​There are two basic types of OLED displays.  RGB (red, green, blue) displays that are made up of pixels that contain red, green, and blue sub-pixels, and WOLED displays, which consist of blue and yellow/green layers that combine to form white light, which is then converted into reed, green, and blue sub-pixels through a color filter.  As we have noted previously, Samsung Display (pvt) has developed another type of OLED display that is based on a blue and green OLED layer that is converted into more precise red, green, and blue sub-pixels using quantum dots.  While this is a highly simplified picture of these OLED structures, there is a nuance that is quite important and that is the actual OLED materials used to create these displays.
There are two general types of OLED emitting materials, fluorescent and phosphorescent, and while those terms both encompass light-emitting materials, they are quite different.  While both materials generate light when electrically stimulated fluorescent materials generate light in a ‘singlet state’ while phosphorescent OLED materials generate light in a ‘triplet state’, and before you fall back into the glaze of Chemistry 101, the simplified explanation of what that means is phosphorescent OLED materials can emit close to 100% of the light generated, while fluorescent OLED materials can emit ~25%.  Given that the objective of all displays is to generate the most amount of light with the least amount of power, phosphorescent OLED materials are preferred, however there is a catch.
Red and green phosphorescent OLED materials are commonly used in RGB displays, however blue phosphorescent OLED materials tend to be unstable and have lifetimes that are shorter than necessary for most displays, so OLED display producers have been forced to use blue fluorescent OLED materials to fill the gap in RGB displays.  This means that the blue layer would be producing les light than its red and green phosphorescent counterparts, so OLED display designers double or triple the blue layer to balance the system.  While that works from a visual point-of-view, it requires considerably more power and is therefore an inefficient device, and many companies are working toward finding a stable phosphorescent blue OLED material to eliminate that inefficiency.
While we have read through literally hundreds of papers and IP filings that are looking for solutions to the phosphorescent blue issue, no commercial blue phosphorescent OLED emitter material has appeared in the market.  Universal Display (OLED), the holder of the IP for heavy metal red and green phosphorescent OLED emitter material, which it exclusively supplies to all OLED display manufacturers, has one of the largest blue phosphorescent material R&D programs and has stated that they expect to have a commercial blue phosphorescent OLED emitter available in 2024 while others have stated earlier goals, many of which have passed without success.  A recent article in the South Korean press indicated that Samsung Display itself was doing research toward the development of a blue phosphorescent OLED emitter which would allow the company to replace the three layers of blue fluorescent emitter material in its QD/OLED stack with one blue phosphorescent blue layer, reducing power requirements and simplifying the deposition process, but thus far we do not believe that has occurred. 
More likely would be a collaborative effort between Samsung Display and UDC toward such a product, with SDC sharing the material science behind their blue material, which is based on a platinum/carbene combination, and UDC extending the characteristics of the material to reach commercial specifications.  The SDC material has a LT70 lifetime[1] of 1,113 hours at 1,000 nits, which would be about the peak brightness of an iPhone 13 Pro Max, and the LT70 degradation would occur in roughly a year, but the press note suggests that SDC’s research has progressed considerably since the paper was written, with ‘visible results’ expected by SDC within a year from the original writing (~15 months ago).
Much of the article was speculation concerning SDC’s internal development efforts toward developing a blue phosphorescent emitter but the paper on which that speculation is based noted that the materials being developed were reactive to host materials commonly used and further development of those host materials would be necessary to take advantage of the newly developed blue phosphorescent emitter materials. This leads us to believe that a commercial blue phosphorescent emitter system is still a further away than the press article might suggest.  All in, we expect all major OLED display producers are doing at least some research toward the development of a stable blue phosphorescent OLED emitter, likely in conjunction with UDC or other OLED materials suppliers.  While progress is certainly being made in the development of such a material, the fact that new research has been published could move development forward but is only a gateway to the commercial development and production of a new material.  We keep our expectations low as many promises have been made in the past and the development of blue LEDs was far more challenging and time-consuming than its red and green cousins, so we know it will eventually be done but take all timeline assumptions with a grain of salt..


[1] LT70 means the length of time it takes for the material to lose 30% of its light output.

