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

Once again thank you, everyone, for taking the time to join us. This is IMI's 2023 Third Quarter Analyst Briefing. Joining us today is our CEO, Arthur Tan; our President; Jerome Tan; and our CFO, Laurice Dela Cruz. We'll be starting with some market updates before going on to financials, some key takeaways and then we'll open the floor up for some Q&A right at the end. Jerome, please.

Thanks, Brian, and welcome everybody. I'll go through the macroeconomic environment quickly, but nothing or no significant change from the last quarter update. If you look at the global economic growth, the world economy is still on a gradual path to recovery dealing with the aftermath of the pandemic, supply chain disruptions, geopolitical tensions and the rising cost of living. The expected soft landing in 2024, however, is notable even though the war in the Ukraine and now in the Middle East has disrupted energy markets and the global monetary policies tightening to combat the high inflation. Despite all of this, the global economy is experiencing some slowdown, but not the severe recession expected. Nevertheless, the growth persists at a sluggish space. It's expected to be more tempered compared to the forecast middle of this year. The Eurozone and China are seeing a lower forecast while the U.S. and Japan are seeing improvement, particularly in the U.S. with the jobs remaining still quite firm and a big drop in employment levels. So global growth are expected to grow next year at 2.9% from 3% this year. Global inflation has also started to trend down so I think this is positive. As the U.S. Fed have also signaled possible end to tightening. This would help also our business in terms of reducing the funding cost as we expect that to at least not increase in the near term, but start to expect then towards the medium term some easing in terms of the cost of funding. These conditions would help IMI in terms of the operating environment. While the market growth is a bit slower, I think it would help IMI in terms of the cost of living increases so that should start to be tempered and also the funding cost will start to ease as I mentioned earlier. Going on to the next page just quickly in terms of the global manufacturing sector. It remains downbeat. In October, the index fell to 48.8. So anything below 50 is a contraction and it's down from 49.2 in September. So this I believe the 16th month wherein it's showing month-on-month reduction so it's on the 16th month. I think as manufacturers remain cautious and work on clearing the excess inventory in the system. The main drag here is Europe and to a larger extent Asian manufacturers, particularly in China. In terms of global electronics PMI, it's believed that the electronics sector followed a similar down trend, but an uptick in September reaching 47.7. So we believe it's a sign of kind of a bottoming out. So we're looking forward to some improvements going forward. Next page. Just to highlight again the -- I think you've seen this many times. Just to run through quickly in terms of what's driving growth at least for IMI in the mobility space is really the shift towards the EV automotive movements and the mobility. So the worldwide EV market grew by 6.2 million units or 49% growth in the first half of this year. Full year is projected to grow by 39%. So this is really accelerating the growth also in the mobility. The fact that a lot of the electronics goes into the EV that also help drive our growth in mobility. And typically, the EV markets also use more ADAS components. So this is also one of the key subsegments of IMI, which would also benefit in this inclement in EV. Going now to IMI in terms of the financials, I'll start off with the regional and segment updates and then pass it on to Lau for the final performance update. Total revenue in Q3 declined by 3% versus the same period last year. Mobility, our main segment or focus segment, continues to see some strong growth despite the challenging economic environment. Our Mobility segment grew 12% in Q3 versus the same period last year. While there are still some pockets of component shortages within mobility, we are seeing the supply chain starting to normalize and we expect it to normalize towards the end of this year and into beginning of next year. We also have continued strong performance in terms of new project wins, which I'll show in the next few slides. Total annual revenue potential of new businesses is about $161 million in the first 9 months of 2023. Our industrial segment, however, is lagging. It continues to see weakness driven by the excess inventory in the downstream market and the slowdown in the property segment in China also impacting the security in our industrial segments. So those are 2 key reasons why you're seeing a 22% drop in our industrial segment versus the same period last year. The other factor is we lost 1 of the major industrial business starting in 2023, which is where our customer was acquired by a bigger company and they decided to consolidate their manufacturing capabilities to the parent companies, EMS provider. The other segment that we serve is telecommunication. While this is not the core segment, it's still a significant part of our segment. This has also shown slowdown as this is result of the aggressive pricing that we're seeing in the local EMS companies in China where since this is not our core strategy, our focus is really to still continue to maintain our profitability. So instead of sacrificing our margins, we have purposely also declined some of the very aggressive pricing in the telecommunications sector. So this is driving the drop in the telecom segment as well. The other segment, aerospace has shown some growth. This is mainly our subsidiary STI in the U.K. This growth is driven more by the low volume numbers in 2022 as well as more material milestone sales. Material milestone sales are basically sale of the raw materials to the customers while we are not able to complete the finished goods because of allocation parts. So it's really in effect in other words not really a full sale of finished goods, but more a sale of the raw materials back to the customer. So that's driving the increase in aerospace and defense. And then the last item to comment is on the consumer, we're seeing a drop also in the Consumer segment. This is mainly coming from our VIA subsidiary and the driver of the growth is really from the consumer laptop business, which has declined in terms of demand. Moving on to the regional updates. On a regional basis, you will see Philippines and China continues to underperform mainly driven by a reduction in our industrial segment, in our telecommunication segment. Telecommunication particularly related to the China business. However, we continue to focus on streamlining our overhead costs and operating efficiency, which allows Philippines and China business to improve its gross profit margin. In the case of the Philippines, a significant improvement while in the case of China despite the drop in revenues, we are able to maintain our margins as well. In the Philippines, maybe just to highlight, we recently announced our partnership with Zero Motorcycle. So that has started partnership in Q3 of this year and expected to ramp significantly in Q4 and into next year. Our Europe region shows very strong growth. These are new projects that we have won I think late last year and starting to ramp up this year, particularly in Czech Republic and Serbia. So you'll see significant growth in Czech Republic, 70% growth quarter versus same period last year and also in Bulgaria, Serbia 28% growth. In Mexico, growth is moderate driven also by a ramp-up of new projects and increases in price as we continue to work with our customers to improve the margins in Mexico. However, there are significant inflation and also the strengthening of the Mexican peso impacting the margin of Mexico in the same period versus last year. We continue to focus on improved efficiency, reduction in scrap and also going back to the customers to look at how we can improve our margins through price increases by passing on some of these inflationary costs and also looking at ways to reduce our raw material price by consolidating some of the raw materials and supply from the lower cost regions. STI and VIA continues to show decline. As you probably all know, in last quarter we announced the sale of STI. I would just like to note that as of October 31, we have closed the transaction. So Q3 still shows the full STI P&L, but starting November this year we will no longer be carrying STI. So that would allow us to focus more on our core business going forward. As I mentioned earlier in terms of the new wins, year-to-date September we're showing still a healthy growth, $247 million of annual revenue potential won in the first 9 months this year versus $165 million last year. So despite the slowing macro environment, we are still seeing a strong pipeline in terms of new projects coming in and also new business being won. Particularly Mobility is still quite strong for IMI going from $76 million in the first 9 months last year to $161 million of new wins in the first 9 months of this year. The bold ones that you see below are the third quarter wins. We have the electric motorcycle and the battery and then a number of the new wins is also mainly driven by Mobility and the Industrial segment. In terms of win location, I guess the challenging area for us is China. As we mentioned, it continues to be impacted by the geopolitical tension. So since a lot of IMI current customers and prospective customers are either European or U.S., there is I guess less appetite for them to bring in new projects into China and competing with the local customers, local EMS companies are more competitive in China. So we're not able to win as many business. So that's 1 area that we will continue to look at ways to see how we can improve in terms of competitiveness and also trying to tie up with some other Western companies that still operate in China. So that's on the business segment, region and new wins update. So I'll turn it over to Lau for the financial performance. Thank you.

