Japan Display Inc

TSE:6740

Earnings Call Transcript 2022-Q2

[Kumi Higuchi, executive]

Second quarter earnings call. My name is Kumi Higuchi from Japan Display Investor Relations, and I will be the moderator today.

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 second quarter. Scott-san, please.

[Scott Anderberg Callon, executive]

Thank you. And I'm looking at a screen that has been -- okay. That's gone away. Good. Perfect. Thank you, everybody. Again, I'm Scott Callon. Thank you so much for joining today. We're grateful for your time. So let's get to it.

Five key sets of actions and outcomes in the first half. One is we've addressed a situation, which is really difficult. And I'll go into detail on all these points, but we ended up driving higher sales and with our operating loss, that was overwhelmingly better than our forecast. We've had -- second point, we've had very strong progress in new product rollout, development of the next-generation technology road map, which is super exciting.

Third point, we continue to focus on sustainability. And again, I will discuss this later, joining the UN Global Compact and Apple's 100% renewable energy initiative. We repaid INCJ JPY 20 billion. So it's a little bit about, in the U.S., $ 200 million to reduce debt and strengthen our financial position, and we increased capital via Ichigo Trust adding some additional warrants.

So let me talk about the market environment. There really are kind of 2 elements to this. It's kind of the customer environment and the operating environment and they're very, very different. The customer environment is the demand side, what a customer is asking from us. And it's actually incredibly strong. What we're hearing from our customers is they want us to build and ship as much as possible. And so that's the good news, demand is phenomenal.

The bad news is on the supply side, where things are just truly devastating. Just unprecedentedly difficult. You're probably hearing this from other companies. Absolutely severe impact from the semiconductor shortage. There was input inflation that is very significant. There are global supply chain disruptions, that you're all very familiar with. So it's an interesting contrast between phenomenal demand and a very, very difficult supply situation.

Now we're managing through it, but I just need -- in the interest of utter candor, if we're going to talk about the market environment, we need to talk about how difficult it is to manage our production capacity and delivery to our customers in the current environment.

The one change -- and so we put this -- we did this map 3 months ago, sort of a weather forecast. The one change from the last time, as you can see in Mobile China/Other, with the semiconductor shortage is beginning to increasingly bite for customers. And so I've written that it increases smartphone demand uncertainty, which is to say, we are having some of our Chinese smartphone customers saying they don't have parts. And so even if we can ship to them, they can't take the parts and so we're seeing some cancellations.

And what's interesting is overall demand actually remains very high from our Chinese mobile customers because other customers are saying, "That's fine. We'll take your production. We have the parts." But it is -- it's an absolute war out there. There's a battle for parts. There's a battle to keep the supply chain up and running. And this is very, very difficult.

Bottom of the page, we have the one on cloud that's becoming very sunny. That probably should be like a thousand suns at this point. And the reason is, as you know, I talk on a quarterly basis about our capabilities in VR, which at this point, I think the world has decided we're going to start calling it metaverse, which is fine. But we are overwhelmingly #1 in this space. We are a metaverse builder, a metaverse maker. There is no way that you can create the fusion and the totally immersive environment that was imagined, for example, by Mark Zuckerberg in his keynote address for Meta, without our technology.

We are -- we have the ability to deliver ultra high-end resolution devices. Our goal in this space -- and we'll give you a lot more detail on how we intend to grow very substantially in this area. But just like you have Intel dominates in Windows CPU, you have Sony dominate in CMOS sensor, NVIDIA dominate in the GPU space, we think we are fully capable of JDI inside across all high-end, truly, fully immersive displays in the metaverse space. It's incredibly exciting and important.

And it's potentially, utterly transformational not only for the economics of our firm, but for our ability to deliver to the world, because this is a very, very significant technological transition. And we are -- in terms of being able to supply the high-end, fully immersive displays, we have no peers and we're going to continue to drive forward very hard. We have -- also, because we are the premier provider of ultra-high resolution displays to metaverse devices, we have intimate understanding of the technology road map of every major supplier, and we're involved. And so it's super exciting.

