Magnachip Semiconductor Corporation (MX) Q2 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the MagnaChip Second Quarter 2016 Financial Results Conference Call. [Operator Instructions] As a reminder today's conference call is being recorded. I would now like to introduce your first speaker for today, Bruce Entin. You have the floor.

Thank you for joining us to discuss MagnaChip's financial results for the second quarter ended June 30, 2016. The second quarter earnings release we filed today and other releases 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 earnings 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 briefly recap the company's overall business strategy as well as provide financial guidance for the third quarter of 2016. 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 second quarter earnings release available on our Web site under the Investor Relations tab at www.magnachip.com. I would now like to turn the call over to YJ Kim. YJ?

Thank you, Bruce, and good afternoon to everyone on our Q2 2016 conference call. Revenue in Q2 exceeded expectations for the second consecutive quarter as our business turnaround gained momentum. Customer demand was strong and broad-based across standard products group and the foundry services group. MagnaChip achieved total revenue of $167.1 million in the second quarter, a double digit increase of 13% from Q1 and an increase of 3% from the second quarter of 2015. Q2 revenue was at the highest level since the fourth quarter of 2014 and was higher than the revenue achieved in any individual quarter in 2015. The 13% sequential increase in Q2 revenue was even more notable because it was achieved despite closure in February of our 6 inch fab that contributed approximately $9 million in revenue in Q1. AMOLED display driver ICs were the key growth driver and a major catalyst for our revenue upside in Q2, with increased demand coming primarily from mid-range Smartphone makers in China. In addition, our foundry business continued its long recovery and posted a sequential revenue gain for the first time in more than two years. The improvement in the tone of our business can be traced directly back to mid-2014 when we made major course corrections in our business and go to market strategies. Specifically, we broadened our customer base, successfully targeted global IC makers and those fabless phones now are contributing in a big way to the improvement in our foundry business. We combine our display and power solution business unit into a single standard products group under unified leadership. This has led to a best-in-class product development process, a broader AMOLED product lineup, power product portfolio optimization, more timely customer deliveries and improved product quality. We streamlined MagnaChip and [slimmed] [ph] out the management ranks by one-third which sped up decision making, made managers more accountable and helped ensure that everyone was on the same page. And finally, we engaged an external foundry to get access to leading edge technology for AMOLED display driver ICs that are manufactured based on our specialized process on cost effective 12 inch wafers. Our strategy to engage with external foundries is a game changer for MagnaChip because it makes us more competitive in the market with leading edge AMOLED processes. It frees up our internal capacity to service additional demand from foundry customers. It allows us to grow revenue without investing heavily in CapEx and, finally, coupling the external foundry with our own process design kit and AMOLED process IP creates barriers to entry for potential newcomers. The changes in strategy I have just outlined have gone a long way to put our business back on track and position MagnaChip for growth over the longer-term. I will talk more about our strategy later but first let's cover the business and product related highlights in Q2, beginning with our standard products group. Revenue in our standard products group, which includes both the display solutions and power solutions business lines, increased 19% sequentially in Q2 from Q1, and 26% year-over-year. Q2 revenue in the power solutions business was up 1% from Q1 and down 11% year-over-year with 34% of Q2 revenue coming from premium products. In our power business, we are enhancing our product portfolio with new designs targeted at industrial and power management applications. Revenue in the display solutions business increased 28% sequentially in Q2 from Q1 and increased 52% year-over-year, fueled in large part by very strong demand for or AMOLED ICs. Revenue for our AMOLED ICs jumped 73% in Q2 from Q1 and rose over three fold from the same period a year ago. AMOLED demand now has increased sequentially for four straight quarters. To put this growth in perspective, AMOLED ICs accounted for 65% of Q2 revenue in the display solutions business, up from 48% in Q1. Over the last few quarters, a wave of Smartphone makers in China have adapted AMOLED technology for their mobile devices and MagnaChip is clearly riding that wave. We have been designing to 29 different Smartphone models from Smartphone makers around the world, including several OEMs in China and our AMOLED product roadmap gives us confidence that we will be well-positioned to win targets in the next design cycle as well. Our success in the AMOLED space did not come overnight. We have been developing mobile AMOLED products since 2009 and have a strong working relationship with the top two AMOLED panel vendors in the world. Our accumulated engineering knowhow over the last seven years in IC design, process technology and Smartphone applications, creates a significant barrier to entry for any newcomer considering entering this space. We believe we have leveraged our deep experience to become the industry's second largest supplier of AMOLED ICs. In summary, we are more than pleased with the growth of our AMOLED IC business and we are bullish about our prospects longer-term. But it should come as a surprise to no one that the law of large numbers makes it a challenge to sustain the current rate of growth for any give quarter-to-quarter. Now, let me turn our attention to the performance of our foundry services group. Revenue in the foundry services group increased 4% sequentially in Q2 from Q1 and was down 21% from Q2 of 2015. What was equally gratifying is that the increase in total foundry revenue in Q2 reversed the three straight quarterly declines in revenue dating back to the third quarter of 2015. Another way to measure our progress in the foundry business is by comparing our revenue growth on an apples to apples basis by excluding production from our 6 inch fab which we close in February. Our 8 inch foundry revenue grew 22% in Q2 compared to Q1 and 1% from the comparable second quarter a year ago. This rebound is driven by the strategy shift we embarked on to engage with global fabless leaders in markets, ranging from communication and power as well as in other segments with high volume potential. As a result of our efforts, we are now seeing their business ramp as their tape-outs turn into volume production. Our database tape-outs with foundry customers are up 21% through Q2 and while more customer projects do not always result in greater future revenue, I am encouraged by our progress thus far. That’s it for now. I will come back to wrap up the call and provide Q3 guidance after Jonathan give you more details of our financial performance in the second quarter. Jonathan?

