Notes
to Condensed Consolidated Financial Statements
September
30, 2019
(Unaudited)
Note
1. Basis of Presentation
The
accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally
accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Rule 8-03 of
Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All
such adjustments are of a normal recurring nature. Operating results for the three and nine months ended September 30, 2019 are
not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2019. The balance sheet at December 31, 2018 has been derived from the audited
consolidated financial statements at that date. For further information, refer
to the consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K relating to Research
Frontiers Incorporated (the “Company”) for the fiscal year ended December 31, 2018.
Note
2. Business
Research
Frontiers Incorporated (“Research Frontiers” or 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. Such devices, often referred
to as “light valves” or suspended particle devices (SPDs), use colloidal particles that are either incorporated within
a liquid suspension or a film, which is usually enclosed between two sheets of glass or plastic having transparent, electrically
conductive coatings on the facing surfaces thereof. At least one of the two sheets is transparent. SPD technology, made possible
by a flexible light-control film invented by Research Frontiers, allows the user to instantly and precisely control the shading
of glass/plastic manually or automatically. SPD technology has numerous product applications, including SPD-Smart™ windows,
sunshades, skylights and interior partitions for homes and buildings; automotive windows, sunroofs, sun-visors, sunshades, rear-view
mirrors, instrument panels and navigation systems; aircraft windows; museum display panels, eyewear products; and flat panel displays
for electronic products. SPD-Smart light control film is now being developed for, or used in, architectural, automotive, marine,
aerospace and appliance applications.
The
Company has historically utilized its cash, cash equivalents, short-term investments, and the proceeds from the sale of its investments
to fund its research and development of SPD light valves, for marketing initiatives, and for other working capital purposes. The
Company’s working capital and capital requirements depend upon numerous factors, including the results of research and development
activities, competitive and technological developments, the timing and cost of patent filings, and the development of new licensees
and changes in the Company’s relationships with its 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. We have incurred recurring losses since inception and expect to continue to incur losses as a
result of costs and expenses related to our research and continued development of our SPD technology and our corporate general
and administrative expenses. Our capital resources and operations to date have been substantially funded through sales of our
common stock, exercise of options and warrants and royalty fees collected. As of September 30, 2019, we had working capital of
approximately $7.6 million, cash of approximately $7.0 million, shareholders’ equity of approximately $7.8 million
and an accumulated deficit of approximately $114.2 million. 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-$550,000 per
quarter. We may eliminate some operating expenses in the future, which will further reduce our cash flow shortfall if needed.
We expect to have sufficient working capital for at least the next 3 years to fund operations based upon current expense levels.
In
the event that we are unable to generate sufficient cash from our operating activities or raise additional funds, we may delay,
reduce or curtail our operations. The Company may seek to obtain additional funding through future equity issuances. There can
be no assurance as to the availability or terms upon which such financing and capital might be available. Eventual success of
the Company and generation of positive cash flow will be dependent upon the 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 fund its operations.
Note
3. Recently Adopted Accounting Pronouncement
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
standard provides practical expedients in order to simplify adoption, including the following:
|
|
●
|
An
entity need not reassess whether any expired or existing contracts are or contain leases.
|
|
|
●
|
An
entity need not reassess the lease classification for any expired or existing leases. Instead, any leases previously classified
as operating leases will continue to be classified as operating leases, while any leases previously classified as capital
leases will be classified as finance leases.
|
|
|
●
|
An
entity need not reassess initial direct costs for any leases.
|
The
Company used the above practical expedients as the transition method in the application of the new lease standard at January 1,
2019. The Company applied a policy election to exclude short-term leases from balance sheet recognition and 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 or the initial direct costs for any existing leases which were not previously
accounted for as leases, are or contain a lease. At adoption on January 1, 2019, an operating lease liability of $1,134,000
and an operating lease right of use asset of $941,000 were recorded. The operating lease liability was $193,000 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.
Note
4. Fair Value Measurements
The
fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between
willing parties. The carrying amounts of all financial instruments classified as a current asset or current liability are deemed
to approximate fair value because of the short maturity of those instruments.
Accounting
Standards Codification (“ASC”) Topic 820 “Fair Value Measurements and Disclosures” (“ASC Topic 820”)
establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair
value measurements. ASC Topic 820 applies other previously issued accounting pronouncements that require or permit fair value
measurements but does not require any new fair value measurements.
