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

I think we can go ahead and start. Joining us today from IMI is Arthur Tan, our CEO; Jerome Tan, our President; and our CFO, Ms. Laurice Dela Cruz. We'll be starting with some market updates and then moving on to the financials in the latter part of the briefing. Go ahead, Jerome.

Thank you, Brian. I'll start off as usual with some global economic outlook, but I won't spend a lot of time. I'm sure a lot of you have been following the news that's happening globally. The first page just shows the global growth rate. Coming out of the pandemic in 2020, we see a very strong growth in 2021, but that has decelerated in 2022. A lot of the items have been reported before and in the news. Global supply chain disruption, component shortage, very tight labor market and geopolitical tensions adding to very high inflation or price increases, which has prompted a lot of central banks across the globe to really start tightening and addressing the inflation. So that's an impact on 2022. We also expected to see further slowdown because of the actions being taken in 2023, globally it is expected to be lower than 2022. This has been revised downward since last month and I think across the region most of them are relatively slower for '23 is the expectation except for China at 4.6%. But as you know, China would need a target of about 5.5% GDP growth to be able to maintain their employment levels. So that's still a big slowdown in China affecting the world globally. So for IMI, we're seeing still continued strength in terms of growth in some segments, automotive and industrial in particular. I think this is driven by the megatrends that we have talked about before and we'll touch on that a little bit in the next few pages. But just we're watching this and so far a lot of our customers are still maintaining their forecasts for '22 and into next year, but we're watching this carefully as there are indications at least on the global macro environment that this might slow down next year. So less visibility at this point for next year. Next page, please. Next page is on inflation, I won't again dwell too much on this. But you'll see closer to the right-hand side, that's the forecast this year with inflation peaking to about -- at least the expectation is peaking to Q3 this year around 8% and then starts to ease and we also see indications of that in certain sectors, right? And you also see news that a number of companies are slowing down in terms of their hiring so that might lead to the start of some easing in inflation. The one on the bottom right is forecast from a year-ago so that has already been superseded significantly by recent forecast. And IMI is not immune to this, right? So we're also seeing increased costs on the labor front and as well as the energy front as well in certain regions, particularly in Europe and in the Philippines in terms of energy costs. Next page. This is the PMI. So for PMI, production levels at global electronic manufacturers fell to a 20-month low of 53.7 in June. The continued slowdown is driven more by firms in the consumer and computing -- sorry, in communication sector and expansion we still see in the computing and industrial electronics areas. Again part of the drop is also the continued effects of the supply chain issue and material shortages. What does help is really we are starting to see manufacturers start to produce more inventory to stockpile. So part of that expansion is also related to stockpiling. The positive side of this sort of easing is in terms of availability of some of the component parts. We are also starting to see some easing in this respect. So we're able to get some components faster now and the lead times have stabilized in a lot of the component segments. Next page, please. We shared with you this page. The white bar is what we expected during the -- when the component shortage situation came up last year. So initially we were expecting by the second half of this year, we will start to see normalization. But because of the spike in COVID and lockdown in certain areas in Asia, particularly in China, and geopolitical tensions in Europe, that has also delayed the recovery. So the red bar now shows our more current view on when we start to see normalization and, let's say, it probably would be more towards the end of the next year. Automotive segment, which a big portion of our revenue is in this segment, is a bit behind because of the slow acceptance of purchasing at a higher price and also replacing alternative components. As you know in automotive, they have very strict requirements in terms of safety and so just switching out the components require full cycle testing, which is very expensive. So a lot of the customers in the automotive segment are much slower to replace alternative components unlike industrial. Industrial also a lot of our customers serve the OEM so they have more flexibility in terms of adjusting their prices to their end consumers and therefore, more accepting in terms of accepting increased prices in inflation and raw material parts from IMI. Next page, please. This page just share with you the outlook in the mobility space, particularly in vehicles. So you'll see the vehicle per -- sorry, the passenger vehicle sales have actually dropped during the pandemic and it's slowly going back and expected to go back to the pre-pandemic level next year. But a lot of this return to the pre-pandemic level is really driven by electric vehicles so switching out from the internal combustion engine into EV. And so that's what's driving the growth that we still see in the automotive segment. And a lot of the applications that IMI produce is really agnostic to either an ICE or an electric vehicle. So that's also driving our growth as EV cars replace the ICE faster and also electric vehicles would have higher electronic components in terms of the whole value of the car. So that's what's driving the growth for us in the mobility space. Next page. The other drivers or the segments that we participate in is on the, as I mentioned earlier, EV. The other area in the electrification of the mobility that's driving the growth is the charging market. So Europe is expecting to deploy 1.3 million public charging stations by 2025 and then U.S. as well they have ambitious plans to install 500,000 EV charging station by 2030. So that's also driving a lot of new business opportunities for IMI. And of course China as well with a lot of the electric vehicles being launched in China, they also are very aggressive in terms of building the infrastructure for EV. On the industrial side, the global sensors in the IoT devices will reach a market size of $205 billion. That's a compounded annual growth rate of about 30% from 2021 to 2028. Also the integrated sensors market is expected to grow about 9% in more or less the same period. And this integrated sensors are -- as the world drives towards more renewables, these sensors that can sense