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

All right. I think we can go ahead and start. I'm Brian Jalijali, Global Head of Investor Relations and Business Development Finance. Joining us today for our earnings briefing is our President, Jerome Tan; and our CFO, Laurice Dela Cruz. Jerome will be starting with some market updates, and Lau will be taking on the financials of the company for Q4 and full year 2022. All right. Go ahead, Jerome.

Thanks, Brian. Thanks, everyone, for joining, and good morning. I'll start off with a recap of the global economy. The global fight against inflation, Russia's war in the Ukraine and a resurgence of COVID-19 in China weighed heavily on the global economic activity in 2022. The first 2 factors will continue to impact growth in 2023. As an example, one of the main drivers is really to fight inflation. A number of the central banks across the regions, particularly U.S. and Europe, have increased their funding costs significantly in 2022. For example, I think the U.S. fund's rate has gone up from 25 basis points in March to 4.25% in December. So it just shows you that the speed and magnitude of the rate increase is dampening a lot of the economic activity basically to fight inflation. The global growth is also projected to fall from an estimated 3.4% in 2022 to 2.9% in 2023, but then that is expected to rise to 3.1% in 2024. So we are expecting some recovery in the following year. And U.S. and Europe is seeing a significant drop in '22 to '23, mainly because of this rising interest rate environment. China, on the other hand, has suffered because of the zero COVID policy in 2022 so they expect to have positive recovery in 2023 as they open up the economy. This recent update has improved, in fact, compared to the Q3 analyst briefing we shared. It has a much better outlook than the one from July 2022. Although there's a global slowdown which would impact our top line, the positive side is we do see this slowdown also helping on the component shortage issue and the supply chain issue as well. So there is some positive impacts on this slowdown as well. And it would also help on the easing of the inflationary pressures. The next page just shows the manufacturing PMI. On the left-hand side, the Global Manufacturing Index at 49.1 as of January. It remained below the 50 mark, which indicates a contraction, but rose from the 48.7 in the prior month. So it shows the deceleration of the decline for the second successive month. So basically still on the contraction phase but less severe than prior months. On the global electronics, we do see continued contraction. It's now at 48.9. Although there is some discrepancy among the subsegments, the consumer and industrials are recording upticks, in fact, while the communication and computing continues to show shortfalls. So it just shows you the state of the electronic manufacturing where it's still on the contraction or reduction phase. Going on to the next page, so what do we expect for 2023? Most of these items are already experienced in 2022, but we expect them to continue. And IMI has continually focused on addressing these trends. The first one is really inflation. Most of the electronic manufacturers expect and are concerned about inflation, particularly rising costs and rising energy prices. As I said, the slowdown of the global economy will help ease this inflationary pressure and reduce the difficulty of hiring and retaining professional employees as well as direct labor employees. What we are looking at is continuously driving improvements among our manufacturing operations across the site through LEAN activities and Kaizen continuous improvement methodology. That has resulted in a number of cost reductions that helped offset our inflation cost increases. We also continue to negotiate -- to the extent that we can, pass on the cost to the customers by renegotiating the price with our customers. The second item is increased inventory levels. A soft demand outlook and continued component shortage continues is leading to higher inventory levels across the industry, and IMI is not spared in this particular case as well. But we do continue to look at how we buy our raw materials, making sure that it's based on need date against the long lead time or critical parts and not just buying the raw materials just because we have purchased orders from the customers. So there's a lot of work working together with the customers and making sure that we buy the right amount of inventory for their purchase orders. We also continue to look at alternative parts to be able to complete the build and ship out the finished goods. In the case of IMI, we have more flexibility for the industrial segment. That's why if you look at our backlog, there is less backlog coming from the industrial segment as opposed to automotive, which is more difficult to find alternate parts to be able to replace because these are in safety related, and it's not as easy to switch alternative parts. The next is decoupling of the U.S. and China, so a lot of geopolitics going on between the U.S. and China. U.S. manufacturing orders from China have declined for 40% and new export controls being imposed on semiconductor and chip manufacturing technology to China. In the case of IMI, we have less direct impact because we are not sourcing the sensitive chip supplies. But we continue to look at regional sources for our components outside of Asia. Although majority of the components are still coming from Asia because in terms of cost basis, it's still cheaper to produce in Asia and even to ship, even if you include the total cost of ownership, including the shipment to Europe and U.S. components coming out of Asia, it's still at a much cheaper level. Reshoring. So related to the third item, there are a lot of manufacturers now diversifying or moving out of China and reshoring back into the U.S., with the government in the U.S. providing a lot of incentive to reshore. And also the unpredictability last year of China due to the COVID zero policy and the expensive supply chain shipping from Asia to U.S. has brought a lot of the U.S.-based customers to relook at where they have their manufacturing suppliers. And for IMI, our focus is to continue to use our Mexico facility to be able to capture these opportunities in the region. And then lastly, sustainability. Our awareness of the need for a sustainable product has never been higher. Global warming is literally a burning topic in a lot of the discussions, not only with the investors but also with our customers, that are also supporting this reduction in greenhouse gas emission. So in the case of IMI, we are also capitalizing on this trend to be able to help support a shift towards more renewable and sustainable solutions. And you'll see a lot of our projects are related to renewables, particularly in the EV space, to help drive a shift towards that electric vehicle in the mobility space. Next page just shows the situation in terms of the component or semiconductor shortage. As you see, the 3 Cs, consumer, communication, computing, you're seeing a lot of easing of component shortages. In fact, there are oversupply in a lot of the logic and memory chips. However, in the automotive and industrial, there's still shortages of components, particularly in the analog devices and MCUs. So this gives us an opportunity for those that are non-analog and MCU parts, we are able to now go back to the supplier and try and negotiate a much lower price. But in the case of the MCU and analog wherein we're short, we're still impacted by the supply. Although the shortage list have come down quite significantly, but the effect of this component shortage is still lingering. We expect this to improve in the second half or start to normalize in the second half of this year. So that would help, then also for us to clear a lot of our backlogs that we've accumulated at the end of 2022. Next page, it just shows the freight costs or shipping costs. Logistic costs have actually come down. It was, I think, at the