ASC
Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. ASC Topic 820 establishes a fair value hierarchy that distinguishes
between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs)
and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available
in the circumstances (unobservable inputs).
We
value financial instruments using a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value.
These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets for identical assets or liabilities;
Level 2, defined as inputs other than quoted prices for similar assets or liabilities in active markets that are either directly
or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring
an entity to develop its own assumptions.
As
of September 30, 2019, and December 31, 2018, the fair value of the Company’s financial assets and non-warrant liabilities
including cash and cash equivalents, royalties receivable, accounts payable and accrued expenses approximated carrying value due
to the short-term maturity of these instruments. The carrying value of the previous warrant liabilities was adjusted to fair value
each reporting period using the Black-Scholes method to determine the fair value of the warrants. The issued warrants treated
as warrant liabilities had different exercise prices depending on the date of exercise. The lowest exercise price for these warrants
was used in the Black Scholes method to value the warrant liabilities since it was deemed a reasonable approximation of fair market
value. The Company’s warrant liability was considered a Level 3 financial instrument and the corresponding liabilities were
reclassified to equity during the three months ended June 30, 2019, therefore there was no warrant liability as of September 30,
2019. The estimated fair value for warrant liabilities for the period ended December 31, 2018 using the Black-Scholes method was
$501,414.
Note
5. Patent Costs
The
Company expenses costs relating to the development, acquisition or enforcement of patents due to the uncertainty of the recoverability
of these items.
Note
6. Revenue Recognition
Company
recognizes revenue in accordance with ASC 606 Revenue
from Contracts with Customers (Topic 606). The standard provides a single comprehensive revenue recognition model for
all contracts with customers and supersedes existing revenue recognition guidance. The revenue standard contains principles that
an entity will apply to determine the measurement of revenue and timing of when it is recognized. The underlying principle is
that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects
to be entitled to in exchange for those goods or services.
This
new ASC 606 guidance was adopted by the Company beginning January 1, 2018. ASC 606 was applied using the modified retrospective
method, with the cumulative effect of the initial adoption being recognized as an adjustment to opening retained earnings at January
1, 2018.
ASC
606 follows a five-step approach to determining revenue recognition including: 1) Identification of the contract; 2) Identification
of the performance obligations; 3) Determination of the transaction price; 4) Allocation of the transaction price and 5) Recognition
of revenue.
The
Company determined that its license agreements provide for three performance obligations which include: (i) the Grant of Use to
its Patent Portfolio (“Grant of Use”), (ii) Stand-Ready Technical Support (“Technical Support”)
including the transfer of trade secrets and other know-how, production of materials, scale-up support, analytical testing, etc.,
and (iii) access to new Intellectual Property (“IP”) that may be developed sometime during the course of the contract
period (“New Improvements”). Given the nature of IP development, such New Improvements are on an unspecified basis
and can occur and be made available to licensees at any time during the contract period.
When
a contract includes more than one performance obligation, the Company needs to allocate the total consideration to each performance
obligation based on its relative standalone selling price or estimate the standalone selling price if it is not observable. A
standalone selling price is not available for our performance obligations since we do not sell any of the services separately
and there is no competitor pricing that is available. As a consequence, 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. Comparable license agreements must consider several factors including: (i) the materials
that are being licensed, (ii) the market application for the licensed materials, and (iii) the financial terms in the license
agreements that can increase or decrease the risk/reward nature of the agreement.
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. The Company focuses a significant portion of its time and resources to provide
the Technical Support and New Improvements services to its licensees which further supports the conclusions reached using the
royalty rate analysis.
The
Technical Support and New Improvements performance obligations are co-terminus over the term of the license agreement. For purposes
of determining the transaction price, and recognizing revenue, the Company combined the Technical Support and New Improvements
performance obligations because they have the same pattern of transfer and the same term. We maintain a staff of scientists and
other professionals whose primary job responsibilities throughout the year are: (i) being available to respond to Technical Support
needs of our licensees, and (ii) developing improvements to our technology which are offered to our licensees as New Improvements.
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 initial contract period
as these performance obligations are satisfied. If the agreement is not terminated at the end of the initial contract period,
it will renew on the same terms as the initial contract for a one-year period. Consequently, any fees or minimum annual royalty
obligations relating to this renewal contract will be allocated similarly to the initial contract over the additional one-year
period.
