Back in March, we indicated that Nichia (pvt), the largest LED packager worldwide, had won a white LED patent lawsuit (appeal) in Germany against Harvatek (6168.TT), based on the initial European Patent Office grant in July 2015.  At the same time, Nichia also began litigation against Everlight (2393.TT) under the same patent grants.  Nichia won the suit against Harvatek, although Harvatek says the products in question are only a small portion of its total revenue.  The lawsuit against Everlight in the US courts was based on Nichia’s ‘250’ patent, which is a basic manufacturing process patent for LEDs in a resin package.
Nichia, whose claims go back to 2013, won in district court against Everlight, but an appeal was filed which led to the Appeal Court decision in favor of Nichia on three patents.  Everlight’s XI3030, 3535 and a number of other Everlight LED products are part of the ruling.  While the court denied Everlight’s assertions concerning the Nichia patent’s validity, and Nichia’s request for a permanent injunction, the parties were ordered to meet to discuss any potential monetary damages, which led to the Everlight appeal request.  We would expect both companies will meet and sign a license agreement to satisfy the courts.

AU Optronics (AUO) purchased equipment worth $18.437m and $27.264m from Shibaura Mechatronics (66590.JP) and Tokyo Electron (8035.JP) respectively as of 5/9/2017.  We monitor display producer equipment purchases whenever available and in the case of Taiwanese panel producers, they must be reported by the purchasing party if the company is listed on the Taiwan exchanges.  In AUO’s case, the company announced equipment purchases in 2016 of $354.9m, including the purchase of 21.6 acres of land in Tainan, but has already purchased $365.5m so far this year.
We note that AUO made 80% of its equipment purchases in the 1st half of 2016 (actually in the 1st quarter), while using the same metric this year (assuming no further purchases through 6/30/17) would imply a full year 2017 spend of $438.6m, 124% higher than last year.  That said, it is too early to make such assumptions for 2017, but it would seem that the overall equipment spend for AUO is trending higher than last year.  We note also that the new Taiwan dollar declined from NT$33.42 in January 2016 to NT$32.02 in December 2016, and is now at NT$30.29, a ~10% decline, but even against the currency change, AUO is trending far ahead of its equipment spend last year.
AU Optronics, based on our assumptions of both company and overall industry growth, held a 12.8% share of the industry’s display capacity last year, which we expect to increase to 13.6% this year.  In 2016, AUO’s gross capacity grew 2.8% but we expect ~8% growth this year as they continue the build out of their Kunshan, China Gen 6 fab.  While AUO runs with ~13% less capacity than its main Taiwan rival, Innolux (3481.TT), it has closed that gap somewhat from the ~17% in 4Q 2015, which we expect will peak around 12% by the end of this year, but aggressive build plans for Innolux will likely push that gap back to ~16% by the end of next year, unless AUO decides to build an ultra-large format display plant in 2018/2019.  Such an idea has been mentioned, but no decision has been made as of yet, and we include no capacity from such a fab in our industry model for AUO.

AU Optronics (AUO) reported April sales of NT$27.78b, down 10.5% m/m but up 7.6% y/y.  We note that last year panel prices were in decline for the 1st half of the year, making y/y comparisons relatively easy this year, with April 2016 being the last month during which declining sales were seen.  Large panel shipments were 8.66m units, down 12% m/m and down 3% y/y. Small panel shipments were 12.75m units, up 0.2% m/m but down 6.9% y/y.

The parent of Hong Kong based Truly (732.HK), has indicated that the JV between the company and a number of investment firms will get additional funding of $482m.  Xinli Semiconductor (pvt) will own 59.7% of the JV, while a state-owned investment fund will hold 23.5% and the local government will own16.7%, both of whom were original investors in the JV.  The particular JV involved is said to produce ‘sheet transistor panels’, which would be considered backplanes, and OLED displays, so we have to assume it is part of Truly’s OLED plans, which include the expansion of the company’s Gen 4.5 rigid OLED fab, and the construction of a Gen 6 rigid/flexible OLED fab that was in the planning stage last year.  The Gen 6 fab, if built as expected, would be a two phase 30,000 sheet/month project with production some time between late 2018 and early 2020.  There is considerable speculation about the timing of the fab, but the funding mentioned above could be an indicator that plans have progressed, giving the potential for the earlier production timetable.

