Magnachip Semiconductor Corporation (MX) Q3 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the MagnaChip Semiconductor's Third Quarter Earnings Conference Call. At this time, all participant lines are in a listen-only mode to reduce background noise, but later we will be conducting a question-and-answer session. Instructions will follow at that time. [Operator Instructions] I would now like to introduce your first speaker for today Robert Pursel, Director of Investor Relations. You have the floor sir.

Thank you for joining us to discuss MagnaChip’s financial results for the third quarter ended September 30, 2015. The third 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 website for one year. Access information is provided in the 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 fourth 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 as 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 third quarter earnings release available on our website under the investor relations tab at www.magnachip.com. I would now like to turn the call over to YJ Kim. YJ?

Thank you, Robert and good afternoon to everyone on our Q3 earnings conference call. During Q3 we continued to make steady progress on the business and operation fronts and executed well on our standard product and foundry strategies. We came in at the high end of our guidance for both revenue and gross margin, and continued to sharply reduce spending in Q3. We were disciplined with our cost controls in the third quarter. As a result, we are well on our way to exceeding our full year target to reduce total normalized spending by over $40 million in 2015. Jonathan will talk more about this later. Having said all that, there is no getting around the fact that we continue to face major challenges due to past strategic missteps that will continue to constrain our financial performance for several quarters. Before we dive into the detail Q3 financial results, I like to make a few general comments about how we are changing the way we are doing business at MagnaChip. Our new leadership team has been in the driver’s seat on a permanent basis for the last five months. During that time, we have moved with a renewed sense of urgency and made substantial changes in our go to market strategy with the goal of getting MagnaChip back on the right track. Here are some of the ways we are working to create a foundation for longer-term growth. One, we have shifted our go to market strategy. Although the high-end smartphone market is important for us, we are no longer overly dependent on a limited number of customers in this segment. Two, we now have a more diversified customer base in attractive gross markets such as automotive, industrial, mid-range smart phones, UHD TV and IoT. In particular, we are gaining traction in the mid-range smartphone market, where our standard products closely align with customer requirements. To illustrate the point, our AMOLED display product are now designed into 26 mid-range smartphone models. This compares with 20 models in Q2 and 14 in Q3 a year ago. Three, it was not long ago that China was a virtually untapped market for certain MagnaChip products, but we now have expanded our footprint there. Now we are setting our sites on becoming more of a factor in the foundry and standard products business in China. For MagnaChip China represents a growth opportunity. Now turning to our Q3 2015 financial results, we reported revenue of $154 million, which was at the high-end of our guidance, but which represented a 5% sequential decline and a 21% decline year-over-year. Let me give you some commentary on each of our two business segments. In our Foundry business, third quarter revenue was $71 million, down 9% sequentially and down 28% year-over-year. The gross profit in the Foundry business was 26% in the third quarter, up from 22% in the previous quarter. New production ramps in the quarter from several customers partially offset the expected decline in our legacy high-end smartphone product. Our Foundry pipeline is showing improvement. Database tape-outs increased 24% in the first nine months of 2015 compared to the same period a year ago. Despite these encouraging future indicators, we continue to expect that the financial performance of our Foundry business will be under pressure until these designs have the potential to translate into meaningful production. One final note on our Foundry business. We have substantially ramped up our Foundry marketing efforts this year to attract new customers. This year, we have already conducted a total of four Foundry technology symposiums for potential customers in the US, Taiwan and our first ever in China. In November, we are hosting our second symposium in China in Shenzhen, following a successful symposium in Shanghai a month ago. At that September event, 83 attendees from 25 companies participated because of their interest in our broad analog and mixed signal technology portfolio. Now let me turn to the Standard Products Group. Combined revenue for the Display Solutions and Power Solutions business lines totaled $83 million, virtually flat from the second quarter of 2015 and down 13% year-over-year. The gross profit for the Standard Products Group was 19% in the third quarter, down from 22% in the previous quarter. Revenue for the Display Solutions portion of the Standard Products Group was $48 million in Q3 2015, down 1% sequentially and down 18% year-over-year. The sequential decline in revenue was due primarily to a soft macro environment in the television and computing markets. Revenue for our premium AMOLED display products was up 47% in Q3 from Q2, but down 24% compared to the third quarter a year ago. For the first nine months of 2015, AMOLED revenue increased 20% compared to the comparable nine months period in 2014, due to strengths in mid-range smartphones. Revenue for Power Solutions in the third quarter of 2015 was 34 million, up 1% sequentially and down 5% year-over-year. We continue to focus on premium Power products, which accounted for 34% of our total Power Solutions revenue, up from 31% in Q2 2015, and 29% in Q3 a year ago. Power Solutions were especially strong in China, where revenue climbed 14% sequentially. 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 $154 million and gross profit of 22% for the quarter ended September 30, 2015. On a sequential basis, revenue declined 5% and declined 21% year-over-year. As YJ mentioned, our third quarter revenue was at the high-end of our revenue guidance as we benefited from the adoption of our Standard Products by companies in China. Our Foundry business continues to feel the effects of our past strategic missteps and remains weak, although our pipeline of projects continues to grow. Gross profit was $34.7 million or 22.5% of revenue for the third quarter. This was up from 21.8% last quarter, mainly due to benefits from cost reduction, product mix and a one-time reserve adjustment of 3.6 million, which we mentioned during our last quarter’s earnings call. Excluding the effect of this reserve adjustment, normalized gross margin in Q3 was 20.1%. Lower fab utilization in Q3 will lead to a drop in gross margins in Q4. As you know, we launched a comprehensive cost review earlier this year, and set a goal to reduce normalized spending by $40 million for calendar 2015. I am pleased to note that we are well on our way to exceeding that goal. In just the first nine months of the year, we have reduced normalized spending by approximately $38 million as compared to the same period a year ago. The cost savings we have achieved this year have come primarily through certain manufacturing and operating expense reductions. Looking ahead, we will continue to identify cost savings opportunities in the fourth quarter of 2015 and beyond. In Q3, our fab utilization slipped to the high 60% range from the high 70% range in Q2. This decrease was the result of both prudent management of inventory as well as a decline in our revenue. An encouraging sign is that our foundry database tape-outs increased 24% in the first nine months of the year, which we believe can translate into improved fab utilization in the future. Having said that, the current level of utilization will continue to impact us in the near to mid-term. We are taking steps to improve fab loading over time by targeting new markets and customers and we are cutting costs, optimizing our product portfolio and closing our 6 inch fab. Total operating expenses were $43 million, down from $51 million last quarter. On a normalized basis, the total operating expenses for the third quarter were $40 million compared to $41 million for the previous quarter. Our normalized operating expenses adjust for certain items that mainly include restatement and legal related expenses, and non-cash equity-based compensation charges. Our normalized operating expenses for Q3 this year of $40 million is down by approximately $5 million compared to the same period last year. On a GAAP basis, net loss for the third quarter was $57 million or a loss of $1.65 per share. Adjusted net loss, a non-GAAP measure, was $10 million, while adjusted EBITDA, also a non-GAAP measure, was a positive $1 million. Turning to the balance sheet, cash and cash equivalents totaled $69 million at the end of the third quarter compared to $73 million at the end of last quarter. Capital expenditures were $2 million in Q3 and we expect capital expenditures will be approximately $10 million for the full year. Inventory at the end of Q3 was $58 million, down sequentially from $72 million reflecting our focus on managing our working capital. Now let me turn the call back to YJ for his closing comments and fourth quarter financial guidance. YJ?

