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MagnaChip Semiconductor Corporation (NYSE:MX)

Citi Global Technology Conference Call

September 10, 2013 11:50 am ET

Executives

Sang Park – Chairman and Chief Executive Officer

YJ Kim – Executive Vice President and General Manager-Display Solutions Division

Unidentified Analyst

Good morning, everyone, we’re going to keep on schedule and move onto our next presenter. We have MagnaChip here both Sang Park, the Chairman and CEO as well as YJ Kim, who is the GM of their Display Solution Business. Sang is going to come over and do a brief presentation summarizing the Company and then we’ll move into Q&A after that. So with that, let me pass it over to Sang.

Sang Park

Thanks you, Ross [ph]. MagnaChip is an analog and mixed-signal semiconductor company. Through our foundry, power and display solutions division, we service both directly and indirectly to global leaders in smartphone, tablet PCs, LED TV, notebook, PCs and other electronic product. Our broad exposure to diversified end-market act as a stable revenue generator and provide continued opportunity for year-over-year growth.

The consumer electronics market changes quickly driven by new killer applications. This is a competitive advantage for MagnaChip. We are adaptable and quick, killer applications are being introduced at a rapid pace and MagnaChip adapt to change quickly. For example, our business, at the top two smartphone and tablet makers, it has grown from 19% of total revenue in 2010 to 46% in 2012 driven by 105 different products at 30 unit customers. We have a strong relationship and the linkage with the key blue chip customers. Asia is where most of world’s consumer electronics are built and because we are located in Korea, we are critically and geographically aligned with our customers.

We have a mixed business model, which provide manufacturing flexibility. We can produce multiple product in any of our three wafer fabs because they share a common technology platform. This gives us the cost advantage over our peers and rapid new product ramp capabilities. Because of these factors we are self sitting in smartphone and tablet PC market. However our success doesn’t stop there. We are preparing for the future growth by diversifying new market which include industrial energy and automotive.

Over the last four years from 2009 to 2012, MagnaChip’s revenue grew 14% annually on average while industry grew 9%. We did it because our expanding Power business and alignment with our fast growing markets, smartphone and tablet PCs. We started our Power business four years ago and it quickly grow into $125 million in revenue or 15% of total revenue in 2012.

As it became clear that smartphone and tablet PC applications were becoming the new killer applications, we quickly shifted our focus to this expanding market. From 2010 to 2012, revenue from this market grew 340%. Smartphone and tablet grew from 7% to 28% of MagnaChip’s total revenue. The number of product increased from 15% to 79% and number of customers increased from 10% to 26%.

We believe that smartphone market can continuously expand by adding mid-to-low end smartphone offerings. Currently we support seven phone makers and their nine models with our various MagnaChip product for the mid and low-end market and we are winning more sockets and new customers.

Typically, average sales price decline every year and semiconductor company respond by increasing CapEx spending to try to improve the average revenue per wafer. However, MagnaChip has been able to increase the revenue per wafer by 6% annually on average the last three years through product and target market shift without raising CapEx beyond our target $60 million budget. Looking ahead, we have a lot of room to continue to improve our average revenue per wafer compared to our analog peers.

Our Power business grew to $125 million in 2012 from $30 million in just three years. Our strategy for the Power Solutions is global account penetration targeting emerging markets and the premium product development.

In 2008 we first engaged with Samsung and from then we continued our global customer penetration with the companies such as LG, Compal, Quanta, TCL and Hisense in China. We are also expanding our customer base into global industrial accounts like Delta and Emerson. Not only have we expanded the customer pipeline, but also our target applications have expanded from TVs and multiple PCs to mobile, lighting and the industrial applications. Along with our targeted market expansion, we have executed new product development programs to enhance our broad product portfolio.

Our newly introduced Super Junction MOSFET is doing well, accepted by customers and we believe that it can begin to generate significant revenue from third quarter of this year. We initially entered to the power market with MOSFET and quickly expanded our range of solutions to the power-management ICs, power modules and high-power discrete as well as a Super Junction MOSFET product. Because of this quick product development execution, we offer 33 times more product in 2012 compared to 2008.

Our strategy for the Display Solutions is described as a focused customer with a focus on emerging markets. We are focused on top two panel makers who owns the 51% of market. Our cultural similarity as well as geographic proximity have helped us developing long-time customer relationships. Display Solutions has been a stable revenue generator while also providing a bridge from other standard product to the top two LCD makers, Samsung and LGD.

