Integrated Micro-Electronics, Inc. (IMI) Earnings Call Transcript & Summary

Good afternoon, everyone. Welcome to IMI's quarter 3, 9 months operating and financial briefing. With us this afternoon is IMI's CEO, Arthur Tan, who's going to present the operating environment in the EMS industry; IMI's President, Jerome Tan, who's going to provide highlights of the operations in IMI Group; and IMI's Chief Finance Officer, Laurice Dela Cruz is going to provide the financial highlights for quarter 3. Please reserve your questions after the end of the presentation as we are going to entertain them in the Q&A. Thank you.

Thank you, Anthony. I guess I'll go ahead and start if that's okay with everyone. First of all, thank you for finding time and being able to join us this afternoon here in Manila, and then we'll go ahead and try to give you a snapshot of how the first 3 quarters have transpired for IMI and specifically the third quarter this last quarter. Let me start by just kind of painting a picture for what I would assume most of you are already familiar with and have been tracking very substantially during the last months. As we know, the world continues to be a volatile place, although the indications have shown that the recovery on a global basis is ongoing. We're starting to see some muted projections for 2022 primarily because of some of the tail of the issues that we are actually entered into in 2019 and 2020 that is still continuing to manifest itself and certainly affects several markets, both directly and indirectly for everyone, including the electronic industry and of course, including IMI. What this chart does indicate is that on a forward basis, where you can see that there is still a growth pattern that's being led by the developed markets followed by the emerging markets. And of course, China continues to be a robust one. What's kind of holding it back for us, as we know, is some of the geopolitical trade issues that is lingering, although we're seeing some opening of that as well as the supply chain issue, which is actually first and forefront for a lot of the different markets that we serve. Next, please. So the one -- the initial catalyst for a lot of these volatility, which was a health issue that morphed itself to definitely an economic issue is the COVID-19. And as it continues to have its tail because the vaccination has not been linearly done across the world, and what we're seeing is that the vaccination rate for some of the developed countries are significantly higher as composed (sic) [ compared ] to the emerging countries. And based on the globalized supply chain, there is a significant amount of interdependency between the emerging market and some of the products and components that are actually being built there as well as some of the manufacturing, the core manufacturing facilities in spite of the consuming part of the world, which is the developed part of the economy that's already started to come back. So we see that there is an increased demand, and these are manifested by the fact that the services part of the industry is still challenged because of the COVID. And so the disposable income has been geared towards more the goods rather than the services. And then this brought about by the limitation of the semiconductor facilities to produce enough chips to be able to support the demand side for all the different markets, mobility, the CCC and as well as Aerospace and Defense. On top of that, we've had a container shortage and predictably, a lot of the deployment of the storage containers were done during COVID for nongood services, but actually to be able to deploy a lot of the PPEs and other materials needed in order to combat the infection rate that is happening across the world. Now being part of that is they're finding its way back into the main trade zones and hubs has been a long arduous process and has been very costly, and it's now -- we're seeing now the effect of that. There has been a considerable amount of effort that's been done in order to alleviate that. And right now, at least, in spite the fact that the lead times have started -- is still quite out there for certain material, the time frame for being able to plan around it is easing up and getting a little bit better. Port congestion, as you know, is already part of that, again, primarily because of lockdowns and everything else and also the limited number of staff that is allowed in a given workspace and area also compounds that problem. On the factory part, there's been less and more and less factory shutdowns that we see. Now it's actually being done at the OEM level, where we're seeing this and primarily because of just not having a complete bump of all the materials needed in order to complete the product. And that's the reason that's forcing the shutdown. It's no longer being forced to shut down because of the epidemic or the pandemic but more so now because of supply chain. And then the other part there is the labor shortage. These last 2 years, the work from home environment, the amount of money that have been deployed on the social infrastructure in order to help alleviate the people that are actually no work, no pay situation has -- is still drawing out. And so we're starting to see governments now easing back on that, and therefore, we expect that the labor shortage will also be normalized as we move towards the end of the year. Next. So my last -- from my side here is just the global manufacturing [ and electronics PMI ]. What you notice here is that we still are in an expansion mode last September at 54.1. And so we're seeing some of this. There's been some normalization that came down. And primarily, this is driven because of labor and material shortages. However, the demand side is still there. We're seeing an increase in backlog. And so what we're anticipating is as the amount of shortages starts going down, and it's not going to be an immediate one, but it's going to be a tail. The materials that is available for certain markets will allow it to recover faster than those that are customized for specific products. So we'll see the general products, which uses more standard devices to recover first, and then thereafter we will be the ones that actually use more of the customized ASICs. Moving forward, I guess our view here is that we're continuing to see some healthy projects coming down the pipeline, which is why we're very, very optimistic on the strategy that we have set forth prior to the pandemic. The digitization is moving at a pace far faster than what everybody anticipated. The need for putting more focus on the carbon neutrality for all of the different industries, and this could only be done through a significant amount of technology anchored on electronics. And then the last part would be the -- this directional shift that the whole industry in mobility space have taken and has put in a stake on the ground on specific years that all these OEMs will be transitioning to a full EV platform. And then that will be coupled by autonomous driving in order to alleviate the need for more roads, but more highly optimized utilization of the infrastructure that we have. So under that premise, we feel very confident about the strategies we have set forth in IMI. The team, led by Jerome, continues to focus and deliver on the key things that is necessary in order to allow us to be prepared for the coming surge that we anticipate. At the same time, be prudent enough that we continue to work and he's going to -- and we can show this to you as far as the recovery of the company on a financial basis. So with that, I would close and transfer back to Jerome for the -- and Lau for the details, and then we'll hold and talk to everybody again later when we get into the Q&A portion. Thank you.

