Japan Display Inc. (6740) Earnings Call Transcript & Summary

Good day, everyone, and thank you for joining the call today for Japan Display's March 2021 earnings. My name is Kumi Higuchi from Japan Display. I'm the Head of Investor Relations and will be the moderator today. Before we start, I would like to direct participants to our website at www.j-display.com, where you can find a copy of March 2021 earnings presentation. Our management will review this presentation during today's call. [Operator Instructions] Also, a video of the presentation today will be up on our official YouTube channel, starting from tomorrow. Today's speakers are Scott Callon, our Chairman and CEO; and Akihito Okochi, our Chief Financial Officer. Now Scott Callon will start the presentation with an overview of the ended fiscal year. Scott-san, please.

We're grateful for it. We'll do this presentation in 3 parts. I'll start by going through an overview of FY '21/3, so the March '21 fiscal year, then Okochi-san will go through the numbers and I'll come back and talk to our strategy. So I mean, in a word, it was a very hard year. It was hard for everybody on this call. It was hard for the world. It was hard for Japan. It was hard for JDI because of COVID. So that was -- we spent the year working really, really hard to keep everything up and shipping, and we did that. I think that it was a critical success. And we had to manage the supply chain through this, which was also a very difficult ask. But it happened. We did progress our technology R&D road map, and we began mass production of 76 new products during the year, which is up 9% versus the previous year, which was just an extraordinary effort by everybody involved, the R&D teams, the engineers, doing the design and those in the factories. We have to cut our fixed and variable costs, so we did. We generated a positive gross profit and we significantly reduced operating loss. That's not nearly enough. There's a lot more to be done, and we are doing it. We reinforced our capital with a large-scale equity financing from Ichigo Trust, and we significantly strengthened our governance and established systems to prevent recurrence of appropriate accounting. For those of you who are not familiar, we did something really wrong. It should never happen. We had inappropriate financials in previous years. And we've fixed all of it. So let me go quickly through the business. We don't have endless amount of time on this call, so I'll just step through some of the highlights. In the mobile space, we did -- we made a mistake. We thought that -- several years ago, we thought that smartphone demand was going to remain with high-end LCDs. And in fact, what happened was there was a shift to OLED. And so we lost significant amount of orders from a major customer. In response to that, we need to cut our costs in a big way and we have, including the sale of the Hakusan Plant. So that's a plant in northeastern Japan in the city called Hakusan that was designed to do very high-end LCDs that we no longer needed. And the good news is very strong sales of smartphone LCDs into the Chinese market. It's something I'll touch on later, but it is clearly the case where substantial demand is coming at us in a positive way. On automotive, that was the most impacted sector for us by COVID with the sales going through the floor in Q1 and then a very strong rebound from Q2. And by the end of the year, we're seeing year-on-year increases in our automotive space relative to the previous year. Non-mobile, the key events there are we going to see very strong demand on shipping of our OLED product for wearables. And I'll talk about this a little bit later but LCDs for ultra-high-resolution VR devices, where we have a clear technical and productive -- production and yield advantage relative to our competitors. In R&D, again a good year for us in terms of moving forward on the technology road map. We have a lot of things that we want to surprise the world with that are exciting. Our biggest challenge in R&D historically is that we haven't been fast enough in getting the product to market or having been thoughtful about which places we want to place our technology bets in order to generate the highest earnings. And so that's a change that we've made. The final point, we know on a company-wide basis that there has been a COVID impact that we continue to deal. There are trade conflicts, which have seem to have lessened somewhat. The tightening of global semiconductor supply and demand is a daily battle. You should know that. The shortage in driver ICs, so in our case, display drivers is a critical negative. We have incorporated significant downside from the shortage in this year's forecast. We're hopeful that -- and there's every sign that the situation is improving on the margin, but it's still a daily battle. And I'm personally involved as CEO and talking with suppliers and customers and trying to sort out how we allocate product, the chips in the best way in order to serve our customers. Absolutely critical for us to increase our cost competitiveness in this year. So again, I'm talking about the year until March 2021. We reduced our fixed cost by JPY 27 billion, so roughly USD 270 million. That's huge. I mean, the plan is to take down our break-even point very substantially. And so when we drive higher volumes, and we expect this year will be the bottom, so fiscal year March 2022, so the year that we're currently in, that this will be the bottom for us from a revenue perspective. We're pretty confident -- we're very confident. We already hit the bottom from an earnings perspective in the year that we're talking about today, FY '21/3. So we've doubled bottom and we're coming up from here. And you drive down your