Earnings Call Transcript - NEON Q3 2020

Operator, Operator

Hello, everyone. Thank you for standing by, and welcome to Neonode’s Third Quarter 2020 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session with the company’s covering analysts. At this time for opening remarks and introduction, I would like to turn the call over to David Brunton, Neonode’s Head of Corporate Investor Relations. David, please go ahead and start the conference.

David Brunton, Head of Corporate Investor Relations

Welcome and thank you for joining us. On today’s call, we will review our third quarter 2020 financial results and provide a corporate update. Our update will include details of customer activities, technology developments, and other items of interest. Before turning the call over to our CEO, Dr. Urban Forssell, and CFO, Maria Ek, I would like to make the following remarks concerning forward-looking statements. All statements in this conference call other than historical facts are forward-looking statements, the words anticipate, believe, estimate, expect, tend, will, guide, confidence, targets, projects, and other similar expressions typically are used to identify forward-looking statements. These forward-looking statements do not guarantee the future performance that may involve or be subject to risks, uncertainties, and other factors that may affect Neonode’s business financial position and other operating results which include but are not limited to the risk factors and other qualifications contained in Neonode’s annual report on 10-K, quarterly reports on 10-Q, and other reports filed by Neonode with the SEC to which your attention is directed. Therefore, actual outcomes and results may differ materially from what is expected or implied by these forward-looking statements. Neonode expressly disclaims any intent or obligation to update these forward-looking statements. At this time, it is my pleasure to turn the call over to Urban. Urban, please go ahead.

