Magnachip Semiconductor Corporation (MX) Q1 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter 2017 MagnaChip Semiconductor Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder this call is being recorded. I would now like to introduce your host for today’s conference, Mr. Bruce Entin, Director, Investor Relations. Please go ahead, sir.

Thank you for joining us to discuss MagnaChip's financial results for the first quarter ended March 31, 2017. The first quarter earnings release that we filed today after the stock market closed 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 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 briefly recap the Company's overall business strategy as well as provide financial guidance for the second quarter of 2017. 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 first 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 Q1 2017 conference call. The first quarter marked another step forward for MagnaChip on the path to sustained profitability. We achieved our financial objectives in Q1 and made significant progress against our operational goals. Here are a few highlights. Revenue of $161.7 million was well above the midpoint of our prior guidance and gross margin of 25.7% was just 30 basis points shy of the top end of the range. Both figures easily outpace year ago levels. Adjusted EBITDA increased 63% from the first quarter a year ago. We ended Q1 with over $132 million in cash on the balance sheet, up more than $49 million from the prior quarter. We implemented and made significant progress in our headcount reduction plan that's expected to have a positive impact on labor expenses in SG&A beginning in Q2 and improve gross margin in the second half of this year. Fab utilization inched up into the low 90% range in Q1 as overall foundry revenue grew approximately 30% year-over-year and 8-inch wafer foundry revenue grew more than 50% as compared to the first quarter a year ago. We taped out a 40-nanometer AMOLED display driver IC as planned and expect to sample in this month. We began sampling our 55-nanometer flexible AMOLED display driver IC in Q1 that enables curved edge to edge screens and expect to go into volume production starting in the second half of the year. We secured design wins from Smartphone makes in China and increased wafer starts from our external foundry to meet an anticipated increase in AMOLED demand in the second half of the year. That’s the high level view. Here are the actuals. Total revenue for the first quarter was $161.7 million, up 9.2% as compared to $148.1 million for the first quarter of 2016 and a decline of 10.4% compared to $180.5 million for the fourth quarter of 2016. The year-over-year increase was due primarily to an increase of nearly 30% in foundry revenue. The sequential decline in revenue was attributed primarily to low demand for mobile AMOLED display driver ICs. The declines stem from seasonal factors and a timing mismatch between the expected drop off in revenue from the existing products and when our 40-nanometer product family and new 55-nanometer flexible products begin to generate revenue. Total gross profit in the first quarter was $41.6 million or 25.7% as compared with $34.2 million or 23.1% for the first quarter of 2016 and $46.1 million or 25.5% in the fourth quarter of 2016. The gross margin for the full 2016 year was 22.7%. In our view, the Q1 profit metrics demonstrate the success so far of the business strategy we launched two years ago and sets a solid foundation for us to build upon for the rest of this year. Based upon our current view of the business and the expected outcomes of the headcount reduction plan, we continue to anticipate that gross margin and adjusted EBITDA will show improvement in 2017. Now let's turn to the Q1 performance of our two operating segments, beginning with the foundry. Foundry revenue in the first quarter was $77.5 million, up 29.3% from revenue of $60 million in the first quarter of 2016 and about flat with $77.8 million in the fourth quarter of 2016. Considering the typical seasonal factors in Q1, this was a solid revenue performance for our foundry business. Foundry revenue from new products doubled in Q1 as compared to the first quarter a year ago. Foundry gross profit margin was 20.5% in the first quarter as compared with 23.8% in the first quarter of 2016 and 30.3% in the fourth quarter of 2016. The progress we have made in foundry gross margin over the course of the past year is a proof point that we are moving in the right direction. As a general statement though, our overarching goal will always be to maximize improvement in our overall company gross margin. Overall, we are upbeat about the longer-term prospects for our foundry business because we are riding the industry wave and the broad adoption of analog based power solution for a whole range of applications. The growing importance of analog technology in power management can be traced to the explosive rise of mobile devices that require low power to extend battery life, reduce heat, improve product reliability and conserve energy. Likewise, power hungry data centers, factories, automobiles and large screen TVs are big users of power solutions. Analog technology, EEPROM and mixed-signal are core competencies are MagnaChip. As an example, our BCD process which combines bipolar, CMOS and DMOS, is pure analog, an ideal for power applications. We may be the only foundry able to combine BCD technology with EE technology in a single process node at 0.13 micron and we believe we