Universal Display Corporation — Q3 2018 Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2018, compared with the corresponding 2017 periods. The unaudited filing covers Universal Display Corporation and its subsidiaries, including Adesis. The company develops, licenses and commercializes OLED technologies and materials for display and lighting applications.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Revenue | $77.6 million | $61.7 million | $177.3 million | $219.8 million |
| Gross margin | $61.4 million; 79.2% | $48.2 million; 78.2% | $142.1 million; 80.1% | $182.0 million; 82.8% |
| Operating income | $26.0 million | $15.8 million | $41.5 million | $88.4 million |
| Net income | $22.8 million | $13.5 million | $39.6 million | $71.1 million |
| Diluted EPS | $0.48 | $0.28 | $0.83 | $1.49 |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $95.0 million | $71.3 million |
- Q3 revenue increased 25.7% year over year, while nine-month revenue decreased 19.3%. OLED material sales represented 96% of Q3 revenue and 95% of nine-month revenue.
- Q3 operating income rose $10.2 million, and net income rose $9.3 million. For the nine-month period, operating income declined $46.9 million and net income declined $31.5 million.
- Research and development expense increased to $13.6 million in Q3 and $38.9 million for nine months. Nine-month selling, general and administrative expense increased to $34.5 million.
- Interest income increased to $2.1 million in Q3 and $5.2 million for nine months, primarily because of higher investment balances.
- At September 30, 2018, cash and cash equivalents were $101.6 million and short-term investments were $392.0 million, for total reported liquidity of $493.6 million. Working capital was $503.5 million.
- Total liabilities were $208.2 million and shareholders’ equity was $675.5 million. The filing does not disclose conventional bank debt or debt securities as outstanding borrowings.
- Cash dividends were $0.06 per common share in Q3 and $0.18 per share for the first nine months. A $0.06 fourth-quarter dividend was declared for payment on December 28, 2018.
Material changes versus the prior comparable periods
- ASC 606 adoption: Effective January 1, 2018, the company adopted the new revenue standard using the modified retrospective method. Adoption reduced opening retained earnings by $17.9 million, net of tax, and increased deferred revenue by $21.3 million.
- ASC 606 reduced reported Q3 2018 revenue by $14.1 million and nine-month revenue by $56.2 million versus amounts that would have been reported under the prior standard. Without ASC 606, nine-month 2018 revenue would have been $233.4 million and net income would have been $85.2 million, based on the filing’s reconciliation.
- The company attributed the nine-month revenue decline primarily to ASC 606 and near-term weakness in the mobile display segment, which primarily affected the first quarter. Management nevertheless stated that it expects the overall OLED display market to continue growing.
- Inventory increased to $69.0 million from $36.3 million at December 31, 2017. The company recorded a $1.0 million inventory write-down because of lower-than-anticipated customer demand and excess inventory in certain products.
- Deferred revenue increased to $109.8 million, including $69.1 million current and $40.7 million long term. The balance is expected to be recognized as materials are shipped over the remaining contract periods.
- New or continuing commercial relationships include multi-year OLED license and material agreements with Samsung Display, LG Display, Tianma, BOE and Visionox. Significant customer contracts expire in 2022.
- During the first nine months, the company repurchased 3,774 shares for $477,000 and paid $11.6 million of employee stock-compensation withholding taxes.
Outlook, risks, contingencies and unusual items
- Management expects sufficient cash, cash equivalents and short-term investments to meet obligations for at least the next twelve months. It also stated that additional financing could be required for research, development, commercialization, patent activities and working capital, and that financing may not be available on acceptable terms.
- Revenue remains concentrated: four customers accounted for 88% of Q3 revenue and 88% of nine-month revenue, based on the customer percentages disclosed. Approximately 95% to 96% of revenue came from outside North America, and substantially all chemical materials were purchased from one supplier.
- The company’s Korean tax matter resulted in recognition of a $37.5 million long-term receivable for estimated refunds, an $18.3 million long-term payable for estimated U.S. federal tax amounts, and a $19.2 million reduction in deferred tax assets. Management believes a favorable settlement is more likely than not, but the estimates may change. LG Display is also being audited by Korean tax authorities for 2015 and 2017 withholding taxes.
- The company has $18.5 million of inventory purchase commitments as of September 30, 2018 and was obligated to pay up to $5.9 million to USC for research work through April 2020.
- Patent oppositions remain pending in Europe, including proceedings involving patents covering phosphorescent OLED technology. The company believes its claims should largely be upheld but cannot assure the outcome and expects to incur significant defense costs.
- Near-term results may fluctuate with OLED material sales volume, customer production and royalty activity, timing of license payments, research and patent expenditures, and new commercial relationships. The company identified revenue recognition, inventory valuation and income taxes as critical accounting areas.
- The company reported no material changes to previously disclosed risk factors, no defaults upon senior securities, and no off-balance-sheet arrangements. Management concluded that disclosure controls were effective as of September 30, 2018.
Investor verification points
- Reconcile reported revenue and earnings with the ASC 606 impact, particularly the $56.2 million nine-month revenue reduction versus prior accounting.
- Assess the sustainability and timing of deferred revenue recognition, including the $109.8 million balance and the $5.9 million committed material backlog.
- Monitor mobile OLED demand, customer concentration, Samsung and LG Display activity, and the ramp-up of Tianma, BOE and Visionox relationships.
- Evaluate inventory growth and the potential for additional write-downs given the $1.0 million charge and lower-than-anticipated customer demand.
- Follow the Korean tax audit and mutual agreement process, including the $37.5 million receivable and $18.3 million payable recognized from the anticipated settlement.
- Review the status and potential commercial significance of the European patent oppositions and related legal expenses.
- Verify cash generation excluding the substantial deferred-revenue and tax-related working-capital effects, and confirm liquidity relative to planned R&D, capital spending and patent commitments.