Urban Forssell, CEO

Thank you, Dave, and welcome to this call. I will review with you today, some strategy and business updates. After this, I will turn over to Maria for some financial details about this third quarter. To start off the strategy presentation, I want to reiterate that at the beginning of this year, we organized our business into three separate business areas. We call them HMI products, HMI solutions, and remote sensing solutions. In this call, I will talk a little bit about each one of them and give you some insights into both the strategy and the current business activities that we have. HMI stands for Human Machine Interface. Those of you that have followed me for the last 10 or 12 years know that this has been the key focus for our business leading up to 2020. It still continues to be very important. That’s why HMI products and HMI solutions are both focusing on these areas. In HMI products, we sell our standardized sensor modules for contactless touch, touch, and gesture sensing. The focus there is on customers in the elevator and interactive kiosk segments. HMI solutions is the separate business where we focus on customized engineering solutions made for touch and gesture sensing at this point. The focus is on customers in the military, avionics, and industrial segments. Remote sensing solutions is a software business for us, where we focus on driver and in-cabin monitoring. In terms of customers, we are targeting OEM and Tier 1 suppliers in the automotive space in Europe, North America, and Asia, respectively. This is an introduction, and I would like to reiterate that Neonode works with two main technology platforms, one of them called zForce that underpins our touch and gesture sensing technologies. Contactless touch, which you will hear us talking about in this call, is a very hot and sought-after technology solution that we can provide to customers who want to avoid touching keypads and displays in public spaces, particularly focused due to the COVID-19 pandemic. Our software platform multisensing underpins our offerings for driver and cabin monitoring. For driver monitoring, the objective is often to monitor and detect drowsiness and distraction with drivers. In-cabin monitoring is more focused on occupancy and situational context monitoring inside the vehicle, including passengers and objects in the passenger compartment. In this review, I will start to talk about the business area of HMI solutions, where we offer customized touch and gesture control solutions for demanding customers in the military, avionics, and industrial segments. This solution business focuses on 100% bespoke solutions that we adapt to each customer's specific needs and each application. We offer scalable solutions, and this business is based on a consultative long-term relationship approach. We are leveraging our advanced zForce technology, which offers cost-effective touch and gesture control, good electromagnetic interference (EMI) and electromagnetic compatibility (EMC) properties. We have very good functional performance, good quality, and low latency. We can also operate for military applications with night vision systems frequently used in helicopters and aircraft as well as on ground vehicles that we are looking at today. This slide illustrates the types of applications we deal with. Touch on displays or touch on other surfaces is often in demanding environments and rugged applications where operators would like to have a touch operation of a system or a display function, allowing them to use gloved hands or stylus pens to control the underlying system. We can also, with our infrared-based technology, offer touch on any surface: not only on displays but also on glass windows, walls, tables, and more. A strong offering that we have, which is important in medical applications, is that we do not deteriorate the image quality of the underlying display, which is sometimes crucial for examining X-ray images. We have two main variants of our zForce technology. One is blocking technology; the working principle is that on two sides, we have light-emitting diodes, and on the opposing side, we have photodiodes receiving these infrared light beams. If you place a finger or an object, you will break one or more of these light beams, which can be detected, hence detecting the touch. This is the simplest way I can explain our zForce blocking technology. We also work with a second variation we call reflective technology, where we have one-sided sensor elements that emit infrared light and detect reflections from objects in that light field. By clever arrangement of the light-emitting diodes and the photodiodes, and use of advanced optical lenses, we can accurately position objects in that three-dimensional light field. This field can be hovering above a display or any other surface, allowing us to develop in-air touch or gesture sensing applications. We are focusing on military, avionics, and industrial segments. These are two very interesting and large markets that grow steadily every year. We believe we have significant opportunities in these two segments, which have not been the focus for Neonode until this year. We are seeing about the segmentation and sub-segmentation; military avionics, if you consider that defense is roughly one-third of the total volume, and civilian aircraft accounts for two-thirds. The 150K units we estimate may not sound like much, but typically in military and avionics, the budgets for development and the average sales price for display units with touch is quite high, making it a very interesting segment for us to operate. The industrial segment is larger in terms of volume as well as turnover; it's fragmented but is still a compelling opportunity for us. As for printers and automotive applications, they are not our main focus, but we will continue to work in those legacy segments in a more opportunistic way compared to military, avionics, and industrial where we aim for a stronger focus going forward. Given the interesting market size and growth potential, we believe we can achieve good growth in these segments. Combined, they have a substantial technical overlap so we estimate that we can reuse the same type of solutions for both military avionics and industrial segments. Typically, the customer base consists of large companies, and around 85% of the largest companies in these two segments are based in the U.S. This justifies our increasing presence and focus on the U.S. market. Turning to HMI products, we continue our work with HMI, focusing on human-machine interaction utilizing infrared technology for contactless touch and gesture sensing. Our offering is based on standardized sensor modules produced in our subsidiary in Sweden, delivered directly or indirectly to our customers via distributors. This is a more classical product business where we sell products, which typically have a higher average sales price compared to our HMI solutions business, which is more of a licensing model. These sensor modules that we offer are easy to integrate and well suited for retrofit applications and new OEM designs, offering great design freedom while maintaining high accuracy and performance. With the COVID-19 pandemic, we recognized that our technology was well suited to address the challenges caused by the pandemic, particularly concerning avoiding physical touch on displays and keypads in public spaces such as airports, shopping malls, or hotels. We have the technology and the products, and our order book continues to grow each week as more companies express interest in purchasing these products. Shown in the pictures here are examples of applications we've developed with our value-added partners addressing the contactless touch challenge. It's important that we articulate that with contactless touch, we can utilize our sensors to project a light field on the surface or in the air, creating what we call a parallel plane configuration where an invisible infrared light field can detect fingers pointing without requiring physical contact. Another main alternative is to work with holographic displays, and we are collaborating with several companies involved in developing and selling holographic displays. By using our sensor modules, it is possible to interact with the hovering images projected into mid-air. We see the biggest opportunities for our solution in interactive kiosks and elevators, which are both promising markets due to massive installed bases and strong growth forecasts. The elevator market, for instance, has close to 20 million units with strong growth, which fuels demand for retrofit as well as new equipment. Our work with interactive kiosks spans across various segments including vending machines, point-of-sale systems in fast food restaurants, coffee machines, ATMs, and self-service kiosks at airports, train stations, etc. So, in closing, Neonode is very much focused on contactless touch for both elevators and interactive kiosks, with significant opportunities in both sectors.