cost, you drive down your break-even point. And so when you rebound, you make money. And the goal is to make a lot of money for our shareholders. So we took down our fixed cost by about JPY 27 billion. We took down our variable cost by over JPY 10 billion. Those are very, very important deliverables for the firm. In terms of business activity, the 3 keys, we're strengthening our governance, rebuilding our financial base and building new businesses. I'm not going to talk in -- we have Q&A today, so I'll take Q&As on things that you care about. Very specifically though, as I said earlier, we had a problem, a governance problem that we fixed. Completely revamped the Board, revamped our control structures, went through a process, very detailed with the regulator, both the FSA and the TSE, Tokyo Stock Exchange taking a lead on it. We went through this process of all the things that we diagnosed that we've done wrong, how we're going to fix them. And we've completed all of them. We sold -- as I mentioned earlier, we -- the Hakusan Plant. We built it to do high-end LCD. When the market shifted away to OLED, we no longer needed it. The 2 key deliverables from that from a financial perspective are it takes down our costs by JPY 8 billion per annum. And also on the bottom of the page, you can see we took a gain on sale on it of about JPY 90 billion, so on the yen to the dollar, that's about USD 190 million. We also did a financing with Ichigo. That is -- it's been partially exercised. So JPY 19 billion has come in. There's another JPY 36 billion to come, which we fully expect that we will get this year. So that's what I have in terms of the past year. Okochi-san will now go through the financials and I'll return and talk about the forward strategy.

I'm CFO, Akihito Okochi, and I will cover our financials. This is the financial results summary. And as you can see here, the net sales were JPY 341 billion and net loss, JPY 42.7 billion, and EBITDA, JPY 12.5 billion, negative numbers. As I explained at the third quarter financial announcement on February 10, the major customer shifted their smartphone display from LCD to OLED and the consolidated sales dropped to this number. This is almost equal to the forecast JPY 342.5 billion at the previous financials announcement. On the left bottom side, as you can see here, this is the sales by product categories. You can -- mobile, Europe and America, sales was JPY 162.6 billion. The majority is for our main smartphone customer. And the sale became half amount of the previous year. On the other hand, non-mobile increased and automobile has been back to normal. Non-mobile, especially wearable OLED, which started the mass production in last year for the main customer, and ultra-high-resolution LCD for VR, the sales increased JPY 6.6 billion, 30%, to JPY 56.2 billion from previous year. Automobile sales was bottomed at the first quarter and it has been back to normal since second quarter. And for -- as for first quarter, it's bigger than the previous year. I expect the sales will be stable here, gradually growing going forward. And I'll explain the details in the part of fiscal year '21 forecast. As for P&L, although sales significantly dropped, we made every effort to cut fixed cost by Hakusan Plant sale, management reforming 2019 and any other cost reduction. And then gross profit became positive. Operating income improved by JPY 12.2 billion, EBITDA improved JPY 7 billion, respectively. I will explain the details by the next slide. As Scott explained earlier, we achieved a fixed cost of JPY 28 billion reduction and variable cost 3 points improved, respectively, as announced at the second quarter financials announcement. As a result, operating income improved JPY 3.3 billion comparing to previous forecast, JPY 29.6 billion. However, as you recognize as well, we do need more measures in order to make JDI profitable. So we subsequently take measures and moving forward them. Well, we'll achieve the EBITDA profitable positive at the fourth quarter as we announced before. Next slide. You can see the change factors of our operating income from '19 to '20. As I explained earlier, due to significant sales drop from JPY 504 billion to JPY 341.7 billion, shipment volume and product mix decreased close to JPY 29.8 billion loss and we strongly implemented cost reduction, as I explained earlier. Hakusan Plant sale, significant fixed cost cut by management reform or -- and any other costs written here made JPY 27.5 billion in total. Additionally, there are no specific significant factors as the previous year. As a result, operating income improved when it became JPY 26.2 billion loss. And next slide. This is the changing factors by quarter base. On the left side, you see the comparison of fourth quarter of 2019 and '20 year-over-year base. On Y-o-Y base, due to sales drop, shipment volume and product mix declined JPY 4.7 billion. But cost reduction, as explained in the previous page, made JPY 2.7 billion improvement. And then final operating income became JPY 7.6 billion loss. On the right-hand side, the comparison, third quarter and the fourth quarter. And JPY 10 million increase -- JPY 1 billion increase by shipment volume and product mix, mainly [indiscernible] operating income improvement. I will talk about balance sheet here and cash flow statement in the next slide. Firstly, balance sheet. Fixed cost -- fixed asset was decreased by Hakusan Plant, as explained. And total assets was significantly downsized from JPY 389.7 billion to JPY 225 billion, 42% decrease. Related to Hakusan Plant sale, advances received debt -- as relevant to debt was fully repaid. Although net loss was JPY 41.7 billion, additional equity injection by Ichigo, net asset was JPY 41.8 billion and shareholders' equity