peak, around almost 5x the normal or pre-pandemic levels, but it has since come down. So this is just to show that the freight cost has also normalized. It's now about 1.1x pre-pandemic level starting late last year. So this would also help improve our costs as we continue to purchase the cheapest or the lowest-priced components and then ship to our facilities in Europe and North America. Next page, just a little bit on the mobility or automotive segment, which is I think over 50% of our revenue. In 2022, the estimate for global vehicle sales is around 79.4 million units or 1.9% less than 2021. In '23, according to various assumptions, sales are expected to remain flat or slightly positive, between 79 to 81 million units. So in terms of light vehicle sales, the volume is really flat. However, the positive forecast for us is really the shift from the traditional combustion engine into electric vehicle adoption. So the push for that, and you'll see in the next page, in terms of the growth or the market share of EV has increased significantly as a percent of share of the total light vehicle. The positive forecasts are mainly coming from expected increased registrations in China and India. So these 2 countries are driving the growth in the light vehicle and increasing the push for electrified car as well. While the demand for the EV is increasing, I think the challenge is still the infrastructure base. But we are seeing a lot of companies now addressing the infrastructure build for chargers. That would also eventually help push the increased adoption of the electric vehicles. Going to the next page, on the EV sales. During the 12 months of 2022, more than 10 million new passenger plug-in electric vehicles were registered globally for the first time, over 10 million. That's a 55% increase year-over-year compared to 6.5 million in 2021. The average market share now has amounted to 14%, including 10% for just all electric vehicles. So 1 in 10 new passenger cars is electric now. And you see in the graph the big pickup is really starting from Q3 of 2020, the dark blue line and then continuous growth in 2021 and 2022. Just to do a quick update on our net zero road map. As you all know, in 2021, IMI joined Ayala Corporation in committing to net zero by 2050. So among the AC subsidiaries, IMI is one that potentially has a big role to play in the new carbon economy as the world shifts towards more renewable energy sources and technologies that produce lower levels of greenhouse gas emissions. With the focus on reducing carbon emissions and mitigating the effects of climate change, IMI's purpose is now geared towards opportunities to develop and manufacture technologies that save lives, save energy and improve quality of life. So in the past couple of years, a number of governments and corporations have declared their own carbon emissions addressing the climate change, so more than 90% of publicly listed companies adopting ESG and carbon targets. We also have observed similar movements with our customer base and are aligning ourselves as well as one of the suppliers to be able to help our customers achieve also their net zero objectives. So we're committed to have an internal goal of reducing 50% of our greenhouse gas emissions for our Scope 1 and 2 by 2030 and 25% reduction in our Scope 3 by the same year, 2030. Okay. So next page is the financial section. So I'll give an update on the segments. So if you look at Q4, we continue to see growth in Q4. Year-on-year growth is 12% for quarter 4. And quarter-on-quarter, it's a 5% growth. This is mainly driven by our auto and industrial segment. Both continues to be a major factor for our growth. In automotive, full year, our automotive revenues would have increased much higher, if not for the impact of the decline in the euro since a big portion of our contracts are euro-based. The FX impact on our top line is about $40 million lower because of the lower euro to U.S. dollar exchange rate. We are seeing a significant ramp-up of new customers in Q4, particularly from our customers, Brose and BorgWarner, that is present in Mexico and in Europe, mainly. However, our automotive continues to suffer from component shortage which dampened its growth in 2022. Despite that, we are seeing continued increases in new projects. Our pipeline wins for 2022 is at $201 million equivalent annual revenue potential that we won in 2022. On the industrial side, the industrial growth is driven by also ramp-up of new projects in new and existing customers, particularly in the Philippines and in Serbia. Industrial has less issues, as I mentioned earlier, on the component shortages. As our customers, a number of them are OEMs, they have more flexibilities in terms of using alternate components to avoid some of the critical shortage in components. Aerospace, however, continues to be a lag for us. It's down 15% year-on-year in Q4; and full year, down 16%. It's more difficult to find the specialized component chip for aerospace and defense, therefore, hindering a lot of our deliveries in 2022. Consumer also saw a decline. This is in relation to what I mentioned earlier, communication and particularly laptop decline in 2022 as the world emerges from the COVID pandemic situation. Other consumers have also declined due to the slowing economic environment. And then telco and medical, we also saw a decline. Telco particularly, we have decided to exit our low-margin business for a certain customer. So that is the main reason for the drop. And medical decline is also because of increased inventory in the supply chain wherein the customers are clearing these inventories so, therefore, having a much slower growth in Q4 but is expected to normalize starting in 2023. Going on to the next page on segment updates. You'll see most sites that are handling our focus segments, which is automotive and industrial, like the Philippines is showing a very strong growth year-on-year and also quarter-on-quarter. Similarly, in China for our Jiaxing business, which is more focused on automotive business, it's driving the growth in China. However, it's still hampered by component shortage. So the sales in Jiaxing is not as strong as we had expected because of this. And then overall, China is lower because of the telco and the medical that I just mentioned earlier. In Europe, Bulgaria, Serbia and Czech Republic, we are seeing strong growth, and this is particularly driven by the automotive business with the new projects that's being ramped up, in particular in Czech Republic. In Mexico, we're also seeing strong growth, although the growth is not as high, only a 10% year-on-year growth for Q4, because it's more affected really by the component shortage compared to the other regions that we have. And also because of this, it's also incurring a lot of expedited costs by air shipping instead of sea shipment. So that's also impacting on its profitability. But the demand for onshoring in North America continues, so we're seeing a lot of opportunities in terms of new projects for Mexico. VIA and STI remained flat due to the reason I mentioned earlier, as VIA, a big portion of their customers are consumer-based as well as STI being impacted by the aerospace and defense component shortage. Going on to the next page, in terms of new wins, we are able to recover in Q4. If you remember, in the first 3 quarters, we are lagging behind 2021 in terms of new wins, but we are able to catch up. So we have achieved $350 million of new wins for IMI core business; and for STI, $59 million of new business, below 2021. And if you look at the notable wins for '22, you'll notice a lot of the wins are related to electric vehicles. So we have a win on the EV motorcycle assembly, control and sensors and also battery management system, which is directly related to controlling EVs. So we expect to see more and more of the growth in new wins are coming from the shift towards more renewable sector within the automotive business. Next page is the financial update. I turn it over to Lau to go through the financial results.

