RESEARCH FRONTIERS INC annual report, FY2017

Research Frontiers Inc. — 2017 Form 10-K Summary

Business Context and Reporting Period

Research Frontiers develops and licenses patented suspended particle device (SPD-Smart) light-control technology for automotive, aerospace, architectural, marine, transportation, museum and specialty applications. The Company operates as a single business segment, does not directly manufacture products, and depends on licensees and their customers for commercialization and royalty revenue. The filing covers the fiscal year ended December 31, 2017; fourth-quarter data is included where relevant.

More than 40 licensees served global markets.
License agreements generally provide royalties of 5%–15% of net sales, plus possible fees and minimum annual royalties.
Automotive applications, including Daimler’s Magic Sky Control systems, remained the principal source of royalty income.
Four licensees represented 35%, 15%, 10% and 9% of 2017 fee income, indicating significant customer concentration.

Financial Performance and Position

Metric	2017	2016
Fee income	$1.509 million	$1.236 million
Operating expenses	$3.128 million	$4.086 million
Research and development	$0.800 million	$1.418 million
Total expenses	$3.928 million	$5.504 million
Operating loss	$2.419 million	$4.268 million
Net loss	$2.414 million	$4.238 million
Basic and diluted loss per share	$0.10 loss	$0.18 loss
Net cash used in operating activities	$1.471 million	$4.005 million
Cash and cash equivalents	$1.738 million	$1.692 million
Working capital	$2.051 million	$4.220 million
Total shareholders’ equity	$2.567 million	$4.905 million

2017 fourth-quarter fee income was $279,439 and net loss was $668,354, or $0.03 per share. The filing does not present a meaningful operating or net margin because the Company generated an operating loss; fee income covered approximately 38% of total expenses.

At December 31, 2017, the Company had $597,441 of net royalty receivables against an allowance for doubtful accounts of $1.051 million. Current liabilities were $313,747. The Company reported no short-term investments at year-end after selling a $1.523 million certificate of deposit in February 2017. No cash dividends were paid or planned.

Material Changes Versus Prior Comparable Period

Fee income increased $272,973, or approximately 22%, primarily from higher fees associated with automotive, marine, display and architectural licensees. Aircraft-related fee income was slightly lower.
Operating expenses declined approximately 23%, reflecting lower payroll and related costs, marketing and investor-relations costs, patent costs and bad-debt expense.
Research and development expense declined approximately 44% as a result of lower payroll and material costs. Excluding non-cash compensation, research and development spending was approximately $788,000 in 2017 versus $1.402 million in 2016.
Net loss improved by approximately $1.825 million, or 43%, despite continued operating losses.
Operating cash burn improved substantially, declining from $4.005 million in 2016 to $1.471 million in 2017.
Cash increased only $46,244 because operating cash use was largely offset by $1.523 million of proceeds from the sale of an investment.
Total assets and equity declined materially because of continuing losses and depletion of available investments.
The Company remediated the material weakness previously identified in controls over the allowance for doubtful accounts. Management concluded internal control over financial reporting was effective as of December 31, 2017.

Outlook, Risks, Contingencies and Unusual Items

Management expects automotive to remain the largest near- and intermediate-term market and expects additional royalty opportunities from new automotive, aircraft, marine, rail, museum and architectural products. No quantified revenue or earnings guidance was provided.
The Company projected a quarterly cash-flow shortfall of approximately $350,000–$450,000 over the next 12 months, before potential additional expense reductions.
In February 2018, shareholders provided an interest-free five-year $1.25 million loan. Subject to specified conditions, the loan is expected to convert into common stock at the market price when issued, with warrants exercisable at a premium. No payments are due during the five-year term.
Management stated that, based on expense reductions and the February financing, existing resources were expected to fund operations for at least 18 months and, elsewhere in the filing, until at least the fourth quarter of 2019. This expectation depends on revenue, spending and financing assumptions.
The Company has incurred recurring losses since inception, with an accumulated deficit of approximately $109.1 million, and acknowledges that additional financing may be required.
Commercial SPD film was available in volume from a single supplier, Hitachi Chemical, creating supply-chain concentration risk.
Revenue is concentrated among a small number of licensees, and licensees may terminate agreements or fail to commercialize products.
Research Frontiers faces competition from electrochromic, liquid-crystal, photochromic and thermochromic technologies, many backed by substantially larger companies.
Diamond Sea Glaze’s marine license terminated at the end of December 2017. Dassault also terminated the Falcon 5X aircraft program, although a replacement Falcon program was planned.
Research Frontiers’ patent-infringement litigation against E Ink and other defendants remained unresolved; in December 2017, the Federal Circuit ruled in E Ink’s favor on claim construction.
The Company had approximately $1.479 million of future operating lease obligations through March 2025 and employment agreements providing 2018 base salaries of $450,000 and $255,000 for two officers.
The Company recorded no income tax expense or benefit and maintained a full valuation allowance against deferred tax assets, including approximately $73 million of federal net operating loss carryforwards.

Important Facts for Investors to Verify

Reconcile the February 2018 $1.25 million loan’s conversion terms, warrant coverage, maturity and potential dilution with subsequent filings.
Assess whether fee-income growth is recurring and whether automotive royalty volumes and model coverage are expanding.
Review the collectability and concentration of royalty receivables, including the $1.051 million allowance against gross receivables.
Evaluate liquidity relative to the stated quarterly cash shortfall and the Company’s need for additional financing.
Review license agreements for termination rights, minimum royalties, geographic limitations and concentration among major licensees.
Monitor the status and potential financial impact of the E Ink patent litigation and the Company’s patent expirations.
Confirm the implementation impact of ASC Topic 606 revenue recognition and other accounting standards adopted after year-end.
Consider dilution from 978,910 outstanding employee options and 458,000 warrants or non-employee options at December 31, 2017, as well as the February 2018 financing.