Thank you, Jonathan. We are still in a turnaround mode, and have a long way to go, but we are making step-by-step progress and heading in the right direction. To recap, we one, continue to reduce normalized spending by approximately $38 million in just the first nine months of the year. We are well on our way to exceeding our previously stated goal to reduce normalized spending by over $40 million for all of 2015. Two, are making headway in attracting new Foundry clients, particularly in the US and China. Three, are continuing to optimize our product portfolio and fine-tune our go to market strategy. While we met our quarterly guidance numbers in Q3, I will be the first to say that a sustainable recovery will take several more quarters due to the nature of the Foundry business. In conclusion, our financial results are still burdened by past missteps, but we are looking ahead, not back. We are acting with a sense of urgency and will continue to take actions to position MagnaChip for profitable growth over the long-term. For our forward-looking guidance, we anticipate fourth quarter revenue will be in the range of $143 million to $153 million. We anticipate gross profit will be in the range of 14% to 16%. Now, I will turn the call back to Robert. Robert?

Thank you YJ. So Andrew, this concludes our prepared remarks. We will now open the call for questions.

Thank you. Ladies and gentlemen, our first question for today is from the line of Suji De Silva from Topeka. Your line is open.

Hi guys.

Andrew, we will take questions now.

Hello, can you hear me Robert?

