Universal Display Corporation — FY 2016 Form 10-K Summary
Business context and reporting period
Universal Display Corporation develops, licenses and commercializes organic light-emitting diode (OLED) technologies and materials for display and solid-state lighting applications. The company primarily earns revenue from OLED material sales, intellectual-property licensing and royalties, and contract research services. The filing covers the fiscal year ended December 31, 2016, with comparative information for 2015 and 2014.
- The company owns, exclusively licenses or has sole sublicensing rights to more than 4,200 issued and pending patents worldwide.
- Samsung Display Co., Ltd. accounted for 63% of 2016 revenue; 98% of revenue was generated outside North America, primarily in South Korea.
- The company does not directly manufacture or sell OLED display or lighting products and relies on manufacturing partners, including PPG Industries for OLED materials production.
Financial performance and key metrics
| ($ in millions, except per-share data) | 2016 | 2015 | Change |
|---|---|---|---|
| Revenue | $198.9 | $191.0 | 4% |
| Material sales | $99.3 | $113.1 | (12%) |
| Royalty and license fees | $96.1 | $77.8 | 24% |
| Contract research services | $3.5 | $0.2 | 1576% |
| Gross profit | $172.6 | $128.0 | 35% |
| Gross margin | 86.8% | 67.0% | Up 19.8 pts. |
| Operating income | $68.4 | $32.3 | 112% |
| Operating margin | 34.4% | 16.9% | Up 17.5 pts. |
| Net income | $48.1 | $14.7 | 227% |
| Net margin | 24.2% | 7.7% | Up 16.5 pts. |
| Diluted EPS | $1.02 | $0.31 | 227% |
| Cash flow from operations | $80.3 | $113.6 | (29%) |
Commercial material sales declined 16% to $85.1 million. Phosphorescent emitter sales declined 3% to $97.9 million, while host material sales declined 89% to $1.4 million. The company reported that customers increasingly used products that did not include its host materials.
- Research and development expense was $42.7 million, compared with $44.6 million in 2015.
- Selling, general and administrative expense increased to $32.9 million from $29.0 million, primarily reflecting Adesis-related activity.
- Amortization of acquired technology and other intangible assets increased to $16.5 million from $11.0 million following the BASF patent acquisition and Adesis acquisition.
- Income tax expense was $20.5 million, with an effective tax rate of 29.9% versus 55.6% in 2015.
- Interest income was $2.1 million; other expense was $1.9 million, primarily foreign-exchange losses associated with the BASF patent acquisition.
Liquidity, capital resources and debt
- Cash and cash equivalents were $139.4 million and short-term investments were $188.6 million at December 31, 2016, for total reported liquidity of $328.0 million.
- Total liquidity declined from $395.5 million at December 31, 2015, primarily because cash and investments funded the BASF patent acquisition and Adesis acquisition.
- Working capital was $345.2 million, compared with $413.2 million at year-end 2015.
- Cash used in investing activities was $38.5 million, including $96.0 million for BASF-related intangible assets, $33.4 million for Adesis net of cash acquired, and $7.3 million of capital expenditures.
- The filing does not disclose outstanding debt or borrowings; no material debt balance is identified in the presented balance sheet.
- Management expects existing cash, cash equivalents and short-term investments to fund obligations for at least the next twelve months.
Material changes versus the prior comparable period
- Revenue growth was driven by a $18.4 million increase in royalty and license fees, including $75.0 million recognized under the Samsung Display license agreement versus $60.0 million in 2015.
- Profitability improved substantially because 2015 included a $33.0 million inventory write-down related primarily to host materials. Excluding that charge, 2015 adjusted net income was $44.8 million, compared with $48.1 million in 2016.
- Operating income increased by $36.1 million, while net income increased by $33.1 million.
- Operating cash flow declined by $33.3 million because 2015 included $48.8 million of customer prepaid royalty and license-fee receipts recorded as deferred revenue, compared with $3.4 million in 2016.
- In June 2016, the company acquired more than 500 BASF OLED patents and related rights for approximately $96.0 million.
- In July 2016, the company acquired Adesis for approximately $33.9 million in cash, plus contingent consideration; Adesis contributed $3.5 million of 2016 revenue after acquisition.
- The company entered into a five-year OLED technology license and materials agreement with Tianma in 2016.
Guidance, outlook, commentary, risks and unusual items
- The company plans to invest approximately $15 million in 2017 to expand PPG Industries’ Ohio facility and double commercial production capacity for UniversalPHOLED emitter products; completion was expected in the third quarter of 2017.
- Management expects existing host material sales to remain at reduced levels. Host materials are not required for customers to use the company’s phosphorescent emitter materials and face greater competition.
- The Samsung Display license agreement and related material-purchase agreement run through December 31, 2017; the LG Display agreements run through the end of 2022.
- Fundamental phosphorescent OLED patents begin expiring in the United States in 2017 and 2019, with additional expirations in other jurisdictions from 2018 through 2020. The company states that patent expiration could weaken its competitive position.
- Active patent oppositions and invalidation proceedings remain pending in Europe and Japan. The company believes its claims should be upheld but cannot assure a favorable outcome.
- The company relies substantially on a limited number of customers and a single principal materials supplier, PPG Industries. Changes in customer product designs, manufacturing efficiency, inventory levels or OLED demand could reduce material purchases and royalties.
- OLED adoption remains dependent on commercialization by manufacturers, competition from LCD, LED, fluorescent, TADF and micro-LED technologies, and successful development of new OLED applications.
- The company has an unfunded supplemental executive retirement-plan liability of $27.6 million and total estimated retirement-plan benefit payments of $48.5 million.
- The board declared a first common-stock dividend of $0.03 per share in February 2017, payable March 31, 2017. Future dividends remain discretionary.
- The company had no material off-balance-sheet arrangements and reported effective internal control over financial reporting with an unqualified audit opinion from KPMG LLP.
Most important facts for investors to verify
- Whether Samsung Display renews or replaces its license arrangement after its scheduled 2017 expiration and how renewal economics affect future revenue.
- The sustainability of royalty growth and the extent to which revenue remains concentrated in Samsung Display and South Korea.
- Whether emitter-material volumes and pricing offset continued weakness in host-material sales.
- The commercial impact of BASF’s acquired patent portfolio and the return generated on the $96.0 million investment.
- Progress, integration costs and revenue contribution from the Adesis acquisition, including contingent consideration.
- Results of pending patent oppositions and the effect of fundamental PHOLED patent expirations beginning in 2017.
- Execution of the planned PPG capacity expansion and the company’s ability to maintain adequate, cost-competitive material supply.
- The effect of adopting new accounting standards, particularly revenue recognition in 2018 and share-based compensation accounting in 2017.