Today is primarily about what we've done in the last quarter. but there is an important set of technology initiatives, and we're working very hard on investing heavily and building out our advantage in metaverse. So stay tuned.

Let me talk about the Q2, only better than expected. We are rushing towards where we need to be. I mean we still had operating loss, but we're rushing towards profitability at an extraordinary pace. So we thought we're going to end the quarter down JPY 8 billion. So that's, what, about a little over USD 70 million. We then actually upward revised to -- and I'm sorry, there should be a minus there, minus JPY 2.0 billion and minus JPY 1.3 billion. So minus JPY 2 billion and minus JPY 1.2 billion is where we ended up. So that's actually an 85% improvement. And we'll adjust these slides online, apologies for the mistake.

That's an 85% improvement from where we thought we were going to be over a 3-month period. It just tells you we had tremendous success in managing the semiconductor shortage. We grew our customer business. We passed on increased costs to selling prices. And so it was nowhere near where we want to be and where we expect to be. But arguably, relative to where we were, [ below ] quarter, and we fully expect to continue and we're going to get the profitability very fast.

On a cash basis, so cash earnings basis, EBITDA, the improvements were big enough for us to get to EBITDA profitability. So JPY 4.7 billion improvement in the quarter, we thought we were going to end up negative JPY 3.7 billion, plus JPY 1 billion. And that's kind of where we see our future. And of course, much bigger numbers in terms of our profitability going forward.

We upwardly revised our full year sales forecast twice. The first one, from JPY 254 billion to JPY 280 billion was primarily the 3 factors I said earlier. We're getting more parts, appears better than our peers. We have robust customer demand. We have been able to pass on our costs. So that's the plus 10%. We then increased another 6%. That's a little bit -- over half of that is going to be FX. So the end is currently JPY 114. We revised up our FX forecast from JPY 108 million to JPY 112 million for the second half of this year.

And then the other part of the plus 6% us delivering on the first 3, what I said earlier, getting parts, getting more customer orders and shipping against them and increasing prices to reflect our input prices. And that's going well. Customers want what we want to provide, and so we're passing on pricing -- our input price and cost increases in terms of our sales prices.

We are working, as we should, on sustainability and decarbonization. Global warming is real. It's devastating for the planet. So we joined the United Nations Global Compact. That is primarily about human rights and fair treatment of labor and holistically doing the right thing for the world, for society.

During the quarter, we also joined Apple's 100% renewable energy initiative. As you can see, Apple made an announcement at the end of last month with JDI, with us in it. We fully support everything they're doing. And this means we will be cutting overall production for Apple to 100% renewable energy over the next few years. This is really important for the planet, and we are honored to be presenting in this program.

We also did, as I said earlier, additional equity financing from Ichigo Trust, we took another JPY 8 billion. That leaves another JPY 11 billion on exercise, which we expect to take in as appropriate.

Let me tell you what we're doing to move towards structural profitability. First thing is fixed cost reductions. So we've actually taken down our fixed costs in the last 2 years by 21%. We have a pretty broad definition of fixed cost, it includes kind of factory power costs. And costs, in other words, that other companies would define as variable costs. In a sense, we're being conservative in the way we're accounting for this.

But it's all -- another way of putting it is we really, really want to push down hard across our cost structure, and so we're very focused on a broad definition of fixed costs and pushing them down hard. And so we've had considerable success with this, and we will continue to -- we think there's more to come.

The decrease is less this year because, as I said earlier, it includes things like factory power costs and energy prices have gone up fairly substantially. So on a real basis, we've got a stronger push down this year than what appears on the graphs in front of you, I'm sorry, on the graph front of it.

Turning to a breakeven point. So to get more profitable, we need to get to breakeven. You can see in front of you our current breakeven point in terms of sales is JPY 330 billion a year. As you can also see, our forecast right now is JPY 297 billion. So we're JPY 30 billion short. That's why we will be unprofitable this year. And by the way, breakeven is your marginal profit against sales minus fixed costs. So you actually have 2 levers, and we've been working very hard on both levers.