Thank you, Art. We'll start off with the Q3 segment updates. Our Q3, we closed total revenue at $326 million. The growth was a bit muted in Q3, only up 4% versus same period last year. I think 2 factors. One is in Q3 2020, we started to see the economies opening up, and the recovery started last year. So there was an increased growth in Q3 in 2020. So coming off that, this year, the growth could have been higher, the second factor affecting it is the component shortage, right? So as of Q3, end of Q3, our total backlog has increased to close to $90 million. Compared to Q2, our backlog was more around the $60 million. So that continues to be a challenge for us. If you look at our automotive, it's actually down 3% versus last year. Again, the bulk of the backlogs that we have are going into the automotive segment. We have approximately $40 million of backlog in the auto segment. And as you -- as we navigate through this quarter, we also start to see the component shortage spreading from initially the automotive segment going into the industrial segment as well as the other segment. But the 2 main segments that are being impacted by component shortage the most is the automotive and industrial. The -- as Art said, the good news is the -- on the automotive side, we continue to still see very strong pipeline for new projects. And a lot of the projects that we're seeing also are in the renewable or electric vehicle space. So that, I think, going forward would drive a lot of the growth in the automotive segment. On the Industrial segment, as I mentioned, the component shortage continue to spread, so not necessarily just the chipset, but also spreading into other components like MCUs and PCB as well, and we're starting to see price increases in those passive as well as PCB and electromechanical space. A lot of the growth is still coming from the security devices as long -- as well as the asset tracking business. In Q3 also, we're seeing the similar situation happen in the aerospace and defense. The component shortage also is creating a number of backlogs in our Aerospace and Defense segment. So although, it's still growing at a healthy pace at 8%. In the telecom sector, we see the supply chain issue being resolved. I think in the second half till the rest of the year, we expect our telecom infrastructure business to continue to see stronger growth as the supply chain issue has been resolved starting in Q3. And so year-to-date, our total growth in revenue is about 23%. If -- assuming we don't have the backlog, it would have gone -- increased by about 35%. So a big impact on our top line as well as our margins coming from the component shortage. Next page, please. So looking at the individual regions. So the Philippines, which is mainly industrial, you'll see -- and China as well, you'll see a positive growth of 6% and 10% in the third quarter. This is mainly the effect of the component shortage in the Philippines, in particular, only started to manifest itself later on in the quarter and China as well, strong growth is coming mainly from the telecom sector, wherein we saw improvement in the supply chain. The biggest impact for us in terms of growth is Mexico, where a lot of the automotive customers have challenges securing components. Therefore, the main drop in growth in Mexico is really driven by the component shortage. In addition, because a lot of the components are sourced from Asia as well as Europe, it also suffered higher freight cost and logistics issues having the supply coming from different regions. For VIA and STI, we see we are starting to ramp up on the electric vehicle in the new Germany facility. So we expect that growth to continue into the fourth quarter and into next year. As I mentioned, STI, where we have the aerospace and defense business as well as some of the industrial business, we see a more -- a bigger impact on the component shortage starting in Q3 as opposed to first half. So that also have a muted effect on the revenue or top line of this business. Next page, please. In terms of wins, in third quarter, the win was much lower. Total wins that we had in Q3 was $47 million. Although if you look at our year-to-date total wins, we're totaling 352 for the first 9 months of 2021. This is already hitting the same level as our full year 2020, particularly on the wholly owned subsidiary, the one with the bracket, 287 new wins year-to-date. September, that's already higher than our 2020 and 2019 full year new wins, and we expect this trend to continue. We still have a very strong pipeline, and we have a number of projects we expect to close beginning of this fourth quarter. I guess similarly highlighted in our last analyst meeting, a number of major projects that we've won is related to electric vehicles. So the first 2 items in the notable wins, these are major programs, each I think the first one is around $60 million of our annual revenue potential, and the second one is about $30 million of annual revenue potential. So we do see our ticket sizes in terms of new wins growing as well, as well as a lot of growth coming from the electric vehicle space. And then I'll turn it over to Lau for more of the financial highlights and metrics and then I'll close later on. Lau?

