# Universal Display Corp \\pa\\: Form 10-Q for the period ended Jun 30, 2011

- Company: [Universal Display Corp \\pa\\](/companies/oled.md) (CIK 1005284)
- Form: 10-Q
- Filed: 2011-08-09
- Accepted by EDGAR: Aug 8, 2011, 21:56 ET
- Period: 2011-06-30
- Accession: 0001005284-11-000072
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1005284/000100528411000072/form10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1005284/000100528411000072/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2011-06-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2011-04-01 to 2011-06-30 | $11.3m | us-gaap:Revenues |
| Revenue | 6 months, 2011-01-01 to 2011-06-30 | $20.9m | us-gaap:Revenues |
| Cost of revenue | 3 months, 2011-04-01 to 2011-06-30 | $142.5k | us-gaap:CostOfGoodsSold |
| Cost of revenue | 6 months, 2011-01-01 to 2011-06-30 | $245.2k | us-gaap:CostOfGoodsSold |
| Research and development | 3 months, 2011-04-01 to 2011-06-30 | $5.6m | us-gaap:ResearchAndDevelopmentExpense |
| Research and development | 6 months, 2011-01-01 to 2011-06-30 | $12.1m | us-gaap:ResearchAndDevelopmentExpense |
| Selling, general and administrative | 3 months, 2011-04-01 to 2011-06-30 | $4.5m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Selling, general and administrative | 6 months, 2011-01-01 to 2011-06-30 | $8.4m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 3 months, 2011-04-01 to 2011-06-30 | −$1.1m | us-gaap:OperatingIncomeLoss |
| Operating income | 6 months, 2011-01-01 to 2011-06-30 | −$3.8m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2011-04-01 to 2011-06-30 | $8.4k | us-gaap:InterestExpense |
| Interest expense | 6 months, 2011-01-01 to 2011-06-30 | $18.1k | us-gaap:InterestExpense |
| Income tax | 3 months, 2011-04-01 to 2011-06-30 | $289.4k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 6 months, 2011-01-01 to 2011-06-30 | $585.8k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2011-04-01 to 2011-06-30 | $3.3m | us-gaap:NetIncomeLoss |
| Net income | 6 months, 2011-01-01 to 2011-06-30 | −$8.6m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2011-04-01 to 2011-06-30 | −$0.03 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 6 months, 2011-01-01 to 2011-06-30 | −$0.20 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2011-04-01 to 2011-06-30 | $0.07 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 6 months, 2011-01-01 to 2011-06-30 | −$0.20 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2011-04-01 to 2011-06-30 | 45,201,175 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 6 months, 2011-01-01 to 2011-06-30 | 41,977,113 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 6 months, 2011-01-01 to 2011-06-30 | $1.8m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 6 months, 2011-01-01 to 2011-06-30 | $1.5m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2011-06-30 | $65.2m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2011-06-30 | $335.8m | us-gaap:AssetsCurrent |
| Total assets | at 2011-06-30 | $347.0m | us-gaap:Assets |
| Current liabilities | at 2011-06-30 | $18.2m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2011-06-30 | $29.2m | us-gaap:Liabilities |
| Shareholders' equity | at 2011-06-30 | $317.8m | us-gaap:StockholdersEquity |
| Shares outstanding | at 2011-06-30 | 45,556,985 shares | dei:EntityCommonStockSharesOutstanding |

## Management's discussion and analysis

As filed, 34,099 characters.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes above.

### CAUTIONARY STATEMENT

### CONCERNING FORWARD-LOOKING STATEMENTS

This discussion and analysis contains some “forward-looking statements.” Forward-looking statements concern our possible or assumed future results of operations, including descriptions of our business strategies and customer relationships. 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 in these circumstances.

As you read and consider this discussion and analysis, 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 in the section entitled (Risk Factors) in our Annual Report on Form 10-K for the year ended December 31, 2010, as supplemented by any disclosures in Item 1A of Part II of our Quarterly Report for the quarter ended March 31, 2011, and by any disclosures in Item 1A of Part II below. 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 in the 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.

### 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 and solid-state lighting 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. Over time, we anticipate that 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 PHOLED™ and other OLED technologies 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 $225,594,271 as of June 30, 2011.

