Research Frontiers Inc: Form 10-Q for the period ended Jun 30, 2020

Critical Accounting Policies:

The following accounting policies are important to understanding our financial condition and results of operations and should be read as an integral part of the discussion and analysis of the results of our operations and financial position. For additional accounting policies, see Note 2 to our December 31, 2019 consolidated financial statements, “Summary of Significant Accounting Policies.”

The Company adopted ASC 606, the new revenue recognition standard, beginning January 1, 2018. The Company determined that its license agreements provide for three performance obligations: (i) Grant of Use, (ii) Technical Support, and (iii) New Improvements.

The best method for determining standalone selling price of our Grant of Use performance obligation is through a comparison of the average royalty rate for comparable license agreements as compared to our license agreements. Based on the royalty rate comparison referred to above, any pricing above and beyond the average royalty rate would relate to the Technical Support and New Improvements performance obligations.

We recognize revenue when or as the performance obligations in the contract are satisfied. For performance obligations that are fulfilled at a point in time, revenue is recognized at the fulfillment of the performance obligation. Since the IP is determined to be a functional license, the value of the Grant of Use is recognized in the first period of the contract term in which the license agreement is in force. Since the costs incurred to satisfy the Technical Support and New Improvements performance obligations are incurred evenly throughout the year, the value of the Technical Support and New Improvements services are recognized throughout the contract period as these performance obligations are satisfied.

The Company operates in a single business segment which is engaged in the development and marketing of technology and devices to control the flow of light. Our revenue source comes from the licensing of this technology and all of these license agreements have similar terms and provisions.

The Company has entered into license agreements covering products using the Company’s SPD technology. When royalties from the sales of licensed products by a licensee exceed its contractual minimum annual royalties, the excess amount is recognized by the Company as fee income in the period that it was earned. Certain of the fees are accrued by, or paid to, the Company in advance of the period in which they are earned resulting in deferred revenue.

Royalty receivables are stated less allowance for doubtful accounts. The allowance represents estimated uncollectible receivables usually due to licensees’ potential insolvency. The allowance includes amounts for certain licensees where risk of default has been specifically identified. The Company evaluates the collectability of its receivables on at least a quarterly basis and records appropriate allowances for uncollectible accounts when necessary.

The Company expenses costs relating to the development or acquisition of patents due to the uncertainty of the recoverability of these items. All of our research and development costs are charged to operations as incurred. Our research and development expenses consist of costs incurred for internal and external research and development. These costs include direct and indirect overhead expenses.

The Company has historically used the Black-Scholes option-pricing model to determine the estimated fair value of each option grant. The Black-Scholes model includes assumptions regarding dividend yields, expected volatility, expected lives, and risk-free interest rates. These assumptions reflect our best estimates, but these items involve uncertainties based on market conditions generally outside of our control. As a result, if other assumptions had been used in the current period, stock-based compensation expense could have been materially impacted. Furthermore, if management uses different assumptions in future periods, stock-based compensation expense could be materially impacted in future years.

On occasion, the Company may issue to consultants either options or warrants to purchase shares of common stock of the Company at specified share prices. These options or warrants may vest based upon specific services being performed or performance criteria being met. In accounting for equity instruments that are issued to other than employees for acquiring, or in conjunction with selling, goods or services, the Company is required to record consulting expenses based upon the fair value of such options or warrants on the earlier of the service period or the period that such options or warrants vest as determined using a Black-Scholes option pricing model and are marked to market quarterly using the Black-Scholes option valuation model.

Effective January 1, 2019, the Company adopted the Financial Accounting Standards Board’s Standard, Leases (Topic 842), as amended. The standard requires all leases to be recorded on the balance sheet as a right of use asset and a lease liability. The Company used a transition method that applies the new lease standard at January 1, 2019. The Company applied a policy election to exclude short-term leases from balance sheet recognition and also elected certain practical expedients at adoption. As permitted, the Company did not reassess whether existing contracts are or contain leases, the lease classification for any existing leases, initial direct costs for any existing lease, which were not previously accounted for as leases, are or contain a lease. At adoption on January 1, 2019, an operating lease liability of $1,133,821 and an operating lease right of use asset of $941,284 was recorded. The operating lease liability was $192,537 more than the operating lease right of use asset due to unamortized lease incentive from periods prior to the adoption of the new lease standard. There was no cumulative earnings effect adjustment.

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements, and reported amounts of revenues and expenses during the reporting periods. Actual results could differ from these estimates. An example of a critical estimate is the full valuation allowance for deferred taxes that was recorded based on the uncertainty that such tax benefits will be realized in future periods.

Results of Operations:

Overview

The majority of the Company’s fee income comes from the activities of several licensees participating in the automotive market. The Company currently believes that the automotive market will be the largest source of its royalty income over the next several years. The Company’s royalty income from this market may be influenced by numerous factors including various trends affecting demand in the automotive industry and the rate of introduction of new technology in OEM product lines. In addition to these macro factors, the Company’s royalty income from the automotive market could also be influenced by specific factors such as whether the Company’s SPD-SmartGlass technology appears as standard equipment or as an option on a particular vehicle, the number of additional vehicle models that SPD-SmartGlass appears on, the size of each window on a vehicle and the number of windows on a vehicle that use SPD-SmartGlass, fluctuations in the total number of vehicles produced by a manufacturer, and in the percentage of cars within model like produced with SPD-SmartGlass, and changes in pricing or exchange rates. Certain license fees, which are paid to the Company in advance of the accounting period in which they are earned resulting in the recognition of deferred revenue for the current accounting period, will be recognized as fee income in future periods. Also, licensees offset some or all of their royalty payments on sales of licensed products for a given period by applying these advance payments towards such earned royalty payments.

In 2019, the Company received royalty revenues from sales of the Magic Sky Control option on the S-Class Coupe, Maybach and S-Class Sedan, and SL and SLK/SLC roadsters in excess of the minimum annual royalty levels for the two licensees supplying products using the Company’s technology to Daimler. As such, royalties from these five car models, as well as sales of SPD-SmartGlass products by our licensees to McLaren Automotive, were accretive to the Company’s royalty revenue. Production efficiencies are expected to continue and accelerate with the introduction of the higher vehicle production volumes for various car models going forward, and the Company expects that lower pricing per square foot of the Company’s technology could expand the market opportunities, adoption rates, and revenues for its technology in automotive and non-automotive applications. The Company expects to generate additional royalty income from the near-term introduction of additional new car and aircraft models from other OEM’s (original equipment manufacturers), continued growth of sales of products using the Company’s technology for the marine industry in yachts and other watercraft, in trains, in museums, and in larger architectural projects.

Because the Company’s license agreements typically provide for the payment of royalties by a licensee on product sales within 45 days after the end of the quarter in which a sale of a licensed product occurs (with some of the Company’s more recent license agreements providing for payments on a monthly basis), and because of the time period which typically will elapse between a customer order and the sale of the licensed product and installation in a home, office building, automobile, aircraft, boat or any other product, there could be a delay between when economic activity between a licensee and its customer occurs and when the Company gets paid its royalty resulting from such activity.

As discussed in Note 2, the Company currently does not have the ability to assess whether the COVID-19 pandemic is likely to have a material impact on our near-term financial results. Most of the products using the Company’s technology are manufactured by licensees overseas in Europe and Asia who have been similarly affected by the pandemic. The disruption caused by COVID-19 could result in lower levels of sale activity for products using our technology resulting in lower level of royalties owed to us from the sale of these products. The duration of the potential business disruptions and related financial impact cannot be reasonably estimated at this time.

Three months ended June 30, 2020 compared to the three months ended June 30, 2019

The Company’s fee income from licensing activities for the three months ended June 30, 2020 was $176,113 as compared to $301,035 for the three months ended June 30, 2019 representing a $124,922 decline between these two periods. Lower fees in the automotive and aircraft markets (believed to be related to temporary customer shutdowns in these industries due to the COVID-19 pandemic) was partially offset by higher fee income from licensees in the architectural and display markets.

Operating expenses decreased by $307,392 for the three months ended June 30, 2020 to $631,963 from $939,355 for the three months ended June 30, 2019. This decrease is the result of lower non-cash charges for stock options granted to employees and directors in the earlier year ($291,000), lower payroll and related costs ($40,000) and lower professional fees ($20,000), partially offset by higher bad debts ($35,000).

Research and development expenditures decreased by $167,250 to $146,731 for the three months ended June 30, 2020 from $313,981 for the three months ended June 30, 2019. This decrease is the result of lower non-cash charges for stock options granted to employees in the earlier year ($66,000) as well as lower payroll and related costs ($61,000) and lower materials costs ($19,000) and lower allocated facility costs ($11,000).

In connection with the issuance of certain warrants during the third quarter of 2018, the Company recorded a non-cash expense of $404,435 to mark these warrant liabilities to their market value for the three months ended June 30, 2019. The warrant liability was reclassified to equity as of the end of the second quarter of 2019, thus no adjustment in the market value of the warrant liabilities was needed for any period after June 30, 2019.

The Company’s net investment income for the three months ended June 30, 2020 was $9,460 as compared to $6,258 for the three months ended June 30, 2019. The difference was primarily due to higher cash balances available for investment.

In addition, the Company recorded $194,140 of other income for the three months ended June 30, 2020 representing the portion of the PPP loan estimated to be forgiven through such date.

As a consequence of the factors discussed above, the Company’s net loss was $398,981 ($0.01 per common share) for the three months ended June 30, 2020 as compared to $1,350,478 ($0.05 per common share) for the three months ended June 30, 2019.

Six months ended June 30, 2020 compared to the six months ended June 30, 2019

The Company’s fee income from licensing activities for the six months ended June 30, 2020 was $532,286 as compared to $719,692 for the six months ended June 30, 2019 representing a $187,406 decrease between these two periods. Lower fees in the automotive and aircraft markets (believed to be related to temporary customer shutdowns in these industries due to the COVID-19 pandemic) was partially offset by higher fee income from licensees in the architectural and display markets.

Operating expenses decreased by $238,116 for the six months ended June 30, 2020 to $1,452,404 from $1,690,520 for the six months ended June 30, 2019. This decrease was primarily due to lower non-cash charges related to the grant of stock options to employees and directors in the earlier year ($291,000) as well as lower professional fees ($29,000), and lower patent costs ($15,000) partially offset by higher payroll and related costs ($65,000), higher bad debts ($31,000).

Research and development expenditures decreased by $213,895 to $330,049 for the six months ended June 30, 2020 from $543,944 for the six months ended June 30, 2019. This decrease was primarily due to lower non-cash charges related to the grant of stock options to employees in the earlier year ($66,000) as well as lower payroll and related costs ($101,000), lower materials costs ($22,000) and lower allocated facility costs ($10,000).

In connection with the issuance of certain warrants during the third quarter of 2018, the Company recorded a non-cash expense of $652,025 to mark these warrant liabilities to their market value for the six months ended June 30, 2019. The warrant liability was reclassified to equity as of the end of the second quarter of 2019, thus no adjustment in the market value of the warrant liabilities was needed for any period after June 30, 2019.

The Company’s net investment income for the six months ended June 30, 2020 was $32,452 as compared to $12,422 for the six months ended June 30, 2019. The difference was primarily due to higher cash balances available for investment.

In addition, the Company recorded $194,140 of other income for the three months ended June 30, 2020 representing the portion of the PPP loan estimated to be forgiven through such date.

As a consequence of the factors discussed above, the Company’s net loss was $1,023,575 ($0.03 per common share) for the six months ended June 30, 2020 as compared to $2,154,375 ($0.07 per common share) for the six months ended June 30, 2019.

Financial Condition, Liquidity and Capital Resources:

The Company has primarily utilized its cash, cash equivalents, short-term investments, and the proceeds from its investments to fund its research and development, for marketing initiatives, and for other working capital purposes. The Company’s working capital and capital requirements depend upon numerous factors, including, but not limited to, the results of research and development activities, competitive and technological developments, the timing and costs of patent filings, and the development of new licensees and changes in the Company’s relationship with existing licensees. The degree of dependence of the Company’s working capital requirements on each of the foregoing factors cannot be quantified; increased research and development activities and related costs would increase such requirements; the addition of new licensees may provide additional working capital or working capital requirements, and changes in relationships with existing licensees would have a favorable or negative impact depending upon the nature of such changes.

During the six months ended June 30, 2020, the Company’s cash and cash equivalents balance decreased by $750,614 principally as a result of cash used for operations of $1,239,647 partially offset by cash proceeds from a PPP loan/grant of $202,052 and cash received from the exercise of options and warrants by employees and investors of $284,207. As of June 30, 2020, the Company had cash and cash equivalents of $5,841,346, working capital of $6,270,142 and total shareholders’ equity of $6,316,740.

Our quarterly projected cash flow shortfall, based on our current operations adjusted for any non-recurring cash expenses for the next 12 months, is approximately $450,000-$500,000 per quarter. We expect to have sufficient working capital for at least the next 34 months of operations. We may seek to eliminate some operating expenses in the future to reduce our cash flow shortfall.

The Company expects to use its cash to fund its research and development of SPD light valves, its expanded marketing initiatives, and for other working capital purposes. The Company believes that its current cash and cash equivalents would fund its operations until early 2023. There can be no assurances that expenditures will not exceed the anticipated amounts or that additional financing, if required, will be available when needed or, if available, that its terms will be favorable or acceptable to the Company. Eventual success of the Company and generation of positive cash flow will be dependent upon the extent of commercialization of products using the Company’s technology by the Company’s licensees and payments of continuing royalties on account thereof. To date the Company has not generated sufficient revenue from its licensees to fully fund its operations.

The information required by Item 3 has been disclosed in Item 7A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. There has been no material change in the disclosure regarding market risk.

Evaluation of Disclosure Controls and Procedures:

Our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act, are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. We designed our disclosure controls and procedures to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officer, to allow timely decisions regarding required disclosure. Our chief executive officer and chief financial officer, with assistance from other members of our management, have reviewed the effectiveness of our disclosure controls and procedures as of June 30, 2020 and, based on their evaluation, have concluded that our disclosure controls and procedures were effective.

Changes in Internal Control Over Financial Reporting:

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the three months ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Forward-Looking Statements:

The information set forth in this Report and in all publicly disseminated information about the Company, including the narrative contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” above, includes “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and is subject to the safe harbor created by that section. Readers are cautioned not to place undue reliance on these forward-looking statements as they speak only as of the date hereof and are not guaranteed.