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. The value of the Technical Support and New Improvements obligations is allocated throughout the contract
period based on the satisfaction of its performance obligations. If the agreement is not terminated at the end of the contract
period, it will renew on the same terms as the original agreement for a one-year period. Consequently, any fees or minimum annual
royalties (“MAR”) relating to this renewal contract will be allocated similarly over that additional year.
The
Company’s license agreements have a variable royalty fee structure (meaning that royalties are a fixed percentage of sales
that vary from period to period) and frequently include a minimum annual royalty commitment. In instances when sales of licensed
products by its licensees exceed the MAR, the Company recognizes fee income as the amounts have been earned. Typically, the royalty
rate for such sales is 10-15% of the selling price. While this is variable consideration, it is subject to the sales/usage royalty
exception to recognition of variable consideration in ASC 606 10-55-65 and therefore is not recognized until the subsequent sales
or usage occurs or the MAR period commences.
Because
of the immediate recognition of the Grant of Use performance obligation: (i) the first period of the contract term will generally
have a higher percent allocation of the transaction price under ASC 606 than under the accounting guidance used prior to the adoption
of ASC 606, and (ii) the remaining periods in the year will have less of the transaction price recognized under ASC 606 than under
the accounting guidance used prior to the adoption of ASC 606. After the initial period in the contract term, the revenue for
the remaining periods will be based on the satisfaction of the technical support and New Improvements obligations. Since most
of our license agreements start as of January 1st, the revenue recognized for the contract under ASC 606 in our first quarter
will tend to be higher than the accounting guidance used prior to the adoption of ASC 606.
The
Company does not have any contract assets under ASC 606 as of September 30, 2019.
Certain
of the contract fees are accrued by, or paid to, the Company in advance of the period in which they are earned resulting in deferred
revenue. Such excess amounts are recorded as deferred revenue and are recognized into income in future periods as earned.
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 majority of the Company’s licensing 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 each model produced with SPD-SmartGlass, and changes in pricing
or exchange rates.
As
of September 30, 2019, the Company has seven license agreements that are in their initial multiyear term (“Initial Term”)
with continuing performance obligations going forward. The Initial Term of four of these agreements will end as of December 31,
2019, one will end as of December 31, 2020, one will end as of December 31, 2021, and one will end as of December 31, 2022. The
Company currently expects that all seven of these agreements will renew annually at the end of the Initial Term. As of September
30, 2019, the aggregate amount of the revenue to be recognized upon the satisfaction of the remaining performance obligations
for the seven license agreements is $282,632. The revenue for these remaining performance obligations for each of the seven license
agreements is expected to be recognized evenly throughout their remaining period of the Initial Term.
Note
7. Fee Income
Fee
income represents amounts earned by the Company under various license and other agreements relating to technology developed by
the Company. During the first nine months of 2019, three licensees accounted for 10% or more of fee income of the Company; these
licensees accounted for approximately 43%, 15% and 10% of fee income recognized during such period. During the first nine
months of 2018, four licensees accounted for 10% or more of fee income of the Company; these licensees accounted for approximately
33%, 14%, 11% and 10%, respectively, of fee income recognized during this period. During the three-month period
ended September 30, 2019, two licensees accounted for 10% or more of fee income of the Company; these licensees
accounted for approximately 53% and 15% of fee income recognized during such period. During the three-month period ended
September 30, 2018, three licensees accounted for 10% or more of fee income of the Company; these licensees accounted for approximately
33%, 14% and 14%, respectively, of fee income recognized during such period.
Note
8. Stock-Based Compensation
The
Company has granted options/warrants to consultants. GAAP requires that all stock-based compensation be recognized as an expense
in the financial statements and that such costs be measured at the fair value of the award at the date of grant. These awards
generally vest ratably over 12 to 60 months from the date of grant and the Company charges to operations quarterly the current
market value of the options using the Black-Scholes method. During the three and nine months ended September 30, 2019 and 2018
there were no charges related to options granted to consultants.
