10-K 1 f10k2012_neonode.htm ANNUAL REPORT

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, 2012
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. 1-35526
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)

2350 Mission College Blvd., Suite 190, Santa Clara, CA 95054
(Address of principal executive offices and Zip Code)
(408) 496-6722
(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, par value $0.001 per share | The NASDAQ Stock Market LLC

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
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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o

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 ý
| 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 29, 2012 (the last business day of the second quarter of the registrant’s current fiscal year) as reported on the NASDAQ Stock Market, was $149,518,702.
The number of shares of the registrant’s common stock outstanding as of March 4, 2013 was 33,673,245
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for the 2013 Annual Meeting of Stockholders are incorporated herein by reference as set forth in Part III. Such proxy statement will be filed with the Securities and Exchange Commission within 120 days of the registrant’s fiscal year ended December 31, 2012.

NEONODE INC.
2012 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS

PART I
Item 1. | BUSINESS | 4
Item 1A. | RISK FACTORS | 11
Item 1B. | UNRESOLVED STAFF COMMENTS | 16
Item 2. | PROPERTIES | 16
Item 3. | LEGAL PROCEEDINGS | 16
Item 4. | MINE SAFETY DISCLOSURES | 16
PART II
Item 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES | 16
Item 6. | SELECTED FINANCIAL DATA | 17
Item 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 17
Item 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 25
Item 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA | 26
Item 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE | 64
Item 9A. | CONTROLS AND PROCEDURES | 64
Item 9B. | OTHER INFORMATION | 66
PART III
Item 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE | 66
Item 11. | EXECUTIVE COMPENSATION | 66
Item 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS | 66
Item 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE | 66
Item 14. | PRINCIPAL ACCOUNTING FEES AND SERVICES | 66
PART IV
Item 15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES | 66
SIGNATURES | 68

SPECIAL NOTE ON FORWARD LOOKING STATEMENTS
This Annual Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, adopted pursuant to the Private Securities Litigation Reform Act of 1995. Statements that are not purely historical may be forward-looking. You can identify some forward-looking statements by the use of words such as “believes,” “anticipates,” “expects,” “intends” and similar expressions. Forward-looking statements involve inherent risks and uncertainties regarding events, conditions and financial trends that may affect our future plans of operation, business strategy, results of operations and financial position. A number of important factors could cause actual results to differ materially from those included within or contemplated by such forward-looking statements, including, but not limited to 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, our customer concentration and dependence on a limited number of customers, a reliance on our future customers’ ability to develop and sell products that incorporate our technology, 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, For a discussion of these and other factors that could cause actual results to differ from those contemplated in the forward-looking statements, please see ‘‘Item 1A. Risk Factors’’ and elsewhere in this Annual Report, and in our publicly available filings with the Securities and Exchange Commission. Forward-looking statements reflect our analysis only as of the date of this Annual Report. Actual events or results may differ materially from the results discussed in or implied by the forward-looking statements. We do not undertake any responsibility to update or revise any of these factors or to announce publicly any revisions to forward-looking statements, whether as a result of new information, future events or otherwise.
PART I

ITEM 1. | BUSINESS

Neonode Inc. (collectively with our subsidiaries, is referred to in this Annual Report as “Neonode”, “we”, “us”, “our”, the “Company”) develops and licenses optical MultiSensing™ touch and user interface (“UI”) solutions. The cornerstone of our touch and interface solutions is zForce®, our patented touch technology. Based on zForce, Neonode has developed a variety of features that sense any object - its size, its pressure on a surface, its depth, its velocity and even its proximity to any type of surface. This feature set is branded MultiSensing™ technology. Neonode’s MultiSensing technology is suited for consumer and industrial electronic devices and supports unlimited gestures, multi-touch and sweeps navigation.
Neonode licenses its MultiSensing technology to Original Equipment Manufacturers (“OEMs”) and Original Design Manufacturers (“ODMs”) who embed our MultiSensing technology into devices that they produce and sell. Neonode’s MultiSensing technology is being incorporated into wide array of high volume color LCD products worldwide: mobile phones, tablets, e-readers, office equipment, in-car infotainment displays and HMI systems, GPS, gaming devices and toys. In 2012, we expanded our MultiSensing technology through Neonode’s customized NN1001 single optical controller chip, developed in close collaboration with Texas Instruments. The NN1001 controller chip began shipping to customers in May 2012. Neonode’s MultiSensing solution is used on more than twelve million touch consumer devices in the global market place.
Our technology licensing model allows us to focus on the development of solutions for multi-touch enabled screens, and thus we do not manufacture products or components. We license the right to use zForce and Neonode MultiSensing touch technology which, together with standard components from partners, create an optical touch solution.
The Company is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and files or furnishes reports, proxy statements, and other information with the Securities and Exchange Commission (“SEC”). The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at www.sec.gov. The reports and other information filed by the Company with the SEC are available free of charge on the SEC’s website. The public may read and copy any materials filed by the Company with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
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Our website is www.neonode.com. Through our website, we make available free of charge all of our filings with the SEC, including our annual reports on Form 10-K, our quarterly reports on Form 10-Q, and our current reports on Form 8-K as well as Form 3, Form 4, and Form 5 Reports for our directors, officers, and principal stockholders, together with amendments to those reports filed or furnished pursuant to Sections 13(a), 15(d), or 16 under the Exchange Act. These reports are available as soon as reasonably practicable after their electronic filing or furnishing with the SEC. Our website also includes corporate governance information, such as our Code of Business Conduct (including our Code of Ethics for the Chief Executive Officer and Senior Financial Officers) and our Board Committee Charters. We are not including the information contained on our website as part of, nor incorporating it by reference into, this Annual Report on Form 10-K.
Our History
Neonode Inc., 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. (the “Merger”), and SBE, Inc.’s name was subsequently changed to “Neonode Inc.” upon the completion of the Merger. Prior to the Merger, Neonode Inc. had been 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 Company’s headquarters is located in Santa Clara, California, USA.
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 a viable market did not develop. We subsequently discontinued the manufacturing of mobile phones and the operations of Neonode AB. On January 1, 2009, we acquired Neonode Technologies AB as a wholly-owned subsidiary and began licensing our touch technology to OEMs and ODMs.
Overview of the Touchscreen Market
There are different touchscreen technologies available in the market with different or slightly different profiles, power consumption, level of maturity, and cost price:

● | 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.

● | Resistive -- uses conductive and resistive layers separated by thin space.

● | Optical Infrared -- uses infrared beams that are broken by finger or heat from the finger sensed from a camera to detect a touch.

● | Surface acoustic wave -- uses ultrasonic waves that pass over the touchscreen panel.

● | 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 or conductive sensors directly into a Liquid Crystal Display (“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.

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● | Dispersive signal technology -- uses sensors to detect the mechanical energy in the glass that occur due to a touch.

● | 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.

Currently, the two dominant types of touchscreen technologies available in the market are capacitive and resistive. Capacitive technology is the technology that the Apple iPhone uses and resistive technology is what is found on certain automatic teller machines. A capacitive touchscreen reacts to the finger’s tiny electric impulses. Capacitive touchscreens work best if the user has unimpeded contact between the finger and the screen. 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.
Our MultiSensing Solution
Neonode’s touchscreen interface is optical infrared, rather than capacitive or resistive. Our MultiSensing optical touch solutions are based on our patented zForce technology. It uses infrared light that is projected over the screen. Infrared light pulses are sent out up to 1,000 times per second to capture a frame and detect touch activation. Up to 1,000 coordinates are produced by using mathematical algorithms to calculate the exact position of a touch object when a user's fingers move across the screen.
Both capacitive and resistive technologies make use of a “touch sensor/window” or an overlay in combination with a controller Integrated Circuit (“IC”) to function. In comparison zForce use a “lightguide” (to reflect and focus light) together with IC components to operate. Our zForce optical touchscreen technology has a number of key advantages over other touchscreen technologies, including:

● | No additional layers are added to the screen that may dilute the screen contrast 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 an extremely simple manufacturing process when compared to the expensive layered capacitive and resistive screens;
● | 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 is one of the few viable touchscreen solutions that will operate as well on the new revolutionary reflective display panels that will offer paper-like reading experience in almost any ambient lighting condition while greatly reducing power consumption. Manufacturers of reflective display panels are targeting e-Reader, mobile phone and tablet PC markets because these devices require the clear viewing screen and low power consumption of the reflective display panels; and
● | 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 thick gloves. In addition, zForce allows for waterproofing of the device.

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zForce
Our patented zForce interface allows OEMs and ODMs to incorporate touch and sweep navigation into their consumer and industrial electronic devices. The markets for our zForce technology include e-Readers, mobile phones, automotive, office equipment (such as printers), GPS, toys and games and tablet markets. Key attributes of zForce include:

● | operates on all screen types and provides a crystal-clear viewing experience in any lighting condition, even bright sunlight;

● | runs on Electronic Paper Displays that creates a readable experience close to ink on paper because it reflects light like ordinary paper;

● | operates on LCD (Liquid Crystal Displays);

● | supports high-resolution pen writing in combination with finger navigation that includes, e.g., gestures, multi-touch, and sweeps;

● | provides a 100% clear viewing experience—unlike traditional resistive and capacitive touchscreens; and

● | can be applied to any flat surface.

In addition, zForce enables:

● | touch detection for any object;

● | a smooth touch experience with no necessary pressure for touch detection;

● | greater industrial design flexibility for equipment and device manufacturers;

● | pressure sensing; and

● | 3D scanning and proximity sensing.

Laptop PC, Tablets and e-Readers
We believe zForce is the world’s most-used optical touch technology for e-Readers today with customers such as Barnes & Noble, Sony, Mundo, Netronix and Kobo, all of whom have integrated our zForce technology into their e-Readers.
In addition, Oregon Scientific MEEP tablet for children started shipping in November 2012 and we have several other customers, such as Shenzhen Wave, currently developing tablets and Laptop PCs that are expected to go into production and begin shipping in 2013.
Mobile Phones
Our mobile phone multi-sensing and proximity technology platform, Smartphone One, is suitable for smart phones and tablets and enhances the user experience for feature phones. We are currently in product design activities with tier one and tier two mobile phone handset makers, such as Shenzhen Wave, who are developing both smart and feature phone handsets that are expected to go into production and begin shipping in 2013.
Automotive
Touch interface displays in vehicles must operate in a wide range of ambient lighting and temperature conditions. A resistive screen may be operated with gloves on, but the membrane layer reduces transparency and can cause glare. The zForce solution is well placed to make inroads in the automotive market since it provides a brighter, more readable display, with a full operating temperature range that can easily be used while wearing gloves. We are currently engaged with many of the global automotive OEMs and their tier one suppliers, such as Alpine and Pro Point, developing automotive HMI, infotainment and navigation systems.
Printers and Office Equipment
Photo printers and combination printer/scanner/fax machines typically require feature-rich menus and settings, and OEMs have increasingly replaced mechanical buttons with resistive touchscreen displays. zForce offers an improved user experience, with brighter display, ultra-light touch, and support for gestures (such as swipe to access menus and screens). We have technology license agreements with and are engaged in product development activities with two of the top five global leading printer and office equipment OEMs. Product shipments are expected to begin in 2013 with rollout continued through 2014.
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Home Electronics
Mechanical buttons, dials and membrane switches still mostly control machines in the kitchen and laundry room. New designs can use zForce with or without an underlying display. For example, touch sensitive buttons can be achieved by placing the light guide around a pre-printed array. A touch panel can include illumination without a display. A feature-rich device like a high-end dryer can be made much more streamlined and user friendly with a touch display. We are currently engaged with OEMs in the home electronics market who are designing touch enable products such as kitchen stove tops, ovens and laundry room washer and dryers.
Neonode NN1001 Single Chip Touch Controller
The NN1001 is the next generation touch technology solution that utilizes zForce that we developed in collaboration with Texas Instruments. It is designed to simplify the integration to reduce bill of material (BOM) cost, as well as increase the performance where integrated. The NN1001 can only be sold to customers who have a technology license agreement with Neonode. We believe the Single Chip Touch Controller outperforms capacitive touch solutions at a lower cost.

● | The NN1001 has a scanning speed of 1000 Hz (latency down to 1ms) and consumes less than 1mW at 100Hz.

● | The NN1001 tracks any high-speed multi-touch gesture with any object (finger, gloved finger and passive pens) with high accuracy.

● | The NN1001 connects to any microcontroller or application processor with a high speed SPI interface. The controller works in single or multiple configurations supporting screen sizes up to 20 inch.

● | The NN1001 supports advanced power management and implements the Neonode AlwaysON™ technology where the touch is active even when the device is in sleep or off mode.

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.
The Company has 4 issued U.S. patents and an additional 33 U.S. patents pending. Outside the U.S. the Company has an additional 5 issued patents and 31 patents pending. The number of issued and pending patents and patents filed under international Patent Cooperation Treaty (“PCT”) for each jurisdiction is listed in the table below:

Jurisdiction | No. of Issued Patents | No. of Patents Pending
United States (U.S.) | 4 | 33
Europe | 0 | 6
Japan | 1 | 3
China | 1 | 3
Canada | 1 | 4
Australia | 1 | 4
Singapore | 1 | 4
PCT | Not Applicable | 7
Total: | 9 | 64

The Company’s patents cover two general categories of product: (i) the Company’s MultiSensingTM touch screen hardware, and (ii) user interfaces and product design. Three of the Company’s issued U.S. patents (Touch Screen for Mobile Telephone (U.S. 7,880,732), Light-Based Touch Screen (U.S. 8,339,379) and On a Substrate Formed or Resting Display Arrangement (U.S. 8,068,101)) and all five foreign issued patents, relate to touch screen hardware. One issued U.S. patent (U.S. 8,095,879 entitled USER INTERFACE FOR MOBILE HANDHELD COMPUTER UNIT) covers sweep gestures on a touch screen user interface. Of the Company’s 64 patents pending, 58 are utility patents and 6 are design patents.
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We have been granted trademark protection for the word NEONODE in the U.S., the European Union (EU), Sweden, Norway, and Australia. In addition we have filed an application for the word NEONODE in the US to cover additional goods including touchscreen controller Application Specific Integrated Circuits (ASIC). We have been granted protection for the figurative mark NEONODE in the U.S., the EU, Sweden, Australia, China, Norway, Russia and Switzerland. We have been granted trademark protection for the word ZFORCE in the U.S. and EU. In addition we have filed an application for the word ZFORCE in the U.S. to cover additional goods including touchscreen controller ASICs. We filed applications for the trademarks ALWAYSON, ALWAYSON TOUCH, MULTISENSING, LIQUID SENSING and IT MAKES SENSE in the U.S.
The Company’s user interface software described in some of the aforementioned patent applications may also be protected by copyright laws in most countries, including 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.
Distribution, Sales and Marketing
We consider both OEMs and ODMs to be our primary customers. OEMs and ODMs determine the design and pricing requirements and make the overall decision regarding the use of our multi-sensing touch and user interface solutions in their products. The use and pricing of our multi-sensing touch and user interface solutions are 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 our 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 Santa Clara, California, U.S. and our current sales force is comprised of sales offices located in Sweden, South Korea, Japan, Taiwan, and the Netherlands.
Technology License Agreements
As of December 31, 2012, we have entered into twenty-four technology license agreements compared to twelve and four technology license agreements as of December 31, 2011 and 2010, respectively. We signed four additional technology license agreements with customers subsequent to December 31, 2012. The products related to these license agreements are e-Readers, Tablet PCs, mobile phones, commercial and consumer printers, automotive consoles, toys and games and GPS devices.
We are dependent on a number of OEM customers and the loss of any one of these customers could have a material adverse effect on our future revenue stream. In the short term, we anticipate that we remain dependent on a limited number of customers for substantially all of our future revenues. 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.
Our accounts receivable as of December 31, 2012 was due from fifteen customers. Our net revenues for the year ended December 31, 2012 were earned from twenty customers. Our customers are located in the U.S., Europe and Asia. Customers who accounted for 10% or more of our net revenues during the year ended December 31, 2012 are as follows:

● | Amazon - 32%

● | KOBO Inc. – 26%

● | Sony Corporation - 17%

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Our accounts receivable as of December 31, 2011 was due from five customers. Our net revenues for the year ended December 31, 2011 were earned from seven customers. Our customers are located in the U.S., Europe and Asia. Customers who accounted for 10% or more of our net revenues during the year ended December 31, 2011 are as follows:

● | Amazon - 40%

● | Barnes & Noble - 26%

● | Sony Corporation - 21%

● | KOBO Inc. - 11%

Our net revenues for the year ended December 31, 2010 were earned from seven customers. Customers who accounted for 10% or more of our net revenues during the year ended December 31, 2010 are as follows:

● | Sony Corporation - 46%

● | Sony Ericsson Mobile Communications AB - 38%

Competition
Our market is intensely competitive and characterized by rapidly changing technology, evolving standards and new product releases by our competitors. Our competitors, and the interface technology they offer, include the following:

Company |  | Technology
3M |  | Capacitive, Dispersive Signal Touch
Synaptics |  | Capacitive sensors and IC controllers
ATMEL |  | Capacitive touch IC controllers
Cypress |  | Capacitive touch IC controllers
Maxim |  | Capacitive touch IC controllers
Nextwindow |  | Optical with camera sensor
Zytronic |  | Capacitive
Tyco Electronics |  | Capacitive, Resistive, Surface Wave,
Touch International |  | Resistive and Capacitive
Mass Multimedia Inc. |  | All touchscreen technologies
Young Fast |  | Capacitive sensor and module maker
TPK |  | Capacitive (provides the capacitive touch sensor for the Apple iPhone)

Research and Development
In fiscal years 2012, 2011 and 2010 we spent $5.7 million, $1.9 million and $1.9 million, respectively, in each year on research and development activities. Our research and development is predominantly in-house, but is also done in collaboration with external partners and specialists.
Employees
On December 31, 2012, we had forty-six full-time employees and one part-time employee. There were a total of six full-time and one part-time employee in our general & administrative group, twelve in our sales and marketing group and twenty-six in our engineering group. We have employees located in the U.S., Sweden, Israel, the Netherlands, South Korea, Taiwan and Japan. None of our employees are represented by a labor union. We have experienced no work stoppages. We believe our employee relations are positive.
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ITEM 1A. | RISK FACTORS

An investment in our common stock involves a high degree of risk. Before deciding to purchase, hold, or sell in our common stock, you should consider carefully the risks described below in addition to the cautionary statements and risks described elsewhere and the other information contained in this Annual Report and in our other filings with the SEC, including subsequent reports on Forms 10-Q and 8-K. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of these known or unknown risks or uncertainties actually occur, our business, financial condition, results of operations or cash flows could be seriously harmed. This could cause the trading price of our common stock to decline, resulting in a loss of all or part of your investment.
Risks Related To Our Business
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 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. We may not be successful in growing our 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.

