Inventories – Inventories are stated at the lower of cost or market and were comprised of barcode-reading equipment at our NeoMedia Europe location.  Cost is determined using the first-in, first-out method.

 

		As of December 31,
		2008				2007
		(in thousands)
Raw material		$	61			$	59
Finished goods			137				218
Work in process			-				1
Total			198				278
Less: reserve for slow-moving and obsolete inventory			(81	)			(80	)
Total Inventory, net of reserves		$	117			$	198

 

Goodwill – Goodwill consists of the excess of the purchase price paid for NeoMedia Europe over the fair value of the identifiable net assets and liabilities acquired, based on an independent appraisal of the assets and liabilities acquired. In accordance with FAS 142, “Goodwill and Other Intangible Assets,” goodwill is no longer amortized, but is tested for impairment, at least annually, by applying the recognition and measurement provisions of FAS 142, which compare the carrying amount of the asset to its fair value. If impairment of carrying value based on the calculated fair value exists, we measure the impairment through the use of projected discounted cash flows.

 

Other Intangible Assets – Intangible assets acquired as part of a business combination are accounted for in accordance with FAS 141, “Business Combinations,” and are recognized apart from goodwill if the intangible asset arises from contractual or other legal rights or the asset is capable of being separated from the acquired enterprise.  Intangible assets are reviewed for impairment by applying the recognition and measurement provisions of FAS 142, which compare the carrying amount of the intangible asset to its fair value.  If the carrying amount exceeds fair value, an impairment loss is recognized.  Intangible assets are amortized, using the straight-line method, over the estimate of their period of benefit of five to seventeen years.  Other intangible assets consist of patents, customer contracts, copyrighted material, acquired software products, and brand names which are amortized straight-line over the expected life of each asset. The estimated service lives of other intangible assets are as follows:

 

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Capitalized patents	5 - 17 years
Customer contracts	5 years
Copyrighted materials	5 years
Acquired software products	7 years
Brand names	10 years

 

Evaluation of Long-Lived Assets – We periodically perform impairment tests on each of our intangible assets, which include goodwill, capitalized patent costs, customer base and trademarks, and capitalized and purchased software costs.  In doing so, we evaluate the carrying value of each intangible asset with respect to several factors, including historical revenue generated from each intangible asset, application of the assets in our current business plan, and projected cash flow to be derived from the asset.

 

The determination of the fair value of certain acquired assets and liabilities is subjective in nature and often involves the use of significant estimates and assumptions. Determining the fair values and useful lives of intangible assets especially requires the exercise of judgment.  Where practicable, we will obtain an independent valuation of intangible assets, and place reliance on such valuation.  Then on an ongoing basis, we use the weighted-average probability method outlined in FAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,”  to estimate the fair value. This method requires significant management judgment to forecast the future operating results used in the analysis. In addition, other significant estimates are required such as residual growth rates and discount factors. The estimates we have used are consistent with the plans and estimates that we use to manage our business, based on available historical information and industry averages. The judgments made in determining the estimated useful lives assigned to each class of assets acquired can also significantly affect our net operating results.

 

According to FAS 144, a long-lived asset should be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. We follow the two-step process outlined in FAS 144 for determining if an impairment charge should be taken: (1) the expected undiscounted cash flows from a particular asset or asset group are compared to the carrying value; if the expected undiscounted cash flows are greater than the carrying value, no impairment is taken, but if the expected undiscounted cash flows are less than the carrying value, then (2) an impairment charge is taken for the difference between the carrying value and the expected discounted cash flows.  The assumptions used in developing expected cash flow estimates are similar to those used in developing other information used by us for budgeting and other forecasting purposes.  In instances where a range of potential future cash flows is possible, we use a probability-weighted approach to weigh the likelihood of those possible outcomes.  For purposes of discounting cash flows we use a discount rate equal to the yield on a zero-coupon US Treasury instrument with a life equal to the expected life of the intangible asset or asset group being tested.

