Neonode Inc. 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes thereto included elsewhere in this Annual Report. Overview Our company provides advanced optical sensing solutions for contactless touch, touch, and gesture sensing. We also provide software solutions for scene analysis that feature advanced machine learning algorithms to detect and track persons and objects in video streams for cameras and other types of imagers. We base our contactless touch, touch, and gesture sensing products and solutions using our zForce technology platform and our scene analysis solutions on our MultiSensing technology platform. We market and sell our solutions to customers in many different markets and segments including, but not limited to, office equipment, automotive, industrial automation, medical, military and avionics. In 2010, we began licensing to Original Equipment Manufacturers (“OEMs”) and Tier 1 suppliers who embed our technology into products they develop, manufacture, and sell. Since 2010, our licensing customers have sold approximately 85 million devices that use our technology. In October 2017, we augmented our licensing business and began manufacturing and shipping sensor modules that incorporate our technology. We sell these embedded sensors modules to OEMs and systems integrators for use in their products. As of December 31, 2021 we had 34 valid technology license agreements with global OEMs and Tier 1 suppliers. As of December 31, 2020, that number was 42. During the year ended December 31, 2021, we had 11 customers using our touch technology in products that were being shipped to their customers. The majority of our license fees earned in 2021 and 2020 were from customer shipments of printers. As of December 31, 2021, we had entered into 11 agreements with value added resellers (“VARs”) for integration of our sensor modules in the products they offer to global OEMs, ODMs and systems integrators. In addition to this, we distribute our embedded sensor modules through Digi-Key Corporation, Serial Microelectronics HK Ltd, and Nexty Electronics Corporation. During 2021, our three distributors sold and shipped 8,613 sensor modules and related development kits. We anticipate our future revenue will be generated by a combination of royalties from our existing and new license customers plus sales of our sensor modules. 16 During 2021 and 2020 we continued to focus our efforts on maintaining our current licensing customers and achieving design wins for new products both with current and future customers. We made investments enhancing the design and improving the production yield of our TSMs and improving the related firmware and configuration tools software platforms. We also made investments to expand our partner networks for sales and distribution of TSMs. We intend to continue expanding our TSM product offerings in 2022 and beyond, including new TSM variants and new sensor products for delivery to our key markets. We expect that over time the sales of TSMs and other sensor products may constitute the majority of our revenue. Critical Accounting Policies and Estimates Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and include the accounts of Neonode Inc. and its wholly owned subsidiaries, as well as Pronode Technologies AB (Sweden), a 51% majority owned subsidiary of Neonode Technologies AB, one of our wholly owned subsidiaries. The non-controlling interests are reported below net loss including non-controlling interests under the heading “Net loss attributable to non-controlling interests” in the consolidated statements of operations, below comprehensive loss under the heading “Comprehensive loss attributable to non-controlling interests” in the consolidated statements of comprehensive loss, and shown as a separate component of stockholders’ equity in the consolidated balance sheets. See “Non-controlling Interests” below for further discussion. All inter-company accounts and transactions have been eliminated in consolidation. The accounting policies affecting our financial condition and results of operations are more fully described in Note 2 to our consolidated financial statements. Certain of our accounting policies require the application of judgment by management in selecting appropriate assumptions for calculating financial estimates, which inherently contain some degree of uncertainty. Management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances. The historical experience and assumptions form the basis for making judgments about the reported carrying values of assets and liabilities and the reported amounts of revenue and expenses that may not be readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following are critical accounting policies and related judgments and estimates used in the preparation of our consolidated financial statements. Estimates The preparation of financial statements in conformity with U.S. GAAP requires making estimates and judgments 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 and judgments. Significant estimates and judgments include, but are not limited to: for revenue recognition, determining the nature and timing of satisfaction of performance obligations, the standalone selling price of performance obligations, and transaction prices and assessing transfer of control; measuring variable consideration and other obligations such as product returns and refunds, and product warranties; provisions for uncollectible receivables; determining the net realizable value of inventory; recoverability of capitalized project costs and long-lived asset; for leases, determining whether a contract contains a lease, allocating consideration between lease and non-lease components, determining incremental borrowing rates, and identifying reassessment events, such as modifications; the valuation allowance related to our deferred tax assets; and the fair value of options issued for stock-based compensation. 