The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the section entitled "Selected Financial Data" in this report and our Consolidated Financial Statements and related notes to this report. This discussion and analysis contains forward-looking statements based on our current expectations, assumptions, estimates and projections. These forward-looking statements involve risks and uncertainties. Our actual results could differ materially from those indicated in these forward-looking statements as a result of certain factors, as more fully discussed in Item 1A of this report, entitled "Risk Factors."
OVERVIEW
We are a leader in the research, development and commercialization of organic light emitting diode (OLED), technologies and materials for use in display applications, such as mobile phones, televisions, wearables, tablets, portable media devices, notebook computers, personal computers, and automotive applications, as well as specialty and general lighting products. Since 1994, we have been 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; • technology development and support, including third-party collaboration efforts and providing support to third parties for commercialization of their OLED products; and • contract research services in the areas of chemical materials synthesis research, development and commercialization for non-OLED applications. 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 generally 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, we entered into a commercial license agreement withSamsung Display Co., Ltd. (SDC). This agreement, which covers the manufacture and sale of specified OLED display materials, was effective as ofJanuary 1, 2018 and lasts through the end of 2022 with an additional two-year extension option. Under this agreement, we are 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 our intellectual property assets for a limited period of time that is less than the estimated life of the assets. At the same time that we entered into the current patent license agreement with SDC, we also entered into a material purchase agreement with SDC. Under the material purchase agreement, SDC agrees to purchase from us 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 our ability to meet these requirements over the term of the supplemental agreement. In 2015, we entered into an OLED patent license agreement and an OLED commercial supply agreement with LG Display Co., Ltd. (LG Display), which were effective as ofJanuary 1, 2015 . The 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 our 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 life of the agreements as well as minimum royalty revenue to be generated under the patent license agreement. We generate 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. 31 -------------------------------------------------------------------------------- In 2016, we entered into long-term, multi-year OLED patent license and material purchase agreements withTianma Micro-electronics Co., Ltd. (Tianma). Under the license agreement, we have granted Tianma non-exclusive license rights under various patents owned or controlled by us to manufacture and sell OLED display products. The license agreement calls for license fees and running royalties on Tianma's sales of licensed products. Additionally, we supply phosphorescent OLED materials to Tianma for use in its licensed products. In 2017, we entered into long-term, multi-year agreements with BOE Technology Group Co., Ltd. (BOE). Under these agreements, we have granted BOE non-exclusive license rights under various patents owned or controlled by us to manufacture and sell OLED display products. We also supply phosphorescent OLED materials to BOE for use in its licensed products. In 2018, we entered into long-term, multi-year OLED patent license and material purchase agreements with Visionox Technology, Inc. (Visionox). Under the license agreement, we have granted Visionox non-exclusive license rights under various patents owned or controlled by us to manufacture and sell OLED display products. The license agreement calls for license fees and running royalties on Visionox's sales of licensed products. Additionally, we supply phosphorescent OLED materials to Visionox for use in its licensed products. In 2019, we entered into an evaluation and commercial supply relationship withWuhan China Star Optoelectronics Semiconductor Display Technology Co., Ltd. (CSOT). We have been collaborating with CSOT in the area of OLED display product design and manufacture and expect to continue to do so. In 2016, we acquiredAdesis, Inc. (Adesis) with operations inNew Castle, Delaware . Adesis is a contract research organization (CRO) that provides support services to the OLED, pharma, biotech, catalysis and other industries. As ofDecember 31, 2019 , Adesis employed a team of 94 research scientists, chemists, engineers and laboratory technicians. Prior to our acquisition of Adesis 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 by providing contract research services for non-OLED applications to those third-party customers. Contract research services revenue is earned by providing chemical materials synthesis research, development and commercialization for non-OLED applications on a contractual basis for those third-party customers. We also generate technology development and support revenue earned from development and technology evaluation agreements and commercialization assistance fees, along with, to a minimal extent, government contracts. Relating to our government contracts, we may receive reimbursements by government entities for all or a portion of the research and development costs we incur. Revenues are recognized as services are performed, proportionally as research and development costs are incurred, or as defined milestones are achieved.
