Universal Display Corp \Pa\ Q1 FY2023 Earnings Call

Good day, ladies and gentlemen, and welcome to Universal Display Corporation's First Quarter 2023 Earnings Conference Call. My name is Paul, and I will be your conference moderator for today's call. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference call over to Darice Liu, Senior Director of Investor Relations. Please proceed.

Thank you, and good afternoon, everyone. Welcome to Universal Display's First Quarter Earnings Conference Call. Joining me on the call today are Steve Abramson, President and Chief Executive Officer; and Brian Millard, Vice President and Chief Financial Officer. Before he begins, let me remind you today's call is property of Universal Display. Any redistribution, retransmission or rebroadcast of any portion of this call in any form without the express or written consent of Universal Display is strictly prohibited. Further, this call is being webcast live and will be made available for a period of time on Universal Display's website. This call contains time-sensitive information that is accurate only as of the date of the live webcast of this call May 3, 2023. During this call, we may make forward-looking statements based on current expectations. These statements are subject to a number of significant risks and uncertainties, and our actual results may differ materially. These risks and uncertainties are discussed in the company's periodic reports filed with the SEC and should be referenced by anyone considering making any investments in the company's securities. Universal Display disclaims any obligation to update any of these statements. Now I'd like to turn the call over to Steve Abramson.

Thanks, Darice, and welcome to everyone on today's call. For the first quarter of 2023, we reported revenue of $130 million, operating profit of $45 million, and net income was $40 million or $0.83 per diluted share. Macro uncertainties continue to linger and weigh on near-term demand. However, we remain confident in the long-term growth path of OLEDs in addition to the significant IT adoption cycle that is expected to commence next year. OLED activity is increasing in several segments of consumer electronics. Last month, Samsung Display announced a $3.1 billion investment to retrofit its Asan plant to a Gen 8.6 OLED IT facility, and it has been reported that other leading panel makers are planning to invest in new capacity as well. Fueling this new CapEx is a nascent OLED IT market. According to Omdia Market Research, 470 million displays for IT products were shipped last year, and only 9.1 million units or 2% were OLED. Omdia forecasts that due to leading OEMs broadening their adoption of OLED in their product portfolio, IT OLED panels will reach 12.9 million units this year and will double to 25.4 million units next year, and by 2028, OLED tablet and notebook panel shipments will reach 74.3 million units. Foldable is another area of growth and excitement. DSCC forecasts that foldable smartphone shipments will increase 45% year-over-year in 2023 to 18.6 million units. DSCC expects to see at least 37 different foldable models shipped this year from 10 different brands, with Google, OnePlus, and Tecno entering the foldable market for the first time. This is an increase from last year when there were 19 different foldable smartphone models from 7 different brands. IDC, another market research firm, projects a 5-year CAGR of 27.6% for foldable phone shipments as units reached 48.1 million units in 2027. Switching gears to automotive. According to Omdia, the automotive industry has emerged as a key market for displays, becoming the fifth largest display application market in terms of shipments as of 2022. Omdia forecasted shipments in the automotive OLED display market will surge to 6.9 million units in 2027 from 770,000 units in 2022, thanks to OLED display's rapid response rate, low power consumption, lightweight, and slim design. In just the past 3 months, Samsung Display signed an agreement with Ferrari to develop OLED displays for Ferrari's next-generation models. LG Display is reportedly planning to supply a 30-inch OLED panel for electric car maker Lucid's upcoming models. Buick showcased its first electric SUV, the 2025 Electra E5 in China with a 30-inch curved OLED dashboard display. Hyundai Motors developed the world's first 30-inch rollable OLED display for automotive applications. For large area OLED panels, LG Display announced it will release a 77-inch transparent OLED product by the end of this year, and Samsung Display announced that its hybrid acuity OLED panel yield now exceeds 90%. We work closely with our customers as they map out their new product introductions for the coming years, and we are developing new OLED technologies and materials to support their product road maps. We have crafted a comprehensive approach for the invention of energy-efficient, high-performing phosphorescent materials. This includes our machine learning, synthetic, mechanistic, analytical, and process chemistry expertise, all created and driven by our global team of scientists, engineers, and technicians. We are continuously discovering, developing, and delivering next-generation reds, greens, yellows, and hosts to meet the ever-changing and ever-evolving specifications for energy efficiency, operational lifetime, and color. As a pioneer in the OLED ecosystem with approximately 3 decades of experience and know-how, we are leveraging our first-mover advantage and continue to be at the forefront of the OLED materials industry. With respect to Blue, we continue to make excellent progress in our ongoing development towards a commercial phosphorescent blue emissive system. We continue to believe we are on track to introduce our all-phosphorescent RGB stack into the commercial market in 2024. We believe that the introduction of our full suite of red, green, and blue phosphorescent emissive materials will unlock a vast array of opportunities for higher energy efficiency and higher performance across a broad range of OLED applications. On the OVJP front, we are making advancements with our groundbreaking dry printing manufacturing process platform. Two critical milestones that we are currently driving towards are the printing of all layers in the FOLED device and achieving scale print uniformity. We believe that achieving these milestones will be significant in our path to commercializing OVJP. To learn more about UDC, including our phosphorescent OLED and OVJP programs, please visit Booth 828 at SID Display Week in Los Angeles later this month. Additionally, this afternoon, we announced the acquisition of Merck KGaA's phosphorescent emitter portfolio and a new multiyear collaboration agreement. The portfolio encompasses over 550 patents in 172 patent families and will complement and boost our strong global IT framework of more than 5,500 issued and pending patents. The new collaboration pertains to certain UDC green and yellow phosphorescent emitters for use with Merck KGaA's transport and host materials to create advanced OLED stacks. On that note, let me turn the call over to Brian.

