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

Good afternoon, everyone. As many of you may know, we made an announcement earlier today about our divestment in STI. Along with the financials, we'll be talking about that transaction as well. Joining us today are our President, Jerome Tan; and our CFO, Laurice Dela Cruz. Jerome?

Good afternoon, everyone. We'll start off with the usual economic growth outlook. The latest economic growth outlook -- this was based on a report in July, showed a slight improvement in the 2023 global outlook to 3%. If you look at the upper left, compared to the April data showing 2.5% -- sorry, 2.8% growth, so a slight improvement versus the April data. The improvements came mostly from the resilient U.S. economy that continue to be strong or to have strong consumer support and labor market despite the high interest rate environment. I guess this positive news is a relief for IMI as well -- as well as a lot of the businesses, as the severe global recession scenario caused by the rising inflation and high interest rate environment were a concern for us late last year, and it is not likely to materialize going forward. With that said, the global growth has slowed, particularly in the EU and in the China regions where IMI has also been active. And we are starting to see a slower growth in Q2 from these regions. As our customers continue to clear their existing inventories in the sales channel and the demand -- overall demand remains flat. On the upside, we believe the inflation has peaked reducing the need for tighter monetary policy going forward. And the domestic demand could prove to be more resilient with the help of a stimulus that [indiscernible] has been talking about introducing. So we're waiting to see what type of stimulus the government was put in into China, which will drive a lot of the global growth and the regional growth in China. Going on to the next page, just using the indicator that we follow, which is the global manufacturing PMI and the electronics PMI. The conditions in the global manufacturing sector deteriorated towards the end of the second quarter. This decline was a consequence of a continuous decrease in new order intakes. Again, this is a general industry and global industry trend. As a result, manufacturers adopt a more cautious approach, significantly reducing purchasing activities, destocking inventories. Employment remains broadly flat overall and business optimism has dipped to a 7 month low. The global manufacturing PMI posted 48.8 in June, a 6-month low and slightly below the 49.6 PMI index in May. Factory output declined in June having risen during the past 4 months as the easing of the supply chain and the lifting of restriction in Mainland China abated the contraction. The main factor underlying lower production however is the further reduction in new order intake, as I mentioned earlier. The global electronics PMI posted 47.6 in June, down slightly from 47.9 in May. This level was also the lowest recorded in the last 2 years and mainly reflected the sharper adverse sales development. Global electronics production was in contraction territory for the first time in 3 months during June. The survey respondents frequently link deterioration to weak demand and inflationary pressures and economic weakness. A lot of these contractions coming from the lower output in the consumer and computing electronics segment. Next page. Although the trend to outsource, this shows the EMS market by industry segment. I think the -- I believe the overall trend is -- sorry, the overall compounded growth rate for the electronic EMS for the period 2022 to 2027 remains at around 4.4%. And the trend of the outsource -- the trend to outsource is expected to continue as EMS growth outpaced overall electronic assembly growth. We expect this to continue to support the EMS industries and companies in this space like IMI. Although the trend to outsource is greatest among computer and communication industries. We continue to see more opportunities to outsource in the automotive segment, particularly in the shift from the traditional mechanical automotive suppliers into electronics. And a lot of this is driven by the move towards electrification, where there are less mechanical parts and more electronic content in the electric vehicles. Going on to the next page. The trend of increasing electronic content is in automotive is shown in this chart. This is basically the automotive PCB compounded annual growth rate. It's showing a much faster growth at 12% compared to the EMS electronic market growth rate of 4.4%. Global PCB market predicts 5.2% contraction in 2023. Despite this downturn, the automotive PCB market presents a growing trend, primarily driven by the continuous rise in the global EV penetration and the increasing electrification of vehicles. TrendForce, which is the source of this data, predicts a 40% annual increase in automotive PCB in 2023, with a value reaching USD 10.5 billion. This accounts for 13% of the total PCB market, which is up from 11% last year. By 2026, this figure is expected to grow to $14.5 billion increasing its share of the total PCB market to 15%. The growth indicates a compounded annual growth rate of 12% from 2022 to 2026. EV adoption is a significant growth driver for this, given the average PCB values for the BEVs are around 5x to 6x that of the conventional ICE vehicles. Over half of these PCBs are installed in the BEV's control system, which houses the battery management system. The rise in autonomous driving, which is also a trend in the automotive or mobility space and its growing adoption rate also means more integration of cameras, radars and other electronic devices that will further help boost the growth in this automotive PCB segment. Next page. We just wanted to share an update on IMI's ESG initiatives. If you recall, we presented out of the 17 UN sustainability development goals, IMI supports 11 of those goals. On the left-hand side, if you look at our employee mix, we have on the gender equality metrics in the UN sustainability goals, we are showing almost equal split between male and female in our workforce. And this is not only on the direct labor of IMI, but it's also evident across the management team across IMI. With regards to shift towards more clean energy, we have also shown progress with 26% of our energy use coming from renewables. One particular case to highlight is in Serbia, and the energy provided actually using 100% renewables. So that helps a lot in improving our targets for the renewable source for energy. GHG emission for Scope 1 and 2, we have reduced by 15% in 2022. So we are on track to meet our targets that we stated recently, which is 50% total reduction by 2030. In terms of waste diverted from landfill, close to 99% of our waste don't go to the landfill but goes into renewable or upcycling facilities to help on the sustainability efforts in the Philippines. Recycled tonnage remains the same. So we continue to monitor recycled waste. And target to improve or increase the recycle waste management. Also I would like to note that these nonfinancial KPIs is now being certified by independent third party, which is the D&D business assurance company based out of Singapore. It's like an EY or SGV audit firm that does audit for the financial statements. So these are audited figures that we're sharing as well. Okay. Maybe now we can move on to the financial update. On the Q2 2023 segment updates, overall growth for Q2 has slowed. It's down 3% versus the same period last year mainly driven by declines in our industrial consumer and telecommunications sector. The Automotive segment remains strong, driven by continued ramp-up of new projects, particularly in Europe, both in our Serbian and in our Czech Republic facilities. Our Industrial business, however, shows a significant drop, down 18% in Q2 versus last year. And the drop is mainly driven by the slowdown in the Chinese market, which impacted the demand for industrial applications, as well as the challenges that the China market has on the property sector wherein the commercial and residential buildings growth have stopped basically. So that decreases the demand for industrial applications of these commercial buildings and residential buildings from one of our key customers. In addition, there is a delay in the model upgrade for our EV charging customer. The upgrade is expected to be resolved or completed by Q3. So we expect to see a recovery in the second half for this EV charging customer, which is served out of our Chengdu facility. There is also a major exit from -- sorry, an exit from a major customer beginning in 2023, which is an asset tracking business. These customers of ours was acquired by a bigger company and the new owner of our customer has decided to consolidate their suppliers into a U.S.