MagnaChip Semiconductor Earnings Call Transcript

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MagnaChip Semiconductor (NYSE:MX)

Q2 2008 Earnings Call

July 18, 2008 10:00 am ET

Executives

Joseph Villalta - Ruth Group

Robert J. Krakauer - President, Chief Financial Officer and Director

Margaret Sakai - Senior Vice President, Finance

Sang Park - Chairman and CEO

 

Analysts

 

Eric Ruple - MTR Securities

Jeff Harlib - Lehman Brothers

Bryan Pierce – UBS

N. Quinn Bolton - Needham & Company

Oliver Corlett - R.W. Pressprich & Company

Operator

Welcome to the MagnaChip Semiconductor second quarter 2008 results conference call. (Operator Instructions) It is now my pleasure to introduce your host, Joseph Villalta of The Ruth Group.

 

Mr. Joseph Villalta

Welcome to MagnaChip second quarter 2008 earnings call. Joining us today from the company are Sang Park, the company’s Chairman and CEO, Rob Krakauer, President, and Margaret Sakai, Senior Vice President, Finance. After management’s prepared remarks we will have then have time for questions.

If you have not received the copy of sales results release, please call 646-536-7026 at the Ruth Group or you can get a copy of MagnaChip’s global website at www.magnachip.com.

Before we begin the formal remarks, the company’s attorney’s advised us that this conference call contains statements about future events and expectations which are forward-looking-statements. Any statement in this call that is not a statement of historical facts maybe deemed to be a forward-looking statement that involve a number of risks and uncertainties that could cause actual results to differ materially. In some cases, you could identify forward-looking-statements by such terms as “believe,” “expect,” “anticipate,” “intend,” “estimate,” the negative of these terms or other comparable terminology.

Factors that could cause actual results to differ include general business and economic conditions and the state of the semiconductor industry. Demand for end-use products by consumers and inventory levels of such products in the supply chain. Changes in demand from significant customers, changes in customer order patterns, changes in product mix, capacity utilization, level of competition, pricing pressure, and declines in average selling price, delays in new products introduction, continued success in technological innovations, and delivery of products as the future customer’s demand.

Shortage in supply of materials or capacity requirements, availably of financing, exchange rate fluctuations, litigation and other risks as described in the Company’s SEC filings including in its annual form on Form 10-K for the period ending December 31,2007. Although we believe that these expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. This does not place undue reliance on these forward-looking-statements.

At this time, I would now like to turn the call over to Mr. Park.

Sang Park

Despite challenging market conditions in Q2, revenue came in at $194.7 million, a decrease of 4.1% as compared to the first quarter of 2008 and a slight increase as compared to the second quarter of 2007. We achieved this result even though demand was lower than expected, as our customers tighten their inventory control due to current uncertain economic environment. Importantly, we continued to add new accounts and to offer new products and services which we expect to contribute to revenue growth in the future quarters.

In our power solution business we are pleased with how quickly we have ramped up this business in line. We shipped our first products and recorded our first revenue in this quarter. We have built our new product pipeline with the launch of our 30 volts and 40 volts MOSFET series and development of the LDO and USB Solutions.

We have assigned a new contract with the three leading Asian Distributors to support our sales in the region. We expect this new [Inaudible 07:26] to help us in our market entry by supporting us in design and process and in supply chain management. Further, in keeping with our commitment to produce environmentally friendly product, our power solutions offer halogen-free packaging for LCD backlight and battery pack applications.

We expect our power solutions beginning to ramp even more quickly in the second half of 2008. We expect the number of products released to go more than five-fold. As we expand our portfolio to include more new products, for example, high-voltage MOSFET.

Our new MOSFET products are being well received by customers as they offer better thermal performance than competitor’s products. In our display solutions business, we added a large new account to which we are selling our distinctive Chip on Glass or COG solution. We have also expanded our AMOLED product offering in the growing mid-size display market. We have both of the QQVGA and HVGA solutions now available to meet the rising demand for the high-resolution displays.