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

- the timing of our receipt of license fees and royalties, as well as fees for future technology development and evaluation activities;
- the timing and volume of sales of our OLED materials for both commercial usage and evaluation purposes;
- the timing and magnitude of expenditures we may incur in connection with our ongoing research and development activities; and
- the timing and financial consequences of our formation of new business relationships and alliances.

### RESULTS OF OPERATIONS

### Three Months Ended June 30, 2011 Compared to Three Months Ended June 30, 2010

We had an operating loss of $1,070,753 for the three months ended June 30, 2011, compared to an operating loss of $1,909,144 for the three months ended June 30, 2010. The decrease in the operating loss was due to the following:

- an increase in revenue of $2,805,586; offset by
- an increase in operating expenses of $1,967,195.

We had net income of $3,312,700 (or $0.07 earnings per basic share and $0.03 loss per diluted share) for the three months ended June 30, 2011, compared to a net loss of $4,436,095 (or $0.12 loss per basic and diluted share) for the three months ended June 30, 2010.

The increase in net income was due mainly to a gain on stock warrant liability of $4,496,367 for the three months ended June 30, 2011, compared to loss on stock warrant liability of $2,582,428 for the same period in 2010.

Our revenues were $11,252,415 for the three months ended June 30, 2011, compared to $8,446,829 for the three months ended June 30, 2010.

Commercial revenue increased to $5,278,704 for the three months ended June 30, 2011, compared to $1,951,892 for the three months ended June 30, 2010. Commercial revenue relates to the incorporation of our OLED technologies and materials into our customers’ commercial products, and includes commercial chemical revenue, royalty and license revenues, and commercialization assistance revenue. The increase in commercial revenue was primarily due to the following:

- an increase of $1,560,960 in commercial chemical revenue;
- an increase of $1,162,162 in royalty revenue, which mainly represented royalties received under our patent license agreement with Samsung Mobile Display Co., Ltd. (Samsung SMD); and
- an increase of $583,986 in license fee revenue.

We cannot accurately predict how long our material sales to particular customers will continue, as our customers frequently update and alter their product offerings in response to market demands. Continued sales of our OLED materials to these customers will depend on several factors, including pricing, availability, continued technical improvement and competitive product offerings.

In July 2010, we entered into an amendment to our patent license agreement with Samsung SMD. The amendment extended the term of this agreement for three months, and has subsequently been extended at three month intervals through September 30, 2011. As of the date of this filing, we are continuing to negotiate with Samsung SMD on the terms of a new business arrangement.

Developmental revenue decreased to $5,973,711 for the three months ended June 30, 2011, compared to $6,494,937 for the three months ended June 30, 2010. Developmental revenue relates to OLED technology and material development and evaluation activities for which we are paid, and includes contract research revenue, development chemical revenue and technology development revenue. The decrease in developmental revenue was due to:

- a decrease of $2,026,347 in technology development revenue, due to the recognition of revenue during the three months ended June 30, 2010 of non-refundable payments of $2,100,000 that were received from a customer through the fourth quarter of 2006; offset by
- an increase of $1,380,337 in development chemical revenue, mainly due to increased purchases of development chemicals by customers that are preparing for commercial production; and
- an increase in contract revenue of $124,784.

The $2,100,000 received from a customer referenced above was for technical assistance previously provided under an agreement to conduct OLED development, evaluation and sampling activities. These payments were made between the years 2001 and 2006, and the agreement itself expired at the end of 2006. We had previously classified these payments as deferred revenue because they were creditable against the license fee under a commercial license agreement in the event we entered into one with the customer. In May 2010, based on information received from the customer regarding its future OLED plans, we determined that the likelihood of us entering into a commercial license agreement was remote. As a result of this determination, we recorded the $2,100,000 payment as technology development revenue in the second quarter of 2010. No similar revenue was recognized during the three months ended June 30, 2011.