 

We recognized impairment charges of $0.3 million and $3.1 million during the years ended December 31, 2008 and 2007, respectively as a result of writing down the carrying value of our long-term investments to their net realizable value.

 

Property, Plant and Equipment – Property, plant and equipment, including software, are stated at cost less accumulated depreciation and amortization.  The straight-line depreciation method is used for property, plant, and equipment over the estimate of their useful lives. Changes in technology or changes in the intended use of property, plant, and equipment may cause the estimated period of use or the value of these assets to change.  Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable.  Estimates and assumptions used in both setting depreciable lives and testing for recoverability require management judgment.  Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the improvement.  Gains and losses related to the retirement or disposal of fixed assets are recognized in the period in which the transaction occurred.  The cost of normal maintenance and repairs is charged to operations as incurred.  Material expenditures, which increase the life of an asset, are capitalized and depreciated over the estimated remaining life of the asset.  The estimated service lives of property and equipment are as follows:

 

Furniture and fixtures	7 years
Equipment	3 - 5 years

 

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Fair-valued Financial Instruments – Fair value measurement requirements are embodied in certain accounting standards applied in the preparation of our financial statements. The most significant application is in connection with our Convertible Preferred Stock, Convertible Debentures and Warrants, where we determine the fair value of certain hybrid instruments carried at fair value under FAS 155 and certain derivative liabilities which are recorded at fair value under FAS 133. See Note 5 for further information regarding the accounting treatment of our financing instruments.  In applying FAS 157 to the determination of fair values, we do not believe that the amounts would have been materially different than those reflected in our consolidated financial statements under previous standards.

 

Shipping and Handling Costs – Shipping and handling costs are passed through to our customers, and are recorded as revenue with the associated costs recorded as cost of goods sold.

 

Research and Development – Costs associated with the planning and designing phase of software development, including coding and testing activities, and related overhead, necessary to establish technological feasibility of our internally-developed software products, are classified as research and development and expensed as incurred.

 

Stock Based Compensation – FAS 123R “Share-Based Payment”, requires that all stock-based compensation be recognized as an expense in the financial statements and that such cost be measured at the grant date fair value of the award.

 

We record the grant date fair value of stock-based compensation awards as an expense over the vesting period of the related stock options.  In order to determine the fair value of the stock options on the date of grant, we use the Black-Scholes-Merton option-pricing model.  Inherent in this model are assumptions related to expected stock-price volatility, option life, risk-free interest rate and dividend yield.  Although the risk-free interest rates and dividend yield are less subjective assumptions, typically based on factual data derived from public sources, the expected stock-price volatility, forfeiture rate and option life assumptions require a greater level of judgment which make them critical accounting estimates.

 

We use an expected stock-price volatility assumption that is based on historical volatilities of the underlying stock which is obtained from public data sources.  With regard to the weighted-average option life and forfeiture rate assumptions, we consider the behavior of past grants.

 

Income Taxes – We account for income taxes under the provisions of FAS 109, “Accounting for Income Taxes”, which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statement or tax returns.  Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the difference is expected to reverse.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.  We have recorded a 100% valuation allowance as of December 31, 2008 and 2007.

 

Beginning January 1, 2007, we adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN 48”). The Interpretation prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. See Note 10 to our Consolidated Financial Statements for discussions of our implementation of FIN 48.

 

Translation of Foreign Currency – The U.S. dollar is the functional currency of our operations, except for our operations at NeoMedia Europe, which use the Euro as their functional currency.  Foreign currency transaction gains and losses are reflected in income.  Translation gains and losses arising from translating the financial statements of NeoMedia Europe into U.S. dollars for reporting purposes are included in “Accumulated other comprehensive income (loss).”