AP Systems (265520.KS) announced a $115.6m deal with a customer but provided no details as to who the customer was, citing ‘requesting (sic) the trade secret of the other party’ for the lack of detail.  While somewhat unusual for equipment companies to announce large deals with redacted details, they tend to be oriented toward a particular South Korean company that is a major producer of consumer electronics.  AP Systems is a provider of a number of large tools for the display industry, particularly laser based annealing for LTPS backplanes, and for laser lift-off of glass substrates when producing flexible OLED displays.  As OLED producers delve further into flexible OLED production, the necessity of such tools is obvious, and the desire for some of those producers to remain anonymous is also obvious, although the two largest OLED producers are situated in South Korea.  One can draw conclusions….
Wonik (240810.KS) also signed a deal, this time with Samsung Electronics (005930.KS) for $35.5m.  Wonik is a supplier of a variety of deposition tools for the display space, which included heat treatment, PECVD deposition tools, and ALD[1].


[1] ALD _ Atomic Layer Deposition – A process by which materials are deposited on a substrate one atomic layer at a time.  This allows for precise control of material thickness but is a slower process than other deposition methods.

While the Chairman of Foxconn (2354.TT) meets with the Trump administration about building something for the display industry in the US, as we noted last week and a number of times previously, the details, such as they are, are beginning to coalesce toward a slightly less grandiose project.  The original expectation for such a plant in the US was a Gen 10+ fab that would build TV panels to supply the US market, bypassing overseas production and assembly in Mexico, with jobs aplenty for workers in those states willing to give the necessary tax breaks.
But there are a number of issues that would surround such a fab that are now coming to the surface, making the project, should it become a reality, a slightly different animal.  First, the infrastructure necessary to build and operate an ultra-large format LCD fab is substantial, with many Gen 8 and larger fabs built in Science Parks, where a significant number of supporting companies have facilities to supply the large fab.  These Science Parks are common in Taiwan, South Korea, and China, and are being developed for other regions like Vietnam and India, but do not exist in the US for the display industry, as little display production is done in the US.
Second, Foxconn has decided to revive the Sharp (6753.JP) brand, as an outgrowth of their controlling stake taken last August.  Toward that end they ended supply agreements with both Samsung Display (pvt) and Chinese TV brand Hisense (600060.CH), in order to channel Sharp’s TV panel production toward its own brand.  While we still question the necessity of such a move, it came after Sharp had licensed the Sharp brand in the US to Hisense through 2020.  When Foxconn requested that Hisense terminate the agreement so Foxconn could sell the Sharp brand here, Hisense refused, not surprisingly so, which boxes Foxconn out of the US market with the Sharp brand.  The necessity for Foxconn to produce TV panels in the US makes little sense given that circumstance, and the chance that a TV panel fab will be built in the US remains low.
The new story is that Foxconn is considering a Gen 6 fab that will focus on production of small to medium sized displays for “IoT applications, including automotive, medical care, and mobile terminal displays”[1].  This new tact falls in line with the fact that Foxconn is Apple’s (AAPL) primary OEM, and producing displays for Apple products in the US would assuage administration ire over the importation of consumer products made in foreign countries.  That said, providing the technology, infrastructure, and cost structure necessary to build high volume product for Apple in the US would still be a daunting task for Foxconn, but when faced with the specter of high import tariffs threatened by the administration, there could be a case made.  More likely such a fab would provide less demanding and more premium oriented products for a variety of applications that are less sensitive to competitive cost structure, and not as critical to the world’s most valuable brand.
But, when all cards are laid on the table, it will come down to the potential deals that Foxconn can make with the Federal, but more likely state and city governments for ‘incentives’ to lighten the cost burden of producing displays outside of Asia.  We would expect something to be built eventually, maybe a display fab, or an automated assembly plant, as the photo-ops have already been taken and tacit commitments have been made, but we do not expect a shift in the world’s display production to the US to any large degree, despite what gets said by CEOs as they try to keep the US from creating an untenable trade situation that will upend the consumer electronics industry even more than it already is. JOHO.