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 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.
We are dependent on a limited number of customers.
Our accounts receivable as of December 31, 2012 was due from fifteen customers. Our net revenues for the year ended December 31, 2012 were earned from twenty customers. Our customers are located in the U.S., Europe and Asia. Customers who accounted for 10% or more of our net revenues during the year ended December 31, 2012 are as follows:

● | Amazon - 32%

● | KOBO Inc. - 26%

● | Sony Corporation - 17%

In the fourth quarter of 2012, Amazon discontinued shipping its Kindle e-Readers that incorporated our touch technology. Amazon accounted for 32% of our total net revenue in 2012 and 40% of our total net revenue in 2011. We don’t anticipate receiving any future near-term revenues from Amazon. The loss of a major customer, a reduction in net revenues from any major customer for any reason, or a failure of a major customer to fulfill its financial or other obligations due to us could have a material adverse effect on our business, financial condition, and future revenue stream.
We are dependent on the ability of our customers to design, manufacture and sell their products that incorporate our touchscreen technologies, particularly in markets other than eReaders.
Our products and technologies are licensed to other companies which must be successful in designing, manufacturing and selling the products that incorporate our technologies. The majority of our license fees earned in 2012, 2011 and 2010 were from customer shipments of eReader products. We expect that customer shipments of eReaders products will decline in the future. 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.
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.
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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, inability to deliver 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.
Our operating results may fluctuate significantly as a result of a variety of factors, many of which are outside of our control.
We are subject to the following factors, among others, that may negatively affect our operating results:

● | the announcement or introduction of new products or technologies by our competitors;
● | our ability to upgrade and develop our products and infrastructure to accommodate growth;
● | our ability to attract and retain key personnel in a timely and cost effective manner;
● | technical difficulties;
● | the amount and timing of operating costs and capital expenditures relating to the expansion of our business, operations, and infrastructure; and
● | general economic conditions as well as economic conditions specific to the hand-held device and/or touchscreen industry.

As a result of our limited operating history and the nature of the markets in which we compete, it is extremely difficult for us to forecast accurately. We have based our current and future expense levels largely on our investment plans and estimates of future events, although certain of our expense levels are, to a large extent, fixed. We may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. Accordingly, any significant shortfall in revenues relative to our planned expenditures would have an immediate adverse effect on our business, results of operations and financial condition. Further, as a strategic response to changes in the competitive environment, we may from time to time make certain pricing, service, or marketing decisions that could have a material and adverse effect on our business, results of operations, and financial condition. Due to the foregoing factors, our revenues and operating results are and will remain difficult to forecast.
We may require additional capital to fund our operations, which capital may not be available on commercially attractive terms or at all.
We may in the future 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 for at least the next twelve months. However, if our operations do not become cash flow positive, 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 when needed 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.
We must significantly enhance our sales and product development organizations.
We will need to improve the effectiveness and breadth of our sales efforts 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 efforts 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.
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We will need to increase the size of our organization, and we may be unable to manage our growth effectively.
Our failure to manage growth effectively could have a material and adverse effect on our business, results of operations and financial condition. We anticipate that expansion of our organization will be required to address internal growth to handle licensing and research activities. This expansion may place a significant strain on management, operational, and financial resources. To manage the expected growth of our operations and personnel, we must both improve our existing operational and financial systems, procedures, and controls, and implement new systems, procedures, and controls. We must also expand our finance, administrative, and operations staff. Our current personnel, systems, procedures, and controls may not adequately support future operations. Management may be unable to hire, train, retain, motivate, and manage the necessary personnel, or to identify, manage and exploit existing and potential strategic relationships and market opportunities.
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 future 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.
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.
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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.
Risks Related to Owning Our Stock
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 1,000,000 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.

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Future sales of our common stock by our stockholders could negatively affect our stock price.
Sales of a substantial number of shares of our common stock in the public market by our stockholders, or the perception that these sales might occur, could depress the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities.
Future sales of our common stock by us 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.
If our internal controls over financial reporting are not considered effective, our business and stock price could be adversely affected.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal controls over financial reporting as of the end of each fiscal year, and to include a management report assessing the effectiveness of our internal controls over financial reporting in our annual report on Form 10-K for that fiscal year. Section 404 also requires our independent registered public accounting firm to attest to, and report on, management’s assessment of our internal controls over financial reporting.
Our management, including our chief executive officer and principal financial officer, does not expect that our internal controls over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud involving a company have been, or will be, detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become ineffective because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We cannot assure you that we or our independent registered public accounting firm will not identify a material weakness in our internal controls in the future. A material weakness in our internal controls over financial reporting would require management and our independent registered public accounting firm to consider our internal controls as ineffective. If our internal controls over financial reporting are not considered effective, we may experience a loss of public confidence, which could have an adverse effect on our business and on the market price of our common stock.
If securities analysts do not publish research or if securities analysts or other third parties publish inaccurate or unfavorable research about us, the price of our common stock could decline.
The trading market for our common stock will rely in part on the research and reports that securities analysts and other third parties choose to publish about us. We do not control these analysts or other third parties. The price of our common stock could decline if one or more securities analysts downgrade our common stock or if one or more securities analysts or other third parties publish inaccurate or unfavorable research about us or cease publishing reports about us.
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ITEM 1B. | UNRESOLVED STAFF COMMENTS

None.

ITEM 2. | PROPERTIES

Neonode Technologies AB has a lease with Vasakronan Fastigheter AB for 2,723 square feet of office space located at Linnegatan 89D, Stockholm, Sweden for approximately $8,000 per month including property tax (excluding VAT). The annual payment for this space equates to approximately $93,000 per year including property tax (excluding VAT). This lease is valid thru December 31, 2014, with a nine month notice period. The contract will be extended for an additional three years if it is not terminated according to the terms in the contract.
On April 15, 2012, Neonode Technologies AB entered into a lease with No Picnic for 2,853 square feet of office space located at Storgatan 23C, Stockholm, Sweden for approximately $14,000 per month including property tax (excluding VAT). The annual payment for this space equates to approximately $174,000 per year including property tax (excluding VAT). This lease is valid through April 15, 2013.
On March 22, 2012, we entered into a three year lease with 2350 Mission Investors LLC for 3,185 square feet of office space located at 2350 Mission College Blvd, Suite 190, Santa Clara, CA 95054 USA. The initial lease payment is $7,007 per month, increasing to $7,657 per month over the term of the lease. This lease is valid through July 31, 2015. The annual payment for this space equates to approximately $86,000 per year.

ITEM 3. | LEGAL PROCEEDINGS

We are not currently involved in any material legal proceedings. However, from time to time, we may become subject to additional legal proceedings, claims, and litigation arising in the ordinary course of business, including, but not limited to, employee, customer and vendor disputes

ITEM 4. | MINE SAFETY DISCLOSURES

Not applicable.
PART II

ITEM 5. | MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is quoted on the NASDAQ Stock Market under the symbol NEON. As of January 22, 2013, there were approximately 176 stockholders of record of our common stock. However, we estimate there were approximately 4,228 stockholders as of January 22, 2013 whose shares are held in “street name” by brokers and other institutions on behalf of stockholders of record.

Fiscal Quarter Ended |
|  | March 31 |  |  | June 30 |  |  | September 30 |  |  | December 31 |
Fiscal 2012 |  |  |  |  |  |  |  |  |  |  |  |
High |  | $ | 5.00 |  |  | $ | 6.50 |  |  | $ | 6.99 |  |  | $ | 4.99 |
Low |  | $ | 3.60 |  |  | $ | 2.95 |  |  |  | 3.48 |  |  | $ | 3.48 |
Fiscal 2011 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
High |  | $ | 3.35 |  |  | $ | 4.40 |  |  | $ | 4.70 |  |  | $ | 5.97 |
Low |  | $ | 1.25 |  |  | $ | 2.95 |  |  |  | 3.40 |  |  | $ | 4.00 |

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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 discussion and analysis should be read in conjunction with the consolidated financial statements and the notes thereto included in this Annual Report.
Overview
Neonode develops and licenses MultiSensing™ touch user interfaces and optical multi-touch solutions. Based on zForce®, our patented touch technology, Neonode has developed a variety of features that sense an object’s size, its pressure on a surface, its depth, its velocity and even its proximity to any type of surface. Neonode licenses MultiSensing touch technology to Original Equipment Manufacturers (“OEMs”) and Original Design Manufacturers (“ODMs”) who embed our technology into devices that they produce and sell. Our technology licensing model allows us to focus on the development of solutions for multi-touch enabled screens, and thus we do not manufacture products or components. We license the right to use zForce and Neonode MultiSensing software which, together with standard components from partners, create an optical touch solution.
During the year ended December 31, 2012, we had seven customers using our touchscreen technology in products that were shipping products to customers. We had an additional seventeen customers with signed license agreements currently in the product development stage. 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 our technology license agreements.
The number of customers shipping products has increased in 2012 compared to 2011 and 2010 as customer products incorporating our touch technology complete the design phase and are released to the market. The majority of our license fees currently earned in 2012, 2011 and 2010 are from customer shipments of eReader products. In the fourth quarter of 2012, Oregon Scientific began shipping its MEEP children’s tablet. We expect to have other customers to begin shipping products such as mobile phones, printers, tablets, GPS devices, children’s tablets and automotive infotainment systems in 2013. License fees earned from customer shipments of eReaders are expected to decrease as a percentage of total revenue as other customer products are introduced to the market. In the fourth quarter of 2012, Amazon discontinued shipping its Kindle e-Readers that incorporated our touch technology. Amazon accounted for 32% of our total net revenue in 2012 and 40% of our total net revenue in 2011. We don’t anticipate receiving any future near-term revenues from Amazon.
As of December 31, 2012, we had twenty-four signed technology license agreements with global OEMs. This compares with twelve and four signed technology license agreements with global OEMs as of December 31, 2011 and 2010, respectively. Seven of our customers are currently shipping products and we anticipate others will initiate product shipments as they complete their final product development and manufacturing cycle throughout 2012.
In the first quarter of 2013 to date, we signed technology license agreements with four new customers in the mobile phone, automotive and tablet markets. In addition, we are currently developing prototype products and are engaged in product engineering design discussions with numerous global OEMs who are in the process of qualifying our touchscreen technology for incorporation in various products such as printer products, GPS devices, e-Readers, Tablet PCs, touch panels for automobiles, household appliances, mobile phones and games and toys. The development and product release cycle for these products typically takes six to eighteen months.
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Current and future drivers of the touchscreen market include mobile phones, printers, automotive, household appliances, tablet PCs, e-Readers, navigation screens, etc. The proliferation and mass market acceptance of touchscreens have prompted new applications and uses for existing and new offerings, thus making the production and utilization of these modules one of the fastest growing tech segments. The typical sales cycle is six to eighteen months with new customers while existing customer lead times are typically six to nine months. During the initial cycle, there are three phases: evaluation, design, and commercialization. In the evaluation phase, prospects validate the Neonode technology using a Neonode evaluation kit and may produce short runs of prototype products. During the design phase, true product development and solution definition begins. This phase tends to be the longest and delays typically occur which may extend the term of the overall cycle. In the final phase, commercialization, the customer enters into full production mode, ships products to the market and Neonode earns its license revenue.
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements are in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of Neonode Inc. and its wholly-owned subsidiary based in Sweden, Neonode Technologies AB.
All inter-company accounts and transactions have been eliminated in consolidation. The 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 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 GAAP requires making estimates and assumptions that affect, at the date of the consolidated 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, collectability of accounts receivable, recoverability of long-lived assets, the valuation allowance related to our deferred tax assets and the fair value of options and warrants issued for stock-based compensation.
Revenue Recognition
Engineering Services:
We may sell engineering consulting services to our customers on a flat rate or hourly rate basis. We recognize revenue from these services when all of the following conditions are met: (1) evidence existed of an arrangement with the customer, typically consisting of a purchase order or contract; (2) our services were performed 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 has not been satisfied, we defer recognition of revenue. Generally, we recognize revenue as the engineering services stipulated under the contract are completed and accepted by our customers.
Licensing Revenues:
We also derive revenue from the licensing of internally developed intellectual property (“IP”). We enter into IP licensing agreements that generally provide licensees the right to incorporate our IP components in their products with terms and conditions that vary by licensee. The IP licensing agreements generally include a nonexclusive license for the underlying IP. Fees under these agreements may include license fees relating to our IP and royalties payable following the production 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.
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Accounts Receivable and Allowance for Doubtful Accounts
Our 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 our customers when determining or modifying their credit limits. We regularly evaluate the collectability 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.
Product Research and Development
Research and development (“R&D”) costs are expensed as incurred. R&D costs consist mainly of personnel related costs in addition to some external consultancy costs such as testing, certifying and measurements.
Stock-Based Compensation Expense
We 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 grant date, and recognize it as compensation expense over the period the employee is required to provide services in exchange for the award, usually the vesting period, net of estimated forfeitures. We account for equity instruments issued to non-employees at their fair value. The measurement date for the fair value for the equity instruments issued is determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor is reached, or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instruments is primarily recognized over the term of the consulting agreement. The fair value of the stock-based compensation is periodically re-measured and income or expense is recognized during the vesting term. 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.
Foreign Currency Translation and Transaction Gains and Losses
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 income (loss). Gains or losses resulting from foreign currency transactions are included in general and administrative expenses in the accompanying consolidated statements of operations and were ($50,000), ($44,000) and ($23,000) during the years ended December 31, 2012, 2011 and 2010, respectively. For the years ended December 31, 2012, 2011 and 2010, our foreign currency translation gains (losses) totaled ($8,000), $76,000 and $33,000, respectively.
Net Loss per Share
Net loss per share amounts have been 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 number of shares of common stock and potential common stock equivalents used in computing the net loss per share for the year ended December 31, 2012, 2011 and 2010, respectively, exclude the potential common stock equivalents, as the effect would be anti-dilutive.
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Comprehensive Loss
Our comprehensive loss includes foreign currency translation gains and losses as a result of consolidation. The cumulative amount of translation gains and losses are reflected as a separate component of shareholders’ equity in accumulated other comprehensive income.
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 6.78, 6.5 and 7.21 Swedish Krona to one U.S. Dollar for the years ended December 31, 2012, 2011 and 2010, respectively. The exchange rate for the consolidated balance sheets was 6.52 and 6.92 Swedish Krona to one U.S. Dollar as of December 31, 2012 and 2011, respectively.
Deferred Revenue
As of December 31, 2012 and 2011, we have $2.1 million and $1.5 million, respectively, of deferred license fee revenue related to prepayments for future license fees from three and one customers, respectively, and a total of $0.6 million and $0.4 million, respectively, of deferred engineering development fees from thirteen and four customers, respectively. We defer the license fees until we have met all accounting requirements for revenue recognition as per unit royalty products are distributed or licensed by the Company’s customers and the engineering development fee revenue until such time as the engineering work has been completed and accepted by our customers.
New Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance that requires new disclosures for fair value measurements and provides clarification for existing disclosure requirements. The guidance is effective for interim and annual periods beginning after December 15, 2009, except for gross presentation of activity in level 3 which is effective for annual periods beginning after December 15, 2010, and for interim periods in those years. We adopted the guidance for new disclosures for fair value measurements and clarification for existing disclosure requirements as of January 1, 2010 and there was no material impact on our consolidated financial statements. Additionally, we adopted the guidance regarding level 3 activity on January 1, 2011 and there was no material impact to our consolidated financial statements. See Note 7, “Fair Value Measurements” to our consolidated financial statements included elsewhere in this Annual Report for additional information on the fair value of financial instruments.
In May 2011, the FASB amended fair value measurement and disclosure guidance to achieve convergence with International Financial Reporting Standards (“IFRS”). The amended guidance modifies the measurement of fair value, clarifies verbiage, and changes disclosure or other requirements in U.S. GAAP and IFRS. The guidance is effective during interim and annual periods beginning after December 15, 2011. We adopted the guidance as of January 1, 2012 and there was no material impact on our consolidated financial statements.
Results of Operations
Net Revenue
Net revenue for the year ended December 31, 2012 was $7.1 million, compared to $6.1 million and $440,000 for the year ended December 31, 2011 and 2010, respectively. Our net revenue for the year ended December 31, 2012 included $6.2 million from technology license fees from product shipments from eight customers and $925,000 in non-recurring engineering services related to our touchscreen solution from fifteen customers. Our net revenue for the year ended December 31, 2011 included $5.8 million from technology license fees from four customers and $287,000 in non-recurring engineering services related to our touchscreen solution from six customers. Under the terms of one of our contracts entered into in 2010, the customer prepaid $3.0 million of technology licenses prior to shipment of its first product. The $3.0 million pre-payment was included in deferred revenue and was amortized to revenue as units were licensed or distributed. For the year ended December 31, 2012 and 2011, $536,000 and $1.5 million in license fees related to units licensed or distributed under the $3.0 million prepayment have been recognized as revenue, respectively, and as of December 31, 2012, $1.0 million remained in deferred revenue from this customer’s prepayment. Our net revenue for the year ended December 31, 2010 was $440,000 and includes $387,000 in fees for engineering design services from five customers, $50,000 for the sale of components to one customer, and $3,000 from technology license fees related to our touchscreen solution from one customer.
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As of December 31, 2012, we had twenty-four signed technology license agreements with global OEMs. This compares with twelve and four signed technology license agreements with global OEMs as of December 31, 2011 and 2010, respectively. Seven of our customers are currently shipping products and we anticipate others will initiate product shipments as they complete their final product development and manufacturing cycle throughout 2012.
Gross Margin
Gross margin was $5.7 million for the year ended December 31, 2012 compared to $5.2 million and $172,000 for the years ended December 31, 2011 and 2010, respectively. Our cost of revenues includes the direct cost of production of certain customer prototypes, costs of company employed engineering personnel and engineering consultants to complete the engineering design contract. Our gross margin has increased due to the increase in our total revenue particularly our license fee revenue. The gross margin related to our license fees is 100% and when license fees as a percentage of our total revenue increase our gross margin will increase.
Product Research and Development
Product research and development (“R&D”) expenses for each of the year ended December 31, 2012 were $5.7 million compared to $1.9 million for both the years ended December 31, 2011 and 2010. R&D costs consist of the cost of prototypes and other materials, consultants, and the amount of time our engineering department spent engaged in customer specific activities.
We continue to pursue and expand 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, 2012, our R&D department had twenty-six full-time employees. Our R&D department had eighteen full-time employees compared to eight full-time employees and one part-time consultant at December 31, 2011 and 2010, respectively. Included in R&D expenses are approximately $315,000 of non-cash stock option and warrant expense for the year ended December 31, 2012 compared to approximately $11,000 and $0 for the same periods in 2011 and 2010, respectively.
Sales and Marketing
Sales and marketing (“S&M”) expenses for the year ended December 31, 2012 were $4.4 million, compared to $1.8 million and $566,000 for the years ended December 31, 2011 and 2010, respectively. This increase in 2012 as compared to 2011 and 2010 is primarily related to an increase in sales personnel, marketing, trade shows and travel expenses. As of December 31, 2012, our sales and marketing department has twelve full-time employees compared to nine full-time employees and three employees at December 31, 2011 and 2010, respectively. Included in S&M expenses are approximately $1.4 million of non-cash stock option and warrant expense for the year ended December 31, 2012 compared to approximately $99,000 and $140,000 for the same periods in 2011 and 2010, respectively.
Our sales activities focus primarily on OEM customers who will integrate our touchscreen technology into their products. Our OEM customers will then sell and market their products incorporating our technology to their customers.
21

