Management's Discussion of Results of
Operations (Excerpts) |
For purposes of readability, Zenith attempts to strip out all tables in excerpts from the Management Discussion. That information is contained elsewhere in our articles. The idea of this summary is simply to review how well we believe Management does its reporting. Also, this highlights what Management believes is important.
In our Decision Matrix at the end of each article, a company with 0 to 2 gets a "-1", and 3 to 5 gets a "+1."
On a scale of 0 to 5, 5 being best, Zenith rates this company's Management's Discussion as a 5.
OVERVIEW We are a leader in the research, development and commercialization of organic light emitting diode, or OLED, technologies and materials for use in displays for mobile phones, televisions, tablets, wearables, portable media devices, notebook computers, personal computers and automotive applications, as well as specialty and general lighting products. Since 1994, we have been exclusively engaged, and expect to continue to be primarily engaged, in funding and performing research and development activities relating to OLED technologies and materials, and commercializing these technologies and materials. We derive our revenue primarily from the following: • sales of OLED materials for evaluation, development and commercial manufacturing; • intellectual property and technology licensing; • contract research services in the areas of organic and organometallic materials synthesis research, development and commercialization; and • technology development and support, including government contract work and support provided to third parties for commercialization of their OLED products. Material sales relate to our sale of OLED materials for incorporation into our customers’ commercial OLED products or for their OLED development and evaluation activities. Material sales are recognized at the time title passes, which is typically at the time of shipment or at the time of delivery, depending upon the contractual agreement between the parties. We receive license and royalty payments under certain commercial, development and technology evaluation agreements, some of which are non-refundable advances. These payments may include royalty and license fees made pursuant to license agreements and also license fees included as part of certain commercial supply agreements. These payments are included in the estimate of total contract consideration by customer and recognized as revenue over the contract term based on material units sold at the estimated per unit fee over the life of the contract. In 2018, the Company entered into a commercial license agreement with Samsung Display Co., Ltd. (SDC). This agreement, which covers the manufacture and sale of specified OLED display materials, was effective as of January 1, 2018 and lasts through the end of 2022 with an additional two-year extension option. Under this agreement, the Company is being paid a license fee, payable in quarterly installments over the agreement term of five years. The agreement conveys to SDC the non-exclusive right to use certain of the Company's intellectual property assets for a limited period of time that is less than the estimated life of the assets. At the same time the Company entered into the current patent license agreement with SDC, the Company also entered into a supplemental material purchase agreement with SDC. Under the supplemental material purchase agreement, SDC agrees to purchase from the Company a minimum amount of phosphorescent emitter materials for use in the manufacture of licensed products. This minimum commitment is subject to SDC’s requirements for phosphorescent emitter materials and the Company’s ability to meet these requirements over the term of the supplemental agreement. In 2015, the Company entered into an OLED patent license agreement and an OLED commercial supply agreement with LG Display Co., Ltd. (LG Display), which were effective as of January 1, 2015 and superseded the existing 2007 commercial supply agreement between the parties. The new agreements have a term that is set to expire by the end of 2022. The patent license agreement provides LG Display a non-exclusive, royalty bearing portfolio license to make and sell OLED displays under the Company's patent portfolio. The patent license calls for license fees, prepaid royalties and running royalties on licensed products. The agreements include customary provisions relating to warranties, indemnities, confidentiality, assignability and business terms. The agreements provide for certain other minimum obligations relating to the volume of material sales anticipated over the term of the agreements as well as minimum royalty revenue to be generated under the patent license agreement. The Company generates revenue under these agreements that are predominantly tied to LG Display's sales of OLED licensed products. The OLED commercial supply agreement provides for the sales of materials for use by LG Display, which may include phosphorescent emitters and host materials. In 2016, the Company entered into long-term, multi-year OLED patent license and material purchase agreements with Tianma Micro-electronics Co. Ltd. (Tianma). Under the license agreement, the Company has granted Tianma non-exclusive license rights under various patents owned or controlled by the Company to manufacture and sell OLED display products. The license agreement calls for license fees and running royalties on licensed products. Additionally, the Company supplies phosphorescent OLED materials to Tianma for use in its licensed products. In 2017, the Company entered into long-term, multi-year agreements with BOE Technology Group Co., Ltd. (BOE). Under these agreements, the Company has granted BOE non-exclusive license rights under various patents owned or controlled by the Company to manufacture and sell OLED display products. The Company also supplies phosphorescent OLED materials to BOE. In 2018, the Company entered into long-term, multi-year OLED patent license and material purchase agreements with Visionox Technology, Inc. (Visionox). Under the license agreement, the Company has granted Visionox non-exclusive license rights under