Magnachip Semiconductor Corporation

Thank you, Vanessa. Good afternoon, and thank you for joining us for MagnaChip's Third Quarter 2012 Earnings Conference Call.

A copy of the press release, issued today, is available on our Investor Relations website. A 72-hour telephone replay will be available shortly after today's call, and this webcast will be archived on the company website for 1 year.

Access information is provided in today's press release.

Joining us today are Sang Park, MagnaChip Chairman and CEO; and Margaret Sakai, Executive Vice President and Chief Financial Officer. Sang will begin the call with an overview of our third quarter business, including segment highlights and Margaret will discuss our Q3 financial results.

Following Margaret's financial discussion, Sang will discuss our fourth quarter guidance, after which, we will open the call for questions.

During the course of this conference call, we may make forward-looking statements about MagnaChip's business outlook, including statements regarding our expectations for revenue, target growth and operating margins, as well as cost savings for 2012 and beyond.

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 on today's press release.

During the call, we will also discuss non-GAAP financial measures. The non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles.

A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in today's press release.

I would now like to turn the call over to Sang Park for a review of our third quarter business. Sang?

Thank you, Robert. I'm very pleased that we delivered third quarter revenue of $221.9 million and record gross margin of $76.4 million or 34.5% of revenue.

This is the seventh consecutive quarter that we have met or exceeded our financial guidance.

Q3 revenue grew 9.5% sequentially, making MagnaChip one of the top performer in our industry again this quarter. We saw strong demand from smartphone and tablet PC customers, which are continuing in spite of growing macro weakness.

The smartphone and tablet PC demand is well diversified with MagnaChip supplying about 50 unit products to 26 different customers. Our Q3 revenue increased 10.7% from the same quarter last year, which reflects our successful alignment shift to new fast-growing markets and customers.

Looking ahead at fourth quarter, our revenue guidance midpoint of 21% over year-over-year growth will put us at the top end of semiconductor group once again, continuing our strong operating performance. We are achieving this result during the period of weak demand from markets, such as our computing and consumer electronics, due to global economic uncertainties.

We expect potential upside when these non-mobile application customers return back to normalized demand in the future.

In addition to strong revenue growth, our Q3 gross margin was up 350 basis points sequentially, and up 630 basis points since Q1 2012 due to higher fab utilization and improved product mix shift. We project that our product mix and customer portfolio shift will continue to enhance our gross margin going forward given similar fab utilization rate.

Looking ahead, we are confident that our midterm business model can be achieved as we have projected.

Now let me discuss the highlights of our 3 business segments. For our Power Solutions segment, third quarter revenue was $33.8 million, up less than 1% sequentially, but up 28.4% year-over-year.

While computing-related demand going through macro slowdown, we are seeing growth in mobile application, as well as our industrial business, especially in Korea and China, with our high-power modules.

In spite of soft demand in computing sector in Taiwan, we are gaining market share as we broaden our product offerings. In Korea, our Power Solutions market share continued to expand, driven by design-ins and design wins at Samsung and LG for LED TV backlighting solutions.

We have also expanded our customer base in China with our new hybrid LED driver that combines with a high-voltage MOSFET and LED driver into one package, reducing the IC footprint by as much as 50%. The total number of power products we now offer has increased 90% from this time last year.

In mobile applications, we are ramping battery and charger design wins with a discrete MOSFET for use with the new AMOLED smartphones. We are also expanding our product portfolio from discrete MOSFETs with a new design-ins of higher margin premium products, such as DC-DC converters for AMOLED displays.

Our new product development pipeline shows that approximately 80% of our projects are for premium power products, such as the Power Management IC and power modules and Super Junction MOSFET, up from 70% last quarter. This is a 130% increase from where we were this time last year.

We delivered the first working sample of our Super Junction MOSFET to customers and expect that it will contribute to revenues starting next year. We expect these and other new power products will contribute to our future growth.

For our Display Solutions segment, revenue was $69.4 million for the third quarter, down 9.6% sequentially and down 24.4% year-over-year. The weakness in this segment has been due to relatively slow computing LCD panel market and the general market weakness in Japan.

As a part of our planned product shift strategy to higher margin products, we are gradually decreasing some of our low margin driver business.

In spite of general slowdown in the large panel LCD display segment, our new design activities in AMOLED market have quickly expanded. We have design wins at major Korean maker for their new AMOLED smartphones and design-ins for next flagship smartphone.

The number of AMOLED project is up 200% from where it was in Q3 of last year.

Looking at core of our display business, our relationship with the LG display and Samsung have continued to be -- remain strong.