[1] According to Taiwan-based supply chain makers, as per Digitimes

We have been following Universal Display (OLED) for over 10 years, and spend a great deal of time on the OLED space.  Rarely have we had the opportunity to use the word ‘Syzygy’, an ancient Greek word used to describe a straight line configuration of three celestial bodies, but we use it to describe the 1st quarter results at UDC, as everything aligned to create what is probably the best quarter in the company’s history.  Yes, there have been those times when OLED TVs were released, or when Samsung Display (pvt) or LG Display (LPL) signed long-term agreements with UDC, but not when the numbers added up as they did in the 1Q results.  So…
Revenue was 65% above consensus and EPS was $0.22 against a $0.00 consensus, so there was no question that things went far better than expected in the quarter, but most important were material sales, as noted in Fig. 1.  Emitter sales are the lifeblood of UDC, and while the on a broad basis they have been improving, in 2016 they had become somewhat stagnant, with only modest growth.  In particular we focus on red emitter, which is used in all small panel OLED displays, and should mirror the growth of small panel OLED capacity.  Yes, there are lots of factors that can affect the quarterly use of red emitter material, but growth is what the OLED industry is all about, and there was little last year, despite the consistent tech headlines about the rapid growth of the industry.   That was not the case in 1Q ’17, as red emitter reached the highest level in the company’s history and resumed the growth path that began a few years back.
There have been lots of reasons why red emitter varied from what should have been a steady growth rates, and we would be happy to discuss them all with investors on request, but there was no reason to cite those reasons in 1Q, as the two largest OLED producers ordered both red and green emitter materials in quantities that reflect the growth of the industry.  We expect that we will hear, “They could have ordered too little in 4Q”, or “They probably over-ordered in 1Q”, but the point is that material sales were significantly better than expected.  The harder question is why were they better than expected?, and technically that answer is not known, even by Universal Display, as they ship materials to their customers, who do not disclose to what fab or to what product the material is headed, but there are some factors that could have made a difference.

