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Edited Transcript of MX.N earnings conference call or presentation 30-Apr-19 9:00pm GMT

Q1 2019 MagnaChip Semiconductor Corp Earnings Call

May 4, 2019 (Thomson StreetEvents) -- Edited Transcript of MagnaChip Semiconductor Corp earnings conference call or presentation Tuesday, April 30, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bruce Entin

MagnaChip Semiconductor Corporation - Head of IR

* Jonathan W. Kim

MagnaChip Semiconductor Corporation - CFO, CAO & Executive VP

* Young-Joon Kim

MagnaChip Semiconductor Corporation - CEO & Director

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Conference Call Participants

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* Ari Shusterman

Needham & Company, LLC, Research Division - Analyst

* Atif Malik

Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment & Specialty Semiconductor Analyst

* Sujeeva Desilva

Roth Capital Partners, LLC, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to MagnaChip Semiconductor Corp's First Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to turn the call over to Mr. Bruce Entin, Head of Investor Relations. Sir, you may begin.

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Bruce Entin, MagnaChip Semiconductor Corporation - Head of IR [2]

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Thank you, and thank you for joining us to discuss MagnaChip's financial results for the first quarter ended March 31, 2019. 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 website. The telephone replay of today's call will be available shortly after the completion of the call, and the webcast will be archived on the 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 discuss the company's recent operating performance and market outlook for our product categories, and Jonathan will provide an overview of Q1 results and provide financial guidance for Q2 2019. 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 our 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 earnings release available on our website under the Investor Relations tab at www.magnachip.com.

I will now turn the call over to YJ Kim. YJ?

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Young-Joon Kim, MagnaChip Semiconductor Corporation - CEO & Director [3]

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Welcome to everyone on the Q1 conference call. Revenue of $157.4 million in Q1 was down 5% from a year ago but exceeded our guidance of $150 million to $155 million due to stronger customer demand for products from our Standard Products Group. OLED DDICs and power standard products both set all-time revenue records for the first quarter of a year despite soft seasonal trends and a weak China smartphone market. OLED DDIC revenue of $48.5 million increased 41.5% year-over-year and power standard product revenue of $42 million increased nearly 9%.

Foundry revenue of $57.1 million declined 26% from Q1 a year ago, which was disappointing but was in line with guidance we provided. We pointed out on the Q4 earnings call in February that the Foundry business will be under severe pressure in Q1 and would remain weak for the first half of 2019. That scenario is playing out as forecasted. But notably, the Foundry business is stabilizing around these levels and current market signals point to a gradual improvement in the second half of the year. The downdraft in Foundry in Q1 was primarily due to inventory correction by customers stemming from softening global market conditions and macroeconomic uncertainties. General uncertainty about China, fears of a trade war and typical seasonality also contributed to the weakness. We also decided to be more selective about taking new Foundry business in Q1 as a result of the strategic evaluation process of the Foundry business and Fab 4 that was undertaken in February by the company. While the Foundry business will remain weak in Q2, customer inventories are slowly being worked down. The China market appears to have leveled off and several new products from Foundry customers are in early-stage production. For now, at least, it seems the worse of the Foundry downturn is behind us.

Before we leave the topic of the Foundry, let me address the strategic evaluation process involving our Foundry business and Fab 4. As a reminder, Fab 4 is the larger of our two 8-inch fabs and accounts for approximately 73% of the company's total wafer capacity. Fab 4 primarily serves the wafer needs of our Foundry customers.

We first announced the strategic evaluation process in our Q4 2018 earnings release. We have since named J.P. Morgan as our financial adviser and Paul, Weiss as our legal adviser. Both are highly regarded global firms with broad experience and successful track records. We undertook this strategic evaluation process because we believe it's the -- in the best interest of shareholders, customers and employees, and we intend to be mindful of the best interest of all of our stakeholders as we work our way through this process. We intend to provide updates to the market in a timely manner when meaningful milestones are achieved. So please stay tuned.

Now turning to the takeaways in the Standard Products Group. Q1 revenue in Standard Products Group, or SPG, was $100.3 million, up 13.5% from the first quarter of 2018. Display represented 58% of SPG and Power represented 42%. OLED DDICs represented 83% of the Display segment as compared to about 69% in Q1 a year ago, which demonstrates both the growth in our OLED business as well as our success in strategically reducing the contribution of lower-margin and legacy LCD drivers.

