Magnachip Semiconductor Corporation

Good day, ladies and gentlemen, and thank you for standing by. At this time, I would like to welcome everyone to the Quarter 3 2020 MagnaCHIP Semiconductor Corporation Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during that time, simply press star, then the number 1 on your telephone keypad. If you would like to draw your question, press the pound key. Thank you. It is now my pleasure to turn the conference over to Ms. Sol Yeon-Jong. Ma'am, please go ahead.

Thank you. And thank you, everyone, for joining us to discuss Meganechip's financial results for the third quarter ended September 30, 2020. The third 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, MagnaCHIP's Chief Executive Officer, and Young Woo, our Chief Financial Officer. Y.J. will discuss the company's recent operating performance and business overview, Young will review financial results for the quarter and provide guidance for the fourth 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 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 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 measures of MagnaCHIP's operating performance A reconciliation of non-GAAP financial measures to the most directly comparable GAAP measures can be found in our third quarter earnings release available on our website under the investor relations at www.magnachip.com. I now will turn the call over to YJ Kim. YJ?

Hello, everyone. Thank you for joining our call today. COVID-19 indeed changed the way we live, work, and think. And our team members at MagnetChip have been actively adapting to the new normal by adhering to our multiple safety protocols and business continuity plan. We hope that you and your family are all healthy and well. We successfully completed the sale of the foundry business and Fab Four Slightly ahead of our internal schedule for a purchase price of about $350.6 million. We used $227.4 million of the proceeds to fully redeem all of the 6.625% senior notes due 2021 on October 2nd of 2020, lowering the future interest expense Thank you for joining us. Semiconductor Corporation, Jk Minh, Hyuk Woo These two one-time items together negatively impacted our gross profit margin by 3 percentage points. Adjusted for the impact of these one-time factors, we delivered non-gap diluted earnings per share of $0.14. Now, let's take a closer look at our product business, starting with the display business. I remind you that we have completely exceeded the non-auto LCD business in Q2 2020. As a reference point, our display revenue in Q3 of 2019 was $90.6 million, which included about $10.4 million of non-automotive LCD business. Our display revenue was $69.6 million for the third quarter, up 0.6% sequentially and down about 14% year-over-year, adjusting the non-automotive LCD revenue in 2019. Q3 OLED drive IC revenue was $67.6 million, up 0.9% sequentially and down 13.7% year-over-year. In September, we recorded a $2.3 million excess inventory charge increase Our panel customers have de-risked the Huawei business and we don't expect further impact from the Huawei ban other than this unusual excess inventory charge. Please note that our Q4 guidance does not include any of Huawei business. Now, let me highlight three key takeaways for our display business. First, starting with demand. During our last earnings call, we mentioned an upswing in demand for our OLED product, which was outstripping our supply capability in Q3 due to the recent Theodore Kim, Shin Young Park, Theodore Kim, Shin Young Park, Both our revenue and design activities were driven by a major Korean smartphone OEM and Chinese OEMs. One of the notable achievements that we are very excited about is that a major Korean smartphone OEM has launched a new key model with our display driver in early October. This end customer's model is being well adapted in the market as it keeps the flagship features that consumers want Theodore Kim, Shin Young Park, Theodore Kim J.D., Seung-Hoon Lee, Jk Minh, Hyuk Woo MagnetChip's top market position as non-captive supplier in the OLED DDIC market reflects that our advanced technology and distinctive portfolio resonate with our customers. We continue to focus on empowering our customers through relentless innovation and imperial support. Last but not least, The 5G momentum. We are enjoying the booming 5G smartphone industry, especially with our high frame rate HFR OLED drive ICs. In Q3, we were awarded 8 new design wins, and 7 of them were 5G and HFR models using 28nm process. You may recall that our revenue from 5G smartphones accounted for about 20% of the total OLED revenue in first half 2020. In Q3, 5G revenue represented about 40% of the OLED revenue. According to the market data, the global 5G smartphone shipment in 2020 will be about 200 million units, and it will likely to be more than double in 2021. The emerging global 5G trend bodes well with the underlying strengths in our product portfolio. Now, let's turn to the power business. The