have one of the smallest EE cell in 0.13 micron in the business. That translates to smaller die, lower power consumption and lower manufacturing cost. The combination of analog based BCD and EE technology is ideal for producing power management solutions and power ICs used in smartphones, IoT devices and for USBC applications. Foundry revenue from BCD and EE technology rose 13% in Q1 as compared to Q4 2016 and 209% as compared to the same period a year ago. Fortunately for us, the pace of analog technology is not scalable like digital technology. As a result, we don’t need to invest huge R&D sums in bleeding edge process technologies and our capital spending budget is a fraction of what others spend. Most importantly, our fabs have a life span measured in decades not years like digital fabs. Those familiar with analog technology will understand that it is highly likely that our two analog and mixed signal fabs in Korea will still be producing 8-inch wafers in submicron geometry ten years from now, when digital fabs will be confronting the end of physical limits of the Moore's Law. Now turning to our Standard Products Group. Revenue in the Standard Products Group was $84.2 million in the first quarter, down 4.3% from the first quarter a year ago and down 17.9% from $102.5 million in the fourth quarter of 2016. Standard Products Group gross margin was 23.1% in the first quarter as compared with 23.6% in the first quarter of 2016 and 21.8% in the fourth quarter of 2016. We don’t break out gross margin by business line but a key reason for the margin improvement in the Standard Products Group in Q1 stems from the work we have done over the past three years to streamline and improve the margin profile of our Power Products portfolio. With that, let's take a look at the Power Solutions business. Revenue for power standard products was $35.3 million, an increase of 17.9% from $29.9 million in the first quarter a year ago, and was down 6.5% from $37.7 million in Q4 2016 due to typical seasonality. The year-over-year increase was primarily due to a ramp in production of new power ICs, super junction products and battery MOSFETs. We also believe we now are one of the leaders in battery MOSFET. The increase in demand for power ICs was driven primarily by the need to power multichannel LEDs in UHD televisions and the increase in super junction revenue stems from a ramp up in demand from the computing, industrial and LCD television markets. Over the last two years we have taken major steps to improve margins in the power product line. In some cases, money losing offerings were killed. In other cases, we shrunk the sales side in a given geometry or migrated products to lower geometries to reduce die size, power consumption and lower the cost. We have also taken steps to further expand the power portfolio with higher margin products with a more competitive power IC offerings. Now let's turn to the display business. Revenue for display standard products was $48.9 million, down 15.8% from $58.1 million in the first quarter of 2016 and down 24.6% from the fourth quarter of 2016. The declines reflect previously disclosed seasonal factors and a timing mismatch with our AMOLED display driver ICs which was partially offset by higher demand of source drivers for ultra high-definition TVs. Our display drivers are now designed into 35 different models of large screen UHD televisions. AMOLED revenue declined 48% in Q1 as compared to Q4 2016 and represented 33% of total display revenue. Despite the revenue decline, AMOLED margins exceeded the corporate average in Q1. We believe we are bumping along the bottom with respect to AMOLED revenue and we continue to sequential revenue growth will resume in Q3 over Q2 as volume production commences from new design wins. From there we expect AMOLED to gain traction in Q4, setting us up nicely for 2018. A few qualitative observations. We taped out our new 40-nanometer AMOLED display driver IC in Q1 and expect to sample it this month. As we told you we would do on our last earnings call. We are optimistic about the revenue potential for this product beginning in the latter part of second half of 2017 and into 2018. We are excited about our new 55-nanometer flexible AMOLED display driver that we first spoke about on our last earnings call. In Q1, we sampled the market with this AMOLED driver which maximizes screen real estate and enables curved edge to edge screens. And as I mentioned at the beginning of this call, we have increased the number of wafer starts for our new AMOLED product at our external 12-inch foundry to meet production requirements for demand in the second half of the year. Meanwhile, our older 55 and 110-nanometer AMOLED products continue to generate volume production although at lower levels than in 2016. To sum up on AMOLED, we are bullish on the underlying trends in the AMOLED market and we are confident in our ability to capitalize on the opportunities in front of us. We have been in the AMOLED business for ten years, have unique IP, engineering expertise and a proprietary process design kit as well as access to an external foundry to supply wafers in high volume. Most important, we have big relationships with top two OLED panel makers in the world who happen to be in Korea, who currently produce the great majority of the OLED panels in the world. In short, we are confident about our AMOLED growth prospect. I will come back to wrap up the call and provide Q2 guidance after Jonathan gives you more details of our financial performance. Jonathan?

