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PANL > SEC Filings for PANL > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for UNIVERSAL DISPLAY CORP \PA\

Form 10-Q for UNIVERSAL DISPLAY CORP \PA\


7-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes above.

CAUTIONARY STATEMENT
CONCERNING FORWARD-LOOKING STATEMENTS

This discussion and analysis contains some "forward-looking statements." Forward-looking statements concern possible or assumed future results of operations, including descriptions of our business strategies and customer relationships. These statements often include words such as "believe," "expect," "anticipate," "intend," "plan," "estimate," "seek," "will," "may" or similar expressions. These statements are based on assumptions that we have made in light of our experience in the industry, as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate in these circumstances.

As you read and consider this discussion and analysis, you should not place undue reliance on any forward-looking statements. You should understand that these statements involve substantial risk and uncertainty and are not guarantees of future performance or results. They depend on many factors that are discussed further in the section entitled (Risk Factors) in our Annual Report on Form 10-K for the year ended December 31, 2011, as supplemented by disclosures, if any, in Item 1A of Part II below. Changes or developments in any of these areas could affect our financial results or results of operations and could cause actual results to differ materially from those contemplated in the forward-looking statements.

All forward-looking statements speak only as of the date of this report or the documents incorporated by reference, as the case may be. We do not undertake any duty to update any of these forward-looking statements to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

OVERVIEW

We are a leader in the research, development and commercialization of organic light emitting diode (OLED) technologies for use in flat panel display, solid-state lighting and other applications. Since 1994, we have been exclusively engaged, and expect to continue to be exclusively engaged, in funding and performing research and development activities relating to OLED technologies and materials, and in attempting to commercialize these technologies and materials. We derive our revenue from the following:

intellectual property and technology licensing;

sales of OLED materials for evaluation, development and commercial manufacturing; and

technology development and support, including government contract work and support provided to third parties for commercialization of their OLED products.

While we have made significant progress over the past few years developing and commercializing our family of OLED technologies (including our PHOLED, TOLED, FOLED) and materials, we have incurred significant losses since our inception, resulting in an accumulated deficit of $209.6 million as of September 30, 2012.

We anticipate fluctuations in our annual and quarterly results of operations due to uncertainty regarding, among other factors:

the timing and volume of sales of our OLED materials for both commercial usage and evaluation purposes;

the timing of our receipt of license fees and royalties, as well as fees for future technology development and evaluation activities;

the timing and magnitude of expenditures we may incur in connection with our ongoing research and development activities; and

the timing and financial consequences of our formation of new business relationships and alliances.


RESULTS OF OPERATIONS

Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011

We had an operating loss of $6.1 million for the three months ended September 30, 2012, compared to operating income of $5.9 million for the three months ended September 30, 2011. The decrease in operating income was due to the following:

a decrease in revenue of $9.3 million; in addition to

an increase in operating expenses of $2.7 million.

We had a net loss of $5.5 million (or $0.12 per basic and diluted share) for the three months ended September 30, 2012, compared to net income of $6.0 million (or $0.13 per basic and $0.12 per diluted share) for the three months ended September 30, 2011.

Our revenues were $12.5 million for the three months ended September 30, 2012, compared to $21.8 million for the three months ended September 30, 2011. The decrease in our overall revenue was primarily due to decreases in both material sales and royalty and license fees.

Material sales decreased to $11.0 million for the three months ended September 30, 2012, compared to $15.4 million for the same period in 2011. Material sales relate to the sale of our OLED materials for our customers' evaluation, manufacture and development activities, and for incorporation into their commercial OLED products. The decrease in material sales was primarily due to lower host and green emitter sales when compared to the same period in 2011, which we believe is a result of temporary customer delays in commercial production, offset by increased red emitter sales.

Material sales included sales of both phosphorescent emitter and host materials. Phosphorescent emitter sales were 83% of our total material sales for the three months ended September 30, 2012, compared to 50% of our total material sales for the three months ended September 30, 2011. Host material sales were 17% of our total material sales for the three months ended September 30, 2012, compared to 50% of our total material sales for the three months ended September 30, 2011. We believe we can participate in the host materials business due to our long experience in developing emitter materials, which are used together with host materials in the emissive layer of an OLED. However, our customers are not required to purchase our host materials in order to utilize our phosphorescent emitter materials, and the host material sales business is more competitive than the phosphorescent emitter material sales business. Thus, our long-term prospects for host material sales are uncertain.