17 Revenue Recognition We recognize revenue when control of products is transferred to our customers, and when services are completed and accepted by our customers; the amount of revenue we recognize reflects the consideration we expect to receive for those products or services. Our contracts with customers may include combinations of products and services (e.g., a contract that includes products and related engineering services). We structure our contracts such that distinct performance obligations, such as product sales or license fees, and related engineering services, are clearly defined in each contract. License fees and sales of our AirBars and TSMs are on a per-unit basis are on a per-unit basis. Therefore, we generally satisfy performance obligations as units are shipped to our customers. Non-recurring engineering service performance obligations are satisfied as work is performed and accepted by our customers. We recognize revenue net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities. We treat all product shipping and handling charges (regardless of when they occur) as activities to fulfill the promise to transfer goods. Therefore, we treat all shipping and handling charges as expenses. License fees We earn revenue from licensing our internally developed intellectual property (“IP”). We enter into IP licensing agreements that generally provide licensees the right to incorporate our IP components into their products, with terms and conditions that vary by licensee. Fees under these agreements may include license fees relating to our IP, and royalties payable to us following the distribution 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. For technology license arrangements that do not require significant modification or customization of the underlying technology, we recognize technology license revenue when the license is made available to the customer and the customer has a right to use that license. At the end of each reporting period, we record unbilled license fees, using prior royalty revenue data by customer to make estimates of those royalties. Explicit return rights are not offered to customers. There have been no returns through December 31, 2021. Product sales We earn revenue from sales of TSM hardware products to our OEM, ODM and Tier 1 supplier customers, who embed our hardware into their products, and from sales of branded consumer products that incorporate our TSMs that are sold through distributors or directly to end users. These distributors are generally given business terms that allow them to return unsold inventory, receive credits for changes in selling prices, and participate in various cooperative marketing programs. Our sales agreements generally provide customers with limited rights of return and warranty provisions. The timing of revenue recognition related to AirBar modules depends upon how each sale is transacted - either point-of-sale or through distributors. We recognize revenue for AirBar modules sold point-of-sale (online sales and other direct sales to customers) when we provide the promised product to the customer. Because we use distributors to provide AirBar TSMs to our customers, we must analyze the terms of our distributor agreements to determine when control passes from us to our distributors. For sales of AirBar and TSMs sold through distributors, we recognize revenues when our distributors obtain control over our products. Control passes to our distributors when we have a present right to payment for products sold to the distributors, the distributors have legal title to and physical possession of products purchased from us, and the distributors have significant risks and rewards of ownership of products purchased. Distributors participate in various cooperative marketing and other incentive programs, and we maintain estimated accruals and allowances for these programs. If actual credits received by distributors under these programs were to deviate significantly from our estimates, which are based on historical experience, our revenue could be adversely affected. Under U.S. GAAP, companies may make reasonable aggregations and approximations of returns data to accurately estimate returns. Our AirBar and TSM returns and warranty experience to date has enabled us to make reasonable returns estimates, which are supported by the fact that our product sales involve homogenous transactions. The reserve for future sales returns is recorded as a reduction of our accounts receivable and revenue and was $69,000 and $78,000 as of December 31, 2021 and 2020, respectively. The warranty reserve is recorded as an accrued expense and cost of sales and was $36,000 and $25,000 as of December 31, 2021 and 2020, respectively. If the actual future returns were to deviate from the historical data on which the reserve had been established, our revenue could be adversely