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Universal Display (OLED) reported its third quarter results on Thursday after the market close. The very strong results sent shares to fresh highs for the year, as shares are trading with year to date gains of over 40%.

Despite the strong operational growth, I remain cautious as the company has a lot more to prove to justify the current valuation amidst competition and technological changes.

Third Quarter Results

Universal Display generated third quarter revenues of $32.8 million, up 162.5% on the year before. The company turned a $5.5 million loss into net earnings of $5.5 million, resulting in earnings of $0.12 per share.

The profits are a true surprise as analysts were looking for losses of $0.04 per share on revenues of $21.8 million.

Looking Into The Results

Note that Universal Display did not recognize any revenues under the licensing agreement with Samsung Display. The agreement resulted in $20 million in revenues for the second quarter, with a similar amount expected in the fourth quarter.

The cost of sales increased from 8.8% to 29.8% of total revenues over the past quarter, but the gross margin compression was more than offset by sales leverage of other expense items. Absolute R&D expenses fell slightly to $7.9 million, plunging from 65.4% to just 24.0% of total sales.

The company also saw very modest increases in absolute selling, general and administrative expenses as well as expenses related to acquired and amortized technologies.

Outlook

Based on the solid third quarter results, Universal Display expects to generate annual revenues of $142 to $144 million. Note that previously the company expected annual revenues of $110 to $125 million.

Analysts were looking for revenues of $127.4 million for the full year. The guidance implies that fourth quarter revenues are expected to come in between $44.8 and $46.8 million.

Valuation

Universal Display ended its third quarter with $248.3 million in cash, equivalents and short-term investments. The company operates without the assumption of debt, for a solid net cash position.

Revenues for the first nine months of the year came in at $97.2 million, up 76.3% on the year before. The company nearly quadrupled net earnings to $16.2 million, resulting in earnings of $0.35 per share.

Factoring in 26% gains on Friday, with shares exchanging hands at $37 per share, the market values Universal Display at $1.7 billion. This values operating assets of the firm at $1.45 billion.

As such, operating assets are valued at little over 10 times annual revenues and 70 times earnings, based on earnings estimates of $20 million for the year.

Universal Display currently does not pay a dividend.

Some Historical Perspective

Investors have seen great returns, accompanied by great volatility over the past five years. Shares rose from just $7 in 2009 to highs of nearly $60 in 2011. Ever since, shares have traded in a wide $20-$50 trading range.

Between 2009 and 2013, Universal Display is expected to roughly ten-fold its annual revenues from $16 million to an expected $143 million. The company reported losses of around $20 million in 2009 and 2010, but has reported profits since 2011.

Investment Thesis

Universal Display reported a blow-out quarter in the third quarter which did not include a $20 million license payment from Samsung. Excluding this expected payment for the fourth quarter, "other" revenues are seen between roughly $25 and $27 million for the fourth quarter. This is down from $33 million in revenues being generated over the past quarter, suggesting a sequential decline in revenues.

The LED company, which makes components for organic light-emitting diode technology, attributed the strong quarter on the commercial adoption of some materials used in its products.

At this pace annual revenues of $150-$200 million are possible going forwards, as earnings could come in around $25 million as a bold guess.

At the valuation of $1.45 billion on an operating basis, that values the company at little over 8 times annual revenues and roughly 60 times annual earnings.

Despite all the discussions based upon the viability of the patents, the strength of the technological IP portfolio as well as increased competition and changed technology, Universal Display reported strong results. Key risks include the large reliance on Samsung and its Galaxy phone lines for now. The license agreement generating $40 million in annual revenues with Samsung is crucial as well.

While the quarter has been very strong, the company still has a lot to prove to justify the current valuation. The company needs to see continued revenue growth, which should continue to be profitable, amidst increased competition and changing technological developments.

While I appreciate the strong growth at the moment, the company has still much more to prove to me to justify the $1.5 billion price tag.

I remain on the sidelines.

Source: Universal Display: Still Much To Prove After A Very Strong Quarter