Universal Display Corporation (OLED) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to the 24th Oppenheimer Tech Conference. This morning, we have the pleasure to host a fireside chat with the CFO of Universal Display, Sidney Rosenblatt. Welcome, Sidney.

Thank you very much for having us today, Martin.

Great. Let's dive right into the questions. You just reported your 2Q earnings last week, and one focus on the call was the gross margin. Material gross margin also has been a recurring topic for investors, and it varied between quarter-on-quarter. Sometimes those variants can be greater than 500 basis points, as we saw in the most recent quarter. Can you maybe provide us with more context and color on the 2Q gross margin and just, in general, some of the moving parts to your material gross margin when you look at your business in the longer term?

Yes. Yes. Thank you very much. I mean that is one of the questions that we have received. In terms of material gross margins for us, we have consistently stated over the past 5 years that our gross margins -- material gross margins are approximately 70%. We guided this year between 65% and 70%. In prior years, we guided from 70% to 75%. The company's overall margin is 80%, and that has been very consistent. In terms of quarter-to-quarter gross margin changes, it really is something because we have a number of very large customers. And our customer mix is really the display manufacturer. So -- I mean, our largest customers as far as -- is Samsung, LG, BOE and then some of the other Chinese manufacturers have been up in the third customer C for a long time, and sometimes it switches. The moving parts in our gross margin really are fourfold. One is developmental materials and developmental materials are materials that we don't make in commercial quantities. And we don't have commercial pricing for those materials for us, making them or selling them. And these are materials that when you work with a customer, you're developing something that they may ask you to develop and you will make very small quantities of those. And they end up being very expensive, and there's very little margin to them. So in any quarter where there's more developmental materials than there may have been in prior quarters, and this is very lumpy because as we develop these you may not ship any in one quarter, then you may ship quite a bit as in Q4 of last year. So this does impact our material gross margins. The other parts of it are -- one is our costs. And one of the things that we have pointed out is iridium, which is one of the components of our phosphorescent emitters, pricing has gone up significantly during COVID. It's starting to come down. We buy it by the troy ounce and it was a few thousand dollars a troy ounce for a long time. And then with COVID, some of the South African palladium mines shut down and it spiked up to $6,500 or $6,600 a troy ounce. It's back in the $5,500 range today. And so that's something that we actually have been buying over the years and have a significant inventory of that on our balance sheet. And if you look on our balance sheet, in I think footnote 3, it talks about the fact that raw materials is almost $50 million, and that's pretty much iridium. So we have plenty of it. It isn't that it's going to be an issue. The question is when does the cost get bled into our cost of materials. Two other pieces that impact our material gross margins are product mix, which products we actually sold more of in that specific quarter, and some materials have higher gross margins than others; and customer mix. And customer mix is based upon our largest customer. In this quarter, Samsung was 51%. And if you're a large customer, you get cumulative volume discounts and so the more that you buy, the more discount you will receive. When you take all 4 of those moving parts, our gross margins do quarter-to-quarter usually are not real consistent. However, for the year, we still expect it to be between 65% and 70% and closer to the 70% side than the 65%. You're muted.

Got it. That's a very clear rundown of components. When we look at very isolated cases such as the iridium price hike, how easy is it for you to pass the cost to customers, let's say, if the high price of iridium persists?

Well, we signed long-term contracts with our customers. So that when you sign a license agreement, you get pricing for your materials for the life of that agreement. And the way that we price these in these agreements is looking out and we try to build in what we think may be some pricing impacts. But we do not have the ability to pass on increasing costs once the contract is signed. What we try to do, obviously, is manage our costs. So if one of the components go up, such as iridium, a, we try to manage how much of it, how -- what the cost is that goes into it; and b, looking at other components and look at efficiencies to try to accelerate some of the things that we are doing to be more efficient to reduce our costs. If we get our -- if our costs go down, it goes to our margin. It doesn't go to the customer. But the customer does know what it's going to pay for the commercial materials that we are selling when we enter into an agreement with them.

Got it. Next, I want to address the potential adoption of OLED displays on IT applications. And that has drawn quite some new interest in OLED market. And for your perspective, how do you size the market for OLED materials for IT demand? And what do you think will be near-term and long-term potential for UDC?