Hello, good morning, everyone. So I'll be providing details on the quarter 4 performance. So our revenues in Q4 is better than previous quarter from increasing activities in our Europe subsidiaries. And this is further boosted by the recovery of the euro towards the quarter 4. And we also have some increased demand in some of our China sites despite the COVID challenges, which our China team was able to manage. On the GP margins, we are continuously improving as we really just recovered the unfavorable purchase price variances from our customers, which totaled almost $50 million for the full year. And we also have negotiated price increases with a total impact of $21 million for the full year. Although you'll see that there's a significant upside in Q4, and this is somehow driven by our change in accounting estimate for the useful life of machine, from the previous 7 years, we changed it to 10 years. And this is based on our assessment of how long our machines are actually being used. And this is also to align with the industry standard because most of our competitors are using 10 years for the useful life. On the operating income, it's showing an increase, mainly because of the change in useful life. But let's say, if we will exclude that Q4 catch-up adjustment and the other one-off items, there is a slight decline of just about $2 million, $2.5 million from Q3. There are still some challenges in materials in terms of few spot buys, some FX impact on our dollar purchases and a few expedited freight costs, especially those that are going to North America and Europe. There were also additional inventory and the financial provisions that we booked in Q4. This is somehow offset by improvement in the combined VIA and STI operating income in Q4. So that explanation holds true also for the non-GAAP EBITDA, except that the reported EBITDA was lower due to the impact of the useful life change, and we also include FX losses in the EBITDA computation. Finally, on the net income, the positive operating income of $7 million was offset by significant FX losses as the recovery of the euro and the British pound has negative impact on VIA and STI U.S. dollar assets. For Q4 alone, we incurred $4.8 million of FX losses. And there were also impairment losses recognized under nonoperating income related to decline in forecast and end of life of some of our businesses. Therefore, we decided to impair some of the fixed assets, which is somehow offset by the upside adjustment in the depreciation. With this, we ended the year with a total net loss of $6.8 million, but this is better than last year, which was a $10.6 million loss. Okay, so this is just the usual split of our wholly owned subsidiaries and non-wholly owned. As mentioned earlier, the increase in the quarter 4 for our wholly owned is mainly coming from Europe and our China subsidiaries. For the non-wholly owned, the increase is mainly coming from STI, although VIA reported a strong quarter 3 driven primarily by the growth in the automotive end market, there was a slight decline in Q4 from slowdown of the consumer business and also impact of the shortage on their camera business. On net income, you'll see on the wholly owned that we have recorded 4 quarters of positive income both in the reported and non-GAAP. With this, we ended the core business with a positive $11.5 million for the full year. Whereas for VIA and STI, they remain to be lagging in terms of recovery. But in terms of operating performance, the losses were much lower in the second half compared to the first half by almost 50%. There was just a significant FX loss in Q4 of about $5.8 million, but the non-GAAP losses have significantly reduced in the quarter 4. Finally, these 2 subsidiaries ended the year with a combined net loss of $18.2 million for the full year. Okay, so on the capital structure, we have additional bank debt of $26 million, and this is mainly to support the new programs that we have started production towards the second half of the year. Our cash, however, decreased by $36 million, and this is mainly because of the increase in working capital, particularly the increasing inventory levels still due to the impact of the shortage, which caused backlogs of about $63 million by end of 2022. We also invested a total of $21 million in CapEx to support the new programs, both for the existing and the new customers. Our equity also decreased by $28 million, and this is just mainly due to the weakening of the euro, which goes into the cumulative translation adjustments coming from our non-USD subsidiaries. Our current ratio remains to be healthy at 1.51 compared to last year of 1.59. However, our debt-to-equity ratio increased from last year due to the additional loans needed to fund the upcoming projects. Our book value is at PHP 9.62, and we are still trading below book value. I think, as of yesterday, our share price is at PHP 4.98, which is almost half of our book value. Next slide. Regarding our capital investment, we have invested less CapEx for this year, and these are just focusing mostly on the new automotive businesses, particularly in Czech Republic and Mexico. And also we have some new camera business in the Philippines. And some of the increases are also to add additional capacity in our China facilities because of the growing demand. That's it from my end. I'll turn you back to Jerome for the key takeaways.