Hi and good afternoon, everyone. So I'll be presenting the third quarter financial performance of the company. On the revenues, our revenues remains to be challenged by demand softness and the depletion of stocks on the customer side and this is particularly on the industrial and the consumer segments causing our top line to decline by $10 million or 3% from Q3 of last year. But this is being offset by the recovery of the automotive market in Europe. Compared to the previous quarter, Q3 has lower activities in July and August mainly because of the Europe summer holidays and also slower demand in China, particularly in the medical and the consumer business. On margins, after adjusting the change in depreciation life for last year so that we compare apples-to-apples, our contribution is actually slightly better as we are realizing some material cost reductions, but the lower revenues are causing lower utilization of our fixed overheads. Compared to the previous quarter, quarter 2 is actually on the high side because we have higher collections of unfavorable purchase price variances and also the sub retroprice adjustments from beginning of the year. On operating income, which will also flow to the net income and EBITDA, the gap from last year of about $6 million is coming from $1.6 million impact on the GE from the lower revenues causing the [indiscernible] and about $4 million increase in selling and admin expenses mainly due to inflation, increase in tech-related costs and we have some inventory provisions for this year compared to last year wherein we actually reversed some provisions. On the GAAP net income, the $6 million gap in operating income is offset by higher unrealized FX gains from last year mainly from the euro currency, which is being included in the non-GAAP computation. Next slide, please. So this slide is just to show the split of the IMI core performance versus the non-wholly owned subsidiaries. On the core business, the revenues actually increased from last year and this is from the recovery of the auto segment and the ramp-up of the new programs, but offset by the slowdown of demand in the other segments particularly in the industrial, consumer and medical. The decline in net income of about $3.6 million from last year is partly a decline in the GP by $1.4 million mainly from the impact of inflation. And as mentioned by Jerome, the Forex also has an impact when the local currencies are appreciating against the U.S. dollar. This is particularly applicable for Mexico wherein the appreciation of Mexican peso from last year was about 15% from MXN 20 to MXN 17 per USD 1 and RMB also has depreciated by 6% and this too has a negative effect on our margins. As for Mexico, we are a U.S. dollar functional currency while for China we are at RMB functional currency. But at least for China, they were able to manage the cost efficiently despite the decline in revenues to offset the inflation and the ForEx impact. We also have higher GEE of $2.4 million, as mentioned, from the inventory provisions and high technology costs. And also interest expense continue to increase in rates and we also have additional -- and that's additional $900,000 for the quarter compared to last year. On the non-wholly owned, the lower revenue is actually coming from the VIA lower consumer, but it's offset by aerospace increasing in revenues. The non-GAAP net loss is slightly lower than last year for the 2 wholly-owned subsidiaries, but the big portion of the loss is still STI due to the margins and the working capital challenges. And as mentioned by Jerome and as you may have read from our disclosure that we have closed STI last October 31 and we shall finalize the impact of this based on the closing balances. So we already booked some impairment of about $84 million in June. So we think this will not increase significantly, just some at least on the closing balances as well as additional transaction costs. So moving forward, STI will no longer be consolidated beginning November 1. On the capital structure, nothing much to highlight here as our ratios are still within the target range and even after we deconsolidate STI in Q4, we will have the acceptable financials. Our cash have declined mainly from the increase in inventories and the ramp-up of the new businesses in the automotive segment and also some demand pushouts or events because of the clearing of inventories from the customer set. So most of our cash are still on the inventory and we are working on the depletion of the inventories and closely monitoring our loading strategies to minimize the excess inventories. On the next slide, our CapEx as of September sits at $18.6 million and this is for the new programs particularly in Syria, Mexico and the Philippines. For the full year, I think we expect to spend CapEx of up to $25 million. This is to support the expansion and increase in capacity for the new business that are expected to ramp up next year. So that's all for the financials. I'll turn you over to Jerome for the summary.