also, let's say, pollution output as well as control sensors are being integrated together. So that's also driving the growth. And in addition to that, security also is becoming a strong factor and we see that at IMI wherein security required applications are driving a lot of our growth. In aerospace and defense, aerospace and defense is also expected to grow as travel slowly resumes post pandemic. However, in IMI, our market that we serve is more on the defense so you'll see the defense market actually is not growing at this stage. Although in the medium term, there are a lot of commitments from the NATO countries with the -- because of the war in Ukraine and Russia, they have committed to increase defense spending. So we expect in the medium term, that's going to drive the increase in the aerospace and defense -- sorry, in the defense sector. This just shows a update on the freight and logistics costs. You will see that the logistics costs peaked I think around Q1 and came down in the last few months. But a lot of the reduction is also because of the lockdown in China. And you'll see it starts to pick up again in the last couple of months I think or last month because China is starting to open up. But I do expect that -- or we do expect that because of the expected slowdown in global economy, we don't see that the freight costs will go up to the peak levels that we've seen in Q1. Now I'll touch on a couple of the segment updates, next page. So in our segment updates, as I mentioned earlier, auto and industrial is still showing strong growth despite backlogs that we have of about $90 million of backlog. First half growth in automotive is 10% growth while in industrial it's 17% and quarter-on-quarter Q1 to Q2, we still see the continued growth, 12% growth in automotive from Q1 to Q2 and 28% for industrial. As I mentioned, aerospace and defense is not growing for us mainly due to a big portion of their supply chain or components are very specialized components, which is even more difficult to find compared to the industrial or automotive space. Going back to the automotive segment. In addition, it's also impacted by the foreign currency exchange, particularly euro and U.S. since we have a significant amount of our contracts in our European-based operations that's in euro currency. That represents about a $15 million revenue impact due to foreign exchange in automotive. We are working very closely now with the Tier 1s and as well as the OEMs to try to get better allocations and we're seeing slight improvement in allocations in automotive that's also driving part of the improved growth versus Q1. On the industrial space, we have less impact on FX since most of the industrial are served out of China. Philippines and Mexico, which are all U.S. dollar currency. We are also a bit more successful in being able to pass on increased costs in the industrial as a lot of our industrial customers serve directly to the end markets and they have ability to adjust their price more quickly and also able to switch alternative components more quickly than the automotive segment. And then I think aerospace and defense, I mentioned that the challenge continues to be the shortage in segment and also the focus in increasing spending is also not yet there. It's more new programs that we expect to come in more in the medium term. Next page, please. In terms of our different regions, similarly China, Philippines, Czech Republic and Mexico; those are growing if you see versus last year and also Q1 versus Q2 because mainly these sites operate in terms of automotive and industrial, which is driving the growth. In the Philippines, the growth is driven by some recovery of backlogs although the backlog continues to be quite high at $36 million. The negative part of operating in the Philippines is we're starting to see rising costs in energy and also there's a recent mandate which increased -- that was announced by the government that's also increasing our operating expense in the Philippines. In China again we have strict government lockdowns, I'm sure you've read in the news, in different locations. So despite that, we are able to deliver a high growth in China 16% versus first half last year and then Q1 versus Q2 26% increase. This is mainly driven by also strong demand in the automotive segment and as well as industrial segment. In Europe you'll see like for instance Serbia and Bulgaria showing a little growth, but actually a lot of that is driven by the FX so if you exclude the FX, their growth is much higher than what we've shown here in this chart. Mexico and Czech Republic is showing much higher growth also driven by ramp-up of new business that's coming on stream in Q2. STI and VIA continues to be challenged. They are affected by in addition to component shortages, also a slowdown of consumer demand as the laptop sales starts to decline or not growing as fast as the prior period. And I also already talked about the aerospace and defense in China so we have not been able to serve because of component shortage. Next page, please. Next page is our new wins. You'll see our new wins is significantly lower in the first half of 2022. If we look at the businesses except STI, it's down from $254 million of new wins in the first half of last year to $131 million, 2 things to note here. In 2021 first half we had 2 major programs of about 120 ARP that was won in that period, which we don't have the same level of new wins this year. So that's affected -- that's 1 factor for the significant drop. The other significant drop is in 2022 a lot of our focus as well as the Tier 1 customer focus is really chasing after the shortage of the components and also price discussions with their customers, with the OEM and for us with our Tier 1 customers in mobility. So you'll see mobility shows a significant drop. Because of that focus, there are less projects that we were actively bidding where the customer is actively engaged in. The positive sign is the industrial. You see industrial has grown significantly. As I mentioned, they have less price sensitivity as they are able to price to the end markets. So there are a lot more projects and that's also partly driven by projects that's going into the U.S. for North America that's also driving part of our wins. And the other thing to note here is Philippines increased the share of their wins and it's driven mostly by the industrial projects wherein that's traditionally where our Philippine operations serves a lot of our industrial customers. And then on the notable wins, the other point to note that is out of the Top 10 wins that we have, more than 5 of our Top 10 new wins have project size of more than $10 million. So it just shows the confidence from our customers and new customers to be able to award IMI with much bigger projects compared to a few years ago where our average ticket size is closer to $1 million to $2 million for each project. With that, I'll turn it over to Lau to go through the financials.