We cannot accurately predict how long our phosphorescent emitter material sales or host material sales to particular customers will continue, as our customers frequently update and alter their product offerings in response to market demands. Continued sales of our OLED materials to these customers will depend on several factors, including pricing, availability, continued technical improvement and competitive product offerings.

Royalty and license fees decreased to $396,000 for the three months ended September 30, 2012, compared to $4.6 million for the three months ended September 30, 2011. A substantial portion of the decrease was due to the timing of receipts related to our patent license agreement with Samsung Display Co., Ltd. (SDC), the successor-in-interest to Samsung Mobile Display Co., Ltd. (SMD). In August 2011 we entered into a patent license agreement with SDC which replaced and superseded the then existing patent license agreement with SMD. This patent license agreement with SDC runs through December 31, 2017.

Our current patent license agreement with SDC covers the manufacture and sale of specified OLED display products. Under the agreement, SDC has agreed to pay us a fixed license fee, payable in semi-annual installments over the agreement term. These installments, that are due in the second and fourth quarter of each annual period, increase on an annual basis over the term of the license agreement. The installment amounts replaced the quarterly royalty reporting structure in the prior patent license agreement. The installment amounts were determined through negotiation based on a number of factors, including, without limitation, estimates of SDC's OLED business growth as a percentage of published OLED market forecasts, the use of red and green phosphorescent materials in SDC's OLED display products, and appropriate royalty rates relating to SDC's practice under the licensed patents. Based upon the extended payment arrangement, such amounts are not considered fixed and determinable for revenue recognition purposes until such time the installments become due and payable. As a result, license fees under our new agreement with SDC will be recognized as they become due and payable, which is currently scheduled to be in the second and fourth quarter of each year; therefore our quarterly license fees, will fluctuate accordingly, depending on the timing of such payments.

At the same time we entered into the current patent license agreement with SDC, we also entered into a new supplemental material purchase agreement with SDC. Under the current supplemental material purchase agreement, SDC agrees to


purchase from us a minimum dollar amount of phosphorescent emitter materials for use in the manufacture of licensed products. This minimum purchase commitment is subject to SDC's requirements for phosphorescent emitter materials and our ability to meet these requirements over the term of the supplemental agreement. The minimum purchase amounts increase on an annual basis over the term of the supplemental agreement. These amounts were determined through negotiation based on a number of factors, including, without limitation, estimates of SDC's OLED business growth as a percentage of published OLED market forecasts and SDC's projected minimum usage of red and green phosphorescent emitter materials over the term of the agreement.

Cost of material sales decreased to $1.1 million for the three months ended September 30, 2012, compared to $2.4 million for the three months ended September 30, 2011, based on the aforementioned decrease in material sales. Cost of material sales includes the cost of producing materials that have been classified as commercial and shipping costs for such materials, but excludes the cost of producing certain materials, which cost has already been included in research and development expense. Commercial materials are materials that have been validated by us for use in commercial OLED products.

Depending on the amounts, timing and stage of materials being classified as commercial, we expect cost of materials sales to fluctuate from quarter to quarter. As a result of these timing issues, and due to decreased sales of commercial materials, cost of material sales decreased for the three months ended September 30, 2012, compared to the same period in 2011. For the three months ended September 30, 2012 and 2011, costs associated with $6.4 million and $10.0 million, respectively, of material sales relating to commercial materials were included in cost of material sales.

We incurred research and development expenses of $8.2 million for the three months ended September 30, 2012, compared to $6.1 million for the three months ended September 30, 2011. The following significant changes occurred:

increased costs of $992,000 incurred under our agreement with PPG Industries to assist us in developing our proprietary OLED materials and to supply us with those materials for evaluation purposes and for resale to our customers;

increased costs of $501,000 related to sponsored research and development contracts; and

increased employee costs of $367,000 primarily due to increased salaries, costs associated with retirement benefits and stock-based compensation for certain executive officers, as well as new employees.

