The shares of Universal Display Corp.'s common stock ("UDC"; NASDAQ: OLED) experienced a counterintuitive and unjustified response to UDC's purported "beat and raise," which was actually a "miss and lower." UDC's engineered earnings "beat and raise" rested on UDC management's private representations to analysts during the second quarter, which resulted in analyst estimates that were unrealistically low and lower than any informed OLED industry observer would have suspected, so long as UDC sales were in any way keeping pace with OLED display shipments.
UDC purported "beat and raise" created a temporary distraction from the fact that UDC's reported results were lower than indicated by OLED product sales and its financials continue to show disturbing trends. Below we address UDC's engineered Q3 beat, its negative financial results, and attempts to obscure information about its patent challenges and Samsung contract.
Introduction:
UDC's third quarter growth was actually worse than industry OLED mobile display shipments. With UDC's updated guidance, UDC admits that in the fourth quarter it will experience another quarter-over-quarter decrease in OLED material sales. This result would be drastically out of line with the 12% quarter-over-quarter growth in OLED mobile shipments expected by the industry in Q4, according to data compiled by the OLED Association. At the same time, UDC failed to provide any meaningful information concerning its patent challenges. In fact, UDC even failed to disclose the date of the coming final EP-238 trial and hearing on its "fundamental" key patent claims; UDC's 10-Q only states dismissively that a hearing will occur "in the second half of 2013."
UDC's omission and avoidance of the EP-238 trial is especially egregious, since the patent represents its most basic claims to phosphorescent iridium compounds, and the European Patent Office ("EPO") has already questioned the validity of claims to "every OLED" which UDC did not disclose to investors. A highly regarded expert with unique experience in the subject matter gave an opinion finding that UDC made no valid invention in the experiments used to support EP-238 and UDC's other key patents.
UDC also gave one-sided, distorted opinion concerning recent decisions in JP-024 and EP-395. The opinions that UDC provides investors directly conflict with their admissions in court which show UDC relied on others' inventions, and conflict with its statements to the Securities and Exchange Commission ("SEC") about potential "obsolescence" of UDC's purported technology and "competition" to justify its irregular accounting of Samsung's license payments.
Prior to UDC's Q3 release, asensio.com warned that if UDC's materials sales in any way kept pace with display shipments, then UDC would dramatically beat analyst estimates, which were based on management's evasive statements and misrepresentations that one of its analysts called "frustrating." The fact that UDC seems to have misinformed analysts and then promoted its miss as a beat only distracts investors from the sustained negative trends in UDC's financial statements, all the negative and adverse developments that UDC is experiencing in patent litigation and how these patent challenges negatively affect the value of its patents, which Lowe Hauptman experts state are entirely undeserved. In fact, Lowe Hauptman is advocating in court that EP-238 be revoked in its entirety.
Red's Continued Demise:
UDC's red emitter sales continue to show year-over-year and quarter-over-quarter declines, even though red emitter material is UDC's most established product in a market that UDC has repeatedly told investors that it "owns." Despite the year-over-year decline in red emitter sales in dollars, UDC stated that it actually sold more red material in grams than in the prior year quarter, according to UDC's 10-Q. This means that the unit price discounts to Samsung are so severe that UDC is still reporting less revenue, despite extraordinary increases in OLED shipment volumes.
Growth Solely from Low-Margin, Low Value Host Material:
UDC's growth in the third quarter is almost exclusively attributable to sales of low-margin host materials, which UDC admits represents a competitive business where UDC lacks significant intellectual property. UDC's gross margin continues to move lower. In fact, its materials gross margin is now at 67%, lower than management's outlook only two quarters ago, when management stated that it would remain "in the 70% to 75% range."
Negative Sales Forecast:
UDC's new guidance for 2013 implies that UDC will only generate $25 million in revenue in the fourth quarter, net of the semi-annual Samsung licensing fee. This means that UDC will be experiencing another contraction in material sales quarter-over-quarter, despite the double digit growth expected in Q4 OLED mobile display shipments.
SEC Accounting Controversy:
UDC's conference call shed no light on the SEC investigation into UDC's accounting, especially the accounting of revenue from Samsung's license fee payments. UDC has never given investors a simple explanation of its irregular accounting of the Samsung payments. UDC's explanation to the SEC refers to nonsensical "ratable recognition" and "proportional performance" to explain why Samsung license revenue is only recognized when the fees "become due and payable." This was the subject of a previous asensio.com report. We believe that the real motivation behind UDC's irregular accounting policy has to do with Samsung's termination rights, which were not part of the redacted agreement filed with the SEC.
Patent Litigation Claims:
In UDC's Q3 earnings conference call, management did not mention the fact that its most central patent claims will be the subject of a hearing in a matter of days (Nov. 21 - 22) that might result in a sudden death situation for UDC's business and UDC's Samsung contract. UDC also did not disclose that the Nov. 21st hearing will be final. UDC still has not disclosed that the judicial Board of Appeal that will be making a final decision after the November 21st hearing has already made formal negative findings in an order about UDC's case.
Despite these material omissions, UDC went out of the way to publicize a less significant patent being "upheld," even though no written decision has been released yet, even though UDC admits that the patent's claims were 'narrowed', and even though it was a preliminary decision, not a final decision rendered by the Boards of Appeal.
UDC's Four Supposed Inventions:
During the Q3 earnings call, UDC management referred to "four early fundamental phosphorescent OLED inventions." The expert opinion that was cited in our earlier reports and that was filed in UDC's central patent opposition case shows that UDC made no invention. UDC scientists conducted simple optimization experiments using others' inventions and then claimed credit for all "phosphorescent OLED." asensio.com published an expert-informed review of the experiments that UDC claimed to be the basis for its "inventions." Patent authorities have been chipping away at the ludicrous scope of UDC's claims, including in EP-238 and EP-870. Based on our expert consultations, we believe UDC's "invention" claims will face a devastating blow at the hearing that starts Nov. 21st.