-based EMS company. Aerospace and Defense show improvement in Q2. This is mainly coming from our STI subsidiaries and mainly due to material sales to its customers. And these are material sales that are based on milestones, particularly time milestones. However, the value-add sales that is where we generate more of the margins, are still behind targets for this year. On the consumer and telecommunications business, they are both significantly down. On the consumer, it's mainly driven by the -- as you have probably have a slowdown in the consumer electronics, particularly the laptop due to oversupply in the market. And this is mainly coming from our VIA subsidiary, which serves the computer display market. On the telecommunication sector, the drop is mainly driven by an exit of our low-margin customer that we've decided to exit late last year. Moving on to the regional updates. From the regional performance basis, we see a significant drop in the Philippines and in China. In the Philippines, the drop is mainly coming from the drop in demand as our customer faces excess inventory in the sales channel. And also and these are particularly affecting our industrial customer out of the Philippines. On the other hand, there are continue to be some key component shortages. that has also increased the backlog of the Philippine operations. Although it's much lower backlog from before. I think the backlog as of Q2 is around $14 million. in the Philippines. It is mostly automotive and some industrial customers. In addition, the loss that I mentioned of the industrial customer, that's being served out of the Philippines. So, that also affected the growth in the Philippine region. However, contribution margins have improved as the easing of the supply chain and the slowdown of demand also showed positive improvement on the direct material costs. In addition to that, we have continued to execute on manufacturing efficiencies that have showed improvement in our overall contribution margin. In China, slowdown in demand from some industrial businesses as I mentioned, partly driven by the Chinese property market. while the automotive customers continue to suffer the shortages as well. So a similar situation in both China and in the Philippines. The revenue slowdown also has been mitigated by better profitability margins as you -- and I think Lau will report this if you look at our third quarter margins, it has improved significantly quarter-on-quarter. In Europe, particularly -- in Europe, sorry, our Czech -- particularly our Czech and our Serbia facility, we've seen significant growth. This is mainly due to ramp-up of our customers based out of these 2 facilities, contributing to better revenues and profitability as well. Higher utilization rates have also improved our overhead utilization. which leads to better margins as well in our European businesses. In Mexico, we continue to see the growth in North America as a number of the customers continue to look at diversifying out of China. So there are quite a bit of new business ramp-up in Mexico, in particular, the existing customer we recently won additional businesses in the steering -- automotive steering space. which we expect to have a start-up production towards the end of this year. On VIA and STI, I guess the thing to note really is on the STI. So we recently announced, this morning, in fact, that we have entered into an agreement to sell our stake in STI. Basically, STI will be wholly sold through a new purchaser, both IMI and the minority shareholder of STI have signed the agreement to sell the business. Unfortunately, STI has not been able to deliver its acquisition objectives, partly also affected by the series of macro events since we acquired STI, including events like Brexit and then we went into the pandemic and then the supply chain disruptions. As we see, in order to turn around the business, it would require additional funding and increased management efforts from the IMI team to be able to drive the turnaround in STI. So with that challenge and the need for us to really focus on the IMI core business or wholly owned subsidiaries, we've decided that it might be best to have an alternative partner for STI that would be able to help them and guide them through the turnaround of the business. The divestment of STI will then allow IMI to focus its resources and cash as well on the priority markets of mobility, industrial and smart energy. The purchaser is I Capital, [ Imperial Capital ] which is a private equity fund specializing in turnaround situations and also have investment in various industries, including the aerospace industry. So with the exit, we will be taking a onetime hit. And I think Lau will provide a bit more color into the onetime hit, which is $84 million that is reflected in our Q2 result. Although looking forward, it would -- we believe it would improve the profitability margins and the EBITDA performance of IMI -- of the remaining IMI Group going forward. Moving on to the next page. So despite the near-term slowdown that we are seeing, our new business wins continue to pace our Q1 wins and is on track to meet our targets for 2023. If you look at the split of the [ new wins ] mobility continued to drive a significant portion of our win. And a lot of the wins are going into Mexico and in the Philippines as more customers diversify out of China, the China supply chain. Some of the notable wins as you see below, I guess in particular, we have a significant win related to the steering application and additional business or additional wins from that customer also in Q2. And also a number of the wins are related to electrification, for instance, the energy battery management with an ARP of approximately $18 million. Okay. Moving on to next page. Just want to highlight a short partnership that we have with Zero Motorcycle. You've probably seen that in the news recently. Zero Motorcycle is a complete EV motorcycle business. It's based out of California, and the world leader in our electric -- sorry, electric motorcycle and powertrains. It's Cypher III+. With its Cypher III+, Zero developed operating system. It enables the rider to have a new level of customization and connection. This is really their, I think, intellectual property in terms of having a software that runs the operating system for an electric vehicle. It is not a new company. It's been in existence for 15 years which a lot of us probably have not heard of before. I actually haven't heard of Zero until we started discussions with them a few months ago. They have already sold 18,000 bikes mainly in the U.S. and in Europe. So they have over 150 million miles of experience. And Zero picked IMI, mainly because of our experience in not only electronic manufacturing, but also motorcycle assembly with the KPM assembly at IMI. And as we grow the business of Zero, our initial production is expected to be for export into Europe mainly. But it would also slowly progress into the other markets that Zero serves. We expect to start production -- or we have started production already in July and expect to grow the output to about 16,000 motorcycles per year and generating additional 150 jobs in the Philippines. And on the right-hand side, you just see the potential market for Zero electric motorcycle. The top chart shows its motorcycle market has $73 billion worth of core value. And the bottom line is the powertrain, $29 billion. So the Zero is mainly focused on the motorcycle that eventually, they are also going to go into other partnerships in the other train powertrain business like the all-terrain vehicles. So this is a very exciting venture for us because it will showcase our assembly for motorcycle capabilities as well as our electronic manufacturing capabilities. And the thinking for us is to move from just motorcycle assembly and go into PCB production, which we are currently already doing for Zero into more of the electronic requirements for the electric motorcycle. That's basically a business update. I'll turn it over to Lau for the financial details. Lau?