General and Administrative
General and administrative (“G&A”) expenses for the year ended December 31, 2012 were $4.7 million compared to $3.5 million and $3.6 million for the years ended December 31, 2011 and 2010, respectively. The increase in the year ended December 31, 2012 compared to 2011 and 2012 is primarily due to an increase in headcount and legal fees, particularly legal fees related to patent filings. As of December 31, 2012 we had seven full-time employees in our G&A department fulfilling management and accounting responsibilities compared to three employees and one part-time consultant as of both December 31, 2011 and 2010. Included in G&A expenses are approximately $1.8 million of non-cash stock option and warrant expense for the year ended December 31, 2012 compared to approximately $439,000 and $2.1 million for the same periods in 2011 and 2010, respectively.
The slight decrease in 2011 as compared to 2010 is primarily related to a decrease in non-cash fair value of warrants issued to employees that was partially offset by an increase in patent related legal fees and financial consultant costs.
Amortization of Fair Value of Stock Issued to Related Parties for Purchase of Neonode Technologies AB
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 19,800 shares of the Company’s Series A Preferred stock. 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 were employees of us and/or Neonode AB, and as such were related parties.
The fair value of the conversion feature of the 19,800 shares of Series A Preferred shares issued to the related parties to acquire Neonode Technologies AB that were converted into a total of 9,516,447 shares of our common stock was $9.5 million based on our stock price on March 31, 2009, the date our shareholders approved the increased conversion ratio. Because this transaction was essentially the issuance of shares to key employees for their continued service to enhance the Company, the $9.5 million revised fair value of the common stock has been amortized to compensation expense at the rate of $1.6 million per quarter for six quarters beginning January 1, 2009. The amortization of the $9.5 million in compensation expense related the value of the stock issued to the related parties to acquire Neonode Technologies AB was completed on June 30, 2010. For the year ended December 31, 2010, $3.2 million has been recorded as compensation expense in our consolidated statement of operations.
Interest Expense
Interest expense for the year ended December 31, 2011 was $288,000, compared to $179,000 for the year ended December 31, 2010. The increase is primarily due to an increase in the outstanding debt balance from $2.8 million at December 31, 2010 to $4.2 million for the majority of the year ended December 31, 2011. We did not have any interest expense for the year ended December 31, 2012.
Foreign Currency Translation and Transaction Gains and Losses
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 general and administrative expenses in the accompanying consolidated statements of operations and were $50,000, $44,000 and $23,000 during the years ended December 31, 2012, 2011 and 2010, respectively. Foreign currency translation gains (losses) were ($8,000), $76,000 and $33,000 during the years ended December 31, 2012, 2011 and 2010, respectively.
22

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 for the year ended December 31, 2011 was $14.7 million, compared to $20.0 million for the year ended December 31, 2010. The amount in 2011 includes $8.6 million in net change in derivative liabilities, $4.3 million of debt discount and debt issuance cost amortization, $1.5 million in excess amount of debt discount recognized as interest expense associated with derivatives, and $0.4 million associated with the fair value of shares issued for bonus interest related to the automatic conversion of the Senior Convertible Secured Notes - 2011. The amount in 2010 includes $16.3 million in net change in derivative liabilities, $2.7 million of debt discount and debt issuance cost amortization, and $1.0 million in excess amount of debt discount recognized as interest expense associated with derivatives.
Loss on extinguishment of debt
Loss on extinguishment of debt for the year ended December 31, 2010 of $2.4 million was primarily the result of the warrant repricing and debt extension financing transaction. During September and October 2010, all of the holders of the convertible notes and the holders of the stock purchase warrants issued in the 2009 and 2010 Senior Secured Convertible Debt Financing Transactions agreed to extend the maturity date of their convertible debt from December 31, 2010 to June 30, 2011. In addition, holders of 2,766,857 stock purchase warrants also agreed to exercise their previously granted three-year warrants for a discounted exercise price. In accordance with relevant accounting guidance, the transaction qualified for debt extinguishment accounting.
Income Taxes
Our effective tax rate was 0% in the year ended December 31, 2012, 2011 and 2010, respectively. We recorded valuation allowances in 2012 and 2011 for deferred tax assets related to net operating losses due to the uncertainty of realization.
Net Loss
As a result of the factors discussed above, we recorded a net loss of $9.3 million for the year ended December 31, 2012, compared to a net loss of $17.1 million and $31.6 million for the years ended December 31, 2011 and 2010, respectively.
Off-Balance Sheet Arrangements
We do not have any transactions, arrangements, or other relationships with unconsolidated entities that are reasonably likely to affect our liquidity or capital resources other than the operating leases noted above. We have no special purpose or limited purpose entities that provide off-balance sheet financing, liquidity, or market or credit risk support; or engage in leasing, hedging, research and development services, or other relationships that expose us to liability that is not reflected on the face of the consolidated financial statements.
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.

23

At December 31, 2012, we had cash of $9.1 million, as compared to $12.9 million at December 31, 2011.
Working capital (current assets less current liabilities) was $7.7 million at December 31, 2012, compared to an adjusted working capital of $13.6 million at December 31, 2011.
Net cash used in operating activities for the year ended December 31, 2012 was primarily the result of (i) a net loss of approximately $9.3 million and (ii) approximately $1.9 million in net cash provided by changes in operating assets and liabilities, primarily accounts receivable and deferred revenue. Cash used to fund net losses is reduced by approximately $3.6 million in non-cash operating expenses, mainly comprised of depreciation and amortization and stock-based compensation.
Accounts receivable decreased approximately $1.3 million at December 31, 2012 compared with December 31, 2011, primarily as a result of net revenues of approximately $2.3 million in the fourth quarter of 2012 compared to approximately $4.0 million in the fourth quarter of 2011. During 2012 and 2011, we were successful in collecting cash from sales to our customers substantially in accordance with our standard payment terms to those customers.
Deferred revenue increased approximately $0.8 million during 2012 primarily as a result of additional license technology agreements and engineering projects entered into during 2012 as compared to 2011.
Net cash used in operating activities for the year ended December 31, 2011 was primarily the result of (i) a net loss of approximately $17.1 million and (ii) approximately $1.6 million in net cash used by changes in operating assets and liabilities, primarily accounts receivable and deferred revenue. Cash used to fund net losses is reduced by approximately $15.3 million in net non-cash operating expenses, mainly comprised of stock-based compensation and discounts and deferred financing fees and the valuation of conversion features and warrants.
Accounts receivable increased approximately $3.2 million at December 31, 2011 compared with December 31, 2010, primarily as a result of net revenues of approximately $4.0 million in the fourth quarter of 2011 compared to approximately $81,000 in the fourth quarter of 2010. During 2011 and 2010, we were successful in collecting cash from sales to our customers substantially in accordance with our standard payment terms to those customers.
Deferred revenue increased approximately $1.4 million during 2011 primarily as a result of additional license technology agreements and engineering projects entered into during 2011 as compared to 2010.
Net cash used in operating activities for the year ended December 31, 2010 was primarily the result of (i) a net loss of approximately $31.6 million and (ii) approximately $0.04 million in net cash used by changes in operating assets and liabilities. Cash used to fund net losses is reduced by approximately $5.4 million of non-cash stock-based compensation, $2.4 million of loss on extinguishment of debt and $20.0 million on discounts and deferred financing fees and the valuation of conversion features and warrants.
In the years ended December 31, 2012, 2011 and 2010, we purchased $310,000, $114,000 and $14,000, respectively of fixed assets, consisting primarily of computers and engineering equipment.
Net cash provided by financing activities totaled approximately $200,000 during the year ended December 31, 2012 from the exercise of warrants for shares of our common stock.
Net cash provided by financing activities for the year ended December 31, 2011 was approximately $15.5 million, which consist of net proceeds of approximately $4.2 million from issuances of convertible debt, net proceeds of approximately $500,000 from exercise of warrants and net proceeds of approximately $10.8 million from issuances of common stock. Such increases were offset by repayment of convertible debt of approximately $30,000.
Net cash provided by financing activities for the year ended December 31, 2010 was approximately $4.1 million, which consist of net proceeds of approximately $1.6 million from issuances of convertible debt, net proceeds of approximately $50,000 from exercise of warrants and net proceeds of approximately $2.4 million from issuances of common stock.
24

Historically, the majority of our cash has been provided by borrowings from senior secured notes and bridge notes that have been convertible into shares of our common stock or from the sale of our common stock and common stock purchase warrants to private investors. During 2011, we raised approximately $15.5 million through debt and equity offerings. We believe we have sufficient cash to operate for at least the next twelve months.
In the future, we may require sources of capital in addition to cash on hand to continue operations and to implement our strategy. If our operations do not become cash flow positive, 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.
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.

ITEM 7A | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable
25

ITEM 8. | FINANCIAL STATEMENTS

Index to the Consolidated Financial Statements | Page
Report of Independent Registered Public Accounting Firm | 27
Consolidated Balance Sheets as of December 31, 2012 and 2011 | 28
Consolidated Statements of Operations for the years ended December 31, 2012, 2011 and 2010 | 29
Consolidated Statements of Comprehensive Loss for the years ended December 31, 2012, 2011 and 2010 | 30
Consolidated Statements of Stockholders’ Equity (Deficit) for the years ended December 31, 2012, 2011 and 2010 | 31
Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011 and 2010 | 34
Notes to Consolidated Financial Statements | 35

26

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Neonode Inc.
We have audited the accompanying consolidated balance sheets of Neonode Inc. (a Delaware corporation) and subsidiary (the “Company”) as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive loss, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Neonode Inc. and subsidiary as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 14, 2013 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KMJ Corbin & Company LLP
Costa Mesa, California
March 14, 2013
27

NEONODE INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)

|  | As of |  |  | As of |
|  | December 31, |  |  | December 31, |
|  | 2012 |  |  | 2011 |
ASSETS |  |  |  |  |  |  |  |
Current assets: |  |  |  |  |  |  |  |
Cash |  | $ | 9,097 |  |  | $ | 12,940 |
Accounts receivable |  |  | 2,123 |  |  |  | 3,345 |
Prepaid expenses and other current assets |  |  | 550 |  |  |  | 234 |
Total current assets |  |  | 11,770 |  |  |  | 16,519 |
Non-current assets: |  |  |  |  |  |  |  |
Deposit |  |  | 68 |  |  |  | -- |
Property and equipment, net |  |  | 330 |  |  |  | 108 |
Total non-current assets |  |  | 398 |  |  |  | 108 |
Total assets |  | $ | 12,168 |  |  | $ | 16,627 |
LIABILITIES AND STOCKHOLDERS' EQUITY |  |  |  |  |  |  |  |
Current liabilities: |  |  |  |  |  |  |  |
Accounts payable |  | $ | 539 |  |  | $ | 447 |
Accrued expenses |  |  | 804 |  |  |  | 601 |
Deferred revenue |  |  | 2,725 |  |  |  | 1,906 |
Total current liabilities |  |  | 4,068 |  |  |  | 2,954 |
Total liabilities |  |  | 4,068 |  |  |  | 2,954 |
Commitments and contingencies (Note 11) |  |  |  |  |  |  |  |
Stockholders' equity: |  |  |  |  |  |  |  |
Series A Preferred stock, 444,541 shares authorized with par value |  |  |  |  |  |  |  |
of $0.001 per share; 83 shares issued and outstanding |  |  |  |  |  |  |  |
at December 31, 2012 and 2011. (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) |  |  | -- |  |  |  | -- |
Series B Preferred stock, 54,425 shares authorized with par |  |  |  |  |  |  |  |
value of $0.001; 95 and 114 shares issued and outstanding at |  |  |  |  |  |  |  |
December 31, 2012 and 2011, 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) |  |  | -- |  |  |  | -- |
Common stock, 70,000,000 shares authorized at |  |  |  |  |  |  |  |
December 31, 2012 and 2011, respectively, with par value of |  |  |  |  |  |  |  |
$0.001; 33,331,182 and 32,778,993 shares issued and |  |  |  |  |  |  |  |
outstanding at December 31, 2012 and 2011, respectively |  |  | 33 |  |  |  | 33 |
Additional paid-in capital |  |  | 146,677 |  |  |  | 142,955 |
Accumulated other comprehensive income |  |  | 5 |  |  |  | 13 |
Accumulated deficit |  |  | (138,615 | ) |  |  | (129,328 | )
Total stockholders' equity |  |  | 8,100 |  |  |  | 13,673 |
Total liabilities and stockholders' equity |  | $ | 12,168 |  |  | $ | 16,627 |

The accompanying notes are an integral part of these consolidated financial statements.
28

NEONODE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)

|  | Year Ended December 31, |
|  | 2012 |  |  | 2011 |  |  | 2010 |
Net revenues |  | $ | 7,137 |  |  | $ | 6,067 |  |  | $ | 440 |
Cost of revenues |  |  | 1,465 |  |  |  | 908 |  |  |  | 268 |
Gross margin |  |  | 5,672 |  |  |  | 5,159 |  |  |  | 172 |
Operating expenses: |  |  |  |  |  |  |  |  |  |  |  |
Product research and development |  |  | 5,741 |  |  |  | 1,858 |  |  |  | 1,873 |
Sales and marketing |  |  | 4,372 |  |  |  | 1,812 |  |  |  | 566 |
General and administrative |  |  | 4,721 |  |  |  | 3,533 |  |  |  | 3,588 |
Amortization of fair value of stock issued |  |  |  |  |  |  |  |  |  |  |  |
to related parties for purchase of Neonode |  |  |  |  |  |  |  |  |  |  |  |
Technologies AB (formerly Cypressen AB) |  |  | -- |  |  |  | -- |  |  |  | 3,168 |
Total operating expenses |  |  | 14,834 |  |  |  | 7,203 |  |  |  | 9,195 |
Operating loss |  |  | (9,162 | ) |  |  | (2,044 | ) |  |  | (9,023 | )
Other expense: |  |  |  |  |  |  |  |  |  |  |  |
Interest and other expense |  |  | -- |  |  |  | (288 | ) |  |  | (179 | )
Loss on extinguishment of debt |  |  | -- |  |  |  | -- |  |  |  | (2,416 | )
Non-cash items related to debt discounts and |  |  |  |  |  |  |  |  |  |  |  |
deferred financing fees and the valuation of |  |  |  |  |  |  |  |  |  |  |  |
conversion features and warrants |  |  | -- |  |  |  | (14,735 | ) |  |  | (19,963 | )
Total other expense |  |  | -- |  |  |  | (15,023 | ) |  |  | (22,558 | )
Loss before provision for income taxes |  |  | (9,162 | ) |  |  | (17,067 | ) |  |  | (31,581 | )
Provision for income taxes |  |  | 125 |  |  |  | 78 |  |  |  | 45 |
Net loss |  | $ | (9,287 | ) |  | $ | (17,145 | ) |  | $ | (31,626 | )
Loss per common share: |  |  |  |  |  |  |  |  |  |  |  |
Basic and diluted loss per share |  | $ | (0.28 | ) |  | $ | (0.64 | ) |  | $ | (1.73 | )
Basic and diluted – weighted average number |  |  |  |  |  |  |  |  |  |  |  |
of common shares outstanding |  |  | 33,003 |  |  |  | 26,784 |  |  |  | 18,293 |

The accompanying notes are an integral part of these consolidated financial statements.
29

NEONODE INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)

|  | Years ended December 31, |
|  | 2012 |  |  | 2011 |  |  | 2010 |
Net loss |  | $ | (9,287 | ) |  | $ | (17,145 | ) |  | $ | (31,626 | )
Other comprehensive income (loss): |  |  |  |  |  |  |  |  |  |  |  |
Foreign currency translation gain (loss) |  |  | (8 | ) |  |  | 76 |  |  |  | 33 |
Total comprehensive loss |  | $ | (9,295 | ) |  | $ | (17,069 | ) |  | $ | (31,593 | )

The accompanying notes are an integral part of these consolidated financial statements
30

NEONODE INC
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(in thousands)

|  | Series A Preferred Stock Shares Issued |  |  | Series A Preferred Stock Amount |  |  | Series B Preferred Stock Shares Issued |  |  | Series B Preferred Stock Amount |  |  | Common Stock Shares Issued |  |  | Common Stock Amount |  |  | Additional Paid-in Capital |  |  | Accumulated Other Comprehensive Income (Loss) |  |  | Accumulated Deficit |  |  | Total Stockholders’ Equity (Deficit) |
Balances, January 1, 2010 |  |  | 3 |  |  | $ | - |  |  |  | 1 |  |  | $ | - |  |  |  | 16,659 |  |  | $ | 17 |  |  | $ | 74,288 |  |  | $ | (96 | ) |  | $ | (80,557 | ) |  | $ | (6,348 | )
Employee stock option and warrant compensation expense |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 2,262 |  |  |  | - |  |  |  | - |  |  |  | 2,262 |
Amortization of fair value of stock issued to related parties for purchase of Neonode Technologies AB (formerly AB Cypressen) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 3,168 |  |  |  | - |  |  |  | - |  |  |  | 3,168 |
Reclassification of derivative liabilities to additional paid-in capital |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 19,286 |  |  |  | - |  |  |  | - |  |  |  | 19,286 |
Common stock issued to settle lawsuit |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 498 |  |  |  | - |  |  |  | 647 |  |  |  | - |  |  |  | - |  |  |  | 647 |
Exchange of Series A preferred stock for common stock |  |  | (3 | ) |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 1,577 |  |  |  | 2 |  |  |  | (2 | ) |  |  | - |  |  |  | - |  |  |  | - |
Exchange of Series B preferred stock for common stock |  |  | - |  |  |  | – |  |  |  | (1 | ) |  |  | - |  |  |  | 73 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Proceeds for issuance of warrants |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 49 |  |  |  | - |  |  |  | - |  |  |  | 49 |
Common stock issued upon conversion of debt including beneficial conversion feature amounts |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 186 |  |  |  | - |  |  |  | 179 |  |  |  | - |  |  |  | - |  |  |  | 179 |
Common stock issued to brokers |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 57 |  |  |  | - |  |  |  | 65 |  |  |  | - |  |  |  | - |  |  |  | 65 |
Common stock issued to investors in the 2010 warrant repricing financing transaction |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 2,767 |  |  |  | 3 |  |  |  | 2,418 |  |  |  | - |  |  |  | - |  |  |  | 2,421 |