Thank you, Steve. And again, thank you, everyone, for joining our call today. Looking at the first quarter, our revenue was $130 million, compared to $150 million in the first quarter of 2022. Results were in line with our expectations of a softer first half of the year compared to the second half. Our total material sales were $70 million in the first quarter compared to material sales of $87 million in the first quarter of 2022. Green emitter sales, which include our yellow-green emitters, were $54 million. This compares to $66 million in the first quarter of 2022. Red emitter sales were $16 million. This compares to $20 million in the prior year's quarter. As it has been discussed in the past, material buying patterns can vary quarter-to-quarter. First quarter royalty and license fees were $55 million compared to the prior year period of $60 million. First quarter revenue was $5 million, an increase of $1 million from the comparable period in 2022. First quarter cost of sales in 2023 and 2022 were both $33 million. This translates into total gross margins of 75% in the first quarter of 2023 compared to 78% in the first quarter of 2022. Cost of OLED material sales in the first quarter of 2023 were $29 million, translating into material gross margins of 58%. This compares to $30 million and material gross margins of 65% in the first quarter of 2022. Impacting first quarter gross margins was a $3.3 million increase in our inventory provision and $4.7 million related to the underutilization of our new Shannon facility. The combined impact of these items is approximately 6% to total gross margins. First quarter operating expenses, excluding the cost of sales, were $52 million. In the first quarter of 2022, it was $55 million. The year-over-year decrease is primarily due to lower stock-based compensation expense and the Fuji Film patents becoming fully amortized in July of last year. We continue to expect 2023 OpEx to increase 5% to 10% year-over-year as we continue to invest in our people, our global infrastructure, and our innovation engine. Operating income was $45 million in the first quarter, translating into an operating margin of 35%. This compares to the prior year period of $62 million and operating margin of 41%. The income tax rate was 23% in the first quarter of 2023. We expect our tax rate for the year to be approximately 22%. First quarter 2023 net income was $40 million or $0.83 per diluted share. This compares to $50 million or $1.05 per diluted share in the comparable period in 2022. We ended the quarter with approximately $845 million in cash, cash equivalents, and investments. Regarding guidance, we are reaffirming our expectation that 2023 revenues will be in the range of $550 million to $600 million. Lastly, our Board of Directors approved a $0.35 quarterly dividend, which will be paid on June 30, 2023, to stockholders of record as of the close of business on June 16, 2023. The dividend reflects our expected continued positive cash flow generation and commitment to return capital to our shareholders. With that, I'll turn the call back to Steve.

