Universal Display Corporation — Q1 2017 Form 10-Q Summary
Business context and reporting period
Universal Display Corporation develops, licenses, and commercializes organic light-emitting diode (OLED) technologies and materials for display and lighting applications. Revenue is generated primarily from OLED material sales, intellectual-property licensing and royalties, and contract research services. This unaudited report covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016.
The company owns, exclusively licenses, or has the sole right to sublicense more than 4,200 patents issued and pending worldwide. Contract research revenue includes activity from Adesis, acquired in July 2016.
Financial performance and key metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $55.6 million | $29.7 million | Up 87% |
| Material sales | $46.6 million | $24.3 million | Up 92% |
| Royalty and license fees | $7.0 million | $5.3 million | Up 32% |
| Contract research services | $1.9 million | $57 thousand | Up $1.8 million |
| Gross profit | $42.6 million | $24.7 million | Up 73% |
| Gross margin | 76.6% | 83.0% | Down 6.4 percentage points |
| Operating income | $12.1 million | $2.5 million | Up $9.5 million |
| Operating margin | 21.7% | 8.6% | Up 13.1 percentage points |
| Net income | $10.4 million | $1.9 million | Up 432% |
| Net margin | 18.7% | 6.6% | Up 12.1 percentage points |
| Diluted EPS | $0.22 | $0.04 | Up $0.18 |
| Cash flow from operations | $1.6 million | $0.2 million | Up $1.4 million |
Material sales growth was driven by higher demand and volume for red and green phosphorescent emitters. Commercial material sales increased 62% to $35.8 million, while developmental material sales increased 395% to $10.8 million. Phosphorescent emitter sales rose 94% to $46.2 million; host material sales declined 11% to $392 thousand.
Cost of sales increased to $13.0 million from $5.1 million. Commercial material cost as a percentage of commercial material sales increased to 27% from 23%, primarily because of lower average selling prices per gram. Operating expenses increased to $30.5 million from $22.1 million, reflecting higher research and development, selling and administrative costs, amortization, patent costs, and royalty expense.
As of March 31, 2017, cash and cash equivalents were $96.1 million and short-term investments were $228.9 million, providing $325.0 million of immediately identified cash and short-term investments. Working capital was $350.5 million. Total assets were $655.4 million and total liabilities were $90.3 million. The filing does not report outstanding debt or a revolving credit facility. The company had $14.8 million of long-term investments.
Material changes versus the prior comparable period
- Revenue increased $25.9 million, led by a $22.3 million increase in material sales.
- Operating income increased $9.5 million despite higher operating expenses.
- Adesis contributed to the significant increase in contract research services revenue and also increased selling, general and administrative expenses.
- Amortization expense increased $2.7 million due primarily to the BASF patent portfolio and Adesis intangible assets.
- Cash provided by operations improved modestly, but accounts receivable increased by $11.3 million and limited operating cash conversion.
- Investing activities used $40.1 million, compared with $14.1 million provided in the prior-year quarter, primarily because of net purchases of investments.
- The company began paying a quarterly common-stock dividend of $0.03 per share; $1.4 million was paid during the quarter.
- Adoption of ASU 2016-09 produced a $26.5 million beginning retained-earnings benefit from excess tax benefits related to share-based compensation. The reported effective tax rate was 18.5%; without the accounting change, management stated it would have been 27.8%.
Guidance, outlook, risks, contingencies, and unusual items
Management stated that existing cash, cash equivalents, and short-term investments are expected to be sufficient to meet obligations for at least the next twelve months. No quantitative revenue or earnings guidance was provided.
The Samsung Display commercial license agreement runs through the end of 2017, with license-fee installments generally due in the second and fourth quarters. The company anticipates renewal of the agreement as of January 1, 2018. The LG Display agreements run through the end of 2022, and the Tianma agreements run for five years from July 2016.
Key risks include dependence on a limited number of customers, concentration in South Korea, reliance on one major chemical-material supplier, fluctuations in OLED material demand and pricing, timing of license and royalty payments, inventory obsolescence, patent challenges, and the need to fund research, development, commercialization, and patent activities. Customer A represented 51% of Q1 2017 revenue and customer B represented 35%; approximately 94% of revenue came from outside North America.
The company had $6.3 million of inventory purchase commitments as of March 31, 2017 and was obligated to fund up to $7.2 million of research work under the extended USC research agreement through April 2020. Active European patent oppositions remain pending, including proceedings involving core phosphorescent OLED technologies. Management does not believe the identified proceedings will have a material consolidated financial impact, but it cannot assure a favorable outcome.
The company adopted the new revenue-recognition standard beginning January 1, 2018 and planned to use the modified retrospective method. It was evaluating the potential effects of other recently issued accounting standards. Management reported effective disclosure controls and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether the Samsung Display license is renewed on comparable or improved economic terms after its scheduled 2017 expiration.
- Whether the sharp increase in phosphorescent emitter demand and developmental material sales is sustained, and how pricing affects gross margin.
- Customer concentration, especially the combined contribution of the two largest customers.
- Cash conversion, accounts receivable collection, and the effect of continued investment purchases and dividends on liquidity.
- Potential outcomes and legal costs of the pending European patent oppositions.
- Revenue-recognition effects when the major license agreement is renewed and the company adopts the new standard in 2018.
- Future amortization, research and development spending, patent costs, and obligations related to Adesis, BASF, USC, and PPG.