**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington, D.C.
      20549**





**FORM 10-K**





**þ**
            **ANNUAL
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
                OF 1934****For
                the fiscal year ended December 31, 2007****or****o**
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
                OF 1934****For
                the transition period from to**





Commission
      File No. **0-8419**





**NEONODE
      INC.**


*(Exact
      name of Registrant as specified in its charter)*





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





**Sweden** Warfvingesväg 45, SE-112 51 Stockholm, Sweden


**USA** 4000
      Executive Parkway, San Ramon, CA., 94549


*(Address
      of principal executive offices and Zip Code)*





**Sweden** 46-8-678
      18 50


**USA** (925)
      355-2000


*(Registrant's
      Telephone Numbers, including Area Code)*





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





Title
                of Each Class
            Name
                of Each Exchange on Which Registered**Common
                Stock**
            **The
                NASDAQ Capital Market**





**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 companyý





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





The
      approximate aggregate market value of the common stock held by non-affiliates
      of
      the registrant, based on the closing price for the registrant’s common stock on
      June 29, 2007 (the last business day of the second quarter of the registrant’s
      current fiscal year) as reported on the Nasdaq Capital Markets, was $5,699,977.





The
      number of shares of the registrant’s common stock outstanding as of March 26,
      2008 was 25,918,162.





**DOCUMENTS
      INCORPORATED BY REFERENCE**





Portions
      of the registrant’s definitive proxy statement for the 2008 Annual Meeting of
      Stockholders is incorporated by reference in Part III of this Form 10-K to
      the
      extent stated herein













**NEONODE
      INC.**





**2007
      ANNUAL REPORT ON FORM 10-K**





**TABLE
      OF CONTENTS**




**PART I**Item 1.
            BUSINESS
            2Item 1A.
            RISK
                FACTORS
            7Item
                1B.
            UNRESOLVED
                STAFF COMMENTS
            16Item 2.
            PROPERTIES
            16Item 3.
            LEGAL
                PROCEEDINGS
            17Item 4.
            SUBMISSION
                OF MATTERS TO A VOTE OF SECURITY HOLDERSEXECUTIVE
                OFFICERS OF THE REGISTRANT
            17**PART II**Item 5.
            MARKET
                FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
                PURCHASES OF EQUITY SECURITIES
            18Item 6.
            SELECTED
                FINANCIAL DATA
            18Item 7.
            MANAGEMENT’S
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
                OPERATIONS
            19Item 7A.
            QUANTITATIVE
                AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
            29Item 8.
            FINANCIAL
                STATEMENTS AND SUPPLEMENTARY DATA
            29Item 9.
            CHANGES
                AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
                DISCLOSURE
            62Item 9A.
            CONTROLS
                AND PROCEDURES
            62Item 9B.
            OTHER
                INFORMATION
            63**PART III**Item 10.
            DIRECTORS,
                EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
            63Item 11.
            EXECUTIVE
                COMPENSATION
            64Item 12.
            SECURITY
                OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
                STOCKHOLDER MATTERS
            64Item 13.
            CERTAIN
                RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
                INDEPENDENCE
            65Item 14.
            PRINCIPAL
                ACCOUNTING FEES AND SERVICES
            65**PART IV**Item 15.
            EXHIBITS,
                FINANCIAL STATEMENT SCHEDULES
            65SIGNATURES
            67











**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**





**Overview**





Our
      business focus is a combination of licensing our touchscreen technology to
      other
      companies and developing and selling our own products using our technology
      in
      mobile device markets. The cornerstone of our business is our innovative patent
      pending touchscreen solutions. We believe that in the future keyboards and
      keypads with moving parts will become obsolete and that our touchscreen
      solutions and technologies will be at the forefront of a new wave of input
      technologies that will be able to run everything from small mobile devices
      to
      large industrial applications.





We
      believe our current product, the Neonode N2, is the world’s smallest touchscreen
      mobile phone handset. The N2 fits in the palm of your hand and is designed
      to
      allow the user to navigate the menus and functions with simple finger based
      taps
      and sweeps. The N2 incorporates our patent pending touchscreen and other
      proprietary technologies to deliver a mobile phone with a completely unique
      user
      experience that doesn’t require keypads, buttons or other moving parts.





The
      first
      model of our touchscreen multimedia mobile phone, the N1, was released in
      November 2004. The N1 was primarily a concept phone that was sold in limited
      quantities from late 2004 to early 2006. The N2 is our first production-quality
      product. We began shipping the N2 to customers in mid-July 2007 and have shipped
      approximately 31,000 units from July 2007 through December 31,
      2007.





We
      believe, the N2 is the smallest touchscreen multimedia mobile phone in the
      world
      that works on any  GSM
      based
      mobile phone network. The
      N2
      features include :


·  A
      touchscreen mobile multimedia phone that is also an MP3 and video
      player;


·  Innovative
      design, including the N2’s small size, a variety of available colors, and an
      attractive look and feel;


·  Fast,
      flexible and easy software downloads through the internet and SD cards;
      and


·  Large
      storage capacity for media content, with up to 32 Gigabytes available
      storage.





According
      to the Gardner Group there were approximately 1.2 billion cell phones sold
      globally in 2007 and the growth of cell phone market is expected be more than
      10% in both 2008 and 2009. Some of the key growth categories are smart phones
      and multimedia devices which is where the Neonode N2 competes. Both these
      categories are expected to grow dramatically in the coming years.





We
      believe the Neonode N2 and our ongoing product developments will benefit from
      key market developments and trends, including:


·  Production
      capacity and scalability;




2




·  Increased
      availability of off the shelf technology;


·  Increased
      focus on enhancing the user experience, demonstrated by the popularity of
      designer phones such as the iPhone


·  Convergence
      of multiple applications in a single device, including games, videos, music
      and
      cameras.


·  Increased
      popularity of Touchscreen based devices such as the iPhone and HTC
      Touch.





**History**





Neonode,
      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 it 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 $2,200,000 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 is 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). The stockholders of SBE, Inc. approved the
      transaction in a special meeting of stockholders held on August 10, 2007.
      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 is located in
      Stockholm, Sweden.





Unless
      the context otherwise requires, all references herein to “Neonode” refer to
      Private Neonode prior to the Merger, and Neonode Inc. (formally known as SBE,
      Inc.) and its wholly-owned subsidiaries after the Merger.





**The
      Neonode Principle**





Our
      product design goal is to deliver a user experience that is faster, easier,
      more
      enjoyable than comparable products. To achieve that goal, we focus on enhancing
      the user experience between the user and device in four key areas:


·  Durable,
      precise and fast touchscreen technology;


·  Fast,
      fun
      and easy user interface;


·  Innovative
      design and ergonomics


·  Variety
      of useful accessories and ease of usability





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 by integrating with and enhancing 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 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 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 positions us to offer innovative integrated digital
      lifestyle solutions.





**Strategy**





Our
      overall strategy is to develop innovative differentiated touchscreen hardware
      and software technologies. Our business model combines the licensing of our
      technology to other companies who develop mobile devices along with developing
      and selling our own Neonode branded touchscreen mobile media products. Our
      Neonode brand of products is currently targeting consumers in the middle to
      high
      middle segment of the mobile multimedia phone market who value style combined
      with innovative technology. Our mobile phone handset is not locked into any
      individual mobile telephone operator’s network and can be used on any Global
      System for Mobile (GSM) phone network in the world, thereby allowing the end
      users to select the network and calling plans. We may develop future mobile
      phone handsets that are tailored for specific mobile network operator’s
      needs.




3





Together
      with a network of third party partners such as Sykes and TRS who provide our
      first line product support and product delivery logistics, we are focused on
      building a large-scale product development and customer support infrastructure.





We
      are
      building a sales channel with an initial focus on European distributors and
      now
      plan to expand our marketing distribution to Asia, Latin America and the United
      States. We also sell our products through our web site to areas where we do
      not
      have a distributor or reseller presence. We have an agreement with a provider
      of
      call center, customer technical support and credit card payment processing
      for
      our web sales.





**Neonode
      USA**





Neonode
      USA is our affiliated company formed in early 2008 together with Distribution
      Management Consolidators LLC (DMC), a sales channel development and supply
      chain
      management company. Neonode USA, exclusively markets and sells our innovative
      products within North America, Latin America and China ("Neonode USA Territory")
      and is the exclusive worldwide licensor of our intellectual property to third
      parties. The Neonode USA’s main office is located in New York, USA.




As
        Neonode USA is a venture between us and another company, DMC, there is a
        risk
        that in the event that DMC was to terminate its participation in Neonode
        USA, or
        Neonode USA was to reach an impass as to as to a key strategic decision,
        the
        marketing and sales efforts in the Neonode USA Territory would materially
        suffer.


**Products**





We
      developed a series of touchscreen multimedia mobile phones that convert the
      functionality of a desktop computer to a mobile phone interface. We began
      shipping our latest mobile phone, the N2, to customers in July 2007. In addition
      to connecting to any GSM supported cellular telephone network in the world,
      our
      N2 multimedia mobile phone is based on an open platform Windows CE technology
      that provides simplicity in connecting to any personal computer for updating
      contact information, calendars and downloading of media files via Bluetooth
      or
      USB connections. It also allows users to watch movies or music videos in full
      screen, play music, take pictures with a two mega-pixel camera and play video
      games, all with internet pod casting capabilities. The Windows CE environment
      allows third party software developers and individual users to develop
      customized software applications and video games for use on our N2 phone.





Our
      N2
      mobile phone is based on a patent pending user interface that incorporates
      one-hand on screen navigation with a simple user interface that recognizes
      gestures rather than defined keys. As a result, our interface features a large
      display without physical buttons using what we believe is the smallest
      touchscreen handset in the mobile phone industry. Our standard N2 phone
      incorporates a standard one gigabyte SD memory card which is currently
      expandable to eight gigabytes with what we expect to be future expandability
      to
      32 gigabytes. The SD memory card has the storage capacity for thousands of
      songs
      and pictures and several movies. Our multimedia mobile phone has battery life
      of
      approximately six hours of music and video playback time. In addition, standby
      time is estimated to be 200 hours with a talk-time of approximately four
      hours.





We
      also
      license our patent pending touchscreen hardware and software designs to third
      party companies for incorporation into diverse products that incorporate
      touchscreen technology such as MP3 and video players, digital cameras, Global
      Positioning Systems (GPS) and alarm system touch pads. In 2005, we entered
      into
      a license agreement with a major Asian mobile telephone manufacturer where
      we
      licensed our touch screen technology for use in a mobile phone to be included
      in
      their product assortment. The original license agreement was for a two-year
      period and was exclusive. Upon expiration of the exclusive period in July 2007,
      we extended the license agreement on a non-exclusive basis for an additional
      year. We may also provide consulting services related to the implementation
      of
      our software. The fees for these consultancy services may vary from hourly
      rates
      to monthly rates and will be based on reasonable market rates for such
      services.





Our
      technology and product designs are based on our patent pending zForce TM and
      NenoTM hardware and software technology. zForceTM is our optical 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
      was patented in several countries by Neonode in 2002 and has a 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 being produced on the screen and are then converted
      into mathematical algorithms when your fingers move across the screen. This
      input method is unique for Neonode and is enabled by the zForceTM Technology.




4





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





Our
      zForceTM has a number of key advantages over each of these technologies
      including:


·
            There
                are no additional layers 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 screens and
                as 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 our 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 touch screen technologies but at a much lower cost. It works in all
      climates and, unlike the competing technologies, can be used with gloves. In
      addition, zForceTM allows for waterproofing.





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 supports 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.”




5




We
      have
      been granted design protection in Sweden for the design of a mobile phone,
      and
      have applied for design protection in Sweden for a new a design of our mobile
      phone.





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.





We
      also
      license technologies from third parties for integration into our products.
      We
      believe that the licensing of complementary technologies from third parties
      with
      specific expertise is an effective means of expanding the features and
      functionality of our products, allowing us to focus on our core competencies.





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 and typically
      extending for a period of time beyond termination of the
      relationship.





**Distribution,
      Sales and Marketing**





We
      are
      building a network of distributors covering Europe, India and Asia and planning
      to expand our network to the remaining countries in Europe, the United States,
      Asia and Latin America in 2008. We currently have seven distributors selling
      our
      products in 13 European countries.





Our
      products are customizable for each country or region using the GSM standard.
      Our
      phone supports all local languages and a number of well known carriers such
      as
      Vodafone, Tim, Telia and Telenor have included our phone in their core product
      assortment and are selling it with carrier subsidies where the carrier provides
      incentives to the customer if they sign up for calling plans. In addition to
      the
      distributor sales channel, we are using the Neonode.com web store as a direct
      sales channel to sell our products and third-party products in countries where
      we do not have a sales presence.





Our
      internal sales and marketing organization supports our channel marketing
      partners by providing sales collateral, such as product data sheets,
      presentations, and other sales/marketing resource tools. Our sales staff
      solicits prospective customers, provides technical advice with respect to our
      products and works closely with marketing partners to train and educate their
      staff on how to sell, install, and support our product lines.





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





Our
      direct sales force and marketing operations are based out of our corporate
      headquarters in Stockholm, Sweden.





**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 mobile multimedia telecommunications 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 2007 and 2006 we spent $4.5 million and $2.2 million,
      respectively, on research and development activities.





A
      critical part of our research and development is focused on touch screen
      technology. We believe there is strong potential for zForceTM but understand the
      need for constant development and enhancement of the technology to keep our
      leading position in the market in relation to finger based touch screens.






6


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 ensure a steady stream of new innovations and areas of
      use.





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


·  Software


·  Optical


·  Mechanical


·  Electrical





Our
      product development efforts are focused principally on our strategic product
      lines, including a new touch screen phone with additional
      functionality.





**Manufacturing**





We
      do not
      engage in any manufacturing operations. We have a strong relationship with
      our
      manufacturing partner Balda AG and their manufacturing plant in Malaysia.
      Together, we believe we have the ability to increase production volumes to
      meet
      the demands from the markets and our expansion plans.





**Competition**





Competition
      in the mobile computing device market is intense and characterized by rapid
      change and complex technology. The principal competitive factors affecting
      the
      market for our mobile computing devices are access to sales and distribution
      channels, price, styling, usability, functionality, features, operating system,
      brand, marketing, availability of third-party software applications and customer
      and developer support. Our devices compete with a variety of mobile devices,
      including pen-and keyboard-based devices, mobile phones and converged voice/data
      devices.





Our
      principal competitors include: mobile handset and Smartphone manufacturers
      such
      as Apple, High Tech Computer (HTC), Palm, Motorola, Nokia, Research in Motion,
      Samsung, Sony-Ericsson and Hewlett-Packard; hand held devices made by consumer
      electronics companies such as Garmin, NEC, Sharp Electronics and Yakumo; and
      a
      variety of early-stage technology companies.





Some
      of
      these competitors, such as HTC, produce multimedia phones as carrier-branded
      devices in addition to their own branded devices.





In
      addition, our devices compete for a share of disposable income and enterprise
      spending on consumer electronics, telecommunications and computing products
      such
      as MP3 players, Apple’s iPods, media/photo views, digital cameras, personal
      media players, digital storage devices, handheld gaming devices, GPS devices
      and
      other such devices.





Many
      of
      our competitors have greater financial resources and are well established.
      Competition within the communications market varies principally by application
      segment.





**Backlog**





On
      December 31, 2007, we did not have any firm order backlog of product orders
      from
      our customers.





**Employees**





On
      December 31, 2007, we had 42 full-time employees and augment our staffing needs
      with consultants as needed. Our employees are located in our corporate
      headquarters in Stockholm, Sweden and branch offices located in Portugal, Hong
      Kong, Shanghai, China and the United States. None of our employees is
      represented by a labor union. We have experienced no work stoppages. We believe
      our employee relations are positive.


**ITEM 1A.**
                  **RISK
                    FACTORS**




7




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,
      2007 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 in the future 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 strategy. In March 2008 we closed an aggregate of $4.5
      million of private equity financing. If our operations do not become cash flow
      positive as projected 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 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.





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





Neonode
      was formed in 2006 as a holding company owning and operating Neonode AB, which
      was formed in 2004 and has been primarily engaged in the business of developing
      and selling mobile phones. 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. Our success will depend on many factors, including, but not limited
      to:


·  the
      growth of mobile telephone usage;


·  the
      efforts of our marketing partners;


·  the
      level
      of competition faced by us; and


·  our
      ability to meet customer demand for products 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 and services that
      our customers and end users choose to buy. If we are unsuccessful at developing
      and introducing new products 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 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 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.




8




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 a potentially different
      sales and support environment. 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.





***We
      are dependent on third parties to manufacture and supply our products and
      components of our products.***





Our
      products are built by a limited number of independent manufacturers. Although
      we
      provide manufacturers with key performance specifications for the phones, these
      manufacturers could:


·  manufacture **** phones **** with
      defects that fail to perform to our specifications;


·  fail
      to
      meet delivery schedules; or


·  fail
      to
      properly service phones or honor warranties.





Any
      of
      the foregoing could adversely affect our ability to sell our products and
      services, which, in turn, could adversely affect our revenues, profitability
      and
      liquidity, as well as our brand image.





***We
      may become highly dependent on wireless carriers for the success of our
      products.***





Our
      business strategy includes significant efforts to establish relationships with
      international wireless carriers. We cannot assure you that we will be successful
      in establishing new relationships, or maintaining such relationships, with
      wireless carriers or that these wireless carriers will act in a manner that
      will
      promote the success of our multimedia phone products. Factors that are largely
      within the control of wireless carriers, but which are important to the success
      of our multimedia phone products, include:


·
            testing
                of our products on wireless carriers’
networks;


·
            quality
                and coverage area of wireless voice and data services offered by
                the
                wireless carriers;


·
            the
                degree to which wireless carriers facilitate the introduction of
                and
                actively market, advertise, promote, distribute and resell our multimedia
                phone products;


·
            the
                extent to which wireless carriers require specific hardware and software
                features on our multimedia phone to be used on their
                networks;


·
            timely
                build out of advanced wireless carrier networks that enhance the
                user
                experience for data centric services through higher speed and other
                functionality;


·
            contractual
                terms and conditions imposed on them by wireless carriers that, in
                some
                circumstances, could limit our ability to make similar products available
                through competitive carriers in some market
                segments;


·
            wireless
                carriers’ pricing requirements and subsidy programs;
                and


·
            pricing
                and other terms and conditions of voice and data rate plans that
                the
                wireless carriers offer for use with our multimedia phone
                products.





For
      example, flat data rate pricing plans offered by some wireless carriers may
      represent some risk to our relationship with such carriers. While flat data
      pricing helps customer adoption of the data services offered by carriers and
      therefore highlights the advantages of the data applications of its products,
      such plans may not allow its multimedia phones to contribute as much average
      revenue per user to wireless carriers as when they are priced by usage, and
      therefore reduces our differentiation from other, non-data devices in the view
      of the carriers. In addition, if wireless carriers charge higher rates than
      consumers are willing to pay, the acceptance of our wireless solutions could
      be
      less than anticipated and our revenues and results of operations could be
      adversely affected.





Wireless
      carriers have substantial bargaining power as we enter into agreements with
      them. They may require contract terms that are difficult for us to satisfy,
      which could result in higher costs to complete certification requirements and
      negatively impact our results of operations and financial condition. Moreover,
      we may not have agreements with some of the wireless carriers with whom they
      will do business and, in some cases, the agreements may be with third-party
      distributors and may not pass through rights to us or provide us with recourse
      or contact with the carrier. The absence of agreements means that, with little
      or no notice, these wireless carriers could refuse to continue to purchase
      all
      or some of our products or change the terms under which they purchase our
      products. If these wireless carriers were to stop purchasing our products,
      we
      may be unable to replace the lost sales channel on a timely basis and our
      results of operations could be harmed.