Thank you, YJ and good afternoon everyone. MagnaChip reported, on a GAAP basis, revenue of $167 million with the second quarter ended June 30, 2016. A sequential gain of 13% from Q1 and an increase of 3% year-over-year. The double digit increase in Q2 revenue easily topped our prior guidance of a 5% to 9% increase, making this the second straight quarter in which revenue beat expectations. As YJ mentioned, Q2 revenue was at the highest level since Q4 2014 but another key indicator of our turnaround is that the sequential revenue gain in Q2 reversed a trend of five consecutive sequential declines in the quarterly revenue. Our quarter-to-quarter and year-over-year comparisons are even better than they appear at first glance because we had approximately $9 million in revenue in Q1 2016 and approximately $18 million in revenue in Q2 2015 from our 6 inch fab that we closed at the end of February of this year. The upside in Q2 revenue was due primarily to continued strong demand for AMOLED ICs, especially from Smartphone makers in China. We also were encouraged by our foundry business which regained its footing in Q2. Let me give you quick snapshot of the actual dollar amounts of the revenue for each of our two product groups. The standard product group revenue was $105 million in Q2, up 19% from $88 million in Q1 and up 26% from $83 million in Q2 2015. The foundry services group revenue in Q2 was $62 million, up 4% from $60 million in Q1 and down 21% from $79 million in Q2 of 2015, which included approximately $18 million of revenue from the 6 inch fab that was closed this year. YJ pretty well covered the standard product business so let me spend a few moments providing addition commentary about our foundry business. As was mentioned, our foundry revenue improved significantly when comparing demand in a comparable periods for 8 inch to 8 inch wafers. The same holds true when we compare rates of fab utilization. Total fab utilization in Q2 was about 80%. In Q1, we have reported total fab utilization in the 70% range but if we remove 6 inch wafers from the equation than utilization in Q1 would have been closer to the mid-70% range. We will resist the temptation to report database tape-outs every quarter because the numbers can be lumpy and not all tape-outs generate large volumes. But as was mentioned a few minutes ago, we made good progress on tape-outs in the first half of 2016. The bottom line is that we moved in the right direction in Q2 with regards to filling our fabs and although I should note that we are always to the normal seasonal trends in the consumer related business which may affect utilization rates from time to time. Turning back to the P&L. Gross profit was $37 million or 22% of revenue for the second quarter compared to $34 million or 23.1% for the first quarter of 2016 and $35 million or 21.8% for the second quarter a year ago. Second quarter gross profit was just below the midpoint of our projected range of 21% to 24%. Total operating expenses for the second quarter was $44 million compared with $30 million in the first quarter. SG&A in Q2 included a onetime extraordinary charge of approximately $5 million, which included a previously announced onetime charge of approximately $4 million related to termination benefits payable under a voluntary resignation program for employees who left the company when an underutilized 6 inch fab was closed at the end of February. The remainder of the onetime charge pertains to transition costs related to employees who had worked in our 6-inch fab. I would like to remind you that in Q1, we reported that we completed the final sell of our 6 inch equipment to a third party, which netted MagnaChip a gain of approximately $8 million. This was reported as part of our operating expenses. We also reported in Q1 that there was a benefit of $2 million recorded in our SG&A from a reversal of a non-income based tax related accrual. Taking into consideration these special items in Q1 as well as Q2, then operating expenses actually have come down slightly from Q1 to Q2. It is important to note that the voluntary resignation of the employees that I discussed will reduce our spending by approximately $8 million per year and has reduced our severance benefit accrual by about $8 million. Net loss on a GAAP basis for the second quarter of 2016 totaled $17.8 million $0.51 per basic share as compared to net income of $8.1 million or $0.23 per basic and diluted share in the first quarter of 2016 and a net loss of $30.6 million or $0.90 per basic share for the second quarter of 2015. The net loss in the second quarter of 2016 included a onetime extraordinary charge of approximately $5 million that was mentioned previously. Adjusting that loss, a non-GAAP financial measure, for the second quarter of 2016, totaled $1.9 million or $0.05 per basic share compared to adjusted net loss of $2.8 million for the first quarter of 2016 or $0.08 per basic share and compared to just a net loss of $11 million or $0.32 per basic share in the second quarter of 2015. Turning to the balance sheet. Cash and cash equivalents totaled $83.9 million at the end of the second quarter, essentially flat compared to what the first quarter, when taking into account one time effects in the second quarter of $10 million product prepayment from a key strategic foundry customer. One housekeeping item I would like to note is that we made the regularly scheduled semi-annual coupon payment on our senior notes of approximately $8 million after the second quarter close. Inventory at the end of the second quarter was $70 million compared with $71 million in Q1 and down from $72 million at the end of the same period last year. We continue to focus on working capital while also producing sufficient levels of inventories needed to support our business. Accounts receivable was $55 million at the end of Q2 or flat from $55 million in Q1 and down from $68 million for Q2 2015. We anticipate capital expenditures in 2016 will total approximately $15 million, down from a previous forecast of $20 million due to a shift in timing related to CapEx. Capital expenditures in Q2 were approximately $2 million. In summary, as we move deeper into the second half of the year, we continue to explore opportunities to extract costs and tightly control spending and to improve gross margin. At the same time, we also view it as a high priority to grow the business as a way to leverage underutilized capacity and offset fixed manufacturing costs to help contribute to our cash flow. Now let me turn the call back to YJ for his closing comments and third quarter financial guidance. YJ?

