neon 5.24.10 [1]

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NEONODE INC. Pure-Play Riding the Rise of the Touch Screen Market

Rob Goldman May, 24 2010 [email protected]

NEONODE, INC. (OTC: BB – NEON - $0.033)

COMPANY SNAPSHOT Neonode Inc. is the leading provider of optical touch screen solutions for hand-held and small to midsize devices. Neonode licenses proprietary hardware design and software, and provides related engineering design services to OEMs, and third-party manufacturers, that enable companies to produce high functionality touch screens at a low cost. zForce™, proprietary patented touch screen technology, is the driving force behind the Company’s success. Neonode Technologies AB, is a wholly owned subsidiary of Neonode, Inc., which is based in Stockholm, Sweden.

KEY STATISTICS

Price as of 5/21/10 $0.033

52 Wk High – Low $0.04–.027

Est. FD Shares Out. 600M

Market Capitalization $19.8M

3 Mo Avg Vol 62,000

Exchange OTC:BB

COMPANY INFORMATION

Neonode, Inc. Linnegatan 89 SE-115, 23 Stockholm Sweden 925-768-0260 www.neonode.com David Brunton, CFO 925-768-0260 [email protected]

INVESTMENT HIGHLIGHTS According to industry research group iSuppli Corp., the global market for touch screen modules is expected to grow from 341M units in 2008 to 833M units in 2013, a roughly 20% CAGR. Revenue is slated to rise from $3.4B to $6.4B during the same timeframe.

Drivers of the touch screen market include mobile phones, laptops, tablet PCs, e-book readers, navigation screens, etc. The proliferation and mass market acceptance of touch screens 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.

With superior patent-protected technology, Neonode is the low-cost, high-performance small – medium sized touch screen solutions provider. Neonode has invested $20M in its zForce™ touch screen technology and it has been in commercial use for five years. Plus, the Company has amassed one of the largest patent and intellectual property rights portfolios in the space.

Neonode is engaged in a highly profitable business model. As a licensor of proprietary hardware design and software to OEMs and ODMs, Neonode should generate 50-60% operating margins next year.

The Company’s hit list includes some of the biggest names in consumer electronics and electronics manufacturing services. Given the inherent low cost, technology, and engineering advantages, and based on its penetration efforts, we believe that Neonode will be cash-flow positive by 4Q10 and could generate $12M in revenue in 2011, based on sales to these global giants.

Neonode is a great inexpensive way to play the explosive growth of the touch screen market. We believe that Neonode will gain critical mass in sales next year and earn at least $6M. We derive our price target of $0.20 based on a 20x multiple to next year’s $6M in EBITDA. We note that our revenue and earnings forecasts could be too conservative. Also, as the Company signs new customers, we deem it likely that Neonode could be acquired for its IP at a significant premium. Thus, we rate NEON a Speculative Buy.

Price Target: $0.20 Rating: Speculative Buy

NEONODE, INC. (OTC: BB – NEON)

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NEONODE: AT A GLANCE

Touch Screen Overview Touch screen technology has a 30-year history of utilization, initially in industry and the military where external peripherals such as mice and keyboards were not effective or practical in specific environments. A touch screen is an electronic visual display screen that detects the location of a “touch” within the visual display screen area of electronic devices such as computer monitors, mobile phones, e-book readers, handheld video games, satellite navigation devices, etc. When touched by hand these screens convert the touch to x and y coordinates and are thus activated, and perform the required task. The use of a touch screen enables users to engage and interact directly with the touch screen without requiring the use of a cursor controlled by a mouse, keyboard or touch pad. In this fashion, no device or instrument such as a stylus needs to be used in conjunction with a unit containing a touch screen. In the mainstream, consumers were originally introduced to the concept of touch screen technology through the use of a stylus as an input tool (versus a finger) with PDAs, tablet PCs, smart phones, and handheld devices. Due to the ease-of-use and functionality, the public at large has embraced the use of touch screen technology with traditional electronic devices. However, the mass proliferation and implementation of touch screen technology reached a new apex in 2007, with the introduction of multi-screen technology featured in the iPhone, by Apple Inc. (NASDAQ: AAPL). Now, according to industry research group iSuppli Corp., the global market for touch screen modules is expected to grow from 341M units in 2008 to 833M units in 2013, a roughly 20% CAGR. Revenue is also slated to rise from $3.4B to $6.4B during the same timeframe. Multi-touch screen technology is an enhancement to the original touch screen technology and allows users to apply multiple finger actions simultaneously onto the screen in order to perform multiple actions or commands. The incredible popularity of the iPhone, and subsequent Apple products such as the iPod Touch and iPad are based upon the functionality of this multi-touch screen technology. Apple holds a trademark over the term multi-touch and owns a patent in multi-touch technology that was awarded in January 2009. (More on this later in this report.)

