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Summary

  • The operational update scheduled for June 25 will likely reveal that UniPixel has suffered another setback and has failed to start production of its touch sensors in the quarter.
  • UniPixel's claim that roll-to-roll plating is a remaining but a surmountable challenge is contradicted by the CTO's past statements, the company's sub-contractor website, and the history of its technology.
  • The new CEO has picked the wrong market segment to attack, even if the engineering issues go away.
  • The sub-par characteristics and cost of Diamond Guard, UniPixel's other potential revenue source, prevent it from succeeding in the market place.
  • Back-of-the envelope fair value is about $3.50 a share now.

Production has NOT started

Last week, Uni-Pixel (NASDAQ:UNXL) scheduled an operational update for June 25,

to discuss the company's progress towards achieving a reliable, high-volume, roll-to-roll production process for its projected capacitive, multi-touch sensor films.

The upcoming call got investors unusually excited, even though a progress update had been already promised for the second quarter on the last earnings call ("we said we're going to report on development milestones in the second quarter, so we are"). Last week, the stock briefly moved up over 80% from the low on June 4 on speculation that Uni-Pixel has finally solved its engineering challenges and has started or is about to start production after a long series of repeated delays and missed deadlines in the past four years (for a detailed history of Uni-Pixel's developments, please see the article "Uni-Pixel's Declining Production Capability And Inconsequential Purchase Orders").

However, investors may have completely misinterpreted the company's reason for scheduling the update. On June 25, Uni-Pixel will likely report that while progress has been made, just like in every quarter in the past, it has failed to start production. Since both Uni-Pixel and its manufacturing partner, Kodak (NYSE:KODK), had previously anticipated that the start of the manufacturing ramp for the sensor product line would occur in the second quarter of 2014, with commercial production scheduled to begin by July 1, a failure to start production would simply be admission of another delay.

The reason behind the press release on June 5 may be a disclosure situation precipitated by the company's miscommunication with its "eco-system partner," Intel (NASDAQ:INTC). Intel's Senior Touch Technologist presented a touch tutorial on June 1st at the SID Display Week 2014 conference. It mentioned on slide 76:

Uni-Pixel finally started production of their roll-to-roll printable copper metal-mesh in 2Q-2014.

It is unclear how Uni-Pixel became aware of Intel's presentation (although an investor request for clarification was sent to Uni-Pixel on June 3), but the company contacted Intel, objecting to that statement, since, in fact, production had not started yet. Intel then removed the incorrect statement from the materials on June 4th. Another slide with a description of Uni-Pixel's manufacturing process was also removed, just to be "as conservative as possible," even though Uni-Pixel had not asked for that other change. The next morning, Uni-Pixel issued the press release about the upcoming operational update.

In a follow-up, Intel's representative stated (personal communication):

I do not know when Uni-Pixel will start production, and I am very unwilling to guess, given the recent incident.

These developments occurred less than a month after the newly appointed CEO had reassured investors about the company's close relationship with Intel:

I have also met with our touch screen ecosystem partner to discuss our progress and new strategy. They are encouraged by our strategy and have expressed their continued desire to work with us pending our successful demonstration of a roll-to-roll manufacturing process.

In addition to Uni-Pixel's direct statement to Intel that production has not yet started, there is some indirect evidence that the company is not ready to enter the market. The company's management was conspicuously absent from the Cowen Technology, Media, & Telecom Conference held at the end of May. Last year, Uni-Pixel's management used that venue to show investors what were then described as actual sensor products off the production line to be presented to potential clients at the all-important Computex industry show the following week. Uni-Pixel did not attend this year's Computex (June 2-7) either. Finally, Uni-Pixel is not (as of June 11) on the list of presenting companies at the Liolios Group Gateway Conference scheduled for September 4 (Liolios is Uni-Pixel's IR firm). It is unlikely that the company would have missed such great recent opportunities to communicate with investors and potential clients, if it had solved or were close to solving its production problems.

