UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

 

Commission file number 1-12031

 

UNIVERSAL DISPLAY CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(609) 671-0980

 

Securities registered pursuant to Section 12(b) of the Act:

None

 

Securities registered pursuant to Section 12(g) of the Act:

 

Common Stock (par value $0.01 per share)
(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o     Accelerated filer þ     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant computed by reference to the closing sale price of the registrant’s common stock on the NASDAQ Global Market as of June 30, 2006, was $344,611,872. Solely for purposes of this calculation, all executive officers and directors of the registrant and all beneficial owners of more than 10% of the registrant’s common stock (and their affiliates) were considered affiliates.

 

As of March 8, 2007, the registrant had outstanding 31,535,616 shares of common stock.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s Proxy Statement for the 2007 Annual Meeting of Shareholders, which is to be filed with the Securities and Exchange Commission no later than April 29, 2007, are incorporated by reference into Part III of this report.

 

TABLE OF CONTENTS

 

CAUTIONARY STATEMENT
CONCERNING FORWARD-LOOKING STATEMENTS

 

This report and the documents incorporated by reference in this report contain some “forward-looking statements.” Forward-looking statements concern possible or assumed future events, results and business outcomes. These statements often include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate,” “seek,” “will,” “may” or similar expressions. These statements are based on assumptions that we have made in light of our experience in the industry, as well as our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances.

 

As you read and consider this report, you should not place undue reliance on any forward-looking statements. You should understand that these statements involve substantial risk and uncertainty and are not guarantees of future performance or results. They depend on many factors that are discussed further under Item 1A below (Risk Factors), including:

 

 

Changes or developments in any of these areas could affect our financial results or results of operations, and could cause actual results to differ materially from those contemplated by any forward-looking statements.

 

All forward looking statements speak only as of the date of this report or the documents incorporated by reference, as the case may be. We do not undertake any duty to update any of these forward-looking statements to reflect events or circumstances after the date of this report, or to reflect the occurrence of unanticipated events.

 

Our Company

 

We are a leader in the research, development and commercialization of organic light emitting diode, or OLED, technologies and materials. OLEDs are thin, lightweight and power-efficient solid-state devices, highly suitable for use in full-color displays and as lighting products. We believe OLED displays will capture a share of the growing flat panel display market because they offer potential advantages over competing display technologies with respect to brightness, power efficiency, viewing angle, video response time and manufacturing cost. We also believe that OLED lighting products have the potential to replace many existing light sources in the future because of their high efficiency, excellent color rendering index, low heat generation and novel form factors. Our technology leadership and intellectual property position should enable us to share in the revenues from OLED displays and lighting products as they enter mainstream consumer markets.

 

Our primary business strategy is to further develop and license our proprietary OLED technologies to manufacturers of products for display applications, such as cell phones, MP3 players, laptop computers and televisions, and specialty and general lighting products. In support of this objective, we also develop new OLED materials and sell those materials to product manufacturers. Through our internal research and development efforts and our relationships with world-class partners such as Princeton University, the University of Southern California, the University of Michigan, Motorola, Inc. and PPG Industries, Inc., we have established a significant portfolio of proprietary OLED technologies and materials. We currently own, exclusively license or have the sole right to sublicense more than 750 patents issued and pending worldwide.

 

In 2006, three manufacturers purchased our proprietary OLED materials for use in commercial OLED display products: Samsung SDI Co., Ltd. of South Korea, AU Optronics Corporation of Taiwan and Tohoku Pioneer Corporation of Japan. We also have entered into a patent license agreement with Samsung SDI, under which we expect to start receiving royalties in 2007 based on Samsung SDI’s commencement of sales of active matrix OLED display products. In addition, we are working with many other companies who are evaluating our OLED technologies and materials for possible use in commercial OLED display and lighting products, including Seiko Epson Corporation, Konica Minolta Technology Center, Inc. and Sony Corporation.

 

Market Overview

 

The Flat Panel Display Market

 

Flat panel displays are essential for a wide variety of portable consumer electronics products, such as cell phones, MP3 players, digital cameras and laptop computers. Due to their narrow profile and light weight, flat panel displays are also becoming the display of choice for larger product applications, such as desktop computer monitors and televisions.

 

Liquid crystal displays, or LCDs, currently dominate the flat panel display market. However, we believe that OLED displays are an attractive alternative to LCDs because they offer a number of potential advantages, including:

 

 

Based on these characteristics, product manufacturers are starting to adopt small-area OLED displays for use in portable electronic devices, such as cell phones and MP3 players. These manufacturers are also working to

develop OLED displays for use in larger applications, such as computer monitors and televisions. We believe that if these efforts are successful, they could result in sizeable markets for OLED displays.

 

In addition, due to the inherent transparency of organic materials and through the use of transparent electrode technology, OLEDs eventually may enable the production of transparent displays for use in products such as automotive windshields and windows with embedded displays. Organic materials also make technically possible the development of flexible displays for use in an entirely new set of product applications, such as display devices that can be rolled up for storage.

 

The Solid-State Lighting Market

 

Traditional incandescent light bulbs are extremely inefficient because they convert only about 5% of the energy they consume into visible light, with the rest emerging as heat. Fluorescent lamps use excited gases, or plasmas, to achieve a higher energy conversion efficiency of about 20%. However, the color rendering index, or CRI, of most fluorescent lamps — how good their color is compared to an ideal light source — is inferior to that of an incandescent bulb.

 

Solid-state lighting relies on the direct conversion of electricity to visible white light using semiconductor materials. By avoiding the heat and plasma-producing processes of incandescent bulbs and fluorescent lamps, solid-state lighting products can have substantially higher energy conversion efficiencies, which in theory could approach 100%.

 

There are currently two basic types of solid-state lighting devices: inorganic light emitting diodes, or LEDs, and OLEDs. Current LEDs are very small in size (about one square millimeter) and are extremely bright. Having been developed about 25 years before OLEDs, they are already employed in single-color specialty lighting products, such as traffic lights, billboards, replacements for neon lighting and as border or accent lighting. However, their intense brightness makes them less desirable for general illumination and diffuse lighting applications.

 

OLEDs, on the other hand, are larger in size and far more moderate in brightness than LEDs. This allows them to be viewed directly, without using diffusers that are required to temper the intense brightness of LEDs. In principle, OLEDs can also be manufactured inexpensively, and may be deposited on any suitable flat surface including glass, plastic or metal foil. Given these characteristics, product manufacturers are working to develop OLEDs for diffuse lighting applications and eventually general illumination. If these efforts are successful, we believe that OLED lighting products could begin to be used for applications currently addressed by incandescent bulbs and fluorescent lamps.

 

Our Competitive Strengths

 

We believe our position as one of the leading technology developers in the OLED industry is the direct result of our technological innovation. We have built an extensive intellectual property portfolio around our OLED technologies and materials, and are working diligently to enable our manufacturing partners to adopt our OLED technologies and materials for commercial usage. Our key competitive strengths include:

 

Technology Leadership.  We are a recognized technology leader in the OLED industry. We and our research partners pioneered the development of our PHOLED^tm phosphorescent OLED technology, which can be used to produce OLEDs that are up to four times as efficient as traditional fluorescent OLEDs and significantly more efficient than current backlit LCDs. We believe that our PHOLED technology is well-suited for industry usage in the commercial production of OLED displays and lighting products. Through our relationships with companies such as PPG Industries and our academic partners, we have also developed other important OLED technologies, as well as novel OLED materials that we believe will facilitate the adoption of our various OLED technologies by product manufacturers.

 

Relationships with Leading Product Manufacturers.  We have established relationships with well-known manufacturers that are using, or are evaluating, our OLED technologies and materials for use in commercial products. In 2006, Samsung SDI, AU Optronics and Tohoku Pioneer purchased our proprietary OLED materials for use in commercial OLED display products, and we licensed one of our ink jet printing patents and certain related patent filings to Seiko Epson. In 2005, we entered into a license agreement with Samsung SDI for its manufacture of

active matrix OLED display products, and in 2002 we entered into a cross-license agreement with DuPont Displays, Inc. for its manufacture of solution-processed OLED display products. We also continue to work with many product manufacturers who are evaluating our OLED technologies and materials for use in commercial OLED displays and lighting products, including Samsung SDI, Seiko Epson, Konica Minolta and Sony.

 

Broad Portfolio of Intellectual Property.  We believe that our extensive portfolio of patents, trade secrets and know-how provides us with a competitive advantage in the OLED industry. Through our internal development efforts and our relationships with Princeton University, the University of Southern California, the University of Michigan and Motorola, we own, exclusively license or have the sole right to sublicense more than 750 patents issued and pending worldwide related to our PHOLED and other OLED technologies and materials. We also continue to accumulate valuable trade secret information and technical know-how relating to our OLED technologies and materials.

 

Business Model Focused on Technology Licensing.  We are focused on licensing our OLED technologies to product manufacturers on a non-exclusive basis. Our current business model does not involve the manufacture or sale of OLED products. PPG Industries currently manufactures our proprietary OLED materials for us, which we then qualify and resell to OLED manufacturers. Our business model involves the receipt of license fees and royalties from product manufacturers based on their sales of licensed OLED products, and/or revenues based on our sales of OLED materials to them for use in their OLED products. We believe this business model allows us to concentrate on our core strengths of technology development and innovation, while at the same time providing significant operating leverage. We also believe that this approach may reduce potential competitive conflicts between us and our customers.

 

Established U.S. Government Contracts to Fund Research and Development.  In 2006, we started or continued working under approximately 15 research and development contracts with U.S. government agencies, such as the U.S. Department of the Army, the U.S. Department of the Navy and the U.S. Department of Energy. Under these contracts, the U.S. government funds a portion of our efforts to develop next-generation OLED technologies for applications such as flexible displays and solid-state lighting. This enables us to supplement our internal research and development budget with additional funding.

 

Experienced Management and Scientific Advisory Team.  Our management team has significant experience in developing business models focused on licensing disruptive technologies in high growth industries, which serves to differentiate us from our competitors. In addition, our management team has assembled a Scientific Advisory Board that includes some of the leading researchers in the OLED industry, such as Professor Stephen R. Forrest of the University of Michigan (formerly of Princeton University) and Professor Mark E. Thompson of the University of Southern California.

 

Our Business Strategy

 

Our current business strategy is to both promote and continue to expand our portfolio of OLED technologies and materials for widespread use in OLED displays and lighting products. We presently are focused on the following steps to implement our business strategy:

 

Target Leading Product Manufacturers.  We are targeting leading manufacturers of flat panel displays and lighting products as potential commercial licensees of our OLED technologies and purchasers of our OLED materials. For example, in April 2005 we entered into a patent license agreement with Samsung SDI for its manufacture and sale of active-matrix OLED display products. In 2006, we also sold our proprietary phosphorescent OLED materials to Samsung SDI, AU Optronics and Tohoku Pioneer for use in commercial OLED display products. We also provide technical assistance and support to several manufacturers of displays and lighting products who are evaluating our OLED technologies and materials, or utilizing them in product development and/or for pre-commercial product manufacturing. We concentrate on working closely with these manufacturers because we believe that the successful incorporation of our technologies and materials into commercial products is critical to their widespread adoption.

