MagnaChip Semiconductor (MX) Q3 2019 Earnings Call Transcript

MagnaChip Semiconductor (MX -1.03%)
Q3 2019 Earnings Call
Oct 23, 2019, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Q3 2019 MagnaChip Semiconductor Corporation earnings conference call. [Operator instructions] Please be advised that today's conference is being recorded. [Operator instructions] I would now like to hand the conference over to your speaker today, Bruce Entin, head of investor relations. Please go ahead, sir.

Bruce Entin -- Head of Investor Relations

Thank you for joining us to discuss MagnaChip's financial results for the third quarter ended September 30, 2019. The third-quarter earnings release we filed today after the stock market closed and other releases 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 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 our Q3 financial results and provide financial guidance for Q4 2019. There will be a question-and-answer session following today's prepared remarks. During the course of this 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'll 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 third-quarter earnings release available on our website under the Investor Relations tab at www.magnachip.com.

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

YJ Kim -- Chief Executive Officer

Thanks, Bruce. Welcome to everyone on the Q3 conference call. Q3 was MagnaChip's highest revenue quarter since our IPO in 2011. Revenue of $229.7 million increased 11.5% year over year and 12% sequentially and was at the high end of our guidance range of $220 million to $230 million.

Display and power, both achieved record revenue in Q3 and foundry turned in its best revenue quarter in five years. Display, power, and foundry all showed year over year and quarter-over-quarter revenue growth, while our OLED business had its highest revenue quarter ever. Total gross profit margin was 26.5%, which exceeded our guidance range of 22% to 24% due primarily to increased revenue and higher fab utilization that benefited foundry, as well as power and non-OLED standard products manufactured in-house. Gross margin now has increased sequentially for two consecutive quarters and was about 12 percentage points higher in Q3 than the abnormally low level recorded in Q1 of this year.

Jonathan will provide commentary on gross margin shortly. Let's begin our review of Q3 with OLED. OLED revenue was a record $78.3 million, which broke the previous record of $73 million set less than 90 days ago in Q2. OLED revenue increased over 34% from a year ago and was up over 7% sequentially.

Our OLED business in Q3 benefited from the launch of six OLED smartphones in Asia with our OLED display drivers. In the first nine months of this year, 20 OLED smartphones were launched worldwide with our OLED display drivers. We were awarded a record 11 new OLED DDIC design wins in Q3, including three midrange designs from a major smartphone maker in Korea. Of the 11 design wins, seven were based on our 40-nanometer product family and four were based on our newest and advanced 28-nanometer drivers that have the lowest power on the market.

Of our 21 cumulative OLED design wins through Q3 of this year, one-third have been from our two 28-nanometer OLED display drivers. 40-nanometer display drivers will account for the majority of OLED design wins and revenue in 2019. And in 2020, we expect that our 28-nanometer display drivers will become mainstream products. On the Q2 earnings call back in July, I mentioned, we had three different versions of our 28-nanometer OLED display driver.

However, in Q3, we added a fourth to the product lineup. Two of those 28-nanometer drivers are in mass production and two others are being sampled. By the end of the year, we anticipate we'll have a total of about a dozen different product versions of 40 and 28-nanometer display drivers in various stages of development and production and we do not plan to stop here. In summary, we believe we are building upon our position as the leading independent developer and supplier of OLED display drivers for smartphones today.

In the future we plan to extend that position of strength to TVs, tablets, computers, and automotive as well. Let's now turn to our power standard products business. Power revenue of $48.7 million set a record. Power revenue increased 9.5% from a year ago and gross profit margin reached its highest level ever.

Smartphones, industrial lighting, and e-bikes were among the biggest drivers of customer demand. Revenue from premium product -- premium power products, which include Super Junction MOSFETs, IGBT, and Power IC grew by double digits compared to a year ago and represented nearly 50% of the power revenue in Q3. Our battery FET product that protects smartphone batteries recorded its highest revenue since the product was introduced in 2008. We have the No.

1 market share in Korea and we are currently in development about a dozen different battery projects to align with customer product requirements in Asia. Our power business is benefiting from changing industry trends. Mobile devices like smartphones require ultra-low power devices to support advanced application processors and extend battery life, while products like power tools and e-bikes have motors that require mid and high-voltage power devices. Our power product lineup meets all those requirements.