9




Wireless
      carriers could also significantly affect our ability to develop and launch
      products for use on their wireless networks. If we fail to address the needs
      of
      wireless carriers, identify new product and service opportunities or modify
      or
      improve our multimedia phone products in response to changes in technology,
      industry standards or wireless carrier requirements, our products could rapidly
      become less competitive or obsolete. If we fail to timely develop products
      that
      meet carrier product planning cycles or fail to deliver sufficient quantities
      of
      products in a timely manner to wireless carriers, those carriers may choose
      to
      emphasize similar products from our competitors and thereby reduce their focus
      on its products which would have a negative impact on our business, results
      of
      operations and financial condition.





Carriers,
      who control most of the distribution and sale of, and virtually all of the
      access for, multimedia phone products could commoditize multimedia phones,
      thereby reducing the average selling prices and margins for our products which
      would have a negative impact on our business, results of operations and
      financial condition. In addition, if carriers move away from subsidizing the
      purchase of mobile phone products, this could significantly reduce the sales
      or
      growth rate of sales of mobile phone products. This could have an adverse impact
      on our business, revenues and results of operations.





***As
      we build strategic relationships with wireless carriers, we may be exposed
      to
      significant fluctuations in revenue for our multimedia phone
      products*** .





Because
      of their large sales channels, wireless carriers may purchase large quantities
      of our products prior to launch so that the products are widely available.
      Reorders of products may fluctuate quarter to quarter, depending on end-customer
      demand and inventory levels required by the carriers. As we develop new
      strategic relationships and launch new products with wireless carriers, our
      revenue could be subject to significant fluctuation based on the timing of
      carrier product launches, carrier inventory requirements, marketing efforts
      and
      our ability to forecast and satisfy carrier and end-customer demand. We do
      not
      have a history of selling to wireless carriers and as a result do not have
      do
      not have a basis for estimating what the potential fluctuations in our revenue
      will be from the sale of our multimedia phones.





***The
      mobile communications industry is highly competitive and many of our competitors
      have significantly greater resources to engage in product development,
      manufacturing, distribution and marketing.***





The
      mobile communications industry, in which we are engaged, is a highly competitive
      business with companies of all sizes engaged in business in all areas of the
      world, including companies with far greater resources than we have. There can
      be
      no assurance that other competitors, with greater resources and business
      connections, will not compete successfully against us in the future. Our
      competitors may adopt new technologies that reduce the demand for our products
      or render our technologies obsolete, which may have a material adverse effect
      on
      the cost structure and competitiveness of our products, possibly resulting
      in a
      negative effect on our revenues, profitability or liquidity.





***Our
      future results could be harmed by economic, political, regulatory and other
      risks associated with international sales and
      operations.***





Because
      we sell our products worldwide and most of the facilities where our devices
      are
      manufactured, distributed and supported are located outside the United States,
      our business is subject to risks associated with doing business internationally,
      such as:


·
            changes
                in foreign currency exchange rates;


·
            the
                impact of recessions in the global economy or in specific sub
                economies;


·
            changes
                in a specific country’s or region’s political or economic conditions,
                particularly in emerging markets;


·
            changes
                in international relations;


·
            trade
                protection measures and import or export licensing
                requirements;


·
            changes
                in tax laws;


·
            compliance
                with a wide variety of laws and regulations which may have civil
                and/or
                criminal consequences for them and our officers and directors who
                they
                indemnify;


·
            difficulty
                in managing widespread sales operations;
                and


·
            difficulty
                in managing a geographically dispersed workforce in compliance with
                diverse local laws and customs.




10




In
      addition, we are subject to changes in demand for our products resulting from
      exchange rate fluctuations that make our products relatively more or less
      expensive in international markets. If exchange rate fluctuations occur, our
      business and results of operations could be harmed by decreases in demand for
      our products or reductions in margins.





While
      we
      sell our products worldwide, one component of our strategy is to expand our
      sales efforts in countries with large populations and propensities for adopting
      new technologies. We have limited experience with sales and marketing in some
      of
      these countries. There can be no assurance that we will be able to market and
      sell our products in all of our targeted international markets. If our
      international efforts are not successful, our business growth and results of
      operations could be harmed.





***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 products, especially as we expand
      into new markets. 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 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 them 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.





***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.***




11




As
      part
      of our business strategy, we target customers and relationships with suppliers
      and original distribution manufacturers in countries with large populations
      and
      propensities for adopting new technologies. However, many of these countries
      do
      not address misappropriation of intellectual property or 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 do not correctly forecast demand for our products, we could have costly
      excess production or inventories or we may not be able to secure sufficient
      or
      cost effective quantities of our products or production materials, and our
      revenues, cost of revenues and financial condition could be adversely
      impacted.***





The
      demand for our products depends on many factors, including pricing and channel
      inventory levels, and is difficult to forecast due in part to variations in
      economic conditions, changes in consumer and enterprise preferences, relatively
      short product life cycles, changes in competition, seasonality and reliance
      on
      key sales channel partners. It is particularly difficult to forecast demand
      by
      individual variations of the product, such as the color of the casing or size
      of
      memory. Significant unanticipated fluctuations in demand, the timing and
      disclosure of new product releases or the timing of key sales orders could
      result in costly excess production or inventories or the inability to secure
      sufficient, cost-effective quantities of our products or production materials.
      This could adversely impact our revenues, cost of revenues and financial
      condition.





***We
      rely on third parties to sell and distribute our products and we rely on their
      information to manage our business. Disruption of our relationship with these
      channel partners, changes in their business practices, their failure to provide
      timely and accurate information or conflicts among its channels of distribution
      could adversely affect our business, results of operations and financial
      condition.***





The
      distributors, wireless carriers, retailers and resellers who sell or distribute
      our products also sell products offered by our competitors. If our competitors
      offer our sales channel partners more favorable terms or have more products
      available to meet their needs or utilize the leverage of broader product lines
      sold through the channel, those wireless carriers, distributors, retailers
      and
      resellers may de-emphasize or decline to carry our products. In addition,
      certain of our sales channel partners could decide to de-emphasize the product
      categories that we offer in exchange for other product categories that they
      believe provide higher returns. If we are unable to maintain successful
      relationships with these sales channel partners or to expand our distribution
      channels, our business will suffer.





Because
      we intend to sell our products primarily to distributors, wireless carriers,
      retailers and resellers, we are subject to many risks, including risks related
      to product returns, either through the exercise of contractual return rights
      or
      as a result of its strategic interest in assisting them in balancing
      inventories. In addition, these sales channel partners could modify their
      business practices, such as inventory levels, or seek to modify their
      contractual terms, such as return rights or payment terms. Unexpected changes
      in
      product return requests, inventory levels, payment terms or other practices
      by
      these sales channel partners could negatively impact our business, results
      of
      operations and financial condition.





We
      will
      rely on distributors, wireless carriers, retailers and resellers to provide
      us
      with timely and accurate information about their inventory levels as well as
      sell-through of products purchased from us. We will use this information as
      one
      of the factors in our forecasting process to plan future production and sales
      levels, which in turn will influence our public financial forecasts. We will
      also use this information as a factor in determining the levels of some of
      our
      financial reserves. If we do not receive this information on a timely and
      accurate basis, our results of operations and financial condition may be
      adversely impacted.





Distributors,
      retailers and traditional resellers experience competition from Internet-based
      resellers that distribute directly to end-customers, and there is also
      competition among Internet-based resellers. We also sell our products directly
      to end-customers from our Neonode.com web site. These varied sales channels
      could cause conflict among our channels of distribution, which could harm our
      business, revenues and results of operations.





***If
      our multimedia phone products do not meet wireless carrier and governmental
      or
      regulatory certification requirements, we will not be able to compete
      effectively and our ability to generate revenues will
      suffer.***




12




We
      are
      required to certify our multimedia phone products with governmental and
      regulatory agencies and with the wireless carriers for use on their networks.
      The certification process can be time consuming, could delay the offering of
      our
      products on carrier networks and affect our ability to timely deliver products
      to customers. As a result, carriers may choose to offer, or consumers may choose
      to buy, similar products from our competitors and thereby reduce their purchases
      of our products, which would have a negative impact on our products sales
      volumes, our revenues and our cost of revenues.





***We
      depend on our suppliers, some of which are the sole source and some of which
      are
      our competitors, for certain components, software applications and elements
      of
      our technology, and our production or reputation could be harmed if these
      suppliers were unable or unwilling to meet our demand or technical requirements
      on a timely and/or a cost-effective basis.***





Our
      multimedia products contain software applications and components, including
      liquid crystal displays, touch panels, memory chips, microprocessors, cameras,
      radios and batteries, which are procured from a variety of suppliers, including
      some who are our competitors. The cost, quality and availability of software
      applications and components are essential to the successful production and
      sale
      of our device products. For example, media player applications are critical
      to
      the functionality of our multimedia phone devices.





Some
      components, such as screens and related integrated circuits, digital signal
      processors, microprocessors, radio frequency components and other discrete
      components, come from sole source suppliers. Alternative sources are not always
      available or may be prohibitively expensive. In addition, even when we have
      multiple qualified suppliers, we may compete with other purchasers for
      allocation of scarce components. Some components come from companies with whom
      we competes in the multimedia phone device market. If suppliers are unable
      or
      unwilling to meet our demand for components and if we are unable to obtain
      alternative sources or if the price for alternative sources is prohibitive,
      our
      ability to maintain timely and cost-effective production of our multimedia
      phone
      will be harmed. Shortages affect the timing and volume of production for some
      of
      our products as well as increasing our costs due to premium prices paid for
      those components. Some of our suppliers may be capacity-constrained due to
      high
      industry demand for some components and relatively long lead times to expand
      capacity. ******





***If
      we are unable to obtain key technologies from third parties on a timely basis
      and 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 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.





***Our
      product strategy is to base our products on software operating systems that
      are
      commercially available to competitors.***





Our ****** multimedia
      phone is based on a commercially available version of Microsoft’s Windows CE. We
      cannot assure you that we will be able to maintain this licensing agreement
      with
      Microsoft and that Microsoft will not grant similar rights to our competitors
      or
      that we will be able to sufficiently differentiate our multimedia phone from
      the
      multitude of other devices based on Windows CE.





In
      addition, there is significant competition in the operating system software
      and
      services market, including proprietary operating systems such as Symbian and
      Palm OS, open source operating systems, such as Linux, other proprietary
      operating systems and other software technologies, such as Java and RIM’s
      licensed technology. This competition is being developed and promoted by
      competitors and potential competitors, some of which have significantly greater
      financial, technical and marketing resources than we have, such as Access,
      Motorola, Nokia, Sony-Ericsson and RIM. These competitors could provide
      additional or better functionality than we do or may be able to respond more
      rapidly than we can to new or emerging technologies or changes in customer
      requirements. Competitors in this market could devote greater resources to
      the
      development, promotion and sale of their products and services and the
      third-party developer community, which could attract the attention of
      influential user segments.





If
      we are
      unable to continue to differentiate the operating systems that we include in
      our
      mobile computing devices, our revenues and results of operations could be
      adversely affected.





***The
      market for multimedia phone products is volatile, and changing market
      conditions, or failure to adjust to changing market conditions, may adversely
      affect our revenues, results of operations and financial condition, particularly
      given our size, limited resources and lack of
      diversification.***




13




We
      operate in the multimedia phone market which has seen significant growth during
      the past years. We cannot assure you that this significant growth in the sales
      of multimedia devices will continue. If we are unable to adequately respond
      to
      changes in demand for our products, our revenues and results of operations
      could
      be adversely affected. In addition, as our products mature and face greater
      competition, we may experience pressure on our product pricing to preserve
      demand for our products, which would adversely affect our margins, results
      of
      operations and financial condition.





This
      reliance on the success of and trends in our industry is compounded by the
      size
      of our organization and our focus on multimedia phones. These factors also
      make
      us more dependent on investments of our limited resources. For example, Neonode
      faces many resource allocation decisions, such as: where to focus our research
      and development, geographic sales and marketing and partnering efforts; which
      aspects of our business to outsource; and which operating systems and email
      solutions to support. Given the size and undiversified nature of our
      organization, any error in investment strategy could harm our business, results
      of operations and financial condition.





***Our
      products are subject to increasingly stringent laws, standards and other
      regulatory requirements, and the costs of compliance or failure to comply may
      adversely impact our business, results of operations and financial
      condition.***





Our
      products must comply with a variety of laws, standards and other requirements
      governing, among other things, safety, materials usage, packaging and
      environmental impacts and must obtain regulatory approvals and satisfy other
      regulatory concerns in the various jurisdictions where our products are sold.
      Many of our products must meet standards governing, among other things,
      interference with other electronic equipment and human exposure to
      electromagnetic radiation. Failure to comply with such requirements can subject
      us to liability, additional costs and reputational harm and in severe cases
      prevent us from selling our products in certain jurisdictions.





For
      example, many of our products are subject to laws and regulations that restrict
      the use of lead and other substances and require producers of electrical and
      electronic equipment to assume responsibility for collecting, treating,
      recycling and disposing of our products when they have reached the end of their
      useful life. In Europe, substance restrictions began to apply to the products
      sold after July 1, 2006, when new recycling, labeling, financing and
      related requirements came into effect. Failure to comply with applicable
      environmental requirements can result in fines, civil or criminal sanctions
      and
      third-party claims. If products we sell in Europe are found to contain more
      than
      the permitted percentage of lead or another listed substance, it is possible
      that we could be forced to recall the products, which could lead to substantial
      replacement costs, contract damage claims from customers, and reputational
      harm.
      We expect similar requirements in the United States, China and other parts
      of
      the world.





As
      a
      result of these new European requirements and anticipated developments
      elsewhere, we are facing increasingly complex procurement and design challenges,
      which, among other things, require us to incur additional costs identifying
      suppliers and contract manufacturers who can provide, and otherwise obtain,
      compliant materials, parts and end products and re-designing products so that
      they comply with these and the many other requirements applicable to
      them.





***Allegations
      of health risks associated with electromagnetic fields and wireless
      communications devices, and the lawsuits and publicity relating to them,
      regardless of merit, could adversely impact our business, results of operations
      and financial condition.***





There
      has
      been public speculation about possible health risks to individuals from exposure
      to electromagnetic fields, or radio signals, from base stations and from the
      use
      of mobile devices. While a substantial amount of scientific research by various
      independent research bodies has indicated that these radio signals, at levels
      within the limits prescribed by public health authority standards and
      recommendations, present no evidence of adverse effect to human health, we
      cannot assure you that future studies, regardless of their scientific basis,
      will not suggest a link between electromagnetic fields and adverse health
      effects. Government agencies, international health organizations and other
      scientific bodies are currently conducting research into these issues. In
      addition, other mobile device companies have been named in individual plaintiff
      and class action lawsuits alleging that radio emissions from mobile phones
      have
      caused or contributed to brain tumors and the use of mobile phones pose a health
      risk. Although our products are certified as meeting applicable public health
      authority safety standards and recommendations, even a perceived risk of adverse
      health effects from wireless communications devices could adversely impact
      use
      of wireless communications devices or subject them to costly litigation and
      could harm our reputation, business, results of operations and financial
      condition.





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




14




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 mobile phone handsets, 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.





***Our
      common stock is at risk for delisting from the Nasdaq Capital Market if we
      fail
      to maintain minimum listing maintenance standards. If it is delisted, our stock
      price and your liquidity may be impacted.***





Our
      common stock is listed on the Nasdaq Capital Market under the symbol NEON.
      In
      order for our common stock to continue to be listed on the Nasdaq Capital
      Market, we must satisfy various listing maintenance standards established by
      Nasdaq. Among other things, as such requirements pertain to us, we are required
      to have stockholders’ equity of at least $2.5 million or market capitalization
      of $35 million and public float value of at least $1.0 million and our common
      stock must have a minimum closing bid price of $1.00 per share .





***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;




15




·
            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.





***If
      registration rights that we have previously granted are exercised, then the
      price of our common stock may be adversely affected.***





We
      have
      agreed to register with the SEC the shares of common issued to former Neonode
      stockholders in connection with the merger and to participants in a private
      placement funding we completed on March 4, 2008. In
      addition, we have granted piggyback registration rights to the investors who
      participated in our March private placement. In
      the
      event these securities are registered with the SEC, they may be freely sold
      in
      the open market, subject to trading restrictions to which our insiders holding
      the shares may be subject from time to time. In the event that we fail to
      register such shares in a timely basis, we may have liabilities to such
      stockholders. We expect that we also will be required to register any securities
      sold in future private financings. 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.





**ITEM 1B.**
            **UNRESOLVED STAFF
              COMMENTS**





Not
      applicable.


**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 expires on March 31, 2013. The annual payment for these
      premise equates to approximately $288,000 per year and is indexed to the
      consumer price index in Sweden. As an incentive to enter into the agreement
      as
      one of the firs tenants to occupy the building, the NCC Property G AB has given
      Neonode AB discounts amounting to approximately $120,000 allocated over the
      first eight months of the leasing period. Prior to taking occupancy of this
      new
      facility, 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.




16




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 begins on April 1, 2008 and expires on March 31, 2013. The annual
      payment for these premise amounts to $28,000 per year and is indexed to the
      consumer price index in Sweden. Neonode AB has the right to terminate the lease
      on March 31, 2011 if notice of termination is given by Neonode AB at least
      9
      months prior to March 31, 2011.





In
      addition, we lease 2,000 square feet of office space in San Ramon, California
      on
      a month-to-month basis at cost of $5,000 per month. We have occupied this space
      since March 2007 under a lease with One Stop Systems, Inc. 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 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 the merger with SBE, we will 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**





We
      may
      from time to time become a party to various legal proceedings arising in the
      ordinary course of business. As of December 31, 2007, we had no known material
      current, pending, or threatened litigation.





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





A
      special
      meeting of stockholders was held on Tuesday, December 18, 2007, at the offices
      of DavenportMajor Executive Search, located at 12770 High Bluff Drive, Suite
      320, San Diego, California 92130.





The
      stockholders approved the following six items:





(i)  The
      election of Mikael Hagman to the Board of Directors


For
            Withhold13,495,640
            6,550





(ii)  The
      election of John Reardon to the Board of Directors


For
              Withhold13,496,144
              6,370




(iii)  The
      approval of an amendment to the Neonode’s Certificate of Incorporation to effect
      an increase in the number of authorized shares of common stock from 40,000,000
      to 75,000,000.


For
                Against
                Abstain13,453,474
                48,378
                662


(iv)  The
      ratification of the terms of the financing transaction in September 2007
      pursuant to which Neonode issued units consisting of common stock, convertible
      notes and warrants.


For
                  Against
                  Abstain13,493,084
                  8,762
                  668


(v)  The
      approval of the convertibility into units of the September 2007 offering of
      outstanding 8% Senior Secured Notes.


For
                  Against
                  Abstain13,492,567
                  8,598
                  1,389


(vi)  The
      ratification of the selection of BDO Feinstein International AB as the company’s
      independent auditors for 2007.


For
                  Against
                  Abstain13,495,923
                  5,929
                  662





**EXECUTIVE
      OFFICERS OF THE REGISTRANT**




17




Our
      executive officers and their respective ages and positions as of December 31,
      2007 are set forth in the following table. There are no familial relationships
      between our directors or our executive officers and any other director or
      executive officer.