We were awarded 6 OLED design wins in Q1 from leading smartphone makers in China and also started volume production of OLED display drivers for midrange smartphones from a major Korean brand. 8 new OLED smartphones using our OLED DDICs launched in Q1.

We also launched the industry's most power-efficient 28-nanometer OLED display driver, which is manufactured with the industry's most advanced process technology use for DDICs. Our 28-nanometer OLED device is 20% smaller, 20% more power-efficient as compared to the previous 40-nanometer generation, and is expected to improve call quality by reducing EMI, or electromagnetic interference levels, by 20%. The 28-nanometer driver supports various display types such as rigid, flexible, foldable and virtual reality and augmented reality applications and maximizes design flexibility for the latest full-screen displays, such as bezel-less and hold-type displays. We've already won 2 design-ins at leading smartphone manufacturers in Asia with our 28-nanometer DDIC with revenue expected to begin in the second half of this year. We now have 9 advanced OLED display drive ICs in our portfolio and have accumulated 47 OLED design wins from smartphone makers in China and Korea with 39 models currently in production. Looking ahead, we believe 5G network deployments will accelerate applications such as VR and AR, where users will need a 120-hertz OLED display, and we're well aligned with this technology. If 5G spurs a smartphone upgrade cycle, as many analysts expect, then this has the potential to be a net positive for MagnaChip.

Turning now to the television market. We've been a supplier of display components into the LCD TV market for several years, but we now are extending our reach into the fast-growing OLED TV market. In Q1, we kicked off a project to develop a major new OLED DDIC for ultra-high definition TV displays for a major OLED panel maker in Korea with initial production scheduled for the tail end of 2019. We are also working on developing a micro LED driver for very large next-generation TVs. Micro LED TVs are for the potential for high luminances, fast response time, excellent contrast ratio and long product lifetimes.

Lastly, during Q1, we also formed an OLED ecosystem initiative to optimize the functionality of OLED display platform solutions in a wide range of products, with the goal to improve our competitive position in the marketplace. ELAN Microelectronics, HiDeep and Melfas Inc. are the first 3 partners we've announced. Each will collaborate with MagnaChip to develop and standardize innovative human interface solutions based upon smart touch, stylus and fingerprint technologies.

We also intend to extend the collaboration beyond smartphone and mobile devices into new applications, including IoT and automotive. We believe automotive infotainment, side mirrors and console applications are ideal for OLED DDICs, but electrical -- electric vehicles will also be an especially attractive market for our Power Standard Products because electric motors consume huge numbers of high-voltage power products.

Speaking of the Power segment, let's turn to a review of that business. Revenue from premium power products increased nearly 46% in Q1 from Q1 a year ago and accounted for nearly 55% of power standard product revenue as compared with 40% in the first quarter of 2018.

Our Battery FET power standard product helps protect lithium-ion batteries in smartphones. We are working on nearly a dozen different battery-related projects for smartphone makers in Korea and China. We have the #1 market share for the battery FET at a leading Korean smartphone maker.

We also continue to make inroads in the automotive sector, as we won 2 new designs and started a shipment of 1 high-voltage power standard products to a major auto manufacturer. That development came on the heels of being awarded 5 power discrete design wins in Q4 2018 for automotive applications that we expect to go through full qualification in 2019. We expect to begin production on these devices in 2020.

We continue to believe that automotive sector will account for approximately 5% of our power discrete revenue in 2021 and 10% in 2022 due mainly to the sharp growth expected in the electric vehicle market.

Now I'd like to share our current business outlook for Q2 and the full year. We currently expect robust revenue growth in Q2, fueled by strong customer demand for our Standard Products, particularly OLED DDIC for smartphones in China and Korea. OLED DDIC revenue is expected to grow about 30% sequentially. Revenue from power standard product is anticipated to increase by double digits from Q1. Foundry revenue is expected to be flattish sequentially in Q2, but a gradual improvement in the second half of the year now seems plausible.