And for our Semiconductor Manufacturing Service Foundry segment, third quarter revenue was $118 million, up 29.2% sequentially and up 44% -- 44.6% year-over-year. Beginning in March of this year, we experienced a significant wafer loading increase due to ramping up of smartphone and tablet PC-related application, with more than 30 products being shipped.

Foundry revenue from our U.S. and Europe customers exceeded more than half of our overall Foundry business this quarter.

This geography has grown largely as a result of expanding base of smartphone and tablet-related applications. And we expect this demand will continue to be strong in Q4.

The design-in pipeline for new smartphone and tablet PC applications continued to grow, with a 70% increase in 2012 compared to same period last year. We expect this design activity will contribute to the revenue growth in 2013.

Also, our customer pipeline for the premium products such as EEPROM BCD has been very strong, with a number of new customers increasing by approximately 1.5x this quarter compared to the Q3 of last year. We are continuously expanding our technology offerings to meet ongoing needs of our customers for better analog technology performance.

These enhanced technologies include our new offering of 0.13-micron low noise mixed signal process. This new process enhance the operation of high-quality audio products for the smartphone applications.

We are also offering MTP, multi-time programming solution in 0.35-micron BCD, supporting advanced power management IC, which require multi-programming and analog trimming for the next generation mobile applications.

During the quarter, we also announced an enhanced 0.18-micron embedded EEPROM process that integrates a 20-volts high voltage transistor option to improve SNR, signal-to-noise ratio performance for touch control ICs. We believe that our Foundry business is well positioned for the continued growth.

Now Margaret will discuss our financial highlights. Margaret?

Thank you, Sang. Let me provide some financial highlights and a brief review of our statement of operations.

Third quarter was a very good quarter for MagnaChip. Revenue of $221.9 million was above the midpoint of our guidance range, and the gross margin of 34.5% was 150 basis points higher than the top end of our guidance.

Revenue growth was 9.5% quarter-over-quarter. This was driven by our Semiconductor Manufacturing Services Foundry segments due to a combination of our continued effort to improve product mix with higher ASP products and our targeted shift to U.S.

and the European fabless and the fab-like customers. Gross margin of $76.4 million was the highest in our history and the gross margin of 34.5% of revenue was 350 basis points higher than the prior quarter.

90% factory loading imports, the current and the prior quarter; significant product ramp up of premium and the higher ASP products, which was a result of our strong pipeline of new design-ins; and our ongoing lean manufacturing cost management.

GAAP net income for the third quarter was $48.4 million or $1.30 per diluted share, while non-GAAP or adjusted earnings per share was $30.4 million or $0.81. Our adjusted earnings per share this quarter improved, as a result of a higher gross margin and our lower operating expense to revenue ratio.

During the third quarter, we repurchased 444,000 shares of our common stock for an aggregate total of $6 million under our common stock repurchase program initially announced in October 2011.

Now turning to our statement of operations. Revenue for the third quarter was $221.9 million for an increase of 9.5% sequentially, and an increase of 10.7% year-over-year.

Revenue by business segment for the third quarter was $118 million for Foundry services, $69.4 million for Display Solutions and $33.8 million for Power Solutions.

Our Foundry services segment delivered the highest quarterly revenue in our history. Gross margin reached $76.4 million this quarter, the highest dollar amount in the company's history.

Gross margin was up 350 basis points, compared to the prior quarter and represented 34.5% as a percent of revenue.

Total operating expense for the third quarter was $40.9 million or 18.4% of revenue, compared to 19.7% of revenue for the prior quarter. Operating income was $35.6 million or 16% of revenue, compared to 11.4% of revenue for the prior quarter.

Net interest expense was $5.7 million in line with last quarter.

GAAP net income for the third quarter was $48.4 million or $1.30 per diluted share. This compares to $4.3 million or $0.12 per diluted share for the second quarter.

GAAP net income was primarily impacted by foreign currency translation gain of $21.8 million in the current quarter, compared to translation losses of $10.6 million in the prior quarter.

Depreciation was $6.3 million and amortization was $2.2 million for the third quarter. Adjusted net income, a non-GAAP measurement, for the third quarter was $30.4 million or $0.81 per diluted share, compared to $17.9 million or $0.48 per diluted share for the second quarter of 2012.

Turning to the balance sheet. Total combined cash balance, cash and cash equivalents, plus restricted cash, was $165.8 million at the end of the third quarter, compared to $161 million at the end of the second quarter.

Cash provided from operations for the third quarter totaled approximately $23 million. This compares to $26.7 million for the prior quarter.

