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NEOMEDIA TECHNOLOGIES INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 14, 2014

Overview

NeoMedia has positioned itself to lead the world in mobile barcode technology and solutions that enable the mobile ecosystem. NeoMedia harnesses the power of the mobile device in innovative ways with state-of-the-art mobile barcode technology. With this technology, mobile devices with cameras become barcode scanners, enabling a range of practical applications including mobile marketing and mobile commerce. In addition, we offer licensing of our extensive intellectual property portfolio. We are focusing our activities primarily in the United States and Europe, although we are also active in other markets via partners or our self-service products.

Our key focus areas are to: 1) maximize our patent portfolio through IP licensing monetization and enforcement; 2) provide service to enterprises, brands and retailers to maximize the reach of our barcode creation and reader solutions; and, 3) partner with key mobile marketing entities to expand the depth of our offering to provide full end-to-end solutions for our customers.

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NeoMedia has been active in, and strives 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. In September 2011, we announced an agreement with Global IP Law Group to help further monetize our patent portfolio globally. During the second quarter of 2014, we closed thirteen (13) new IP agreements bringing the total quantity of agreements closed to over sixty (60). In addition, dozens of companies have retained NeoMedia for its QR creation and management services, as a result of our licensing activities.

On the product side of our business, our barcode management solutions include our barcode reader (NeoReader) as well as our barcode creation solutions (NeoSphere and QodeScan). Mobile barcodes continue to be an increasingly important activation element for brands and marketers and we continue to see growth in terms of new customer additions and traffic across our network.

We believe that NeoMedia remains strong and consistent in its approach to market and that we will continue to differentiate ourselves on the basis of our high quality product and service offerings, our responsive customer service and support organization, our customizable and full service solutions and our robust intellectual property portfolio.

NeoReader has experienced continued growth particularly in enterprise implementations. NeoReader continues to be pre-installed on Sony Mobile devices and is available for download from the key "app stores" including Apple App Store™, Google Play™, Nokia Ovi Store, BlackBerry App World™, Windows® Marketplace, Facebook and Amazon. Our barcode reader now has approximately 50+ million installations world-wide. Our reader is offered to consumers free of charge, leveraging an ad supported model. We anticipate the growth in consumer utilization will continue as barcodes continue to be utilized for a wide variety of vertical applications. We also offer NeoReader SDK for enterprise opportunities. Our research suggests that we are one of the few providers in the global ecosystem to offer Aztec code support, in addition to QR, Data Matrix, Code 39, PDF417 and a variety of 1D symbologies on iOS, Android and Windows Phone.

In 2013, we launched QodeScan, our low cost self-service barcode creation product. QodeScan is for those users who don't have high scan volumes but would like the insight into analytics that a managed service provides. In addition to QodeScan, we continue to offer our NeoSphere product intended for enterprises, agencies and other large volume users. We have many Fortune 500 brands using our NeoSphere product in their global barcode operations. Our QR creation services utilize an indirect methodology for our customers, which is also embodied in our intellectual property.

Legal costs continue to be high for us. The costs to maintain our public company status, to enforce our IP licensing initiatives and to satisfy our investor obligations continue to keep our legal fees high and account for approximately forty percent (40%) of total operating expenses for us in Q2-2014. We expect the significant legal expenditures to continue throughout 2014.

Results of Operations



Income (Loss) from Operations

The following table sets forth certain data derived from our condensed consolidated statements of operations (in thousands):

Three Months Six Months Ended Ended June 30, June 30 2014 2013 2014 2013 Revenues $ 654$ 1,667$ 1,657$ 2,269 Cost of revenues (87 ) (269 ) (245 ) (300 ) Gross profit 567 1,398 1,412 1,969 Sales and marketing expenses (40 ) (47 ) (55 ) (108 )



General and administrative expenses (742 ) (665 ) (1,345 ) (1,522 ) Research and development costs

(145 ) (172 ) (322 ) (384 ) Other Operating Income - 227 - 227



Income (loss) from operations $ (360 )$ 741$ (310 )$ 182

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Revenue. Revenues for the three months ended June 30, 2014 and 2013 were $654,000 and $1,667,000, respectively, a decrease of $1,013,000, or 61%. Revenues for the six months ended June 30, 2014 and 2013 were $1,657,000 and $2,269,000, respectively, a decrease of $612,000, or 27%. The decrease in revenue is primarily attributed to a lesser focus on sales given other internal projects related to the merger and ongoing litigation activities.