31

|  | Series A Preferred Stock Shares Issued |  |  | Series A Preferred Stock Amount |  |  | Series B Preferred Stock Shares Issued |  |  | Series B Preferred Stock Amount |  |  | Common Stock Shares Issued |  |  | Common Stock Amount |  |  | Additional Paid-in Capital |  |  | Accumulated Other Comprehensive Income (Loss) |  |  | Accumulated Deficit |  |  | Total Stockholders’ Equity (Deficit) |
Foreign currency translation adjustment |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 33 |  |  |  | - |  |  |  | 33 |
Net loss |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (31,626 | ) |  |  | (31,626 | )
Balances, December 31, 2010 |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 21,817 |  |  |  | 22 |  |  |  | 102,360 |  |  |  | (63 | ) |  |  | (112,183 | ) |  |  | (9,864 | )
Stock option and warrant compensation expense to employees and vendors |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 550 |  |  |  | - |  |  |  | - |  |  |  | 550 |
Common stock issued upon exercise of warrants |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 543 |  |  |  | 1 |  |  |  | 514 |  |  |  | - |  |  |  | - |  |  |  | 515 |
Proceeds from sale of common stock, net of offering costs |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 3,000 |  |  |  | 3 |  |  |  | 10,784 |  |  |  | - |  |  |  | - |  |  |  | 10,787 |
Reclassification of derivative liabilities to additional paid-in capital |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 20,075 |  |  |  | - |  |  |  | - |  |  |  | 20,075 |
Fair value of warrants issued in connection with issuance of 2011 senior secured convertible debt |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 937 |  |  |  | - |  |  |  | - |  |  |  | 937 |
Exchange of Series A preferred stock for common stock |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 40 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Exchange of Series B preferred stock for common stock |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 6 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Common stock issued upon conversion of outstanding convertible debt and accrued bonus income |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 7,313 |  |  |  | 7 |  |  |  | 7,615 |  |  |  | - |  |  |  | - |  |  |  | 7,622 |
Common stock issued for settlement of accrued expenses |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 60 |  |  |  | - |  |  |  | 120 |  |  |  | - |  |  |  | - |  |  |  | 120 |
Foreign currency translation adjustment |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 76 |  |  |  | - |  |  |  | 76 |
Net loss |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (17,145 | ) |  |  | (17,145 | )
Balances, December 31, 2011 |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 32,779 |  |  |  | 33 |  |  |  | 142,955 |  |  |  | 13 |  |  |  | (129,328 | ) |  |  | 13,673 |

32

|  | Series A Preferred Stock Shares Issued |  |  | Series A Preferred Stock Amount |  |  | Series B Preferred Stock Shares Issued |  |  | Series B Preferred Stock Amount |  |  | Common Stock Shares Issued |  |  | Common Stock Amount |  |  | Additional Paid-in Capital |  |  | Accumulated Other Comprehensive Income (Loss) |  |  | Accumulated Deficit |  |  | Total Stockholders’ Equity (Deficit) |
Stock option and warrant compensation expense to employees |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 3,499 |  |  |  | - |  |  |  | - |  |  |  | 3,499 |
Common stock issued upon exercise of common stock warrants |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 550 |  |  |  | - |  |  |  | 223 |  |  |  | - |  |  |  | - |  |  |  | 223 |
Exchange of Series B preferred stock for common stock |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | 2 |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |
Foreign currency translation adjustment |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (8 | ) |  |  | - |  |  |  | (8 | )
Net loss |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | - |  |  |  | (9,287 | ) |  |  | (9,287 | )
Balances, December 31, 2012 |  |  | - |  |  | $ | - |  |  |  | - |  |  | $ | - |  |  |  | 33,331 |  |  | $ | 33 |  |  | $ | 146,677 |  |  | $ | 5 |  |  | $ | (138,615 | ) |  | $ | 8,100 |

The accompanying notes are an integral part of these consolidated financial statements.
33

NEONODE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

|  | Years Ended December 31, |
|  | 2012 |  |  | 2011 |  |  | 2010 |
Cash flows from operating activities: |  |  |  |  |  |  |  |  |
Net loss |  | $ | (9,287 | ) |  | $ | (17,145 | ) |  | $ | (31,626 | )
Adjustments to reconcile net loss to net cash used in operating activities: |  |  |  |  |  |  |  |  |  |  |  |
Stock-based compensation |  |  | 3,499 |  |  |  | 550 |  |  |  | 5,430 |
Fair value of common stock issued in settlements |  |  | - |  |  |  | - |  |  |  | 647 |
Depreciation and amortization |  |  | 97 |  |  |  | 26 |  |  |  | 11 |
Loss on extinguishment of debt |  |  | - |  |  |  | - |  |  |  | 2,416 |
Debt discounts and deferred financing fees and the valuation of conversion features and warrants |  |  | - |  |  |  | 14,735 |  |  |  | 19,963 |
Changes in operating assets and liabilities: |  |  |  |  |  |  |  |  |  |  |  |
Accounts receivable |  |  | 1,253 |  |  |  | (3,228 | ) |  |  | (146 | )
Prepaid expenses and other current assets |  |  | (296 | ) |  |  | (79 | ) |  |  | (16 | )
Accounts payable and accrued expenses |  |  | 239 |  |  |  | 322 |  |  |  | (414 | )
Deposits |  |  | (68 | ) |  |  | - |  |  |  | - |
Deferred revenue |  |  | 819 |  |  |  | 1,366 |  |  |  | 540 |
Net cash used in operating activities |  |  | (3,744 | ) |  |  | (3,453 | ) |  |  | (3,195 | )
Cash flows used in investing activities: |  |  |  |  |  |  |  |  |  |  |  |
Purchase of property and equipment |  |  | (310 | ) |  |  | (114 | ) |  |  | (14 | )
Cash flow from financing activities: |  |  |  |  |  |  |  |  |  |  |  |
Proceeds from issuance of convertible debt |  |  | - |  |  |  | 4,228 |  |  |  | 1,597 |
Repayment of convertible debt |  |  | - |  |  |  | (25 | ) |  |  | - |
Proceeds from exercise of warrants |  |  | 223 |  |  |  | 515 |  |  |  | 49 |
Proceeds from issuance of common stock, warrant repricing and preferred stock |  |  | - |  |  |  | 10,787 |  |  |  | 2,421 |
Net cash provided by financing activities |  |  | 223 |  |  |  | 15,505 |  |  |  | 4,067 |
Effect of exchange rates on cash |  |  | (12 | ) |  |  | 91 |  |  |  | 25 |
Net (decrease) increase in cash |  |  | (3,843 | ) |  |  | 12,029 |  |  |  | 883 |
Cash at beginning of year |  |  | 12,940 |  |  |  | 911 |  |  |  | 28 |
Cash at end of year |  | $ | 9,097 |  |  | $ | 12,940 |  |  | $ | 911 |
Supplemental disclosure of cash flow information: Cash paid for interest |  | $ | - |  |  | $ | 27 |  |  | $ | 180 |
Cash paid for income taxes |  | $ | 125 |  |  | $ | 78 |  |  | $ | 45 |
Supplemental disclosure of non-cash transactions from investing and financing activities: Exchange of preferred stock for common stock |  | $ | - |  |  | $ | - |  |  | $ | 806 |
Reclassification of derivative liabilities to additional paid-in capital upon conversion of debt and exercise of warrants |  | $ | - |  |  | $ | 20,075 |  |  | $ | 19,286 |
Value of shares of common stock and warrants issued to brokers in connection with financing, recorded as debt issuance costs and debt discount |  | $ | - |  |  | $ | - |  |  | $ | 129 |
Debt issuance costs recorded as part of 2011 financing transaction |  | $ | - |  |  | $ | 35 |  |  | $ | - |
Debt discount recorded as part of convertible debt financing transactions, including warrants issued in financing transactions |  | $ | - |  |  | $ | 4,228 |  |  | $ | 1,761 |
Accounts payable converted in 2010 convertible debt offering |  | $ | - |  |  | $ | - |  |  | $ | 163 |
Accrued expenses settle with shares of common stock |  | $ | - |  |  | $ | 120 |  |  | $ | - |
Conversion of debt and accrued interest to shares of common stock |  | $ | - |  |  | $ | 7,222 |  |  | $ | 179 |
Debt issuance costs recorded in connection of debt extinguishment transactions |  | $ | - |  |  | $ | 20,075 |  |  | $ | 4,336 |
Reduction of derivative liabilities upon conversion of debt and exercise of warrants |  | $ | - |  |  | $ | - |  |  | $ | 8 |

The accompanying notes are an integral part of these consolidated financial statements.
34

NEONODE INC.
Notes to the Consolidated Financial Statements

1. | Nature of the business and operations

Background and Organization
Neonode Inc. was incorporated in the State of Delaware in 1997 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 (renamed Neonode Technologies AB), a Swedish engineering company, and Neonode Technologies AB became our wholly owned subsidiary.
On March 25, 2011, we filed a Certificate of Amendment of our Amended and Restated Certificate of Incorporation affecting a reverse stock split of the Company’s issued and outstanding shares of common stock and preferred stock at a ratio of twenty-five-to-one (the “Reverse Split”). The Certificate of Amendment provided that each twenty-five (25) outstanding shares of the Corporation’s common stock, par value $0.001 per share, was exchanged and combined, automatically, without further action, into one (1) share of common stock, and each twenty-five (25) outstanding shares of the Corporation’s preferred stock, par value $0.001 per share, was exchanged and combined, automatically, without further action, into one (1) share of preferred stock. The Reverse Split was declared effective on March 28, 2011 and has been reflected in this Annual Report on Form 10-K.
Operations
Neonode Inc., develops and licenses MultiSensing™ touch user interfaces and optical multi-touch solutions. The cornerstone of our interface solutions is zForce®, our patented touch technology. Neonode licenses its MultiSensing touch technology to Original Equipment Manufacturers (“OEMs”) and Original Design Manufacturers (“ODMs”) who embed Neonode technology into devices that they produce and sell.

2. | Summary of Significant Accounting Policies

Principles of Consolidation
The preparation of our consolidated financial statements is in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of Neonode Inc. and its wholly owned Swedish subsidiary Neonode Technologies AB. All intercompany accounts and transactions have been eliminated in consolidation.
Estimates
The preparation of financial statements in conformity with GAAP 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, collectability of accounts receivable, recoverability of long-lived assets, the valuation allowance related to our deferred tax assets, and the fair value of options and warrants issued for stock-based compensation.
Cash and Cash Equivalents
We have not had any liquid investments other than normal cash deposits with bank institutions to date. If in the future the Company purchases cash equivalents, the Company will consider all highly liquid investments with original maturities of three months of less to be cash equivalents.
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Concentration of Cash Balance Risks
Cash balances are maintained at various banks in the United States of America (“U.S.”) and Sweden. At times, deposits held with financial institutions in the U.S. may exceed the amount of insurance provided by the Federal Deposit Insurance Corporation (“FDIC”), which provided basic deposit coverage with limits up to $250,000 per owner. In addition to the basic insurance deposit coverage, the FDIC is providing temporary unlimited coverage for non-interest bearing transaction accounts until December 31, 2012. The Swedish government provides insurance coverage up to 100,000 euro per customer and covers deposits in all types of accounts. As of December 31, 2012, the Company has approximately $8.1 million in excess of insurance limits.
Accounts Receivable and Allowance for Doubtful Accounts
Our 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 collectability 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. An allowance for doubtful accounts was not necessary at December 31, 2012 and 2011.
Property and Equipment
Property 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 as follows:

Estimated useful lives
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 or term of the lease, whichever is shorter.
Upon retirement or sale of property and equipment, cost and accumulated depreciation and amortization are removed from the accounts and any gains or losses are reflected in the consolidated 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. At December 31, 2012, we believe there is no impairment of our long-lived assets. There can be no assurance, however, that market conditions will not change or sufficient commercial demand for our products and services will materialize, which could result in impairment of long-lived assets in the future.
36

Foreign Currency Translation and Transaction Gains and Losses
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 income (loss). Gains or (losses) resulting from foreign currency transactions are included in general and administrative expenses in the accompanying consolidated statements of operations and were ($50,000), ($44,000) and ($23,000) during the years ended December 31, 2012, 2011 and 2010, respectively. Foreign currency translation gains (losses) were ($8,000), $76,000 and $33,000 during the years ended December 31, 2012, 2011 and 2010, respectively.
Concentration of Credit and Business Risks
In the short term, we anticipate that we will depend on a limited number of customers for substantially all of 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.
Our accounts receivable as of December 31, 2012 was due from fifteen customers. Our net revenues for the year ended December 31, 2012 were earned from twenty customers. Our customers are located in the U.S., Europe and Asia. Customers who accounted for 10% or more of our net revenues during the year ended December 31, 2012 are as follows:

● | Amazon - 32%

● | KOBO Inc. – 26%

● | Sony Corporation - 17%

Our accounts receivable as of December 31, 2011 was due from five customers. Our net revenues for the year ended December 31, 2011 were earned from seven customers. Our customers are located in the U.S., Europe and Asia. Customers who accounted for 10% or more of our net revenues during the year ended December 31, 2011 are as follows:

● | Amazon - 40%

● | Barnes & Noble - 26%

● | Sony Corporation - 21%

● | KOBO Inc. - 11%

Our net revenues for the year ended December 31, 2010 were earned from seven customers. Customers who accounted for 10% or more of our net revenues during the year ended December 31, 2010 are as follows:

● | Sony Corporation - 46%

● | Sony Ericsson Mobile Communications AB - 38%

Risk and Uncertainties
Our long-term success is dependent on us obtaining sufficient capital to fund our operations and to develop our products, and bringing such products to the worldwide market to obtain sufficient sales volume to be profitable. To achieve these objectives, we may be required to raise additional capital through public or private financings or other arrangements. If additional capital is needed we 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.
37

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 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 our consolidated 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 Krona, including a significant portion of our product research and development expenses 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.
Revenue Recognition
Engineering Services:
We may sell engineering consulting services to our customers on a flat rate or hourly rate basis. We recognize revenue from these services when all of the following conditions are met: (1) evidence existed of an arrangement with the customer, typically consisting of a purchase order or contract; (2) our services were performed 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 has not been satisfied, we defer recognition of revenue. Generally, we recognize revenue as the engineering services stipulated under the contract are completed and accepted by our customers.
Licensing Revenues:
We also derive revenue from the licensing of internally developed intellectual property (“IP”). We enter into IP licensing agreements that generally provide licensees the right to incorporate our IP components in their products with terms and conditions that vary by licensee. The IP licensing agreements generally include a nonexclusive license for the underlying IP. Fees under these agreements may include 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. As of September 30, 2011, Neonode met all the accounting requirements for revenue recognition as per unit royalty products are distributed or licensed by the Company’s customers. Prior to September 30, 2011, we deferred the technology license fee revenue until such time as the warranty period stipulated in the license agreement expired because we did not have sufficient historical experience in estimating potential warranty costs. For technology license arrangements that do not require significant modification or customization of the underlying technology, we recognize technology license revenue when: (1) we enter into a legally binding arrangement with a customer for the license of technology; (2) the customer distributes or license the products; (3) the customer payment is deemed fixed or determinable and free of contingencies or significant uncertainties; and (4) collection is reasonably assured.
38

From June 2010 to September 30, 2011, we entered into 12 technology license contracts with customers. During that time there were no warranty related costs incurred for any customer products after they had been released to market. During the quarter ended September 30, 2011, the Company performed an analysis and determined that it had sufficient historical evidence regarding estimated warranty costs and therefore began recognizing technology license fee revenues, net of warranty costs, if any, as the products incorporating the Neonode technology are distributed or licensed by our customers, assuming all other revenue recognition criteria has been met. Our customers report to us the quantities of products distributed by them after the end of the reporting period stipulated in the contract, generally 30 to 45 days after the end of the month or quarter.
Explicit return rights are not offered to customers. There have been no returns through December 31, 2012.
Software Products:
We may derive revenues from software licensing sales. We will 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.
For software license arrangements that do not require significant modification or customization of the underlying software, we will 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 allocate revenues to all deliverables based on their relative selling price using a specific hierarchy. The hierarchy is as follows: vendor-specific objective evidence (“VSOE”), third-party evidence of selling price (“TPE”) or best estimate of selling price (“BESP”).
When a sale involves multiple elements, we will allocate the entire fee from the arrangement to each respective element based on VSOE of fair value and recognize revenue when each element’s revenue recognition criteria are met. VSOE of fair value for each element is established based on the price charged when the same element is sold separately. We have established VSOE for our software licenses based on historical stand-alone sales to third parties or from the stated renewal rates contained in the customer contracts. Maintenance service revenue is recognized on a straight-line basis over the support period.
We have not yet demonstrated VSOE for the professional services that are rendered in conjunction with our software license sales. In accordance with the hierarchy we would attempt to establish the selling price of professional services using TPE. Our product contains significant differentiation such that the comparable pricing of products with similar functionality cannot be obtained. We are typically not able to obtain TPE for professional services.
When we are unable to establish selling prices using VSOE or TPE, we use BESP. The objective of BESP is to determine the price at which we would transact a sale if professional services were sold on a stand-alone basis. BESP is generally used for offerings that are not typically sold on a stand-alone basis or for highly customized offerings.
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. To date, we have not sold any software products.
Deferred Revenue
From time-to-time the Company receives pre-payments from its customers related to future services or future license fee revenues. We defer the license fees until we have met all accounting requirements for revenue recognition as per unit royalty products are distributed or licensed by the Company’s customers and the engineering development fee revenue until such time as the engineering work has been completed and accepted by our customers.
39

Advertising
Advertising costs are expensed as incurred. Advertising costs amounted to approximately $312,000, $241,000 and $28,000 for the years ended December 31, 2012, 2011 and 2010, respectively.
Product Research and Development
Research and development (“R&D”) costs are expensed as incurred. R&D costs consist mainly of personnel related costs in addition to some external consultancy costs such as testing, certifying and measurements.
Stock-Based Compensation Expense
We measure the cost of employee services received in exchange for an award of equity instruments, including stock options, based on the fair value of the award on the grant date, and recognize the value as compensation expense over the period the employee is required to provide services in exchange for the award, usually the vesting period, net of estimated forfeitures.
We account for equity instruments issued to non-employees at their fair value. The measurement date for the fair value for the equity instruments issued is determined at the earlier of (i) the date at which a commitment for performance by the consultant or vendor is reached, or (ii) the date at which the consultant or vendor’s performance is complete. In the case of equity instruments issued to consultants, the fair value of the equity instruments is primarily recognized over the term of the consulting agreement. The fair value of the stock-based compensation is periodically re-measured and income or expense is recognized during the vesting term.
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.
Income Taxes
We recognize deferred tax liabilities and assets for the expected future tax consequences of items that have been included in the consolidated 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 when, in our opinion, realization is uncertain based on the “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, 2012 and 2011. 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 determination was made. The provision for income taxes represents the net change in deferred tax amounts, plus income taxes payable for the current period.
We follow the relevant accounting guidance related to uncertain tax positions, which provisions include a two-step approach to recognizing, de-recognizing and measuring uncertain tax positions. As a result, we did not recognize a liability for unrecognized tax benefits. As of December 31, 2012 and 2011, we had no unrecognized tax benefits.
40