Thank you, Jerome, and good afternoon, everyone. So I'll be presenting the second quarter performance versus the previous quarter. So just a brief background on the industry status although Jerome mentioned most of the factors. The component supply situation is recovering at a slower rate than expected and this is aggravated further by the Russia-Ukraine conflict and the China lockdowns. The lead times are still long especially for the semiconductors averaging about 22 weeks or more, but most of the other components are already stabilizing. So with this, on our revenues. Despite the lockdowns in China and the continuous strengthening of the U.S. dollar against our contract currencies, we increased revenues in Q2 compared to Q1 by 7% mainly because of the significant increase in the revenue activities of the Philippine operations coming from the industrial businesses and the ramp-up of some of the new projects. Also there was a strong recovery for the China entities with the arrival of the materials after the lockdowns. But our Europe entities is still challenged with the FX depreciation and also with the component shortage. On the other hand, VIA and STI have lower revenues in Q2 mainly because VIA was also impacted by the lockdowns in its Suzhou entity and there are some portfolio adjustments and slowdown in the consumer end market while STI is still affected by the long lead time parts and customer change requirements thereby delaying the revenues to future quarters. On the operating income so we are currently on an operating loss position and the operating loss slightly increased as we started to feel the impact of inflation in Q2. So aside from the continuous increase in material prices, we are experiencing also increasing people cost from the wage increases that already started in Europe and maybe in the second quarter we will feel it in Philippines and China -- in second half I mean. And also the effects of attrition and shortage of skilled labor across our sites provides us for adjustment in the salaries. Also the freight costs, as mentioned by Jerome, it started to increase again after the opening of the Shanghai ports, but we don't expect it to increase further to the peak sometime in Q4 of 2021. So the operating loss was somehow tempered by the FX gains in Q2. So from the $4.6 million operating loss, we reported a net loss of $3.6 million as it was offset by the favorable FX gain on the part of VIA and STI because the euro and the GBP weakening is resulting to FX gains on its balance sheet revaluation. Next slide, please. This is just a breakdown of the wholly-owned subsidiaries and nonwholly owned. So you'll see that the growth is mainly coming from the core business, which grew 12% from Q1 driven by the Philippines and China factories. However, the net income is quite lower than Q1, basically the main driver here is the FX loss for the core business. Opposite to the VIA and STI, the core business is on an FX loss position with the euro and RMBs weakening. However, it is somehow tempered by the aggressive recoveries of our unfavorable purchase price variances and some price increase negotiations. So part of the increase in revenues are actually the recoveries of those UPPVs and price adjustments. On the other hand, the nonwholly-owned subsidiaries are driving now our lower revenue and our lower net income. But as mentioned earlier, this was offset by the FX gain of $5.9 million for the second quarter. Next slide, Brian. On the capital structure so we would just like to highlight that there was an increase in the loans of $16 million, but actually $10 million of this is just a principal cleanup in December. So the real increase is just $6 million and we are using this to fund our working capital requirements because of the increasing demand especially in the second quarter. Our balance sheet ratios are still okay and we are still compliant with all our bank covenants. On the equity, the decrease in our equity was just driven by the FX so this is the cumulative translation adjustment. Next slide, Brian. So despite the current market condition, we ensure to continue improving our facilities by upgrading our equipment and assessing also some expansion projects. As of first half, we spent around $11 million of CapEx versus $17 million compared to last year. For the full year, we expect to spend maybe a bit higher than the 2021 or maybe at same level of the 2021 -- sorry, I'm looking at 2020. Maybe lower than 2021 around $20-plus million because we are expecting some new projects for expansion and to also support the ramp-up of our new projects.