As the leading provider of optical touch screen solutions for handheld and small-to-midsized devices. Neonode, Inc. is focused exclusively on touch screen technology. Neonode Inc is the holding company that owns 100% of Neonode Technologies AB, with headquarters in Stockholm, Sweden. The Company spent many years and $20 million in development of its proven optical touch screen technology that now has a five-year history of commercial use. Neonode owns seven key patents related to its proprietary zForce™ technology as well as related patents pending. Neonode licenses zForce™ to OEMs (Original Equipment Manufacturers) and ODMs (Original Design Manufacturers) seeking very small and low profile touch screen designs for handheld and medium-sized devices. zForce™ offers these customers the greatest functionality and design flexibility available on the market at the lowest cost. The proliferation of handheld and small-to-mid-sized mobile devices for use in communications, entertainment, and even in the workplace is driving Neonode’s customers and prospects to introduce products that offer new designs and functionality. The Company’s business model is a traditional IP license model, akin to other design firms that license technology for a fee (per unit) with related services billed by the hour. Neonode has a small but growing customer base and expects to announce new design wins in the coming months. At present we believe that Neonode could be cash flow positive beginning in 4Q10, and generate at least $12M in revenue next year with EBITDA of $6M. The Company has nearly two dozen major firms on its hit list and we expect several of them to contract with Neonode for design projects for new products with runs of tens of thousands up to millions over the next 12-18 months.




Leveraging its five years as a successful technology firm known for its innovative touch screen solutions on their proprietary mobile phones, the Company has a small, but growing customer base and a hit list of two dozen firms that represent a who’s who in consumer electronics production and sales. Going forward, we believe that the bulk of license revenue will be generated by customers producing e-book readers, tablet PCs and mobile phones. We estimate that Neonode already has at least 10 firms currently in the evaluation phase and more than a dozen at the RFQ stage, which illustrates the Company’s growing momentum.

The typical sales cycle is 9-18 months with new customers while existing customer lead times are typically 6-9 months. During the initial cycle, there are three phases: Evaluation, Design, and Commercial. In the Evaluation phase, prospects validate the Neonode technology using a Neonode Evaluation kit and may produce short runs. During the design phase, true product development begins, with solution definition occurring as well. This phase tends to be the longest and it should be noted that this phase is where delays typically occur, drawing out the term of the overall cycle. In the final phase, Commercialization, the customer enters into full production mode, and Neonode books license revenue.

The right to use Neonode’s IP and software is typically in the form of a straight license but can be packaged into a chip. The key role for Neonode is to help customers optimize their Neonode touch screen solutions and support the customer in the development of the product. Revenue is generated through the sale of IP and a software license based on number of units that are produced.

Varied Technologies The leading touch screen technologies are Resistive and Capacitive. Resistive touch screens are made of two flexible sheets coated with a resistive material and separated by an air gap or microdots. When contact is made to the surface of the touch screen, the sheets are pressed together, indicating the exact location of the touch. Resistive touch screens have high resolution and thus provide accurate touch control. Since the touch screen responds to pressure on its surface, contact can be made with a finger or any other pointing device. This technology may work best with a stylus although it can support multi-touch inputs. The cost to produce these touch screens tend to be relatively low when compared with capacitive touch screen technologies. Capacitive touch screen panels are comprised of glass coated with a transparent conductor. Since the human body is also a conductor consists of when the surface of the screen is touched, a distortion of the body's electrostatic field occurs, thus prompting a change in capacitance, or ability of the body to hold a charge. Capacitive touch screens, which are used by Apple and others, are well suited for finger and multi-touch. However, this method is very expensive, does not support stylus instruments and may require a greater thickness of touch. We should note that the most popular subset of this method is known as Projected Capacitive Touch Sensing. The Neonode Approach Neonode produces and sell the best performing and most cost-efficient touch screen solution in the market. As a pure play touch screen technology provider, Neonode targets those OEMs and ODMs focused on the design and production of electronic devices that wish to incorporate touch screen and specifically multi-touch screen technology. With a primary focus on small – medium sized devices, Neonode is poised to garner considerable market share in the mobile phone, e-book reader, digital picture frame, tablet PCs, and portable satellite navigation touch screen segment. Neonode sells the right to use Neonode’s proprietary hardware design and software, which together with standard system components such as PCBs and a system controller from Neonode partners such as Silicon Laboratories (NASDAQ: SLAB) create a complete optical touch screen solution, zForce™.