Capacity Expansion – We have heard it before…as OLED capacity expands, material sales should increase, but it doesn’t seem to work that way in reality, and our OLED industry model, which was designed to be predictive, has been wrong for the last year.  We even factor in variables as to how fast OLED producers are able to ramp actual production once they turn on a particular line or fab, which can be very different than assumptions that consider only stated capacity, and we still came up with material sales that were above UDC’s reported numbers in 2016.  So is there a fundamental disconnect between OLED capacity expansion and the use of emitter materials?  Yes, as there are a number of variables that can affect the ramp of an OLED line or fab, as noted, but we do not believe they were responsible for the relative weakness in emitter sales growth last year.  Fabs are being built and products produced, and while expansion is not quite as linear as investors would like, they should be using more emitter material.  They did in 1Q, as UDC saw not only an increase in emitter dollar value, but an increase in the number of kilograms shipped, which is more significant.  But if capacity expansion should be the driver for OLED emitter growth, it should have driven emitter sales, particularly red emitter in a more linear manner for the last year.
Producer Efficiency – OLED emitter materials are expensive, and OLED display producers are always looking for ways to reduce that cost.  Finding OLED stack combinations that use less emitter but can produce the same results is an ongoing goal for panel producers.  Further, the methods currently used for depositing OLED materials on substrates are inefficient, with much of the material being wasted in the process.  Making improvements in deposition efficiency should have an effect on emitter sales, and we factor those variables into our model also, but most improvements in OLED process tool efficiency would come as new lines are added and more efficient tools are used, and upgrading existing lines tends to be problematic for producers who are running at near or full capacity.  We believe that producer efficiency has been a factor in containing emitter growth, but has not been the key factor in the relative flatness of UDC’s emitter sales last year.
Material Discounts – While sounding onerous, UDC gives its emitter material customers discounts based on volume.  There are a number of dollar volume trigger points that lower the per gram price of the emitters as OLED producers ramp production.  These discounts play an important part in UDC’s material sales numbers as they can offset increased material usage.  We note also that while UDC develops new emitter and stack materials all the time, and presents them to customers, those customers do not change their stack formulations easily, as such changes could mean fab downtime, temporary yield degradation, or requalification of a product by the brand customer.  But new materials have a distinct benefit to UDC as they ‘reset’ the discount timeline, and return emitter ASP’s to pre-discount levels.  While we also build this into our OLED industry model, the adoption of new materials has a very significant effect on sales, and we believe that much of the stagnation seen in last year’s emitter growth was a result of delays in the adoption of new emitter materials by a major customer.
We believe that a major customer made a backplane change, and adopted new emitter materials at the beginning of this year, and as capacity using the new materials increases, there is an increase in UDC’s emitter sales as the ASP resets.  We believe this is a significant part of the incremental emitter sales improvement seen in the 1st quarter’s results, particularly as the product attached to the new materials is a high volume product that has been in pre-release production since the beginning of the year.  As the product sells, we expect the new materials to begin to reach some of the material discount trigger points, which will lower material ASP’s, but as said UDC customer builds new capacity this year, we would expect the new emitter materials to be adopted for those fabs, with the increased volumes offsetting the material discounting.  We note that the volume of green emitter material is higher than red in a typical RGB OLED display and thus moves more quickly down the discount timeline.
What about Royalty & License?
In theory, license and royalty revenue should be a secondary indication of OLED industry growth, but in the case of UDC, it has a few variables.  First, the agreement UDC has with Samsung Display is based on escalating fixed license payments, and does not reflect unit volume royalties.  This distorts the License/Royalty revenue line as Samsung’s payments occur in 2Q & 4Q each year (Fig. 2), so we represent the data without Samsung’s fixed royalty/license payments in Fig. 3, which shows a more linear progression.  That said, the components of the License/Royalty line are both ‘sign-up’ license payments from a variety of potential OLED producers, both in display and OLED lighting, which enable those producers to use UDC materials in R&D and development projects, and actual royalty revenue.  The true royalty revenue is generated primarily by LG Display, whose agreement with UDC calls for a unit based royalty on OLED products being sold by LG Display to brand customers.  This royalty is reported on a 1 quarter lag basis, so the royalty from LG Display seen in the 1Q ’17 quarter is based on sales from 4Q 2016.  We don’t discount the fact that other producers might also be generating unit based royalty revenue for UDC, but we believe LG Display is the bulk of that income segment.
The chart with Samsung license removed (Fig. 3) shows the steady progression of increasing license/royalty revenue, and while a specific breakdown is not given, should indicate that both new initial licensees have been added over the last four years, and that unit volume royalties are being generated as commercial OLED product (other than Samsung’s) are sold.  There is one variable that does affect the royalty line growth, and that is unit volume pricing.  The unit volume royalty is calculated on the transfer price of an OLED display as it leaves the LG Display factory.  Each product type (smartphone display, TV display, Watch Display) and each product has a different transfer price, all of which vary according to brand negotiations and market demand, which makes estimates for unit based royalties a moving target, both for the analyst community and UDC, who receives an accounting from customers roughly 60 days after the quarter ends.  The royalties generated can therefore be affected by mix, OLED panel pricing, and volume negotiations, all of which have to be built into royalty models.  That said, as long as the trendline is up, it should indicate the expansion of the OLED industry and increasing royalty revenue for UDC, which it is shown in Fig. 3.  

There is a caveat here, as the long-term license agreement that UDC has with Samsung Display, their largest customer, ends at the end of the year.  Obviously both parties have a significant stake in renewing, extending, or updating a new agreement, but there is no indication as to whether such negotiations will wind up with fixed license/royalty payments as it has been, or whether they will switch to a unit based royalty as UDC’s other clients use.  These license/royalty negotiations will be critical to UDC’s financials in 2018 and beyond and the accompanying material supply agreements, albeit heavily redacted, will also be key to UDC’s material sales.  While the current contract negotiations took at least 18 months, we would expect if a new agreement is not reached by year-end, the current agreement will be extended until final negotiations are concluded, with little short-term impact.  That said, any substantive change in the important terms of an extended agreement, particularly a change in the royalty method, would have a significant impact on UDC’s quarterly revenue volatility.