various patents owned or controlled by the Company to manufacture and sell OLED display products. The license agreement calls for license fees and running royalties on licensed products. Additionally, the Company supplies phosphorescent OLED materials to Visionox for use in its licensed products. In 2016, we acquired Adesis, Inc. (Adesis) with operations in New Castle, Delaware. Adesis is a contract research organization (CRO) that provides support services to the OLED, pharma, biotech, catalysis and other industries. As of September 30, 2019, Adesis employed a team of 91 research scientists, chemists, engineers, and laboratory technicians. Prior to our acquisition in 2016, we utilized more than 50% of Adesis’ technology service and production output. We continue to utilize a significant portion of its technology research capacity for the benefit of our OLED technology development, and Adesis uses the remaining capacity to operate as a CRO in the above-mentioned industries providing contract research services to those third party customers. Contract research services revenue is earned by performing organic and organometallic synthetics research, development and commercialization on a contractual basis for our customers. We also generate technology development and support revenue earned from government contracts, development and technology evaluation agreements and commercialization assistance fees, which include reimbursements by government entities for all or a portion of the research and development costs we incur in relation to our government contracts. Revenues are recognized as services are performed, proportionally as research and development costs are incurred, or as defined milestones are achieved. Revenue During the three months ended September 30, 2019, we recognized revenue of $97.5 million, an increase of $19.9 million from $77.6 million in the three months ended September 30, 2018. The increase in revenue was due to higher material sales as a result of stronger demand in the OLED display market. Revenue derived from OLED sales comprised 97% of total revenue for the three months ended September 30, 2019 as compared to 96% for the three months ended September 30, 2018. The remaining portion of our revenue was derived from contract research services. Contract research services include revenue earned by our subsidiary, Adesis, which performs organic and organometallic synthetics research, development and commercialization on a contractual basis for our customers. Cost of sales Cost of sales for the three months ended September 30, 2019 increased by $1.2 million as compared to the three months ended September 30, 2018, primarily due to an increase in the level of material sales. Included in the cost of sales for the three months ended September 30, 2018, was an increase in inventory reserve of $1.0 million due to excess inventory levels in certain products. There was no increase in inventory reserve for the three months ended September 30, 2019. As a result of the increase in material sales, gross margin for the three months ended September 30, 2019 increased by $18.8 million as compared to the three months ended September 30, 2018, with gross margin as a percentage of revenue increasing to 82% from 79%. Research and development Research and development expenses increased to $16.8 million for the three months ended September 30, 2019, as compared to $13.6 million for the three months ended September 30, 2018. The increase in research and development expenses was primarily due to higher employee-related compensation expenses and operating costs, including increased contract research activity. Selling, general and administrative Selling, general and administrative expenses increased to $12.6 million for the three months ended September 30, 2019, as compared to $12.1 million for the three months ended September 30, 2018. The increase in selling, general and administrative expenses was primarily due to higher employee-related compensation expenses. Amortization of acquired technology and other intangible assets Amortization of acquired technology and other intangible assets was $5.5 million for both of the three-month periods ended September 30, 2019 and 2018. Patent costs Patent costs decreased to $1.7 million for the three months ended September 30, 2019, as compared to $1.9 million for the three months ended September 30, 2018. Royalty and license expense Royalty and license expense increased to $2.8 million for the three months ended September 30, 2019, as compared to $2.2 million for the three months ended September 30, 2018. The increase was due to increased royalties incurred under our amended license agreement with Princeton, USC and Michigan, resulting from an increase in qualifying material sales. See Note 9 to the Consolidated Financial Statements for further discussion. Interest and other income, net Interest income, net was $2.7 million for the three months ended September 30, 2019, as compared to $2.1 million for the three months ended September 30, 2018. The increase in interest income, net was primarily due to the increase in available-for-sale investments held in the current quarter over amounts held in the comparable period in 2018. Other income (expense), net primarily consisted of net exchange gains and losses on foreign currency transactions and rental income. We recorded other income, net of $53,000 for the three months ended September 30, 2019 as compared to other expense, net of $7,000 for the three months ended September 30, 2018. Income tax expense We are subject to income taxes in both the United States and foreign jurisdictions. The effective income tax rate was an expense of 15.3% and 18.9% for the three months ended September 30, 2019 and 2018, respectively, and we recorded income tax expense of $6.7 million and $5.3 million, respectively, for those periods. The recorded amounts include deductions for employee share awards in excess of compensation costs (“windfalls”) under ASU No. 2016-09. For the three months ended September 30, 2019, without the $693,000 benefit of ASU No. 2016-09, the effective income tax rate and income tax expense would have been 16.9% and $7.4 million, respectively, and