Turning now to our view of the full year. On our Q4 earnings call in February, we said, we are cautiously optimistic that revenue likely will decline by no more than mid-single-digit percentage points in 2019 as compared with 2018, despite current weakness in Foundry. While the distribution of revenue by quarter may vary this year for each of our 3 business units, we continue to remain cautiously optimistic for 2019.

Now I'll turn the call over to Jonathan and come back for the Q&A. Jonathan?

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Jonathan W. Kim, MagnaChip Semiconductor Corporation - CFO, CAO & Executive VP [4]

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Thank you, YJ, and welcome to everyone on the call. Let's do a brief recap of revenue by business segment and then discuss profitability metrics.

Revenue of $157.4 million in Q1 declined 5.1% from $165.8 million in the same period a year ago due to a decline in Foundry revenue, offset in part by an increase in revenue from Standard Products. Foundry revenue of $57.1 million declined 26.3% from $77.4 million in Q1 a year ago due primarily to inventory correction by customers stemming from softening global market conditions and macroeconomic uncertainties.

As mentioned previously, we also were more selective about new business as a result of the strategic evaluation of the Foundry business and Fab 4.

Revenue in the Standard Products Group was $103 million -- $100.3 million, up 13.5% from $88.4 million in Q1 a year ago. This increase was primarily due to an increase in revenue related to our mobile OLED display driver ICs due to the introduction of new OLED smartphones by Chinese and Korean manufacturers and higher demand for premium power products, such as high-end MOSFETs and IGBTs, primarily for TV and industrial applications. This increase was offset, in part, by a strategic reduction of our lower-margin LCD business. The LCD business totaled $9.7 million in Q1, a decline of 37% from Q1 a year ago and down 42.9% from Q4 2018.

Turning now to profitability metrics. Total gross profit in Q1 was $22.7 million, down 49.1% from $44.6 million in Q1 a year ago. Gross margin was 14.4% in Q1 compared to gross margin of 26.9% in Q1 a year ago. Gross margin in Q1 was within the guidance range of 14% to 16%. A significant drop in fab utilization affected gross margin for both the Foundry Services Group and Standard Products Group. Total fab utilization for the company was mid to high 60% in Q1 as compared to mid to high 80% range in Q1 a year ago. We believe fab utilization will show modest improvement in Q2 with gradual improvement expected in the second half of the year. Notably, raw wafer costs stabilized in Q1, and we expect those costs to trend flat to down during 2019, following negotiations with our wafer vendors.

Gross profit margin in the Foundry Services Group was 6.4% compared to 26.7% for Q1 2018 due to factors described elsewhere on this call. Gross profit margin in our Standard Products Group was 19% compared to 27.2% in Q1 2018. The gross profit in the Standard Products Group was impacted by an inventory reserve of $3.3 million related to a legacy display product. In addition, lower fab utilization related, in part, to a strategic reduction in revenue of our lower-margin LCD business also was a contributing factor.

Turning now to operating expenses in Q1. SG&A was $18.1 million or 11.5% of revenue as compared to $17.6 million or 10.6% in Q1 2018. SG&A was flattish year-over-year on a normalized basis, excluding a onetime payment to settle a claim with a prior customer. R&D was $20 million or 12.7% of revenue, about flat as compared to $19.6 million or 11.8% in Q1 a year ago. The increase was related to OLED development activities. Both SG&A and R&D in 2019 are expected to be lower than in 2018 as we continue to focus on cost control.

Turning now to the balance sheet. Cash was $105.8 million at the end of Q1 2019 as compared to $132.4 million in Q4 2018, due primarily to a decline in gross profit dollars caused mainly by a significant drop in fab utilization. We anticipate our cash balance will increase in Q2 due primarily to an anticipated increase in gross profit dollars. Accounts receivable totaled $92.1 million, an increase of 15.1% from $80 million in Q4 2018. Over 70% of the increase was attributable to the timing of payments from certain customers as the quarter end fell on a weekend and the related payments were collected during the first week of Q2. Inventories totaled $80.8 million, up 12.8% from $71.6 million in Q4 2018, due primarily to meet an anticipated increased in customer demand for OLED and power standard products. CapEx was $11.2 million in Q1 as compared to $7.3 million in Q1 2018. We provide CapEx on a cash basis and a significant portion of capital deployment was deployed in Q4 2018 but paid for in Q1 2019. CapEx on a normalized basis for 2019 will be lower than the normalized CapEx expenditures made in 2018, which was approximately $29 million.