Thank you, Jonathan. To summarize, our business recovery is well underway due in large part to strategic changes we have made over the past 24 months. For now, we are riding the wave of adaption of our AMOLED ICs. We have more than tripled the number of offerings of AMOLED ICs over the past two years and we will continue to focus on winning new designs. In addition, we will continue to work closely with external foundries to provide us with the next generation 40 and 28 nanometer AMOLED ICs on 12 inch wafers for the mobile device market. And we plan to continue to broaden our AMOLED product line to create compelling solutions that meet the demanding future requirements of customers. The foundry business is in the midst of a recovery. Our focus going forward is to sustain our customer momentum and execute on our process roadmap for best in class PCB technology for power applications, mixed-signal technology for fingerprint and non-volatile memory technology for IOT and touch applications. In our power solutions business, our focus is to improve margins based on continued portfolio optimization. We are encouraged by the tone of business so far in the Q3, which is typically a seasonal peak for MagnaChip. At the same time, we are laser focused on keeping our lid on costs and preserving our cash because we know this business is both seasonal and cyclical. With that, let's turn now to our forward looking guidance. For the third quarter of 2016, MagnaChip anticipates revenue to be in the range of $180 million to $185 million, a sequential increase of 8% to 11%, reflecting continued strong demand for AMOLED ICs and double-digit improvement in foundry and power demand. Gross profit to be in the range of 21% to 24% as a percent of revenue. Before I turn the call over to Bruce, I would like to take a moment to publicly acknowledge the passing of Robert Pursel, our Head of Investor Relations for the past five years. He is greatly missed by all of us. Bruce Entin is working with us through this transition period. Bruce?