Even though the display market has been relatively flat or stable, we do have several growth drivers. For example, AMOLED for the smartphone and tablet PC has been a growth area for us. We are now designed into a main platform as the number one smartphone maker. As this customer begin to expand our AMOLED production capacity next year we expect that our AMOLED display revenue will grow as well.

The UHD and OLED TV markets are just starting to develop. We believe these can help drive additional upside into next year because they use two to four times more display driver chips for each TV set. We are also introducing our new product category we call sensor IC. These products are being developed at the request of our customers. The first product in the development are smart hall sensor and e-Compass.

Even in the weak macroeconomy our foundry service grew 15% and outperformed both total semiconductor market, which declined 2% and our direct foundry peers who grew 11%. Now how are we going to be able to do that? We did this by focusing on fast growing smartphone and tablet PC markets.

Our team executed quickly and grew this targeted business over three times from 2011 to 2012. We also diversified the business across 16 customers and 45 product with the three major application market that include touch IC, audio IC and RF switch. By continuing to enhance our customer mix shift, our U.S. and European customer revenue has increased from 33% to 48% of our foundry revenue in 2012. This helped us to expand gross margin and revenue per wafer.

We expect to add new U.S. European customer this year and continuously expand our presence in U.S. and Europe. We also identified key emerging growth driver for the future growth and they’re including biometric ICs for the smartphone applications, LED lighting and energy harvesting for the green energy applications and various product for the automotive applications.

Since 2009, we achieved the margin improvement by growing revenue maintaining a high fab utilization rate and managing strict cost control. For revenue 2012 our revenue increased by 6% compared to 2011 which was higher than the overall semi decline of 2% during the slower economy market.

For the gross margin the increase in revenue contribute to the higher gross margin, 32.2% of gross margin for the 2012 was the highest annual growth margin MagnaChip ever achieved. And was 190 basis point improvement over 2011.

Our gross margin improvement was the result of our mixed business model, expansion of product and market and higher than industry average fab utilization rate and the very strict cost control.

For the OpEx, we have carefully managed our operating expenses during this period of growth and will continue to do so. Going forward, we expect to keep our operating expense between 18% and 19% of revenue. In 2012, total operating expense including $3.3 million one-time charges was 18.8% of revenue, which was the same as 2011 despite revenue increased 6% in 2012.

This slide summarizes our midterm business model with anticipated revenue growth and normal fab utilization. Midterm for us is about three years. Gross margin target is 35% to 38% of revenue. We’ll keep the operating expense at 18% to 19% of revenue or lower. We expect the CapEx between $55 million to $65 million per year including maintenance CapEx of $5 million to $10 million. We now expect our cash tax expense will be between $5 million to $10 million per year. However, we believe our NOL balance will fully utilize by December 2014.

In summary, we believe that we are able to deliver 1% or 2% gross margin improvement every year with a 5% to 15% revenue increase every year assuming normal fab utilization, that's the end of our presentation. Ross?

Unidentified Analyst

Great thanks Sang. Why don't we start off just talking a little bit about how you guys have executed in the last year. You’ve talked about your smartphone and tablet customer base expanding as a percentage of your sales quite nicely and there is obviously two very large producers in that space that are meaningful end customers in both Apple and Samsung. Most companies in your sector in the semi sector have not been able to make it through that the back-to-back inventory adjustments as well as MagnaChip has, talk a little bit about how you're able to pull that off?

Sang Park

I guess that we diversified with more than 70 products and 26 customers really helped us. And also the first half of this year revenue from smartphone and tablet PC still growing, but it is less than 35% of our company total revenue. That also helped us to manage those inventory corrections.

Unidentified Analyst

How are you viewing the state of the industry heading into the back half of this year, in the last two second halves in 2011 and 2012, unfortunately we had some rather pronounced slowdown, how are you seeing the second half of this year as compared to what we’ve seen in the last two.

Sang Park

This market is strictly relate to the new product introductions. So waited to make the announcement today that is going to have a huge impact to the supply chain. So again it is really up to end-users. I believe that it is going to be a slow little bit second, fourth quarter into first quarter, but again growing again from the second quarter of next year.

Unidentified Analyst

How about the supply side of the equation, it’s a little bit different in the markets you play into it, but as far as kind of general distribution inventory, but nonetheless, we’ve had some relatively large inventory adjustments within the cell phone space as a whole, do you believe that those are now behind us and more specifically do you believe they are behind MagnaChip?