power revenue came in at 46.7 million, up 17.3% sequentially and down 4.2% year-over-year. The complete recovery from the power outage took longer than we anticipated, which limited the FAT3 output at full capacity, resulting in a lower utilization during Q3. Despite this handicap, we achieved a double-digit sequential growth and managed the production. The market momentum and our product pipeline remain strong. Now, let me highlight key takeaways for our power business. First, starting with demand. As both China and Korea were gradually recovering from the global pandemic, our power revenue in the third quarter was mainly driven by personal transportation and TV applications. The rebound in Chinese and Korean TV markets drove strong demand for our Super Junction MOSFET and Power IC products in Q3, and the trend is continuing in Q4. We expect our power business in Q4 to grow 15% to 20% year-over-year. Driven by the combination of capacity constraint and strong demand, our channel inventory level became below our normal operating range. We are striving to address the continued demand and also to replenish the channel inventory to a more balanced level in the future. Let me also underline the progress we are making in the China market under our go-to-market strategy with a newly established leadership team. To efficiently target the fast-growing China market, we set up a regional support system with a dedicated sales and marketing function. The team focused our product to be more optimized for the Chinese market demand, and we directly engaged with numerous power customers that resulted in new wins from a wide range of applications, including TV, industrials, and mobiles. We are encouraged by the great momentum in China power business. Looking ahead, I am very excited about our power business potential. By 2022, we will have introduced a complete set of next-generation power discrete product portfolios. These new generation premium product families will carry superior performance with a much improved cost. The upgrade will take place at Our Fab 3, and by that time, our Fab 3 will be up and running with about 40% additional capacity. Now, turning to our long-term plan. We are repositioning magnet chip to achieve sustainable and profitable growth. As we close the divestiture ahead of our original schedule, We decided to accelerate our disclosure of pro forma financials rather than wait till the future analyst day. Let me provide our key goals we are targeting to achieve by 2023. While our quarterly reports are based on the total revenue including the transitional Fab 3 foundry services, in accordance with GAAP, We are providing the following metrics based on the standard product business revenue excluding the transitional FAP3 foundry service. Such service is expected to cease after a certain period of time. We plan to 1. Grow our top line at a double-digit CAGR 2. Consistently achieve above 30% gross profit margin 3. Reduce Adjusted UpX to be below 18% of revenue. 4. Exceed 10% Adjusted Operating Income Margin. This will enhance our ability to generate free cash flow. 5. Tax rate to be approximately 14% to 16% in the next 2 to 3 years due to the net operating loss carry forwards to be offset Semiconductor Corporation, Young-Joon Kim, Shin Young Park, Theodore Kim, Shin Young Park, Theodore Kim, Shin Young Park, Investment we are making in FAS3 for 2020 and 2021. From 2022, we expect the capital spending to return to the moderate level of 3% of revenue or below. 7. By 2023, we will generate free cash flow in excess of 8% of revenue. These additional financial pro forma metrics will give you a better understanding of our long-term outlook and value creation. We also would like to further share our capital allocation plan in the near future. Our board and management are actively evaluating all available options to maximize our shareholders' value. Now that we communicated these key pro forma financial metrics, it seems more prudent that we reschedule our analyst day to Q1 2021 due to uncertainties around COVID-19 and related matters. We will then share our capital allocation plan and our growth strategic initiatives. We believe this rescheduling will allow for more comprehensive discussions with investors and analysts. The date will be announced in the near future. In closing, Q3 represented a pivotal chapter of MagnetChip as we successfully closed the sale of Foundry Business and Fab Four that ultimately resulted in MagnetChip becoming a pure place products company with a very healthy balance sheet for the first time. Theodore Kim, Shin Young Park, Theodore Kim, Shin Young Park, We are encouraged by the robust growth opportunities ahead of us which creates a stronger foundation for profitable growth. We continue to push the envelope on enhancing our competitive position through continuous technology advancement, addressable market expansion, and strategic customer engagement. Now, I will turn the call over to Dr. Woo and come back for the Q&A.