 

Reclassifications  – Due to the completed divestitures of 12Snap, Telecom Services, and Micro Paint Repair during 2007 and 2008, results of operations from these units have been reclassified under the caption “Discontinued Operations” for all periods shown in the accompanying consolidated statement of operations, and prior year assets and liabilities relating to these business units are combined into the captions “Assets held for sale” and “Liabilities held for sale,” respectively, in the accompanying consolidated balance sheets.

 

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Note 3 -  Discontinued Operations

 

MPR, Mobot, Sponge, 12Snap, and Telecom Services Businesses – During August 2006, we decided to sell our Micro Paint Repair business unit; this sale was completed on November 15, 2007.  In the fourth quarter of 2006, we disposed of two subsidiaries, Mobot and Sponge, including all assets and liabilities associated with these two subsidiaries.  During the first quarter of 2007, we decided to sell our remaining non-core business units, including 12Snap and Telecom Services.  Our sale of 12Snap was completed in April 2007, and our sale of Telecom Services was completed in October 2007.  The results of operations of these business units have been reclassified as discontinued operations for all periods presented and the assets of these operations are included in Assets held for sale in the consolidated balance sheet..

 

The operating results of these business units, which have been classified as discontinued operations, are indicated in the following table. There is no tax expense or benefit to report due to our net operating loss carry forward tax position.

 

		Micro Paint Repair				Mobot				Sponge				12Snap				Telecom Service				Total
2008
Net sales		$	-			$	-			$	-			$	-			$	-			$	-
Cost of sales			-				-				-				-				-				-
Gross profit			-				-				-				-				-				-
Sales and marketing expenses			-				-				-				-				-				-
General and administrative expenses			258				-				-				65				-				323
Research and development costs			-				-				-				-				-				-
Loss from operations of discontinued business			(258	)			-				-				(65	)			-				(323	)
Loss on disposal of business			-				-				-				-				-				-
Loss from discontinued operations		$	(258	)		$	-			$	-			$	(65	)		$	-			$	(323	)
2007
Net sales		$	1,200			$	-			$	-			$	2,621			$	1,550			$	5,371
Cost of sales			1,518				-				-				361				479				2,358
Gross profit			(318	)			-				-				2,260				1,071				3,013
Sales and marketing expenses			784				30				58				1,181				343				2,396
General and administrative expenses			702				-				1				434				1,008				2,145
Research and development costs			171				15				-				407				-				593
Loss from operations of discontinued business			(1,975	)			(45	)			(59	)			238				(280	)			(2,121	)
Loss on disposal of business			(457	)			-				-				(2,724	)			(3,429	)			(6,610	)
Loss from discontinued operations		$	(2,432	)		$	(45	)		$	(59	)		$	(2,486	)		$	(3,709	)		$	(8,731	)

 

As of December 31, 2008 our other long term assets include our 7.5% remaining investment in Sponge, which is valued at $260,000.

 

Note 4 - Capital Stock

Common Stock. Holders of common stock are entitled to one vote for each share held of record on each matter submitted to a vote of shareholders. Holders of our common stock do not have cumulative voting rights, which means that the holders of more than one half of our outstanding shares of common stock, subject to the rights of the holders of preferred stock, can elect all of our directors, if they choose to do so. In this event, the holders of the remaining shares of common stock would not be able to elect any directors. Subject to the prior rights of any class or series of preferred stock which may from time to time be outstanding, if any, holders of common stock are entitled to receive ratably, dividends when, as, and if declared by our Board of Directors out of funds legally available for that purpose and, upon our liquidation, dissolution, or winding up, are entitled to share ratably in all assets remaining after payment of liabilities and payment of accrued dividends and liquidation preferences on the preferred stock, if any. Holders of common stock have no preemptive rights and have no rights to convert their common stock into any other securities.  The outstanding common stock is duly authorized and validly issued, fully-paid, and non-assessable. Except as otherwise required by Delaware law, and subject to the rights of the holders of preferred stock, all stockholder action is taken by the vote of a majority of the outstanding shares of common stock present at a meeting of stockholders at which a quorum consisting of a majority of the outstanding shares of common stock is present in person or by proxy.  Shares repurchased are held as treasury shares and used for general corporate purposes including, but not limited to, satisfying obligations under our employee benefit plans. Treasury stock is recorded at cost.