Good afternoon, everyone. So I'll just continue the presentation of the financials. And this is to show you the quarterly performance of the group. As you can see, we still increased our revenue from Q2 from $319 million to $326 million despite the additional backlogs that we have in Q3 of about $28 million, but this is a bit lower than what we have reported in the first half. So although the revenues are increasing, you can see some challenges in the margins, and this is because of the continuous suppression in the supply chain as the new rounds of government mandated restrictions slowed down the business and also the recovery of our suppliers. Some of the major factors that are affecting our margins are more on the materials side. So prices of the materials began to increase in Q3, and we are seeing around 2% of increase compared to the first half wherein we still benefited from the price or cost reductions on our purchases that we had from last year, wherein we have savings of around 0.9%. We have -- we are trying to pass it on to the customers, but of course, there's timing between the price increase and the price negotiations, because some of the businesses we have, the bidding or the negotiations happen like every 2 years. So we expect to pass it on for the next year or maybe some of those can be passed on next quarter. The other issue is the continuous increase in the freight cost due to high demand and port congestions. Our -- the cost of freight now is 500% higher than last year. For example, on a standard 40-foot container, the prices last year was just about $2,000. Now it's more than $10,000, $10,000 to $15,000 and that brought our freight percentage to sales from 1.3% last year, now it's at 1.9% of revenues, and that's affecting our operating income. If you can see there's a gap of around $4.9 million here. Same with the net income, the gap is around $4.9 million. On a non-GAAP basis, it's around $3.7 million difference between Q3 and Q2. And out of those -- out of that gap, around $4.5 million is linked to the materials, combined material increase and the freight cost increase. Another factor is on the labor side. And because we have a lot of mandated wage increase in our China factories and also we have some unplanned salary increases to address the high attrition. And we tend to use more contract workers, which we know are more expensive because of the attrition, right. Then moving on to the next page, just to split the wholly owned subsidiary performance versus the non-wholly owned, VIA and STI. You can see that there is a slight increase in our wholly owned revenues, $2 million, and this is mainly coming from Philippines due to the recovery of our -- some of our industrial security, the power module business and also consumer business. Also, China, the -- our telecom business in China recovered in Q3 as the forecast of the customers are more stable now and the component shortage issue has somehow eased off. But this was offset by the worsening situation in our Mexico and Serbia -- specifically Mexico and Serbia factory, wherein we experienced a decline in the revenues. And with that, because of the low utilization, we experienced -- we incurred some losses in those sites wherein we have low revenues because of low utilization. On VIA and STI, it improved by $5 million, and this is mainly coming from VIA because of the ramp-up of the new automotive business, but slightly offset by STI because of the material delays and some of the businesses were pushed out to next year because of the availability of the components. But you will see that we're -- the combined net income of the 2 are still in a negative position, because VIA had some increase in the R&D expenses and also they have front-loaded some of their resources in preparation for developing the new products for Q4 until next year. Okay. Moving forward to the capital structure. Just to highlight here that we have some decrease in the cash mainly $36 million decrease coming from the operating activities, and the main reason are the increase in inventories around $85 million increase in inventories, and that could be linked to the backlogs that we have. Also, we have some investments of around $24 million CapEx in preparation for some expansion projects for next year. We also increased our debt from about $63 million increase of our debt, $40 million of that was used to redeem the preferred shares we have with AC Industrial and the remaining $23 million are used for working capital and CapEx. And the decline in the equity is because of the redemption of the preferred shares, which brought -- which increased our debt-to-equity ratio from 0.41 to 0.63. Okay. And our book value per share now is at PHP 9.51. So we are trading below book value. I think we closed today at PHP 8.51. Okay. And as mentioned earlier, we began investing again on CapEx and the CapEx of $24 million this year are attributable to VIA and the Philippines because there are some expansion and new projects in VIA and Philippines. Great. Then just to close on the final slide, maybe I'll turn you back to Jerome for the key takeaways.