Sang Park

It’s really up to whether they diversified or they may have only few sockets. So consumer market applications, it’s moving fast and a lot of synclinal ups and downs. The only way you can survive in this market and still continuously doing well is again diversifying. Now what we do is we are winning the more socket of course in the high-end, but at the mid to low end, we have been preparing for working for this up and down, and by adding the more new sockets, so we will be supporting our low-end touch IC supplier mostly from Korea and Taiwan and also we have a new sensor product that’s going to help us add winning the more socket.

So only way again is more diversifying and working with the more customers and working with the top two both of them and able to balance this very synclinal nature of business.

Unidentified Analyst

The last question and kind of current business conditions. I believe your typical fourth quarter seasonality, if there is such a thing that’s typical, that is down low to mid single digits I will say kind of flat to down five range historically. Is there anything that you are seeing either the new products that you just mentioned, the timing of some of the launches that will have later today that you think could change normal seasonality for this year versus what we have seen in the past?

Sang Park

So I wish I know. But we have to wait a few days and see how the announcement kind of impact the supply chain, but typically fourth quarter is a weak quarter for this industry as well as our first quarter. So there is a limited visibility as of today into the fourth quarter. I believe that it is slightly weaker than we anticipated.

Unidentified Analyst

The fourth quarter is slightly weaker than you anticipated, what will be driving that.

Sang Park

Again, the limited visibility, we don't know exactly, but we want to position ourselves in the conceptive site.

Unidentified Analyst

Okay. But if we get into some of the specific sub-segments of your business, the 50% of your business on the foundry side FMS [ph] has shown significant growth, I know getting your revenue per wafer up has been part of that, just to get people a framework to look at it, if that business grew roughly 16% last year how do that 15%, how much of that would be unit versus ASP?

Sang Park

Just looking at our utilization rate, probably I would say revenue per wafer grew faster than total demand.

Unidentified Analyst

And is that something that you believe is most of that is behind us, are we at the beginning of that trajectory, do you think it is going to be kind of a steady climb where you can keep adding new customers and keep that 6% CAGR going?

Sang Park

We started this foundry business mostly providing our foundry service to Asian customers including Taiwan and Korea. And now we are shifting into U.S. customer and European customers with a more value-added engineering solutions. So year-to-year we increased the percentage we are doing business from U.S. by 10% and we’re expecting this transition continuing to the future as a matter of fact we have a very healthy pipeline with a new U.S. customers and we expect to announce the new names in the next six months that’s going to help us second half of next year into 2015.

Unidentified Analyst

One little sort of housekeeping question, I believe when you were up at the podium you mentioned some specific percentage I think you said what from 38% to 48% of your foundry business, now is the U.S. and European customers that was 2011 and 2012?

Sang Park

That’s only yes, from 2011 to 2012.

Unidentified Analyst

Where do you think that ends this year?

Sang Park

No, that’s probably 2012 to 2013.

Unidentified Analyst

Got you. okay, so that’s where we are now, and what’s the competitive offering that is allowing you to garner those higher quality customers.

Sang Park

We have specialized foundry provider, our main target customers so mid to small sized players and their designer is looking for the some very specific process solutions, process technology solutions, and our engineers really good at and providing again the new options and whatever they need make the designers to function much easier to design to, so that’s why we get popular with the customers that we providing the service.

Unidentified Analyst

How should investors think about when you are expanding the foundry business the good news is the revenue per wafer is going up, when you grab all these new customers, unless you’re adding absolute capacity with CapEx, seems like a bit of zero sum game how do you handle the transition from the old customers to the new?

YJ Kim

We will, we are relationship driven. So we don’t want to drop any customers overnight. We’ve been working with existing customers and actually we’ve been reducing allocation to those customers, but they come back and helped us when the smartphone market becoming more weaker than anticipated. So therefore that’s the reason that we are able to keep our older customer base in a good relationship. So what we do is slowly over time and we make the transitions.

Unidentified Analyst

So the CapEx side of the equation, is that ever an issue when you’re going and bidding for business from these U.S. or European-based customers that they look at the absolute capacity you have and want you to put in more?

Sang Park

Well, again that our main target customers are small to medium fab customers. They’re not asking humongously big demand.