Name
            Age
            PositionMikael
                Hagman
            40
            President
                and Chief Executive OfficerDavid
                W. Brunton
            57
            Vice
                President, Finance, Chief Financial Officer, Treasurer and
                SecretaryThomas
                Ericsson
            37
            Chief
                Technical Officer





*Mikael
      Hagman* - **** Mr.
      Hagman joined Neonode as Chief Executive Officer in March 2007 from Sony where
      he served as Chief Executive Officer for Sony Corp. in Sweden and Finland.
      During his eight years with Sony, Mr. Hagman held a number of positions and
      served on the board of Sony Nordic AS. **** While
      at
      Sony Mr. Hagman was nominated for several Pan European committees and
      participated in forums that developed Sony’s commercial strategies. **** Prior
      to
      Sony **** Mr.
      Hagman worked for United Biscuits Ltd in various leading sales and marketing
      roles across Nordic. He currently serves on the board of directors of AIK
      Fotboll AB, a publicly traded company listed on NGM (Nordic Growth Markets).
      AIK
      Fotboll AB is one of Sweden’s leading soccer clubs. **** He
      has
      served on the board of various industry associations (Consumer Electronics
      Association, Elektronik branchen, SRL).





*David
      W Brunton* - Mr.
      Brunton joined SBE 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.





*Thomas
      Eriksson* - Mr.
      Eriksson co-founded Neonode in 2001 as Vice President and Chief Technology
      Officer. Prior to founding Neonode AB, he founded several companies with
      products ranging from car electronics test systems and tools to GSM/GPRS/GPS
      based fleet management systems including M2M applications and wireless modems.
      Mr. Eriksson has over 15 years of experience in product design and electronics
      engineering.





**PART
      II**





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




Our
      common stock is quoted on the Nasdaq 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, 2007, there were approximately 1,611 holders of record of our
      common stock.





Fiscal
                Quarter EndedFiscal
                2007
            March
                31(1)
            June
                30(1)
            September
                30(1)
            December
                31High
            $3.95
            $4.00
            $7.94
            $4.82Low
            1.70
            1.62
            2.85
            2.89Fiscal
                2006(1)High
            $8.65
            $5.75
            $2.45
            $2.20Low
            0.99
            2.45
            1.60
            1.65


**** (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.





18




**ITEM 7.**
            **MANAGEMENT’S
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS 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, 2007 and 2006 and the related notes included therein.*





**Overview**





We
      believe our current product, the Neonode N2, is the world’s smallest touchscreen
      mobile phone handset. The N2 fits in the palm of your hand and is designed
      to
      allow the user to navigate the menus and functions with simple finger based
      taps
      and sweeps. The N2 incorporates our patent pending touchscreen and other
      proprietary technologies to deliver a mobile phone with a completely unique
      user
      experience that doesn’t require any keypads, buttons or other moving parts.





The
      first
      model of our touchscreen multimedia mobile phone, the N1, was released in
      November 2004. The N1 was primarily a concept phone that was sold in limited
      quantities from late 2004 to early 2006. The N2 is our first production-quality
      product. We began shipping the N2 to customers in mid-July 2007 and have shipped
      approximately 31,000 units from July 2007 through December 31,
      2007.





Our
      business focus is a combination of licensing our touchscreen technology to
      other
      companies and developing and selling our own products using our technology
      in
      mobile device markets. The cornerstone of our business is our innovative patent
      pending touchscreen solutions. We believe that in the future keyboards and
      keypads with moving parts will become obsolete and that our touchscreen
      solutions and technologies will be at the forefront of a new wave of input
      technologies that will be able to run everything from small mobile devices
      to
      large industrial applications.





Neonode
      was incorporated in the State of Delaware in 2006 to be the parent of Neonode
      AB, a company founded in February 2004 and incorporated in Sweden. In a February
      2006 corporate reorganization, Neonode issued shares and warrants to the
      stockholders of Neonode AB in exchange for all of the outstanding stock and
      warrants of Neonode AB. Following the reorganization, Neonode AB became a
      wholly-owned subsidiary of Neonode. Since there was no change in control of
      the
      group, the reorganization was accounted for with no change in accounting basis
      for Neonode AB and the assets and liabilities were accounted for at historical
      cost in the new group. The consolidated accounts comprise the accounts of the
      combined companies as if they had been owned by Neonode throughout the entire
      reporting period.





We
      have
      incurred net operating losses and negative operating cash flows since inception.
      As of December 31, 2007, we had an accumulated deficit of $58.7 million. We
      expect to incur additional losses and may have negative operating cash flows
      through the end of 2008. The report of our independent registered public
      accounting firm in respect of the 2007 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
      long-term success is dependent on obtaining sufficient capital or operating
      cash
      flows to fund our operations and development of our products, bringing such
      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.




19




We
      are
      subject to certain risks common to technology-based companies in similar stages
      of development. See “Risk Factors” above. Principal risks include uncertainty of
      growth in market acceptance for our products, history of losses since inception,
      ability to remain competitive in response to new technologies, costs to defend,
      as well as risks of losing patent and intellectual property rights, reliance
      on
      limited number of suppliers, reliance on outsourced manufacture of our products
      for quality control and product availability, ability to increase production
      capacity to meet demand for our products, concentration of our operations in
      a
      limited number of facilities, uncertainty of demand for our products in certain
      markets, ability to manage growth effectively, dependence on key members of
      our
      management and development team, limited experience in conducting operations
      internationally, and ability to obtain adequate capital to fund future
      operations.





**Background**





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 (formally
      known as SBE, Inc.) are included in the results of operations presented
      elsewhere and discussed herein only from August 10, 2007. Thus the audited
      consolidated financial statements appearing elsewhere in this Annual Report
      on
      Form 10-K and discussion of our financial condition and results of operations
      for the year ended December 31, 2006 below reflect Old Neonode’s stand-alone
      consolidated operations. 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.





**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. 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
      results of which 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 consolidated
      financial statements.





***Revenue
      Recognition***





Our
      policy is to recognize revenue for 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 have consisted primarily to distributors located in various 13
      regions. We may allow, from time to time, certain distributors price protection
      subsequent to the initial product shipment. P rice
      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 sufficient
      history of making price adjustments. We, therefore, defer recognition of revenue
      (in the balance sheet line item “deferred revenue”) derived from sales to these
      customers until they have resold our products to their customers. Although
      revenue recognition and related cost of sales are deferred, we record an
      accounts receivable at the time of initial product shipment. As standard terms
      are generally FOB shipping point, payment terms are enforced from shipment
      date
      and legal title and risk of inventory loss passes to the distributor upon
      shipment.




20




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





Revenue
      from products sold directly to end-users though our web sales channels is
      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 are provided at the time of shipment.





We
      derive
      revenue from license 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 will generally include a
      nonexclusive license for the underlying IP. Fees under these agreements may
      include license fees relating to our IP and royalties payable following the
      sale by our licensees of products incorporating the licensed technology. The
      license for our IP has standalone value and can be used by the licensee without
      maintenance and support.





Revenue
      for the twelve months ended December 31, 2007 and 2006 includes revenue from
      the
      sales of our first mobile phone, the N1 and current product, the N2 multimedia
      mobile phones and revenue from a 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. The exclusive rights
      do
      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 provides 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 March 31, 2008,
      the Asian manufacturer had not sold any mobile telephones using our
      technology.





The
      net
      revenue related to this agreement has been allocated over the term of the
      agreement, amounting to $463,000 in 2007 and $851,000 in 2006, respectively.
      The
      contract also includes consulting services to be provided by Neonode on an
“as
      needed basis.” The fees for these consultancy services vary from hourly rates to
      monthly rates and are 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.





***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 the customer 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 their 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.





***Warranty
      Reserves***





Our
      products are 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 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.





***Research
      and Development***




21




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.





***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 Debts and Debts 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.





***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, 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. We account for these derivatives under SFAS 133.





SFAS
      133
      requires that we analyze all material contracts and determine whether or not
      they contain embedded derivatives. Any such derivatives 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.





***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, 2007 and 2006. 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 30, 2007, unrecognized tax benefits approximated $0.




22




***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 FASB issued 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. We do not believe that the adoption of SFAS
      141R will have material impact on our consolidated results of operations and
      financial condition.





In
      September 2006, the FASB issued SFAS 157, Fair Value Measurements. The
      standard provides guidance for using fair value to measure assets and
      liabilities. SFAS 157 clarifies the principle that fair value should be
      based on the assumptions market participants would use when pricing an asset
      or
      liability and establishes a fair value hierarchy that prioritizes the
      information used to develop those assumptions. Under the standard, fair value
      measurements would be separately disclosed by level within the fair value
      hierarchy. The statement is effective for us beginning in fiscal year 2009.
      In
      February 2008, the FASB issued FASB Staff Position (FSP) SFAS 157-2,
      Effective Date of FASB Statement No. 157 (FSP SFAS 157-2) that
      deferred the effective date of SFAS 157 for one year for certain
      nonfinancial assets and nonfinancial liabilities. We have not determined the
      effect, if any, the adoption of this statement will have on our results of
      operations or financial position.





In
      February 2007, the FASB issued SFAS 159, The Fair Value Option for
      Financial Assets and Financial Liabilities-Including an Amendment of FASB
      Statement 115, which is effective for fiscal years beginning after
      November 15, 2007. This statement permits an entity to choose to measure
      many financial instruments and certain other items at fair value at specified
      election dates. Subsequent unrealized gains and losses on items for which the
      fair value has been elected will be reported in earnings. We are currently
      evaluating the potential impact of this statement.





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 Company is currently evaluating the
      potential impact of this statement.





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
      and its related interpretations, 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.
      Early adoption is permitted. We do not expect SFAS 161 to have a material
      impact on our financial position, and we will make all necessary disclosures
      upon adoption, if applicable.





**Results
      of Operations**





On
      August
      10, 2007, SBE announced the completion of the previously announced merger of
      its
      wholly-owned subsidiary, Cold Winter Acquisition Corporation, with and into
      Neonode Inc., pursuant to which Neonode changed its name to “Cold Winter, Inc.”
and became a wholly-owned subsidiary of the Company. Following the closing
      of
      the merger transaction, the Company was renamed “Neonode Inc.” The
      newly-combined Company’s headquarters is located in Stockholm, Sweden. SBE
      issued approximately 20.4 million shares of its common stock in exchange for
      5.8
      million outstanding shares of Neonode Inc. common stock and the assumption
      of
      outstanding options and warrants to purchase an additional 7.9 million shares
      of
      Neonode Inc. common stock. The Company’s common stock started trading on the
      Nasdaq Capital Market on August 13, 2007 under the new ticker symbol “NEON.”




23




For
      accounting purposes, the Merger was accounted for as a reverse merger with
      Old
      Neonode as the accounting acquirer. This transaction was treated as a
      recapitalization. Thus, the historical financial statements of Old Neonode
      have
      become our historical financial statements and the results of operations of
      our
      company (formally known as SBE, Inc.) are included in the results of operations
      presented elsewhere and discussed herein only from August 10, 2007. Thus the
      audited consolidated financial statements appearing elsewhere in this Annual
      Report on Form 10-K and discussion of our financial condition and results of
      operations for the year ended December 31, 2006 below reflect Old Neonode’s
      stand-alone consolidated operations. 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.





The
      following table sets forth, as a percentage of net sales, certain statements
      of
      operations data for the twelve months ended December 31, 2007 and 2006. These
      operating results are not necessarily indicative of our operating results for
      any future period.




**2007**
            
            **2006**Net
                sales
            
            
            100
            %
            
            100
            %Cost
                of sales
            
            
            74
            %
            
            79
            %**Gross
                profit**
            
            
            **26**
            **%**
            
            **21**
            **%***Operating
                expenses:*Research
                and development
            
            
            142
            %
            
            135
            %Sales
                and marketing
            
            
            100
            %
            
            45
            %General
                and administrative
            
            
            162
            %
            
            112
            %Total
                operating expenses
            
            
            404
            %
            
            292
            %**Operating
                loss**
            
            
            **(379**
            **%)**
            
            **(272**
            **%)***Other
                income (expense):*Interest
                income and other, net
            
            
            (9
            %)
            
            (14
            %)Interest
                expense
            
            
            (9
            %)
            
            (14
            %)Charges
                related to debt extinguishments and debt discounts
            
            
            (125
            %)
            
            (12
            %)Non-cash
                charges for conversion features & warrants
            
            
            (1,024
            %)
            
            1
            %Total
                other expense
            
            
            (1,167
            %)
            
            (39
            %)**Net
                loss**
            
            
            **(1,547**
            **%)**
            
            **(311**
            **%)**Non-cash
                inducement charge related to corporate reorganization February 28,
                2006
            
            
            -
            
            
            6
            %**Net
                loss attributable to common shareholders**
            
            
            **(1,547**
            **%)**
            
            **(318**
            **%)**





***Net
      Sales***





Net
      sales
      for the year ended December 31, 2007 were $3.1 million, an approximately 94%
      increase from $1.6 million for the year ended December 31, 2006. Revenue for
      the
      year ended December 31, 2007 and 2006 includes $2.7 million and $793,000 revenue
      from the sales of our multimedia mobile phones, respectively. In addition,
      license revenue in 2007 and 2006 amounted to $463,000 and $851,000. License
      revenue was 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 their product assortment. In this agreement, we received
      an initial payment of approximately $2.0 million plus will 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 without the exclusive rights. The increase
      in
      Net Sales is attributable to the launch of the N2 model of our multimedia mobile
      phone in mid-February 2007. The N2 phone represents our first general release
      mobile phone handset and we began shipping to our first European customers
      in
      July of 2007.




24




We
      sell
      our products through a direct sales force that supports our distributors. In
      2007, we concentrated our sales efforts on the European and Indian markets.
      In
      2008, we plan an expansion into the North American, South American and Chinese
      markets through Neonode USA, a joint venture between Neonode Inc and
      Distribution Management Consolidators Worldwide, LLC (DMC).





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.





***Gross
      Profit***





Gross
      profit as a percentage of net sales was 26% and 21% in the years ended December
      31, 2007 and 2006. Our cost of sales include the direct cost of production
      of
      the phone plus the cost of our internal production department and accrued
      estimated warranty costs. The primary reason for the increase in gross profit
      is
      a result of the fact that our cost of sales includes write-downs of obsolete
      inventory relating to the N1 phones of $565,000 for the twelve months ended
      December 31, 2006 as compared to $0 for the 12 months ended December 31,
      2007.





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.





We
      expect
      our gross profit to increase in 2008 as we begin to produce and sell our N2
      mobile phone handsets in larger quantities. Our target range for gross profit
      is
      between 28% and 30% once we increase production volumes.





***Product
      Research and Development***





Product
      research and development (R&D) expenses for the year ended December 31, 2007
      were $4.4 million, a 100% increase over $2.2 million for the same period ending
      December 31, 2006.





The
      main
      factors that contributed to the increase in R&D costs are as
      follows:


·
            an
                increase in the headcount of our engineering department from 10 to
                14
                amounting to an increase of $509,000 along with significant increases
                in
                external consultancy costs of $741,000. In 2007, in order to recruit,
                retain and motivate employees, we began to increase employee’ssalaries
                to market levels. Prior to 2007, Neonode’s employee’s salaries were below
                market level; and


·
            an
                increase in engineering expenditures in the late stage processes
                of
                bringing the N2 into commercial production amounting to
                $280,000.





We
      plan
      to continue to increase expenditures on critical R&D projects and have
      planned increases in both the headcount of our engineering department and the
      purchase of critical design and testing technology. We have a product roadmap
      of
      future mobile phone handsets and technologies and expects to increase our
      R&D budgets in order to develop these products and technologies to meet
      market demands.





***Sales
      and Marketing***





Sales
      and
      marketing expenses for the year ended December 31, 2007 were $3.1 million
      compared to $746,000 for the same period in 2006, an increase of 329%.





The
      increase in 2007 over 2006 is primarily related to increases in product
      marketing activities such as advertising agency fees as well as an 80% increase
      in sales and marketing headcount . During 2007, we launched our N2 model phone
      handset at the 3GSM trade show in Barcelona, Spain. In addition, the sales
      force
      was strengthened for the product rollout on the European market.





Sales
      and
      marketing programs are focused on design wins with new customers and, therefore,
      as new customer sales increase, sales and marketing expenses are expected to
      increase. We
      expect
      our sales and marketing expenses to continue to increase as we position the
      Company to take advantage of new market opportunities for our N2 and future
      mobile phone handsets and participate in more sales lead generation and branding
      initiatives, such as, industry trade events, public relations and direct
      marketing. Our
      target range for sales and marketing expense is between 12% and 15% of total
      sales once we increase production volumes.




25




***General
      and Administrative***





General
      and administrative (G&A) expenses for the year ended December 31, 2007 were
      $5.1 million, a 183% increase from $1.8 million for the same period in 2006.





The
      increase in 2007 over 2006 is primarily related to:


·
            approximately
                $1.5 million in legal and accounting costs associated with bringing
                our
                accounting and reporting up to US GAAP standards in preparation for
                the
                merger with SBE in August 2007; and


·
            an
                increase in headcount and general overhead expense including the
                personnel
                additions from the August 10, 2007 merger with SBE amounting to $1.3
                million.





We
      expect
      the basic general and administrative expense to continue to increase due to
      increasing demands on legal, accounting, insurance and other costs, including
      compliance with Sarbanes-Oxley regulations, associated with being a public
      company as a result of the merger with SBE. However, the absence of one-time
      costs incurred in 2007 associated with the merger with SBE should mitigate
      some
      of this increase so that total G&A should not continue to increase at the
      same rate as in 2007.





***Interest
      Expense and Other Expense***





Interest
      expense for the twelve months ended December 31, 2007 was $295,000 million
      as
      compared to $229,000 for the twelve months ended December 31, 2006. The $66,000
      increase is due to a combination of a increase in interest bearing debt
      outstanding during 2007 and an increase in the interest rate.





***Charges
      related to debt extinguishments and debt discounts***





Charges
      related to debt extinguishments and debt discounts for the twelve months ended
      December 31, 2007 amounted to $3.9 million compared to $200,000 for the twelve
      months ended December 31, 2006. The $3.7 million increase is due a combination
      of debt extinguishment costs related to the conversion of senior secured notes
      and bridge notes of $1.9 million, the debt discount amortization and the
      write-off of excess debt discounts related to the bridge notes and September
      26,
      2007 financing amounting to $1.6 million and $210,000 related to the
      amortization of debt issuance costs.





***Non-Cash
      Charges for Conversion Feature and Warrants***





On
      August
      10, 2007, all the senior secured notes, loan from Petrus and Almi and accrued
      interest totalling $14.3 million were converted to 10,096,197 shares of our
      common stock and 5 year warrants to purchase 5,048,095 shares of our common
      stock at $2.83 per share. We computed
      the fair value of the conversion option related to the notes using the
      Black-Scholes option pricing model on the day of the conversion to common stock
      and warrants and compared the computed fair value to the recorded value of
      the
      notes and related accrued interest. The $32.1 million in the non-cash charges
      for conversion feature and warrants is comprised of $35.6 million increase
      in
      the computed fair value of the embedded conversion features related to
      convertible debt and a $1.5 million benefit related the valuation of warrants
      recorded as a liability. These net charges were recorded as a non-cash valuation
      charge in the
      statements of operations pursuant to Emerging Issues Task Force Issue (EITF)
      03-7 *,
      Accounting for the Settlement of the Equity-Settled Portion of a Convertible
      Debt Instrument that Permits or Requires the Conversion Spread to Be Settled
      in
      Stock* ,
      and APB
      26, *Early
      Extinguishment of Debt.*





***Income
      Taxes***





Our
      effective tax rate was 0% in the year ended December 31, 2007 and 2006,
      respectively. We recorded valuation allowances in 2007 and 2006 for deferred
      tax
      assets related to net operating losses due to the uncertainty of realization.
      In
      the event of future taxable income, our effective income tax rate in future
      periods could be lower than the statutory rate as such tax assets are
      realized.





