Ladies and gentlemen, thank you for standing by and welcome to the Q2 2020 MagnaChip Semiconductor Corporation Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded [Operator Instructions]. I would now like to hand the conference over to your speaker today, Ms. So-Yeon Jeong, Head of IR. Please go ahead.

Thank you. Hello, everyone, and thank you for joining us to discuss MagnaChip's financial results for the second quarter ended June 30, 2020. The second quarter earnings release that was filed today after the stock market closed can be found on the company's Investor Relations website. A telephone replay of today's call will be available shortly after the completion of the call, and the webcast will be archived on our website for one year. Access information is provided in the earnings press release. Joining me today are YJ Kim, MagnaChip's Chief Executive Officer; and Young Woo, our Chief Financial Officer. YJ will discuss the company's recent operating performance and business overview, and Young will review financial results for the quarter and provide guidance for the third quarter. There will be a Q&A session following the prepared 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 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 -- on our SEC filings. During the call, we also will 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 second quarter earnings release available on our website under the Investor Relations at www.magnachip.com. Now I'll turn the call over to YJ Kim. YJ?

Thank you. Hello, everyone. Thank you for joining our call today. First of all, I'd like to welcome both, So-Yeon Jeong, our Head of IR; and Dr. Young Woo, our CFO, to their first earnings call at MagnaChip. Both will play important roles as MagnaChip opens a new chapter as a pure-play standard products company. I also want to acknowledge changes in our Board of Directors. Semiconductor veteran Mr. Camillo Martino was named Chairman in June and Ms. Liz Chung of Microsoft Korea joined our newly expanded Board in July. During the second quarter, our team executed well and delivered excellent results in keeping with our commitment to safety of our employees and continuity of services to our customers. We demonstrated our ability to be resilient to the impact of the COVID-19. We continue to take further steps to mitigate potential risks related to the health and safety of our employees and to the supply chain management. Key non-GAAP financial metrics exceeded our expectations. Revenue for the combined business came in above the high end of the guidance range due to strong demand in our Power and Foundry businesses. Gross margin surpassed expectations driven by improved product mix and higher fab utilization. Non-GAAP diluted earnings per share from continuing operation was $0.13 as compared to $0.03 in Q1. On a sequentially flattish revenue, our bottom line improved due to higher gross margin. For the fifth consecutive quarter, we generated operating cash flow. In Q2, the cash flow from operations was $36 million. At the end of second quarter, our cash balance increased to $192.8 million, marking the highest level since the IPO in March 2011. In addition to delivering outstanding financial results, our team has made substantial progress with the pending sale of the Foundry business and Fab 4. I…

Thank you, YJ, and hello, everyone. It's nice to meet you over the phone. I'm very excited and honored to join MagnaChip and to drive its transformation with a great team, and I look forward to engaging with our key shareholders. Before I go into the financial review, I would like to reiterate that we believe segregating the transition of Fab 3 Foundry Services revenue from the continuing operations revenue provide investors with a better understanding of our core business result. Revenue in Q2 from continuing operations without transitional Fab 3 Foundry Services was $109 million, up 1.6% from Q1 and down 17.5% from Q2 a year ago, which was primarily due to the COVID-19 that negatively impacted the global smartphone market. Both sequential and year-over-year decline was also attributable to the strategic exit of non-auto LCD DDIC business, which accounted for $6.3 million in Q1 2020 and $9.6 million in Q2 2019. Display revenue in Q2 was $69.2 million, down 10.8% quarter-over-quarter and down 70.9% year-over-year. The decline in the Display business was in part due to the above-mentioned exit of non-auto LCD business. Power revenue in Q2 was $49.8 million, up 20% quarter-over-quarter and down 16.7% year-over-year. The sequential improvement of the Power business was due to a solid rebound in the China market. Non-GAAP combined revenue from both the continuing and the discontinued operations in Q2 was $204.7 million, which exceeded the high end of the guidance range. It was up 3.9% sequentially and flattish with the same quarter a year ago. The sequential improvement was attributable to the increased revenue from our Power business and discontinued operations, which offset the decline in the Display business. Before I go into the gross margin detail, I would like to remind you that when the business is labeled discontinued…

Thank you, YJ and Young. So operator, this concludes our prepared remarks, and we'll now open the call for questions.

[Operator Instructions] Your first question comes from the line Raji Gill from Needham & Company. Please go ahead.

Thanks for all the details. They're very helpful. And congrats on good momentum despite the volatility in the industry. YJ, a question on the OLED business. You talked about, I think, inefficient lead times. I was wondering if you could kind of elaborate further in terms of what's going on regarding capacity to meet OLED. And how do you see kind of the smartphone market shaping up to be in the second half? There's many new product launches that are happening. So I wanted to get a sense of how you're looking at the smartphone business in the second half and how that could affect your OLED business. Thank you.