Maria Ek, CFO

Thanks, Urban. You can find our third quarter earnings release and 10-Q available for download from the investors section of our website at neonode.com. I'd like to start with a summary of the quarter. Revenues are up by $0.2 million compared to the same quarter in 2019. This growth is driven by sales of sensor modules, which were licensed for nearly 15 years. Our operating expenses are higher than planned for the quarter, at $3.0 million compared to $2.4 million in the same quarter of 2019. However, on a performance basis, removing one-time costs, our operating expenses for the third quarter 2020 were similar to those of 2019. Due to these factors, our operating loss increased by $3.6 million compared to the same quarter in 2019. We reported net revenues of $1.5 million for the third quarter of 2020, which is an increase of 14.1% from the comparable quarter last year and nearly double compared to the second quarter this year. Our revenues from our solutions business consist almost exclusively of our license fees and were $1.2 million during the third quarter of 2020 as well as in 2019. However, revenues related to automotive have increased from $0.4 million to $0.5 million, while revenues on consumer electronics decreased from $0.8 million to $0.7 million. We are observing generally lower license revenues due to slower sales in global markets related to the COVID-19 pandemic. The increase in automotive revenues is a positive development related to a customer project that was completed a couple of years ago, which went into production in 2020 and is expected to remain in production for at least five years. In the third quarter of 2020, our customers licensed our technology to ship 1.7 million devices with an average licensing fee of $0.69, totaling more than 77 million devices with Neonode technology sold to date. In our HMI client business area, we have seen an increased number of product sales in the third quarter with revenues of $0.3 million compared to $0.1 million in the same period last year. Most of these product sales were through our partners in the U.S. and China. As of the end of September, we had a backlog of $0.5 million with planned shipments within the next three quarters. We continue to receive new purchase orders for new product shipments, which has led to increased manufacturing activities to meet this demand. Our gross margin for sales was 87% for the third quarter 2020 compared to 95% in the same period of 2019. The decrease is due to an increase in higher product sales and gross margins ranging from 30% to 50% in 2020 compared to 100% gross margin we achieved in 2019. We expect these trends to continue as our sensor module sales increase as a percentage of total revenues. Operating expenses increased by 25% to $3.7 million for the third quarter 2020 compared to 2019, mostly due to one-time costs, although partially offset by lower payables and reduced travel. Excluding the one-time costs, our operating expenses would have decreased by 2%. Financial results for the third quarter show a loss of $1.7 million or $0.16 per share compared to a net loss of $1.5 million or $0.12 per share for the third quarter of 2019. If you exclude one-time costs, our net loss for the third quarter would have been $1.1 million or $0.11 per share. Net cash used in operating activities during the third quarter of 2020 increased by $0.4 million compared to the same period last year, primarily due to the increased net loss. We had cash and accounts receivables of $30.3 million at the end of September, which we believe is sufficient capital to position the company to capture the growing customer demand across all our business units. With that, I would like to hand back over to Urban for closing remarks.

Urban Forssell, CEO

Thank you, Maria. In closing this presentation, I would love to highlight a few points here. First of all, our zForce technology, which Neonode has been developing since the mid-2000s, is very well patent-protected and positions us ideally to address lifestyle shifts towards contactless touch solutions brought on by COVID-19. In comparison to other companies that are trying to exploit the surge in demand for contactless solutions, we have existing improvement and ready technology. We are ramping up production and seeing increased demand, believing there is an enormous market opportunity for this both in new retrofit equipment. We are focusing on the two very large segments, interactive kiosks and elevators, with a global reach in North America, Europe, and Asia. We will continue to engage in these markets in the coming quarters and years. This is an exciting time for us, and we continue to build orders for these products. Additionally, we are seeing significant interest in our zForce and multisensing technologies from customers in avionics and industrial control systems as well as the automotive industry. In summary, we believe we have a strong position and good future in all three business areas. We also have adequate cash resources due to the private placements completed in August to grow and accelerate. The focus for us over the next 12 to 18 months is clearly on execution, with expectations of improving both in top line and bottom line in future calls. This concludes our presentation, and I would now like to open up for questions from our analysts. Dave, I will pass it to you.

David Brunton, Head of Corporate Investor Relations

Okay. So, Christy, you want to open it up for questions.

Operator, Operator

You have a question from Viktor Westman of Redeye.

Viktor Westman, Analyst

You've been doing quite a rebuild of the organization around them. And I just wanted to ask here, how long do you think it will take before we see some effects from this transformation and the changes, and what are the first effects we will see?