Cost of Revenues. Cost of revenues was $87,000 for the three months ended June 30, 2014 compared with $269,000 for the three months ended June 30, 2013, a decrease of $182,000, or 68%. Cost of revenues was $245,000 for the six months ended June 30, 2014 compared with $300,000 for the six months ended June 30, 2013, a decrease of $55,000 or 18%. Cost of revenues primarily relate to third-party professional fees incurred in connection with the sale of our IP licenses. The decrease in the costs are due to the corresponding decrease in IP licensing revenues.

Sales and Marketing. Sales and marketing expenses were $40,000 and $47,000 for the three months ended June 30, 2014 and 2013, respectively, a decrease of $7,000, or 15%. Sales and marketing expenses were $55,000 and $108,000 for the six months ended June 30, 2014 and 2013, respectively, a decrease of $53,000 or 49%. The decrease in sales and marketing expenses related to our participation at a few key industry events held in May 2013 . We expect sales and marketing expenses will stay at current 2014 levels.

General and Administrative.General and administrative expenses were $742,000 and $665,000 for the three months ended June 30, 2014 and 2013, respectively, an increase of $77,000, or 12%. General and administrative expenses were $1,345,000 and $1,522,000 for the six months ended June 30, 2014 and 2013, respectively, a decrease of $177,000 or 12%. The prior year's quarter general and administrative expenses were unusually low due to certain cost reduction activities during the period. General and administrative expenses also increased during the second quarter of 2014 due to higher public company costs incurred in connection with our merger as well as higher legal fees associated with litigation activities.

Research and Development.Research and development expenses were $145,000 and $172,000 for the three months ended June 30, 2014 and 2013, respectively, a decrease of $27,000, or 16%. Research and development expenses were $322,000 and $384,000 for the six months ended June 30, 2014 and 2013, respectively, a decrease of $62,000 or 16%. Research and development expenses decreased due to cost containment efforts.

Other Income (Expenses)



The following table sets forth certain data derived from our condensed consolidated statements of operations (in thousands):

Three Months Six Months Ended June 30, Ended June 30, 2014 2013 2014 2013 (Restated) (Restated) Gain(loss) from change in fair value of hybrid financial instruments $ (628 )$ (433 )$ (1,173 )$ 24,054 Gain from change in fair value of derivative liability - warrants 207 258 580 3,424 Gain (loss) from change in fair value of derivative liability - Series C and D preferred stock and debentures 107 55 244 1,998 Interest income - 16 - 16 Gain on extinguishment of debt 4,247 - 4,247 - Total other income $ 3,933$ (104 )$ 3,898$ 29,492 Page 21



Gain (Loss) on Extinguishment of Debt. During the second quarter of 2014, we modified and consolidated our outstanding debentures resulting in a $4,247,000 gain on extinguishment.

Gain (Loss) from Change in Fair Value of Hybrid Financial Instruments. We carry certain of our debentures at fair value in accordance with the applicable accounting codification 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 June 30, 2014 and 2013, the liability related to these hybrid instruments fluctuated, resulting in a loss of $628,000 and a loss of $433,000, respectively. For the six months ended June 30, 2014 and 2013, the liability related to these hybrid instruments fluctuated, resulting in a loss of $1,173,000 and a gain of $24,054,000, 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 our preferred stock and our debentures, at fair value. For the three months ended June 30, 2014 and 2013, the liability related to these instruments fluctuated, resulting in gains of $207,000 and $258,000, respectively. For the six months ended June 30, 2014 and 2013, the liability related to warrants fluctuated resulting in gains of $580,000 and $3,424,000, 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 June 30, 2014 and 2013, the liability related to these hybrid instruments fluctuated, resulting in a gain of $107,000 and a gain of $55,000, respectively. For the six months ended June 30, 2014 and 2013, the liability related to the derivative instruments embedded in the Series C and D Preferred Stock and these debentures fluctuated, resulting in a gain of $244,000 and a gain of $1,998,000,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 as well as changes in the terms of the related security agreements. Because our common 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.