Net Loss Per Share
Net loss per share amounts have been computed based on the weighted-average number of shares of common stock outstanding during the years ended December 31, 2012, 2011 and 2010. 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 number of shares of common stock and potential common stock equivalents used in computing the net loss per share for years ended December 31, 2012, 2011 and 2010 exclude the potential common stock equivalents, as the effect would be anti-dilutive (see Note 15).
Comprehensive Loss
Our comprehensive loss includes foreign currency translation gains and losses. The cumulative amount of translation gains and losses are reflected as a separate component of stockholders’ equity in the consolidated balance sheets, as accumulated other comprehensive income.
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 6.78, 6.50 and 7.21 Swedish Krona to one U.S. Dollar for the years ended December 31, 2012, 2011 and 2010, respectively. The exchange rate for the consolidated balance sheets was 6.52 and 6.92 Swedish Krona to one U.S. Dollar as of December 31, 2012 and 2011, respectively.
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, accounts receivable, accounts payable and accrued expenses and are deemed to approximate fair value due to their short maturities.
There were no assets or liabilities recorded at fair value on a recurring basis in 2012.
New Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board (“FASB”) issued guidance that requires new disclosures for fair value measurements and provides clarification for existing disclosure requirements. The guidance is effective for interim and annual periods beginning after December 15, 2009, except for gross presentation of activity in level 3 which is effective for annual periods beginning after December 15, 2010, and for interim periods in those years. We adopted the guidance for new disclosures for fair value measurements and clarification for existing disclosure requirements as of January 1, 2010 and there was no material impact on our consolidated financial statements. Additionally, we adopted the guidance regarding level 3 activity on January 1, 2011 and there was no material impact to our consolidated financial statements. See Note 7, “Fair Value Measurements” for additional information on the fair value of financial instruments.
In May 2011, the FASB amended fair value measurement and disclosure guidance to achieve convergence with International Financial Reporting Standards (“IFRS”). The amended guidance modifies the measurement of fair value, clarifies verbiage, and changes disclosure or other requirements in U.S. GAAP and IFRS. The guidance is effective during interim and annual periods beginning after December 15, 2011. We adopted the guidance as of January 1, 2012 and there was no material impact on our consolidated financial statements.
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3. | Prepaid Expenses and Other Current Assets

Prepaid expense and other current assets consist of the following (in thousands):

| As of December 31, |
| 2012 |  | 2011 |
Prepaid insurance |  | $ | 80 |  |  | $ | 46 |
Prepaid rent |  |  | 52 |  |  |  | 49 |
VAT receivable |  |  | 204 |  |  |  | 110 |
Other |  |  | 214 |  |  |  | 29 |
Total prepaid expenses and other current assets |  | $ | 550 |  |  | $ | 234 |

4. | Property and Equipment

Property and equipment consist of the following (in thousands):

| As of December 31, |
| 2012 |  | 2011 |
Computers, software, furniture and fixtures |  | $ | 475 |  |  | $ | 151 |
Less accumulated depreciation and amortization |  |  | (145 | ) |  |  | (43 | )
Property and equipment, net |  | $ | 330 |  |  | $ | 108 |

Depreciation and amortization expense is $97,000, $26,000 and $11,000 for the years ended December 31, 2012, 2011 and 2010, respectively.

5. | Accrued Expenses

Accrued expenses consist of the following (in thousands):

| As of December 31, |
| 2012 |  | 2011 |
Salaries, payroll taxes, vacation and benefits |  | $ | 621 |  |  | $ | 560 |
Accrued consulting fees and other |  |  | 183 |  |  |  | 41 |
Total accrued expenses |  | $ | 804 |  |  | $ | 601 |

6. | Convertible Debt

There is no convertible debt outstanding at December 31, 2012 and 2011.
Senior Convertible Secured Notes- 2007
At December 31, 2012 and 2011, we had no convertible promissory notes (“Senior Convertible Secured Notes-2007”) that bore interest at the greater of 8% or LIBOR plus 3% interest per annum, convertible into shares of our common stock at an original conversion price of $87.50 per share outstanding. The Senior Convertible Secured Notes – 2007 were originally due August 26, 2010. On September 22, 2010, we entered into a debt modification agreement with the two holders of an aggregate of $126,362 of convertible promissory notes that were due on August 26, 2010. Based on the terms of the modification, this transaction qualified as a debt extinguishment under the relevant accounting guidance. As part of the debt extinguishment, the maturity date of the convertible promissory notes was extended until April 26, 2011. We entered into a debt-for-equity repayment plan whereby we retired the convertible promissory notes in equal installments by issuing our common stock priced at a 15% discount from the average market closing price for the five days ending on the 25th of each month over the eight month period beginning September 26, 2010 ending on April 26, 2011. The holders of the notes had the right to convert the outstanding balance priced at $2.25 per share if the market value of our common stock was greater than $2.50 per share for five consecutive days.
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During the year ended December 31, 2011, we issued the note holders 31,570 shares of our common stock pursuant to the debt-for-equity repayment plan and retired the remaining note principal balance on April 26, 2011. We recorded $84,657 of note principal reduction and $1,054 of interest payment.
September 2009 Senior Convertible Secured Notes Financing Transaction
During the period from August 25, 2009 through December 15, 2009, we completed a private placement of convertible notes totaling $987,000 that were converted, at the holder’s option, into shares of our common stock at a conversion price of $0.50 per share (the “Convertible Notes - 2009”). The convertible note holders had the right to have the conversion price adjusted to equal the lower stock price if we issued common stock or convertible notes at a lower conversion price than $0.50 per share during the period that the notes were outstanding. The Convertible Notes - 2009 that were originally due on December 31, 2010 were extended to June 30, 2011 (see below under Warrant Repricing and Debt Extension Financing Transaction – 2010) and bore an annual interest rate of 7%, payable on June 30 and December 31 of each year that the convertible notes were outstanding. In addition, we issued 986,983 three-year warrants to the convertible note holders with an exercise price of $1.00 per share. The warrants may be exercised and converted to common stock, at the warrant holder’s option, beginning on the six-month anniversary of the date of issuance until the warrant expiration date. During the year ended December 31, 2011 we issued 1,851,486 shares of our common stock to holders of Convertible Notes – 2009 who converted principal of $912,036 and $13,707 of related accrued interest. On June 30, 2011, we paid in cash the remaining outstanding principal balance of $25,000 of Convertible Notes – 2009. As of December 31, 2011, all of the Convertible Notes – 2009 had been paid in full with cash or have been converted to shares of our common stock.
The embedded conversion feature of the Convertible Notes – 2009 met the definition of a derivative financial instrument and was classified as a liability in accordance with relevant accounting guidance. The note holders had the right to convert the debt into shares of our common stock, and the notes included price protection whereby these notes were protected for as long as the notes remained outstanding against future private placements made at lower share prices, and therefore, the total number of shares of our common stock that the convertible notes could be convertible into was not fixed. The embedded conversion features were revalued on each balance sheet date and marked-to-market with the change recorded to non-cash items related to debt discounts, deferred financing fees and the valuation of conversion features and warrants in the consolidated statements of operations. As a result of the conversions and repayments during the year ended December 31, 2011, the Company reclassified approximately $4.6 million of the related derivative liabilities to additional paid-in capital. As of December 31, 2011, the fair value of the remaining embedded conversion features was $0 due to the repayment or conversion of all the Convertible Notes - 2009. The Company recorded a loss of $2.3 million due to the change in the fair value of the embedded conversion features of these Convertible Notes – 2009 during the year ended December 31, 2011.
During the years ended December 31, 2011 and 2010, we recorded a total of $15,000 and $62,000, respectively, in interest expense related to the principal balance of the Convertible Notes – 2009.
Senior Convertible Secured Notes- 2010
During the period from January 2010 through June 30, 2010, we received $1,597,000 in cash proceeds and converted $163,000 of accounts payable related to a private placement of convertible notes (“Convertible Notes – 2010”) and stock purchase warrants that were convertible, at the holder’s option, into shares of our common stock at a conversion price of $0.50 per share and we issued 1,760,712 stock purchase warrants that had an exercise price of $1.00 per share. The convertible note holders had the right to have the conversion price adjusted to equal the lower stock price if we issued stock or convertible notes at a lower conversion price than $0.50 during the period that the notes were outstanding. These convertible notes were originally due on December 31, 2010 and were extended to June 30, 2011 (see below under Warrant Repricing and Debt Extension Financing Transaction – 2010) and bore an annual interest rate of 7%, payable on June 30 and December 31 of each year that the convertible notes were 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. During the year ended December 31, 2011, we issued 3,557,171 shares of our common stock to holders of Convertible Notes – 2010 who converted principal of $1,750,143 and $28,442 of related accrued interest. As of December 31, 2011, all of the Convertible Notes – 2010 had been converted to shares of our common stock.
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The embedded conversion feature of the Convertible Notes – 2010 met the definition of a derivative financial instrument and was classified as a liability in accordance with accounting guidance. The note holders had the right to convert the debt into shares of our common stock, and the notes include price protection whereby these notes were protected for as long as the notes remained outstanding against future private placements made at lower share prices, and therefore, the total number of shares of our common stock that the convertible notes could be convertible into was not fixed. The embedded conversion features were revalued on each balance sheet date and marked-to-market with the increase or decrease in fair value was recorded to non-cash items related to debt discounts and deferred financing fees and the valuation of conversion features and warrants in the consolidated statements of operations. As a result of the conversions during the year ended December 31, 2011, the Company reclassified approximately $8.7 million of the related derivative liabilities to additional paid-in capital. As of December 31, 2011, the fair value of the remaining embedded conversion features is $0 as all the Convertible Notes – 2010 were converted. The Company recorded a loss of approximately $4.4 million due to the change in the fair value of the embedded conversion feature of these Convertible Notes – 2010 during the year ended December 31, 2011.
During the year ended December 31, 2011 and 2010, we recorded a total of approximately $28,000 and $109,000, respectively, in interest expense related to the principal balance of the Convertible Notes – 2010.
Warrant Repricing and Debt Extension Financing Transaction - 2010
During September and October 2010, all of the holders of the convertible notes and the holders of the stock purchase warrants issued in the 2009 and 2010 Senior Secured Convertible Debt Financing Transactions agreed to extend the maturity date of their convertible debt from December 31, 2010 to June 30, 2011 under the same terms and conditions as the original notes. Holders of 2,766,857 stock purchase warrants also agreed to exercise their previously granted three-year warrants with an exercise price of $1.00 for a discounted exercise price of $0.88 per share. They received 2,766,857 shares of our common stock and 2,766,857 replacement three-year warrants with an exercise price of $1.38 for each warrant exercised. We raised a total of $2.4 million by these warrant exercises. In accordance with relevant accounting guidance, we noted that the transaction qualified for debt extinguishment accounting. As a result, the remaining debt discounts were written off and charged to interest expense and fair value of the replacement warrants were recorded to loss on extinguishment of debt, which was deemed to be the date that the convertible debt holder signed the modification agreement. As the Company did not have sufficient unissued authorized shares to cover all dilutive instruments until the increase in authorized shares on December 13, 2010, these replacement warrants were initially recorded as derivative liabilities at their grant date fair value. On December 13, 2010, the Company increased its authorized shares and then had sufficient authorized shares to cover all dilutive instruments and as such the replacement warrants were re-valued on that date (totaling $4,335,785) and the Company reclassified the replacement warrants to additional paid-in-capital in accordance with relevant accounting guidance.
Senior Convertible Secured Notes- 2011
During March and April 2011, we received approximately $4.2 million in cash proceeds related to a private placement of convertible notes (“Senior Convertible Secured Notes – 2011”), bearing interest at a rate of seven percent (7%) per annum, that was scheduled to mature on March 1, 2014 and that were convertible at the holder’s option into 1,691,320 shares of our common stock at a conversion price of $2.50 per share. The notes were automatically convertible into shares of the Company’s common stock in the event that on or before the note due date either (a) the Company’s common stock was traded at a price per share of $6.25 or higher for five (5) consecutive trading days, or (b) the Company consummated a financing in the amount of at least $5 million. The accrued interest was payable in stock, using the $2.50 conversion price, or cash, at the holder’s option, on June 30 and December 31 of each year.
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In connection with the March and April 2011 financing transactions the Company valued the warrants issued to the convertible note holders on a relative fair value basis using the Black-Scholes option pricing model, totaling $937,000. This relative fair value of the warrants was recorded as a debt discount. The embedded conversion feature of the notes was determined to meet the definition of a derivative liability and as of the date of issuance was valued at $4.8 million. In accordance with relevant accounting guidance, the Company recorded an additional debt discount up to the full face amount of the notes, recorded the derivative liability for the embedded conversion feature at $4.8 million and recorded the fair value in excess of face amount of debt as interest expense on the issuance date of $1.5 million. The debt discount was amortized in full upon the conversion of the notes to common stock on December 14, 2011. As of December 31, 2011, the fair value of the embedded conversion feature was $0 due to the conversion of all the Senior Convertible Secure Notes – 2011. The Company recorded a loss of $1.9 million due to the change in fair value of the embedded conversion feature for the year ended December 31, 2011 which is included in the accompanying consolidated statement of operations as a component of the non-cash items related to debt discounts and deferred financing fees and the valuation of conversion features and warrants.
During the year ended December 31, 2011, the Company issued 27,851 shares of unregistered common stock to note holders of the Senior Convertible Secured Notes – 2011 private placement financing transaction in lieu of cash for their $69,628 accrued interest payment that was due June 30, 2011. In addition, the Company paid $10,277 of the accrued interest in cash to note holders who declined to convert their interest payment to stock.
During the year ended December 31 2011, the Company issued 422,830 new five-year common stock purchase warrants to the investors, with an exercise price of $3.13 per share (the “March 2011 Warrants”), with each investor receiving a number of March 2011 Warrants that is equal to twenty-five percent (25%) of the investor’s note to the Company. The March 2011 Warrants may be exercised by cash payment or through cashless exercise by the surrender of warrant shares having a value equal to the exercise price of the portion of the warrants being exercised.
In October and November 2011, note holders of $575,000 of the original $4.2 million Senior Convertible Secure Notes – 2011 exercised their right to convert their notes and accrued interest and were issued 232,125 shares of our common stock.
On December 13, 2011, following a public offering pursuant to a Registration Statement on Form S-3, the Company received gross proceeds in excess of $5 million. Pursuant to the terms, as defined, in the Senior Convertible Secure Notes – 2011 agreements, the remaining outstanding principal balance immediately following such date, plus accrued interest, was automatically convertible into shares of common stock at a conversion price of $2.50 per share. In accordance with the terms of the agreement, the Company automatically converted approximately $3.7 million of remaining principal and approximately $130,000 of accrued interest into 1,513,237 shares of the Company’s common stock. In addition, the Company issued 99,461 shares of common stock related to the bonus interest feature associated with the mandatory conversion of the debt. The fair value of the shares issued were computed based on the stock price of the Company’s common stock on December 14, 2011 and were valued at $397,845 and recorded as additional interest expense in non-cash items related to debt discounts and deferred financing fees and the valuation of conversion features and warrants in the consolidated statement of operations. As a result of the conversions and repayments of the Senior Convertible Secure Notes - 2011 during the year ended December 31, 2011, the Company reclassified approximately $6.7 million of derivative liabilities to additional paid-in capital. The Company recorded a loss of $1.9 million for the year ended December 31, 2011 due to the change in fair value of the embedded conversion features. As of December 31, 2011, the fair value of the embedded conversion features was $0. As of December 31, 2011, all of the Senior Convertible Secure Notes - 2011 plus accrued interest was paid or converted into shares of common stock.
During the year ended December 31, 2011 we recorded a total of approximately $232,000 in interest expense related to the principal balance of the Senior Convertible Secured Notes – 2011.

7. | Fair Value Measurements

Accounting guidance defines fair value, establishes a framework for measuring fair value, and expands disclosure requirements about fair value measurements. The accounting guidance does not mandate any new fair value measurements and is applicable to assets and liabilities that are required to be recorded at fair value under other accounting pronouncements.
There were no assets or liabilities recorded at fair value on a recurring basis in 2012.
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The three levels of the fair value hierarchy are described as follows:
Level 1: Applies to assets or liabilities for which there are quoted prices (unadjusted) in active markets for identical assets and liabilities. We had no Level 1 assets or liabilities.
Level 2: Applies to assets or liabilities for which there are inputs other than quoted prices included in Level 1 that are observable, either directly or indirectly. We had no Level 2 assets or liabilities.
Level 3: Applies to assets or liabilities for which there are unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of the assets or liabilities. We valued warrants and embedded conversion features that were without observable market values and the valuation required a high level of judgment to determine fair value (Level 3 inputs). The Company estimated the fair value of these warrants and embedded conversion features using the Black-Scholes option pricing model using the following assumptions:

|  | For the year |
|  | ended December 31, 2010 |
Annual dividend yield |  |  | - |
Expected life (years) |  |  | 0.50 – 4.8 |
Risk-free interest rate |  |  | 0.18% - 1.90 | %
Expected volatility |  |  | 117% - 221 | %

|  | For the year |
|  | ended December 31, 2011 |
Annual dividend yield |  |  | - |
Expected life (years) |  |  | 0.08 – 3.0 |
Risk-free interest rate |  |  | 0.08% - 1.27 | %
Expected volatility |  |  | 110% - 263 | %

The following table shows the classification of our liabilities that were subject to fair value measurements and the roll-forward of these liabilities for the years ended December 31, 2011 and 2010 (in thousands):
Fair Value of Embedded Conversion Features and Warrants

January 1, 2010 |  | $ | 4,507 |
Ne Derivatives added in connection with issuance of debt and equity |  |  | 5,236 |
Derivatives reclassified to equity in connection with repayment and conversion of debt |  |  | (19,286) |
Net increase in fair value |  |  | 16,261 |
December 31, 2010 |  | $ | 6,718 |

Ne Derivatives added in connection with issuance of debt and equity |  |  | 4,762 |
Derivatives reclassified to equity in connection with repayment and conversion of debt |  |  | (20,075) |
Net increase in fair value |  |  | 8,595 |
December 31, 2011 |  | $ | - |

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8. | Deferred Revenue

As of December 31, 2012 and 2011, we have $2.1 million and $1.5 million, respectively, of deferred license fee revenue related to prepayments for future license fees from three and one customers, respectively, and a total of $0.6 million and $0.4 million, respectively, of deferred engineering development fees from thirteen and four customers, respectively. We defer the license fees until we have met all accounting requirements for revenue recognition as per unit royalty products are distributed or licensed by the Company’s customers and the engineering development fee revenue until such time as the engineering work has been completed and accepted by our customers.