affected. Non-Recurring Engineering For technology license or TSM contracts that require modification or customization of the underlying technology to adapt the technology to customer use, we determine whether the technology license or TSM, and required engineering consulting services represent separate performance obligations. We perform our analysis on a contract-by-contract basis. If there are separate performance obligations, we determine the standalone selling price (“SSP”) of each separate performance obligation to properly recognize revenue as each performance obligation is satisfied. We provide engineering consulting services to our customers under a signed Statement of Work (“SOW”). Deliverables and payment terms are specified in each SOW. We generally charge an hourly rate for engineering services, and we recognize revenue as engineering services specified in contracts are completed and accepted by our customers. Any upfront payments we receive for future non-recurring engineering are recorded as unearned revenue until that revenue is earned. 18 We believe that recognizing revenue from non-recurring engineering as progress towards completion of engineering services and customer acceptance of those services occurs best reflects the economics of those transactions, because engineering services as tracked in our systems correspond directly with the value to our customers of our performance completed to date. Hours performed for each engineering project are tracked and reflect progress made on each project and are charged at a consistent hourly rate. Revenues from non-recurring engineering contracts that are short-term in nature are recorded when those services are complete and accepted by customers. Revenues from non-recurring engineering contracts with substantive defined deliverables for which payment terms in the SOW are commensurate with the efforts required to produce such deliverables are recognized as they are completed and accepted by customers. Estimated losses on all SOW projects are recognized in full as soon as they become evident. During the year ended December 31, 2021, we recorded no losses and during the year ended December 31, 2020, we recorded $47,000 of losses. Accounts Receivable and Allowance for Doubtful Accounts Our accounts receivable is 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. Inventory Our inventory consists primarily of components that will be used in the manufacturing of our TSMs. We classify inventory for reporting purposes as raw materials, work-in-process, and finished goods. Inventory is stated at the lower of cost or net realizable value, using the first-in, first-out (“FIFO”) valuation method. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Any adjustments to reduce the cost of inventories to their net realizable value are recognized in earnings in the current period. Due to the low sell-through of our AirBar products, management has decided to fully reserve work-in-process for AirBar components, as well as AirBar related raw materials. Management has further decided to reserve for a portion of AirBar finished goods, depending on type of AirBar and in which location it is stored. The AirBar inventory reserve was $0.8 million and $0.9 million as of December 31, 2021 and 2020, respectively. Management decided to reserve for TSM inventory related to a quality issue in production. The TSM inventory reserve was $0.2 million as of December 31, 2021. 19 Projects in Process Projects in process consist of costs incurred during the completion of various projects for certain customers. These costs are primarily comprised of direct engineering labor costs and project-specific equipment costs. These costs are capitalized on our balance sheet as an asset and deferred until revenue for each project is recognized in accordance with our revenue recognition policy. There were no costs capitalized in projects in process as of December 31, 2021 and 2020, respectively. Property and Equipment Property and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method based upon estimated useful lives of the assets as follows: Estimated useful lives Computer equipment 3 years Furniture and fixtures 5 years Equipment 7 years Equipment purchased under a finance lease is depreciated over the term of the lease, if that lease term is shorter than the estimated useful life. Upon retirement or sale of property and equipment, cost and accumulated depreciation and amortization are removed from the accounts and any gains or losses are reflected in the consolidated statement of operations. Maintenance and repairs are charged to expense as incurred. Long-Lived Assets We assess any impairment by estimating the future cash flows from the associated asset in accordance with relevant accounting guidance. If the estimated undiscounted future cash flow related to these assets decreases or the useful life is shorter than originally estimated, we may incur charges for impairment of these assets. As of December 31, 2021, we believe there was no impairment of our long-lived assets. There can be no assurance, however, that market conditions will not change or sufficient demand for our products and services will continue, which could result in impairment of long-lived assets in the future. Research and Development Research and development (“R&D”) costs are expensed as incurred. R&D costs consist mainly of personnel related costs in addition to some external consultancy costs such as testing, certifying and measurements. Stock-Based Compensation Expense We measure the cost of employee services received in exchange for an award of equity instruments, including share options, based on the estimated fair value of the award on the grant date, and recognize the value as compensation expense over the period the employee is required to provide services in exchange for the award, usually the vesting period, net of estimated forfeitures. 