***Net
      Loss***




26




As
      a
      result of the factors discussed above, we recorded a net loss attributable
      to
      shareholders of $48.4 million for the year ended December 31, 2007 compared
      to a
      net loss available to shareholders of $5.2 million in the comparable period
      in
      2006.




**Off-Balance
      Sheet Arrangements**





We
      do not
      have any transactions, arrangements, or other relationships with unconsolidated
      entities that are reasonably likely to affect our liquidity or capital resources
      other than the operating leases. We have no special purpose or limited purpose
      entities that provide off-balance sheet financing, liquidity, or market or
      credit risk support; or engage in leasing, hedging, research and development
      services, or other relationships that expose us to liability that is not
      reflected on the face of the financial statements.





**Liquidity
      and Capital Resources**





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





·  actual
      versus anticipated sales of our products;


·  our
      actual versus anticipated operating expenses;


·  the
      timing of our product shipments;


·  the
      timing of payment for our product shipments;


·  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 liquidation of liabilities in the ordinary course of business.
      The
      report of our independent registered public accounting firm in respect of the
      2007 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. 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.





Our
      cash
      is subject to interest rate risk. We invest primarily on a short-term basis.
      Our
      financial instrument holdings at December 31, 2007 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. Certain of Neonode loans are in
      Swedish kronor and fluctuations in the exchange rate of the U.S. Dollar compared
      to the Swedish krona will impact both the interest and future principal payments
      associated with these loans.





In
      January 2008, we offered our customers a design modification for the N2 phones
      held in their inventory. We expect the cost of the modification program to
      be
      approximately $200,000 As part of the modification program we offered to
      transport the inventory to our manufacturing partner (Balda Malaysia) and
      provide the modifications at no cost to our customers. As a result, certain
      of
      our customers are withholding payment of amounts due us until the modifications
      are completed and the inventory is returned to them.





At
      December 31, 2007, we had cash and cash equivalents of $6.8 million (with $5.7
      million held as restricted cash), as compared to $369,000 at December 31, 2006.
      In the twelve month period ended December 31, 2007, $11.1 million of cash was
      used in operating activities, primarily as a result of our net loss reduced
      by the following non-cash items (in thousands):




27




Depreciation
                and amortization
            
            $
            298Deferred
                interest
            
            
            340Debt
                discounts and deferred financing fees
            
            
            2,557Stock-based
                compensation expense
            
            
            408Write-off
                of merger costs in excess of cash received from SBE, Inc.
            
            
            263Debt
                extinguishment loss
            
            
            1,524Change
                in fair value of embedded derivatives and warrants
              recorded
                as a liability
            
            
            32,079$
            37,469





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 at December 29, 2007 and the funds were
      released by our bank to cash on January 2, 2008.





During
      the twelve months ended December 31, 2007, we sold a combination of convertible
      notes and equity for cash totaling $17.2 million. Adjusted working capital
      (current assets less current liabilities not including non-cash liabilities
      related to warrants and embedded derivatives) was $5.8 million at December
      31,
      2007, compared to an adjusted working capital deficit of $5.7 million at
      December 31, 2006.





In
      the
      twelve months ended December 31, 2007, we purchased $437,000 of fixed assets,
      consisting primarily of manufacturing tooling, computers and engineering
      equipment.





On
      February 12, 2007, we completed a $5.0 million convertible senior secured note
      financing with interest at 4% per annum and on June 15, 2007, we completed
      an
      additional $3.0 million convertible senior secured note financing with interest
      at 4% per annum. On August 10, 2007, all the senior secured notes, loan from
      Petrus, and Almi 1 and related accrued interest totaling $14.3 million were
      converted to 10,096,197 shares of our common stock and 5 year warrants to
      purchase 5,048,095 shares of our common stock at $2.83 per share.





On
      August
      8, 2007, we completed a $3.2 million offering of convertible notes (the Bridge
      Notes) bearing 8% interest, due December 31, 2007, and convertible into a
      combination of shares of our common stock, warrants and convertible debt. We
      also issued an option to invest $750,000, at the same terms and conditions
      as
      the Bridge Notes, to a particular investor. On September 26, 2007, the August
      Bridge Notes’ maturity date was extended to June 30, 2008 and the conversion
      period was pushed back to no earlier than March 15, 2008 and before June 30,
      2008. In consideration, we issued 219,074 additional warrants to the Bridge
      Note
      holders. On March 31, 2008, the expiration of the option was extended until
      June
      30, 2008. On September 26, 2007, $450,000 of the $3.2 million was converted
      to
      75,817 shares of our common stock, warrants to purchase 105,612 shares of our
      common stock at a price of $3.92 per share and a $227,450 promissory note under
      the same terms as conditions as the September 2007 private placement, described
      below. The note holders of the remaining $2.8 million of unconverted notes
      have
      the right to convert their notes to equity and debt securities anytime between
      March 15, 2008 and June 30, 2008 under the same terms as the September 26,
      2007
      private placement 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 higher
      of
      LIBOR plus 3% or 8% 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 warrants to purchase 1,326,837 shares of our common stock at a price
      of $3.92 per share.





During
      2007 we provided bank guaranties totalling $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 02, 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.





On
      March
      4, 2008, we sold $4.5 million in securities 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 million.





The
      majority of our cash for the twelve months ended December 31, 2007 was provided
      by borrowings from senior secured notes and bridge notes that have been or
      are
      convertible into shares of our common stock. Unless we are able to increase
      our
      sales to reach cash breakeven or increase our secured lines or credit or enter
      into new lines of credit, we may have to raise additional funds through the
      issuance of additional debt or equity securities. If we raise additional funds
      through the issuance of preferred stock or debt, these securities could have
      rights, privileges or preferences senior to those of common stock, and debt
      covenants could impose restrictions on our operations. The sale of equity or
      debt could result in additional dilution to current stockholders, and such
      financing may not be available to us on acceptable terms, if at all.




28




**ITEM 7A.**
            **QUANTITATIVE AND QUALITATIVE
              DISCLOSURES ABOUT MARKET RISK**





Not
      applicable.


**ITEM 8.**
              **FINANCIAL STATEMENTS AND
                SUPPLEMENTARY DATA**





**Index
                to the Financial Statements**
            Page***Financial
                Statements***Report
                of Independent Registered Public Accounting Firm
            30Consolidated
                Balance Sheets at December 31, 2007 and 2006
            31Consolidated
                Statements of Operations for the years ended December 31, 2007 and
                2006
            32Consolidated
                Statements of Stockholders’ Deficit for the years ended December 31, 2007
                and 2006
            33Consolidated
                Statements of Cash Flows for the years ended December 31, 2007 and
                2006
            34Notes
                to Consolidated Financial Statements
            35***Financial
                Statement Schedule***Schedule
                II — Valuation and Qualifying Accounts
            61


29


**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, 2007 and 2006, and the related consolidated statements of
        operations, stockholders’ equity (deficit), and cash flows for each of the two
        years in the period ended December 31, 2007. 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,
        2007
        and 2006, and the results of its operations and its cash flows for each of
        the
        two years in the period ended December 31, 2007, in conformity with accounting
        principles generally accepted in the United States of America.
 
 As
        discussed in Note 2, to the consolidated financial statements, effective
        January
        1, 2006, the Company adopted the provisions of Statement of Financial Accounting
        Standards No. 123 (revised 2004), Share Based Payment.
 
 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,
        2008
 
 BDO
                  Feinstein International AB
              BDO
                  Feinstein International AB/s/
                  Johan Pharmanson
              /s/
                  Tommy BergendahlAuthorized
                  Public Accountant
              Authorized
                  Public Accountant




30




**Neonode
                Inc.****Consolidated
                Balance Sheets**




**December
                31,***Amounts
                in thousands, except for share and per share amounts*
            
            **2007**
            
            **2006****ASSETS***Current
                Assets*Cash
            
            $
            1,147
            
            $
            369Restricted
                cash
            
            
            5,702
            
            
            -Accounts
                receivable, net of allowances for doubtful accounts of
              $4,264
                for Dec. 31, 2007 and $0 Dec. 31, 2006, respectively
            
            
            868
            
            
            46Inventories,
                net
            
            
            6,610
            
            
            -Prepaid
                expenses
            
            
            1,081
            
            
            621Other
                current assets
            
            
            650
            
            
            117Total
                current assets
            
            
            16,058
            
            
            1,153Machinery
                and equipment, net
            
            
            375
            
            
            65Intangible
                assets, net
            
            
            95
            
            
            155Other
                long-term assets
            
            
            395
            
            
            -**Total
                assets**
            
            $
            16,923
            
            $
            1,373**LIABILITIES
                AND STOCKHOLDERS' DEFICIT***Current
                liabilities*Current
                portion of convertible long-term debt (Note 12)
            
            $
            132
            
            $
            5,112Accounts
                payable
            
            
            5,065
            
            
            245Accrued
                expenses
            
            
            1,391
            
            
            893Deferred
                revenue
            
            
            2,979
            
            
            462Liability
                for warrants to purchase common stock
            
            
            5,971
            
            
            -Embedded
                derivatives of convertible debt
            
            
            3,536
            
            
            124Other
                liabilities
            
            
            674
            
            
            313Total
                current liabilities
            
            
            19,748
            
            
            7,149Long-term
                convertible debt (Note 12)
            
            
            60
            
            
            854**Total
                liabilities**
            
            
            19,808
            
            
            8,003Commitments
                and contingencies (Notes 15, 17 and 18)*Stockholders'
                deficit*Common
                stock (75,000,000 shares authorized, par value $0.01;
              23,780,670
                and 10,282,110 shares issued and outstanding at Dec. 31,
              2007
                and 2006, respectively)
            
            
            238
            
            
            102Additional
                paid-in-capital
            
            
            55,191
            
            
            3,407Accumulated
                other comprehensive income
            
            
            354
            
            
            88Accumulated
                deficit
            
            
            (58,668
            )
            
            (10,227
            )Total
                stockholders' deficit
            
            
            (2,885
            )
            
            (6,630
            )**Total
                Liabilities and Stockholders' Deficit**
            
            $
            16,923
            
            $
            1,373




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


31





**Neonode
                Inc.****Consolidated
                Statements of Operations**




**Twelve
                Months Ended December 31,***Amounts
                in thousands, except for per share amounts*
            
            **2007**
            
            **2006**Net
                product sales
            
            $
            2,669
            
            $
            793Net
                technology license sales
            
            
            463
            
            
            851Total
                net sales
            
            
            3,132
            
            
            1,644Cost
                of sales
            
            
            2,317
            
            
            1,297**Gross
                profit**
            
            
            **815**
            
            
            **347***Operating
                expenses:*Research
                and development
            
            
            4,449
            
            
            2,226Sales
                and marketing
            
            
            3,147
            
            
            746General
                and administrative
            
            
            5,080
            
            
            1,846Total
                operating expenses
            
            
            12,676
            
            
            4,818**Operating
                loss**
            
            
            **(11,861**
            **)**
            
            **(4,471**
            **)***Other
                income (expense):*Interest
                income and other, net
            
            
            (277
            )
            
            (237
            )Interest
                expense
            
            
            (295
            )
            
            (229
            )Charges
                related debt extinguishments and debt discounts
            
            
            (3,929
            )
            
            (199
            )Non-cash
                charges for conversion features and warrants
            
            
            (32,079
            )
            
            18Total
                other expense
            
            
            (36,580
            )
            
            (647
            )**Loss
                before non-cash inducement charge**
            
            
            **(48,441**
            **)**
            
            **(5,118**
            **)****Net
                loss**
            
            
            **(48,441**
            **)**
            
            **(5,118**
            **)**Non-cash
                inducement charge related to corporate reorganization Feb. 28,
                2006
            
            
            -
            
            
            106**Net
                loss attributable to common shareholders**
            
            $
            (48,441
            )
            $
            (5,224
            )***Loss
                per common share****:*Basic
                and diluted
            
            $
            (3.15
            )
            $
            (0.52
            )Weighted
                average common shares outstanding
            
            
            15,400
            
            
            10,119




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





32





**Neonode
                Inc.****Consolidated
                Statements of Stockholder's
                Deficit**




*Amounts
                in thousands*
            
            Shares
                issued (1)
            
            Par
                value
            
            Additional
                paid-in- capital
            
            Accumulated
                Comprehensive loss
            
            Accumulated
                deficit
            
            Stock-holders'
                equity (deficit)
            
            Comprehensive
              loss**Balances,
                December 31,**
              **2005**
            
            
            **9,233**
            
            **$**
            **92**
            
            **$**
            **2,608**
            
            **$**
            **146**
            
            **$**
            **(5,109**
            **)**
            **$**
            **(2,263**
            **)**Issuance
                of common stock
            
            
            127
            
            
            1
            
            
            197
            
            
            -
            
            
            -
            
            
            198Issuance
                of common stock and warrants as part of Company reorganization Feb.
                28,
                2006
            
            
            922
            
            
            9
            
            
            713
            
            
            -
            
            
            -
            
            
            722Non-cash
                inducement charge in conjunction with reorganization Feb.28, 2006
            
            
            -
            
            
            -
            
            
            (106
            )
            
            -
            
            
            -
            
            
            (106
            )Reclassification
                of warrants to liability
            
            
            -
            
            
            -
            
            
            (5
            )
            
            -
            
            
            -
            
            
            (5
            )Foreign
                currency translation adjustment
            
            
            -
            
            
            -
            
            
            -
            
            
            (58
            )
            
            -
            
            
            (58
            )
            $
            (58
            )Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (5,118
            )
            
            (5,118
            )
            
            (5,118
            )Comprehensive
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            $
            (5,176
            )**Balances,
                December 31,**
              **2006**
            
            
            **10,282**
            
            
            **102**
            
            
            **3,407**
            
            
            **88**
            
            
            **(10,227**
            **)**
            
            **(6,630**
            **)**Purchase
                of stock options by
              certain
                employees for cash
            
            
            -
            
            
            -
            
            
            161
            
            
            -
            
            
            -
            
            
            161Employee
                stock option compensation expense
            
            
            -
            
            
            -
            
            
            408
            
            
            -
            
            
            -
            
            
            408Reclassification
                of warrantsto
                equity
            
            
            -
            
            
            -
            
            
            5
            
            
            -
            
            
            -
            
            
            5Advisory
                warrants issued on5/18/07
            
            
            -
            
            
            -
            
            
            158
            
            
            -
            
            
            -
            
            
            158Conversion
                of pre-merger debt Aug. 10, 2007 to common stock and
                warrants
            
            
            10,096
            
            
            101
            
            
            49,371
            
            
            -
            
            
            -
            
            
            49,472Merger
                with SBE on Aug.10,
                2007
            
            
            2,296
            
            
            23
            
            
            (23
            )
            
            -
            
            
            -
            
            
            -Equity
                contributed by SBEin
                merger
            
            
            -
            
            
            -
            
            
            1,197
            
            
            -
            
            
            -
            
            
            1,197Merger
                costs
            
            
            -
            
            
            -
            
            
            (122
            )
            
            -
            
            
            -
            
            
            (122
            )Conversion
                of certain August Bridge Notes on September 26, 2007
            
            
            76
            
            
            1
            
            
            295
            
            
            -
            
            
            -
            
            
            296Equity
                from September 2007 private placement
            
            
            952
            
            
            10
            
            
            659
            
            
            -
            
            
            -
            
            
            669Issuance
                costs for equity in September 2007
            
            
            -
            
            
            -
            
            
            (376
            )
            
            -
            
            
            -
            
            
            (376
            )Issuance
                of common stock under stock based compensation plans
            
            
            23
            
            
            -
            
            
            52
            
            
            -
            
            
            -
            
            
            52Cashless
                exercise of employee warrants
            
            
            56
            
            
            1
            
            
            (1
            )
            
            -
            
            
            -
            
            
            -Foreign
                currency translation adjustment
            
            
            -
            
            
            -
            
            
            -
            
            
            266
            
            
            -
            
            
            266
            
            $
            266Net
                loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (48,441
            )
            
            (48,441
            )
            
            (48,441
            )Comprehensive
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            $
            (48,175
            )**Balances,
                December 31,**
              **2007**
            
            
            **23,781**
            
            **$**
            **238**
            
            **$**
            **55,191**
            
            **$**
            **354**
            
            **$**
            **(58,668**
            **)**
            **$**
            **(2,885**
            **)**




(1)
                Shares issued have been adjusted for share exchanges.The
                accompanying notes are an integral part of these Consolidated Financial
                Statements.





33





**Neonode
                Inc.****Consolidated
                Statements of Cash Flows**




**Twelve
                Months Ended December 31,***Amounts
                in thousands*
            
            **2007**
            
            **2006****Cash
                Flows from Operating Activities:**Net
                loss
            
            $
            (48,441
            )
            $
            (5,118
            )Adjustments
                to reconcile net loss to cash used in operating
                activities:Depreciation
                and amortization
            
            
            298
            
            
            90Deferred
                interest
            
            
            340
            
            
            76Debt
                discounts and deferred financing fees
            
            
            2,405
            
            
            240Stock
                option expense
            
            
            408
            
            
            -Stock
                compensation expense related to corporate reorganization
            
            
            -
            
            
            722Inducement
                charge related to corporate reorganization
            
            
            -
            
            
            (106
            )Write-down
                of inventories
            
            
            -
            
            
            133Write-off
                of excess merger expenses
            
            
            158
            
            
            -Debt
                extinguishment loss
            
            
            1,524
            
            
            -Change
                in fair value of embedded derivatives and warrants
            
            
            32,079
            
            
            (18
            )**Changes
                in operating assets and liabilities:**Accounts
                receivable and other current assets
            
            
            (1,324
            )
            
            (97
            )Prepaid
                expenses
            
            
            (339
            )
            
            (379
            )Inventories
            
            
            (6,616
            )
            
            38Accounts
                payable, accrued expenses and other liabilities
            
            
            5,605
            
            
            425Deferred
                revenue
            
            
            2,547
            
            
            (851
            )**Net
                cash used in operating activities**
            
            
            **(10,678**
            **)**
            
            **(4,845**
            **)****Cash
                Flows From Investing Activities:**Acquisition
                of property and equipment
            
            
            (437
            )
            
            (34
            )**Net
                cash used in investing activities**
            
            
            **(437**
            **)**
            
            **(34**
            **)****Cash
                Flows From Financing Activities:**Proceeds
                from issuance of convertible debt
            
            
            16,965
            
            
            5,000Deferred
                financing fees
            
            
            (821
            )
            
            (307
            )Payments
                on long-term notes payable
            
            
            (92
            )
            
            (93
            )Restricted
                cash
            
            
            (5,463
            )
            
            -Proceeds
                from sale of software business
            
            
            90
            
            
            -Cash
                from SBE merger
            
            
            1,123
            
            
            -Merger
                costs
            
            
            (227
            )
            
            -Proceeds
                from sale of employee stock options
            
            
            213
            
            
            -Proceeds
                from issuance of common stock
            
            
            -
            
            
            198**Net
                cash provided by financing activities**
            
            
            **11,788**
            
            
            **4,798**Effect
                of exchange rate changes on cash
            
            
            105
            
            
            251**Net
                Increase in cash and cash equivalents**
            
            
            **778**
            
            
            **170**Cash
                and cash equivalents - beginning of period
            
            
            369
            
            
            199**Cash
                - end of period**
            
            $
            **1,147**
            
            $
            **369****Supplemental
                Disclosures of Cash Flow Information:**Interest
                paid
            
            $
            100
            
            $
            14Fair
                value of common stock and warrants issued in company reorganization
            
            $
            -
            
            $
            722Fair
                value of warrants issued to financial advisor
            
            $
            158
            
            $
            -Conversion
                of pre-merger debt to common stock and warrants
            
            $
            49,472
            
            $
            -Fair
                value of warrants issued to Bridge Note holders
            
            $
            705
            
            $
            -Fair
                value of equipment acquired in the merger with SBE, Inc.
            
