Magnachip Semiconductor Corporation

Ladies and gentlemen, thank you for standing by and welcome to the Q2 2020 Magna CHIP Semiconductor Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star one on your telephone. Please be advised that the conference is being recorded.

Thank you. Hello, everyone, and thank you for joining us to discuss MagnetChip's financial results for the second quarter ended June 30, 2020. The second quarter earnings release that was filed today after the stock market closed can be found on the company's investor relations website. 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 Y.J. Kim, Magna CHIP's Chief Executive Officer, and Young Woo, our Chief Financial Officer. Y.J. will discuss the company's recent operating performance and business overview, and Young will review financial results for the quarter and provide guidance for the third quarter. There will be a Q&A session following the 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 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 on our SEC filings. During the call, we also will 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 Neganachip'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 website under the investor relations at www.magnachip.com. Now, I'll turn the call over to YJ Kim. YJ?

Thank you. Hello, everyone. Thank you for joining our call today. First of all, I'd like to welcome both So-Yeon Jung, our head of IR, and Dr. Young-Woo, our CFO, to their first earnings call at Magnetrip. Both will play important roles as Magnetrip opens a new chapter as a pure-play standard products company. I also want to acknowledge changes in our board of directors. Semiconductor veteran Mr. Camilo Martino was named chairman in June, and Ms. Liz Chung of Microsoft Korea joined our newly expanded board in July. During the second quarter, our team executed well and delivered excellent results. In keeping with our commitment to safety of our employees and continuity of services to our customers, we demonstrated our ability to be resilient to the impact of the COVID-19. We continue to take further steps to mitigate potential risks related to the health and safety of our employees and to the supply chain management. Key non-GAAP financial metrics exceeded our expectations. Revenue for the combined business came in above the high end of the guidance range due to strong demand in our power and foundry businesses. Gross margin surpassed expectations driven by improved product mix and higher FAB utilization. Non-GAAP diluted earnings per share from continuing operation was $0.13 as compared to $0.03 in Q1. On a sequentially flattish revenue, our bottom line improved due to higher gross margin. For the fifth consecutive quarter, we generated operating cash flow. In Q2, the cash flow from operations was $36 million. At the end of second quarter, our cash balance increased to $192.8 million, marking the highest level since the IPO in March 2011. In addition to delivering outstanding financial results, our team has made substantial progress with the pending sale of the foundry business and FAF4. I am comfortable with our progress to date, and we are working diligently to complete the remaining tasks to close this transaction. These tasks mostly relate to separating the shared R&D infrastructure and building. We are separating the IT systems, re-establishing a new IT infrastructure, and a new quality and reliability assurance lab for the continuing business. relocating our OLED test and development center and transferring power process R&D capability from Fab Four to Fab Three. I am proud of and thankful for what our team has accomplished during the quarter. Based on the progress we've made so far, we are now slightly ahead of our internal schedule and anticipate that the transaction will likely close in the third quarter instead of our previous estimate of the September-October timeframe. Now, let's take a close look at the continuing business starting with the display. During the second quarter, we completely exceeded all non-auto LCD TDDIC business as part of our strategic efforts to improve profitability and sharpen focus. As a reference point, we have reported approximately 6 million of non-auto LCD revenue as recently as Q1. If we use an Apple to Apple comparison, our Q2 display business revenue would have been 2.7% down from Q1 had we