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NEOM - Neomedia Techs Inc
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ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
NeoMedia has positioned itself to pioneer 2D mobile barcode technology and infrastructure solutions that enable the mobile barcode ecosystem world-wide. We believe that our extensive intellectual property portfolio differentiates us from the competition. We strive to harness the power of the mobile phone in innovative ways with state-of-the-art mobile barcode technology. With this technology, mobile phones with cameras become barcode scanners and this enables a range of practical applications including consumer oriented advertising, mobile couponing, and business-to-business track and trace solutions. We offer barcode management and infrastructure, reader solutions and IP licensing, as well as mobile couponing products and services. Our direct customers include brand owners and agencies looking to offer innovative mobile barcode solutions to their customer base. Our globally focused indirect channel includes handset manufacturers, mobile marketing platform providers, mobile marketing agencies and value added resellers.
As reported in "eMarketer" (May 2011), the market for barcode services is rapidly developing in several regions around the world. The use of QR codes and other mobile action codes, including Microsoft Tags and 2D barcodes, grew 617% from January to December, 2011 in the Top 100 U.S. magazines, according to Nellymoser (January 2012). As companies of all sizes begin to recognize the economic potential of mobile barcodes, we continue to focus our efforts on positioning ourselves to take part in this rapidly expanding marketplace. We are focusing our sales activities primarily in the United States, Europe and Latin America and are expanding our business development activities, through partnerships, to markets in Africa and Asia Pacific.
In 2011, we focused on building a strong foundation which included strengthening the NeoMedia brand and helping to grow the industry through ongoing press relations and industry evangelization based on education and best practices as well as aligning the organization in terms of strategic focus and staffing. We will continue to focus on these same initiatives throughout 2012. We work closely with our customers to help ensure effective barcode implementations, increase their brand and consumer awareness and ultimately, drive the overall adoption of their mobile barcode initiatives. From our perspective, this evangelization activity has been successful and we believe that the NeoMedia brand is well positioned in the market. From a sales strategy perspective, we are pleased with the results of two of our strategic approaches. The first is the maximization of our patent portfolio through IP licensing, and the second is our two tiered sales focus on partnering with brands and agencies directly as well as partnering with key mobile marketing organizations to maximize the reach of our barcode management and infrastructure solutions.
NeoMedia has been active in, and strived to be an innovator in, the mobile barcode field since the mid-1990s, and during that time has spearheaded the development of a robust IP portfolio that encompasses many preferred mobile implementations. Our IP portfolio currently consists of seventy four issued and pending patents. We have always licensed our portfolio to others in the ecosystem; however, our current IP licensees have generated significantly less revenue for us than we had anticipated. As the market for mobile barcodes continues to grow and we are able to collect royalties from existing licensees, we believe that these revenues should increase significantly. In September 2011, we announced an agreement with Global IP Law Group to help further monetize our patent portfolio and lead the licensing of our IP, focusing on the US market. We were hopeful that our IP licensing activities would begin to show significant results, in the form of new IP licensees, beginning in the fourth quarter of 2011, but given the lengthy negotiation process, we anticipate that revenues from licenses will be delayed until the second and third quarters of 2012. We plan to continue our vigorous pursuit of litigation against entities that we believe are infringing our patents and we believe this will help to drive further IP licensing activities.
Our barcode management and infrastructure solution includes both our barcode reader (NeoReader) as well as our barcode infrastructure solutions (NeoSphere). We continue to enter into strategic agreements with mobile marketing agencies for our services. These companies typically represent brands and mobile technology solutions in Europe and the United States. Currently there are twenty-two signed agreements and we have been seeing increasing campaign activity through these partnerships with leading consumer brands. NeoMedia solutions are now used by a number of Fortune 500 brands in the United States and abroad through both our indirect and direct sales channels.
Mobile barcodes continued to be an increasingly important engagement tool for brands and marketers in Q1 2012. Our platform has generated more than 73,000 mobile barcodes for use in marketing and advertising campaigns worldwide and continues to climb. The scan growth rate from our NeoReader product was up over 138% over Q1-2011. For NeoSphere, 1D scanning growth from Q1-2011 to Q1-2012 increased 27% and 2D scanning growth increased over 212%. In Q1-2012, we saw scan activity from 194 countries. We continue to be faced with downward price pressure in the market given the fragmented competitive environment for mobile barcode solutions as well as the 'battle' between free and fee based solutions. NeoMedia will continue to differentiate itself on the basis of its high quality product and service offerings and intellectual property portfolio. The sales process for mobile barcodes is a consultative sales process and in most cases, organizations are seeking an end-to-end solution, including mobile websites, applications, rich media, etc. Accordingly, NeoMedia has extended its partner relationships in order to be able to offer its customers a full service solution. These sales cycles tend to be much longer and much more resource intensive.