Thank you, Y.J., and welcome to everyone on the call. Let's start with the key financial metrics for Q3. Total revenue in Q3 was $124.8 million, up 5% from Q2, and down 16.3% from Q2 a year ago. Revenue from the standard product business was $16.3 million, up 6.7% from Q2 and down 16.5% from the same quarter a year ago. The sequential increase was driven mainly by strong demand in our power product for personal transportation and TV applications. The year-over-year decline was primarily due to the U.S. government export restrictions on Huawei, that impacted the shipment of certain OLED display driver ICs to our customers. The year-over-year decline was also attributable to the strategic exit of non-auto LCD business, which amounted to $10.4 million in Q3 2019 and $1 million in Q3 2020. Display revenue in Q3 was $69.6 million Up 0.6% quarter-over-quarter and down 23.2% year-over-year. Adjusting the non-auto-asset business, it was down about 13% year-over-year. Power revenue in Q3 was $46.7 million, up 17.3% quarter-over-quarter and down 4.2% year-over-year. The sequential improvement in the power business was due to a solid rebound in the China market. Gross profit margin in Q3 was 22.9%, down 4.1% point from Q2, and down 1.7% point or 70 basis point from Q3 a year ago. There are two unusual items, as mentioned by YJ earlier, that collectively translated into a negative 3% gross profit margin hit in the third quarter. Turning now to operating expenses in Q3. Operating expenses were $25.4 million or 20.3% of total revenue as compared to $23.5 million or 19.8% in Q2 and 20.9 million dollar or 14% for the same quarter a year ago. SG&A in Q3 was 12.9 million dollar as compared to the 12.4 million dollar in Q2 and 10.7 million dollar in Q3 2019. R&D in Q3 was 12.5 million dollar as compared to 11.1 million dollar in Q2 and $10.2 million in Q3 last year. Stock compensation charges included in the operating expenses were $2 million in Q3, $1.4 million in Q2 and $0.4 million in Q3 of last year. Adjusted operating income in Q3 was $8.8 million down from $10.1 million Theodore Kim, Shin Young Park, Theodore Kim, Shin Young Park, Theodore Kim, Shin Young Park, Net of tax was $273 million, up from $29.2 million in Q2, and up from negative $1.6 million in Q3 a year ago. This sharp increase was primarily due to the recognition of gain on sale of the founded businesses and the FAP4 of $287.1 million. Q3 net income from continuing operations was $8.5 million, down from $11.8 million in Q2, and up from negative $14.2 million in Q3 2019. Our earnings per share, including results from discontinued operations, was $7.74 in Q3, up from $0.84 in Q2 2019, and up from negative 5 cents in Q3 a year ago. Our earnings per share from continuing operations was 24 cents in Q3, down from an earnings per share of 34 cents in Q2, and up from a loss per share of 41 cents in Q3 2019. Our non-GAAP diluted earnings per share from continuing operations was 14 cents in Q3, Theodore Kim, Shin Young Park, Theodore Kim, Shin Young Park, Theodore Kim, Shin Young Park, There were 35.3 million basic weighted average number of shares outstanding and 46.6 million diluted weighted average number of shares outstanding in Q3. The difference between share counts primarily relates to the dilutive effect of including the company's exchangeable notes as if they were converted into shares at the Beginning of the period. Now moving to the balance sheet, cash was $542.1 million at the end of Q3. This compares to $192.8 million at the end of Q2. In Q3, we completed the sale of the foundry business at Fab Four for a purchase price of Approximately $350.6 million in cash. We plan to use some of our net operating loss carry forward to offset capital gain tax on this sale transaction. The capital gain tax, which is currently estimated to be in the range of $14 to $16 million, will be finalized and paid in Q1 2021 as part of our annual 2022 corporate income tax filing. On October 2nd, we fully redeemed 2021 senior notes. As part of this redemption, we paid the withholding tax of $20.5 million as we moved the proceeds from our Korean subsidiary, to the ultimate parent company in the U.S. who was the issuer of the senior notes. Account receivable was 19% from Q2, up 19% from Q2. The increase in account receivable in Q3 was attributable to the timing of payment from certain customers as the quarter end fell on a holiday in Korea and the related payments were collected by the following week. Our day's sales outstanding for Q3 was 43 days. Inventories were down 26.1% from Q2 due primarily to the limited ability to manufacture the product in Fab 3 at full capacity caused by the delayed recovery from the power outage. Our average days in inventory for Q3 was 32 days. CapEx was $7.5 million in Q3 as compared to $5.5 million in Q2. Before moving to the fourth quarter guidance, I would like to note that we commenced our voluntary resignation program which is available for all employees from the October 16th. Due to the voluntary nature of this program, we are unable to provide an estimated amount of the related severance and other termination benefits for those employees under the program at this time. Once completed, this will help enhance our profitability. Now moving to Q4 guidance. The COVID-19 global pandemic is still evolving and continues to reduce our forward visibility. While actual results may vary, MagnaChip currently anticipates for Q4 2020 revenue to be in the range of $128 to $136 million, which represents approximately 3% Thank you, I.J. and Young.