I told you on the previous page, we've pushed [ down ] our fixed cost. We've also very substantially increased the marginal profitability, the embedded profitability in a product mix that reflects us moving towards higher value-add products that are distinct and unique and differentiated JDI, and our customers are willing to pay for our ability to deliver unique value.

So we're JPY 30 billion short this year. To give you some sense of what next year looks like, we're obviously going to do a bunch of work on this, meaning between now and then we'll have to see what happens in the world with COVID and with the global supply chain and with the semiconductor crisis.

But currently, our sense is that we're going to end up with pushing down the breakeven point even further. It will be some mix of cost reductions, but primarily led by improved profitability in the product mix. So we think we get to breakeven sales of about JPY 300 billion next year, so another 10% -- take another 10% down out of our breakeven point.

We think sales looks like it would be JPY 330 billion, it could be JPY 340 billion. We'll have to see when we get closer what the world looks like at that point in time. In other words, we expect to get to profitability next year. We are experiencing very, very fast improvement in profitability based on just a lot of actions that had to be taken to cut costs and cut products that are unprofitable and focus the resources on the firm, and our customer engagement on delivering kind of high-end products that serve their needs better than anybody else.

The other point that's very, very important is it's not very interesting to have structural profitability if you're completely dependent on the single customer, even if it's a phenomenally great customer. And so you can see on the left side of the chart, what went wrong for us is a dramatic decline in sales in mobile U.S. and Europe, primarily a single customer, which wasn't sufficiently replaced by a growth in activity in our other product areas that are shown on the right side.

And so -- the bad news is we lost this business, the good news is we've lost the business. We've absorbed it. We pushed down our cost structure in order to absorb it. And at this point, we're going to have a significant development in our capabilities in non-mobile. So that's wearable, metaverse and automotive.

Mobile China and other, actually, that business has become profitable. Our primary fab in Japan is Mobara, we call it -- it's in Mobara. It's sort of an English penetration of that. In Chiba, we call it J1, it's over half of production capability with a [indiscernible] 114, arguably, it may well be the single most competitive G6 plant in the world in terms of its cost competitiveness.

So we bring a combination of having -- in many cases, continue to have #1 technology capability in the world and #1 lowest cost structure. It's enormously powerful. So that the mobile -- Chinese mobile business had not been profitable for us, it has now become profitable. And so we're happy to continue to grow that. The automotive business and the wearable and metaverse areas of both places that we're going to see growth, possibly explosive growth.

The strategy, this is a chart we showed 6 months ago, unchanged, strengthening existing businesses, build new businesses. What's worth pointing out is the KPIs that we articulated, we're well on track in getting to. We wanted to get to EBITDA positive by Q4. We actually got positive by Q2. We're going to have a drop down in Q3 and then go positive again in Q4, but we're well on track on this. In terms of the KPIs of building new businesses, we actually have -- we've hit this KPI also. We've gone to market with -- already with a new business transparent displays.

Transparent displays that are relatively dark, but arguably transparent have been around for a while. But we are the only company in the world that is shipping display glass. It is literally glass in terms of transparency and it is a display. It is unique technology, no one else can compete with it. We're shipping a product right now. We're talking with customers about changing the existing format of displays, which are kind of -- they block things, you cannot see through them, to putting glass with displays.

The product is currently being used in multiple occasions in Japan, at windows, at like city offices, there are going to be banks, there are going to be train stations. The ability to have -- kind of talk to somebody and be delivering kind of display feature. The current functionality is directed at people who are hard at hearing. So you can actually -- there's an embedded direct translation of the conversation that's going on.

So the -- so you can have a conversation with someone and not only is the speech, but it's also right in front of you, visible and yet you can look through it and see the person on that side. Everything you're speaking appears in text. So obviously, it can also be used for translation of -- so you speak English and the person sees Japanese on the screen, et cetera, et cetera. So it's a really interesting technology and unique, and we'll see how much we can grow that business.