Well, there's been a lot of chatter on IT recently for OLEDs. And some of it has to do with reports of a Gen-8.5 system that is being designed using movable shadow mask that is specifically designed for IT products or tablets. And without really mentioning names, I mean, there's a lot of folks that look at who sells the most tablets and things like that. There's a lot of chatter. I'm not going to pass on rumors that are out there. But IT is one of the areas that we think is a growth area for OLEDs. Today, the IT market is about 450 million units annually, which includes laptops, monitors and tablets. And today, the OLED share of that market is under 1%. So that is something that I think is one of the areas for growth that all of our customers are looking at. In addition, for smartphones, the estimates for this year are about 600 million units, 550 million to 600 million units out of a TAM of 1.3 million units. So it's in the 35 or above percent range. TVs, they expect -- they expect TVs to be around, I think, 7 million to 8 million units this year going to 10 million next year out of a TAM of 240 million to 260 million units. And I think maybe I just misspoke when I talked about the TAM for mobile sizes. It's not 1.3 million, it's 1.3 billion units. So when these numbers come out of your head, sometimes they all sound the same. So I apologize for that.

Got it. And so we know there's a very substantial potential market for IT due to the low penetration. What do you think needs to happen for a real meaningful high-volume adoption of all that on IT? What are the potential catalysts you can foresee?

Well, clearly, the #1 catalyst is the benefits of OLED picture quality and efficiency in terms of power usage. So OLED screens have been rated, whether it's for mobile sizes or tablets or TVs, as the best display ever because of the fact that they have a true black background and that they switch on and off internally 3x faster than video rates. And now you're starting to see applications looking at -- the mobile sizes was the first market that was really addressed by anyone. And the display business historically has been one that, over time, you go from smaller to larger to larger to larger sizes. Once your manufacturing processes and your efficiencies start to catch up, you then can go to a larger size. Because, to be honest, it's yield. So the yield issue is one that once you get to a certain yield, then you're willing to go to the next level. And Samsung has pretty much stated that they're going to be opening -- they're looking at targeting the IT market and notebooks.

Got it. And for you, based on current market development, how soon can we see IT becoming a meaningful source of sales to you?

Well, for us, the increase in sales is not so much related to a specific product, but it's based upon square meters of glass. So it is new capacity and new square meters of glass that we coat with our material. If what you're doing is just converting some of your existing mobile size that you're using and you're going to use it for IT, we're probably not going to sell a lot more material. It's when you add capacity and you add new lines that then it would have a step function up for us in terms of our material sales because we coat the entire substrate.

So in other words, we really need to see new capacity dedicated to IT so that we have -- we'll have a better clarity on new revenue sources freely coming from IT?

Yes. When our customers' yields go up, it's good for them because they sell more product. For us, it's -- we would sell the same amount, whether it's 50% yielded or 90% yielded. But for us, it's when they add new capacity, that's new material revenue opportunities for us.

Yes, makes sense. Next, I want to discuss investor concerns, alternative materials and the competition to replace phosphorescent OLED. And UDC is known for very strong IP position and almost a complete dominance of the phosphorescent OLED. And can you maybe give us more context around your material's performance versus other alternatives such as TADF?

Yes. And we have -- the phosphorescent materials, just to give a little background, OLEDs were initially invented by Kodak Corporation back in the early '80s. And they invented a material that was called a fluorescent emitter. And the way that the materials actually emitted light was you put current into the molecule, it would go into an excited state and you then would -- it would then recombine to its original form. And the energy that came out, 25% of the energy came out in the form of light and 75% came out as wasted heat. Our scientists invented the process called phosphorescence, which is a conversion of that 75% into usable light. So what this has what's called the 100% internal quantum efficiency. In English, it means you use 75% less power to get the same amount of light out. And so our materials are very, very efficient. When Samsung adopted our green emitter in 2013, they stated that they got a 25% increase in battery life. Folks have been working on other materials and thermally activated delayed fluorescence, or TADF, as you're talking about, is taking that original fluorescent emitter and trying to make it more efficient. And what they're trying to do is get closer to phosphorescence. You're never going to get more than 100%. So these, in our mind, are -- we've never really looked at them as an option because it's not as efficient as phosphorescence. We've got red materials and green materials that are in all the commercial products today. And we're working on a blue phosphorescent emitter. And we've stated that we've made excellent progress on the blue phosphorescent emitter. But even if one of these other materials work, they would be an interim solution until you get to a blue phosphorescent emitter. So there's been a lot of chatter over the years on TADF technology that we're working on it. I mean I've been on panels over the years with the TADF guys, and it's coming, it's coming, it's coming. And it's -- everybody is realizing how hard it is. We've been doing this for 25 years. We have the largest phosphorescent development team. We spend -- we'll spend almost $100 million on R&D this year, and it's really focused on OVJP, which is a small part of it, and that -- and we've looked at that we'll talk about probably later, but it's material science. I mean that's what we do. And we work with all of our customers. We develop materials specifically for the customer for whatever their needs are, whatever their specs are. We own it and then we sell it to them. So as part of your license fee or royalty or whatever relationship you have with us, you get a lot of value. So we are not just a toll taker in terms of IP, we provide value to our customer, we provide the self-emissive materials that go into the displays and we provide them with an R&D team.

