Bruce Entin - Director, IR Young-Joon Kim - CEO Jonathan Kim - EVP & CFO.

Suji Desilva - Roth Capital Atif Malik - Citigroup Robert Mertens - Needham.

Good day, ladies and gentlemen, and welcome to the Q4 2017 MagnaChip Semiconductor Corporation Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Bruce Entin, Director of Investor Relations. You may begin..

Thank you for joining us to discuss MagnaChip's financial results for the fourth quarter and fiscal year ended December 31, 2017. The fourth quarter earnings release that we filed today after the stock market closed and other releases can be found on the company's Investor Relations website.

The 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 1 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 begin the call with a discussion of the company's recent operating performance. Jonathan will provide an overview of our Q4 financial results. And then YJ will provide a brief recap, as well as provide financial guidance for the first quarter of 2018. There will be a question-and-answer session following today's remarks.

During the course of this conference call, we may make forward-looking statements about MagnaChip's business outlook and expectations.

Our forward-looking statements and all other statements that are not historical facts reflect our beliefs and predictions as of today and, therefore, are subject to risks and uncertainties as described in the Safe Harbor discussion found in our SEC filings. During the call, we will 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 fourth quarter earnings release available on our website under the Investor Relations tab at www.magnachip.com. I'll now turn the call over to YJ Kim.

YJ?.

to provide the highest level of services to global IC customers, of course, requires a specialized analog processes but also top-quality and high-efficient fab operations.

2.5 years ago, we hired a top-quality expert from a Tier 1 semiconductor company, and the results have been impressive as he displayed recognized MagnaChip with its best quality award last 2 years, and we also won a highly prestigious supply award from another top customer last 2 years.

We recently hired a top manufacturing efficiency expert from a Tier 1 semiconductor company. Our new manufacturing team already has identified cost savings and efficiency methods to improve throughput and line yields and reduce downtime, all of which would benefit gross margin over time.

Now let me offer some perspective on the Standard Products Group, starting with Power, followed by Display. A few years ago, our Power product portfolio had far too many commodity fab fillers, and the business was a drag on corporate margin.

Fast forward to now, we optimized the product portfolio by killing many undifferentiated products and by developing higher-value premium products that carry better margins. Premium products, including Super Junction, IGBT and Power ICs accounted for more than 40% of Power revenue in Q4, up nicely from Q3 and up by nearly 40% from Q4 2016.

If we include high-margin vary [ph] fab, the portfolio mix is even healthier. As I've mentioned previously, profit margin in the Power business has increased by about 15 percentage points over 4 years and profit margin continued to improve in Q4 over Q3 2017. Our Power business is on the right track as we begin 2018.

Our Display business is comprised of OLED business and what we referred to on past calls as the non-OLED business. The non-OLED business is a group of LCD display drivers sold in highly competitive, price-sensitive markets as well as in the high-margin automotive segment.

On our Q3 call, we identified the low margin portion of this business as a headwind because portions of it often fall short of our internal profit objectives. In some ways, this business resembles our Power business a few years ago, which is why we are actively pursuing a similar portfolio optimization strategy.

As an example, we have recently walked away from low-margin, non-OLED Display business, which will temporarily affect the revenue and fab utilization in Q1 but which is consistent with our strategy of improving product mix and MagnaChip's overall profitability over the long run. OLED is a different story.

Despite a challenging market in 2017, the gross margin in our OLED business exceeded our annual corporate average for the second year in a row. And with a new product lineup, our OLED business is once again poised to be a key growth driver for MagnaChip in 2018.

We believe we are in the early stages of market adoption for OLED technology, which is quickly becoming the de facto standard for a wide range of mobile devices, UHD televisions and virtual reality devices.

We also believe that OLED display technology eventually will be adapted into other large and growing markets, including IoT, foldable smartphones, new foldables and automotive. This is an attractive market that inevitably will draw in competitions.

But for now, we are the largest independent supplier shipping high-resolution OLED display drivers in volume. We are particularly well positioned to capitalize on future market trends and by having close ties to world's top 2 OLED panel makers that command overwhelming panel market share. They also happen to be our neighbours in Korea.

With that, I will turn it over to Jonathan. I will return afterwards to wrap up and provide our business outlook and financial guidance for the first quarter of 2018.

