Magnachip Semiconductor LLC (MX)

[eastunder]

Rating Action: Moody's affirms MagnaChip's Caa1 ratings; outlook remains negative

https://www.moodys.com/research/Moodys-affirms-MagnaChips-Caa1-ratings-outlook-remains-negative--PR_318642?WT.mc_id=AM%7eWWFob29fRmluYW5jZTQyX1NCX1JhdGluZyBOZXdzX0FsbF9Fbmc%3d%7e20150216_PR_318642


Global Credit Research - 16 Feb 2015


Hong Kong, February 16, 2015 -- Moody's Investors Service has affirmed MagnaChip Semiconductor Corporation's Caa1 corporate family rating, as well as the Caa1 senior unsecured bond rating on its USD225 million, 6.625% notes due 2021, following the filing of the company's restated financial results with the Securities and Exchange Commission (SEC) on 12 February 2015.

The outlook on the ratings remains negative.

MagnaChip filed its financial statements for the fiscal year ended 31 December 2013 (FY2013) on Form 10-K, which also included restated financial statements for 2011 and 2012. In addition, the company filed its quarterly reports on Form 10-Q for the first three quarters of 2014, with each report including the comparative quarterly financials for 2013 on a restated basis.



RATINGS RATIONALE

"The rating affirmations reflect MagnaChip's vulnerable business and financial profile, as revealed in its most recent filings of financial statements for the reporting periods from 31 December 2011 to 30 September 2014," says Annalisa DiChiara, a Moody's Vice President and Senior Analyst.

The impact of MagnaChip's restatement of its revenues and earnings was more significant than Moody's had expected. In particular, the restatement adjustments on revenue recognition were the most severely negatively affected in the first nine months of 2013, and totaled USD78 million, and additional factors contributing another USD2 million.

Company explained that the revenue adjustments were mainly related to correcting the timing and amount of revenue recognized on the sale of products sold through certain distributors.

The company also made adjustments to costs, which, when combined with the revenue adjustments, resulted in a restated operating profit for the first nine months of 2013 of just USD6 million; an amount which was significantly lower than the USD84 million the company had originally reported for the same period.



"Moreover, the weak financial results for fiscal year 2013 and also in the first nine months of 2014 indicate significant operational challenges, which, when coupled with the company's high level of expenses related to the restatement process and legal costs, have significantly deteriorated the company's profitability and cash flows," adds DiChiara.

According to the restated financials, the company reported a 9% year-on-year fall in revenues in 2013, and a 5% fall for the first nine months of 2014. The company attributed some of the revenue decline to a slower than anticipated growth of certain high-end smartphone OEMs, and the resultant inventory correction in parts of the semiconductor supply chain.

Lower revenues, combined with lower fab utilization rates, and the slower rate of business development also negatively affected the company's gross margins. As a result, MagnaChip's restated gross margins contracted to around 20% for FY2013 and for the first nine months of 2014 versus 30% achieved in FY2012.

In early 2014, the company started incurring significant costs associated with the internal investigation into the company's internal controls and the restatement of its financials, as well as shareholder litigation. Such costs totaled USD29 million as at 30 September 2014; further widening the company's operating losses, which totaled approximately USD80 million for the 12 months to 30 September 2014.

Moody's notes that the company's profitability and credit metrics deteriorated significantly in 2013 and 2014.

Nonetheless, the company reported a cash balance of USD125 million as at 30 September 2014. While MagnaChip does not have any scheduled debt maturities over the next 12 months, its interest expenses total approximately USD14 million in 2015.

The $225 million, 6.625% senior unsecured notes due 2021 is the only debt outstanding.

On 20 June 2014, the company was served a notice of default for breaching a financial reporting covenant under the bond indenture. Moody's current ratings for MagnaChip assume that the recent filing of the financial reports has cured the covenant breach and has averted a potential notes acceleration, which was due to trigger on 14 February 2015.

Management has also indicated that capex for 2015 will total just USD25 million, an amount which is approximately half the USD50 million three-year average for capex between FY2011 and FY2013. The lower spending will help preserve cash against the backdrop of weak industry fundamentals.

However, Moody's does not expect any significant cash flow generation from MagnaChip's operations over the next 6-12 months, given that the company's operating profit is expected to remain under pressure over this period.

While the company's cash position remains adequate at this time, higher than expected costs associated with efforts to resolve the material weaknesses in the company's internal controls and potential cash outlays associated with shareholder lawsuit, could deplete cash more quickly than Moody's expects, and present a more fragile liquidity position over time, particularly given that the company has no back up banking facilities in place.

Moody's notes that any delay in the filing of its financial reports could once again trigger a breach of the financial reporting covenant under the company's bond indenture.

The negative ratings outlook reflects the challenges the company needs to overcome to restore its operating and financial profile, including generating positive earnings and cash flows, as well as the successful completion of the remediation of material weaknesses in its internal controls.

Given the negative outlook, an upgrade of the company's ratings is unlikely over the near-term.

However, the outlook could revert to stable if the company:

(1) Resumes the timely filing of its financial statements with the SEC;

(2) Successfully turns around its operations such that operating profit turns positive on a meaningful and sustained basis;

(3) Maintains an adequate liquidity profile; and

(4) Demonstrates evidence of improved financial controls and practices.

Furthermore, a change in the ratings outlook would only occur if the pending litigation with respect to the class action lawsuit is resolved, and if the SEC's investigation is resolved, with limited adverse impact on the company's operating performance, including revenue growth, liquidity and cash flows.

On the other hand, downward ratings pressure could emerge if the company:

(1) Fails to file its quarterly statement for 1Q2015 or annual report for 2014 in a timely manner;

(2) Encounters any significant delays or hurdles in completing by 2015, the remediation of material weaknesses in internal controls;

(3) Fails to turn around its operations, such that it continues reporting operating losses; or

(4) Reports cash on hand below USD50 million.

Moreover, any additional findings of material weaknesses related to internal controls and/or any adverse outcomes of litigation or SEC investigation proceedings, such that the company incurs significant cash outflows, will also be negative for the ratings.

The principal methodology used was the Global Semiconductor Industry Methodology published in December 2012. Please see the Credit Policy page on www.moodys.com for a copy of this methodology.

MagnaChip Semiconductor Corporation is a Korean-based designer and manufacturer of analog and mixed-signal semiconductor products, mainly for high-volume consumer applications, such as TVs, PCs, mobile phones, and tablets.