 

Enhance Our Existing Portfolio of PHOLED Technologies and Materials.  We believe that a strong portfolio of proprietary OLED technologies and materials is critical to our success. Consequently, we are continually seeking

to expand this portfolio through our internal development efforts, our collaborative relationships with academic and other research partners, and other strategic opportunities. One of our primary goals is to develop new and improved PHOLED technologies and materials with increased efficiencies, enhanced color gamut and extended lifetimes, which are compatible with different manufacturing methods, so that they can be used by various manufacturers in a broad array of OLED products.

 

Develop Next-Generation Organic Technologies.  We continue to conduct research and development activities relating to next-generation OLED technologies. Our current research and development initiatives involve flexible OLED displays, transparent or top-emitting OLED displays and OLEDs for solid-state lighting. We also are funding research by our academic partners on the use of organic thin-film technology in applications such as lasers, photodetectors and other related devices. Our focus on next-generation technologies is designed to enable us to continue our position as a leading provider of OLED and other organic electronics technologies and materials as new markets emerge.

 

Business and Geographic Markets

 

We derive revenue from three business areas:

 

 

Most manufacturers of flat panel displays and lighting products who are or might potentially be interested in our OLED technologies and materials are currently located in foreign countries, particularly the Asia-Pacific region. Consequently, we receive a substantial portion of our revenues from external customers that are domiciled outside of the United States, and our business is heavily dependent on our relationships with these customers. In particular, two customers located in the Asia-Pacific region, Samsung SDI and AU Optronics, accounted for 14% and 24%, respectively, of our consolidated revenues for 2006.

 

For more information on our revenues, costs and expenses associated with the various lines of our business, as well as a breakdown of revenues from domestic and foreign sources, please see our audited consolidated financial statements and the notes thereto, as well as “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this report and incorporated herein by reference.

 

Our Phosphorescent OLED Technologies

 

Phosphorescent OLEDs, or PHOLEDs, our key proprietary technology, utilize novel materials and device structures that allow OLEDs to emit light through a process known as phosphorescence. Conversely, traditional fluorescent OLEDs emit light through an inherently less efficient process. Theory and experiment show that PHOLEDs exhibit device efficiencies up to four times higher than those exhibited by fluorescent OLEDs. Phosphorescence substantially reduces the power requirements of an OLED and is potentially useful for hand-held devices, such as mobile phones, where battery power is often a limiting factor. Phosphorescence also may be important for large-area displays such as televisions, where higher device efficiency and lower heat generation may enable longer product lifetimes and increased energy efficiency.

 

We believe that we have a strong intellectual property portfolio that covers our existing PHOLED technology and materials. We also conduct extensive work to develop new and improved PHOLED technologies and materials, and to enhance our intellectual property position. In 2006, we announced several advances in the development of our proprietary blue PHOLED materials and device architectures. We also established collaborative relationships with Idemitsu Kosan Co., Ltd. and Nippon Steel Chemical Company to develop and evaluate new PHOLED materials for use in vacuum thermal evaporation, or VTE, manufacturing systems. In addition, we continued to work closely with our customers in their evaluation and qualification of our proprietary PHOLED materials for potential use in the production of commercial OLED displays and lighting products.

 

Our Additional Proprietary OLED Technologies

 

Our research, development and commercialization efforts also encompass a number of other OLED device and manufacturing technologies, including the following:

 

TOLED^tm Transparent OLEDs.  We have developed a technology for the fabrication of OLEDs that have transparent cathodes. Conventional OLEDs use a reflective metal cathode and a transparent anode. In contrast, TOLEDs use a transparent cathode and either a transparent, or reflective or opaque metal anode. TOLEDs utilizing transparent cathodes and reflective metal anodes are known as “top-emission” OLEDs. In a “top-emission” active-matrix OLED, light is emitted without having to travel through much of the device electronics where a significant portion of the usable light is lost. This results in OLED displays having image qualities and lifetimes superior to those of conventional active-matrix OLEDs. TOLEDs utilizing transparent cathodes and transparent anodes may also be useful in novel flat panel display applications requiring semi- transparency or transparency, such as graphical displays in automotive windshields.

 

FOLED^tm Flexible OLEDs.  We are working on a number of technologies required for the fabrication of OLEDs on flexible substrates. Most OLED and other flat panel displays are built on rigid substrates such as glass. In contrast, FOLEDs are OLEDs built on non-rigid substrates such as plastic or metal foil. FOLEDs are intended to be either conformable to specific shapes or repeatedly bent or flexed. Eventually, FOLEDs may be capable of being rolled into a cylinder, similar to a window shade. These features create the possibility of new flat panel display product applications that do not exist today, such as a portable, roll-up Internet connectivity and communications device. Manufacturers also may be able to produce FOLEDs using more efficient continuous, or roll-to-roll, processing methods. We currently are conducting research and development on FOLED technologies internally, under several of our U.S. government programs and in connection with the government-sponsored Flexible Display Center at Arizona State University.

 

OVPD^tm Organic Vapor Phase Deposition.  The standard approach for manufacturing a small molecule OLED, including a PHOLED, is based on a VTE process. With a VTE process, the thin layers of organic material in an OLED are deposited in a high-vacuum environment. An alternate approach for manufacturing a small molecule OLED is based on OVPD. In contrast to the VTE process, the OVPD process utilizes a carrier gas stream in a hot walled reactor in a low pressure environment to deposit the layers of organic material in an OLED. The OVPD process may offer advantages over the VTE process through more efficient materials utilization and enhanced deposition control. Over the past several years, we have been working with Aixtron AG, a leading manufacturer of metal-organic chemical vapor deposition equipment, to develop and qualify equipment for the fabrication of OLED displays utilizing the OVPD process.

 

P²OLED^tm Printable Phosphorescent OLEDs.  OLEDs can be manufactured using other processes as well. Another method involves preparing solutions of the various organic materials in an OLED that can be solution-processed by techniques such as spin coating or inkjet printing onto the substrate. Solution-processing methods, and inkjet printing in particular, have the potential to be lower cost approaches to OLED manufacturing and scalable to large area displays. Others have demonstrated that solution- processing methods can be used to produce OLEDs containing polymer-based fluorescent emission organic materials, and we are developing printable P²OLEDs to demonstrate that these methods can be used with our small molecule-based phosphorescent emission technologies. We are currently working on P²OLEDs under a Joint Development Agreement with Seiko Epson, and we are collaborating with Mitsubishi Chemical Corporation to develop and evaluate novel P²OLED materials. In December 2005, we completed work under a Joint Development Agreement with DuPont Displays, Inc. for the development of novel P²OLED materials and device structures.

 

Our Strategic Relationships with Product Manufacturers

 

We have established evaluation, technology development, licensing and material supply relationships with numerous manufacturers of displays and lighting products. As of December 31, 2006, we had entered into 29 such relationships, three of which were newly established in 2006. These relationships generally are directed towards tailoring our proprietary OLED technologies and materials for use by each individual manufacturer. Our ultimate objective is to license our OLED technologies and sell our OLED materials to these manufacturers for their

commercial production of OLED products. Our key relationships with product manufacturers in 2006 included the following:

 

Samsung SDI.  In April 2005, we entered into an OLED Patent License Agreement with Samsung SDI. Under this agreement, we granted Samsung SDI license rights to make and sell active-matrix OLED displays. In the fourth quarter of 2006, we began supplying one of our proprietary PHOLED materials to Samsung SDI for use in the manufacture of these OLED displays. We also continue to supply other of our proprietary PHOLED materials to Samsung SDI for evaluation and development activities under a separate agreement that has been in place since July 2001.

 

Sony.  We have been supporting Sony Corporation in its development of active-matrix OLED display products under various agreements since February 2001. We are currently operating under an evaluation agreement with Sony that has been in place since February 2005. That agreement enables us to sell our proprietary PHOLED materials to Sony for evaluation.

 

Seiko Epson.  In December 2004, we entered into a joint development agreement with Seiko Epson Corporation. Under this agreement, we are conducting development activities with Seiko Epson relating to the application of our proprietary PHOLED technology and materials to ink-jet printing processes used by Seiko Epson. We also supply our proprietary PHOLED materials to Seiko Epson for evaluation and for use under this development program, and in July 2006 we licensed one of our ink-jet printing patents and certain related patent filings to Seiko Epson.

 

Tohoku Pioneer.  In August 2003, we began supplying our proprietary red PHOLED material to Tohoku Pioneer Corporation, a subsidiary of Pioneer Corporation, for the commercial production of a passive-matrix OLED display product. Tohoku Pioneer continued purchasing this material from us in 2006.

 

Konica Minolta.  In September 2005, we entered into an agreement with Konica Minolta for the joint development of high-efficiency white OLEDs for application as backlights. In 2006, the collaboration became more focused on incorporating our proprietary PHOLED technology into Konica Minolta’s white OLED devices. Konica Minolta continues to purchase PHOLED materials from us for evaluation under the agreement.

 

AU Optronics.  In February 2006, we entered into a Commercial Supply Agreement with AU Optronics Corporation. Under this agreement, we supplied AU Optronics with one of our proprietary PHOLED materials for use in a commercial active-matrix OLED display product. That activity continued until the third quarter of 2006 when AU Optronics discontinued its display product.

 

DuPont Displays.  In December 2005, we completed work under a Joint Development Agreement with DuPont Displays, Inc. for the development of novel phosphorescent materials and device structures for solution-processed OLEDs. In December 2002, we entered into a Cross-License Agreement with DuPont Displays for its manufacture of solution-processed OLED display products. As of December 31, 2006, we had not received any royalties from DuPont under that agreement.

 

Our OLED Materials Supply Business

 

In support of our primary objective of licensing our OLED technologies, we supply our proprietary OLED materials to display manufacturers and others. We device-qualify our materials before shipment in order to ensure the materials meet required specifications. We believe that our inventory-carrying practices, along with the terms under which we sell our OLED materials (including payment terms) are typical for the markets in which we operate.

 

PPG Industries has manufactured OLED materials solely for us since October 2000. In July 2005, we renewed our relationship with PPG Industries by entering into an OLED Materials Supply and Service Agreement. This agreement was effective as of January 1, 2006, and extended the term of our relationship with PPG Industries through December 31, 2008. Under the new agreement, PPG Industries continues to supply us with OLED materials for research and development, and for resale to our customers, both for their evaluation and for use in commercial OLED products. Through our collaboration with PPG Industries, key raw materials are sourced from multiple suppliers to ensure that we are able to meet the needs of our customers on a timely basis.

 

In 2006, we continued supplying Tohoku Pioneer with one of our proprietary PHOLED materials for use in a commercial passive-matrix OLED display product. For the first seven months of 2006, we also supplied one of our proprietary PHOLED materials to AU Optronics for use in a commercial active-matrix OLED display product. In the fourth quarter of 2006, we began supplying one of our proprietary PHOLED materials to Samsung SDI, also for use in a commercial active-matrix OLED display product. Throughout the year, we supplied these and other of our proprietary OLED materials to various other product manufacturers for evaluation and for purposes of development, manufacturing qualification and product testing.