​There are many issues that affect the OLED industry and UDC as a primary supplier and IP holder, but after years of anticipating how the growth of the technology would show up in UDC’s results, we would like to bask in the sunlight for at least a moment before dealing with the inevitable puts and takes of the display business, and we ask Kim Jong-un to hold off for at least the weekend before escalating tensions on the Korean peninsula, the source of ~86% of UDC’s revenue. 
 
“I love it when a plan comes together” – Col. John “Hannibal” Smith – The A Team

Israel based Orbotech (ORBK) reported an in-line quarter, noting that it has increased confidence in the visibility of projects in its display tool business, and is seeing continued strength in its PCB tool business as the industry moves to more complex and flexible boards for mobile products.  Orbotech produces a variety of yield management tools for the display space, with almost every panel producer as customers, and does the same for the PCB space, which is undergoing a move from generic boards to small structure and flexible PCBs that are used in many mobile devices.  Orbotech’s Semiconductor division also produces tools used in advanced packaging solutions, such as multi-board and Fan-out technology.
Orbotech is involved in a number of ultra-large fab projects, and has begun delivering product to one such fab, with others falling into current bookings, and has seen increasing strength in customer demand for tools oriented toward flexible OLED display production.  They have adapted their highly regarded LCD tools to this new platform and have already seen significant orders given their lead in the space.  As the only supplier of a tool in the PCB space that is able to repair PCB boards using both subtractive (common) and additive (no one else has the technology) modes, they have seen significant interest in their tool becoming an industry standard.  We will have more on Orbotech tomorrow, as we believe their new product development, which has been fueling the company’s growth, is on the trail of another high value market.

Apple has a ‘mysterious’ plant at the Longtan Science Park in Taoyuan, Taiwan. The plant is in an isolated corner of the park with only one company nearby, and is surrounded by forests.  At noon, no cars passed the plant, there is no logo or name on the outside of the building, and a photographer sitting in a taxi was warned away by former FBI guards as soon as he lifted his camera.  Sounds like the beginning of a new ‘Mission Impossible’ film or ‘Taken 13’ (they have his daughter in there), but it is really Apple’s Taiwan skunk works, and you are not allowed in.
Apple has been in the factory since mid-2015, although most were not aware of its existence until late 2015.  Apple ‘borrowed’ some of AU Optronics (AUO) OLED engineers, a few graduate students with expertise in optoelectronics, and brought in some staff from LuxVue (pvt), a micro-LED developer that Apple bought in May 2014, along with a number of technologist from various Taiwanese firms.  Of course, they do not talk about what is being worked on at the fab, and it is under the utmost security, with employees allowed to stay only at the company designated hotel, and in rooms that are bugged by the company on a regular basis, not because they are afraid others will try to gather information, but to make sure employees don’t reveal any information, even when they are asleep!  Even the former President of the Republic of China, Ma Ying-jeou, was rejected when he requested to visit the plant.
So what are they doing?  They are trying to find a way to move past their rival/partner Samsung Electronics by developing new display technologies, and it likely doesn’t matter what the technology is, as long as it is viable in a commercial manufacturing setting.  While some of the staff is versed in OLED, we would expect the bulk of the research being done in this facility (BTW, there is an Apple logo on the wall of the entrance hall inside, or so we are told) is related to micro-LEDs, a technology that Apple is expected to use in the next version of the Apple Watch.  The technology, which we have mentioned a number of times in the past, is based on very small self-emitting LEDs that become the sub-pixels of a display screen. 
The concept has been around for a number of years, with Sony (SNE) being the most vocal about its commercial potential, but the technology needed to both make the LEDs themselves, and place/connect them in a device is still being developed.  Should Apple find a way to do this in a cost effective manner, (current estimates are that micro-LEDs costs are 3 to 4x that of competitive display technologies) it could allow them to reduce their potential reliance on Samsung Electronics for OLED displays, and give them an edge on the technology side, which would be a very significant marketing advantage.  Will we get updates on their progress? We doubt it, but an occasional hint here and there, and an actual product (or even a demo of a potential product) will give a few clues as to their progress.  …anyone with BlackOps experience please contact us…