NeoMedia continues to promote an open and interoperable approach to the market to empower the mobile ecosystem - and deploys a partial indirect (also called managed direct or DNS prefixed) solution for our customers.
NeoReader has also experienced continued growth in Q1-2012. With pre-install agreements with Sony Ericsson and Samsung Electronics Italy, as well as downloadable via our own website, http://get.neoreader.com, and the key "app stores" including Android, Apple, Blackberry, Nokia and Ovi, our reader now has a reach to over 20 million consumers. In the past twelve months, NeoReader downloads have increased 422% and we anticipate that this growth will continue as we improve our discoverability on the major app stores. Our reader is offered free of charge for consumers and we anticipate this growth in consumer utilization will continue and help encourage brand adoption of mobile barcodes. NeoMedia also offers NeoReader Enterprise and SDK for enterprise opportunities and is one of the few providers able to offer Aztec based solutions.
We will continue to look critically at our business to ensure that all business lines are effective and contributing to the ongoing success of NeoMedia. We will continue to attempt to maximize all revenue opportunities for our business in what we view as a time of market growth and opportunity, with a goal to get to self-sufficiency and profitability as soon as possible.
Management Changes
On January 3, 2012, the Board of Directors of the Company appointed James A. Doran as Chief Financial Officer and Corporate Secretary. On February 8, 2012, James A. Doran resigned from his position as Chief Financial Officer and Corporate Secretary of the Company.
On January 31, 2012, the Company finalized the removal process (that commenced on January 11, 2012) of Dr. Christian Steinborn from the position of Managing Director of NeoMedia Europe GmbH. Ms. Laura Marriott, our Chief Executive Officer, was appointed as the Managing Director of NeoMedia Europe GmbH.
On February 10, 2012, Colonel (Ret.) Barry S. Baer was appointed by the Board of Directors as Chief Financial Officer and Corporate Secretary of the Company. Colonel Baer is a based in the Company's Boulder, Colorado headquarters.
Comparison of the Three Months Ended March 31, 2012 and 2011
Results of Operations
We continue to focus on growing our patent licensing and barcode infrastructure business. During the three months ended March 2012 and 2011, our operating losses were $835,000and $1.4 million, respectively. Our net loss was ($165.5) million and net income was $8.8 million for the three months ended March 2012 and 2011, respectively. Our net income (loss) includes gains and losses from the change in fair value of our hybrid financial instruments, warrants and debentures. We incur these gains and losses principally as a result of changes in the market value of our common stock. During the three months ended March 31, 2012, we reported losses on our hybrid financial instruments, warrants and debentures, totaling ($162.3) and during the three months ended March 31, 2011, we reported gains on our hybrid financial instruments, warrants and debentures, totaling $10.9 million. Due to the volatility of our stock price during the three months ended March 31, 2012, changes in the fair value of our derivative liabilities have a material impact on our overall net income (loss) which makes quarter and annual comparisons difficult.
Revenues. Revenues for the three months ended March 31, 2012 and 2011, respectively, were $726,000 and $369,000, an increase of $357,000, or 97%. Our revenues and product mix have changed as a result of changes in our operations and business strategy. We are no longer detailing the line items of our product revenues in an effort to preserve competitive advantage; however, two business lines, IP licensing and 2D Core (NeoSphere and NeoReader), account for the bulk of our revenue.
Cost of Revenues. Cost of revenues was $22,000 for the three months ended March 31, 2012 compared with $238,000 for the three months ended March 31, 2011, a decrease of $216,000, or 91%. Research and development decreased as we optimized our team for barcode management and infrastructure development and reduced the resources for our hardware operation.
Sales and Marketing. Sales and marketing expenses were $205,000 and $316,000 for the three months ended March 31, 2012 and 2011, respectively, a decrease of $111,000, or 35%. We expect that our sales and marketing expense will increase as we continue to promote our business strategy and core technology.