Cost of chemicals sold decreased to $142,540 for the three months ended June 30, 2011, compared to $218,417 for the three months ended June 30, 2010. Cost of chemicals sold includes the cost of producing materials that have been classified as commercial and shipping costs for such materials, but excludes the cost of producing certain commercial materials which costs have already been included in research and development expense. Cost of chemicals sold does not include costs associated with producing materials that have not yet been classified as commercial, which costs are included in research and development expenses. Depending on the timing and stage of materials being classified as commercial, we expect the cost of chemicals for these materials to fluctuate from quarter to quarter. As a result of the aforementioned, cost of chemicals sold decreased for the three months ended June 30, 2011 compared to the same period 2010, although quantities sold increased.

We incurred research and development expenses of $5,551,492 for the three months ended June 30, 2011, compared to $5,500,507 for the three months ended June 30, 2010. Although total expenses remained consistent over the corresponding periods, the following significant changes occurred:

- employee costs increased by $414,501, due primarily to new employees, increased salaries and stock compensation for certain executive officers; and
- amortization costs decreased by $409,501, due to certain acquired technology being fully amoritzed as of December 31, 2010

Selling, general and administrative expenses were $4,495,821 for the three months ended June 30, 2011, compared to $3,624,582 for the three months ended June 30, 2010. The overall increase in these costs was driven in part to increased commercial activities and non-cash expenses related to stock compensation and in part by costs incurred to establish new subsidiaries in Hong Kong, Korea and Japan. Specifically, we incurred increased costs in the following areas:

- increased costs of $270,464 related to stock compensation for members of our Board of Directors; and
- increased employee costs of $188,605, due primarily to increased salaries and stock compensation for certain executive officers;
- costs of $127,133 resulting from the incorporation and commencement of operations of certain of our foreign subsidiaries.

Patent costs increased to $1,915,060 for the three months ended June 30, 2011, compared to $843,907 for the three months ended June 30, 2010. The increase was mainly due to increased costs associated with our aggressive defense of certain ongoing and new patent challenges to our issued patents, as well as the timing of prosecution and maintenance costs associated with a number of patents and patent applications.

Interest income increased to $184,877 for the three months ended June 30, 2011, compared to $61,125 for the three months ended June 30, 2010. The increase was mainly attributable to interest earned on higher average cash and investment balances as a result of proceeds received from the completion of our public offering in March 2011.

At June 30, 2011, we had outstanding warrants to purchase 214,746 shares of common stock, which warrants contain a “down-round” provision requiring liability classification. The change in fair value of these warrants during the period resulted in a $4,496,367 non-cash gain on our statement of operations for the three months ended June 30, 2011, compared to a $2,582,428 non-cash loss for the three months ended June 30, 2010. We will continue to report the warrants as a liability, with changes in fair value recorded in the statement of operations, until such time as these warrants are either exercised or expire in August 2011.

For the three months ended June 30, 2011, we incurred an income tax expense of $289,361. No corresponding expense was incurred for the three months ended June 30, 2010. We filed for and were granted a five-year exemption from withholding tax on royalty payments received from Samsung SMD under our patent license agreement as part of a tax incentive program in Korea. The exemption was granted in May 2005 and remained in effect until May 2010. Since then, Samsung SMD has been required to withhold tax upon payment of royalties to us. In 2011 and 2010, the withholding tax rate for royalty payments made by Samsung SMD was 16.5%. For the three months ended June 30, 2011, foreign income taxes of $289,361 were withheld in connection with royalty payments. We anticipate the amount of withholding taxes to increase as associated payments received from Samsung SMD increase in the future.

### Six Months Ended June 30, 2011 Compared to Six Months Ended June 30, 2010

We had an operating loss of $3,814,776 for the six months ended June 30, 2011, compared to an operating loss of $6,133,476 for the six months ended June 30, 2010. The decrease in the operating loss was due to the following:

- an increase in revenue of $8,159,476; offset by
- an increase in operating expenses of $5,840,776.

We had a net loss of $8,568,156 (or $0.20 per basic and diluted share) for the six months ended June 30, 2011, compared to a net loss of $7,414,426 (or $0.20 per basic and diluted share) for the six months ended June 30, 2010. The increase in net loss was mainly due to an increase in loss on stock warrant liability of $2,560,660, and an increase in income tax expense of $1,049,979, offset by a decrease in operating loss.