Universal Display (OLED) reported 1Q results of $150.47m, up 2.9% q/q and up 12.3% y/y (typical 1Q is down 11.3% q/q on a 5 year average), which was above consensus of $144.5m and our $123.7m base expectation.  Material sales grew 1.1% q/q and 8.6% y/y while royalty/license revenue grew 6.8% q/q and 17.5% y/y, with overall margins flat q/q at 78.0% but down from 82.6% one year ago, although consistent with the last three quarters.  EPS was $1.05, ahead of $0.98 consensus, up 7.2% q/q but down 3.6% y/y.  UDC finished the quarter with $17.67 in cash, ST and LT investments ($17.36 in 4Q 2021)..
While this was a relatively uneventful quarter for UDC, primarily reflecting continued adoption of OLED across a wide variety of CE display based products, the company indicated that while they have not seen the effects of Chinese COVID lockdowns, continuing inflation, or similar economic headwinds from their customer base, they do acknowledge that such issues are affecting the CE space and could change customer plans.  That said, they reiterated previous full-year guidance of $625m to $650m.  One point of note in recent quarters has been the decline in emitter material gross margins, which while relative stable in 1Q, have declined from 72.8% in 2019 to 67.2% last year.  Contributing to that decline has been a need to carry higher inventory levels and increasing raw material costs, a portion of which is iridium a key part of phosphorescent emitters, which saw a five-fold price increase last year.   While iridium has come off its peak in 3Q last year ($6,100+) and reached as low as $3,850 in 4Q ’21, it is now back up to ~$5,000/oz., indicating that volatility in UDC’s material margins will likely continue.  While this seems to be a concern to others, we believe the general stability of material margins (63% - 67%) is more important than returning to levels seen in pre-pandemic days until global inflation is brought under control, especially as material sales continue to grow, which will give UDC more leverage toward iridium purchases as the material returns to less lofty levels over time.

On a regional basis South Korea continues to hold the largest share of UDC’s revenue at 60%, essentially flat during 2020 and 2021, while China has grown from 32% to 35% since 2019.  Sales to South Korea were $90m and UDC’s ‘Customer A’ and ‘Customer B’ represented ~$100m in sales so we can assume that A & B were Samsung Display (pvt) and LG Display (LPL).  China represented ~$55m in UDC sales and ‘Customer C’ and ‘Customer D’ represented $33m, likely representing BOE (200725.CH) and Visionox (002387.CH).  UDC’s top four customers represented 89% of material and royalty/license sales in 1Q which is consistent with the last two years, along with the ratio of material sales to license/royalty revenue, which was 1.45, in line with last year’s average of 1.47.

Material sales are the key to UDC’s business, and since the adoption of ASC 606 material sales ‘regulate’ the recognition of license/royalty revenue, but that aside, we look closely at the long-term growth of both red and green emitter sales to gauge the growth in overall OLED device area.  While there are subtle changes in material efficiency, formulations, and quarterly buying patterns, red emitter and green emitter is used in every RGB display and yellow/green is used in most[1] OLED TV displays so they are certainly data points in understanding the growth of OLED in the display space, with both having remained above trend line for the last 5 quarters.
There are a number of potential OLED fab projects under consideration that will likely have an impact on UDC’s long-term material sales should they become actual production lines.  Samsung Display, LG Display, and BOE are also considering building Gen 8.5 OLED fabs to better serve the newest OLED application, IT products, and while these will likely not be in production until late 2023 at the earliest, even in their phase one states they will represent a significant boost to overall OLED capacity, and given UDC’s lock on phosphorescent OLED emitter materials and its existing relationships with all OLED producers, we expect there will be another leg to the OLED growth story as OLED IT product demand begins to grow over the next few years..  There will be competition from other display technologies but OLED has established itself as a viable display prpduction process and with the infrastructure already in production will likely have the same staying power as LCD has had over the last twenty+ years.


[1] Samsung’s QD/OLED display does not use yellow/green emitter.