General and Administrative.General and administrative expenses were $1,000,000 and $794,000 for the three months ended March 31, 2012 and 2011, respectively, an increase of $206,000, or 26%. G&A expenses increased as a result of legal fees and other related commitments.
Research and Development. Research and development expenses were $334,000 and $401,000 for the three months ended March 31, 2012 and 2011, respectively, a decrease of $67,000, or 17%. Research and development decreased as we optimized our team for barcode management and infrastructure development and reduced the resources for our hardware operation.
Loss from Operations. For the three months ended March 31, 2012 and 2011, respectively, our loss from operations was $835,000 and $1.4 million. This improvement was primarily the result of increased revenue and gross profit.
Gain (Loss) from Change in Fair Value of Hybrid Financial Instruments. We carry certain of our debentures at fair value, in accordance with FASB ASC 815-15-25, and do not separately account for the embedded conversion feature. The change in the fair value of these liabilities includes changes in the value of the accrued interest due under these instruments, as well as changes in the fair value of the common stock underlying the instruments. For the three months ended March 2012 and 2011, the liability related to these hybrid instruments fluctuated, resulting in a loss of $31.2 million and a gain of $2.5 million, respectively.
Gain (Loss) from Change in Fair Value of Derivative Liabilities - Warrants. We account for our outstanding common stock warrants that were issued in connection with the preferred stock and our debentures, at fair value. For the three months ended March 2012 and 2011, the liability related to warrants fluctuated resulting in a loss of $41.5 million and a gain of $1.8 million, respectively.
Gain (Loss) from Change in Fair Value of Derivative Liabilities - Series C and D Preferred Stock and Debentures. For our Series C and D preferred stock, and certain of our debentures, we account for the embedded conversion feature separately as a derivative financial instrument. We carry these derivative financial instruments at fair value. For the three months ended March 2012 and 2011, the liability related to the derivative instruments embedded in the Series C and D preferred stocks and these debentures fluctuated, resulting in a loss of $89.6 million and a gain of $6.7 million, respectively.
The changes in the fair values of our hybrid financial instruments and our derivative liabilities were primarily the result of fluctuations in the value of our common stock during the period. Because our stock price has been volatile and because many of our derivative financial instruments include relatively low fixed conversion or exercise prices, it is possible that further fluctuations in the market price of our common stock could cause the fair value of these instruments to increase or decrease significantly in future periods. The fair values of these instruments are subject to volatility so long as the preferred stock, debentures and warrants are outstanding. These instruments will no longer be volatile upon their conversion or exercise into common stock.
Interest Expense Related to Convertible Debt. Interest expense related to debentures that are carried at amortized cost and which are not carried as hybrid financial instruments at fair value was $2,392,000 and $753,000 for the three months ended March 31, 2012 and 2011, respectively. These fluctuations in interest expense were primarily the result of increased debenture financing outstanding during the three months ended March 2012 compared with the three months ended March 2011.
Net Income (Loss). As a result of the above, during the three months ended March 31, 2012 and 2011, we experienced a net loss of ($165.5) million and net income of $8.8 million, respectively. This change resulted primarily from losses in the fair value of our hybrid and derivative instruments during the three months ended March 31, 2012 compared with a gain in 2011.
Liquidity and Capital Resources
As of March 31, 2012, we had $294,000 in cash and cash equivalents, an increase of $264,000, compared with $30,000 as of December 31, 2011.
Cash used in operating activities decreased to $966,000 for the three months ended March 31, 2012 compared with $1.5 million for the period ended March 31, 2011, representing increased revenues and decreased operational expenses.
Cash used in investing activities was $3,000 and $4,000 for the three months ended March 31, 2012 and 2011, respectively, representing the purchase of equipment.
Cash provided by financing activities during the three months ended March 31, 2012 was $1.225 million, reflecting gross proceeds of $1,300,000 from three Secured Debentures issued to YA Global, net of $75,000 in structuring and due diligence fees.
Conversions of our preferred stock or debentures into common stock have a positive effect on our future liquidity. During the year ended December 31, 2011, investors converted 3,250 shares of Series C preferred stock, 11,050 shares of Series D preferred stock, and $2,099,689 of principal and accrued interest on the convertible debentures. These conversions reduced the carrying value of the debentures and the associated derivative financial instruments, the Series C and D preferred stock, the Debentures payable carried at fair value, and as a result, strengthened our balance sheet. During the three months ended March 31, 2012, investors converted 246 shares of Series C preferred stock, 4,058 shares of Series D preferred stock, and $1,643,180 of principal and accrued interest on the convertible debentures. These conversions have reduced the carrying value of the derivative financial instruments, the Series C and D preferred stock, the debentures payable carried at fair value, and the Series C and D convertible preferred stock, and as a result, have continued to strengthen our balance sheet.
