Notes
to Consolidated Financial Statements
June
30, 2018
(Unaudited)
Note
1. Basis of Presentation
The
accompanying unaudited consolidated condensed 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 six months ended June 30, 2018 are not
necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2018. 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, 2017.
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; train windows, 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 and cash equivalents 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 forgoing 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 on the nature of such
changes. 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. As of June 30, 2018, the Company
had cash and cash equivalents of $1,861,972, working capital (total current assets less total current liabilities) of $2,144,166
and total shareholders’ equity of $2,581,038. Since last year the Company has reduced its cash shortfall.
On
August 13, 2018, the Company announced that a group of investors led by a licensee of the Company’s SPD technology agreed
to make a $2,000,000 equity investment in the Company (please see Note 9 for additional details of this transaction). With the
addition of proceeds from this investment, the Company expects as of this filing to have sufficient working capital for at least
the next 24 months of operations.
Note
3. 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
4. Revenue Recognition
In
May 2014, the FASB issued guidance on revenue recognition (ASC 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. The comparative prior periods have not been adjusted and continue to be reported under FASB ASC Topic 605, Revenue Recognition
(“ASC 605”). The Company’s policy relating to revenue under ASC 605 is described in Note 2(e) of the Company’s
Form 10-K for the year ended December 31, 2017. The policies described herein refer to those in effect as of 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 commitments. 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. In the second quarter of 2018, the
Company reported $40,193 lower revenue under ASC 606 as compared to the accounting guidance used prior to the adoption of ASC
606 due to the higher percent of the transaction price being recognized in the first quarter. In the first six months of 2018,
the Company reported $4,425 higher revenue under ASC 606 as compared to the accounting guidance used prior to the adoption of
ASC 606 due to the higher percent of the transaction price being recognized in the first quarter.
ASC
606 was applied using the modified retrospective method to all contracts that were not completed contracts as of the implementation
date, with the cumulative effect of the initial adoption being recognized as an adjustment to opening retained earnings at January
1, 2018. As of January 1, 2018, we had four license agreements that were still under their multi-year initial term. The Company
elected to use the Modified Retrospective approach when adopting the provisions of ASC 606. Using the Modified Retrospective Approach,
with the adoption of ASC 606 as of January 1, 2018, the Company will not recognize $58,021 of revenue in future periods from these
four license agreements that it would have recognized under ASC 605. The non-recognition of future revenues associated with the
adoption of ASC 606 is solely from a financial reporting standpoint and does not impact the Company’s licensees’ obligations
to pay royalties to the Company under their license agreements. The Company recorded a cumulative adjustment to decrease opening
accumulated deficit and increase accounts receivable balance as of January 1, 2018 by $58,021.
|
Royalties
receivable balance, net - December 31, 2017
|
|
$
|
597,441
|
|
|
Cumulative
effect of adoption of ASC 606
|
|
|
58,021
|
|
|
Opening
royalties receivable balance, net - January 1, 2018
|
|
$
|
655,462
|
|
As
of June 30, 2018, the net closing royalties receivable balance is $634,340. Had ASC 606 not been adopted, the Company’s
net closing accounts receivable balance as of June 30, 2018 would have been $661,858. The Company does not have any contract
assets under ASC 606 as of January 1, 2018 and June 30, 2018. There was $824 of revenue recognized during the six months ended
June 30, 2018 that was included in contract liability (deferred revenue) as of the beginning of the period and the balance of
this account as of June 30, 2018 is $102,848. Had ASC 606 not been adopted, the Company’s deferred revenue balance as of
June 30, 2018 would have been $114,028.
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 June 30, 2018, the Company has five license agreements that are in their initial multiyear term (“Initial Term”)
with continuing performance obligations going forward. The Initial Term of two 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 five of these agreements will renew annually at the end of the Initial Term. As of June 30,
2018, the aggregate amount of the revenue to be recognized upon the satisfaction of the remaining performance obligations for
the five license agreements is $320,966. The revenue for these remaining performance obligations for each of the five license
agreements is expected to be recognize evenly throughout their remaining period of the Initial Term.
Note
5. 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 six months of 2018, three licensees accounted for 10% or more of fee income of the Company; these
licensees accounted for approximately 33%, 13% and 12%, respectively of fee income recognized during such period. During
the first six months of 2017, three licensees accounted for 10% or more of fee income of the Company; these licensees accounted
for approximately 31%, 17% and 13%, respectively of fee income recognized during this period.
Note
6. 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 six months ended June 30, 2018 and 2017 there
were no charges related to options granted to consultants.
During
the three and six months ended June 30, 2018,
the Company granted 150,182 fully vested options to employees and recorded
share-based compensation of $69,309
.
The Company valued these grants using the Black-Scholes
option pricing model with the following assumptions:
|
|
|
June
30, 2018
|
|
|
|
|
|
|
|
Fair
value on grant date
|
|
$
|
0.462
|
|
|
Expected
Dividend yield
|
|
|
-
|
|
|
Expected
volatility
|
|
|
51
|
%
|
|
Risk
free interest rate
|
|
|
2.77
|
%
|
|
Expected
term of the option
|
|
|
5
years
|
|
The
Company did not grant any stock options to employees and directors during the three and six months ended June 30, 2017.
There
was no compensation expense recorded relating to restricted stock grants to employees and directors during the three and six months
ended June 30, 2018 and 2017.
Note
7. 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 not more likely than not
that the Company would achieve profitable operations and be able to utilize the benefit of the net operating loss carryforwards.
Note
8. Equity
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 has 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.
The
Company did not sell any equity securities during the three and six months ended June 30, 2017.
Note
9. Subsequent Event
On
August 13, 2018, the Company announced that a group of investors led by a licensee of the Company’s SPD technology agreed
to make a $2,000,000 equity investment in the Company. As of the date of this filing, the Company has received $500,000 of the
investment proceeds from this offering. With the addition of the anticipated proceeds from this investment, the Company expects
to have sufficient working capital for at least the next 24 months of operations. Based on the current funding received and additional
strategic cost cutting measures implemented at the date of this filing, the Company will have sufficient working capital of at
least the next 15 months of operations. At the closing, the investors will receive 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.
Note
10. Treasury Stock
The
Company did not repurchase any of its stock during the three and six month periods ended June 30, 2018 and 2017.
Note
11. Fair Value Measurements
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.