Q1 2023 Universal Display Corp Earnings Call

Participants

Brian Millard; VP, CFO & Treasurer; Universal Display Corporation

Darice Liu; Director of IR & Corporate Communications; Universal Display Corporation

Steven V. Abramson; President, CEO & Director; Universal Display Corporation

Brian K. Lee; VP & Senior Clean Energy Analyst; Goldman Sachs Group, Inc., Research Division

Christopher Grenga; Analyst; Needham & Company, LLC, Research Division

Kinney Chin; VP; TD Cowen, Research Division

Mehdi Hosseini; Senior Analyst; Susquehanna Financial Group, LLLP, Research Division

Nam Hyung Kim; Senior Analyst; Arete Research Services LLP

Shek Ming Ho; Director & Senior Analyst; Deutsche Bank AG, Research Division

Zhihua Yang; Associate; Oppenheimer & Co. Inc., Research Division

Presentation

Operator

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. (Operator Instructions) 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.

Darice Liu

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 Steve begins, let me remind you today's call is a property of Universal Display. Any redistribution, retransmission or rebroadcast of any portion of this call in any form without the expressed 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.

Steven V. 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 the consumer electronics landscape.
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 forecast 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 forecast the foldable smartphone shipment 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 [Techno] 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 displays 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. [Blue] showcased its first electric SUV, the 2025 Electra E5 in China with a 30-inch curved OLED dashboard display. And Hyundai MOBIS developed the world's first 30-inch rollable OLED display for automotive applications.
And for large area OLED panels, LG Display announcement 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 gamut. 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 where for a commercial phosphorescent and blue emissive system. We continue to believe that 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.

Brian Millard

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. Adesis' 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 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 Fujifilm 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, in our global infrastructure and in our innovation engine.
Operating income was $45 million in the first quarter, translating into 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. And 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.

Steven V. Abramson

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 saves 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 seedlings 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.

Question and Answer Session

Operator

(Operator Instructions) Our first question is from Brian Lee with Goldman Sachs.

Brian K. Lee

Sorry, I jumped on late, so apologies if you already covered this. But did you sell any blue development pro materials in the quarter? How much if you did? And then how many customers [account lines were they] purchasing blue this quarter for sampling purposes?

Brian Millard

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.

Brian K. Lee

Okay. Great. And then 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?

Steven V. Abramson

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.

Operator

Our next question is from Krish Sankar with TD Cowen.

Kinney Chin

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

Brian Millard

Yes. Steven, great 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. And 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.

Kinney Chin

Got it. And just as my follow-up, Brian, just wondering about inventory days. So I know things like the dollar levels and of 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 are to adopt OLED panels.
And so I guess my question is, the higher inventory days that you guys are running at, should we expect that to go back down towards the 12-month mark over time as demand recovers? Or is the -- is there a structural change in your demand profile from customers because of TVs and IT panels going forward, where we should expect inventory days to maybe stay in this 12 to 16 months type of range?

Brian Millard

Yes. So on inventory, there's really kind of 2 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.
And so 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.

Operator

Our next question is from Sidney Ho with Deutsche Bank.

Shek Ming Ho

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?

Steven V. Abramson

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 blue in next-generation phosphorescent materials and continue to build upon our industry-leading position.

Shek Ming Ho

Okay. That's fair. The second question is, I noticed that for Q1, the revenue outside your 2 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 (inaudible) and OEMs?

Brian Millard

Yes. So we continue -- we have a number of customers, as you know, beyond the top 2, and we've seen those entities continue to increase their share with us over recent periods. So nothing really specific. I think there's also variability in our customers' buying patterns quarter-to-quarter that also contributes to some periods, the top 2 maybe a little less than in others. But it's not a structural change in our view, it's just kind of a little bit of a one-off, I think, that you're seeing in Q1.

Operator

Our next question is from Mehdi Hosseini with SIG.

Mehdi Hosseini

A follow-up to the Merck topic. Should I take this patient 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?

Steven V. Abramson

No, it is not -- we're not renewing efforts on the host. This is an emitter portfolio acquisition, and it was basically to provide our team with additional pathways so that we can develop future materials, broader materials for our customers, for the industry and accelerate the ecosystem.