adjusted for this change. COVID-19 negatively impacted the global smartphone market during Q1 and extended into Q2, but we performed relatively well compared to the market during the first half of 2020. According to the market data, global smartphone market declined about 20% year-over-year during the first half of 2020, but our OLED DDI business was up 12.4% in the first half. The above-market performance was due in part to the accelerated launch scheduled from some of our customers. Our Q2 OLED DDIC revenue was $67 million, down 3.9% sequentially and down 8.3% year-over-year. Let me highlight four key takeaways for our display business. Firstly, regarding our new product launches, on our Q1 earnings call in May, we said we expected smartphone makers using our OLED drivers to launch 18 models in the first half, 10 models being scheduled to launch in Q2. Actually, 12 models were launched, bringing the total launch of 20 new smartphone models in the first half. Secondly, regarding customer design wins, we won eight new OLED DDIC design wins in Q2, including five based on the 28 nanometer manufacturing process. Our 28 nanometer products feature notable reduction in chip size and power consumption and continue to demonstrate strong design momentum in this growing product family. Thirdly, regarding advanced features in 5G phones, We are expanding our high frame rate HFR OLED DDIC product line. We launched five HFR OLED DDIC products to date and all of these now support 144 Hz for Full HD Plus displays and 120 Hz for the QHD Plus displays. Faster display response time is vital to full-featured 5G smartphones and we are well positioned to capitalize on the booming 5G smartphone industry. Our revenue from 5G smartphone accounted for about 20% of the total OLED revenue in first half 2020. Finally, regarding diversification, we continue to diversify the OLED business into automotive applications. During the second quarter, we taped out our first OLED automotive product. Leveraging our strategic alignment with major OLED panel makers, we plan to expand our design wings for automotive displays. Looking ahead, while quarterly revenue may fluctuate, we remain excited about the long-term outlook for the OLED market trend and our unique position. Recently, we experienced an upswing in demand for our OLED products. This recent increase in demand is outstripping our supply capability in Q3 because of insufficient lead time. The standard lead time for our OLED products is 2.5 to 3 months. Now, let's turn to the power business. The total annual power semiconductor market is approximately $45 billion, which presents us a tremendous opportunity for longer-term growth. It is important to note that today our manufacturing process, R&D, was centralized in our main Fab Four facility to support both our Fab Four and Fab Three. With the closing of the pending foundry transaction, FAB3 will become a dedicated FAB for our power business. Currently, critical product development and sizeable production for power are conducted at FAB4. Therefore, we will now be transferring all of our power process R&D to FAB3 and plan to equip the FAB to continue supporting our customers seamlessly. We also strengthened our power business leadership recently by hiring a 35 plus year veteran of Power Semiconductor as the General Manager. Our power business remains an essential part of a long-term growth and diversification strategy. Now let's talk about our power business in Q2. Power revenue experienced a strong rebound from Q2. China showed some signs of recovery from the global pandemic. The revenue came in at $39.8 million, up 20% sequentially and down 16.7% year-over-year. We saw pent-up demand for our medium-voltage MOSFET products driven by the increased popularity of personal transportation such as e-bike and e-motorcycles in China. We are seeing gross momentum with our PowerIC product line. Our PowerIC for one of the applications in the solid state drive is gaining traction at a global memory company and we are expanding our PowerIC lineup to serve with notebook PC and smartphone application in addition to TV applications. During Q2, We saw design-in and design-win activities across MB MOSFET, Battery Fest, Super Junction MOSFET, and PowerIC product lines addressing a wide range of applications. We are encouraged by a growing design pipeline in our power business.

