Universal Display Corporation — Q2 2019 Form 10-Q Summary
Business context and reporting period
Universal Display Corporation develops, licenses and commercializes OLED technologies and materials for display and lighting applications. Revenue is generated primarily from OLED material sales, intellectual-property licensing and royalties, contract research services through Adesis, and technology development and support. The filing covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.
Approximately 98% of second-quarter revenue and 97% of first-half revenue came from OLED materials. Revenue outside North America represented 97% of both second-quarter and first-half 2019 revenue. Three customers accounted for 86% of second-quarter revenue and 84% of first-half revenue.
Financial performance and liquidity
| Metric | Three months ended June 30, 2019 | Three months ended June 30, 2018 | Six months ended June 30, 2019 | Six months ended June 30, 2018 |
|---|---|---|---|---|
| Revenue | $118.2 million | $56.1 million | $205.9 million | $99.7 million |
| Gross margin | $94.1 million; 79.6% | $44.5 million; 79.3% | $166.0 million; 80.6% | $80.6 million; 80.9% |
| Operating income | $48.7 million | $10.9 million | $83.0 million | $15.4 million |
| Net income | $43.4 million | $10.8 million | $74.9 million | $16.8 million |
| Diluted EPS | $0.92 | $0.23 | $1.58 | $0.35 |
| Operating cash flow | Not separately provided | Not separately provided | $83.9 million | $50.0 million |
Second-quarter revenue increased 110.4% year over year, while first-half revenue increased 106.5%. Second-quarter operating margin was approximately 41.2%, compared with 19.4% in the prior-year quarter; first-half operating margin was approximately 40.3%, compared with 15.5% in the prior-year period. Net margin was approximately 36.7% in the second quarter and 36.4% for the first half.
- Second-quarter research and development expense increased to $18.8 million from $12.9 million, primarily due to higher employee compensation and operating costs.
- Second-quarter selling, general and administrative expense increased to $15.9 million from $11.6 million, primarily due to higher employee-related compensation.
- First-half royalty and license expense increased to $6.0 million from $2.8 million as qualifying material sales increased.
- Inventory reserves increased by $3.9 million in the second quarter and $4.2 million in the first half, reflecting excess inventory in certain products.
At June 30, 2019, cash and cash equivalents were $324.3 million and short-term investments were $228.4 million, totaling $552.7 million, compared with $515.3 million at December 31, 2018. Working capital was $549.0 million versus $501.7 million at year-end 2018. The filing does not report outstanding borrowings or traditional debt; total liabilities were $260.0 million, including deferred revenue, retirement benefit liabilities and other liabilities.
- Operating activities provided $83.9 million of cash, compared with $50.0 million in the prior-year period.
- Investing activities provided $53.5 million, principally reflecting net sales of investments, compared with cash used of $62.3 million in the prior-year period.
- Capital expenditures were $20.3 million, including the purchase of adjacent Ewing, New Jersey property and expansion facilities.
- Financing activities used $24.1 million, including $9.4 million of dividends, $14.5 million of employee tax withholding payments and $0.6 million of share repurchases.
Material changes versus the prior comparable period
- Management attributed the revenue increase to stronger OLED display-market demand and customer purchases accelerated in response to potential U.S.-China trade concerns.
- Management estimated that China-related customer pre-purchases increased second-quarter revenue by approximately $15 million to $20 million, pulled forward from the second half of 2019.
- China revenue increased to $55.0 million in the second quarter from $8.5 million, while South Korea revenue increased to $58.8 million from $42.1 million.
- Deferred revenue was $127.1 million at June 30, 2019, including $82.5 million current and $44.7 million long term. The company had $9.0 million of committed phosphorescent-emitter purchase-order backlog expected to be fulfilled within 90 days.
- The company adopted ASC 842 on January 1, 2019, recognizing $8.3 million of operating lease right-of-use assets and lease liabilities. At June 30, operating lease liabilities totaled $7.6 million on a present-value basis.
- The company formed UDC Ventures LLC in March 2019 to invest in companies developing potentially synergistic products and technologies.
Guidance, outlook, commentary, risks and unusual items
Management stated that cash, cash equivalents and short-term investments are expected to be sufficient to meet obligations for at least the next twelve months. No formal revenue or earnings guidance was provided in the filing. Management noted that results may fluctuate based on OLED material shipment timing, license fees and royalties, research and development and patent expenditures, customer demand, and new business relationships.
- Revenue recognition depends on estimates of customer material volumes, royalties and total contract consideration. Significant customer contracts individually representing more than 10% of revenue expire in 2022.
- Customer concentration and geographic concentration are significant: three customers represented most revenue, and substantially all revenue was generated outside North America.
- Substantially all chemical materials were purchased from one supplier. Inventory purchase commitments were $14.3 million at June 30, 2019.
- The company recorded a $20.2 million long-term asset related to potential refunds of Korean withholding taxes on 2018 and 2019 royalty payments and a $2.1 million tax expense for withholding associated with Korean-registered patents. Separate estimated Korean withholding-tax refunds and related U.S. tax liabilities were also recorded for earlier years. These estimates may change upon settlement.
- UDC Ireland paid a $13.2 million Korean withholding-tax and interest assessment related to 2015–2017 payments involving LG Display; the payment is recorded as a long-term asset while the matter proceeds through the Korean Tax Tribunal.
- An opposition proceeding involving European Patent No. 1933395 concluded in March 2019 with maintenance of the patent claims submitted during the appeal. An appeal remains pending concerning European Patent No. 1390962, and the outcome is uncertain.
- Management identified revenue recognition and deferred revenue, inventories, and income taxes as critical accounting policies. The filing reported no material changes to previously disclosed risk factors and no off-balance-sheet arrangements.
- The board declared a third-quarter dividend of $0.10 per common share on July 30, 2019, payable September 30, 2019, subject to applicable record-date requirements and future board approval.
Important facts for investors to verify
- Whether the estimated $15 million to $20 million of China-related pre-purchases created a comparable-period pull-forward or demand risk for the second half of 2019.
- The sustainability of customer demand, particularly from the three customers representing the majority of revenue.
- Changes in deferred revenue, material shipments, royalties and revenue estimates under ASC 606.
- The adequacy of inventory reserves and the effect of excess inventory on future gross margins.
- Developments in the Korean withholding-tax matters, including potential refunds, U.S. tax consequences and the $13.2 million assessment.
- The status and scope of the remaining European patent opposition and any effect on the company’s phosphorescent OLED licensing and materials business.
- Future capital spending, lease obligations, research commitments and the company’s ability to maintain liquidity while funding OLED research and patent activities.