 

During the past year, we also announced three separate collaborative relationships with other manufacturers of OLED materials, all of which are non-exclusive. These include relationships with Nippon Steel Chemical Company (NSCC) and Idemitsu Kosan Co., Ltd., both of which are focused on matching our proprietary PHOLED emitters with the host and other OLED materials of these companies, and a relationship with Mitsubishi Chemical Company under which we collaborate to develop solution-processible P²OLED materials. We believe that collaborative relationships such as these are important for ensuring success of the OLED industry and broader adoption of our PHOLED and other OLED technologies.

 

Research and Development

 

Our research and development activities are focused on the advancement of our OLED technologies and materials for displays, lighting and other applications. We conduct this research and development both internally and through various relationships with our commercial business partners and academic institutions. In the years 2006, 2005 and 2004, we spent approximately $19,864,944, $19,183,390 and $16,651,335, respectively, on both internal and third-party sponsored research and development activities with respect to our various OLED technologies and materials.

 

Internal Development Efforts

 

We conduct a substantial portion of our OLED development activities at our state-of-the-art development and testing facility in Ewing, New Jersey. We purchased this 40,200 square foot facility in December 2004, and in early 2006 we completed a two-phase expansion project at the facility.

 

At our Ewing facility, we perform technology development, including device and process optimization, prototype fabrication, manufacturing scale-up studies, process and product testing, characterization and reliability studies, and technology transfer with our business partners. The facility houses five OLED deposition systems, including a system brought on line in 2005 that is designed to process full-color, flexible OLED devices and a prototype organic vapor phase deposition (OVPD) system that we are using to study our proprietary OVPD technology. In addition, the facility contains equipment for substrate patterning, organic material deposition, display packaging, module assembly, and extensive testing in Class 100 and 100,000 clean rooms and opto-electronic test laboratories. These capabilities were enhanced in 2005 as part of the first phase of our expansion project.

 

As part of the second phase of our expansion project, we constructed state-of-the-art synthetic chemistry laboratories at our Ewing facility. In these laboratories, our scientists conduct OLED materials research and make small quantities of new materials that we then test in OLED devices. Through 2005, we conducted this materials research in laboratory space that we leased in Princeton, New Jersey. This activity was transferred to our Ewing facility in January 2006.

 

As of December 31, 2006, we employed a team of 40 research scientists, engineers and laboratory assistants at our facilities in Ewing, New Jersey. This team includes chemists, physicists, engineers with electrical, chemical and mechanical backgrounds, and highly-trained experimentalists. In 2006, this team was expanded through the hiring of new researchers, including several chemists from PPG Industries who had been working on our OLED materials development program for a number of years.

 

University Sponsored Research

 

We have long-standing relationships with Princeton University and the University of Southern California (USC), dating back to 1993, for the conduct of research relating to our OLED and other organic thin-film technologies and materials for applications such as displays and lighting. This research has been performed at Princeton University under the direction of Dr. Stephen R. Forrest and at USC under the direction of Dr. Mark E. Thompson. In 2006, Dr. Forrest transferred to the University of Michigan, where we continue to fund his research.

 

We have been funding research at Princeton University under a Research Agreement we executed with the Trustees of Princeton University in August 1997. In April 2002, we extended the term of this Research Agreement through July 2007. We have exclusive license rights to all OLED and other thin-film organic electronic patents (other than for organic photovoltaic solar cells) arising out of research conducted under this agreement.

 

In connection with Dr. Forrest’s transfer to the University of Michigan, in May 2006 we entered into a new Sponsored Research Agreement with USC under which we will provide up to $4.6 million in continued funding for the organic electronics research being conducted by Drs. Forrest and Thompson. Work by Dr. Forrest is being funded through a subcontract between USC and the University of Michigan. The funding arrangement runs through April 2009. As with the 1997 Research Agreement, we have exclusive license rights to all OLED and thin-film organic electronic patents (other than for organic photovoltaic solar cells) arising out of this research.

 

In October 2005, we entered into a separate Sponsored Research Agreement with Princeton University to fund research under the direction of Dr. Sigurd Wagner on thin-film encapsulation and fabrication of OLED devices. The term of this funding relationship runs through September 2007, and we have exclusive license rights to all patents arising out of the research.

 

In December 2004, we entered into a Sponsored Research Agreement with the Yuen Tjing Ling Industrial Research Institute of National Taiwan University (TLIRI). Under that agreement we funded a research program under the direction of Dr. Ken-Tsung Wong relating to new OLED materials. We received exclusive rights to all intellectual property developed under that program. In 2006, we extended the program through February 2007. We are presently negotiating another extension to sponsor further research at TLIRI under the direction of Dr. Wong.

 

In April 2004, we entered into a Contract Research Agreement with the Chitose Institute of Science and Technology of Japan (CIST). Under that agreement, we funded a research program headed by Dr. Chihaya Adachi relating to high-efficiency OLED materials and devices. We were granted exclusive rights to all intellectual property developed under this program. This relationship with CIST ended in March 2006 when Dr. Adachi transferred to Kyushu University. However, we have continued our relationship with Dr. Adachi under a separate consulting arrangement that currently runs through March 2007, and we are in discussions with Dr. Adachi to extend the arrangement beyond that date.

 

In July 2003, we entered into an agreement with Kyung Hee University to conduct research as a subcontractor under one of our government programs to develop prototypes of a transparent, conformable PHOLED display. This research was under the direction of Dr. Jin Jang. The program ended in April 2005; however, in March 2006 we entered into an arrangement with Kyung Hee University to sponsor additional research directed by Dr. Jang on flexible, amorphous silicon TFT backplane technology. That arrangement is scheduled to expire in March 2007, but we are in discussions with Dr. Jang to continue our relationship with him beyond that date.

 

PPG Industries

 

Our relationship with PPG Industries on the development of OLED materials changed in 2006. We assumed sole responsibility over OLED materials research and development, and we hired four chemists from the PPG Industries’ OLED materials development team to work for us in our newly constructed synthetic chemistry laboratories. Under our OLED Materials Supply and Service Agreement, PPG Industries remains responsible, under our direction, for manufacturing scale up and the supply of these OLED materials for use by us and for resale to our customers.

 

Aixtron

 

In July 2000, we entered into a Development and License Agreement with Aixtron AG of Aachen, Germany to jointly develop and commercialize equipment for the manufacture of OLEDs using the OVPD process. A pre-production OVPD manufacturing tool was delivered to our Ewing, New Jersey facility in January 2002. We continue to work with Aixtron to upgrade this tool for use in research and development of our OVPD technology.

 

Under the Development and License Agreement, we granted Aixtron an exclusive license to produce and sell equipment used to manufacture OLEDs and other devices using our proprietary OVPD process. Aixtron is required to pay us royalties on its sales of this equipment. Purchasers of the equipment also must obtain rights to use our proprietary OVPD process to manufacture OLEDs and other devices using the equipment, which they may do through us or Aixtron. If these rights are granted through Aixtron, Aixtron is required to make additional payments to us under our agreement.

 

Aixtron has reported to us the delivery of five OVPD systems since July 2002, including a second-generation system that was sold to RiTdisplay Corporation of Taiwan in April 2003. We recorded our first royalty income from Aixtron’s sale of these systems in the fourth quarter of 2004.

 

U.S. Government-Funded Research

 

We have entered into several U.S. government contracts and subcontracts to fund a portion of our efforts to develop next-generation OLED technologies and materials for applications such as flexible displays and energy-efficient solid-state lighting. These include, among others, Small Business Innovation Research (SBIR) Phase I program contracts for the demonstration of technical merit and feasibility and SBIR Phase II program contracts for continued research and development and the fabrication of prototypes. On contracts for which we are the prime contractor, we subcontract portions of the work to various entities and institutions, including Princeton University, the University of Southern California, the University of Michigan, Pennsylvania State University, Kyung Hee University in South Korea, L-3 Communications Corporation — Display Systems (L-3DS), the Palo Alto Research Center (PARC), a subsidiary of Xerox Corporation, and Vitex Systems, Inc. All of our government contracts and subcontracts are subject to termination at the election of the contracting governmental agency. Our government contracts include, among others, the following:

 

 

 

The Army Flexible Display Center

 

We have been a charter member of The Army Flexible Display Center (FDC) since its establishment at Arizona State University in December 2004. The FDC is being supported through a $51.5 million Cooperative Agreement between Arizona State University and the U.S. Army Research Laboratory. The goal of the FDC is to develop flexible, low power, light-weight, information displays for future usage by soldiers and for other military and commercial applications. We believe our involvement with the FDC enhances our flexible OLED display technology development efforts.

 

The United States Display Consortium

 

We are a member of the United States Display Consortium (USDC), a cooperative industry and governmental effort aimed at developing an infrastructure to support North American flat panel display manufacturing. The USDC’s role is to provide a common platform for flat panel display manufacturers, developers, users and the manufacturing equipment and supplier base. It has more than 100 members, as well as support from ARL. We are one of 12 members on the Governing Board of the USDC and we actively participate on its Technical Council. In addition, our President, Steven Abramson, served as Vice-Chairman of the USDC’s Governing Board during 2006.

 

Intellectual Property

 

Along with our personnel, our primary and most fundamental assets are patents and other intellectual property. This includes numerous U.S. and foreign patents and patent applications that we own, exclusively license or have the sole right to sublicense. It also includes a substantial body of trade secrets and technical know-how that we have accumulated over time.

 

Our Patents

 

Our research and development activities, conducted both internally and through collaborative programs with our partners, have resulted in the filing of a substantial number of patent applications relating to our OLED technologies and materials. As of December 31, 2006, we owned, through assignment to us alone or jointly with others, 68 issued and pending patents in the U.S., together with numerous counterparts filed in various foreign countries. These patents will start expiring in 2020.

 

Patents We License from Princeton University, the University of Southern California and the University of Michigan

 

We exclusively license the bulk of our patent rights, including our key PHOLED technology patents, under an Amended License Agreement we executed with the Trustees of Princeton University and the University of Southern California (USC) in October 1997. Based on Dr. Stephen Forrest’s recent transfer to the University of Michigan, in January 2006 the University of Michigan was added as a party to this agreement. As of December 31, 2006, the patent rights we license from these universities included 206 issued and pending patents in the U.S., together with

numerous counterparts filed in various foreign countries. These patents will start expiring in 2014, but our key PHOLED technology patents licensed from these universities will not start expiring until 2017.

 

Under the Amended License Agreement, Princeton University, USC and the University of Michigan granted us worldwide, exclusive license rights to specified patents and patent applications relating to OLED technologies and materials. Our license rights also extend to any patent rights arising out of the research conducted by Princeton University, USC or the University of Michigan under our various research agreements with these entities. We are free to sublicense to third parties all or any portion of our patent rights under the Amended License Agreement. The term of the Amended License Agreement is perpetual, though it is subject to termination for an uncured material breach or default by us, or if we become bankrupt or insolvent.

 

Princeton University is primarily responsible for the filing, prosecution and maintenance of all patent rights licensed to us under the Amended License Agreement pursuant to an Interinstitutional Agreement between Princeton University, USC and the University of Michigan. However, we manage this process and have the right to instruct patent counsel on specific matters to be covered in any patent applications filed by Princeton University. We are required to bear all costs associated with the filing, prosecution and maintenance of these patent rights.