ratio increased 4.5 points to 17.6% percent. There's still JPY 36 billion unexercised portion of stock acquisition rights by Ichigo. We plan to improvement capital enhancement by such exercise in this year. Cash flow -- consolidated cash flow. As for operating cash flow, net loss before tax was JPY 41.7 billion and working capital was JPY 20.6 billion positive because of the shrinking of LCD smartphone business to our main customer. With this -- with other factors, operating cash flow was JPY 23.1 billion negative. As for cash flow investment -- investing activities, we controlled our CapEx and decreased JPY 9.1 billion. Financing cash flow, equity finance from Ichigo, JPY 5.5 billion for preferred stock and JPY 19.4 billion are exercise of stock acquisition rights. And in total, JPY 20.2 billion cash flow statement. Net free cash flow was improved to JPY 13 billion to JPY 30.2 billion negative and cash balance was JPY 55.3 billion. Finally, this is the -- this is forecast. From this time, we've decided to disclose the sales breakdown for both full year and quarter. Full year forecast is JPY 254 billion. And as explained at the financial announcement on February 10, the main customer shifted from LCD to OLED. And then mobile, Europe and America, will continuously decrease. But automobile and non-mobile business will continue to do well. Automobile, as I explained, regard of the COVID-19 effect, we see a big demand globally, not only United States, Europe, China and Japan. But on the other hand, we continue to closely pay attention to the potential effect by semiconductor components shortage. Even we conservatively assume such effect, we expect JPY 103 billion sales, 17% more than previous year. In non-mobile, we expected JPY 70 billion, 25% increase due to the good sales of both wearable OLED to main customer and ultra-high-resolution LCD for VR. Mobile, except Europe and America, we see continuously high demand in China market. However, considering this profitability, we do not plan to [indiscernible] grow this business and expect the same level as previous year. Despite of sales business model, its profitability is improving right now. As for P&L, we see -- we still expect JPY 8.8 billion operating loss because of sales decline. However, as announced earlier, we target this fourth quarter EBITDA profitable positive. And we expect OLED wearable sales increase and the cost reduction and other measures. Finally, the sales was bottomed for this year. And P&L, operating income was bottomed at the previous year. And we aim to achieve the EBITDA positive for this year. In order to do so, we are still looking into the strategies and we'll -- our CEO, Scott, will explain the strategy later on. Thank you.

So let me go through the strategy. Three central points. First is game change, meaning we've been unprofitable for a number of years. JDI has absolutely world-class technology, engineering, customer trust, customer commitment, employee commitment and had the wrong cost structure and very specifically made the wrong bet on the future of smartphone technology. And that put a $2 billion hole in the balance sheet coming from the Hakusan Plant. So we need to do a major reset of who we are and we are. So nothing small is going to happen. This is a world-class company with world-class capabilities. And we're going to execute a game change in order to get those capabilities out into the world. The second one is JDI is different, meaning we need to be different. I'm fully uninterested in having a me-too strategy. The firm has a distinctive set of capabilities that are world-class. We're going to deploy those capabilities in a way that is unique and differentiated. And our view on that is that if you want to serve customers in the world, you need to be different. I mean, if you do the same thing as three other firms, what exactly is your contribution? So a very strong focus on going big in game change, a very strong focus on being truly differentiated as a second pillar of the strategy. And third is we're a personal tech company. We build products that are used in people's daily lives. There's no question that displays are a foundational technology for modern life. Those displays are used in smartphones. They're used in wearables. They're used in VR devices. They're used in notebooks. They're used in cars. That is our key deliverable to the world as products that serve people's daily lives. In terms of the specific strategy, it's implementation. It's two focuses. One is strengthening existing businesses and another is building new businesses. And the KPIs are very important. So we're guiding to JPY 8.8 billion loss in Q1. And I'll go through why we think this KPI is [indiscernible] one we do. But we're targeting turning EBITDA positive, so cash positive, cash earnings positive in the fourth quarter of this year, absolutely critical deliverable. And that's just the first step, right? We want to be a robustly profitable as a firm and we think we can get there. And the second KPI is we're going to build new businesses. And very specifically, we expect to launch multiple service, solution and platform businesses this year, so not fiscal year but calendar year, by December, leveraging our new -- our key device technologies. In terms of what we want to do, what are the kinds of businesses that we're willing to be involved and what kinds are not? I mean, this is kind of the threshold criteria we're using on do we stay in a business? Do we extend the business? Do we enter a business? One, colloquially, 3 bigs, meaning there needs to be a big need, there needs to be a big market and we need to have big impact. We're not interested in -- this is about a game change. We're not interested in doing things that are