Mehdi Hosseini

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

Brian Millard

No, it was a $66 million purchase price. So we've -- 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.

Mehdi Hosseini

Okay. All right. And then just -- it's very encouraging to hear that you actually are recognizing emitter revenue -- or I'm sorry, blue emitter revenue. Should I assume that a couple of hundred thousand dollars a quarter of revenue is enough for your customers to -- and your customers' customers develop the required semiconductor components to qualify the panels? Or would you have to sell more as they retool and prepare for high-volume manufacturing next year?

Brian Millard

Yes. So in terms of the quantities of blue, it is an increasing quantity. I think what we sold in Q1, dollar-wise, is pretty similar to what we sold for all of last year. So it has increased in Q1. I think those quantities certainly will increase somewhat as we get closer to a commercialization. But we feel comfortable with the 2020 for us having commercial material available next year and the time lines and feel comfortable with the pace that we're making with that as well as what we're hearing from our customers.

Mehdi Hosseini

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 end product]?

Brian Millard

I think there certainly would be -- there's just kind of playing out the sequencing our customers, we need to do build panels, feel comfortable with the performance of those and then have conversations with theirs. So I think that there'll be increasing activity as we approach commercialization or commercial launch of a panel with our blue phosphorescent material in it.

Operator

Our next question is from Nam Kim with Arete Research.

Nam Hyung Kim

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

Steven V. Abramson

No, Nam. This is just an emitter acquisition.

Brian Millard

Yes, the collaboration agreement -- 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.

Nam Hyung Kim

Okay. Another question. I think none of your customers signed the contract on blue yet. 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 implication on additional licensing contracts on blue with your customer.

Brian Millard

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

Operator

(Operator Instructions) Our next quarter is from Jim Ricchiuti with Needham & Company.

Christopher Grenga

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?

Brian Millard

Thanks, Chris. So on the inventory charge, we did record a $3.3 million inventory provision in Q1, and that was really -- each quarter, we have to take a look at our sales plan and the quantities we have on hand. And as we did that this period, there were certain materials that we had excess quantities of and just needed to provide for.
So that's really a composition of that. It's something we have to do every quarter. Sometimes it's a really small number or no number. This quarter, it happened to be $3 million. And then as it relates to Shannon, we had $4.7 million in Q1 of underutilization. That's slightly higher than the run rate that we had last year. And I think as we've worked with the team, I think there's going to be a slight uptick, maybe slightly more than $1 million of underutilization cost this year, but still more or less in that ballpark of what we've previously disclosed. And it should be pretty linear in terms of cadence over the year, slightly more than $1 million per month.

Christopher Grenga

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 an acceleration in the back half of the year to achieve the guidance?

Brian Millard

Yes. I think it's -- 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. So I think a lot of what we're saying is an echo of others in the ecosystem, which 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.
And also some of that has to do with product launch cycles that are planned for the second half of the year, which also demand additional quantities of material to meet those launches. So there's a number of factors that we're monitoring, but all that kind of informs the reaffirmation of our guidance range.

Christopher Grenga

Great. And one -- just one more, if I may, on Merck, are the emitters broadly relevant to consumer electronics generally? Or is there any particular typology or size that those emitters, that newly acquired portfolio of IP would be more or less relevant to?

Steven V. Abramson

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

Operator

Our next question is from Martin Yang with Oppenheimer.

Zhihua Yang

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?

Brian Millard

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

Zhihua Yang

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

Brian Millard

Yes. So there's no change in terms of the structure of the contract with respect to minimum requirements from the old agreement to the new ones. So that's completely unchanged. So if there's a wording change, it's just a nuance on our side as opposed to anything structural in the contracts.

Zhihua Yang

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

Brian Millard

Yes. So the revenue model is exactly the same in that we have to look at our -- recognize on a per unit basis as we ship material, both the material revenues as well as the royalty and license revenues, and that's 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. But there is just a different payment structure that makes us feel like revenue recognition and cash collection should be much more closely correlated in this next -- in this current contract.

Operator

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

Brian Millard

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

Operator

This conclude today's conference call. You may now disconnect.