Universal Display Corporation: FY2017 Form 10-K
Business context and reporting period
Universal Display Corporation develops and commercializes OLED technologies, phosphorescent OLED materials and related intellectual property for display and solid-state lighting applications. The company primarily earns revenue from OLED material sales, technology licensing and royalties, and contract research services. The filing covers the fiscal year ended December 31, 2017; quarterly data is also provided for the fourth quarter ended December 31, 2017.
UDC does not manufacture or sell finished OLED displays or lighting products. Its business is concentrated in Asia-Pacific markets, with approximately 97% of 2017 revenue generated outside North America. Samsung Display Co., Ltd. accounted for 62% of consolidated 2017 revenue.
Key financial metrics
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Total revenue | $335.6 million | $198.9 million | +69% |
| Material sales | $200.3 million | $99.3 million | +102% |
| Royalty and license fees | $126.5 million | $96.1 million | +32% |
| Contract research services | $8.9 million | $3.5 million | +156% |
| Gross profit | $280.9 million | $172.6 million | +63% |
| Operating income | $146.2 million | $68.4 million | +114% |
| Net income | $103.9 million | $48.1 million | +116% |
| Diluted EPS | $2.18 | $1.02 | +114% |
| Cash flow from operations | $133.4 million | $80.3 million | +66% |
Calculated FY2017 margins were approximately 83.7% gross, 43.6% operating and 30.9% net. Material sales gross margin was 75%, unchanged from 2016. Phosphorescent emitter sales increased 103% to $198.7 million, while host material sales remained minimal at $1.6 million.
Fourth-quarter revenue was $115.9 million, net income was $32.8 million, and diluted EPS was $0.69. Quarterly results are uneven because significant license revenue is generally received in the second and fourth quarters.
Liquidity, capital resources and balance sheet
- Cash and cash equivalents were $132.8 million at December 31, 2017.
- Short-term investments were $287.4 million and long-term investments were $14.8 million, for total cash and investments of approximately $435.1 million.
- Working capital was $455.4 million, compared with $345.2 million at year-end 2016.
- Total assets were $780.0 million and shareholders’ equity was $659.1 million.
- Total liabilities were $120.9 million, including $63.8 million of current liabilities. The filing does not identify outstanding conventional debt; no debt balance is presented in the summarized balance sheet.
- Capital expenditures were $29.8 million, primarily related to the purchase of Adesis’s Delaware facility and expansion of OLED material production capacity managed by PPG Industries.
- UDC paid $5.7 million of common-stock dividends during 2017, equal to $0.12 per share, and stated that it expects to continue quarterly dividends subject to board discretion.
Material changes versus the prior comparable period
- Revenue growth was driven principally by higher demand and volume for red and green phosphorescent emitter materials, as well as higher royalty and license fees.
- Operating income increased by $77.8 million, despite higher research and development, selling, general and administrative, amortization, patent and royalty expenses.
- Research and development expense increased to $49.1 million from $42.7 million. Selling, general and administrative expense increased to $46.8 million from $32.9 million, partly due to the full-year contribution of Adesis, acquired in July 2016.
- Cash flow from operations increased by $53.1 million, while accounts receivable and inventory increased to support higher sales and production activity.
- Cash used in investing activities increased to $125.6 million, primarily because of net investment purchases and higher capital expenditures. The 2016 comparison included the $96.0 million BASF patent acquisition and the $33.4 million Adesis acquisition.
- UDC adopted ASU 2016-09, recording a $26.5 million cumulative retained-earnings benefit related to excess tax benefits from share-based compensation.
- The Tax Cuts and Jobs Act produced a one-time fourth-quarter tax charge of $11.5 million. Without that charge, management estimated the 2017 effective tax rate would have been 22.8%, versus the reported 30.5%.
- The company entered into long-term, multi-year license and supply agreements with BOE. The prior Samsung Display agreements expired December 31, 2017 and were replaced in February 2018 by new five-year agreements, with a two-year extension option and minimum annual material purchase obligations.
Guidance, outlook, commentary and risks
The filing does not provide numerical revenue or earnings guidance. Management expects OLED adoption to expand across mobile, television, wearable, automotive and lighting applications, but emphasizes that future results depend on customer commercialization, product demand, material volumes, royalty arrangements and research outcomes.
Management stated that cash, cash equivalents and short-term investments should be sufficient to meet obligations for at least the next twelve months. Contractual commitments totaled approximately $77.7 million, including estimated retirement plan payments, purchasing obligations, research commitments, lease obligations and minimum royalties. The company also had up to $6.6 million of remaining obligations under its extended university research agreement through April 2020.
- Customer concentration: Samsung Display represented 62% of 2017 revenue and the top three customers represented approximately 92% based on the concentration disclosures.
- Supplier concentration: UDC relies substantially on PPG Industries to manufacture OLED materials and had $14.2 million of inventory purchase commitments at year-end.
- Intellectual property: Fundamental phosphorescent OLED patents expired in the United States in 2017 or are scheduled to expire in 2019, with additional foreign expirations in 2018 and 2020. Patent oppositions and appeals remained pending in Europe.
- Technology and market risk: LCD, LED, fluorescent, TADF, micro-LED and other competing technologies could limit OLED adoption or reduce demand for UDC materials.
- Customer process risk: More efficient customer manufacturing and material-utilization processes could reduce material purchases even if OLED unit production increases.
- Inventory risk: Changes in customer product designs, production plans or demand could result in excess or obsolete inventory and future write-downs.
- Revenue volatility: License fees may be large, annual or semi-annual payments, making quarterly comparisons and forecasting difficult.
- Tax and legal contingencies: The company is exposed to foreign withholding taxes, tax audits, patent litigation and indemnification obligations relating to customer intellectual-property claims.
UDC adopted the modified-retrospective method for ASC 606 revenue recognition beginning January 1, 2018. Management estimated adoption would increase deferred revenue by $21.3 million, reduce retained earnings by $21.0 million and increase unbilled receivables by $0.3 million.
Most important facts for investors to verify
- Whether the replacement Samsung Display agreements sustain historical license revenue and material purchase levels.
- The durability of 2017’s sharp phosphorescent emitter volume growth and the effect of customer material-efficiency improvements.
- Revenue concentration by customer, especially Samsung Display and LG Display, and the terms of minimum purchase and royalty obligations.
- The commercial impact of U.S. and foreign patent expirations, pending European patent proceedings and competing OLED or alternative display technologies.
- The accounting and earnings effects of ASC 606 adoption beginning in 2018.
- Whether inventory growth and PPG production-capacity expansion remain aligned with customer demand without creating obsolescence risk.
- The effect of the Tax Cuts and Jobs Act, foreign withholding taxes and future changes in the effective tax rate.
- Future dividend sustainability, capital spending requirements and any need for additional financing.