small, that don't move the needle, that don't change the world. And so the third point, big impact is important also. There's a big need -- because there's a big need, there's a big market. And JDI's participation, we can't really have much of an impact, we're not interested in that. We really want to have an impact as a firm, and we think we can. And the second one is JDI needs to be different. So again, there needs to be a unique set of capabilities and durable to customers, otherwise why we even are involved. And needless to say, it needs to be highly profitable. So those are -- I mean -- and these are hard screens. The Venn diagram, the joint set of all these things together, is not a big one. And that's the point. We're going to be focused on where we can really deliver value for customers in the world. One of the things that went wrong is we lost a bunch of orders from a huge customer in U.S. -- in mobile in U.S. and Europe. And we would prefer to have that business not have it. But the reality is we had a business that was very focused on a single major customer. And the risk of that is you lose a customer. And so we've gone through -- the bad thing has happened. And the lesson that was learned is you need to have more robust, more diverse, less concentrated product segments such you don't have a problem where you fall over when you lose a major customer. And so that's where we are today. So at peak, the major customer was about 60% of our business in mobile. It's down to 19%. And it's on mobile in U.S. and Europe. What's grown is non-mobile and automotive. And those have much more diverse customer sets, so we don't have critical customer risk anymore like we did. And also very explicitly, and this is part of the strategy. One of the reasons why automotive is a very good business is because you get -- you're shipping against cars that have a model life of 5 years or 10 years and they also have after-service around that. So typically, the order stream for automotive is going to be 5, 10 years. So it's a very stable business. So what I'm getting at is it's a strategic priority of the firm and one what we're delivering against is to have substantially more diverse and more stable earnings. And we will continue to focus on that and deliver against that. Let me talk a little bit about the market environment. The -- so if we're at -- we're forecasting a loss, we think, of JPY 8.8 billion, JPY 2.3 billion of that is linked to the semiconductor shortage. So that's -- presumably, at some point, the world gets through this. So that's just a one-off. But how do we -- why do we think it's credible? And we do think it's credible that we get to EBITDA breakeven by the fourth quarter. And it's really linked to the upside earnings opportunities. So one of the things, and we've let the market know this already. We have done a major -- are doing a major expansion of our OLED production capacity. That will be done by -- and it's a back-end expansion, meaning the front end, which is where the heavy CapEx has to occur, has already happened. So this is actually being entirely done by ams, our back-end partner. And that production capability expansion that happens on the back end means that we could do substantially greater sales of OLED. And we fully expect we're going to get the customer business and are talking with a key customer for that purpose. So we think that's a big driver and that appears in Q3 and Q4. The second one is improvements in pricing and product mix. Big point on this, quite honestly, is difficult conversations with customers on -- we are a major supplier to you, in many cases, particularly in auto space. Over half the time, we're the single-source supplier. And the reason we're a single source is because we have this extraordinary track record of technology and quality and reliability and these super-trustworthy engineers. And it speaks to the degree of trust for Japan and Japanese companies across the world. When we make a commitment, we keep our promises. And so our customers, which are primarily global customers, want to do business with us. And they don't want to do business with anyone else. I mean, literally, we're going to single source you. And if that's the case, it's -- the conversation with the customer is like, "We need some help. I mean, this business is not profitable for us." And so none of these are easy conversations. It's not easy for our sales guys. It's not easy for me when I'm involved. But we think there are improvements in pricing and product available that won't begin to show up in the second half of this year and will happen -- will show up over time in 20 -- in the next year, in the '23 March year and going forward. And the other thing that's clearly happened is a global tightness in display supply and we have greater pricing power. And so that shows up really from kind of July pricing, which is going to be our Q2. We think we see a significant upward repricing of what we're doing in the LCD space. And that will be an earnings driver. So those are the kind of the visible upside opportunities. The downside risk is the semiconductor shortage. We have priced in that quite a bit. We've taken about JPY 30 billion in revenues out of our -- this year forecast on the basis of we're not going to have enough semiconductors, so specifically driver ICs, to meet customer demand. I mean, it's a way of saying we have more customer demand than we think we may be able to supply. And the downside earnings risk is, relative to our forecast, is also upside. So in other words, we priced in a lot of risk as we should. I mean, this is a disruption of the global supply chain that has never happened. There is an absolute critical shortage of integrated circuits. And we are battling with that