Yes, let's double-click on the value you provide to customers. It is to my understanding that your material doesn't stand still, constantly go through performance enhancements as you develop new techniques and new compositions. So maybe give us a view of your performance improvements in longer-term time horizon, like in the past 5 years, 10 years. How do we understand how much you have changed your material and how that's reflected in the performance improvement of the panels.

Yes. So the 3 things that you need is lifetime, color and efficiency for materials. And color is what the customer wants. They have drive schemes. Some like a deeper red, some like a lighter red, depending on what your drive scheme is. And green, the same thing, and they do the same thing with blue. So the color is clearly the way that you drive it and you may want to shift it 1 nanometer or another. Lifetime, when we actually first started in this business, and they were talking about lifetime of materials, they were talking about 10,000 hours of lifetime, which is 6 hours a day for 4 years. And it was when you turned it on initially to 50% brightness. So because these materials degrade over time. And so what has occurred over the years is it's gotten -- those -- that bar has gotten much higher. Today, displays are rated at 50,000 hours of lifetime from initial brightness to 95% brightness, essentially no degradation. And so that's 6 hours a day for 20 years for a mobile-sized screen. I'm not so sure any of these are going to last that long. Without going through what we've actually done, I can tell you that the first red material that was in the Galaxy One, nobody would ever use today. It doesn't meet any of the commercial specifications today. So we are constantly improving it. Our customers are constantly raising the bar. Our customers always want longer lifetime. They want to shift the colors. They want a couple -- 0.5 volt more or 0.5 volt less or some candelas higher or lower. It's just -- that is something that we have teams that work with all of our customers pretty much consistently all the time to do this. So the materials have gotten so much better. No one would ever use -- 2 generations ago probably would never go in a product today because they're not going to give you the efficiency you want. And they're not going to give you the power savings that you want because everybody wants their battery to last longer.

Yes, that makes sense. And so that's a very good historical perspective. If we look into the future, where do you see the next frontier of the performance improvement for OLED display?

Well, I think they're constantly looking to improve it. Look, the key for mobile size is battery life. So do you want more efficient screen? I think 70% to 80% of your power is actually used by your screen. And we call these a phone, but we really don't make phone calls on them. I mean this is a mobile communications device, and everybody is always sitting there using the screen. So you want the best screen and you want it to be as efficient as possible because you want to add functionality to it. You may want to get your battery to last longer, and that's something by putting a new material such as a blue material in it, which will get rid of a fluorescent emitter and give you an extended battery life. There's also little tweaks in your roles, constantly working on recipes and materials to improve the efficiency of the display. So I think it is something that is always going to be a moving target. As I said, OLED screens have been rated the best screens ever, whether it's mobile sizes or whether it's tablet sizes or whether it's TVs.

And can you -- so in that vein, can you maybe talk about the cadence at which you improve your existing materials and maybe your invention of new materials? Does it often tie to your customers' product release cadence? And if not, is there a set product cycle, so to speak?

Well, without talking for our customers, what I can tell you is they are constantly designing whether they all have new product introductions every year. Whether or not they actually change the recipe in the screen every year or whether they do it every other year or every third year, that's really customer by customer. So -- but we are constantly working with them. We're working on next generation and the next-generation materials that they're saying they need today. So we're working on materials today that probably are not going to go into a product until 2023.