Selling, general and administrative expenses were $5.3 million for the three months ended September 30, 2012, compared to $5.0 million for the three months ended September 30, 2011. The overall increase in these costs was primarily due to increased salaries, costs associated with retirement benefits and stock-based compensation for certain executive officers, as well as new employees.

Patent costs and amortization of acquired technology increased to $3.7 million for the three months ended September 30, 2012, compared to $1.9 million for the three months ended September 30, 2011. The increase was mainly due to increased amortization costs of $2.1 million due to the amortization expense associated with technology acquired in July 2012 (see Note 6 in Notes to Consolidated Financial Statements for further discussion), which was offset by a decline in the number of outstanding patent disputes, as well as the timing of prosecution and maintenance costs associated with a number of patents and patent applications.

Royalty and license expense decreased to $283,000 for the three months ended September 30, 2012, compared to $462,000 for the three months ended September 30, 2011. The decrease was mainly due to decreased royalties incurred under our amended license agreement with Princeton University (Princeton), the University of Southern California (USC), and the University of Michigan (Michigan), resulting from lower material sales and decreased royalty and license fees. See Note 5 in Notes to Consolidated Financial Statements for further discussion.

Interest income decreased to $272,000 for the three months ended September 30, 2012, compared to $364,000 for the three months ended September 30, 2011. The decrease was mainly attributable to interest earned on lower average cash and investment balances as a result of the purchase of acquired technology during the three months ended September 30, 2012 (see Note 6 in Notes to Consolidated Financial Statements for further discussion).

During the three months ended September 30, 2011, the change in fair value of outstanding warrants to purchase shares of common stock, which contained a "down-round" provision requiring liability classification resulted in a $240,000 non-cash gain on our statement of comprehensive loss for the three months ended September 30, 2011. In August 2011, all remaining outstanding stock warrants to purchase shares of our common stock were exercised.


There was an income tax benefit of $326,000 and an expense of $536,000 for the three months ended September 30, 2012 and 2011, respectively. See "Provision for Income Tax" below for additional information.

Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

We had operating income of $5.3 million for the nine months ended September 30, 2012, compared to $2.1 million for the nine months ended September 30, 2011. The increase in operating income was due to the following:

an increase in revenue of $12.5 million; offset by

an increase in operating expenses of $9.3 million.

We had net income of $4.3 million (or $0.09 per basic and diluted share) for the nine months ended September 30, 2012, compared to a net loss of $2.6 million (or $0.06 per basic and diluted share) for the nine months ended September 30, 2011. In 2011, the net loss included a $4.2 million loss on stock warrant liability. In August 2011, all remaining outstanding stock warrants to purchase shares of our common stock were exercised.

Our revenues were $55.1 million for the nine months ended September 30, 2012, compared to $42.6 million for the nine months ended September 30, 2011. The increase in our overall revenue was primarily due to increased OLED material sales, as well as increased royalty and license fees received and therefore recognized under our patent license agreement with SDC.

Material sales increased to $34.4 million for the nine months ended September 30, 2012, compared to $26.6 million for the same period in 2011. Material sales relate to the sale of our OLED materials for our customers' evaluation, manufacture and development activities, and for incorporation into their commercial OLED products. The increase in material sales was due to the overall expanded adoption of our technology and materials in the marketplace by display manufacturers, particularly from SDC.

Material sales included sales of both phosphorescent emitter and host materials. Phosphorescent emitter sales were 83% of our total material sales for the nine months ended September 30, 2012, compared to 63% of our total material sales for the nine months ended September 30, 2011. Host material sales were 17% of our total material sales for the nine months ended September 30, 2012, compared to 37% of our total material sales for the nine months ended September 30, 2011. We believe we can participate in the host materials business due to our long experience in developing emitter materials, which are used together with host materials in the emissive layer of an OLED. However, our customers are not required to purchase our host materials in order to utilize our phosphorescent emitter materials, and the host material sales business is more competitive than the phosphorescent emitter material sales business. Thus, our long-term prospects for host material sales are uncertain.