Jonathan?.

Thank you, YJ, and welcome to everyone on the call. On our last conference call, we identified opportunities to expand our market presence and increase revenue in 2018 and also acknowledged that we faced headwinds.

We identified those headwinds as a soft China smartphone market, lower-than-desired profit margins in a portion of our non-OLED Display business and higher prices for wafers due to an industry-wide shortage.

YJ identified actions we're taking to put the OLED business back on track and to streamline and improve the results in the non-OLED Display business. And as I said before, we're working all the angles. Here are some of the specific steps we've taken and may continue to take to offset the effects of higher wafer costs.

Number one, we have, from time to time, made prepayments to our suppliers to secure adequate supply and/or favorable pricing to support our business. During Q4, we ramped up this activity and made prepayments of approximately $7 million to certain wafer suppliers.

Prepayment arrangement, which is a common practice, is recorded within other current assets on our balance sheet.

Number two, we signed a longer term wafer supply agreement, and we intend to continue to be opportunistic about acquiring raw wafers at attractive prices, including using multi-period purchase supply agreements as is appropriate for our business.

Number three, we increased buffer stock of raw wafers in inventory, which was a deliberate move to ensure adequate supply at attractive prices. And number four, as YJ mentioned, we have already taken steps to adjust pricing with our customers to reflect increase in wafer costs.

And one additional note, our manufacturing team has identified other cost savings and efficiency methods in the supply chain and in the fab floor to mitigate the increase in wafer pricing.

When we look out upon the 2018 fiscal year, we believe, based on our current view of the business and the anticipated outcomes of the many steps we're taking to address headwinds, that we have the potential for gross margin in 2018 to be flattish give or take with the gross margin results recorded in fiscal 2017.

I'd like to remind you that our Q4 financial results can be found on our fourth quarter earnings release available on our website under the Investor Relations tab. With that, I'd like to share some selected financial highlights. Total revenue for Q4 2017 was $174.6 million, down 3.3% as compared to $180.5 million from Q4 a year ago.

Total revenue for the full fiscal 2017 was $679.7 million, down 1.2% from $688 million in 2016. Our top 10 largest customers accounted for 57% of revenue in 2017, down from 64% in the same period a year ago. Total gross profit in Q4 was $49.4 million or 28.3% of revenue as compared with $46.1 million or 25.5% in Q4 of 2016.

For the year, gross margin of 27.6% increased nearly 5 percentage points from 22.7% in 2016 due primarily to improved product mix, higher fab utilization, product portfolio optimization and completion of a headcount reduction plan.

Selling, general and administrative expenses were $23.6 million or 13.5% of revenue for Q4 as compared to $23.1 million or 12.8% of revenue for Q4 a year ago.

The increase in SG&A in Q4 as compared to $17.3 million in the last quarter relates to special charges taken primarily as a result of a tax audit by the Korean National Tax Services, or the KNTS.

As discussed in our 8-K filed on November 30, 2017, the aggregate tax and penalty assessed by the KNTS was $6 million, of which $3.3 million had already been accrued by the company. In addition, KNTS has assessed an administrative fine of approximately $2 million in connection with their tax audit.

One other item that I'd like to highlight is to remind you that SG&A in Q3 2017, which was $17.3 million, included an adjustment of certain accruals related to performance-based compensation expense.

For the time being, we continue to believe that our SG&A on a normalized basis will continue to trend at approximately $18 million to $19 million on a quarterly basis.

While we are on the subject of taxes, as you know, our operations are subject to income and transaction taxes in the United States and in multiple foreign jurisdictions, including Korea. We're examining the effects from the recently enacted U.S. tax law and we believe that the 2018 net P&L impact will be immaterial.

We recorded a net tax benefit of $1.2 million in Q4 2017 as compared to a tax expense of $0.9 million in Q3 2017. The difference of $2.1 million is due primarily to reversal of certain income tax liabilities as a result of a reassessment of our tax positions in Q4.

Research and development expenses were $18.1 million or 10.4% of revenue in Q4 as compared to $17.7 million or 9.8% during the same period in 2016. We continue to believe that R&D expense will likely rise in 2018 as we continue to invest in new initiatives, including new OLED products, to fuel profitable growth in the future.