            $
            79
            
            $
            -Fair
                value of option granted to financial advisor that expiresJune
                2008
            
            $
            716
            
            $
            -Equity
                contributed by SBE in merger
            
            $
            1,197
            
            
            -Conversion
                of August Bridge Note
            
            $
            296
            
            $
            -




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


34





**NEONODE
      INC**





**Notes
      to the Consolidated Financial Statements**





**1.**  **Nature
      of the business and operations**





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 current 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
      comprise the accounts of the Companies as if they had been owned by the Company
      throughout the entire reporting period. In connection with the reorganization,
      the Company commenced borrowing from a group of new investors.





Our
      business focus is a combination of licensing our touchscreen technology to
      other
      companies and developing and selling our own products using our technology
      in
      mobile device markets. We design, develop and sell multimedia mobile phones
      with
      a focus on unique design and user experience. Our first model, the N1, was
      released in November 2004. Our next generation multimedia mobile phone, the
      Neonode N2, was launched in February 2007 with first customer shipments of
      the
      phone mid-July 2007. For the year ended December 31, 2007 and 2006, our
      customers are primarily located in 13 Europe and India regions.





***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, 2007, we
      had
      an accumulated deficit of $58.7 million and adjusted working capital (current
      assets less current liabilities not including non-cash liabilities related
      to
      warrants and embedded derivatives) of $5.8 million. 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. The
      ability to generate revenues in the future will depend substantially on success
      of resolving quality problems, raising additional funds through debt or equity,
      and entering customer contracts with customers that are financially stable.





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
      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 on 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.





In
      March
      2008, we completed a private placement offering of $4.5 million of our common
      stock. 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.





***Merger***





On
      August
      10, 2007, SBE announced the completion of the previously announced merger of
      its
      wholly-owned subsidiary, Cold Winter Acquisition Corporation, with and into
      Neonode Inc., pursuant to which Neonode changed its name to “Cold Winter, Inc.”
and became a wholly-owned subsidiary of the company. Following the closing
      of
      the merger transaction, the company was renamed “Neonode Inc.” The
      newly-combined company's headquarters is located in Stockholm, Sweden. SBE
      issued approximately 20.4 million shares of its common stock in exchange for
      5.8
      million outstanding shares of Neonode Inc. common stock and the assumption
      of
      outstanding options and warrants to purchase an additional 7.9 million shares
      of
      Neonode Inc. common stock. The Company’s common stock started trading on the
      Nasdaq Capital Market on August 13, 2007 under the new ticker symbol “NEON.”





35





For
      accounting purposes, the merger is considered a recapitalization of Neonode
      with
      the issuance of stock for cash, other assets and the assumption of liabilities
      by Neonode under which Neonode is considered to be acquiring SBE. Accordingly,
      the fair value of the assets and liabilities of SBE are combined with Neonode
      as
      of August 10, 2007 while the historical results of Neonode are reflected in
      the
      results of the combined company. The consolidated financial statements include
      SBE’s operations from August 10, 2007.





Neonode
      shareholders exchanged each share of Neonode common stock for 3.5319 shares
      of
      SBE common stock (exchange ratio) in the recapitalization. Each Neonode warrant
      and stock option that was outstanding on the closing date has been converted
      into SBE warrants and stock options by multiplying the Neonode stock options
      by
      the same exchange ratio described above. The new exercise price was also
      determined by dividing the old exercise price by the same exchange ratio. Each
      of these warrants and options is subject to the same terms and conditions that
      were in effect for the related Neonode warrants and options. Neonode
      stockholders and employees own approximately 28.5 million shares of the
      Company’s common stock or instruments convertible into common stock, or 90.6% of
      the fully diluted capitalization, including warrants and options, of the
      combined company.





The
      following table is the number of shares of common stock, warrants and stock
      options outstanding immediately following the consummation of the merger, on
      August 10, 2007:





**On
                August 10, 2007**
            
            **SBE**
            
            **Neonode**
            
            **Total**Common
                Stock
            
            
            2,295,529
            
            
            20,378,251
            
            
            22,673,780Warrants
                to purchase common stock
            
            
            232,000
            
            
            5,965,397
            
            
            6,197,397Employee
                stock options
            
            
            437,808
            
            
            2,117,332
            
            
            2,555,140Total
            
            
            2,965,337
            
            
            28,460,980
            
            
            31,426,317





***Adjustment
      to Number of Shares of Common Stock Outstanding***





The
      number of shares of Neonode common stock outstanding as of December 31, 2006
      and
      presented on the Consolidated Balance Sheets has been adjusted to reflect the
      number of shares of SBE, Inc. issued to Neonode
      shareholders in conjunction with the recapitalization that culminated on August
      10, 2007. Neonode Shareholders exchanged each share of Neonode common stock
      for
      3.5319 shares of SBE common stock (exchange ratio).





December
                31,2006Historical
                shares of common stock outstanding
            
            
            2,911,217Adjusted
                shares of common stock outstanding
            
            
            10,282,127





**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 and
      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. Please refer to the Merger section above for description of
      our
      reverse merger with SBE, Inc. that was completed on August 10, 2007.





***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.




36




***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 totalling $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 02, 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.





***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 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 their 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.





***Inventories***





Inventories
      are stated at the lower of cost, using the first-in, first-out method, or
      market. Our policy is to establish inventory reserves when conditions exist
      that
      suggest that our inventory may be in excess of anticipated demand or is obsolete
      based upon our assumptions about future demand for our products and market
      conditions.





***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 livesTooling
              1
                  yearComputer
                  equipment
              3
                  yearsFurniture
                  and fixtures
              5
                  years





Equipment
      purchased under capital leases are 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
      on such assets 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.





***Intangible
      Assets***





Intangible
      assets consists of patents, with finite lives are recorded at cost less
      accumulated amortization. Amortization is computed over the estimated useful
      life of the asset, which is generally five years for our patents.




37




***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 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. To date, we have not had any
      impairment of long-lived assets.





***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 such
      translation are included as a separate component of accumulated other
      comprehensive income. Gains or losses resulting from foreign currency
      transactions are included in other income (expense). Foreign currency
      transaction gains and losses which are included in other income and (expense)
      were $362,000 and $265,000 during the twelve month periods ending December
      31,
      2007 and 2006, 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.





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***





Our
      policy is to recognize revenue for 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 have consisted primarily to distributors located in various 13
      regions. We may allow, from time to time, certain distributors price protection
      subsequent to the initial product shipment. P rice
      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 sufficient
      history of making price adjustments. We, therefore, defer recognition of revenue
      (in the balance sheet line item “deferred revenue”) derived from sales to these
      customers until they have resold our products to their customers. Although
      revenue recognition and related cost of sales are deferred, we record an
      accounts receivable at the time of initial product shipment. As standard terms
      are generally FOB shipping point, payment terms are enforced from shipment
      date
      and legal title and risk of inventory loss passes to the distributor upon
      shipment.




38




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





Revenue
      from products sold directly to end-users though our web sales channels is
      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 are provided at the time of shipment.





We
      derive
      revenue from license 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 will generally include a
      nonexclusive license for the underlying IP. Fees under these agreements may
      include license fees relating to our IP and royalties payable following the
      sale by our licensees of products incorporating the licensed technology. The
      license for our IP has standalone value and can be used by the licensee without
      maintenance and support.





Revenue
      for the twelve months ended December 31, 2007 and 2006 includes revenue from
      the
      sales of the N1 and N2 multimedia mobile phones and revenue from a 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. Another component of the agreement provides for a fee of
      approximately $2.65 per telephone if the Asian manufacture 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 March 31, 2008,
      the Asian manufacturer had not sold any mobile telephones using our technology.





The
      net
      revenue related to this agreement has been allocated over the term of the
      agreement, amounting to $463,000 in 2007 and $851,000 in 2006, respectively.
      The
      contract also includes consulting services to be provided by Neonode on an
“as
      needed basis”. The fees for these consultancy services vary from hourly rates to
      monthly rates and are 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.





***Warranty
      Reserve***





Our
      products are generally warranted against defects for twelve months following
      the
      sale. We have a twelve 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 an estimate of repair costs.
      Shipping and handling charges are expensed as incurred.





***Advertising***





Advertising
      costs are expensed as incurred. External advertising costs amounted to $661,000
      and $157,000 for the years ending December 31, 2007 and 2006,
      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 consists mainly of personnel related costs in addition
      to
      some external consultancy costs such as testing, certifying and measurements.





***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 product 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. In addition, we usually sell to customers with either prepayment, letter
      of credit or bank guarantees. Our customers are generally distributors of
      telecommunications equipment. We will maintain allowances for potential credit
      losses, if necessary.




39




***Risk
      and Uncertainties***





Our
      long-term success is dependent on obtaining sufficient capital to fund our
      operations and development of our products, 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 uncertainty of growth in market
      acceptance for our products; history of losses since inception, ability to
      remain competitive in response to new technologies, costs to defend, as well
      as
      risks of losing patent and intellectual property rights, reliance on limited
      number of suppliers, reliance on outsourced manufacture of our products for
      quality control and product availability, ability to increase production
      capacity to meet demand for our products, concentration of our operations in
      a
      limited number of facilities, uncertainty of demand for our products in certain
      markets, ability to manage growth effectively, dependence on key members of
      our
      management and development team, limited experience in conducting operations
      internationally, and ability to obtain adequate capital to fund future
      operations.





Since
      we
      are in the process of launching a new generation of our product, the first
      customers may comprise over 15 percent of revenue and we will need to rely
      on a
      smaller customer base as we grow. In addition we will produce telephones through
      an agreement with a production partner. This exposes us to the risk that the
      partner may not fulfil contracted volumes or deliveries. Even the sources of
      components used in our product could cause delays in production and deliveries.





We
      are
      exposed to a number of economic and industry factors that could result in
      portions of our inventory becoming either obsolete or in excess of anticipated
      usage, or subject to lower of cost or market issues. 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 availability of key components from our suppliers.





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 products as well as our
      ability to introduce new versions of our products to meet the evolving needs
      of
      our customers.





***Stock
      Based Compensation Expense***





Effective
      January 1, 2006, we adopted 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. SFAS 123R supersedes our previous accounting
      under APB 25, *Accounting
      for Stock Issued to Employees* ,
      and
      related interpretations for periods beginning in fiscal 2006. In March 2005,
      the
      SEC issued Staff Accounting Bulletin (SAB) No. 107 relating to SFAS 123R. We
      adopted SFAS 123R using the modified prospective transition method as permitted
      under SFAS 123R. Accordingly, prior period amounts have not been restated.
      Under
      this application, we are required to record compensation expense for awards
      granted after the date of adoption and for the unvested portions of previously
      granted awards that remain outstanding at the date of adoption. Prior to the
      adoption of SFAS 123R, we used the intrinsic value method as prescribed by
      APB
      25 and thus recognized no compensation expense for options granted with exercise
      prices equal to the fair market value of our common stock on the date of grant.




40


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, *Accounting
      for Convertible Debts and Debts issued with Stock Purchase
      Warrants* ,
      if such
      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.





***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, 2007 and 2006. 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, 2007, we had no unrecognized tax
      benefits.





***Net
      Loss Per Share***





Net
      loss
      per share amounts have 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, 2007 and 2006, excluded the potential common
      stock equivalents, as the effect would be anti-dilutive.





***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' Equity.





***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 6.759 and 7.377 Swedish Krona to one U.S. Dollar for the year ended December
      31, 2007 and 2006, respectively. The weighted average exchange rate for the
      consolidated Balance Sheets was 6.4675 and 6.8725 Swedish Krona to one U.S.
      Dollar as of December 31, 2007 and 2006, respectively.




41




***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.





***Effects
      of Recent 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 FASB issued 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. We do not believe that the adoption of SFAS
      141R will have material impact on our consolidated results of operations and
      financial condition.





In
      September 2006, the FASB issued SFAS 157, *Fair
      Value Measurements* .
      The
      standard provides guidance for using fair value to measure assets and
      liabilities. SFAS 157 clarifies the principle that fair value should be
      based on the assumptions market participants would use when pricing an asset
      or
      liability and establishes a fair value hierarchy that prioritizes the
      information used to develop those assumptions. Under the standard, fair value
      measurements would be separately disclosed by level within the fair value
      hierarchy. The statement is effective for us beginning in fiscal year 2009.
      In
      February 2008, the FASB issued FASB Staff Position (FSP) SFAS 157-2, *Effective
      Date of FASB Statement No. 157* (FSP
      SFAS 157-2) that deferred the effective date of SFAS No. 157 for
      one year for certain nonfinancial assets and nonfinancial liabilities. We have
      not determined the effect, if any, the adoption of this statement will have
      on
      our results of operations or financial position.





In
      February 2007, the FASB issued SFAS 159, *The
      Fair Value Option for Financial Assets and Financial Liabilitie* s-Including
      an Amendment of FASB Statement 115, which is effective for fiscal years
      beginning after November 15, 2007. This statement permits an entity to
      choose to measure many financial instruments and certain other items at fair
      value at specified election dates. Subsequent unrealized gains and losses on
      items for which the fair value has been elected will be reported in earnings.
      We
      are currently evaluating the potential impact of this statement.





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 Company is currently evaluating the
      potential impact of this statement.





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
      and its related interpretations, 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.




42




**3.**  **Inventories**





At
      December 31, 2007 and 2006, inventories consisted of parts, materials and
      finished products as follows (in thousands):


**December
                31,****2007**
            
            **2006**Parts
                and materials
            
            $
            247
            
            $
            -Finished
                products
            
            
            1,243
            
            
            -Finished
                goods held at Balda
            
            
            5,120
            
            
            -Total
                inventories
            
            $
            6,610
            
            $
            -





Parts
      and
      materials consist of components purchased by us in order to reduce the
      production lead time of our products. Finished products consist of N1 phones
      and
      accessories located at our 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.





During
      2006 we took write-down charges of $565,000 related to components and spare
      parts of the N1 phones. In 2006 management made a decision to stop further
      production of the N1 phone and deemed the component and spare parts inventories
      not to be of any use in the coming production of the N2 mobile
      phone.





**4.**  **Prepaid
      Expenses**





Prepaid
      expenses consist of the following (in thousands):


**December
                31,****2007**
            
            **2006**Prepayment
                to supplier
            
            $
            -
            
            $
            350Deferred
                financing fees
            
            
            819
            
            
            149Prepaid
                rent
            
            
            87
            
            
            83Prepaid
                interest
            
            
            70
            
            
            -Prepaid
                insurance
            
            
            16
            
            
            -Other
            
            
            89
            
            
            39Total
                prepaid expenses
            
            $
            1,081
            
            $
            621





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





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





**5.**  **Other
      Current Assets**





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


**December31,****2007**
            
            **2006**Value
                added tax receivable
            
            $
            -
            
            $
            116Receivable
                from Balda for components
            
            
            648
            
            
            1Other
            
            
            2
            
            
            -Total
                other current assets
            
            $
            650
            
            $
            117




43




**6.**  **Machinery
      and Equipment**





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


**December
                31,****2007**
            
            **2006**Tooling
            
            $
            341
            
            $
            -Furniture
                and equipment
            
            
            102
            
            
            31Computers
            
            
            228
            
            
            93less
                accumulated depreciation
            
            
            (296
            )
            
            (59
            )Machinery
                and equipment, net
            
            $
            375
            
            $
            65Depreciation
                expense
            
            $
            231
            
            $
            29





**7.**  **Intangible
      Assets**





Intangible
      assets consist of the following (in thousands):


**December
                31,****2007**
            
            **2006**Patents
            
            $
            349
            
            $
            328less
                accumulated amortization
            
            
            (254
            )
            
            (173
            )Patents,
                net
            
            $
            95
            
            $
            155Amortization
                expense
            
            $
            67
            
            $
            61





We
      have
      not recorded any further investment in our patents since 2004. The change in
      the
      carrying value of intangibles is due to balance sheet currency fluctuations
      between the U.S. Dollar and the Swedish krona (SEK), since the patents are
      held
      by the Swedish subsidiary with a functional currency in SEK. The amortization
      of
      patents for future years, 2008 and 2009 is estimated at approximately $71,000,
      and $24,000, respectively.





**8.**  **Accrued
      Expenses**





Accrued
      expenses consist of the following (in thousands):


**December
                31,****2007**
            
            **2006**Legal
                settlement
            
            $
            -
            
            $
            291Earned
                salary, vacation and benefits
            
            
            359
            
            
            164Accrued
                pension premiums
            
            
            233
            
            
            21Accrued
                Interest expense
            
            
            106
            
            
            161Accrued
                legal, audit and consulting fees
            
            
            425
            
            
            255Other
                costs
            
            
            268
            
            
            1Total
                accrued expenses
            
            $
            1,391
            
            $
            893





For
      a
      description of the legal settlement see note 18.




44




**9.**  **Other
      Liabilities**





Other
      liabilities consist of the following (in thousands):


**December
                31,****2007**
            
            **2006**VAT
                payable
            
            $
            187
            
            $
            -Customer
                pre-payments
            
            
            -
            
            
            145Warranty
                reserve
            
            
            92
            
            
            -Employee
                withholding taxes
            
            
            111
            
            
            65Social
                security fees
            
            
            160
            
            
            52Accrued
                liability to suppliers
            
            
            120
            
            
            -Other
            
            
            4
            
            
            51Total
                other liabilities
            
            $
            674
            
            $
            313




**10.**  **Deferred
      Revenue**





We
      may
      allow, from time to time, certain distributors price protection and pricing
      adjustments subsequent to the initial product shipment. Since we only recently
      began shipping products, any future price concessions are difficult to reliably
      estimate. Therefore, we defer recognition of revenue (in the balance sheet
      line
      item “deferred revenue”) derived from sales to these customers until they have
      resold our products to their customers or the price protection period ends.
      Although revenue recognition and related cost of sales are deferred, we record
      an accounts receivable at the time of initial product shipment. As standard
      terms are generally FOB shipping point, payment terms are enforced from shipment
      date and legal title and risk of inventory loss passes to the distributor upon
      shipment. In addition, where revenue is deferred upon shipment and recognized
      on
      a sell-through basis, we may offer price adjustments to our distributors to
      allow the distributor to price our products competitively for specific resale
      opportunities. As of December 31, 2007, we have $3.0 million of deferred revenue
      that will be recognized as our customers sell our products and the applicable
      price protection ends.