In addition, as with our power solutions, we are focusing on environmentally friendly products. For example, many of our display drivers offer smart mobile luminous control or SMLC technology which reduced the power consumption of displays.

Our Imaging Solution business achieved a significant number of design wins in the second quarter. We have five mega pixel products currently under development and we recently launched a 2.2 micron on 10 inch [ph 9:34] VGA sensor. We have several new solutions now available for the Security and PC market including two new products currently designing in four growing PC and notebook camera market. Development of our 1.75 micron solution is on track. We have broken into several first tier mobile manufacturers for our new family of sensors.

Our semiconductor manufacturing service business has a number of new technologies. Such as a 0.18 ultra low noise, triple gate, and dual trench and 0.35 BCD that are creating a new business opportunities for us. We also have number of new accounts in the final stage of qualifications and just to announce that we have began final qualification of UltraCMOS SOS (Silicon-On-Sapphire) technology with Peregrine Semiconductor. Our SRAM technology offering one of the smallest cell sizes available in the market is helping us further expand our customer base.

Additionally, we launched [Inaudible 10:47] process for the power product customers expanding our offering to provide more one step [ph 10:58] of this to our customers. We recorded our gross margin over 25% which was a significant accomplishment in this market environment.

Importantly, our new product portion of revenue is continuing to rise and we expect it to be at an all time high in the second half of 2008. We believe this will drive profits and sustain demand throughout 2008 and into 2009.So, we expect the market to remain tough throughout the year. Our newly introduced products and strong customer relationships provide our solid base for the performance improvement.

Now, I would like to turn this call to Margaret for the review of financials.

Margaret Sakai

Our revenue for three months ended at June 29, 2008 was $194.7 million compared to $203.1 million in the first quarter of 2008. This is a decrease of 4.1% from the prior quarter. The decrease was due to the combination of higher than expected average selling price erosion and the lower than expected sales in our display storage of product as our customers tightened their inventory control.

Revenue by segment for the quarter was $82.7 million for Display Solutions, $20.9 million for Imaging Solutions, $86.7 million for semiconductor manufacturing services, $0.1 million for power solutions and $1.3 million in other revenue.

We are pleased to report our power solutions as our new segment this quarter and marked a degree of a volume shipment for this unit during the quarter. Revenue by geography was 51% from Korea, 24% from Great China, 12% from Japan and the 13% from the rest of the world.

Revenue by random markets for the quarter was 27% from computing, 18% from wireless, 10% from consumer, and the 45% from wafer foundry. Our wafer foundry business is further broken down as 17% from computing, 13% from wireless, 65% from consumer, and the 5% from industrial.

The recent results reflect the challenges we experienced in the wireless market in second quarter as we were exposed to factors and geography that were particularly high risk in terms of demand and inventory corrections such as China. In the second quarter, we had one customer greater than 10% and the top ten customers represented 58.7% of the total revenue.

Gross margin was $49.2 million or 25.2% of the revenue for the quarter ended at June 29, 2008 compared to $47.9 million or 23.6% of the revenue in the prior quarter. Gross margin improvement was driven by continued across the management and the product mix. Operating expenses were $58.5 million or 30.1% of our revenue in the current quarter compared to $54.7 million or 26.9% of our revenue in the first quarter.

Our Index expense in the second quarter was $35.5 million or 18.2% of revenue compared to $36.3 million or 17.9% of the revenue in the prior quarter. We had an operating loss of $9.4 million during the quarter compared to an operating loss of a $6.8 million in the first quarter.

Net interest expense for the second quarter was $15.8 million compared to $15.7 million in the prior quarter. Net loss for the three months and dated June 29, 2008 was $59.6 million compared to our loss of $67.9 million in the prior quarter. Net loss includes other non-operating expense which is comprised of the net effect of currency gains and losses during that period. Most of these currency effects are non-cash impact on outstanding inter company debt.