Thank you, YJ, and welcome to everyone on the call. As YJ said, our primary focus is to improve gross margin, overall profitability and to engage in initiatives to fuel revenue growth. Gross margin of 25.7% and adjusted EBITDA margin of 8.1% in Q1, both were at their highest levels in four years since Q1 2013. Adjusted EBITDA of $13.1 million was just $1 million shy of the Q4 figure of $14.1 million and was up by $5.1 million compared to $8 million in Q1 2016. And as YJ said earlier, we anticipate that gross margin and adjusted EBITDA both will show improvements in 2017. Our goal to improve gross margin and overall profitability is rooted in a financial discipline that drives all decision making about the business and how we manage our P&L and balance sheet. A few events in Q1 illustrate our commitment to improve margins and overall profitability. In Q1, we launched a previously announced headcount reduction program that is expected to reduce the workforce by over two times the size of a similar action in 2016 that affected 159 employees. During the first quarter, the company reduced the workforce by approximately 140 positions. Once completed, the workforce reduction will have an expected payback period of less than 1.5 years with an estimated annual cost savings between $23 million and $27 million. The company believes it remains on track to complete the plan of workforce reduction within the cash cost range of $29 million to $33 million. During the first quarter the company recorded early termination of charges of $11.1 million and made cash payments totaling approximately $10 million in connection with the headcount reduction. The cash payments were comprised of approximately $4 million related to the early termination charge and the remainder relates to statutory severance. The company expects to complete or substantially complete the plan of workforce reduction by end of the second quarter and expects to record an additional early termination charge of approximately $1 million to $2 million in that quarter. The cost cutting initiative is expected to have a positive impact on labor expenses in SG&A beginning in Q2, contribute to gross margin improvement in the second half and have an overall positive effect on adjusted EBITDA while still preserving our ability to serve customer needs. Aside from the headcount reduction, we are pulling other operational levers to generate cash, focus on our core businesses and improve profitability. As an example, we closed a money losing legacy 6-inch fab in Q1 a year ago. Sold the equipment for approximately $8 million and recognized a gain in Q1 of this year of approximately $17 million from the sale of the vacant fab building. In space of approximately 13 months, we [got] [ph] approximately $25 million in cash from the legacy fab that increased our overall gross margin due to a better product mix and higher 8-inch fab utilization. Lastly, during Q1 we spun out our money losing sensor product business which was part of this. We sold the sensor product business because the operating margin was negative, product revenue was minimal and the long-term ROI wasn’t attractive. While we continue to service foundry customers in the sensor business, our own sensor standard product business was a cash drain and a management distraction. Now turning back to the P&L and operating expenses for Q1. Selling, general and administrative expenses were $23.1 million or 14.3% of revenue compared to $20 million or 13.5% of revenue for the same period a year ago. The increase of $3.2 million was primarily attributable to a $3 million accrual for a civil penalty representing a final settlement with the SEC's investigation related to the company's [restatement] [ph] several years ago. Research and development expenses were $18 million or 11.1% of revenue for Q1 compared to $17.8 million or 12% of revenue for Q1 2016. We recorded a restructuring gain in other of $17 million in Q1 that resulted from a $16.6 million gain on the sale of the building related to the closure of our 6-inch fab and a $0.5 million gain on sale of our sensor business. As mentioned earlier, termination charges of $11.1 million were recorded for the early retirement benefits payable to the employees affected under the headcount reduction commenced in Q1. Operating income increased by $2.1 million in Q1 as compared to Q1 a year ago. Interest expenses were $5.2 million and $4.1 million for Q1 2017 and Q1 2016 respectively. The increase of $1.1 million was attributable to the interest expense recorded for the exchangeable notes issues in January 2017. Now turning to foreign exchange. Net foreign currency gain for Q1 was $41.8 million compared to net foreign currency gain of $8.2 million for Q1 a year ago. The net foreign currency gain for Q1 in both 2017 and 2016 was due to the appreciation and the value of the Korean won relative to the U.S. dollar during the period. A substantial portion of our net foreign currency gain is non-cash translation gain or loss associated with the intercompany long-term loans to our Korean subsidiary. The loans are denominated in U.S. dollars and are affected by changes in the exchange rate between the Korean won and the U.S. dollar. Net income on a GAAP basis for the first quarter of 2017 was $43.7 million or $1.30 per basic share, and $1.05 per diluted share as compared to net income of $8.1 million or $0.23 per basic and diluted share for the first quarter of 2016 and net loss of $49.8 million or $1.42 per basic share in the fourth quarter of 2016. Net income in the first quarter of 2017 was attributable primarily to a non-cash foreign exchange gain on intercompany loans. Adjusted net income, a non-GAAP financial measure, for the first quarter of 2017, was $25 million or $0.01 per basic and diluted share as compared with an adjusted net loss of $2.8 million for the first quarter of 2016 or $0.08 per basic share and compared to an adjusted net income in the fourth quarter of 2016 that totaled $1.6 million or $0.05 per basic share and $0.04 per diluted share. Turning to the balance sheet. Cash and cash equivalents totaled $132.6 million at the end of the first quarter as compared with $83.4 million at the end of the fourth quarter of 2016. We completed a $75 million exchangeable notes offering in Q1 and raised an additional $11.25 million after initial purchasers exercise their right to purchase additional principal amount of the notes. After paying issuance fees, the company used $11.4 million of the net proceeds from the offering to buyback its common stock. Inventory at the end of the first quarter was $61 million compared with $57 million in Q4 2016 and $71 million at the end of the first quarter 2016. Accounts receivable was $81.7 million in Q1 as compared with $61.8 million at the end of Q4 2016 and as compared with $55.2 million at the end of the first quarter 2016. The increase in accounts receivable was part of a deliberate and strategic financial decision to limit the practice of offering discounts to customers in exchange for early payments. The change in practice was made possible by the substantial increase in our cash position. Capital expenditures in Q1 were $5.4 million. We expect our capital expenditures to be $25 million to $30 million for the full year. In summary, we have taken a aggressive steps to reduce costs and stirrup the balance sheet in order to support the operational progress we have made to put MagnaChip on the path to sustained profitability. Now let me turn the call back to YJ for his closing comments and second quarter financial guidance. YJ?