And then there are 2 new other technology businesses that we've launched, which, apologies, they're going to remain secret. Codename V and codename L, they're both businesses that directly report to me that are going all out really, really fast. We expect to come to market with that product -- with products/services solutions next year. And so there is a major kind of set of initiatives that we think are going to be very powerful, building new businesses. So apologies.

At this -- up until now, we've had a tendency to announce we're going to do something and it's going to be a year or 2 years from now. Our view has become if we're going to do some really exciting, we should wait until we ready to ship and then announce it we're going to ship. So with apologies, V and L, the 2 new major technology and go-to-market initiatives, I'm not going to give any disclosure on today.

So that's the overview of where we have taken things in the last couple of months. And I'm now going to have Okochi-san, our CFO, go through the details of the 3 months earnings. Thank you very much.

[Akihito Okochi, executive]

Thank you. So I'll explain about the Q2 financial -- first half financial results. Firstly, as Scott explained earlier, our -- we achieved the EBITDA positive number for quarter 2. In the table above, we show actual consolidated numbers. Left side is the actual of the half and half. And right side is the actual -- so in the table below, we show the actual numbers assuming the semiconductor shortage impact -- excluding semiconductor shortage impact.

As for Q2 sales, since the trends, which are our main customers see the demand decrease and semiconductor shortage impact us is continuing, the sales dropped significantly year-on-year basis. As for P&L, we improved the product mix and reduced the variable costs and fixed costs. As a result, the breakeven point fell or reduced. And operating profit, ordinary income and net income substantially improved. Also EBITDA, as explained, turned positive.

Comparing to outlook, which we announced on August 5, sales JPY 3.9 billion positive and operating income, JPY 6.8 billion positive, as we could manage semiconductor show this issue better than expected. Excluding semiconductor shortage impact Q2 accounting period, EBITDA is expected to be JPY 4.2 billion positive, and operating income is expected to JPY 2.1 billion positive, Our P&L is obviously getting better and better.

Although ongoing semiconductor shortage impact is still uncertain as explained earlier, we keep negotiating with all suppliers and technology partner and customers on a daily basis in order to reduce the damage. And we believe that activity will make Q3, Q4 financial better and contributed to stable profit for 2020 or -- I'll explain about the focus in more details.

This is the sales by product. On the left-hand side, we show the Q2 last year with the breakout of product categories. Mobile means smartphone, PC and tablets, which was divided into -- one is for U.S. and Europe customer and the other is for Chinese and other customers. Other categories are automotive and non-mobile, like VR, metaverse, wearable, OLEDs and digital still camera and so forth.

For U.S. and EU customers of mobile, Q2 last year was JPY 63.1 billion, but Q2 this year substantially decreased to JPY 22 billion. However, this sharp decline will ease from Q3. The ratio of the sale of -- for U.S. and EU customer decreased to 31%. That means portfolio diversification is proceeding as expected, as Scott mentioned earlier. And we explained at the previous announcement, please refer to slide -- Page 21 for details later on.

For automotive, Thanks for the production and sales effort despite of semiconductor shortage, the sales increased 14% quarter-on-quarter basis. However, we could meet completely strong demands from our customers, Tier 1 and OEM makers. Because of that, the sales became JPY 23.9 billion, which is the same level as last year. For non-mobile, OLED for wearable and ultra-high resolution LCD to VR metaverse are well increasing. The sales became JPY 16 billion. That is a 3% increase year-on-year basis, 77% increase quarter-on-quarter basis.

Next, this is the waterfall chart showing your operating income changing factors. On the left side, you see the comparison of Q2 of 2020 and Q2 2021 year-on-year basis. On the right-hand side, you see the comparison on the quarter-on-quarter basis.

On year-on-year basis due to the sales drop from JPY 111.8 billion to JPY 79.9 billion (sic) [ JPY 71.9 billion ], JPY 3.1 billion decrease by shipment, volume and product mix. However, reducing the manufacturing fixed costs and SG&A and inventory increase for Q3, orders increase and shrink -- shrunk of inventory lockdown, as a result, operating loss improved to JPY 1.2 billion. On quarter-on-quarter basis, sales increase and shipment, volume and product mix significantly improved operating loss.