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

[Operator Instructions] Our first question for the day comes from the line of Suji De Silva from ROTH Capital. Your line is open.

I was saddened to hear the news on Robert. My condolences certainly. Great job on the quarter, really on the guidance here. Can you give us an update on strategic review process? I know it's been underway for quite a while. Any update you can provide there?

Right. I mean as we previously discussed, the strategic review committee process is ongoing and as you know they have been set up to assist the board and obviously the board's objective is to maximize shareholder value. And so looking at various options and as soon as they make a decision, we will make sure to make it public.

Thanks for that. And then looking at the business itself. The gross margin here, it's settling in. Where can that trend is, you think, going forward? What are the puts and takes that drive that?

Yes. Suji, as you know I think that we really focus on turning around the business. We diversified our customers product portfolios and so we have finally seen the revenue ramp in all three cylinders. Both in the AMOLED, foundry and power. And then we really drove hard on the cost reduction where we saved more than $50 million last year, continue to drive that. And utilization is going up. So now the management is putting high priority to also get the margin on track so that we can provide the best value to our shareholders. And Jonathan?

Sure. So we did guide our next gross margin to be 21% to 24% and as YJ mentioned, we have really set out to fix and turn around the business and by executing our strategy, we increase revenue as well as our utilization and our cash position. And our results for the quarter show a significant improvement in all of those areas. And so we will continue to focus on these activities as well as becoming increasingly focused on further improvement in our product mix which should impact gross margin in a positive manner. Now do keep in mind that we did do a voluntary retirement program where we had about 170 people participate and as a result we should be saving about $8 million per year. However, there were employees from the 6 inch fab who did not participate in the voluntary retirement plan and these employees were transferred to our 8 inch fabs to meet increasing demand in those fabs. But those related costs are still being absorbed. So as we look ahead, as we expand our revenue, as we look at our cost structure, as we look at our product mix, we are going to continue to work on improving our gross margin.

Yes. And one of the activities that we are readying the next generation AMOLED IC on the 40 nanometer, so I think that going forward, that also should up the gross margin for the future generation of AMOLED ICs.

Good. Very helpful color there. And along those lines, is there a revenue or timing we could think about to getting the EPS breakeven. You had a $0.05 loss here now. I think you highlighted the OpEx trend, it sounds like it's going to be stable, I mean is there a utilization level that gets us to that point? Any color there would help?

Yes. I think you hit good point. As to specific timeline, we are not going to disclose a timetable. However, be assured that we are working hard on improving our revenues as well as looking at our cost structure. So that going forward we will have improved gross margin and also we are doing the best we can to improve those financial measures that you just discussed.

Okay. Fair enough. And OpEx you expect flat to potentially down. Is that the way to think about it, roughly?

Yes. So when you look at our operating expenses, there were some special items that I discussed and so as you may recall, in Q1 we had a gain of about $8 million in connection with the six inch equipment that we sold to a third party. We also in a had a reversal of about $2 million related to a non-income based tax accrual. And so there were about $10 million benefit that was taken in Q1. In Q2, given the fact that we did or voluntary retirement program, there was approximately $5 million. I mean there were some additional special cost associated with some transfer cost of the employees. And so when you take out those special items, our operating expenses overall decreased slightly between Q1 and Q2 but as we look ahead, we do think that our operating expenses [need] [ph] to be flattish. Our R&D expenses may go up a little bit given the fact that we are continuing to increase our revenues as new opportunities come up.