Detected area

(finger)




zForce™ Competition Lower overall cost Capacitive as much as 65% higher Multi-touch finger support Most Resistive does not support it 100% transparent Use touch overlay; causes reflections Durable protection (glass) Touch screen overlay can break Low power consumption Greater power consumption in small screens Fast movement capture Limited ability No calibration needed Resistive is temperature sensitive Component based LCD dependent (less durable)

zForce™ We believe that Neonode offers the lowest cost and best performance small – medium sized touch screen solutions available to OEMs and ODMs today. With seven patents and additional related patents pending, $20M already invested in the technology and five years of commercialization, Neonode is not an upstart or new entrant into this arena. On the contrary, its enviable patent portfolio clearly gives customers confidence in the product and keeps Neonode’s cost low. Separately, given that Neonode was awarded certain touch screen patents prior to the Apple multi-touch screen award in 2009, the Company may join Apple as the only firm with such an asset, which may ultimately prove to be a financial windfall for Neonode. Unlike the popular capacitive or resistive technologies, Neonode utilizes an infrared (optical) technology. An infrared touch screen an array of X-Y infrared LED and photo detector pairs around the edges of the screen to detect a disruption in the pattern of LED beams. A major benefit of such a system is that is can detect essentially any input including a finger, gloved finger, stylus or pen. zForce™ uses a small frame around the display with LEDs and photoreceptors on the opposites sides hidden behind a infrared-transparent bezel. A controller sequentially pulses the LEDs to create a grid of infrared light beams across the display. Much like other methodologies, a touch obstructs one or more of the beams which then identify the X and Y coordinates. Neonode offers a paradigm shift in Touch Screen Technology. In our view, zForce™’s advantages over larger firms such as industry leader Synaptics (NASDAQ: SYNA) provide Neonode with outstanding positioning and make the customer’s design decision a no-brainer. These inherent characteristics enable Neonode to replace customers’ Resistive and Capacitive touch screen technology at a lower cost, while maintaining or exceeding existing performance and functionality. Some of these advantages include:




FINANCIALS

Based on its penetration efforts, we believe that Neonode will be cash-flow positive by 4Q10 with $1-2m in sales for the year, and could generate $12M in revenue in 2011. As a licensor of hardware design and software to OEMs and ODMs, Neonode should generate 50-60% operating margins next year, with EBITDA of $6M. Pricing is difficult to quantify at this stage. However, our preliminary forecast reflects our expectation that over the next 12 months, a license fee per unit sold should stay in the $1.00 area, and drop below $1.00 late next year as volumes increase. Our forecasts will become more refined as we head into Q4.

Although our estimated fully diluted share count is currently 600 million, that could rise modestly over the next 12 months, with warrant exercise or debt conversion. However, we believe we have accounted for nearly all of these contingencies. It should be noted that insiders are extremely active in operations and in ownership, as they presently maintain over 40% equity ownership in Neonode.

INVESTMENT RISKS AND COMPETITION

In our view, the greatest risks in the near term are delays in adoption or production. These include a delay in procurement or deployment of existing contracts, or potentially new ones. In addition, production runs could potentially be reduced for reasons having nothing to do with the touch screen functionality or design. Delays in procurement could also lead to customer losses due to competition by other, larger players. The Company may also require working capital to build up its sales and marketing force in order to fully take advantage of the current market conditions and the inherent advantages of its solutions. All of these risks are consistent with companies of Neonode’s size. Neonode has competitors of varying sizes, including Synaptics, the projected capacitive touch sensing leader. Despite its large size, Synaptics utilizes a different model and has a larger cost structure. Moreover, as noted in its 1Q10 report, nearly half of its revenue was generated from the PC channel. Importantly, since Neonode is focused on the high growth high margin small – medium sized touch screen sector, it has limited competition.

VALUATION AND CONCLUSION

At current prices, Neonode is a great inexpensive way to play the explosive growth of the touch screen market. With superior patent-protected technology, Neonode is the low-cost, high-performance small – medium sized touch screen solutions provider, and is poised to garner meaningful market share over the next 12-18 months. The Company’s zForce™ touch screen technology has tremendous advantages over the competition and the Company has amassed one of the largest patent and intellectual property rights portfolios in the space.

Plus, given that Neonode was awarded certain touch screen patents prior to the Apple multi-touch screen award in 2009, the Company may join Apple as the only firm with such an asset, which may ultimately prove to be a financial windfall for Neonode. An initial windfall would be in the form of the Company gaining attention due to the strength of its IP portfolio, while a later event may be an M&A transaction whose price could be a significant premium to Neonode’s operating or P/E multiple.