Hello, good afternoon, everyone. So I'll be providing more details of the second quarter performance. But before I start, I just wanted to highlight the change in the presentation by showing the adjusted or non-GAAP numbers in the chart, so as to better reflect the operational performance trend of the company. And the numbers in the boxes indicate the reported numbers that will be published in our financial statements. Although we did some adjustments to the 2022 numbers to spread out the impact of the change in depreciation on a per quarter basis to show a more normalized trend. Okay. So with that, for our Q2 performance, the revenue declined by about $12 million or 3% versus the same period of last year. And this is mainly driven by the exit in one of the major Philippine industrial customer, also our China communication business and the lower demand in the local China market, as well as the decline in overseas manufacturing demand going out of China due to the complex political economic environment in China. So this is partially offset by the increasing activities in our European factories and Mexico factories. With the ramp-up and the start of production for the new EV related and industrial segments and a general increase in demand for some automotive customers. On the non-wholly owned subsidiaries, the combined revenues declined due to the increased volatility in the customer demand. Versus the previous period or previous quarter, the Q2 revenues slightly declined as the decline in demand in the Philippines and also in VIA were offset by the growth from China, Europe and Mexico. On operating income, the significant improvement from Q2 of last -- versus last year is from the increase in the GP margins, mainly due to the reduction of the material cost and the positive effect of aligning the sales prices and that the UPPVs or the unfavorable purchase price variances for this year are also lower. In the second quarter, we also realized some retroactive price adjustments for our customers in Europe and Mexico amounting to about $2 million for second quarter. However, the improvement in the material cost was slightly offset by higher labor costs mainly due to unfavorable FX impact as a result of the strengthening of the local currencies against U.S. dollar. So this is reflective in Mexico for the Mexican peso, and also in the Philippines for the Philippine peso. There are also some wage increases, particularly in Europe and also in Mexico. And also additional headcount for the new programs that were recently added towards last quarter of last year. And also the improvement in the margins can be attributable to the reduced operating costs across all sites and this is being done through lean manufacturing and optimization of the existing resources. So on the net income, the adjusted net income has been positive since Q3 of 2022, and it continues to improve in 2023. This is despite the high interest cost. And likewise, the EBITDA have been improving for the first 2 quarters of 2023 as the component shortage situation and the manufacturing efficiency improves. And we also continue to negotiate prices to recover the increase in cost and also some FX fluctuations in the contracts. So as mentioned by Jerome, for Q2, we have recognized a onetime loss amounting to $84 million related to the divestment in STI. So earlier today, we released a disclosure on the sale of STI to I Capital. And the agreement was signed yesterday, but the closing will take place after satisfaction of the condition precedent, which is mainly approval of the government under the United Kingdom National Security and Investment Act of 2021. So with this, based on the indicative price discussions, when we were doing the June numbers, we performed an impairment test based on the purchase valuation. And with that, we determined a onetime loss of $84 million, which includes impairment of the goodwill of $55 million and the remaining $29 million is allocated proportionately to certain assets like fixed assets, accounts receivable and inventory. So with this onetime loss, IMI's equity will actually reduce significantly by 22%, but our financial leverage ratios are still within our target range. But moving forward, the exit will improve our profitability. And if we base it on our Q1 LTM, last 12 months EBITDA, there will be an improvement of about $6 million in the EBITDA without STI. At the same time, the company's cash position will also be better preserved to support the core growth opportunities of the IMI wholly-owned subsidiaries. On the next slide, please. So this is just the split of the wholly owned and the non-wholly owned subsidiaries performance. So for the core business, while Q1 started relatively low due to the remaining component issues the activities in Q2 started to pick up from the, successful start of production of our new programs and also recovery of backlogs from previous periods. On the bottom line, actually, the core business have been profitable since 2021. For non-wholly owned, Q2 declined due to pushouts of demands in the consumer and automotive sector. However, if you look at the chart for the bottom line, the net loss is slowly narrowing down as these entities focus on margin improvements despite the reduction in revenues. Next slide, please. So this slide shows our capital structure. And just to highlight here the increase in the bank debts which is mainly to fund the new businesses, particularly in Czech Republic and Mexico. Our cash balance also declined because of the slow depletion of our inventories due to changing demand and pushouts to later quarters. And there is some time lag between our collections and payments from the customers and suppliers. As mentioned earlier, the loss from the STI divestment will reduce our equity. But our balance sheet ratios remains to be acceptable or within the target range. We are also showing a simulation of the balances. Once we consolidate STI on a line-by-line basis, the ratios will actually improve if we deconsolidate STI upon completion. So our book value per share is at PHP 7.68 which is higher than our share price now. I think from yesterday, our share price, we are trading at PHP 4.50. Okay. So on the capital investments, we still have controlled CapEx in 2023 as we only spent on critical CapEx items, particularly related to the expansion projects. As of Q1 -- as of first half of the year, our capital expenditures stands at $11.1 million. This is almost the same level as the 2022 on an annualized basis.

