Research Frontiers Incorporated — 2019 Q3 Form 10-Q Summary
Business Context and Reporting Period
Research Frontiers develops and licenses suspended particle device technology that controls the flow of light. Its products target automotive, architectural, aerospace, marine, appliance, display and other applications. The company operates as one business segment and derives revenue primarily from license fees and royalties.
This unaudited filing covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods. The company had 31,090,291 common shares outstanding as of November 7, 2019.
Financial Highlights
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Fee income | $462,869, versus $359,725 | $1,182,560, versus $1,117,849 |
| Operating expenses | $666,356, versus $572,968 | $2,356,875, versus $2,228,757 |
| Research and development | $207,368, versus $190,647 | $751,312, versus $660,086 |
| Operating loss | $(410,855), versus $(403,890) | $(1,925,627), versus $(1,770,994) |
| Net loss | $(397,712), or $(0.01) per share | $(2,552,087), or $(0.09) per share |
| Net investment income | $13,143 | $25,565 |
Calculated operating margins were approximately negative 89% for the third quarter and negative 163% for the nine-month period. Calculated net margins were approximately negative 86% and negative 216%, respectively. The filing does not present a conventional gross margin because the company reports fee income and operating costs rather than product cost of revenue.
- Cash and cash equivalents were $7.02 million at September 30, 2019, compared with $2.97 million at December 31, 2018.
- Working capital was approximately $7.59 million and shareholders’ equity was approximately $7.83 million.
- The company reported no debt, but recorded operating lease liabilities totaling approximately $1.01 million, including $163,276 current and $851,672 long term.
- Net cash used in operating activities was $1.66 million for the first nine months, compared with $1.64 million in the prior-year period.
- Net cash provided by financing activities was $5.77 million, primarily from common-stock issuances and option and warrant exercises.
- Cash increased by $4.05 million during the first nine months. Capital expenditures were $65,081.
Material Changes Versus the Prior Comparable Period
- Third-quarter fee income increased $103,144, or approximately 29%, driven by higher automotive and aircraft fees, partly offset by lower architectural and display-market income.
- Nine-month fee income increased $64,711, or approximately 6%, with similar market mix effects.
- Third-quarter operating expenses increased $93,388, primarily from higher marketing, investor-relations and patent costs. Research and development increased $16,721.
- Nine-month operating expenses increased $128,118, reflecting higher stock-based compensation, investor-relations and marketing costs, and accounting fees, partly offset by lower cash payroll and discontinued VariGuard costs. Research and development increased $91,226.
- Third-quarter net loss improved from $688,301 to $397,712 because the prior-year quarter included a $286,631 non-cash warrant market adjustment and 2019 had higher fee income.
- Nine-month net loss increased from $2.05 million to $2.55 million, primarily because the 2019 period included a $652,025 non-cash warrant market adjustment and higher operating and research costs.
- Shares outstanding increased from 27.67 million at December 31, 2018 to 31.09 million at September 30, 2019, reflecting equity issuances and option and warrant exercises.
Guidance, Outlook, Risks and Unusual Items
Management expects automotive applications to remain the largest source of royalty income over the next several years. It cited commercial production for McLaren beginning in the first quarter of 2019 and expects potential additional royalties from new automotive and aircraft models, marine applications, trains, museums and larger architectural projects. No formal revenue or earnings guidance was provided.
- The company expects a quarterly cash-flow shortfall of approximately $450,000 to $550,000 based on current operations and expects existing working capital to fund operations for at least three years, with cash projected to fund operations until at least the third quarter of 2022 under current assumptions.
- The company has incurred recurring losses since inception and has not generated sufficient license revenue to fund operations. It may reduce expenses or seek additional equity financing; the availability and terms of future financing are uncertain.
- Royalty revenue depends on licensee commercialization, vehicle and aircraft production volumes, adoption of SPD technology, product pricing, exchange rates and broader automotive demand. Licensee concentration is significant: three licensees represented approximately 43%, 15% and 10% of nine-month 2019 fee income.
- The company adopted the new lease standard on January 1, 2019, adding approximately $941,000 of right-of-use assets and $1.13 million of operating lease liabilities without a cumulative earnings adjustment.
- Warrants previously classified as a liability were amended and reclassified to equity in 2019. The resulting $652,025 nine-month non-cash market adjustment affected reported net loss; no warrant market adjustment was recorded in the third quarter.
- Deferred tax assets remain fully reserved because management considers realization of tax benefits unlikely. The company had an accumulated deficit of approximately $114.2 million.
- Management concluded that disclosure controls were effective as of September 30, 2019, and reported no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether projected automotive, aircraft and other licensee commercialization will generate sustained royalty growth sufficient to narrow operating losses.
- The durability of the company’s cash runway given the stated quarterly cash shortfall and continued research, marketing and patent expenditures.
- The renewal and economics of the seven license agreements with remaining performance obligations of $282,632, including four initial terms ending December 31, 2019.
- Revenue concentration and the financial condition, production levels and payment practices of major licensees.
- Potential dilution from 2,029,462 outstanding warrants and other options and warrants excluded from diluted loss per share.
- The impact of non-cash warrant valuation adjustments, stock-based compensation and lease obligations on future reported results and equity.