We cannot accurately predict how long our phosphorescent emitter material sales or host material sales to particular customers will continue, as our customers frequently update and alter their product offerings in response to market demands. Continued sales of our OLED materials to these customers will depend on several factors, including pricing, availability, continued technical improvement and competitive product offerings.

Royalty and license fees increased to $16.3 million for the nine months ended September 30, 2012, compared to $9.9 million for the nine months ended September 30, 2011. A substantial portion of the increase was due to the receipt and therefore recognition of $15 million of royalty and license fee payments received under our patent license agreements with SDC in the second quarter of 2012. In August 2011 we entered into a patent license agreement with SDC which replaced and superseded the then existing patent license agreement. This patent license agreement with SDC runs through December 31, 2017.

Technology and development revenues decreased to $4.5 million for the nine months ended September 30, 2012, compared to $6.1 million for the nine months ended September 30, 2011. The decrease was due principally to the timing of work performed and costs incurred in connection with several new and completed government programs. However, the overall value of our government contracts remained relatively constant during both periods.

Our current patent license agreement with SDC covers the manufacture and sale of specified OLED display products. Under the license agreement, SDC has agreed to pay us a fixed license fee, payable in semi-annual installments over the agreement term. These installments increase on an annual basis over the term of the license agreement. The installment amounts replaced the quarterly royalty reporting structure in the prior patent license agreement. The installment amounts were determined through negotiation based on a number of factors, including, without limitation, estimates of SDC's OLED business growth as a percentage of published OLED market forecasts, the use of red and green phosphorescent materials in SDC's OLED display products, and appropriate royalty rates relating to SDC's practice under the licensed patents. Based upon the extended payment arrangement, such amounts are not considered fixed and determinable for revenue recognition purposes until such time the installments become due and payable. As a result, license fees under our new agreement with


SDC will be recognized as they become due and payable, which is currently scheduled to be in the second and fourth quarter of each year; therefore our quarterly license fees, will fluctuate accordingly, depending on the timing of such payments.

At the same time we entered into the current patent license agreement with SDC, we also entered into a new supplemental material purchase agreement. Under the current supplemental material purchase agreement, SDC agrees to purchase from us a minimum dollar amount of phosphorescent emitter materials for use in the manufacture of licensed products. This minimum purchase commitment is subject to SDC's requirements for phosphorescent emitter materials and our ability to meet these requirements over the term of the supplemental agreement. The minimum purchase amounts increase on an annual basis over the term of the supplemental agreement. These amounts were determined through negotiation based on a number of factors, including, without limitation, estimates of SDC's OLED business growth as a percentage of published OLED market forecasts and SDC's projected minimum usage of red and green phosphorescent emitter materials over the term of the agreement.

Cost of material sales increased to $3.8 million for the nine months ended September 30, 2012, compared to $2.7 million for the nine months ended September 30, 2011, based on the aforementioned increase in material sales. Cost of material sales includes the cost of producing materials that have been classified as commercial and shipping costs for such materials, but excludes the cost of producing certain materials, which cost has already been included in research and development expense. Commercial materials are materials that have been validated by us for use in commercial OLED products.

Depending on the amounts, timing and stage of materials being classified as commercial, we expect cost of materials sales to fluctuate from quarter to quarter. As a result of these timing issues, and due to increased sales of commercial materials, cost of material sales increased for the nine months ended September 30, 2012, compared to the same period in 2011. For the nine months ended September 30, 2012 and 2011, costs associated with $22.0 million and $16.2 million, respectively, of material sales relating to commercial materials were included in cost of material sales.

We incurred research and development expenses of $22.1 million for the nine months ended September 30, compared to $18.2 million for the nine months ended September 30, 2011. Research and development expenses increased overall due to increased research and development efforts. The following significant changes occurred:

increased costs of $987,000 related to sponsored research and development contracts;

increased costs of $959,000 incurred under our agreement with PPG Industries;

increased consulting costs of $765,000 related to outsourced research and development efforts;

increased employee costs of $659,000 primarily due to increased salaries, costs associated with retirement benefits and stock-based compensation for certain executive officers, as well as new employees; and

increased lab-related costs of $372,000.

