As we approach the end of the third quarter, expectations are rising for production deliveries to begin in the fourth quarter. At the same time there are concerns about a possible slippage of product shipment, potential competition and insider sales.
No News So Far, is Good News
Since our last article on Uni-pixel (UNXL) in mid-June, there has been steady progress on scaling Uniboss to be a disruptive product in the touch sensor market replacing the incumbent ITO sensors. The unrelenting progress has been masked by a lack of press releases. But in Uni-pixel's situation, no news is indeed good news. Third quarter was to be the quarter when the company scaled its production runs while building out higher capacity. It was all manufacturing related - kind of indoor activity. While new business development and alliances are important for the future, at this time Uni-pixel's core focus must be to get production out the door in high quantities.
A lot could have gone wrong thus far in the third quarter considering the sensitive manufacturing process - we could have heard of manufacturing failures or lack of progress with Kodak because of technology issues, or a notice from the PC partner threatening or terminating the relationship due to the inability of the product to perform and scale as expected, or missing capacity ramp targets by wide margins, an inflexible supply chain, etc. - all events that would have dramatically affected timelines and most likely triggered press releases. Consequently, the earlier mention of 'no news being good news.'
If Uni-pixel can Produce in Scale, it can Sell
In our previous article, we had talked about the transformative appeal of the metal-mesh technology using the additive process. In our opinion, this is the essence of Uni-pixel. Its ability to execute an additive process successfully in scale can transform the industry. There will be many metal-mesh providers. But Uni-pixel at this time is the one pursuing an entirely additive process. In a high-volume market that runs into millions of sensor units a months, being a low-cost provider is a key prerequisite to survive, assuming product quality is at par if not better than peers. However, being a low-cost provider is also a low-margin business if the cost distribution of various suppliers is highly similar. One way for a company to capture market share and higher-margin is by operating on a significantly lower cost curve than competition. Uni-pixel is seeking to deliver a product that performs at least at par with metal-mesh and ITO competition, but at a significantly lower cost curve achieved through the additive process.
It's hard to imagine the compelling economics of an additive process and how it has the potential to transform industries. Many years ago Hutchinson Technology (HTCH) was a leader in supplying suspension assemblies for hard disk drives to all the leading disk drive manufacturers like Seagate and Western Digital. At that time, Japanese companies developed an additive manufacturing process. The higher-cost subtractive process used by Hutchinson was uncompetitive. The Japanese could do it at ~ one-fifth to one-fourth the cost of Hutchinson, which was then the volume leader. In a couple of quarters, the business for Hutchinson was gone. Over many years, Hutchinson has clawed back and is now a leading volume manufacturer once again. But its example reveals the transformative impact on cost dynamics of a successful additive manufacturing process.
Thus, when investors wonder whether the production shipments will happen on October 1, in time for the holiday season, they have to realize that the holiday season this year has no impact on Uni-pixel due to the company's limited manufacturing ability. More important is for the company to get the product right. The demand for a high-quality, high-yield Uniboss product will be there even if the holiday season is not. If the company can get this right and build in scale, the market can pivot toward Uniboss. If Uni-pixel can produce, it can sell.
Getting it right is not a straight-forward task. This is not baking muffins with a clear-cut recipe. The chemistry involved is fluid and dynamic, and because of the pioneering nature of the work, there is no pre-existing template to rely on. It's a cumulative learning process. I was amongst the early analysts to cover a company called Cree Research (CREE). It was then a $100 to $150 million company, which was developing LEDs using a highly innovative process involving Silicon Carbide wafers. Growing these SiC wafers was an intricate job due to the highly fluid chemistry and material sciences involved, and there were many bumps. But with patience and persistence, the company got it right and grew into one of the leading LED manufacturers. What Uni-pixel is pursuing is relatively less complex but still highly intricate. Besides its own domain experts, the company has the benefit of tapping into the material sciences experience of its partner Kodak.
One thing that has struck us is how rapidly and close-to-schedule the company continues to ramp up its capacity. One of the key reasons for this successful transition thus far has to be the company's ability to draw on the expertise of Kodak, thus resolving some issues in days and weeks, what could possibly have taken months to resolve on its own. Keeping in mind, that even a highly-experienced engineering firm like Atmel (ATML) had to encounter multiple delays in qualifying its touch sensor X-sense facility, the steady progress thus far at Uni-pixel is noteworthy.
Incidentally, any delay relating to Kodak co-branding is an immaterial delay. It does not swing the revenue needle near term, one way or the other. In our opinion, the critical success factor at this time remains manufacturing scalability and Kodak is already making a strong contribution in that area.
October 1 is not a "Red Line"
There has been concern regarding the October 1 "drop-dead" comment by Reed Killion, CEO, "For us, the drop-dead date to ship product would be in October, October 1st." The contextual framework could have been better clarified in this comment, for what it meant was that the company has to be ready to produce by that date. What Mr. Killion did not mean was that production will be leaving the doors by October 1, as can be possibly misinterpreted. A shipping date of October 1, was not possible to set, for there is no Purchase Order in hand yet. This was a disclosure of an internal whip or an edict issued by Mr. Killion for the company to focus and get it done. If the date slips, it's important to understand the reason for the slippage. As per recent updates by investment firm Cowen and others, most likely the Automated Tester won't be delivered until the end of October. If that's the primary reason, then investors should consider themselves lucky. For there is a lot that can go wrong within the additive manufacturing process to engender delays.
Recent insider sales, particularly by the CFO, have generated a lot of angst. Such sales are always painful from an investor standpoint, particularly when the company is moving closer to achieving higher manufacturing scalability. In an early stage emerging growth company, a CFO has at least 3 key tasks: make payroll; plan and raise sufficient growth capital; and keep the bank satisfied. After raising sufficient growth capital, at a stock price which was twice where it's today, the CFO is performing his key tasks well. The Insider sale as per a filed plan, even though unfortunate in its timing, is not a game-changer.
It all comes down to manufacturing success at higher production levels. The company should be able to provide additional updates in October. Insider sales can cause near-term volatility in the stock price but are immaterial in the broader context. One has to focus on the manufacturing successes or setbacks, and buy and sell for the right reasons. Not simply because of insider selling.
Over the last 10 months, Mr. Killion and his team have delivered on nearly all key milestones relating to touch sensor development - licensing arrangements with PC/OEM and an Ecosystem partner; capacity ramp; as well as Kodak relationship. Mr. Killion has this year brought on board additional strong talent in the manufacturing and business development areas. There is a determination to succeed, and Mr. Killion realizes nothing speaks like shipments and revenues. By the time of the next earnings call, we hope he would be standing on 1st and Goal or perhaps even reached the end zone, which to us would be shipping products.
Presently, the company trades at a "show me first" valuation of ~$190 million and a $15.64 share price. It's a speculative play with a highly attractive risk/reward. There can be many a slip between the cup-and-the-lip. But if this pace of progress continues and the manufacturing ramp successfully delivers high yields at higher production points, the potential earnings power can be above the $3 to $4/share projected by analysts for 2014. A growth-related multiple of 25x to 30x in the early years would be easily forthcoming in this bull market, delivering a target price that can conceivably reach triple digits over time.
I am Long Uni-pixel. If you decide to invest, do your own due diligence. I maintain a reasonable stop-loss. I may add or exit at any time without notification.