Unidentified Analyst

And am I right in the math that I don’t believe you have a 10% customer for your total sales. That would be a straight foundry customer. So since that’s half of your business, you don’t have…

Sang Park

You’re correct.

Unidentified Analyst

You don’t have anybody that’s even 20% of your foundry business in a single customer.

Sang Park

Not now.

Unidentified Analyst

Hopefully?

Sang Park

Continuously.

Unidentified Analyst

On the CapEx side of the equation, how much do you need the revenue for wafer to go up to avoid spending any more than kind of the I think $60 million was the midpoint per year CapEx that you’re talking about.

Sang Park

Average revenue per wafer now we are slightly below $600. Just looking at analog peers like Fairchild $1,300, I believe and On Semi $1,200. So that’s the room for improvement. Obviously they don’t do any foundry business, but yet, we have a significant opportunity to grow incomes from revenue per wafer without adding new capacity and that’s our plan, that’s our strategy, shifting our product and shifting our customers and growing our revenue.

Unidentified Analyst

And is that something that you think again 6% CAGR you’ve talked about, is that a fair assumption for investors going forward with that accelerate decelerate?

Sang Park

I think that’s probably baseline. I expect we are going to do better than that.

Unidentified Analyst

Why don’t we switch gears over to the display side of the market; as you said in your presentation, that’s been a steady business, a nice cash generator for the company historically, now you have some new product areas and sensors, some of the AMOLED that’s been doing for a little bit of time, so there is actually some interesting drivers within that business, talk a little bit about how you see them folding in and if you want to have, YJ talk about it as well. How should investors start to think about that as a growth business as opposed to a stable business?

Sang Park

I think 2014 is the year that it’s going to change our display solution business. It’s been very stable, it’s only focused on top two customers in conventional applications. From next year, we have three growth pad, and number one is TV market is going to change from a high-definition TV to ultra high-definition TV and because of its resolution requirement, use about two to four times more driver chips. So obviously that’s a upside for us, starting from next year.

And second opportunity for us is the AMOLED. We have been working with this customer for last seven years. We are only one of the two supplier in addition to their internal supplier and they're spending their AMOLED production capacity next year. We are perfectly online with many different platforms and that's really upside opportunity.

We've started our new business which is sensor and I’d like to have YJ Kim who just made a trip to China. By the way YJ Kim just joined the MagnaChip about three months ago from Cavium Networks, so his personal objective is get the PE ratio of MagnaChip up to Cavium, am I right? Okay, now you want to talk about sensor.

YJ Kim

Yes, sensor is a great business. We started business because the customer wanted us to start and it's really good in the sense that it requires a very advanced process technology and mixed signal circuitry. MagnaChip is very well positioned for that, and China trip based on the advantage of our feature set, differentiation, low-power. So we think that the sensor has some potential and one of the 19 watt sensor it’s much better margin than the corporate average we expect to contribute in the future.

Unidentified Analyst

When do you think the sensor side kicks in is that first half of next year, second half of next year and any more specific than that?

YJ Kim

Yes, so we don't want to really set the high expectation, we will start, we already start sampling, but we hope that it will start contributing sometime early next year.

Sang Park

My expectation is the fourth quarter.

Unidentified Analyst

I appreciate all of you are conservative on the fourth quarter and now the new guy has a high bar for the fourth quarter.

Unidentified Analyst

Why don’t we take a – try and see if there is any questions from the audience, again just wait for the microphone if there are in fact any questions. While you guys think of, this one to stump Sang here, why don’t we move over to the margin side. There is one. Sorry about that. Go ahead.

Question-and-Answer Session

Unidentified Analyst

There is a more rapid than expected shift to low-end smartphones. Did that effect the longer term gross margin model of about 100 basis points a year or that’s already been accounted for that model?

Sang Park

That’s really good question. We have a lot of additional opportunity in the mid -to-low, as I mentioned touch, low-end touch IC through the foundry service and as well as the sensor product and we got also a lot of power opportunity, but this is select and focus. We are not just going in there in the open market with the low margin billings. That’s not our strategy. Our sensor product, if it wins the new socket will be premium product for us, but will be a very attractive price for the customers. So again we’re doing some – the design winnings in premium product only. So it wouldn’t impact our margin, but it’s going to help us on revenue and give us fine.