 

We are required under the Amended License Agreement to pay Princeton University royalties for licensed products sold by us or our sublicensees. These royalties amount to 3% of the net sales price for licensed products sold by us and 3% of the revenues we receive for licensed products sold by our sublicensees. These royalty rates are subject to renegotiation for products not reasonably conceivable as arising out of the research agreements if Princeton University reasonably determines that the royalty rates payable with respect to these products are not fair and competitive. Princeton University shares portions of these royalties with USC and the University of Michigan under their Interinstitutional Agreement.

 

We have a minimum royalty obligation of $100,000 per year during the term of the Amended License Agreement. We paid Princeton University royalties under the Amended License Agreement in the amounts of $177,436 for 2006, $110,098 for 2005, and $100,000 for 2004. We also are required under the Amended License Agreement to use commercially reasonable efforts to bring the licensed OLED technology to market. However, this requirement is deemed satisfied if we perform our obligations under the research agreements and, when those agreements end, if we invest a minimum of $800,000 per year in research, development, commercialization or patenting efforts respecting the patent rights licensed to us under the Amended License Agreement.

 

Patents We License from Motorola

 

In September 2000, we entered into a License Agreement with Motorola whereby Motorola granted us perpetual license rights to what are now 74 issued U.S. patents relating to Motorola’s OLED technologies, together with numerous foreign counterparts in various countries. These patents will start expiring in 2012. We have the right to freely sublicense these patents to third parties and, with limited exceptions, Motorola has agreed not to license these patents to others in the OLED industry. Motorola remains responsible for the filing, prosecution and maintenance of all patent rights licensed to us under the License Agreement, including all associated costs. Motorola is obligated to keep us informed as to the status of these activities.

 

We are required under the License Agreement to pay Motorola royalties on gross revenues received by us on account of our sales of OLED products or components, or from our OLED technology licensees, whether or not these revenues relate specifically to inventions claimed in the patent rights licensed from Motorola. We have the option to pay these royalties to Motorola in either all cash or 50% cash and 50% shares of our common stock. We also had minimum royalty obligations to Motorola of $250,000 for the two-year period ended on December 31, 2002, $500,000 for the two-year period ended on December 31, 2004, and $1,000,000 for the two-year period ended on December 31, 2006. Thereafter, we have no minimum royalty obligations to Motorola.

 

In connection with our execution of the License Agreement, in 2000 we issued to Motorola 200,000 shares of our common stock, 300,000 shares of our Series B Convertible Preferred Stock, and seven-year warrants to purchase an additional 150,000 shares of our common stock at an exercise price of $21.60 per share. These warrants became exercisable on September 29, 2001, and will remain exercisable until September 29, 2008. On October 6,

2004, all 300,000 shares of the Series B Convertible Preferred Stock were converted into 418,916 shares of our common stock. The warrants issued to Motorola currently remain outstanding.

 

Intellectual Property Developed under Our Government Contracts

 

We and our subcontractors have developed and may continue to develop patentable OLED technology inventions under our various U.S. government contracts and subcontracts. Under these arrangements, we or our subcontractors generally can elect to take title to any patents on these inventions, and to control the manner in which these patents are licensed to third parties. However, the U.S. government reserves rights to these inventions and associated technical data that could restrict our ability to market them to the government for military and other applications, or to third parties for commercial applications. In addition, if the U.S. government determines that we or our subcontractors have not taken effective steps to achieve practical application of these inventions in any field of use in a reasonable time, the government may require that we or our subcontractors license these inventions to third parties in that field of use.

 

Trade Secrets and Technical Know-How

 

We have accumulated, and continue to accumulate, a substantial amount of valuable trade secret information and technical know-how relating to OLED technologies and materials. Where practicable, we share portions of this information and know-how with display manufacturers and other business partners on a confidential basis. We also employ various methods to protect this information and know-how from unauthorized use or disclosure, although no such methods can afford complete protection. Moreover, because we derive some of this information and know-how from academic institutions such as Princeton University, USC and the University of Michigan, there is an increased potential for public disclosure.

 

Competition

 

The industry in which we operate is highly competitive. We compete against alternative flat panel display technologies, in particular LCDs, as well as other OLED technologies. We also compete against other lighting technologies, in particular inorganic LEDs.

 

Flat Panel Display Industry Competitors

 

Numerous domestic and foreign companies have developed or are developing LCD, plasma and other flat panel display technologies that compete with our OLED display technologies. We believe that OLED display technologies ultimately can compete with LCDs and other display technologies for many product applications on the basis of lower power consumption, better contrast ratios, faster video rates and lower manufacturing cost. However, other companies may succeed in continuing to improve these competing display technologies, or in developing new display technologies, that are superior to OLED display technologies in various respects. We cannot predict the timing or extent to which such improvements or developments may occur.

 

Lighting Industry Competitors

 

Traditional incandescent bulbs and fluorescent lamps are well-entrenched products in the lighting industry. In addition, compact fluorescent lamps and solid-state LEDs have recently been introduced into the market and would compete with OLED lighting products. Having attributes different than fluorescent lamps and LEDs, OLEDs might not compete directly with these products for all lighting applications. However, manufacturers of LEDs and compact fluorescent lamps may succeed in more broadly adapting their products to various lighting applications, or others may develop competing solid-state lighting technologies that are superior to OLEDs. Again, we cannot predict whether or when this might occur.

 

OLED Technology and Materials Competitors

 

Eastman Kodak Company has licensed its competing fluorescent OLED technology and other patents to a number of display manufacturers, several of whom are presently manufacturing OLED products. Another OLED industry participant, Cambridge Display Technology, Ltd., licenses its competing polymer OLED technology and

recently entered into a joint venture with Sumitomo Chemical Company to develop polymer OLED materials. Many display manufacturers themselves are engaged in research, development and commercialization activities with respect to OLED technologies and materials. In addition, other manufacturers of OLED materials, such as Idemitsu Kosan Co., Ltd., are selling products that compete with our proprietary PHOLED materials.

 

Our existing business relationships with Samsung SDI and other product manufacturers suggest that our OLED technologies and materials, particularly our PHOLED technologies and materials, may achieve some level of market penetration in the flat panel display and lighting industries. However, our competitors may succeed in improving their competing OLED technologies and materials so as to render them superior to ours. We cannot be sure of the extent to which product manufacturers ultimately will adopt our OLED technologies and materials for the production of commercial flat panel displays and lighting products.

 

Employees

 

As of December 31, 2006, we had 62 full-time employees and two part-time employees, none of whom are unionized. We believe that relations with our employees are good.

 

Our Company History

 

Our corporation was organized under the laws of the Commonwealth of Pennsylvania in April 1985. Our business was commenced in June 1994 by a company then known as Universal Display Corporation, which had been incorporated under the laws of the State of New Jersey. On June 22, 1995, a wholly-owned subsidiary of ours merged into this New Jersey corporation. The surviving corporation in this merger became a wholly-owned subsidiary of ours and changed its name to UDC, Inc. Simultaneously with the consummation of this merger, we changed our name to Universal Display Corporation. UDC, Inc. now functions as an operating subsidiary of ours and has overlapping officers and directors.

 

Our Compliance with Environmental Protection Laws

 

We are not aware of any material effects that compliance with Federal, State or local environmental protection laws or regulations will have on our business. We have not expended material amounts to comply with any environmental protection laws or regulations and do not anticipate having to do so in the foreseeable future.

 

Our Internet Site

 

Our Internet website can be found at www.universaldisplay.com. Through our website, free of charge, you can access our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and any amendments to those reports that we may file with or furnish to the SEC. These materials are made available through our website as soon as reasonably practicable after we electronically file the material with the SEC.

 

The following factors, as well as other factors affecting our operating results and financial condition, could cause our actual future results and financial condition to differ materially from those projected.

 

If our OLED technologies and materials are not feasible for broad-based product applications, we may never generate revenues sufficient to support ongoing operations.

 

Our main business strategy is to license our OLED technologies and sell our OLED materials to manufacturers for incorporation into the flat panel display and lighting products that they sell. Consequently, our success depends on the ability and willingness of these manufacturers to develop, manufacture and sell commercial products integrating our technologies and materials.

 

Before product manufacturers will agree to utilize our OLED technologies and materials for wide-scale commercial production, they will likely require us to demonstrate to their satisfaction that our OLED technologies and materials are feasible for broad-based product applications. This, in turn, may require additional advances in

our technologies and materials, as well as those of others, for applications in a number of areas, including, without limitation, advances with respect to the development of:

 

 

We cannot be certain that these advances will ever occur, and hence our OLED technologies and materials may never be feasible for broad-based product applications.

 

Even if our OLED technologies are technically feasible, they may not be adopted by product manufacturers.

 

The potential size, timing and viability of market opportunities targeted by us are uncertain at this time. Market acceptance of our OLED technologies will depend, in part, upon these technologies providing benefits comparable or superior to current display and lighting technologies at an advantageous cost to manufacturers, and the adoption of products incorporating these technologies by consumers. Many potential licensees of our OLED technologies manufacture flat panel displays and lighting products utilizing competing technologies, and may, therefore, be reluctant to redesign their products or manufacturing processes to incorporate our OLED technologies.

 

During the entire product development process for a new product, we face the risk that our technology will fail to meet the manufacturer’s technical, performance or cost requirements or will be replaced by a competing product or alternative technology. For example, we are aware that some of our licensees and prospective licensees have entered into arrangements with our competitors regarding the development of competing technologies. Even if we offer technologies that are satisfactory to a product manufacturer, the manufacturer may choose to delay or terminate its product development efforts for reasons unrelated to our technologies.

 

Mass production of OLED products will require the availability of suitable manufacturing equipment, components and materials, many of which are available only from a limited number of suppliers. In addition, there may be a number of other technologies that manufacturers need to utilize to be used in conjunction with our OLED technologies in order to bring OLED products containing them to the market. Thus, even if our OLED technologies are a viable alternative to competing approaches, if product manufacturers are unable to obtain access to this equipment and these components, materials and other technologies, they may not utilize our OLED technologies.

 

There are numerous potential alternatives to OLEDs, which may limit our ability to commercialize our OLED technologies and materials.

 

The flat panel display market is currently, and will likely continue to be for some time, dominated by displays based on LCD technology. Numerous companies are making substantial investments in, and conducting research to improve characteristics of, LCDs. Plasma and other competing flat panel display technologies have been, or are being, developed. A similar situation exists in the solid-state lighting market, which is currently dominated by LED products. Advances in any of these various technologies may overcome their current limitations and permit them to become the leading technologies in their field, either of which could limit the potential market for products utilizing our OLED technologies and materials. This, in turn, would cause product manufacturers to avoid entering into commercial relationships with us, or to terminate or not renew their existing relationships with us.

 

Other OLED technologies may be more successful or cost-effective than ours, which may limit the commercial adoption of our OLED technologies and materials.

 

Our competitors have developed OLED technologies that differ from or compete with our OLED technologies. In particular, competing fluorescent OLED technology, which entered the marketplace prior to ours, may become entrenched in the industry before our OLED technologies have a chance to become widely utilized. Moreover, our competitors may succeed in developing new OLED technologies that are more cost-effective or have fewer

limitations than our OLED technologies. If our OLED technologies, and particularly our phosphorescent OLED technology, are unable to capture a substantial portion of the OLED product market, our business strategy may fail.