Our first questioner has his line open.

Sure, hi. Suji De Silva of Topeka here. Can you guys give us an update on the strategic process that you have announced a few months ago?

So, we have set up the strategic review committee to assist the company in reviewing various strategic alternatives. That process is continuing and to the extent there are any significant decisions made I will make that available in the public domain.

Okay, thanks, and then the Foundry customers, I think you had said in the prepared remarks that the growth there is from some new customers that – I mean, when would those customers you are referring to acquired and when would we see first revenues from customers you will be gaining now as you start to reengage for Foundry customers.

Yes, Suji that is a very good question. So, as we said, that we are showing this sign of improving in terms of the pipeline and the database tape-out has increased 24% from a year ago. So that is a future sign. But as you know in the Foundry business a short, the production could take several quarters, up to six quarters. So when those go into the production, we expect revenue to recover on the Foundry. So it really varies between the customer and the thing. So I cannot really put a specific timeline on that, but when those go into production we expect the revenue to come.

Okay. The time frame helps there YJ and then, the gross margin number, I wasn’t clear, the 14% to 16% guidance, is that comparable to the 22.5% you did this quarter and what is the utilization delta that maybe moving in that direction?

Right. So you bring up a good point about utilization, which is the most significant impact to gross margin, and in terms of comparability, remember we had a reversal of 3.6 million, which helped the gross margin in Q3. So as we guide to Q4 that would need to be normalized, and so in terms of the utilization I think the impact is probably going to be about 4.5% of the gross margin and another item that I would like to mention, I mean, in connection with the utilization is the fact that we are taking a closer look at our inventory to make sure that we are only producing inventory items that we would need in terms of supporting our sales. And so we are trying to put a tighter control around our inventory production, which benefits our cash burn. However, at the same time given the fact that, we have – as we are taking control over the production of inventory, that does actually impact the utilization negatively. So that is an offset but we believe that it is a prudent thing to do for us to try to manage our working capital, and we think it is a good program to be in place.

Okay, very helpful. And last question on the Opex side, you will get to your $40 million plus of reduction this year, and [Indiscernible] certain run rate in 4Q, should we think that is the run rate going forward for ’16 or is there further room for you to reduce the run rate from that level?

So, we are looking at a number of different categories and we will continue to work hard to maximize our cost savings. I can't quantify exactly what those numbers will look like. But we will – again, we will do our best to reduce those costs and the expectation on the operating expense side we think it will be flattish.

Okay, great. Thanks guys.

Thank you. Our next question comes from the line of Rajvindra Gill from Needham & Company. Your line is open.

Hi, this is Joshua on behalf of Raj. Thank you for taking my question. Given the margin guidance, is it somewhat safe to assume that the majority of the sequential drop in the guidance – the revenue guidance at the mid-point is related to the Foundry business, maybe help explain so the puts and takes in the gross margin heading into next quarter?

Yes. So let me speak in terms of the revenue portion. So on the sequential drop, it will be more toward the Foundry, but again there is a seasonality, as you know. So I think that we are within that. In terms of the margin, I like Jonathan to comment.

Sure. Again the margin is impacted by our utilization, and discussed the fact that the utilization dropped a significant amount, Q2 to Q3. Just to put some color around what the utilization rate is doing is as we look into the next quarter, we believe that the utilization will be flattish.

Okay, thank you. That is helpful. And then was the reversal, what was the split there between the segments and is that artificially bumping up the Foundry business in 3Q?

That is correct. The reversal had to do with a settlement that we did and that was related to the Foundry business.

Okay, great. Thank you. And then, display and power were as you guys said pretty flat QoverQ, can we kind of assumed that this is a bottom, and when would you expect this business to return to growth if so? Thank you and I appreciate you answering my questions.

Yes. So, we certainly gave the guidance on the Q4 that the range is $143 million to $153 million for the company. We have a very limited visibility beyond Q4, but in general I think the mid-range smartphone will continue to do at the similar momentum it has done and there is some seasonality of the foundry side, and then the power, some seasonality. So that is what we can see, and beyond Q4 we do have very little visibility.

Okay. Thank you.

Thank you. That is all the questions that we have in the queue at this time. So I would like to turn the call back over to management for closing remarks.

Thank you, Andrew. This concludes our Q3 earnings conference call. Please look for details of our future events on MagnaChip's Investor Relations website, and thank you for joining us today.

Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program, and you may all disconnect your telephone lines. Everyone have a great day.