Unidentified Analyst

Why don’t we switch over onto the margin side? So again I think you talked about a 35% to 38% gross margin as your target and if I remember right, you’ve been in the low 30s, kind of 33% level for the last year. So if we think about roughly three to five points of upside, what are the primary drivers of that?

Sang Park

Primary drivers will be the Display Solutions with our new revenue in the premium product and also Power Solutions. We entered the market with commodity type MOSFET and now we have our brand name known to the customers. We got a lot of PMIC opportunities and even Super Junction MOSFET, which is a premium product for us, we introduced second quarter and starting from the third quarter, I believe this product line which is brand new kind of be more than 10% of our Power revenue.

So again that Power side, we’re expecting that margins kind of continuously improve. In foundry side, it’s the customer shift from Taiwan to U.S. definitely that’s going to help us because we bring more value product to the customer.

Unidentified Analyst

I know you have your target margin goal on the OpEx as a percentage of sales at 18%, 19% level. How do you improve the price per wafer that you’re getting invest in new areas like in the sensor side et cetera and keep that OpEx at that same percent of sales? Isn’t there by definition some need to ramp the OpEx ahead of time before you get the revenues from those new areas?

Sang Park

It’s the matter of shifting resource and making our engineers more flexible. You’re looking down more fundamental how we expand our product line that’s subtle [ph] within similar product families or technology families and therefore we’re shifting our resource from one design team to another design team. So that’s how we’re expanding into the new market.

Unidentified Analyst

And within the one segment that we haven’t touched on is the Power side of things and that’s been growing at a very nice cliff. I think over the last couple of years, it grew from $90 million to now upwards of $150 million a year. The initial ramp in that seems to be lower and it seems now you’re getting the higher end side. I think this is more of a mix play at this point to help profitability a utilization play or what is going to drive the growth in margins on that going forward?

Sang Park

Obviously I was a courageous adding the new product line. We call it a premium product. So such as a super junction I mentioned earlier, quickly being well accepted, very successful and we will continue to adding new product lines. And number two, even today we’re supplying 2% of what Samsung buy in power solutions. So we’re just next to it.

We started business in this new product line only a few years ago, but typically when you take our office within the Samsung campus and they’re taking as a strategic supplier and we’re expecting 10% to 15% is something that we look forward to as long as we execute with the product they need. So there is a lot of room for each account of customers. So therefore we feel comfortable that we will be continuously growing this business in double-digit in next few years.

Unidentified Analyst

One more question. Hold on for the mike please.

Unidentified Analyst

Can you talk about how you’re differentiating in power business, I assume that market is fairly kind of stable to low, I don’t know, single-digit growth and you guys are obviously seeing really in a multiple that for a while. It sounds like you’re comfortable that will continue. So you’re presumably taking share, I mean how are you differentiating kind of that market? I’m assuming that’s largely commodity low growth, but the growth rate has been spectacular. So can you talk?

Sang Park

Well, there are two positive product families, one is the commodity product and the other one is application specific, such as the PMIC. We have a two different approach, but I think that answering your question, relocating Asia and we are probably only power IDM outside of Japan in Asia, and we are very comparatively service well to the customers, and that’s going to help us continuously expand within the customers which means, we develop things much quicker and also we listen to the customers we had a really clear year and speaks same language at the same time, so that’s really helping us to.

So we’re getting to the market with this commodity product and they are giving us the customer product request to sensor product line, he was talking about again that we started at the request of customer. So that’s helping us, that’s differentiating us.

Unidentified Analyst

Any last question from the audience? I guess the last one then from my side and the last 30 second that we have is, you are in a good position as far as the cash and your balance sheet, you did a bit of a refi recently talk a little bit about your strategy for cash returns?

Sang Park

This is a top priority supporting our internal and operational needs such as the CapEx and so on, and number two is returning value to the shareholders, buying back stocks, and number three is M&A opportunity, and whenever it makes sense that’s our cash priority. Can I say something else…

Unidentified Analyst

Sure, yes.

Sang Park

We believe the last three years, we’ve been doing real good and executing and delivering what we promise. And our work forces are very stabilized and they look for the new additional jump. So we come out with a good growth path next three years and we are very confident we do have a good growth roadmap for each business units, and that’s how much we’re confident that again that not spending any additional CapEx by product shift, customer shift we will not continuously grow.

Unidentified Analyst

Great, Sang thank you very much. And I think now we have one of the keynotes. So we’ll wrap it up.

Sang Park

Thank you.

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