Depreciation and amortization expense was $20.60 million or approximately 10.6% of the revenue in the second quarter. EBITDA for the second quarter was $11.3 million compared to $13.6 million in the prior quarter. While EBITDA is not defined by generally accepted accounting principles, it is commonly used to measure our Company’s ability to establish debt.

Our current revolving line of credit of $100 million had financial covenant linked to EBITDA performance. We were in full compliance with the day’s covenants at the end of this second quarter. Headcount as of June 29, 2008 was 3,600 [Inaudible 16:37] a slight increase from the first quarter. Capital expenditures before the second quarter was $11.1 million versus $16.6 million in that year ago quarter.

Total available cash and the cashing equivalent were $36.5 million as of the end of the second quarter. We had excellent working capital performance during the quarter making improvement in both AP and AL days. Accounts payable days were 89 compared to 83 days in the first quarter of 2008. Inventory days of the supply were 40 compared to 38 days in the prior quarter.

Net inventory was at $63.5 million compared to $64.9 million in the prior quarter. Account receivable, net of our retail stores was $149.2 million at quarter end. Our account receivable days of sales outstanding was 70 in the current quarter compared to 65 days in the prior quarter due to the timing of receipt at the quarter end.

Now let me turn the call over to Bob.

Robert Krakauer

 

Microeconomic environment continues to have many uncertainties about consumer spending and in market demand. And accordingly, our customers have continued to tighten their inventory levels. This has been most pronounced in our wireless business.

We improved our gross margin performance this quarter despite weakened and expected revenue; we made improvements on several fronts. Labor productivity improved by 5.9% from earlier this year due to the implementation of our systematic labor productivity management system that gives our Fab managers visibility and to opportunities for improvement as well as to the hard work of our employees.

Material procurement savings have been 7.7% year to date and help offset downward ASP pressure. In particular we have made both efficiency savings as well as procurement price savings for key commodities in our display driver business for year-to-date savings of 14.1%. Supply constraints and price increases we saw last year for wafers has alleviated in 2008 and we are now seeing price declines in this commodity category.

Inventory management and the need for less reserve contributed 620 basis points of improvement. Our much of our overhead cost structure is fairly fixed. We have achieved price savings of around 8% for repairs and supplies that are included in factory overhead year-to-date; combined with higher factory utilization we achieved volume leverage related improvements of 260 basis points versus the prior quarter.

These efforts as well as a higher percentage of mix of new products contributed to higher quarter over quarter gross margins. Tax utilization was 87% for the quarter, based on the ramp of products in our imaging solutions and the mobile display driver businesses. We continue to expect to be at full utilization of Fab5 by the end of the third quarter.

Now, on to guidance. We expect revenue in the third quarter to be in the range of $205 million to $215 million based on customer forecast and design wins and progress. We have several technology and product introductions that should materialize into new revenue and market share in the fourth quarter. Despite difficult consumer and market conditions globally, we expect revenue to be in the range of $240 million to $260 million. We have made a major push into the power market and expect this business to be at an annualized rate of $80 million in the fourth quarter from zero, one year ago.

This significant growth is indicative of the power of our customer relationships and the strategic market need for a large power IBM located in Asia. We expect gross margins for the third quarter to improve 50 to a 130 basis points. This forecast includes many variables and uncertainties that are outside of the company’s control.

However, it includes our forecast of revenues, productivity efforts, impact of expected volume increases, and assumption on product mix, partially offset by forecasted average selling price erosion. With additional volume leverage from higher revenue and based on expectations and forecast for the same variables as discussed on the third quarter, we hope to achieve our goal of 30% gross margins in the fourth quarter.

We forecast a reduced operating loss from the third quarter and a return to operating profits in the fourth quarter with an operating margin between 3.5% and 5%. We have obtained operating lease commitments and planned to enter into operating leases on approximately $60 million worth of equipments in the third quarter.

In addition, we concluded a focused effort on capital productivity that had been able to achieve higher unit volumes with the less capital investment, and therefore, we are reducing our guidance for capital expenditure for the full year to approximately $35 million.

Forecast of cash and liquidity have many variables and uncertainties, including the assumptions on end market demand, revenue, timing of design wins, gross margins, operating expenses, exchange rates, working capital terms, timing of capital purchases, and other factors.

We forecast that while liquidity will be tighter in the third quarter, we expect to generate cash in the fourth quarter and we are targeting to be at the same liquidity position at the end of the year as we were at the end of the second quarter. Thank you for your continued interest in Magna Chip.

That concludes our prepared remarks and we can now take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Eric Ruple - MTR Securities.

Eric Ruple -MTR Securities

Can you give us any sense of what you are thinking about the capital expenditure requirements will be for 2009 at this time, Bob?

Rob Krakauer

Yes, given the capital productivity we are achieving right now, I would expect it to be about 8% of revenue.

Eric Ruple - MTR Securities

 

And on the liquidity, do you have any plans to put another facility in place or something to improve liquidity up from the $30 million to $36 million that you are targeting for the end of the year?

Rob Krakauer

Obviously, we would have those options and I would announce those at the time that we would do them. At this time as I have mentioned, we believe that our liquidity will be about the same as we exit the year based on our forecast.

Eric Ruple-MTR Securities

Did you provide revenue guidance for Q4?

Rob Krakauer

I did, it is $240 million to $260 million.

Eric Ruple - MTR Securities

On the working capital, in the last quarter there was a big uptake in working capital and then I believe that you would receive a relatively large cash inflow right as the quarter began. I was hoping that receivables could have come down a little more this quarter about flat. Any comment or guidance what we should expect next quarter?

Rob Krakauer

Yes. The second quarter for us was very back-end loaded so there’s really been actually our fundamental AR days now intra quarter actually improved in Q2. The issue is that the actual operational revenue was very back-end loaded so that quite impacted that. We expect AR days, the not fundamentally changed marks in Q3.

Operator

Your next question comes from Harlib - Lehman Brothers.

Jeff Harlib - Lehman Brothers

Just on the CapEx, now you are saying $35 million, I assume, with $60 million of leases on top of that, right?

Rob Krakauer

Correct.

Jeff Harlib - Lehman Brothers

So, how were you able to be at that level, given your expected revenue ramp into Q4 and your current utilization of 87%? It seems like a low number.

Sang Park

Well, we expect that our utilization will be around 100% to 103% in the fourth quarter and obviously with that CapEx spending in third quarter, and increase in capacity we will be able to do $260 million without much of problem.

Jeff Harlib - Lehman Brothers

Is that better efficiency on your existing equipment?

Rob Krakauer

It is. We actually did a concerted effort to review capital productivity and we were very pleased with the results and expect to continue to be able to make some of those gains through the back up of this year.

Jeff Harlib - Lehman Brothers

And the ramp you are expecting in Q4, can you talk about, you mentioned power solutions is clearly one of the areas. Can you just mention looking at your other businesses, where you expect that ramp, in which business and the way you spend on design wins to support that?

Sang Park

 

Well, CMOS imaging sensor, 2.2 micron product effort will help us to ramp up in fourth quarter. And also, within the supply in so called chip on glass solutions, full light disc to the notebook computers and that is going to take off in the fourth quarter and the same thing with our mobile DDI; we expect the mid-size display is going to be more in demand in Q2 than the fourth quarter. So it’s across the border and our foundry business offering new technology which I introduced at my readings and those that [Inaudible 28:10] help. But again, though this is not just fourth quarter and we are anticipating this ramp will continuously increase into 2009.