 

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Preferred Stock. We are authorized to issue 25 million shares of preferred stock, par value $0.01 per share.  We may issue preferred stock in one or more series and having the rights, privileges, and limitations, including voting rights, conversion rights, liquidation preferences, dividend rights and preferences and redemption rights, as may from time to time be determined by our Board of Directors.  Preferred stock may be issued in the future in connection with acquisitions, financings, or other matters, as our Board of Directors deems appropriate.  In the event that we determine to issue any shares of preferred stock, a certificate of designation containing the rights, privileges, and limitations of this series of preferred stock will be filed with the Secretary of State of the State of Delaware. The effect of this preferred stock designation power is that our Board of Directors alone, subject to Federal securities laws, applicable blue sky laws, and Delaware law, may be able to authorize the issuance of preferred stock which could have the effect of delaying, deferring, or preventing a change in control of our company without further action by our stockholders, and may adversely affect the voting and other rights of the holders of our common stock. The issuance of preferred stock with voting and conversion rights may also adversely affect the voting power of the holders of our common stock, including the loss of voting control to others.

 

Series A Preferred Stock.  During December 1999, our Board of Directors approved a Certificate of Resolutions Designating Rights and Preferences of Preferred Stock, filed with the Secretary of State of the State of Delaware on December 20, 1999.  By this approval and filing, 200,000 shares of Series A Preferred Stock were designated.  Series A Preferred carries the following rights:

 

·

The right to receive mandatory cash dividends equal to the greater of $0.001 per share or 100 times the amount of all dividends (cash or non-cash, other than dividends of shares of common stock) paid to holders of the common stock, which dividend is payable 30 days after the conclusion of each calendar quarter and immediately following the declaration of a dividend on common stock;

 

·	One hundred votes per share of Series A Preferred on each matter submitted to a vote of our stockholders;

 

·	The right to elect two directors at any meeting at which directors are to be elected, and to fill any vacancy on our Board of Directors previously filled by a director appointed by the Series A Preferred holders;

 

·

The right to receive an amount, in preference to the holders of common stock, equal to the amount per share payable to holders of common stock, plus all accrued and unpaid dividends, and following payment of 1/100th of this liquidation preference to the holders of each share of common stock, an additional amount per share equal to 100 times the per share amount paid to the holders of common stock;

 

·

The right to exchange each share of Series A Preferred for 100 times the consideration received per share of common stock in connection with any merger, consolidation, combination or other transaction in which shares of common stock are exchanged for or converted into cash, securities or other property; and

 

·	The right to be redeemed in accordance with our stockholders rights plan.

 

While accrued mandatory dividends are unpaid, we may not declare or pay dividends or distributions on, or redeem, repurchase or reacquire, shares of any class or series of junior or parity stock.

 

The Series A Preferred was created in connection with our stockholders rights plan.  No shares of Series A Preferred were outstanding as of December 31, 2008.

 

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Series A Convertible Preferred Stock.  On June 19, 2001, our Board of Directors approved a Certificate of Designations to create 500,000 shares of a Class of Series A Convertible Preferred Stock, which was filed with the Secretary of State of the State of Delaware on June 20, 2001.  By this approval and filing, 47,511 shares are designated as Series A Convertible Preferred Stock and remain to be issued.  Our Series A Convertible Preferred Stock, par value $0.01 per share, has the following rights:

 

·

Series A Convertible Preferred is convertible into shares of common stock at a one-to-one ratio, subject to proportional adjustments in the event of stock splits or combinations, and dividends or distributions of shares of common stock, at the option of the holder; shares are subject to automatic conversion as determined in each agreement relating to the purchase of shares of Series A Convertible Preferred;