Roll-to-Roll plating cannot be the only obstacle

On the last earnings call, the CEO insisted that Uni-Pixel has finalized the printing part of the manufacturing process and confirmed scale performance. He then identified the low yield in the roll-to-roll plating step as the biggest remaining constraint preventing the start of production. That should have come as a surprise, as Uni-Pixel's Chief Technology Officer had told investors on a WFG conference call in March last year that roll-to-roll plating had never been a problem (about 20 min. into the call):

The first [roll-to-roll] plating line was delivered here on December 26 and now it is March 24-25th here, and we thought we would have it up a little bit faster than that. Nobody has ever done this before at the scale we are doing it in a roll-to-roll fashion, so we found during the process that we have to have more optical inspection, we have to have more automated chemical controls, things like that, and we added them as we went along. That's the bad news. The good news is that the plating has gone a little bit faster than we thought. The quality is as good as we thought, if not better. We are running close to a 100% yield on that plating line. So, if printed, it plates.

Uni-Pixel has a credibility problem here. If roll-to-roll plating were fixed in March 2013, then why would the CEO say in May 2014 that it is not? Alternatively, if the CTO was less than truthful to investors last year, why is he still with the company?

Moreover, improving the plating yield may be harder than investors have been led to believe. Shockingly, the website of Uni-Pixel's plating sub-contractor appears to cast a doubt about Uni-Pixel's ability to overcome the plating challenge. It states that polyester (also known as PET) - the substrate used by Uni-Pixel - is simply not plateable (see tables under section "Resin Selection Key for Successful Plastic Plating Application"). This sub-contractor should know, as Uni-Pixel's initial three lines of roll-to-roll plating equipment are installed at its facilities (see 10K, page 10). The remaining four lines are at Kodak's facilities, however, Kodak has no expertise in plating, and Uni-Pixel's engineers themselves have been haphazardly attempting to solve the yield issues, willing to try anything their plating chemistry vendor, Atotech, could come up with (personal communication with an engineer who worked on the joint Uni-Pixel/Kodak project).

The serious difficulties experienced by Uni-Pixel's team in finalizing the manufacturing process are to be expected. Far from being innovative, Uni-Pixel's process can be boiled down to printing of fine patterns of catalytic ink on a flexible substrate, followed up by electroless plating. A cursory review of previous work attempting to commercialize such a technology has identified at least two relevant patents that have already expired, "Printed circuits" filed in 1980 and "Fabricating metal articles from printed images" filed in 1993. If companies with significantly larger resources have been unsuccessful in overcoming the yield challenges associated with this technology in the past 20-35 years, Uni-Pixel's chances for a fix in the foreseeable future appear slim.

Uni-Pixel's targeted market, small tablets, is no longer growing

On the last earnings call, Uni-Pixel announced a change in the sensor product focus. While last year it was all about Windows tablets, notebooks, monitors and all-in-one PCs, the development efforts have now shifted to a single category, small tablets, for the initial target launch.

At first glance, tablets, and small tablets in particular, should be an easy market to enter, if the sensors could be produced indeed. As stated on the call:

Touch penetration in the tablet market is 100%. DisplaySearch, the research firm, expects this market to grow at a 13% compound annual growth rate from 2013 to 2018. This is exceptional growth and underscores the magnitude of the initial opportunity we are pursuing.

Apparently, the CEO's optimism was based on an earlier, February 6 report, which also projected that tablets with screens smaller than 9 inches would comprise approximately two-thirds of overall shipments in 2014, and that the largest market share would go to 7-inch screens, Uni-Pixel's target segment, exceeding 30% by 2017.

Yet, just two weeks after the earnings call, DisplaySearch admitted that "no party can go on forever," as tablet shipments in Q1 2014 had in fact registered their first ever decline year-over-year. Subsequently, DisplaySearch clarified that there is more to the decline than just seasonal weakness and product transitions. Shipments of small tablets are now facing serious challenges from the emergence of large-screen smartphones, and are expected to decline.