Yes. I think the key takeaway is we are experiencing improvement in the component lead time. Automotive and industrial, although still challenged in terms of component shortage, but the shortage list is getting shorter and shorter. So we expect that to improve towards the second half of this year. As I mentioned also, the shift towards more electrified cars is also driving a lot of our growth, and we expect that to continue. At IMI, we will continue to focus on continuous improvement and automation really to offset the increased labor costs or people costs and also to address the high retention that we're seeing in some of our regions. The other area is to continue to focus on supply chain, particularly to drive down our inventory levels. As we get more of the critical parts, we will be able to build and ship out our finished goods and, at the same time, working with our customers to do more prudent loading and buying of raw materials so as not to have excess inventory. At the same time, now that we have some excess inventory in the system to really work with our customers, to have them buy back the excess inventories under their contractual obligations. And of course, there's still a lot of uncertainty in the market, especially with the recent financial or bank failures in the U.S. and issues on the financial environment globally. So that continues to be a new uncertain factor that might impact the global economy, although it seems like the global economy is quite resilient. Despite a lot of the bad news, if you look at the stock market, which may be an indication of future market, it's still holding relatively well, considering the big issues that we've been having in the last week or so. So those will be our focus, is really how to continue to drive improvement in our margins. And there are opportunities for us to pull back some of the margin erosions that we have seen in the last 2 years. With that, I'll open it up for questions. Art, if you want to add something as well. So Brian, we'll open it up for questions.

