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 1934For
      the fiscal year ended December 31, 2008oro
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      OF 1934For
      the transition period from to





Commission
File No. 0-8419





NEONODE
INC.


(Exact
name of Registrant as specified in its charter)





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





Sweden Linnegatan 89, SE-115
23 Stockholm, Sweden


USA 651 Byrdee Way, Lafayette,
CA. 94549


(Address
of principal executive offices and Zip Code)





Sweden+ 46 8 667 17
17


USA + 1 925 768
0620


(Registrant's
Telephone Numbers, including Area Code)





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





Title
      of Each Class
              Name
      of Each Exchange on Which RegisteredCommon
      Stock
              NONE





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





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





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes  ̈ No ý





Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days. Yes ý
No  ̈




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein and will not be contained, to the best of
the registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. o





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definitions of “large accelerated filer”, “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.




Large
      accelerated filer  ̈
              Accelerated
      filer  ̈Non-accelerated
      filer  ̈
              Smaller
      reporting company ý





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act. Yes  ̈ No ý





The
approximate aggregate market value of the common stock held by non-affiliates of
the registrant, based on the closing price for the registrant’s common stock on
June 30, 2008 (the last business day of the second quarter of the registrant’s
current fiscal year) as reported on the Nasdaq Capital Markets, was $7,278,950.





The
number of shares of the registrant’s common stock outstanding as of March 23,
2009 was 37,009,589.


The
number of shares of the registrant’s Series A Preferred stock outstanding as of
March 23, 2009 was 855,522.96.


The
number of shares of the registrant’s Series B Preferred stock outstanding as of
March 23, 2009 was 92,795.94.





DOCUMENTS
INCORPORATED BY REFERENCE





None




2


NEONODE
INC.





2008
ANNUAL REPORT ON FORM 10-K





TABLE
OF CONTENTS




PART IItem 1.
                BUSINESS
                4Item 1A.
                RISK
      FACTORS
                13Item
      1B.
                UNRESOLVED
      STAFF COMMENTS
                18Item 2.
                PROPERTIES
                18Item 3.
                LEGAL
      PROCEEDINGS
                19Item 4.
                SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
                19PART IIItem 5.
                MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES
                20Item 6.
                SELECTED
      FINANCIAL DATA
                20Item 7.
                MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
                21Item 7A.
                QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
                35Item 8.
                FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA
                35Item 9.
                CHANGES
      AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE
                79Item 9A.
                CONTROLS
      AND PROCEDURES
                79Item 9B.
                OTHER
      INFORMATION
                80PART IIIItem 10.
                DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
                80Item 11.
                EXECUTIVE
      COMPENSATION
                86Item 12.
                SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS
                90Item 13.
                CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE
                92Item 14.
                PRINCIPAL
      ACCOUNTING FEES AND SERVICES
                93PART IVItem 15.
                EXHIBITS,
      FINANCIAL STATEMENT SCHEDULES
                95SIGNATURES
                96




3


SPECIAL
NOTE ON FORWARD LOOKING STATEMENTS





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





PART
I




ITEM
      1.
            BUSINESS





We
are providing optical touchscreen solutions for handheld devices. The
cornerstone of our solutions is our innovative optical infrared touchscreen
technology, zForceTM. We believe that keyboards and keypads with moving parts
will become obsolete for handheld devices and that our touchscreen solutions
will be at the forefront of a new wave of finger-based input technologies that
will enable the user to interact and operate everything from small mobile
devices to large industrial applications using a combination of touches, swipes,
and hand gestures.





Our
History and Restructuring





Neonode
Inc., formerly known as SBE, Inc., was incorporated in the state of Delaware on
September 4, 1997.





On
January 11, 2007, SBE, Inc. entered into an Agreement for the Purchase and Sale
of Assets with One Stop Systems, Inc., a manufacturer of industrial-grade
computing systems and components (One Stop), pursuant to which SBE Inc sold all
of the assets associated with its embedded hardware business (excluding cash,
accounts receivable and other excluded assets specified in the asset purchase
agreement) to One Stop for approximately $2.2 million in cash plus One Stop’s
assumption of the lease of SBE, Inc.’s corporate headquarters building and
certain equipment leases.





On August
10, 2007, Cold Winter Acquisition Corporation (Cold Winter Acquisition Sub), a
Delaware corporation and wholly-owned subsidiary of SBE, Inc., consummated a
merger and reorganization where Cold Winter Acquisition Sub was merged with and
into Neonode Inc. a Delaware Corporation (Old Neonode), with Old Neonode
continuing after the merger as the surviving corporation and a wholly-owned
subsidiary of SBE, Inc. (Merger). SBE, Inc.’s name was subsequently changed to
“Neonode Inc.” in connection with the completion of the Merger.





Old
Neonode was incorporated in the State of Delaware in 2006 and was the parent of
Neonode AB, a company founded in February 2004 and incorporated in
Sweden.





After the
Merger with Cold Winter Acquisition Sub, Old Neonode changed its name to Cold
Winter, Inc. (Cold Winter).  Following the closing of the Merger, the
business and operations of Cold Winter prior to the Merger became the primary
business and operations of the newly-combined company. The newly-combined
company’s headquarters was located in Stockholm, Sweden.


4


Through
our wholly owned subsidiary, Neonode AB, we developed our touchscreen technology
and an optical touchscreen mobile phone product, the Neonode N2, which provided
a completely unique user experience that did not require any keypads, buttons,
or other moving parts.  We began shipping the N2 to our first
customers in July 2007 but faced difficult circumstances in finding a viable
market for our N2 mobile phone. . We faced a competitive landscape in which our
major competitors were much better positioned and capitalized. Over time, we
found that we lacked the requisite marketing and co-marketing funding to enter
the mainstream mobile phone handset markets and as a result were forced to focus
our sales efforts on web based sales and smaller less efficient
markets.   In addition, as a result of some technology issues
that impacted the N2 phone reception in certain geographical regions (reception
in certain geographical regions had more static, but the N2 phones still
functioned). Beginning March 2008, we began to initiate a voluntary recall of
our N2 phones to provide a solution to eliminate the static reception issues of
our phones.  The voluntary recall slowed our ability to market our
phones in the certain geographical regions until the voluntary recall process
was completed in May 2008.





Neonode
AB filed for liquidation under the Swedish bankruptcy laws on December 9, 2008
and as of that date ceased to be owned and operated by Neonode Inc. Effective
with Neonode AB’s bankruptcy filing on December 9, 2008, Neonode Inc. is no
longer in the mobile phone business and there are no known financial obligations
related to the accounts payable or other debts of Neonode AB that Neonode Inc
has responsibility. The operations of Neonode AB are included in the
consolidated accounts of Neonode until December 9, 2008.  As of
December 31, 2008, the Swedish bankruptcy court continues to pursue sales
opportunities for Neonode AB’s remaining inventory of N2 mobile phones. Although
we may be the beneficiary of a portion of any sales proceeds from such sales,
the majority of any future sales proceeds from the sale of the N2s in Neonode
AB’s inventory will be distributed to the creditors of Neonode AB by the Swedish
bankruptcy court.





AB
Cypressen nr 9683 (Cypressen), a company incorporated in Sweden, was acquired by
Neonode Inc. on December 29, 2008 and became a wholly owned subsidiary on that
date. Neonode issued shares of our Series A Preferred stock to the stockholders
of Cypressen in exchange for all of the outstanding stock of Cypressen. . The
Cypressen Stockholders are or were employees of the Company and/or Neonode AB,
and as such are related parties. Cypressen did not have any operations in 2008.
The Consolidated Balance Sheet of the Company as of December 31, 2008 includes
the accounts of Cypressen which is comprised of cash totaling approximately
$12,000.  The acquisition of Cypressen by Neonode Inc. does not
qualify as a business combination, and accordingly the fair value of the
Preferred Stock Series A shares issued to the sellers of Cypressen shares are
accounted for as compensation.  As there is an 18 month service
requirement, the value of the Series A Preferred Stock is amortized over the 18
month period beginning from December 31, 2008.





We
have not generated sufficient cash from the sale of our products or
licensing of our technology to support our operations and have incurred
significant losses. During the twelve months ended December 31, 2008, we raised
approximately $9.6 million net cash proceeds though the sale of our securities,
most recently $1.1 million on December 31, 2008. Unless we are able to increase
our revenues and/or decrease expenses substantially in addition to securing
additional sources of financing, we will not have sufficient cash to support our
operations through the end of 2009.




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





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





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


5


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





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





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





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





·
            On
      December 30, 2008, we entered into a financing transaction in which we
      raised approximately $1.1 million as of December 31, 2008 through the sale
      of shares of Series A Preferred Stock  that are convertible into
      shares of our common stock in accordance with the Company’s Certificate of
      Designations filed with the Delaware Secretary of
  State;





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





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





Current
Business Overview





We
provide optical touchscreen solutions for handheld devices.  Our
touchscreen solutions are based on our optical infrared touchscreen technology
which we refer to as zForceTM.  Our mission is to make the easiest (to use
and integrate), best (functionality and design) and cheapest touch screen
solution for handheld devices. We believe that keyboards and keypads with moving
parts will become obsolete for handheld devices and that our touchscreen
solutions will be at the forefront of a new wave of finger-based input
technologies that will enable the user to interact and operate everything from
small mobile devices to large industrial applications using a combination of
touches, swipes, and hand gestures.





The
Neonode Principle





Our
technology design goal is to deliver a user experience that is cheaper, faster
and easier than the competing touchscreen solutions. To achieve that goal, we
focus on enhancing the experience between the user and the device by providing
the following:


6


·
            Durable,
      precise and fast touchscreen
technology;


·
            Fast,
      fun and easy user interface;


·
            Multi-touch
      finger applications for dragging and
dropping;


·
            Simplified
      user interaction with complex
devices.





We
believe that for both professionals and consumers the mobile device,
particularly the mobile phone, is positioned to become the center of an evolving
digital lifestyle that integrates and enhances the utility of advanced digital
devices such as phone, voice and text mail, digital music, digital video and
still cameras, television, personal digital assistants, web browsing and other
digital devices, into a single mobile handheld computing and communication
device. The attributes of the mobile device that will enable this functionality
include a high-quality user interface, easy access to relatively inexpensive
data storage, the ability to run complex applications, and the ability to
connect easily to a wide variety of other digital devices and to the Internet.
We intend to provide the functionality and ease of integration with a personal
computer (PC) or other media devices, along with a uniquely differentiated
touchscreen user interface, that we hope will position us to offer innovative
integrated digital lifestyle solutions.




Product
Solutions





We
develop touchscreen interface technologies that enrich the user’s experience in
interacting with the user’s mobile computing, communications, and entertainment
devices. Our innovative touchscreen user interfaces can be engineered to
accommodate many diverse platforms and our experience in human factors and
usability can be utilized to improve the features and functionality of our
solutions. Our extensive arrays of technology include software, mechanical and
electrical designs, and pattern recognition and touch sensing
technologies.





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





Technologies





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





zForceTM
has been  patented in several countries and is patent-pending in the
US. It uses infrared light that is projected as a grid over the screen. The
infrared light pulses 120 times a second so the grid is constantly being
refreshed. Coordinates are produced on the screen and are then converted into
mathematical algorithms when a user's fingers move across the screen. This input
method is unique for Neonode and is enabled by the zForceTM
technology.





Currently,
there are two dominate types of touchscreen technologies available in the
market: - capacitive and resistive. Capacitive technology is the technology that
the Apple iPhone uses and resistive technology is what is found on most
stylus-based PDAs.  Resistive technology is pressure sensitive
technology. Best used for detailed work and for selection of a particular spot
on a screen, resistive technology is not useful for sweeping or motion, such as
zooming in and out.  Capacitive technology, which is used on a laptop
computer mouse pad, is very good for sweeping gestures and motion. The screen
actually reacts to the tiny electric impulses of your finger. Capacitive
touchscreens work if the user has unimpeded contact between his finger and the
screen.





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


7





·
            No
      additional layers are added to the screen that dilutes the screen
      resolution and clarity. Layering technology is required to activate the
      capacitive and resistive technologies and can be very
    costly;·
            The
      zForceTM 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 the point sensitive
      stylus based resistive screens;·
            zForceTM,
      an abbreviation for zero force necessary, means that you do not have to
      use any force to select or move items on the screen like you would with a
      stylus;·
            zForceTM
      is cost efficient due to the lower cost of materials and extremely simple
      manufacturing process when compared to the expensive layered capacitive
      and resistive screens; and·
            zForceTM
      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.





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





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





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





NenoTM
includes the following features:





·
            Media
      players for streaming video, movies and music that support all the
      standard applications, including
              WMA,WMV,
      MP3,WAV,DivX and AVI MPEG1⁄4;·
            Internet
      explorer 6.0 browser;·
            Image
      viewer with camera preview and capture;·
            Organizer
      with calendar and task with Microsoft Outlook
    synchronization;·
            Calendar,
      alarm, calculator and call list;·
            Telephony
      manager for voice calls;·
            Messaging
      manager for SMS, MMS, IM and T9;·
            File
      manager;·
            Task
      manager for switching between applications;·
            Notebook;
      and·
            Games.





Intellectual
Property





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





We have
applied for patent protection of our invention named “On a substrate formed or
resting display arrangement” in six countries through a patent cooperation
treaty (PCT) application and in 24 designated countries through an application
to the European Patent Office (EPO). We applied for a patent in Sweden relating
to a mobile phone and have also applied for a patent in the United States
regarding software named “User Interface.”


8


We have
been granted trademark protection for the word NEONODE in the European Union
(EU), Sweden, Norway, and Australia. In addition, we have been granted
protection for the figurative mark NEONODE in Sweden. Additional applications
for the figurative trademark are still pending in Switzerland, China, Russia and
the United States.





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





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





Distribution,
Sales and Marketing





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





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





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





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





Research and Development





We
continue to invest in research and development of current and emerging
technologies that we deem critical to maintaining our competitive position in
the touchscreen user interface markets. Many factors are involved in determining
the strategic direction of our product development focus, including trends and
developments in the marketplace, competitive analyses, market demands, business
conditions, and feedback from our customers and strategic partners. In fiscal
years 2008 and 2007, we spent $3.3 million and $4.4 million, respectively, on
research and development activities.





We carefully monitor innovations in
other technologies and are constantly seeking new areas for application of
zForceTM. We have developed a technology roadmap that we believe will result in a
steady stream of new innovations and areas of use.  We no longer develop mobile phone
products but now focus our development efforts on our touchscreen
technology.


9


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





·
            Software


·
            Optical


·
            Mechanical


·
            Electrical





Overview
of the Touchscreen Market and Competition





Competing
Touchscreen Technologies:





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





·
            Resistive
      (uses conductive and resistive layers separated by thin
    space)


·
            Surface
      acoustic wave (uses ultrasonic waves that pass over the touchscreen
      panel)


·
            Capacitive
      and projected capacitive (a capacitive touchscreen panel is coated with a
      material, typically indium tin oxide that conducts a continuous electrical
      current across the sensor. When the sensor's 'normal' capacitance field
      (its reference state) is altered by another capacitance field, e.g.,
      someone's finger, electronic circuits located at each corner of the panel
      measure the resultant 'distortion' in the sine wave characteristics to
      detect a touch)


·
            Infrared
      (uses infrared beams that are broken by finger or heat from the finger
      sensed from a camera to detect a
touch)


·
            Strain
      gauge  (uses 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 are placed around the edges
      (mostly the corners) of the screen and a light source to create a shadow
      of the finger)


·
            In-cell
      optical touch technology (embeds photo sensors directly into a LCD glass.
      By integrating the touch function directly into an LCD glass the LCD will
      act like a low resolution camera to “see” the shadow of the
      finger)


·
            Dispersive
      signal technology (uses sensors to detect the mechanical energy in the
      glass that occur due to a touch)


·
            Acoustic
      pulse recognition ( uses more than two piezoelectric transducers located
      at some positions of the screen to turn the mechanical energy of a touch
      (vibration) into an electronic
signal)





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





Resistive
Touchscreen Technology:





1.
            Uses
      conductive and resistive layers separated by thin
  space.


2.
            Touch
      creates contact between resistive circuit layers closing a
      switch.


3.
            A
      controller layer is inserted between layers to determine touch
      coordinates.





Advantages:


·
            High
      resolution


·
            Low
      cost


·
            Proven
      solution for low cost touchscreen
applications


·
            Support
      for large screen sizes





Disadvantages:


·
            Not
      fully transparent (more backlight needed=>high power consumption,
      reflections, loss of colors)


·
            Requires
      frequent recalibration to work
properly


10


·
            Large
      frame size (limited active area of the total display area and outer
      dimensions of the device)


·
            Sensitive
      to scratches





Surface
Capacitive Touchscreen Technology





1.
            Two
      sides of a glass substrate are coated with uniform conductive indium tin
      oxide coating (ITO).  Silicon dioxide hard coating is coated on
      the front side of ITO coating layer. There are electrodes on the four
      corners for launching electric
current.


2.
            Voltage
      is applied to the electrodes on the four
  corners.


3.
            A
      finger touches the screen and draws a minute amount of current to the
      point of contact.


4.
            The
      controller precisely calculates the proportion of the current passed
      through the four electrodes and figures out the X/Y coordinate of a touch
      point.





Advantages:


·
            No
      “edge” or bezel on the top of the on the screen
  display


·
            Medium
      to high resolution


·
            Support
      for large screen sizes





Disadvantages:


·
            Expensive,
      typical three to four times the cost of a resistive touchscreen
      solution


·
            Not
      fully transparent (more backlight needed=>high power consumption,
      reflections, loss of colors)


·
            Cannot
      be used with gloves or pen. Only supports
  fingers


·
            Limited
      temperature range for operation


·
            Limited
      capturing speed (for gestures)


·
            No
      multi-touch support





Projected
Capacitive Touchscreen Technology:





1.
            This
      touch technology requires one or more etched ITO layers forming multiple
      horizontal (X) and vertical (Y) electrodes, which derive drive from a
      sensing chip


2.
            AC
      signals drive one axis and the response through the screen cycles back via
      the other electrodes.


3.
            Position
      detection comes by measuring the distribution of the change in signals
      between the X and Y electrodes. Math algorithms then determine the XY
      coordinates of the touch by processing signal-level
  changes





Advantages:


·
            No
      “edge” or bezel on the top of the on the screen
  display


·
            Medium
      to high resolution


·
            Multi-touch
      support





Disadvantages:


·
            Very
      expensive, typical 10 times the cost of a resistive touchscreen
      solution  (only for high end
devices)


·
            Not
      fully transparent (more backlight needed=>high power consumption,
      reflections, loss of colors)


·
            Cannot
      be used with gloves or pen (only support
  fingers)


·
            Limited
      temperature range for operation (not for car navigation systems,
      etc)


·
            Limited
      capturing speed (no support for
gestures)


·
            Limited
      screen size (typical maximum 3-4 inch) due to poor signal to noise ratio
      (SNR)


·
            No
      pen support





Neonode
zForce Touchscreen Technology:





1.
            zForce
      uses a small frame around the display with LEDs and photoreceptors on the
      opposites sides hidden behind a infrared-transparent
  bezel.


11


2.
            A
      controller sequentially pulses the LEDs to create a grid of infrared light
      beams across the display.


3.
            A
      touch obstructs one or more of the beams which identify the X and Y
      coordinates which also give area
information.


4.
            Interpolation
      with analog reading and processing of the signal give multiple touch
      readings/high speed gesture
support.





Advantages:


·
            Multi-touch
      support





·
            Fully
      transparent (maximum display
quality)


·
            Fast
      capturing of movements (support for
gestures)


·
            Support
      for extended temperature range


·
            Support
      for large screen sizes


·
            Low
      cost for high performance





Disadvantages:


·
            Bezel
      height of 0.5 mm (edge around the
display)


·
            No
      pen support





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





Touchscreen
Technologies Competitors:





Company
                  
                  Technology3M
                  
                  Surface
      Capacitive, Dispersive Signal TouchSynaptics
                  
                  CapacitiveRPO
                  
                  Optical
      wave guide with cameraNextwindow
                  
                  Optical
      with cameraZytronic
                  
                  Projective
      CapacitiveTyco
      Electronics
                  
                  Capacitive,
      Resistive, Surface Wave, Surface capacitiveTouch
      International
                  
                  Resistive,
      Projected Capacitive, Surface CapacitiveMass
      Multimedia Inc
                  
                  All
      touchscreen technologiesTPK
                  
                  Acoustic
      Recognition, Force Intuition, Wire Resistive, Digital Wire Resistive
      (provide the capacitive touchscreen for the Apple
  iPhone)





Technology
License Agreements





As of
December 31, 2008, we do not have any technology license agreements with
customers.





Employees





On
December 31, 2008, we were in the process of restructuring and refinancing the
Company and we had three full-time employees. We augment our staffing needs with
consultants as needed. As of February 1, 2009, we had nine full time employees
of which eight are employees of Cypressen. Our employees are located in our
corporate headquarters in Stockholm, Sweden and a branch office the United
States. None of our employees are represented by a labor union. We have
experienced no work stoppages. We believe our employee relations are
positive.


12




ITEM
      1A.
            RISK
      FACTORS




In
addition to the other information in this Annual Report on Form 10-K,
stockholders or prospective investors should carefully consider the following
risk factors:





Risks
Related To Our Business





Our
independent registered public accounting firm issued a going concern opinion on
our financial statements, questioning our ability to continue as a going
concern.





Due to
our need to raise additional financing to fund our operations and satisfy
obligations as they become due, our independent registered public accounting
firm has included an explanatory paragraph in their report on our December 31,
2008 consolidated financial statements regarding their substantial doubt as to
our ability to continue as a going concern. This may have a negative impact on
the trading price of our common stock and adversely impact our ability to obtain
necessary financing.





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





We will
require sources of capital in addition to cash on hand to continue operations
and to implement our business plan. We project that we have sufficient liquid
assets to continue operating until the end of June 2009. We are currently
evaluating different financing alternatives, including but not limited to
selling shares of our common or Preferred stock or issuing notes that may be
converted in shares of our common stock which could result in the issuance of
additional shares.   If our operations do not become cash flow
positive, we will be forced to seek credit line facilities from financial
institutions, additional private equity investment, or debt arrangements. No
assurances can be given that we will be successful in obtaining such additional
financing on reasonable terms, or at all. If adequate funds are not available on
acceptable terms, or at all, we may be unable to adequately fund our business
plan, which could have a negative effect on our business, results of operations,
and financial condition. In addition, if funds are available, the issuance of
equity securities or securities convertible into equity could dilute the value
of shares of our common stock and cause the market price to fall, and the
issuance of debt securities could impose restrictive covenants that could impair
our ability to engage in certain business transactions.





The current worldwide financial and
credit markets are difficult to access.





The continuing crisis in the worldwide
financial and credit markets make it extremely difficult to access sources of
capital or borrowings.   Credit line facilities from financial
institutions, additional private equity investment, and debt arrangements may
not be available to us for some time in the future.  No assurances can
be given that we will be successful in obtaining such additional financing on
reasonable terms, or at all. If adequate funds are not available on acceptable
terms, or at all, we may be unable to adequately fund our business plans, which
could have a negative effect on our business, results of operations, and
financial condition.





Our
wholly owned Swedish subsidiary, Neonode AB, is liquidating under the Swedish
bankruptcy laws





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


13


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





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





·
              the
      growth of  touchscreen interface
  usage;


·
              the
      efforts and success of our OEM and other
  customers;


·
              the
      level of competition faced by us;
and


·
              our
      ability to meet customer demand for engineering support, new technology
      and ongoing service.





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





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





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





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





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




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


14


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





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





We
must significantly enhance our sales and product development
organizations.





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





We are dependent
on the services of our key personnel.





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





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





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





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





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





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 intellectual property claims. 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.


15


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 would reduce our competitive advantage and ability to compete in those
regions and negatively impact our business.





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





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





Changes
in financial accounting standards or practices may cause unexpected fluctuations
in and adversely affect our reported results of operations.




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





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





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





Risks
Related to Owning Our Stock





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.


16


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





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





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





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





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


·
            actual
      or anticipated fluctuations in our operating results or future
      prospects;·
            our
      announcements or our competitors’ announcements of new
      products;·
            the
      public’s reaction to our press releases, our other public announcements
      and our filings with the SEC;·
            strategic
      actions by us or our competitors, such as acquisitions or
      restructurings;·
            new
      laws or regulations or new interpretations of existing laws or regulations
      applicable to our business;·
            changes
      in accounting standards, policies, guidance, interpretations or
      principles;·
            changes
      in our growth rates or our competitors’ growth rates;·
            developments
      regarding our patents or proprietary rights or those of our
      competitors;·
            our
      inability to raise additional capital as needed;·
            concern
      as to the efficacy of our products;·
            changes
      in financial markets or general economic conditions;·
            sales
      of common stock by us or members of our management team;
    and·
            changes
      in stock market analyst recommendations or earnings estimates regarding
      our common stock, other
              comparable
      companies or our industry
generally.




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





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


17


If
our shareholders approve an amendment to our Certificate of Incorporation
to increase the number of shares of authorized stock, then the price of our
common stock may be adversely affected.





Our Board
of Directors has recommended that our shareholders approve an increase in the
number of our authorized shares of common stock and the conversion rates for the
Series A and Series B Preferred Stock that we issued as part of the refinancing
and capital raising transactions that we entered into in December 2008,
including the purchase of AB Cypressen nr 9863.  If approved, the sale of a
significant amount of shares in the open market, or the perception that these
sales may occur, could cause the trading price of our common stock to decline or
become highly volatile.





Our
common stock has been delisted from the Nasdaq Capital Market and is currently
traded on the OTC Bulletin Board Market. Our stock price and your liquidity may
continue to be impacted.





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





ITEM
      1B.
            UNRESOLVED
      STAFF COMMENTS





None




ITEM
      2.
            PROPERTIES





On
October 22, 2007, our subsidiary Neonode AB entered into a lease agreement with
NCC Property G AB for 9,500 square feet office space at Warfvingsesvag 41,
Stockholm, to be used as the corporate headquarters. The lease period began on
April 1, 2008 and was to expire on March 31, 2013. The annual payment for this
premise was approximately $288,000 per year and was indexed to the consumer
price index in Sweden. As an incentive to enter into the agreement as one of the
first tenants to occupy the building, the NCC Property G AB gave Neonode AB
discounts amounting to approximately $120,000 allocated over the first eight
months of the leasing period. Effective with the bankruptcy filing of Neonode AB
on December 9, 2008, the lease associated with the office space located at
Warfvingsesvag 41, Stockholm was terminated and Neonode Inc. has no further
obligations relating to this lease agreement.





On
October 21, 2007, Neonode AB also entered into a lease agreement with NCC
Property G AB for 10 parking spaces located at Warfvingsesvag 41, Stockholm. The
lease period began on April 1, 2008 and was to expire on March 31, 2013. The
annual payment for these premises amounted to $28,000 per year and was indexed
to the consumer price index in Sweden. Neonode AB had the right to terminate the
lease on March 31, 2011 if notice of termination was given by Neonode AB at
least 9 months prior to March 31, 2011. Effective with the bankruptcy filing of
Neonode AB on December 9, 2008, the lease associated with the parking spaces
located at Warfvingsesvag 41, Stockholm was terminated and Neonode Inc. has no
further obligations relating to this lease agreement.





Prior to
taking occupancy of the facility located at Warfvingsesvag 41, Stockholm,
Sweden, during fiscal year 2007 through March 31, 2008, we occupied 6,000 square
feet of office space in Stockholm under a lease which has now
expired.





On
January 12, 2009, our subsidiary, Cypressen entered into a 12 month lease with
Vasakronan Fastigheter AB for approximately 2,000 square feet of office space
located at Linnegatan 89, Stockholm, Sweden for approximately $5,000 per month.
The annual payment for this space equates to approximately
$60,000.


18


In
addition, we had leased 2,000 square feet of office space in San Ramon,
California on a month-to-month basis at cost of $3,000 per month. We occupied
this space from March 2007 under a lease with One Stop Systems, Inc. We
terminated the month-to-month lease on January 31, 2008 and relocated to office
space located in Lafayette, California that is provided by our Chief Financial
Officer on a rent free basis.  In addition, in connection with the
sale of the SBE, Inc. hardware business, on March 29, 2007, SBE signed a
definitive agreement providing for the assumption of the lease of the prior SBE
San Ramon, California headquarters office space for 22,000 square feet that was
effective with the closing of the sale of the hardware business transaction. As
the result of our merger with SBE, we continue to be secondary guarantor on the
lease for the term of the San Ramon lease which terminates in March
2010.





ITEM
      3.
            LEGAL
      PROCEEDINGS





On September 4, 2008, we received a
summons to appear in the United States District Court for the Southern District
of New York because one of our investors in previous private placements
transactions, Alpha Capital Anstalt (Alpha) alleged that we failed to issue
certain stock certificates pursuant to the terms and conditions of the September
2007 investment subscription agreements. Alpha was asking the court to award
them $734,650 in damages plus attorneys fees. Although we believed the claim had
no merit, we signed a definitive settlement agreement on January 21, 2009 and
issued Alpha 1,096,997 shares of our common stock as settlement in full. On
February 13, 2009 a notice was sent to the Court by Alpha’s legal counsel
requesting dismissal of the action.





On
December 9, 2008, Empire Asset Management (Empire), a broker dealer that acted
as the Company’s financial advisor and exclusive placement agent in previous
private placement transactions, initiated a law-suit against the Company in the
Supreme Court of the State of New York alleging that the Corporation
misrepresented the success of its business with the purpose of inducing Empire’s
customers to invest in the Company.  Empire is seeking compensatory
damages in an unspecified amount for the harm allegedly suffered.  The
Company intends to defend vigorously against the action.





On March
24, 2009, we were informed that a complaint had been filed against the Company
by an investor, Mr. David Berman, who invested $600,000.00 in the Company on
March 4, 2008 and May 16, 2008. We were informed that Mr. Berman invested in the
Company through Empire.  To date the Company has not received a copy
of the complaint, but the Company intends to defend vigorously against the
action.





ITEM
      4.
            SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY
HOLDERS





A special meeting of stockholders was
held on Tuesday, March 31, 2009, at our corporate headquarters office located at
Linnegatan 89, 11523 Stockholm, Sweden.





The
stockholders approved the following three items:





(i)       An
amendment to the Company’s Certificate of Incorporation to effect an increase in
the number of authorized shares of our stock from 77,000,000 to 700,000,000 and
an increase in the number of shares of our common stock from 75,000,000 to
698,000,000.





For
                    
                    Against
                    
                    
                    Abstain19,203,139
                    
                    
                    581,120
                    
                    
                    
                    19,272








(ii)       An
amendment to the Company’s Certificate of Incorporation to increase the
conversion rate of the Series A Preferred Stock such that each share of Series A
Preferred Stock, which has been convertible into 1 share of common stock, is now
convertible into 480.63 shares of common stock.





For
                      
                      Against
                      
                      
                      Abstain19,927,882.20
                      
                      
                      579,875
                      
                      
                      
                      18,672


19





(iii)     An
amendment to the Company’s Certificate of Incorporation to increase the
conversion rate of the Series B Preferred Stock such that each share of Series B
Preferred Stock, which had been convertible into 1 share of common stock, is now
convertible into 132.07 shares of common stock.





For
                      
                      Against
                      
                      
                      Abstain19,926,293.20
                      
                      
                      580,464
                      
                      
                      
                      19,672





PART
II





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




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





For 2008
and 2007 our stock was traded on the Nasdaq Capital Market under the symbol
NEON. The following table presents quarterly information on the price range of
our common stock, indicating the high and low bid prices reported by the Nasdaq
Capital Market. These prices do not include retail markups, markdowns or
commissions. As of December 31, 2008, there were approximately 2,634 holders of
record of our common stock.





Fiscal
      Quarter EndedFiscal
      2008
                      
                      March
      31 (1)
                      
                      
                      June
      30 (1)
                      
                      
                      September
      30 (1)
                      
                      
                      December
      31High
                      
                      $
                      3.70
                      
                      
                      $
                      3.09
                      
                      
                      $
                      0.49
                      
                      
                      $
                      0.19Low
                      
                      
                      1.74
                      
                      
                      
                      0.35
                      
                      
                      
                      0.10
                      
                      
                      
                      0.03Fiscal
      2007(1)High
                      
                      $
                      3.95
                      
                      
                      $
                      4.00
                      
                      
                      $
                      7.94
                      
                      
                      $
                      4.82Low
                      
                      
                      1.70
                      
                      
                      
                      1.62
                      
                      
                      
                      2.85
                      
                      
                      
                      2.89


(1) Prior to our reverse merger with SBE,
Inc. on August 10, 2007, our common stock traded under the symbol SBEI. The
stock prices presented for SBEI for the period prior to August 10, 2007 are
adjusted for a 1 for 5 reverse stock split effective March 29,
2007.