Thanks, Brian. Energy efficiency and sustainability are key foundational elements in UDC's core competencies. Our patented and award-winning phosphorescent OLED technology and universal FOLED materials can enhance the performance of displays and lighting products, providing real power-saving advantages for longer battery operation in portable electronics and less energy consumption in larger displays and lighting products. In our recently published 2022 Corporate Social Responsibility Report, which can be found on our website, we estimate that our phosphorescent technology and materials in OLED smartphones save more than 860,000 metric tons of carbon dioxide equivalent per year. Using an EPA calculator, this is comparable to carbon sequestered by more than 14 million tree ceilings growing for 10 years. In addition to the continuous generation-to-generation improvements in our red and green phosphorescent materials, the introduction of our phosphorescent blue into the commercial market is expected to further increase energy efficiency and translate into added power savings, longer battery life, brighter displays, and lower panel temperature. We believe that our broadening phosphorescent portfolio will enable new product designs and applications and support our customers' sustainability initiatives, driving growth for UDC and the OLED industry. And lastly, I would like to thank each of our employees for their drive, desire, dedication, and heart in elevating and shaping Universal Display's accomplishments and advancements. We are committed to being a leader in the OLED ecosystem, achieving superior long-term growth, and delivering cutting-edge technologies and materials for the industry, for our customers, and for our shareholders. And with that, operator, let's start the Q&A.

Our first question is from Brian Lee with Goldman Sachs.

Sorry, I jumped on late, so apologies if you already covered this. But did you sell and do development on materials in the quarter? How much if you did? And then how many customers can win where the purchasing blue this quarter for purposes?

Yes. Brian, thanks for the question. So we did have sales of blue materials, both host and emitter development sales in the period, a few hundred thousand dollars' worth across a number of customers.

Okay. Great. And then the second question, just on the TV market. I know there's been a lot of back and forth in the press about LG and Samsung doing a deal on OLED panels for TV. Maybe high level, can you speak to some of the implications that you see for the market? And then also for UDC, any potential upside maybe to your internal views around the TV market this year given this sort of go forward?

Brian, as you know, we can't speak for our customers. We think the OLED TV market is great. OLED TVs are great. And the more Samsung and LG sell, the better it is for us.

Our next question is from Krish Sankar with TD Cowen.

This is Steven calling on behalf of Krish. First one, if I could, a Steve or for Brian. In terms of linearity in the third quarter, can you talk about how customer orders trended relative to your original expectations? And on coming into this current quarter. How has your conversations with customers been and your sentiment especially relative to any delays or pushouts to deposits in orders?

Yes. Stephen, question. So yes, in terms of the quarter, I mean, as we said in the release, it really did play out in line with our expectations. So there really wasn't anything out of the ordinary that we saw in Q1. The reaffirmation of guidance for the year is evidence that I think what we're seeing and hearing from customers for the rest of the year is also in line with those expectations and what we had originally planned. I think it's certainly expected to be a second half weighted story. We do expect the first half to be lighter. And I think you're seeing that in the Q1 result. But everything we're hearing from the customers is really consistent with where we were back in February as well.

Got it. And just as my follow-up, Brian, just wondering about inventory days. So I know things like the dollar levels and inventory days came down a little bit this quarter. But just in terms of big picture conceptually, your inventory days have been well above 12 months for a number of quarters now. And I guess just kind of looking back historically, the last time there was a big step up from, I think, the roughly 9-month type of range to above 12 months was back in 2017 when premium smartphones began to adopt OLED panels. And so I guess my question is, should we expect that to go back down towards the 12-month mark over time as demand recovers? Or is there a structural change in your demand profile from customers because of TVs and IT going forward, where we should expect inventory days to maybe stay in this 12 to 16 months type of range?