During
the nine-month period ended September 30, 2018, the Company granted 150,182 fully vested options to employees and recorded share-based
compensation of $69,309. All of the options granted to employees during the nine-month period ended September 30, 2018 occurred
during the second quarter of 2018. The Company valued these grants using the Black-Scholes option pricing model with the following
assumptions:
|
Fair value on grant date
|
|
$
|
0.462
|
|
|
Expected dividend yield
|
|
|
0
|
|
|
Expected volatility
|
|
|
51
|
%
|
|
Risk free interest rate
|
|
|
2.77
|
%
|
|
Expected term of the option
|
|
|
5
years
|
|
During
the nine-month period ended September 30, 2019, the Company granted 233,500 fully vested options to employees and directors and
recorded share-based compensation of $356,228. All of the options granted to employees during the nine-month period ended September
30, 2019 occurred during the second quarter of 2019. The Company valued these grants using the Black-Scholes option pricing model
with the following assumptions:
|
Fair
value on grant date
|
|
$
|
1.5256
|
|
|
Expected
dividend yield
|
|
|
0
|
|
|
Expected
volatility
|
|
|
61
|
%
|
|
Risk
free interest rate
|
|
|
1.84
|
%
|
|
Expected
term of the option
|
|
|
5
years
|
|
There
was no compensation expense recorded relating to restricted stock grants to employees and directors during the three and nine
months ended September 30, 2019 and 2018.
As
of September 30, 2019, there were 1,166,500 shares available for future grant under our 2019 Equity Incentive Plan, which was
approved by the Company’s shareholders in June 2019.
Note
9. Income Taxes
Since
inception, the Company has incurred losses from operations and as a result has not recorded income tax expense. Benefits related
to net operating loss carryforwards and other deferred tax items have been fully reserved since it was more likely than not that
the Company would not achieve profitable operations and be able to utilize the benefit of the net operating loss carryforwards.
Note
10. Basic and Diluted Loss Per Common Share
Basic
loss per share excludes any dilution. It is based upon the weighted average number of common shares outstanding during the period.
Dilutive loss per share reflects the potential dilution that would occur if securities or other contracts to issue common stock
were exercised or converted into common stock. The Company’s dilutive loss per share equals basic loss per share for the
periods ended September 30, 2019 and 2018, respectively, because all common stock equivalents (i.e., options
and warrants) were antidilutive in those periods. The number of options and warrants that were not included (because their effect
is antidilutive) was 3,324,213 and 2,975,985 for the three and nine months ended September 30, 2019 and 2018, respectively.
Note
11. Equity
During
the nine months ended September 30, 2019, the Company received $1,170,546 in proceeds from the exercise of outstanding options
and warrants and issued 1,060,718 shares of its common stock in connection with these exercises. In addition, during the
nine months ended September 30, 2019, the Company issued 363,125 shares of its common stock in connection with the cashless
exercise of 603,569 of its outstanding options and warrants. During the three-month period ended September 30, 2019, the Company
received $64,647 in proceeds from the exercise of outstanding options and warrants and issued 56,848 shares of its common
stock in connection with these exercises. There were no proceeds from the exercise of outstanding warrants and/or options during
the three or nine month period ended September 30, 2018.
On
or around February 16, 2018, a small group of long-time shareholders of the Company who are accredited investors made an interest-free
five-year convertible loan of $1.25 million to the Company which, upon the occurrence of certain conditions which have already
occurred, automatically converted into 1,388,893 shares of common stock at a price equal to the market price of the Company’s
common stock when the loan was made, plus warrants expiring February 28, 2023 to purchase 1,388,893 shares of common stock at
an exercise price of $1.10, $1.20 or $1.35 per share depending on the exercise date. No payments are due on this note during its
five-year term or after conversion into equity. On April 23, 2018, Research Frontiers Incorporated filed a prospectus supplement
relating to the issuance and sale of the above common stock and warrant securities with the Securities and Exchange Commission.
The Company recorded this transaction as an equity transaction whereby the proceeds were accounted for as the issuance of the
Company’s common stock on the date that the proceeds were received.
On
September 7, 2018, the Company announced that it had sold common stock to a group of investors led by Gauzy Ltd., a licensee of
the Company’s SPD technology (Gauzy). The aggregate proceeds from these stock offerings was $2.0 million. At the closing,
the investors received 2,173,916 shares of Research Frontiers common stock at a price of $0.92 per share, as well as five-year
warrants to purchase 1,086,957 shares of Research Frontiers common stock at an exercise price of $1.10, $1.20 or $1.38 per share
depending on the exercise date. In connection with the issuance of certain of these warrants during the third quarter of 2018,
the Company recorded $223,370 as a warrant liability upon the issuance of these warrants on August 13, 2018 and recorded a non-cash
expense of $278,044 to mark the warrants to their estimated market value as of December 31, 2018. This resulted in a liability
of $501,414 recorded on the Company’s December 31, 2018 balance sheet.