Accounts receivable net of reserves was $148.5 million, compared to $135.1 million last quarter. Days of sales outstanding was 62, up from 61 last quarter, and within our target range of between 55 to 65 days.

Net inventory was $75 million or 47 days of inventory, which was down from 49 last quarter and, again, within our target range of 40 to 50 days.

Capital expenditure was $10.2 million in the third quarter and $57.5 million year-to-date. We expect total CapEx for this year will be in the range of $60 million to $65 million, which includes maintenance CapEx.

Now let me turn the call over to Sang for our fourth quarter guidance.

Thank you, Margaret. For our Q4 guidance, when we look at customer forecast, current booking activity and backlog, we expect our revenue will be in the range of $213 million to $222 million.

Based on this revenue level and our current wafer loading, we anticipate our gross margin will be in the range of 33.5% to 34.5%.

So Vanessa, this concludes our prepared remarks. We will now open the call for questions.

A couple of questions. Perhaps if I start off with regard to a question regarding the loading and seasonality comment you made.

Obviously, in the Foundry business, given that it's tied to very large distinct product cycles, that could be a lumpy business. I was wondering if you could help us understand your expectations for normal seasonality of that business heading into the first quarter.

It seems to me that Foundry may be holding up a little bit stronger than I had personally expected for the fourth quarter. So again, wanting to understand the shape of that business into the first quarter, do you have any view of where, perhaps, revenue or loadings could go into first quarter, which I would assume would be a seasonal low for that business?

Okay, Terence. Obviously, we don't provide guidance for the Q1.

But definitely, we can give you the status of what's going on, on wafer loadings. Smartphone and tablet-related Foundry business continues to be strong.

Non-mobile application is a little soft. So I'd expect throughout the Q4 and Foundry-related loading will be slightly down, but probably better than our historical seasonality.

Okay, terrific. The second question I had was on gross margin.

Specifically around your comments around display, saying, I think you said that AMOLED-related revenue was up, obviously, significantly year-on-year; yet, on the other hand, you're attempting to deemphasize some portions of commodity display. As you go through that process and perhaps deemphasize display, is it possible that actually gross margin improves in that business heading into 2013, despite having lower revenue levels?

It's not only display as a whole. Obviously, a couple of products that we're providing wafer service and has been one of the lowest margin product, and that's the one with a mutual agreement with the customer we're slowly decreasing.

So definitely, year 2013, providing the same wafer fab utilization rate, I expect gross margin will improve.

I guess first question on gross margin. A great number here, and a very nice guide.

I'm just curious. It looks like Foundry is running ahead of kind of the peak number you're talking about, around 41%.

And I'm curious, is there something structurally changed there other than running a very high utilization? Meaning, is there customer concentration issues here?

Is there other benefits that we should be thinking about that had structurally shifted the gross margin for your Foundry business, incrementally higher from where you were targeting just 12 months ago?

C.J., this is exactly what we've been talking about for last few quarters. As we're shifting customer portfolio, as we're shifting our product and gross margin will improve.

And we give you enough, the head up. And this revenue from Foundry, it's not 1 or 2 customers, it's about 27 -- 26 customers and with more than 50 products -- almost 50 products.

And so, it's a very well diversified. Of course, that Cirrus Logic is one of the largest customer.

But overall, we're into mixed-signal of Foundry business. At the same time, touch is ramping up.

And also, the RF switch business we do with Peregrine has a very, very strong growth. All those add up to a very well diversified and healthy Foundry business.

That's helpful. And I know you guys don't guide to March, but I guess the natural question here is, what kind of visibility do you have today?

And based on that, how do you plan to manage your loadings into November, December?

November, December is, historically, it's a slow month. And I'm sure that we see some of the trend because of non-mobile application demand.

But still, our smartphone and tablet-related demand is continuously strong.

A couple of questions, again, related to display. Well, actually, what I was wondering is, when I look at your revenues, obviously, you had an expected slowdown.

Is that due to this -- solely to this product pruning you talked about and also the fact that your largest Japanese customer is clearly struggling? Or did we see any changes in your estimated market share on the tablet display side, basically, for one of your Korean customers?

And I've got a couple of follow-ups.

Are you talking about display in general? Or are you talking about our customers?

I'm talking about the Display segment in general for you, basically. So minus 9.6% Q-over-Q you've got, related to the pruning you talked about, plus Japan specifically, or is there -- are there any changes in your market share into tablets, PCs -- Fu, of course, one of your Korean customers.

Obviously, our display customers, they have a reasonably good quarter and TV market is a so-so and notebook-related is really not strong. That's where we're hurting our revenue.