Yes, please, for any questions, feel free to type them into the chat box, and I'll read them out. We also have our CEO, Art Tan, joining us to answer any questions.

Yes. Well, thank you, Brian. And while people are trying to put in some questions, just to give a little bit more insight, the points that were raised by Jerome and Lau are pertinent in identifying the current challenges and the situation we have. I'd like to give a perspective of the overall business in the markets and several of our key customers in both the industrial and automotive field. And what I'd like to say is that they still continue to feel very, very positive in this dynamic disruption that's happening where a significant portion of this next generation of convergence between mobility office interface, human-machine interface, and overall need for data and analytics is driving a significant portion of electronics our way. The other part that actually was very conducive for IMI more and more is key customers are beginning to understand the value proposition of having a well-diversified partner in being able to adapt and quickly be able to support different major regions in the world with facilities and with access to talent and engineering as well as component supply chain portfolio. So given those, becoming more and more important in the market, I think bodes well on a future path for IMI to be able to take advantage of the emerging -- businesses. Go ahead, Brian.

All right. A few questions have started to come in. First, recurring profit for Q4, Lau, I guess. Go ahead, Lau.

Sorry, can you read the question again.

They're asking what the recurring profit for Q4 is. I guess that's ex any one-offs or nonrecurring income or loss.

Okay. So if I can just repeat the question, what if there are no recurring losses, is it correct?

Ex any nonrecurring losses.

I think the better comparison is probably Q3 because we have less of a seasonal drop in Q4 wherein there are a number of adjustments both from our customer side and our side because it's year-end. And I think if you look at the recurring, if I remember correctly, if you go back to the quarterly split, Brian, you can look at the non-GAAP, which excludes the one-offs. So the next page would show at least on a core basis as well. And please go ahead, Lau, if you have anything to add.

Yes. In terms of the Q4 non-GAAP, maybe you can go back, Brian, to the previous slide. Okay, so if, let's say, without the depreciation, there will be a slight decrease in the Q4 non-GAAP operating income. Mainly, there was a lower contribution margin, partly because of the few spot buys and some FX impact on the materials. We still have some expedited costs, especially in our Mexico facility. But other than that, I think most of the sites are already improving in terms of contribution margin. It was only for some few sites that are causing the slight decline in the non-GAAP.