In any event, we believe that Neonode will gain critical mass in sales next year and earn at least $6M on $12M in revenue. We derive our price target of $0.20 based on a 20x multiple to next year’s $6M in EBITDA. We note that our revenue and earnings forecasts could be too conservative. Thus, we rate NEON a Speculative Buy.

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Analyst: Robert Goldman

Rob Goldman has 20 years of investment and company research experience as a senior research analyst and as a portfolio and mutual fund manager. During his tenure as a sell-side analyst, Rob was a senior member of Piper Jaffray's Technology and Communications teams. Prior to joining Piper, Rob led Josephthal & Co.'s Washington-based Emerging Growth Research Group. In addition to his sell-side experience Rob served as Chief Investment Officer of a boutique investment management firm and Blue and White Investment Management, where he managed Small Cap Growth portfolios and The Blue and White Fund. Analyst Certification

I, Robert Goldman, hereby certify that the view expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the recommendations or views expressed in this research report. Disclaimer

This Opportunity Research report was prepared for informational purposes only. Goldman Small Cap Research, (a division of Two Triangle Consulting Group, LLC) produces research via two formats: Goldman Select Research and Goldman Opportunity Research. The Select product reflects the Firm’s internally generated stock ideas while the Opportunity product reflects sponsored research reports. It is important to note that while we may track performance separately, we utilize the same coverage criteria in determining coverage of all stocks in both research formats. While stocks in the Opportunity format may have a higher risk profile, they typically offer greater upside as well. Goldman Small Cap Research has been compensated by the Company or a related party, in the amount of $7,000 for a three month subscription service. The Firm does not accept any equity compensation. All information contained in this report was provided by the Company. Our analysts are responsible only to the public, and are paid in advance to eliminate pecuniary interests, retain editorial control, and ensure independence. Analysts are compensated on a per report basis and not on the basis of his/her recommendations. The information used and statements of fact made have been obtained from sources considered reliable but we neither guarantee nor represent the completeness or accuracy. Goldman Small Cap Research did not make an independent investigation or inquiry as to the accuracy of any information provided by the Company, or other firms. Goldman Small Cap Research relied solely upon information provided by the Company through its filings, press releases, presentations, and through its own internal due diligence for accuracy and completeness. Such information and the opinions expressed are subject to change without notice. A Goldman Small Cap Research report or note is not intended as an offering, recommendation, or a solicitation of an offer to buy or sell the securities mentioned or discussed. This report does not take into account the investment objectives, financial situation, or particular needs of any particular person. This report does not provide all information material to an investor’s decision about whether or not to make any investment. Any discussion of risks in this presentation is not a disclosure of all risks or a complete discussion of the risks mentioned. Neither Goldman Small Cap Research, nor its parent, is registered as a securities broker-dealer or an investment adviser with the U.S. Securities and Exchange Commission or with any state securities regulatory authority. ALL INFORMATION IN THIS REPORT IS PROVIDED “AS IS” WITHOUT WARRANTIES, EXPRESSED OR IMPLIED, OR REPRESENTATIONS OF ANY KIND. TO THE FULLEST EXTENT PERMISSIBLE UNDER APPLICABLE LAW, TWO TRIANGLE CONSULTING GROUP, LLC WILL NOT BE LIABLE FOR THE QUALITY, ACCURACY, COMPLETENESS, RELIABILITY OR TIMELINESS OF THIS INFORMATION, OR FOR ANY DIRECT, INDIRECT, CONSEQUENTIAL, INCIDENTAL, SPECIAL OR PUNITIVE DAMAGES THAT MAY ARISE OUT OF THE USE OF THIS INFORMATION BY YOU OR ANYONE ELSE (INCLUDING, BUT NOT LIMITED TO, LOST PROFITS, LOSS OF OPPORTUNITIES, TRADING LOSSES, AND DAMAGES THAT MAY RESULT FROM ANY INACCURACY OR INCOMPLETENESS OF THIS INFORMATION). TO THE FULLEST EXTENT PERMITTED BY LAW, TWO TRIANGLE CONSULTING GROUP, LLC WILL NOT BE LIABLE TO YOU OR ANYONE ELSE UNDER ANY TORT, CONTRACT, NEGLIGENCE, STRICT LIABILITY, PRODUCTS LIABILITY, OR OTHER THEORY WITH RESPECT TO THIS PRESENTATION OF INFORMATION. For more information, visit our Disclaimer: www.goldmanresearch.com

neon 5.24.10 [1]

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