We believe that the electric vehicle market will be the next attractive long-term business opportunity for MagnaChip. In summary, our power business has grown 14% and 13% in each of the past two years over 12% of the first nine months compared to a year ago despite growing just 2% sequentially in Q3. We expect a slowdown in power in Q4 but we view that this business has the potential for long-term growth. Now turning to the foundry business.

Foundry revenue in Q3 was $90.3 million, up 7.7% year over year and up 23.6% sequentially. The strong performance of the foundry business can be traced to especially strong demand from the computing and consumer segments. In addition, foundry products that had been in the early stages of production earlier in the year continued to ramp and we also saw a significant increase in demand for our BCD, EEPROM and high-voltage technologies. Now let me provide an update on the strategic evaluation process.

On behalf of the MagnaChip's management and board of directors, I am pleased to report that we continue to make substantial progress on our previously announced strategic evaluation process of the foundry business and Fab 4, including discussions with multiple interested parties toward a possible sale of the business, as well as consideration of accretive business conversions, joint ventures and partnerships. As stated previously, our decisions regarding the outcome of the various options of the strategic evaluation process will be guided by what the management and the board consider to be the best available path to improve MagnaChip's profitability and to maximize shareholder value. I want to thank the board for its substantial efforts and outstanding commitment to the company and our shareholders. Now I'd like to share my perspective on the current business environment and my longer-term outlook.

We got off to a slow start this year because of trade tensions that caused macro uncertainties and our industry wide inventory correction, but our business has rebounded nicely. As we said on our last call and as we reiterate now, we believe total revenue this year will show modest growth despite the slow start to the year. We achieved about $200 million worth of OLED revenue in the first nine months of the year, which is more than we had for the entire 2018 when we had $188 million. As in the past, we anticipate a seasonal drop off of OLED revenue in Q4, but we now anticipate it will be less severe in percentage terms than a year ago.

Taking the long view, the future looks bright for OLED. We know the leading smartphone makers in Korea and the U.S. have embraced OLED displays and now, we have new market research data that demonstrate that OLED adoption by smart China smartphone makers is on the rise. Based on proprietary data compiled by supply chain market research, OLED smartphones represented 13.6% of all smartphone models introduced by Chinese smartphone makers in 2017.

That number increased to 25% in 2018 and is expected to increase, again, to 46.8% in 2019. By 2025, supply chain market research estimates that 75.2% of all smartphone introduced in China by Chinese smartphone makers will have the OLED displays based on trend life analysis. Power revenue through the three quarters was about 82% of what we achieved all of last year. Power business will decline in Q4 as we are seeing seasonal softness in consumer and communication segments in our customer base.

However, we feel good about the longer-term picture for this under the radar business that has grown faster than the industry over the past two years. The foundry business will soften in Q4 due to seasonality. We have 100% of our IP and manufacturing in Korea. And this year, up to now, MagnaChip generated more than 90% of its revenue in Asia.

As a result, we feel fortunate to have a unique place in the Asia supply chain that we feel positions us well to capitalize on different kinds of business opportunities in Korea, China, and greater Asia. Now I'll turn the call over to Jonathan and come back for the Q&A. Jonathan?

Jonathan Kim -- Chief Financial Officer

Thank you YJ, and welcome to everyone on the call. Let's start with revenue for the two business segments and then move to a review of profitability, fab utilization, operating expenses and balance sheet items. Revenue in the standard products group, which includes display and power business lines was a record $139.2 million, up 14.1% year over year and up 5.5% sequentially from the previous record of $132 million in Q2. Display revenue was a record $90.6 million, up 16.7% year over year and up 7.5% from the previous record of $84.3 million in Q2 of this year.

The year-over-year increase was primarily attributable to an increase in revenue related to our mobile OLED display drivers due to the launch of new OLED smartphones by smartphone makers in Asia. This increase was offset in part by a strategic reduction of our lower margin LCD business. OLED revenue in Q3 represented 86.4% of our display business as compared to 75% in Q3 2018. Power revenue as noted earlier was $48.7 million, up 9.5% year over year and 2% quarter over quarter.