Thanks, Lau. I think key takeaway is really the component shortage challenge now compounded with the logistics challenges as well and the very tight labor market. Originally, we thought that it would start to at least have some sign of easing in Q3, but because of the surge in the pandemic or COVID-19 in some of the Asian manufacturing centers where a lot of the chip back end assembly is done, that extended the recovery period. At the same time, it seems like the component shortage also is spreading towards the other segments like industrials and aerospace and defense. I think the good news there is it seems like a lot of the -- or at least our customers acknowledge that there is inflation arising from this component shortage and the logistics issues. So a number of them are quite open to adjustment in the prices. So particularly more on the industrial segment, that one is easier to pass on as the prices are really reviewed more on an annual basis. On the automotive segment and also industrial, the benefit there is they have, I think, more flexibility in terms of substituting with alternate components if there is a tight component for a particular volume. Unlike in the automotive, it's more -- they're more sensitive or more difficult for them to really switch alternative components without revalidating because of the safety requirements of automotive. We do see, however, a number of our -- a majority of our automotive customers are open to price negotiations, which most of them we will do in end of this year for our pricing next year. So we do see next year, we would be able to pass on a significant portion of the increased cost in logistics on the freight and costs and freight out as well as some of the increases in energy costs, labor costs as well as the component increases. We also continue to see a very strong pipeline. I think with the recovery of the component shortage and supply chain towards maybe mid to second half of next year, that will be able to support strong demand overall in our segments that would enable us to recover a lot of the backlog and grow -- or go back to the growth that we're seeing pre-pandemic. I think those are the main highlights and key takeaways. I'll open it up now for questions.

[Operator Instructions] Maybe I'll start the question. First, what's the effect on your China factory on the current China power outages and rationing?

On the -- we're monitoring it quite carefully. So far, the impact is, I would say, there is some impact, but not yet substantial. A number of our facilities, particularly the one in Jiaxing is still considered Grade A. So in terms of allocation of power, they would be the last one to be reduced in terms of power consumption. So, so far, not a big impact, the impact we do see is coming from some of our suppliers, particularly in PCB because they -- some of the suppliers are affected by the power shortage. So we do see some of the tightness increase in PCB prices -- sorry, in the PCBs as well as increasing prices in the printed Circuit Boards.

Okay. Here's a question. What area in terms of logistics ate most of your margin?

I think that would be, in particular, in Mexico, because as we mentioned, a number of their supply is coming from Asia. And as Lau mentioned, the freight charges for these components coming into Mexico has increased, sometimes almost 5x in price. So what we're doing now is trying to look for alternative sources within North America and maybe from Europe, which is a closer location to source. But that's the area where we see significant impact on the freight. But it's mainly across the board, but Mexico is the biggest impact.

There's another question. Maybe providing more highlights on what happened in Serbia and Mexico during the past quarter.