Subsequent Event
On April 26, 2012, we entered into a Securities Purchase Agreement and issued and sold a secured debenture to YA Global in the principal amount of $450,000. The debenture is convertible at the option of the holder, at a conversion price equal to the lesser of (i) $0.10 or (ii) 95% of the lowest closing bid price of our common stock for the 60 trading days preceding the date of conversion. The stated maturity date of the debenture is July 29, 2012.
Going Concern - We have historically incurred net losses from operations and we expect that we will continue to have negative cash flows as we implement our business plan. There can be no assurance that our continuing efforts to execute our business plan will be successful and that we will be able to continue as a going concern. The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America ("US GAAP"), which contemplates our continuation as a going concern. Net income (loss) for the three months ended March 31, 2012 and 2011, respectively, was ($165.5) million and $8.8 million, of which ($162.3) million and $10.9 million, respectively, were net (losses)/gains related to our financing instruments. At March 31, 2012, we have an accumulated deficit of $410.8 million. We also have a working capital deficit of $234.7 million, of which $215.6 million is related to our financing instruments, including $103.4 million related to the fair value of warrants and those debentures that are recorded as hybrid financial instruments, and $112.2 million related to the amortized cost carrying value of certain of our debentures and the fair value of the associated derivative liabilities. Our working capital deficit also includes a continuing purchase price guarantee obligation of $4.5 million associated with an acquisition of a business in 2006, which we subsequently sold in 2007.
The items discussed above raise substantial doubt about our ability to continue as a going concern.
We currently do not have sufficient cash, or commitments for financing, to sustain our operations for the next twelve months. We will require additional financing in order to execute our operating plan and continue as a going concern. Our management's plan is to secure adequate funding to bridge the commercialization of our patent licensing and barcode ecosystem businesses. We cannot predict whether this additional financing will be in the form of equity, debt, or another form and we may not be able to obtain the necessary additional capital on a timely basis, on acceptable terms, or at all. In the event that these financing sources do not materialize, or that we are unsuccessful in increasing our revenues and profits, we may be unable to implement our current plans for expansion, repay our debt obligations as they become due or respond to competitive pressures, any of which circumstances would have a material adverse effect on our business, prospects, financial condition and results of operations. In the past we have entered into financing and investment agreements with YA Global. Should YA Global choose not to enter into any further financing arrangements with us as they have in the past, or if we do not find alternative sources of financing to fund our operations or if we are unable to generate significant product revenues, we may not have sufficient funds to sustain our current operations. Our debenture obligations to YA Global currently mature on July 29, 2012.
The financial statements do not include any adjustments relating to the recoverability and reclassification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.
Sources of Cash and Projected Cash Requirements -
As of March 31, 2012, our cash balance was $294,000. NeoMedia's past financing agreements with YA Global have certain ramifications that could affect future liquidity and business operations. For example, pursuant to the terms of the debenture agreements between us and YA Global, without YA Global's consent we cannot (i) issue or sell any shares of our Common Stock or our preferred stock without consideration or for consideration per share less than the closing bid price immediately prior to its issuance, (ii) issue or sell any preferred stock, warrant, option, right, contract, call, or other security or instrument granting the holder thereof the right to acquire our Common Stock for consideration per share less than the closing bid price immediately prior to its issuance, (iii) enter into any security instrument granting the holder a security interest in any of our assets or (iv) file any registration statements on Form S-8. In addition, pursuant to security agreements between us and YA Global, YA Global has a security interest in all of our assets. Such covenants could severely harm our ability to raise additional funds from sources other than YA Global, and would likely result in a higher cost of capital in the event we secured funding. Additionally, pursuant to the terms of the Investment Agreement between us and YA Global in connection with our Series C preferred stock, we cannot (i) enter into any debt arrangements in which we are the borrower, (ii) grant any security interest in any of our assets or (iii) grant any security below market price.
Critical Accounting Policies and Estimates
There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
May 15, 2012
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