[Editor's Note: This article was updated at 4:30 p.m. on 7/27/01 to include ThermoView Industries' dispute of statements made by Asensio and Company.]

We shorted shares of genomics tool maker Affymetrix (Nasdaq: AFFX) in June, and when I wrote the first draft of this column, we were up over 20%. For some reason, after the company came out with Q2 earnings, the stock jumped and our entire paper profit was wiped out in one day.


Not that we're covering. But it does remind us that a short presents the theoretical risk of unlimited losses, as well as paying margin interest. (Enjoy our special, Is Shorting Stocks Foolish? for the whole skinny on the subject.) That's why we would think seriously, as always, about covering at 20% to 30% over our short price. We're not there yet, but we do have to pay close attention -- much more than we would to investments we're holding for long-term gain.  

Another short idea
Now that we're in a shorting frame of mind, here's another idea, for which I thank Motley Fool Analyst Zeke Ashton (TMF Centaur), who is also Editor of our new monthly research report, The Motley Fool Select. Zeke, who penned Monday's excellent Rule Breaker column, "The Trouble With Intellectual Property," has told me about a short candidate he learned about through well-known short seller Manuel Asensio, whose new book Whitney Tilson recently examined. In the Rule Breaker Port (which was previously the Fool Port, which held shorts from day one), we view shorting itself as a breaking of the rules.

Research backwaters
The company is Research Frontiers (Nasdaq: REFR). This company, with a $319 million market cap, does not appear to make or sell anything, despite protestations that it exists to license its patented suspended-particle technology for products to control the amount of light passing though a device, such as glass. Yup, this money-losing company seems to do nothing else but enrich its 13 employees and managers, as well as directors, through a 15-year history of press release puffery.

Hype machine?
And what a publicity machine it is. At first glance, reviewing the press releases at the company's website (click "press releases"), you might think Research Frontiers is a hotbed of technological wonder. Asensio provides intriguing evidence that there's less than meets the eye.

Take the company's June 14, 2001 announcement that "Research Frontiers Announces Its First Profit Targets as Part of New 'Road Map' for the Future." Asensio released a report that "REFR issues unsubstantiated future profit forecast," adding: "No orders or new developments were announced. In fact, REFR is a 35-year-old company with an uninterrupted history of losses and commercial failure. REFR did not provide any information on the amount of profits it expects nor the exact source of its expected revenues, and this is not the first time expected profits have been announced. According to the February 1997 issue of the Business Journal, Robert L Saxe, REFR's President, believed profits were possible in 1998. REFR has had end-product licensees since 1986."

Asensio went farther in a prepared statement that "REFR uses 12-year-old promotion in its supposedly new story." He said, "REFR seems to be promoting the idea of converting aircraft window shades from something mechanical, simple, and unquestionably effective to something that uses electricity and controls, is unproven, highly questionable, and complex to install and maintain and cannot change from totally clear to totally dark."

Now there's a business with potential. Not.

Who are their customers, anyway?
In response to the company's June 26, 2001 release, "ThermoView Industries to Offer "SPD" Smart Windows," Asensio published "REFR involved in yet another questionable deal," in which he observes that ThermoView is a penny stock promoted by R.J. Faulkner, a company "paid to promote stocks through the production of investment research and financial communications," and which has promoted both ThermoView and Research Frontiers. ThermoView, with a $7.8 million market cap at the time, reverse-merged with a "shell company whose prior controlling shareholder, and prior officer and director, David P. Yeaman, was convicted in 1999 of securities fraud, wire fraud and conspiracy."

Asensio's research on this point, however, is pointedly disputed by ThermoView. In a June 16, 2001 press release, ThermoView retorted: "ThermoView was founded in April 1998 as a result of a name change from Oak Hill, Inc., a Nevada corporation. Oak Hill, Inc. was originally organized in 1988 as Jackal, Inc. A July 12 news release issued by NASD member Asensio and Company, a company which actively engages in short-selling transactions, contains erroneous statements about ThermoView and its formation.