And their tablet business is strong. We don't do a whole lot of tablet smart-related business with those 2 Korean customers.

That's one of the reason that our revenue is a little bit declining. But yes, we are very strongly involved in AMOLED.

And that's going to continuously help -- that's going to help us next quarter, too. Did I answer your question?

Yes, pretty much. I think that makes sense.

Now you led me to my follow-up actually or my first follow-up. I've got another one after it.

But on the AMOLED side, do I take the comment you just made as an indication you would expect your AMOLED-related business to be up sequentially into the fourth quarter?

Yes. And also I can answer your question about Japan.

Obviously, it's just sad to see that Japan market is declining continuously. And we don't have a significant revenue anymore from our Japan market.

We do have some, but it's getting smaller. So that's another reason that's impacting our, overall, the revenue for our Display side.

Okay. Oh well, I guess we should take this as de-risking, which is, I think, positive.

And my last question is going back to your gross margin performance and once again, congratulations on that. As you said, that just is coming to fruition after laying of the plan a while back.

Are we seeing, at this point, the Power gross margins crossing over with Displays considering the trajectory you laid out? So I understand Foundry is a big part of this gross margin performance, but do we see now the Power segment being higher gross margin than Display?

Actually, this quarter, Q3, our Power gross margin is not as strong as we anticipated. One of the reason is because we're expanding this high-power -- the module business.

And I believe that will produce some good profit in the future. We do have a lot of the related cost goes to initial -- the business that we're getting into this market.

So therefore, I think that Power margin achieving what we project is definitely going to help our company-wide gross margin as well.

I have to ask what you see the product mix should be in terms of the 3 segments next -- for the next quarter?

Are you talking about revenue, Jay?

I mean, which segment do you expect to be up, which down? Just give us a little bit of color on how the mix will be.

I got it. Our Display business will be flat or slightly up.

And our Power business will be flat or slightly down. I emphasize slightly.

And our Foundry business will be flat or maybe slightly down. So that's one of the reason that we have pretty reasonably strong guidance into Q4.

Okay. In terms of the Power business, I know things are a little weak in the notebook side, but in terms of just the competitive landscape, are you sensing that you're gaining some market share in that business?

Or do you feel that the price pressure is pretty aggressive there, that it's preempting any market share gains?

Actually month-to-month and quarter-to-quarter, our resale increased, which means that, obviously, we're winning more market share and it is the distributors taking very conservative positions. And that's one of the reason that we think that Q2, Q3, Q4, a little slowdown, but expect that a strong Q1 getting back to and inventory gets to minimum level.

Real growth driver for the Power is coming from non-MOSFET business, such as TV backlighting and our high-power modules. And we just shipped the Super Junction, for example, and customer give us very a positive feedback.

All these [indiscernible] are non-MOSFET and premium product and will lead us to additional growth next year. And eventually that's going to help us, our gross margin as well.

Okay. Can you give us some update on how the IGBT stuff is doing, following the acquisition?

Are you seeing any meaningful contribution from that? Or do you expect it to be a little further out?

If you're talking about IGBT module or I call high-power module, the acquisition we have done, that win is contributing around 10% of Power. I think that, that business is -- really has real good potential getting into so-called global customers.

So we're expecting next year will be a good growth.

Okay. On the semicon Foundry side, I know Samsung and the fruit company are both launching a lot of new products heading towards Christmas.

I guess I'm trying to reconcile where you see the Foundry flatness or slowdown potentially. I mean, it looks like they seem to be launching new products towards the Christmas season, which would indicate to us that there is potentially some ramp up in some of that business.

Where is the slowdown coming from?

Well, we have a limited visibility, obviously. The whole -- the supply chain from us to Samsung maybe about 5 months through the layers.

And therefore, whatever business in 5 months from now, and we still see strong the wafer loading. So probably customers looking as a healthy business in a couple of quarters.

Okay. Looking ahead to 2013, as you know, the overall semiconductor industry, especially the manufacturing in device has been very weak and yet, you seem to be delivering pretty good numbers.

What are some of the risks as you look at the business into 2013? And how do you hope to alleviate some of that risk as you look ahead to some of the strategies as you execute into 2013?

Obviously, our strategy is, we go and bring new product to the customers and broadening our product portfolio and aligning with the high-growth market and customers. That's been exactly how we're doing it.

I think we will be okay next year.

Thank you, Vanessa. Our next earnings release and conference call is scheduled for January 30, 2013.

So please look for details for this and other upcoming financial events on MagnaChip's Investor Relations website at www.magnachip.com. Thank you for joining us today.