 

If we fail to make advances in our OLED research and development activities, we might not succeed in commercializing our OLED technologies and materials.

 

Further advances in our OLED technologies and materials depend, in part, on the success of the research and development work we conduct, both alone and with our research partners. We cannot be certain that this work will yield additional advances in the research and development of these technologies and materials.

 

Our research and development efforts remain subject to all of the risks associated with the development of new products based on emerging and innovative technologies, including, without limitation, unanticipated technical or other problems and the possible insufficiency of funds for completing development of these products. Technical problems may result in delays and cause us to incur additional expenses that would increase our losses. If we cannot complete research and development of our OLED technologies and materials successfully, or if we experience delays in completing research and development of our OLED technologies and materials for use in potential commercial applications, particularly after incurring significant expenditures, our business may fail.

 

If we cannot form and maintain lasting business relationships with OLED product manufacturers, our business strategy will fail.

 

Our business strategy ultimately depends upon our development and maintenance of commercial licensing and material supply relationships with high-volume manufacturers of OLED products. We have entered into only a limited number of such relationships. All of our other relationships with product manufacturers currently are limited to technology development and the evaluation of our OLED technologies and materials for possible use in commercial products. Some or all of these relationships may not succeed or, even if they are successful, may not result in the product manufacturers entering into commercial licensing and material supply relationships with us.

 

Under our existing technology development and evaluation agreements, we are working with manufacturers to incorporate our technologies into their commercial products. However, these technology development and evaluation agreements typically last for limited periods of time, such that our relationships with the product manufacturers will expire unless they continually are renewed. These manufacturers may not agree to renew their relationships with us on a continuing basis. In addition, we regularly continue working with manufacturers evaluating our OLED technologies and materials after our existing agreements with them have expired while we are attempting to negotiate contract extensions or new agreements with them. Should our relationships with the various product manufacturers not continue or be renewed, our business would suffer.

 

Our ability to enter into additional commercial licensing and material supply relationships, or to maintain our existing technology development and evaluation relationships, may require us to make financial or other commitments. We might not be able, for financial or other reasons, to enter into or continue these relationships on commercially acceptable terms, or at all. Failure to do so may cause our business strategy to fail.

 

Conflicts may arise with our licensees or joint development partners, resulting in renegotiation or termination of, or litigation related to, our agreements with them. This would adversely affect our revenues.

 

Conflicts could arise between us and our licensees or joint development partners as to royalty rates, milestone payments or other commercial terms. Similarly, we may disagree with our licensees or joint development partners as to which party owns or has the right to commercialize intellectual property that is developed during the course of the relationship or as to other non-commercial terms. If such a conflict were to arise, a licensee or joint development partner might attempt to compel renegotiation of certain terms of their agreement or terminate their agreement entirely, and we might lose the royalty revenues and other benefits of the agreement. Either we or the licensee or joint development partner might initiate litigation to determine commercial obligations, establish intellectual property rights or resolve other disputes under the agreement. Such litigation could be costly to us and require substantial attention of management. If we were unsuccessful in such litigation, we could lose the commercial

benefits of the agreement, be liable for other financial damages and suffer losses of intellectual property or other rights that are the subject of dispute. Any of these adverse outcomes could cause our business strategy to fail.

 

If we cannot obtain and maintain appropriate patent and other intellectual property rights protection for our OLED technologies and materials, our business will suffer.

 

The value of our OLED technologies and materials is dependent on our ability to secure and maintain appropriate patent and other intellectual property rights protection. Although we own or license many patents respecting our OLED technologies and materials that have already been issued, there can be no assurance that additional patents applied for will be obtained, or that any of these patents, once issued, will afford commercially significant protection for our OLED technologies and materials, or will be found valid if challenged. Moreover, we have not obtained patent protection for some of our OLED technologies and materials in all foreign countries in which OLED products or materials might be manufactured or sold. In any event, the patent laws of other countries may differ from those of the United States as to the patentability of our OLED technologies and materials and the degree of protection afforded.

 

The strength of our current intellectual property position results primarily from the essential nature of our fundamental patents covering phosphorescent OLED devices and certain materials utilized in these devices. Our existing fundamental phosphorescent OLED patents expire in 2017 and 2019. While we hold a wide range of additional patents and patent applications whose expiration dates extend (and in the case of patent applications, will extend) beyond 2019, many of which are also of key importance in the OLED industry, none are of an equally essential nature as our fundamental patents, and therefore our competitive position after 2019 may be less certain.

 

We may become engaged in litigation to protect or enforce our patent and other intellectual property rights, or in International Trade Commission proceedings to abate the importation of goods that would compete unfairly with those of our licensees. In addition, we are currently participating in, and will likely have to participate in the future in, interference or reexamination proceedings before the U.S. Patent and Trademark Office, and opposition, nullity or other proceedings before foreign patent offices, with respect to our patents or patent applications. All of these actions place our patents and other intellectual property rights at risk and may result in substantial costs to us as well as a diversion of management attention. Moreover, if successful, these actions could result in the loss of patent or other intellectual property rights protection for the key OLED technologies and materials on which our business depends.

 

In addition, we rely in part on unpatented proprietary technologies, and others may independently develop the same or similar technologies or otherwise obtain access to our unpatented technologies. To protect our trade secrets, know-how and other proprietary information, we require employees, consultants, financial advisors and strategic partners to enter into confidentiality agreements. These agreements may not ultimately provide meaningful protection for our trade secrets, know-how or other proprietary information. In particular, we may not be able to fully or adequately protect our proprietary information as we conduct discussions with potential strategic partners. If we are unable to protect the proprietary nature of our technologies, it will harm our business.

 

We or our licensees may incur substantial costs or lose important rights as a result of litigation or other proceedings relating to our patent and other intellectual property rights.

 

There are a number of other companies and organizations that have been issued patents and are filing patent applications relating to OLED technologies and materials, including, without limitation, Eastman Kodak Company, Cambridge Display Technology, Fuji Film Co., Ltd., Canon, Inc., Pioneer Corporation, Semiconductor Energy Laboratories Co. and Mitsubishi Chemical Corporation. As a result, there may be issued patents or pending patent applications of third parties that would be infringed by the use of our OLED technologies or materials, thus subjecting our licensees to possible suits for patent infringement in the future. Such lawsuits could result in our licensees being liable for damages or require our licensees to obtain additional licenses that could increase the cost of their products, which might have an adverse affect on their sales and thus our royalties or cause them to seek to renegotiate our royalty rates.

 

In addition, we may be required from time-to-time to assert our intellectual property rights by instituting legal proceedings against others. We cannot assure you that we will be successful in enforcing our patents in any lawsuits

we may commence. Defendants in any litigation we may commence to enforce our patents may attempt to establish that our patents are invalid or are unenforceable. Thus, any patent litigation we commence could lead to a determination that one or more of our patents are invalid or unenforceable. If a third party succeeds in invalidating one or more of our patents, that party and others could compete more effectively against us. Our ability to derive licensing revenues from products or technologies covered by these patents could also be adversely affected.

 

Whether our licensees are defending the assertion of third-party intellectual property rights against their businesses arising as a result of the use of our technology, or we are asserting our own intellectual property rights against others, such litigation can be complex, costly, protracted and highly disruptive to our or our licensees’ business operations by diverting the attention and energies of management and key technical personnel. As a result, the pendency or adverse outcome of any intellectual property litigation to which we or our licensees are subject could disrupt business operations, require the incurrence of substantial costs and subject us or our licensees to significant liabilities, each of which could severely harm our business.

 

Plaintiffs in intellectual property cases often seek injunctive relief in addition to money damages. Any intellectual property litigation commenced against our licensees could force them to take actions that could be harmful to their business and thus to our royalties, including the following:

 

 

If our licensees are forced to take any of the foregoing actions, they may be unable to manufacture and sell their products that incorporate our technology at a profit or at all. Furthermore, the measure of damages in intellectual property litigation can be complex, and is often subjective or uncertain. If our licensees were to be found liable for infringement of proprietary rights of a third party, the amount of damages they might have to pay could be substantial and is difficult to predict. Decreased sales of our licensees’ products incorporating our technology would have an adverse effect on our royalty revenues under existing licenses. Any necessity to procure rights to the third-party technology might cause our existing licensees to renegotiate the royalty terms of their license with us to compensate for this increase in their cost of production or, in certain cases, to terminate their license with us entirely. Were this renegotiation to occur, it would likely harm our ability to compete for new licensees and have an adverse effect on the terms of the royalty arrangements we could enter into with any new licensees.

 

As is commonplace in technology companies, we employ individuals who were previously employed at other technology companies. To the extent our employees are involved in research areas that are similar to those areas in which they were involved at their former employers, we may be subject to claims that such employees or we have, inadvertently or otherwise, used or disclosed the alleged trade secrets or other proprietary information of the former employers. Litigation may be necessary to defend against such claims. The costs associated with these actions or the loss of rights critical to our or our licensees’ business could negatively impact our revenues or cause our business to fail.

 

We have a history of losses and may never be profitable.

 

Since inception, we have incurred significant losses and we expect to incur losses until such time, if ever, as we are able to achieve sufficient levels of revenue from the commercial exploitation of our OLED technologies and materials to support our operations. This may never occur because:

 

 

 

We may require additional funding in the future in order to continue our business.

 

Our capital requirements have been and will continue to be significant. We may require additional funding in the future for the research, development and commercialization of our OLED technologies and materials, to obtain and maintain patents and other intellectual property rights in these technologies and materials, and for working capital and other purposes, the timing and amount of which are difficult to ascertain. Our cash on hand may not be sufficient to meet all of our future needs. When we need additional funds, such funds may not be available on commercially reasonable terms or at all. If we cannot obtain more money when needed, our business might fail. Additionally, if we attempt to raise money in an offering of shares of our common stock, preferred stock, warrants or depositary shares, or if we engage in acquisitions involving the issuance of such securities, the issuance of these shares will dilute our then-existing shareholders.

 

Many of our competitors have greater resources, which may make it difficult for us to compete successfully against them.

 

The flat panel display and solid-state lighting industries are characterized by intense competition. Many of our competitors have better name recognition and greater financial, technical, marketing, personnel and research capabilities than us. Because of these differences, we may never be able to compete successfully in these markets.

 

The consumer electronics industry has historically experienced significant downturns, which may adversely affect the demand for and pricing of our OLED technologies and materials.

 

Because we do not sell any products to consumers, our success depends upon the ability and continuing willingness of our licensees to manufacture and sell products utilizing our technologies and materials, and the widespread acceptance of those products. Any slowdown in the demand for our licensees’ products would adversely affect our royalty revenues and thus our business. The markets for flat panel displays and lighting products are highly competitive. Success in the market for end-user products that may integrate our OLED technologies and materials also depends on factors beyond the control of our licensees and us, including the cyclical and seasonal nature of the end-user markets that our licensees serve, as well as industry and general economic conditions.