20 We account for equity instruments issued to non-employees at their estimated fair value. 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. Non-controlling Interests We recognize any non-controlling interest, also known as a minority interest, as a separate line item in equity in the consolidated financial statements. A non-controlling interest represents the portion of equity ownership in a less-than-wholly owned subsidiary not attributable to us. Generally, any interest that represents less than 50% of the outstanding voting shares is deemed to be a non-controlling interest; however, there are other factors, such as decision-making rights, that are considered as well. We include the amount of net income (loss) attributable to non-controlling interests in consolidated net income (loss) on the face of the consolidated statements of operations. We provide either in the consolidated statement of stockholders’ equity, if presented, or in the notes to consolidated financial statements, a reconciliation at the beginning and the end of the period of the carrying amount of total equity (net assets), equity (net assets) attributable to the parent, and equity (net assets) attributable to the non-controlling interest that separately discloses: (1) Net income or loss; (2) Transactions with owners acting in their capacity as owners, showing separately contributions from and distributions to owners; and (3) Each component of other comprehensive income or loss. Foreign Currency Translation and Transaction Gains and Losses The functional currency of our foreign subsidiaries is the applicable local currency, the Swedish Krona, the Japanese Yen, the South Korean Won and the Taiwan Dollar. The translation from Swedish Krona, Japanese Yen, South Korean Won or the Taiwan Dollar to U.S. Dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for income statement accounts using a weighted average exchange rate during the period. Gains or (losses) resulting from translation are included as a separate component of accumulated other comprehensive income (loss). Gains or (losses) resulting from foreign currency transactions are included in general and administrative expenses in the accompanying consolidated statements of operations and were $(66,000) and $(252,000) during the years ended December 31, 2021 and 2020, respectively. Foreign currency translation gains (losses) were $(4,000) and $235,000 during the years ended December 31, 2021 and 2020, respectively. Net Loss per Share Net loss per share amounts have been computed based on the weighted-average number of shares of common stock outstanding during the years ended December 31, 2021 and 2020. Net loss per share, assuming dilution amounts from common stock equivalents, is computed based on the weighted-average number of shares of common stock and potential common stock equivalents outstanding during the period. The weighted-average number of shares of common stock and potential common stock equivalents used in computing the net loss per share for years ended December 31, 2021 and 2020 exclude the potential common stock equivalents, as the effect would be anti-dilutive. Other Comprehensive Income (Loss) Our other comprehensive income (loss) includes foreign currency translation gains and losses. The cumulative amount of translation gains and losses are reflected as a separate component of stockholders’ equity in the consolidated balance sheets as accumulated other comprehensive loss. 21 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 rates for the consolidated statements of operations were as follows: Years ended December 31, 2021 2020 Swedish Krona 8.58 9.21 Japanese Yen 109.82 106.73 South Korean Won 1,144.95 1,179.20 Taiwan Dollar 27.93 29.45 Exchange rates for the consolidated balance sheets were as follows: As of December 31, 2021 2020 Swedish Krona 9.03 8.22 Japanese Yen 115.12 103.23 South Korean Won 1,190.75 1,088.59 Taiwan Dollar 27.71 28.09 Deferred Revenues Deferred revenues consist primarily of prepayments for license fees, and other products or services that we have been paid in advance. We earn this revenue when we transfer control of the product or service. Deferred revenues may also include upfront payments for consulting services to be performed in the future, such as non-recurring engineering services. We defer license fees until we have met all accounting requirements for revenue recognition, which is when a license is made available to a customer and that customer has a right to use the license. Engineering development fee revenues are deferred until engineering services have been completed and accepted by our customers. We defer sensor modules revenues until distributors sell the products to their end customers. The following table presents our deferred revenues by source (in thousands); Years ended December 31, 2021 2020 Deferred license fees revenues $ 28 $ 28 Deferred NRE revenues 