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





**December
                31,****2007**
            
            **2006**Liability
                for warrants to purchase common stock
            
            $
            5,971
            
            $
            -Embedded
                derivative of convertible debt
            
            $
            3,536
            
            $
            124





**12.**  **Convertible
      Debt and Notes Payable**





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





**December
                31,****2007**
            
            **2006**Senior
                Convertible Secured Notes August (face value $2,800)
            
            $
            2,634
            
            $
            -Pre-merger
                Convertible Secured Notes (face value $5,000)
            
            
            -
            
            
            5,000Senior
                Convertible Secured Notes September (face value $3,085)
            
            
            1,112
            
            
            -Pre-merger
                Convertible Loan - Petrus Holding SA
            
            
            -
            
            
            780Loan
                - Almi Företagspartner 2
            
            
            120
            
            
            201Pre-merger
                Convertible Loan - Almi Företagspartner 1
            
            
            -
            
            
            94Capital
                lease
            
            
            72
            
            
            5Total
                fair value of notes outstanding
            
            
            3,938
            
            
            6,080Unamortized
                debt discount
            
            
            3,746
            
            
            114Total
                debt, net of debt discount
            
            
            192
            
            
            5,966Less:
                short-term portion of long-term debt
            
            
            132
            
            
            5,112Long-term
                debt
            
            $
            60
            
            $
            854




45





Future
      maturities of notes payable (in thousands):





Year
                ended December 31,
            
            Future
                Maturity of Notes Payable2008
            
            $
            2,8952009
            
            
            242010
            
            
            3,085Thereafter
            
            
            -Total
                principal payments
            
            $
            6,004








The
      short-term portion of the unamortized debt discounts amounts to $2.6
      million. ******





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


Year
                ending December 31:
            
            Future
                minimum payments on capital leases2008
            
            $
            442009
            
            
            37Total
                minimum lease payments
            
            $
            81Less:
                Amount representing interest
            
            
            (9
            )Present
                value of net minimum lease payments
            
            $
            72





***Pre-Merger
      Notes***





*Convertible
      Loan Agreement - Petrus Holding SA (Petrus)*





On
      December 22, 2004, Neonode AB entered into a Loan agreement with Petrus, a
      company incorporated under the laws of Luxemburg. The funds under this loan
      agreement were received in January 2005. In this loan arrangement, Petrus
      granted a loan denominated in Swedish krona (SEK) amounting to SEK 5,000,000,
      or
      approximately $758,000 U.S. Dollars, to Neonode AB at an interest rate of 5%
      per
      annum. The loan shall be repaid no later than December 22, 2009. The Petrus
      loan
      is subordinated in right of payment to all indebtedness of Neonode to Almi
      Företagspartner Stockholm AB.





*Convertible
      Loan Agreements - ALMI Företagspartner Stockholm AB (Almi)*





*Almi
      1*




46




On
      April
      29, 2004, Neonode AB entered into a loan agreement with Almi in the initial
      amount of SEK 1,000,000, or approximately $136,000 U.S. Dollars, with the
      following principle conditions. The credit period for the loan is expected
      to be
      44 months starting April 29, 2004 with an annualized interest rate of 9.75%.
      Neonode was not required to make any repayments of principle for the first
      14
      months, after which the loan should be repaid with quarterly principle payments
      of SEK 91,000. or approximately $12,400 U.S. Dollars. We have the right to
      redeem the loan at any time prior to expiration subject to a prepayment penalty
      of $14,000. A floating charge (chattel mortgage) of SEK 1,000,000, or
      approximately $136,000 U.S. Dollars, is pledged as security.





*Almi
      2*





On
      April
      6, 2005, Neonode AB entered into a second loan agreement with Almi in the amount
      of SEK 2,000,000, or approximately $257,000 U.S. Dollars, with 40,000 detachable
      warrants in Neonode AB (corresponding to 72,000 warrants when converted into
      Neonode Inc. shares). The loan has an expected credit period of 48 months with
      an annualized interest rate of 2%. We were not required to make any repayments
      of principle for the first nine months. Quarterly repayments of principle
      thereafter amounted to SEK 154,000, or approximately $19,800 U.S. Dollars.
      We
      have 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 principle
      amount over the remaining term of the loan. A floating charge (chattel mortgage)
      of SEK 2,000,000, or approximately $257,000 U.S. Dollars, is pledged as
      security.





The
      warrants have a term of five years with a strike price of $10.00. The warrants
      may be called by us for $0.10 should the price of the Company's common stock
      trade over $12.50 on a public exchange for 20 consecutive days. The warrants
      were analyzed under EITF 00-19, *Accounting
      for Derivative Financial Instruments Indexed to, and Potentially Settled in,
      a
      Company’s Own Stock* ,
      and
      were determined to be equity instruments. In accordance with APB 14, 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 without the warrants 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 Black-Scholes option pricing model were a term of
      five
      years, volatility of 30% and interest rate of 4.50%.The aggregate debt discount
      amounted to $42,000 and was amortized over the expected term of the loan
      agreement.





*Convertible
      Senior Secured Notes*





On
      February 28, 2006, we commenced borrowing from a new group of investors (AIGH).
      The senior secured notes issued under the note purchase agreement bear interest
      at 4% and have a maturity date of August 28, 2007. At December 31, 2006, we
      had
      drawn down $5.0 million ($4.0 million in February 2006 and an additional $1.0
      million in November 2006) out of the total amount of $5.5 million available.
      The
      senior secured notes were collateralized by the common stock shares of Neonode
      AB and are subordinated in right of payment to all indebtedness of Neonode
      AB to
      Almi. In addition, our Board of Directors Chairman and two founders, Per
      Bystedt, Thomas Ericsson and Magnus Goertz pledged their beneficial holdings
      in
      Neonode Inc. as collateral for the senior secured notes. The senior secured
      notes were convertible under three scenarios:





(i)
      In
      the event of a successful initial public offering on or before August 28, 2007,
      the Convertible Senior Secured Notes, including without limitation all accrued
      interest and other obligations under the notes, shall automatically convert
      without any action of the holder into units in the Company at a price of $5
      per
      unit, each unit consisting of one share of Company common stock and 0.5
      five-year warrant, each exercisable to purchase one share at $10 per share.
      These warrants may be called by us for $0.10 should the price of the Company’s
      common stock trade over $12.50 on a public exchange for 20 consecutive
      days.




(ii)
      The
      Convertible Senior Secured Notes may be prepaid without premium or penalty,
      in
      whole or in part, on 20 days notice; provided that the bridge note investors
      shall have the opportunity, prior to such prepayment, to convert the amounts
      borrowed under the bridge notes into common stock of the Company at a ratio
      equal to the outstanding debt and interest divided by $5.





(iii)
      In
      the event that we fail to complete a registered public offering with gross
      proceeds in excess of $5,500,000 by August 28, 2007, the Convertible Senior
      Secured Notes shall be converted into common stock of the Company at a price
      per
      share equal to the fair market value of such shares as determined by
      negotiation. The number of shares to be issued as a result of such a negotiation
      cannot be less than the amounts borrowed including accrued interest under the
      bridge notes divided by $5.




*Derivatives*




47




The
      senior secured notes issued on February 28, 2006 and November 20, 2006 contained
      an embedded derivative instrument (conversion feature) with three triggers.
      Pursuant to SFAS 133 and EITF 00-19, this conversion feature was considered
      an
      embedded derivative requiring bifurcation from the debt host, and is included
      in
“Embedded derivates of convertible debt” at fair value each reporting period.
      This was because there were an indeterminable number of shares the senior
      secured notes could convert into, and the embedded conversion feature met a
      definition of a derivative. If the feature was freestanding, it would meet
      the
      definition of a liability. Accordingly, bifurcation was required from the debt
      host instrument. At the time of issuance of the $4.0 million senior secured
      notes on February 28, 2006, the fair value of the conversion feature was
      $125,000, which was recorded as a debt discount and amortized to interest
      expense over the expected term of the senior secured notes. An additional
      $24,000 was added to the fair value of the conversion feature on November 20,
      2006 upon issuance of an additional $1.0 million in senior secured notes.
      Changes in the fair value of the conversion feature are recorded in “Non-cash
      charges for conversion features and warrants.” During 2006, we recorded $72,000
      of interest expense associated with the amortization of the debt discount along
      with a reduction of $25,000 associated with the changes in the fair value of
      the
      conversion feature liability.





*Debt
      Modifications*





In
      March
      2006 the Almi 1 loan with an outstanding balance of SEK 646,000, approximately
      $83,000 U.S. Dollars, was amended to provide for conversion rights as defined
      in
      the provisions for the senior secured notes as described in (i) above under
      the
      Convertible Senior Secured Notes and a waiver of further principle payments
      until the conversion date. In addition, the Almi 2 loan was amended to state
      that in the event the related 40,000 warrants are called by Neonode Inc., Almi
      is entitled to make payment for the securities issued by reducing the par value
      of the outstanding balance of the Almi 2 loan. For accounting purposes, the
      change in terms was accounted for as a modification of the Almi 1 loan.





On
      October 26, 2006 the Petrus loan agreement was amended to include accrued
      interest to May 31, 2006 in the loan amount, which increased the loan amount
      to
      SEK 5,353,000, approximately $758,000 U.S. Dollars, and instated the same
      conversion rights as the senior secured notes as defined under scenario (i)
      above. For accounting purposes, the change in terms was accounted for as a
      modification.





***Additional
      Issuances of Convertible Senior Secured Notes***





In
      February 2007, we completed an additional $5.0 million convertible senior
      secured note financing. The note bears interest at 4% per annum and has a
      maturity date of September 30, 2007. The terms and conditions of these notes
      are
      substantially the same as for the existing senior secured notes, as amended
      on
      January 19, 2007. Pursuant to SFAS 133 and EITF 00-19, the conversion feature
      valued at $135,000 was considered an embedded derivative requiring bifurcation
      from the debt host, and is included in “Embedded derivatives of convertible
      debt” at fair value each reporting period. Prior to the consummation of the
      merger, the related debt discount was amortized to interest expense and the
      loan
      was converted on August 10, 2007.





On
      May
      18, 2007, the maturity date for all outstanding senior secured notes was
      extended from September 30, 2007 to December 31, 2007. All other terms remained
      the same. For accounting purposes, the change in terms was accounted for as
      a
      modification of the debt in accordance with EITF 96-19.





On
      June
      15, 2007, we completed an additional $3.0 million convertible senior secured
      note financing. The note bears interest at 4% per annum and has a maturity
      date
      of December 31, 2007. The terms and conditions of these notes are substantially
      the same terms and conditions as the existing senior secured notes. Pursuant
      to
      SFAS 133 and EITF 00-19, this conversion feature amounting to $114,000 was
      considered an embedded derivative requiring bifurcation from the debt host,
      and
      is included in “Embedded derivatives of convertible debt” at fair value each
      reporting period. The debt discount was amortized to interest expense. Prior
      to
      the consummation of the merger, the loan was converted on August 10,
      2007.





***Conversion
      of Outstanding Pre-Merger Convertible Debt***





On
      August
      10, 2007, just prior to the consummation of the reverse merger, all the above
      convertible debt and accrued interest were converted to 2,858,574 shares of
      Neonode Inc. common stock and warrants to purchase 1,429,286 shares of Neonode
      Inc. common stock. Immediately prior to the conversion of the pre-merger
      convertible debt, the embedded conversion feature of such convertible debt
      became much more valuable, due to the fact that a reverse merger with SBE was
      imminent.




48




Immediately
      prior to the conversion, we determined the
      fair
      value of the embedded conversion feature of these notes and loans to be $35.6
      million, using SBE’s share price as of August 10, 2007. The expense associated
      with the valuation of the embedded conversion feature was the result of the
      fixed exchange ratio of pre-merger Neonode common stock to that of SBE common
      stock. The change in the fair value of the loan conversion feature was recorded
      as a non-cash valuation charge in the
      statement of operations. We then compared
      the total value of the common stock and warrants to be issued upon conversion
      to
      the book value of the loans and the updated fair value of the related conversion
      feature, resulting in a non-cash charge of $376,000. The fair value of the
      common stock issued upon conversion amounted to $49.5 million and was recorded
      under stockholders equity. The fair value of the detachable warrants issued
      upon
      conversion amounted to $404,000, which was computed using the Black-Scholes
      option pricing model. The warrants were classified as a liability in accordance
      in EITF 00-19, as the warrants met the liability classification due to the
      underlying shares required to be registered and maintained effectiveness without
      any penalties to the Company. Maintaining effectiveness is not within our control, and accordingly, the
      warrants were classified as a liability. The assumptions used for the
      Black-Scholes option pricing model were a term of five years, volatility of
      116%
      and interest rate of 4.20%. For the
      twelve months ending December 31, 2007, non-cash charges amounting $32.1 million
      were recorded to the statement of operations relating the changes in valuations
      of the above conversion feature.





The
      conversion of the notes were accounted for using extinguishment accounting
      based
      on the guidance in APB 26, *Early
      Extinguishment of Debt.* To
      account for the conversion of the senior secured notes when an embedded
      conversion feature has been bifurcated as a liability, the following steps
      were
      taken:


·
            Update
                the valuation of the bifurcated derivative to the legal conversion
                date
                (August 10, 2007).


·
            Adjust
                the carrying value of the host debt instrument to reflect accretion
                of any
                premium or discount on the host debt instrument up to the date of
                legal
                conversion (August 10, 2007).


·
            Amortize
                debt issue costs to the date of legal conversion (August 10,
                2007).


·
            Ensure
                that the book basis in the host debt instrument considered all components
                of book value, including the unamortized portion of any premiums
                or
                discounts on the debt host recorded as an adjustment to the debt
                host and
                any unamortized debt issue costs recorded as deferred charges.


·
            Calculate
                the difference between the re-acquisition price and net carrying
                amount of
                the debt by comparing the fair value of the securities (warrants
                and
                common stock) issued upon conversion to the updated net carrying
                value of
                the sum of the bifurcated embedded derivative liability and the debt
                host.
                Record any difference as an extinguishment gain or loss in the income
                statement and statement of cash
                flows.





The
      extinguishment accounting of the conversion of the senior secured notes resulted
      in a charge totaling $376,000, which is included “Charges related debt
      extinguishments and debt discounts.”





The
      securities issued in the merger have not been registered under the Securities
      Act of 1933 and may not be offered or sold in the United States absent
      registration or an applicable exemption from registration requirements.





On
      August
      10, 2007, in conjunction with the reverse merger with SBE accounted for as
      a
      recapitalization, all the pre-merger Neonode Inc. common stock and warrants
      was
      exchanged into 10,096,197 shares of our (SBE) common stock and warrants to
      purchase 5,048,095 shares of our (SBE) common stock. The warrants have an
      exercise price of $2.83 per share and expire on August 10, 2012. The warrants
      may be called by us for $0.10 should the price of the Company's common stock
      trade over $3.54 on a public exchange for 20 consecutive days.





***Senior
      Convertible 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 August 1, 2007 and September 26, 2007. We received $3,250,000 from
      the
      Bridge Note offering and issued an option to invest $750,000, at the same terms
      and conditions as the Bridge Notes, to one of the Bridge Note
      investors/financial advisor as part of a longer range financing plan. The August
      Bridge Notes and the option to invest $750,000 expires on June 30,
      2008.





The
      fair
      value of the $750,000 option to invest at a future date was $716,000 as
      calculated using the Black-Scholes option pricing model on the date of issue.
      The assumptions used for the Black-Scholes option pricing model were a term
      of
      0.39 years, volatility of 99% and interest rate of 4.16%. The fair value 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. At December 31, 2007, this
      option was extended to March 31, 2008 as part of debt negotiations in a private
      placement that closed in March 2008. On March, 31, 2008, the expiration of
      the
      option was extended until June 30, 2008. The value of the extension of this
      option was calculated using the Black-Scholes option pricing model and amounted
      to $474,000. The assumptions used for the Black-Scholes option pricing model
      were a term of 0.39 years, volatility of 33% and interest rate of 4.16%. The
      $474,000 warrants were recorded as a liability with the corresponding amount
      recorded as a deferred financing fee, which is being amortized using the
      effective interest method over the life of the August Bridge Notes. Such
      warrants met the liability classification—see below.




49




The
      Bridge Notes were convertible into the same rights and terms of any future
      financing occurring by December 31, 2007, if such financing was greater than
      $5
      million. On September 26, 2007, we sold $5.7 million of securities (see next
      section). As a result, all Bridge Notes became convertible into September 26,
      2007 units which consist of common stock, warrants and convertible debt.





On
      September 26, 2007, certain holders of the Bridge Notes converted an aggregate
      of $454,900 of debt and accrued interest. The conversion was accounted for
      as an
      extinguishment as described above and resulted in a charge amounting to
      $608,000. We converted these Bridge Notes into the following components based
      on
      their fair values at conversion:


·
            $227,450
                three-year promissory notes bearing the higher of LIBOR plus 3% or
                8%
                interest per annum, convertible into shares of our common stock at
                a
                conversion price of $3.50 per share,


·
            75,817
                shares of our common stock,


·
            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 assumptions used
                for the
                Black-Scholes option pricing model were a term of 5 years, volatility
                of
                33% and interest rate of 4.2%. The warrants are recorded as other
                current
                liability ( see below) and will be fair valued at each period end
                as long
                as they are outstanding; and,


·
            The
                fair value of the embedded conversion feature related to the convertible
                notes amounting to $152,000, was bifurcated from the host instrument
                (see
                below) and was recorded as “Embedded derivatives of convertible debt” and
                a debt discount.





We
      registered these shares related to the September 26, 2007 conversion pursuant
      to
      a Registration Statement on Form S-3 declared effective on December 3,
      2007.





The
      remaining $2.8 million of Bridge Notes, after the September 26, 2007 conversion,
      are due June 30, 2008, bear 8% per annum interest and are convertible into
      purchase units that are made up of a combination of shares of our common stock,
      debt and warrants. The note holders have a right to convert their notes anytime
      before June 30, 2008 into a total of 933.33 purchase units. Each purchase unit
      of $3,000 is comprised of one $1,500 three-year promissory note bearing the
      higher of LIBOR plus 3% or 8% 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 $3.92 per share. For accounting purposes the embedded conversion
      feature was determined to meet the definition of a derivative, and if
      freestanding, was a 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, total number of shares the instrument could be
      convertible into were not fixed. Accordingly, the embedded conversion feature
      is
      bifurcated from the debt host instrument and booked as a liability, pursuant
      to
      the guidance in SFAS 133 and EITF 00-19, with the offset to debt discount.
      The
      related warrants were also recorded as a liability, due to the same reason.





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 for the Black-Scholes option
      pricing model were a term of 0.76 years, volatility of 99% and interest rate
      of
      4.16%. The $3.3 million was recorded as “Embedded derivatives of convertible
      debt” and a debt discount. The debt discount exceeded the amount of recorded
      debt, which resulted in a charge of $654,000 for the difference between the
      debt
      discount and the value of the debt. The remaining debt discount balance is
      allocated to interest expense based on the effective interest rate method,
      with
      such interest rate of 7,330%, over the nine-month term of the notes. 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 charges for
      conversion features & warrants.” The liability of the embedded conversion
      feature amounted to $2.1 million at December 31, 2007 which is a decrease of
      $1.2 million from September 30, 2007.