Our revenues were $20,852,955 for the six months ended June 30, 2011, compared to $12,693,479 for the six months ended June 30, 2010.

Commercial revenue increased to $10,022,779 for the six months ended June 30, 2011, compared to $3,782,039 for the six months ended June 30, 2010. Commercial revenue relates to the incorporation of our OLED technologies and materials into our customers’ commercial products, and includes commercial chemical revenue, royalty and license revenues, and commercialization assistance revenue. The increase in commercial revenue was primarily due to the following:

- an increase of $2,697,045 in commercial chemical revenue;
- an increase of $2,392,990 in royalty revenue, which mainly represented royalties received under our patent license agreement with Samsung SMD; and
- an increase of $1,111,296 in license fee revenue.

We cannot accurately predict how long our material sales to particular customers will continue, as our customers frequently update and alter their product offerings in response to market demands. Continued sales of our OLED materials to these customers will depend on several factors, including pricing, availability, continued technical improvement and competitive product offerings.

In July 2010, we entered into an amendment to our patent license agreement with Samsung SMD. The amendment extended the term of this agreement for three months, and has subsequently been extended at three month intervals through September 30, 2011. As of the date of this filing, we are continuing to negotiate with Samsung SMD on the terms of a new business arrangement.

Developmental revenue increased to $10,830,176 for the six months ended June 30, 2011, compared to $8,911,440 for the six months ended June 30, 2010. Developmental revenue relates to OLED technology and material development and evaluation activities for which we are paid, and includes contract research revenue, development chemical revenue and technology development revenue. The increase in developmental revenue was due to:

- an increase of $3,026,887 in development chemical revenue, mainly due to increased purchases of development chemicals by customers that are preparing for commercial production; and
- an increase in contract revenue of $917,505; offset by
- a decrease of $2,025,656 in technology development revenue, due to recognition of revenue during the six months ended June 30, 2010 of non-refundable payments totaling $2,100,000 that were received from a customer through the fourth quarter of 2006.

The $2,100,000 received from a customer referenced above was for technical assistance previously provided under an agreement to conduct OLED development, evaluation and sampling activities. These payments were made between the years 2001 and 2006, and the agreement itself expired at the end of 2006. We had previously classified these payments as deferred revenue because they were creditable against the license fee under a commercial license agreement in the event we entered into one with the customer. In May 2010, based on information received from the customer regarding its future OLED plans, we determined that the likelihood of us entering into a commercial license agreement was remote. As a result of this determination, we recorded the $2,100,000 payment as technology development revenue in the second quarter of 2010. No similar revenue was recognized during the six months ended June 30, 2011.

Cost of chemicals sold decreased to $245,202 for the six months ended June 30, 2011, compared to $317,037 for the six months ended June 30, 2010. Cost of chemicals sold includes the cost of producing materials that have been classified as commercial and shipping costs for such materials, but excludes the cost of producing certain commercial materials which costs have already been included in research and development expense. Cost of chemicals sold does not include costs associated with producing materials that have not yet been classified as commercial, which costs are included in research and development expenses. Depending on the timing and stage of materials being classified as commercial, we expect the costs of chemicals for these materials to fluctuate from quarter to quarter. As a result of the aforementioned, cost of chemicals sold decreased for the six months ended June 30, 2011 compared to the same period 2010, although quantities sold increased.

We incurred research and development expenses of $12,106,610 for the six months ended June 30, 2011, compared to $10,329,304 for the six months ended June 30, 2010. The increase was mainly due to:

- increased costs of $1,008,923 incurred under our agreement with PPG Industries;
- increased employee costs of $890,801, due primarily to new employees, increased salaries, costs associated with retirement benefits and stock compensation for certain executive officers; and
- increased costs of $435,724, due to overall expanded research and development efforts to support the growth of our business; offset by
- decreased amortization costs of $827,996 due to part of our acquired technology being fully amortized as of December 31, 2010.

