Magnachip Semiconductor Corporation (MX) Q2 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the MagnaChip Semiconductor's Q2 Earnings Call. Currently at this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] Also, as a reminder, this conference call is being recorded. I would now like to turn the call over to your host, Mr. Robert Pursel. Sir, you may begin.

Thank you for joining us to discuss the Company's financial results for the second quarter ended June 30, 2015. The second quarter earnings release we filed today can be found on the Company's Investor Relations Web-site. A telephone replay of today's call will be available shortly after the completion of the call and the Webcast will be archived on our Web-site for one year. Access information is provided in the second quarter earnings press release. Joining me today are YJ Kim, MagnaChip's Chief Executive Officer, and Jonathan Kim, our Chief Financial Officer. YJ will begin the call with a discussion of the Company's recent operating performance. Following YJ, Jonathan will provide an overview of our financial results. YJ will then discuss the Company's overall business strategy as well as financial guidance for the third quarter of 2015. There will be a question-and-answer session following today's prepared remarks. During the course of this conference call, we may make forward-looking statements about MagnaChip's business outlook and expectations. Our forward-looking statements and all other statements that are not historical facts reflect our beliefs and predictions as of today and therefore are subject to risks and uncertainties that are described in the Safe Harbor discussion found in our SEC filings. During the call, we will also discuss non-GAAP financial measures. The non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles but are intended to illustrate an alternative measure of MagnaChip's operating performance that may be useful. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in our second quarter earnings release. I would now like to turn the call over to YJ Kim. YJ?

Thank you, Robert. Back in May, when we reported our first quarter earnings, we made a commitment to report our second quarter earnings in early August. So I'm pleased to welcome everyone who is joining our conference call today. Before I discuss the Q2 results, I'd like to share with you the big picture of the challenges we are facing and the actions we are taking to address them. Those of you have some history with us know that we made strategic missteps in the past by concentrating our foundry business too narrowly on a limited number of customers in the high-end smartphone business. When our business slowed down from these customers, our revenue and fab utilization declined and much work was needed to be done to restore our competitive position with key semiconductor customers in the analog and mixed-signal markets. It is important to note that we won't solve this problem overnight. Having said that, we are in a rebuilding mode and have created a foundation upon which we can build. We are taking actions now with a real sense of urgency to put MagnaChip on a path to recovery, restore shareholder value and regain investor confidence over time. Here are some of the actions we've taken over the past few months. We began a comprehensive cost and portfolio optimization review that we expect will result in a reduction in total normalized spending of more than $40 million in 2015. These savings are expected to be achieved through improved manufacturing efficiency, better negotiated raw material pricing, reduced labor and overhead expenses and careful management of our spending in general. We have made substantial changes in our management team and streamlined decision-making by eliminating or replacing about 30% of our executive positions. We have created a task force to divide and initiate strategy to win new foundry business with the top analog and mixed-signal providers in the industry. While we believe we are making good progress in this area, it can take up to six quarters to ramp production following new wins. We have secured high-volume Standard Products design wins for mid-range smartphones and large display televisions as we continue to make strides to diversify our customer base and expand market share with key customers in targeted markets. We have combined our Display and Power Solutions business lines into a single Standard Products Group in an effort to maximize engineering efficiency and provide a more comprehensive product portfolio to key accounts. Now turning to our Q2 2015 highlights, we reported revenue of $162 million, a 1.7% sequential decline and a decline of 5.8% year-over-year. Let me give you some commentary on each of our two business segments. In our Foundry business, our second quarter 2015 revenue was $79 million, up 6% sequentially and down 12.6% year-over-year. The gross profit in the Foundry business was 21.8% in the second quarter, up from 20.6% in the previous quarter. Our Foundry business results in Q2 benefited from an improved product mix and cost saving activities. During the first half of 2015, we made good progress in diversifying our Foundry customer base and taped out 20% more foundry designs from analog and mixed-signal semiconductor suppliers than we did in the first half in 2014. While these tape-outs are an encouraging sign, it should be noted that new Foundry business can often take up to six quarters to ramp up following the design win. As a result, despite our efforts, we expect that the financial performance of our Foundry business will continue to be under pressure for the next several quarters, but I am confident that we are taking the right steps to restore our competitive position for long-term growth. Now let me turn to the Standard Products Group. Combined revenue for the Display Solutions and Power Solutions business line totaled $82.9 million, down 8.1% from the first quarter of 2015 and up 1.6% year-over-year, due primarily to weakness in our smartphone and large display businesses. The gross profit for the Standard Products Group was 21.7% in the second quarter, up from 21.5% in the previous quarter. Revenue for the Display Solutions portion of the Standard Products Group was $48.9 million in Q2 2015, down 13.2% sequentially and up 7.9% year-over-year. The sequential decline in revenue was due primarily to a soft macro environment in the television market and our smartphone business. Revenue for Power Solutions in the second quarter of 2015 was $34 million, up 0.5% sequentially and down 6.3% year-over-year. The year-over-year decline was due primarily to overall demand weakness in China as well as in the smartphone and TV segments that we address. Our primary focus in the Power business line is on developing new higher value products, which include high-end MOSFETs for LED lighting, industrial market as well as power management ICs for IoT and consumer applications. Now, let me turn the call over to Jonathan for a discussion of our financial results. Jonathan?