on a daily basis, working on optimizing supply chain and moving things around for customers to avoid line shutdowns and working with suppliers of how do we get more products and optimizing the timing of that product to link up to clients' own needs. So we priced in a bunch already in terms of downside earnings risk on this. If it gets worse than that, then we'll have more earnings risk. If it gets better than that, then we'll do better than what we have in our forecast. On the margin, things are getting better. But more capacity is coming on, but it's still really terrible. I mean, it is an unprecedented bad situation and something that, as CEO of JDI, I'm personally involved in because I should be. It's a very important issue. I won't go through in detail, I'll happily take Q&A. But across the board, we've got a lot of things we're doing that are important. It's OLED, it's sensors, it's automotive, industrial, health care, new businesses. I wanted to touch a little bit on the VR market. We have very high hopes for this market. VR is -- we've got some data from our market information provider on the right-hand of the page that speaks to display market growth, which is compounding based on their estimate of 27% over a multiyear period, which is great. I mean, we'll take 27% CAGR. But truth of the matter is there is yet to be a killer app in VR. And we so hope there is one. And the reason is we have a significant competitive advantage in the ultra-high-resolution LCDs that have become fundamental to VR. The current market is primarily in the 800 ppi market. We're clearly going to 1,000 ppi or above. We are totally capable of delivering ASAP. It appears to be the case that our competitors are having yield problems and technology problems in achieving these levels. So this is a good business for us. You'll notice that I didn't put into the upside earnings opportunity on the previous slide, higher VR sales because -- and we just pointed OLED. We actually think the VR, we've got kind of baked-in earnings growth that's come out of OLED this year and VR from the end of next year, where there is kind of a product transition that occurs. And we expect to have significant earnings driver. And if there is something more than this VR, this market growth that we have in the page, that will be very, very good for JDI. So we have some option value. And if any of you are programming killer apps through VR, we thank you. Let me talk about one other very important technology initiative. And this is the first time we've disclosed this. We fell behind in OLED, not from a technology perspective but from a CapEx perspective. We continue to have -- and this is kind of the strength of JDI's engineers and technology leaders. We continue to beat the competition in our technology and at the level of mass production. So it's not that we create new things in lab, it's that we produce at volume the best product in the world from a functionality perspective, from a quality perspective. So we're shipping current-generation OLED, existing-generation OLED. And as I said earlier, we will expand it. What's on this page is we're working on an absolute revolution in the space. And the reason why this is important is so JDI fell behind OLED, so what's the plan? And do you have a plan? And is it ambitious? And we have a plan. It's very ambitious. We've gotten to -- we have -- we're in sampling of next-generation, ultra-high-brightness and ultra-high-resolution OLED. It is an overwhelmingly superior OLED technology. It will completely change not only the OLED space but the display space. And you choose, with displays, either brightness or power consumption. So you can either have a much brighter display or you can have half the power consumption. This technology allows for that. It's also using -- it is, of course, high definition. It uses the capabilities of OLED to be flexible. It has a totally unique product capability. You can actually integrate sensors into it, so -- which is a brand-new deliverable for the technology. And what's not on the page is actually lower cost. So this will completely change the OLED and display ecosystem. We're not doing this by ourselves. We do have partners on this, as we should, in order to do something as big and revolutionary as this. I'm not going to go into details, but it's -- we will continue to update you on how we're progressing on this technology. And the way -- the reason we're talking about it today for the first time ever is we're making -- we've made a lot of progress. We're confident that we're going to be shipping this. And we look forward to a massive victory, the revenge of the JDI in the OLED space. The final point is we're going into a number of new businesses. It actually is the case in Japan that you have articles of incorporation that describe what you're going to do as a business and our current articles of incorporation only talk about displays. And we kind of do sensors and solutions and services and all sorts of things that are not currently part of our mandate as a company. So we announced today that we will be changing our articles. So we will be amending our articles of incorporation, subject to shareholder approval in June, in order to do whole bunch of new things. So those are Okochi-san and my prepared remarks. We're happy to take any and all Q&A as JDI works on personal tech for a better world. I'll just stand here if you have any questions.

[Operator Instructions] There seems to be no questions. We will now close the conference.

That's all right. Thank you, everybody, again. It's a tough world out there. Take care. Be safe. We're really grateful for your time. Thanks for spending time with us today.

Thank you very much for joining today. Thank you, and have a nice day.