The year-over-year increase was due primarily to higher demand for premium power products such as high-end MOSFETs, primarily for TV and industrial applications. Foundry services group revenue was $90.3 million, up 7.7% year over year and up 23.6% from Q2 of this year. The increase was primarily attributable to an increase in demand from the computing and communication segments. The standard products group represented 60.6% of total revenue, up from 59.2% in Q3 a year ago and down from 64.3% in Q2 of this year.

Display was 39.4% of total revenue in Q3, up from 37.7% a year ago and down from 41.1% in Q2 2019. Power was 21.2% of total revenue, about flat with 21.6% in Q3 a year ago and down from 23.3% in Q2 2019. The foundry services group represented 39.3% of total revenue, down from 40.7% in Q3 a year ago and up from 35.6% in Q2 2019. Let's now recap profitability metrics in Q3.

We believe gross profit is an important financial metric to monitor because of the potential flow through to operating income, adjusted EBITDA and cash flows. Total gross profit was $60.9 million, up 9.2% year over year and 38.8% quarter over quarter. Operating income was $25.9 million, up 41.9% year over year and up nearly threefold quarter over quarter. Adjusted EBITDA was $35.5 million, up 27.2% year over year and up 108.6% quarter over quarter.

And operating cash flows of $12.9 million, up nearly threefold year over year but down 55.4% quarter over quarter, due primarily to our semiannual interest payment of debt and as well as timing of certain payments. Total gross profit margin of 26.5% was down from 27.1% a year ago and up from 21.4% in Q2 of 2019. The improvement in total gross profit and gross profit margin in Q3 versus Q2 was due primarily to an increase in fab utilization and better-than-expected revenue in the foundry business. Fab utilization in Q3 was in the low 90% range as compared to the low 80% range in Q2 and compared to the high 80% range in Q3 of 2018.

We currently expect that fab utilization will decrease in Q4 primarily due to an anticipated seasonal softness in foundry and power. Now let's look at gross profit margin by segment. Gross profit from our standard products group segment was $35.2 million or about flat, compared to $35.2 million in Q3 2018 and up 11.5% from $31.6 million in Q2 of this year. Gross profit margin in standard products group was 25.3% down, compared to 28.8% in Q3 a year ago and up from 23.9% in Q2 of this year.

The year-over-year decline in gross margin was primarily attributable to lower manufacturing yields of a newly introduced mobile display product during its initial stages of production from an external supplier. The company has already seen improvements in yields in Q4. Gross profit from our foundry services group segment was $25.5 million, up 25% from $20.4 million in Q3 2018 and up nearly 110% from gross profit of $12.2 million in Q2 of this year. Gross profit margin in foundry was 28.3% versus 24.4% in Q3 a year ago and 16.7% in Q2 of this year.

Gross profit and gross profit margin improved sequentially due primarily to higher fab utilization and a favorable product mix. Turning now to operating expenses in Q3. SG&A was $15.8 million or 7.3% of revenue as compared to $18.6 million or 9% of revenue in Q3 a year ago and was down slightly from $17 million or 8.3% of revenue in Q2 of this year. The decrease was primarily attributable to the timing of equity-based compensation that will cause SG&A to increase in Q4.

SG&A in the second half of 2019 will be about flattish with what we reported for the first half of this year. R&D was $17.4 million or 7.6% of revenue, compared to $18.9 million or 9.2% of revenue in Q3 a year ago and down 8.5% from $19 million or 9.3% of revenue in Q2 of this year. The year-over-year decrease was primarily attributable to the timing of certain employee incentives and decrease in outside service fees and various overhead expenses. Operating expenses, excluding special charges in 2019 are expected to be slightly lower than 2018 as we continue to focus on cost control.

Turning now to the balance sheet. Cash was $131.3 million at the end of Q3 as compared to $123.8 million at the end of Q2 due primarily to an increase in gross profit dollars. We generated net operating cash flow of $12.9 million in Q3, marking the second consecutive quarter of net positive operating cash flow. We generated $17.2 million in net operating cash flow in the first half of 2019.

Our current expectation is that we will have positive operating cash flow for the 2019 year, which will likely be the highest we generated in the last five years. Accounts receivable totaled $106.3 million, an increase of 9.8% from $96.8 million in Q2 of this year. The increase in accounts receivable in Q3 was attributable to the timing of payments from certain customers. Virtually all of our accounts receivable are current.