Turning to the Foundry Services Group.

Foundry Services Group revenue was $95.8 million, the highest recorded revenue on 8-inch lines since the IPO. Revenue was up 11% sequentially and up 31% year-over-year, driven by the surge in demand for work-from-home related products as a result of the COVID-19 pandemic. Now, let's talk about our strategic transition. The sale of foundry business and FAFO allows us to transform into a streamlined, pure play products company focused on the attractive display and power markets. While we can't be immune to the risk of macroeconomic conditions, we are fundamentally resetting our business goal, and I'd like to share with you our key goal that we are targeting to achieve by 2023. First, profitable revenue growth. For display, we will ride on the continued global adoption of OLED panels by smartphone makers as well as the proliferation of new OLED applications. For power, we will focus on premium products and penetrating new high-growth segments such as the automotive market. While we improve our financial performance in existing businesses, we may also consider inorganic growth options that are synergistic and EPS-accretive if the right strategic opportunity presents itself. We plan to grow at a double-digit CAGR from 2020 to 2023. Second, gross margin. For display, we exceeded the low-margin non-auto LCD business. We will capitalize on this as we launch new products in emerging display applications. For power, through a combination of re-establishing our R&D center, increasing our manufacturing output in Fab3, and also leveraging external foundry services, we will drive a more favorable product Premium Product Mix. Considering all this, we plan to consistently achieve above 30% gross margin in a few years. Third, operating expenses. The continuing operations are currently carrying some stranded costs, which make some time to unwind. As a streamlined standard product company, we will right-size up-backs and exercise financial discipline. Collectively, these initiatives will bring a significant improvement to our operating income. As I mentioned during last earnings call, our goal is to first reach a 10% adjusted operating income level of the standard product business and then to continue to improve thereafter. By the end of the first quarter of 2021, we should be largely freed of approximately $21 million in annual interest expenses, which will substantially benefit our net income. We are not stopping here. These goals are important milestones in our continuous journey towards profitable growth. Today, we share with you some financial benefits of the new magnitude. Once the pending transaction closes, we will be able to share more financial metrics. We also plan to host an analyst day in the future and present strategic initiatives to illustrate how we will get there. In summary, we deliver better than expected financial results while accelerating the closing schedule of the pending foundry business sale. We will continue our execution to deliver a successful close and strengthen our business foundation for profitable growth. We remain well positioned to navigate through this challenging time, and as the industry environment improves, we will emerge stronger and capitalize on attractive market trends. Now, I will turn the call over to Dr. Woo and come back for Q&A.