Maybe I'll take -- I can take that. It's really, again, component shortage. I think in Serbia, one of our customers in industrial segment have a component de-commit from the suppliers, so they were not able to meet the target deliveries. And so we're working together with our customers, because these are customer nominated parts as well, trying to get allocation from the customers into our Serbia facility. In Mexico, it's the same story. There are a number of, I think, particularly some of the customers, which is requiring that NXP chipset as well as I think one semi is the other one?

Semi. Yes.

Yes. Those 2 components are difficult to come by. Again, these are customer nominated suppliers, also the customers are trying to help us do the allocation. If you recall, NXP also had that severe winter -- or sorry, a severe storm in Texas where there's -- they have a lot of their manufacturing facilities there, so that also added to the tightness in the supply.

Another question. When do you expect the component shortage to bottom out?

We think it's most likely will bottom out in Q1. Well, no, sorry, maybe Q4. We think Q1 we will start to see improvements. But I think the more significant recovery probably would be second half of next year.

And to add to that, we're also seeing material price reduction in the second half of next year. So at least -- but for the first half, probably the prices will still be high.

And here's another comment. That is, car and electronic industries are converging. And well, the company is in the middle of it, and how are you having difficulties and how do we address this?

Sorry, Anthony what's that one?

The convergence of the car and electronic industry and IMI is in the middle of it and how are we experiencing the difficulties and how do we address it?

Let me take a stab on that to start, and then I'll let Jerome finish up. I guess the convergence is happening. There's no question about it as the platform evolves to an electrified platform, then there will be more and more dependence on the electronic part of the vehicle design. Now given that, there's also going to be less parts that will be then used -- less moving parts in the vehicles. What's going to be consistent is that irregardless of whether it's an internal combustion engine platform or an electrified platform, there are certain things that is required for a vehicle to function on the road, and this is where IMI is actually thriving in. We're still very much involved in the electronic systems, subsystems for certain functions of vehicles that is necessary whether it is an internal combustion engine platform or an electrified platform. And then there are those specific capabilities within IMI that is centered on the EV platform itself. And that's where we're seeing all the significant new wins that we're seeing. So on a pipeline basis, our current pipeline continues to serve this transition as the platforms are converging. So we're not going to lose any of that. What we're seeing is that more and more the transition to an electrified platform is accelerating. And so we see that now. The challenge there, and this is not unique to IMI, is that as more dependence go into this electronic market, the more there is a dependence for the semiconductor components, but that's not unique to IMI. That's unique to the entire industry. And everybody globally down to the policymakers, the governments, the supply chain itself are addressing that aggressively. And I mean aggressively that we're seeing several new mega factories for chip manufacturing that's actually being built in locations that in the past, we were not even looking at. And so there's going to be a decentralized value chain that's going to emerge out of this pandemic. And that will just help companies like IMI for us to be able to multisource our supply chain and then be able to then serve a wider breadth of customers. I don't know if Jerome wants to add anything to that.

I think not much. As you pointed out, we are seeing -- we're in the midst of it, and we are seeing more and more projects. If you look at our pipeline, we have a lot more projects now directly related to battery management, power management, unlike before, it's more electronics, not specifically for power management.

Here's another one. Is IMI able to participate in solar energy project? Or is it purely under AC Industrial?

I think not so much directly. IMI, we don't -- we do -- we have projects related to DC to DC borrowing where there -- but it's more the component around the solar. But I think ACI is more directly into the solar.

Yes. Let me qualify that statement a little bit in the form that one of the major ACI companies that is directly involved in that solar space is Merlin Solar. Underneath Merlin Solar, there are key IP-related technology platforms necessary for it to be able to serve that unique applications in the solar space. And in that, the one major griding process for Merlin is actually done in only one location in the world, and that is done in Laguna under IMI. So in that sense, we are very much involved in that entire supply chain for next-generation solar technology that's going to come out of Merlin Solar under ACI. Now the adjacent component for a solar system is what Jerome was mentioning, which is the power inverters, which continues to be a very key requirement for putting a solar system into play. So that part, IMI is also a touch point because we're producing those specific power modules necessary for this uptake in the solar industry, regardless of whether it is Merlin Solar or any other solar technology. So where IMI is actually involved on 2 fronts, both under the ACI umbrella for Merlin and also from a general just the solar renewable market that taking off for our power modules. I hope that answers that.