Thank you, Jonathan. We weathered a significant AMOLED slowdown in Q1 due to the previously disclosed seasonal factors and a timing mismatch but still show significant improvement in several key financial metrics. Now, we have set our sights on increasing gross margin and overall profitability in 2017 and we are confident we will get there based upon cost cutting actions and the introduction of new products with attractive margins. Based on our current view of the business, we believe our revenue in Q1 of $161.7 million is likely at the bottom of the full year and we continue to believe we can achieve modest revenue growth in 2017 over 2016. Challenges remain but our results are among the strongest in years and we continue to see our financial results moving in the right direction. We have a well balanced product line up, a robust product roadmap and a specialized analog foundry business, all of which is tightly aligned with the needs of our global customers and with prevailing industry trends. With that, let's turn now to our forward-looking guidance. For the second quarter of 2017, MagnaChip anticipates revenue to be in the range of $162 million to $168 million or up sequentially nearly 4% at the high end of the range as compared with Q1 2017, and compared to $167.1 million in the second quarter of 2016. Gross profit is anticipated to be in the range of 25% to 27% as compared to 25.7% in the first quarter of 2017 and as compared to 22% in the second quarter of 2016. Now I will turn the call back to Bruce. Bruce?

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

[Operator Instructions] Our first question is from the line of Rajvindra Gill of Needham & Company. Your line is open.

This is [Robin Martins] [ph] on behalf of Raji. Just one quick housekeeping item. Did you mention that the headcount reduction program will be completed in the second quarter, in the next quarter?

