Business Context and Reporting Period
Research Frontiers Incorporated filed this unaudited Form 10-Q for the quarter ended March 31, 2018. The company operates in one segment, developing and licensing suspended particle device technology used to control light in automotive, architectural, aerospace, marine, appliance, eyewear and display applications. Most licensing income is generated by automotive-related licensees.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Fee income | $433,269 | $393,116 |
| Operating expenses | $1,009,825 | $1,136,255 |
| Research and development | $218,616 | $211,293 |
| Total expenses | $1,228,441 | $1,347,548 |
| Operating loss | $(795,172) | $(954,432) |
| Net loss | $(793,767) | $(952,555) |
| Basic and diluted loss per share | $(0.03) | $(0.04) |
| Net cash used in operating activities | $(685,903) | $(645,600) |
Fee income increased $40,153, or approximately 10%, primarily because of higher automotive, aircraft and architectural revenue, partly offset by lower display revenue. Operating expenses declined $126,430, mainly from lower payroll, professional fees and allocated insurance costs; patent costs increased. Research and development expense increased $7,323.
Cash and cash equivalents were $2.30 million at March 31, 2018, compared with $1.74 million at December 31, 2017. Working capital was $2.60 million and shareholders’ equity was $3.08 million. Total assets were $3.60 million and current liabilities were $519,828. The filing does not report outstanding conventional bank debt; an interest-free convertible loan was converted into equity under the stated conditions.
Cash flow benefited from $1.25 million of financing proceeds and was reduced by $685,903 of operating cash use and $5,399 of capital expenditures. Cash increased $558,698 during the quarter to $2.30 million. The company reported no income tax expense because its operating losses and deferred tax benefits remain fully reserved.
Material Changes and Unusual Items
- The company adopted ASC 606 revenue recognition on January 1, 2018 using the modified retrospective method. Prior-period results were not restated.
- ASC 606 increased first-quarter 2018 reported revenue by $48,746 compared with the former accounting method. The adoption reduced opening accumulated deficit and increased opening royalties receivable by $58,021.
- Reported first-quarter fee income was $433,269; under the former method, the filing states it would have been $384,524.
- On or around February 16, 2018, accredited shareholders provided $1.25 million through a five-year interest-free convertible loan. The loan automatically converted into 1,388,893 common shares and warrants to purchase 1,388,893 shares at exercise prices of $1.10, $1.20 or $1.35, depending on exercise date. No principal payments are due following conversion.
- Four licensees each represented at least 10% of first-quarter fee income, accounting for approximately 33%, 14%, 12% and 11%, respectively, indicating customer concentration.
- The company received royalty revenue above minimum annual royalty levels from the Magic Sky Control option on certain Daimler S-Class vehicles.
Liquidity, Outlook and Risks
Management estimates a quarterly cash-flow shortfall of approximately $350,000 to $450,000 over the next 12 months, based on current operations and excluding non-recurring cash expenses. Management expects expense reductions and current resources to provide sufficient working capital for approximately 15 months of operations, but stated that it may seek additional financing and provided no assurance that financing will be available on acceptable terms.
The company has not generated sufficient licensee revenue to fund operations. Future positive cash flow depends on commercialization of products using its technology and continuing royalty payments. Royalty revenue is exposed to automotive production volumes, vehicle take rates, adoption as standard or optional equipment, pricing, exchange rates, technology introduction timing and broader industry demand. Licensee payments may also lag the underlying product sales.
Management expects automotive applications to be the largest source of royalty income over the next several years and is pursuing cost reductions and expanded marketing. The filing provides no formal revenue or earnings guidance. Results for the quarter are not necessarily indicative of the full-year results.
Investor Verification Items
- Verify the sustainability and cash-collection timing of royalty revenue, including the concentration among major licensees.
- Assess the effect of ASC 606 on the timing of reported revenue, deferred revenue and royalties receivable.
- Monitor the projected quarterly cash shortfall, expense-reduction plans and the need for additional financing.
- Review dilution from the 1,388,893 shares issued and the 1,388,893 warrants outstanding, including applicable exercise prices.
- Evaluate automotive commercialization, Magic Sky Control production and take rates, and the company’s ability to expand beyond automotive applications.