Inventories totaled $72.7 million, up 8.2% from $67.2 million in Q2 of this year, primarily due to higher revenue, particularly of OLED display drivers. CAPEX was $1.7 million in Q3 as compared to $3.8 million in Q2 and $11.2 million in Q1 of 2019. CAPEX in 2019 is expected to be significantly lower than the normalized CAPEX expenditures made in 2018, which was approximately $29 million. With that, please refer to our third-quarter earnings release for our guidance for Q4, which is available on our website under the Investor Relations tab.

I'll now turn the call back to Bruce. Bruce?

Bruce Entin -- Head of Investor Relations

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

Questions & Answers:

Operator

[Operator instructions] Our first question comes from Raji Gill.

Raji Gill -- Analyst

Thank you, and congrats on really good results in light of this uncertain environment. YJ, I wanted to see if you could maybe elaborate a little bit on the foundry sale. Could you maybe discuss what has kind of changed incrementally from your discussions say at the beginning of the year versus now in terms of potential interest? And you had also mentioned that you and the management and the board would evaluate a variety of options and would determine what is the best outcome. Can you elaborate on kind of what metrics or kind of how you are going to frame that in terms of whether -- you to decide which exit strategy you are going to have for the fab business?

YJ Kim -- Chief Executive Officer

Yes, a very good question. So the management and the board are clearly looking at the venue where to maximize shareholder value. As we laid it out, we're looking at range of options from a potential sale to joint venture, to any accretive measure in partnership to maximize shareholder value. So we are very consistent on that front but beyond that, I cannot disclose anything like timeline and so forth.

Raji Gill -- Analyst

But are you still committed to the end of the year, I think, is what you had said at the beginning of the year that there would be some sort of strategic action on that fab?

YJ Kim -- Chief Executive Officer

If you go back to our February announcement to last announcement now, we have not put any timeline on it. So we are continuing this path and we understand where we are coming from and we haven't set a time line.

Raji Gill -- Analyst

And in terms of the business, the improvement -- significant improvement in the gross margins because of the higher utilization rates. Can you talk a little bit about the recovery that you are seeing in foundry? You talked about computing and consumer, I would imagine a lot of those end products are going into China. Is there any thoughts about what's happening in China in terms of those end products and recovery that's going on there?

YJ Kim -- Chief Executive Officer

Yes. So I think your question was on the foundry. Right?

Raji Gill -- Analyst

Yes, the foundry, which is -- which I believe a large percentage of it is going into China.

YJ Kim -- Chief Executive Officer

So if you look at us as a company, about 95% of the business is outside U.S. and today, we said about 90% of the business is in Asia. If you ask for exactly on the China, about 50% of those 90% of business is in the greater China for us. Going back to the consumer and computing segment uptick we saw in the foundry, some of the product we started production starting early this year.

We saw a ramp up in Q2 and we continue to see the ramp-up in Q3. Some of the communications, we had very good product launches and demand in China that created additional revenue upside in Q3 and those were the -- some of the next level details.

Raji Gill -- Analyst

And on the OLED traction, which has been growing really well, you talked about maybe a little bit less seasonal kind of change in Q4 than initially that you had in last year. What's the cause for the OLED being less seasonal in Q4 this year versus last year? And the attach rates that you are seeing on OLED going into next year, can you talk a little bit about kind of what design they are for, are they more of your flexible high-end designs? Are they across the board? And how are you competitively positioned there?

YJ Kim -- Chief Executive Officer

Yes. Thanks for the question and there were multiple questions, so let me try to answer that. So on the question of why we see a better slope on the fourth quarters than last year is one of the key indicators as you know is number of design wins. Last Q3 of 2018, we had six design wins.

If you look at the design wins we just announced for the Q3 is 11. So 11 is much higher and that carries a some momentum going through some of the revenue for the Q3. While we had record revenue in the Q3 last year, Q2 was slightly higher than Q3 and that carries into momentum into fourth quarter of this year. So I think that's one way to look at it for that.

In terms of the market research done by supply chain management, they are estimating about roughly 46% of the new product introduction from Chinese smartphone makers is OLED this year. So obviously, the momentum in China also on the OLED is growing, and so we are seeing similar trend there. As far as our products concern for the next year, I think we mentioned that this year 40-nanometer was most majority. Next year, we expect the 28-nanometer to become mainstream products.