for the three months ended September 30, 2018, without the $29,000 benefit of ASU No. 2016-09, the effective income tax rate and income tax expense would have been 19.0% and $5.4 million, respectively. During the three months ended September 30, 2019, the Company released a deferred tax liability of $1.9 million due to the expiration of the statute of limitations for the 2015 Federal tax return. Without the release of the deferred tax liability, the effective income tax rate and income tax expense would have been 19.6% and $8.6 million, respectively for the three months ended September 30, 2019. Nine Months Ended September 30, Revenue During the nine months ended September 30, 2019, we recognized revenue of $303.4 million, an increase of $126.1 million from $177.3 million in the nine months ended September 30, 2018. The increase in revenue was due to higher material sales as a result of stronger demand in the OLED display market. Revenue derived from OLED sales comprised 97% of total revenue for the nine months ended September 30, 2019 as compared to 95% for the nine months ended September 30, 2018. The remaining portion of our revenue was derived from contract research services. Contract research services include revenue earned by our subsidiary, Adesis, which performs organic and organometallic synthetics research, development and commercialization on a contractual basis for our customers. Cost of sales Cost of sales for the nine months ended September 30, 2019 increased by $22.0 million as compared to the nine months ended September 30, 2018, primarily due to an increase in the level of material sales. Included in the cost of sales for the nine months ended September 30, 2019 and 2018, was an increase in inventory reserve of $4.2 million and $1.0 million, respectively, due to excess inventory levels in certain products. As a result of the increase in material sales, gross margin for the nine months ended September 30, 2019 increased by $104.2 million as compared to the nine months ended September 30, 2018, with gross margin as a percentage of revenue increasing to 81% from 80%. Research and development Research and development expenses increased to $51.4 million for the nine months ended September 30, 2019, as compared to $38.9 million for the nine months ended September 30, 2018. The increase in research and development expenses was primarily due to higher employee-related compensation expenses and operating costs, including increased contract research activity. Selling, general and administrative Selling, general and administrative expenses increased to $40.5 million for the nine months ended September 30, 2019, as compared to $34.5 million for the nine months ended September 30, 2018. The increase in selling, general and administrative expenses was primarily due to higher employee-related compensation expenses. Amortization of acquired technology and other intangible assets Amortization of acquired technology and other intangible assets was $16.5 million for both of the nine-month periods ended September 30, 2019 and 2018. Patent costs Patent costs decreased to $5.1 million for the nine months ended September 30, 2019, as compared to $5.7 million for the nine months ended September 30, 2018. Royalty and license expense Royalty and license expense increased to $8.8 million for the nine months ended September 30, 2019, as compared to $5.0 million for the nine months ended September 30, 2018. The increase was due to increased royalties incurred under our amended license agreement with Princeton, USC and Michigan, resulting from an increase in qualifying material sales. Interest and other income, net Interest income, net was $8.3 million for the nine months ended September 30, 2019, as compared to $5.2 million for the nine months ended September 30, 2018. The increase in interest income, net was primarily due to the increase in available-for-sale investments held in the current year over amounts held in the comparable period in 2018. Other income (expense), net primarily consisted of net exchange gains and losses on foreign currency transactions and rental income. We recorded other income, net of $740,000 for the nine months ended September 30, 2019 as compared to other expense, net of $66,000 for the nine months ended September 30, 2018. Income tax expense We are subject to income taxes in both the United States and foreign jurisdictions. The effective income tax rate was an expense of 15.8% and 15.0% for the nine months ended September 30, 2019 and 2018, respectively, and we recorded income tax expense of $21.1 million and $7.0 million, respectively, for those periods. The recorded amounts include deductions for employee share awards in excess of compensation costs (“windfalls”) under ASU No. 2016-09. For the nine months ended September 30, 2019, without the $3.5 million benefit of ASU No. 2016-09, the effective income tax rate and income tax expense would have been 18.5% and $24.6 million, respectively, and for the nine months ended September 30, 2018, without the $1.8 million benefit of ASU No. 2016-09, the effective income tax rate and income tax expense would have been 18.8% and $8.8 million, respectively During the nine months ended September 30, 2019, the Company released a deferred tax liability of $1.9 million due to the expiration of the statute of limitations for the 2015 Federal tax return. Without the release of the deferred tax liability, the effective income tax rate and income tax expense would have been 17.2% and $23.0 million, respectively for the nine months ended September 30, 2019. Liquidity and Capital Resources Our principal sources of liquidity are our cash and cash equivalents and our short-term investments. As of September 30, 2019, we had cash and cash equivalents of $235.5 million and short-term investments of $361.5 million, for a total of $597.0 million. This compares to cash and cash equivalents of $211.0 million and short-term investments of $304.3, for a total of $515.3 million, as of December 31, 2018. Cash provided by operating activities for the nine months ended September 30, 2019 was $137.7 million resulting from $111.9 million of net income and $88.3 million due to