Thank you, Y.J., and hello, everyone. It's nice to meet you over the phone. I'm very excited and honored to join MagmaChip and to drive its transformation with the great team, and I look forward to engaging with our key shareholders. Before I go into the financial review, I would like to reiterate that we believe segregating the transitional factory foundry services revenue from the continuing operations revenue provide investors with a better understanding of our core business research. Revenue in Q2 from continuing operations without transitional factory foundry services was $109 million, up 1.6% from Q1, and down 17.5% from Q2 a year ago, which was primarily due to the COVID-19 that negatively impacted the global smartphone market. Both sequential and year-over-year decline was also attributable to the strategic exit of non-auto LCD DDIC business, which accounted for $6.3 million in Q1 2020 and $9.6 million in Q2 2019. Display revenue in Q2 was $69.2 million, down 10.8% quarter-over-quarter, and down 70.9% year-over-year. The decline in the display business was in part due to the above-mentioned exit of non-auto LCD business. Power revenue in Q2 was $39.8 million, up 20% quarter-over-quarter and down 16.7% year-over-year. The sequential improvement of the power business was due to a solid rebound in the China market. Non-GAAP combined revenue from both the continuing and discontinued operations in Q2 was $204.7 million, which exceeded the high end of the guidance range. It was up 3.9% sequentially and flattish with the same quarter a year ago. The sequential improvement was attributable to the increased revenue from our power business and the discontinued operations which offset the decline in the display business. Before I go into the gross margin detail, I would like to remind you that when the business is labeled discontinued and the assets are classified as held for sale, all depreciation and amortization corresponding to those assets stops. Therefore, GAAP gross profit from our continued operations and Nungap combined gross profit from total operations in Q2 benefited from this accounting treatment by approximately $2 million during the second quarter. Gross profit margin in Q2 from continuing operations without transitional factory foundry services was 29.5% up 3.2% percentage point from Q1 and up 5.5% from Q2 a year ago. The sequential increase in gross profit margin was due primarily to improved product mix and higher FAP utilization. The year-over-year improvement was primarily attributable to a reserve of $2.2 million related to a legacy display product that was recorded in Q2 of 2019. Non-GAAP combined gross profit margin from continuing and discontinued operations in Q2 was 30.8%, which exceeded the high end of the guidance range. It was up 5.5 percentage points sequentially and up 9.4 percentage points with the same quarter a year ago as a result of improved product mix and higher PEP utilization. Gross profit margin in Q2 also benefited from the above-mentioned accounting treatment relating to the assets classified as those held for sale effective March 31, 2020. Turning now to operating expense in Q2, operating expenses from continuing operations were $23.5 million or 21.6% of revenue from continuing operations without transitional factories' foundry services as compared to the $23.2 million or 20.9% in Q1 and $22.9 million or 17.3% for the same quarter a year ago. Q2 operating expenses include $1.5 million of stock-based compensation charges. SG&A in Q2 was $12.4 million as compared to the $12.1 million in Q1 and $11.1 million in Q2 2019. R&D in Q2 was $11.1 million as compared to the $10.5 million in Q1 and $11.8 million in Q2 last year. Adjusted operating income for continuing operations in Q2 was $10.1 million, up from $7.3 million in Q1 2020, and up from $9.4 million in Q2 a year ago. Adjusted EBITDA for continuing operations in Q2 was $12.7 million, up from $9.9 million in Q1 2020, and up from 12 million in Q2 a year ago. EPS, on a gap basis, our earnings per share for continuing operations was 34 cents, up from a loss per share of 89 cents in Q1 2020, and up from a loss per share of 25 cents in Q2 2019. Our non-GAAP diluted EPS for continuing operations in Q2 was $0.13, up from $0.03 in Q1 and up from $0.11 in Q2 last year. The difference between our GAAP and non-GAAP EPS was primarily due to the elimination of the non-cash net foreign currency gain of $8.5 million. Now, moving to the balance sheet of the continuous operations, Theodore Kim J.D. consecutive quarter of net positive operating cash flow. Once the pending transaction closes, we intend to deliver and strengthen the balance sheet. The transaction-related tax exposure is estimated to be up to 15% of the net cash proceed of $344.7 million from the transaction. Accountancy swivel was down 20% from Q1. The decrease in accountancy swivel in Q2 was attributable to the timing of payment from certain customers. Our day sales outstanding for Q2 was 41 days. Inventories was up 26% from Q1 due primarily to an anticipated increase in customer demand for our A standard product. Our average days in inventory for Q2 was 54 days. CapEx was $5.5 million in Q2 as compared to the $3.4 million in Q1. Let me give you more details on our CapEx plan. For 2020, we have some unusual moving parts. We will support both the continuing and discontinued operations with necessary investment. In addition, we will also start to re-establish the process R&D in factory, build the QRA lab, and relocate the OLED test and the development centers as YJ mentioned earlier. Lastly, we are in the process of separating the IT systems and establishing a new IT infrastructure to support the continuing business after the sale. This will require a one-time investment of $21 million. With that, we expect the total capex for 2020 to be around $35 million. For 2021, we plan to complete the reestablishment of the factory. Once completed, our factory will have dedicated R&D capability, be equipped to seamlessly assume the critical project, and support the growing demand for our power product. This special investment, which is estimated to be around $22 million, will allow us to pursue a revenue potential that equates to a payback period of less than three years. With that, the total capex for 2021 is anticipated to be flat to shift from 2020. Now, moving to the Q3 guidance. On July 20, our factory facility in Gumi, South Korea, experienced a temporary power outage for approximately 9 hours and 15 minutes. We are nearly fully operational in our factory facility as of today. The accident caused damage to our working process wafers with an estimated total cost of up to approximately $2.3 million. The related impact to our revenue from continuing operations is expected to be negligible. The COVID-19 global pandemic and escalated trade tensions are rapidly evolving situations and reduce our forward visibility. While actual results may vary, Magnachip Country Anticipate for Q3 2020 Revenue from the continuing operations to be in the range of $118 million to $124 million including $9.5 million to $10 million of the transitional factory foundry services at cost. We want to Remind you that we accepted non-auto LCD DDIC business in Q2. Gross profit margin from continuing operations to be in the range of 25% to 27%. Without the estimated power outage impact, gross profit margin from continuing operations would have been in the range of 27% and 29%. With that, I will turn to the call over to the So-Yeon. So-Yeon.