Okay. And then two last sets of questions around the business segments. First on foundry. The new customer ramp, does that show kind of coming inflection point and what geographies are the new fabless customers coming in. Are you seeing the China customers ramping or is that ahead in time?

So Suji, I think the first thing we did was to go after the global leaders in the market. I think that’s giving that some hint where the geography is coming but if you look at the big picture from the foundry, about 80% of revenue comes outside Korea. And as you know where the global leaders in the communication and power located, so that’s where the production ramp is occurring and we are very encouraged by those key customers of ours that are new to us.

Okay. Great. And then last question is really about the AMOLED business here. It had very strong growth. Would it be natural with the program ramps you have had, to expect some pause or perhaps a leveling out of the AMOLED revenue. Is this the run rate we can expect steady state or should we expect your share gains continue with steady momentum in that?

Yes. So I think if you look in a big picture, the IHS thinks that it's going to grow about 38% this year and the CAG of 23% over next five year. Clearly, from our Q2, we grow 73%. We grew 42% in Q1. With those rates already, we are going to nicely achieving a double the growth rate from last year. But at the same time my remark that it's going to be hard to keep up with that kind of growth rate. But I think the important things that we will be more than doubling from last year. And then on the longer-term, I think we are very well positioned. And what's also nice thing about it is the Smartphone is driving the de facto standard for the mid-range and high end Smartphone. And we are more than prepared than anyone else to take advantage of the growth in the AMOLED and the other application includes the small watches, the automotive and virtual reality. So I think the AMOLED is being adapted more, so it's really good that the market could be really well growing and we will take advantage of it.

Thank you. Our next question is from the line of [Robert Merchants] [ph] from Needham and Company. Your line is open.

Hi. This is [Robert Merchants] [ph] on behalf of Raji Gill. I want you guys to just sort of characterize the competitive landscape of the OLED IC and what your competitive advantage is? I know you were talking a little bit earlier about your IP?

Yes. First of all, let's look at the big picture in the AMOLED versus LCD. The AMOLED is much more complicated than LCD. It takes about ten days to produce your panel, LCD takes about three. So the complexity is more than 3x. So that’s not that easy to achieve. Today there are two prominent panel vendor, as you know, Samsung and LG have done a great job and today in Smartphone, Samsung probably has more than 95% , 99% of the supply. And we do have a great relationship with those two leaders in the AMOLED panel first of all. Second, we have been developing the AMOLED IC since 2009 and we are producing more than three times of the AMOLED IC than we have done in two years. And as I mentioned before, we are working on the 40 nanometer product. We are also working on the next gen 28. And we also use our own process design kit, even though we are using external foundry. And we also provide our own IP to them. And we also have a great system application expertise. So all these creates a barrier to entry and we also heard from industry rumors that others have tried and even with the four time try, the part doesn’t work. So it's not that trivial. So we are going to continue to execute. We believe that we can produce the AMOLED smaller than anyone else at given geometry. We have a special process IP that we can have about six to seven layers less than the competition. So all these create barrier for entry.

Great. Thank you. I think that clarified some stuff for me. Also I wanted to ask real quick about what your thoughts were on the adoption rate of the OLED displays in the Chinese Smartphone market and if thought there are any sort of capacity constraints for OLED?

So the industry market data research from IHS is showing 23% compound annual growth rate for next five years. This year they expect more than 38% growth. So that’s the landscape. So now with some of the China customer what we hear is that some key vendors have about 40% of their product using AMOLED. So it's an encouraging sign. So we are looking at more applications such as smart watches, virtual reality headset adapting the AMOLED. So we think that that’s really good. And in terms of the fab capacity, I think there is no constraints. In terms of the AMOLED panel production, you hear about the big investment that is made by the Samsung and LG. So we think that that’s going to grow with the market.

[Operator Instructions] It looks like we have no other questioners in the queue.

So thank you, Andrew. So this concludes our second quarter earnings conference call. Please look for details of our future events on MagnaChip's investor relations Web site and thank you all 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 at this time. Everyone have a great day.