Selling, general and administrative expenses were $8,367,778 for the six months ended June 30, 2011, compared to $6,266,828 for the six months ended June 30, 2010. The overall increase in these costs was driven in part to increased commercial activities and non-cash expenses related to stock compensation and in part by costs incurred to establish new subsidiaries in Hong Kong, Korea and Japan. Specifically, we incurred increased costs in the following areas:

- increased employee costs of $790,401, due primarily to increased salaries and stock compensation for certain executive officers;
- increased costs of $272,593 related to net periodic benefit costs of the Universal Display Corporation Supplemental Executive Retirement Plan (SERP) for certain executive officers, which was implemented in 2010 (see Note 10 in the Notes to Consolidated Financial Statements);
- costs of $261,835 resulting from the incorporation and commencement of operations of certain of our foreign subsidiaries; and
- increased costs of $258,739 related to stock compensation for members of our Board of Directors.

Patent costs increased to $3,528,102 for the six months ended June 30, 2011, compared to $1,625,166 for the six months ended June 30, 2010. The increase was mainly due to increased costs associated with our aggressive defense of certain ongoing and new patent challenges to our issued patents, as well as the timing of prosecution and maintenance costs associated with a number of patents and patent applications.

Interest income increased to $280,350 for the six months ended June 30, 2011, compared to $136,780 for the six months ended June 30, 2010. The increase was mainly attributable to interest earned on higher average cash and investment balances as a result of proceeds received from the completion of our public offering in March 2011.

At June 30, 2011, we had outstanding warrants to purchase 214,746 shares of common stock, which warrants contain a “down-round” provision requiring liability classification. The change in fair value of these warrants during the period resulted in a $4,429,845 non-cash loss on our statement of operations for the six months ended June 30, 2011, compared to a $1,869,185 non-cash loss for the six months ended June 30, 2010. We will continue to report the warrants as a liability, with changes in fair value recorded in the statement of operations, until such time as these warrants are either exercised or expire in August 2011.

For the six months ended June 30, 2011, we incurred an income tax expense of $585,817, compared to an income tax benefit of $464,162 for the six months ended June 30, 2010. We had previously filed for and were granted a five-year exemption from withholding tax on royalty payments received from Samsung SMD under our patent license agreement as part of a tax incentive program in Korea. The exemption was granted in May 2005 and remained in effect until May 2010. Since then, Samsung SMD has been required to withhold tax upon payment of royalties to us. In 2011 and 2010, the withholding tax rate for royalty payments made by Samsung SMD was 16.5%. For the six months ended June 30, 2011, foreign income taxes of $585,817 were withheld in connection with royalty payments. We anticipate the amount of withholding taxes to increase as associated payments received from Samsung SMD increase in the future.

During the three months ended March 31, 2010, we sold approximately $3.8 million of our state-related income tax net operating losses (NOLs) and $194,088 of our research and development tax credits under the New Jersey Technology Tax Certificate Transfer Program. We received proceeds of $464,162 from our sale of these NOLs and research and development tax credits, and we recorded these proceeds as an income tax benefit. No corresponding sales have occurred during the six months ended June 30, 2011.

### Liquidity and Capital Resources

As of June 30, 2011, we had cash and cash equivalents of $65,240,065 and short-term investments of $261,158,726, for a total of $326,398,791. This compares to cash and cash equivalents of $20,368,852 and short-term investments of $52,794,545, for a total of $73,163,397, as of December 31, 2010. The increase in cash and cash equivalents and short-term investments of $253,235,394 was primarily due to the completion in March 2011 of our public offering of 5,750,000 shares of our common stock at a price of $46.00 per share. The offering resulted in net proceeds to us of $249,667,306.

Cash provided from operating activities was $1,840,143 for the six months ended June 30, 2011, compared to cash used of $2,757,981 for the same period in 2010. The increase in cash provided in operating activities was primarily due to the following:

- a decrease in net loss of $3,579,874, which amount excludes the impact of non-cash items; and
- the impact of the timing of receipt of accounts receivable of $1,247,766; offset partially by
- the impact of the timing of other asset purchases, including inventory, of $808,867

Cash used in investing activities was $210,354,026 for the six months ended June 30, 2011, compared to $13,270,033 for the same period in 2010. The increase in cash used in investing activities was mainly due to increased purchases of short-term investments as a result of the completion of our public offering described below.