"Jackal, Inc., organized in Nevada, has no connection with Jackal Industries, Inc., a Utah corporation founded in 1986 and subsequently reorganized in Nevada in 1993. The July 12 news release indicated that ThermoView consummated a reverse merger in 1997, when in fact the merger took place in April 1998. Also the July 12 news release incorrectly indicated that ThermoView merged with Jackal Industries, Inc. and had some association with a former officer and director of Jackal Industries, Inc.

"'We have no knowledge of any past or present association with Jackal Industries, Inc. or David Yeaman as suggested in Asensio and Company's press release," stated [ThermoView president and CEO, Charles L.] Smith.'"

The ThermoView controversy aside, Asensio continues: "In 1992 REFR was promoting SPD smart windows through a REFR licensee with Japan Steel Works, Ltd. Since 1986 REFR has announced at least eight licensing deals for the manufacturing and sales of SPD products ranging from sunglasses to aircraft cabin windows. In 1989 REFR announced the successful testing and planned commercialization of SPD sunglasses.

"In 1994 Automotive News reported that REFR was close to selling SPD self-dimming rear-view mirrors. In 1997 REFR claimed profits were possible in 1998. REFR is 35 years old. Neither REFR nor any of its licensees have ever sold an SPD based product. REFR has also announced three licensing deals to manufacture SPD emulsion since 1999 and five licensing deals to manufacture SPD film since 1995. We found no evidence that any SPD emulsion or film has ever been sold."

Enough to whet your appetite for a further look?

Compensation for what?
Asensio and others appear to have the following view: Research Frontiers basically issues press releases that ballyhoo product deals that never materialize into cash and profits, hoping to drive up the price of its shares. An increased stock price then allows the payment of bonuses to employees, officers, and directors, who then exercise options, providing cash to the company. A higher share price also allows the company to sell shares, such as through a three-year deal it established with London-based Ailouros Ltd., a money management fund, and raise more cash for management to extract.   

Reviewing the company's year 2000 10-K, I found support for this view by looking at compensation. 

The company's operating expenses increased 89% in 2000, "primarily the result of increased compensation." That compensation was "performance options and warrants issued to consultants... payment to employees for certain performance bonuses..." With no profits and revenue of $337,000, I have to ask, performance for what? Also, what value are the consultants adding? Performance of any kind is simply not evident over the last five years, looking at the company's only cash income categories: licensing revenue ("fee income") and loss per share:

               2000  1999  1998  1997  1996
fee income $334K $128K $108K $ 60K $ 50K loss per share (0.63)(0.34)(0.24)(0.32)(0.25)

Who deserves a performance bonus for this record? But then, it appears that all management has to do is increase the stock price, and this company appears to buck the alleged truism that in the long run a stock's price relates to its company's underlying earnings.

The performance bonus certainly has paid off, for employees. It's 1% of the increase, if any, in the company's market value for a given period, capped at an employee's salary, or $55,000 for non-employee directors. Quite rich compensation for a 35-year-old unprofitable company. Chairman, President, and Treasurer Robert Saxe earned $836,000 last year, and Executive Vice President, General Counsel, and Director Joseph Harary earned $641,000.  

Hiding compensation expenses as R&D?
Another red flag appears in the research and development costs. These increased $647,226 in 2000, to $2.6 million, "primarily the result of high research-related salaries and performance bonuses, a high materials cost, [and] patent and depreciation expenses." Would someone tell me which employees are performing this R&D, what materials they are buying, and what on earth is depreciating?  

I'm no accountant, but it looks to me as if this company, which has 13 employees, exists primarily to give them a living without actually having to do anything other than get others to support them. 

Should we short it?
There's probably more to understanding Research Frontiers, but this is quite enough to excite me. Jeff Fischer said that this story reminds him of our 1996 Halloween column about shorting Copytele (Nasdaq: COPY).  Take a look. Then let us know whether you think Research Frontiers is a good short, and please share your thoughts on the RB Strategies discussion board!

Tom Jacobs' (TMF Tom9) household is scheduled to get cable TV and high-speed cable Internet access at home today. Welcome them to the 21st century! At press time, he owned no shares in companies mentioned in this column. To see his stock holdings, view his profile, and check out The Motley Fool's disclosure policy.