Universal Display Corporation — 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 displays and lighting. Revenue is generated from OLED material sales, intellectual-property licensing and technology development/support. This unaudited filing covers the three and six months ended June 30, 2014, compared with the corresponding 2013 periods.
Key financial metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $64.1 million | $49.4 million | $102.0 million | $64.3 million |
| Operating income | $28.8 million | $21.7 million | $35.5 million | $14.6 million |
| Net income | $20.4 million | $15.4 million | $24.4 million | $10.6 million |
| Diluted EPS | $0.44 | $0.33 | $0.52 | $0.23 |
| Operating margin | 45.0% | 44.0% | 34.8% | 22.7% |
| Net margin | 31.8% | 31.2% | 24.0% | 16.5% |
| Cash flow from operations | — | — | $25.0 million | $15.5 million |
Q2 revenue comprised $35.9 million of material sales, $28.1 million of royalty and license fees, and $0.1 million of technology development and support revenue. Six-month revenue comprised $71.3 million of material sales, $29.8 million of royalty and license fees, and $0.9 million of technology development and support revenue.
At June 30, 2014, cash and cash equivalents were $75.6 million and short-term investments were $215.3 million, for total cash and short-term investments of $290.9 million. Working capital was $337.7 million. The filing reports no debt or borrowings. Total liabilities were $39.0 million and shareholders’ equity was $448.4 million.
Material changes versus the prior comparable periods
- Q2 revenue increased 30%, while six-month revenue increased 58%.
- Q2 material sales rose 32% to $35.9 million; six-month material sales rose 79% to $71.3 million, primarily because of increased commercial OLED chemical sales and broader adoption of the company’s technology.
- Royalty and license fees increased 32% in Q2 and 33% for the six-month period. The company recognized $25.0 million of payments under its Samsung Display license agreement in Q2 and the first six months, compared with $20.0 million in the comparable 2013 periods.
- Technology development and support revenue declined 87% in Q2 and 55% for the six-month period because of fewer government contracts and timing of revenue recognition.
- Research and development expense increased to $10.5 million in Q2 and $20.7 million for six months, primarily due to higher development costs and raw-material usage under the PPG relationship.
- Q2 cost of commercial material sales increased to 37% of commercial material sales from 32%; excluding a $3.0 million Japanese pass-through tax settlement, the ratio was 30%. The six-month ratio was 33%, or 30% excluding that settlement.
- Operating income increased 33% in Q2 and 143% for six months. Net income increased 33% in Q2 and 130% for six months, despite higher income tax expense.
- The company repurchased 234,800 common shares for approximately $7.0 million during Q2 and authorized a program to repurchase up to $50.0 million over 12 months.
Cash flow, liquidity and outlook
Operating cash flow for the first six months was $25.0 million, compared with $15.5 million in 2013. Investing activities used $11.0 million, primarily reflecting net investment purchases and $3.0 million of capital expenditures. Financing activities used $9.0 million, including share repurchases and employee tax withholding payments. Cash and cash equivalents increased by $5.0 million from year-end 2013.
Management expects existing cash, cash equivalents and short-term investments to be sufficient to meet obligations for at least the next twelve months. Management also states that additional financing could be required in the future for research, commercialization, patent activities and working capital, but availability and terms are not assured.
The filing does not provide formal revenue or earnings guidance. Management expects quarterly results to fluctuate based on the timing and volume of OLED material sales, receipt of license and royalty payments, research and patent expenditures, and new business relationships.
Risks, contingencies and unusual items
- Revenue is highly concentrated: three customers represented 92% of Q2 revenue and 92% of six-month revenue; the largest customer represented 62% and 52%, respectively.
- Nearly all revenue originated outside North America, principally South Korea and Japan. Revenue is primarily denominated in U.S. dollars, limiting reported foreign-exchange exposure.
- The company relies substantially on one supplier for chemical materials and has significant dependence on the Samsung Display license and supplemental material purchase arrangements.
- Host-material sales increased substantially but are more competitive, customers are not required to purchase host materials, and management states that their long-term prospects are uncertain.
- Several patent oppositions and invalidation proceedings remain pending in Europe and Japan. One European patent was revoked in its entirety, while other patents were narrowed or remain subject to appeal. The company expects to incur significant legal and patent-related costs and cannot assure favorable outcomes.
- The company was obligated to pay up to $7.3 million to USC for research work during the remaining term of its agreement, which expires April 30, 2017, in addition to minimum royalties and other contractual commitments.
- Deferred revenue was $6.3 million at June 30, 2014. The company’s major Samsung Display license runs through the end of 2017 and includes increasing semiannual payments.
- The effective tax rate was 29.6% for Q2 and 31.8% for the six-month period. Deferred tax asset realization depends on future taxable income and other assumptions.
- The company adopted new income-tax presentation guidance in the first quarter of 2014 without a material impact. A new revenue-recognition standard will apply beginning in 2017; the adoption method and impact were still under evaluation.
- Management reported effective disclosure controls and no material changes to internal control over financial reporting.
Investor verification items
- Verify the sustainability and timing of Samsung Display royalty payments and minimum material-purchase commitments.
- Assess customer concentration and the effect of any changes in OLED production volumes or customer sourcing decisions.
- Separate recurring material economics from the $3.0 million Japanese pass-through tax settlement and other nonrecurring items.
- Monitor gross margins, particularly commercial material costs and the more competitive host-material business.
- Track pending patent oppositions, appeals and related legal expenditures, especially proceedings involving core phosphorescent OLED technologies.
- Review the utilization of the $50.0 million share-repurchase authorization against research, commercialization and patent-funding needs.
- Evaluate deferred tax asset realizability, future tax rates and the eventual effect of the new revenue-recognition standard.