Research Frontiers Inc. — FY2013 Form 10-K Summary
Business context and reporting period
Research Frontiers develops and licenses patented suspended particle device (SPD-Smart) light-control technology. Licensees manufacture film, laminates, electronics and finished products for automotive, aerospace, architectural and marine applications. The Company also launched the developmental VariGuard direct-sales business in 2013 for specialty display applications. The filing covers the fiscal year ended December 31, 2013, with comparative results for 2012 and 2011.
Research Frontiers had more than 40 licensees, operated as a single business segment, employed 13 full-time employees as of March 10, 2014, and did not directly manufacture SPD products. License agreements generally provide royalties of 5% to 15% of licensed-product net sales, together with potential minimum annual royalties and other fees.
Financial performance and liquidity
| Metric | FY2013 | FY2012 | Change |
|---|---|---|---|
| Fee income | $2.161 million | $1.957 million | +10% |
| Operating expenses | $5.841 million | $3.996 million | +46% |
| Research and development | $2.203 million | $1.672 million | +32% |
| Operating loss | $5.883 million | $3.710 million | Loss increased |
| Net loss | $5.845 million | $3.064 million | Loss increased 91% |
| Net loss per share | $0.25 | $0.15 | Loss increased |
| Net cash used in operations | $3.245 million | $2.679 million | Use increased |
Derived margins were approximately negative 272% at the operating level and negative 270% at the net-income level in 2013, based on fee income. The filing does not present a gross margin because the Company’s primary revenue is licensing and fee income.
- Cash and cash equivalents were $5.866 million at December 31, 2013, compared with $8.390 million in 2012.
- Short-term investments were $5.077 million, bringing cash, cash equivalents and short-term investments to approximately $10.9 million.
- Working capital was $11.783 million; total assets were $12.032 million and shareholders’ equity was $11.870 million.
- Current liabilities were only $162,000. The filing does not disclose funded debt; no debt balance is reported on the balance sheet.
- Cash used in operations was partially offset by $795,000 of proceeds from option and warrant exercises. No common stock issuance proceeds were reported in 2013, compared with $12.251 million in 2012.
- Operating lease obligations totaled approximately $2.165 million, including $163,000 due within one year and $1.294 million due after five years.
Fourth-quarter 2013 information
Unaudited fourth-quarter fee income was $425,592, compared with $552,044 in the fourth quarter of 2012. Fourth-quarter operating loss was $2.626 million and net loss was $2.616 million, compared with operating and net losses of $613,000 and $604,000, respectively, in the fourth quarter of 2012. Fourth-quarter 2013 basic and diluted net loss was $0.11 per share.
The unusually large fourth-quarter 2013 loss primarily reflected annual stock and option compensation charges and directors’ fees. The filing indicates that 2013 stock and option compensation charges were concentrated in the first and fourth quarters.
Material changes versus the prior comparable period
- Fee income increased $204,000, principally from higher automotive product sales and higher minimum annual royalty and other payments.
- Operating expenses increased $1.846 million, driven primarily by approximately $1.167 million of additional non-cash compensation, $227,000 of higher payroll costs, $296,000 of higher marketing and investor-relations costs, $95,000 of higher patent costs and $81,000 of bad debts.
- Research and development expense increased $531,000. Non-cash R&D compensation rose to approximately $648,000 from $143,000.
- Total non-cash stock-based compensation increased to approximately $2.719 million from $879,000, materially increasing the reported net loss.
- The Company’s cumulative deficit reached $93.317 million. It has not generated sufficient licensing revenue to fund operations and has never paid a cash dividend.
- Automotive commercialization advanced: Magic Sky Control was announced for the Mercedes-Benz S-Class sedan and coupe beginning in the second half of 2014. The S-Class roof was described as substantially larger than the SLK and SL roofs.
- Research Frontiers formed VariGuard in 2013; management described its revenue as immaterial relative to licensing activities.
- The Company added licensees targeting automotive aftermarket and architectural markets in Russia and Brazil.
Guidance, outlook, commentary and risks
Management identified automotive glass as the largest and most predictable near- and intermediate-term market for royalty income and expects continued product adoption and manufacturing improvements to increase royalties. The Company stated that, based on existing cash expenditures, reserves and budgeted revenue, it did not expect to require additional funding in the foreseeable future, while cautioning that higher expenditures or weaker revenues could create a financing need.
- Profitability depends substantially on licensees and their customers commercializing SPD products; Research Frontiers cannot control licensee production, marketing or launch timing.
- Hitachi Chemical was identified as the sole source of commercial quantities of SPD film. A prolonged supply disruption could adversely affect licensee sales and Research Frontiers’ royalties.
- The Company faces competition from electrochromic, liquid-crystal and other smart-glass technologies, often from substantially better-capitalized companies.
- SPD technology remains dependent on continued research, product reliability, cost reductions and broader market acceptance. Video-display applications require further improvements in switching speed.
- Automotive, aircraft, marine and construction-market downturns could reduce licensee commercialization and royalty income.
- The Company recorded a full valuation allowance against deferred tax assets, including approximately $58 million of federal net operating loss carryforwards, because profitable operations have not been established.
- In July 2013, Research Frontiers filed patent-infringement litigation against E Ink, Amazon, Sony, Barnes & Noble and related entities. The Company sought injunctive relief and damages; no hearing or trial date had been set. A contingency fee arrangement reduced exposure to litigation costs.
- A February 2013 stockholders’ Rights Plan generally applies upon a person or group acquiring or offering to acquire 15% or more of the common stock, subject to stated exceptions.
- In February 2014, the Company extended its office lease through March 31, 2025 at reduced rental costs over the lease term.
Most important facts for investors to verify
- Whether automotive launches, particularly Mercedes-Benz S-Class adoption beginning in the second half of 2014, translate into sustained royalty growth.
- Quarterly royalty concentration, licensee sales, minimum annual royalties and the collectability of royalty receivables.
- Cash-burn trends relative to the approximately $10.9 million of cash, cash equivalents and short-term investments at year-end.
- Progress toward additional commercial SPD-film suppliers and the effect of any Hitachi Chemical supply disruption.
- Future stock-based compensation, dilution from 1.48 million employee options and 1.38 million warrants and non-employee options outstanding at year-end.
- Developments, potential damages or costs associated with the patent litigation.
- Whether management’s commercialization outlook is consistent with the Company’s continuing operating losses and reliance on external capital or licensee royalties.