Thank you. Another one. Do you think fourth quarter performance will look similar to third quarter?

I can answer that, and then Lau can add. I think Q4, well, the challenge with Q4 is there might be some seasonality, right? So some of the locations might be closed, particularly in the Philippines, Mexico. But at the same time, we think the margins should improve because as I mentioned, a number of the increases in the logistics cost and labor costs, where we have been in the midst of our renegotiating with the customers in terms of pricing. So I think we should be able to start passing on some of these costs, albeit maybe not a very significant cost passed on in Q4, but we do expect the costs to be passed on or increased passing on that cost more towards Q1 next year.

And yes, just to add to that, Q3 we have a low month, which is August, because it's a holiday for the Europe, and the same with Q4, December is historically a low month also. But in terms of revenue, yes, we're banking on should there be some recoveries from the backlogs. And as mentioned by Jerome, if we will be able to pass some of the cost in Q4, then Q4 should be better in terms of margins.

Although what we see is in terms of improvement in the recovery in the backlogs, it's still going to be quite challenged. Strong EBITDA improvement might come...

Next year.

From lower -- or passing of the raw material and some of the freight costs in Q4. But I think bigger improvement we will see next -- starting next year.

Yes.

Okay. I think the chat box for Q&A is already empty. I think that's it for this afternoon. Maybe Art, Jerome, just final words.

I'll let Jerome speak a little, and then I'll close.

I think, as Art mentioned, it continues to be a challenging Q3. And I think this year for the rest of the year, we continue to see a challenging environment in terms of the shortages, logistics issues. I think we do see some light at the end of the tunnel. I think as Art mentioned also, a number of the semicon manufacturers are trying to increase their output. So we should see some easing. Customers now -- our customers specifically, are more receptive to price negotiation, because they're seeing it everywhere in terms of our cost price was going up and inflation rising. So I think for us, it may not be as transitory as a number of economists make it. I think also the general consensus there is a part of the inflation, we will start to see coming off next year. So with that, we should be able to also pass on some of our costs to the customer, at least to help mitigate the margin challenges.

Thanks, Jerome. Yes, I guess from my perspective, as I look a little bit further down the road than just the normal quarterly view, my view continues to be very strong that the key strategies that IMI has put forth in developing its core capabilities and targeting specific markets over the last 5 years is actually now ready to start paying dividends on. Yes, there are some headwinds, but these are -- these bumps on the road, these headwinds, the current financial issue that we're seeing are not IMI specific only. These are very, very much being addressed and lived by everybody in this space. In fact, what it's doing is creating more opportunities for us. And this is manifested by the increased rate of new business wins that we're getting quarter-over-quarter, year-over-year in spite of this pandemic. What it shows you is that the quality of the projects that are now forthcoming is becoming much more sensitive to the partners of choice that these OEMs are willing to take, and this is a testament to IMI being in this space for over 4 decades and seeing that our internal core capability strategies and where we put our CapEx is very much in line with where the direction of the markets and the products are going. So from that perspective, I don't have a crystal ball to say that the supply chain issue is going to finish in a quarter or 2 quarters, but what I do have is a very clear view that the target markets that we've developed, that we've targeted, that we've focused on, the capabilities of the investments we've done over the years in developing key manufacturing technologies and engineering capabilities are very well aligned to where these markets are going. And each of them have already put a stake on the ground that the kinds of products that they're going to be releasing will definitely need companies like IMI to partner with. So that would be my view of what's in store for the future. Thank you.

Thank you, Art. Thank you, Jerome. Thank you, Laurice, and thank you, everyone, for joining us this afternoon for our Q3 and 9 months financial and operating results. If you need to get a copy of the presentation, it's going to be uploaded in the company website. Please do visit the website and learn more about the updates and new projects of IMI, not only in the electronics space, but in the community and the environment as well. Thank you, and have a pleasant afternoon.

Thank you everyone.

Thanks, everyone. Stay safe.