Yes. So on inventory, there are really kind of two main drivers there for the increase you've seen in recent periods. The first being in our raw materials inventory, which is where the bulk of the increase has been. We have iridium, which is a key raw material for us and is included in a number of our materials. We have been building a strategic stockpile of that. We feel comfortable with the quantities of iridium that we have on hand, but that's been some of what you've seen in the increased dollar value in the last few years. Also, on the finished goods side, we're a sole-source supplier for our customers. So we need to make sure that we have the quantities on hand to meet their demands. But the increases that you've seen on that side have not been necessarily because of anything specific we're hearing from the customers, but more just our own planning. But we're always making sure that we're being disciplined and not getting too far ahead of the demand curve there and how we build up our supply.

Our next question is from Sydney Ho with Deutsche Bank.

I got a couple of questions. First one is on the acquisition of Merck's patent portfolio. Can you walk us through what you get that is not already covered by your IT portfolio? Does that accelerate your product development, let's say, the blue emitters? Or does that mean going forward, you will be more active in selling host materials or just kind of strengthen your royalty and licensing business?

This is really to expand and buttress our patent portfolio, our emitter patent portfolio. So we clearly have the leading position in phosphorescent emitters, and when Merck's patent portfolio became available, we felt it was a very good addition to our portfolio, and it will broaden tools at our team's disposal as we develop next-generation post-reset materials and continue to build upon our industry-leading position.

Okay. That's fair. The second question is, I noticed that for Q1, the revenue outside your two top customers are now 44% of total revenue, which seems like the highest that I can remember. Can you talk about the breadth of that revenue stream? And do you have any concerns that there is a lot of excess inventory at those customers, especially given the persisting weakness we've been hearing from Chinese OEMs?

Yes, we have a number of customers beyond the top two, and we've observed those entities increasing their share with us recently. There's variability in our customers' buying patterns from quarter to quarter, which can impact the top two customers' contributions at times. However, we don't see this as a structural change; it's more of a one-off occurrence that we're experiencing in Q1.

Our next question is from Mehdi Hosseini with SIG.

A follow-up to the Merck topic. Should I take this patent acquisition as a sign that you are renewing efforts to drive revenue from the host? And if not, then what's the main objective here?

No, we are not renewing efforts on the host. This acquisition is focused on the emitter portfolio, aimed at providing our team with additional pathways to develop future and broader materials for our customers and the industry, and to accelerate the ecosystem.

Okay. Got it. And I'm assuming that your acquisition of patents won't have any near-term impact on your financials. Fair?

No, it was a $66 million purchase price. That cash outflow has occurred, and we'll be amortizing that over a 10-year period. So there'll be roughly $6 million of annual expense going forward.

Okay. It's very encouraging to hear that you are actually recognizing blue emitter revenue. Should I assume that a couple of hundred thousand a quarter of revenue is sufficient for your customers and their clients to develop the necessary semiconductor components to qualify the panels? Or would you need to sell more as they prepare for high-volume manufacturing next year?

Yes. So in terms of the quantities of blue, it is an increasing quantity. I think what we sold in Q1 is pretty similar to what we sold for all of last year. It has increased in Q1. I think those quantities certainly will increase somewhat as we get closer to commercialization. But we feel comfortable with the 2024 launch having commercial material available next year and the timelines and feel comfortable with the pace that we're making with that as well as what we're hearing from our customers.

I guess what I'm trying to better understand is if there is a lagging effect between the volume shipment from you to your customer and the time it would take for your customers to work with their customers to qualify for and project.

I believe there will definitely be a sequence of events. Our customers need time to build panels, ensure they are satisfied with their performance, and then engage with their clients. Therefore, I anticipate an increase in activity as we near the commercialization or official launch of a panel featuring our blue phosphorescent material.

Our next question is from Nam Kim with Arete Research.

Sorry, a quick clarification on Merck, your IP acquisition. Again, you just said you will enhance the emitter patent portfolio. You also said in pre-COVID remarks. And I also remember, Merck used to supply the layer for one of your customers. So I just wonder, are you interested in entering into any other OLED material business like HTL other than the current EML layer business?

No, Nam. This is just an emitter acquisition.

Yes, Nam, the collaboration agreement that we announced today as well in the release that we put out, that's focused on collaborating with Merck and providing our emitters so they can use those in their development of host and transport layers.