With that, here's our guidance for Q2. For the second quarter of 2019, MagnaChip anticipates revenue to be in the range of $173 million to $181 million, up 12.5% at the midpoint of the projected range when compared with revenue of $157.4 million in the first quarter of 2019 and down 11.4% year-on-year when compared to the $199.7 million revenue recorded in the second quarter of 2018. Revenue guidance for the second quarter reflects an expectation that standard product revenue will show double-digit sequential improvement and Foundry revenue will be flattish as compared with Q1 2019. Gross profit margins to be in the range of 16% to 18% as compared to 14.4% in the first quarter of 2019 and 27% in the second quarter of 2018. Gross margin guidance reflects the expectation that fab utilization in the Foundry business has stabilized.

With that, I'll turn the call back to Bruce. Bruce?

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Bruce Entin, MagnaChip Semiconductor Corporation - Head of IR [5]

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Suji Desilva from Roth Capital.

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Sujeeva Desilva, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [2]

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Congratulations on the recovery you guys were targeting here and stabilization for Foundry. So on the OLED side, you have a bunch of things going on here, but I'm curious how the pipeline for 28-nanometer wins is shaping up and how that looks versus the current sort of win profile? Will that expand your footprint and share or will it sustain the position you have and move it forward?

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Young-Joon Kim, MagnaChip Semiconductor Corporation - CEO & Director [3]

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Suji, thank you. So as you mentioned today, we have up to 2 OLED 20-nanometer design wins so far. One we did in Q1; another one just came in, in April. So we continue to have progress on the design wins. As you know, we just sampled that device a few months ago -- a month ago. We expect the production to begin in second half of this year. And I think with that, we'll see -- hope to see more design wins. What's critical about this 28-nanometer is, what we said before, this is most power-efficient. This -- our design has the lowest power in the industry, also it reduce the EMI by 20%, which improves the call quality. And 28-nanometer is what you need to do ultra-high definition on the smartphone and big application like AR, VR to foldable and things like that. So we are excited that we see a good platform that we have that's going to generate new design win going forward.

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Sujeeva Desilva, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [4]

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Okay. And then on your existing OLED driver position, do you find that -- how is the China smartphone inventory situation at this point after a few months of working down? And is that impacting you? Or are you exposed to some of the new programs -- the newer phones that are seeing sort of initial ramps?

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Young-Joon Kim, MagnaChip Semiconductor Corporation - CEO & Director [5]

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So obviously, if you look at our Q1, we actually had stronger-than-expected OLED sales. So what that translate to is that there are new smartphones, new models being launched than we said we had launched about 8 or 9 phones in Q1. So the momentum is there for still new phones. And the 40-nanometer provides very good price point on the rigid platform. So I think we have that kind of a phenomenon.

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Sujeeva Desilva, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [6]

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Okay. And then on the non-OLED part that you've taken some action with in the display business, is that current level of just under $10 million, is that a sustainable level from here forward? Or is there another step-down in that amount comprehended in your guidance?

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Young-Joon Kim, MagnaChip Semiconductor Corporation - CEO & Director [7]

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For now, I think it's safe to -- or not safe but I think it's good to assume that it's around $10 million level for this year.

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Sujeeva Desilva, Roth Capital Partners, LLC, Research Division - Senior Research Analyst [8]

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Okay. Okay. And then one question on the Foundry side. The utilization you gave us for the quarter, what's -- given all the actions you're taking and this activity that you experience from the customers, what's the steady-state utilization target that we can now think about versus what you might be under typical operating conditions? Or is it similar?

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Young-Joon Kim, MagnaChip Semiconductor Corporation - CEO & Director [9]

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My -- I think -- I don't think we can say exact number. But as we remarked -- said today that we see a gradual improvement throughout second half. So we hope to keep increasing the utilization.

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Operator [10]

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And our next question comes from the line of Ari Shusterman.