Cash provided by financing activities was $253,385,096 for the six months ended June 30, 2011, compared to $5,081,173 for the same period in 2010. The increase in cash provided by financing activities was due primarily to the completion in March 2011 of a public offering of 5,750,000 shares of our common stock at a price of $46.00 per share. The offering resulted in proceeds to us of $249,667,306, which was net of $14,832,694 in underwriting discounts and commissions and other costs associated with completion of the offering.

Working capital was $317,547,099 as of June 30, 2011 which included a stock warrant liability of $4,588,178, compared to $57,354,822 as of December 31, 2010, which included a stock warrant liability of $10,659,755. The stock warrants associated with this liability will either expire or be exercised by August 2011, resulting in no cash outlay by us. Working capital, excluding the stock warrant liability, was $322,135,277 as of June 30, 2011 and $68,014,577 at December 31, 2010. Again, the increase in working capital was primarily due to proceeds from the common stock offering we completed in March 2011.

We anticipate, based on our internal forecasts and assumptions relating to our operations (including, among others, assumptions regarding our working capital requirements, the progress of our research and development efforts, the availability of sources of funding for our research and development work, and the timing and costs associated with the preparation, filing, prosecution, maintenance, defense and enforcement of our patents and patent applications), that we have sufficient cash, cash equivalents and short-term investments to meet our obligations for at least the next 12 months.

We believe that potential additional financing sources for us include long-term and short-term borrowings, public and private sales of our equity and debt securities and the receipt of cash upon the exercise of outstanding warrants and options. It should be noted, however, that additional funding may be required in the future for research, development and commercialization of our OLED technologies and materials, to obtain, maintain and enforce patents respecting these technologies and materials, and for working capital and other purposes, the timing and amount of which are difficult to ascertain. There can be no assurance that additional funds will be available to us when needed, on commercially reasonable terms or at all, particularly in the current economic environment.

### Critical Accounting Policies

### Revenue Recognition and Deferred Revenue

We receive non-refundable cash payments under certain development and technology evaluation agreements with our customers. These payments are generally recognized as revenue over the term of the agreement. On occasion, however, these payments are creditable against license fees and/or royalties payable by the customer if a license agreement is subsequently executed with the customer. These payments are classified as deferred revenues, and are recorded as liabilities in the consolidated balance sheet until such time as revenue can be recognized. Revenue is deferred until a license agreement is executed or negotiations have ceased and there is no appreciable likelihood of executing a license agreement with the customer. If a license agreement is executed, these payments are recorded as revenue over the estimated useful life of the licensed technology and the revenue is classified based on the terms of the license. Otherwise, these payments are recorded as revenue at the time negotiations with the customer show that there is no appreciable likelihood of executing a license agreement. If we used different estimates for the useful life of the licensed technology, reported revenue during the relevant period would differ. As of June 30, 2011, $8,263,725 was recorded as deferred revenue, of which $3,366,667 may be recognized under license agreements that have not yet been executed or deemed effective. For the three and six months ended June 30, 2010, $2,100,000 of revenue was recognized relating to cash payments received that were creditable against license fees and/or royalties for which we determined there was no appreciable likelihood of executing a license agreement with the customer. For the six months ended June 30, 2011, there was no such revenue recognized.

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.

### Valuation of Stock-Based Compensation

We recognize in the statement of operations the grant-date fair value of equity-based compensation issued to employees and directors (see Note 9 of the Notes to Consolidated Financial Statements). We also record an expense for equity-based compensation grants to non-employees, in exchange for goods or services, based on the fair value, which is remeasured over the vesting period of such awards.

We use the Black-Scholes option-pricing model to estimate the fair value of options and warrants we have granted for purposes of recording charges to the statement of operations. In order to calculate the fair value of the options and warrants, assumptions are made for certain components of the model, including expected volatility, expected dividend yield rate and expected option life. Expected volatilities utilized in the model are based mainly on the historical volatility of our stock price over a period commensurate with the expected life of the share option. The risk-free interest rate is derived from the U.S. Treasury yield curve in effect at the time of grant. In the case of stock options granted to employees, we estimate the expected term of options granted based on our historical experience with our employees’ exercise of stock options. In the case of stock options granted to non-employees, the contractual life is used. Although we use our best estimates when setting these assumptions, changes to the assumptions could cause significant adjustments to the valuation of future grants or the remeasurement of non-employee awards.