What that means is that we expect much of the design win activity will be based on the new -- current and new 28-nanometer offering going into 2020. And we will have full free offering of the chip on glass, chip on plastic, which is for the flexible OLED, as well as a one-layer COF, which is for the rigid and then two-layer COF for the high-end flexible. So we'll have a very good portfolio going into next year. And we also said this year, by end of this year, I expect about dozen product portfolio.

This is quite significant. If you look at last year, end of the 2018, I had six products lineup, variety of different products going into 2019. So I think we are well-positioned getting into 2020.

Raji Gill -- Analyst

Great. Thank you.

Operator

Our next question comes from Suji Desilva with ROTH Capital. You may proceed with your question.

Suji Desilva -- ROTH Capital Partners -- Analyst

Can you talk about the metrics like revenue per wafer. Are those improving with the customer mix here? The utilization seems pretty similar to prior peaks. So I'm wondering if you are shifting mix toward higher-value customers in foundry?

Jonathan Kim -- Chief Financial Officer

You are cutting out there. Can you repeat your question again?

Suji Desilva -- ROTH Capital Partners -- Analyst

Sure. It was about the foundry and whether the wafer mix has been improving because you had record revenues here with similar utilization to past peaks?

Jonathan Kim -- Chief Financial Officer

Sure. Yes. So the product mix did improve. And as we mentioned on our prepared remarks, the better-than-expected gross margin was primarily related to our better-than-expected revenues on the foundry side, which increased the utilization, as well as better product mix.

So those were the two factors that were driving the better-than-expected gross margin.

Suji Desilva -- ROTH Capital Partners -- Analyst

OK. And then on the OLED side, the 28-nanometer products as those start to ramp into volume, do expect share gains here? Is there an ASP uplift that you have with those newer products versus the 40-nanometer product line?

YJ Kim -- Chief Executive Officer

That's a very fair question. So our 28-nanometer offers the best power consumption in the industry today. And what our 28-nanometer brings to the table is that you see the foldable started to take off, although it's in embryonic stage. So market research data showing that the analysts are expecting to raise the shipment next year on the foldable phones.

So things like that will really determine that the lowest power consumption is very important attribute. In terms of going into the ASP side, the ASP is going to be determined by not whether it's 40 or 28-nanometer, but the feature of the display driver, is this the QHD driver, is this the 21 by 9, does it have PCOP or two layers COF packaging. So those are the more attributes to determine ASPs.

Suji Desilva -- ROTH Capital Partners -- Analyst

OK. And then my last question is on the manufacturing for the OLED and the gross margin. When do you expect the wafer yield from that new supplier to hit production? It will take several quarters? Or will it come in fairly quickly you think? Any thoughts there would be helpful.

YJ Kim -- Chief Executive Officer

Yes. So that's very good question. As you know, the 28-nanometer is a state-of-art OLED process technology available. We are the first one as a independent supplier going into production.

In fact, we started producing in the third quarter and now, in the first months into the fourth quarter, our yield is very good now. So we feel comfortable from this quarter that the 28-nanometer is back into the range that we are expecting in terms of yield. So I like to thank my team who has gone to our foundries and developing this process over the last 18 months and bringing it to production. But I can tell you that the 28-nanometer OLED process is not available, we've done it with the foundry.

We now made it full production ready.

Suji Desilva -- ROTH Capital Partners -- Analyst

OK. Congrats on the progress.

YJ Kim -- Chief Executive Officer

Thanks.

Operator

[Operator instructions] And I'm not showing any further questions at this time. I would now like to turn the call back over to Bruce Entin for any further remarks.

Bruce Entin -- Head of Investor Relations

OK. Thank you, Josh. So this concludes our third-quarter 2019 earnings conference call. Please look for details of our future events on MagnaChip's Investor Relations website.

Thanks for joining us today.

Operator

[Operator signoff]

Duration: 37 minutes

Call participants:

Bruce Entin -- Head of Investor Relations

YJ Kim -- Chief Executive Officer

Jonathan Kim -- Chief Financial Officer

Raji Gill -- Analyst

Suji Desilva -- ROTH Capital Partners -- Analyst

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