​Much of the Q&A was related to the company’s previous statements concerning the development of a blue phosphorescent emitter and host system, which the company reiterated this quarter.  There is considerable significance to such a development, although UDC is not alone in its efforts toward such a material.  Some additional color on the project was given in that the company expects to meet technical targets[1] by the end of this year and might see some revenue from such a product at the end of 2023, although real revenue generation from a blue emitter system will be in 2024. 
As we would expect there is considerable interest in the development of a phosphorescent blue emitter as it would improve OLED stack characteristics and increase power efficiency, but more toward UDC’s interests would be the addition of a 3rd material revenue stream for RGB displays.  We note also that the license agreement and material supply contract UDC has with its first and sometimes largest customer, Samsung Display (pvt), does not include blue emitter material, which would imply an additional or supplemental agreement between the parties when blue emitter material becomes commercially available.  As UDC is working directly with its customers on the development of a blue phosphorescent emitter, since they will ultimately decide whether it is ready for commercial use, we expect early revenue would likely be in the form of ‘developmental’ emitter sales, as management noted might show in 2023, with full scale commercial product in 2024.
UDC’s Organic Vapor Jet Deposition development project is also progressing with 23 employees at the end of 1Q working toward putting together the key subsystems necessary for an alpha system that will serve to verify the technology’s ability to scale.  An actual commercial product is still a few years away (we would expect a pilot system in 2024 and a gen 6 commercial product in late 2025 or early 2026) although competition from a number of different deposition technologies continues to pressure the development of such a tool.  In the interim we would expect a cost burden between $1.2m and $1.6m per year.
All in, 1Q 2022 was a good quarter for Universal Display, both from a financial standpoint and an emotional one.  There was little to explain on the conference call, as the issues facing UDC’s customers are well known to investors.  More to the point is whether the growth in OLED display penetration can offset the weakness that is expected to continue in CE product demand.  While the LCD display business has been on the positive side of the scale during the COVID-19 pandemic, we are slowly moving back to a more normalized demand cycle in the CE space, where competition for consumer dollars will no longer be related to how fast a producer can get a product on shelves, but more does it provide enough incentive for the consumer to shell out dollars with less buying power than two years ago.  While LCD manufacturers extol the progress made in their space over the last few years, OLED displays are still considered the best technically, and while there will be issues with every display technology, OLED has become embraced by CE brands as a way to raise the quality of CE products.  Given that UDC is in the unusual position of being a ‘window’ into the OLED space, the company should be a focus for any technology investor.  Of course, valuation is absolutely up to the individual…


[1] Typically those targets are material efficiency, color point, and lifetime.  While UDC likely has a good idea what minimums are necessary for a commercial blue emitter/host system, each customer has its own targets, which makes the adoption timeline particular to each customer.

​The layers of materials used in an OLED display are quite thin, with key layers as thin as 10nm, but when those materials are used in hundreds of millions of devices, those thin layers add up.  Suppliers of materials for OLED stacks are constantly vying for a place with key OLED display producers, Samsung Display (pvt) being the largest.  SDC changes it stack materials when it can see an appreciable change in stack performance, as such changes can spark considerable design and process changes and require requalification with customers, a time-consuming task that can have a number of iterations.  That said, a win can lead to considerable revenue and a (hopefully) long-term relationship with producers.
While there are a few stack materials where there is only one supplier, usually a material ‘helper’ that increases the effectiveness of a key stack material, a number of OLED materials see considerable competition, particularly those that are not in the emitting layer, as both red and green phosphorescent OLED emitters are licensed and produced only by Universal Display (OLED), while emitter ‘host’ material in which the emitter is ‘doped’ are produced by a number of suppliers.  As new stacks are developed by OLED producers material suppliers submit their latest materials for evaluation, with the intention of becoming or remaining a supplier of as many materials as possible in each new stack.
As we noted recently, Samsung Display will be updating its OLED stack later this year (M12) and there are already a few changes or additions to stack material suppliers.  While we cannot confirm all material suppliers yet, there are a few that we believe are confirmed, and a number that we believe will be confirmed eventually.  In the diagram below we show the typical OLED stack layers for Samsung’s most recent RGB OLED stacks (M10, M11) and M12 which will be adopted this year.  Those suppliers that we can confirm in M12 are in black.  Those that we believe will be chosen but have not confirmed are in red, and we note also that where multiple suppliers are listed, there is the possibility that a supplier for one SDC customer might be different from a supplier for another customer.  We thank UBI, The Elec, and a number of suppliers for their contributions to the graphic.

