Notes
to Condensed Consolidated Financial Statements
March
31, 2020
(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 months ended March 31, 2020 are not necessarily indicative of
the results that may be expected for the fiscal year ending December 31, 2020. The condensed consolidated financial statements
as of December 31, 2019 are derived from audited financial statements. 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 for the fiscal year ended December 31, 2019.
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 primarily utilized its cash, cash equivalents, and investments generated from sales of our common stock, proceeds
from the exercise of options and warrants, and royalty fees collected 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 limited 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 March 31, 2020, we had working capital of approximately $6.3 million, cash of approximately
$5.8 million, shareholders’ equity of approximately $6.4 million and an accumulated deficit of approximately $116.1
million. Our 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. Based on our current expectations of our cash flow shortfall
for the next 12 months, our working capital would support our activities for the next 34 months.
In
the event that we are unable to generate sufficient cash from our operating activities or raise additional funds, we may be required
to delay, reduce or severely curtail our operations or otherwise impede our on-going business efforts, which could have a material
adverse effect on our business, operating results, financial condition and long-term prospects. 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.
Recent
Global Events:
On
March 11, 2020 the World Health Organization declared the novel strain of coronavirus (COVID-19) a global pandemic and recommended
containment and mitigation measures worldwide. As a result, the Company expects operations at its facility to be affected in some
capacity, as the COVID-19 virus continues to proliferate and the federal, state and local governments under which we operate continue
to adopt new rules. The Company has put in place enhanced procedures, such as restricting international and domestic travel, adopting
a variety of steps designed to ensure social distancing in our facilities, including working remotely where available, and increasing
our cleaning and sanitizing procedures in our facilities, in an effort to protect its employees and communities.
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 our technology are manufactured by licensees overseas in Europe and Asia
who have been similarly affected by the pandemic. The disruption caused by public health crises, such as 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, but could materially adversely affect our business, financial condition, results of operations, and cash flows.
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:
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An
entity need not reassess whether any expired or existing contracts are or contain leases.
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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.
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An
entity need not reassess initial direct costs for any leases.
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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. 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
5. 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.
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 MAR 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.
The
Company does not have any contract assets under ASC 606 as of March 31, 2020.
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 March 31, 2020, the Company has four license agreements that are in their initial multiyear term (“Initial Term”)
with continuing performance obligations going forward. The Initial Term of one of these agreements will end as of December 31,
2020, one will end as of December 31, 2021, one will end as of December 31, 2022, and one will end as of December 31, 2024. The
Company currently expects that all four of these agreements will renew annually at the end of the Initial Term. As of March 31,
2020, the aggregate amount of the revenue to be recognized upon the satisfaction of the remaining performance obligations for
the four license agreements is $197,671. The revenue for these remaining performance obligations for each of the four license
agreements is expected to be recognized evenly throughout their remaining period of the Initial Term.
Note
6. 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 three months
of 2020, five licensees accounted for 10% or more of fee income of the Company; these licensees accounted for approximately
28%, 16%, 13%, 12% and 10% of fee income recognized during such period. During the first three months of 2019, five
licensees accounted for 10% or more of fee income of the Company; these licensees accounted for approximately 31%, 14%, 13%, 11%
and 10%, respectively, of fee income recognized during this period.
Note
7. 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 months ended March 31, 2020 and 2019 there were no options granted to consultants or
related charges.
There were no grants of restricted
stock or compensation expense recorded relating to restricted stock grants to employees and directors during the three months
ended March 31, 2020 and 2019.
As
of March 31, 2020, there were 882,500 shares available for future grant under our 2019 Equity Incentive Plan, which was approved
by the Company’s shareholders in June 2019.
Note
8. 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
9. 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 March 31, 2020 and
2019 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 2,788,403
and 2,752,766 for the three months ended March 31, 2020 and 2019, respectively.
Note
10. Equity
During
the three months ended March 31, 2020, the Company issued 156,845 shares of its capital stock in connection with the cashless
exercise of 243,091 outstanding options. During the three months ended March 31, 2019, the Company received $1,101,782 in proceeds
from the exercise of outstanding warrants and issued 1,001,620 shares of its capital stock in connection with these exercises.
The Company did not sell any equity securities
during the three months ended March 31, 2020 and 2019.
As
of March 31, 2020, there were 1,483,143 warrants outstanding.
Note
11. Subsequent Event
On April 17, 2020,
the Company borrowed $202,052 under the Small Business Administration Paycheck Protection Program (“PPP Loan”). The
PPP Loan requires no collateral, has a 1% fixed annual interest rate, has a term of two years, and has no prepayment penalties
or fees. All or some of the PPP Loan may be forgiven for the amounts spent by the Company, subject to certain conditions and limitations,
on authorized expenses such as payroll, rent and utilities over the eight weeks after receiving the loan.
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 4.9 years as of March 31, 2020. 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 are 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 March 31, 2020 is 5.5%.
Operating
lease expense for the three months ended March 31, 2020 was approximately $53,000. The Company has no material
variable lease costs or sublease income for the three months ended March 31, 2020. 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
thousand and associated lease liabilities of approximately $1.1 million.
Maturities
of operating lease liabilities as of March 31, 2020 were as follows:
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March 31, 2020
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For the remainder of 2020
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$
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160,156
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For the year ended December 31, 2021
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207,229
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For the year ended December 31, 2022
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213,320
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For the year ended December 31, 2023
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217,151
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For the year ended December 31, 2024
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221,869
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For the year ended December 31, 2025 and beyond
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55,874
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Total lease payments
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1,075,599
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Less: imputed lease interest
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(139,426
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)
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Present value of lease liabilities
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$
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936,173
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