Thanks, Lau. Just a few key takeaways. As mentioned, the sale of STI to Rcapital was successfully closed in October. So moving forward, STI financials will normally be deconsolidated. So that allows also IMI to focus on the core business as well as also stop funding into STI, which has been a drag for IMI. We also are starting to see normalization of the operating environment although at a much slower pace. I think the top line will be a challenge in terms of growth. But in terms of the rising cost inflation and the high attrition rate on the human resource side, at least that would benefit of a slowing environment. It would then make the operations a bit more normalized for us going forward and allow us to better plan our operations. The main uncertainty remains the geopolitical issues as far as I see. So that one is the area wherein anything can happen as you see with what's happening in the Middle East. So far the impact on the Middle East conflict does not have any significant direct impact on IMI at the moment. So we're hoping that, that does not escalate further. So hopefully things will try to be resolved. Just Lau mentioned, our focus is really continue improving our operating leverage, trying to reduce our cost, be more efficient and big focus on working capital, which has allowed us to generate cash to allow us to redeploy our cash into the new business as we see. Our pipeline continues to be down particularly in the Mobility space as the segment transitions into more renewable mobility in the Mobility space. That's our key takeaway. So Art, if you want to add a few more points.

Thank you, Jerome. I just want to try and add basically as what was already shown and what Jerome has articulated as well as Lau. We're taking a much more conservative approach in how we're doing our business, making sure that the expansion and the growth in the business that we're taking will contribute more in bringing us back to our levels of profitability. We're also looking very aggressively into the current layout and deployment of our assets across the world. To make sure that we match it to the new markets that are evolving on global basis, taking into account that there are some regional issues that we need to be prepared with. Those that were already articulated, which is the conflict that continues to evolve as well as the trade issue with China that is also continuing to have an impact. So nonetheless, our current sites remain to be attractive on a regional basis for the different businesses and the market that's growing and we are trying very well. The commercial team is doing an excellent job in capitalizing on these opportunities of new projects and our operational team is really optimizing our current footprint as well as rationing our utilization of the deficits. So I would say that yes, growth may be a little bit more muted, but the muted is not because it is not available. It's just that we're taking a much more conservative approach towards the business that we take and making sure that we continue to go towards our level of profitability. That's it.