​Universal Display (OLED) is a unique company, having an unusual lock on IP associated with phosphorescent OLED materials and their use in light emitting devices.  They are the licensor and de facto supplier of such materials to every OLED display producer, and because of that IP have no direct commercial competition from other potential phosphorescent emitter suppliers.  There are alternative OLED emitter materials, such as TADFs (Thermally Activated Delayed Fluorescence) but few, if any, are in use by major OLED display producers, and there are certainly alternative display technologies that can rival OLED, but OLED technology has established itself as a viable alternative to LCD display technology for mobile displays, and as a high quality alternative to LCD in the TV display space and has a developing and expanding ecosystem and capacity base.
The company generates material sales from contracts with OLED suppliers and license/royalty fees based on its IP, either based on a yearly flat license fee (Samsung Display (pvt)) or a royalty based on device production value (LG Display  (LPL) & Others).   This puts UDC in a position to capture much of the growth in the OLED display business, and over the last few years has grown sales as the OLED display market has grown, although as a JIT supplier quarterly sales can be volatile as customer order patterns rarely correlate to short-term capacity expansion or industry unit volume growth.  OLED demand growth is based on three general product categories, mobile devices (smartphones/tablets/watches), IT products (laptops and monitors), and TVs.  OLED IT products are the newest and likely fastest growing category from a relatively small base, while OLED TVs are well-established although a small (~2%) share of the overall total TV market, and OLED displays are now the most popular display technology for smartphones.
OLED capacity growth comes from primarily from the expansion of OLED fabs, primarily Gen 6 (smartphones, tablets, laptops) and Gen 8 fabs (TVs), as demand grows, but basing material growth on industry capacity growth can be difficult as while there is considerable incremental OLED capacity growth both planned and underway, utilization and yield can be as important or more so than stated capacity growth.  From UDC’s perspective however, fab utilization is more important than yield, as an underutilized fab requires less OLED emitter material, while a fab with poor yields still requires OLED materials for all displays, even if they do not pass qualification. 
Material sales have represented between 53.6% and 59.9% of sales over the last three years, with our estimate for 2022 being 58.1% of total sales, with the balance primarily derived from license/royalty revenue, however in 2018 the adoption of ASC 606 revenue recognition rules changed the way UDC recognizes revenue.  Previous to that rule the company recognized license revenue from a major customer (Samsung Display) when it was paid, which was twice yearly, with license and royalty revenue from other customers recognized as received (albeit with a 1Q lag).  Under ASC 606, license and royalty revenue is recognized as a function of material sales, with the estimated value of the contract being trued-up each year.  So instead of large swings in license and royalty revenue, the mix ratio remains more rational between 1.4 (material to license/royalty) and 1.6.
There are also subtleties in the three OLED materials that UDC markets.  Red and green OLED emitters are used in all RGB (Red, green, blue) OLED devices, which would include all applications mentioned above except OLED TVs, while  OLED TVs use a yellow/green OLED emitter, although UDC does not break out yellow/green OLED material sales separately.  This leaves one missing color, blue, which is not currently available in phosphorescent emitters.  Almost all OLED material suppliers are researching the development of a blue Phosphorescent emitter material, particularly as UDC’s material IP would not cover such a material (although device IP would still be in effect), leaving open the ability to supply major OLED display producers, however UDC has a significant blue phosphorescent development team that has been working on the project for years.
The company made comments about its progress developing a blue phosphorescent emitter during its 4Q conference call that offset a bit of disappointment over the company’s 2022 guidance, which was a bit below consensus.  While the details about actual specifications for UDC’s most current blue OLED emitter were not given, the company did state that it expects to meet ‘preliminary goal specs’ by the end of this year and followed with the introduction of an all phosphorescent OLED stack (meaning red, green, and blue) in 2024.  This is the first time that the company has given a timeline for the introduction of a competitive blue OLED emitter and host, which seems to have ignited a fever for the shares today.  While we are certainly encouraged to hear that UDC continues to make progress toward the development of a blue phosphorescent emitter, we believe there are still many hurdles that have to be crossed before UDC can claim being the winner in the ‘blue’ race.
While UDC’s blue development project has certainly included conversations with major customers about the specifications they need for such a material, some of those specifications are moving targets, with a balance between three categories that would determine the usefulness of a blue phosphorescent emitter.  They are efficiency, or the ability of a material to convert electrical energy to light, the color point, or the actual ‘blue’ color itself, which is considered a ‘deep blue’ as opposed to a ‘light blue’, and the lifetime, the time it takes for the material to degrade to a specific point.  The difficulty is developing OLED materials comes from the balance between these three major factors, and while there have been advances made in each of the categories, it is the combination of all three that would make such a material commercially viable and as competition from other display technologies continues, those specifications also change
The inclusion of a blue phosphorescent emitter in an RGB OLED stack would also lead to design changes, such as the balance between the amount of each color needed and the sub-pixel arrangement, and the TFT backplane used to excite each sub-pixel.  While these are not insurmountable changes, they also go toward the production changes necessary to include an efficient blue phosphorescent emitter and weigh on how quickly OLED producers can make those changes when a blue phosphorescent material is introduced into a mass production environment.  We note also that the industry did not instantly adopt green phosphorescent emitter material even when it met industry specifications years ago, so we look toward the adoption of a blue phosphorescent emitter across the industry as a gradual one.
All of this said, we don’t want to suggest that UDC is not making significant progress toward the development of a phosphorescent blue emitter, quite the opposite, but we caution investors to focus on UDC’s ‘nearer’ term potential which could easily be overshadowed by chatter about the ‘blue wave’.  UDC’s guidance for 2022 ($625 - $650m) implies a single-point growth rate of 15.2%, which we believe is a relatively conservative view of the prospects for OLED materials this year, particularly in the face of silicon and component shortages that have limited display production over the last few months. Some of the factors that could help to lessen those shortages might also be reflected in reduced unit demand, and the fact that UDC has material price agreements with its customers that make it difficult to quickly adjust material prices to rising raw material costs, put us in agreement with a conservative approach to growth this year, at least at this point, but we expect there is considerable room for incremental growth as OLED displays move into the IT space and OLED TV production continues to expand.