9. | Stockholders’ Equity

On February 29, 2012, the Company filed a Certificate of Correction with the Secretary of State of Delaware effectively reducing the amount of its authorized shares from 848,000,000 shares of Common Stock and 2,000,000 shares of Preferred Stock to 70,000,000 shares of Common Stock and 1,000,000 shares of Preferred Stock. This correction reflects the new capital structure of the Company following its 1-for-25 reverse split that became effective at the close of business on March 25, 2011.
On May 1, 2012, the Company began trading its common stock on the NASDAQ Stock Market under trading symbol NEON.
Common Stock
On March 16, 2012, John Reardon, a member of our board of directors, exercised a warrant to purchase 200,000 shares of common stock using the net exercise provision allowed in the warrant and received 174,798 shares of our common stock.
During the year ended December 31, 2012, Series B Preferred stockholders exchanged 19 shares of Series B Preferred stock for 2,509 shares of our common stock.
During the year ended December 31, 2012, warrant holders (excluding members of our board of directors) exercised warrants to purchase 361,000 shares of common stock using the net exercise provision allowed in the warrant and received 235,144 shares of our common stock. Warrant holders exercised warrants to purchase 17,500 shares of common stock and paid a cash exercise price of $3.13 per share for total proceeds of $54,775. In addition, during 2012 a warrant holder exercised a warrant to purchase 122,238 shares of common stock and paid a cash exercise price of $1.38 per share for total proceeds of $168,668.
During the year ended December 31, 2011, Series A Preferred stockholders exchanged 82.79 shares of Series A Preferred stock for 39,790 shares of our common stock, and Series B Preferred stockholders exchanged 26.04 shares of Series B Preferred stock for 6,282 shares of our common stock.
During the year ended December 31, 2011, the Company issued a total of 5,408,657 shares of common stock as a result of the conversion of approximately $2.7 million of the Senior Convertible Secured Notes – 2009 and 2010 private placement financing transactions debt principal and accrued interest.
During the year ended December 31, 2011, the Company received proceeds of approximately $515,000 from the exercise of 493,426 warrants for shares of common stock.
During the year ended December 31, 2011, we issued the note holders of Senior Convertible Secured Notes- 2007 31,570 shares of our common stock pursuant to the debt-for-equity repayment plan and retired the remaining note principal balance and accrued interest totaling $86,000 on April 26, 2011.
During the year ended December 31, 2011, the Company issued 60,000 shares of common stock and issued a 3-year warrant to purchase 20,000 shares of common stock at an exercise price of $2.00 per share in satisfaction of certain accrued expenses totaling $120,000.
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On April 25, 2011, Davisa Ltd (a related party) exercised warrants to purchase 50,000 shares of common stock. The Company recorded an additional $50,000 as stock based compensation to compensate Davisa Ltd by waiving the $1.00 exercise price and issued 50,000 shares of our common stock to Davisa Ltd for services provided in connection with the private placement of convertible notes and warrants in the March 2011 financing transaction.
During the year ended December 31, 2011, the Company issued 27,851 shares of unregistered common stock to note holders of the Senior Convertible Secured Notes – 2011 private placement financing transaction in lieu of cash for their $69,628 accrued interest payment that was due June 30, 2011 (see Note 6).
During the year ended December 31, 2011, we issued the note holders of Senior Convertible Secured Notes- 2011 a total of 1,844,814 shares of our common stock and retired the note principal balance and accrued interest totaling $4.6 million. Included in the total shares issued of 1,844,814 is 99,461 shares of common stock issued for bonus interest (as determined) totaling $399,000.
During the year ended December 31, 2011, we issued 3.0 million shares of our common stock to investors who completed an equity financing transaction that closed on December 13, 2011 in which we raised $12.0 million and received $11.2 million in cash, net of direct selling costs but before other direct offering costs of approximately $0.4 million.
On March 21, 2010, we issued 35,000 shares of our common stock and a warrant to purchase 35,000 shares of our common stock at an exercise price of $1.00 per share to an investor for services provided for the private placement of convertible note and warrant in the 2010 financing transaction. The fair value of the 35,000 shares of common stock is $26,000 based on our common stock closing price on the date of issuance. The $26,000 fair value of the warrants is included in common stock and additional paid-in capital in the consolidated balance sheets and was originally recorded as debt issuance costs and subsequently amortized to interest expense on the consolidated statement of operations for the year ended December 31, 2010 (See Note 6).
On May 27, 2010, we issued 3,136 shares of our common stock to a holder of two convertible promissory notes who elected to convert and retire the $1,600 of convertible promissory notes plus accrued interest at the $0.50 conversion price pursuant to the note agreements (see Note 6).
On September 8, 2010, we issued 16,894 shares of our common stock to the holder of a convertible promissory note that was due on August 26, 2010. We retired the $12,500 convertible promissory note and $170 of accrued interest (see Note 6).
On September 13, 2010, we issued 450,263 shares of our common stock in settlement of the Empire lawsuit and we settled all outstanding warrants held by Empire. In addition, our insurance carrier paid a cash settlement to Empire. The value of the shares issued to Empire were $562,828 (based on the trading price of $1.25 per share on the date of settlement) and were charged to settlement expense included in general and administrative expenses in the accompanying consolidated statement of operations for the year ended December 31, 2010. The fair value of Empire’s warrants was reclassified to additional paid-in-capital at the date of settlement.
On September 22, 2010, we issued 120,111 shares of our common stock to a holder of two convertible promissory notes who elected to convert and retired the $59,000 of convertible promissory notes plus accrued interest at the $0.50 conversion price pursuant to the note agreements (see Note 6).
On September 23, 2010, we issued 6,933 shares of our common stock and a warrant to purchase 6,933 shares of our common stock at an exercise price of $1.00 per share to an investor for services provided for the private placement of convertible note and warrant in the 2010 financing transaction. The fair value of the shares of common stock and warrants totaling $24,000 are recorded as interest expense with an offsetting amount to equity (see Note 6).
On September 25, 2010, we issued 15,000 shares of our common stock and a warrant to purchase 15,000 shares of our common stock at an exercise price of $1.00 per share to an investor for services provided for the private placement of convertible note and warrant in the 2010 financing transaction. The fair value of the shares of common stock and warrants totaling $52,000 are recorded as interest expense with an offsetting amount to equity (see Note 6).
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On September 29, 2010, we issued 11,462 shares of our common stock for the conversion of principal and interest of senior convertible secured notes originally issued in 2007 (see Note 6).
During September 2010, we issued 348,464 shares of our common stock for the exercise of warrants in connection with the 2009 and 2010 convertible debt financings. The warrants were exercised at $0.88 per share based on the warrant repricing and debt extension agreement (see Note 6).
On October 11, 2010, we issued 48,000 shares of our common stock in settlement of the Berman lawsuit and canceled all outstanding warrants held by Berman. In addition, our insurance carrier paid a cash settlement to Berman and we paid an additional cash settlement to Berman. The value of the shares issued to Berman were valued at $84,000 (based on the trading price of $1.75 per share on the date of settlement) and were charged to settlement expense included in general and administrative expenses in the accompanying consolidated statement of operations for the year ended December 31, 2010.
On October 18, 2010, we issued 1,235,636 shares of our common stock for the exercise of warrants in connection with the 2009 and 2010 convertible debt financings. The warrants were exercised at $0.88 per share based on the warrant repricing and debt extension agreement (see Note 6).
On October 27, 2010, we issued 12,966 shares of our common stock for the conversion of principal and interest of senior convertible secured notes originally issued in 2007 (see Note 6).
On November 4, 2010, we issued 792,086 shares of our common stock for the exercise of warrants in connection with the 2009 and 2010 convertible debt financings. The warrants were exercised at $0.88 per share based on the warrant repricing and debt extension agreement (see Note 6).
On November 19, 2010, we issued 390,672 shares of our common stock for the exercise of warrants in connection with the 2009 and 2010 convertible debt financings. The warrants were exercised at $0.88 per share based on the warrant repricing and debt extension agreement (see Note 6).
On December 13, 2010, we increased the number of our authorized shares of common stock from 698,000,000 to 848,000,000.
On December 13, 2010, we issued 9,866 shares of our common stock for the conversion of principal and interest of senior convertible secured notes originally issued in 2007 (see Note 6).
On December 29, 2010, we issued 12,002 shares of our common stock for the conversion of principal and interest of senior convertible secured notes originally issued in 2007 (see Note 6).
Preferred Stock
The terms of the Series A and Series B Preferred stock are as follows:

| ● Dividends and Distributions.

| Series A Preferred: | The holders of shares of Series A Preferred stock are entitled to participate with the holders of our common stock with respect to any dividends declared on the common stock in proportion to the number of shares of common stock issuable upon conversion of the shares of Series A Preferred stock held by them.

| Series B Preferred: | The holders of shares of Series B Preferred stock are entitled to participate with the holders of our common stock with respect to any dividends declared on the common stock in proportion to the number of shares of common stock issuable upon conversion of the shares of Series B Preferred stock held by them.

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| ● Liquidation Preference.

| Series A Preferred: | In the event of any liquidation, dissolution, or winding up of our operations, either voluntary or involuntary, subject to the rights of any other series of Preferred stock to be established by the Board of Directors (the “Senior Preferred Stock”), the holders of Series A Preferred stock shall be entitled to receive, after any distribution to the holders of Senior Preferred Stock and prior to and in preference to any distribution to the holders of common stock, $0.001 for each share of Series A Preferred stock then outstanding.

| Series B Preferred: | In the event of any liquidation, dissolution, or winding up of our operations, either voluntary or involuntary, subject to the rights of the Series A Preferred stock and Senior Preferred Stock, the holders of Series B Preferred stock shall be entitled to receive, after any distribution to the holders of Senior Preferred Stock and prior to and in preference to any distribution to the holders of common stock, $0.001 for each share of Series B Preferred stock then outstanding.

| ● Voting

The holders of shares of Series A Preferred stock and Series B Preferred stock shall have one vote for each share of Series A Preferred stock and Series B Preferred stock held by them.

| ● Conversion

Initially, each share of Series A Preferred stock and each share of Series B Preferred stock was convertible into one share of our common stock. Any modification to the conversion rate requires shareholder approval (see below). On March 31, 2009, our shareholders approved a resolution to increase the authorized share capital, and to increase the conversion ratio to 480.63 shares of common stock for each share of Series A Preferred stock and to 132.07 shares of our common stock for each shares of Series B Preferred stock, thus completing the restructuring begun in December 2008.
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Conversion of Preferred Stock Issued to Common Stock
On April 24, 2009, we initiated the process of allowing the shareholders of our preferred stock to convert the Series A and B Preferred stock to shares of our common stock. In order to convert the preferred stock to common stock each preferred stock shareholder is required to submit the preferred stock certificate to our transfer agent and request conversion to common stock. The conversion to common stock is not mandatory and shareholders who own preferred stock may choose not to convert their preferred stock to shares of our common stock. The following table summarizes the amounts at December 31, 2012:

|  | Shares of Preferred Stock Not Exchanged as of December 31, 2012 |  |  | Conversion Ratio |  |  | Shares of Common Stock after Conversion of all Outstanding Shares of Preferred Stock Not yet Exchanged at December 31, 2012 |
Series A Preferred stock |  |  | 83 |  |  |  | 480.63 |  |  |  | 39,892 |
Series B Preferred stock |  |  | 95 |  |  |  | 132.07 |  |  |  | 12,547 |
Total remaining not exchanged |  |  | 178 |  |  |  |  |  |  |  | 52,439 |

10. | Stock-Based Compensation

We have several approved stock option plans for which stock options and restricted stock awards are available to grant to employees, consultants and directors. All employee and director stock options granted under our stock option plans have an exercise price equal to the market value of the underlying common stock on the grant date. There are no vesting provisions tied to performance conditions for any options, as vesting for all outstanding option grants was based only on continued service as an employee, consultant or director. All of our outstanding stock options and restricted stock awards are classified as equity instruments.
Amortization of Fair Value of Stock Issued to Related Parties for Purchase of Neonode Technologies AB
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 19,800 shares of the Company’s Series A Preferred stock. 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 were employees of us and/or Neonode AB, and as such are related parties.
The fair value of the conversion feature of the 19,800 shares of Series A Preferred shares issued to the related parties to acquire Neonode Technologies AB that was converted to a total of 9,516,447 shares of our common stock was $9.5 million based on our stock price on March 31, 2009, the date our shareholders approved the increased conversion ratio. Because this transaction was essentially the issuance of shares to key employees for their continued service to enhance the Company, the $9.5 million revised fair value of the common stock has been amortized to compensation expense at the rate of $1.6 million per quarter for six quarters beginning January 1, 2009. The amortization of the $9.5 million in compensation expense related the value of the stock issued to the related parties to acquire Neonode Technologies AB was completed on June 30, 2010. For the year ended December 31, 2010 $3.2 million has been recorded as compensation expense in our consolidated statement of operations.
Stock Options
As of December 31, 2012, we had three equity incentive plans:

| ● | The 1996 Stock Option Plan (the “1996 Plan”), which expired in January 2006;
| ● | The 1998 Non-Officer Stock Option Plan (the “1998 Plan”), which expired in June 2008; and
| ● | The 2006 Equity Incentive Plan (the “2006 Plan”).

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We also have one non-employee director stock option plan as of December 31, 2012:

| ● | The 2001 Non-Employee Director Stock Option Plan (the “Director Plan”), which expired in March 2011.

The following table summarizes information with respect to all options to purchase shares of common stock outstanding under the 1996 Plan, the 1998 Plan, the 2006 Plan and the Director Plan at December 31, 2012:

Options Outstanding |  | Options Exercisable |
Range of Exercise Price |  | Number Outstanding at 12/31/12 |  | Weighted Average Remaining Contractual Life (years) |  | Weighted Average Exercise Price |  | Number Exercisable at 12/31/12 |  | Weighted Average Exercise Price |
$ 4.25 |  |  | 1,475,000 |  | 6.3 |  | $ | 4.25 |  | 814,028 |  | $ | 4.25 |
$ 4.26 - $ 7.00 |  |  | 229,000 |  | 6.9 |  | $ | 5.05 |  | 30,751 |  | $ | 5.27 |
$ 7.01 - $ 125.00 |  |  | 11,200 |  | 1.7 |  | $ | 108.75 |  | 11,200 |  | $ | 108.75 |
|  |  | 1,715,200 |  | 6.4 |  | $ | 5.04 |  | 855,979 |  | $ | 5.65 |

A summary of the combined activity under all of the stock option plans is set forth below:

|  | Weighted Average Number of Shares |  |  | Exercise Price Per Share |  |  | Weighted-Average Exercise Price |
Outstanding at January 1, 2010 |  |  | 19,884 |  |  | $ | 35.39 – 687.50 |  |  | $ | 103.63 |
Granted |  |  | -- |  |  | $ | -- |  |  | $ | -- |
Cancelled or expired |  |  | (80 | ) |  | $ | 348.75 |  |  | $ | 348.75 |
Exercised |  |  | -- |  |  | $ | -- |  |  | $ | -- |
Outstanding at December 31, 2010 |  |  | 19,804 |  |  | $ | 35.39 – 687.50 |  |  | $ | 101.36 |
Granted |  |  | -- |  |  | $ | -- |  |  | $ | -- |
Cancelled or expired |  |  | (480 | ) |  | $ | 135.00- 687.50 |  |  | $ | 523.23 |
Exercised |  |  | -- |  |  | $ | -- |  |  | $ | -- |
Outstanding, vested and expected to vest at December 31, 2011 |  |  | 19,324 |  |  | $ | 35.39 – 368.75 |  |  | $ | 92.19 |

Granted |  |  | 1,704,000 |  |  | $ | 4.02 -6.28 |  |  | $ | 4.35 |
Cancelled or expired |  |  | (8,124 | ) |  | $ | 35.39- 368.75 |  |  | $ | 69.36 |
Exercised |  |  | -- |  |  | $ | -- |  |  | $ | -- |
Outstanding, vested and expected to vest at December 31, 2012 |  |  | 1,715,200 |  |  | $ | 4.02 – 125.00 |  |  | $ | 5.04 |

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The assumptions used to value stock options granted to directors, employees and consultants during the year ended December 31, 2012 are as follows:

|  | For the year |
|  | ended December 31, 2012 |
Annual dividend yield |  |  | - |
Expected life (years) |  |  | 3.8 – 4.3 |
Risk-free interest rate |  |  | 0.43% - 0.62 | %
Expected volatility |  |  | 169% - 187 | %

The aggregate intrinsic value of the 1,715,200 stock options that are outstanding, vested and expected to vest at December 31, 2012 is $909,800.
During the years ended December 31, 2012, 2011 and 2010, the Company recorded $3.4 million, $87,000 and $142,000, respectively, of compensation expense related to the vesting of stock options. The fair value of the stock-based compensation was calculated using the Black-Scholes option pricing model as of the grant date of the stock option.
The 1996 Plan terminated effective January 17, 2006, and the 1998 Plan terminated effective June 15, 2008. Although we can no longer issue stock options out of the plans, the outstanding options at the date of termination will remain outstanding and vest in accordance with their terms. Options granted under the Director Plan vest over a one to four-year period, expire five to seven years after the date of grant and have exercise prices reflecting market value of the shares of our common stock on the date of grant. Stock options granted under the 1996, 1998 and 2006 Plans are exercisable over a maximum term of ten years from the date of grant, vest in various installments over a one to four-year period and have exercise prices reflecting the market value of the shares of common stock on the date of grant.
On January 30, 2012, the Board of Directors of Neonode Inc. (“Board”) adopted an amendment to the 2006 Plan to increase the number of shares of common stock authorized for issuance under the 2006 Plan by an additional two million (2,000,000) shares.
We granted 169,000 stock options to purchase shares of our common stock to a consultant during the year ended December 31, 2012.
We also granted 1,175,000 stock options to purchase shares of our common stock to our employees and 360,000 stock options to purchase shares of our common stock to members of our Board during the year ended December 31, 2012.
We did not grant any options to purchase shares of our common stock to employees, consultants or members of our Board during the years ended December 31, 2011 and 2010.
Warrants
During 2012, certain warrant holders exercised their warrants under the cash and net cash provisions, as defined in the agreements. See Note 9 for details of such exercises and number of common stock shares issued.
On December 3, 2010, we issued 120,000 warrants at an exercise price of $1.63 per share to an employee. The fair value of the warrants was $198,000 on the date of grant, using the Black-Scholes option pricing model, which has been amortized to expense over 24 months. During the years ended December 31, 2012, 2011 and 2010, we recorded $91,000, $99,000 and $8,000, respectively, of stock based compensation expense related to vesting of such warrants.
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We issued 80,000 five-year stock purchase warrants at an exercise price of $2.50 per share to our legal advisor during the year ended December 31, 2011. We also issued 20,000 three-year stock purchase warrants at an exercise price of $2.00 per share to one of our U.S. based employees during the year ended December 31, 2011. In addition, we issued 20,000 three-year stock purchase warrants at an exercise price or $4.05 per share to an engineering consultant during the year ended December 31, 2011. These warrants to purchase an aggregate of 120,000 shares of our common stock vested on the date of grant. The vested warrant granted to our legal advisor has a fair value on the date of grant of $193,000 and is included in general and administrative expense for the year ended December 31, 2011. The vested warrant granted to our employee has a fair value on the date of grant of $37,000 and is included in product research and development expense for the year ended December 31, 2011. The vested warrant granted to our engineering consultant has a fair value on the date of grant of $73,000 and is included in product research and development expense for the year ended December 31, 2011.
We issued 20,000 three-year stock purchase warrants at an exercise price of $3.90 per share with a vesting period over 24 months to an employee during the year ended December 31, 2011. The unvested warrant granted to an employee has a fair value on the date of grant of $75,000. This amount will be expensed over the vesting period and $38,000 and $11,000 of expense related to this warrant is included in product research and development expense for the year ended December 31, 2012 and 2011, respectively. The fair value of stock-based compensation related to the issuance of warrants is calculated using the Black-Scholes option pricing model as of the grant date of the underlying warrant.
The stock-based compensation expense for the years ended December 31, 2012, 2011 and 2010 reflects the fair value of the vested portion of options and warrants granted to directors, employees and non-employees. Stock-based compensation expense for the year ended December 31, 2010 also includes $3.2 million of amortization of the value of stock issued to related parties for the purchase of Neonode Technologies AB. Stock-based compensation expense in the accompanying consolidated statements of operations is as follows (in thousands):

|  | Year ended |
|  | December 31, |
|  | 2012 |  |  | 2011 |  |  | 2010 |
Product research and development |  | $ | 315 |  |  | $ | 11 |  |  | $ | - |
Sales and marketing |  |  | 1,407 |  |  |  | 99 |  |  |  | 140 |
General and administrative |  |  | 1,777 |  |  |  | 440 |  |  |  | 5,290 |
Stock compensation expense |  | $ | 3,499 |  |  | $ | 550 |  |  | $ | 5,430 |

|  | Remaining unamortized expense at December 31, 2012 |
Stock-based compensation |  | $ | 3,568 |

