Universal Display Corporation — Q1 2018 Form 10-Q Summary
Business context and reporting period
Universal Display develops, licenses and commercializes OLED technologies and materials for display and lighting applications. Revenue is generated primarily from OLED material sales, technology licensing, royalties, contract research and technology development services. The filing covers the three months ended March 31, 2018, compared with the three months ended March 31, 2017.
Major commercial relationships include Samsung Display, LG Display, BOE Technology and Tianma. Samsung's prior agreements expired at the end of 2017 and were replaced by new five-year license and supplemental material purchase agreements, effective in 2018, with a two-year extension option.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $43.6 million | $55.6 million | Down $12.0 million |
| Gross profit | $36.1 million | $42.6 million | Down $6.5 million |
| Gross margin | 82.9% | 76.6% | Up approximately 6.3 points |
| Operating income | $4.5 million | $12.1 million | Down $7.5 million |
| Operating margin | 10.4% | 21.7% | Down approximately 11.3 points |
| Net income | $6.0 million | $10.4 million | Down $4.4 million |
| Net margin | 13.7% | 18.7% | Down approximately 5.0 points |
| Diluted EPS | $0.13 | $0.22 | Down $0.09 |
| Operating cash flow | $38.8 million | $1.6 million | Up $37.2 million |
OLED material sales represented 94% of revenue, compared with 97% in the prior-year quarter; contract research services represented 6%, compared with 3%. Approximately 94% of revenue came from outside North America. South Korea represented $30.8 million of revenue and China represented $8.9 million.
At March 31, 2018, cash and cash equivalents were $177.2 million and short-term investments were $280.1 million, for total cash and current investments of $457.3 million. Total assets were $795.1 million, total liabilities were $152.5 million and shareholders' equity was $642.6 million. The filing does not report outstanding debt. Working capital was $448.7 million.
Material changes versus the prior comparable period
- Revenue declined 21.6%, which management primarily attributed to near-term weakness in the mobile OLED display segment.
- Gross margin improved because of higher average selling prices, primarily reflecting customer mix, despite lower revenue.
- Operating expenses increased $1.1 million. Research and development increased to $12.4 million, selling, general and administrative expense increased to $10.8 million, and patent costs increased to $1.7 million.
- Interest income increased to $1.3 million from $0.7 million because of higher available-for-sale investments.
- The effective tax rate was a 3.8% benefit in Q1 2018 versus an 18.5% expense in Q1 2017. The 2018 tax benefit included a $1.3 million benefit from excess tax deductions related to employee share awards.
- Cash from operations increased substantially, primarily because of changes in deferred revenue and accounts receivable. The increase was partly offset by a $17.4 million increase in inventory.
- Capital expenditures increased to $8.7 million from $0.6 million, including research and development laboratory equipment and expansion of the Adesis manufacturing facility.
- The company adopted ASC Topic 606 using the modified retrospective method. Adoption reduced opening retained earnings by $17.9 million, net of tax, increased deferred revenue by $21.3 million at January 1, 2018, and reduced Q1 2018 reported revenue by $24.7 million versus the prior accounting method. Without ASC 606, Q1 revenue would have been approximately $68.2 million and net income approximately $25.9 million, based on the filing's reconciliation.
Guidance, outlook, risks and unusual items
Management did not provide quantitative revenue or earnings guidance in the filing. Management expects the overall OLED display market to continue growing despite near-term weakness in mobile displays and anticipates fluctuations based on material sales timing and volume, license and royalty receipts, research and development and patent expenditures, and new business relationships.
Management expects existing cash, cash equivalents and short-term investments to satisfy obligations for at least the next twelve months. It also notes that additional financing could be required for OLED research, development, commercialization, patent activities and working capital, and that financing may not be available on acceptable terms.
- Customer concentration is significant: three customers accounted for 55%, 16% and 11% of Q1 2018 revenue, respectively. The largest customer represented 55% of revenue.
- Substantially all chemical materials were purchased from one supplier. Inventory purchase commitments were $17.1 million at March 31, 2018.
- Revenue recognition depends on estimates of customer material usage, contract-term royalties and expected transaction prices under ASC 606. Changes in these estimates can affect current-period revenue.
- Deferred revenue was $79.2 million at March 31, 2018 and is expected to be recognized as materials are shipped over the remaining contract periods. Backlog of committed phosphorescent emitter material orders was $6.8 million, expected to be fulfilled within 90 days.
- Patent oppositions remain pending, including proceedings involving European patents covering phosphorescent and white OLED technologies. Management does not believe the individual proceedings are likely to have a material financial impact, but acknowledges that defending the patents may require significant resources.
- The company has an unfunded supplemental executive retirement plan liability of $33.8 million for seven participants.
- The company reported no off-balance-sheet arrangements and no material changes to previously disclosed risk factors.
- The board declared a second-quarter dividend of $0.06 per common share, payable June 29, 2018. Q1 dividends paid totaled $2.8 million.
Most important facts for investors to verify
- Whether the mobile OLED market weakness persists and how Samsung, LG Display, BOE and Tianma production and sales affect material volumes and royalties.
- The effect of ASC 606 estimates and future changes in deferred revenue, contract transaction prices and royalty assumptions on reported revenue and earnings.
- Customer concentration and renewal, minimum-purchase and royalty provisions under the multi-year commercial agreements.
- Inventory growth, supplier concentration and the adequacy of the $17.1 million inventory purchase commitments relative to demand.
- Progress and outcomes of the remaining European patent opposition and appeal proceedings.
- Sustained operating cash flow after considering working-capital movements, capital expenditures and dividend and equity-related cash outflows.
- The timing and amount of additional investment required for OLED research, commercialization, facility expansion and patent enforcement.