8 22 Deferred AirBar revenues - 10 Deferred sensor modules revenues 70 78 $ 106 $ 138 22 New Accounting Pronouncements In September 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326)-Measurement of Credit Losses on Financial Instruments , (“ASU 2016-13”), supplemented by subsequent accounting standards updates. The new standard requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. ASU 2016-13, as amended, is scheduled to become effective for fiscal years beginning after December 15, 2023, with early adoption permitted. In the future, we will evaluate the impact that ASU 2016-13, as amended, will have on our consolidated financial statements, specifically regarding our trade receivables; however, we do not expect any significant impact from implementation of the new standard. Results of Operations A summary of our financial results for the years ended December 31, 2021 and 2020 is as follows (in thousands, except percentages): 2021 2020 Variance in Dollars Variance in Percent Revenue: License fees $ 4,787 $ 4,618 $ 169 3.7 % Percentage of revenue 82.0 % 77.2 % Products 955 950 5 0.5 % Percentage of revenue 16.4 % 15.9 % Non-recurring engineering 94 416 (322 ) (77.4 )% Percentage of revenue 1.6 % 7.0 % Total Revenue $ 5,836 $ 5,984 $ (148 ) (2.5 )% Cost of Sales: Products $ 922 $ 802 $ 120 15.0 % Percentage of revenue 15.8 % 13.4 % Non-recurring engineering 33 276 (243 ) (88.0 )% Percentage of revenue 0.6 % 4.6 % Total Cost of Sales $ 955 $ 1,078 $ (123 ) (11.4 )% Total Gross Margin $ 4,881 $ 4,906 $ (25 ) (0.5 )% Operating Expense: Research and development $ 3,546 $ 4,139 $ (593 ) (14.3 )% Percentage of revenue 60.8 % 69.2 % Sales and marketing 2,839 2,534 305 12.0 % Percentage of revenue 48.6 % 42.3 % General and administrative 5,603 4,424 1,179 26.7 % Percentage of revenue 96.0 % 73.9 % Total Operating Expenses $ 11,988 $ 11,097 $ 891 8.0 % Percentage of revenue 205.4 % 185.4 % Operating Loss $ (7,107 ) $ (6,191 ) $ (916 ) 14.8 % Percentage of revenue (121.8 )% (103.5 )% Other expenses 15 32 (17 ) (53.1 )% Percentage of revenue 0.3 % 0.5 % Net loss attributable to Neonode Inc. (6,450 ) (5,605 ) (845 ) 15.1 % Percentage of revenue (110.5 )% (93.7 )% Net loss per share attributable to Neonode Inc. per share $ (0.54 ) $ (0.56 ) $ 0.02 (3.6 )% 23 Revenues All of our sales for the years ended December 31, 2021 and 2020 were to customers located in the United States, Europe and Asia. The decrease in total gross revenues by 2.5% for the year ended December 31, 2021 as compared to 2020 was primarily caused by lower NRE revenue, offset by higher license fees and product sales. The following tables present the net revenues distribution by geographical area and revenue stream for the years ended December 31, 2021 and 2020 (dollars in thousands): 2021 2020 Amount Percentage Amount Percentage AMER License fees $ 2,102 93.6 % $ 1,880 74.7 % Products 144 6.4 285 11.3 % Non-recurring engineering - - % 353 14.0 % $ 2,246 100.0 % $ 2,518 100.0 % APAC License fees $ 2,394 77.2 % $ 2,338 82.8 % Products 661 21.3 % 452 16.0 % Non-recurring engineering 48 1.5 % 33 1.2 % $ 3,103 100.0 % $ 2,823 100.0 % EMEA License fees $ 291 59.8 % $ 400 62.2 % Products 150 30.8 % 213 33.1 % Non-recurring engineering 46 9.4 % 30 4.7 % $ 487 100.0 % $ 643 100.0 % 24 The following table presents disaggregated revenues by revenue stream for the years ended December 31, 2021 and 2020 (dollars in thousands): Year ended December 31, 2021 Year ended December 31, 2020 Amount Percentage Amount Percentage Net license revenues from automotive (licensing) $ 1,602 27.5 % $ 1,110 18.5 % Net license revenues from consumer electronics (licensing) 3,185 54.5 % 3,508 58.6 % Net revenues from touch sensor modules (products) 955 16.4 % 950 15.9 % Net revenues from non-recurring engineering services 94 1.6 % 410 6.9 % Other revenue - - % 6 0.1 % $ 5,836 100.0 % $ 5,984 100.0 % License fees increased by 3.7% in 2021 as compared to 2020. License revenues in the first half of 2020 were depressed by the general COVID-19 driven economic slow-down. During the second half of 2020 our license revenues started to re-bound and this trend continued during the first and second quarters of 2021. For the third quarter of 2021, revenues decreased primarily due to overall global supply-chain constraints and more specifically semiconductor component shortages within the printer and automotive markets combined with renewed pandemic-driven lock-downs in our key markets. For the fourth quarter of 2021, license revenues increased by 60% over the third quarter due to a more balanced supply/demand equation in the semiconductor markets, which allowed increased product shipments by our printer and automotive customers. Revenues from product sales were $1.0 million, the same as for 2020. In the first half of 2021 we saw an increase in product sales. In the second half of 2021, product sales were negatively impacted when COVID-19 driven lock-downs were implemented in our key markets. Our elevator and kiosks customers in Asia have been first adopters for our contactless touch technology and as expected, most of our initial TSM sales are related to retrofit solutions. New customer equipment launches have much longer product development and production cycles that can take 4 to 18 months or longer. Revenues from NRE services decreased 77.4% in 2021 as compared to 2020. In 2021, NRE revenues related to projects