So, operator, this concludes our prepared remarks, and we'll now open the call for questions.

At this time, if you would like to ask a question, please press star 1 on your telephone keypad. Again, if you wish to ask a question, simply press star 1 on your telephone keypad. We'll pause for just a moment to see if we have any questions. And your first question comes from the line of Raji Hill from Needham. Your line is now open.

Thank you and congratulations everyone on really good results despite the uncertain environment. Two questions, one short-term and one long-term. On the short-term, the gross margin guidance is showing a bit of an uptick after the issue that you faced in Q3 related to the power outage. I wanted to get your thoughts in terms of how we should be thinking about the gross margins in Q4, but also going into 2021. I know you talked about kind of this 30% gross margin target, but are the power outages kind of complete and going forward, the gross margin improvement over the next several quarters should be driven by mix or improvement on price? Just wondering if What are the thoughts on the gross margin, the puts and takes for the near term?

Sure, Raj. Thank you. So, yes, the power outage is now under control. It got control in early October. And in terms of the guidance we provided fourth quarter, 25 to 27, that includes all the FAS3 transitional service for FSG. which as you know has little or no margin. So the product business unit margin obviously is a couple points higher. And we will be sharing more of near-term margin forecast at the analyst day which now has been rescheduled. But what we provided is by 2023 where we see that the company will be fully Product Streamline Companies. So we are providing clear guidelines. And until then, we still will have some of the transitional service, FAP3. So we'll give more detailed breakout during the analyst day.

And in terms of the growth in power, so there was a rebound in China, as you said, in Korea, driven by personal transportation and TV technology. And that was a nice reversal. How do we think about power in 2021? What are the major growth drivers in power? Are you seeing adoption of electric vehicles accelerating in China and Korea? Is that fueling a lot of the growth in 2021? And what are the other markets in power that you're excited about?

Yes, so today we serve the four segments well. That's communication, consumers, computing, and industrial. I can say that industrial and the consumer is the bigger segment for us. We are also excited about some of the SSD penetration that's in the computing space. And as you know, we are also working on 10,000-hour call-in automotive. We have alluded before that that should come in the second half next year, but it won't be a meaningful revenue. We expect the automotive to be 5% to 10% in a few years out. We are excited about that. As I said before today, by 2022, we will have a complete new set of the A discrete power portfolio from super junction to IGBT to medium voltage to power battery fat that will have much higher performance as well as much improved cost. So we are very excited about that in the near term as well as the midterm.

And on the OLED side, you mentioned that you're benefiting from the 5G momentum growth. And so just curious in terms of the adoption of OLED, would you say that goes hand-in-hand with the 5G momentum going into next year? So 5G phones are going to double, more than double, that we should expect, I wouldn't say the attach rate is doubling, but we should expect that OLED adoption will continue to kind of accelerate in 2021 to support these 5G phones. Do they kind of go hand-in-hand when these OEMs launch 5G phones with high frame rates?

Yes, I think there are two things. First, the industry transition from LCD to OLED. And as you know, even for next year, that may be 40% or close to 50%. But as time goes by, that's going to accelerate more to OLED. So that's in our favor. Second, in terms of 5G, yes, there's a great momentum. The first half this year, we had about 20%. On the third quarter, about 40%. In fact, the industry was slightly less than what our numbers by a couple of percentage points, but it's the right direction we're seeing. And then according to market research, they see the 5G phone to grow at least about 2.5X this year. So we are very encouraged by all the signs, both on the 5G adoption as well as the industry moving from LCD to OLED. So that should all help out.

Thank you. Your next question comes from the line of Suji Da Silva from Ross Capital. Your line is now open.

Hi, Y.J. Hi, Dr. Wu. Congratulations on the progress here. So on the smartphone market, Y.J., the OLED demand, can you talk about how the China market demand is shaping up? You know, 4Q seems like the backlog's good, and then early calendar year 2020, Are you seeing evidence of a multi-quarter recovery here, or is the visibility still challenging?