Universal Display (OLED) reported 3Q revenue of $143.62m, up 10.8% q/q and up 22.7% y/y.  EPS was $0.97, up 13.7% q/q and up 13.6% y/y.  Both estimates missed consensus of $147m and $1.09, however the company reiterated full year guidance of $530m to $560m, which implies $123m to $153m in 4Q sales, which on a q/q basis is between -14.4% and +6.5%, on a y/y basis is between -13.1% and +8.1%, and also implies a full year sales increase between 23.6% and 30.6%.  Consensus for the full year is $551.  UDC finished the quarter with $16.66 in cash/ST Inv.
The stock has not done well this year, down 19.7% based on yesterday’s closing price, and will likely see additional pressure today, in a year where OLED displays have seen continued adoption and penetration into new markets.  We do not look at UDC from the standpoint of relative value but from the company’s ability to generate sustainable growth, which gives us a bit of a different perspective than those looking to capitalize on short-term trends.  This ‘bigger picture’ does encompass considerable variability in quarterly results, both to the upside and downside, and the stock is certainly not for those looking for price stability, but we see our objective as presenting UDC’s prospects, good and bad, giving investors the ability to see if the sum of those factors are suitable for their goals.
UDC’s business is selling OLED materials, which includes green and red phosphorescent emitters, including a yellow/green that is used in OLED TV panels.  Their customers are those panel producers that have commercial OLED display fabs and to a lesser degree companies or institutions that are involved in OLED R&D projects or pilot production lines.  The company’s top 4 customers have made up between 65% and 99% of the company sales, with that number averaging 87% over the last 8 quarters.  This is even more concentrated when looking at the top two customers who together averaged 71% of sales over the same period. 
This concentration, and the fact that UDC is really a JIT material supplier lead to the sales volatility that is part of UDC’s nature.  Over the long-term this will lessen, but both Samsung Display (pvt) and LG Display (LPL), UDC’s two largest customers will likely continue to expand OLED production at a rapid pace with producers outside of South Korea also building capacity but implementing production at a slower pace.  BOE (200725.CH), UDC’s 3rd largest customer, has been the most aggressive of the Chinese OLED producers and will see increased unit volumes in 2022 and 2023 as it joins Apple’s (AAPL) OLED supply chain, but on a raw OLED capacity basis lags considerably behind both SDC and LGD.  While utilization rates at each OLED producer is another factor in determining their need for OLED materials, raw capacity would represent the best case scenario. 
We see raw OLED capacity growth between 2021 and 2025 with a CAGR of 13.2%, however aside from the gross capacity and fab utilization rate, panel producers change the mix and proportions of the emitter materials in their displays.  While the cost reduction objective is always there, OLED displays are promoted as having superior display characteristics as to display quality, and we believe that maintaining or improving that quality takes precedence over emitter material cost., so while the fear that panel producers will continue to find ways to reduce the amount of emitter material used per m2, we see other factors as more important, and look at emitter material sales on a longer-term basis.  We show both absolute and smoothed (6 quarter average) for both green and red emitter materials below.