Adjusted EBITDA, a non-GAAP financial measure, in Q4 was $20.5 million or 11.8% of revenue as compared with $14.1 million or 7.8% in Q4 2016. Adjusted EBITDA of $78.7 million in fiscal year 2017 increased 93.3% from $40.7 million in 2016. Turning to the balance sheet.

Cash and cash equivalents totaled $128.6 million at the end of Q4, about flat with $128.4 million at the end of Q3 2017. Inventories at the end of Q4 were $73.1 million as compared with $57 million at the end of Q4 2016 and $57.2 million at the end of Q3 2017. As mentioned previously, we deliberately added buffer raw wafer stock in Q4 of this year.

Accounts receivable was $92 million at the end of Q4 as compared with $61.8 million at the end of Q4 2016 and $86 million at the end of Q3 2017.

The year-over-year increase in accounts receivable reflects the timing of shipments, FX effects and a deliberate and strategic financial decision to significantly limit the practice of offering discounts to customers in exchange for early payments. The change in practice was possible by a substantial increase in our cash position from a year ago.

One item that I'd like to highlight is that all of our accounts receivables are current. Accounts payable in Q4 were $65.9 million as compared with $51.5 million at the end of Q4 2016 and $54.3 million at the end of Q3 2017.

The increase in accounts payable, in part, is attributable to FX and a deliberate strategy to purchase raw wafers in advance to shield us from the potential price hikes. Capital expenditures in Q4 were $13.4 million as compared to $8.5 million in Q3 and $7.4 million in Q4 2016.

For fiscal 2017, capital expenditures were $32.7 million as compared with $18.7 million in 2016. The increase was mainly due to equipment purchased to support an anticipated increase in revenue. The remainder was allocated to equipment maintenance and IT investments. We currently expect our capital expenditures in 2018 to be approximately $30 million.

Now I'd like to take a moment to discuss a new revenue accounting standard that became mandatory in 2018 for all publicly traded companies reporting under U.S. GAAP. We believe this new standard mainly affects the accounting of our Foundry Services Group, which requires our Foundry revenues to be recognized over time rather than upon shipment.

Although the timing of revenue recognition may change you to this new accounting standard, we currently do not believe it will have a material impact over time. Now let me sum up. In some respects, 2017 was a transition year for MagnaChip. We cleaned up issues and closed the books on items that were on overhang.

We also took steps to position the company for growth through relentless portfolio optimization, cost savings and by investing in businesses with the potential for the highest rate of return. I'll leave you with the same message from a year ago, we remain fully committed to the overall profitability of MagnaChip.

With that, I'll turn the call back to YJ.

YJ?.

Thank you, Jonathan. The impressive financial performance in Foundry and Power in 2017 were overshadowed by a soft China smartphone market and delayed introductions of new smartphone models that kept our OLED business on hold in Q4. 2018 is shaping up as a completely different story.

OLED is on track to rebound sharply and be a key growth driver for MagnaChip. We have more than twice as many OLED drivers in our lineup now than we had 2 years ago, and our customer base is more diversified.

Our growth will naturally depend upon the success of smartphones in the market, but we clearly are positioned better than ever to benefit from a market upturn. What about competition? It seems like every day, there are rumors about the companies with smartphone OLED drivers, but we have yet to see the product in the marketplace.

What about a new panel makers on the horizon? There's a big difference between running an R&D pilot line and manufacturing OLED panels in high volumes with high yields, low cost and high quality. Right now and for the foreseeable future, there are only 2 OLED panel makers who are doing that. We happen to be the only independent supplier to both.

To sum up, despite considerable market challenges in 2017, we executed our business strategy, improved profitability and set a solid foundation for growth in 2018. Challenges remain, but we also remain committed to once again focus on the overall profitability of MagnaChip and to invest in initiatives to fuel the future growth.

With that, let's turn now to our forward-looking guidance. Typically, Q1 is the seasonally slowest revenue quarter at MagnaChip. Last year, for example, revenue declined in Q1 2017 by 10.4% as compared to Q4 2016.

For Q1 2018, MagnaChip anticipates revenue to be in the ranges of $158 million to $164 million, down sequentially 7.8% at the midpoint of the projected range due to typical seasonal patterns and ongoing portfolio optimization activities.