So maybe just to recap the key takeaways. I think we talked about the onetime loss that we have booked in June related to the pending sale of STI subject to the approval of completion, we expect within, I think, 45 to 60 days may be earlier. Again, this helped us to really conserve our cash and focus on the core wholly owned subsidiaries, and really help us also focus our management resources into these priority markets that we're seeing significant opportunities in mobility and industrial sectors. We also have seen some of the benefits from the successful price negotiations that we [Technical Difficulty] in the last 1.5 years. With gradual easing of the component shortage, we also see some improvement in our direct material lead times and costs as well as our continued manufacturing efficiency initiatives. This has led to improved gross profit margin for the group to 9.6% in Q2. And also the inauguration of the Zero Motorcycle. So I think that's the first step for us to expand our motorcycle assembly operations in the Philippines, especially electric motorcycles and also allow us to continue the partnership with Zero into their continued outsourcing move away from their main manufacturing base in U.S., which is a very high-cost market to produce and to shift that production capability into the Philippines. And in addition to the assembly, we are looking also for to more expanded business opportunities in electronic space for the electric vehicle motorcycles. And lastly, despite the slowdown that we're seeing in 2023, we continue to see encouraging positive opportunities in the new business that will help us drive further growth in 2024 and beyond. So we've been able to secure $152 million annualized revenue potential in the first half of this year, on track to meet our targets for 2023 new business targets. So with that, I'll open it up to questions.