We anticipate fluctuations in our annual and quarterly results of operations due to uncertainty regarding, among other factors:
• the timing, cost and volume of sales of our OLED materials;
• the timing of our receipt of license fees and royalties, as well as
fees for future technology development and evaluation;
• the timing and magnitude of expenditures we may incur in connection
with our ongoing research and development and patent-related activities; and
• the timing and financial consequences of our formation of new business
relationships and alliances.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations is based on our Consolidated Financial Statements, which have been prepared in accordance withU.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect our reported assets and liabilities, revenues and expenses, and other financial information. Actual results may differ significantly from our estimates under other assumptions and conditions. We believe that our accounting policies related to revenue recognition and deferred revenue, inventories and income taxes, as described below, are our "critical accounting policies" as contemplated by theSEC . These policies, which have been reviewed with our Audit Committee, are discussed in greater detail below. 32
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Revenue Recognition and Deferred Revenue
Material sales relate to the sale of our OLED materials for incorporation into our customers' commercial OLED products or for their OLED development and evaluation activities. Revenue associated with material sales is generally 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. Revenue may be recognized after control of the material passes in the event the transaction price includes variable consideration. For example, a customer may be provided an extended opportunity to stock materials prior to use in mass production and given a general right of return not conditioned on breaches of warranties associated with the specific product. In such circumstances, revenue will be recognized at the earlier of the expiration of the customer's general right of return or once it becomes unlikely that the customer will exercise its right of return. The rights and benefits to our OLED technologies are conveyed to the customer through technology license agreements and material supply agreements. These agreements are combined and the licenses and materials sold under these combined agreements are not distinct from each other for financial reporting purposes and as such, are accounted for as a single performance obligation. Accordingly, total contract consideration is estimated and recognized over the contract term based on material units sold during the period at their estimated per unit fee. Total contract consideration includes fixed amounts designated in contracts with customers as license fees as well as estimates of material fees and royalties to be earned. Various estimates are relied upon to recognize revenue. We estimate total material units to be purchased by our customers over the contract term based on historical trends, industry estimates and our forecast process and related amounts to be charged. Additionally, our management estimates the total sales-based royalties based on the estimated net sales revenue of our customers over the contract term. Accounting for Income Taxes
We are subject to income taxes in both the
In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of our deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent on our ability to generate future taxable income to obtain benefit from the reversal of temporary differences, net operating loss carryforwards and tax credits. As part of our assessment we consider the scheduled reversal of deferred tax assets and liabilities, projected future taxable income, and tax planning strategies. During the year endedDecember 31, 2019 , based on previous earnings history, a current evaluation of expected future taxable income and other evidence, we determined to retain the valuation allowance that relates toNew Jersey research and development credits. Actual results could differ from our assessments if adequate taxable income is generated in future periods. To the extent we establish a new valuation allowance or change a previously established valuation allowance in a future period, income tax expense will be impacted. 33
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RESULTS OF OPERATIONS
For a discussion of our results of operations comparison for 2018 and 2017,
refer to our Annual Report on Form 10-K for the fiscal year ended
Comparison of the Years Ended
Year Ended December 31, (Decrease) 2019 2018 Increase REVENUE$ 405,177 $ 247,414 $ 157,763 COST OF SALES 75,374 53,541 21,833 Gross margin 329,803 193,873 135,930 OPERATING EXPENSES: Research and development 71,276 53,717 17,559 Selling, general and administrative 59,613 46,999 12,614 Amortization of acquired technology and other intangible assets 21,962 21,962 - Patent costs 6,833 7,464 (631 ) Royalty and license expense 11,776 6,996 4,780 Total operating expenses 171,460 137,138 34,322 OPERATING INCOME 158,343 56,735 101,608 Interest income, net 10,795 7,659 3,136 Other income (expense), net 767 (83 ) 850 Interest and other income, net 11,562 7,576 3,986 INCOME BEFORE INCOME TAXES 169,905 64,311 105,594 INCOME TAX EXPENSE (31,601 ) (5,471 ) (26,130 ) NET INCOME$ 138,304 $ 58,840 $ 79,464 Revenue During the year endedDecember 31, 2019 , we recognized revenue of$405.2 million , an increase of$157.8 million from$247.4 million in the year endedDecember 31, 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 year endedDecember 31, 2019 as compared to 95% for the year endedDecember 31, 2018 . The remaining portion of our revenue was derived from contract research services. Revenue from contract research services consists of revenue earned by our subsidiary, Adesis, which provides support services to the pharma, biotech, catalysis and other industries on a contractual basis for those third-party customers.
