Business Context and Reporting Period
Universal Display Corporation filed this Form 10-K for the fiscal year ended December 31, 2013, including fourth-quarter results. The company develops and licenses organic light-emitting diode (OLED) technologies and sells proprietary OLED materials for display and lighting applications. Its business model is based primarily on technology licensing, royalties, material sales, and technology-development support rather than manufacturing finished OLED products.
Samsung Display Co., Ltd. (SDC) represented more than 60% of 2013 consolidated revenue, and 99% of revenue was generated outside North America. The company owned, exclusively licensed, or held sole sublicensing rights to more than 3,000 patents and patent applications worldwide.
Financial Highlights
| Metric | FY 2013 | FY 2012 | Change |
|---|---|---|---|
| Total revenue | $146.6 million | $83.2 million | +76% |
| Material sales | $95.7 million | $44.5 million | +115% |
| Royalty and license fees | $47.0 million | $31.7 million | +48% |
| Technology development and support revenue | $3.9 million | $7.1 million | -45% |
| Operating income | $38.2 million | $13.7 million | +180% |
| Operating margin | 26.1% | 16.4% | +9.7 percentage points |
| GAAP net income | $74.1 million | $9.7 million | +667% |
| GAAP diluted EPS | $1.59 | $0.21 | +657% |
| Adjusted net income | $32.6 million | $9.7 million | +238% |
| Adjusted diluted EPS | $0.70 | $0.21 | +233% |
Material sales included $61.6 million of phosphorescent emitter sales and $34.2 million of host material sales. Commercial material sales increased 222% to $88.1 million, while developmental material sales declined 56% to $7.6 million. Commercial material gross margin, calculated against commercial material sales and related cost of sales, was approximately 67.5% in 2013 versus 84.5% in 2012; management attributed the change primarily to product mix.
GAAP net income was materially affected by a $59.4 million release of income tax valuation allowances, partly offset by $17.9 million of deferred tax expense. Excluding these items, adjusted net income was $32.6 million, or approximately 22.3% of revenue, compared with a GAAP net margin of approximately 50.5%.
Fourth-Quarter Results
| Metric | Q4 2013 | Q4 2012 |
|---|---|---|
| Revenue | $49.5 million | $28.1 million |
| Net income | $57.9 million | $5.4 million |
| Basic EPS | $1.26 | $0.12 |
| Diluted EPS | $1.24 | $0.12 |
Fourth-quarter 2013 net income included the $59.4 million income tax valuation allowance release. Fourth-quarter revenue also included $1.5 million of previously deferred payments recognized after management determined that a related commercial license agreement was unlikely to be executed. License revenue is typically concentrated in the second and fourth quarters.
Cash Flow, Liquidity, Debt, and Balance Sheet
- Cash provided by operating activities was $45.0 million, compared with $17.8 million in 2012.
- Cash used in investing activities was $54.8 million, principally reflecting purchases of investments and $4.7 million of capital expenditures.
- Cash used in financing activities was $5.5 million, including $5.5 million of share repurchases and $3.3 million of employee tax-withholding payments, partially offset by option-exercise proceeds.
- Cash and cash equivalents were $70.6 million and short-term investments were $202.0 million at year-end, for total cash and short-term investments of $272.6 million.
- Working capital was $303.8 million, compared with $245.2 million in 2012.
- The filing does not report material conventional debt. Total liabilities were $35.1 million, including $9.4 million for the unfunded supplemental executive retirement plan.
- Shareholders’ equity was $427.7 million, and total assets were $462.8 million.
Management expected existing cash, cash equivalents, and short-term investments to satisfy obligations for at least the next twelve months, while noting that future funding could be required for research, commercialization, patent activities, and working capital.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven by substantially higher commercial OLED material sales and increased SDC-related license revenue.
- Research and development expense increased to $34.2 million from $30.0 million; selling, general and administrative expense increased to $24.7 million from $19.6 million; and patent costs and acquired-technology amortization increased to $17.3 million from $13.4 million.
- Acquired-technology amortization increased following the 2012 acquisition of more than 1,200 Fujifilm OLED patents and applications for $109.1 million including related costs. Net acquired technology was $94.0 million at year-end 2013.
- The company released most federal and state income tax valuation allowances based on its assessment of future taxable income, creating a significant nonrecurring tax benefit.
- The $50 million share-repurchase program ended during the fourth quarter of 2013. The company repurchased 195,599 shares during 2013 for approximately $5.5 million.
- U.S. government-funded technology-development revenue declined as the number and timing of government contracts changed. The Moser Baer white-OLED lighting program ended December 31, 2013.
Outlook, Commentary, Risks, and Unusual Items
The filing provides no formal numerical revenue or earnings guidance. Management expects results to fluctuate because of the timing and volume of material sales, license and royalty payments, research and development expenditures, patent activity, and new business arrangements.
- Revenue concentration is significant: one customer accounted for 60% of 2013 revenue, and another customer accounted for 22%.
- The company relies solely on PPG Industries for manufacturing the OLED materials it sells, under an agreement running through December 31, 2015 with renewal provisions.
- Host material sales are more competitive than phosphorescent emitter sales, and their long-term prospects are uncertain.
- Fundamental phosphorescent OLED patents begin expiring in the United States in 2017 and 2019, creating potential long-term competitive and royalty risks.
- Patent opposition and invalidation proceedings remained pending in Europe and Japan. In November 2013, an EPO appellate board revoked one European patent in its entirety; the company was evaluating appeal and related divisional applications.
- A $4.0 million convertible note investment in Plextronics was exposed to bankruptcy proceedings initiated in January 2014. No impairment was recorded at December 31, 2013 because management expected repayment through an asset sale; a full or partial impairment could be required if the process did not proceed as expected.
- The company had $4.3 million of deferred revenue, $7.9 million of remaining research-related obligations, and an estimated $22.1 million of retirement-plan benefit payments.
- All government contracts are subject to termination at the contracting agency’s election, and the U.S. government retains certain rights to intellectual property developed with government funding.
Important Facts for Investors to Verify
- Whether SDC’s share of revenue and the related license and material-purchase commitments remain sustainable.
- Whether commercial material growth, particularly host material sales, translates into durable margins and recurring demand.
- The recurring earnings impact after excluding the $59.4 million tax valuation allowance release and the $17.9 million deferred tax provision.
- The status and ultimate outcomes of pending patent oppositions, invalidation trials, and the expiration timetable for fundamental PHOLED patents.
- The renewal and commercial terms of the PPG materials-supply agreement and the availability of alternative suppliers.
- The final recovery value of the Plextronics convertible note and any resulting impairment.
- Future cash requirements for research, development, patent prosecution, commercialization, and executive retirement obligations.