While previous purchases and inventory levels at each OLED panel producer guide quarterly emitter material levels, all full color RGB displays contain red emitter, with the biggest category for RGB displays being smartphones.  With displays in the 6” to 7” range the emitter material usage is relatively small, but the numbers are large, with the OLED penetration rate in that category nearing 50%.   All three of UDC’s top customers are considering adding capacity for a move toward producing OLED displays for laptops, some of which has already begun.  As adoption in this relatively new category takes time, as it did with smartphones, we keep our expectations low, but based on the size of the average laptop (we use 14” in this example and a 6.5” smartphone average), the surface area to be coated in a laptop would be 4.6 times that of a smartphone.  This is incremental business for OLED panel producers and for UDC, and would translate to improving red emitter sales under a constant utilization rate scenario.
UDC’s green emitter has a dual function.  It is part of the OLED stack in the abovementioned RGB devices but is also used, in a modified form, as the basis for most OLED TV displays, which are produced exclusively by LG Display.  Again the unit volumes are far smaller than for smartphones, roughly 8m units will be produced this year, but using a weighted average, the surface area of an OLED TV would be the equivalent of 93 smartphones, which, at 8m units this year, would be the equivalent of 745m smartphones, equal to roughly a 50% share equivalent.  Next year LGD is expecting to produce 10m units as it expands its large panel OLED capacity in China, which would represent a 20% surface area increase in yellow/green OLED material, aside from increases in other RGB product categories for green emitter material.
While panel producers evaluate emitter needs on a longer-term basis when planning, the production of OLED displays, both large and small, is full of timing variables, and those variables make predicting UDCs material sales on a short-term basis a very hit or miss proposition, however even with the caveat of higher efficiency OLED production processes, the long-term growth of UDC’s phosphorescent emitter business is tied to capacity, which itself is tied to OLED applications.  As older applications see continued higher penetration rates, new applications bring a need for new capacity and that drives emitter material sales and therefore license and royalty recognition.  While OLED penetration in the smartphone space will slow on a percentage basis, small penetration rate increases in notebooks and TVs will have a disproportionally larger effect on OLED surface area, which will demand more OLED emitter material, and while competition from existing LCD technologies will remain, we expect OLED technology will continue to grow for the next few years.  As the de facto supplier of phosphorescent emitter materials UDC would be the primary benefactor from that growth.
That’s the good news, despite the current investor disappointment with 3Q results, but there are points that can weigh on what looks to be a period of continuing OLED penetration in the display space.  One such issue is margins, particularly material margins, which seem to counterbalance investor enthusiasm toward UDC’s growth prospects.  On a quarterly basis, customer product mix plays into quarterly material margin variations, and that is a variable that cannot be easily quantified without internal customer data, but there are other considerations that come into play with material margins that we explore further below.
UDC bases its OLED emitter material pricing on a schedule based on volume, with price reductions triggered by meeting predetermined volume levels until a ‘terminal’ volume is reached when the price remains.  Should UDC present a new emitter material to a customer that is adopted, the price of that material returns to its initial value and follows the same volume reductions as its predecessor.  This makes it incumbent on UDC to continue to develop new and better emitter materials to bring individual customer emitter prices up and counteract any material efficiency improvement that OLED producers might derive but also adds to sales lumpiness as new emitter material adoption at OLED producers is an on-going process which does not always occur across all products or fabs, which can delay or obfuscate the price improvement until the producer fully adopts the new emitter material.
This method of pricing is good for both parties as it pushes UDC toward new emitter material development that improves OLED display quality, but it does have its downside and that is that such fixed volume price points do not allow UDC to renegotiate existing material pricing if raw material costs change, and with the heavy metal component of most phosphorescent emitter being Iridium, UDC has had to absorb the increase in Iridium prices seen this year.  As UDC has been a longtime buyer of Iridium, they are sensitive and quite aware of the unusual pricing seen in Fig. 2 and Fig. 3, but have little choice but to purchase needed stock despite the higher cost, which is reflected in Fig. 5 which relates raw material inventory to material sales and depresses material margins (Fig. 6), as UDC is locked into a contractual price for the current set of emitters.  If we understand the emitter pricing structure at UDC correctly, if raw material prices remain high, new materials will be able to pass those increases on to customers, something existing material pricing does not allow, so material margins would improve over the longer-term, even at the higher material cost.

​UDC’s ‘other’ business is licensing its IP to those who wish to produce OLED displays on a commercial basis.  Since the adoption of ASC 606, the recognition of such license and royalty revenue is tied to material sales, which exaggerates the effect of periods of extreme material sales.  While this avoids the big swings UDC previously saw due to the twice yearly license payments from Samsung Display, it also obscures the increases in absolute license and royalty revenue that comes from increased unit volumes at UDC’s customers.  All but one of UDC’ customers royalty rates are based on a percentage of the display price as it leaves the factory.  A large increase in unit volumes at a particular UDC customer, which before ASC 606 would show in quarterly results, might now be constrained by it s recognition being tied to material sales.
In a situation where a customer purchased considerable emitter stock in a previous quarter and used that stock to produce a large incremental unit volume in the current quarter, the increased royalty license revenue recognition would be tied to lesser material sales in the current quarter and would not give a true impression of the incremental royalty generated by increased unit volumes.  Again this leads us to looking at all of UDC’s metrics on a longer-term basis and to suppress the desire to predict material sales and license/royalty on a short-term basis.  Of course there will be issues that could affect even the longer-term metrics, but trying to predict the month to month material order patterns of three or four OLED producers is not only an impossible task but one that will inevitably miss the bigger picture.   To us, knowing what to look at on a long-term basis is the key to understanding UDC’s business and how it will grow in the future. 