Thank you, sir. So he asked a couple of questions there, so I'll try to answer one by one. So yes, we are seeing uptick recently. And as you know, on the 12-inch, the -- it's not just the 12-inch but the OLED, the lead time -- standard lead time takes about 2.5 months to 3 months from a wafer start to go into then wafer out to the back-end assembly test or testing. So that's about 2.5 to 3 months' time frame. So let's say, if we get some uptick in demand that we don't have additional inventory than we have, then you have to go through that 2.5 to 3 months. So it's a fortunate thing that the -- right now, the demand is outstripping our supply capability. So we'll continue to address that. I think it's a good thing. On the second, in terms of the visibility for smartphone market, again, we are still facing COVID-19, the global pandemic still. So the outlook is murky. However, I think the situation for every vendor will be different. But as I said recently, the demand is outstripping our supply for the current quarter, and then we will talk about the first quarter for the -- at the next earnings. But right now, that is our current situation.

Okay. And on the rebound in Power in China and the strong sequential growth of about 20-odd percent, how do we think about that going into the second half as well? The Power business grew quite significantly the last three quarters of 2019, and then there was a big inventory correction in Q4. But you're going up against some tough compares in the third quarter. But how do we look at kind of the Power business going into the back half of the year?

Yes. So very good question. So I see a strong demand in Power as well, in general. So we see the momentum there in the market. So again, I can't give you a 6-month forecast, but I feel good about the demand that is being generated on the Power as well. So -- but combined, we are guiding between $118 million to $224 million for this quarter for OLED, those product line on the third quarter.

So if I look at -- if I strip out the transitional services and at the midpoint of your guidance, it's about $111 million and in Q2 for both Power and Display was about $109 million, so about $2 million sequential increase but down from the third quarter of last year, which was about $139 million. So the year-over-year decline in third quarter is primarily related to, would you say, the smartphone display -- the global COVID-19 impacting smartphone and power? I'm just trying to understand the year-over-year decline.

Yes. So I think the -- this year, the industry faces a slowdown, as you know the whole semiconductor. So that's what have been. But I think despite the uncertain pandemic, I think we showed very good -- relatively good results in the first half. When the smartphone declined 20% year-over-year on the first half last year to this year, we grew 12.4% on OLED. But in the second half, I think it's -- we remain optimistic. But at the same time, the visibility market due to the global pandemic there. But in general, we're showing incremental from the second quarter.

And just last question for me in terms of the gross margins, and I'll get back in the queue. So the -- there's a drop in gross margins because of that power outage. You said it would have been higher. But it's still, I think, below what it would be in 2Q. And so I'm just want to understand that. And then you talked about kind of achieving a 30% gross margin in a few years. Wondering -- without giving too much specifics, what are the drivers of the margins to get above 30% in a few years? I mean if I look at this quarter, you already did $29.5 million in standard products on a normalized level. So you're almost there already and putting aside what happened with the power outage in 2Q, I mean going to 3Q, you're kind of close to the 30% if I'm looking at it on the standard products. So just want to get a sense of how you're kind of thinking about 30% and what's going -- what's underneath that.

Yes. So again, you asked a couple of questions. So let's -- let me clarify one by one. So on the Q2, if you look at the continuous operation, our gross margin was 27% that includes the transitional service. On the Q3, if you look at our earnings release, we said, without the power outage, the gross margin would be in between 27% to 29%, which puts it at 28%, which is upward trend from 27%, okay? So that's the first answer for that to clarify. To your really good question, let me try to answer. So we are looking for sustainable gross margin improvement. If you look at our past history, we have really good quarter, and then we fluctuate. Our goal is to really get sustainable gross margin above 30%. So that is our goal. And how we're going to do that? We'll do a disciplined investment in existing business, going up to attractive markets as well as attractive portfolio, reestablish power manufacturing process R&D and the technology pipeline in Fab 3, and we will also consider any synergistic, accretive, inorganic opportunity if it presents itself. So -- and we will consider all available option to accelerate the profit or growth and being accretive in EPS. And that's our goal. And that's what we're talking about is a sustainable that is above 30%. And as I said before, first, we'll shoot for 10% operating adjusted income, and then we'll move thereafter upwards. I hope that answers your question.

Okay, great. Yes, I just do want to clarify on the gross profit margin. Because I'm looking at the press release, and it says gross profit margin for standard products is 29.5%, which I'm assuming is Display and Power and Foundry was 32.3% and then you're saying 27% for continuing operations. So I'm just confused at what's the difference between the standard products. What's in that 29.5% for standard products? And why is that different from 27% for continuing operations? Is that the transitional services?

Yes. The transitional service at $10 million is at zero cost, zero margin. That's why when you sum those up, that becomes 27% in the Q2.

Okay. But you did 29.5% in Display and Power, collectively.

That's right. That's right.