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.


20




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





The
following Management’s Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that involve risks and
uncertainties. Words such as “believes,” “anticipates,” “expects,” “intends” and
similar expressions are intended to identify forward-looking statements, but are
not the exclusive means of identifying such statements. Readers are cautioned
that the forward-looking statements reflect our analysis only as of the date
hereof, and we do not assume any obligation to update these statements. Actual
events or results may differ materially from the results discussed in or implied
by the forward-looking statements. The following discussion should be read in
conjunction with the company’s financial statements for the years ended
December 31, 2008 and 2007 and the related notes included
therein.





Overview





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





Through
our wholly owned subsidiary, Neonode AB, we developed our touchscreen technology
and an optical touchscreen mobile phone product, the Neonode N2 that provided a
unique user experience that did not require any keypads, buttons or other moving
parts. On December 1, 2008, we transferred the Neonode AB intellectual property
including patents, copyrights and trademarks from Neonode AB to Neonode inc.
pursuant to an intercompany debt pledge agreement. On December 9, 2008, Neonode
AB filed for liquidation under the Swedish bankruptcy laws.  Neonode
AB had a total of approximately 10,000 N2 mobile phones in inventory at the time
of its bankruptcy filing. Effective with Neonode AB’s bankruptcy filing on
December 9, 2008, Neonode Inc. is no longer in the mobile phone business and
there are no known financial obligations related to the accounts payable or
other debts of Neonode AB that Neonode Inc has responsibility. The Swedish
bankruptcy court continues to pursue sales opportunities for Neonode AB’s
remaining inventory of N2 mobile phones. Although we may be the beneficiary of a
portion of any sales proceeds from such sales.  The majority of any
future sales proceeds from the sale of the N2s in Neonode AB’s inventory will be
distributed to the creditors of Neonode AB by the Swedish bankruptcy
court.





We
have not generated sufficient cash from the sale of our products or licensing of
our technology to support our operations and have incurred significant losses.
During the twelve months ended December 31, 2008, we raised approximately $9.6
million net cash though the sale of our securities, most recently $1.1 million
on December 31, 2008. Unless we are able to increase our revenues and decrease
expenses substantially in addition to securing additional sources of financing,
we will not have sufficient cash to support our operations through the end of
2009.





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





We have
incurred net operating losses and negative operating cash flows since inception.
As of December 31, 2008, we had an accumulated deficit of $64.6 million. We
expect to incur additional losses and may have negative operating cash flows
through the end of 2009. The report of our independent registered public
accounting firm in respect of the 2008 fiscal year, included elsewhere in this
annual report, includes an explanatory going concern paragraph which raises
substantial doubt to continue as a going concern, which indicates an absence of
obvious or reasonably assured sources of future funding that will be required by
us to maintain ongoing operations. Although we have been able to fund our
operations to date, there is no assurance that our capital raising efforts will
be able to attract the additional capital or other funds needed to sustain our
operations.





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


21


In
addition to the immediate risks relating to our ability to continue as a going
concern and to obtain funding under the current market conditions, we are
subject to certain risks common to technology-based companies in similar stages
of development. See “Risk Factors” above. Principal risks include risks relating
to the uncertainty of growth in market acceptance for our technology, a history
of losses since inception, our ability to remain competitive in response to new
technologies, the costs to defend, as well as risks of losing, patents and
intellectual property rights, a reliance on our future customers’ ability to
develop and sell products that incorporate our technology, the concentration of
our operations in a limited number of facilities, the uncertainty of demand for
our technology in certain markets, our ability to manage growth effectively, our
dependence on key members of our management and development team, our limited
experience in conducting operations internationally, and our ability to obtain
adequate capital to fund future operations.





Accounting
Treatment





2007
Financial Statements





The
merger (Merger) of Old Neonode with our wholly-owned acquisition subsidiary
closed on August 10, 2007. For accounting purposes, the Merger was accounted for
as a reverse merger with Old Neonode as the accounting acquirer. Thus, the
historical financial statements of Old Neonode have become our historical
financial statements and the results of operations of our Company (formerly
known as SBE, Inc.) are included in the results of operations presented
elsewhere and discussed herein only from August 10, 2007. The audited
consolidated financial statements appearing elsewhere in this Annual Report on
Form 10-K and the discussion of our financial condition and results of
operations for the year ended December 31, 2007 appearing below include the
results of operations of formerly SBE, Inc. only from August 10, 2007. Our
consolidated financial statements include Old Neonode’s accounts, those of its
wholly-owned subsidiary, Neonode AB, and, from August 10, 2007, SBE, Inc.’s
accounts and the accounts of SBE, Inc.’s wholly-owned subsidiary Cold Winter,
Inc.





2008
Financial Statements





For 2008,
the audited consolidated statements of operations and cash flows appearing
elsewhere in this Annual Report on Form 10-K and the discussion of our financial
condition and results of operations for the year ended December 31, 2008
appearing below include the results of operations of our former wholly owned
subsidiary, Neonode AB, for the period January 1, 2008 through December 9, 2008,
the date Neonode AB filed for bankruptcy, as subsequent to that date, we no
longer control the operations of Neonode AB.  The audited consolidated
balance sheet as of December 31, 2008 includes the accounts of Neonode Inc. and
its new wholly owned subsidiary, Cypressen, which Neonode Inc. purchased on
December 29, 2008.  Operating results for Cypressen from date of
acquisition to December 31, 2008 has been insignificant.





Critical
Accounting Policies and Estimates





The
preparation of our financial statements are in conformity with generally
accepted accounting principles in the United States of America (GAAP) and
include the accounts of Neonode Inc. and its subsidiary based in Sweden, Neonode
AB, through December 9, 2008, the date Neonode AB filed for bankruptcy. The
balance sheet as of December 31, 2008 includes the accounts of our wholly owned
subsidiary based in Sweden, Cypressen. Operating results for Cypressen from date
of acquisition to December 31, 2008 has been insignificant.  All
inter-company accounts and transactions have been eliminated in consolidation.
Our accounting policies affecting our financial condition and results of
operations are more fully described in Note 2 to our consolidated financial
statements. Certain of our accounting policies require the application of
judgment by management in selecting appropriate assumptions for calculating
financial estimates, which inherently contain some degree of uncertainty.
Management bases its estimates on historical experience and various other
assumptions that are believed to be reasonable under the circumstances, The
historical experience and assumptions form the basis for making judgments about
the reported carrying values of assets and liabilities and the reported amounts
of revenue and expenses that may not be readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions. We believe the following are some of the more critical accounting
policies and related judgments and estimates used in the preparation of our
consolidated financial statements.


22


Revenue
Recognition





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





We
recognize revenue from product sales when title transfers and risk of loss has
passed to the customer, which is generally upon shipment of products to our
customers. We estimate expected sales returns and record the amount as a
reduction of revenues and cost of sales at the time of shipment. Our policy
complies with the guidance provided by the Securities and Exchange Commission’s
Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial
Statements, issued by the Securities and Exchange Commission. We
recognize revenue from the sale of our mobile phones when all of the following
conditions have been met: (1) evidence exists of an arrangement with the
customer, typically consisting of a purchase order or contract; (2) our products
have been delivered and risk of loss has passed to the customer; (3) we have
completed all of the necessary terms of the contract; (4) the amount of revenue
to which we are entitled is fixed or determinable; and (5) we believe it is
probable that we will 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. Judgments are required in evaluating the credit
worthiness of our customers. Credit is not extended to customers and revenue is
not recognized until we have determined that collectibility is reasonably
assured.





To date,
our revenues generated by the sale of Neonode AB’s mobile phones have consisted
primarily by sales to distributors. From time to time, we allowed certain
distributors price protection subsequent to the initial product shipment. Price
protection may allow the distributor a credit (either in cash or as a discount
on future purchases) if there is a price decrease during a specified period of
time or until the distributor resells the goods. Future price adjustments are
difficult to estimate since we do not have a sufficient history of making price
adjustments. Therefore, we deferred recognition of revenue (in the balance sheet
line item “deferred revenue”) derived from sales to these customers until they
resold our products to their customers. Although revenue recognition and related
cost of sales were deferred, we recorded an accounts receivable at the time of
initial product shipment. As standard terms were generally FOB shipping point,
payment terms were enforced from the shipment date, and legal title and risk of
inventory loss passed to the distributor upon shipment.




For
products sold to distributors with agreements allowing for price protection and
product returns, we recognized revenue based on our best estimate of when the
distributor sold the product to its end customer. Our estimate of such
distributor sell-through was based on information received from our
distributors. Revenue was not recognized upon shipment since, due to various
forms of price concessions; the sales price was not substantially fixed or
determinable at that time.





Revenue
from products sold directly to end-users though our web sales channels were
generally recognized when title and risk of loss has passed to the buyer, which
typically occurs upon shipment. Reserves for sales returns are estimated based
primarily on historical experience and were provided at the time of
shipment.





Revenue
for the twelve months ended December 31, 2007 includes revenue from the sales of
our first mobile phone, the N1, and from our second product, the N2 multimedia
mobile phone, and revenue from one licensing agreement with a major Asian
manufacturer. In July 2005, we entered into a licensing agreement with a major
Asian manufacturer whereby we licensed our touchscreen technology for use in a
mobile phone to be included in their product assortment. In this agreement, we
received approximately $2.0 million in return for granting an exclusive right to
use our touchscreen technology over a two-year period that ended July
2007.  The exclusive rights did not limit our right to use our
licensed technology for our own use, nor to grant to third parties rights to use
our licensed technology in devices other than mobile phones. Another component
of the agreement provided for a fee of approximately $2.65 per telephone if the
Asian manufacturer sells mobile phones based on our technology.  In
July 2007, we extended this license agreement on a non-exclusive basis for an
additional term of one year.  As of December 31, 2008, the Asian
manufacturer had not sold any mobile telephones using our
technology.





The net
revenue related to this agreement was allocated over the term of the agreement,
amounting to $463,000 in 2007 and no revenue in 2008 since the initial contract
period ended in July 2007. The contract also included consulting services to be
provided by Neonode on an “as needed basis.” The fees for these consultancy
services varied from hourly rates to monthly rates and were based on reasonable
market rates for such services. To date, we have not provided any consulting
service related to this agreement.


23


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





Neonode
AB derived revenue from the licensing of our internally developed intellectual
property (IP). We 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 included 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. On December 1, 2008, we
transferred the Neonode AB intellectual property including patents, copyrights
and trademarks to Neonode inc. pursuant to an intercompany debt pledge
agreement.





Hardware Product:





We may from time-to-time develop
custom hardware products for our customers that incorporate our touchscreen
technology. Our policy is to recognize revenue from hardware product sales when
title transfers and risk of loss has passed to the customer, which is generally
upon shipment of our hardware products to our customers. We defer and recognize
service revenue over the contractual period or as services are rendered. We
estimate expected sales returns and record the amount as a reduction of revenue
and cost of hardware and other revenue at the time of shipment. Our policy
complies with the guidance provided by the Securities and Exchange Commission
(SEC) Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial
Statements. Judgments are required in evaluating the credit worthiness of
our customers. Credit is not extended to customers and revenue is not recognized
until we have determined that collectibility is reasonably assured. Our sales
transactions are denominated in U.S. dollars or Euros. The software component of
our hardware products is considered incidental.  Therefore, we do not
recognize software revenue related to our hardware products separately from the
hardware product sale. To date, we have not sold any hardware
products.





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





-
            all
      prices are fixed and determinable at the time of
  sale;


-
            title
      and risk of loss pass at the time of shipment (FOB shipping
      point);


-
            collectibility
      of the sales price is probable (the OEM is creditworthy, the OEM is
      obligated to pay and such obligation is not contingent on the ultimate
      sale of the OEM’s integrated
solution);


-
            the
      OEM’s obligation to us will not be changed in the event of theft or
      physical destruction or damage of the
product;


-
            we
      do not have significant obligations for future performance to directly
      assist in the resale of the product by the OEMs;
  and


-
            there
      is no contractual right of return other than for defective
      products.




Software
Products:





We may derive revenues from the
following sources: (1) software, which includes our NenoTM software licenses and
(2) engineering services, which include consulting. We account for the licensing
of software in accordance with American Institute of Certified Public
Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue Recognition.
SOP 97-2 requires judgment, including whether a software arrangement includes
multiple elements, and if so, whether vendor-specific objective evidence (VSOE)
of fair value exists for those elements. These documents include post delivery
support, upgrades, and similar services. To date, we have not sold any software
products.


24


For software license arrangements that
do not require significant modification or customization of the underlying
software, we recognize new software license revenue when: (1) we enter into a
legally binding arrangement with a customer for the license of software; (2) we
deliver the products; (3) customer payment is deemed fixed or determinable and
free of contingencies or significant uncertainties; and (4) collection is
reasonably assured. We initially defer all revenue related to the software
license and maintenance fees until such time that we are able to establish VSOE
for these elements of our software products.  Revenue deferred under
these arrangements is recognized to revenue over the expected contract term. We
will also continue to defer revenues that represent undelivered
post-delivery engineering support until the engineering support has been
completed and the software product is accepted.





Engineering
Services:





We may sell engineering consulting
services to our customers on a flat rate or hourly rate basis. We recognize
revenue as the engineering services stipulated under the contact are completed
and accepted by our customers. To date, we have not sold any engineering
services.





Allowance
for Doubtful Accounts





Our
policy is to maintain allowances for estimated losses resulting from the
inability of our customers to make required payments. Credit limits are
established through a process of reviewing the financial history and stability
of each customer. Where appropriate, we obtain credit rating reports and
financial statements of our customers when determining or modifying their credit
limits. We regularly evaluate the collectibility of our trade receivable
balances based on a combination of factors. When a customer’s account balance
becomes past due, we initiates 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.





Warranty
Reserves





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





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





Research
and Development




Research
and Development (R&D) costs are expensed as incurred. R&D costs are
accounted for in accordance with Statement of Financial Accounting Standards
(SFAS) No. 2, Accounting for
Research and Development Costs.Research and development costs consists
mainly of personnel related costs in addition to some external consultancy costs
such as testing, certifying, and measurements.


25


Long-lived
Assets





We assess
any impairment by estimating the future cash flow from the associated asset in
accordance with SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. If the estimated undiscounted cash flow
related to these assets decreases in the future or the useful life is shorter
than originally estimated, we may incur charges for impairment of these assets.
The impairment is based on the estimated discounted cash flow associated with
the asset.





Stock
Based Compensation Expense





We
account for stock-based employee compensation arrangements in accordance with
SFAS 123 (revised 2004), Share-Based Payment (SFAS
123R). We account for equity instruments issued to non-employees in
accordance with SFAS 123R and Emerging Issues Task Force (EITF) 96-18, Accounting for Equity Instruments
that are Issued to Other than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services, which require that such equity instruments be
recorded at their fair value and the unvested portion is re-measured each
reporting period. When determining stock based compensation expense involving
options and warrants, we determine the estimated fair value of options and
warrants using the Black-Scholes option pricing model.





Accounting
for Debt Issued with Stock Purchase Warrants





We
account for debt issued with stock purchase warrants in accordance with
Accounting Principles Board (APB) Opinion 14, Accounting for Convertible Debt and
Debt Issued with Stock Purchase Warrants, if they meet equity
classification. We allocate the proceeds of the debt between the debt and the
detachable warrants based on the relative fair values of the debt security
without the warrants and the warrants themselves. The warrants were classified
as a liability pursuant to the guidance provided in paragraph 17 of EITF 00-19.
The warrants were recorded among “Liability for warrants to purchase common
stock” and are valued at fair valued at the end of each reporting period using
the Black-Scholes option pricing model. As of December 31, 2008, all of the
outstanding warrants are classified as equity.





Liability for
Warrants and Embedded Derivatives





We do not
enter into derivative contracts for purposes of risk management or speculation.
 However, from time to time, we enter into contracts that are not
considered derivative financial instruments in their entirety but that include
embedded derivative features. Such embedded derivatives are assessed at
inception of the contract and every reporting period, depending on their
characteristics, are accounted for as separate derivative financial instruments
pursuant to SFAS 133, Accounting for Derivative
Instruments and Hedging Activities, as amended (together, SFAS 133), if
such embedded conversion features, if freestanding, would meet the
classification of a liability. SFAS 133 requires that we analyze all material
contracts and determine whether or not they contain embedded derivatives. Any
such embedded conversion features that meet the above criteria are then
bifurcated from their host contract and recorded on the consolidated balance
sheet at fair value and the changes in the fair value of these derivatives
are recorded each period in the consolidated statements of operations as an
increase or decrease to Non-cash charges for conversion features and
warrants.





Similarly,
if warrants meet the classification of liabilities in accordance with EITF
00-19, Accounting
  for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company's Own
Stock , then the fair value of the warrants are recorded on the
consolidated balance sheet at their fair values, and any changes in such fair
values are recorded each period in the consolidated statements of operations as
an increase or decrease to Non-cash charges for conversion features and
warrants.


26


Income
taxes





We
account for income taxes in accordance with SFAS 109, Accounting for Income Taxes.
SFAS 109 requires recognition of deferred tax liabilities and assets for the
expected future tax consequences of items that have been included in the
financial statements or tax returns. We estimate income taxes based on rates in
effect in each of the jurisdictions in which we operate. Deferred income tax
assets and liabilities are determined based upon differences between the
financial statement and income tax bases of assets and liabilities using enacted
tax rates in effect for the year in which the differences are expected to
reverse. The realization of deferred tax assets is based on historical tax
positions and expectations about future taxable income. Valuation allowances are
recorded against net deferred tax assets where, in our opinion, realization is
uncertain based on the “not more likely than not” criteria of SFAS
109.





Based on
the uncertainty of future pre-tax income, we fully reserved our net deferred tax
assets as of December 31, 2008 and 2007. In the event we were to determine that
we would be able to realize our deferred tax assets in the future, an adjustment
to the deferred tax asset would increase income in the period such a
determination was made. The provision for income taxes represents the net change
in deferred tax amounts, plus income taxes payable for the current
period.





Effective
January 1, 2007, we adopted the provisions of Financial Accounting
Standards Board (FASB) Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income
Taxes , which provisions included a two-step approach to recognizing,
de-recognizing and measuring uncertain tax positions accounted for in accordance
with SFAS 109. As a result of the implementation of FIN 48, we recognized no
increase in the liability for unrecognized tax benefits and a decrease in the
related reserve of the same amount. Therefore upon implementation of FIN 48, we
recognized no material adjustment to the January 1, 2007 balance of
retained earnings. As of December 31, 2008, we had no unrecognized tax
benefits.




New
Accounting Pronouncements





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





In
December 2007, the Financial Accounting Standards Board (FASB) issued Statement
on Financial Accounting Standards (SFAS) No. 141 (revised 2007), Business Combinations (SFAS
No. 141R). SFAS 141R establishes principles and requirements for how an acquirer
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, any noncontrolling interest in the acquiree
and the goodwill acquired. SFAS No. 141R also establishes disclosure
requirements to enable the evaluation of the nature and financial effects of the
business combination. SFAS No. 141R is effective as of the beginning of an
entity’s fiscal year that begins after 15 December 2008, and will be adopted by
us in the first quarter of 2009. The adoption of SFAS 141R will affect the way
we account for any acquisitions made after January 1, 2009.





In
September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157 (SFAS 157), Fair
Value Measurementswhich defines fair value, establishes guidelines for
measuring fair value and expands disclosures regarding fair value
measurements.  SFAS 157 does not require any new fair value
measurements, but rather eliminates inconsistencies in guidance found in various
prior accounting pronouncements.  SFAS 157 is effective for financial
assets and financial liabilities within its scope for fiscal years beginning
after November 15, 2007 and for interim periods within those fiscal years. We
adopted SFAS 157 for financial assets and financial liabilities within its scope
during the first quarter of 2008, and the adoption did not have an impact on our
financial statements. In February 2008, the FASB issued FASB Staff Position No.
FAS 157-2 (FSP FAS 157-2), Effective Date of FASB Statement No.
157, which defers the effective date of SFAS 157 for all non-financial
assets and non-financial liabilities for fiscal years beginning after November
15, 2008 and interim periods within those fiscal years for items within the
scope of FSP FAS 157-2. The adoption of FSP FAS 157-2 effective January 1, 2009
for the Company’s non-financial assets and non-financial liabilities is not
expected to have an impact on our consolidated financial
statements.





In
December 2007, the FASB issued SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements. SFAS 160 establishes new
standards that will govern the accounting for and reporting of noncontrolling
interests in partially owned subsidiaries. SFAS 160 is effective for fiscal
years beginning on or after December 15, 2008 and requires retroactive
adoption of the presentation and disclosure requirements for existing minority
interests. All other requirements shall be applied prospectively. The adoption
of this standard will have no impact on the financial results of the Company on
the date of adoption.


27


In March
2008, the FASB issued SFAS 161, Disclosures about Derivative
Instruments and Hedging Activities - an amendment of FASB Statement No.
133, as amended and interpreted, which requires enhanced disclosures
about an entity’s derivative and hedging activities and thereby improves the
transparency of financial reporting. Disclosing the fair values of derivative
instruments and their gains and losses in a tabular format provides a more
complete picture of the location in an entity’s financial statements of both the
derivative positions existing at period end and the effect of using derivatives
during the reporting period. Entities are required to provide enhanced
disclosures about (a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under SFAS
133, Accounting for Derivative
Instruments and Hedging Activities, as amended and its related
interpretations (together SFAS 133), and (c) how derivative instruments and
related hedged items affect an entity’s financial position, financial
performance, and cash flows. SFAS 161 is effective for financial statements
issued for fiscal years and interim periods beginning after November 15,
2008.  We do not expect the adoption of SFAS 161 to have a material
impact on our financial position, and we will make all necessary disclosures
upon adoption, if applicable.





In April 2008, the FASB issued EITF
07-05,Determining whether
an Instrument (or Embedded Feature) Is Indexed to an Entity's Own
Stock, (EITF 07-05). EITF
07-05 provides guidance on determining what types of instruments or embedded
features in an instrument held by a reporting entity can be considered indexed
to its own stock for the purpose of evaluating the first criteria of the scope
exception in paragraph 11(a) of FAS 133. EITF 07-05 is effective for financial
statements issued for fiscal years beginning after December 15, 2008 and early
application is not permitted. . We do not believe that the adoption of EITF
07-05 will have a significant impact on our consolidated financial statements,
as the fair value of any financial instruments and related conversion features
are not significant.





In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles.


SFAS 162
identifies the sources of accounting principles and the framework for selecting
the principles to be used in the preparation of financial statements of
nongovernmental entities that are presented in conformity with generally
accepted accounting principles in the United States. SFAS 162 is effective as of
November 15, 2008. The adoption of SFAS 162 did not have any financial impact on
our consolidated financial statements.





In
May 2008, the FASB issued Staff Position (FSP) APB 14-1, Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement). This FSP clarifies that convertible debt instruments that
may be settled in cash upon conversion (including partial cash settlement) are
not addressed by paragraph 12 of APB Opinion No. 14, Accounting for Convertible Debt
and Debt issued with Stock Purchase Warrants. Additionally, this FSP
specifies that issuers of such instruments should separately account for the
liability and equity components in a manner that will reflect the entity's
nonconvertible debt borrowing rate when interest cost is recognized in
subsequent periods. This FSP is effective for financial statements issued for
fiscal years beginning after December 15, 2008, and interim periods within those
fiscal years, and requires retrospective application for all periods presented.
We do not believe that adoption of FSP APB 14-1 will have a significant impact
on our financial position and operating results, as the embedded conversion
features of our convertible debt instruments had been accounted for as a
derivative.





Results
of Operations





On August
10, 2007, Neonode Inc merged with SBE (Nasdaq: SBEI) (Merger). The
newly-combined Company’s headquarters was located in Stockholm, Sweden. The
combined company’s common stock started trading on the Nasdaq Capital Market on
August 13, 2007 under the new ticker symbol “NEON.”


28


2007 Financial
Statements





For
accounting purposes, the Merger was accounted for as a reverse merger with
Neonode as the accounting acquirer. This transaction was treated as a
recapitalization. Thus, the historical financial statements of pre- merger
Neonode became the combined company’s historical financial statements. The
audited consolidated financial statements appearing elsewhere in this Annual
Report on Form 10-K and the discussion of our financial condition and results of
operations for the year ended December 31, 2007 appearing below include the
results of operations of SBE, Inc. only from August 10, 2007 through December
31, 2007 consolidated with the results of pre-merger Neonode for the period
January 1, 2007 through December 31, 2007.





2008
Financial Statements





On
December 9, 2008, our wholly owned Swedish subsidiary, Neonode AB filed for
liquidation under the bankruptcy laws of Sweden. Pursuant to the Swedish
bankruptcy laws, we are no longer responsible for the debt and liabilities nor
do we have any ownership interest in the assets of Neonode AB as of the
effective date of the bankruptcy filing, December 9, 2008. The audited
consolidated statements of operations and cash flows appearing elsewhere in this
Annual Report on Form 10-K and the discussion of our financial condition and
results of operations for the year ended December 31, 2008 appearing below
include the results of operations of our former wholly owned subsidiary, Neonode
AB, only from January 1, 2008 through December 9, 2008, the date Neonode AB
filed for bankruptcy. Pursuant to AICPA Statement of Position, SOP 90-7, Financial Reporting by Entities in
Reorganization Under the Bankruptcy Code,and Accounting Research
Bulletin, ARB 51, Consolidate
Financial Statements.  ARB 51 precludes consolidation of a
majority-owned subsidiary where control does not rest with the majority owners,
for instance, where the subsidiary is in bankruptcy.  Accordingly, we
deconsolidated Neonode AB from our consolidated financial statements on the date
it filed for bankruptcy, December 9, 2008.





On
December 29, 2008, we entered into a Share Exchange Agreement with AB Cypressen
nr 9683 (Cypressen), a Swedish engineering company, and the stockholders of
Cypressen:  Iwo Jima SARL, Wirelesstoys AB, and Athemis Ltd. (the
Cypressen Stockholders), pursuant to which we agreed to acquire all of the
issued and outstanding shares of Cypressen in exchange for the issuance of
495,000 shares of Neonode Inc. Series A Preferred Stock to the Cypressen
Stockholders.   Pursuant to the terms of the Share Exchange
Agreement, upon the closing of the transaction, Cypressen became a wholly-owned
subsidiary of the Company. Neonode’s consolidated balance sheets as of December
31, 2008 include the accounts of Neonode Inc. and its new wholly owned
subsidiary, Cypressen. Cypressen did not have any operations prior to its
acquisition by us on December 29, 2008; therefore, the acquisition of Cypressen
has no accounting impact on the consolidated statements of operations for the
year ended December 31, 2008.





The
following table sets forth, as a percentage of net sales, certain statements of
operations data for the twelve months ended December 31, 2008 and 2007. These
operating results are not necessarily indicative of our operating results for
any future period.




2008
                        
                        
                        2007Net
      sales
                        
                        
                        100
                        %
                        
                        
                        100
                        %Cost
      of sales
                        
                        
                        212
                        %
                        
                        
                        74
                        %Gross
      margin
                        
                        
                        (112
                        )%
                        
                        
                        26
                        %Operating
      expenses:Research
      and development
                        
                        
                        45
                        %
                        
                        
                        142
                        %Sales
      and marketing
                        
                        
                        54
                        %
                        
                        
                        100
                        %General
      and administrative
                        
                        
                        82
                        %
                        
                        
                        162
                        %Total
      operating expenses
                        
                        
                        181
                        %
                        
                        
                        404
                        %Operating
      loss
                        
                        
                        (293
                        )%
                        
                        
                        (379
                        )%Other
      income (expense):Interest
      and other income
                        
                        
                        —
                        
                        
                        
                        2
                        %Interest
      and other expense
                        
                        
                        (5
                        )%
                        
                        
                        (9
                        )%Foreign
      currency exchange rate loss
                        
                        
                        (12
                        )%
                        
                        
                        (11
                        )%Write
      off of receivable from Neonode AB
                        
                        
                        (39
                        )%
                        
                        
                        —Gain
      on debt forgiveness of Neonode AB
                        
                        
                        135
                        %
                        
                        
                        —Gain
      on troubled debt restructuring
                        
                        
                        46
                        %
                        
                        
                        —Non-cash
      items related to debt discounts anddeferred
      financing fees and the valuation ofconversion
      features and warrants
                        
                        
                        86
                        %
                        
                        
                        (1,149
                        )%Total
      interest and other expense
                        
                        
                        212
                        %
                        
                        
                        (1,167
                        )%Net
      loss
                        
                        
                        (81
                        )%
                        
                        
                        (1,547
                        )%


29


Net
Sales





Net sales
for the year ended December 31, 2008 were $7.3 million, an approximately 133%
increase from $3.1 million for the year ended December 31, 2007. Revenue for the
years ended December 31, 2008 and 2007 includes $6.9 million and $2.7 million
revenue from the sales of our multimedia mobile phones, respectively. In
addition, revenue in 2007 included $463,000 in license revenue received from a
July 2005 licensing agreement with a major Asian manufacturer whereby we
licensed our touchscreen technology for use in a mobile phone to be included in
its product assortment. In this agreement, we received an initial payment of
approximately $2.0 million and we were to  receive $2.65 for each
device manufactured using our technology in return for granting an exclusive
right to use our touchscreen technology for a mobile phone handset for a period
that expired in July 2007. We extended the contract for an additional one year
period until July 2008 on a non-exclusive basis without the exclusive rights.
The increase in Net Sales is primarily attributable to the sale of the inventory
of approximately 28,000 of the N2 model of our multimedia mobile phone held by
our manufacturing partner in the fourth quarter of 2008. Our manufacturing
partner applied the cash proceeds from the sale to our outstanding accounts
payable balance with them.




We
began shipping the N2 to our first customers in July 2007 but faced difficult
circumstances in finding a viable market for our N2 mobile phone. We faced a
competitive landscape in which our major competitors were much better positioned
and capitalized. Over time, we found that we lacked the requisite marketing and
co-marketing funding to enter the mainstream mobile phone handset markets and as
a result were forced to focus our sales efforts on web based sales and smaller
less efficient markets.





On
December 9, 2008, Neonode AB filed for liquidation under the Swedish bankruptcy
laws.  Neonode AB had a total of approximately 10,000 N2 mobile phones
in inventory at the time of its bankruptcy filing. Effective with Neonode AB’s
bankruptcy filing on December 9, 2008, Neonode Inc. is no longer in the mobile
phone business and no longer has any known financial obligations related to the
accounts payable or other debts of Neonode AB. The Swedish bankruptcy court
continues to pursue sales opportunities for Neonode AB’s remaining inventory of
the N2 mobile phones. Although we may be the beneficiary of a portion of any
sales proceeds from such sales the majority of any future sales proceeds from
the sale of the N2s in Neonode AB’s inventory will be distributed to the
creditors of Neonode AB by the Swedish bankruptcy court. The intellectual
property of Neonode AB was transferred to Neonode Inc prior to filing for
bankruptcy and Neonode Inc will continue to pursue technology sales and
licensing opportunities through its newly acquired subsidiary AB
Cypressen.




On
October 22, 2008, we terminated our agreement withDistribution Management
Consolidators Worldwide, LLC (DMC Worldwide) and dissolved Neonode USA which was
created for the purpose of distributing the N2 in the US and China and to
license our technology worldwide.





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


30


We do not
have any customers for our touchscreen technology and currently believe that we
will depend on a limited number of OEM customers for substantially all our
future revenue. Failure to anticipate or respond adequately to technological
developments in our industry, changes in customer or supplier requirements, or
changes in regulatory requirements or industry standards, or any significant
delays in the development or introduction of products or services, could have a
material adverse effect on our business, operating results and cash
flows.





Gross
Margin





Gross
margin as a percentage of net sales was (112)% and 26% in the years ended
December 31, 2008 and 2007, respectively. Our cost of sales includes the direct
cost of production of the phone plus the cost of our internal production
department and accrued estimated warranty costs. In the year ended December 31,
2008, our cost of sales includes an inventory write-down charge of $10.2
million. We have experienced limited success in selling our N2 mobile phone
since introduction in 2007 and have reevaluated our selling efforts and the
potential markets for the N2 in 2008. Based upon this reevaluation, we decided
that it was probable that in 2008 we would have to reduce the selling price of
our N2 phones and/or offer our customers substantial incentives in order to sell
the N2. As a result of our revaluation, we recorded a write-down reducing the
value of our inventory to the estimated realizable value of our inventory prior
to Neonode AB filing for bankruptcy on December 9, 2008.





We began
producing and shipping our commercially available N2 mobile phone handsets in
the second half of 2007. The cost of sales for 2007 reflects the cost to produce
the N2 mobile phone handsets and a limited number of N1 and N1m mobile phone
handsets delivered in the first quarter of 2007. The start-up production runs of
the new N2 mobile phone handsets had higher costs of production due to the price
of purchasing components in lower volumes.





Product
Research and Development





Product
research and development (R&D) expenses for the year ended December 31, 2008
were $3.3 million, a 26% decrease compared to $4.4 million for the same period
ending December 31, 2007.





The
main factors that contributed to the decrease in R&D costs are a decrease in
the headcount of our engineering department from 14 to three, primarily at the
end of year, amounting to a decrease in cost of $347,000 related to a decrease
in employee related expense, along with a decrease in external development costs
associated with the development of the N2 of $407,000 and a decrease of $498,000
related to corporate overhead, rent and travel related costs. On October 22,
2008, our Swedish subsidiary, Neonode AB, filed for company reorganization in
compliance with the Swedish Reorganization Act (1996:764). In conjunction with
the reorganization, we reduced our staffing levels across the company and
cancelled all outside contractors and consultants and stopped all R&D
projects related to development and improvement of our mobile phone products.
Under the Swedish Reorganization Act, the Swedish government assumed
responsibility for payment of salaries and benefits to Neonode AB’s employees on
the day the Swedish court approved Neonode AB’s petition for
reorganization.





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





Sales
and Marketing





Sales and
marketing expenses for the year ended December 31, 2008 were $3.9 million,
compared to $3.1 million for the same period in 2007, an increase of
25%.


31


This
increase in the year ended December 31, 2008 over the same period in 2007 is
primarily related to an increase in product marketing activities as we attempted
to sell our N2 mobile phone handset in numerous markets in Europe and
Asia.  During 2007, we launched our N2 model phone handset at the 3GSM
trade show in Barcelona, Spain and began shipments and sales and marketing
efforts in the second half of 2007. On October 22, 2008, our Swedish subsidiary,
Neonode AB, filed for company reorganization in compliance with the Swedish
Reorganization Act (1996:764). In conjunction with the reorganization, we
reduced our staffing levels across the company and cancelled all sales and
promotional activities. Under the Swedish Reorganization Act, the Swedish
government assumed responsibility for payment of salaries and benefits to
Neonode AB’s employees on the day the Swedish court approved Neonode AB’s
petition for reorganization.





Our sales
activities after our corporate reorganization will focus primarily on OEM
customers who will integrate our technology into their products, and the OEM
customers will sell and market their products to their customers. As of March
31, 2009, we have two consultants in our sales and marketing
department.




General
and Administrative





General
and administrative (G&A) expenses for the year ended December 31, 2008 were
$6.0 million, a 17% increase from $5.1 million for the same period in
2007.





The
increase in 2008 over 2007 is primarily related to approximately $2.0 million in
legal and accounting costs, compared to $1.5 million in 2007. The legal and
accounting expense increases are directly related to the costs associated with
our equity raising activities and the accounting complexity associated with
complying with the fair value mark-to-market accounting treatment of complex
derivative and convertible financial instruments. The year ended December 31,
2008 also includes $225,000 in expense related to the termination of the Neonode
USA agreement. On October 22, 2008, our Swedish subsidiary, Neonode AB, filed
for company reorganization in compliance with the Swedish Reorganization Act
(1996:764). In conjunction with the reorganization, we reduced our staffing
levels across the company and cancelled all sales and promotional activities.
Under the Swedish Reorganization Act, the Swedish government assumed
responsibility for payment of salaries and benefits to Neonode AB’s employees on
the day the Swedish court approved Neonode AB’s petition for
reorganization.  As of March 31, 2009, we have two employees and one
consultant in our G&A department fulfilling management and accounting
responsibilities,





Interest
Expense and Other Expense





Interest
expense for the twelve months ended December 31, 2008 was $368,000 as compared
to $295,000 for the twelve months ended December 31, 2007. The $73,000 increase
is due to a combination of an increase in interest bearing debt outstanding
during mid-2007 and the fact that the debt was discounted and we used the
effective interest rate method for recording interest expense.





Foreign
Exchange Loss





Foreign
exchange loss for the twelve months ended December 31, 2008 was $848,000 as
compared to $354,000 for the twelve months ended December 31, 2007. The $494,000
increase is due to a large change in the exchange rate in the US Dollar as
compared to the Swedish Krona in 2008 compared to 2007.





Write-off
of Accounts Receivable from Subsidiary





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





Gain
on debt forgiveness of Neonode AB





We recorded a gain on the forgiveness
of debt of Neonode AB in bankruptcy totaling $9.8 million pursuant to the
requirements of SFAS 15, Accounting by Debtors and Creditors
for Troubled Debt Restructuring.


32


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





Non-cash
items related to debt discounts and deferred financing fees and the valuation of
conversion features and warrants interest for the year ended December 31, 2008
amounted to a gain of $9.6 million as compared to a $36.0 million expense for
the same period in 2007. The change is the direct result of
exchanging  the outstanding debt and a majority of the outstanding
warrants to equity (preferred stock A and B) which resulted in a troubled debt
restructuring gain of $3.4 million in 2008 combined with an overall decrease in
the Company’s common stock price that reduced the fair value of the of
conversion features and warrants during 2008 as compared to 2007 which resulted
in marked-to-market non-cash income of $6.3 million in 2008.





On December 29, 2008, the Company
commenced entering into Note Conversion Agreements with the holders of
convertible notes and promissory notes of the Company in the aggregate amount of
up to $6,341,611, for the issuance of up to 250,014 shares of Series A Preferred
Stock in exchange for the surrender of the Convertible Notes by the note
holders.  A total of 24 out of 27 note holders agreed to the surrender
of notes and accrued interest on such notes in the aggregate amount of
$6,195,805 in consideration for the issuance of 244,265.56 shares of Series A
Preferred Stock on December 31, 2008.  The fair value of the
convertible notes and promissory notes and related embedded conversion features
amounted to $3.1 million immediately prior to conversion, using the
Black-Scholes option pricing model. The assumptions used when calculating the
fair value of the common stock anti-dilution feature were a term of 0.23 years,
volatility of 357.2% and a risk-free interest rate of 0.11%. The fair value of
the Series A Preferred stock on the date of conversion was $10 per share, as the
Company also raised $1.2 million in cash from both inside and outside investors,
with outside investors comprising approximately 51%.  Accordingly, the
Company believes that the $10 per share for the Series A shares is at an
arms-length price.  This conversion resulted in troubled debt
restructuring accounting in accordance with SFAS 15, Troubled Debt Restructuring,and the Company recorded a non-cash gain on conversion of $3.4
million.





On December 29, 2008, the Company
commenced entering into Warrant Conversion Agreements with the holders of
warrants for the purchase of shares, notes, and/or additional warrants of the
Company, for the issuance of up to 108,850 shares of Series B Preferred Stock in
exchange for the surrender of the warrants by the warrant
holders.  The Company has entered into Warrant Conversion Agreements
with 92 out of 129 warrant holders for the issuance of 92,795.23 shares of
Series B Preferred Stock on December 31, 2008. The fair value of the converted
warrants which were recorded as liabilities amounted to $159,000 immediately
prior to conversion, using the Black-Scholes option pricing model. The
assumptions used when calculating the fair value of the warrants prior to
conversion were a term of 4.4 years, volatility of 152.3% and a risk-free
interest rate of 1.37%. The fair value of the Series B Preferred stock on the
date of conversion was $0.022 per share, which is based upon a fully diluted
price per share using the Company’s market capitalization on that date. This
conversion resulted in troubled debt restructuring accounting in accordance with
SFAS 15, Troubled Debt
Restructuring, and the Company recorded a non-cash gain on conversion of
$157,000.





Income
Taxes





Our
effective tax rate was 0% in the year ended December 31, 2008 and 2007,
respectively. We recorded valuation allowances in 2008 and 2007 for deferred tax
assets related to net operating losses due to the uncertainty of realization. As
of December 31, 2008, due to the bankruptcy of Neonode AB, we no longer have any
significant amounts of net operating loss carryforwards and hence no significant
amounts of deferred tax assets.





Net
Loss




As a
result of the factors discussed above, we recorded a net loss of $5.9 million
for the year ended December 31, 2008 compared to a net loss of $48.4 million in
the comparable period in 2007.


33


Liquidity
and Capital Resources





Our
liquidity is dependent on many factors, including sales volume, operating profit
and the efficiency of asset use and turnover. Our future liquidity will be
affected by, among other things:





·
            actual
      versus anticipated licensing of our
technology;


·
            our
      actual versus anticipated operating
expenses;


·
            the
      timing of our OEM customer product
shipments;


·
            the
      timing of payment for our technology licensing
  agreements;


·
            our
      actual versus anticipated gross profit
margin;


·
            our
      ability to raise additional capital, if necessary;
  and


·
            our
      ability to secure credit facilities, if
  necessary.





The
consolidated financial statements included herein have been prepared on a going
concern basis, which contemplates continuity of operations and the realization
of assets and repayment of liabilities in the ordinary course of business. The
report of our independent registered public accounting firm in respect of the
2008 fiscal year, included elsewhere in this annual report, includes an
explanatory going concern paragraph which raises substantial doubt to continue
as a going concern, which indicates an absence of obvious or reasonably assured
sources of future funding that will be required by us to maintain ongoing
operations. Although we have been able to fund our operations to date, there is
no assurance that cash flow from our operations or our capital raising efforts
will be able to attract the additional capital or other funds needed to sustain
our operations. The going concern qualification from our auditors may make it
more difficult for us to raise funds. If we are unable to obtain additional
funding for operations, we may not be able to continue operations as proposed,
requiring us to modify our business plan, curtail various aspects of our
operations or cease operations. In such event, investors may lose a portion or
all of their investment.





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





Our cash
is subject to interest rate risk. We invest primarily on a short-term basis. Our
financial instrument holdings at December 31, 2008 were analyzed to determine
their sensitivity to interest rate changes. The fair values of these instruments
were determined by net present values. In our sensitivity analysis, the same
change in interest rate was used for all maturities and all other factors were
held constant. If interest rates increased by 10%, the expected effect on net
loss related to our financial instruments would be immaterial. The functional
currency of our foreign subsidiary is the applicable local currency, the Swedish
Krona, and is subject to foreign currency exchange rate risk. Any increase or
decrease in the exchange rate of the U.S. Dollar compared to the Swedish Krona
will impact Neonode’s future operating results.





At
December 31, 2008, we had cash and cash equivalents of $17,000, as compared to
$6.8 million (with $5.7 million held as restricted cash) at December 31, 2007.
In the twelve month period ended December 31, 2008, $15.3 million of cash was
used in operating activities, primarily as a result of our net loss increased by
the following non-cash items (in thousands):





Depreciation
      and amortization
                  
                  $
                  339Stock-based
      compensation expense
                  
                  
                  1,163Write-off
      of receivable from Neonode AB
                  
                  
                  2,828Write-down
      of inventory to net realizable value
                  
                  
                  10,155Gain
      on debt forgiveness of Neonode AB
                  
                  
                  (9,820
                  )Gain
      on troubled debt restructuring
                  
                  
                  (3.360
                  )Change
      in fair value of embedded derivatives and warrantsrecorded
      as a liability
                  
                  
                  (6,278
                  )Total
      net non-cash items included in cash used in our operations
                  
                  $
                  (4,973
                  )


34





We
provided bank guaranties totaling $5.7 million as collateral for the performance
of our obligations under our agreement with our manufacturing partner. The
outstanding bank guaranties expired on December 29, 2007 and the funds were
released by our bank to cash on January 2, 2008.





During
the twelve months ended December 31, 2008, we sold a combination of convertible
notes and equity for cash totaling $10.7 million. At December 31, 2008, $1.0
million was included as a stock subscription receivable and the cash proceeds
were received in January and February 2009. Adjusted working capital (deficit)
(current assets less current liabilities not including non-cash liabilities
related to warrants and embedded derivatives) was $962,000 at December 31, 2008,
compared to an adjusted working capital deficit of $5.8 million at December 31,
2007.





In the
twelve months ended December 31, 2008, we purchased $205,000 of fixed assets,
consisting primarily of manufacturing tooling, computers and engineering
equipment.





On
March 4, 2008, we sold $4.5 million in securities, net cash proceeds to us of
$4.0 million, in a private placement to accredited investors. We sold 1,800,000
shares of our common stock for $2.50 per share. After placement agent fees and
offering expenses, we received net proceeds of approximately $4.0 million.
Empire Asset Management Company acted as financial advisor for the transaction
and was paid a cash fee of approximately $450,000 and received 120,000 shares of
our common stock.





On
May 21, 2008, we completed a $5.1 million, net cash proceeds to us of $4.1
million, financing primarily to prior security holders, directors, affiliates of
management and institutional investors. We offered our existing warrant holders
an opportunity to exercise Neonode common stock purchase warrants on a
discounted basis for a limited period, ended May 19, 2008. In all,
4,004,793 outstanding warrants were exercised at a strike price of $1.27 per
warrant. We issued 4,004,793 shares of our common stock and two new common stock
purchase warrants, with an exercise price of $1.45, for each outstanding warrant
exercised. A total of 8,009,586 new common stock purchase warrants were issued
to investors who surrendered or purchased shares under the warrant exchange
offer. We also extended the maturity date of $2.85 million of convertible debt
that was due on June 30, 2008 until December 31, 2008 by issuing the note
holders 510,293 common stock purchase warrants, with an exercise price of
$1.45.   Empire Asset Management Company acted as financial
advisor for the transaction and was paid a cash fee of approximately $510,000
and received a warrant to purchase 400,480 shares of our common stock at $1.27
per share and a warrant to purchase 800,959 shares of our common stock at $1.45
per share.





On
December 30, 2008, we commenced entering into Subscription Agreements with
certain subscribers (the “Subscribers”), for the  issuance of up to
150,000 shares of Series A Preferred Stock to the Subscribers, at a price equal
to $10 per share, for an aggregate purchase price of up to
$1,500,000.  As of December 31, 2008, we entered into Subscription
Agreements with 10 subscribers who signed Subscription Agreements and agreed to
invest an aggregate of $1,121,904.  We issued 112,190.40 shares of our
Series A Preferred Stock to the investors on December 31, 2008. We collected all
the proceeds from the financing transaction in January and February
2009.





The
majority of our cash has been provided by borrowings from senior secured notes
and bridge notes that have been or are convertible into shares of our common
stock or from the sale of our common stock and common stock purchase warrants to
private investors. We have been able to convert approximately $6.1 million of
the $6.3 million outstanding convertible debt to equity. The $139,000
convertible note that was not converted into equity is due in August
2010.  We will require sources of capital in addition to cash on hand
to continue operations and to implement our strategy. Our operations are not
cash flow positive and we may be forced to seek credit line facilities from
financial institutions, additional private equity investment or debt
arrangements. No assurances can be given that we will be successful in obtaining
such additional financing on reasonable terms, or at all. If adequate funds are
not available on acceptable terms, or at all, we may be unable to adequately
fund our business plans and it could have a negative effect on our business,
results of operations and financial condition. In addition, if funds are
available, the issuance of equity securities or securities convertible into
equity could dilute the value of shares of our common stock and cause the market
price to fall, and the issuance of debt securities could impose restrictive
covenants that could impair our ability to engage in certain business
transactions.


35





ITEM
      7A.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK





Not
applicable.





ITEM 8.
            FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA





Index
      to the Financial Statements
                              
                              PageFinancial
      StatementsReport
      of Independent Registered Public Accounting Firm
                              
                              37Consolidated
      Balance Sheets at December 31, 2008 and 2007
                              
                              38Consolidated
      Statements of Operations for the years ended December 31, 2008 and
      2007
                              
                              39Consolidated
      Statements of Stockholders’ Deficit for the years ended December 31, 2008
      and 2007
                              
                              40Consolidated
      Statements of Cash Flows for the years ended December 31, 2008 and
      2007
                              
                              41Notes
      to Consolidated Financial Statements
                              
                              42Financial
      Statement ScheduleSchedule
      II — Valuation and Qualifying Accounts
                              
                              78


36


Report
of Independent Registered Public Accounting Firm





Board of
Directors and Stockholders


Neonode
Inc.


Stockholm,
Sweden





We have
audited the accompanying consolidated balance sheets of Neonode Inc. as of
December 31, 2008 and 2007, and the related consolidated statements of
operations, stockholders’ deficit, and cash flows for each of the two years in
the period ended December 31, 2008. In connection with our audits of the
financial statements, we have also audited the schedule listed in the
accompanying index. These financial statements and the schedule are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these financial statements and the schedule 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. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, 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 financial statements referred to above present fairly, in all
material respects, the financial position of Neonode Inc. at December 31, 2008
and 2007, and the results of its operations and its cash flows for each of the
two years in the period ended December 31, 2008, in conformity with accounting
principles generally accepted in the United States of America.





Also, in
our opinion, the financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly,
in all material respects, the information set forth therein.





The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in the Liquidity section of Note
1 to the consolidated financial statements, the Company has suffered recurring
losses and negative cash flows from operations and has a working capital
deficiency that raise substantial doubt about its ability to continue as a going
concern. The financial statements do not include any adjustments that might
result from the outcome from this uncertainty.





Stockholm,
Sweden





April 14,
2009





BDO
      Feinstein International AB
              BDO
      Feinstein International AB/s/
      Johan Pharmanson
              /s/
      Tommy BergendahlAuthorized
      Public Accountant
              Authorized
      Public Accountant


37




NEONODE
INC.


CONSOLIDATED
BALANCE SHEETS


(In
thousands)





December
                    
                    
                    December31, 2008
                    
                    
                    31, 2007ASSETSCurrent
      assets:Cash
      and cash equivalents
                    
                    $
                    17
                    
                    
                    $
                    1,147Restricted
      cash
                    
                    
                    —
                    
                    
                    
                    5,702Trade
      accounts receivable, net of allowance for doubtful accounts of $0
      and  $4,264 at December 31, 2008 and 2007,
      respectively
                    
                    
                    —
                    
                    
                    
                    868Inventory
                    
                    
                    —
                    
                    
                    
                    6,610Prepaid
      expense
                    
                    
                    46
                    
                    
                    
                    1,081Other
                    
                    
                    —
                    
                    
                    
                    2Total
      current assets
                    
                    
                    63
                    
                    
                    
                    15,410Property,
      plant and equipment, net
                    
                    
                    116
                    
                    
                    
                    375Patents,
      net
                    
                    
                    —
                    
                    
                    
                    95Other
      long term assets
                    
                    
                    —
                    
                    
                    
                    395Total
      assets
                    
                    $
                    179
                    
                    
                    $
                    16,275LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Current
      portion of convertible long term debt and leases
                    
                    $
                    17
                    
                    
                    $
                    132Accounts
      payable
                    
                    
                    688
                    
                    
                    
                    4,417Accrued
      expenses
                    
                    
                    320
                    
                    
                    
                    1,391Deferred
      revenues
                    
                    
                    —
                    
                    
                    
                    2,979Embedded
      derivatives of convertible debt and warrants
                    
                    
                    —
                    
                    
                    
                    9,507Other
      liabilities
                    
                    
                    —
                    
                    
                    
                    674Total
      current liabilities
                    
                    
                    1,025
                    
                    
                    
                    19,100Long
      term convertible debt and leases
                    
                    
                    207
                    
                    
                    
                    60Total
      liabilities
                    
                    
                    1,232
                    
                    
                    
                    19,160Commitments
      and contingencies (note 19)Stockholders'
      deficit:Series
      A Preferred Stock, 899,081 shares authorized with par value $0.001 at
      December 31, 2008 855,522 shares issued and outstanding at December
      31, 2008. (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)
                    
                    
                    3,531
                    
                    
                    
                    —Series
      B Preferred Stock, 108,850 shares authorized with par value $0.001at
      December 31, 2008 92,796 shares issued and outstanding at December
      31, 2008. (In the event of dissolution,  each share of Series B
      Preferred Stock has a liquidation preference equal to par value
      of  $0.001 over the shares of Common Stock)
                    
                    
                    2
                    
                    
                    
                    —Common
      stock, 75,000,000 shares authorized with par value $0.001 at December
      31, 2008 and 2007, respectively; 35,058,011 and 23,780,670 shares
      issued and outstanding at December 31, 2008 and 2007,
      respectively
                    
                    
                    35
                    
                    
                    
                    24Common
      stock additional paid in capital
                    
                    
                    61,016
                    
                    
                    
                    55,405Stock
      subscription receivable
                    
                    
                    (1,035
                    )
                    
                    
                    —Accumulated
      other comprehensive income
                    
                    
                    —
                    
                    
                    
                    354Accumulated
      deficit
                    
                    
                    (64,602
                    )
                    
                    
                    (58,668
                    )Total
      stockholders' deficit
                    
                    
                    (1,053
                    )
                    
                    
                    (2,885
                    )Total
      liabilities and stockholders' deficit
                    
                    $
                    179
                    
                    
                    $
                    16,275





The
accompanying notes are an integral part of these Consolidated Financial
Statements.


38


NEONODE,
INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


(In
thousands, except per share amounts)





Year
      endedDecember
      31,2008
                
                
                2007Net
      revenue
                
                $
                7,282
                
                
                $
                3,132Cost
      of sales
                
                
                15,459
                
                
                
                2,317Gross
      margin
                
                
                (8,177
                )
                
                
                815Operating
      expensesProduct
      research and development
                
                
                3,288
                
                
                
                4,449Sales
      and marketing
                
                
                3,943
                
                
                
                3,147General
      and administrative
                
                
                5,957
                
                
                
                5,080Total
      operating expenses
                
                
                13,188
                
                
                
                12,676Operating
      loss
                
                
                (21,365
                )
                
                
                (11,861
                )Interest
      and other income
                
                
                16
                
                
                
                77Interest
      and other expense
                
                
                (368
                )
                
                
                (295
                )Foreign
      currency exchange rate loss
                
                
                (848
                )
                
                
                (354
                )Write-off
      of receivable from Neonode AB
                
                
                (2,828
                )
                
                
                —Gain
      on forgiveness of Neonode AB’s  net liabilities
                
                
                9,820
                
                
                
                —Gain
      on troubled debt restructuring
                
                
                3,360
                
                
                
                —Non-cash
      items related to debt discounts and deferred financing fees and the
      valuation of conversion features and warrants
                
                
                6,278
                
                
                
                (36,008
                )Total
      interest and other expense
                
                
                15,430
                
                
                
                (36,580
                )Net
      loss
                
                $
                (5,934
                )
                
                $
                (48,441
                )Basic
      and diluted loss per share
                
                $
                (0.21
                )
                
                $
                (3.15
                )Basic
      and diluted – weighted average shares used in per share
      computations
                
                
                28,164
                
                
                
                15,400




The
accompanying notes are an integral part of these Consolidated Financial
Statements.


39




Amounts in thousands
                                                                                
                                                                                Common
                                                                                  stock shares
                                                                                  issued (1)
                                                                                
                                                                                
                                                                                Par
                                                                                  value of
                                                                                  common
                                                                                  stock
                                                                                
                                                                                
                                                                                Additional
                                                                                  paid-in- capital on
                                                                                  common stock
                                                                                
                                                                                
                                                                                Series A
                                                                                  Preferred
                                                                                  stock
                                                                                  shares
                                                                                  issued
                                                                                
                                                                                
                                                                                Series A
                                                                                  Preferred
                                                                                  stock
                                                                                
                                                                                
                                                                                Series B
                                                                                  Preferred
                                                                                  stock
                                                                                  shares
                                                                                  issued
                                                                                
                                                                                
                                                                                Series B
                                                                                  Preferred
                                                                                  stock
                                                                                
                                                                                
                                                                                Stock
                                                                                  subscription
                                                                                  receivable
                                                                                
                                                                                
                                                                                Accumulated
                                                                                  Comprehensive
                                                                                  loss
                                                                                
                                                                                
                                                                                Accumulated
                                                                                  deficit
                                                                                
                                                                                
                                                                                Stock-holders'
                                                                                  equity (deficit)Balances,
      December 31, 2006
                                                                                
                                                                                
                                                                                10,282
                                                                                
                                                                                
                                                                                $
                                                                                10
                                                                                
                                                                                
                                                                                $
                                                                                3,499
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                $
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                $
                                                                                -
                                                                                
                                                                                
                                                                                $
                                                                                -
                                                                                
                                                                                
                                                                                $
                                                                                88
                                                                                
                                                                                
                                                                                $
                                                                                (10,227
                                                                                )
                                                                                
                                                                                $
                                                                                (6,630
                                                                                )Exercise
      of stock options by certain employees for cash
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                161
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                161Employee
      stock option compensation expense
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                408
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                408Reclassification
      of warrants to equity
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                5
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                5Advisory
      warrants issued on 5/18/07
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                158
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                158Conversion
      of pre-merger debt Aug. 10, 2007 to common stock and
    warrants
                                                                                
                                                                                
                                                                                10,096
                                                                                
                                                                                
                                                                                
                                                                                10
                                                                                
                                                                                
                                                                                
                                                                                49,462
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                49,472Merger
      with SBE on Aug. 10, 2007
                                                                                
                                                                                
                                                                                2,296
                                                                                
                                                                                
                                                                                
                                                                                2
                                                                                
                                                                                
                                                                                
                                                                                (2
                                                                                )
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                0Equity
      contributed by SBE in merger
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                1,197
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                1,197Merger
      costs
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                (122
                                                                                )
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                (122
                                                                                )Conversion
      of certain August Bridge Notes on September 26, 2007
                                                                                
                                                                                
                                                                                76
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                296
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                296Issuance
      of common stock in September 2007 private placement net of
      cost
                                                                                
                                                                                
                                                                                952
                                                                                
                                                                                
                                                                                
                                                                                1
                                                                                
                                                                                
                                                                                
                                                                                292
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                293Issuance
      of common stock under stock based compensation plans
                                                                                
                                                                                
                                                                                23
                                                                                
                                                                                
                                                                                
                                                                                0
                                                                                
                                                                                
                                                                                
                                                                                52
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                52Cashless
      exercise of employee warrants
                                                                                
                                                                                
                                                                                56
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -Foreign
      currency translation adjustment
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                266
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                266Net
      loss
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                (48,441
                                                                                )
                                                                                
                                                                                
                                                                                (48,441
                                                                                )
                                                                                
                                                                                
                                                                                266(48,441
                                                                                )Comprehensive
      loss
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -(48,175
                                                                                )Balances,
      December 31, 2007
                                                                                
                                                                                
                                                                                23,781
                                                                                
                                                                                
                                                                                
                                                                                23
                                                                                
                                                                                
                                                                                
                                                                                55,406
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                354
                                                                                
                                                                                
                                                                                
                                                                                (58,668
                                                                                )
                                                                                
                                                                                
                                                                                (2,885
                                                                                )Employee
      stock options exercised for cash
                                                                                
                                                                                
                                                                                21
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                38
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                38Common
      stock issued related to employee liabilities
                                                                                
                                                                                
                                                                                657
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                54
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                54Employee
      stock option compensation expense
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                1,163
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                1,163Conversion
      of debt to common stock and warrants
                                                                                
                                                                                
                                                                                10
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                15
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                15Shares
      of common stock issued pursuant to private placement  and
      warrant repricing financing transactions net of $1,137,000 cash and
      $5,385,000 non-cash  issuance costs
                                                                                
                                                                                
                                                                                10,589
                                                                                
                                                                                
                                                                                
                                                                                11
                                                                                
                                                                                
                                                                                
                                                                                4,274
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                4,285Conversion
      of warrant liability to equity
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                67
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                67Issuance
      of Series A Preferred stock in financing transaction, net of accrued
      issuance costs of $46,000
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                112
                                                                                
                                                                                
                                                                                
                                                                                1,076
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                1,076Issuance
      of Series A Preferred stock in debt conversion transaction, net of stock
      given in lieu of cash issuance costs of $41,000
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                248
                                                                                
                                                                                
                                                                                
                                                                                2,443
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                2,443Issuance
      of Series A Preferred stock in acquisition of Cypressen
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                495
                                                                                
                                                                                
                                                                                
                                                                                12
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                12Stock
      subscription receivable associated with financing transaction on December
      31, 2008
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                (1,035
                                                                                )
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                (1,035
                                                                                )Issuance
      of Series B Preferred stock in warrant conversion
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                
                                                                                93
                                                                                
                                                                                
                                                                                
                                                                                2
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                2Foreign
      currency translation adjustment
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                (354
                                                                                )
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                (354
                                                                                )
                                                                                
                                                                                
                                                                                345Net
      loss
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                (5,934
                                                                                )
                                                                                
                                                                                
                                                                                (5,934
                                                                                )
                                                                                
                                                                                
                                                                                345(5,934
                                                                                )Comprehensive
      loss
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -(5,580
                                                                                )Balances,
      December 31, 2008
                                                                                
                                                                                
                                                                                35,058
                                                                                
                                                                                
                                                                                $
                                                                                35
                                                                                
                                                                                
                                                                                $
                                                                                61,016
                                                                                
                                                                                
                                                                                
                                                                                855
                                                                                
                                                                                
                                                                                $
                                                                                3,531
                                                                                
                                                                                
                                                                                
                                                                                93
                                                                                
                                                                                
                                                                                $
                                                                                2
                                                                                
                                                                                
                                                                                $
                                                                                (1,035
                                                                                )
                                                                                
                                                                                $
                                                                                -
                                                                                
                                                                                
                                                                                $
                                                                                (64,602
                                                                                )
                                                                                
                                                                                $
                                                                                (1,053
                                                                                )


40


NEONODE
INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(In
thousands)





Twelve
      months endedDecember
      31,2008
                
                
                2007Cash
      flows from operating activities:Net
      loss
                
                $
                (5,934
                )
                
                $
                (48,441
                )Adjustments
      to reconcile net loss to net cash used by operating
      activities:Stock
      based compensation expense
                
                
                1,163
                
                
                
                408Depreciation
      and amortization
                
                
                339
                
                
                
                298Gain
      on sale of property and equipment
                
                
                16
                
                
                
                —Deferred
      interest
                
                
                —
                
                
                
                340Write-down
      of inventory to net realizable value
                
                
                10,155
                
                
                
                —Write-off
      of merger expense in excess of cash received
                
                
                —
                
                
                
                158Write-off
      of receivable from Neonode AB
                
                
                2,828
                
                
                
                —Gain
      on forgiveness of Neonode AB’s net liabilities
                
                
                (9,820
                )
                
                
                —Gain
      on troubled debt restructuring
                
                
                (3,360
                )Debt
      discounts and deferred financing fees and the valuation of conversion
      features and warrants
                
                
                (6,278
                )
                
                
                36,008Changes
      in operating assets and liabilities:Cumulative
      effect of the foreign exchange translation rates on the assets and
      liabilities of  Neonode AB for the period January 1, 2008
      through December 9, 2008, the date of bankruptcy
                
                
                5,223
                
                
                
                —Accounts
      receivable and other assets
                
                
                870
                
                
                
                (1,324
                )Inventories
                
                
                (3,089
                )
                
                
                (6,616
                )Prepaid
      expenses
                
                
                1,035
                
                
                
                339Accounts
      payable and other accrued expense
                
                
                (5,474
                )
                
                
                5,605Deferred
      revenue
                
                
                (2,979
                )
                
                
                2,547Net
      cash used in operating activities
                
                
                (15,305
                )
                
                
                (10,678
                )Cash
      flows from investing activities:Proceeds
      from sale of property and equipment
                
                
                32
                
                
                
                —Purchase
      of property, plant and equipment
                
                
                (205
                )
                
                
                (437
                )Net
      cash used in investing activities
                
                
                (173
                )
                
                
                (437
                )Cash
      flows from financing activities:Proceeds
      from issuance of convertible debt
                
                
                —
                
                
                
                16,965Deferred
      financing fees
                
                
                —
                
                
                
                (821
                )Payment
      on notes payable
                
                
                —
                
                
                
                (92
                )Proceeds
      from purchase of employee stock options
                
                
                38
                
                
                
                213Cash
      increase resulting from merger and acquisition transactions and sale of
      software business
                
                
                12
                
                
                
                1,213Proceeds
      from issuance of common stock, warrant repricing and preferred
      stock
                
                
                9,733
                
                
                
                —Equity
      issuance costs
                
                
                (1,137
                )
                
                
                —Merger
      costs
                
                
                —
                
                
                
                (227
                )Restricted
      cash
                
                
                5,702
                
                
                
                (5,463
                )Net
      cash provided by financing activities
                
                
                14,348
                
                
                
                11,788Effect
      of exchange rate changes on cash
                
                
                —
                
                
                
                105Net
      increase (decrease) in cash and cash equivalents
                
                
                (1,130
                )
                
                
                778Cash
      and cash equivalents at beginning of period
                
                
                1,147
                
                
                
                369Cash
      and cash equivalents at end of period
                
                $
                17
                
                
                $
                1,147Supplemental
      disclosure of cash flow information:Interest
      paid
                
                $
                121
                
                
                $
                100Supplemental
      disclosure of non-cash transactions:Fair
      value of warrants issued in repricing
                
                $
                13,786
                
                
                $
                —Fair
      value of warrants and Series A Preferred stock issued to financial
      advisors and Bridge Note holders for financing and restructuring
      transaction costs
                
                $
                5,472
                
                
                $
                863Conversion
      of September convertible notes
                
                $
                35
                
                
                $
                —Fair
      value of August note surrendered towards the exercise of re-priced
      warrants
                
                $
                375
                
                
                $
                —Fair
      value of Series A and B Preferred stock issued to convert convertible
      notes and warrants  to equity
                
                $
                2,445
                
                
                $
                —Fair
      Value of stock issued to employees in settlement of employee related
      vacation and severance liabilities
                
                $
                54
                
                
                $
                —Fair
      value of warrant liability converted to equity
                
                $
                67
                
                
                
                —Conversion
      of pre-merger debt to common stock and warrants
                
                $
                —
                
                
                $
                49,472Fair
      value of 495,000 shares of Series A Preferred stock issued to related
      parties for 100% of AB Cypressen
                
                $
                4,950
                
                
                $
                —Preferred
      Stock Series A Subscription Receivable
                
                $
                1,035
                
                
                $
                —Fair
      value of equipment acquired in the merger with SBE, Inc.
                
                $
                —
                
                
                $
                79Fair
      value of option granted to financial advisor that expires June
      2008
                
                $
                —
                
                
                $
                716Equity
      contributed by SBE in merger
                
                $
                —
                
                
                $
                1,197Conversion
      of August Bridge Note
                
                $
                —
                
                
                $
                296





The
accompanying notes are an integral part of these Consolidated Financial
Statements.


41


NEONODE
INC.





Notes
to the Consolidated Financial Statements





1.   Nature of the business and
operations





Neonode
Inc. (the Company) was incorporated in the State of Delaware in 2006 as the
parent of Neonode AB, a company founded in February 2004 and incorporated in
Sweden. In February 2004, Neonode AB acquired the assets, including intangible
assets, relating to the mobile phone business, in exchange for cash of $168,000
and the assumption of a loan of $141,000. The Company allocated the
consideration to intangible assets in the amount of $284,000 and to equipment in
the amount of $25,000 based on relative fair values. In February, 2006, a
corporate reorganization was effected by issuing all of the shares of Neonode
Inc. to the stockholders of Neonode AB based upon the number and class of shares
owned by each in exchange for all of the outstanding stock of Neonode AB.
Following the reorganization, Neonode AB became a wholly-owned subsidiary of
Neonode Inc. The reorganization was accounted for with no change in accounting
basis for Neonode AB, since there was no change in control of the Group. The
consolidated accounts for the year ended December 31, 2007 and through December
9, 2008, the date that Neonode AB filed for bankruptcy, comprise the accounts of
the Companies as if they had been owned by the Company throughout the reporting
periods.





On August
10, 2007, Cold Winter Acquisition Corporation (Cold Winter Acquisition Sub), a
Delaware corporation and wholly-owned subsidiary of SBE, Inc., consummated a
merger and reorganization where Cold Winter Acquisition Sub was merged with and
into Neonode Inc. a Delaware Corporation (Old Neonode), with Old Neonode
continuing after the merger as the surviving corporation and a wholly-owned
subsidiary of SBE, Inc. (Merger). SBE, Inc.’s name was subsequently changed to
“Neonode Inc.” in connection with the completion of the Merger.





After the
Merger with Cold Winter Acquisition Sub, Old Neonode changed its name to Cold
Winter, Inc. (Cold Winter).  Following the closing of the Merger, the
business and operations of Cold Winter prior to the Merger became the primary
business and operations of the newly-combined company. The newly-combined
company’s headquarters was located in Stockholm, Sweden.





On
December 9, 2008, Neonode AB filed for liquidation under the Swedish bankruptcy
laws. Effective with Neonode AB’s bankruptcy filing on December 9, 2008, Neonode
Inc. is no longer in the mobile phone business and there are no known financial
obligations related to the accounts payable or other debts of Neonode AB that
Neonode Inc has responsibility. The Consolidated Statements of Operations and
Consolidated Statements of Cash Flows include the accounts of Neonode AB for the
year ended December 31, 2007 and the period January 1, 2008 through December 9,
2008, the date Neonode AB filed for bankruptcy.





On
December 29, 2008, we entered into a Share Exchange Agreement with AB Cypressen
nr 9683 (Cypressen), a Swedish engineering company, and the stockholders of
Cypressen:  Iwo Jima SARL, Wirelesstoys AB, and Athemis Ltd (the
Cypressen Stockholders), pursuant to which we agreed to acquire all of the
issued and outstanding shares of Cypressen in exchange for the issuance of
shares of Neonode Inc Series A Preferred Stock to the Cypressen
Stockholders.   Pursuant to the terms of the Share Exchange
Agreement, upon the closing of the transaction, Cypressen became a wholly-owned
subsidiary of the Company.   The Cypressen Stockholders are or
were employees of the Company and/or Neonode AB, and as such are related
parties. Cypressen did not have any operations in 2008. The Consolidated Balance
Sheet of the Company as of December 31, 2008 includes the accounts of Cypressen
which is comprised of cash totaling approximately $12,000. The acquisition of
Cypressen by Neonode Inc. does not qualify as a business combination, and
accordingly the fair value of the Preferred Stock Series A shares issued to the
sellers of Cypressen shares are accounted for as compensation.  As
there is an 18 month service requirement, the value of the Series A Preferred
Stock is amortized over the 18 month period beginning from December 31,
2008.


42


We
specialize in finger based optical infrared touchscreen technology which we
refer to as zForceTM. Our mission is to make the easiest (to use and
integrate), best (functionality and design) and cheapest touch screen solution
for handheld devices. Through our wholly owned subsidiary, Neonode AB, we
developed an optical touchscreen mobile phone product, the Neonode N2 that
provided a completely unique user experience that did not require any keypads,
buttons, or other moving parts.  We began shipping the N2 to our first
customers in July 2007 but faced difficult circumstances in finding a viable
market for our N2 mobile phone. We faced a competitive landscape in which our
major competitors were much better positioned and capitalized. Over time, we
found that we lacked the requisite marketing and co-marketing funding to enter
the mainstream mobile phone handset markets and as a result were forced to focus
our sales efforts on web based sales and smaller less efficient markets. In
addition, as a result of some technology issues that impacted the N2 phone
reception in certain geographical regions (reception in certain geographical
regions had more static, but the N2 phones still functioned). Beginning March
2008, we began to initiate a voluntary recall of our N2 phones to provide a
solution to eliminate the static reception issues of our phones.  The
voluntary recall  slowed our ability to market our phones in the
certain geographical regions until the voluntary recall process was completed in
May 2008. On December 9, 2008, Neonode AB filed for liquidation under the
Swedish bankruptcy laws.  Neonode AB had a total of approximately
10,000 N2 mobile phones in inventory at the time of its bankruptcy filing. The
Swedish bankruptcy court continues to pursue sales opportunities for Neonode
AB’s remaining inventory of N2 mobile phones. Although we may be the beneficiary
of a portion of any sales proceeds from such sales, the majority, if not all, of
any future sales proceeds from the sale of the N2s in Neonode AB’s inventory
will be distributed to the creditors of Neonode AB by the Swedish bankruptcy
court.





Liquidity





The accompanying financial statements
have been prepared on a going concern basis, which contemplates the realization
of assets and the satisfaction of liabilities in the ordinary course of
business. We have incurred net operating losses and negative operating cash
flows since inception. As of December 31, 2008, we had an accumulated deficit of
$64.6 million and working capital deficit (current assets less current
liabilities not including non-cash liabilities related to warrants and embedded
derivatives) of $962,000. Our operations are subject to certain risks and
uncertainties frequently encountered by companies in the early stages of
operations. Such risks and uncertainties include, but are not limited to,
technical and quality problems in new products, ability to raise additional
funds, credit risks and costs for developing new products. Our ability to
generate revenues in the future will depend substantially on our ability to
resolve quality problems, raise additional funds through debt or equity, and
enter customer contracts with customers that are financially stable.
In December 2008, we completed a
private placement offering of $1.1 million of our Preferred stock. The stock
subscription agreements related to this private placement were executed as of
December 31, 2008 and the cash proceeds were received in January and February of
2009. The subscription receivable related to this private placement transaction
was recorded as an offset to our equity at December 31, 2008. We were successful
in negotiating a deferral of payment of approximately $200,000 of our
outstanding accounts payable and accrued expenses at December 31, 2008 until
December 2009 and we converted approximately $53,000 of our accounts payable to
shares of our common stock in January 2009.





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


43


Refinancing
and Capital Raising Transactions





On
December 27, 2008, to reorganize the capital structure and to raise capital to
finance the Company’s business going forward, our Board of Directors
approved our entry into several refinancing and capital raising agreements
(together, the “Refinancing Agreements”) relating to the unregistered sale of up
to an aggregate amount of 899,081 shares of our Series A Preferred stock, par
value $0.001 per share and 108,850 shares of our Series B Preferred stock, par
value $0.001. It is contemplated that each share of Series A Preferred will be
converted into 480.63 shares of our common stock and that each share of Series B
Preferred will be converted into 132.07 shares of our common stock.





On
December 29, 2008, we commenced entering into Note Conversion Agreements with
the holders of our convertible notes and promissory notes in the aggregate
amount of up to $6,341,611, for the issuance of up to 250,014 shares of Series A
Preferred Stock, in exchange for the surrender of the Convertible Notes by the
note holders.  A total of 24 out of 27 note holders agreed to the
surrender of notes and accrued interest on such notes in the aggregate amount of
$6,195,805 in consideration for the issuance in the aggregate of 244,265.56
shares of Series A Preferred Stock on December 31, 2008.





On December 29, 2008, we commenced
entering into Warrant Conversion Agreements with the holders of warrants for the
purchase of our shares, notes, and/or additional warrants, for the issuance of
up to 108,850 shares of Series B Preferred Stock in exchange for the surrender
of the warrants by the warrant holders.  We entered into Warrant
Conversion Agreements with 92 out of 129 warrant holders for the issuance in the
aggregate of 92,795.23 shares of Series B Preferred Stock on December 31,
2008.





On December 30, 2008, we commenced
entering into Subscription Agreements with certain subscribers (Subscribers),
for the issuance of up to 150,000 shares of Series A Preferred Stock to the
Subscribers, at $10 per share, for an aggregate purchase price of up to
$1,500,000.  As of December 31, 2008, we entered into Subscription
Agreements with 10 subscribers who have signed Subscription Agreements and have
agreed to invest an aggregate of $1,121,904.  We issued 112,190.40
shares of our Series A Preferred Stock to the Subscribers on December 31,
2008.





On December 29, 2008, we entered into a
Share Exchange Agreement with AB Cypressen nr 9683 (Cypressen), and the
stockholders of Cypressen:  Iwo Jima SARL, Wirelesstoys AB, and
Athemis Ltd. (the Cypressen Stockholders), pursuant to which we agreed to
acquire all of the issued and outstanding shares of Cypressen in exchange for
the issuance of 495,000 shares of Series A Preferred Stock to the Cypressen
Stockholder on December 31, 2008.  Pursuant to the terms of the Share
Exchange Agreement, upon the closing of the transaction, Cypressen became a
wholly-owned subsidiary of the Company.





In addition, on December 31, 2008, we
issued 4,068 shares of Series A Preferred Stock to Ellis International LP as
full consideration for certain services supplied by Ellis International LP to
the Company.   We recorded a value of $41,000 for the shares
issued to Ellis International LP.





Neonode
AB Bankruptcy





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





We
account for our investment in Neonode AB in accordance with the AICPA Statement
of Position, SOP 90-7,
Financial Reporting by Entities in Reorganization Under the Bankruptcy Code,and Accounting Research Bulletin, ARB 51, Consolidate Financial
Statements.  ARB 51 precludes consolidation of a majority-owned
subsidiary where control does not rest with the majority owners, for instance,
where the subsidiary is in bankruptcy.  Accordingly, we deconsolidated
Neonode AB from our consolidated financial statements on the date it filed for
bankruptcy, December 9, 2008.





Our
Consolidated Statements of Operations and Consolidated Statements of Cash Flows
includes the accounts of Neonode AB for the year ended December 31, 2007 and for
the period January 1, 2008 through December 9, 2008, the date Neonode AB filed
for bankruptcy. Since we no longer have an ownership interest in Neonode AB, we
recorded a write-off of our receivable from Neonode AB totaling $2.8 million on
the date Neonode AB filed for bankruptcy. We also recorded a gain on debt
forgiveness of Neonode AB in bankruptcy totaling $9.8 million pursuant to the
requirements of SFAS 15, Accounting by Debtors and Creditors
for Troubled Debt Restructuring.


44


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





2.   Summary of significant accounting
policies





Principles
of Consolidation





The
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America. The
consolidated financial statements for the year ended December 31, 2007 include
the accounts of Neonode Inc. and its subsidiary based in Sweden, Neonode AB. All
inter-company accounts and transactions have been eliminated in consolidation.
The consolidated Statements of Operations and Cash Flows for the year ended
December 31, 2008 include the accounts for Neonode Inc. and  Neonode
AB for the period January 1, 2008 through December 9, 2008, the date that
Neonode AB filed for bankruptcy. The Consolidated Balance Sheet as of December
31, 2008 includes the accounts of Neonode Inc and Cypressen.





Estimates





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




Cash





We have
not had any liquid investments other than normal cash deposits with bank
institutions to date.





Restricted
Cash





We have
provided bank guaranties totaling $5.7 million as collateral for the performance
of our obligations under our agreement with our manufacturing partner. The
outstanding bank guaranties expired at December 29, 2007 and the funds were
released by our bank to cash on January 2, 2008. The cash restricted from
withdrawal by our bank to secure the obligations of the bank guaranty is shown
as restricted cash within current assets as of December 31, 2007.





Accounts
Receivable and Allowance for Doubtful Accounts





Our net
accounts receivable are stated at net realizable value. Our policy is to
maintain allowances for estimated losses resulting from the inability of our
customers to make required payments. Credit limits are established through a
process of reviewing the financial history and stability of each customer. Where
appropriate, we obtain credit rating reports and financial statements of the
customer when determining or modifying its credit limits. We regularly evaluate
the collectibility of our trade receivable balances based on a combination of
factors. When a customer’s account balance becomes past due, we initiates
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.


45





Machinery
and Equipment





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




Estimated useful lives





Tooling
                      1 yearComputer equipment
                      3 yearsFurniture and fixtures
                      5 years





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





Upon
retirement or sale of property and equipment, cost and accumulated depreciation
are removed from the accounts and any gains or losses are reflected in the
statement of operations. Maintenance and repairs are charged to expense as
incurred.





Long-lived
Assets





We
assess any impairment by estimating the future cash flow from the associated
asset in accordance with Statement of Financial Accounting Standards (SFAS) No.
144, Accounting for the
Impairment or Disposal of Long-Lived Assets . If the estimated
undiscounted future cash flow related to these assets decreases or the useful
life is shorter than originally estimated, we may incur charges for impairment
of these assets. The impairment is based on the estimated discounted cash flow
associated with the asset.





Foreign
Currency Translation





The
functional currency of our foreign subsidiary is the applicable local currency,
the Swedish Krona. The translation from Swedish Krona to U.S. Dollars is
performed for balance sheet accounts using current exchange rates in effect at
the balance sheet date and for income statement accounts using a weighted
average exchange rate during the period. Gains or losses resulting from
translation are included as a separate component of accumulated other
comprehensive loss. Gains or losses resulting from foreign currency transactions
are included in other income (expense). In addition, as Neonode AB entered into
bankruptcy and we no longer control that entity, the foreign currency
translation adjustment account relating to Neonode AB was written off into our
statement of operations during the year ended 2008.  Foreign currency
transaction losses included in other income and (expense) were $848,000 and
$354,000 during the years ended December 31, 2008 and 2007,
respectively.





Liability for
Warrants and Embedded Derivatives





We do not
enter into derivative contracts for purposes of risk management or speculation.
 However, from time to time, we enter into contracts that are not
considered derivative financial instruments in their entirety but that include
embedded derivative features. Such embedded derivatives are assessed at
inception of the contract and every reporting period, depending on their
characteristics, are accounted for as separate derivative financial instruments
pursuant to SFAS 133, Accounting for Derivative
Instruments and Hedging Activities, as amended (together, SFAS 133), if
such embedded conversion features, if freestanding, would meet the
classification of a liability. SFAS 133 requires that we analyze all material
contracts and determine whether or not they contain embedded derivatives. Any
such embedded conversion features that meet the above criteria are then
bifurcated from their host contract and recorded on the consolidated balance
sheet at fair value and the changes in the fair value of these derivatives
are recorded each period in the consolidated statements of operations as an
increase or decrease to Non-cash charges for conversion features and
warrants.


46


Similarly,
if warrants meet the classification of liabilities in accordance with EITF
00-19, Accounting
  for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company's Own
Stock , then the fair value of the warrants are recorded on the
consolidated balance sheet at their fair values, and any changes in such fair
values are recorded each period in the consolidated statements of operations as
an increase or decrease to Non-cash charges for conversion features and
warrants.





Revenue
Recognition





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





Our
policy is to recognize revenue from product sales when title transfers and risk
of loss has passed to the customer, which is generally upon shipment of products
to our customers. We estimate expected sales returns and record the amount as a
reduction of revenues and cost of sales at the time of shipment. Our policy
complies with the guidance provided by the Securities and Exchange Commission’s
Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial
Statements, issued by the Securities and Exchange Commission. We
recognize revenue from the sale of our mobile phones when all of the following
conditions have been met: (1) evidence exists of an arrangement with the
customer, typically consisting of a purchase order or contract; (2) our products
have been delivered and risk of loss has passed to the customer; (3) we have
completed all of the necessary terms of the contract; (4) the amount of revenue
to which we are entitled is fixed or determinable; and (5) we believe it is
probable that we will 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. Judgments are required in evaluating the credit
worthiness of our customers. Revenue is not recognized until we have determined
that collectibility is reasonably assured.





To date,
our revenues generated by the sale of Neonode AB’s mobile phones have consisted
primarily of sales to distributors. From time to time, we allowed certain
distributors price protection subsequent to the initial product shipment. Price
protection would have allowed the distributor a credit (either in cash or as a
discount on future purchases) if there was a price decrease during a specified
period of time or until the distributor resold the goods. We deferred
recognition of revenue (in the balance sheet line item “deferred revenue”)
derived from sales to these customers until they resold our mobile phone
products to their customers. Although revenue recognition and related cost of
sales were deferred, we recorded accounts receivable at the time of initial
product shipment. As standard terms were generally FOB shipping point, payment
terms were enforced from the shipment date and legal title and risk of inventory
loss passed to the distributor upon shipment.




For
products sold to distributors with agreements allowing for price protection and
product returns, we recognized revenue based on our best estimate of when the
distributor sold the product to its end customer. Our estimate of such
distributor sell-through was based on information received from our
distributors. Revenue was not recognized upon shipment since, due to various
forms of price concessions; the sales price was not substantially fixed or
determinable at that time.





Revenue
from products sold directly to end-users though our web sales channels were
generally recognized when title and risk of loss has passed to the buyer, which
typically occurs upon shipment. Reserves for sales returns are estimated based
primarily on historical experience and were provided at the time of
shipment.


47


Revenue
for the twelve months ended December 31, 2007 includes revenue from the sales of
our first mobile phone, the N1, and from our second product, the N2 multimedia
mobile phone, and revenue from one licensing agreement with a major Asian
manufacturer. In July 2005, we entered into a licensing agreement with a major
Asian manufacturer whereby we licensed our touchscreen technology for use in a
mobile phone to be included in their product assortment. In this agreement, we
received approximately $2.0 million in return for granting an exclusive right to
use our touchscreen technology over a two-year period that ended July
2007.  The exclusive rights did not limit our right to use our
licensed technology for our own use, nor to grant to third parties rights to use
our licensed technology in devices other than mobile phones. Another component
of the agreement provided for a fee of approximately $2.65 per telephone if the
Asian manufacturer sells mobile phones based on our technology.  In
July 2007, we extended this license agreement on a non-exclusive basis for an
additional term of one year. As of December 31, 2008, the Asian manufacturer had
not sold any mobile telephones using our technology.





The net
revenue related to this agreement was allocated over the term of the agreement,
amounting to $463,000 in 2007. The contract also included consulting services to
be provided by Neonode on an “as needed basis.” The fees for these consultancy
services varied from hourly rates to monthly rates and  were based on
reasonable market rates for such services. To date, we have not provided any
consulting service related to this agreement.





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





Post-Restructuring
Technology Licensing Business:





Our
policy is to recognize revenue from technology IP licenses upon the acceptance
of our technology by our customers. Our policy complies with the guidance
provided by SAB No. 104. We will recognize revenue from the licensing of our
technology when all of the following conditions have been met: (1) evidence
exists of an arrangement with the customer, typically consisting of a purchase
order or contract; (2) our products have been delivered and risk of loss has
passed to the customer; (3) we have completed all of the necessary terms of the
contract; (4) the amount of revenue to which we are entitled is fixed or
determinable; and (5) we believe it is probable that we will 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. Judgments
are required in evaluating the credit worthiness of our customers. Credit will
only be extended to customers and revenue will only be recognized after we have
determined that collectibility is reasonably assured. To date we have not
entered into any technology licensing contracts except for those previously
discussed.





Hardware Product:





We may from time-to-time develop
custom hardware products for our customers that incorporate our touchscreen
technology. Our policy is to recognize revenue from hardware product sales when
title transfers and risk of loss has passed to the customer, which is generally
upon shipment of our hardware products to our customers. We defer and recognize
service revenue over the contractual period or as services are rendered. We
estimate expected sales returns and record the amount as a reduction of revenue
and cost of hardware and other revenue at the time of shipment. Our policy
complies with the guidance provided by SAB No. 104. Judgments are required in
evaluating the credit worthiness of our customers. Credit will only be extended
to customers and revenue will only be recognized after we have determined that
collectibility is reasonably assured. Our sales transactions are denominated in
U.S. dollars or Euros. The software component of our hardware products is
considered incidental.  Therefore, we do not recognize software
revenue related to our hardware products separately from the hardware product
sale. To date, we have not sold any hardware products.





When selling hardware, we expect our
agreements with Original Equipment Manufacturers (OEMs) to incorporate clauses
reflecting the following understandings:





-
            all
      prices are fixed and determinable at the time of
  sale;


-
            title
      and risk of loss pass at the time of shipment (FOB shipping
      point);


-
            collectibility
      of the sales price is probable (the OEM is creditworthy, the OEM is
      obligated to pay and such obligation is not contingent on the ultimate
      sale of the OEM’s integrated
solution);


-
            the
      OEM’s obligation to us will not be changed in the event of theft or
      physical destruction or damage of the
product;


48


-
            we
      do not have significant obligations for future performance to directly
      assist in the resale of the product by the OEMs;
  and


-
            there
      is no contractual right of return other than for defective
      products.





Software
Products:





We may derive revenues from the
following sources: (1) software, which includes our NenoTM software licenses and
(2) engineering services, which include consulting. We account for the licensing
of software in accordance with American Institute of Certified Public
Accountants (AICPA) Statement of Position (SOP) 97-2, Software Revenue Recognition.
SOP 97-2 requires judgment, including whether a software arrangement includes
multiple elements, and if so, whether vendor-specific objective evidence (VSOE)
of fair value exists for those elements. These documents include post delivery
support, upgrades, and similar services.





For software license arrangements
that do not require significant modification or customization of the underlying
software, we recognize new software license revenue when: (1) we enter into a
legally binding arrangement with a customer for the license of software; (2) we
deliver the products; (3) customer payment is deemed fixed or determinable and
free of contingencies or significant uncertainties; and (4) collection is
reasonably assured. We initially defer all revenue related to the software
license and maintenance fees until such time that we are able to establish VSOE
for these elements of our software products.  Revenue deferred under
these arrangements is recognized to revenue over the expected contract term. We
will also continue to defer revenues that represent undelivered post-delivery
engineering support until the engineering support has been completed and the
software product is accepted. To date, we have not sold any software
products.





Engineering
Services:





We may sell engineering consulting
services to our customers on a flat rate or hourly rate basis. We recognize
revenue as the engineering services stipulated under the contact are completed
and accepted by our customers. To date, we have not sold any engineering
services.





Warranty
Reserves





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





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





Advertising





Advertising
costs are expensed as incurred. External advertising costs amounted to $452,000
and $661,000 for the years ending December 31, 2008 and 2007,
respectively.





Research
and Development





Research
and Development (R&D) costs are expensed as incurred. R&D costs are
accounted for in accordance with Statement of Financial Accounting Standards
(SFAS) No. 2, Accounting for
Research and Development Costs. Research and development costs consist
mainly of personnel related costs in addition to some external consultancy costs
such as testing, certifying and measurements.


49


Concentration
of Risk





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





Risk
and Uncertainties





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





We are
subject to certain risks common to technology-based companies in similar stages
of development. Principal risks include risks relating to the uncertainty of
market acceptance for our products, a history of losses since inception, our
ability to remain competitive in response to new technologies, the costs to
defend, as well as risks of losing, patents and intellectual property rights, a
reliance on a limited number of suppliers, the concentration of our operations
in a limited number of facilities, the uncertainty of demand for our products in
certain markets, our ability to manage growth effectively, our dependence on key
members of our management and development team, our limited experience in
conducting operations internationally, and our ability to obtain adequate
capital to fund future operations.





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





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





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





Stock
Based Compensation Expense





We follow
the guidance under  SFAS 123 (revised 2004) Share-Based Payment (SFAS
123R), which establishes standards for the accounting of transactions in
which an entity exchanges its equity instruments for goods or services,
primarily focusing on accounting for transactions where an entity obtains
employee services in share based payment transactions. SFAS 123R requires a
public entity to measure the cost of employee services received in exchange for
an award of equity instruments, including share options, based on the fair value
of the award on the grant date, and to recognize it as compensation expense over
the period the employee is required to provide service in exchange for the
award, usually the vesting period.


50





We
account for equity instruments issued to non-employees in accordance with SFAS
123R and Emerging Issues Task Force (EITF) 96-18, Accounting for Equity Instruments
that are Issued to Other than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services, which require that such equity instruments be
recorded at their fair value and the unvested portion is re-measured each
reporting period. When determining stock based compensation expense involving
options and warrants, we determine the estimated fair value of options and
warrants using the Black-Scholes option pricing model.





Accounting
for Debt Issued with Detachable Stock Purchase Warrants





We
account for debt issued with stock purchase warrants in accordance with APB
Opinion 14, Accountingfor
Convertible Debts and Debts issued with Stock Purchase Warrants, if the
warrants meet equity classification. We allocate the proceeds of the debt
between the debt and the detachable warrants based on the relative fair values
of the debt security without the warrants and the warrants themselves, if the
warrants are equity instruments. At each balance sheet date we make a
determination if these warrants instruments are classified as liabilities or
equity.  The warrants were classified as a liability pursuant to the
guidance provided in paragraph 17 of EITF 00-19. The warrants were recorded
among “Liability for warrants to purchase common stock” and are valued at fair
valued at the end of each reporting period using the Black-Scholes option
pricing model. As of December 31, 2008, all of the outstanding warrants are
classified as equity.





Income
Taxes





We
account for income taxes in accordance with SFAS 109, Accounting for Income Taxes.
SFAS 109 requires recognition of deferred tax liabilities and assets for the
expected future tax consequences of items that have been included in the
financial statements or tax returns. We estimate income taxes based on rates in
effect in each of the jurisdictions in which it operates. Deferred income tax
assets and liabilities are determined based upon differences between the
financial statement and income tax bases of assets and liabilities using enacted
tax rates in effect for the year in which the differences are expected to
reverse. The realization of deferred tax assets is based on historical tax
positions and expectations about future taxable income. Valuation allowances are
recorded against net deferred tax assets where, in our opinion, realization is
uncertain based on the “not more likely than not” criteria of SFAS
109.





Based on
the uncertainty of future pre-tax income, we fully reserved our net deferred tax
assets as of December 31, 2008 and 2007. In the event we were to determine that
we would be able to realize our deferred tax assets in the future, an adjustment
to the deferred tax asset would increase income in the period such a
determination was made. The provision for income taxes represents the net change
in deferred tax amounts, plus income taxes payable for the current
period.





Effective
January 1, 2007, we adopted the provisions of Financial Accounting
Standards Board (FASB) Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income
Taxes , which provisions included a two-step approach to recognizing,
de-recognizing and measuring uncertain tax positions accounted for in accordance
with SFAS 109. As a result of the implementation of FIN 48, we recognized no
increase in the liability for unrecognized tax benefits. Therefore upon
implementation of FIN 48, we recognized no material adjustment to the
January 1, 2007 balance of retained earnings. As of December 31, 2008,
we had no unrecognized tax benefits.





Net
Loss Per Share





Net loss
per share amounts has been computed in accordance with SFAS 128, Earnings per Share. For each
of the periods presented, basic loss per share amounts were computed based on
the weighted average number of shares of common stock outstanding during the
period. Net loss per share, assuming dilution amounts from common stock
equivalents, are computed based on the weighted average number of shares of
common stock and potential common stock equivalents outstanding during the
period. The weighted average numbers of shares of common stock and potential
common stock equivalents used in computing the net loss per share for the twelve
month periods ending December 31, 2008 and 2007 exclude the potential common
stock equivalents, as the effect would be anti-dilutive.


51


Comprehensive
Loss





We apply
SFAS 130, Reporting
Comprehensive Income, which establishes standards for reporting and
displaying all changes in equity other than transaction with owners in their
capacity as owners. Our comprehensive loss includes foreign currency translation
gains and losses reflected in equity. We have reported the components of
comprehensive loss in our Consolidated Statements of Stockholders'
Deficit.





Cash
Flow Information





Cash
flows in foreign currencies have been converted to U.S. dollars at an
approximate weighted average exchange rate for the respective reporting periods.
The weighted average exchange rate for the Consolidated Statements of Operations
was 6.58 and 6.76 Swedish Krona to one U.S. Dollar for the year ended December
31, 2008 and 2007, respectively. The weighted average exchange rate for the
Consolidated Balance Sheets was 7.84 and 6.47 Swedish Krona to one U.S. Dollar
as of December 31, 2008 and 2007, 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 and
cash equivalents, receivables and payables and current portions of long-term
debt are deemed to approximate fair value due to their short maturities. The
carrying amounts of long-term debt and capitalized lease obligations are also
deemed to approximate their fair values. Since no quoted market prices exist for
certain of our financial instruments, the fair values of such instruments have
been derived based on our assumptions, the estimated amount and timing of future
cash flows and estimated discount rates. Different assumptions could
significantly affect these estimates.





New
Accounting Pronouncements





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





In
December 2007, the Financial Accounting Standards Board (FASB) issued Statement
on Financial Accounting Standards (SFAS) No. 141 (revised 2007), Business Combinations (SFAS
No. 141R). SFAS 141R establishes principles and requirements for how an acquirer
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, any noncontrolling interest in the acquiree
and the goodwill acquired. SFAS No. 141R also establishes disclosure
requirements to enable the evaluation of the nature and financial effects of the
business combination. SFAS No. 141R is effective as of the beginning of an
entity’s fiscal year that begins after 15 December 2008, and will be adopted in
the first quarter of 2009. The adoption of SFAS 141R will affect the way we
account for any acquisitions made after January 1, 2009.





In
September 2006, the FASB issued Statement of Financial Accounting Standards
No. 157 (SFAS 157), Fair
Value Measurementswhich defines fair value, establishes guidelines for
measuring fair value and expands disclosures regarding fair value
measurements.  SFAS 157 does not require any new fair value
measurements, but rather eliminates inconsistencies in guidance found in various
prior accounting pronouncements.  SFAS 157 is effective for financial
assets and financial liabilities within its scope for fiscal years beginning
after November 15, 2007 and for interim periods within those fiscal years. We
adopted SFAS 157 for financial assets and financial liabilities within its scope
during the first quarter of 2008, and the adoption did not have an impact on our
financial statements. In February 2008, the FASB issued FASB Staff Position No.
FAS 157-2 (FSP FAS 157-2), Effective Date of FASB Statement No.
157, which defers the effective date of SFAS 157 for all non-financial
assets and non-financial liabilities for fiscal years beginning after November
15, 2008 and interim periods within those fiscal years for items within the
scope of FSP FAS 157-2. The adoption of FSP FAS 157-2 effective January 1, 2009
for the Company’s non-financial assets and non-financial liabilities is not
expected to have an impact on our consolidated financial
statements.


52


In
December 2007, the FASB issued SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements. SFAS 160 establishes new
standards that will govern the accounting for and reporting of noncontrolling
interests in partially owned subsidiaries. SFAS 160 is effective for fiscal
years beginning on or after December 15, 2008 and requires retroactive
adoption of the presentation and disclosure requirements for existing minority
interests. All other requirements shall be applied prospectively. The adoption
of this standard will have no impact on the financial results of the Company on
the date of adoption.





In March
2008, the FASB issued SFAS 161, Disclosures about Derivative
Instruments and Hedging Activities - an amendment of FASB Statement No.
133, as amended and interpreted, which requires enhanced disclosures
about an entity’s derivative and hedging activities and thereby improves the
transparency of financial reporting. Disclosing the fair values of derivative
instruments and their gains and losses in a tabular format provides a more
complete picture of the location in an entity’s financial statements of both the
derivative positions existing at period end and the effect of using derivatives
during the reporting period. Entities are required to provide enhanced
disclosures about (a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under SFAS
133, Accounting for Derivative
Instruments and Hedging Activities, as amended and its related
interpretations (together SFAS 133), and (c) how derivative instruments and
related hedged items affect an entity’s financial position, financial
performance, and cash flows. SFAS 161 is effective for financial statements
issued for fiscal years and interim periods beginning after November 15,
2008.  We do not expect the adoption of SFAS 161 to have a material
impact on our financial position, and we will make all necessary disclosures
upon adoption, if applicable.





In April
2008, the FASB issued EITF 07-05, Determining whether an Instrument
(or Embedded Feature) Is Indexed to an Entity's Own Stock, (EITF 07-05).
EITF 07-05 provides guidance on determining what types of instruments or
embedded features in an instrument held by a reporting entity can be considered
indexed to its own stock for the purpose of evaluating the first criteria of the
scope exception in paragraph 11(a) of FAS 133. EITF 07-05 is effective for
financial statements issued for fiscal years beginning after December 15, 2008
and early application is not permitted. . We do not believe that the adoption of
EITF 07-05 will have a significant impact on our consolidated financial
statements, as the fair value of any financial instruments and related
conversion features are not significant.





In
May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles. SFAS 162 identifies the sources of accounting
principles and the framework for selecting the principles to be used in the
preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles in the
United States. SFAS 162 is effective on November 15, 2008. The adoption of SFAS
162 did not have any financial impact on our consolidated financial
statements.





In
May 2008, the FASB issued Staff Position (FSP) APB 14-1, Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement). This FSP clarifies that convertible debt instruments that
may be settled in cash upon conversion (including partial cash settlement) are
not addressed by paragraph 12 of APB Opinion No. 14, Accounting for Convertible Debt
and Debt issued with Stock Purchase Warrants. Additionally, this FSP
specifies that issuers of such instruments should separately account for the
liability and equity components in a manner that will reflect the entity's
nonconvertible debt borrowing rate when interest cost is recognized in
subsequent periods. This FSP is effective for financial statements issued for
fiscal years beginning after December 15, 2008, and interim periods within those
fiscal years, and requires retrospective application for all periods presented.
We do not believe that adoption of FSP APB 14-1 will have a significant impact
on our financial position and operating results, as the embedded conversion
features of our convertible debt instruments had been accounted for as a
derivative.


53


3.   Inventories





At
December 31, 2007, inventories consisted of parts, materials and finished
products as follows (in thousands):


December 31,
                
                December 31,2008
                
                2007Parts
      and materials
                
                $
                —
                
                
                $
                247Finished
      goods held at customer locations
                
                
                —
                
                
                
                1,243Finished
      goods held at manufacturing partner
                
                
                —
                
                
                
                5,120Total
      inventories
                
                $
                —
                
                
                $
                6,610





Parts and
materials consist of components purchased by us in order to reduce the
production lead time of our products. Finished goods held at manufacturing
partner locations consist of N2 phones and accessories located at our prior
manufacturing partner or with our web sales partner.  Finished goods
held at customer locations consists of N2 phones that have been shipped to
distributors but remain in their inventories at the end of the period for which
revenue has been deferred.





We
experienced limited success in selling our N2 mobile phone since introduction in
the third quarter of 2007 and reevaluated our selling efforts and the potential
markets for the N2 during the second quarter of 2008. Based upon this
reevaluation, we decided that it was probable that we may have to reduce the
selling price of our N2 phones and/or offer our customers substantial incentives
in order to sell the N2. As a result of our revaluation, we recorded a $10.2
million expense in the year ended December 31, 2008.





On
December 9, 2008, Neonode AB filed for liquidation under the laws of Sweden and
as of that date the Company no longer had any ownership interest in the assets
of Neonode AB.





4.   Prepaid Expenses





Prepaid
expenses consist of the following (in thousands):


December 31,2008
                
                
                2007Prepayment
      to supplier
                
                $
                —
                
                
                $
                819Prepaid
      rent
                
                
                —
                
                
                
                87Deferred
      financing fees
                
                
                —
                
                
                
                70Prepaid
      insurance
                
                
                —
                
                
                
                16Other
                
                
                46
                
                
                
                89Total
      prepaid expenses
                
                $
                46
                
                
                $
                1,081





The
prepayment to supplier at December 31, 2007 is to our production partner and is
for the sourcing of component inventories relating to the N2 mobile telephone
launched in 2007.





The
deferred financing fees at December 31, 2007 consist of legal fees, advisor fees
and the value of detachable warrants issued to advisors relating to the issuance
of debt financing.





54




5.   Other Current
Assets





Other
current assets consist of the following (in thousands):


December31,2008
                
                2007Receivable
      for components
                
                $
                —
                
                
                $
                648Other
                
                
                —
                
                
                
                2Total
      other current assets
                
                $
                —
                
                
                $
                650




6.   Machinery and
Equipment





Machinery
and equipment consists of the following (in thousands):


December 31,2008
                
                
                2007Tooling
                
                $
                —
                
                
                $
                341Furniture
      and equipment
                
                
                —
                
                
                
                102Computers
                
                
                146
                
                
                
                228less
      accumulated depreciation
                
                
                (30
                )
                
                
                (296
                )Machinery
      and equipment, net
                
                $
                116
                
                
                $
                375Depreciation
      expense for the year ended
                
                $
                287
                
                
                $
                231





7.   Intangible Assets





Intangible
assets consist of the following (in thousands):


December 31,2008
                
                2007Patents
                
                $
                —
                
                
                $
                349less
      accumulated amortization
                
                
                —
                
                
                
                (254
                )Patents,
      net
                
                $
                —
                
                
                $
                95Amortization
      expense for the year ended
                
                $
                52
                
                
                $
                67





We have
not recorded any further investment in our patents since
2004.  Pursuant to an intercompany pledge agreement signed in February
2006 securing intercompany borrowings, we transferred the intellectual property,
including assignment of the patents, copyrights and trademarks, from Neonode AB
to Neonode Inc. prior to Neonode AB filing for liquidation under the Swedish
bankruptcy laws on December 9, 2008.





8.   Accrued Expenses





Accrued
expenses consist of the following (in thousands):


December 31,2008
                
                
                2007Earned
      salary, vacation and benefits
                
                $
                -
                
                
                $
                359Accrued
      pension premiums
                
                
                -
                
                
                
                233Accrued
      interest expense
                
                
                8
                
                
                
                106Accrued
      legal, audit and consulting fees
                
                
                312
                
                
                
                425Other
      costs
                
                
                —
                
                
                
                268Total
      accrued expenses
                
                $
                320
                
                
                $
                1,391


55





9.   Other Liabilities





Other
liabilities consist of the following (in thousands):


December 31,2008
                
                
                2007VAT
      payable
                
                $
                —
                
                
                $
                187Warranty
      reserve
                
                
                —
                
                
                
                92Employee
      withholding taxes
                
                
                —
                
                
                
                111Social
      security Swedish payroll related fees
                
                
                —
                
                
                
                160Accrued
      liability to suppliers
                
                
                —
                
                
                
                120Other
                
                
                —
                
                
                
                4Total
      other liabilities
                
                $
                —
                
                
                $
                674




All of the Other Liabilities were
related to the operation of Neonode AB that filed for liquidation under the
Swedish bankruptcy laws on December 9, 2008.  We are not responsible
for the liabilities of Neonode AB after the bankruptcy filing date.





10.   Deferred Revenue





We
allowed certain distributors of our N2 mobile phone price protection and pricing
adjustments subsequent to the initial product shipment and as a result we
deferred recognition of revenue (in the balance sheet line item “deferred
revenue”) derived from sales to these customers until they resold our products
to their customers or the price protection period ended. Although revenue
recognition and related cost of sales are deferred, we recorded an accounts
receivable at the time of initial shipment of the N2 phones. As standard terms
were generally FOB shipping point, payment terms were enforced from shipment
date and legal title and risk of inventory loss passes to the distributor upon
shipment. As of December 31, 2007, Neonode AB had $3.0 million of deferred
revenue that would have been recognized as our customers sold our products and
the applicable price protection ends, of which $2.4 million was recognized as
revenue during 2008.


.


11.   Liability for Warrants and Embedded
Derivatives (in thousands):





December 31,2008
                
                2007Liability
      for warrants to purchase common stock
                
                $
                —
                
                
                $
                5,971Embedded
      derivative of convertible debt
                
                $
                —
                
                
                $
                3,536





We converted 12.2 million shares of the
outstanding warrants and $6.1 million of the outstanding convertible debt to
shares of our Preferred stock on December 31, 2008. After the exchange of the
warrants and notes for our Preferred stock, we have 2.1 million warrants and
$139,000 of convertible debt outstanding at December 31, 2008.  All
anti-dilution provisions related to the convertible debt have been
extinguishedas a
result of the exchangeand accordingly, we
marked-to-market the embedded conversion feature immediately prior to the
exchange, and then the new value of $3.4 million was written-off as part of the
troubled debt restructuring gain (see Note 12).








12.   Convertible Debt and Notes
Payable





Our
convertible debt and notes payable consists of the following (in
thousands):


56





December 31,2008
                
                
                2007Senior
      Convertible Secured Notes August (face value $2.8 million as of December
      31, 2007)
                
                $
                —
                
                
                $
                2,634Senior
      Convertible Secured Notes September (face value $139,000 and $3.1 million
      as of December 31, 2008 and 2007 , respectively)
                
                
                139
                
                
                
                1,112Loan
      - Almi Företagspartner 2
                
                
                —
                
                
                
                120Capital
      lease
                
                
                85
                
                
                
                72Total
      fair value of notes outstanding
                
                
                224
                
                
                
                3,938Unamortized
      debt discount
                
                
                —
                
                
                
                3,746Total
      debt, net of debt discount
                
                
                224
                
                
                
                192Less:
      short-term portion of long-term debt and leases
                
                
                17
                
                
                
                132Long-term
      debt and leases
                
                $
                207
                
                
                $
                60





Future
maturities of notes payable (in thousands):





Year ended December 31,
                  
                  Future
                    Maturity of
                    Notes Payable2009
                  
                  $
                  —2010
                  
                  
                  139Total
      principal payments
                  
                  $
                  139





Future
lease payments related to capital leases are as follows (in
thousands):


Year ending December 31:
                  
                  Future minimum
                    payments on
                    capital leases2009
                  
                  $
                  262010
                  
                  
                  262011
                  
                  
                  262012
                  
                  
                  262013
                  
                  
                  2Total
      minimum lease payments
                  
                  $
                  106Less:
      Amount representing interest
                  
                  
                  (21
                  )Present
      value of net minimum lease payments
                  
                  $
                  85





The
Company returned the leased copy machine located in the closed US office to
Xerox in January 2009.





57




Loan
Default:


At
December 31, 2008, we failed to pay the $8,000 interest payment due on September
30, 2008 to the three convertible debt holders who hold notes with a total
combined principal balance of $139,000 and who did not participate in the debt
restructuring transaction. As a result, on December 31, 2008, we are in default
as defined under the Senior Convertible Secured Notes September
2007.  Under the terms of default the interest rate was increased to
10.5% from the higher of 8% or LIBOR plus 3% effective September 30, 2008
through December 31, 2008. We made the required interest payment in January 2009
and cured the loan default and the future interest rate has been reduced from
10.5% to the higher of 8% or LIBOR plus 3%.





Troubled
Debt Restructuring





Conversion
of Senior Convertible Notes to Series A Preferred Stock:





On December 31, 2008, 24 out of 27
convertible and promissory note holders agreed to the surrender of notes and
accrued interest on such notes in the aggregate amount of $6,195,805 in
consideration for the issuance of 244,265.56 shares of Series A Preferred
Stock.  The carrying value of the convertible notes, promissory notes,
and debt discount plus the fair value of the related embedded conversion
features amounted to $5.9 million immediately prior to conversion, using the
Black-Scholes option pricing model. The assumptions used when calculating the
fair value of the common stock anti-dilution feature were a term of 0.23 years,
volatility of 357.2% and a risk-free interest rate of 0.11%. The fair value of
the Series A Preferred stock on the date of conversion was $10 per share, as we
also raised $1.2 million in cash from both inside and outside investors, with
outside investors comprising approximately 51%.  This conversion
resulted in troubled debt restructuring accounting in accordance with SFAS 15,
Troubled Debt
Restructuring, and we recorded a non-cash gain on conversion of $3.3
million.  The remaining $139,000 convertible notes outstanding after
the conversion transaction have a due date of August 31, 2010 and bear an annual
interest rate of the greater of 8% or LIBOR plus 3%, payable quarterly in cash
or shares of our common stock at the option of the Company.




Conversion
of Warrants to Series B Preferred Stock:





On December 31, 2008, 92 out of 129
holders of warrants for the purchase of shares, notes, and/or additional
warrants of the Company agreed to the surrender of 12,255,560 warrants in
exchange for the issuance of 92,795 shares of Series B Preferred Stock. The fair
value of the converted warrants which were previously recorded as liabilities
amounted to $112,000 immediately prior to the exchange, using the Black-Scholes
option pricing model. The assumptions used when calculating the fair value of
the warrants prior the exchange were a term of 4.4 years, volatility of 152.3%
and a risk-free interest rate of 1.37%. The fair value of the Series B Preferred
stock on the date of exchange was $0.0245 per share, which is based upon a fully
diluted price per share using our market capitalization on that date. This
transaction resulted in troubled debt restructuring accounting in accordance
with SFAS 15, Troubled Debt
Restructuring, and we recorded a non-cash gain on conversion of $109,000.
The remaining outstanding warrants no longer meet the classification of
liabilities in accordance with EITF 00-19 since the toxic securities (the
anti-dilution feature) from September 26, 2007 financing are no longer
applicable,and, as such,
the remainder of the warrants previously recorded as a liability on the
consolidated balance sheet has been reclassified to equity at December 31, 2008
at the fair value of $67,000.





58





Remaining
Outstanding Warrants to Purchase Common Stock:





Outstanding
Warrants as of December 31, 2008





Description
                    
                    Issue
                      Date
                    
                    Exercise
                      Price
                    
                    Shares
                    
                    Expiration
                      DateSeptember
      2007 Investor Warrants
                    
                    9/26/2007
                    
                    $
                    1.45
                    
                    5,804
                    
                    
                    9/26/2012May
      2008 Broker Warrants
                    
                    5/20/2008
                    
                    $
                    1.27
                    
                    161,074
                    
                    
                    5/20/2013May
      2008 Broker Warrants
                    
                    5/20/2008
                    
                    $
                    1.45
                    
                    481,457
                    
                    
                    5/20/2013May
      2008 Investor Warrants
                    
                    5/22/2008
                    
                    $
                    1.45
                    
                    1,476,068
                    
                    
                    5/20/2013Total
      warrants outstanding
                    
                    
                    
                    
                    
                    
                    2,124,403




These
transactions were accounted for as a troubled debt restructuring modification of
terms pursuant to Statement of SFAS 15,Accountingby Debtorsand Creditors of Troubled DebtRestructurings. On December 31, 2008,
the gain resulting from the conversions of the Notes, embedded conversion
features and warrants, calculated in accordance with SFAS 15, was determined as
follows:





Conversion
      of carrying value of Senior Secured Notes, net of discount
                    
                    $
                    2,661Conversion
      of carrying value of embedded conversion features
                    
                    
                    3,051Conversion
      of carrying value of warrants
                    
                    
                    93Total
      conversion of carrying value of debt, embedded conversion features and
      warrants
                    
                    
                    5,805Decreases
      to gain:Fair
      value of Series A and B Preferred stock issues in exchange
                    
                    
                    2,445Gain
      on Troubled Debt Restructuring
                    
                    $
                    3,360




On both a
basic and diluted income per share basis the $3.4 million gain was
$0.12 per share for the twelve months ended December 31,
2008.





Senior
Convertible Secured August Bridge Notes





On August
8, 2007, we made an offering of convertible notes pursuant to a Note Purchase
Agreement (August Bridge Notes or Bridge Notes), dated as of July 31, 2007,
amended most recently on March 24, 2008. The August Bridge Notes were originally
convertible into the units described below. We received $3,250,000 from the
Bridge Note offering and issued an option to an investor/financial advisor to
invest $750,000, at the same terms and conditions as the Bridge Notes. The
August Bridge Notes originally matured on December 31, 2007; however, the
maturity date of these notes was extended to December 31, 2008 and the option to
invest expired on December 31, 2008.




The
August Bridge Notes were due December 31, 2008, and bore 8% per annum interest
and were convertible into purchase units that are made up of a combination of
shares of our common stock, convertible debt and warrants. The note holders had
a right to convert their notes plus accrued interest anytime before December 31,
2008 into purchase units. Each purchase unit of $3,000 is comprised of one
$1,500 three-year promissory note bearing the higher of 8% or LIBOR plus 3%
interest per annum, convertible into shares of our common stock at a conversion
price of $3.50 per share, 600 shares of our common stock and 5 year warrants to
purchase 696.5 shares of our common stock at a price of $1.27 per share. For
accounting purposes, the embedded conversion feature was determined to meet the
definition of a derivative and was recorded as liability. This was because the
holder of the notes could convert debt and accrued interest, where interest is
at the greater of 8% or LIBOR plus 3%, and therefore, the total number of shares
the instrument could be convertible into was not fixed. Accordingly, the
embedded conversion feature was bifurcated from the debt host instrument and
treated as a liability, with the offset to debt discount. The related warrants
were also recorded as a liability for the same reason.


59





The fair value of the embedded
conversion feature related to the Bridge Notes was calculated at September 26,
2007 using the Black-Scholes option pricing model and amounted to $3.3 million.
The assumptions used when calculating the fair value of the embedded conversion
feature related to the Bridge Notes were a term of 0.76 years, volatility of 99%
and a risk-free interest rate of 4.16%. The $3.3 million fair value was recorded
as “Embedded derivatives of convertible debt” and a debt discount. The remaining
debt discount balance is allocated to interest expense based on the effective
interest rate method, with an effective interest rate of 393%, over the
remaining term of the notes. At December 31, 2007, the fair value of the
liability related to the conversion feature was revalued using the Black-Scholes
option pricing model and totaled $2.1 million and was less than the amount of
recorded debt, which resulted in a benefit for the year ended December 31,
2007of $1.2 million. The assumptions used when calculating the fair value of the
embedded conversion feature related to the Bridge Notes were a term of 0.76
years, volatility of 99% and a risk-free interest rate of 4.16%. The value of
the embedded conversion feature is revalued at each period-end and the liability
is adjusted with the offset recorded as “Non-cash financial items.”





On
December 31, 2008, all of the Bridge Notes plus accrued interest were converted
into 123,641 shares of our Series A Preferred stock. Please see above section,
Troubled Debt Restructuring, under the Conversion of Senior Convertible Notes to
Series A Preferred Stock for accounting treatment.




August
Bridge Notes Extension Warrants





On September 26, 2007, the August
Bridge Note holders that had not converted their debt were given three year
warrants to purchase up to 219,074 shares (1st
Extension Warrants) of our common stock at a price of $3.92 per share in
exchange for an agreement to extend the term of their notes from the original
date of December 31, 2007 until June 30, 2008. The fair value of the warrants
issued to the holders of the remaining Bridge Notes was calculated at September
26, 2007 as $706,000 using the Black-Scholes option pricing model. The
assumptions used for calculating the fair value of the 1st
Extension Warrants were a term of 3 years, volatility of 116% and a risk-free
interest rate of 4.16%. The 1st
Extension Warrants were classified as a liability pursuant to the guidance
provided in paragraph 17 of EITF 00-19,Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a Company’s Own
Stock. The fair value of the warrants was recorded as a debt issuance
cost and is allocated to interest expense based on the effective interest rate
method over the nine month term of the notes with the offsetting entry to a
liability. As a result of the extension of the loan maturity period, the
agreement to delay conversion of the bridge notes and the issuance of the 1st
Extension Warrants, the modifications were significant enough to trigger debt
extinguishment accounting resulting in a debt extinguishment charge for the year
ended December 31, 2007 amounting to $442,000. The liability for the 1st
Extension Warrants issued to the August Bridge Note holders is revalued at the
end of each reporting period and the change in the liability is recorded as
“Non-cash financing items.”





On
December 31, 2008, all of the 1st
Extension Warrants related to the Bridge Notes were exchanged into 1,659 shares
of our Series B Preferred stock.





·
              At
      December 31, 2008, we compared the fair value of the Series B Preferred
      stock issued upon conversion of the outstanding 219,074 1st
      Extension Warrants related to the Bridge Notes. The carrying value of the
      warrants was calculated using the Black-Scholes option pricing model. The
      resulting gain is includedin the Non-cash
      items related to gain on troubled debt restructuring in our Consolidated
      Statements of Operations for the year ended December 31,
    2008.


·
            At
      December 31, 2007, the liability related to the 1st
      Extension Warrants amounted to $608,000. The assumptions used when
      calculating the fair value of the 1st
      Extension Warrants at December 31, 2007 were a term of 2.76 years,
      volatility of 116% and a risk-free interest rate of
  4.16%.


60


On May 21, 2008, the August Bridge Note
holders that had not converted their debt were given additional three year
warrants (2nd
Extension Warrants) to purchase up to 510,294 shares of our common stock at a
price of $1.45 per share in exchange for an agreement to extend the term of
their notes from June 30, 2008 until December 31, 2008. The 2nd
Extension Warrants were classified as a liability pursuant to the guidance
provided in paragraph 17 of EITF 00-19. The liability for the 2nd
Extension Warrants issued to the August Bridge Note holders is revalued at the
end of each reporting period using the Black-Scholes option pricing model and
the change in the liability is recorded as “Non-cash financing items.” The
assumptions used when calculating the fair value of the 2nd
Extension Warrants were a term of 3 years, volatility of 125.57% and a risk-free
interest rate of 2.68%.





On
December 31, 2008, all of the 2nd
Extension Warrants related to the Bridge Notes were exchanged for 3,864 shares
of our Series B Preferred stock.





·
            At
      December 31, 2008, we calculated the fair value of the Series B Preferred
      stock issued upon conversion of the outstanding 510,294 2nd Extension
      Warrants related to the Bridge Notes. The carrying value of the warrants
      was calculated using the Black-Scholes option pricing model. The resulting
      gain is includedin the Non-cash
      items related to gain on troubled debt restructuring in our Consolidated
      Statements of Operations for the year ended December 31,
    2008.




Option
to Invest in Bridge Notes





In conjunction with the issuance of the
August Bridge Notes, we issued and investor an option to invest up to $750,000
under the same terms and conditions as the August Bridge Notes. The initial fair
value of the option to purchase $750,000 of the August Bridge Notes amounted to
$716,000 based on the Black-Scholes option pricing model. The assumptions used
when calculating the fair value of the original option to invest were a term of
0.39 years, volatility of 99% and interest rate of 4.16%. The initial fair value
of the option to invest was recorded as a deferred financing fee to be allocated
to interest expense using the effective interest rate method over the nine month
term of the notes with the offset recorded as other current liability. The
liability for the option to purchase additional August Bridge Notes is revalued
at the end of each reporting period and the change in the liability is recorded
as “Non-cash items relating to debt discounts and deferred financing fees and
the valuation of conversion features and warrants.”




·
                At
      December 31, 2007, the liability related to the fair value of the option
      warrants amounted to $474,000. The assumptions used when calculating the
      fair value of the warrants at December 31, 2007 were a term of 0.39 years,
      volatility of 33% and a risk-free interest rate of
  4.16%.


·
                The
      fair value of the option to purchase $750,000 of the August Bridge Notes
      originally issued on August 8, 2007 and due to expire on December 31, 2007
      was extended until March 15, 2008 on December 31, 2007 and revalued based
      on the Black-Scholes option pricing model. The assumptions used when
      calculating the fair value of the extended option to invest were a term of
      0.21 years, volatility of 99% and interest rate of 3.36%. The fair value
      of the extension totaled $475,000 and was recorded as a deferred financing
      fee to be allocated to interest expense using the effective interest rate
      method over the 12 month remaining term of the August Bridge Notes with
      the offset recorded as other current liability.


·
              The
      fair value of the option to purchase $750,000 of the August Bridge Notes
      originally issued on August 8, 2007 and extended until March 15, 2008 was
      extended until June 30, 3008 on March 15, 2008 and revalued based on the
      Black-Scholes option pricing model. The assumptions used when calculating
      the fair value of the extended option to invest were a term of 0.25 years,
      volatility of 79% and interest rate of 1.38%. The fair value of the
      extension totaled $823,000 and was recorded as a deferred financing fee to
      be allocated to interest expense using the effective interest rate method
      over the nine months remaining term of the August Bridge Notes with the
      offset recorded as other current
liability.





On April 17, 2008, the option holder
exercised $375,000 of the original $750,000 option amount and was issued a note,
at the same terms and conditions as the August Bridge Notes. The option to
invest the $375,000 unexercised portion was extended until December 31, 2008 in
conjunction with the May 2008 financing. The fair value of the unexercised
option to purchase $375,000 of the August Bridge Notes was revalued based on the
Black-Scholes option pricing model. The assumptions used when calculating the
fair value of the extended option to invest were a term of 0.5 years, volatility
of 107% and interest rate of 1.23%. The fair value of the extension totaled
$324,000 and was recorded as a deferred financing fee to be allocated to
interest expense using the effective interest rate method over the six months
remaining term of the August Bridge Notes with the offset recorded as other
current liability. The exercise of $375,000 of the original $750,000 option
reduced the liability for the option by $314,000.





61





On May 21, 2008, as part of the May 21,
2008 warrant repricing financing transaction described below, the $375,000 of
Bridge Note debt was cancelled and was converted into 295,275 shares common
stock and 590,550 warrants at an exercise price of $1.45 per share.




On December 31, 2008, all of the
590,550 5-year warrants were exchanged for 4,471 shares of our Series B
Preferred stock. The option to invest the remaining unexercised $375,000 of the
original $750,000 option to invest terminated on December 31, 2008 without the
option holder exercising the option.





·
            At
      December 31, 2008, we calculated the fair value of the Series B Preferred
      stock issued upon conversion of the outstanding 590,550 Warrants. The
      carrying value of the warrants was calculated using the Black-Scholes
      option pricing model. The resulting gain is includedin the Non-cash
      items related to gain on troubled debt restructuring in our Consolidated
      Statements of Operations for the year ended December 31,
    2008.





Senior
Convertible Secured Notes September 26, 2007 Financing





On September 26, 2007, we sold $5.7
million of securities in a private placement, comprised of $2.9 million of
three-year promissory notes bearing the greater of 8% or LIBOR plus 3% interest
per annum, convertible into shares of our common stock at a conversion price of
$3.50 per share, 952,499 shares of our common stock, and 5 year warrants to
purchase 1,326,837 shares of our common stock at a price of $3.92 per
share.





In addition, on September 26, 2007,
certain holders of the August Bridge Notes converted an aggregate of $454,900 of
debt and accrued interest into units offered in the September 26, 2007
financing. The debt holders of the August Bridge Notes that were converted
received (i) $227,450 three-year promissory notes bearing the higher of 8% or
LIBOR plus 3% interest per annum, convertible into shares of our common stock at
a conversion price of $3.50 per share, (ii) 75,817 shares of our common stock,
and (iii) 5-year warrants to purchase 105,612 shares of our common stock at a
price of $3.92 per share. The fair value of the 5-year warrants totaled $340,000
and was calculated using the Black-Scholes option pricing model.




The total
issuance of securities and debt on September 26, 2007 to investors and Bridge
Note holders who converted was (i) $3.1 million of three-year promissory notes
bearing the higher of 8% or LIBOR plus 3% interest per annum, convertible into
shares of our common stock at a conversion price of $3.50 per share, (ii)
1,028,316 shares of our common stock, and (iii) 5-year warrants to purchase
1,432,449 shares of our common stock at a price of $3.92 per share.




The embedded conversion feature of the
convertible debt issued on September 26, 2007 met the definition of a derivative
financial instrument and is classified as a liability in accordance with SFAS
133 and EITF 00-19. The note holder has the right to convert the debt and
accrued interest and the interest rate is calculated at the greater of 8% or
LIBOR plus 3%, and therefore, the total number of shares of our common stock
that the convertible note can be convertible into is not fixed. Accordingly, the
embedded conversion features are revalued on each balance sheet date and marked
to market with the adjusting entry to “Non-cash financial items.” The fair value
of the conversion feature related to the September 26, 2007 convertible notes
totaled $1.4 million at September 26, 2007 and was recorded as a debt discount.
On the issuance date, we allocated the proceeds first to the warrants based on
their fair value with the remaining balance allocated between debt, $771,000,
and equity, $669,000, based on their relative fair values.





For the year ended December 31, 2008,
$1.1 million of the debt discount is included in Gain on troubled debt
restructuring and $12,000 is included in interest expense in the Consolidated
Statements of Operations.


62





On
December 31, 2008, $3.1 million of the Senior Secured Convertible Notes plus
accrued interest were converted into 120,624 shares of our Series A Preferred
stock. After conversion, $139,000 of the Senior Secured convertible Notes due
August 31, 2010 remains outstanding. Please see above section, Troubled Debt
Restructuring, under the Conversion of Senior Convertible Notes to Series A
Preferred Stock for accounting treatment.





·
            At December 31, 2007, the
      liability related to the embedded conversion feature of the convertible
      debt amounted $1.4 million. The liability related to the embedded
      conversion feature was $0 at December 31, 2008 because the right of the
      Company to repurchase the notes expired September 25, 2008 and as such the
      embedded conversion feature was no longer
    applicable.





The warrants issued in conjunction with
the September 26, 2007 financing met the definition of a liability pursuant to
the provisions of EITF No. 00-19. The fair value of the warrants issued in
conjunction with issuance of shares of our common stock and convertible debt
totaled $4.3 million on its issuance date and was recorded as a liability. The fair value of the
warrants on the date of issuance was calculated using the Black-Scholes option
pricing model using a term of 5 years, volatility of 116% and a risk-free
interest rate of 4.2%.




All of
the warrants, except for warrants to purchase 5,804 shares of our common stock,
related to the Senior Convertible Secured Notes from September 2007 were
exchanged for 8,994 shares of our Series B Preferred stock at December 31,
2008.





At December 31, 2008, The remaining
outstanding 5,804 warrants no longer met the classification of liabilities in
accordance with EITF 00-19 since the anti-dilution feature related to September
26, 2007 financing expired when the value of outstanding notes payable dropped
below $2,000,000. The fair value of the warrants was measured at year end and
the change in the fair value is included in the Consolidated Statements of
Operations in the Non-cash items related to debt discounts and deferred
financing fees and the valuation of conversion features and warrants The fair
value of $174,000 is included in equity as of December 31, 2008.




As part
of the September 26, 2007 Private Placement, we issued 142.875 unit purchase
warrants to Empire Asset Management Company (Empire) for financial advisory
services provided in connection with the placement. Each unit purchase warrant
has a strike price of $3,250 and is comprised of a $1,500 three-year promissory
note, bearing the higher of 8% or LIBOR plus 3% interest per annum, convertible
into shares of our common stock at a conversion price of $3.50 per share, 500
shares of our common stock and a five-year warrant to purchase 696.5 shares of
our common stock at a purchase price of $3.92 per share. At the date of
issuance, the fair value of the unit purchase warrants issued to Empire totaled
$614,000 and was included in the issuance costs related to the September
financing. The assumptions used for the Black-Scholes option pricing model were
a term of five years, volatility of 99% and a risk-free interest rate of 4.2%.
The liability for the option to purchase additional units is revalued at the end
of each reporting period and the change in the liability is recorded as
“Non-cash financing items”.




On
December 31, 2008, all of the Unit Purchase Warrants related to the Senior
Convertible Secured Notes were exchanged for 5,990 shares at no exercise price
of our Series B Preferred stock. Please see above section, Troubled Debt
Restructuring, under the Conversion of Warrants to Series B Preferred Stock for
accounting treatment.





·
            At
      December 31, 2008, the liability related to the Unit Purchase Warrants
      amounted to $0 resulting in a $509,000 decrease for the year ended
      December 31, 2008 compared to the fair value of these unit purchase
      warrants of $509,000 at December 31, 2007. The $509,000 gain is included
      in the Non-cash items related to gain on troubled debt restructuring in
      our Consolidated Statements of Operations for the year ended December 31,
      2008.


63


May
21, 2008 Warrant Repricing





On May 21, 2008, we offered our
existing warrant holders an opportunity to exercise Neonode common stock
purchase warrants on a discounted basis and to receive two new five year common
stock purchase warrants with an exercise price of $1.45 for each outstanding
warrant exercised. In all, 8,009,586 new warrants were issued, including 590,550
to the option holder who converted the $375,000 of debt. The warrants were
classified as a liability pursuant to the guidance provided in paragraph 17 of
EITF 00-19. The warrants were recorded among “Liability for warrants to purchase
common stock” and are valued at fair valued at the end of each reporting period
using the Black-Scholes option pricing model. The fair value of the warrants
totaled $13.8 million. The assumptions used for the calculation of the fair
value were a term of 5 years, volatility of 110.28% and interest rate of
3.09%.




On
December 31, 2008, 6,618,889 of the warrants were exchanged for 50,117 shares of
our Series B Preferred stock. Please see above section, Troubled Debt
Restructuring, under the Conversion of Warrants to Series B Preferred Stock for
accounting treatment. 1,476,068 of the warrants issued related to the Warrant
Repricing remain outstanding after the December 31, 2008 restructuring and
warrant conversion.




·
            At
      December 31, 2008, the remaining 1,476,068 outstanding warrants no longer
      meet the classification of liabilities in accordance with EITF 00-19 and,
      as such, these warrants previously recorded as a liability on the
      consolidated balance sheet was reclassified to equity using the $44,000
      fair value on December 31, 2008. The assumptions used when calculating the
      fair value of the warrants at December 31, 2008 were a term of 4.3 years,
      volatility of 143.1% and a risk-free interest rate of
    1.46%.




Anti-Dilution
Feature and Price Protection





The
September 26, 2007 financing agreement contained anti-dilution features for each
of the common stock, convertible debt and the warrants whereby these instruments
are protected separately for 18 months or until the outstanding debt is less
than $2.0 million against future private placements made at lower share prices.
September 2007 common stock investors would receive additional shares if there
are future issuances of common stock with a lower price. September 2007
convertible debt and warrant holder investors would receive an adjustment to the
conversion price or exercise price, respectively. Accordingly, there are no
longer anti-dilution features in such common stock, convertible debt and
warrants since December 31, 2008, when the outstanding debt was reduced to
$139,000. The 2,124,403 remaining outstanding warrants contain price protection
whereby these instruments are protected separately for the life of the warrants.
Under the price protection clause, if we issued warrants at a lower exercise
price than the remaining outstanding warrants, the exercise price of such
warrants would be reduced to the lower price. The warrant holders would not be
entitled to additional shares of common stock, only the reduction in the
exercise price.





Common
Stock





On March 4, 2008, we issued 1,800,000
shares of common stock to investors of a private placement at a price of $2.50
per share. The issuance of these shares triggered the anti-dilution feature
related to common stock issued in the September 26, 2007 financing transaction.
As a result we were required to issue an additional 207,492 shares of our common
stock to investors in the September 26, 2007 financing. On December 31, 2008, as
part of the refinancing and capital raising transactions, we issued 4,421,072
shares of our common stock to investors in the September 26, 2007 financing to
satisfy the anti-dilution features contained in the financing agreement. Because
we reduced the outstanding debt to less than $2.0 million, the anti-dilution
features contained in the financing agreement are no longer outstanding as of
December 31, 2008.





·
            At December 31, 2008, the
      liability related to the common stock anti-dilution feature amounted to
      $0, resulting in a $1.4 million decrease since the initial
      valuation.


64


Warrants





As part of the May 21, 2008 financing
transaction, we issued 400,480 warrants at a price of $1.27 per share and an
additional 800,959 warrants at a price of $1.45 per share to Empire for
financial advisory services provided in connection with the transaction. At the
date of issuance, the fair value of the warrants issued to Empire totaled $2.0
million and was included in the issuance costs related to the May 21, 2008
financing transaction. The assumptions used for the Black-Scholes option pricing
model were a term of 5 years, volatility of 110.28% and a risk-free interest
rate of 3.09%. (see Note 14 Stockholders’ Equity)





On
December 31, 2008, 559,228 of the warrants were exchanged for 4,234 shares of
our Series B preferred stock. At December 31, 2008, 161,074 of the $1.27
warrants and 481,457 of the $1.45 Warrants remain outstanding after
restructuring.




·
            At
      December 31, 2008, the remaining 642,531 outstanding warrants no longer
      meet the classification of liabilities in accordance with EITF 00-19 and,
      as such, the warrants previously recorded as a liability on the
      consolidated balance sheet was reclassified to equity using the fair value
      of the warrants on December 31, 2008. The assumptions used when
      calculating the fair value of the warrants at December 31, 2008 were a
      term of 4.3 years, volatility of 143.1% and a risk-free interest rate of
      1.46%.




Derivatives





As discussed above, the senior secured,
bridge and promissory notes issued above contain embedded conversion features.
The conversion features are considered embedded derivatives and are included in
“Embedded derivative of convertible debt.” At the time of issuance of the senior
secured notes, the fair value of the conversion feature was recorded as a debt
discount and amortized to interest expense over the expected term of the senior
secured notes using the effective interest rate method. Changes in the fair
value of the conversion feature are recorded in “Non-cash charges for conversion
features and warrants.” During the years ended December 31, 2008 and 2007, we
recorded charges of $12,000 and $441,000 of interest expense associated with the
amortization of the debt discounts along with a (benefit)/charge of $(2.6)
million and $33.6 million associated with the changes in the fair value of
embedded conversion features recorded as liabilities, respectively. As of
December 31, 2008, we no longer have any embedded conversion features that are
accounted for as a derivative, since the anti-dilution feature described above
no longer applies.





Loan
Agreement with Almi Företagspartner




On April 6, 2005, Neonode AB entered
into a loan agreement with Almi Företagspartner (“Almi”) in the amount of SEK
2,000,000, with 72,000 warrants to purchase Neonode Inc. shares. The loan had an
expected credit period of 48 months with an annualized interest rate of 2%. We
were not required to make any repayments of principal for the first nine months.
Quarterly repayments of principal thereafter amounted to SEK 154,000. We had the
right to redeem the loan at any time prior to expiration subject to a prepayment
penalty of 1%, on an annualized basis, of the outstanding principal amount over
the remaining term of the loan. A floating charge (chattel mortgage) of SEK
2,000,000, was pledged as security. On December 9, 2008, Neonode AB filed for
liquidation under the Swedish bankruptcy laws and the note with Almi is no
longer an obligation of the Company after that date.The Almi note was written
off when Neonode AB filed for bankruptcy on December 9, 2008 and is included in
the gain on debt forgiveness of Neonode AB on the Consolidated Statements of
Operations for the year ended December 31, 2008.





The warrants had a term of five years
with a strike price of $10.00. The warrants were callable by us for $0.10 should
the price of our common stock trade over $12.50 on a public exchange for 20
consecutive days. The warrants were analyzed under EITF 00-19, and were
determined to be equity instruments. In accordance with Accounting Principles
Board Opinion No. (APB) 14, Accounting for Convertible Debt and
Debt Issued with Stock Purchase Warrants, because the warrants are equity
instruments, we have allocated the proceeds of the second Almi loan between the
debt and detachable warrants based on the relative fair values of the debt
security and the warrants themselves. To calculate the debt discount related to
the warrants, the fair market value of the warrants was calculated using the
Black-Scholes options pricing model. The assumptions used for the Almi loan debt
discount were a term of five years, volatility of 30% and a risk-free interest
rate of 4.50%.The aggregate debt discount amounted to $42,000 and i amortized
over the expected term of the loan agreement.


65


On December 31, 2008, Almi exchanged
all 72,000 warrants for 545 shares of our Series B Preferred stock.





13.   Fair Value Measurement of Assets and
Liabilities




In
September 2006, the FASB issued SFAS No. 157,Fair Value Measurements,
which became effective for us on January 1, 2008. SFAS 157 defines
fair value, establishes a framework for measuring fair value and expands
disclosure requirements about fair value measurements. SFAS 157 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. Implementation of this standard did not have a
material effect on our results of operations or consolidated financial
position.




In
February 2008, the FASB issued FASB Staff Position (FSP)
FAS No. 157-1,Application of FASB Statement No. 157 to FASB Statement No. 13 and Its
Related Interpretive Accounting Pronouncements That Address Leasing
Transactions  (FSP 157-1), which became effective for the
company on January 1, 2008. This FSP excludes FSAS No. 13,Accounting for Leases,
and its related interpretive accounting pronouncements from the provisions of
FAS 157.




Also
in February 2008, the FASB issued FSP FAS 157-2,Effective Date of FASB Statement
No. 157, which delayed our application of SFAS 157 for certain
nonfinancial assets and liabilities until January 1, 2009. In this regard,
the major categories of assets and liabilities for which we will not apply the
provisions of FAS 157 until January 1, 2009, are long-lived assets
that are measured at fair value upon impairment and liabilities for asset
retirement obligations.




Our
implementation of SFAS 157 for financial assets and liabilities on
January 1, 2008, had no effect on our existing fair-value measurement
practices but requires disclosure of a fair-value hierarchy of inputs we use to
value an asset or a liability. The three levels of the fair-value hierarchy are
described as follows:




Level 1:
Quoted prices (unadjusted) in active markets for identical assets and
liabilities. We had no level 1 assets or liabilities.




Level 2:
Inputs other than Level 1 that are observable, either directly or
indirectly. We had no level 1 assets or liabilities.





Level 3:
Unobservable inputs. We valued our Series A and Series B Preferred stock that
both were without observable market values and the valuation required a high
level of judgment to determine fair value (level 3 inputs).


The
following table shows the classification of our liabilities at December 31, 2008
that are subject to fair value measurements and the roll-forward of these
liabilities from December 31, 2007:





As
discussed in note 12.   Convertible Debt and Notes Payable, the value of
the Series A preferred stock was based upon a negotiated price to raise cash,
which was $10.00 per share, where 51% of the investors were new
investors.


66





December 31,
                  2008
                
                
                Decrease
                
                
                Increase
                
                
                December 31,
                  2007Series
      A Preferred stock
                
                $
                3,531
                
                
                $
                -
                
                
                $
                3,531
                
                
                $
                -Series
      B Preferred stock
                
                
                2
                
                
                
                -
                
                
                
                2
                
                
                
                -Total
      Liabilities at Fair Value
                
                $
                3,533
                
                
                $
                -
                
                
                $
                3,533
                
                
                $
                -




14.   Stockholders’
Equity





Common
Stock:





On
January 28, 2008, a holder of convertible notes issued on September 26, 2007
elected to convert an aggregate amount of debt and accrued interest amounting to
$35,000. The conversion resulted in the issuance of 10,000 shares of common
stock at $3.50. The debt discounts, conversion features and deferred financing
fees that related to the loans that were converted amounted to an aggregate of
$20,000. The net amount of $15,000 was recorded in equity.




On March
4, 2008, we sold $4.5 million in securities in a private placement to accredited
investors. We sold 1,800,000 shares (Investor Shares) of our common stock, for
$2.50 per share. After placement agent fees and offering expenses, we received
net cash proceeds of approximately $4,000,000.





In
addition, we issued an aggregate of 207,492 shares of common stock to investors
who participated in the September 26, 2007 private placement pursuant to
anti-dilution provisions contained in the September 26, 2007 Private Placement
Subscription Agreement. Empire acted as financial advisor in the private
placement and received compensation in connection with the private placement of
approximately $450,000 in cash and 120,000 shares of our common stock valued at
$152,400 on the date of issuance.





On
May 21, 2008, we completed a $5.1 million, net cash proceeds to us of $4.1
million, private placement, primarily to prior security holders, directors,
affiliates of management and institutional investors. We offered our existing
warrant holders an opportunity to exercise Neonode common stock purchase
warrants on a discounted basis. In all, 4,004,793 outstanding warrants were
exercised at a strike price of $1.27 per warrant (including $375,000 of
surrender of debt). We issued 4,004,793 shares of our common stock and two new
common stock purchase warrants, with an exercise price of $1.45, for each
outstanding warrant exercised. A total of 8,009,586 new common stock purchase
warrants were issued to investors who surrendered or purchased shares under the
warrant exchange offer. We also extended the maturity date of $2.85 million of
convertible debt that was due on June 30, 2008 until December 31, 2008 by
issuing the note holders 510,293 common stock purchase warrants, with an
exercise price of $1.45. Empire acted as financial advisor for the transaction
and was paid a cash fee of approximately $510,000 and received a warrant to
purchase 400,480 shares of our common stock at $1.27 per share and a warrant to
purchase 800,959 shares of our common stock at $1.45 per share.




On
September 4, 2008, we issued 107,638 shares of our common stock to one of our
Swedish employees in settlement of a severance payment dispute totaling
$20,400.




On
November 17, 2008, we issued 549,808 shares of our common stock to our US based
employees upon their termination from employment for payment of their accrued
vacation liability totaling $35,700.




67




On
December 31, 2008, we issued 4,421,072 shares of our common stock to investors
who participated in the September 26, 2007 private placement pursuant to
anti-dilution provisions contained in the September 26, 2007 Private Placement
Subscription Agreement.





Series A Preferred
Stock:





On December 31, 2008 we issued
855,522.98 shares of Series A Preferred Stock that at the date of issuance had a
conversion rate of one share of common stock for each share of Series A
Preferred Stock. Our shareholders approved a resolution to increase the
conversion ratio to 480.63 shares of common stock for each share of Series A
Preferred Stock at a special meeting of our shareholders held on March 31, 2009.
Upon conversion, the shares of Series A Preferred Stock will convert into
411,190,010 shares of our common stock.





On
December 31, 2008, we issued the following Series A Preferred
Stock:





·
            112,290.40
      shares to investors in a private placement who invested
      $1,121,904.


·
            244,265.56
      shares to convertible debt holders who converted $6,195,805 of principal
      and accrued interest.


·
            495,000
      shares to acquire Cypressen.


·
            4,067.02
      shares for brokerage services in regards to the refinancing and capital
      raising transactions.





Series
B Preferred Stock:





On
December 31, 2008, we issued 92,795.94 shares of Series B Preferred Stock to
warrant holders to convert their warrants to equity. At the date of issuance,
these warrants had a conversion rate of one share of common stock for each share
of Series B Preferred Stock. Our shareholders approved a resolution to increase
the conversion ratio to 132.07 shares of common stock for each share of Series B
Preferred stock at a special meeting of our shareholders held on March 31, 2009.
Upon conversion, the shares of Series B Preferred Stock will convert into
12,255,560 shares of our common stock.




On
December 31, 2008, after the refinancing and capital raising transactions, we
have 35,058,011 shares of common stock, 855,522.98 shares of Series A Preferred
stock, 92,795.94 shares of Series B Preferred stock, 2,124,403 million warrants
to purchase our common stock and 1,322,978 employee stock options outstanding.
Upon shareholder approval, all the outstanding Series A and B Preferred Stock
will be converted to 423,445,570 shares of common stock.





15.   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.





Stock
Options





As of
December 31, 2008, we had four 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


·
            The 2007 Neonode Stock Option
      Plan (the Neonode Plan), we will not grant any additional equity awards
      out of the Neonode Plan; and


·
            The 2006 Equity Incentive Plan
      (the 2006 Plan).




We also
had one non-employee director stock option plan as of December 31,
2008:


68





·
            The 2001 Non-Employee Director
      Stock Option Plan (the Director
Plan).





The
following table details the outstanding options to purchase shares of our common
stock pursuant to each plan at December 31, 2008:





Plan
                      
                      Options
                        Outstanding
                      
                      
                      Available
                        for Issue
                      
                      
                      Outstanding
                        Options
                        Vested1996
      Plan
                      
                      
                      46,000
                      
                      
                      
                      —
                      
                      
                      
                      46,0001998
      Plan
                      
                      
                      66,395
                      
                      
                      
                      —
                      
                      
                      
                      29,900Neonode
      Plan
                      
                      
                      880,330
                      
                      
                      
                      —
                      
                      
                      
                      880,3302006
      Plan
                      
                      
                      287,753
                      
                      
                      
                      94,801
                      
                      
                      
                      71,247Director
      Plan
                      
                      
                      42,500
                      
                      
                      
                      —
                      
                      
                      
                      15,500Total
                      
                      
                      1,322,978
                      
                      
                      
                      94,801
                      
                      
                      
                      1,042,977





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, the Neonode Plan and the Director Plan at December 31, 2007:





Options Outstanding
                
                Options ExercisableRange of Exercise Price
                
                Number
                  Outstanding at
                  12/31/08
                
                Weighted Average
                  Remaining
                  Contractual Life
                  (years)
                
                Weighted Average
                  Exercise Price
                
                Number
                  Exercisable at
                  12/31/08
                
                Weighted Average
                  Exercise Price$
      0.00 -   $ 1.00
                
                
                40.000
                
                6.42
                
                $
                0.60
                
                —
                
                $
                —$
      1.01 -   $ 2.00
                
                
                353,190
                
                3.04
                
                $
                1.42
                
                353,190
                
                $
                1.42$
      2.01 -   $ 3.00
                
                
                560,140
                
                0.22
                
                $
                2.14
                
                560,140
                
                $
                2.14$
      3.01 -   $ 4.00
                
                
                122,000
                
                5.96
                
                $
                3.46
                
                2,000
                
                $
                4.00$
      4.01 -   $ 5.00
                
                
                211,248
                
                4.96
                
                $
                4.87
                
                91,247
                
                $
                4.82$
      5.01 - $ 6.00
                
                
                3,400
                
                1.38
                
                $
                5.30
                
                3,400
                
                $
                5.30$
      6.01 - $ 27.50
                
                
                33,000
                
                2.73
                
                $
                17.46
                
                33,000
                
                $
                17.461,322,978
                
                2.52
                
                $
                2.85
                
                1,042,977
                
                $
                2.63





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
                          
                          
                          Exercise PriceOutstanding at December 31, 2006
                          
                          
                          552,657
                          
                          
                          $
                          1.80 - $91.88
                          
                          
                          $
                          10.96Granted
                          
                          
                          2,383,482
                          
                          
                          $
                          1.42 - $8.49
                          
                          
                          $
                          2.32Cancelled or expired
                          
                          
                          (478,657
                          )
                          
                          $
                          3.20 - $91.88
                          
                          
                          $
                          11.04Exercised
                          
                          
                          ( 22,750
                          )
                          
                          $
                          1.80 - $2.33
                          
                          
                          $
                          2.28Outstanding at December 31, 2007
                          
                          
                          2,434,732
                          
                          
                          $
                          1.42 - $27.50
                          
                          
                          $
                          2.58Granted
                          
                          
                          570,000
                          
                          
                          $
                          0.60 - $3.45
                          
                          
                          $
                          3.17Cancelled or expired
                          
                          
                          (1,660,754
                          )
                          
                          $
                          1.84 - $12.95
                          
                          
                          $
                          2.58Exercised
                          
                          
                          ( 21,000
                          )
                          
                          $
                          1.84 - $1.84
                          
                          
                          $
                          1.84Outstanding at December 31, 2008
                          
                          
                          1,322,978
                          
                          
                          $
                          0.60 - $27.50
                          
                          
                          $
                          2.85




69




The 1996
Plan terminated effective January 17, 2006 and the 1998 Plan terminated
effective June 15, 2008 and 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.





The
Neonode Plan has been designed for participants (i) who are subject to Swedish
income taxation (each, a Swedish Participant) and (ii) who are not subject to
Swedish income taxation (each, a Non-Swedish Participant). The options issued
under the plan to the Non-Swedish Participant are five year options with 25%
vesting immediately and the remaining vesting over a three year period. The
options issued to Swedish participants are vested immediately upon issuance. The
fair value of the options issued out of the Neonode Plan at the date of issuance
was calculated using the Black-Scholes option pricing model. These calculations
assumed risk free interest rates ranging from 4.5% to 4.875%, a volatility of
50% and share prices ranging from $4.69 to $4.78. We will not grant any
additional equity awards out of the Neonode Plan.





We
granted options to purchase 570,000 shares of our common stock to employees or
members of our Board of Directors during the year ended December 31, 2008. We
granted options to purchase 2,383,482 shares of our common stock to employees or
members of our Board of Directors during the year ended December 31, 2007. The
fair value of stock-based compensation related to the employee and director
stock options is calculated using the Black-Scholes option pricing model as of
the grant date of the underlying stock options.





The stock
compensation expense reflects the fair value of the vested portion of options
for the Swedish and Non-Swedish participants at the date of issuance, the
amortization of the unvested portion of the stock options, less the option
premiums received from the Swedish participants. Employee and director
stock-based compensation expense related to stock options in the accompanying
condensed statements of operations is as follows (in thousands):





Twelve
      months
                    ended
                    December
                    31,
      2007
                  
                  
                  Twelve
      months
                    ended
      December
                    31,
      2008
                  
                  
                  Remaining
                    unamortized
                    expense
      at
                    December
      31,2008Stock
      based compensation
                  
                  $
                  408
                  
                  
                  $
                  1,163
                  
                  
                  $
                  503





The
remaining unamortized expense related to stock options will be recognized on a
straight line basis monthly as compensation expense over the remaining vesting
period which approximates 3 years.





The fair
value of each option grant was estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions:





Options
      granted in the year ended December 31
                  
                  2008
                  
                  
                  2007Expected
      life (in years)
                  
                  
                  2.67
                  
                  
                  
                  4.27Risk-free
      interest rate
                  
                  
                  2.86
                  %
                  
                  
                  5.55
                  %Volatility
                  
                  
                  150.56
                  %
                  
                  
                  114.27
                  %Dividend
      yield
                  
                  
                  0.00
                  %
                  
                  
                  0.00
                  %


70





The
weighted average grant-date fair value of options granted during the fiscal
years ended December 31, 2008 and 2007 was $3.17 and $1.54, respectively. The
total intrinsic value of options exercised during the fiscal years ended
December 31, 2008 and 2007 was $1,272 and $42,766, respectively.





The fair
value of stock-based awards to employees 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. 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.





16.   Warranty Obligations and Other
Guarantees





The
following is a summary of our agreements that we have determined are within the
scope of FASB Interpretation (FIN) No. 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others.




Our mobile phone products were
generally warranted against defects for 12 months following the sale. We had a
12 month warranty from the manufacturer of the mobile phones. Reserves for
potential warranty claims not covered by the manufacturer are provided at the
time of revenue recognition and are based on several factors, including current
sales levels and our estimate of repair costs. Shipping and handling charges are
expensed as incurred. We accrue the estimated costs to be incurred in performing
warranty services at the time of revenue recognition and shipment of the
products to our customers. Our estimate of costs to service our warranty
obligations is based on our expectation of future conditions. To the extent we
experience increased warranty claim activity or increased costs associated with
servicing those claims, the warranty accrual will increase, resulting in
decreased gross margin. On December 9, 2008, Neonode AB filed for liquidation
under the Swedish bankruptcy laws and we have no further obligations related to
product warranties effective with the bankruptcy filing.





The following table sets forth an
analysis of our warranty reserve (in thousands):





Year ended
                    December 31,
                    2008
                  
                  
                  Year ended
                    December 31,
                    2007Warranty
      reserve at beginning of period
                  
                  $
                  95
                  
                  
                  $
                  –Less:
      Cost to service warranty obligations
                  
                  
                  —
                  
                  
                  
                  –Obligation
      of Neonode AB
                  
                  
                  (95
                  )
                  
                  
                  —Plus:
      Increases to reserves
                  
                  
                  –
                  
                  
                  
                  95Total
      warranty reserve included in other accrued expenses
                  
                  $
                  —
                  
                  
                  $
                  95





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 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, 2008 and 2007, respectively.





71







We
enter into indemnification provisions under our agreements with other companies
in the ordinary course of business, typically with business partners,
contractors, customers andlandlords.
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 agreements as of December 31, 2008 and 2007,
respectively.




On
September 4, 2008, we received a summons to appear in the United States District
Court for the Southern District of New York because one of our investors in
previous private placements transactions, Alpha Capital Anstalt (Alpha) alleged
that we failed to issue certain stock certificates pursuant to the terms and
conditions of the September 2007 investment subscription agreements. Alpha was
asking the court to award them $734,650 in damages plus attorneys fees. Although
we believed the claim had no merit, we signed a definitive settlement agreement
on January 21, 2009 and issued Alpha 1,096,997 shares of our common stock as
settlement in full. On February 13, 2009 a notice was sent to the Court by
Alpha’s legal counsel requesting dismissal of the action.




On
December 9, 2008, Empire Asset Management (Empire), a broker dealer that acted
as the Company’s financial advisor and exclusive placement agent in previous
private placement transactions, initiated a law suit against the Company in the
Supreme Court of the State of New York alleging that the Corporation
misrepresented the success of its business to induce Empire’s customers to
invest in the Company.  Empire is seeking compensatory damages in an
unspecified amount for the harm allegedly suffered.  The Company
believes that the action has no merit and intends to defend vigorously against
the action. The Company’s Directors and Officer (D&O) insurance provider has
extended coverage and will provide us with legal representation. Our D&O
insurance policy has a $150,000 retention provision and we accrued a legal
expense and accounts payable totaling $150,000 at December 31, 2008 related to
the potential payment of the retention under our D&O insurance
policy.





On March
24, 2009, the Company as informed that a complaint had been filed against the
Company by an investor, Mr. David Berman, who invested $600,000.00 in the
Company on March 4, 2008 and May 16, 2008. The Company was informed that Mr.
Berman invested in the Company through Empire. To date the Company has not
received a copy of the complaint, but the Company believes that the action has
no merit and intends to defend vigorously against the action.




We are
the secondary guarantor on the sublease of our previous headquarters until March
2010. We believe we will have no liabilities on this guarantee and have not
recorded a liability at December 31, 2008.




17.   Income Taxes





Loss
before income taxes was distributed geographically as follows (in
thousands):




Twelve
      Months
                  Ended
      Dec. 31,
                
                
                Twelve
      Months
                  Ended
      Dec. 31,2008
                
                
                2007Domestic
                
                $
                1,976
                
                
                $
                (39,608
                )Foreign
                
                
                (7,910
                )
                
                
                (8,833
                )Total
                
                $
                (5,934
                )
                
                $
                (48,441
                )


72





We had no
provision (benefit) for income taxes for the year ended December 31, 2008 and
2007.





The
effective income tax rate differs from the statutory federal income tax rate for
the following reasons:




Twelve Months
                    Ended Dec. 31,
                  
                  
                  Twelve Months
                    Ended Dec. 31,2008
                  
                  
                  2007Amount
      at standard tax rates
                  
                  
                  (34
                  )
      %
                  
                  
                  (35
                  )
      %Non-deductible
      loss on revaluation of embedded conversion features and extinguishment of
      convertible debt
                  
                  
                  —
                  
                  
                  
                  30
                  %Increase
      in valuation allowance for deferred tax asset
                  
                  
                  —
                  
                  
                  
                  5
                  %Other
      permanent differences due to Neonode AB bankruptcy
                  
                  
                  34
                  %
                  
                  
                  —Effective
      tax rate
                  
                  
                  0
                  %
                  
                  
                  0
                  %





Significant
components of the deferred tax balances are as follows (in
thousands):




December 31,2008
                
                
                2007Deferred
      tax assets:Net
      operating loss carryforwards
                
                $
                —
                
                
                $
                5,703Amortization
                
                
                —
                
                
                
                1,305Other
                
                
                305
                
                
                
                210Total
      deferred tax assets
                
                $
                305
                
                
                $
                7,218Valuation
      allowance
                
                
                (305
                )
                
                
                (7,218
                )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 Cypressen, 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 and due to the
competitive character of the hand-held media device/mobile telephone market. The
main components of our deferred tax benefits at December 31, 2007 are the
accumulated net operating loss carry-forwards, which are almost entirely related
to the operations of Neonode AB in Sweden. The main components of our deferred
tax benefits at December 31, 2008 are related to accrued employee benefits and
stock compensation. 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. On
December 31, 2008, effective with our corporate reorganization, we no longer
have any tax operating loss carryforwards.





Effective
January 1, 2007, we adopted the provisions of FIN 48 which includes a
two-step approach to recognizing, de-recognizing and measuring uncertain tax
positions accounted for in accordance with SFAS 109. As a result of the
implementation of FIN 48, we recognized no increase in the liability for
unrecognized tax benefits. Therefore upon implementation of FIN 48, we
recognized no material adjustment to the January 1, 2007 balance of
retained earnings. A reconciliation of the unrecognized tax benefits for the
year ended December 31, 2008 is as follows:


73





Balance
      at January 1, 2008
                
                $
                0Additions
      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, 2008
                
                $
                0





We
adopted a policy to classify accrued interest and penalties as part of the
accrued FIN 48 liability in the provision for income taxes. For the year ended
December 31, 2008, 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, 2008, we had no accrued
interest and penalties related to uncertain tax matters.








By the
end of 2008, 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.





We file
income tax returns in the U.S. federal jurisdiction, California and Sweden. The
1995 through 2008 tax years are open and may be subject to potential examination
in one or more jurisdictions. We are not currently under federal, state or
foreign income tax examination.





18.   Employee Benefit
Plans





We
participate in a number of individual defined contribution pension plans for our
employees in Sweden. Contributions relating to these defined contribution plans
for the years ended December 31, 2008 and 2007 were $363,000 and $237,000
respectively. A part of the restructuring, we no longer participate in any
pension plans for our employees in Sweden.





19.   Commitments and
Contingencies


On
December 9, 2008, Empire Asset Management (Empire), a broker dealer that acted
as the Company’s financial advisor and exclusive placement agent in previous
private placement transactions, initiated a law suit against the Company in the
Supreme Court of the State of New York alleging that the Corporation
misrepresented the success of its business to induce Empire’s customers to
invest in the Company.  Empire is seeking compensatory damages in an
unspecified amount for the harm allegedly suffered.  The
Company believes that the action has no merit and intends to defend
vigorously against the action. The Company’s Directors and Officer (D&O)
insurance provider has extended coverage and will provide us with legal
representation. Our D&O insurance policy has a $150,000 retention provision
and we accrued a legal expense and accounts payable totaling $150,000 at
December 31, 2008 related to the potential payment of the retention under our
D&O insurance policy.





On March
24, 2009, the Company as informed that a complaint had been filed against the
Company by an investor, Mr. David Berman, who invested $600,000.00 in the
Company on March 4, 2008 and May 16, 2008. The Company was informed that Mr.
Berman invested in the Company through Empire. To date the Company has not
received a copy of the complaint, but the Company believes that the action has
no merit and intends to defend vigorously against the action.





Operating
Leases





On
January 12, 2009, our subsidiary, Cypressen entered into a 12 month lease with
Vasakronan Fastigheter AB for approximately 2,000 square feet of office space
located at Linnegatan 89, Stockholm, Sweden for approximately $5,000 per month.
The annual payment for this space equates to approximately
$60,000.


74





The
future minimum lease payments under this non-cancellable operating lease are as
follows as of December 31, 2008 (in thousands):




Future
                          minimum
                          payments on
                          operating leasesYear
      Ending December 31,2009
                        
                        $
                        60





Total
rent expense under the leases for office space located in Sweden and the US
under leases that have been cancelled was $378,000and $343,000 for the years
ended December 31, 2008 and 2007, respectively.





20.   Concentration of Credit and Business
Risks





Our trade
accounts receivable for Neonode AB as of December 31, 2007 are concentrated
among a small number of customers, principally located in Europe and India. Two
customers accounted for 68% of our outstanding accounts receivable at December
31, 2007.




Sales to
individual customers in excess of 15% of net sales for the year ended December
31, 2007 included sales to My Phone located in Greece of $992,000, or 32% of net
sales and Brightpoint located in Sweden and Norway of $749,000, or 24% of net
sales. All sales were executed in Euros or U.S. dollars.





We depend
on a limited number of customers for substantially all revenue to date. Failure
to anticipate or respond adequately to technological developments in our
industry, changes in customer or supplier requirements or changes in regulatory
requirements or industry standards, or any significant delays in the development
or introduction of products or services, could have a material adverse effect on
our business, operating results and cash flows.





21.   Net Loss Per
Share





Basic net
loss per common share for the year ended December 31, 2008 and 2007 was computed
by dividing the net loss for the relevant period by the weighted average number
of shares of common stock outstanding. Diluted earnings per common share is
computed by dividing net loss by the weighted average number of shares of common
stock and common stock equivalents outstanding.





Common
stock equivalents of approximately 26,133and 404,000 stock options and 2.1
million and 7.7 million warrants to purchase common stock are excluded from the
diluted earnings per share calculation for the year ended December 31, 2008 and
2007, respectively, due to their anti-dilutive effect.





Year
      ended(in thousands, except per share
      amounts)
                              
                              December 31,2008
                              
                              
                              2007BASIC
      AND DILUTEDWeighted
      average number ofcommon
      shares outstanding (a)
                              
                              
                              28,164
                              
                              
                              
                              15,400Number
      of shares for computation ofnet
      loss per share
                              
                              
                              28,164
                              
                              
                              
                              15,400Net
      loss
                              
                              $
                              (5,934
                              )
                              
                              $
                              (48,441
                              )Net
      loss per share basic and diluted
                              
                              $
                              (0.21
                              )
                              
                              $
                              (3.15
                              )


75




(a)
            In
      loss periods, common share equivalents would have an anti-dilutive effect
      on net loss per share and therefore have been
  excluded.





22.   Segment
Information





We have
one reportable segment, as defined in SFAS 131, Disclosures about Segments of an
Enterprise and Related Information. Prior to December 9, 2008, the date
Neonode AB filed for bankruptcy, we operated in one industry segment: the
development of intellectual property related to optical infrared touchscreen and
the sale of associated products and licenses that encompass this technology. In
December 2008, prior to our subsidiary, Neonode AB, filing for bankruptcy we
transferred the patents, copyrights and all technology intellectual property to
Neonode Inc pursuant to an intercompany debt pledge agreement and continue to
develop and license our touchscreen technology. We have carried out
substantially all of our operations through our subsidiary Neonode AB located in
Sweden, although we did carry out some development activities together with our
manufacturing partner in Malaysia. The majority of the sales of our mobile
phones were concentrated in Europe.





In
addition to phone sales, revenues included license revenue from an Asian
manufacturer amounting to $463,000 for 2007.




23.   Related Party
Transactions





Refinancing
and Capital Raising Transactions





Per
Bystedt, our Chairman of the Board and Chief Executive Officer is personally
involved in our refinancing and capital raising activities. Mr. Bystedt,
the beneficial holder of approximately 8.42% of the Company’s outstanding shares
of stock as of January 31, 2009, is the beneficial owner of Iwo Jima
SARL. Iwo Jima SARL entered into a Subscription Agreement on December
30, 2008 and invested $100,000 in the Company in exchange for the issuance of
10,000 shares of Series A Preferred Stock, and is one of the three Cypressen
Stockholders who participated in the share exchange transaction with the Company
pursuant to the Share Exchange Agreement on December 29, 2008. Iwo Jima SARL
also surrendered warrants in exchange for the issuance of Series B Preferred
Stock. Iwo Jima SARL holds 161,788.17 shares of Series A Preferred Stock and
7,210.96 shares of Series B Preferred Stock. Mr. Bystedt holds 84,149 employee
stock options to purchase our common stock. Assuming the conversion of the
outstanding Preferred stock into common stock at the increased conversion rates,
Mr. Bystedt will beneficially own approximately 17.41% of our outstanding common
stock.





Mr.
Magnus Goertz, the beneficial holder of approximately 5.15% of the Company’s
outstanding shares of stock as of January 31, 2009, is the beneficial owner of
Athemis Ltd., which company is one of the three Cypressen Stockholders who
participated in the share exchange transaction with the Company pursuant to the
Share Exchange Agreement. Athemis Ltd. holds 151,788.17 shares of Series A
Preferred Stock. . Mr. Goertz holds 132,446 employee stock options to purchase
our common stock. Assuming conversion of the outstanding Preferred stock into
common stock at the increased conversion rates, Mr. Goertz will beneficially own
approximately 15.93% of our outstanding common stock.




Mr.
Thomas Eriksson, the beneficial holder of approximately 3.14% of the Company’s
outstanding shares of stock as of January 31, 2009, is the beneficial owner of
Wirelesstoys AB, which company is one of the three Cypressen Stockholders who
participated in the share exchange transaction with the Company pursuant to the
Share Exchange Agreement. Wirelesstoys AB holds 151,788.17 shares of Series A
Preferred Stock. . Mr. Eriksson holds 97,127 employee stock options to purchase
our common stock Assuming conversion of the outstanding Preferred stock into
common stock at the increased conversion rates, Mr. Eriksson will beneficially
own approximately 15.76% of our outstanding common stock.




76




Mr. David
W. Brunton, our Chief Financial Officer, purchased 4,854.74 shares of Series A
Preferred Stock from each of the Cypressen Stockholders (Iwo Jima SARL,
Wirelesstoys AB, and Athemis Ltd.) for a total purchase of 14,564.22 shares of
Series A Preferred Stock. As of January 31, 2009, Mr. Brunton holds
approximately 1.1% of the Company’s outstanding shares of stock. Mr. Brunton
holds 245,000 employee stock options to purchase our common stock. Assuming the
conversion of the outstanding Preferred stock into common stock at the increased
conversion rates, Mr. Brunton will beneficially own approximately 1.58% of our
outstanding common stock.





Ms. Susan
Major, a member of our Board of Directors, and the beneficial holder of 0.84% of
the Company’s outstanding shares of stock as of January 31, 2009, was the
beneficial owner of warrants that were converted into 149.14 shares of Preferred
B Stock. . Ms. Major holds 216,595 employee stock options to purchase our common
stock Assuming conversion of the outstanding Preferred stock into common stock
at the increased conversion rates, Ms. Major will beneficially own approximately
0.08% of our outstanding common stock.





24.   Subsequent Events





On January 21, 2009, we signed a
definitive settlement agreement and issued Alpha Capital Anstalt (Alpha)
1,096,997 shares of our common stock as settlement in full of the lawsuit Alpha
filed against us on September 4, 2008. On February 13, 2009 a notice was sent to
the Court by Alpha’s legal counsel requesting dismissal of the action. On
December 31, 2008, we accrued $55,000 as legal expense which is the fair market
value of the shares of common stock issued to Alpha as settlement of the
lawsuit.




In
January and February 2009 we received the cash proceeds related to the December
2008 private placement offering of $1.1 million of our Preferred
stock.




In
January 2009, we converted approximately $53,000 of our outstanding accounts
payable at December 31, 2008 to approximately 763,000 shares of our common
stock.





On March
31, 2009, our shareholders approved proposals to amend our Certificate of
Incorporation




·
              to
      effect an increase in the number of authorized shares of our stock from
      77,000,000 to 700,000,000 and an increase in the number of shares of our
      common stock from 75,000,000 to 698,000,000;


·
              to
      increase the conversion rate of the Series A Preferred Stock such that
      each share of Series A Preferred Stock, which has been convertible into 1
      share of common stock, is now convertible into 480.63 shares of common
      stock,and;


·
            to
      increase the conversion rate of the Series B Preferred Stock such that
      each share of Series B Preferred Stock, which had been convertible into 1
      share of common stock, is now convertible into 132.07 shares of common
      stock.





The above
increases in the conversion rate of the Series A and B Preferred Stock will give
such holders a beneficial conversion feature, and we will account for the
increase in conversion rate at that time. Such increase in the conversion rate
is not yet reflected in these consolidated financial statements as of December
31, 2008.


77


Neonode
Inc.


Schedule
II - Valuation and Qualifying Accounts


For
the Years Ended December 31, 2008 and 2007


(amounts
in thousands)





Column A
                                    
                                    Column B
                                    
                                    Column C
                                    
                                    Column D
                                    
                                    Column EBalance
      at
                                    
                                    Additions
                                    
                                    
                                    
                                    BalanceBeginning
                                    
                                    charged
      to costs
                                    
                                    
                                    
                                    End
      ofDescription
                                    
                                    of Period
                                    
                                    and expenses
                                    
                                    Deductions
                                    
                                    PeriodYear
      ended December 31, 2008Allowance
      for Warranty Reserve
                                    
                                    
                                    $
                                    95
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    (95
                                    )
                                    
                                    $
                                    -Allowance
      for Doubtful accounts
                                    
                                    
                                    $
                                    4,264
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    (4,264
                                    )
                                    
                                    $
                                    -Year
      ended December 31, 2007Allowance
      for Warranty Reserve
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    95
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    95Allowance
      for Doubtful accounts
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    4,264
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    4,264


78





ITEM
      9.
            CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE


None.





I TEM 9A.
            CONTROLS
      AND PROCEDURES





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 the December 31,
2008. Based upon that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were not
effective for the reasons described below.





During
the audit of our consolidated financial statements for the year ended December
31, 2008, management determined that we had certain material weaknesses relating
to our accounting for certain financing transactions, including convertible debt
and derivative financial instruments. A material weakness is a deficiency, or a
combination of deficiencies, in internal control over financial reporting, such
that there is a reasonable possibility that a material misstatement of a
Company’s annual or interim financial statements will not be prevented or
detected on a timely basis. In addition, we entered into several complex
financing transactions (including conversion of convertible debt, derivatives,
conversion of warrants, bankruptcy of Neonode AB and complex valuation and
measurement activities) that resulted in accounting adjustments during our
year-end audit. Because these material weaknesses as to internal control over
financial reporting also bear upon our disclosure controls and procedures, our
Chief Executive Officer and Chief Financial Officer were unable to conclude our
disclosure controls and procedures were effective.





Despite
the conclusion that disclosure controls and procedures were not effective as of
the end of period covered by this report, the Chief Executive Officer and Chief
Financial Officer believe that the financial statements and other information
contained in this annual report present fairly, in all material respects, our
business, financial condition and results of operations.





Internal
Control over Financial Reporting





Report
of Management 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 system has been designed
to provide reasonable, not absolute, assurance to our management and Board of
Directors that the objectives of our control system with respect to the
integrity, reliability and fair presentation of published financial statements
are met. 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
management, including our Chief Executive Officer and Chief Financial Officer,
we assessed the effectiveness of our internal control over financial reporting
as of December 31, 2008. In making this assessment, we used the criteria
established in the framework onInternal Control–Integrated
Framework issued by the Committee of Sponsoring Organizations
(“COSO”) of the Treadway Commission. Based on our assessment, which was
conducted according to the COSO criteria, we have concluded that our internal
control over financial reporting was not effective in achieving its objectives
as of December 31, 2008 due to a material weakness that existed in our
internal controls relating to our accounting for certain financing transactions,
including convertible debt and derivative financial instruments.





79





A
material weakness is a deficiency, or combination of deficiencies, in internal
control over financial reporting, such that there is a reasonable possibility
that a material misstatement of the company’s annual or interim financial
statements will not be prevented or detected on a timely basis. Based on
management’s assessment of our internal control over financial reporting as of
December 31, 2008, the following material weakness existed as of that
date:





The
Company’s controls over accounting for certain financing transactions did not
operate effectively as of December 31, 2008. In addition, we entered into
several complex financing transactions (including conversion of convertible
debt, derivatives, conversion of warrants, bankruptcy of Neonode AB and complex
valuation and measurement activities) that resulted in accounting adjustments
during our year-end audit.




This
annual report is not required to include a report of the Company’s independent
registered public accounting firm due to temporary rules of the Commission that
would permit us to provide only management’s assessment in this annual
report.




This
annual report is not required to include a report of the Company’s independent
registered public accounting firm due to temporary rules of the Commission that
would permit us to provide only management’s assessment in this annual
report.




As
discussed elsewhere in this report, the bankruptcy on December 9, 2008 of our
previous operating subsidiary Neonode AB and the recent acquisition of Cypressen
on December 30, 2008 represented a significant change in our business and
financial operations. Having occurred in the final quarter of the fiscal year,
the bankruptcy and acquisition left management with insufficient time to
finalize integration and consolidate operations to fully assess the
effectiveness of internal control over financial reporting.




As we
move towards complete integration and consolidation of business and financial
operations of Cypressen and Neonode, we expect to take steps to both remedy the
material weaknesses described above and facilitate our management’s assessment
of internal control over financial reporting in accordance with the
Sarbanes-Oxley Act and Commission rules. Our planned steps include:





·
            adding personnel to our financial
      department, consultants, or other resources (including those with public
      company reporting experience) to enhance our policies and procedures,
      including those related to revenue
  recognition;


·
            exploring the suitability of
      further upgrades to our accounting system to complement the new management
      reporting system software described above;
  and


·
            engaging
      a qualified consultant in 2009 to perform an assessment of the
      effectiveness of our internal control over financial reporting and assist
      us in implementing appropriate internal controls on weaknesses determined,
      if any,documenting, and then testing the effectiveness of those
      controls.





ITEM 9B.
            OTHER
      INFORMATION





None


PART
III





ITEM
      10.
            DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE





The
following individuals serve as the Directors and executive officers of our
company. There are no familial relationships between our directors or our
executive officers and any other director or executive officer.





NAME
            
            AGE
            
            POSITIONPer
      Bystedt
            
            44
            
            Chairman
      of the Board of Directors and Chief Executive OfficerJohn
      Reardon
            
            48
            
            DirectorSusan
      Major
            
            57
            
            DirectorKenneth
      Olson
              
              David
      W. Brunton
            
            72
              
              58
            
            Director
              
              Vice
      President, Finance, Chief Financial Officer,Treasurer and
      Secretary





80




Board
of Directors





The Board
is divided into three classes. Each class consists, as nearly as possible, of
one-third of the total number of directors, and each class has a three-year
term. Vacancies on the Board may be filled only by persons elected by a majority
of the remaining directors. A director elected by the Board to fill a vacancy in
a class shall serve for the remainder of the full term of that class, and until
the director’s successor is elected and qualified. This includes vacancies
created by an increase in the number of directors.




The Board
presently has four members. The following is a brief biography of each
director




Per Bystedt -
Mr. Bystedt, age 44, has served as the Chairman of the Board of Directors
and the Chief Executive Officer of the Company since May 2008 and served as the
interim Chief Executive Officer of Old Neonode from October 2005 through
July 2006. Since 1997, Mr. Bystedt has been the Chief Executive
Officer of Spray AB, an internet investment company. From 1991 through 1997,
Mr. Bystedt was a Senior Vice President of various television production
and network companies including Trash Television, ZTV AB, TV3 Broadcasting Group
Ltd and MTG AB. From 2000 through the present, Mr. Bystedt has served as a
member of the board of directors of Axel Johnson AB. From 2000 to 2008, he was a
member of the board of directors of Eniro AB and, from 2005 to 2008, was a
member of the board of directors of Servera AB. From 2005 to 2008,
Mr. Bystedt has been the chairman of the board of directors of AIK Fotboll
AB from 2005 to the present. From 1997 through 2005 he served as a member of the
board of directors of Ahlens AB, and from 1998 through 2000 he was the chairman
of the board of directors of Razorfish, Inc. Mr. Bystedt holds an MBA degree
from the Stockholm School of Economics.




John Reardon -
Mr. Reardon, age 48, has served as a director of SBE, Inc. since
February 2004 and of Old Neonode since February 2007. Mr. Reardon
is the chairman of the Audit Committee and member of the Compensation and
Nominating and Governance Committees of the Company. Mr. Reardon has served
as President and member of the board of directors of The RTC Group, a technical
publishing company since 1990. In 1994, Mr. Reardon founded a Dutch
corporation, AEE, to expand the activities of The RTC Group into Europe.
Mr. Reardon also serves on the board of directors of One Stop Systems,
Inc., a computing systems and manufacturing company. Mr. Reardon holds a BA
degree from National University.




Susan Major - Ms. Major,
age 57, has served as a director of Neonode Inc. since 1997. She is the
co-founder and since 2002 has been the Managing Partner of DavenportMajor
Executive Search. Ms. Major is Chairman of the Compensation Committee and a
member of the Audit and Nominating and Governance Committees. Her expertise
working in the technology industry spans more than 18 years with global high
growth companies coupled with 10 additional years of search experience,
including C-level executive placements for public and emerging, pre-IPO
corporations. Ms. Major specializes in the wireless, telecom, software and
semiconductor sectors and serves Fortune 500 clients such as Motorola and
Qualcomm. While at Motorola, Ms. Major introduced numerous technology
products, including two-way radios, cellular handsets and a first generation
PDA. While at Ameritech, Ms. Major led the marketing efforts that expanded their
paging and wireless data services. In addition, Ms. Major has been awarded two
patents in wireless messaging. Ms. Major holds a BA and a MBA degree from
Northeastern University in Boston





Kenneth Olson -
Mr. Olson, age 72, has served as a director of Neonode Inc. since
June 2008. Mr. Olson is the chairman of the Nominating and Governance
Committee and is a member of the Audit and Compensation Committees of the
Company. Mr. Olson is an electrical engineer and holds an MBA from Pepperdine
University.




81




Mr. Olson
currently serves as a director on the following boards:


·
            Digirad
      Corporation, (NASDAQ - DRAD), (solid-state radionuclide camera systems for
      detection of coronary artery disease; nuclear medicine imaging services);
      director since 4/96;, former Audit Committee chair, currently Governance
      Committee chair and Audit Committee
member


·
            Troxel
      Helmets (equestrian helmet design, marketing, and distribution); advisory
      director since 1996


·
            Santrio,
      Inc.(Web-based systems
      software); director since 2005


·
            EcoLayers,
      Inc.(environmental
      software), director and chairman since
2007





David W Brunton - Mr. Brunton
joined SBE, the predecessor to Neonode Inc, in November 2001 as Vice President,
Finance, Chief Financial Officer, Secretary and Treasurer. From 2000 to 2001 he
was the Chief Financial Officer for NetStream, Inc., a telephony broadband
network service provider. Mr. Brunton is a certified public accountant and holds
a BA degree from California State University.





Independence
of the Board of Directors


A majority of the members of the
board of a company listed on a national exchange must qualify as “independent,”
as affirmatively determined by the board of directors. The Board consults with
the Company’s counsel to ensure that the Board’s determinations are consistent
with all relevant securities laws and regulations regarding the definition of
“independent.”




Although the Company is not required to
comply with these “independent” requirements, the Company has determined that
its Board should continue to qualify as “independent.” Consistent with these
considerations, after review of all relevant transactions or relationships
between each director, or any of his or her family members, and the Company, its
senior management and its independent registered public accounting firm, the
Board affirmatively has determined that all of the Company’s directors, other
than Per Bystedt, are independent directors.




Meetings of the
Board of Directors


The Board
met four times during the Company’s 2008 fiscal year. Each then-serving director
attended 75% or more of the aggregate of the meetings of the Board and of the
committees on which he served, held during the period for which he was a
director or committee member, respectively. In addition, the Company’s
independent directors met in regularly scheduled executive sessions at which
only independent directors are present.




All of
theboard members
attended last year’s annual meeting, either in person or
telephonically.




Board
Committees




The Board
has three committees: an Audit Committee, a Compensation Committee, and a
Nominating and Governance Committee. John Reardon, Kenneth Olson and Susan Major
constitute the members of each committee. During the Company’s 2008 fiscal year,
the Audit Committee met four times, the Compensation Committee met two times,
and the Nominating and Governance Committee met two times. All then-serving
directors attended at least 75% of the meetings of each committee.Below is a
description of each committee of the Board. Each of the committees has authority
to engage legal counsel or other experts or consultants, as it deems appropriate
to carry out its responsibilities. The Board has determined that each member of
each committee meets the applicable rules and regulations regarding
“independence” and that each member is free of any relationship that would
interfere with his or her individual exercise of independent judgment with
regard to the Company.




Audit Committee.John Reardon
is Chairman of the Audit Committee. The members of the Audit Committee are John
Reardon, Susan Major and Kenneth Olson. The Audit Committee of the Board, which
was established in accordance with Section 3(a)(58)(A) of the Exchange Act,
oversees the Company’s corporate accounting and financial reporting process. For
this purpose, the Audit Committee performs several functions, including the
following:





·
            evaluates
      the performance of and assesses the qualifications of the independent
      registered public accounting firm;


·
            determines
      and approves the engagement of the independent registered public
      accounting firm;





82


·
              determines
      whether to retain or terminate the existing independent registered public
      accounting firm or to appoint and engage a new independent registered
      public accounting firm;
 ·
              reviews
      and approves the retention of the independent registered public accounting
      firm to perform any proposed permissible non-audit
    services;
 ·
              monitors
      the rotation of partners of the independent registered public accounting
      firm on the Company’s audit engagement team as required by
      law;
 ·
              confers
      with management and the independent registered public accounting firm
      regarding the effectiveness of internal controls over financial
      reporting;
 ·
              establishes
      procedures, as required under applicable law, for the receipt, retention
      and treatment of complaints received by the Company regarding accounting,
      internal accounting controls or auditing matters and the confidential and
      anonymous submission by employees of concerns regarding questionable
      accounting or auditing matters;
 ·
              reviews
      the financial statements to be included in the Company’s Annual Report on
      Form 10-K; and
 ·
                discusses
      with management and the independent registered public accounting firm the
      results of the annual audit and the results of the Company’s quarterly
      financial statements.
 The Board has adopted a written Audit
Committee Charter that is available on the Company’s website athttp://www.neonode.com/Documents/investor/audit_committee_charter.pdf.


The Board annually reviews the SEC
standards and definition of independence for Audit Committee members and has
determined that all members of the Company’s Audit Committee are independent.
The Company does not have an “audit committee financial expert” as defined in
the rules of the Securities and Exchange Commission serving on the Audit
Committee because the Board believes that the background and financial
sophistication of its members are sufficient to fulfill the duties of the Audit
Committee.




Compensation
Committee.


Susan
Major is Chairman of the Compensation Committee. The members of the Compensation
Committee are John Reardon, Susan Major and Kenneth Olson. The Compensation
Committee of the Board reviews and approves the overall compensation strategy
and policies for the Company. The Compensation Committee duties include the
following:




·
              reviews
      and approves corporate performance goals and objectives relevant to the
      compensation of the Company’s executive officers and other senior
      management;
 ·
              reviews
      and approves the compensation and other terms of employment of the
      Company’s Chief Executive Officer;
 ·
              reviews
      and approves the compensation and other terms of employment of the other
      executive officers; and
 ·
              administers
      and reviews the Company’s stock option and purchase plans, pension and
      profit sharing plans, stock bonus plans, deferred compensation plans and
      other similar programs.





The
Committee has the authority to obtain advice or assistance from consultants,
legal counsel, accounting or other advisors as appropriate to perform its
duties, and to determine the terms, costs and fees for such engagements. All
members of the Company’s Compensation Committee are independent. The Board has
adopted a written Compensation Committee Charter that is available on the
Company’s website at http://www.neonode.com/Documents/investor/compensation_committee_charter.pdf.




The
Compensation Committee conducts an annual performance and compensation review
for each of our executive officers and determines salary adjustments and bonus
and equity awards at one or more meetings generally held during the last quarter
of the year. In addition, the Compensation Committee considers matters related
to individual compensation, such as compensation for new executive hires, as
well as various compensation policy issues throughout the year. For executives
other than the Chief Executive Officer, the Compensation Committee receives and
considers performance evaluations and compensation recommendations submitted to
the Committee by the Chief Executive Officer. In the case of the Chief Executive
Officer, the evaluation of his performance is conducted by the Compensation
Committee, which determines any adjustments to his compensation as well as
awards to be granted. The agenda for meetings of the Compensation Committee is
usually determined by its Chairman with the assistance of the Company’s Chief
Executive Officer and Chief Financial Officer. Compensation Committee meetings
are regularly attended by the Chief Executive and Chief Financial
Officer.




83




The
Committee approves routine on-hire option grants to employees of the Company,
subject to specific limitations. For these grants, the exercise price must be
equal to the closing price on the OTC BB of the Company’s Common Stock on the
trading on the date of grant.




Nominating and Governance
Committee.


Kenneth
Olson is Chairman of the Nominating and Governance Committee. The members of the
Nominating and Governance Committee are John Reardon, Susan Major and Kenneth
Olson. The Nominating and Governance Committee of the Board is responsible for
identifying, reviewing and evaluating candidates to serve as directors of the
Company, consistent with criteria approved by the Board. The Nominating and
Governance duties include the following:




·
              reviewing
      and evaluating incumbent directors;
 ·
              recommending
      candidates to the Board for election to the Board;
  and
 ·
              making
      recommendations to the Board regarding the membership of the committees of
      the Board.
 ·




All
members of the Nominating and Governance Committee are independent. The Board
has adopted a written Nominating and Governance Committee Charter that is
available on the Company’s website at http://www.neonode.com/Documents/investor/nominating_and_governance_committee_charter.pdf.




The
Nominating and Governance Committee believes that candidates for director should
have certain minimum qualifications, including being able to read and understand
basic financial statements, being over 21 years of age and having the highest
personal integrity and ethics. The Nominating and Governance Committee also
intends to consider such factors as possessing relevant expertise upon which to
be able to offer advice and guidance to management, having sufficient time to
devote to the affairs of the Company, demonstrated excellence in his or her
field, having the ability to exercise sound business judgment and having the
commitment to rigorously represent the long-term interests of the Company’s
stockholders. However, the Nominating and Governance Committee retains the right
to modify these qualifications from time to time. Candidates for director
nominees are reviewed in the context of the current composition of the Board,
the operating requirements of the Company and the long-term interests of
stockholders. In conducting this assessment, the committee considers diversity,
age, skills, and such other factors as it deems appropriate given the current
needs of the Board and the Company, to maintain a balance of knowledge,
experience and capability.




In the
case of incumbent directors whose terms of office are set to expire, the
Nominating and Governance Committee reviews such directors’ overall service to
the Company during their term, including the number of meetings attended, level
of participation, quality of performance, and any other relationships and
transactions that might impair such directors’ independence.




In the
case of new director candidates, the Nominating and Governance Committee also
determines whether the nominee must be independent pursuant to applicable SEC
rules and regulations and the advice of counsel, if necessary. The Nominating
and Governance Committee then uses its network of contacts to compile a list of
potential candidates, but may also engage, if it deems appropriate, a
professional search firm. The Nominating and Governance Committee conducts any
appropriate and necessary inquiries into the backgrounds and qualifications of
possible candidates after considering the function and needs of the Board. The
Nominating and Governance Committee meets to discuss and consider such
candidates’ qualifications and then selects a nominee for recommendation to the
Board by majority vote. To date, the Nominating and Governance Committee has not
paid a fee to any third party to assist in the process of identifying or
evaluating director candidates. To date, the Nominating and Governance Committee
has not received any director nominations from stockholders of the
Company.




The
Nominating and Governance Committee will consider director candidates
recommended by stockholders. The Nominating and Governance Committee does not
intend to alter the manner in which it evaluates candidates, including the
minimum criteria set forth above, based on whether the candidate was recommended
by a stockholder or not. Stockholders who wish to recommend individuals for
consideration by the Nominating and Governance Committee to become nominees for
election to the Board may do so by delivering a written recommendation to the
Nominating and Governance Committee at the following address: Neonode Inc.,
Linnegatan 89 11523 Stockholm, Sweden, at least six months prior to any meeting
at which directors are to be elected. Submissions must include the full name of
the proposed nominee, a description of the proposed nominee’s business
experience for at least the previous five years, complete biographical
information, a description of the proposed nominee’s qualifications as a
director and a representation that the nominating stockholder is a beneficial or
record owner of the Company’s stock. Any such submission must be accompanied by
the written consent of the proposed nominee to be named as a nominee and to
serve as a director if elected.




84




Stockholder
Communications with the Board of Directors




The
Company adopted a policy for stockholder communications with the Board. Persons
interested in communicating with any particular director, the independent
directors or the Board as a whole may address correspondence to the intended
recipient, in care of Neonode Inc. at Linnegatan 89, 11523 Stockholm, Sweden. If
no particular director is named, letters will be forwarded, depending on the
subject matter, to the respective Chair of the Audit, Compensation, or
Nominating and Governance Committee.




Code
of Ethics




The
Company adopted the Neonode Inc. Code of Business Conduct that applies to all
officers, directors and employees. All of the Company’s employees must carry out
their duties in accordance with the policies set forth in the Code of Business
Conduct and with applicable laws and regulations. The Code of Business Conduct
contains a separate Code of Ethics that applies specifically to the Company’s
Chief Executive Officer and senior financial officers. The Code of Business
Conduct and Code of Ethics is available on our website at http://www.neonode.com/Documents/investor/business_code_of_conduct.pdf.
If the Company makes any substantive amendments to the Code of Business Conduct
or grants any waiver from a provision of the Code to any executive officer or
director, the Company will promptly disclose the nature of the amendment or
waiver on its website.




ADDITIONAL
INFORMATION - SECTION 16(a) BENEFICIAL OWNERSHIP
REPORTING


COMPLIANCE





Section 16(a) of
the Exchange Act requires our directors and executive officers, and persons who
own more than ten percent of a registered class of our equity securities, to
file with the SEC initial reports of ownership and reports of changes in
ownership of our common stock and other equity securities. Officers, directors
and greater than ten percent stockholders are required by SEC regulation to
furnish us with copies of all Section 16(a) forms they
file.




To our
knowledge, based solely on a review of the copies of such reports furnished to
us and written representations that no other reports were required, during the
fiscal year ended December 31, 2008, all Section 16(a) filing
requirements applicable to our officers, directors and greater than ten percent
beneficial owners were complied with.


85


ITEM
11.


EXECUTIVE
COMPENSATION





The table
below summarizes the total compensation paid to or earned by each of the named
executive officers for the fiscal year ended December 31, 2008:





Summary
Compensation Table


Name
      and
                                Principal
                                Position
                              
                              Year
                              
                              
                              Salary
                                ($)
                              
                              
                              Bonus
                                ($)
                              
                              
                              Stock
                                Awards
                                ($)
                              
                              
                              Option
                                Awards
                                ($)
                              
                              
                              All
      Other
                                Compensation
                                ($)
                              
                              
                              Total
      ($)(b)
                              
                              
                              (a)
                              
                              
                              (c)Per
      Bystedt Chief Executive Officer (f)
                              
                              2008
                              
                              
                              $
                              91,174
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              $
                              91,174Mikael
      Hagman, (d) (e) (g) President and Chief Executive Officer
                              
                              
                              2008
                                2007
                              
                              
                              $
                                $
                              96,147
                                190,167
                              
                              
                              $
                              -
                                73,680
                              
                              
                              
                              -
                                -
                              
                              
                              $
                              -
                                53,782
                              
                              
                              $
                              -
                                23,464
                              
                              
                              $
                                $
                              96,147
                                341,093David
      W. Brunton, Chief Financial Officer
                              
                              
                              2008
                                2007
                              
                              
                              $
                                $
                              165,000
                                185,000
                              
                              
                              $
                              -
                                30,625
                              
                              
                              $
                                $
                              17,897
                                22,750
                              
                              
                              $
                              144,120
                                86,968
                              
                              
                              $
                                $
                              1,040
                                1,632
                              
                              
                              $
                                $
                              328,057
                                326,975


(a)
            Amounts
      are calculated as of the grant date of the option award in accordance with
      the provisions of Statement of Financial Accounting Standards (SFAS) No.
      123R “Share-based Payment.” Please see Note14. “Stock Based Compensation”
      in the Notes to the Consolidated Financial Statements as filed on Neonode
      Inc.’s annual report Form 10K for the valuation assumptions made in the
      Black-Scholes option pricing used to calculate fair value of the option
      awards.