The guidance for the first quarter compares with revenue of $174.6 million in the fourth quarter of 2017 and $161.7 million in the first quarter of 2017.

An increase in silicon wafer prices, a lower fab utilization rate due to seasonal factors and product portfolio optimization activity will result in gross profit margin to be in the range of 26% to 28%. This compares to 28.3% in the fourth quarter of 2017 and 25.7% in the first quarter of 2017. Now I will turn the call back to Bruce.

Bruce?.

Thank you, YJ. So Gigi, this concludes our prepared remarks. We'd now like to open the call for questions..

[Operator Instructions] And our first question is from Suji Desilva from Roth Capital. Your line is now open..

Hi, YJ. Hi, Jonathan. Congratulations on the progress in '17 year. So a question on the OLED smartphone market.

These projects that have been delayed, what's the situation in early '18? Are the programs being released ahead of MWC Barcelona or will they be launching spread out through '18? What's the status of those programs?.

Yes. So thank you, Suji. First of all, we had about 18 design wins end of last year, and we also disclosed today that we have more wins in last month. So of that, the 3 product has gone into production and the launch last year, so that leaves more than about a dozen right now.

And we can't disclose our product launches, but many of that we already shipped for the production, so we expect many of them will be introduced this quarter. And that's why we are very confident that we can grow more than 75% quarter-to-quarter revenue in OLED compared to Q4 last year..

Okay. Great. And then I don't know if you can discuss this, but the Korea flagship smartphone customer that you've won OLED there.

When will that ramp? Or is that already ramping?.

If you're referring to 110-nanometer, that has already been introduced last year..

Okay, that was already introduced. Okay. And then the non-display - I'm sorry, the non-OLED part of the Display business, just to understand how the Display revenues in total tracking.

Can you give us some sense there of what we should expect there? Is that flattish or are you pruning the portfolio there? What's the way to think about that?.

Yes. So we mentioned that there's headwinds on the non-OLED business in last earnings call, and we are emphasizing again this quarter. So just like what we've done in the power optimization to improve the gross margin of the Power portfolio, we are now starting to do that on the display side. So we are taking a look at each product line, each product.

And we are trying to optimize the portfolio as well as the product margin of display - overall display. So we have started to begin that work..

Okay. And then last question on the gross margins and the wafer tightness. Do you expect tightness to persist throughout 2018? Do you see an end to it potentially? And if I understand your guidance, Jonathan, you expect the 2018 to be similar to 2017. And you guided the midpoint 27% versus 27.6% from last year.

Is that the way to think about how gross margin plays out?.

Right. So that is correct. And as we think about the wafer pricing, the market's pretty dynamic, so it's going to be pretty hard to specifically pinpoint the way that the market's going to move, but we do see tightness out in the market. I mean, I think it is a common knowledge in the market that there's shortage with the raw wafers.

With respect to the way that we're looking at 2018 gross margin is that we've talked about a number of steps that we've taking to minimize the impact, including entering into long-term agreements, making prepayments and also beefing up on the buffer stock. So having said all that, we guided Q1 to 26% to 28%, midpoint being 27%.

And also we also made the commentary around 2018 gross margin that we see the potential of it being flattish..

Okay. I'll jump back in queue. Thanks, guys..

Thank you..

Thank you. And our next question is from Atif Malik from Citigroup. Your line is now open..

Hi. Thanks for taking my questions.

First, YJ, can you revenue rank your U.S., Korea and China customer exposure for your OLED business?.

Yes. So we haven't been giving the geographic breakdown, except that we've been mentioning that the - a lot of business now and customer happen to be the China smartphone makers.

So - but to give you more color, out of that 18 design wins that we had as of end of last quarter, we have more than 10 end customer smartphone makers, so it's more diversified. And so we will be either seeing already or be seeing a lot of product launch from all those customers in the Q1 going into Q2..

Great. And then your China commentary is a little bit different from some of the other semiconductor companies on the RF side, which are still seeing a slow China in the March quarter. Is it just a function of your design win that you're seeing better March quarter? And if you could just broadly talk about the health of the OLED smartphones.

I mean, the hole that we're seeing with the U.S.

smartphone maker units, can that hole be filled by other guys in China and Korea?.

Yes. So you're asking a very good question.