Never a dull moment for those involved in Universal Display (OLED), the primary supplier of OLED emissive materials.  After reporting 2Q sales results that were essentially in line with consensus and EPS $0.02 below consensus, the stock opened down 6.5% and has continued to decline at the time of this writing.  Noting that the stock has a 52 week range between $161.01 and $262.77 and that the company has beat expectations in each of the last four quarters, we understand that investors are fearful that there has been some major change in the company’s business or the OLED display space, but believe that such thinking comes from a lack of understanding of the display space and the OLED space in particular.
As always with Universal Display, there are number of moving parts that can affect quarterly numbers and the company reminds investors regularly that such factors can disconnect quarterly results from industry trends, but on a longer-term basis, which is the proper way to look at the OLED display space, we believe the trends tend to coincide.  This has been even more apparent since the advent of accounting rule ASC 606, which tied royalty and license revenue recognition to material sales for long-term contracts and reduced some of the wide swings in royalty and license revenue seen before the rule was put in place.
UDC reported material sales of $77.4m, down 3.0% q/q and up 123.7% y/y, although the y/y comparison, as with many display companies, is against a very weak quarter last year during the onset of COVID-19.  Material sales overall have been growing, as seen in Fig. 1, with the last two quarters above the long-term trend line.  Even breaking down the material sales into the two primary components, red emitter and green (includes yellow/green used by LG Display (LPL)), both remain above the trend lines.   Red OLED emitter is a component of all RGB OLED devices, which would include OLED smartphones, OLED tablets, and OLED notebooks and monitors, so again on a long-term basis, the growth of red emitter material would be linked to the growth of those products.  Green and green/yellow OLED material is used both in the same RGB displays indicated above, and is the primary emitter component of OLED TVs, so it is a bit harder to break out the growth of green OLED material as to product category.
Further complicating the breakdown of UDC’s sales is the fact that the regional breakdown, which in the past tied in closely with South Korean customers Samsung Display (pvt) and LG Display, became distorted when LG Display began producing OLED TV displays at it fab in Guangzhou, China, as those sales fall in with Chinese OLED producers and become harder to isolate.  This situation makes disaggregating UDC’s short-term sales considerably more difficult, and should push investors to rely less on quarterly results and more on yearly results, but that is not the world we live in, so UDC’s shares retain the volatility that trading parameters dictate rather than long-term growth.
There are two positive factors that will affect UDC’s long-term growth in material sales and license/royalty income.  The first is capacity growth, which is simply the timeline for OLED expansion and Greenfield OLED fab projects.  As we focus on projects that are either underway or have passed the early planning stage, we see OLED capacity growing as indicated in the table below.  This implies that out years will not include projects until they have been confirmed, so while we model beyond 2022, we expect 2023 and beyond to change considerably going forward.  Chinese OLED suppliers, such as BOE (200725.CH), Tianma (000050.Ch), and Visionox (002367.CH) are operating OLED production fabs, but relative to South Korean producers, are still in the relatively early stages of product development and full scale mass production.   China is determined to unseat South Korean OLED panel producers from their dominant position in the global market, and as they did in the LCD space, they will continue to expand production until they can capture significant share, which bodes well for the capacity that will further stimulate UDC’s sales. 
The other positive factor is panel size increase, which we have noted previously, and as LG Display continues to expand its OLED TV offerings by increasing panel size and adding capacity and the small panel OLED market, which has been primarily focused on smartphones, is beginning to expand into notebook and monitor panels, which will begin to absorb OLED capacity over the next few years.  With the penetration rate of OLED displays in smartphones nearing 50%, much of the incremental OLED capacity that will be added over the next few years will be dedicated to that market, but as these new OLED application grow, it will push the need for incremental capacity to feed these applications.  In fact there has been speculation that Samsung Display is considering refitting an idle LCD Gen 8.5 fab to produce OLED IT products, and while such plans are not yet in our model, they would be incremental to what is shown in the table below.
Of course there are offsets, particularly the desire by OLED panel producers to reduce the cost of OLED production, a portion of which could be based on replacing current OLED emitters with more efficient ones, and while UDC works toward these same goals for their customers, in theory such more efficient materials could result in smaller quantities being needed to produce the same results. This has been and remains an issue for some investors, who look at any quarterly decrease in material sales as validation that OLED producers are becoming more efficient, both wasting less emitter material and developing ways of using less to achieve the same results.  This is something UDC has been grappling with since its inception, but misses two points. 
First, one of the comparisons that LCD panel producers use against OLED displays is brightness, with LCD displays the brighter option.  OLED panel producers have found a number of ways to improve the brightness of OLED displays, but improving the OLED device’s ability to generate a brighter display is primarily a function of the materials in the OLED stack, so a more efficient material, meaning one that can convert more energy into light, would certainly get the attention of panel producers as they would be better able to compete against other display technologies 
Second, UDC’s OLED material contracts with producers are based on material volumes, which trigger set points at which the cost of the material to the purchaser declines.  Once that volume reaches a ‘terminal’ point, the price remains at the lowest level for the life of that OLED stack.  If UDC is able to generate a new OLED emitter composition that has better characteristics that the previous material, customers will switch, which resets the price table to its highest point, improving material margins.  This incentivizes UDC to produce new and more efficient OLED emitters to attract its customer base toward these premium products, and while that is counterintuitive to some, it is the basis for UDC’s ability to generate material margins in the 65% to 75% range.  While this quarter’s material margins were 67%, after 1Q’s 74%, we see this as a relatively short-term move similar to material cost increases seen by many others in the display space, and we expect a return to higher material margins over the next few quarters.
While the ups and downs of UDC’s shares are vitally important to some investors, we find many are principally focused on quarterly results that can boost performance, but looking at the OLED industry from the perspective of overall growth is a far better way to capture that growth without the distraction of overinflated or underinflated expectations.  We will continue to delve further into Universal Display next week, with more data for those that are interested in how UDC plays into the display space and the growth of the OLED segment.