Jeff Harlib - Lehman Brothers

The image sense of business, where did you spend on the design for the handsets, the 2008 handsets? I know there are different cycles for designing in your products, where do you spend on that?

Robert J. Krakauer

 

Well, we set our first two mega pixel production volume this last quarter, and we are now designed in several of the tier 1 providers. And continue to expand the models that are being assigned to us. So we are very encouraged with the reception that we are receiving right now across the product portfolio.

Jeff Harlib - Lehman Brothers

Can you just say how you see markets entering 3Q as you look at your key, wireless display, foundry, customers entering the third quarter?

Robert J. Krakauer

Well, I think as we mentioned in our comments, we did see weakness out of China, part of that probably due to the various calamities that have occurred, but also just a slow down in that market. I think that’s been generally reported. We saw that in our business as well. So we have tried to factor-in difficult consumer and markets relative to wireless into our forecast, especially in that sector.

Sang Park

The consumer market is definitely weak demand, but somehow, game industry is very solid and still notebook related and PC demand is strong. But overall, obviously our customers are trying to manage their inventory level very conservatively.

Robert J. Krakauer

Yes, I think what’s reflected in our revenue gains is the fact that we have been working for the past couple of quarters on several new technologies in several of our business. We are out now forecasting and seeing design wins that are bearing fruit relative to that investment over the last several quarters.

Sang Park

Right most of those are going to ramp up throughout the Q3 and Q4 and into full volume early next year.

Jeff Harlib - Lehman Brothers

Lastly, just on payables. I think that you mentioned 89 days payables?

Robert J. Krakauer

Yes

Jeff Harlib - Lehman Brothers

Is that a sustainable level? I think it is higher than you have been trending?

Robert J. Krakauer

Yes. We believe it is a sustainable based on the negotiations that we have done.

Jeff Harlib - Lehman Brothers

Negotiations of credit? Mix of investment?

Robert J. Krakauer

With suppliers, yes.

Operator

 

Your next question comes from Bryan Pierce – UBS.

Bryan Pierce – UBS

 

First question I have was about R&D and you have been trending 17%, 18% for the last couple of years and this year. Is that likely quite different across your business line? I was wondering if we could get some color around that, just a color around the CMOS business and the R&D intensity there.

Robert J. Krakauer

Yes, the R&D intensity in our CMOS Image Sensor business over the last year is higher than our other businesses as we have been repairing that business and as I mentioned earlier, we are now starting to bear the fruit of that across until the end of the year.

Bryan Pierce – UBS

Any color into the fixed versus variable nature of that expense across your business lines?

Is there, on the flipside, how much room that you are spending if necessary?

Robert J. Krakauer

 

Yes. The R&D spend is approximately 30% to 40% variable, related to spending on mats and wafers.

Bryan Pierce – UBS

 

On the liquidity front, have you mentioned the letters of credit outstanding at the end of 2Q? I don’t know if I caught that.

Margaret Sakai

Letter of credit outstanding is around $11 million

Bryan Pierce – UBS

Eleven million? Okay and that’s essentially where it was at the end of 1Q. Is that right?

Margaret Sakai

Yes

Bryan Pierce – UBS

On the inventory and SG&A side, past quarters there were some one time adjustments. If we categorize on that, would you say there was a both normalized levels in 2Q or were there are something behind the numbers in 2Q.

Robert J. Krakauer

No, historically we had several occasions where we cleaned up inventories in this quarter. Inventories were well in control, and as I said that quarter over quarter basis was actually a positive.

Bryan Pierce – UBS

 

And SG&A side as well? I think there was something in the?

Robert J. Krakauer

In the first quarter we had a one time reserve from the closure of our FAB1 and we did not have that occur in Q2.

Bryan Pierce – UBS

Q2 would be a more, the run rate there at 12% of revenue. Would you categorize that as more normalized? I would think it would be.

Robert J. Krakauer


Yes.