within product sales. Revenues from NRE is associated with customer custom development projects and typically fluctuates from quarter to quarter and year to year and is entirely dependent on specific customer driven development activities. We expect to continue to earn NRE fees in 2022 and future years. Gross Margin Our total gross margin was 83.6% in 2021 compared to 82.0% in 2020. Gross margin related to product sales was 3.5% in 2021 compared to 15.6% in 2020. In 2021 and 2020 product sales gross margin was impacted by one-time adjustments related to AirBar and TSMs stock write-downs. Our cost of revenues includes the direct cost of production of certain customer prototypes, costs of engineering personnel, engineering consultants to complete the engineering design contracts and cost of goods sold for sensor modules includes fully burdened manufacturing costs, outsourced final assembly costs, and component costs of sensor modules. Research and Development Product R&D expenses for 2021 were 61% of total revenue compared to 69% in 2020. R&D in 2021 decreased 14.3% compared to 2020 primarily due to the move of administrative costs related to production from R&D to general and administrative. There were 25 employees and two consultants in our R&D department as of December 31, 2021 compared to 25 employees and two consultants as of December 31, 2020. Our R&D groups are primarily tasked with developing technology and software platforms to support our TSMs and our customer integration activities for both our sensor hardware and license agreements. Sales and Marketing Sales and marketing expenses for 2021 were 49% of total revenue compared to 42% in 2020. Sales and marketing expenses in 2021 increased 12% compared to 2020 primarily due to higher staff expenses in 2021. We had eight employees and six consultants in our sales and marketing department as of December 31, 2021 compared to six employees and seven consultants as of December 31, 2020. There is approximately $50,000 of stock-based compensation expense included in sales and marketing expenses for the year ended December 31, 2021 compared to $32,000 for the year ended December 31, 2020. Our sales activities focus on OEM, ODM and Tier 1 customers, directly or through VARs, who license our technology or purchase and embed our touch sensor modules into their products. 25 General and Administrative General and administrative (“G&A”) expenses were 96% of revenue in 2021 compared to 74% in 2020. Total G&A expenses in 2021 increased 25.2% from 2020 and was primarily due to the move of administrative costs related to production from R&D to G&A. As of December 31, 2021, we had seven full-time employees and three consultants in our G&A department fulfilling management, HR and accounting responsibilities compared to eight full-time employees and no consultants as of December 31, 2020. There is approximately $107,000 of non-cash stock-based compensation included in G&A expenses for the year ended December 31, 2021 compared to $42,000 for the year ended December 31, 2020. Interest Expense Interest expense for the year ended December 31, 2021 was $15,000 compared to $27,000 for the year ended December 31, 2020. The interest expense for both 2021 and 2020 was primarily related to finance leases. Foreign Currency Translation and Transaction Gains and Losses The functional currency of our foreign subsidiaries is the applicable local currency, the Swedish Krona, the Japanese Yen, the South Korean Won and the Taiwan Dollar. The translation from Swedish Krona, Japanese Yen, South Korean Won or the Taiwan Dollar to U.S. Dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for income statement accounts using a weighted average exchange rate during the period. Gains or (losses) resulting from translation are included as a separate component of accumulated other comprehensive income (loss). Gains or (losses) resulting from foreign currency transactions are included in general and administrative expenses in the accompanying consolidated statements of operations were $(66,000) and $(252,000) during the years ended December 31, 2021 and 2020, respectively. Foreign currency translation gains (losses) were $(4,000) and $235,000 during the years ended December 31, 2021 and 2020, respectively Income Taxes Our effective tax rate was (2)% for the year ended December 31, 2021 and (1)% for the year ended December 31, 2020. We recorded valuation allowances in 2021 and 2020 for deferred tax assets related to net operating losses due to the uncertainty of realization. Net Loss As a result of the factors discussed above, we recorded a net loss of $6.5 million for the year ended December 31, 2021, compared to a net loss of $5.6 million for the year ended December 31, 2020. Contractual Obligation We previously agreed to secure the value of inventory purchased by one of our AirBars manufacturing partners. At December 31, 2021, the guaranteed amount was decreased from $100,000 to $0. We do not have any other transactions, arrangements, or other relationships with unconsolidated entities that are reasonably likely to affect our liquidity or capital resources other than the operating leases incurred in the normal course of business. We have no special purpose or limited purpose entities that provide off-balance sheet financing, liquidity, or market or credit risk support. We do not engage in leasing, hedging, research and development services, or other relationships that expose us to liability that is not reflected on the face of the consolidated financial statements. Operating Leases We did not renew our lease for the office space located at 2880 Zanker Road, San Jose, California 95134 in August 2020 and Neonode Inc. now operates solely through a virtual office in California. 