shorter than 6 months are those for eReaders, which are very simple devices. While Neonode's touch solutions (and relevant subsystems) need only 3 months for integration and testing, they are almost always the smallest part of the larger system (i.e. the overall process from design, through testing, and on to production, is largely out of Neonode's hands).
Moreover, as anyone following Neonode's journey and successful transition from failed startup smartphone OEM (2001-2008), to optical touch licensor (2009-Present), knows, Neonode first commenced its critical silicon partnership with Texas Instruments in May 2012 (with the NN1001 single-chip controller).
Prior to the Texas Instruments relationship, Neonode was relegated to the embryonic, small, and fledgling eReader space, with an initially expensive and space-inefficient discrete solution (that comprised of a whopping 50 chips). Without Texas Instruments' validation, blessing, and sub $0.75 single-chip controller … Neonode would have had zero access beyond the eReader space. For all intensive purposes, Neonode Third (and soon to be wildly successful) Act only first commenced in May 2012.
If one were to analyze NEON's design win announcements from 2012, it is quite apparent that most (if not all) were garnered AFTER the Texas Instruments relationship was signed (1H12), and therefore one must add the relevant design/testing cycle durations, to figure out when new non-eReader ramps will commence:
· Printers : Design/Testing (D/T) Cycle is 18 months = initial ramp in December 2013
· Autos: D/T Cycle is 24-36 months = initial high volume ramp in Summer 2014
· Childrens Tablet: D/T Cycle is 12-15 months = initial ramp in July 2013
· PC Laptop: D/T Cycle is 7-16 months = initial ramp in 1H14 (solution was first ready in 3Q13)
· White Goods: D/T Cycle 12-18 months = initial ramp in 2H14
Thus, as Neonode comes to the end of these "Design Cycle" periods, which commenced in May 2012 (once Texas Instruments started shipping the NN1001 controller), the large new-product (non-eReader) ramps should start ramping and layering-on in a big way during 2014. Management already acknowledged, on the 2Q earnings call, that children's tablet (LeapPad Ultra) and Volvo started shipping, and that high-volume Tier One printers will commence at the end of the year. Management also indicated that Neonode will generate substantial PC revenues in 2014 (1H14 sounds quite possible - especially if NVIDIA integrates Neonode into a x86 PC and/or Tegra reference platform).
With Tier One PC and PC Semiconductor OEM "banging" on Neonode's door, and asking for Neonode's "fresh off the press" sub-$10 Windows 8 laptop touch solution (the lowest cost competitive high-volume/yield solution, by a mile), along with all the new ramps in Printers, Childrens Tablets, Major Appliances, and Autos … and a super high likelihood that Amazon (AMZN-NASDAQ) is coming back to Neonode (after an 18 month hiatus), the shorts (whose position is a whopping 8.86M shares, or about 28% of the float, which equates to 15.4 days-to-cover ratio) have to be absolutely out of their minds.
Thus, my updated 2014 financial estimates are now as follows:
- Printer Revenues = $10M (only contemplates one of Neonode's 2 Tier One OEM)
- PC Revenues = $10M (does not yet contemplate NVIDIA-related potential)
- Auto Revenues = $10M (does not yet contemplate the HUGE car door sensor opportunity that NEON just started talking about)
- Children's Tablet Revenues = $5M (does not contemplate anything beyond LeapPad and MEEP! i.e. the third unnamed Tier One OEM)
- Handsets Revenues = $3M of revenues from Shenzhen Wave, which was announced 2/27/13 (does not contemplate feature-phone revenues from recent licensees, Samsung and LG )
- White Goods (Home Appliances) Revenues = $5M. This should be quite conservative, as management has indicated they already have more than a few licensees in this space … which likely includes the 2 HUGE OEMs in Korea, and another unnamed Tier One OEM in Europe
- eReaders Revenues = $5M (this number has serious upside if Amazon returns in 2014)
- NRE Fees = $3M (one can only imagine what the PC-related engineering fees will look like)
- Please note: I am not including revenues from any other promising end markets like peripherals, cases, wearables (smart watches), GPS, outdoor signage, One Laptop Per Child etc
- TOTAL 2014 Revenues = $51M
- Cash OPEX = $18M
- Pretax Net Income = $33M
- Taxes (@21%) = $7M (Tax Loss Carry Forwards should be ~$11M)
- Net Income = $26M
- Diluted Shares = 40M
- EPS = $0.65
When I apply a 20X forward PE multiple to Neonode's estimated 2014 EPS of $0.65, and then add $9 of present value for a likely IP spin-off, my target price for NEON is $22.