Bryan Pierce – UBS

 

On the power management business, I think you have made a comment about an $80 million run rate to exit the year. How should we think about that? Is that for the full fourth quarter or is that exiting December and you expect to be at the $80 million run rate?

Robert J. Krakauer

It is for the fourth quarter.

Operator

 

Your next question comes from the N. Quinn Bolton - Needham & Company.

N. Quinn Bolton - Needham & Company

 

We are just wondering what assumptions you have made, as you are looking at the second half about some of your customer, inventory policies. Do you see those back up as we get into the second half build, do you think this point or like they would stay pretty conservative with inventory.

Sang Park

We probably get in to the third quarter, they are very conservative. And then again that’s throughout the wireless and then the consumer and then the PC sectors; they are tightening their inventory level.

N. Quinn Bolton - Needham & Company

You mentioned in the comments that the handset market in China is weak. Have you seen any pick ups here ahead of the Olympics? Should you think that the China handset market stays weak until the Beijing games has concluded?

Sang Park

We don’t expect any booms before the Olympics unless we don’t see any this time.

N. Quinn Bolton - Needham & Company

Are customer forecasts indicated to pick up after the Olympics?

Sang Park

That business in China is a very short-term driven, so we have a very little visibility for the next month.

N. Quinn Bolton - Needham & Company

On the fourth quarter revenue, pretty strong revenue growth forecast for that quarter. I know you talked about a number of drivers across each of your product line. So, should we think about similar growth or similar mix in Q4 that you reported here in the second quarter or do you think one of the businesses really drives that incremental growth into the fourth quarter?

Sang Park

 

I think it’s a growth for across the board, and obviously we have a new additional business growing quickly which is the power of solutions, and the covering of our CMOS Image Sensor from the top of the other business continuously growing and those projections that we provided today are coming from our CRM numbers such as salesforce.com and we do very thorough review of sales opportunity, line by line and that’s where our projection came from and so we really look forward to fourth quarter.

Operator

Your next question comes from Oliver Corlett - R.W. Pressprich & Company.

Oliver Corlett - R.W. Pressprich & Company

 

You did not break out the ASP change by segment this quarter. Is that something you’re going to do or not?

Robert J. Krakauer

No, we are not going to do that.

Oliver Corlett - R.W. Pressprich & Company

Generally speaking there were pretty severe declines in ASPs across the board?

Robert J. Krakauer

No, I would not characterize it that way. We had a shift and mix in our foundry business. We have what I called typical ASP erosion of our display driver IC business, and a little of bit of an aggressive ASP erosion in our CMOS side of business.

Oliver Corlett - R.W. Pressprich & Company

And as far as the liquidity situation again, if you had $11 million of LCs and that you had about $4 million available on the revolvers, is that about right?

Robert J. Krakauer

Yes.

Oliver Corlett - R.W. Pressprich & Company

And then given the survey of the cash movements in the last couple of quarters and that thing is pretty tight. Do you expect that will actually generate cash during this quarter of Q3 and bring that down a little bit?

Robert J. Krakauer

No. As per my prepared comments, I expect liquidity would be a little bit tighter by the end of the third quarter and for us to generate cash in the fourth quarter.

Oliver Corlett - R.W. Pressprich & Company

What is the minimum level of cash that you think you can operate it with?

Robert J. Krakauer

We are pretty tightly controlled from our treasury function. I think that number is probably $10 million to $15 million.

Oliver Corlett - R.W. Pressprich & Company

Could you just remind me of what the covenants are on the revolver right now?

Robert J. Krakauer

I think that’s probably best covered in a follow up. It is publicly attached to our SEC filings, but there’s a number different covenants. And we are complying now.

Robert J. Krakauer

Yes. We are in compliance with the covenants and expect to be in compliance with the covenants in the coming quarter.

At this point, if there’s no other question, we appreciate everyone’s continued interest in MagnaChip and we look forward to talking to you again next quarter.

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