26 On December 1, 2020, Neonode Technologies AB entered into a lease for 6,684 square feet of office space located at Karlavägen 100, Stockholm, Sweden. The lease agreement is valid through November 2022. It is extended on a yearly basis unless written notice is provided nine months prior to the expiration date. On December 1, 2015, Pronode Technologies AB entered into a lease agreement for 9,040 square feet of workshop located at Faktorvägen 17, Kungsbacka, Sweden. The lease may be terminated with nine months’ written notice before the termination date. We have three years remaining under this lease. In January 2015, our subsidiary Neonode Korea Ltd. entered into a lease agreement located at B-1807, Daesung D-Polis. 543-1, Seoul, South Korea. The lease was terminated on December 18, 2020 and we now operate solely through a virtual office in South Korea. On September 1, 2019 we entered into a lease of office space located at NishiShinjuku Takagi Building, 1203 NishiShinjuku, Shinjukuku, Tokyo, Japan. The lease is valid through August 31, 2021 and is extended on a yearly basis unless written notice is provided three months prior to the expiration date. For the years ended December 31, 2021 and 2020, we recorded approximately $661,000 and $585,000, respectively, for rent expense. Equipment Subject to Finance Leases In April 2014, we entered into a lease for certain specialized milling equipment. Under the terms of the lease agreement we are obligated to purchase the equipment at the end of the original six-year lease term for 10% of the original purchase price of the equipment. In accordance with relevant accounting guidance the lease is classified as a finance lease. The lease payments and depreciation period began on July 1, 2014 when the equipment went into service. On July 1, 2020 the lease contract was extended for one year. The implicit interest rate of the extended lease period is 9.85% per annum. Between the second and fourth quarters of 2016, we entered into six leases for component production equipment. Under the terms of five of the lease agreements we are obligated to purchase the equipment at the end of the original 3-5 year lease terms for 5-10% of the original purchase price of the equipment. In accordance with relevant accounting guidance the leases are classified as finance leases. The lease payments and depreciation periods began between June and November 2016 when the equipment went into service. The implicit interest rate of the leases is currently approximately 3% per annum. One of the leases is a hire-purchase agreement where the equipment is required to be paid off after five years. In accordance with relevant accounting guidance the lease is classified as a finance lease. The lease payments and depreciation period began on July 1, 2016 when the equipment went into service. The implicit interest rate of the lease is currently approximately 3% per annum. In 2017, we entered into a lease for component production equipment. Under the terms of the lease agreement the lease will be renewed within one year of the end of the original four-year lease term. In accordance with relevant accounting guidance the lease is classified as a finance lease. The lease payments and depreciation periods began in May 2017 when the equipment went into service. The implicit interest rate of the lease is currently approximately 1.5% per annum. In 2018, we entered into a lease for component production equipment. Under the terms of the agreement, the lease will be renewed within one year of the original four-year lease term. In accordance with relevant accounting guidance the lease is classified as a finance lease. The lease payments and depreciation periods began in August 2018 when the equipment went into service. The implicit interest rate of the lease is currently approximately 1.5% per annum. During 2021 we terminated one finance lease by purchasing the related equipment and extended one finance lease for an additional two years. Non-Recurring Engineering Development Costs On April 25, 2013, we entered into an Analog Device Development Agreement (the “NN1002 Agreement”) with Texas Instruments (“TI”), with an effective date of December 6, 2012, pursuant to which TI agreed to integrate our intellectual property into an ASIC. Under the terms of the NN1002 Agreement, we agreed to pay TI $500,000 of non-recurring engineering costs at the rate of $0.25 per ASIC for each of the first two million ASICs sold. As of December 31, 2021, we had made no payments to TI under the NN1002 Agreement. 