Urban Forssell, CEO

Yes, we are actually rebuilding Neonode from the outside in and inside out. We are undergoing quite a significant overhaul, but of course, we are trying to do it in a sensible way and step by step. During the second quarter, we made two strong additions to our team, Johan Swartz and Jonas Waern, who head up our business units for HMI products and HMI solutions, respectively. They are already starting to make an impact on our business and strategy. They've been working to expand our sales force and partner network that I mentioned. Recently, Mr. Atsushi Ishii joined us as the new VP of Engineering, though it is too early for him to make a strong impact. I expect that he, together with Johan and Jonas and the rest of our team, will have an increasingly strong and clear impact on our business and strategy moving forward. So we are quite excited about these new additions. I also want to add that we have hired two senior salespeople, one in the U.S. focusing on military and avionics markets, and another in Europe focusing more on industrial and elevator segments. Both have over 20 years in relevant industries. While this transformation may take a couple of years, we are making efforts to shorten that timeframe by leveraging our scalable platforms and reusing much of our design and development to aid customers in getting their products to market faster. Our technology and experience in touch and gesture sensing applications enable us to do just that.

Viktor Westman, Analyst

You mentioned the military market, and it seems to be moving really fast compared to automotive. Can you say if there is a way to speed up the process of arriving at substantial sales in this segment?

Urban Forssell, CEO

Indeed, while we continue to work with automotive customers, we are actively targeting military customers, as well as others in industries where the sales cycles are long. We have openly communicated that the transformation we are embarking on will take some time—perhaps a couple of years. However, we strive to shorten this timeframe by utilizing our scalable platforms and reusing many designs and developments, which can help our customers get to market faster. This approach adds value for these customers, allowing us to expedite processes compared to their normal development timelines.

Viktor Westman, Analyst

In the industrial segment, can you elaborate on what you mean? Are you referring to rugged environments? Can you provide some examples?

Urban Forssell, CEO

Yes, we view two sweet spots within rugged industrial applications. Firstly, this refers to factory environments involving production halls where there may be moisture, oil in the air, dust, and also outdoor applications that need to function during wintertime, in both hot and cold weather conditions. The second spot involves kiosks and elevators; here we can expect larger OEM customers to seek more bespoke solutions tailored to their products. We aim to capitalize on such opportunities within HMI solutions.

Viktor Westman, Analyst

Can you give us a brief update on the pilot for fixed retailers with the major self-service kiosk manufacturer? They had a rather aggressive rollout plan.

Urban Forssell, CEO

Yes, our customer in this case is a leading player in the interactive kiosk market with a worldwide reach. They are quite committed to pushing ahead with their aggressive plans. Currently, they are receiving positive feedback from a large retail chain operating in South America. They are also working with various chains in North America and parts of Asia-Pacific. While I do not have more substantive news to share at this point, we remain optimistic about the situation as solutions have passed various internal approval stages at our customers, and we expect growth to be gradual. The rollout is likely to continue one by one over the next quarters, but the overall feedback is encouraging.

Viktor Westman, Analyst

Lastly, regarding competition—what alternative technologies do you see in the elevator and kiosk markets? There seems to be a lot of radar or time-of-flight sensors in the market.

Urban Forssell, CEO

In the market for kiosks and ATMs, I consider mobile phone apps a significant competitor as an alternative technology. There is a fragmented market where some use capacitive sensors that react a few millimeters out, but we believe our solution is more straightforward and effective compared to capacitive solutions. Other companies are developing camera-based 3D gesture sensing and potentially utilizing radar and voice controls. Our infrared-based system provides a compelling, simple, and intuitive solution without interfering with underlying displays or keypads, making it perfect for retrofits and easy integration into new products. In elevators, I know some OEMs are promoting mobile apps, but it can be less intuitive for users. Pulling up an app in a public building can be cumbersome; thus, our direct solutions provide a more user-friendly experience. Thank you, and thank you everyone for joining. We will publish the slide deck from this presentation on our website later today at neonode.com. I also want to mention that there is an appendix with references to market data used to build the diagrams and pie charts shown during this presentation. If you're interested, please visit neonode.com later today to see the slide deck from this presentation. Thank you very much, and we hope to see you again for our fourth quarter call beginning next year.

Operator, Operator

Thank you. This does conclude today's conference call. You may now disconnect.