Cost of Sales
Cost of sales for the year endedDecember 31, 2019 increased by$21.8 million as compared to the year endedDecember 31, 2018 , primarily due to an increase in the level of material sales. Included in the cost of sales for the years endedDecember 31, 2019 and 2018, was an increase in inventory reserve of$5.9 million and$3.6 million , respectively, due to excess inventory levels in certain products. As a result of the increase in material sales, gross margin for the year endedDecember 31, 2019 , increased by$135.9 million as compared to the year endedDecember 31, 2018 , with gross margin as a percentage of revenue increasing to 81% from 78%.
Research and development
Research and development expenses increased to$71.3 million for the year endedDecember 31, 2019 , as compared to$53.7 million for the year endedDecember 31, 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$59.6 million for the year endedDecember 31, 2019 , as compared to$47.0 million for the year endedDecember 31, 2018 . The increase in selling, general and administrative expenses was primarily due to higher employee-related compensation expenses. 34
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Amortization of acquired technology and other intangible assets
Amortization of acquired technology and other intangible assets was
Patent costs
Patent costs decreased to$6.8 million for the year endedDecember 31, 2019 , as compared to$7.5 million for the year endedDecember 31, 2018 . The decrease was primarily due to lower outside counsel fees partially offset by higher talent related maintenance costs and higher internal patent prosecution related costs.
Royalty and license expense
Royalty and license expense increased to$11.8 million for the year endedDecember 31, 2019 , as compared to$7.0 million for the year endedDecember 31, 2018 . The increase was due to increased royalties incurred under our amended license agreement withPrinceton ,USC , andMichigan , resulting from an increase in qualifying material sales. See Note 10 in Notes to Consolidated Financial Statements for further discussion.
Interest and other income, net
Interest income, net was$10.8 million for the year endedDecember 31, 2019 , as compared to$7.7 million for the year endedDecember 31, 2018 . The increase in interest income, net was primarily due to the increase in available-for-sale investments held during the year endedDecember 31, 2019 over amounts held during 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$767,000 for the year endedDecember 31, 2019 , as compared to other expense, net of$83,000 for the year endedDecember 31, 2018 .
Income tax expense
We are subject to income taxes in boththe United States and foreign jurisdictions. The effective income tax rate was an expense of 18.6% and 8.5% for the years endedDecember 31, 2019 and 2018, respectively, and we recorded income tax expense of$31.6 million and$5.5 million , respectively, for those periods. The recorded amounts include deductions for employee share awards in excess of compensation costs ("windfalls") under Accounting Standards Update (ASU) No. 2016-09. For the year endedDecember 31, 2019 , without the$3.0 million benefit of ASU No. 2016-09, the effective income tax rate and income tax expense would have been 20.4% and$34.6 million , respectively, and for the year endedDecember 31, 2018 , without the$1.1 million benefit of ASU No. 2016-09, the effective income tax rate and income tax expense would have been 10.2% and$6.6 million , respectively. The Company incurred Korean withholding tax of$14.9 million for both of the years endedDecember 31, 2019 and 2018, which is currently being appealed based on the interpretation of the Korean - U. S. tax treaty and recentKorean Supreme Court decisions.