Thank you, YJ, and good afternoon everyone. MagnaChip reported on a GAAP basis revenue of $162 million and gross profit of 21.8% for the quarter ended June 30, 2015. On a sequential basis, revenue declined 1.7% and declined 5.8% year-over-year. Our second quarter revenue was slightly better than the midpoint of our revenue guidance as a result of a slight upside, mainly from a Foundry customer late in the quarter. Otherwise, we continued to see weakness in our Foundry business. In addition to this continued Foundry weakness, we were also impacted by the overall weakness in the TV market and our smartphone business in the second quarter. As YJ mentioned, we have been navigating through these challenges by diversifying our customer base, expanding our product portfolio and growing our market share within our existing customers. Gross profit was $35.3 million or 21.8% of revenue for the second quarter. This was up from 21.2% last quarter, primarily because of improved product mix in the second quarter as well as a decrease in manufacturing costs. Through our cost savings program, we have identified opportunities where we have been able to make certain manufacturing, labor and material cost reductions. Our current average fab utilization rate is in the high 70% range, below where we would like it to be, and it will continue to be a challenge until we increase loadings from new and existing customers. Total operating expenses were $50.5 million, up from $47.2 million last quarter. On a normalized basis, the total operating expenses for the second quarter were just about flat at $40.7 million compared to $39.9 million for the previous quarter. Our normalized operating expenses adjust for certain items that mainly include restatement and legal related expenses, non-cash equity-based compensation charges and separation costs related to eliminated executive positions discussed by YJ earlier. Our normalized operating expenses for Q2 this year of $40.7 million is down by approximately $5 million compared to the same period last year. On a GAAP basis, net loss for the second quarter was $30.6 million or a loss of $0.90 per share. Adjusted net loss, a non-GAAP measure, was $11.1 million, while adjusted EBITDA, also a non-GAAP measure, was minus $0.9 million. Turning to the balance sheet, cash and cash equivalents totaled $72.7 million at the end of the second quarter compared to $91.4 million at the end of the first quarter. Capital expenditures were $2.3 million this quarter and we expect capital expenditures will be approximately $13 million for the full year. With the restatement process well behind us, we have been focusing on resources and efforts on more fully analyzing all areas of cost saving opportunities. We have identified areas which we believe will lead to over $40 million of total savings in spending during this year. Through June 30, 2015, we have implemented programs that have already saved nearly $20 million in manufacturing as well as in corporate overhead spending. Looking ahead, we have much work to do and many challenges to overcome, but we believe we have the right strategy to begin to restore the health of the business and to increase shareholder value. Now let me turn the call back to YJ for his closing comments and financial guidance. YJ?