 

The markets that we hope to penetrate have experienced significant periodic downturns, often in connection with, or in anticipation of, declines in general economic conditions. These downturns have been characterized by lower product demand, production overcapacity and erosion of average selling prices. Our business strategy is dependent on manufacturers building and selling products that incorporate our OLED technologies and materials. Industry-wide fluctuations and downturns in the demand for flat panel displays and solid-state lighting products could cause significant harm to our business.

 

We rely solely on PPG Industries to manufacture the OLED materials we use and sell to product manufacturers.

 

Our business prospects depend significantly on our ability to obtain proprietary OLED materials for our own use and for sale to product manufacturers. Our agreement with PPG Industries, Inc. provides us with a source for these materials for development and evaluation purposes, as well as for commercial purposes. This agreement, however, is currently scheduled to expire on December 31, 2008. Our inability to continue obtaining these OLED materials from PPG Industries or another source would have a material adverse effect on our revenues from sales of these materials, as well as on our ability to perform development work and to support those product manufacturers currently evaluating our OLED technologies and materials for possible commercial use.

 

The U.S. government has rights to our OLED technologies that might prevent us from realizing the benefits of these technologies.

 

The U.S. government, through various government agencies, has provided and continues to provide funding to us, Princeton University, the University of Southern California and the University of Michigan for research

activities related to certain aspects of our OLED technologies. Because we have been provided with this funding, the government has rights to these OLED technologies that could restrict our ability to market them to the government for military and other applications, or to third parties for commercial applications. Moreover, if the government determines that we have not taken effective steps to achieve practical application of these OLED technologies in any field of use in a reasonable time, the government could require us to grant licenses to other parties in that field of use. Any of these occurrences would limit our ability to obtain the full benefits of our OLED technologies.

 

If we cannot keep our key employees or hire other talented persons as we grow, our business might not succeed.

 

Our performance is substantially dependent on the continued services of senior management and other key personnel, and on our ability to offer competitive salaries and benefits to our employees. We do not have employment agreements with any of our management or other key personnel. Additionally, competition for highly skilled technical, managerial and other personnel is intense. We might not be able to attract, hire, train, retain and motivate the highly skilled managers and employees we need to be successful. If we fail to attract and retain the necessary technical and managerial personnel, our business will suffer and might fail.

 

We can issue shares of preferred stock that may adversely affect the rights of shareholders of our common stock.

 

Our Articles of Incorporation authorize us to issue up to 5,000,000 shares of preferred stock with designations, rights and preferences determined from time-to-time by our Board of Directors. Accordingly, our Board of Directors is empowered, without shareholder approval, to issue preferred stock with dividend, liquidation, conversion, voting or other rights superior to those of shareholders of our common stock. For example, an issuance of shares of preferred stock could:

 

 

As of March 8, 2007, we have issued and outstanding 200,000 shares of Series A Nonconvertible Preferred Stock, all of which are held by an entity controlled by members of the family of Sherwin I. Seligsohn, our Chairman of the Board and Chief Executive Officer. Our Board of Directors has authorized and issued other shares of preferred stock in the past, none of which are currently outstanding, and may do so again at any time in the future.

 

If the price of our common stock goes down, we may have to issue more shares than are presently anticipated to be issued under our agreement with PPG Industries.

 

Under our agreement with PPG Industries, we are required to issue to PPG Industries shares of our common stock as partial payment for services rendered by it, though under limited circumstances we are required to compensate PPG Industries fully in cash in lieu of common stock. The number of shares of common stock that we are required to deliver to PPG Industries is based on a specified formula. Under this formula, the lower the price of our common stock at and around the time of issuance, the greater the number of shares that we are required to issue to PPG Industries. Lower than anticipated market prices for our common stock, and correspondingly greater numbers of shares issuable to PPG Industries, with a resulting increase in the number of shares available for public sale, could cause people to sell our common stock, including in short sales, which could drive down the price of our common stock, thus reducing its value and perhaps hindering our ability to raise additional funds in the future. In addition, such an increase in the number of outstanding shares of our common stock would further dilute existing holders of this stock.

 

Our executive officers and directors own a large percentage of our common stock and could exert significant influence over matters requiring shareholder approval, including takeover attempts.

 

Our executive officers and directors, their respective affiliates and the adult children of Sherwin Seligsohn, our Chairman of the Board and Chief Executive Officer, beneficially own, as of March 8, 2007, approximately 16.2% of the outstanding shares of our common stock. Accordingly, these individuals may, as a practical matter, be able to exert significant influence over matters requiring approval by our shareholders, including the election of directors and the approval of mergers or other business combinations. This concentration also could have the effect of delaying or preventing a change in control of us.

 

Because the vast majority of OLED product manufacturers are located in the Asia-Pacific region, we are subject to international operational, financial, legal and political risks which may negatively impact our operations.

 

Many of our licensees and prospective licensees have a majority of their operations in countries other than the United States, particularly in the Asia-Pacific region. Risks associated with our doing business outside of the United States include, without limitation:

 

 

Any of these factors could impair our ability to license our OLED technologies and sell our OLED materials, thereby harming our business.

 

The market price of our common stock might be highly volatile.

 

The market price of our common stock might be highly volatile, as has been the case with our common stock in the past as well as the securities of many companies, particularly other small and emerging-growth companies. We have included in the section of this report entitled “Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities,” a table indicating the high and low closing prices of our common stock as reported on the Nasdaq National Market for the past two years. Factors such as the following may have a significant impact on the market price of our common stock in the future:

 

 

Our operating results may have significant period-to-period fluctuations, which would make it difficult to predict our future performance.

 

Due to the current stage of commercialization of our OLED technologies and the significant development and manufacturing objectives that we and our licensees must achieve to be successful, our quarterly operating results will be difficult to predict and may vary significantly from quarter to quarter.

 

We believe that period-to-period comparisons of our operating results are not a reliable indicator of our future performance at this time. Among other factors affecting our period-to-period results, our license and technology

development fees often consist of large one-time or annual payments, resulting in significant fluctuations in our revenues. If, in some future period, our operating results or business outlook fall below the expectations of securities analysts or investors, our stock price would be likely to decline and investors in our common stock may not be able to resell their shares at or above their purchase price. Broad market, industry and global economic factors may also materially reduce the market price of our common stock, regardless of our operating performance.

 

The issuance of additional shares of our common stock could drive down the price of our stock.

 

The price of our common stock can be expected to decrease if:

 

 

Because we do not intend to pay dividends, shareholders will benefit from an investment in our common stock only if it appreciates in value.

 

We have never declared or paid any cash dividends on our common stock. We currently intend to retain our future earnings, if any, to finance further research and development and do not expect to pay any cash dividends in the foreseeable future. As a result, the success of an investment in our common stock will depend upon any future appreciation in its value. There is no guarantee that our common stock will appreciate in value or even maintain the price at which shareholders have purchased their shares.

 

None.

 

Our corporate offices and research and development laboratories are located at 375 Phillips Boulevard in Ewing, New Jersey. On December 1, 2004, we acquired the building and property at which this facility is located. During 2005, we conducted a two-stage expansion of our laboratory and office space in the building. We currently occupy the entire 40,200 square feet facility, with the exception of a small portion of office space that we lease to Global Photonic Energy Corporation.

 

We also lease approximately 850 square feet of office space in Coeur d’Alene, Idaho. We have two employees who work in this office. This office space is shared with Global Photonic Energy Corporation.

 

Patent Interference with Semiconductor Energy Laboratory Co., Ltd.

 

In June 2006, Patent Interference No. 104,461 was declared by the United States Patent and Trademark Office (the “USPTO”) between Semiconductor Energy Laboratory Co., Ltd. (“SEL”), and Princeton University and the University of Southern California (the “Universities”). The dispute concerns a U.S. patent issued to SEL that we believe claims aspects of our phosphorescent OLED technology covered under several U.S. patents and patent applications which we exclusively license from the Universities. The Universities are seeking a ruling by the USPTO that they should be granted a patent to the claimed invention and that the SEL patent is invalid because the Universities’ invention was prior to that of SEL.

 

We believe that the substantial and uncontested factual evidence of record in this patent interference strongly supports the Universities’ position of priority to the invention in question, and thus that the Universities should prevail in this action. However, we cannot predict a favorable outcome with certainty, and an adverse ruling by the USPTO against the Universities might be referenced in separate proceedings to challenge related U.S. patents and patent applications that we exclusively license from them. Even if this were to occur, however, we exclusively

license other patent rights from the Universities that substantially cover our phosphorescent OLED technology in the form(s) that we believe it will have commercial value for the foreseeable future.

 

Various cross-motions have been filed and briefed in this proceeding, and they are currently under consideration by the USPTO. Under our agreement with the Universities, we are required to pay all legal costs and fees associated with the proceeding.

 

Patent Opposition Initiated by Cambridge Display Technology, Ltd.

 

On December 8, 2006, Cambridge Display Technology, Ltd. (“CDT”) filed a Notice of Opposition to European Patent No. 0946958 (the “EP ‘958 patent”). The EP ’958 patent, which was issued on March 8, 2006, is the European counterpart patent to U.S. patents 5,844,363, 6,602,540 and 6,888,306, and to pending U.S. patent application 10/966,417, filed on October 15, 2004. These patents and patent applications relate to our flexible OLED, or FOLED, technology. They are exclusively licensed to us by Princeton University, and under the license agreement we are required to pay all legal costs and fees associated with this proceeding.

 

We are in the process of reviewing the Notice of Opposition and preparing our response. We believe that the Princeton University patent being challenged by CDT is valid, and thus that Princeton University should prevail in this action. However, we cannot predict a favorable outcome with certainty.

 

None.

 

EXECUTIVE OFFICERS OF THE REGISTRANT

 

The following table sets forth certain information with respect to our executive officers as of March 8, 2007:

 

 

Our Board of Directors has appointed these executive officers to hold office until their successors are duly appointed.

 

Sherwin I. Seligsohn has been our Chief Executive Officer and Chairman of the Board since June 1995. He also served as our President from June 1995 through May 1996. Mr. Seligsohn founded and since has served as the sole Director, President and Secretary of American Biomimetics Corporation, International Multi-Media Corporation, and Wireless Unified Network Systems Corporation. He is also Chairman of the Board, Chief Executive Officer and President of Global Photonic Energy Corporation. From June 1990 to October 1991, Mr. Seligsohn was Chairman Emeritus of InterDigital Communications, Inc. (“InterDigital”), formerly International Mobile Machines Corporation. He founded InterDigital and from August 1972 to June 1990 served as its Chairman of the Board. Mr. Seligsohn is a member of the Industrial Advisory Board of the Princeton Institute for the Science and Technology of Materials (PRISM) at Princeton University.

 

Steven V. Abramson has been our President and Chief Operating Officer and a member of our Board of Directors since May 1996. From March 1992 to May 1996, he was Vice President, General Counsel, Secretary and Treasurer of Roy F. Weston, Inc., a worldwide environmental consulting and engineering firm. From December 1982 to December 1991, Mr. Abramson held various positions at InterDigital, including General Counsel, Executive Vice President and General Manager of the Technology Licensing Division. Mr. Abramson is a member of the Executive Committee of PRISM, and he was also Vice-Chairman of the Board of Governors of the United States Display Consortium during 2006.

