Research Frontiers Incorporated — 2019 Q2 Form 10-Q Summary
Business context and reporting period
Research Frontiers develops and licenses suspended particle device technology that controls the flow of light. Applications include automotive, architectural, aerospace, marine, appliance, display and eyewear products. The company operates as a single business segment and primarily earns licensing and royalty fee income.
The filing covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods. The company had 31,033,443 common shares outstanding as of August 8, 2019.
Key financial metrics
| Metric | Three months ended June 30, 2019 | Three months ended June 30, 2018 | Six months ended June 30, 2019 | Six months ended June 30, 2018 |
|---|---|---|---|---|
| Fee income | $301,035 | $324,853 | $719,692 | $758,122 |
| Operating expenses | $939,355 | $645,960 | $1,690,520 | $1,655,785 |
| Research and development | $313,981 | $250,824 | $543,944 | $469,440 |
| Operating loss | $(952,301) | $(571,931) | $(1,514,772) | $(1,367,103) |
| Net loss | $(1,350,478) | $(569,891) | $(2,154,375) | $(1,363,658) |
| Loss per share | $(0.05) | $(0.02) | $(0.07) | $(0.05) |
Net loss margins based on fee income were approximately negative 448% for the second quarter and negative 299% for the first six months of 2019. The filing does not present a conventional gross margin because the company primarily reports licensing fee income and operating expenses.
At June 30, 2019, cash and cash equivalents were $7.3 million, working capital was $7.9 million, total assets were $9.3 million and shareholders’ equity was $8.2 million. The company had no debt, but reported $1.1 million of operating lease liabilities, including $159,017 current and $894,510 long-term.
Operating cash flow was $(1.3) million for the first six months of 2019, compared with $(1.1) million in the prior-year period. Investing cash flow was $(62,968), primarily for fixed-asset purchases. Financing cash flow was $5.7 million from common-stock issuances and exercises of options and warrants, resulting in a $4.3 million increase in cash.
Material changes versus the prior comparable period
- Second-quarter fee income declined $23,818, or approximately 7%, while six-month fee income declined $38,430, or approximately 5%.
- Second-quarter operating expenses increased $293,395, primarily from higher noncash stock-based compensation, bad-debt expense, professional fees and cash payroll.
- Research and development expense increased 25% in the second quarter and 16% for the six-month period, partly because of higher stock-based compensation and facility costs.
- Net loss increased substantially, primarily because of a $404,435 second-quarter and $652,025 six-month noncash warrant market adjustment, as well as higher stock-based compensation.
- The company raised $4.6 million in May 2019 through common-stock and warrant offerings, and received $1.1 million from option and warrant exercises during the first six months.
- Shares outstanding increased to 31.0 million at June 30, 2019 from 27.7 million at December 31, 2018, reflecting equity issuances and exercises.
- The company adopted ASC 842 lease accounting on January 1, 2019, recording approximately $941,000 of right-of-use assets and $1.1 million of lease liabilities without a cumulative earnings adjustment.
Guidance, outlook, risks and unusual items
Management projects a quarterly cash-flow shortfall of approximately $450,000 to $550,000 based on current operations and excluding nonrecurring cash expenses. Management expects current working capital to fund operations for at least three years and believes current cash would fund operations until at least the third quarter of 2022, subject to spending remaining within anticipated levels.
Management expects automotive royalties to remain the largest source of royalty income. It cited commercial production of SPD products for McLaren beginning in the first quarter of 2019 and potential additional revenue from automotive, aircraft, marine, train, museum and architectural applications. These expectations depend on licensee commercialization, OEM adoption, production volumes, product configuration, pricing, exchange rates and broader industry demand.
The company has incurred recurring losses since inception and has not generated sufficient license revenue to fund operations. It may seek additional equity financing if operating cash flow is insufficient, but there is no assurance that financing will be available on acceptable terms. Revenue is concentrated among a limited number of licensees, with two licensees representing approximately 36% and 15% of first-half 2019 fee income.
The warrant market adjustment was a noncash expense. Following amendments clarifying warrant terms, the related $1.15 million warrant liability was reclassified to equity. The company also recorded $356,228 of stock-based compensation during the first six months of 2019.
Management concluded that disclosure controls were not effective at the reasonable-assurance level as of June 30, 2019 because of a material weakness involving accounting for warrants issued in a registered offering. Additional review controls were implemented and were described as operating effectively as of June 30, 2019.
Important facts for investors to verify
- Whether royalty growth from automotive, aircraft and other new applications offsets declines in architectural and display licensing income.
- The pace of cash consumption relative to the projected $450,000–$550,000 quarterly shortfall.
- Whether the company’s cash resources continue to support management’s stated runway through at least the third quarter of 2022.
- The effect of future equity offerings, option exercises and warrants on dilution and liquidity.
- The collectability of royalty receivables, which were $772,790 net of a $1.1 million allowance for doubtful accounts.
- Progress in remediating the material weakness related to warrant accounting and the impact of future warrant transactions.
- Renewal of the six license agreements with remaining initial terms; four expire December 31, 2019, one expires December 31, 2021, and one expires December 31, 2022.
- The sustainability of licensee commercialization and whether the remaining $266,924 of revenue obligations is recognized as expected.