That is correct. We anticipate the headcount reduction to be completed by end of the second quarter and we are on track to save between $23 million to $27 million per year.

Okay. Great. And then also you are guiding towards 25% to 27% in gross margins for the next quarter. How do we think about margins going forward in terms of the mix between the foundry business and then also the display and power solutions businesses?

So as we mentioned, we are focused on the overall profitability of the company and so you may have some puts and takes and ups and downs within the segment but the company's overall focus is to make sure that we are executing on strategy to improve our business as well as our profitability for the company.

Great. And then just one more from me before I step back in the queue. In terms of AMOLED, you spoke towards the product mismatch being over in the second half of this year and a ramp in the third quarter and more so in the fourth quarter. So you have a breakdown on what percentage of -- what you are foreseeing in that business line due to current design wins that are already in place.

Yes. So you are asking a very good question. So I think that we already disclosed two new products. One was the 55 nanometer flexible AMOLED display driver IC that allows curved edge to edge design. That we sampled in Q1. And we just taped out the 40 nanometer this quarter. We are going to sample this month on the 40 nanometer. That’s going to prevail with a very nice compelling feature. So I have spoken only two, there will be others. So all these, we expect these two definitely will have impact in the second half ramp and there will be other one or two that will go into production. So we see that there will be a sequential growth in the Q3 nicely and then the set up nicely to Q4 and then set very nicely getting into 2018.

Okay. And the 40 nanometer, is that also flexible display or have you not disclosed that yet?

Since we haven't sampled, we have not disclosed that. And so we probably can do it more of this description in the next call.

Thank you. Our next question is from Suji De Silva of ROTH Capital. Your line is open.

Congratulations on the progress you are making here. In terms of the guidance for Q2 '17, can you give us a sense of how that looks by segment, qualitatively if you can give us specifics there.

Thanks for the question, Suji. As you know we only provide our guidance for revenue and gross margins for the overall company one quarter out at a time. As I discussed earlier, there could be some ups and downs within the segments but for the overall year, we said that we are going to see improvements. And when you look at history, we have been executing on our strategy as well as the profitability of the company. Things have been trending nicely and we certainly think that the company is moving in a good direction.

Okay. Fair enough there. And then as the AMOLED business moves to an external foundry, can you talk about what that will do to your internal utilization trend near term and then does the foundry business backfill that or can you tell us how that will play out near term?

Yes. So Suji, I think as a key point here is that the company now has a dual strategy to grow. So we have external foundry where we can continue to grow our AMOLED revenue and all the new products right now is based on external 12-inch whether it's 55 flexible or the 40 nanometer. So we are going to continue to grow that revenue. And then internally as the legacy 110 nanometer moves up slowly or towards the second half, then that gives more room for us to fill the fab with foundry or more power products so forth. So it gives a lot of multiple choices, whatever that makes sense to increase our overall corporate gross margin and profitability.

Okay. Great. And then last question on the AMOLED business. Can you talk about the competitive landscape and your position as a merchant supplier here? Do you think your share will be where it is now? Do you think it can expand and the features that differentiate you guys from the competition that’s out there. Thanks.

Yes. So first of all, we really haven't seen any non-captive competition in our marketplace so we can't really comment on others but let me put it this way. We are working with the top two panel makers in the world and they happen to be in Korea. And as you know, based on the analyst and industry expectation that these two top OLED panel makers to provide the overwhelming majority of OLED panels for the next two years. So we like our position in the market. We have been in this business for ten years and also the AMOLED and ASIC. Which means that you have to really work with the actual panel makers because in many cases you need to have the IP integrate into your ASIC. We are the second largest AMOLED supplier in the world. We are probably the biggest merchant supplier other than the captive IC makers. So we have many built-in advantages and as we said, we have already been sampling the 55 AMOLED flexible drivers that allows curved screen edge to edge. We just taped out 40 nanometer. We are going to sample that part this month. That’s going to have a compelling feature. So I think we like our position in the market.

Thank you. And I am not showing any further questions. I would like to turn the call back over to management for any further remarks.

Thank you, Christy. So this concludes our first quarter earnings conference call. Please look for details of our future events on our MagnaChip investor relations Web site. Thank you for joining us today.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program and you may all disconnect. Everyone have a great day.