Lastly, the full year focus. As I explained at the previous earnings release, we are gradually expanding the disclosure. This time, we will disclose the sales, EBITDA, operating income and ordinary income and net income of Q3, Q4 and the full year, respectively. Sales Q3 totaled JPY 73 billion; quarter 4, JPY 86 billion; [ full year], JPY 297 billion, and the JPY 17 billion excess from the previous earning release. Breaking down to mobile to Western customers, U.S. and Europe customer, JPY 13 billion in Q3, JPY 20 billion in Q4. And mobile to Chinese customer, JPY 12 billion in Q3 and JPY 9 billion in Q4.

Mobile to U.S. and EU customer sales quarter 3 down and quarter 4 up. The reason why in the Q3 sales [ product shift ] to Q4. Mobile to Chinese customer and others, mainly OLED business and net module business, which [ expected ] profitability is low. So we usually [ sought ] orders considering profitability, and assume to decrease sales to JPY 9 billion. Automobile, as I explained earlier, since we being making every effort on semiconductor issues and other parts, procurement activities, we assume to increase sales JPY 31 billion for Q3 and JPY 37 billion quarter 4, respectively, because of such activities.

Non-mobile, like wearable, OLED, ultra high-end resolution LCD to VR metaverse will grow well, same as automobile. And its sales will increased to JPY 17 billion Q3, JPY 20 billion for Q4, respectively. As for Q3 P&L, we assume to decrease operating income because of electricity charge increase, [ exceedingly ] expense related to sales delay into Q4 on worldwide basis, and R&D expense of very unique products, which are very confidential at this time. However, Q4 P&L, we assume to recover operating income because of sales increase and the continuous fixed and variable cost reduction.

Finally, semiconductors shortage issues still have some uncertainties and could impact on the P&L. It's a bit difficult to foresee it. However, because of our ongoing effort of every -- our ongoing effort of the procurement as our top management priority, our profitability is obviously recovering and actually cause the EBITDA to turn profitable. So we will continually implement business organization by variable fixed costs reduction, organization optimization of our business product portfolio and other measures. So break point -- breakeven point is reducing actually. We keep Q4 EBITDA profitable target, and strongly believe to return to stable profit 2020 onward.

Thank you. This is the end of my presentation.

[Kumi Higuchi, executive]

[Operator Instructions] Any questions? There seem to be no questions. Scott Callon will give a closing message.

[Scott Anderberg Callon, executive]

Can we put up Page 16? Yes. I think it's worth. Thank you, everybody. We're grateful for your time today.

I think it's worth pointing to -- I started with how incredibly severe the impact is right now on the -- because of semiconductor shortage, because of cost inflation and inputs, because of the issues that are happening in global supply chain. And we are experiencing those impacts. So even though our numbers have improved very, very substantially, I think it's worth pointing out -- again, this is a slide that Okochi-san touched upon. But at the bottom, you can see where Q2 would have come out when we didn't have the chip shortage impact, semiconductor impact. In other words, we would have been fully profitable, not just EBITDA but OP.

We think this is the best view as where we are right now. It's a way of saying that we've had an absolute revolution in our profitability. It's been driven by a combination not only of cost cuts, but of shifting product mix to higher profitability products that customers really need from JDI. So anyway, I wanted to show that slide because it's worth understanding where we are on a going-forward basis.

At some point, semiconductor shortage goes away. We don't know if it's next year or the following year, presumably sometime during next year. We have had a fairly effective resolution of it. So even if there's a continuing worldwide shortage, we're confident we're going to have a much, much better 2022 because of the agreements we put in place with our technology partners.

We can pull down the slide and I'll watch you show my face, and say thank you to everybody. It's a very hard time in the world, we know that. We hope you and families are all safe, and we're grateful for your time today. Again, it's an honor for us. Everybody have a very good day.

[Kumi Higuchi, executive]

Thank you very much for joining the call today. You have a great day. Thank you.