### Accounting for Warrants

On January 1, 2009, we adopted certain revised provisions of Accounting Standards Codification (ASC) 815, *Derivatives and Hedging.* These provisions apply to freestanding financial instruments or embedded features that have the characteristics of a derivative and to freestanding financial instruments that are potentially settled in an entity’s own common stock. As a result, certain of our warrants are considered to be derivatives since they contain “down-round” provisions and must be remeasured at fair value at the end of each period as they are recorded as liabilities. The stock warrant liability was $4,588,178 at June 30, 2011.

The fair value of the stock warrant liability is determined by the Black-Scholes option pricing model using assumptions for certain components of the model, including expected volatility and expected annual dividend yield. Expected volatilities utilized in the model are based mainly on the historical volatility of our stock price over a period commensurate with the remaining contractual life of the warrant. The risk-free interest rate is derived from the U.S. Treasury yield curve. The expected term of the warrants is based on the remaining contractual life. Although we use our best estimates when setting these assumptions, changes in assumptions could cause significant adjustments to the future valuation of the stock warrant liability. The change in fair value of the stock warrant liability is recorded as a gain or loss on the statement of operations.

### Retirement Plan

We have recorded a significant retirement plan benefit liability that is developed from actuarial valuations. The determination of our retirement plan benefit liability requires key assumptions regarding discount rates, as well as rates of compensation increases, retirement dates and life expectancies used to determine the present value of future benefit payments. We determine these assumptions in consultation with, and after input from, our actuaries and considering our experience and expectations for the future. Actual results for a given period will often differ from assumed amounts because of economic and other factors.

The discount rate reflects the estimated rate at which the benefit liabilities could be settled at the end of the year. The discount rate is determined by selecting a single rate that produces a result equivalent to discounting expected benefit payments from the plan using the Citigroup Above-Median Pension Discount Curve (Curve). Based upon this analysis using the Curve, we used a discount rate to measure our retirement plan benefit liability of 5.44% at June 30, 2011. A change of 25 basis points in the discount rate would increase or decrease the expense on an annual basis by approximately $21,000.

### Contractual Obligations

Refer to our Annual Report on Form 10-K for the year ended December 31, 2010 for a discussion of our contractual obligations.

### Off-Balance Sheet Arrangements

Refer to our Annual Report on Form 10-K for the year ended December 31, 2010 for a discussion of off-balance sheet arrangements. As of June 30, 2011, we had no off-balance sheet arrangements.

## Market risk

As filed, 1,445 characters.

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 other than our short-term investments and our stock warrant liability disclosed in Note 4 to the consolidated financial statements included herein. We invest in investment grade financial instruments to reduce our exposure. Our primary market risk exposure with regard to financial instruments is to changes in interest rates, which would impact interest income earned on investments.

We record as a liability the fair value of warrants to purchase 214,746 shares of our common stock. The fair value of the stock warrant liability is determined using the Black-Scholes option valuation model, and is therefore sensitive to changes in our stock price and volatility of our common stock. Our primary market risk exposure to the stock warrant liability is to changes in our stock price, which would impact the valuation of the stock warrant liability. Increases in our stock price or the expected volatility of our common stock would increase the fair value of the stock warrant liability and, therefore, result in an additional loss on the statement of operations. Decreases in these items would decrease the fair value of the stock warrant liability and, therefore, result in an additional gain on the statement of operations.

## Controls and procedures

As filed, 1,523 characters.

### 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 June 30, 2011. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures, as of the end of the period covered by this report, are effective 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.

### Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the three months ended June 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 273 characters.

There have been no material changes to the risk factors previously discussed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2010, as supplemented by our Quarterly Report on Form 10-Q for the quarter ended March 31, 2011.

Filed Aug 9, 2011.
Source: SEC EDGAR, the filing index for accession 0001005284-11-000072. Last ingested by Listed: Nov 5, 2026, 15:33 ET. No prices; not investment advice.