(b)
            Amounts
      are the market value of common stock issued to Mr. Brunton under the
      pre-merger SBE, Inc. stock in-lieu of cash payroll plan that was
      implemented in 2007 as a cash preservation measure and the market value of
      common stock issued to Mr. Brunton in 2008 for payment of accrued vacation
      liability.




(c)
            Includes
      $23,464 attributable in fiscal 2007 to Mr. Hagman to payments to the
      Swedish defined contribution retirement plan and $1,040 and $1,632
      attributable in fiscal 2008 and 2007, respectively, to Mr. Brunton for
      premiums paid by the Company for group term life insurance.(d)Mr. Hagman
      became President and Chief Executive Officer effective March 2007 and left
      the Company in March 2008.




(e)
            Mr.
      Hagman is a citizen of Sweden and is employed in Sweden and all payments
      to him are in Swedish Krona (SEK). The amounts in this table are displayed
      in U.S. Dollars (USD) and are converted from the SEK to USD using the
      average exchange rate for fiscal 2008 year 6.58 SEK to the USD and of 2007
      year of 6.79SEK to the USD.




86




(f)
            Mr.
      Bystedt was appointed Chief Executive Officer in May 2008. He is a citizen
      of Sweden and is employed in Sweden and all payments to him are in Swedish
      Krona (SEK). The amounts in this table are displayed in U.S. Dollars (USD)
      and are converted from the SEK to USD using the average exchange rate for
      fiscal 2008 year 6.58 SEK to the USD. The Company accrued but did not pay
      300,000 Krona ($45,587 USD) salary for the first three months that Mr.
      Bystedt was employed as the CEO. Mr. Bystedt was paid 300,000 Krona
      ($45,587) of the amount owed to him for the next three months by the
      Swedish government pursuant to Swedish reconstruction laws. The accrued
      but unpaid balance of $45,587 has not been paid and has been forgiven in
      the Neonode bankruptcy. Mr. Bystedt will not receive any salary for 2009
      until such time that the Board of Directors determines that the Company
      has sufficient cash flow from operations to pay his
  salary.




(g)
            Mr.
      Hagman was awarded 250,000 stock options in January 2008 and the
      compensation expense for 2008 related to option grants reflects the fair
      value of these options calculated on the date of the option award in
      accordance with the provisions of SFAS No. 123R. All 250,000 stock options
      were unvested and forfeited as in March 2008 when he left the
      company.





Outstanding
Equity Awards at Fiscal Year-end




OPTION
      AWARDSName
      & Principal
                                Position
                              
                              Grant
      Date
                              
                              Number
      of
                                Securities
                                Underlying
                                Unexercised
                                Options
      (#)
                                Exercisable
                              
                              
                              Number
      of
                                Securities
                                Underlying
                                Unexercised
                                Options(#)
                                Unexercisable
                              
                              
                              Equity
      Incentive
                                Plan
      Awards:
                                Number
      of
                                Securities
                                Underlying
                                Unexercised
                                UnearnedOptions
                                (#)
                              
                              
                              Option
                                Exercise
                                price
      ($)
                              
                              Option
                                Expiration
                                DateMikael
      Hagman,
                              
                              1/18/2007
                              
                              
                              88,298
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              $
                              2.12
                              
                              1/17/2009President
      & Chief Executive Office (2)David
      W. Brunton,
                              
                              10/22/2002
                              
                              
                              20,000
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              $
                              4.50
                              
                              10/22/2009Chief
      Financial Officer
                              
                              4/12/2004
                              
                              
                              5,000
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              $
                              22.25
                              
                              4/12/20113/31/2005
                              
                              
                              20,000
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              $
                              14.75
                              
                              8/8/20123/21/2006
                              
                              
                              5,000
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              $
                              5.00
                              
                              3/21/20135/30/2007
                              
                              
                              15,000
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              $
                              2.33
                              
                              5/30/20148/10/2007
                              
                              
                              59,999
                              
                              
                              
                              120,001
                              (1)
                              
                              
                              -
                              
                              
                              $
                              4.90
                              
                              8/10/2014




(1)
            Stock
      Option Grants vest 25% on first anniversary date of grant and monthly
      thereafter for the next 36 months.


(2)
            Mr.
      Hagman left the Company in March 2008 and was replaced by Mr. Bystedt our
      Chairman of the Board of Directors. Mr. Bystedt has waived all fees for
      his services as Chief Executive Officer and as Chairman of the Board of
      Directors until such time that we can afford to pay the fees and
      compensation. For stock option information for Mr. Bystedt see the table
      below titled Director
Compensation.


87


Employment
Agreements and Change of Control Arrangements.





David W.
Brunton




Change
in Control Termination. If Mr. Brunton’s employment terminates due to a Change
in Control Termination, Mr. Brunton will be entitled to receive the following
benefits:
  1.
              Salary Continuation. Mr. Brunton shall
      continue to receive an amount equal to six (6) months of Base Salary. Such
      amount shall be paid in equal monthly installments over the six (6) months
      following Change in Control Termination and shall be subject to all
      required tax
withholding.




2.
            Bonus
      Payment. Within fifteen (15) days following the last day of the fiscal
      quarter during which Change in Control Termination occurs. Mr. Brunton
      shall receive the pro-rata share of any bonus to which he would have been
      entitled had his employment with the Companycontinued.
      The bonus amount paid will be the product of the bonus percentage of Base
      Salary derived per his bonus planmultiplied by
      hisBase
      Salary from the beginning of the Fiscal Year through the date of his
      Involuntary Termination Without Cause. Such payment shall be subject to
      all required tax withholding.




3.
            Acceleration
      of Option Vesting. Effective as of the date of Change in Control
      Termination, Mr. Brunton shall be credited with full vesting under all
      options to purchase the Company’s Common Stock that he holds on such
      date.


88


Compensation
of Directors





Effective
January 1, 2008, each non-employee director of the Company receives an annual
retainer of $24,000, payable monthly in arrears. The Chairman of the Board
receives an annual retainer of $30,000, payable monthly in arrears. No director
is entitled to receive a per-meeting fee. The members of the Board are also
eligible for reimbursement for their expenses incurred in attending Board
meetings in accordance with Company policy. The Directors have not been paid
their fees for the months of August through December 2008.





Effective
January 2, 2008, on January 2 of each year (or the next business day if
that date is a legal holiday), each non-employee director is automatically
granted an additional option to purchase 40,000 shares of common stock of the
Company. However, the Company did not grant the non-employee directors any stock
options on January 2, 2009. The exercise price of options granted is 100% of the
fair market value of the common stock subject to the option on the date of the
option grant. Options granted to Directors may not be exercised until the date
upon which the optionee (or the affiliate of the optionee) has provided one year
of continuous service as a non-employee director following the date of grant of
such option, at which point 100% of the option becomes exercisable. The options
will fully vest upon a change of control, unless the acquiring company assumes
the options or substitutes similar options. The term of options granted is
10 years.





Prior to
January 2, 2008, the directors were compensated primarily with grants of stock
options. During the year ended December 31, 2007, the Company granted options
covering 493,903 shares to non-employee directors of the Company, at an exercise
price per share ranging from $1.84 to $4.50. The fair market value of such
common stock on the date of each grant was equal to the closing sales price
reported on the Nasdaq National Market for the date of grant. As of the date of
this Form 10K, no options granted to directors had been exercised.





The table
below summaries the compensation paid by the Company to our Directors for the
fiscal year ended December 31, 2008:





Director
Compensation


Name
                          
                          Fees
                            Earned
      or
                            Paid
      in
                            Cash
                            ($)
                          
                          
                          Stock
                            Awards
                            ($)
                          
                          
                          Option
                            Awards
                            ($)
                          
                          
                          Non-Equity
                            Incentive
      Plan
                            Compensation
                            ($)
                          
                          
                          Nonqualified
                            Deferred
                            Compensation
                            Earnings
                          
                          
                          All
      Other
                            Compensation
                            ($)
                          
                          
                          Total
                            ($)(a)Per
      Bystedt (b)
                          
                          $
                          12,500
                          
                          
                          
                          -
                          
                          
                          $
                          97,932
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          $
                          110,432Susan
      Major (c)
                          
                          $
                          24,000
                          
                          
                          
                          -
                          
                          
                          $
                          274,880
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          $
                          298,880John
      Reardon (c)
                          
                          $
                          24,000
                          
                          
                          
                          -
                          
                          
                          $
                          299,704
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          $
                          323,704Kenneth
      Olson (c) (d)
                          
                          $
                          14,000
                          
                          
                          
                          -
                          
                          
                          $
                          11,366
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          $
                          25,366





(a)
            Amounts
      are calculated as of the grant date of the options award in accordance
      with the provisions of Statement of Financial Accounting Standards
      (“SFAS”) No. 123R “Share-based Payment.” Please see Note14. “Stock Based
      Compensation” in the Notes to the Consolidated Financial Statements as
      filed on Neonode Inc.’s annual report Form 10K for the valuation
      assumptions made in the Black-Scholes option pricing used to calculate
      fair value of the option awards.





(b)
            Mr.
      Bystedt was appointed CEO in May 2008 and subsequent to his appoint ceased
      to earn fees as the Chairman of the Board of
  Directors.





(c)
            Ms.
      Major and Messrs, Reardon and Olson are paid a fee equal to $2,000 per
      month as a member of the Board of Directors. $10,000 of the amounts earned
      by each during 2008 was accrued but not paid until such time that the
      Company earns sufficient cash flow from operations to make such
      payment.





(d)
            Mr.
      Olson was appointed to the Board of Directors in June
  2008.




89




OPTION
      AWARDSName
                                          
                                          Grant
      Date
                                          
                                          Number
      of
                                            Securities
                                            Underlying
                                            Unexercised
                                            Options
      (#)
                                            Exercisable
                                          
                                          
                                          Number
      of
                                            Securities
                                            Underlying
                                            Unexercised
                                            Options(#)
                                            Unexercisable
                                          
                                          
                                          Equity
      Incentive
                                            Plan
      Awards:
                                            Number
      of
                                            Securities
                                            Underlying
                                            Unexercised
                                            UnearnedOptions
                                            (#)
                                          
                                          
                                          Option
                                            Exercise
                                            price
      ($)
                                          
                                          Option
                                            Expiration
                                            DatePer
      Bystedt
                                          
                                          1/18/2007
                                          
                                          
                                          44,149
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          2.12
                                          
                                          1/17/20091/2/2008
                                          
                                          
                                          -
                                          
                                          
                                          
                                          40,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          3.45
                                          
                                          1/2/2015Susan
      Major
                                          
                                          1/18/2007
                                          
                                          
                                          176,595
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          1.42
                                          
                                          1/17/20121/2/2008
                                          
                                          
                                          -
                                          
                                          
                                          
                                          40,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          3.45
                                          
                                          1/2/2015John
      Reardon
                                          
                                          3/17/2004
                                          
                                          
                                          3,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          27.50
                                          
                                          3/17/20114/1/2004
                                          
                                          
                                          2,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          23.30
                                          
                                          4/1/20114/1/2005
                                          
                                          
                                          2,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          13.95
                                          
                                          4/1/20104/1/2006
                                          
                                          
                                          2,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          5.40
                                          
                                          4/1/20114/2/2007
                                          
                                          
                                          2,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          4.00
                                          
                                          4/2/20125/3/2007
                                          
                                          
                                          176,595
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          1.42
                                          
                                          1/17/20125/30/2007
                                          
                                          
                                          4,500
                                          
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          2.33
                                          
                                          5/30/20121/2/2008
                                          
                                          
                                          -
                                          
                                          
                                          
                                          40,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          3.45
                                          
                                          1/2/2015Kenneth
      Olson
                                          
                                          6/19/2008
                                          
                                          
                                          -
                                          
                                          
                                          
                                          40,000
                                          
                                          
                                          
                                          -
                                          
                                          
                                          $
                                          0.60
                                          
                                          6/19/2012




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





The
following table sets forth, as of March 23, 2009, certain information regarding
the estimated ownership of our common stock assuming conversion of all issued
and outstanding Series A and Series B Preferred Stock by: (i) each director;
(ii) each of our “named executive officers,” as defined in Item 402 under
Regulation S-K promulgated by the Securities and Exchange Commission; (iii) all
executive officers and directors of Neonode as a group; and (iv) all those known
by us to be beneficial owners of more than five percent of our common stock.
Unless otherwise indicated, the address for each of the persons and entities set
forth below is c/o Neonode Inc. - Stockholder address.




Percentage
ownership is based on 469,374,109 shares, the estimated number of shares of
common stock outstanding after the conversion of the Series A and B Preferred
Stock at the increased conversion rates.





Beneficial Ownership (1)Beneficial Owner
                              
                              Number of
                                Shares
                              
                              Percent of
                                TotalRamin
      Remo Behdasht
                                58
      Carters Road
                                Dural
      NSW 158 Australia (3)
                              
                              27,929,877
                              
                              
                              5.95
                              %Per
      Bystedt (2)(4)
                                CEO
      and Director
                              
                              81,739,628
                              
                              
                              17.41
                              %Magnus
      Goertz (5)
                              
                              74,756,652
                              
                              
                              15.93
                              %FounderThomas
      Eriksson (6)
                              
                              73,993,853
                              
                              
                              15.76
                              %CEO
      Cypressen & FounderDavid
      Brunton (2)(7)
                                CFO
                              
                              7,404,451
                              
                              
                              1.58
                              %Susan
      Major (2)(8)
                                Director
                              
                              376,802
                              
                              
                              0.08
                              %John
      Reardon (2)
                                Director
                              
                              309,817
                              
                              
                              0.07
                              %Kenneth
      Olson (2)
                                Director
                              
                              40,000
                              
                              
                              0.01
                              %All
      executive officers and directors as a group (5 persons)
(2)
                              
                              89,870,698
                              
                              
                              19.15
                              %


90





(1)
              This table is based upon
      information supplied by officers, directors and principal stockholders.
      Unless otherwise indicated in the footnotes to this table and subject to
      community property laws where applicable, we believe that
      each of the stockholders named in this table has sole voting and
      investment power with respect to the shares indicated as beneficially
      owned.


(2)
              Includes,
      40,000, 70,000, 232,095, 40,000, and 216,595 shares of common stock that
      Messrs. Bystedt, Brunton, Reardon, Olson and Ms. Major, respectively, have
      the right to acquire within 60 days after the date of this table under
      outstanding stock options.


(3)
              Includes,
      27,590,244 shares of common stock related to the conversion of 57,404.29
      shares of Series A Preferred Stock, and 338,633 shares of common stock
      related to the conversion of Series B Preferred Stock that Mr. Behdasht
      received in having converted his debt and warrants under the December 2008
      Refinancing.


(4)
              Includes
      2,987,384 shares of common stock and the conversion of 161,788.17 shares
      of Series A Preferred Stock and 7,210.96 shares of Series B Preferred
      Stock to common stock that is held by Iwo Jima SARL. Iwo Jima SARL may be
      deemed an affiliate of Mr. Bystedt.


(5)
              Includes
      1,805,704 shares of common stock and the conversion 151,788.17 shares of
      Series A Preferred Stock to common stock that is held by Athemis Limited,
      which may be deemed an affiliate of Mr. Goertz.


(6)
              Includes
      1,039,905 shares of common stock and the conversion of 151,788.17 shares
      of Series A Preferred Stock to common stock that is held by Wirelesstoys
      AB, which may be deemed an affiliate of Mr. Eriksson.


(7)
              Includes
      334,450 shares of common stock and the conversion of 14,564.22 shares of
      Series A Preferred Stock to common stock that is held by Mr.
      Brunton.


(8)
            Includes
      140,510 shares of common stock and the conversion of 149.14 shares of
      Series B Preferred Stock to common stock that is held by Ms.
      Major.





The
following table includes information regarding our equity incentive plans as of
the end of fiscal 2008:


91


Equity
Compensation Plan Information





Plan
      category
                
                Number of securities to be
                  issued upon exercise of
                  outstanding options,
                  warrants and rights
                
                
                Weighted-average exercise
                  price of outstanding options,
                  warrants
                  and rights
                
                
                Number of securities
                  remaining available for future
                  issuance under equity
                  compensation plans (excluding
                  securities
                  reflected in column (a)(a)
                
                
                (b)
                
                
                (c)Equity
      compensation plans approved by security holders
                
                
                1,262,387
                
                
                $
                2.83
                
                
                
                94,801Equity
      compensation plans not approved by security holders
                
                
                2,184,996
                
                
                $
                1.32
                
                
                
                —Total
                
                
                3,447,383
                
                
                $
                1.88
                
                
                
                94,801





The
following table details the outstanding options to purchase shares of our common
stock pursuant to each plan at December 31, 2008:





Plan
                  
                  Options
                    Outstanding
                  
                  
                  Available
                    for Issue
                  
                  
                  Outstanding
                    Options
                    Vested1996
      Plan
                  
                  
                  46,000
                  
                  
                  
                  —
                  
                  
                  
                  46,0001998
      Plan
                  
                  
                  66,395
                  
                  
                  
                  —
                  
                  
                  
                  29,900Neonode
      Plan
                  
                  
                  880,330
                  
                  
                  
                  —
                  
                  
                  
                  880,3302006
      Plan
                  
                  
                  287,753
                  
                  
                  
                  94,801
                  
                  
                  
                  71,247Director
      Plan
                  
                  
                  42,500
                  
                  
                  
                  —
                  
                  
                  
                  15,500Total
                  
                  
                  1,322,978
                  
                  
                  
                  94,801
                  
                  
                  
                  1,042,977





(1) The 1998 Plan has not been approved by
our shareholders.


(2) The 2007 Neonode Plan was assumed by
Neonode upon the consummation of the August 2007 SBE Merger with
Neonode.





Summary
of 1998 Non-Officer Stock Option Plan





The
purpose of the 1998 Non-officer Stock Option Plan is to provide a means by which
eligible recipients of options may be given an opportunity to benefit from
increases in value of our common stock through the granting of nonstatutory
stock options. The plan permits the grant of nonstatutory stock options.
Nonstatutory stock options may be granted under the 1998 Plan to our employees
or consultants who are not, at the time of such grants, directors or officers.
The administrator, in its discretion, selects the persons to whom options are
granted, the time or times at which such options are granted, and the exercise
price and number of shares subject to each such grant. We do not expect to issue
any further options under the 1998 Plan.





ITEM
13.        CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE




Refinancing
and Capital Raising Transactions





Per
Bystedt, our Chairman of the Board and Chief Executive Officer is personally
involved in our refinancing and capital raising activities. Mr. Bystedt,
the beneficial holder of approximately 8.42% of the Company’s outstanding shares
of stock as of January 31, 2009, is the beneficial owner of Iwo Jima
SARL. Iwo Jima SARLentered into a Subscription Agreement on December 30,
2008 and invested $100,000 in the Company in exchange for the issuance of 10,000
shares of Series A Preferred Stock, and is one of the three Cypressen
Stockholders who participated in the share exchange transaction with the Company
pursuant to the Share Exchange Agreement on December 29, 2008. Iwo Jima SARL
also surrendered warrants in exchange for the issuance of Series B Preferred
Stock. Iwo Jima SARL holds 161,788.17 shares of Series A Preferred Stock and
7,210.96 shares of Series B Preferred Stock. Mr. Bystedt holds 84,149 employee
stock options to purchase our common stock. Assuming the conversion of the
outstanding Preferred stock into common stock at the increased conversion rates,
Mr. Bystedt will beneficially own approximately 17.41% of our outstanding common
stock.


92





Mr.
Magnus Goertz, the beneficial holder of approximately 5.15% of the Company’s
outstanding shares of stock as of January 31, 2009, is the beneficial owner of
Athemis Ltd., which company is one of the three Cypressen Stockholders who
participated in the share exchange transaction with the Company pursuant to the
Share Exchange Agreement. Athemis Ltd. holds 151,788.17 shares of Series A
Preferred Stock. . Mr. Goertz holds 132,446 employee stock options to purchase
our common stock. Assuming conversion of the outstanding Preferred stock into
common stock at the increased conversion rates, Mr. Goertz will beneficially own
approximately 15.93% of our outstanding common stock.




Mr.
Thomas Eriksson, the beneficial holder of approximately 3.14% of the Company’s
outstanding shares of stock as of January 31, 2009, is the beneficial owner of
Wirelesstoys AB, which company is one of the three Cypressen Stockholders who
participated in the share exchange transaction with the Company pursuant to the
Share Exchange Agreement. Wirelesstoys AB holds 151,788.17 shares of Series A
Preferred Stock. . Mr. Eriksson holds 97,127 employee stock options to purchase
our common stock Assuming conversion of the outstanding Preferred stock into
common stock at the increased conversion rates, Mr. Eriksson will beneficially
own approximately 15.76% of our outstanding common stock.




Mr. David
W. Brunton, our Chief Financial Officer, purchased 4,854.74 shares of Series A
Preferred Stock from each of the Cypressen Stockholders (Iwo Jima SARL,
Wirelesstoys AB, and Athemis Ltd.) for a total purchase of 14,564.22 shares of
Series A Preferred Stock. As of January 31, 2009, Mr. Brunton holds
approximately 1.1% of the Company’s outstanding shares of stock. Mr. Brunton
holds 245,000 employee stock options to purchase our common stock. Assuming the
conversion of the outstanding Preferred stock into common stock at the increased
conversion rates, Mr. Brunton will beneficially own approximately 1.58% of our
outstanding common stock.





Ms. Susan
Major, a member of our Board of Directors, and the beneficial holder of 0.84% of
the Company’s outstanding shares of stock as of January 31, 2009, was the
beneficial owner of warrants that were converted into 149.14 shares of Preferred
B Stock. Ms. Major holds 216,595 employee stock options to purchase our common
stock Assuming conversion of the outstanding Preferred stock into common stock
at the increased conversion rates, Ms. Major will beneficially own approximately
0.08% of our outstanding common stock.





The independent board members review
and approve all transactions that may be deemed to be with related parties of
the Company.The
board members have the authority to obtain advice or assistance from
consultants, legal counsel, accounting or other advisors as appropriate to
perform its duties in relationship to the review and approval of related party
transactions, and to determine the terms, costs and fees for such
engagements.




Independence
of the Board of Directors





As
required under the NASDAQ Stock Market (“NASDAQ”) listing standards, a majority
of the members of a listed company’s board of directors must qualify as
“independent,” as affirmatively determined by the board of directors. The Board
consults with the Company’s counsel to ensure that the Board’s determinations
are consistent with all relevant securities laws and regulations regarding the
definition of “independent,” including those set forth in the applicable listing
standards of NASDAQ.





Consistent
with these considerations, after review of all relevant transactions or
relationships between each director, or any of his or her family members, and
the Company, its senior management and its independent registered public
accounting firm, the Board affirmatively has determined that all of the
Company’s directors, other than Per Bystedt, are independent directors within
the meaning of the applicable NASDAQ listing standards.




The Board
affirmatively determined that all of its directors, other than Per Bystedt were
independent directors within the meaning of the applicable NASDAQ listing
standards. The Board has three committees: an Audit Committee, a Compensation
Committee, and a Nominating and Governance Committee. John Reardon, Kenneth
Olson and Susan Major, each independent directors, constitute the members of
each committee.





ITEM
14.        PRINCIPAL ACCOUNTANT FEES AND
SERVICES





The Audit Committee of the Board has
selected BDO Feinstein International AB as our independent auditors for the
fiscal year ending December 31, 2008. BDO Feinstein International AB has audited
our financial statements since 2006.




Independent
Auditors’ Fees





The following table represents
aggregate fees billed to us for fiscal years ended December 31, 2008 and 2007,
by BDO Feinstein International AB, our principal accountant, and any of the
member firms in the BDO International network .




Fiscal
      Year Ended
                      (in
      thousands)2008
                  
                  
                  2007Audit
      Fees
                  
                  $
                  525
                  
                  
                  $
                  476Audit-related
      Fees(1)
                  
                  
                  66
                  
                  
                  
                  59Tax
      Fees (2)
                  
                  
                  24
                  
                  
                  
                  18All
      Other Fees
                  
                  
                  0
                  
                  
                  
                  0Total
      Fees
                  
                  $
                  615
                  
                  
                  $
                  553


93





(1)
            Fees
      paid for registration, proxy and review of other regulatory
      filings.


(2)
            Fees
      paid for preparation and filing of our federal and state income tax
      returns.





All fees described above were
pre-approved by the Audit Committee.The Audit Committee has
determined that the rendering of the foregoing services separate from the audit
services by BDO Feinstein International AB is compatible with maintaining the
principal accountant’s independence.





Pre-Approval
of Audit and Non-Audit Services





The Audit Committee has not approved
any formal policy concerning pre-approval of the auditors to perform both audit
and non-audit services (services other than audit, review and attest services).
Instead, on a case by case basis, any audit or non-audit services proposed to be
performed are considered by and, if deemed appropriate, approved by the Audit
Committee in advance of the performance of such services. All of the fees earned
by BDO Feinstein International AB described above were attributable to services
pre-approved by the Audit Committee.





PART
IV





ITEM
      15.
            EXHIBITS,
      FINANCIAL STATEMENT SCHEDULES




Financial
Statements





The
financial statements of the registrant are listed in the index to the financial
statements and filed under Item 8 of this report.





Financial
Statement Schedule





Schedule
II - Valuation and Qualifying Accounts is listed in the index to the financial
statements and filed under Item 8 of this report. Schedules not listed have been
omitted because the information required therein is not applicable or is shown
in the financial statements and the notes thereto.





Exhibits





Exhibit #
                
                Description2.1
                
                Agreement
      and Plan of Merger and Reorganization between SBE, Inc. and Neonode Inc.,
      dated January 19, 2007 (incorporated by reference to
      Exhibit 2.1 of our Current Report on Form 8-K filed on January
      22, 2007 ) ( In
      accordance with Commission rules, we supplementally will furnish a copy of
      any omitted schedule to the Commission upon request
    )2.2
                
                Amendment
      No. 1 to the Agreement and Plan of Merger and Reorganization between SBE,
      Inc. and Neonode Inc., dated May 18, 2007, effective May 25, 2007 ( incorporated by reference to
      Exhibit 2.1 of our Current Report on Form 8-K filed on May 29,
      2007 )3.1
                
                Amended
      and Restated Certificate of Incorporation, dated December 20, 2007,
      effective December 21, 20073.2
                  4.1
                  
                  4.2
                  4.3
                
                Bylaws,
      as amended through December 5, 2007
                  Certificate
      of Designations, Preferences and Rights of the Series A and Series B
      Preferred Stock dated 29 December 2008 ( incorporated by reference as
      Exhibit 4.1 of our Current Report on Form 8-K filed on December
      31, 2008 )
                  Certificate
      of Increase of Designation of Series B Preferred Stock dated 2 January
      2009
                  Certificate
      of Increase of Designation of Series B Preferred Stock dated 28 January
      2009





10.1
              
              Senior
      Secured Note, dated August 8, 2007 ( incorporated by reference to
      Exhibit 10.22(a) of our Current Report on Form 8-K filed on
      October 2, 2007 )10.2
              
              Amendment
      to Senior Secured Note, dated September 10, 2007 ( incorporated by reference to
      Exhibit 10.22(b) of our Current Report on Form 8-K filed on
      October 2, 2007 )


94





10.3
              Form
      of Common Stock Purchase Warrant issued pursuant to Amendment to Senior
      Secured Notes, dated September 10, 2007 ( incorporated by reference to
      Exhibit 10.22(c) of our Current Report on Form 8-K filed on
      October 2, 2007 )10.4
              Subscription
      Agreement, dated September 10, 2007 ( incorporated by reference to
      Exhibit 10.23 of our Current Report on Form 8-K filed on October
      2, 2007 )10.5
              Convertible
      Promissory Note ( incorporated by reference to
      Exhibit 10.24 of our Current Report on Form 8-K filed on October
      2, 2007 )10.6
              Form
      of Common Stock Purchase Warrant ( incorporated by reference to
      Exhibit 10.25 of our Current Report on Form 8-K filed on October
      2, 2007 )10.7
              Form
      of Unit Purchase Warrant ( incorporated by reference to
      Exhibit 10.26 of our Current Report on Form 8-K filed on October
      2, 2007 )10.8
              Subscription
      Agreement, dated March 4, 2008 ( incorporated by reference to
      Exhibit 10.1 of our Current Report on Form 8-K filed on March 3,
      2008 )10.8
              Asset
      Purchase Agreement with One Stop Systems, Inc., dated January 11, 2007 (
      incorporated by
      reference to Exhibit 2.1 of our Current Report on Form 8-K filed
      on January 12, 2007 )10.9
              Asset
      Purchase Agreement with Rising Tide Software, dated August 15, 2007 (
      incorporated by
      reference to Exhibit 2.1 of our Current Report on Form 8-K filed
      on August 24, 2007 )10.10
              Lease
      for 4000 Executive Parkway, Suite 200 dated July 27, 2005 with Alexander
      Properties Company10.11
              1998
      Non-Officer Stock Option Plan, as amended ( incorporated by reference to
      Exhibit 99.2 of our Registration Statement on Form S-8
      (333-63228) filed on June 18, 2001 )+10.12
              2001
      Non-Employee Directors’ Stock Option Plan, as amended ( incorporated by reference to
      Exhibit 10.2 of our Annual Report on Form 10-K for the fiscal
      year ended October 31, 2002, as filed on January 27, 2003
      )+10.13
              Director
      and Officer Bonus Plan, dated September 21, 2006 ( incorporated by reference to
      Exhibit 10.1 of our Current Report on Form 8-K filed on
      September 26, 2006 )+10.14
              Executive
      Severance Benefits Agreement with David W. Brunton, dated April 12, 2004 (
      incorporated by
      reference to Exhibit 10.13 of our Quarterly Report on Form 10-Q
      for the period ended January 31, 2005, as filed on March 2, 2005
      )+10.15
              Note
      Conversion Agreement, dated December 31, 2008 ( incorporated by reference to
      Exhibit 10.1 of our Current Report on Form 8-K filed on December
      31, 2008)10.16
              Share
      Exchange Agreement, dated December 30, 2008 ( incorporated by reference to
      Exhibit 10.4 of our Current Report on Form 8-K filed on December
      31, 2008)10.17
              Series
      A Stock Subscription Agreement, dated December31, 2008 ( incorporated by reference to
      Exhibit 10.3 of our Current Report on Form 8-K filed on December
      31, 2008)10.18
              Warrant
      Conversion Agreement, dated December 31, 2008 ( incorporated by reference to
      Exhibit 10.2 of our Current Report on Form 8-K filed on December
      31, 2008 )10.19
              Employment
      Agreement with Per Bystedt10.20
              Employment
      Agreement with Thomas Eriksson10.21
              Employment
      Agreement with Magnus Goertz21
              Subsidiaries
      of the registrant23.1
              Consent
      of BDO Feinstein International AB, Independent Registered Public
      Accounting Firm31.1
              Certification
      of Principal Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act Of 200231.2
              Certification
      of Principal Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act Of 200232
              Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of
2002


+
Management contract or compensatory plan or arrangement


95





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: April 14, 2009
              By:
              /s/ David W.
BruntonDavid
      W. Brunton
                Chief
      Financial Officer,
                Vice
      President, Finance
                and
      Secretary





POWER
OF ATTORNEY





KNOW ALL
PERSONS BY THESE PRESENTS, that each of the undersigned officers and directors
of the registrant constitutes and appoints, jointly and severally, Per Bystedt
and David W. Brunton, and each of them, as lawful attorneys-in-fact and agents
for the undersigned and for each of them, each with full power of substitution
and resubstitution, for and in the name, place and stead of each of the
undersigned officers and directors, in any and all capacities, to sign any and
all amendments to this report, and to file the same, with all exhibits thereto
and all other documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents, and each
of them, full power and authority to do and perform each and every act and thing
necessary or appropriate to be done in and about the premises, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that each of said attorneys-in-fact or any of them, or any of
their substitutes, may lawfully do or cause to be done by virtue
hereof.





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/ Per Bystedt
                      
                      Chief
      Executive Officer,
                      
                      April
      14 , 2009Per
      Bystedt
                      
                      and
      Director, Chairman of the Board(Principal
      Executive Officer)/s/ David W. Brunton
                      
                      Chief Financial Officer, Vice President, Finance and Secretary
                      
                      April 14, 2009David
      W. Brunton
                      
                      (Principal
      Financial and Accounting Officer)/s/ John Reardon
                      
                      Director
                      
                      April
      14, 2009John
      Reardon/s/ Susan Major
                      
                      Director
                      
                      April
      14, 2009Susan
      Major/s/ Kenneth Olson
                      
                      Director
                      
                      April
      14, 2009Kenneth
      Olson


96