 

Sidney D. Rosenblatt has been our Executive Vice President, Chief Financial Officer, Treasurer and Secretary since June 1995, and has been a member of our Board of Directors since May 1996. Mr. Rosenblatt is the owner of and served as the President of S. Zitner Company from August 1990 through December 1998. From May 1982 to August 1990, Mr. Rosenblatt served as the Senior Vice President, Chief Financial Officer and Treasurer of InterDigital.

 

Julia J. Brown, Ph.D. has been our Vice President and Chief Technical Officer since June 2002. She joined us in June 1998 as our Vice President of Technology Development. From November 1991 to June 1998, Dr. Brown was a Research Department Manager at Hughes Research Laboratories where she directed the pilot line production of high-speed Indium Phosphide-based integrated circuits for insertion into advanced airborne radar and satellite communication systems. Dr. Brown received an M.S. and Ph.D. in Electrical Engineering/Electrophysics at the University of Southern California under the advisement of Professor Stephen R. Forrest. Dr. Brown has served as an Associate Editor of the Journal of Electronic Materials and as an elected member of the Electron Device Society Technical Board. She co-founded an international engineering mentoring program sponsored by the Institute of Electrical and Electronics Engineers (“IEEE”) and is a Fellow of the IEEE. Dr. Brown has served on numerous technical conference committees and is presently a member of the Society of Information Display.

 

Our Common Stock

 

Our common stock is quoted on the NASDAQ Global Market under the symbol “PANL.” The following table sets forth, for the periods indicated, the high and low closing prices of our common stock as reported on the NASDAQ Global Market.

 

 

As of March 8, 2007, there were approximately 17,000 holders of record of our common stock.

 

We have never declared or paid cash dividends on our common stock. We currently intend to retain any future earnings for the operation and expansion of our business. We do not anticipate declaring or paying cash dividends on our common stock in the foreseeable future. Any future payment of cash dividends on our common stock will be at the discretion of our Board of Directors and will depend upon our results of operations, earnings, capital requirements, contractual restrictions and other factors deemed relevant by our Board of Directors.

 

Issuance of Securities to PPG Industries

 

Pursuant to our agreements with PPG Industries, Inc. we are required to issue shares of our common stock to PPG Industries on a periodic basis in return for services performed by PPG Industries under those agreements. During the quarter ended December 31, 2006, we issued an aggregate of 91,055 shares of our common stock to PPG

Industries for services provided to us under this agreement. The shares were issued in reliance on the exemption from registration contained in Section 4(2) of the Securities Act of 1933, as amended.

 

Issuance of Securities Upon the Exercise of Outstanding Warrants

 

During the quarter ended December 31, 2006, we issued an aggregate of 22,588 shares of our common stock upon the exercise of outstanding warrants. The warrants had an exercise price of $6.38 per share. The shares were issued in reliance on the exemption from registration contained in Section 4(2) of the Securities Act of 1933, as amended.

Performance Graph

 

The performance graph below compares the change in the cumulative shareholder return of our common stock from December 31, 2001 to December 31, 2006, with the percentage change in the cumulative total return over the same period on (i) the Russell 2000 Index, and (ii) the Nasdaq Electronics Components Index. This performance graph assumes an initial investment of $100 on December 31, 2001 in each of our common stock, the Russell 2000 Index and the Nasdaq Electronics Components Index.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Universal Display Corp., The Russell 2000 Index
And The NASDAQ Electronic Components Index

 

 

 

 

 

The following selected condensed consolidated financial data has been derived from, and should be read in conjunction with, our audited consolidated financial statements and the notes thereto, and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this report and incorporated herein by reference.

 

 

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 Section 1A of this report, entitled “Risk Factors.”

 

Overview

 

We are a leader in the research, development and commercialization of organic light emitting diode, or OLED, technologies for use in flat panel display, solid-state lighting and other applications. Since 1994, we have been

exclusively engaged, and expect to continue to be exclusively engaged, in funding and performing research and development activities relating to OLED technologies and materials, and in attempting to commercialize these technologies and materials. Our revenues are generated through contract research, sales of development and commercial chemicals, technology development and evaluation agreements and license fees and royalties. In the future, we anticipate that the revenues from licensing our intellectual property will become a more significant part of our revenue stream.

 

While we have made significant progress over the past few years developing and commercializing our family of OLED technologies (PHOLED, TOLED, FOLED, etc.) and materials, we have incurred significant losses and will likely continue to do so until our OLED technologies and materials become more widely adopted by product manufacturers. We have incurred significant losses since our inception, resulting in an accumulated deficit of $145,356,626 as of December 31, 2006.

 

We anticipate fluctuations in our annual and quarterly results of operations due to uncertainty regarding:

 

 

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 with U.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 license fees, valuation of acquired technology and stock-based compensation, as described below, are our “critical accounting policies” as contemplated by the SEC. These policies, which have been reviewed with our Audit Committee, are discussed in greater detail below.

 

Revenue Recognition and Deferred License Fees

 

Contract research revenue represents reimbursements by the U.S. government for all or a portion of the research and development expenses we incur related to our government contracts. Revenue is recognized proportionally as research and development expenses are incurred or as defined milestones are achieved. In order to ascertain the revenue associated with these contracts for a period, we estimate the proportion of related research and development expenses incurred and whether defined milestones have been achieved. Different estimates would result in different revenues for the period.

 

We also receive non-refundable advance license and royalty payments under certain of our development and technology evaluation agreements. These payments are classified as deferred revenue and deferred license fees, which represents the cash received and recorded as a liability until such time revenue can be recognized. Payments that are not creditable to a license are recognized as revenue over the life of the agreement. Payments that are creditable to a license are deferred until a license agreement is executed or negotiations have ceased and there is no appreciable likelihood of executing a license agreement with the other party. If a license agreement is executed, these payments would be recorded as revenues over the expected life of the licensed technology; otherwise, they will be recorded as revenues at the time negotiations with the other party show that there is no appreciable likelihood of entering into a license agreement. If we used different estimates for the expected life of this licensed technology, reported revenue during the relevant period would differ. As of December 31, 2006, $10,894,768 was recorded as deferred revenue and deferred license fees.

 

A portion of our license and royalty revenue for 2004 was received from Aixtron AG based on OVPD equipment sold by Aixtron under our development and license agreement with them. This revenue was recognized upon our receipt of notification that the equipment was sold and an acknowledgement from Aixtron that royalties were due.

 

Valuation of Acquired Technology

 

We regularly review our acquired OLED technologies for events or changes in circumstances that might indicate the carrying value of these technologies may not be recoverable. Factors considered important that could cause impairment include, among others, significant changes in our anticipated future use of these technologies and our overall business strategy as it pertains to these technologies, particularly in light of patents owned by others in the same field of use. As of December 31, 2006, we believe that no revision of the remaining useful lives or write-down of our acquired technology was required for 2006, nor was such a revision needed in 2005 or 2004. If such a write-down is required in the future, it could be for up to $6,319,488 — the net book value of our acquired technology as of December 31, 2006.

 

Valuation of Stock-Based Compensation

 

We account for our stock-based compensation (see Notes 2 and 10 of the Notes to Consolidated Financial Statements) under Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment, which addresses all forms of share-based payment awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. It requires companies to recognize in the statement of operations the grant-date fair value of stock options and other equity-based compensation issued to employees. The statement eliminates the intrinsic value-based method prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, that we used prior to 2006. We account for our stock option and warrant grants to non-employees in exchange for goods or services in accordance with SFAS No. 123R and Emerging Issues Task Force No. 96-18 (EITF 96-18). SFAS No. 123R and EITF 96-18 require that we record an expense for our option and warrant grants to non-employees based on the fair value of the options and warrants granted.

 

We use the Black-Scholes option-pricing model to estimate the fair value of options we have granted for purposes of making the disclosure required by SFAS No. 123R. In order to calculate the fair value of the options, assumptions are made for certain components of the model, including risk-free interest rate, volatility, expected dividend yield rate and expected option life. Although we use available resources and information when setting these assumptions, changes to the assumptions could cause significant adjustments to the valuation.

 

Results of Operations

 

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

 

We had a net loss attributable to holders of our common stock of $15,186,804 (or $0.49 per diluted share) for the year ended December 31, 2006, compared to a net loss attributable to holders of our common stock of $15,801,612 (or $0.56 per diluted share) for the year ended December 31, 2005. The decrease in net loss was primarily due to:

 

 

The decrease in net loss was offset to some extent by an increase of $2,203,209 in operating expenses.

 

Our revenues were $11,921,292 for the year ended December 31, 2006, compared to $10,147,995 for the year ended December 31, 2005. The increase in revenues was mainly due to:

 

 

The increase was offset by the following:

 

 

We earned $3,821,903 in contract research revenue from the U.S. government in 2006, compared to $4,653,981 in 2005. The decrease was mainly attributable to the timing of revenue recognition under our government contracts. The number of government contracts we worked under and the level of effort performed under these contracts remained essentially constant from 2005 to 2006.

 

We earned $1,656,851 from our sales of OLED materials for evaluation purposes in 2006, compared to $3,503,685 for corresponding sales in 2005. The decrease was mainly due to a customer that formerly purchased evaluation materials commencing the purchase of commercial materials instead. We cannot accurately predict the amount and timing of such purchases from customers due to the early stage of the OLED industry.

 

For 2006, our commercial chemical revenues and our royalty and license revenues were $1,876,071 and $2,400,179, respectively, compared to $31,395 and $233,555, respectively, for the corresponding period in 2005. The increase was due to purchases of our proprietary PHOLED materials for use in commercial OLED products by two new customers. In the fourth quarter of 2006, we began supplying one of our proprietary PHOLED materials to Samsung SDI for use in a commercial active-matrix OLED display product. We cannot accurately predict how long these material sales will continue, as Samsung SDI is purchasing material from us on a purchase order basis. Continued sales of our PHOLED materials to Samsung SDI will depend on several factors, including, pricing, availability, continued technical improvement and competitive product offerings.

 

For the first seven months of 2006, we also supplied one of our proprietary PHOLED materials to AU Optronics Corporation for use in a commercial active-matrix OLED display product. Under this arrangement, we recognized both commercial chemical revenues and royalty and license revenue of $2,660,000 on account of our sales of these materials to AU Optronics. However, those sales ended when AU Optronics discontinued its manufacture of this display product, and we do not expect material sales to AU Optronics to resume in the foreseeable future. Commercial chemical revenues and royalty and license revenue from our sales of these materials to AU Optronics represented a substantial component of our revenues for 2006.

 

Our royalty and license revenue for 2006 also included fees received under a patent license agreement executed with Samsung SDI in April 2005, and a cross-license agreement executed with DuPont Displays, Inc. in December 2002. In connection with each of these agreements, we received upfront payments of license fees and of royalties, both of which have been classified as deferred revenue and deferred license fees. The deferred license fees are being recognized as license fee revenue over the life of the agreement for Samsung SDI, and over 10 years for DuPont Displays. The deferred royalties in connection with the Samsung SDI agreement will be recognized as Samsung SDI commences sales of commercial OLED products and reports to us the royalties due on account of those sales. We expect to start receiving royalties based on Samsung SDI’s sales of active matrix OLED display products in 2007.