Simultaneously
      with the conversion, in exchange for three year warrants to purchase up to
      219,074 shares of our common stock at a price of $3.92 per share, the holders
      of
      the remaining $2.8 million of unconverted Bridge Notes agreed to extend the
      term
      of their notes from December 31, 2007 until June 30, 2008. In addition, the
      Bridge Note holders agreed to delay the right to convert their Bridge Notes
      until after March 15, 2008 and until June 30, 2008. The fair value of the
      warrants issued to the holders of the $2.8 million of Bridge Note was calculated
      at September 26, 2007 as $706,000 using the Black-Scholes option pricing model.
      These warrants were also classified as a liability due to the same reason as
      above. The assumptions used for the Black-Scholes option pricing model were
      a
      term of 0.76 years, volatility of 116% and interest rate of 4.16%. As a result
      of the extension of the loan maturity period, the agreement to delay conversion
      of the bridge notes and the issuance of additional warrants, the modifications
      were significant enough to trigger debt extinguishment accounting resulting
      in a
      debt extinguishment charge amounting to $540,000.The fair value was recorded
      as
      a debt issuance cost to be 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. The liability is revalued at each period-end and the
      change in the liability is recorded as “Non-cash charges for conversion features
& warrants.” The revalued liability amounted to $608,000 at December 31,
      2007 resulting in an decrease from September 30, 2007 in “Non-cash charges for
      conversion features & warrants” of $98,000 in the fourth quarter of 2007.




50




***September
      2007 Financing Transaction*** **(Senior
      Convertible September Secured Notes)**





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 higher
      of
      LIBOR plus 3% or 8% 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.





The
      embedded conversion feature in the debt host met the definition of a derivative
      and liability classification in accordance with SFAS 133 and EITF 00-19. This
      was because the holder of the notes could convertible debt and accrued interest,
      where interest is at the greater of 8% or LIBOR plus 3%, and therefore, total
      number of shares the instrument could be convertible into were not fixed.
      Accordingly, t the embedded conversion features are revalued on each balance
      sheet date and marked to market with the adjusting entry to “Non-cash charges
      for conversion features & warrants.” 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.





The
      warrants met the definition of a liability for the same reason as the embedded
      conversion feature described above. 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 issue date and was recorded as a liability pursuant
      to the provisions of EITF No. 00-19 *.* The
      fair
      value of the warrants was calculated using the Black-Scholes option pricing
      model. The assumptions used for the Black-Scholes option pricing model were
      a
      term of 5 years, volatility of 33% and interest rate of 4.2%. The value of
      these
      warrants at December 31, 2007 decreased to $3.7 million and the offsetting
      amount of $593,000 was recorded in “Non-cash charges for conversion features
& warrants.”





The
      fair
      value of the conversion feature related to the September 26, 2007 convertible
      notes totaled $1.9 million at September 26, 2007. The debt discount exceeded
      the
      amount allocated to the debt, including $227,000 from conversion of Bridge
      Notes, which resulted in a charge of $902,000 for the difference between the
      debt discount and the value of the debt. The fair value was recorded as a debt
      discount and is allocated to interest expense using the effective interest
      rate
      method over the three year term of the notes. The liability of the embedded
      conversion feature decreased to $1.4 million at December 31, 2007 with the
      offset of $470,000 recorded in “Non-cash charges for conversion features and
      warrants.”





As
      part
      of the September 2007 Private Placement, we incurred cash and non-cash
      transaction expenses amounting to $1.2 million. Empire Asset Management Company
      (Empire) acted as financial advisor in the private placement. We agreed to
      pay
      Empire a fee of $479,000 in cash and issue 142.875 unit purchase warrants.
      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 LIBOR plus 3% or 8% 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 5 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. The assumptions used for the Black-Scholes option pricing
      model were a term of 5 years, volatility of 99% and interest rate of 4.2%.
      At
      December 31, 2007, the fair value of the unit purchase warrants issued to Empire
      decreased to $509,000 with the adjusting offset of $105,000 recorded in
“Non-cash charges for conversion features & warrants.” Transaction costs
      were allocated based on the relative fair values of the individual components
      in
      the financing transaction. $431,000 of transaction costs allocated to the
      warrants were expensed immediately. The note portion of $433,000 was recorded
      as
      a deferred financing fee to be allocated to interest expense using the effective
      interest rate method, with such rate equaling 624% over the 3 year term of
      the
      notes. The equity portion of $376,000 was recorded as an offering expense and
      included as a reduction of shareholders’ equity.





**Outstanding
                Warrants as of December 31, 2007****Description**
            
            **Issue
                Date**
            
            **Exercise
                Price**
            
            **Shares**
            
            **Expiration
                Date**Merger
                Investor Warrants
            
            
            8/10/2007
            
            $
            2.83
            
            
            5,863,678
            
            
            8/10/2012Bridge
                Note Warrants
            
            
            9/26/2007
            
            $
            3.92
            
            
            219,073
            
            
            9/26/2010September
                2007 Unit Warrants
            
            
            9/26/2007
            
            $
            3.92
            
            
            1,432,449
            
            
            9/27/2012SBE
                Investor Warrants (pre-merger warrants)
            
            
            6/27/2003
            
            $
            7.50
            
            
            11,000
            
            
            6/27/2008SBE
                Investor Warrants (pre-merger warrants)
            
            
            6/27/2003
            
            $
            8.75
            
            
            5,000
            
            
            6/27/2008SBE
                Investor Warrants (pre-merger warrants)
            
            
            6/27/2003
            
            $
            10.00
            
            
            10,000
            
            
            6/27/2008SBE
                Investor Warrants (pre-merger warrants)
            
            
            7/26/2005
            
            $
            16.65
            
            
            206,000
            
            
            7/26/2010Total
                warrants outstanding
            
            
            
            
            
            
            
            
            **7,747,200**




51




***Derivatives***





As
      discussed above the senior secured, bridge and promissory notes issued above
      contain embedded conversion features. Pursuant to SFAS 133 and EITF 00-19 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 & warrants.” During the twelve months ending December 31, 2007 and
      2006, we recorded $441,000 and $71,000 of interest expense associated with
      the
      amortization of the debt discounts along with $33.6 million and ($24,000)
      associated with the changes in the fair value of the conversion feature
      liability.





**13.**  **Stockholders’
      Equity**





On
      January 8, 2007, we engaged Griffin Securities, Inc. (Griffin) to act as our
      financial advisor. Under the terms of the agreement, upon the completion of
      a
      merger transaction, we agreed to pay a fee of $250,000 in cash and issue 229,573
      unit purchase warrants to Griffin. Each unit purchase warrant is convertible
      into one share of our common stock at a purchase price of $1.42 per share and
      a
      warrant to purchase one-half share of our common stock at a purchase price
      of
      $2.83 per share. We amended the Griffin agreement to allow the unit purchase
      warrants to be granted subsequent to May 18, 2007. The unit purchase warrants
      were issued to Griffin on June 29, 2007.





The
      fair
      value of the unit purchase warrants issued to Griffin totals $158,000 and was
      calculated using the Black-Scholes option pricing model. The assumptions used
      for the Black-Scholes option pricing model were a term of 5 years, volatility
      of
      50% and interest rate of 4.875%. The fair value was recorded as a prepaid
      expense and was allocated to merger costs at the completion of the merger and
      is
      included in “Non-cash charges for conversion features & warrants” on the
      Consolidated Statements of Operations.





On
      June
      29, 2007, the exercise deadline for 101,719 employee warrants to purchase our
      common stock was extended from June 30, 2007 to December 31, 2007. In December
      2007, the employee warrants were exercised pursuant to the warrant net exercise
      provisions and resulted in the issuance of 55,818 shares of our common stock
      by
      forfeiting the remaining 45,901 shares of common stock.





The
      stock
      based compensation cost associated with the extension of these warrants totalled
      $7,000 and was calculated using the Black-Scholes option pricing model. The
      assumptions used for the Black-Scholes option pricing model were a term of
      0.51
      years, volatility of 50% and interest rate of 4.88%.





On
      August
      10, 2007 in conjunction with the merger transaction accounted for as a
      recapitalization, Neonode shareholders exchanged each share of Neonode common
      stock for 3.5319 shares of SBE common stock (exchange ratio). Each Neonode
      warrant and stock option that was outstanding on the closing date has been
      converted into SBE warrants and stock options by multiplying the Neonode stock
      options by the same exchange ratio described above. The new exercise price
      was
      also determined by dividing the old exercise price by the same exchange ratio.
      Each of these warrants and options is subject to the same terms and conditions
      that were in effect for the related Neonode warrants and options. Immediately
      following the consummation of the merger, Neonode stockholders and employees
      own
      approximately 28.5 million shares of the Company’s common stock or
      instruments convertible into common stock, or 90.6% of the fully diluted
      capitalization, including warrants and options, of the combined company.




52




The
      following table is the number of shares of common stock, warrants and stock
      options outstanding immediately following the consummation of the merger.





**As
                of August 10, 2007**
            
            **SBE**
            
            **Neonode**
            
            **Total**Common
                Stock
            
            
            2,295,529
            
            
            20,378,251
            
            
            22,673,780Warrants
                to purchase common stock
            
            
            232,000
            
            
            5,965,397
            
            
            6,197,397Employee
                stock options
            
            
            437,808
            
            
            2,117,332
            
            
            2,555,140Total
            
            
            2,965,337
            
            
            28,460,980
            
            
            31,426,317




The
      securities issued in the merger have not been registered under the Securities
      Act of 1933, and may not be offered or sold in the United States absent
      registration or an applicable exemption from registration
      requirements.





We
      completed a private placement of our debt and equity securities on September
      26,
      2007 and in consideration, we agreed to delay the filing a registration
      statement to register for resale the shares of the common stock issued to the
      Neonode shareholders plus all the shares underlying the warrants to purchase
      common stock and employee stock options until after March 3, 2008; except that
      up to 600,000 such shares sold in a simultaneous private placement by certain
      officers were registered on December 3, 2007.





**14.**  **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, 2007, we had four equity incentive plans:


·
            The1996
                Stock Option Plan (the 1996 Plan), which expired in January 2006;


·
            The
                1998 Non-Officer Stock Option Plan (the 1998 Plan);


·
            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,
      2007:


·
            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, 2007:





Plan
            
            Shares
              Reserved
            
            Options
              Outstanding
            
            Available
              for
                Issue
            
            Outstanding
              Options
                Vested1996
                Plan
            
            
            546,000
            
            
            61,000
            
            
            ---
            
            
            61,0001998
                Plan
            
            
            130,000
            
            
            35,900
            
            
            36,495
            
            
            35,900Neonode
                Plan
            
            
            2,119,140
            
            
            2,117,332
            
            
            ---
            
            
            2,117,3322006
                Plan
            
            
            1,300,000
            
            
            205,000
            
            
            835,000
            
            
            5,000Director
                Plan
            
            
            68,000
            
            
            15,500
            
            
            27,000
            
            
            15,500Total
            
            
            4,163,140
            
            
            2,434,732
            
            
            898,495
            
            
            2,234,732





53





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 ExercisePrice
            
            Number
                Outstanding at12/31/07
            
            Weighted
                Average Remaining Contractual Life(years)
            
            Weighted
                AverageExercise
                Price
            
            Number
                Exercisable at12/31/07
            
            Weighted
                AverageExercise
                Price$
                0.00 -$
                1.50
            
            
            353,190
            
            
            4.05
            
            $
            1.42
            
            
            353,190
            
            $
            1.42$
                1.51 -$
                2.00
            
            
            911,677
            
            
            0.30
            
            $
            1.84
            
            
            911,677
            
            $
            1.84$
                2.01 -$
                3.00
            
            
            814,865
            
            
            1.29
            
            $
            2.13
            
            
            814,865
            
            $
            2.13$
                3.01 -$
                4.00
            
            
            2,000
            
            
            4.26
            
            $
            4.00
            
            
            2,000
            
            $
            4.00$
                4.01 -$
                5.00
            
            
            240,600
            
            
            5.82
            
            $
            4.86
            
            
            40,600
            
            $
            4.69$
                5.01 - $ 6.50
            
            
            3,400
            
            
            4.13
            
            $
            5.30
            
            
            3,400
            
            $
            5.30$
                6.51 - $ 8.00
            
            
            37,502
            
            
            4.61
            
            $
            6.74
            
            
            37,502
            
            $
            6.74$
                8.01 - $10.00
            
            
            37,498
            
            
            4.61
            
            $
            8.49
            
            
            37,498
            
            $
            8.49$10.01
                - $15.00
            
            
            24,000
            
            
            4.14
            
            $
            14.53
            
            
            24,000
            
            $
            14.53$15.01
                - $30.00
            
            
            10,000
            
            
            3.26
            
            $
            24.04
            
            
            10,000
            
            $
            24.042,434,732
            
            
            1.91
            
            $
            2.58
            
            
            2,234,732
            
            $
            2.37





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, 2005
            
            
            866,702
            
            $
            3.50
                - $91.88
            
            $
            12.91Granted
            
            
            124,400
            
            $
            1.80
                - $7.75
            
            $
            5.27Cancelled
                or expired
            
            
            (429,912
            )
            $
            4.50
                - $80.94
            
            $
            13.36Exercised
            
            
            (8,533
            )
            $
            4.50
                - $4.50
            
            $
            4.50Outstanding
                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
            
            $
            2.58





The
      stock
      options granted in 2006 were to employees of SBE, Inc. that continued to be
      employees of Neonode after the culmination of the merger transaction on August
      10, 2007.





The
      1996
      Plan terminated effective January 17, 2006 and although we can no longer issue
      stock options out of the plan, 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 and 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”). We will not grant
      any additional equity awards out of the Neonode Plan. 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.




54




We
      granted options to purchase 2,383,482 shares of our common stock to employees
      or
      members of our Board of Directors (Board) during the twelve months ending
      December 31, 2007, respectively, compared to grants of 124,400 options to
      purchase shares of our common stock to employees and members of the Board for
      the twelve months ending December 31, 2006, respectively. 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.





Salary
      expense for the twelve months ending December 31, 2007 includes a stock
      compensation charge relating to the above issuance of Swedish Participant and
      Non-Swedish Participant options. The fair value of the options at the date
      of
      issuance of the Swedish options 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 a share prices ranging from $4.69 to
      $4.78. The fair market value of the options was allocated to the vested and
      unvested options. The amount allocated to the unvested portion is amortized
      on a
      straight line basis over the remaining vesting period.





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,
                2006
            
            Twelve
                months ended December
              31,
                2007
            
            Remaining
                unamortized expense at December 31,2007Stock
                based compensation
            
            $
            0
            
            $
            408
            
            $
            964





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 years ended December 31
            2007
            2006Expected
                life (in years)
            4.27
            5.12Risk-free
                interest rate
            5.55%
            4.71%Volatility
            114.42%
            104.47%Dividend
                yield
            0.00%
            0.00%





The
      weighted average grant-date fair value of options granted during the fiscal
      years ended December 31, 2007 and 2006 was $1.54 and $4.52, respectively. The
      total intrinsic value of options exercised during the fiscal years ended
      December 31, 2007 and 2006 was $42,766 and $16,798, 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.




55




**15.**  **Warranty
      Obligations and Other Guarantees**





The
      following is a summary of our agreements that we have determined are within
      the
      scope of FIN 45, *Guarantor's
      Accounting and Disclosure Requirements for Guarantees, including Indirect
      Guarantees of Indebtedness of Others* -- *an
      interpretation of FASB Statements No. 5, 57 and 107 and rescission of FIN
      34.*





Our
      products are generally warranted against defects for twelve months following
      the
      sale. We generally have a twelve month warranty from the manufacturers of our
      products. Our estimate of costs to service our warranty obligations is based
      on
      expectation of future conditions. To the extent we estimate warranty claim
      activity or increased costs associated with servicing those claims, a warranty
      accrual will be created and may increase or decrease from time to time,
      resulting in increases or decreases in gross margin. In January 2007, we offered
      our customers a design modification for the N2 phones held in their inventory.
      We expect the cost of the modification program to be approximately
      $200,000.





We
      enter
      into indemnification provisions under our agreements with other companies in
      the
      ordinary course of business, typically with business partners, contractors,
      customers and landlords. Under these provisions we generally indemnify and
      hold
      harmless the indemnified party for losses suffered or incurred by the
      indemnified party as a result of our activities or, in some cases, as a result
      of the indemnified party's activities under the agreement. 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, 2007 and 2006, respectively.





We
      have
      agreed to indemnify each of our executive officers and directors for certain
      events or occurrences arising as a result of the officer or director serving
      in
      such capacity. The term of the indemnification period is for the officer's
      or
      director's lifetime. The maximum potential amount of future payments we could
      be
      required to make under these indemnification agreements is unlimited. However,
      we have a directors’ and officers’ liability insurance policy that should enable
      us to recover a portion of future amounts paid. As a result of our insurance
      policy coverage, we believe the estimated fair value of these indemnification
      agreements is minimal and have no liabilities recorded for these agreements
      as
      of December 31, 2007 and 2006, respectively.





We
      are
      the secondary guarantor on the building lease assumed by One Stop Systems,
      Inc.
      as part of the sale of the SBE, Inc hardware business on March 30, 2007. This
      lease commitment expires in September 2010.





**16.**  **Income
      Taxes**





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




**Twelve
                Months Ended Dec. 31,**
            
            **Twelve
                Months Ended Dec. 31,****2007**
            
            **2006**Domestic
            
            $
            (39,608
            )
            $
            (1,359
            )Foreign
            
            
            (8,833
            )
            
            (3,759
            )Total
            
            $
            (48,441
            )
            $
            (5,118
            )





We
      had no
      provision (benefit) for income taxes for the year ended December 31, 2007 and
      2006.





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,****2007**
            
            **2006**Amount
                at standard tax rates
            
            
            (35
            %)
            
            (35
            %)Non-deductible
                loss on revaluation of embedded conversion features and extinguishment
                of
                convertible debt
            
            
            30
            %
            
            0Increase
                in valuation allowance for deferred tax asset
            
            
            5
            %
            
            35
            %Effective
                tax rate
            
            
            0
            %
            
            0
            %





56





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




**December
                31,****2007**
            
            **2006**Deferred
                tax assets:Net
                operating loss carryforwards
            
            $
            5,703
            
            $
            2,850Amortization
            
            
            1,305
            
            
            314Other
            
            
            210
            
            
            -Total
                deferred tax assets
            
            $
            7,218
            
            $
            3,164Valuation
                allowance
            
            
            (7,218
            )
            
            (3,164
            )Total
                net deferred tax assets
            
            $
            -
            
            $
            -





Valuation
      allowances are recorded to offset certain deferred tax assets due to
      management’s uncertainty of realizing the benefits of these items. Management
      applies a full valuation allowance for the accumulated losses of Neonode Inc,
      and its subsidiary Neonode AB, since it is not determinable using the “more
      likely than not” criteria that there will be any future benefit of our deferred
      tax assets. This is mainly due to our history of operating losses and due to
      the
      competitive character of the hand-held media device/mobile telephone market.
      The
      main components of our deferred tax benefits are the accumulated net operating
      loss carry-forwards, which are almost entirely related to the operations of
      Neonode AB in Sweden. Currently, under Swedish tax law these benefits do not
      expire and may be carried forward and utilized indefinitely.





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, 2007 is as follows:





**Balance
                at January 1, 2007**
            
            $
            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, 2007**
            
            $
            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, 2007, 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, 2007, we had no accrued
      interest and penalties related to uncertain tax matters.




57




By
      the
      end of 2007, 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
      1994 through 2007 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.





**17.**  **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, 2007 and 2006 were $237,000 and $26,000
      respectively.