Okay. Great. So that was my question that you're going to be in power and standard business going forward, and you're -- you did 29.5%.

We're going to have transitional service for the next 3 years.

No, I understand that. But that could be netted out. Okay. I got it. All right. Thank you so much.

Thank you.

Your next question comes from the line of Suji Desilva from ROTH Capital. Your line is open.

Hello YJ and hello Dr. Woo, good luck in the new role here. So YJ, in terms of the under-shipping of the OLED versus the customer demand, is there anything you can do from the supply side to address those? Or will these persist given your Foundry arrangement?

I think we have enough capacity between multiple Foundries. It's just that lead time, right? So when you have a really uptick in demand, we have to act quickly. And so that's what this is about. But it's a good problem to have. So, I think because of the pandemic, people's forecast has not been as accurate. So I think that's what's happening. And when we have uptick, it takes time to adjust, and we're doing our best to -- so that we can deliver much better results.

Understood. So the challenge is sending the right order size to the foundries. And then the smartphone, the programs you've won, you've won quite a few. Are you seeing any either pull-ins or delays of those programs? Or are they all progressing to the targets in the second half?

So, I think it's important to realize that when we win so many design wins like cumulative over 45, each product launch, some could be hit or home runs or bats. But overall, we are seeing the momentum in our product and portfolio and design win. And also, it's really up to the smartphone makers being successful in the market. So that's outside our control, but I think the trend is that we keep winning, and there's more product launches and more pipeline on our product line. So -- and we feel good about it. And we're also expanding into automotive. First, automotive taped out. Obviously, the automotive, you're not going to see their revenue until next year. But again, we are diversifying, and we are going into more higher premium product line as well in the OLED, and you will see more of this in the future.

Okay. And then last question on the Power segment. I don't know if you've provided the percent that's premium products for the Power segment. And as the premium products grow, I presume the ability to sustain 30% plus gross margins in Power increases. Or does it depend on Fab 3 utilization you've transitioned over? What's the kind of the premium product mix and trend? And then how is that going to help the margins be sustained at these higher levels?

So recently, last, I would say, four quarters, our premium product line was around 50%. So our goal is to continue to increase the premium product portfolio. Obviously, appropriate CapEx that Dr. Woo laid out today is needed to strengthen our product line as well as portfolio, and that margin improvement will follow, having more competitive product in the road map. So I think that all that will lead to a better margin improvement to follow.

Okay. Thanks guys.

And your next question comes from the line of Atif Malik from Citi.

Hi. Thank you for taking my questions. YJ, you gave a couple of interesting numbers, and I have questions on them. The first one, you said 5G smartphones are about 20% of your OLED sales. And I'm curious, how does this percentage grows, let's say, over the next 12 to 18 months? There are interesting share shifts happening in China with the Huawei situation and the Korean -- the smartphone makers better positioned to take share. Also, there are issues happening with China and India. So I'm just trying to understand, does your mix of 5G smartphones accelerate at a higher pace than the industry from this 20% number that you currently have over the next, let's say, 12 to 24 months?

It's a very good question. Thank you. So if you look at market research, I think they estimate about 17% of 5G is smartphone this year. And obviously, we did about 20% in first half. So it's not too far up, but we're still doing slightly better than what the market research said for the whole market. Going forward, I think, yes, there will be more 5Gs. And one of the key features that is happening in 5G is 120-hertz screen and potentially up to 144 for QHD+. So as we said, we have 5 products that we have HFR capability that we launched that becomes a key feature for the 5G. And that HFR feature also allow you to do more virtual reality and games, which is also important as the pandemic, I think, is changing some of the habits and the word of the smartphone users. And the 5G is also continuing to grow with the IoT as well as the autonomous driving and other new applications. So I think 5G will continue to grow. And one of the key features on the 5G is, A, you like to use OLED screen because OLED consumes about 25% less than LCD. And with OLED, you want to have this 120-hertz refresh cycle capability for better AR, VR and gaming. So that's our view.

Great. And the second number that caught my interest was this double-digit compounded annual growth rate in the standard Power products or the premium product you mentioned over 2020 and 2023. You talked about a design win with the Power IC solid-state drive. Can you give more color on the end market that you're going after to get to this double-digit growth over the next few years?

Yes. So our goal is to grow double-digit in -- across all our line, whether it's Power or Display. On the Power, we explained that the -- we won a new major application in solid state. Traditionally, our Power IC was more hovered around TV application. Now we're expanding into the solid-state drive. We are also expanding to the -- some other IT segments. So we are diversifying our Power IC from TV consumer-centric to more different segment and the computing segment and later to potentially industrial and so forth to help with the premium portfolio product line in our Power business.

Great. Thank you.

And I'm showing no other questions at this time.

Okay. Thank you. This concludes our second quarter 2020 earnings conference call. Please look for details of our future events on MagnaChip's Investor Relations website. Thank you for joining us today. Goodbye.