 

We recognized $2,166,288 in technology development revenue in 2006 in connection with technology development and evaluation agreements, compared to $1,725,379 for the same period in 2005. Although the number of contracts did not change, revenues increased due mainly to the timing of revenue recognition under a contract that commenced in the third quarter of 2005. The amount and timing of our receipt of fees for technology development and evaluation services is difficult to predict due to the early stage of the OLED industry.

 

We incurred research and development expenses of $19,864,944 for the year ended December 31, 2006, compared to $19,183,390 for the year ended December 31, 2005. The increase was mainly due to:

 

 

The increase was offset to some extent by the following:

 

 

Included within research and development expenses are patent defense costs of $513,487 and $97,353 for each of 2006 and 2005, respectively. These costs are associated with the Semiconductor Energy Laboratory (SEL) patent interference matter described in response to Item 3 of this report (Legal Proceedings). We anticipate that our patent defense costs may increase as active matrix OLED products using our PHOLED and other OLED technologies and materials enter the consumer marketplace.

 

General and administrative expenses were $8,902,462 for the year ended December 31, 2006, compared to $7,704,931 for the same period in 2005. The increase was due mainly to:

 

 

Royalty and license expenses were $687,436 for the year ended December 31, 2006, compared to $610,098 for the same period in 2005. The increase was due to an increase accrual in royalties due to Princeton University of $67,338.

 

Interest income increased to $2,168,933 for the year ended December 31, 2006, compared to $1,419,858 for the year ended December 31, 2005. This was the result of higher rates of return on investments during 2006.

 

During 2006, we sold approximately $7 million of our state-related income tax net operating losses (NOLs) to New Jersey under the Technology Tax Certificate Transfer Program. In 2006, we received proceeds of $544,567 from the sale of these NOLs and recorded these proceeds as an income tax benefit. During 2005, we sold approximately $5 million of our state-related income tax NOLs and received proceeds from these sales of $424,207. We expect to sell a similar quantity of NOLs in 2007.

 

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

 

We had a net loss attributable to holders of our common stock of $15,801,612 (or $0.56 per diluted share) for the year ended December 31, 2005, compared to a net loss attributable to holders of our common stock of $15,906,198 (or $0.59 per diluted share) for the year ended December 31, 2004. The decrease in net loss was primarily due to:

 

 

The decrease in net loss was offset to some extent by an increase of $3,399,535 in operating expenses.

 

Our revenues were $10,147,995 for the year ended December 31, 2005, compared to $7,006,913 for the year ended December 31, 2004. The increase in revenues was mainly due to:

 

 

The increase was offset by the following:

 

 

We earned $4,653,981 in contract research revenue from the U.S. government in 2005, compared to $2,621,636 in 2004. The increase resulted mainly from our entering into several new government contracts during 2005. These contracts also involved additional prototyping work as compared to the more basic research we conducted under our government contracts in 2004.

 

We earned $3,503,685 from our sales of OLED materials for evaluation purposes in 2005, compared to $2,484,070 for corresponding sales in 2004. The increase was mainly due to an increased volume of OLED materials purchased for evaluation by potential OLED display manufacturers, including our technology development and evaluation partners.

 

For 2005, our commercial chemical revenues and our royalty and license revenues were $31,395 and $233,555, respectively, compared to $147,600 and $403,070, respectively, for the corresponding period in 2004. The decrease was due mainly to the timing of purchases of our proprietary PHOLED materials for use in a commercial OLED product by Tohoku Pioneer Corporation. All commercial chemical revenues in 2005 and 2004 were from this customer.

 

Our royalty and license revenue for 2005 included fees received under our patent license agreement with Samsung SDI and our cross-license agreement with DuPont Displays. Royalty and license revenue for 2004 also included $58,670 of royalty revenue from the sale of OVPD equipment by Aixtron AG, one of our licensees. Aixtron sold no such equipment in 2005.

 

We recognized $1,725,379 in technology development revenue in 2005 in connection with technology development and evaluation agreements, compared to $1,350,537 for the same period in 2004. The increase was primarily due to new technology development and evaluation agreements entered into in 2005.

 

We incurred research and development expenses of $19,183,390 for the year ended December 31, 2005, compared to $16,651,335 for the year ended December 31, 2004. The increase was mainly attributable to:

 

 

Included within research and development expenses are patent defense costs of $97,353 and $24,206 for each of 2005 and 2004, respectively. These costs are associated with the SEL patent interference matter described in response to Item 3 of this report (Legal Proceedings).

 

General and administrative expenses were $7,704,931 for the year ended December 31, 2005, compared to $7,052,047 for the same period in 2004. The increase was due mainly to:

 

 

Royalty expenses were $610,098 for the year ended December 31, 2005, compared to $350,000 for the same period in 2004. The increase was mainly due to the minimum royalty requirement under our agreement with Motorola (Notes 5 and 12 in the Notes to Consolidated Financial Statements). Under this agreement, we are required to make a minimum royalty payment at the end of the two-year period ended December 31, 2006 of $1,000,000, as compared to a payment of $500,000 for the two-year period ended December 31, 2004.

 

Interest income increased to $1,419,858 for the year ended December 31, 2005, compared to $795,620 for the prior year. This was mainly the result of increased cash balances throughout 2005, due to our March 2004 registered offering of common stock, together with higher rates of return on investments during 2005.

 

During 2005, we sold approximately $5 million of our state-related income tax NOLs to New Jersey under the Technology Tax Certificate Transfer Program. In 2005, we received proceeds of $424,207 from the sale of these NOLs and recorded these proceeds as an income tax benefit. During 2004, we sold approximately $8 million of our state-related income tax NOLs and received proceeds from these sales of $612,966.

 

We recorded no deemed dividends for the year ended December 31, 2005, compared to $129,624 in deemed dividends recorded for the prior year. In 2004, we issued a warrant to purchase shares of our common stock and completed a registered offering of our common stock. These actions were deemed dilutive under the terms of a stock-purchase warrant we had previously issued and resulted in the reduction of the exercise price of that warrant and an increase in the number of shares issuable under the warrant. We treated this occurrence as a deemed dividend of $46,176. In 2005, there were no actions deemed dilutive under the terms of this warrant.

 

In 2004, the conversion price of the Series B Convertible Preferred Stock we issued to Motorola, Inc. in September 2000 was adjusted in accordance with the Certificate of Designations for that stock. We accounted for this adjustment as a contingent beneficial conversion feature (CBCF). As a result, we recorded the CBCF as a deemed dividend in the amount of $83,448. There were no such deemed dividends in 2005.

 

Liquidity and Capital Resources

 

As of December 31, 2006, we had cash and cash equivalents of $31,097,533, short-term investments of $17,957,752 and investments in certificates of deposit and other liquid instruments with an original maturity of more than one year of $42,770, for a total of $49,098,055. This compares to cash and cash equivalents of $30,654,249, short-term investments of $17,190,242 and investments in certificates of deposit and other liquid instruments with an original maturity of more than one year of $1,828,708, for a total of $49,673,199, as of December 31, 2005. The small decrease in cash and cash equivalents and short-term and long-term investments of $575,144 was primarily due to cash used in operating activities and purchases of equipment, offset to some extent by proceeds received from stock-purchase warrant and stock option exercises.

 

Cash used in operating activities was $4,703,792 for 2006, as compared to $345,059 for 2005. The increase was primarily due to changes in the following:

 

 

Cash used in investing activities was $1,134,692 for 2006, as compared to cash provided by investing activities of $3,945,069 for 2005. The increase in cash used was due mainly to the partial use of proceeds from the sale of our investments for operating activities.

 

Cash provided by financing activities was $6,281,769 for 2006, as compared to $8,123,658 for 2005. The cash provided by financing activities for both 2006 and 2005 consisted of proceeds from the exercise of stock-purchase warrants and stock options.

 

Working capital decreased to $37,422,740 as of December 31, 2006, from working capital of $38,347,913 as of December 31, 2005. The reduction was primarily due to an increase in current liabilities relating to the classification of deferred license fees as current liabilities. In 2006, we received $3,700,000 in non-refundable payments under our development and technology evaluation agreements that are creditable against license fees under a license agreement, if executed. Therefore, we classify these advanced payments as current deferred license fees until a license agreement is executed or until there is no appreciable likelihood of entering into a license agreement.

 

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 and defense of our patents and patent applications), that we have sufficient cash, cash equivalents and short-term investments to meet our obligations through at least 2008.

 

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 warrants and options. We have an effective shelf registration statement that would enable us to offer, from time to time, up to $44,725,524 of our common stock, preferred stock, debt securities and other securities, subject to market conditions and other factors. 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 and maintain 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 this additional funding will be available to us when needed, on commercially reasonable terms or at all.

 

Contractual Obligations

 

As of December 31, 2006, we had the following contractual commitments:

 

 

 

 

Off-Balance Sheet Arrangements

 

As of December 31, 2006, 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.

 

Recently Issued Accounting Pronouncements

 

Recently issued accounting pronouncements are addressed in Note 2 in the Notes to Consolidated Financial Statements. We do not expect that the adoption of these recently accounting pronouncements will have a material impact on our financial statements or results of operations.

 

We do not utilize financial instruments for trading purposes and hold no derivative financial instruments, other financial instruments or derivative commodity instruments that could expose us to significant market risk. Our

primary market risk exposure with regard to financial instruments is to changes in interest rates, which would impact interest income earned on investments.

 

Our Consolidated Financial Statements and the relevant notes to those statements are attached to this report beginning on page F-1.

 

None.

 

Evaluation of Disclosure Controls and Procedures

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures, as of December 31, 2006, are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed or submitted under the Securities Exchange Act of 1934, as amended, is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure. However, a controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

 

Management’s Report on Internal Control over Financial Reporting and Attestation Report of Public Accounting Firm

 

The report of management on our internal control over financial reporting and the associated attestation report of our independent registered public accounting firm are set forth in Item 8 of this report and are incorporated herein by reference.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting during the quarter ended December 31, 2006 that have materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

None.

 

Information with respect to this item is set forth in our definitive Proxy Statement for the 2007 Annual Meeting of Shareholders, which is to be filed with the Securities and Exchange Commission no later than April 29, 2007, (our “Proxy Statement”), and which is incorporated herein by reference. Information regarding our executive officers is included at the end of Part I of this report.

 

Information with respect to this item is set forth in our Proxy Statement, and is incorporated herein by reference.

 

Information with respect to this item is set forth in our Proxy Statement, and is incorporated herein by reference.

 

Information with respect to this item is set forth in our Proxy Statement, and is incorporated herein by reference.

 

Information with respect to this item is set forth in our Proxy Statement, and is incorporated herein by reference.

 

(a) The following documents are filed as part of this report:

 

(1) Financial Statements:

 

 

(2) Financial Statement Schedules:

 

None.

 

(3) Exhibits:

 

The following is a list of the exhibits filed as part of this report. Where so indicated by footnote, exhibits that were previously filed are incorporated by reference. For exhibits incorporated by reference, the location of the exhibit in the previous filing is indicated parenthetically, together with a reference to the filing indicated by footnote.