The remaining unamortized expense related to stock options and warrants will be recognized on a straight line basis monthly as compensation expense over the remaining vesting period which approximates 1.9 years.
A summary of all warrant activity is set forth below:

Outstanding and exercisable |  | Warrants |  |  | Weighted Average Exercise Price |  |  | Weighted Average Remaining Contractual Life
January 1, 2011 |  |  | 5,139,489 |  |  | $ | 1.27 |  |  |  | 3.23 |
Issued |  |  | 809,543 |  |  |  | 3.08 |  |  |  | - |
Expired/forfeited |  |  | - |  |  |  | - |  |  |  | - |
Exercised |  |  | (543,426 | ) |  | $ | 1.04 |  |  |  | - |
December 31, 2011 |  |  | 5,405,606 |  |  | $ | 1.57 |  |  |  | 2.45 |
Issued |  |  | - |  |  |  | - |  |  |  | - |
Expired/forfeited |  |  | (232) |  |  |  | 31.75 |  |  |  | - |
Exercised |  |  | (700,738 | ) |  | $ | 1.18 |  |  |  | - |
Outstanding and exercisable, December 31, 2012 |  |  | 4,704,636 |  |  | $ | 1.61 |  |  |  | 1.41 |

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During the year ended December 31, 2010, we issued additional convertible debt with warrants and also warrants to a broker. Prior to December 13, 2010, we did not have sufficient unissued authorized shares to settle all outstanding equity instruments, and the warrants were classified as liabilities (see Notes 6 and 7).
As a result of the issuance of convertible notes in early October 2009, we no longer had enough unissued authorized shares to settle all outstanding equity instruments, including convertible preferred stock, convertible debt, options and warrants. Therefore, in accordance with the applicable accounting guidance, all non-employee warrants were required to be recorded as liabilities from that point and marked-to-market at each period until we had sufficient unissued authorized shares to settle all outstanding equity instruments. As a result, we reclassified the fair value of all non-employee warrants not already recorded as liabilities totaling $837,000 as of October 1, 2009 from additional paid-in-capital to embedded derivatives of convertible debt and warrants. The warrants issued to the holders in financings were originally recorded as derivative liabilities as we did not have sufficient authorized unissued shares of common stock to settle all outstanding equity instruments. On December 13, 2010, the Company increased its authorized shares of common stock to cover all potentially dilutive instruments outstanding. As a result, on December 9, 2010, the Company reclassified the fair value of the warrants on that date, totaling $4.3 million to additional paid-in capital, as warrants no longer qualified as derivative instruments.
On September 22, 2010, we issued 5-year warrants to purchase 6,400 shares of our common stock at an exercise price of $1.00 per share to holders of our Senior Convertible Secured Notes – 2007 to extend the maturity date of the notes until April 26, 2011. The fair value of the warrants to purchase 6,400 shares of common stock was $28,000 on the date of issuance and was recorded as expense component of the loss on extinguishment of debt in the accompanying consolidated statement of operations for the year ended December 31, 2010. The warrants were valued using the Black-Scholes option pricing model. The assumptions used for the Black-Scholes option pricing model are a term of 4.98 years, volatility of 162.45%, and a risk-free interest rate of 1.95%.
On September 24, 2010, we issued a warrant to purchase 6,933 shares of our common stock at an exercise price of $1.00 per share to an investor for services provided for the private placement of convertible notes and warrants in the 2010 financing transaction (see Note 6).
On September 27, 2010, we issued a warrant to purchase 15,000 shares of our common stock at an exercise price of $1.00 per share to an investor for services provided for the private placement of convertible notes and warrants in the 2010 financing transaction (see Note 6).
We granted 440,000 stock purchase warrants to our U.S. based employees or members of our Board during the year ended December 31, 2010. The stock purchase warrants have an exercise price equal to $1.38 to $1.63 per shares, which was the market price on the date of grant, October 15, 2010 and December 3, 2010. These stock purchase warrants have a three to five-year term. Warrants to purchase 320,000 shares of our common stock are vested on the date of grant and a warrant to purchase 120,000 shares of our common stock vests over 24 months at the rate of 5,000 shares per month, beginning December 2010. The vested warrants granted to employees had a fair value on the date of grant of $660,000. Approximately $470,000 and $99,000 of the fair value is included in general and administrative expense for the years ended December 31, 2010 and 2011, respectively, and the remaining $90,750 has been amortized to expense on a straight-line monthly basis over the year ended December 31, 2012. The fair value of stock-based compensation related to the employee warrants is calculated using the Black-Scholes option pricing model as of the grant date of the underlying warrant.
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We sold 1,200,000 stock purchase warrants to our Swedish based employees or members of our Board during the year ended December 31, 2010 for approximately $49,000. The stock purchase warrants have an exercise price equal to $1.38 per shares, which was the market price on the date of grant, October 15, 2010. These stock purchase warrants have a three-year term and were vested on the date of the sale. The stock underlying the stock purchase warrants granted to employees or members of our Board has not been registered for resale. The vested warrants granted to employees had a fair value on the date of grant of $1.7 million and is included in general and administrative expense for the year ended December 31, 2010. The fair value of stock-based compensation related to the employee warrants is calculated using the Black-Scholes option pricing model as of the grant date of the underlying warrant.
During September and October 2010, we entered into two different types of amendments with the holders of the convertible notes and stock purchase warrants issued in the Fall of 2009 and Spring of 2010 financing transactions. All of the holders of the convertible notes entered into an amendment pursuant to which the due date of the convertible notes was extended until June 30, 2011. A majority of the holders of the stock purchase warrants entered into an amendment pursuant to which they exercised their previously granted warrants at a discounted exercise price of $0.88 per share and was granted a replacement three-year warrant for each original warrant exercised. A total of 2,766,857 of the original warrants were exercised at the discounted exercise price of $0.88 per share and a total of $2,384,554 was raised by the Company through these exercises of the original warrants. We issued a total of 2,766,857 shares of common stock and replacement warrants to the exercising warrant holders with an exercise price of $1.38 per share.
In the year ended December 31, 2011, the Company issued 422,830 new five-year common stock purchase warrants, with an exercise price of 3.13 per share (see Note 6).
In March 2011, the Company entered into a warrant agreement with investors who participated in the Company’s 2009 and 2010 financing transactions and who had been issued common stock purchase warrants with exercise prices of $0.50 per share, $1.00 per share, and $1.38 per share (the “2009 and 2010 Warrants”). Pursuant to the warrant agreement, each warrant holder who exercised some or all of its outstanding 2009 and 2010 Warrants at the applicable exercise price ($0.50 per share, $1.00 per share, and/or $1.38 per share), received a number of March 2011 Warrants equal to fifty percent (50%) of the number of 2009 and 2010 Warrants exercised by such warrant holder. The warrant holders exercised an aggregate of 493,426 outstanding 2009 and 2010 Warrants, for an aggregate investment of $515,000 and received 493,426 shares of common stock and 246,713 new five-year common stock purchase warrants, with an exercise price of $3.13 per share. The March 2011 Warrants may be exercised by cash payment or through cashless exercise by the surrender of warrant shares having a value equal to the exercise price of the portion of the warrants being exercised.
On April 25, 2011, Davisa Ltd. (a related party) exercised warrants to purchase 50,000 shares of common stock. During the year ended December 31, 2011, the Company recorded an additional $50,000 as stock based compensation to compensate Davisa Ltd. by waiving the $1.00 exercise price, and issued 50,000 shares of our common stock to Davisa Ltd. for services provided for the private placement of convertible notes and warrants in the March 2011 financing transaction.
The fair value of stock-based awards is calculated using the Black-Scholes option pricing model, even though this model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which differ significantly from our stock options. The Black-Scholes model also requires subjective assumptions, including future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term and forfeiture rate of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior, as well as expected behavior on outstanding options and warrants. The risk-free rate is based on the U.S. Treasury rates in effect during the corresponding period of grant. The expected volatility is based on the historical volatility of our stock price. These factors could change in the future, which would affect fair values of stock options granted in such future periods, and could cause volatility in the total amount of the stock-based compensation expense reported in future periods.
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Below is a summary of Outstanding Warrants to Purchase Common Stock as of December 31, 2012: |
Description |  | Issue Date |  | Exercise Price |  | Shares |  | Expiration Date |
August 2009 Employee Warrants |  | 8/25/2009 |  | $ | 0.50 |  | 240,000 |  |  | 8/25/2016 |
January 2010 Investor Warrant |  | 1/28/2010 |  | $ | 1.00 |  | 40,000 |  |  | 1/28/2013 |
2007 Debt Extension Warrants |  | 9/22/2010 |  | $ | 1.00 |  | 16,000 |  |  | 9/22/2015 |
September 2010 Repricing Warrant |  | 9/28/2010 |  | $ | 1.38 |  | 4,000 |  |  | 9/28/2013 |
October 2010 Repricing Warrants |  | 10/18/2010 |  | $ | 1.38 |  | 2,137,593 |  |  | 10/18/2013 |
October 2010 Employee Warrants |  | 10/15/2010 |  | $ | 1.38 |  | 1,280,000 |  |  | 10/15/2013 |
December 2010 Employee Warrants |  | 12/3/2010 |  | $ | 1.63 |  | 200,000 |  |  | 12/3/2015 |
January 2011 Employee Warrant |  | 1/21/2011 |  | $ | 2.00 |  | 20,000 |  |  | 1/21/2014 |
February 2011 Legal Advisor Warrant |  | 2/22/2011 |  | $ | 2.50 |  | 80,000 |  |  | 2/22/2016 |
March 2011 Investor Warrants |  | 3/9/2011 |  | $ | 3.13 |  | 612,943 |  |  | 3/9/2016 |
March 2011 Investor Warrants |  | 4/7/2011 |  | $ | 3.13 |  | 34,100 |  |  | 4/7/2016 |
May 2011 Consultant Warrant |  | 5/17/2011 |  | $ | 4.05 |  | 20,000 |  |  | 5/17/2014 |
September 2011 Employee Warrant |  | 9/12/2011 |  | $ | 3.90 |  | 20,000 |  |  | 9/12/2014 |
Total Warrants Outstanding |  |  |  |  |  |  | 4,704,636 |  |  |  |

11. | Commitments and Contingencies

| Indemnities and Guarantees

We have agreed to indemnify each of our executive officers and directors for certain events or occurrences arising as a result of the officer or director serving in such capacity. The term of the indemnification period is for the officer's or director's lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. However, we have a directors’ and officers’ liability insurance policy that should enable us to recover a portion of future amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal and have no liabilities recorded for these agreements as of December 31, 2012 and 2011.
We enter into indemnification provisions under our agreements with other companies in the ordinary course of business, typically with business partners, contractors, customers and landlords. Under these provisions we generally indemnify and hold harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of our activities or, in some cases, as a result of the indemnified party's activities under the agreement. These indemnification provisions often include indemnifications relating to representations made by us with regard to intellectual property rights. These indemnification provisions generally survive termination of the underlying agreement. The maximum potential amount of future payments we could be required to make under these indemnification provisions is unlimited. We have not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements. As a result, we believe the estimated fair value of these agreements is minimal. Accordingly, we have no liabilities recorded for these indemnification provisions as of December 31, 2012 and 2011.
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Operating Leases
Neonode Technologies AB has a lease with Vasakronan Fastigheter AB for 2,723 square feet of office space located at Linnegatan 89D, Stockholm, Sweden for approximately $8,000 per month including property tax (excluding VAT). The annual payment for this space equates to approximately $93,000 per year including property tax (excluding VAT). This lease is valid thru December 31, 2014, with a nine month notice period. The contract will be extended for an additional three years if it is not terminated according to the terms in the contract.
On April 15, 2012, Neonode Technologies AB entered into a lease with No Picnic for 2,853 square feet of office space located at Storgatan 23C, Stockholm, Sweden for approximately $14,000 per month including property tax (excluding VAT). The annual payment for this space equates to approximately $174,000 per year including property tax (excluding VAT). This lease is valid through April 15, 2013.
On March 22, 2012, we entered into a three year lease with 2350 Mission Investors LLC for 3,185 square feet of office space located at 2350 Mission College Blvd, Suite 190, Santa Clara, CA 95054 USA. The initial lease payment is $7,007 per month, increasing to $7,657 per month over the term of the lease. This lease is valid through July 31, 2015. The annual payment for this space equates to approximately $86,000 per year.
For the years ended December 31, 2012, 2011 and 2010, the Company recorded approximately $400,000, $167,000 and $103,000, respectively for rent expense.
A summary of future minimum payments under operating lease commitments as of December 31, 2012 is as follows (in thousands):

Year ending December 31, |  | Total |
2013 |  | $ | 230 |
2014 |  |  | 181 |
2015 |  |  | 53 |
|  | $ | 464 |

12. | Segment Information

The Company has one reportable segment, which is comprised of the touchscreen technology licensing business. All of our sales for the years ended December 31, 2012, 2011 and 2010 were to customers located in the U.S., Europe and Asia.
The following table presents net revenues by geographic region for the years ended December 31, 2012, 2011 and 2010 (dollars in thousands):

|  | 2012 |
|  | Amount |  |  | Percentage |
Net revenues from customers in the U.S. |  | $ | 3,337 |  |  |  | 47 | %
Net revenues from customers in Europe |  |  | 153 |  |  |  | 2 | %
Net revenues from customers in Asia |  |  | 3,647 |  |  |  | 51 | %
Total |  | $ | 7,137 |  |  |  | 100 | %
|  | 2011 |
|  | Amount |  |  | Percentage |
Net revenues from customers in the U.S. |  | $ | 4,739 |  |  |  | 78 | %
Net revenues from customers in Europe |  |  | 53 |  |  |  | 1 | %
Net revenues from customers in Asia |  |  | 1,275 |  |  |  | 21 | %
Total |  | $ | 6,067 |  |  |  | 100 | %
|  | 2010 |
|  | Amount |  |  | Percentage |
Net revenues from customers in the U.S. |  | $ | -- |  |  |  | -- | %
Net revenues from customers in Europe |  |  | 180 |  |  |  | 41 | %
Net revenues from customers in Asia |  |  | 260 |  |  |  | 59 | %
Total |  | $ | 440 |  |  |  | 100 | %

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13. | Income Taxes

Loss before income taxes was distributed geographically for the years ended December 31, as follows (in thousands):

|  | 2012 |  |  | 2011 |  |  | 2010 |
Domestic |  | $ | (10,283 | ) |  | $ | (16,867 | ) |  | $ | (29,590 | )
Foreign |  |  | 1,121 |  |  |  | (200 | ) |  |  | (1,991 | )
Total |  | $ | (9,162 | ) |  | $ | (17,067 | ) |  | $ | (31,581 | )

The provision for income taxes is as follows for the years ended December 31:

|  | 2012 |  |  | 2011 |  |  | 2010 |
Current |  |  |  |  |  |  |  |  |
Federal |  | $ | - |  |  | $ | -- |  |  | $ | -- |
State |  |  | 2 |  |  |  | 2 |  |  |  | 1 |
Foreign |  |  | 123 |  |  |  | 76 |  |  |  | 44 |
Change in deferred |  |  |  |  |  |  |  |  |  |  |  |
Federal |  |  | (3,653 | ) |  |  | (1,856 | ) |  |  | - |
Federal valuation allowance |  |  | 3,653 |  |  |  | 1,856 |  |  |  | - |
State |  |  | 453 |  |  |  | (206 | ) |  |  | - |
State valuation allowance |  |  | (453 | ) |  |  | 206 |  |  |  |  |
Foreign |  |  | 276 |  |  |  | 122 |  |  |  | - |
Foreign valuation allowance |  |  | (276 | ) |  |  | (122 | ) |  |  | - |
Total current |  | $ | 125 |  |  | $ | 78 |  |  | $ | 45 |

The differences between our effective income tax rate and the U.S. federal statutory federal income tax rate for the years ended December 31, are:

|  | 2012 |  |  | 2011 |  |  | 2010 |
Amounts at statutory tax rates |  |  | 34 | % |  |  | 34 | % |  |  | 34 | %
Non-deductible loss on revaluation of embedded conversion features and extinguishment of convertible debt |  |  | - |  |  |  | (29 | )% |  |  | (24 | )%
Foreign losses taxed at different rates |  |  | 1 | % |  |  | 2 | % |  |  | -- |
Stock-based compensation |  |  | (7 | )% |  |  | -- |  |  |  | (5 | )%
Other |  |  | -- |  |  |  | -- |  |  |  | -- |
Total |  |  | 28 | % |  |  | 7 | % |  |  | 5 | %
Valuation allowance |  |  | (29 | )% |  |  | (7 | )% |  |  | (5 | )%
Effective tax rate |  |  | (1 | )% |  |  | -- | % |  |  | -- | %