Liquidity and Capital Resources
Our principal sources of liquidity are our cash and cash equivalents and our short-term investments. As ofDecember 31, 2019 , we had cash and cash equivalents of$131.6 million and short-term investments of$514.5 million , for a total of$646.1 million . This compares to cash and cash equivalents of$211.0 million and short-term investments of$304.3 million , for a total of$515.3 million , as ofDecember 31, 2018 . Cash provided by operating activities for the year endedDecember 31, 2019 was$193.9 million resulting from$138.3 million of net income and$139.5 million due to changes in our operating assets and liabilities, partially offset by a$83.9 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$157.3 million , an increase in accounts payable and accrued expenses of$15.5 million , an increase in other liabilities of$12.4 million and a decrease in inventory of$109,000 , partially offset by an increase in other assets of$28.5 million and an increase in accounts receivable of$17.3 million . Cash provided by operating activities for the year endedDecember 31, 2018 was$121.8 million resulting from$58.8 million of net income and$95.3 million due to changes in our operating assets and liabilities, partially offset by a$32.3 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$130.6 million , an increase in other liabilities of$29.7 million , a decrease in deferred income taxes of$20.7 million , a decrease in accounts receivable of$9.2 million and an increase in 35 -------------------------------------------------------------------------------- accounts payable and accrued expenses of$1.6 million , partially offset by an increase in other assets of$59.1 million and an increase in inventory of$37.4 million . Cash used in investing activities was$238.7 million for the year endedDecember 31, 2019 , as compared to$21.0 million for the year endedDecember 31, 2018 . The increase was due to the timing of maturities and purchases of investments resulting in net purchases of$208.3 million for the year endedDecember 31, 2019 , as compared to net sales of$4.4 million for the year endedDecember 31, 2018 , and an increase in purchases of intangibles and property, plant and equipment of$5.0 million for the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 . The increase in property, plant and equipment purchases during 2019 was primarily due to the purchase of additional property inEwing, New Jersey as part of our plan to expand operations. Cash used in financing activities was$34.6 million for the year endedDecember 31, 2019 , as compared to$22.6 million for the year endedDecember 31, 2018 . The increase was due to an increase in the cash payment of dividends in the current year of$7.5 million , an increase in the payment of withholding taxes related to stock-based compensation to employees of$4.4 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$91,000 . Working capital was$630.9 million as ofDecember 31, 2019 , compared to$501.7 million as ofDecember 31, 2018 . The increase was primarily due to an increase in short-term investments, accounts receivable and other current assets, partially offset by a decrease in cash and cash equivalents and an increase in deferred revenue and accrued expenses. We anticipate, based on our internal forecasts and assumptions relating to our operations (including, among others, assumptions regarding our working capital requirements, the progress of our research and development efforts, the availability of sources of funding for our research and development work, and the timing and costs associated with the preparation, filing, prosecution, maintenance, defense and enforcement of our patents and patent applications), that we have sufficient cash, cash equivalents and short-term investments to meet our obligations for at least the next twelve months. We believe that potential additional financing sources for us include long-term and short-term borrowings, public and private sales of our equity and debt securities and the receipt of cash upon the exercise of outstanding stock options. It should be noted, however, that additional funding may be required in the future for research, development and commercialization of our OLED technologies and materials, to obtain, maintain and enforce patents respecting these technologies and materials, and for working capital and other purposes, the timing and amount of which are difficult to ascertain. There can be no assurance that additional funds will be available to us when needed, on commercially reasonable terms or at all, particularly in the current economic environment. Contractual Obligations As ofDecember 31, 2019 , we had the following contractual commitments (in thousands): Payments Due by Period Less than More than 5
Contractual Obligations Total 1 year 1-3 years 3-5 years years Estimated retirement plan benefit payments$ 71,501 $ -$ 8,065 $ 9,236 $ 54,200 Lease obligations 10,347 1,958 2,487 2,077 3,825 Purchasing obligations 22,035 22,035 - - - Research related obligations 5,628 5,253 375 - - Minimum royalty obligation (1) 500 100 200 200$100 /year Total (2)$ 110,011 $ 29,346 $ 11,127 $ 11,513 $ 58,025
(1) Under the 1997 Amended License Agreement, we are obligated to pay
minimum royalties of
effect. The agreement has no scheduled expiration date.
(2) See Note 16 to the Consolidated Financial Statements for discussion of
obligations upon termination of employment of executive officers as a result
of a change in our control.
Off-Balance Sheet Arrangements
As ofDecember 31, 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. 36
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Recently Issued Accounting Pronouncements
Recently issued accounting pronouncements are addressed in Note 2 in the Notes to Consolidated Financial Statements.
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