Figure 2 - Red Emitter Sales - Source: SCMR LLC, Company Data           Figure 3 - Red Emitter Sales (Smoothed) - Source: SCMR LLC, Company Data; ​Figure 4 - Green Emitter Sales - Source: SCMR LLC, Company Data  Figure 5 - Green Material Sales (Smoothed) - Source: SCMR LLC, Company Data

Taiwan based Digitimes indicated in an article that Samsung Display (pvt) and LG Display (LPL) are decreasing their reliance on outside sources for organic materials used to produce flexible OLED displays.  While this is ultimately true, that South Korean firms would ideally like to have ultimate control over the materials used in the production of flexible (and other) OLEDs, the article did little to specify any changes that have not been mentioned previously, generally citing mergers and investments by both producers that would help them gain the necessary IP to bring production of flexible OLED materials to Samsung SDI (006400.KS) and LG Chem (051910.KS) respectively.

The article specified that both producers obtained polyamide varnish from Japanese supplier Ube Industries (4208.JP) and a number of other TFT backplane production materials from South Korean suppliers ENF Technology (102710.KS), Dongjin Semichem (005290.KS) and Dongwoo Fine-Chem (pvt), a division of Sumitomo (8053.JP), none of whom struck us as different than would have been expected.  Further, deposition materials, a far more important component of the OLED production process, were specified coming from Idemitsu Kosan (5029.JP), Universal Display (OLED), Dow Chemical (DOW), and Merck (MRK), but hinted that the Samsung purchase of Novaled and an investment in Sun Fine Chem, a division of Hodogaya Chemical (4112.JP) were leading to the acquisition of IP that would allow these organics to be made internally, and finally that flexible substrates and cover glass were sourced from 3M (MMM) and Corning (GLW) respectively.

While there are a great number of materials and suppliers used in the OLED production process, this article did little to shed any light on current or potential changes that have been implemented by South Korean producers.  Samsung purchased Germany based Novaled for $347m back in August 2013, a company known for its ‘PIN OLED’ material that is used to enhance the electron mobility of certain OLED stack layers.  It doesn’t replace other stack components, but works with other stack materials to give better overall stack results, and an investment by Samsung in SFC (Sun Fine-Chem) a division of Hodogaya Chemical, goes back to 2011.

We believe that the only thing relating to OLED materials that has changed recently, other than the usual vying for a position in the OLED stack of these South Korean producers, is the change in backplane made by Samsung Display earlier this year.  This change, to the M8 backplane did make some changes in OLED material suppliers, with red host material moving from Dow to Duksan Neolux (213420.KS) and green host moving from Samsung SDI to Nippon Steel (5401.JP), while other emitter and host materials suppliers remained the same.  While on a long-term basis, OLED producers are always looking to reduce costs, using their leverage to pit one supplier against the other, that doesn’t always lead to using home country or in-house suppliers, as is seen in the change above where green host moved from an in-house South Korean supplier to a Japanese supplier, and both producers evaluate many materials from suppliers to find the right combination of performance and cost.  If a local or in-house supplier can meet those needs, everyone is satisfied, if not, there is no hesitation on the part of Samsung Display and LG Display to use outside suppliers, and that has not changed over the last few years.