Those readers who saw my last article on UDC may have been prepared to be disappointed at their earning release on Thursday, February 23rd. In fact, it looked like the market in general was prepared to be disappointed, as the stock dropped more than 5% during Thursday’s trading. But unlike their Q3 earnings release, their Q4 earnings release and conference call pleased investors, and the stock jumped as much as 22% in Friday’s trading, peaking at an all-time mid-day high of $82.50 before settling to end the day up 20% at $81.00.
In addition to the earnings release, UDC announced its first-ever dividend of 3 cents per share, and indicated that they intend to issue quarterly dividends going forward. Although undoubtedly a positive sign, the value of the dividend (a yield of 0.15% at a stock price of $80) is trivial compared to the signal it sends that UDC intends to continue to grow profits and return cash to shareholders.
The bigger news, of course, was the earnings release, and clearly UDC had a strong Q4 with earnings of $26 million or 55 cents per share, compared with street expectations of 44 cents. Revenues came in at $75 million, leading to full-year revenues of $199 million, near the top of UDC’s guidance range of $190-200 million.
The figure below shows the main income statement highlights for UDC for the last two years. The see-saw pattern in revenues and earnings stems from the Samsung royalty deal, which pays out in Q2 and Q4 of each year, and amounted to $60 million in 2015 and $75 million in 2016.
UDC Quarterly Income Statement Highlights, 2015-2016
It should surprise no one with knowledge of the display industry that UDC saw 94% of its Q4 revenues come from South Korea, with the two biggest customers being Samsung Display and LG Display. Perhaps the surprise comes in the other direction, that they managed to pull 6% of revenues from sources outside of South Korea. Material sales and royalty revenue from China came in at $1.8 million for Q4 and $7.2 million for the full year, growing 122% year-over-year as panel manufacturers BOE and Tianma are accelerating their efforts to bring OLED displays toward volume production. Revenue in the US was $1.9 million, mostly technology development and support revenue resulting from UDC’s acquisition of Adesis in July. Adesis continues to bring in contract revenue, and UDC CEO Steve Abramson indicated that while it was not likely to grow, it was likely to continue at a pace similar to that in the 2nd half of 2016, which would amount to $6-7 million per year.
While UDC does not disclose details of its transactions by customer, they do show the percentage of revenues from top customers, allowing us to construct the picture below of major revenue streams by customer:
UDC Quarterly Royalty & Material Revenue by Customer, 2015-2016
It would appear that the material sales pattern is only loosely connected to the panel maker production, and this is consistent with what we know about the product and its use in the production process. However, the total annual figures for the two companies provide some insight to OLED industry costs. Total revenues from Samsung in 2016 were 63% of all UDC revenues, or $125 million. Based on an estimated total output of 375 million panels, this translates to a revenue of 33 cents per panel. From LGD, 2016 revenues were 28% of the UDC total or $56 million, and assuming that nearly all of this was for TV (it’s fair to say that LGD shipments of OLED for the Apple Watch and other products were negligible compared to TV) then for the 900,000 OLED TV panels shipped in 2016 UDC recognized $62 per panel.
Looking at material sales, UDC reported total material sales of $29.2 million, up 5% over Q4 2015, with an unusually large portion of the sales coming from developmental material. UDC states that their margins on material sales have consistently averaged 70-75%, and this is consistent with their reports on commercial material sales, but margins on developmental materials are lower, only 46% for the full year 2016. UDC commented that materials costs increased in Q4 2016 largely because of the introduction of new phosphorescent emitter products, but also commented that this start-up or ramp-up cost factor would not persist in coming quarters.
In UDC’s earnings call late Thursday afternoon, CEO Steve Abramson and CFO Sydney Rosenblatt highlighted UDC’s opportunity as the OLED industry grows. Abramson listed the many panel makers with plans for new capacity, and the beginning of a “multi-year capex cycle”. On OLED TV, Abramson said that LGD’s production would be increasing from 900,000 in 2016 to 1.5-1.8 million in 2017 to 2.8 million in 2018, lining up closely with DSCC estimates. In our white paper on Quantum Dots issued earlier this year, we estimated OLED TV as 1.7 million in 2017 and 2.6 million in 2018.
In much of their communication before this week’s earnings release, UDC had indicated that after two successive years with little to no growth (0% growth in 2015 and 4% growth in 2016), the company could expect significant growth in 2017. Abramson referred to “double-digit revenue growth” in his comments, and Rosenblatt issued the following main points for 2017 guidance:
One of the questions on the earnings call asked UDC management if they were being conservative in their revenue outlook. Based on my pre-earnings analysis (from one week ago), I had the same question. With 50% growth in OLED input area, we should expect more than 18% growth in material sales revenue. The high end of UDC’s guidance would represent about 26% growth in materials sales, while with a 50% increase in area even with quarterly price decreases of 3% we should expect 32% Y/Y growth. Abramson correctly stated that material sales will depend on the timing and ramp of new capacity, and we agree that there is some uncertainty about the specifics, but I found the UDC guidance too conservative.
There are a few items on UDC’s balance sheet worth noting. First, they have a big pile of cash: $328 million, or $7 per share, equivalent to more than a full year’s revenues and more than two years of expenses. UDC has said in the past that this cash would be used to fund acquisitions and improve its IP portfolio, and in 2016 UDC consolidated the acquisition of the portfolio of BASF and also acquired the contract research company Adesis. On Thursday’s earnings call, although CFO Rosenblatt highlighted the cash on the balance sheet, he did not mention acquisitions, so perhaps that activity will not be a major part of 2017. One the other hand, the cash will be used to pay dividends, but not very much is needed: the $0.03 dividend will cost UDC about $1.4 million.
UDC carries a surprisingly high amount of inventory, which is consistent with their strategy on capacity to highlight their ability to reliably supply the customers’ needs. Longer-term investors may remember, though, that UDC took a $33 million inventory write-off in Q2 2015 as they decided to exit the host material business. While the current inventory level is much lower at $17 million, it still constitutes more than 6 months of inventory on a forward-looking basis. As UDC introduces new emitter materials, they may have a risk that older materials also become obsolete and require write-offs.
UDC certainly faces challenges in 2017, but clearly benefits from the coming wave of OLED products and capacity. As announced earlier this month, UDC will be doubling capacity at PPG’s manufacturing facility for phosphorescent OLED materials, and the company will need to manufacture new materials cost-effectively while managing a more complex product line. Perhaps no task on their annual checklist is more important than a renewal of the Samsung licensing agreement, which will continue to supply 38% of UDC revenues in 2017 per the mid-point of their guidance. The existing agreement expires on December 31, 2017, so look for UDC to announce its renewal soon, and look for UDC to benefit this year from the tremendous increase in the OLED display market.
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