Well, so, you know, first of all, as you know, we only guide one quarter at a time, but what I can say is that the industry is seeing more demand, and so the supply is very tight. So I think it's a reflection of the market being strong. Now, in terms of how the market players are happening, It seems like there is a lot of competition who are trying to win the Huawei sockets. So there is an improved business among the non-Huaweis. For us, we have about a dozen end customers, but they're not our direct customers, so we don't name them. So I think the market is trying to have the – New Dynamics, as well as the industry also having a good silicon demand. So that's what we see in the near future.

Okay, great. And then perhaps you could talk about the trend in foldable smartphones and how that's impacting your mix and products, and OLED is still early, or is that an opportunity to calendar 21 for you?

Yes, we're excited about the new application the OLED is bringing to, you know, I think the affordable is one of them, the automotive is second, and then the TV, you know, I think the next year that there will be more OLED TV for multiple vendors. So I'm very excited about the new application developing and the U.S. particular affordable and the Your next question comes from the line of John Lopez from

Thank you so much.

Can you hear me okay?

Yes.

Terrific. I have a couple. The first one is just on a clarification for the Q4 guidance. Is there any latent impact from the outage going from Q3 to Q4? In other words, are you selling out product in Q4 that has higher production costs that theoretically goes away in 2021?

So that's a very good question. So some of the power products that had a power outage in Q3 that was in the WIP will have that higher cost due to the higher utilization that will ship in the fourth quarter. But the fourth quarter will have a very high utilization as the FAP will be full. So to answer your question, there will be some of that in the first quarter on the power devices.

Gotcha. Okay, helpful. But in theory, that should probably start to work itself out as we go into early next year. Sorry, is that right? So that should largely resolve itself into early 2021?

Yes, by the Q1 treatment, it should have... If the parts are made in the mid-October and later, that should be the, what do you call, ideal conceptual thing.

Perfect. Okay, perfect. Thanks. My second question, I'm wondering, would you mind quantifying your exposure to Huawei in calendar Q3 or even perhaps year-to-date?

Sorry, as I said before, we don't, you know, we don't... Break down the customer by end customer because we don't actually sell to them. We only sell to the panel. But we did say that the one-time exposure on the write-off for those inventory was 2.3 million.

Okay, gotcha. Two really quick ones. The first one, if I look at the display guidance for the calendar fourth quarter, I know you're not guiding specifically, but if we kind of... Very strong. Much stronger than it usually would be seasonally. This is obviously an unusual year, a whole bunch of different ways. But I suppose my question is, assuming that's correct, would you have us think any differently about how seasonality might play in 2021, just given what seems like kind of a stronger end to this year?

So, you know, I think you're correct about seasonality. Seasonality for us typically has been the Q3 is a high season. and Q4, we go down slightly low. So this is unusual pattern. So 21, we'll see what happens then. But you're correct that we're doing much better than the normal seasonality for the company.

Okay, gotcha. My very last one. I'm wondering if you could talk just a minute about the dynamics in the power market One thing in particular we're picking up is a pretty reasonable amount of concern about the potential for sanctions on SMIC, who obviously has a pretty sizable 8-inch footprint. I guess I'm wondering, are you seeing that development specifically driving opportunities for you, either to expand with existing customers or to perhaps pick up new customers? Could you just talk for a minute about the market and what kind of the opportunity set for you might look like to the extent that those developments continue? Sure.

Well, so I think there are two separate things in there. First of all, the discrete devices, we manufacture most of that in our FAP3. There are some stuff still made in the FAP4. But in terms of the, you know, the SMIC, I don't think, you know, if you were to have SMIC make it, I assume it would be more PIMIC, so... But in any rate, I think that would tend to have a better business thing. But we count on our product portfolio on our discrete devices that we have IEP and we make internally, as well as the power IC. So we're going to grow based on that and our competitiveness. And I feel really good about our next generation product. Again, if you have any questions, simply press star 1 on your telephone keypad. That is star 1 on your telephone keypad to ask a question.

And there are no further questions at this time. I would now like to turn back the call over to Ms. Seol Hyun Jung for some closing remarks.

Thank you. This concludes our third quarter 2020 earnings conference call. Please look for details of our future events on MagnaCHIP's Investor Relations website. Thank you for joining us today. Goodbye.