Selling, general and administrative expenses were $14.8 million for the nine months ended September 30, 2012, compared to $13.3 million for the nine months ended September 30, 2011. The increase was primarily due to increased salaries, costs associated with retirement benefits and stock-based compensation for certain executive officers, as well as new employees.

Patent costs and amortization of acquired technology increased to $7.9 million for the nine months ended September 30, 2012, compared to $5.5 million for the nine months ended September 30, 2011. The increase was mainly due to increased amortization costs of $2.1 million due to the amortization expense associated with technology acquired in July 2012 (see Note 6 in Notes to Consolidated Financial Statements for further discussion), as well as the timing of prosecution and maintenance costs associated with a number of patents and patent applications.

Royalty and license expense increased to $1.3 million for the nine months ended September 30, 2012, compared to $882,000 for the nine months ended September 30, 2011. The increase consisted mainly of royalties incurred under our amended license agreement with Princeton, USC and Michigan, resulting from higher material sales and increased royalty revenues. See Note 5 in Notes to Consolidated Financial Statements for further discussion.

Interest income increased to $986,000 for the nine months ended September 30, 2012, compared to $644,000 for the nine months ended September 30, 2011. The increase was mainly attributable to interest earned on higher average cash and investment balances as a result of proceeds received from the completion of our public offering in March 2011.

During the nine months ended September 30, 2011, the change in fair value of outstanding warrants to purchase shares of common stock, which contained a "down-round" provision requiring liability classification resulted in a $4.2 million non-


cash loss on our statement of comprehensive loss for the nine months ended September 30, 2011. In August 2011, all remaining outstanding stock warrants to purchase shares of our common stock were exercised.

Income tax expense was $2.0 million and $1.1 million for the nine months ended September 30, 2012 and 2011, respectively. See "Provision for Income Taxes" below for additional information.

Provision for Income Tax

We are subject to income taxes in both the U.S. and foreign jurisdictions. Judgment is required in evaluating our tax positions for future realization and determining our provision for income taxes. Income tax expense for the three and nine months ended September 30, 2012 and 2011 is primarily comprised of foreign withholding taxes based upon income earned during the period. These foreign taxes are primarily related to foreign taxes withheld on royalty and license fees paid to the US operating entity. SDC has been required to withhold tax upon payment of royalty and license fees to the U.S. operating entity at a rate of 16.5%. We can reasonably estimate the amount of withholding taxes based on anticipated license fee receipts from SDC. Any potential foreign tax credits to be received by the U.S. operating entity for these amounts on our United States tax returns are currently offset by a full valuation allowance as noted below.

For the three months ended September 30, 2012, the total income tax benefit was $326,000, of which a benefit of $250,000 was related to foreign income taxes. For the three months ended September 30, 2011, the total income tax expense was $536,000, all of which was related to foreign income tax benefits.

For the nine months ended September 30, 2012, total income tax expense was $2.0 million, of which approximately $1.8 million was related to foreign income taxes. For the nine months ended September 30, 2011, total income tax expense was approximately $1.1 million, all of which was related to foreign income taxes.

Additionally, we recorded a tax benefit of $93,000 and an expense of $115,000 related to federal and state income taxes during the three and nine month periods ended September 30, 2012 respectively. The effective income tax rate was 5.9% for the three months ended September 30, 2012, and was 31.1% for the nine months ended September 30, 2012.

Although we generated income before income taxes during the nine months ended September 30, 2012, there was no provision for United States federal or state income taxes, excluding certain estimated alternative minimum taxes due to the utilization of net operating loss carryforwards which are offset by a full valuation allowance. At December 31, 2011, we had approximately $178 million of federal and $87 million of state net operating loss carryforwards. Our ability to use these net operating loss carryforwards could be subject to limitation because of certain ownership changes. The utilization of these tax attributes during the period results in a corresponding decrease in deferred tax assets and the related valuation allowance.

The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the period in which the respective temporary . . .

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