All right. Thank you, Art, Jerome, Lau.

At this point, we'll open the floor up for any questions. Feel free to type it in the chat box directed to the proper panel. We have a question here. How much did STI lose in core revenue? Unfortunately, because of how we segment our financials, we will not be able to disclose that at the moment since VIA has not yet released their own financials. So separating out STI from the numbers we just showed will reveal VIA financials before they get to disclose in the New York Stock Exchange. So in a couple of days or weeks, VIA will be disclosing their numbers and there analysts will be able to deduce the split between VIA and STI. So I guess it's also a good chance to say that moving forward, we may change the way we present our numbers since again we're not allowed to disclose VIA numbers ahead of them. So we might shift the presentation of the wholly-owned and non-wholly-owned figures moving forward. Next question. Can we assume that Q4 will be better than Q3? Perhaps Jerome or Lau can take this.

And Lau, please correct me if I'm wrong. I think at least in terms of Q4 outlook, it should probably be at the same level as Q3 operationally. There might be some year-end adjustments based on final audit period. But operationally, I think Q4 should be relatively close because we also have lower months of December at least in some of the regions like Mexico and similarly in Q3 we have the summer holidays in Europe.

Maybe just to add. In my view, there is still uncertainty in the global demand particularly in China, but this will be offset by the start of the ramp-up of the new businesses. Some of the new businesses started to kick off in Q3, which is expected to deliver more revenues in Q4. So there could be offsetting of the revenues. So maybe it's the same as the Q3 performance.

All right. Next question is how exactly will the proceeds of the sale of STI be used? Are there plans to use this to pare down existing debts? I guess first point is the way the transaction is structured, the proceeds will be paid within 2 years. At this point, we have not yet received the proceeds. But within 2 years we'll be receiving the GBP 2.2 million as we have disclosed. On how we will use the proceeds, maybe Lau, if you can give us a few points.

On the proceeds, I think we have some negative carry on the funding that we have extended to STI. So probably we'll be using that to pay off some loans to reduce the loans so that to reduce the negative carry on the interest.

All right. Next question is how much incremental revenues will the partnership with Zero Motorcycle contribute to 2024 top line? Unfortunately, the actual figures we're not be able to disclose. But perhaps Art could give us some flavor on what we can expect with Zero EV Motorcycle.

Yes. So the engagement started and I'm happy to note that so far all the expectations from both parties in terms of our commitment to be able to produce the bikes in a timely manner and for their market to be able to be served from our operations and manufacturing in the Philippines have been going forward. So the demand side continues to be there and that we continue to be able to move and deliver. I think the challenge has been and always have been at the beginning not to -- especially with starting up a new operation just making sure that the material pipeline is put in place as we transition from their operations in California to moving those materials to the Philippines and then getting them produced and then delivered to the different regional locations globally. But aside from those start-up issues, I'm happy to say that as far as volume expectations, we are meeting those and that next year the outlook still remains to be bullish.

Sounds good. Another question for you Art. Will ADAS or advanced driver assistance systems be mandatory in all EU vehicles?

So there are advanced driver assistance system is different levels so there's Level 1, Level 2, Level 3. So the mere fact that you have a reverse camera, which is a passive Level 1 system in your vehicle, is already part of that requirement and is also part of the mandatory requirements. So the rear view camera and then the front view -- the collision avoidance camera, the lane departure cameras and so on moves you into different levels so Level 1, Level 2, Level 3. So full automated driving right now is a Level 4 and at that Level 4, there is still no mandated Level 4 requirement, but there are certain regions and areas already in the world that requires a minimum of up to Level 2, Level 3. And so those are part of the ADAS system that we produce. So we are able to produce components and subsystems that then support both Level 1, 2, 3, 4 and 5 up to the LIDAR system, which is necessary to do a full Level 4, Level 5 autonomous driving. So depending on which area you are, there's already a mandated requirement for certain levels for advanced driver assistance.

All right. So far those are the questions we've received. If nothing else comes up, feel free to e-mail me at [email protected] and we'll get back to you shortly. And I guess that's it for now. Again thank you to everyone for joining us today. Thank you, Art, Jerome, Lau for the presentation. And have a good day, everyone. Thank you.

Thank you.

Thank you, everyone.