Thank you, I.J. and Young. So, operator, this concludes our prepared remarks, and we'll now open the call for questions.

Thank you. As a reminder, to ask a question, you'll need to press star 1 on your telephone. To withdraw your question, press the pound or hash key. Thank you. Your first question comes from the line of Reggie Gil from Needham & Company. Please go ahead.

Yes, thanks, and thanks for all the details. It was very helpful, and congrats on good momentum despite the volatility in the industry. Y.J., a question on the OLED business. You talked about, I think, inefficient lead times. I was wondering if you could elaborate further in terms of what's going on regarding capacity to meet OLED. How do you see the smartphone market shaping up to be in the second half? There's many new product launches that are happening. So I wanted to get a sense of how you're looking at the smartphone business, the second half, and how that could affect your OLED business. Thank you.

Thank you, Siraj. So you asked a couple of questions there, so I'll try to answer one by one. So, yes, we are seeing uptick recently, and as you know, on the 12-inch screen, It's not just the 12-inch, but the OOLED, the lead time, standard lead time, takes about 2.5 months to 3 months from a wafer start to going to a then wafer out to the back-end assembly test or testing. So that's about 2.5 to 3 months time frame. So let's say if we get some uptick in demand that we don't have a Theodore Kim, Shin Young Park, Thank you very much. Theodore Kim J.D.

Thank you very much.

Again, I can't give you a six-month forecast, but I feel good about the demand that has been generated on the power as well. But combinedly, we are guiding between $118 million to $124 million for this quarter for Olido's product line on the third quarter.

So if I strip out the transitional services, And at the midpoint of your guidance, it's about $111 million. And in Q2, for both power and display, it was about $109 million. So about $2 million sequential increase, but down from the third quarter of last year, which was about $139 million. So the year-over-year decline in third quarter is primarily related to, would you say, the smartphone display, you know, the global COVID-19 impacting smartphone and power. I'm trying to understand the year-over-year decline.

Yeah, so I think this year, you know, the industry faces slowdown, as you know, the whole semiconductor. So that's what it's been. But I think despite the uncertain pandemic, I think we showed relatively good results in the first half. When the smartphone declined 20% year over year on the first half last year to this year, we grew 12.4% on OLED. But in the second half, I think, you know, it's... We remain optimistic, but at the same time, the visibility market due to the global pandemic there, but in general, we're showing incremental from the second quarter.

And this last question for me in terms of the gross margins, and I'll get back in the queue. So there's a drop in gross margins because of that power outage You said it would have been higher. But it's still, I think, below what it would be in 2Q. And so I just want understanding that. And then you talked about kind of achieving a 30% growth margin in a few years. Wondering, you know, without giving too much specifics, what are the drivers of the margins, you know, to get above 30%? and a few years. I mean, if I look at, you know, this quarter, you already did 29.5 in standard products, you know, on a normalized level. So you're almost there already, you know, and putting aside what, you know, what happened with the power outage in 2Q, I mean, you're going to 3Q, you're kind of close to the 30% if I'm looking at it on the standard products. So just want to get a sense of how you're kind of thinking about 30% and what's underneath that.

Yes, so again, you asked a couple of questions, so let me clarify one by one. So on the Q2, if you look at the continuous operation, our gross margin was 27%. That includes the transitional service. On the Q3, if you look at our earnings release, we said without the power outage, the gross margin would be in between 27% to 29%. which puts it at 28%, which is upward trend from 27%. Okay, so that's the first answer for that to clarify. To your really good question, let me try to answer. So, you know, we are looking for sustainable gross margin improvement. You know, if you look at our past history, We have really good quarter, and then we fluctuate. Our goal is to really get sustainable gross margin above 30%. So that is our goal. And how are we going to do that? We'll do a disciplined investment in existing business, going after attractive markets, as well as attractive portfolio. We established power manufacturing process R&D and technology pipeline in Fab 3. And we will also consider any synergistic creative inorganic opportunity if it presents itself. And we will consider all available options to accelerate the profit or growth and being creative in EPS. And that's our goal and that's what we're talking about is a sustainable, That is above 30%. And as I said before, first, we'll shoot for 10% operating adjusted income, and then we'll move thereafter upwards. Okay, great. I hope that answers your question.

Yeah, I just do want to clarify on the gross profit margin, because I'm looking at the press release, and it says gross profit margin for standard products is 29.5%, which I'm assuming is display and power, and foundry was 32.3%. and then you're saying 27% for continuing operations. So I'm just confused that what's the difference between the standard products? What's in that 29.5% for standard products and why is that different from 27% for continuing operations? Is that the transitional services?

Yeah, the transitional service at 10 million is at zero cost, zero margin. That's why when you sum those up, that becomes 27% in the Q2.