**18.**  **Commitments
      and Contingencies**





***Legal
      Proceedings***





During
      2006, a reserve was recorded for a dispute that developed between us and a
      supplier. Neonode AB contracted with a supplier for the production and delivery
      of telephones during 2005. Neonode AB believes that the supplier did not deliver
      the telephones in accordance with its obligations under the contract, which
      entitled Neonode AB to terminate the contract. Neonode AB terminated the
      contract in June 2006. Since the contract was terminated due to the supplier’s
      breach of contract, we believed that the supplier had no right to payment in
      excess of what had already been paid for telephones delivered. The invoices
      for
      the produced but not delivered telephones amounted to $860,000. We and the
      supplier came to agreement in a settlement in December 2006 where Neonode AB
      should pay the supplier $410,000 in three instalments for three shipments of
      500
      phones each, after which none of the parties will have any claims on the other
      party except for warranty claims. The first instalment of $119,000 was paid
      in
      December 2006, the remainder in 2007. Since we are not certain that any
      telephones received in this settlement will be sellable in the future, due
      to
      newer models currently being introduced, the cost for the settlement has been
      expensed in 2006.





There
      were no legal proceedings at December 31, 2007.





***Operating
      Leases***





We
      lease
      our office facilities in Sweden under a non-cancellable operating lease
      agreement. 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 expires on March 31, 2013. The annual
      payment for these premise equates to approximately $288,000 per year and is
      indexed to the consumer price index in Sweden. As an incentive to enter into
      the
      agreement as one of the firs tenants to occupy the building, the NCC Property
      G
      AB has given Neonode AB discounts amounting to approximately $120,000 allocated
      over the first eight months of the leasing period. Prior to taking occupancy
      of
      this new facility, 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.





The
      future minimum lease payments under this non-cancellable operating lease are
      as
      follows as of December 31, 2007 (in thousands):




**Future**
              **minimum**
              **payments
                on**
              **operating
                leases**Year
                Ending December 31,2008
            
            $
            2072009
            
            
            3172010
            
            
            3172011
            
            
            3172012
            
            
            317Thereafter
            
            
            106Total
                future minimum lease payments
            
            $
            1,581





Total
      rent expense under the leases was $343,000 and $270,000 for the years ended
      December 31, 2007 and 2006, respectively.





**19.**  **Concentration
      of Credit and Business Risks**




58




Our
      trade
      accounts receivable 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 compared to two customers
      who accounted for more than 41% of total accounts receivable at December 31,
      2006. Ongoing credit evaluations of customers' financial condition are performed
      and, generally, no collateral is required.





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. Sales to individual customers in excess of 15% of net sales for the
      year
      ended December 31, 2006 included sales to a major Asian manufacturer located
      in
      Korea of $851,000, or 52% of net sales and sales to a Russian distributor of
      $740,000, or 45% 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.





Substantially
      all of our manufacturing process is subcontracted to one independent company. The
      chipsets used in our mobile phone handset product are currently available from
      single source suppliers. The inability to obtain sufficient key components
      as
      required, or to develop alternative sources if and as required in the future,
      could result in delays or reductions in product shipments or margins that,
      in
      turn, could have a material adverse effect on our business, operating results,
      financial condition and cash flows.





**20.**  **Net
      Loss Per Share**





Basic net loss
      per
      common share for the years ended December 31, 2007 and 2006 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.




However,
      common stock equivalents of approximately 404,000 and 0 stock options and 7.7
      million and 0 warrants to purchase common stock are excluded from the diluted
      earnings per share calculation for fiscal 2007 and 2006, respectively, due
      to
      their anti-dilutive effect.





(in
                thousands, except per share amounts)
            
            **Years
                ended December 31,****2007**
            
            **2006****Basic
                Earnings Per Share:**Net
                loss available to common shareholders
            
            $
            (48,441
            )
            $
            (5,224
            )Number
                of shares for computation of earnings per share
            
            
            15,400
            
            
            10,119Basic
                loss per share
            
            $
            (3.15
            )
            $
            (0.52
            )**Diluted
                Earnings Per Share:**Weighted
                average number of common shares outstanding during the
                year
            
            
            15,400
            
            
            10,119Assumed
                issuance of stock under warrant plus stock issued the employee and
                non-employee stock option plans
            
            
            (a
            )
            
            (a
            )Number
                of shares for computation of earnings per share
            
            
            15,400
            
            
            10,119Diluted
                loss per share
            
            $
            (3.15
            )
            $
            (0.52
            )




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




59




**21.**  **Segment
      Information**





We
      have
      one reportable segment, as defined in SFAS 131, *Disclosures
      about Segments of an Enterprise and Related Information* .
      We
      currently operate in one industry segment: the development and selling of
      multimedia mobile phones. To date, we have carried out substantially all of
      our
      operations through our subsidiary in Sweden, although we do carry out some
      development activities together with our manufacturing partner in Malaysia.
      We
      intend to manage our future growth on a geographic basis and our management
      will
      evaluate the performance of our segments and allocate resources to them based
      upon income (loss) from operations.





During
      2007, substantially all of our phones were sold in European countries. In 2006
      we discontinued our N1 phone. We sold limited amounts of the N1 without any
      right of return. Over 90% of our phone revenues for 2006 were from
      Russia.





In
      addition to phone sales, revenues included license revenue from an Asian
      manufacturer amounting to $463,000 and $851,000 for 2007 and 2006, respectively.





**22.**  **Related
      Party Transactions**





Petrus
      Holding, Iwo Jima SARL and Spray AB are companies where the Chairman of the
      Board and a significant shareholder of Neonode Inc., Per Bystedt, owns or has
      significant influence. All three companies have invested in senior secured
      notes
      that were convertible in our common stock and warrants to purchase our common
      stock. All the convertible senior secured notes were converted to our common
      stock and warrants to purchase our common stock just prior to the merger with
      SBE on August 10, 2007 (see Notes 1 and 12).





**23.**  **Subsequent
      Events**





Effective
      March 4, 2008, we sold $4.5 million in securities in a private placement to
      accredited investors (“Investors”) pursuant to a Subscription Agreement, dated
      March 4, 2008 (“Subscription Agreement”). We sold 1,800,000 shares (“Investor
      Shares”) of our common stock, $0.001 par value (“Common Stock”), for $2.50 per
      share. After placement agent fees and offering expenses, we received net
      proceeds of approximately $4,000,000.





Pursuant
      to the Subscription Agreement, we granted the Investors piggyback registration
      rights in respect to the Investor Shares and we are obligated to include the
      Investor Shares in the next registration statement we file with the Securities
      and Exchange Commission (“SEC”), subject to limited exceptions. In addition, we
      issued an aggregate of 207,492 shares of Common Stock to investors who
      participated in the September 2007 private placement pursuant to anti-dilution
      provisions contained. Empire Asset Management, Inc. acted as financial advisor
      in the private placement and received compensation in connection with the
      private placement of approximately $450,000 and 120,000 shares of Common
      Stock.





In
      January 2008, we offered our customers a design modification for the N2 phones
      held in their inventory. We expect the cost of the modification program to
      be
      approximately $200,000. As part of the modification program we offered to
      transport the inventory to our manufacturing partner (Balda Malaysia) and
      provide the modifications at no cost to our customers. As a result, certain
      of
      our customers are withholding payment of amounts due us until the modifications
      are completed and the inventory is returned to them.




60





**Neonode
      Inc.**


**Schedule
      II - Valuation and Qualifying Accounts**


**For
      the Years Ended December 31, 2007 and 2006**


**(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, 2007Allowance
                  for Warranty Reserve
              
              $
              -
              
              $
              92
              
              $
              -
              
              $
              92Allowance
                  for Deferred Tax Assets
              
              
              (3,164
              )
              
              -
              
              
              -
              
              
              (7,218
              )Year
                  ended December 31, 2006Allowance
                  for Warranty Reserve
              
              
              -
              
              
              -
              
              
              -
              
              
              -Allowance
                  for Deferred Tax Assets
              
              
              (1,268
              )
              
              -
              
              
              (1,896
              )
              
              (3,164
              )
  61




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





None.





**ITEM
              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,
      2007. 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, 2007, management determined that we had certain material weaknesses relating
      to our revenue recognition policies and 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. During mid-2007
      we began shipping products to customers and initially recorded revenue as
      products were shipped. After evaluation of contracts and actual sell through,
      we
      determined that the proper revenue recognition methods would be “sell through.”
This change resulted in certain accounting adjustments during our year-end
      audit. In addition, we entered into several complex financing transactions
      (including convertible debt, derivatives, bifurcation 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.




The
      factors described below under “Internal Control of Financial Reporting” related
      to the integration and consolidation of the Swedish operating subsidiary we
      acquired on August 10, 2007 further contributed to the conclusion of our Chief
      Executive Officer and Chief Financial Officer.





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**





This
      annual report does not include a report of management’s assessment regarding
      internal control over financial reporting or an attestation report of the
      company’s registered public accounting firm. As discussed elsewhere in this
      report, the merger between SBE and Neonode on August 10, 2007 represented a
      significant change in our business and financial operations. Having occurred
      in
      the final third of the fiscal year, the merger left management with insufficient
      time to finalize integration and consolidate operations to fully assess the
      effectiveness of internal control over financial reporting. Our new operating
      subsidiary was not previously subject to Commission reporting standards,
      including those relating to internal control over financial reporting. The
      merger resulted in new employees, systems, and processes at fiscal year-end
      that
      were significantly different from those in place for the majority of the fiscal
      year. We also experienced a change in most members of senior management and
      the
      board of directors upon the merger. As a result, our management believed it
      was
      impracticable to fully and appropriately assess our internal control over
      financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act.





Even
      if
      our management had provided their conclusion as to the effectiveness of our
      internal control over financial reporting, it would not have been subject to
      attestation by our 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.





Comparable
      to a newly public company and consistent with public guidance from the
      Commission, we believe that having the benefit of a full fiscal year of
      consolidated business and financial operations, we expect our Chief Executive
      Officer and Chief Financial Officer will be positioned to provide the assessment
      of internal control over financial reporting as part of the annual report for
      the fiscal year ending December 31, 2008.




62




As
      of the
      period ended December 31, 2007, we undertook the following changes that have
      materially affected, or are reasonably likely to materially affect, our internal
      control over financial reporting:


·
            We
                implemented corporate governance policies, including an employee
                code of
                conduct and whistleblower provisions, so that employees of our operating
                subsidiary would be aware of our compliance duties and responsibilities;
                and


·
            We
                purchased new management reporting system software, and retained
                a
                consultant to oversee its implementation, to better enable us to
                consolidate our accounting and budgeting systems across different
                international locations and functional
                currencies.





As
      we
      move towards complete integration and consolidation of business and financial
      operations of SBE and Neonode, we expect to take additional steps to both remedy
      the material weaknesses described above and facilitate our management’s
      assessment of internal control over financial reporting in accordance 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;


·
            modifying
                the documentation and testing programs SBE was developing prior to
                the
                merger to appropriately apply to the new Neonode;
                and


·
            engaging
                a qualified consultant in 2008 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**





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 expires on March 31, 2013. The annual payment for these
      premise equates to approximately $288,000 per year and is indexed to the
      consumer price index in Sweden. As an incentive to enter into the agreement
      as
      one of the firs tenants to occupy the building, the NCC Property G AB has given
      Neonode AB discounts amounting to approximately $120,000 allocated over the
      first eight months of the leasing period.





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 begins on April 1, 2008 and expires on March 31, 2013. The annual
      payment for these premise amounts to $28,000 per year and is indexed to the
      consumer price index in Sweden. Neonode AB has the right to terminate the lease
      on March 31, 2011 if notice of termination is given by Neonode AB at least
      9
      months prior to March 31, 2011.





**PART
      III**





**ITEM 10.**
            **DIRECTORS, EXECUTIVE OFFICERS
              AND
              CORPORATE GOVERNANCE**





The
      identification of our executive officers is provided above at the end of Part
      I
      of this Annual Report on Form 10-K.





We
      have
      adopted a code of ethics that applies to our principal officers. The code of
      ethics has been posted on our internet website found at www.neonode.com. We
      intend to satisfy disclosure requirements regarding amendments to, or waivers
      from, any provisions of its code of ethics on our website.





The
      other
      information required by this Item is incorporated by reference to “Election of
      Directors,” “Board of Directors Committees and Corporate Governance” and
“Additional Information - Section 16(a) Beneficial Ownership Reporting
      Compliance” in our definitive proxy statement for our 2008 Annual Meeting of
      Stockholders to be filed within 120 days of the end of our December 31, 2007
      fiscal year (the “2008 Proxy Statement”).





63




**ITEM
              11.**
            **EXECUTIVE
              COMPENSATION**





The
      information required by this Item is incorporated by reference to “Executive
      Compensation” in our 2008 Proxy Statement.





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





The
      information required by this Item, other than as provided below, is incorporated
      by reference to “Security Ownership of Certain Beneficial Owners and Management”
in our 2008 Proxy Statement.





The
      following table includes information regarding our equity incentive plans as
      of
      the end of fiscal 2007:





**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
            4,063,281
            $3.79
            862,000Equity
                compensation plans not approved by security holders
            5,774,291
            $2.87
            36,495Total
            9,837,572
            $3.25
            898,495





The
      following table details the outstanding options to purchase shares of our common
      stock pursuant to each plan at December 31, 2007:





Plan
            
            Shares
              Reserved
            
            Options
              Outstanding
            
            Available
              for
                Issue
            
            Outstanding
              Options
              Vested1996
                Plan
            
            
            546,000
            
            
            61,000
            
            
            ---
            
            
            61,0001998
                Plan(1)
            
            
            130,000
            
            
            35,900
            
            
            36,495
            
            
            35,9002007
                Neonode Plan(2)
            
            
            2,119,140
            
            
            2,117,332
            
            
            ---
            
            
            2,117,3322006
                Plan
            
            
            1,300,000
            
            
            205,000
            
            
            835,000
            
            
            5,000Director
                Plan
            
            
            68,000
            
            
            15,500
            
            
            27,000
            
            
            15,500Total
            
            
            4,163,140
            
            
            2,434,732
            
            
            898,495
            
            
            2,234,732


(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
        Merger with Old 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.





64








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









The
      information required by this Item is incorporated by reference to “Related
      Person Transactions” and “Corporate Governance” in our 2008 Proxy
      Statement.


**ITEM 14.**
              **PRINCIPAL ACCOUNTANT FEES
                AND
                SERVICES**





The
      information required by this Item is incorporated by reference to “Ratification
      Of Selection Of Independent Auditors” in our 2008 Proxy Statement.





**PART
      IV**


**ITEM 15.**
              **EXHIBITS**





**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
                #**
            **Description**2.1
            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
            Bylaws,
                as amended through December 5, 200710.1
            Note
                Purchase Agreement, dated February 28, 200610.2
            Senior
                Secured Note issued to AIGH Investment Partners LLC, dated February
                28,
                200610.3
            Senior
                Secured Note issued to Hirshcel Berkowitz, dated February 28,
                200610.4
            Senior
                Secured Note issued to Joshua Hirsch, dated February 28,
                200610.5
            Security
                Agreement, dated February 28, 200610.6
            Stockholder
                Pledge and Security Agreement (form of), dated February 28,
                200610.7
            Intercreditor
                Agreement, dated February 28, 200610.8
            Note
                Purchase Agreement, dated November 20, 200610.9
            Senior
                Secured Note issued to AIGH Investment Partners LLC, dated November
                20,
                200610.10
            Senior
                Secured Note issued to Hirshcel Berkowitz, dated November 20,
                200610.11
            Senior
                Secured Note issued to Joshua Hirsch, dated November 20,
                200610.12
            Amendment
                to Security Agreement, dated November 20, 200610.13
            Amendment
                to Stockholder Pledge and Security Agreement, dated November 20,
                200610.14
            Amendment
                to Security Agreement, dated January 22,
                2007




65




10.15
            Amendment
                to Stockholder Pledge and Security Agreement, dated January 22,
                200710.16
            Amendment
                to Senior Secured Notes, dated May 22, 2007, effective May 25,
                200710.17
            Note
                Purchase Agreement between SBE, Inc. and Neonode Inc., dated May
                18, 2007,
                effective May 25, 2007 (*incorporated
                by reference to Exhibit 10.1 of our Current Report on Form 8-K
                filed on May 29, 2007*)10.18
            Senior
                Secured Note issued to SBE, Inc., dated May 18, 2007, effective May
                25,
                2007 (*incorporated
                by reference to Exhibit 10.3 of our Current Report on Form 8-K
                filed on May 29, 2007*)10.19
            Amendment
                to Security Agreement, dated July 31, 200710.20
            Amendment
                to Stockholder Pledge and Security Agreement, dated July 31,
                200710.21
            Note
                Purchase Agreement, dated July 31, 200710.22
            Amendment
                to Note Purchase Agreement, dated August 1, 200710.23
            Amendment
                No. 2 to Note Purchase Agreement, dated December 21,
                200710.24
            Amendment
                No. 3 to Note Purchase Agreement, dated March 31, 200810.25
            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*)10.26
            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*)10.27
            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*)10.28
            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*)10.29
            Convertible
                Promissory Note (*incorporated
                by reference to Exhibit 10.24 of our Current Report on Form 8-K
                filed on October 2, 2007*)10.30
            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*)10.31
            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*)10.32
            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*)10.33
            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*)10.34
            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*)10.35
            Lease
                for 4000 Executive Parkway, Suite 200 dated July 27, 2005 with Alexander
                Properties Company10.36
            Lease
                forWarfvingesväg
                45, SE-112 51 Stockholm, Sweden dated October 16, 2007 with NCC Property
                G
                AB10.37
            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*)+10.38
            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*)+10.39
            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*)+10.40
            Employment
                Agreement with Mikael Hagman, dated November 30, 2006+10.41
            Executive
                Severance Benefits Agreement with Kenneth G. Yamamoto, dated March
                21,
                2006 (*incorporated
                by reference to Exhibit 10.16 of our Quarterly Report on
                Form 10-Q for the period ended January 31, 2007, as filed on March
                16, 2007*)+10.42
            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*)+10.43
            Executive
                Severance Benefits Agreement with Kirk Anderson, dated April 12,
                2004
                (*incorporated
                by reference to Exhibit 10.14 of our Quarterly Report on
                Form 10-Q for the period ended January 31, 2005, as filed on March 2,
                2005*)+10.44
            Executive
                Severance Benefits Agreement with Leo Fang, dated May 24, 2006
                (*incorporated
                by reference to Exhibit 10.1 of our Current Report on Form 8-K
                filed on May 26, 2006*)+10.45
            Executive
                Severance Benefits Agreement with Nelson Abal, dated August 4, 2006
                (*incorporated
                by reference to Exhibit 10.1 of our Current Report on Form 8-K
                filed on August 7, 2006*)+21
            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





66





**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, 2008
            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, Mikael Hagman
      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/
                  Mikael Hagman
              
              President
                  and Chief Executive Officer,
              April
                  14, 2008Mikael
                  Hagman
              
              and
                  Director*(Principal
                  Executive Officer)*/s/
                  David W. Brunton
              
              Chief
                  Financial Officer, Vice President, Finance
              April
                  14, 2008David
                  W. Brunton
              
              and
                  Secretary*(Principal
                  Financial and Accounting Officer)*/s/
                  Per Bystedt
              
              Director,
                  Chairman of the Board
              April
                  14, 2008Per
                  Bystedt/s/
                  John Reardon
              
              Director
              April
                  14, 2008John
                  Reardon/s/
                  Susan Major
              
              Director
              April
                  14, 2008Susan
                  Major


67