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Ari Shusterman, Needham & Company, LLC, Research Division - Analyst [11]

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Congrats on the good quarter. So I want to just -- going to your Foundry business, since you guys have stabilized this for, I guess, the most part, do you think you're less likely to sell it as part of your strategic evaluation? And also, there has recently been a rumor that SK Hynix is considering buying this business or considering venue for it. Can you comment on that as well if you have any information?

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Young-Joon Kim, MagnaChip Semiconductor Corporation - CEO & Director [12]

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Well, I think there's a couple of questions there. But look, internally, we continuously review our business and operation team improve our financial performance and the operation efficiencies and maximize shareholder value. And this is why we're doing the strategic evaluation of Foundry business. And I'm sure you understand, I can't really comment on the speculation rumors. But our Specialty 8-inch fab is a strategic asset, and you would expect that it tends to generate a fair amount of interest.

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Ari Shusterman, Needham & Company, LLC, Research Division - Analyst [13]

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Yes. And just transitioning over to the China smartphone market. Do you guys see any sort of stabilization on that in the second half of 2019? Any updates in the past few months, like in terms of orders, anything like that?

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Young-Joon Kim, MagnaChip Semiconductor Corporation - CEO & Director [14]

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Could I understand your question? Are you saying, second half, what's the outlook for the smartphone in China?

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Ari Shusterman, Needham & Company, LLC, Research Division - Analyst [15]

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Correct.

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Young-Joon Kim, MagnaChip Semiconductor Corporation - CEO & Director [16]

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Okay. Well, obviously, we guide 1 quarter at a time, as you know. And what we did say is that Q2, we're looking OLED DDIC to grow about 30%. We also said on overall year, we feel good about revenue growing on the Standard Products Group and the OLED. So I will give more color when we go to next earnings call on the second half.

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Operator [17]

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(Operator Instructions) Our next question comes from the line of Atif Malik from Citi.

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Atif Malik, Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment & Specialty Semiconductor Analyst [18]

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Good job in a tough environment. YJ, I have a question on the OLED smartphone market. There is some kind of speculation that the Chinese handset makers, in particular one of them, could be buying components in light of U.S.-China tariff situation. Are you seeing any of that in your business that there is a pull forward of some component demand towards some handset makers in China?

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Young-Joon Kim, MagnaChip Semiconductor Corporation - CEO & Director [19]

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Atif, thank you. That's very interesting question. I also heard that kind of comments in the industry as well, but who knows. But from what we're concerned with, I mean, we have new design wins continue to grow with multiple Chinese vendor. And as we said, we have about 6 new designs in China smartphone maker. So for us, I think the revenue growth comes with number of design wins as well as success. But I think the Huawei has been growing and strong, so -- but beyond that, I cannot speculate.

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Atif Malik, Citigroup Inc, Research Division - VP and Semiconductor Capital Equipment & Specialty Semiconductor Analyst [20]

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Understood. And then, Jonathan, a question on the gross margins. I'm not asking for an outlook for the second half of the year, but just directionally, it's good to see that the wafer pricing has started to come down now, as you pointed out. How should we think about the different moving parts in your gross margins for the second half of the year, the mix between display, power standards, Foundry utilization improving and then the cost of wafers coming down?

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Jonathan W. Kim, MagnaChip Semiconductor Corporation - CFO, CAO & Executive VP [21]

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So thank you for the question. As we discussed, Q1 and first half of the year really where we're going to be impacted by the decline in utilization are primarily related to the Foundry business, and we've also mentioned that we see that business stabilizing. And so as we are recovering in the second half, we should see an improvement in gross margin as well. And we -- as the utilization improves, the fixed cost allocation to the products will also be decreased. So therefore, the impact to gross margin will be trending up. So directionally, our gross margin will continue to increase in the second half.

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Operator [22]

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And I'm showing no further questions at this time. I'd like to turn the call back to Mr. Bruce Entin for closing remarks.

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Bruce Entin, MagnaChip Semiconductor Corporation - Head of IR [23]

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Okay. Thank you, Victor. So this concludes our first quarter 2019 earnings conference call. Please look for details of our future events on MagnaChip's Investor Relations website. Thank you for joining us today.

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Operator [24]

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