Okay, but you did 29.5% in display and power, you know, collectively. Okay, right. So that was my question that, you know, you're going to be a power and standard business going forward and you're, you know, you did 29.5.

We're going to have transitional service for the next three years.

No, I understand that, but that could be netted out. Okay, I got it. All right, thank you so much.

Thank you.

Your next question comes from the line of Suji De Silva from Rock Capital. Your line is open.

Hello, Y.J., and hello, Dr. Wu. Good luck in the new role here. So, Y.J., in terms of the – In terms of the undershipping of the OLED versus the customer demand, is there anything you can do from the supply side to address those, or will these persist given your foundry arrangement?

I think we have enough capacity between multiple foundries. It's just a lead time, right? So when you have a really uptake in demand, we have to act quickly and So that's what this is about, but it's a good problem to have. So, you know, I think because of the pandemic, people's forecast has not been as accurate. So I think that's what's happening. And when we have an uptick, you know, it takes time to adjust. We're doing our best so that we can deliver much better results.

Understood. The challenge is sending the right order size to the foundries. And then the smartphones, the programs you've won, you've won quite a few. Are you seeing any either pull-ins or delays of those programs, or are they all progressing to the targets in the second half?

So, you know, I think it's important to realize that when we win so many design wins, like cumulative over 45, Each product launch, you know, some could be a hit, home runs, or bad. But overall, you know, we are seeing the momentum in our product and portfolio and design win. And also, it's really up to the smartphone makers being successful in the market. So that's outside our control, but I think the trend is that we keep winning and there's more product launches. and more pipeline on our product line. And we feel good about it. And we're also expanding into automotive. First, automotive taped out. Obviously, the automotive, you're not going to see the revenue until next year. But again, we are diversifying and we are going into more higher premium product line as well in the OLED. And you will see more of this up in the future.

Okay. And then last question on the power segment. I don't know if you provided the percent that's premium products for the power segment. And as the premium products grow, I presume the ability to sustain 30% plus gross margins of power increases, or does it depend on factory utilization you transition over? What's the kind of the premium product mix and trend, and then how is that going to help the margins be sustained at these higher levels?

So, recently, last, I would say, four quarters, our premium product line was around 50%. So, our goal is to continue to increase the premium product portfolio. Obviously, appropriate CapEx that the doctor who laid out today is needed to strengthen our product line, as well as portfolio, and then margin improvement will follow, having more competitive product and the roadmap. I think that all that will lead to a better margin improvement to follow.

Okay. Thanks, guys.

And your next question comes from the line of Atif Malik from Citi. Your line is open.

Hi. Thank you for taking my questions. Y.J., you gave a couple of interesting numbers, and I have questions on them. The first one, you said Thank you very much. Does your mix of 5G smartphones accelerate at a higher pace than the industry from this 20% number that you currently have over the next, let's say, 12 to 24 months?

It's a very good question. Thank you. So if you look at some market research, I think they estimate about 17% of 5G is smartphone this year. And obviously we did about 20% in first half. So it's not too far off, but we're still doing slightly better than what the market research said for the whole market. Going forward, I think, yeah, there will be more 5Gs. One of the key features that is happening in 5G is 120 Hz screen and potentially up to 144 for QHT+. So as we said, we have five products that we have HFR capability that we launched that becomes a key feature for the 5G. And that HFR feature also allows you to do more virtual reality and games, which is also important as the pandemic, I think, is changing some of the habits and the world of the smartphone users. And the 5G is also continuing to grow with the IoT as well as the autonomous driving and other new applications. Thank you. Great.

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We are also expanding to some of the IT segments. So we are diversifying our PIIC from a TV consumer-centric to more different segments and the computing segment, and later to potentially industrial softwares to help with the premium portfolio product line in our power business.

Great. Thank you.

and I'm showing no other questions at this time.

Okay, thank you. This concludes our second quarter 2020 earnings conference call. Please look for details of our future events on Magnetip's investor relations website. Thank you for joining us today. Goodbye.

This concludes today's conference call. Thank you for your participation. You may now disconnect.