So first of all, as you know, I mean, if you look at our ramp this quarter and this '18, we are relying on revenue ramp based on all the new design wins with the new product that we introduced last year, the 4 new driver type that ranging from the low cost midrange to bezel-less midrange to ultra high-end with QHD+ with 21:9 aspect ratio.

And you are seeing our 18 designs and more coming with a different variety type and shapes and trench-type display, et cetera, to the new market. So that's why we have, I will say, a less effect than the China smartphone market that is slow, which impacted us in the fourth quarter. But this quarter, we are counting on the new products.

And what we are also hearing is that the - because of - there's an adoption to OLED in the smartphone for midrange and high end, that the LCD panel makers are pressured to drop their price because they don't have OLED. So I think that's the mixed results you are seeing in the market.

But the good thing for us is we are counting on the new product ramp, and I think this more than 18 design win is a reflection that the market is also moving to OLED because its brightness, crispiness and less power and much better display type..

Okay. And then at CES this year, we saw a bunch of new displays, the foldable, rollable OLED displays.

Can you just talk about your ASPs, or your opportunity? How does that scale as you move to foldable to rollable-type displays?.

Yes. Of course, we cannot anticipate or prelude what those phone may be because the product introduction has not has been there. However, what we can say is that we are ready to take - provide a solution for that kind of phone when it's ready. And I think, typically, in general, those will require more complex and more advanced AMOLED driver IC.

Therefore, the ASP or content could be better than what it is now in general..

Okay. And then last one for Jonathan. A quick clarification on the gross margin being flat this year.

Are you assuming that you will be able to pass the higher wafer cost to some of your foundry customers in that flat gross margin assumption? Can you just revisit that?.

Well, I think this topic is a delicate one, and we talked about the fact that we have raised prices on select power-discrete devices. And we also talked about the fact that we have already reached out to our foundry customers, and we're having discussions around various different pricing options.

And the main goal here is to make sure that the company could be positioned in a way where we can continue to best meet our customers' requirements..

Thanks..

Thank you. And our next question is from Robert Mertens from Needham. Your line is now open..

Hi. Thanks for taking my question. I just wanted to get a little more sense about the puts and takes around your Foundry group. I mean, you had a nice revenue in the previous quarter and again, the highest seen in this quarter. I just wanted to get a sense of how you view that business going forward sort of throughout the year.

And also, if you've done guidance with the different product lines up and down for the next quarter. I'm not sure if I just missed that part..

Yes. So thank you for the question. So typically, we do not give the guidance by product. So this quarter, what we did is give the guidance on the revenues range where the midpoint will be $161 million for the first quarter. We also provided color on the OLED that the - this Q1 quarter, we expect the revenue to grow more than 75%.

Other than that, we have not gave color on each of the product line, whether it's Power or Foundry. Going back to Foundry, we did have double-digit growth in 2017, and we also said the BCD and EEPROM is the key technology foundation growing every year. That trend is - continued to hold.

So - and we are doing our best to diversify customers and more, and that is the progress and trend of that division..

Okay. Great. And if I could just ask one more around utilizations. I know they were particularly high this quarter and last, but guiding into the first quarter, down.

How should we think about that being a part of the overall gross margin story throughout the year? I mean, are you expecting - is the lower utilizations just seasonal for the first quarter before trending back up? Or how should I think about that?.

So there's certainly a seasonal component of the utilization as - and as you are well aware, the utilization will impact gross margin. When we guided 26% to 28% for Q1, that lower utilization has already been baked in.

And so the overall commentary around gross margin for the fiscal year, we said there is a potential for 2018 gross margin to be flattish with 2017, give or take. And so as we look ahead, there is going to be a seasonal decline in utilization. But given that's seasonal, it should pick back up later on the year.

The other item that we talked about was the fact that within the non-OLED business, we are going through the process of product portfolio optimization. So there is a component there where utilization will be impacted. But in the longer term, we believe that, that's going to benefit the company, both on gross margin as well as profitability..

Okay. Great. Thanks for taking my questions..

Thank you..

Thank you. At this time, I am showing no further questions. I would like to turn the call back over to Bruce Entin, Director of Investor Relations, for closing remarks..

Thank you, Gigi. So this concludes our fourth quarter earnings conference call. Please look for details of our future events on MagnaChip's Investor Relations website. Thank you for joining us today..

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect..