Research Frontiers Inc: Form 10-Q for the period ended Jun 30, 2023

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, 2022 consolidated financial statements, “Summary of Significant Accounting Policies.”

The Company recognizes revenue in accordance with ASC 606, Revenue from Contracts with Customers. 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 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.

The preparation of condensed consolidated 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 condensed consolidated 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 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.

The Company has received royalty revenues from sales of products using the Company’s technology that 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 OEMs (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.

Three months ended June 30, 2023 compared to the three months ended June 30, 2022

The Company’s fee income from licensing activities for the three months ended June 30, 2023 was $185,040 as compared to $85,511 for the three months ended June 30, 2022. This increase in fee income was primarily the result of higher royalties from the automotive and aircraft markets as compared to the first quarter of 2022. The Company expects revenue in all market segments to increase further as new car models and other products using the Company’s SPD-SmartGlass technology are introduced into the market.

Operating expenses decreased by $117,545 for the three months ended June 30, 2023 to $564,694 from $682,239 for the three months ended June 30, 2022. This decrease is a result of lower bad debts ($157,000) as well as lower patent costs ($56,000) partially offset by higher legal and professional fees ($48,000) as well as higher directors fees ($20,000), higher payroll and compensation costs ($8,000) and higher allocated insurance costs ($5,000).

Research and development expenditures decreased by $822 to $145,610 for the three months ended June 30, 2023 from $146,432 for the three months ended June 30, 2022. This decrease is a result of lower allocated facilities costs ($8,000) partially offset by higher allocated insurance costs ($4,000) as well as higher equipment rental costs ($3,000).

The Company’s net investment income for the three months ended June 30, 2023 was $31,614 as compared to income of $1,322 for the three months ended June 30, 2022. This difference was primarily due to changes in market values of marketable securities and higher interest rates payable on higher balances available for investment.

As a consequence of the factors discussed above, the Company’s net loss was $493,650 ($0.01 per common share) for the three months ended June 30, 2023 as compared to net loss of $741,838 ($0.02 per common share) for the three months ended June 30, 2022.

Six months ended June 30, 2023 compared to the six months ended June 30, 2022

The Company’s fee income from licensing activities for the six months ended June 30, 2023 was $433,215 as compared to $259,339 for the six months ended June 30, 2022. This increase in fee income was primarily the result of higher royalties from the automotive and aircraft markets as compared to the first six months of 2022. The Company expects revenue in all market segments to increase further as new car models and other products using the Company’s SPD-SmartGlass technology are introduced into the market.

Operating expenses decreased by $130,444 for the six months ended June 30, 2023 to $1,152,493 from $1,282,937 for the six months ended June 30, 2022. This decrease is a result of lower bad debts expense ($162,000) as well as lower patent ($69,000) and investor relations expenses ($16,000) partially offset by higher payroll and compensation costs ($50,000) as well as higher legal and professional fees ($62,000) and higher allocated insurance costs ($10,000).

Research and development expenditures decreased by $425 to $294,832 for the six months ended June 30, 2023 from $295,257 for the six months ended June 30, 2022. This decrease is a result of lower allocated facilities costs ($11,000) partially offset by higher allocated insurance costs ($9,000).

The Company’s net investment income for the six months ended June 30, 2023 was $57,822 as compared to a loss of $51,331 for the six months ended June 30, 2022. This difference was primarily due to changes in market values of marketable securities and higher interest rates payable on higher balances available for investment as well as the sale of marketable securities at a loss in the prior year partially offset by the sale of marketable securities at a gain in the current year.

As a consequence of the factors discussed above, the Company’s net loss was $956,288 ($0.03 per common share) for the six months ended June 30, 2023 as compared to net loss of $1,370,186 ($0.04 per common share) for the six months ended June 30, 2022.

Financial Condition, Liquidity and Capital Resources

The Company has primarily utilized its cash, cash equivalents, marketable securities, 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, 2023, the Company’s cash and cash equivalents balance decreased by $713,342 as a result of cash used to fund operations of $1,222,915 partially offset by cash generated from the exercise warrants of $484,502. As of June 30, 2023, the Company had cash and cash equivalents and marketable securities of approximately $3.5 million, working capital of $4.1 million and total shareholders’ equity of $4.3 million.

Our quarterly projected cash flow shortfall, based on our current operations, adjusted for any non-recurring cash expenses for the next 12 months and adjusted for additional royalties expected to be received for use of our products in new production, for the next 12 months, is approximately $200,000 to $250,000 per quarter. We may eliminate some operating expenses in the future, which will further reduce our cash flow shortfall if needed. Based on these assumptions, we currently expect to have sufficient working capital for more than the next five years of operations.

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 and marketable securities would fund its operations at least through the next twelve months. 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, 2022. 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 acting interim Chief Financial Officer, with assistance from other members of our management, has reviewed the effectiveness of our disclosure controls and procedures as of June 30, 2023, and, based on his evaluation, has 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, 2023 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.