 

·	Each share of Series A Convertible Preferred is entitled to receive a liquidation preference equal to the original purchase price of such share in the event of liquidation, dissolution, or winding up;

 

·

Upon merger or consolidation, or the sale, lease or other conveyance of all or substantially all of our assets, shares of Series A Convertible Preferred are automatically convertible into the number of shares of stock or other securities or property (including cash) to which the common stock into which it is convertible would have been entitled; and

 

·	Shares of Series A Convertible Preferred are entitled to one vote per share, and vote together with holders of common stock.

 

As of December 31, 2008, there were no shares of Series A Convertible Preferred outstanding.

 

Series B Convertible Redeemable Preferred Stock.  On January 16, 2002, our Board of Directors approved a Certificate of Designation, Preferences, Rights and Limitations of Series B 12% Convertible Redeemable Preferred Stock, which was filed with the Secretary of State of the State of Delaware on February 28, 2002.  By this approval and filing, 100,000 shares were designated as Series B 12% Convertible Redeemable Preferred Stock.  Our Series B 12% Convertible Redeemable Preferred Stock, par value $0.01 per share, has the following rights:

 

·	Series B Preferred shares accrue dividends at a rate of 12% per annum, or $1.20 per share, between the date of issuance and the first anniversary of issuance;

 

·	Series B Preferred is redeemable to the maximum extent permitted by law (based on funds legally available for redemption) at a price per share of $15.00, plus accrued dividends (a total of $16.20 per share) on the first anniversary of issuance;

 

·	Series B Preferred receive proceeds of $12.00 per share upon our liquidation, dissolution or winding up;

 

·

To the extent not redeemed on the first anniversary of issuance, Series B Preferred is automatically convertible into the then existing general class of common stock on the first anniversary of issuance at a price equal to $16.20 divided by the greater of $0.20 or the lowest publicly-sold share price during the 90 day period preceding the conversion date, but in no event more than 19.9% of our outstanding capital stock as of the date immediately prior to conversion.

 

·

Upon merger or consolidation, or the sale, lease or other conveyance of all or substantially all of our assets, shares of Series B Preferred are automatically convertible into the number of shares of stock or other securities or property (including cash) to which the common stock into which it is convertible would have been entitled; and

 

·

Shares of Series B Preferred are entitled to one vote per share and vote with common stock, except where the proposed action would adversely affect the Series B Preferred or where the non-waivable provisions of applicable law mandate that the Series B Preferred vote separately, in which case Series B Preferred vote separately as a class, with one vote per share.

 

As of December 31, 2008, no shares of the Series B Convertible Redeemable Preferred Stock have been issued or are currently outstanding.

 

Series C Convertible Preferred Stock.  On February 22, 2006, we filed with the Secretary of State of the State of Delaware a Certificate of Designation of Series C Convertible Redeemable Preferred Stock.  By the approval and filing, 27,000 shares were designated as Series C Convertible Preferred Stock.  Our Series C Convertible Preferred Stock, par value $0.01 per share, have the following rights:

 

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·	The holders of record of the Series C Convertible Preferred shares are entitled to dividends at a rate of 8% per annum, if, as and when declared by the Board of Directors. As of December 31, 2008 and 2007, accumulated undeclared unpaid dividends were $4.6 million and $3.0 million, respectively;

 

·	Series C Convertible Preferred receive proceeds of $1,000 per share upon our liquidation, dissolution or winding up;

 

·	Each share of Series C Convertible Preferred shares is convertible, at the option of the holder, into shares of our common stock at the lesser of (i) $0.02 or (ii) 97% of the lowest closing bid price of our common stock for the thirty trading days immediately preceding the date of conversion; and

 

·	Series C Convertible Preferred shares have voting rights on an as-converted basis with the common stock.