Just some key takeaways, I guess nothing new. Component shortage and supply chain continues to be affecting the entire industry, but it's starting to show some signs of improvement, which we expect to also help us improve at least our gross profit margin in the quarters to come. The [indiscernible] the increasing inflation that we're seeing across in expenses, that will continue to affect our margins. So we're looking at ways that we can adjust also to the extent that we can pass on to our customers these increased costs and also deterioration in FX. What we are seeing is our Q2 gross profit margins have improved, a lot of that driven by recoveries of this unfavorable purchase price variance that we have experienced and also price adjustments that we have successfully negotiated with the customers. And we're continuing to look at the opportunities where we can pass on cost that's uncontrollable from our point of view and negotiate that with our customers to be able to recover part of our margins. We're still seeing strong growth on the positive side in both automotive and industrial, but we're continuing to watch this space as 2020 might bring some uncertainty. So we are continuing to look at our CapEx spending and also working on our working capital management. The challenge is a lot of our inventories are going up because of these component shortages and we're not able to push out a lot of these inventories that's coming in that's resulting from the commits from some of the parts that we would need to build the full kit. So we're continuing to focus on our cash management to be able to ride out this challenging environment where we are at the moment. I think that's it for the presentation part. So we'll open it up to questions. Brian?

[Operator Instructions] We have a question here from one of the attendees. They want to ask about the impact of the CHIPS Act on IMI. Is there any impact on IMI?

I think you mean obviously immediate impact probably not so [ heated ] so because that will still take some time for, let's say, the U.S. in terms of building the semiconductor capability and capacity to go online. And we're in a way already seeing part of that wherein a lot of the U.S. government working on trying to restrict expansion of Chinese semiconductor parts, right? So far we are still able to source the chips that we would require for our production and I don't know the impact of the CHIPS Act or the implications of how that would in terms of how each of the companies try to position themselves. Art, maybe you have some thoughts on that.

My thoughts on that is actually it only bodes well for us primarily because of our position on a regional basis. So the reason why that Act was in place and for us to be able to be self-sustaining for North America so the United States does not depend on Asia for its chips requirement. So from that perspective and having our facility in Mexico and ability to be able to now insource everything else from the United States will just make it a lot more conducive for us to expand our business. So that's my view on a long-term basis.

All right. We have a question here about the ForEx. Are there any management plans to hedge ForEx exposures?

If I can take that. So we're doing hedging on some of the local currency expenses. But we're planning to also look into some net income hedge across the group to temper the exposure, particularly on the euro and RMB.

Jerome, how heavily dependent are we on China for our supply of components?

I think China is still a big source of component supply, right? It's not only for us, but it's across the whole industry. So I think it's still a main supplier of a lot of these components. But I think so far the impact to us is more on if there are lockdowns and the logistics disruptions in being able to source these components. So I think yes.