changes in our operating assets and liabilities, partially offset by a $62.5 million reduction due to non-cash items including amortization of deferred revenue, amortization of intangibles and stock-based compensation. Changes in our operating assets and liabilities related to an increase in deferred revenue of $113.8 million, a reduction of inventory of $8.1 million and an increase in other liabilities of $5.7 million, partially offset by an increase in accounts receivable of $22.6 million, an increase in other assets of $14.9 million, and a reduction of accounts payable and accrued expenses of $1.8 million. Cash provided by operating activities for the nine months ended September 30, 2018 was $95.0 million resulting from $39.6 million of net income and $56.1 million due to changes in our operating assets and liabilities. This increase was partially offset by a $769,000 decrease due to non-cash items including amortization of deferred revenue, amortization of intangibles and deferred income taxes. Changes in our operating assets and liabilities related to an increase in deferred revenue of $99.9 million, an increase in other liabilities of $18.3 million, a decrease in accounts receivable of $9.2 million, and an increase in accounts payable and accrued expenses of $439,000, partially offset by an increase in other assets of $37.9 million and an increase in inventory of $33.8 million. Cash used in investing activities was $83.2 million for the nine months ended September 30, 2019, as compared to $106.2 million for the nine months ended September 30, 2018. The decrease in cash used in investing activities of $23.0 million was primarily due to the timing of maturities and purchases of investments resulting in net purchases of $57.5 million for the nine months ended September 30, 2019, as compared to $85.3 million for the nine months ended September 30, 2018, partially offset by an increase in purchases of intangibles and property, plant and equipment of $4.8 million for the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018. The increase in property, plant and equipment purchases during 2019 was primarily due to the purchase of additional property in Ewing, New Jersey as part of our plan to expand operations. Cash used in financing activities was $30.1 million for the nine months ended September 30, 2019, as compared to $19.9 million for the nine months ended September 30, 2018. The increase in cash used in financing activities of $10.2 million was due to an increase in the cash payment of dividends in the current year of $5.7 million, an increase in the payment of withholding taxes related to stock-based compensation to employees of $4.3 million and an increase in the repurchase of common stock of $172,000, partially offset by an increase in proceeds from the issuance of common stock of $42,000. Working capital was $582.6 million as of September 30, 2019, compared to $501.7 million as of December 31, 2018. The increase in working capital was primarily due to an increase in short-term investments, cash and cash equivalents and accounts receivable, partially offset by a decrease in inventory and an increase in deferred revenue. We anticipate, based on our internal forecasts and assumptions relating to our operations (including, among others, assumptions regarding our working capital requirements, the progress of our research and development efforts, the availability of sources of funding for our research and development work, and the timing and costs associated with the preparation, filing, prosecution, maintenance, defense and enforcement of our patents and patent applications), that we have sufficient cash, cash equivalents and short-term investments to meet our obligations for at least the next twelve months. We believe that potential additional financing sources for us include long-term and short-term borrowings, public and private sales of our equity and debt securities and the receipt of cash upon the exercise of outstanding stock options. It should be noted, however, that additional funding may be required in the future for research, development and commercialization of our OLED technologies and materials, to obtain, maintain and enforce patents respecting these technologies and materials, and for working capital and other purposes, the timing and amount of which are difficult to ascertain. There can be no assurance that additional funds will be available to us when needed, on commercially reasonable terms or at all, particularly in the current economic environment. Off-Balance Sheet Arrangements As of September 30, 2019, we had no off-balance sheet arrangements in the nature of guarantee contracts, retained or contingent interests in assets transferred to unconsolidated entities (or similar arrangements serving as credit, liquidity or market risk support to unconsolidated entities for any such assets), or obligations (including contingent obligations) arising out of variable interests in unconsolidated entities providing financing, liquidity, market risk or credit risk support to us, or that engage in leasing, hedging or research and development services with us. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We do not utilize financial instruments for trading purposes and hold no derivative financial instruments, other financial instruments or derivative commodity instruments that could expose us to significant market risk other than our investments disclosed in “Fair Value Measurements” in Note 4 to the Consolidated Financial Statements included herein. We generally invest in investment grade financial instruments to reduce our exposure related to investments. Our primary market risk exposure with regard to such financial instruments is to changes in interest rates, which would impact interest income earned on investments. However, based upon the conservative nature of our investment portfolio and current experience, we do not believe a decrease in investment yields would have a material negative effect on our interest income. Substantially all our revenue is derived from outside of North America. All revenue is primarily denominated in U.S. dollars and therefore we bear no significant foreign exchange risk.