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Significant components of the deferred tax asset balances at December 31, are as follows (in thousands):

|  | 2012 |  |  | 2011 |
Deferred tax assets: |  |  |  |  |  |
Accruals |  | $ | 873 |  |  | $ | 26 |
Stock compensation |  |  | 1,050 |  |  |  | 1,080 |
Net operating losses |  |  | 6,417 |  |  |  | 4,116 |
Total deferred tax assets |  | $ | 8,340 |  |  | $ | 5,222 |
Basis difference in fixed assets |  |  | (38) |  |  |  | -- |
Valuation allowance |  |  | (8,302 | ) |  |  | (5,222 | )
Total net deferred tax assets |  | $ | -- |  |  | $ | -- |

Valuation allowances are recorded to offset certain deferred tax assets due to management’s uncertainty of realizing the benefits of these items. Management applies a full valuation allowance for the accumulated losses of Neonode Inc., and its subsidiary Neonode Technologies AB, since it is not determinable using the “more likely than not” criteria that there will be any future benefit of our deferred tax assets. This is mainly due to our history of operating losses. Due to the reorganization, the Company believes that the U.S. net operating losses and credits would be subject to the provisions of Section 382 and therefore subject to strict limitations. The Company has not completed a study of the limitations and therefore has not included these loss carryforwards or credits in the analysis of the deferred tax assets. At December 31, 2012, the Company has federal, state and foreign net operating losses of $17.8 million, $8.5 million and $0, respectively. The federal loss carryforward begins to expire in 2029, the California loss carryforward begins to expire in 2019 and the foreign loss carryforward is indefinite. On December 9, 2008, Neonode AB filed for liquidation under the Swedish bankruptcy laws and effective with the filing we are no longer responsible for the liabilities and no longer have any ownership interest in the assets of Neonode AB, including any tax net operating loss carryforwards.
Utilization of the net operating loss and tax credit carryforwards is subject to an annual limitation due to the ownership percentage change limitations provided by Section 382 of the Internal Revenue Code and similar state provisions. The annual limitation may result in the expiration of the net operating losses and tax credit carryforwards before utilization. As of December 31, 2012, the Company has not completed the determination of the amount to be limited under the provision.
As of December 31, 2012, the Company did not recognize $160,000 and $17,000 of federal and state deferred tax assets relating to excess tax benefits for stock-based compensation deductions. Unrecognized deferred tax benefits will be accounted for as a credit to additional paid-in capital when realized through a reduction in income taxes payable.
Effective January 1, 2007, we adopted the provisions of accounting guidance which includes a two-step approach to recognizing, de-recognizing and measuring uncertain tax positions accounted for in accordance with accounting guidance. A reconciliation of the unrecognized tax benefits for the years ended December 31, 2012, 2011 and 2010 is as follows:

Balance at January 1, 2010 |  | $ | - |
Additions for tax positions of prior years |  |  | - |
Reductions for tax position of prior years |  |  | - |
Additions based on tax positions related to the current year |  |  | - |
Decreases - Settlements |  |  | - |
Reductions - Settlements |  |  | - |
Balance at December 31, 2010 |  | $ | - |
Balance at January 1, 2011 |  | $ | - |
Additions for tax positions of prior years |  |  | - |
Reductions for tax position of prior years |  |  | - |
Additions based on tax positions related to the current year |  |  | - |
Decreases - Settlements |  |  | - |
Reductions - Settlements |  |  | - |
Balance at December 31, 2011 |  | $ | - |

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Balance at January 1, 2012 |  | $ | - |
Additions for tax positions of prior years |  |  | - |
Reductions for tax position of prior years |  |  | - |
Additions based on tax positions related to the current year |  |  | - |
Decreases - Settlements |  |  | - |
Reductions - Settlements |  |  | - |
Balance at December 31, 2012 |  | $ | - |

We adopted a policy to classify accrued interest and penalties as part of the accrued tax liability in the provision for income taxes. For the years ended December 31, 2012, 2011 and 2010 we did not recognize any interest or penalties related to unrecognized tax benefits.
Our continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. As of December 31, 2012 and 2011, we had no accrued interest and penalties related to uncertain tax matters.
As of December 31, 2012, we had no uncertain tax positions that would be reduced as a result of a lapse of the applicable statute of limitations. We do not anticipate the adjustments would result in a material change to our financial position.
Payments related to the license agreement with Sony Corporation are net of 10% income tax withholding as required by the Japanese government under the Sweden and Japan international tax treaty. The amounts withheld may be used to offset future payables for income tax in Sweden. In the years ended December 31, 2012, 2011 and 2010, $123,000, $78,000 and $48,000 was withheld, respectively. The amounts withheld expire over five years.
We file income tax returns in the U.S. federal jurisdiction, California and Sweden. The 1997 through 2011 tax years are open and may be subject to potential examination in one or more jurisdictions. We are not currently under any federal, state or foreign income tax examinations.

14. | Employee Benefit Plans

We participate in a number of individual defined contribution pension plans for our employees in Sweden. We contribute five percent (5%) of the employee’s annual salary to these pension plans. Contributions relating to these defined contribution plans for the years ended December 31, 2012 and 2011 were $139,500 and $50,000, respectively. We did not have any defined contribution or other pension plans for our Swedish employees for the year ended December 31, 2010. We match the U.S. employee’s contributions to a 401K retirement plan up to a maximum of six percent (6%) of the employee’s annual salary. Contributions relating to the matching 401K contributions for the year ended December 31, 2012 were $26,900. We did not make any matching contributions to the U.S. employee’s 401K plans in the years ended December 31, 2011 and 2010.

15. | Net Loss Per Share

Basic net loss per common share for the years ended December 31, 2012, 2011 and 2010 was computed by dividing the net loss by the weighted average number of shares of common stock outstanding during the year. Diluted loss per common share is computed by dividing net loss by the weighted average number of shares of common stock and common stock equivalents outstanding during the year.
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Potential common stock equivalents of approximately 4.7 million, 5.4 million and 5.1 million outstanding stock warrants, 52,000, 55,000 and 100,000 shares issuable upon conversion of preferred stock, 1.7 million, 19,000 and 20,000 stock options and 0, 0 and 0.2 million shares issuable upon conversion of notes are excluded from the diluted earnings per share calculation for the years ended December 31, 2012, 2011 and 2010, respectively, due to their anti-dilutive effect.

(in thousands, except per share amounts) |  | Year ended December 31, |
|  | 2012 |  |  | 2011 |  |  | 2010_ |
BASIC AND DILUTED |  |  |  |  |  |  |  |  |
Weighted average number of |  |  |  |  |  |  |  |  |
common shares outstanding |  |  | 33,003 |  |  |  | 26,784 |  |  |  | 18,293 |
Net loss |  | $ | (9,287 | ) |  | $ | (17,145 | ) |  | $ | (31,626 | )
Net loss per shares basic and diluted |  | $ | (0.28 | ) |  | $ | (0.64 | ) |  | $ | (1.73 | )

16. | Related Party Transactions

Mr. Per Bystedt, our Chairman and former Chief Executive Officer, invested a total of $75,000 of the $4.2 million raised in the Senior Convertible Secure Notes -2011 financing transaction and was issued 7,500 March 2011 Warrants to purchase our common stock at an exercise price of $3.13 per share. On December 14, 2011, the Company converted the $75,000 note and $5,337 of related accrued interest, and issued Mr. Bystedt 33,208 shares of our common stock.
On March 31, 2011, Mr. Bystedt and Iwo Jima SARL, a company controlled by Mr. Bystedt, converted $295,434 of 2009 and 2010 convertible notes that were due on June 30, 2010 plus $5,086 of accrued interest to 601,041 shares of our common stock.
On June 30, 2011, the Company issued Mr. Bystedt 572 shares of restricted common stock in lieu of a $1,429 cash interest payment related to the convertible note he purchased in March 2011 (see Note 6).
Employees and relatives of employees of the Company, other than Mr. Bystedt, invested a total of $218,000 of the $4.2 million raised in the March and April 2011 private placement financing transaction and received convertible notes that were converted into 87,364 shares of our common stock and we issued a total of 21,841 March 2011 Warrants to purchase our common stock at an exercise price of $3.13 per share.
Davisa Ltd., a company controlled by Mr. Mats Dahlin who is now a member of the board of directors of the Company and of our wholly owned subsidiary Neonode Technologies AB, participated in the March 2011 warrant exercise agreement and exercised 186,400 warrants with an exercise price of $0.50 per share for $93,200. Davisa Ltd. received 186,400 shares of our common stock and 93,200 March 2011 Warrants to purchase our common stock at an exercise price of $3.13 per share.
On March 9, 2011, Davisa Ltd converted $215,724 of 2009 and 2010 convertible notes that were due on June 30, 2011 plus $2,811 of accrued interest to 437,070 shares of our common stock.
On April 25, 2011, Davisa Ltd. exercised warrants to purchase 50,000 shares of common stock. The Company recorded an additional $50,000 as stock based compensation to compensate Davisa Ltd. by waiving the $1.00 exercise price, and issued 50,000 shares of our common stock to Davisa Ltd. for services provided for the private placement of convertible notes and warrants in the March 2011 financing transaction.
On March 16, 2012, John Reardon, a member of our board of directors, exercised a warrant to purchase 200,000 shares of common stock using the net exercise provision allowed in the warrant and received 174,798 shares of our common stock.
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17. | Subsequent Events

The Company has evaluated subsequent events through the filing of this form 10-K, and determined that no subsequent events have occurred that would require recognition in the consolidated financial statements or disclosure in the notes thereto other than as discussed in the accompanying notes.
Subsequent to December 31, 2012, warrant holders exercised warrants to purchase 106,660 shares of common stock using the net exercise provision allowed in the warrant and received 75,307 shares of our common stock.
In January 2013, we opened Neonode Japan Inc., a wholly owned subsidiary of Neonode Inc. Neonode Japan Inc.’s office is located in Tokyo, Japan. We will serve our customers in Japan through this company. We currently have a Vice President – Sales and General Manager working in this company. We are planning to increase the engineering and sales staffing throughout 2013.
In January 2013, we opened Neonode Americas Inc., a wholly owned subsidiary of Neonode Inc. Neonode Americas Inc.’s office is located in Santa Clara, California. We will serve our customers in the Americas through this company. We currently have ten employees working in this company. We are planning to increase the engineering and sales staffing throughout 2013.
In January 2013, we opened NEON Technology Inc., a wholly owned subsidiary of Neonode Inc. NEON Technology Inc.’s office is located in Santa Clara, California. We will transfer certain user interface (“UI”) and product design patents from Neonode Inc. to NEON Technology Inc.
In February 2013, we opened Neonode UI AB, a wholly owned subsidiary of Neonode Technology AB. Neonode UI AB’s office is located in Stockholm, Sweden. We will provide sales and engineering services to customers of our user interface (“UI”) and product design patents from Neonode UI AB.
On February 26, 2013, David Brunton, CFO, exercised two warrants to purchase a total of 320,000 shares of common stock using the net exercise provision allowed in the warrant and received 266,228 shares of our common stock.
On February 27, 2013, a holder of Series B preferred stock converted 4 shares of series B preferred stock to common stock and received 528 shares of our common stock.
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ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. | CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures
Under the supervision of and with the participation of our management, including the Company’s Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2012. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.
In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Changes in Internal Control over Financial Reporting
During the fourth quarter of 2012, our management has taken the following actions that materially affect, or are reasonably likely to materially affect, our internal control over financial reporting and to remediate the material weaknesses in our internal control over financial reporting previously identified (see below):

● | We enhanced our internal finance and accounting organizational structure, which included hiring additional personnel so that the initiation of transactions, the custody of assets and the recording of transactions are performed by separate individuals to provide adequate segregation of duties within our accounting functions.

● | We engaged a third party consultant with sufficient technical expertise in the area of accounting for income taxes to provide reasonable assurance as to the completeness, accuracy, and review of our consolidated tax provision and disclosures.

● | We enhanced our internal finance and accounting organizational structure, which included hiring additional personnel to provide reasonable assurance as to the translation of our foreign subsidiary operations into U.S. Dollars in our financial consolidation worksheets, specifically related to our accumulated other comprehensive loss.

● | We enhanced our internal finance and accounting organizational structure, which included hiring additional personnel to ensure that the preparation and review of the consolidated statement of cash flows is enhanced.

● | We retained a Sarbanes-Oxley consulting firm to assist us in preparing written policies and procedures for accounting and financial reporting to establish a formal process to close our books and account for all transactions.

Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting has been designed to provide reasonable assurance with respect to the reliability of financial reporting and the presentation of financial statements for external purposes in accordance with generally accepted accounting principles. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected.
Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2012. In making their assessment, our management used the criteria established in the framework on Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations (“COSO”) of the Treadway Commission. Based upon that assessment, our management concluded that our internal control over financial reporting was effective at the reasonable assurance level as of December 31, 2012. The effectiveness of our internal control over financial reporting as of December 31, 2012 has been audited by KMJ Corbin & Company LLP, our independent registered public accounting firm, as stated in their report included herein.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Board of Directors and Stockholders
Neonode Inc.
We have audited the internal control over financial reporting of Neonode Inc. and subsidiary (the "Company") as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on that risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Neonode Inc. and subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Neonode Inc. and subsidiary as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive loss, stockholders' equity (deficit) and cash flows for each of the three years in the period ended December 31, 2012 and our report dated March 14, 2013 expressed an unqualified opinion on those consolidated financial statements.
/s/ KMJ Corbin & Company LLP
Costa Mesa, California
March 14, 2013
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ITEM 9B. | OTHER INFORMATION

None
PART III

ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this Item will be included in the Company’s definitive 2012 Proxy Statement and is incorporated herein by reference.

ITEM 11. | EXECUTIVE COMPENSATION

The information required by this Item will be included in the Company’s definitive 2012 Proxy Statement and is incorporated herein by reference.

ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this Item will be included in the Company’s definitive 2012 Proxy Statement and is incorporated herein by reference.

ITEM13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this Item will be included in the Company’s definitive 2012 Proxy Statement and is incorporated herein by reference.

ITEM 14 | PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this Item will be included in the Company’s definitive 2012 Proxy Statement and is incorporated herein by reference.
PART IV

ITEM 15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES

Financial Statements
The consolidated financial statements of the registrant are listed in the index to the consolidated financial statements and filed under Item 8 of this Annual Report.
Financial Statement Schedules
All financial statement schedules are omitted because the relevant information is not applicable or not present in amounts sufficient to require submission of the schedule or the required information is shown in the consolidated financial statements and the notes thereto included in this Annual Report.
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Exhibit # | Description
3.1 | Amended and Restated Certificate of Incorporation of Neonode Inc., dated April 17, 2009 (incorporated by reference to Exhibit 10.22 of the registrant’s Quarterly Report on Form 10-Q filed on August 4, 2009)
3.1.1 | Certificate of Amendment, dated December 13, 2010 (incorporated by reference to Exhibit 3.1.1 of the registrant’s Annual Report on Form 10-K filed on March 31, 2011)
3.1.2 | Certificate of Amendment, dated March 18, 2011 (incorporated by reference to Exhibit 3.1 of the registrant’s Current Report on Form 8-K filed on March 28, 2011)
3.1.3 | Certificate of Correction, dated February 28, 2012 (incorporated by reference to Exhibit 3.1.3 of the registrant’s Annual Report on Form 10-K filed on March 31, 2012)
3.2 | Bylaws, as amended through December 5, 2007 (incorporated by reference as Exhibit 3.2 of the registrant’s Annual Report on Form 10-K filed on April 15, 2008)
4.1 | Certificate of Designations, Preferences and Rights of the Series A and Series B Preferred Stock dated December 29, 2008 (incorporated by reference as Exhibit 4.1 of the registrant’s Current Report on Form 8-K filed on December 31, 2008)
4.2 | Certificate of Increase of Designation of Series B Preferred Stock dated January 2, 2009 (incorporated by reference as Exhibit 4.2 of the registrant’s Quarterly Report on Form 10-Q filed on October 31, 2011)
4.3 | Certificate of Increase of Designation of Series B Preferred Stock dated January 28, 2009 (incorporated by reference as Exhibit 4.3 of the registrant’s Quarterly Report on Form 10-Q filed on October 31, 2011)
10.1 | Form of Common Stock Purchase Warrant (incorporated by reference to Exhibit 10.3 of the registrant’s Current Report on Form 8-K filed on February 23, 2010)
10.2 | Form of Common Stock Purchase Warrant (incorporated by reference to Exhibit 10.3 of the registrant’s Current Report on Form 8-K filed on October 18, 2010)
10.3 | Form of Common Stock Purchase Warrant for the March 2011 Financing (incorporated by reference to Exhibit 10.20 of the registrant’s Annual Report on Form 10-K filed on March 31, 2011)
10.4 | Form of Common Stock Purchase Warrant dated October 15, 2010 +
10.5 | Employment Agreement with David W. Brunton, dated July 1, 2010 +
10.6 | Consulting Agreement with Per Bystedt, dated January 28, 2011 (incorporated by reference as Exhibit 10.17 of the registrant’s Annual Report on Form 10-K filed on March 31, 2011) +
10.7 | Neonode Inc. 2006 Equity Incentive Plan (incorporated by reference to Exhibit 99.1 of the registrant’s Registration Statement on Form S-8 (333-179313) filed on February 2, 2012) +
10.8 | Agreements used in connection with the 2006 Equity Incentive Plan +
21 | Subsidiaries of the registrant
23.1 | Consent of Independent Registered Public Accounting Firm
31.1 | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act Of 2002
31.2 | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act Of 2002
32 | Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *
101.INS | XBRL Instance Document *
101.SCH | XBRL Taxonomy Extension Schema Document *
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document *
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document *
101.LAB | XBRL Taxonomy Extension Label Linkbase Document *
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document *

+ Management contract or compensatory plan or arrangement
* Furnished herewith
67

SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

|  | NEONODE INC. (Registrant)
Date: March 14, 2013 | By: | /s/ David W. Brunton
| David W. Brunton Chief Financial Officer, Vice President, Finance and Secretary

Pursuant to the requirements for the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacity and dates indicated.

Name |  | Title |  | Date
/s/ Thomas Eriksson |  | Chief Executive Officer, |  | March 14, 2013
Thomas Eriksson |  | and Director |  |
|  | (Principal Executive Officer) |  |
/s/ David W. Brunton |  | Chief Financial Officer, Vice President, Finance |  | March 14, 2013
David W. Brunton |  | and Secretary |  |
|  | (Principal Financial and Accounting Officer) |  |
/s/ John Reardon |  | Director |  | March 14, 2013
John Reardon |  |  |  |
/s/ Mats Dahlin |  | Director |  | March 14, 2013
Mats Dahlin |  |  |  |
/s/ Lars Lindqvist |  | Director and Audit Committee Chair |  | March 14, 2013
Lars Lindqvist |  |  |  |
/s/ Per Bystedt |  | Director and Chairman of the Board |  | March 14, 2013
Per Bystedt |  |  |  |

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