A few days later, another research firm, IDC, lowered its forecast, explaining:

Two major issues are causing the tablet market to slow down. First, consumers are keeping their tablets, especially higher-cost models from major vendors, far longer than originally anticipated. And when they do buy a new one they are often passing their existing tablet off to another member of the family. Second, the rise of phablets - smartphones with 5.5-inch and larger screens - are causing many people to second-guess tablet purchases as the larger screens on these phones are often adequate for tasks once reserved for tablets.

IDC's revised expectations show the market share of small tablets dropping from 55% in 2013 to 50.8% in 2014 and down to 44.5% in 2018, after having doubled in 2013. That forecast may have further downside, as it still implies 4% growth year-over-year in 2014. Recent inventory liquidations in retail stores indicate that the category remains under significant pressure.

Since the cost and performance of ITO-based touch modules in this segment is good enough, Uni-Pixel will find it next to impossible to generate any meaningful sales at a profit, even if it were able to deliver a working sensor. With ITO film pricing dropping below $3 per square foot and phone touch modules pricing expected to drop to $0.40-0.70 per diagonal inch in 2014, according to Asian sources, pricing for small tablets touch modules is about to fall to just above that range, eliminating any chance for a module assembler working with Uni-Pixel's development partner to make a profit using Uni-Pixel's sensor, even if the sensor has a 100% back-end yield and even if Uni-Pixel sells it at cost. When asked on the last earnings call about his expectations for price declines in the industry for the year, the CEO was stumped, replying that he was not sure "what the exact numbers are."

But what about Diamond Guard?

Uni-Pixel's other potential revenue generator is a hard coat branded Diamond Guard. The CEO stated:

We are expecting results during the second quarter that will further advance our 2014 strategy of licensing the application know-how and resin sale to coating companies.

His argument for why it "continues to garner much attention from potential customers" is:

Diamond Guard is a low-cost alternative to glass on touch screen devices, it is super-hard, rated 6H, and scratch resistant, making it highly resistant to abrasion and shattering.

However, there are several reasons why Diamond Guard has been a commercial failure since 2011. First, the product is apparently nothing more than a commodity off-the-shelf acrylic coating, but one can't tell that from Uni-Pixel's datasheet. Carestream, Uni-Pixel's Diamond Guard manufacturing partner, has filed a patent application with details about the coat composition. Second, Diamond Guard is not a "super-hard," but in fact, a very soft and scratchable coat. The datasheet shows that it is rated 6H on the pencil hardness test scale (ASTM D3363 standard) on a PET substrate. A 6H material can be scratched with an ordinary 7H pencil, a piece of glass, a stone, a pen, and basically any metal object. There seem to be better acrylic coat formulations on the market, for example, resin/coats from Clarex and SciCron, up to 8H-9H hardness, however, even those are still much too soft and can't match glass. Diamond Guard is probably worth no more than $0.50 per square foot when applied on PET film, while Uni-Pixel's previously disclosed cost of manufacturing is about $1.50 per square foot.

Estimating the stock's fair value

After another delay, Uni-Pixel continues to burn cash without tangible progress in revenue or profit generation. As a result, the company should be worth no more than its current cash holdings plus the liquidation value of its fixed assets. Assuming a modest burn of $3 million in the second quarter and equipment liquidation value at 70% book, fair value comes to about $3.50 a share [(34 - 3 + 15 x 70%)/12]. The calculation does not account for the potential loss of equipment, with an original cost of approximately $10 million in case of a (unspecified) material breach of the license agreement with Intel (see 10Q, page 9).

While the June 25 update should provide the catalyst for bringing the stock back down in the direction of its fair value, the high short interest could sustain further price volatility. The magnitude of the stock price movements could be further exacerbated, as Uni-Pixel is about to be removed from Russell 2000 index, the investable small-cap segment of the U.S. equity universe (preliminary list of deletions was published on June 13), and has been subject to various portfolio rebalancing trade impacts that could persist for up to a week after the month-end. Once all those effects are over, though, the stock is likely to experience decreased liquidity and diminished institutional interest.

Source: An Update Of Uni-Pixel's Production Status