Thank you, Jonathan. In summary, I am confident about our management team's ability to restore our competitive market position and revenue growth over the long term, but need to caution again that the desired results will take time. Having said that, we are taking aggressive efforts to position MagnaChip for growth by reducing costs, streamlining organization, changing our market strategy, engaging with a broader base of foundry customers, and instilling a sense of urgency throughout MagnaChip. While our cost reduction will become evident in the near-term, our product strategy will take time to unfold because of the nature of the foundry business and the dynamics of the semiconductor industry. I might also note here that the cost reduction program I've talked about may continue to evolve over several months as we evaluate our options with respect to our cost structure. For our forward-looking guidance, we anticipate third quarter revenue will be in the range of $145 million to $155 million. We anticipate gross profit will be in the range of 20% to 22%. Now, I will turn the call back to Robert. Robert?

So Dillon, this concludes our prepared remarks. We will now open the call for questions.

[Operator Instructions] Our first question comes from Suji De Silva of Topeka.

So first question on the outlook, can you talk about what the outlook is for Foundry versus Standard Products, give us some color there?

In terms of our guidance for Q3, we prepared our guidance on a consolidated basis, and in terms of visibility by segment, we don't have – I guess, we're not comfortable providing that visibility, and so what we prepare is to provide the guidance for Q3 on a consolidated basis.

Okay, fair enough. And the cost savings, the $20 million, is that mostly in COGS or any of that OpEx, and as you go to $40 million run rate of cost savings, does some of that help the OpEx or is that mostly the COGS line?

It will certainly help our operating expenses, but it is mainly related to our manufacturing costs. So the main impact will be in COGS.

Okay. And then as we look at the Foundry pipeline of revenues you have versus I guess some of the smartphone customers that are concentrated there, when do you think – what's the magnitude of the business that's coming in that you've secured and when do you think you can return to year-over-year growth for the Foundry business given the pipeline?

Suji, I think you are asking a very important question for us. As we discussed today, we have 20% more design win taped out in the first half of 2015 compared to one year ago in the same period. But at the same time, as you know the design win tape out to the production ramp in the Foundry takes anywhere between four to six quarters. So when these database go into production, we expect to have the business ramp up, but we give one quarter guidance at a time. But typically it's a good indication that we are achieving now 20% better tape out than a year ago.

Okay, thanks YJ. And the last question around the strategic review committee that you formed, can you just give us any color on the rationale there for the formation of that committee and any context there would be very helpful? Thank you very much.

Sure. So the Board established the strategic review committee to assist the Board and the Company with reviewing and evaluating various strategic alternatives that may be available to the Company. We're looking at all options available and one of the things that the strategic review committee is doing is to assist the Company to take a look at strategic alternatives.

Okay. And that process began say a month ago, two months ago, just trying to understand timeframe?

We could say it started in Q2.

Okay, great. Thanks guys.

Our next question comes from Blayne Curtis of Barclays.

Maybe just a follow up on a prior question, maybe if you could just talk about some of the trends you are seeing in the smartphone and TV businesses that was weak in June, as you look into the back half of the year, what's your sense of the health of those markets' inventory levels? And then if you could also just comment on the pipeline in that business, you talked about rebuilding Foundry, what's your outlook for Display and is this a business that could also come back to year-over-year growth?

Thank you for asking that important question first. So television market, as you know there is some softness in the market and I think that is also related to the general weak macro environment in China as much of the TV market is also related to China consumption. In terms of the other key segment, including computing, you also see some macro softness there. And in terms of smartphone business, I think the important thing for us is to grow the market share within our key targeted strategic customers as well as growing the number of applications, whether it's in the mid-range or high-end. And then in terms of Foundry customers, it's also growing the different type of applications within the smartphone. For example, getting into fingerprint application, like that. So those are the things you can imagine us to trying to build a more market share and also grow within the smartphone market segment.

Okay, great. And then just looking at the gross margin, where do you expect utilization rates to trend in September and the back half of the year? And then when you look at the cost savings, I think you said $20 million through June, how much of that $40 million have you realized through September and just the factors between those two into giving that gross margin guidance, the utilization and the cost savings?