27 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: ● licensing of our technology; ● purchases of our TSMs and AirBars; ● operating expenses; ● timing of our OEM customer product shipments; ● timing of payment for our technology licensing agreements; ● gross profit margin; and ● ability to raise additional capital, if necessary. As of December 31, 2021, we had cash of $17.4 million, as compared to $10.5 million as of December 31, 2020. Working capital (current assets less current liabilities) was $19.1 million as of December 31, 2020, compared to working capital of $10.4 million as of December 31, 2020. Net cash used in operating activities for the year ended December 31, 2021 was $7.7 million and was primarily the result of a net loss including noncontrolling interests of approximately $7.3 million. Cash used to fund net losses is offset by approximately $1.3 million in non-cash operating expenses, mainly comprised of depreciation, amortization and stock-based compensations. Accounts receivable and unbilled revenues decreased by approximately $434,000 as of December 31, 2021 compared to December 31, 2020. Inventory increased by approximately $1,440,000 as of December 31, 2021 compared to December 31, 2020. Accounts payable and accrued expenses decreased approximately $406,000 as of December 31, 2021 compared to December 31, 2020. Net cash used in operating activities for the year ended December 31, 2020 of $5.8 million was primarily the result of a net loss including noncontrolling interests of approximately $6.3 million. Cash used to fund net losses is offset by approximately $1.3 million in non-cash operating expenses, mainly comprised of depreciation, amortization and stock-based compensations. 28 Net cash provided by financing activities for the year ended December 31, 2021 was $14.6 million as was mainly the result of issuance of common stock, partly offset by principal payments on finance leases. Net cash provided by financing activities for the year ended December 31, 2020 was $13.6 million as was mainly the result of issuance of common stock, partly offset by principal payments on finance leases. For the years ended December 31, 2021 and 2020, we purchased $67,000 and $60,000, respectively, of fixed assets, consisting primarily of engineering equipment. Registered Direct Offering On October 21, 2021, we entered into a placement agency agreement with Pareto Securities Inc. and Pareto Securities AB pursuant to which we sold to certain Swedish and other European investors an aggregate of 1,808,000 shares of our common stock at a price of $7.75 per share in a registered direct offering that closed on October 26, 2021 (the “Offering”). We received net proceeds of approximately $13.1 million from the Offering after deducting placement agent fees and offering expenses. At-the-Market Offering Program On May 10, 2021, we entered into an At Market Issuance Sales Agreement (the “Sales Agreement”) with B. Riley Securities, Inc. (“B. Riley Securities”) with respect to an “at the market” offering program (the “ATM Facility”), under which we may, from time to time, in our sole discretion, issue and sell through B. Riley Securities, acting as sales agent, up to $25 million of shares of our common stock. Pursuant to the Sale Agreement, we may sell the shares through B. Riley Securities by any method permitted that is deemed an “at the market” offering as defined in Rule 415 under the Securities Act of 1933, as amended. B. Riley Securities will use commercially reasonable efforts consistent with its normal trading and sales practices to sell the shares from time to time, based upon instructions from us (including any price or size limits or other customary parameters or conditions we may impose). We will pay B. Riley Securities a commission of 3.0% of the gross sales price per share sold under the Sales Agreement. We are not obligated to sell any shares under the Sale Agreement. The offering of shares pursuant to the Sale Agreement will terminate upon the earlier to occur of (i) the issuance and sale, through B. Riley Securities, of all of the shares subject to the Sales Agreement and (ii) termination of the Sale Agreement in accordance with its terms. During the twelve months ended December 31, 2021, we sold an aggregate of 235,722 shares of common stock under the ATM Facility, resulting in net proceeds of approximately $1,984,000 after payment of commissions to B. Riley Securities and other expenses of $66,000. 29 Future Sources of Liquidity In the future, we may require sources of capital in addition to cash on hand to continue operations and to implement our strategy. If our operations do not become cash flow positive, we may be forced to seek equity investments or debt arrangements. Historically, we have been able to access the capital markets through sales of common stock and warrants to generate liquidity. Our management believes it could raise capital through public or private offerings if needed to provide us with sufficient liquidity. No assurances can be given, however, 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, no assurance can be given that stockholders will approve an increase in the number of our authorized shares of common stock if needed. The issuance of equity securities or securities convertible into equity could dilute the value of shares of our common stock and cause the market price to fall, and the issuance of debt securities could impose restrictive covenants that could impair our ability to engage in certain business transactions. The functional currency of our foreign subsidiaries is the applicable local currency, the Swedish Krona, the Japanese Yen, the South Korean Won and the Taiwan Dollar. They are 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, Japanese Yen, South Korean Won or Taiwan Dollar will impact our future operating results. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. 30