Okay. Another question. I think none of your customers signed the contract on buyer. Obviously, it's not available commercially today. Should we expect additional royalty licensing income on top of additional material revenue and you have a commercial ramp on Blue next year? I just wonder if there will be any financial implications on additional licensing contracts on blue with your customer.

Yes. Our contracts, our license agreements with our customers, certain of them are portfolio license agreements that do include Blue and certain customers, specifically our contract with Samsung, excludes Blue. So it just kind of depends on a customer-to-customer basis whether there's an incremental opportunity there.

Our next question is from Jim Rashidi with Needham & Company. Brian Millard, Vice President and CFO, responded that their license agreements with customers vary; some are portfolio agreements that include Blue while others, like the one with Samsung, do not include Blue. Therefore, the opportunities depend on each individual customer.

This is actually Chris Grenga on for Jim. With respect to the cost of materials, could you just elaborate on the puts and takes there, particularly the inventory charge? And how should we be thinking about the cadence of the impact of the Shannon facility as we go through the year?

Thanks, Chris. In Q1, we recorded a $3.3 million inventory provision. Each quarter, we review our sales plan and the quantities we have available, and during this review, we identified some materials with excess quantities that required provision. This is a regular process we undergo quarterly, and while sometimes the number is very small or nonexistent, this quarter it was $3 million. Regarding Shannon, we had $4.7 million in underutilization for Q1, which is slightly higher than last year's run rate. As we've collaborated with the team, we expect to see a slight increase in underutilization costs this year, potentially just over $1 million, but still largely in line with previous disclosures. This should occur relatively evenly throughout the year, averaging slightly more than $1 million per month.

And you spoke about the investments that you're seeing and the secular tailwinds, particularly in IT. I'm just I guess, what else are you seeing that gives you confidence that you're going to see acceleration in the back half of the year to achieve the guidance?

Yes. I think a lot of it is what you hear from our customers in terms of the expectation that the second half of the year is going to be better than the first half. A lot of what we're saying is an echo of others in the ecosystem, informed by our forecast information that we get from our field teams and our customers in terms of what they're seeing and expecting and planning for. Some of that has to do with product launch cycles that are planned for the second half of the year, which also demand additional quantity material to meet those launches. There are a number of factors that we're monitoring, all of which kind of inform the reaffirmation of our guidance range.

Great. And one more question about Merck. Are the emitters generally relevant to consumer electronics, or is there a specific type or size that the newly acquired portfolio of intellectual property would relate to more or less?

Well, Merck's been working in this field for a long time, and they have a lot of really smart people working on it. I would say it's broadly applicable across the board.

Our next question is from Martin Yang with Oppenheimer.

I dropped off for the last couple of minutes. So sorry if this has been asked before. Can you remind us your expected ratio between material and royalty sales for the year?

Yes. Martin, so we're expecting a ratio of 1.5:1, so 1.5 materials to 1 royalty license.

Got it. Second question is on your license agreement with Samsung. It seems that you have eliminated language around the purchase agreement on the new material supply agreement that you entered into since late last year. Can you confirm and also maybe comment on how that impacts your revenue recognition and cash flow going forward?

Yes. There is no change in terms of the structure of the contract with respect to minimum requirements from the old agreement to the new ones. That's completely unchanged. If there's a wording change, it's just a nuance on our side as opposed to any change in the contracts.

Got it. So can you maybe clarify on how going forward the revenue recognition will track a bit more closely with cash flows?

Yes. The revenue model is exactly the same in that we have to recognize on a per unit basis as we ship material, both the material revenues as well as the royalty and license revenues, based on estimates of contract purchases over the full term. The payment structure is slightly different in the new contract as opposed to the former. The prior contract had quarterly payments, and this contract has both quarterly and annual payments. Obviously, we can't go into the depths of the details on how those are calculated. However, there is a different payment structure that makes us feel like revenue recognition and cash collection should be much more closely correlated in this current contract.

This concludes the question-and-answer session. I would like to turn the program back to Brian Millard for any closing comments.

Thank you for your time today. We appreciate your interest and support.

This concludes today’s conference call. You may now disconnect.