Thank you, Jerome and Lau. We have a first question here regarding our VIA optronics. Will VIA optronics be able to fulfill the portfolio requirements to stay listed in the U.S.A?

Do you want me to take that, Jerome?

Yes, please.

Okay. So as you may know, we announced their failure to file the 20-F as a requirement for the listing in the New York Stock Exchange. Actually, the reason for the delays are mainly on the review procedures that was done. They went into several level of review with the local auditors, the head office of the auditors, quality reviewers and the SEC itself. So if we understand the discussions, the pending discussions are really more on the comments on the disclosures and some items in the 20-F that are being resolved. But in terms of filing, they are required to cure within 6 months from the time of the announcement of their delinquency. I think the deadline for that would be in October of this year.

End of September.

Yes, end of September, yes. So yes, I think we're still pushing to meet the requirements for VIA. And we are...

And I think based on the latest update, they still believe that they can achieve the September 30 submission filing.

Just going off of VIA again, was VIA profitable in Q2? I'm not sure if they've done their Q2 press release yet. We cannot preempt their own earnings press release and that caused in the conflict with the stock exchange. But would you know, Lau?

We cannot disclose since they haven't really disclosed their Q2 results yet. Apologies.

Okay. Next question is there's a commentary about the face-to-face Annual Stockholders Meeting in 2024. We're certainly assessing all options. A face-to-face ASM is certainly on the table. And we'll keep everybody updated on what we're planning for next year. We have our CEO, Arthur Tan, joining us as well. So if there are any questions anybody would like to address to Art, feel free to type it in the chat box, please. Okay. If there are no further questions. Again, feel free to e-mail me at any time. It's [email protected], and I'll forward it to the relevant people. We'll get an answer to you shortly. Okay. Thank you, everyone, for taking the time for joining us this afternoon. Thank you, Lau. Thank you, Jerome. Thank you, Art -- sorry, there's 1 more question from Christopher Chua. What strategies will IMI be looking for in China?

