Research Frontiers Incorporated: Q3 2015 Form 10-Q Summary
Business context and reporting period
Research Frontiers develops and licenses suspended particle device technology used to control light transmission in glass and film applications, including automotive, architectural, aerospace, marine and appliance products. The company operates as a single business segment and relies primarily on license fees and royalties from licensees. This unaudited report covers the three and nine months ended September 30, 2015.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Fee income | $445,846 | $452,937 | $1,628,736 | $1,156,904 |
| Operating expenses | $895,123 | $778,075 | $3,029,386 | $3,011,681 |
| Research and development | $327,448 | $324,306 | $1,096,420 | $1,123,746 |
| Operating loss | $(766,725) | $(649,444) | $(2,497,070) | $(2,978,523) |
| Net loss | $(767,320) | $(639,806) | $(2,464,985) | $(2,951,649) |
| Basic and diluted loss per share | $(0.03) | $(0.03) | $(0.10) | $(0.13) |
For the nine-month period, fee income increased approximately 41% year over year, while the operating loss narrowed approximately 16%. The quarterly fee income declined approximately 2%, and the quarterly net loss increased approximately 20%. The filing does not present a clear GAAP gross margin; the company’s operating model remains loss-making.
At September 30, 2015, cash and cash equivalents were $6.43 million, short-term investments were $1.51 million, and total current assets were $9.78 million. Working capital was $9.42 million and shareholders’ equity was $10.34 million. Total liabilities were $362,305, consisting of current liabilities; no debt balance is reported. Royalty receivables increased to $1.77 million from $1.18 million at December 31, 2014.
Net cash used in operating activities was $2.86 million for the first nine months, compared with $2.70 million in the prior-year period. Investing activities provided $1.18 million, principally from proceeds from investments, while fixed-asset purchases used $312,943. Financing activities provided $535,123 from option and warrant exercises. Cash decreased $1.14 million during the period, from $7.57 million to $6.43 million.
Material changes versus the prior comparable period
- Nine-month fee income increased by $471,832, primarily from higher automotive royalty activity and a $275,000 fee related to participation in the Milan 2015 Expo.
- Automotive revenue benefited from the Mercedes-Benz S-Class Coupe and S-Class Maybach, as well as royalties above minimum annual levels on certain Magic Sky Control-equipped vehicles.
- Operating expenses rose modestly for the nine-month period and increased materially in the quarter, reflecting higher depreciation on trade-show displays, marketing and investor-relations costs, insurance, travel and patent/legal expenses.
- Research and development expense decreased modestly for the nine-month period, largely because of lower non-cash compensation.
- Stock-based compensation declined to $183,897 from $426,809 for the first nine months of 2014.
- The company did not issue additional equity securities during the first nine months of 2015, but received $535,123 from option and warrant exercises. The prior-year period included $3.28 million of proceeds from a common-stock offering.
- Long-term investments of $1.50 million at December 31, 2014 were reclassified or matured, leaving $1.51 million in short-term investments at September 30, 2015.
Guidance, outlook, risks and unusual items
Management expected the higher-volume Mercedes-Benz S-Class long-wheelbase sedan to contribute more substantially beginning in the fourth quarter of 2015, when a full quarter of production would be reflected. Management also expects production efficiencies and lower pricing per square foot to potentially expand adoption and revenue opportunities.
The company stated that, based on existing expenditures, cash reserves and budgeted revenues, it did not expect to require additional funding for the foreseeable future. However, it has not generated sufficient licensee revenue to fund operations and continues to consume cash. Additional financing may be required if expenditures exceed expectations, and financing may not be available on acceptable terms.
Royalty revenue is concentrated among licensees and is sensitive to automotive production volumes, vehicle-model adoption, pricing, exchange rates, product redesign cycles and timing of royalty payments. Royalty activity from the SLK and SL vehicles was declining because of lower production, pricing reductions and currency fluctuations. Two licensees represented approximately 33% and 15% of nine-month fee income. Approximately 17% of nine-month revenue related to the Milan 2015 Expo fee, an unusual item not present in the prior-year comparable period.
The company has incurred operating losses since inception, has fully reserved deferred tax benefits, and does not record income tax expense. Management reported effective disclosure controls and no material changes in internal control over financial reporting.
Investor verification points
- Verify the sustainability and timing of royalty growth from Mercedes-Benz and other automotive programs, including the expected fourth-quarter V222 contribution.
- Assess the concentration of fee income among major licensees and the potential effect of vehicle volumes, pricing, currency movements and model transitions.
- Reconcile operating cash burn with the $7.94 million of cash, cash equivalents and investments reported at September 30, 2015.
- Review whether the Milan 2015 Expo fee is non-recurring and adjust comparisons accordingly.
- Monitor royalty receivable collections, deferred revenue and the company’s ability to fund continuing research, development and marketing without additional financing.
- Confirm the absence of reported debt and evaluate future capital requirements against the company’s continuing net losses.