Other Comprehensive Income (Loss).For the three months ended June 30, 2014 and 2013, other comprehensive losses were $0 and $22,000, respectively. For the six months ended June 30, 2014, other comprehensive gains were $0 as compared to other comprehensive gains of $133,000 for the six months ended June 30, 2013. The other comprehensive gains and losses were due to the impact of fluctuations in currency exchange rates associated with our translation of the NeoMedia Europe GmbH subsidiary financial statements from its local currency, the Euro, to U.S. dollars. As discussed above, we determined during the third quarter of 2013 that the functional currency of the foreign subsidiary changed to the U.S. dollar and as a result of the change in functional currency, translation gains and losses associated with the conversion of the NeoMedia Europe GmbH financial statements are recorded in our results from operations rather than through other comprehensive income (loss), effective July 1, 2013.

Liquidity and Capital Resources

As of June 30, 2014, we had $64,000 in cash and cash equivalents compared with $267,000 as of December 31, 2013. Cash used in operating activities was $197,000 for the six months ended June 30, 2014 compared with $875,000 used in operations for the six months ended June 30, 2013.

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Payments on short-term notes payable within cash flows from financing activities reflects disbursements for opportunistic low interest rate borrowings that occurred in 2013 and 2014 in order to pay annual insurance premiums.

Going Concern. We have historically incurred operating losses, and we may continue to generate negative cash flows as we implement our business plan. There can be no assurance that our continuing efforts to execute on our business plan will be successful and that we will be able to continue as a going concern. The accompanying condensed consolidated financial statements have been prepared in conformity with US GAAP, which contemplates our continuation as a going concern given fair value accounting related to our debentures. Our net income for the three months ended June 30, 2014 was $3.6 million, compared to a net income of $637,000 for the three months ended June 30, 2013, including $3.9 million of gains and $29.5 million of gains, respectively, related to our financing instruments.

Net cash used by operations during the six months ended June 30, 2014 was $197,000 as compared to net cash used in operations of $875,000 during the six months ended June 30, 2013. As of June 30, 2014, we have an accumulated deficit of $233.3 million. We also have a working capital deficit of $37.4 million, including $35 million in current liabilities for our derivative and debenture financing instruments.

We currently do not have sufficient cash or commitments for financing to sustain our operations for the next twelve months if we are unable to generate sufficient cash flows from operations. Our plan is to develop new client and customer relationships and substantially increase our revenue derived from our products/services and IP licensing. If our revenues do not reach the level anticipated in our plan, we may require additional financing in order to execute our operating plan. If additional financing is required, 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 financing sources are not available, 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 or respond to competitive pressures, any of which would have a material adverse effect on our business, prospects, financial condition and results of operations.

The convertible debentures and preferred stock used to finance the Company, which may be converted into common stock at the sole option of the holders, have a highly dilutive impact when they are converted, greatly increasing the number of shares of common stock outstanding. During the six months ended June 30, 2014, there were 155 million shares of common stock issued for these conversions. We cannot predict if or when each holder may or may not elect to convert into shares of common stock.

Our 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 June 30, 2014, our cash balance was $64,000. The Company'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.

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Critical Accounting Policies and Estimates

The significant accounting policies set forth in Note 2 to our audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2013, as updated by Note 2 to the Unaudited Condensed Consolidated Financial Statements included herein, and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2013, appropriately represent, in all material respects, the current status of our critical accounting policies and estimates, the disclosure with respect to which is incorporated herein by reference.


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Source: Edgar Glimpses


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