I think at least, to your second question of what our margin guidance is for 2023, the question is, is the GPM of 9.1% in Q4 sustainable? Though we can't comment directly on guidance for the future, but any comments on that, Lau?

Yes. So in terms of contribution margin, I think we're on track, meaning it's somehow stable. But we're still challenged in terms of revenues because there are still some issues on the component shortage, which we expect to extend up to maybe second quarter. And some of the delays in the revenues are just pushouts to further quarters. So in terms of contribution margin, it's stable. But of course, any reduction in revenue would cause the gross profit margins to go down because of underutilization or some inefficiencies.

Okay. Great. Another question, are you considering hedging your ForEx exposures?

Yes, we do have some plain vanilla hedges but mostly on the expense side. What we're doing in terms of ForEx exposure is we renegotiate some exposure to the customer. But on the hedging, it's really more on the expenses.

And I guess what's particularly special in 2022 is the big drop in euro to U.S. which normally, most of our customers, we have provisions to adjust foreign exchange. But in the instance wherein you have sudden drops within a short period of time, then there is a lag in trying to recover the FX. So as we don't update the prices related to ForEx like on a monthly basis, it's mostly on a semiannual or annual basis. Then we took the hit in 2022. But we have also now gone back to the customers and renegotiated the more regular, at least quarterly, FX price adjustments to be considered on a quarterly basis.

All right. Thank you for those questions, German de la Paz. A question here from Sir [ Louie Lichauco ], VIA and STI did not contribute much to revenues, but they seem to be a big drag on overall net income, why?

Well, maybe I'll start, then you can add. For VIA, a lot of the losses is related to, as they execute their plan to shift from the consumer segment into automotive segment and from just a hardware supplier into a more systems supplier, they have invested significantly on research and development. That's one. The other one is in preparation for the growth in new programs in automotive. They've also expanded their facility in Nuremberg also to diversify out of China because of the China lockdowns that they are experiencing. So those are investments and additional costs they have taken in 2022, which they expect to see the revenues to come in going forward, right? So there is a more upfront investment in that respect for VIA. And also the other item is the slowdown in the consumer segment, particularly in the laptop, and some component shortages in the automotive space that they serve. So those are a lot of the factors that impacted their profitability. In the case of STI, the drag is really on component shortages, particularly specialized parts, which there are really no components available. So they are not able to serve a lot of their customers, and they have built up backlog. The order book for STI for 2023 has actually increased significantly, almost triple their normal order book. So the challenge is really to get those parts in to be able to convert into finished goods and ship out. So because of that lower revenue in STI and the unutilized fixed overhead, that's the main factor driving the losses in STI.

Maybe just to add, the 2 operations are very specific in their markets for defense and aerospace for STI as well as from VIA in terms of HMI or human machine interface, both on the consumer side and on the automotive side. So the way that it's structured internally here is that we actually consolidate their performance, but they also operate into different business cycles based on the way that they engage with their end customers. Both are predominantly in the long term. However, the way that projects are delivered in each type is very different. So on the defense aerospace type, it's by budget that's given out by each government and the programs that's tied to it. So there is a lag that if you miss that window, then you don't get to participate until that program window starts to open up again. That's been the challenge for STI is when they miss the program window. As for VIA, there is this, as what Jerome mentioned, the transition from being consumer-centric to automotive-centric. And we're seeing now that, that transition is paying off, but we're not going to see the upside on the revenue until the key programs itself go out and start the production for the OEM. So in essence, yes, they're challenged right now on a net income basis. We're seeing that affecting IMI. But we're very hopeful that the pipeline is strong and that they'll be able to deliver on those pipelines.

All right. It seems like there aren't any other questions. The question about Q1 2023 has been covered by Jerome and Lau. So if anybody else has any questions, feel free to send them over, [email protected]. Thank you to everyone for joining us today. Thank you, Art, Jerome, Lau.

Yes, thank you, everyone.

Thank you.

Thanks, everyone. Have a good day.

All right, have a good day. Bye.