Maybe I'll take a stab on that. Sorry, again, for joining on a little bit late, I'm on a different time zone, and so I didn't quite make the start. So I appreciate the coverage that Jerome did, as well as Lau, and you, Brian. I'll just add a little bit on the China side. So China is actually undergoing its own transition into this new market economy that the government is trying to pursue on a domestically centric business. And so we're also looking at how we're going to be able to capitalize on that. Currently, our current businesses in China are already overweighted on the businesses that are already domestic. And so there's very little that's being affected on an export basis from our China operation. So the growth of China will be hinged on the availability of capacity within China itself. And so the focus markets that we're already targeting within China which right now is centered on the automotive, industrial sectors is something that we're actually closely watching as how that's being developed across different regions within China. So the optimization that we're looking for will be centered on the other facilities that we have that are also looking into consumer, as well as the medical and the computer market. So we're in the process of actually checking on how we're going to be able to optimize these capacities that we have already right now. In fact, we have I think our Jiaxing facility is outperforming all of our other facilities right now. I'll let Jerome add more to that. Go ahead, Jerome.

As Art said, a lot of our focus is China is relooking at our portfolio, moving out of the lower-margin sectors like the telecommunications sector, which is a low-margin business for us and into automotive and industrial. So with that exit from one of our customers in telecommunication sector in Shenzhen that allows us to have additional capacity than we can focus on bringing in more industrial segment. At least in Shenzhen, a lot of the customer base there is more industrial rather than automotive. Our Jiaxing remains to be our main automotive business. and that's growing -- continue to grow and expect to grow. We had some challenges this year mainly because of the component shortage in automotive. Otherwise, the growth would have been much higher in Jiaxing. Yes, I think that's kind of our areas that we're focusing on right now.

Thank you, Art and Jerome. Another question here for Art. How did you rationalize your global footprint? And I guess, any plans moving forward about rationalization of our facilities?

Well, there's 2 ways that we look at it. One, as you know, we already have a diversified portfolio base. And we already have a diversified portfolio in terms of geographical locations by being able to serve all the key markets that's driving the economy on a global basis. So we have our footprint in Mexico and the U.S. for North America. We have Serbia, Bulgaria for Europe. And as you know, we have Philippines and China with China for China. In being able to rationalize this geopolitical situation that we have, you always have 2 ways to look at it. One is do you believe that the current status on a geopolitical basis is going to be the normal, or do you believe that these are just occasionally man made with certain time frame that you will now have to go develop a strategy around on whether to double down on the current markets that you already serve, or do you then expand that? So one of the things that we have clearly identified in the past and we continue to look at is on the China+1 strategy that we have and looking at maybe potentially doing a China+2 strategy for that, given that there is continued expansion beyond China. Now within China itself, we're also looking at how to rationalize our current footprint because of the already stated comments made by both Jerome and I on the changes within the China economy itself. So that's -- and then the third one will be how do we continue to overweight on North America, given that there's a lot of focus that's being given in terms of incentive, by the U.S. government for made in the U.S.A. strategy. So those are the 3 main things that we're looking at on how we're rationalizing our geographical reach right now. Yes, I don't know if you want to add anything there, Joe.

No, nothing much to add.

All right. And then, I guess, a question for Lau. When can we expect IMI to turn around to a net income on a consolidated basis?

Yes. Actually, for the first half of the year, if we will remove the onetime loss, we should have reported around 700,000 positive income for the whole IMI, and this still includes the negative margins for STI. So once we complete the deal and we consolidate STI, it should be higher in terms of our bottom line. So right now, ex one-offs it's already at 700,000.

Awesome. Thank you. We've also been getting messages of support, and we're also looking forward to really driving profitable growth for IMI. We are looking forward to turning positive and reporting income numbers in the near future as well. Okay. It seems like no further questions in the chat box. Again, my e-mails is at [email protected]. Feel free to send over any questions. And again, thank you, everyone. Thank you, Art, Jerome, Lau. Stay safe, everyone.

Thanks, everyone. Thanks, Brian.

Thank you, everyone. Bye-bye.

Thank you, everyone. Bye-bye.