On
or around May 30, 2019, the Company sold to accredited investors a total of 1,276,599 shares of common stock and warrants expiring
May 31, 2024 to purchase 638,295 shares of common stock at an exercise price of $3.384, $3.666 or $4.23 per share depending on
the exercise date. Research Frontiers Incorporated also sold to Gauzy, at a price of $1.38 per unit, with each unit comprised
of one share of unregistered common stock and one half of one warrant. The warrant can be converted into one share of unregistered
common stock at an exercise price of $1.656, $1.794 or $2.07 per share depending on the exercise date. Gauzy received a total
of 724,638 shares of unregistered common stock and warrants expiring May 31, 2024 to purchase 362,319 shares of common stock.
The aggregate proceeds from these stock offerings was $4.6 million.
Investors
that participated in the May 30, 2019 offering agreed to amending/clarifying language to the terms of the warrants that they received
in the September 7, 2018 offering. Those investors that received warrants in the September 7, 2018 offering that did not participate
in the May 30, 2019 offering, separately agreed as of June 27, 2019 to the same amending/clarifying language used in the May 30,
2019 offering. The amending/clarifying language relating to the September 7, 2018 warrants does not allow for a net cash settlement
option for the warrants even if no registered shares of common stock are available upon the exercise of the warrant. The Company
recorded a non-cash expense of $0 and $652,025 respectively for the three- and nine-month periods ended September 30, 2019
to mark these warrants to their estimated market value as of their respective amendment/clarification date. The warrant liability
was valued at $1,153,439 (including all valuation adjustments since their issuance) through the date of these new agreements and
amendments and, based on the amended warrant terms, the warrant liability was reclassified to equity as of these dates.
As
of September 30, 2019, there were 2,029,462 warrants outstanding.
Note
12. Leases
The
Company determines if an arrangement is a lease at its inception. This determination generally depends on whether the arrangement
conveys the right to control the use of an identified fixed asset explicitly or implicitly for a period of time in exchange for
consideration. Control of an underlying asset is conveyed if the Company obtains the rights to direct the use of, and to obtain
substantially all of the economic benefits from the use of, the underlying asset. Lease expense for variable leases and short-term
leases is recognized when the obligation is incurred.
The
Company has operating leases for certain facilities, vehicles and equipment with a weighted average remaining lease term of 5.4
years as of September 30, 2019. Operating leases are included in right of use lease assets, other current liabilities and long-term
lease liabilities on the condensed consolidated balance sheet. Right of use lease assets and liabilities are recognized
at each lease’s commencement date based on the present value of its lease payments over its respective lease term. The Company
does not have an established incremental borrowing rate as it does not have any debt. The Company uses the stated borrowing rate
for a lease when readily determinable. When the interest rates implicit in its lease agreements is not readily determinable, the
Company used an interest rate based on the marketplace for public debt. The weighted-average discount rate associated with operating
leases as of September 30, 2019 is 5.5%.
Operating
lease expense for the three months ended September 30, 2019 was approximately $53,000 and approximately $164,000
for the nine months ended September 30, 2019. The Company has no material variable lease costs or sublease income for the nine
months ended September 30, 2019. Subsequent to the Company’s adoption of the new lease accounting guidance on January 1,
2019, the Company recorded new right of use lease assets of approximately $900,000 and associated lease liabilities of
approximately $1.1 million.
Maturities
of operating lease liabilities as of September 30, 2019 were as follows:
|
|
|
September
30, 2019
|
|
|
For the remainder of 2019
|
|
$
|
52,989
|
|
|
For the year ended December 31, 2020
|
|
|
213,146
|
|
|
For the year ended December 31, 2021
|
|
|
207,229
|
|
|
For the year ended December 31, 2022
|
|
|
213,320
|
|
|
For the year ended December 31, 2023
|
|
|
217,151
|
|
|
For the year
ended December 31, 2024 and beyond
|
|
|
277,743
|
|
|
Total lease payments
|
|
|
1,181,578
|
|
|
Less: imputed
lease interest
|
|
|
(166,630
|
)
|
|
Present value of lease liabilities
|
|
$
|
1,014,948
|
|