So our utilization is driven by – mainly related to revenue and we guided our revenue down for Q3. So the expectation is that utilization rates will be lower as well. As I mentioned during my prepared remarks, our current utilization rate is in the high 70% range and we would obviously like to increase that percentage. But as for Q3, the utilization rate will go down. And so, when we look at our gross margin going into Q3, we will get impacted by the utilization rate dipping. However, you'll notice that the guidance for gross margin doesn't trend consistently with revenue. And what I'd like to point out is that in that gross margin guidance, we have included a likely reversal of an accrual in the amount of $3 million or $4 million and this is mainly related to a commercial dispute that we had back in 2013 which we settled, and as part of that settlement there was an agreed upon criteria which the counterparty would need to meet to get the payout and our obligation ends in Q3 of this year. And our expectation is that the counterparty will not meet all of those criteria, and therefore we are expecting a reversal of that accrual, and so the reversal of the accrual is also going to benefit our gross margin in Q3.

Okay, helpful. If I could just one more on OpEx, how should I look for trends into Q3 with OpEx? You said not much cost savings, but directionally, where do you see OpEx going?

So operating expenses, as part of our spending reduction program, we have done a number of things to get a handle on our operating expenses. So, on a normalized basis we are just about flat against the prior quarter. And when you look at our operating expenses year-over-year on a normalized basis, we are actually down by $5 million. So going forward, I think we can expect our operating expenses to be flat or down.

[Operator Instructions] Our next question comes from Rajvindra Gill of Needham & Company.

This is Joshua Buchalter on behalf of Rajvi. So I was hoping you could provide a little more color on the Foundry business' customer diversification. I know you've mentioned that there were some opportunities identified. Does that imply that there is some business that's been secured? I know you mentioned it will take several quarters but how confident should we feel about business?

So in the Foundry, as you can see that we are in the rebuilding mode of the Foundry business and we are definitely in a mode to creating a foundation, so we can build upon. And as part of the indication that we are doing in that direction, there has been 20% more tape-out year-over-year and some of the applications such as smartphones, we are expanding into different applications within the smartphones. The fingerprint for example is an application that's brand new to us. And we are also growing into the automotive industrial IoT where it's more than 30% of the tape-out and design wins that's coming from that space. So we are definitely diversifying more than what we used to, whether it's the smartphone, addressing both mid-range and the high-range, as well as different applications within the smartphone as well as growing other than the typical applications we've been in by having more than 30% in the new growing [auto] [ph] in this segment.

So the 30%, that is on smartphone or is that IoT/auto?

So let me clarify that. When I said that more than 30% of the applications included automotive, industrial and IoT, so that our design wins in the Foundry is diversifying beyond the smartphone and communication.

Sorry, were you going to add there?

No, I think that I just wanted to make clear statement that we are diversifying to other segments and applications.

Okay, got it. Thank you. And then could you maybe help us understand what led to the step-down in the Display business this quarter?

You're breaking up there, Josh. You're saying what led to the step-down in Display?

Correct. Sorry about that.

So could you specify which timeframe you're referring to, so we can answer you more clearly?

Sure. Sequentially from first quarter to second quarter.

Thank you for clarifying the question. So as you know, there is some macro slowdown in China and China is a big consumption of the TV and consumer and communications. And as a result, we see some softness in TV as well as in – computing is a worldwide problem, and then the smartphone also I think that the China market slowed down a little bit, even though we believe the smartphone still is the largest growth market segment, but the pace has slowed down. So, all these things have led to the Q2 drop off from the Q1.

Okay, thank you. And then last question from me, I was wondering, obviously there's several activist investors involved, and I was wondering how the communication flow between the two of you is going, just any more color on that would be helpful?

As for communication between the activist shareholders and the Company, to me I don't think there's anything significant, it's all in the public domain.

Okay, got it. Thank you.

Thank you. I show no further questions in the queue at this time. I'll now turn the call over to Mr. Robert Pursel.

Thank you, Dillon. This concludes our Q2 earnings conference call. Please look for details of our future events on MagnaChip's Investor Relations Web-site. Thank you for joining us today.

Thank you, ladies and gentlemen, for attending today's conference. This concludes the program. You may now disconnect. Good day.