IQE plc (IQE) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to IQE's First Half 2020 Results Presentation. I'm Drew Nelson, Chief Executive. I have with me today, Tim Pullen, who's the CFO; and also Amy Barlow, who's Head of Investor Relations. So I will give a brief introduction. I'll then hand over to Tim to take you through the detailed financials, and then I'll say a few words at the end about our strategic directions. So the usual disclaimer slide, and I hope you can all see it. So I'll give a quick introduction and business update. I'm very pleased to report what we believe is a very strong set of first half results. Our revenues were GBP 89.9 million, which is comfortably ahead of the guidance we gave in the trading update in June, and that represents a 35% year-on-year increase. We had a slight ForEx tailwind of about GBP 2.4 million. But we're very pleased with the revenue performance of the group. Because of our operational leverage, that's returned us to profitability with an adjusted operating profit of GBP 4.3 million. We saw very strong cash conversion, adjusted cash flow from operations of GBP 16.2 million, which represents 100% EBITDA conversion. And because of the strong cash generation and also limited CapEx, we've been able to reduce our net debt from around GBP 16 million at 2019 year-end to just over GBP 7 million as we stand, so a GBP 9 million reduction in net debt. So if I move on to the business performance. As everyone knows, it's been a very challenging global context to the first half of 2020 with the global pandemic. But despite that, we've managed to record -- managed to report record trading. And that really, we believe, shows great resilience. We managed to continue production across all of our sites around the world with no disruption incurred during COVID. We set up a Business Continuity Committee at the very beginning of the pandemic, which was chaired by Tim, and that was -- that met several times every week, looked at the communications across the different sites, looked at all of the local guidance so that we kept pace with that, and it ended up being a very, very powerful committee. We saw strong underlying market demand with focus on telecommunications and connectivity. And during a period of social distancing and remote working, we think, that's worked pretty well for us. In terms of operational progress, continued improvement in utilization and productivity across the group, across all of our manufacturing sites. And we've also taken the decision in the first half to consolidate 2 of our U.S. MBE activities, and we're consolidating those into North Carolina. And we've given ourselves a 3-year window to do that to enable the smooth transfer of customers and staff to the North Carolina site from the Pennsylvania site. As some of you will know, we acquired the North Carolina site from RFMD in 2013. That left us with 2 MBE sites. And from an operational point of view and from a financial point of view, we felt that combining those 2 sites was the most optimal solution. So that's what we are planning to do. In terms of business growth, Wireless has been very strong. You can see an increase of over 50% year-on-year in half 1. And the strength in that has come from sales of power amplifier wafers driven by 5G handset launches and increasing content in 5G handsets. But we also saw very significant growth in gallium nitride on silicon carbide wafers for antenna elements deployed in 5G infrastructure rollouts in base stations. The Photonics demand has continued to be strong, 20% -- or more than 20% increase year-on-year in half 1, and that's been driven by continued growth in the existing major supply chain we have for 3D sensing. We've managed to continue to have a very strong position in that supply chain. And there -- we believe there are going to be content gains in the next launch of handsets, which are continuing to drive that business for us. We've also seen strong laser demand for communications and strong sensor demand for both the aerospace and military applications for our InfraRed division. In terms of macro trends, we believe we continue to be very well placed to execute in opportunities in 5G and connected devices. We think this will be a multiyear replacement cycle and transform the way we work and live. And we're just very much -- we believe, at the start of this multiyear cycle, we've developed a range of products and continue to develop more products, which are very much at the heart of 5G. And so we think we are very well positioned as a company. Obviously, we're not sure whether the path will be as linear as some people expect, but we're very much at the start of the cycle and look forward to continued growth. So with that overview, let me hand over to Tim, and he can take you through the more detailed financials.

Okay. Thanks very much, Drew, and good morning, everybody. If the slides could be progressed, I don't think I've access to it right now, you can move on to the next slide, please. On to the summary financials. So it's with great pleasure that I present these strong set of results. As Drew outlined, we've got a strong revenue performance here, a record first half revenue for the IQE group at 35% year-on-year growth. And as Drew described, that then returns us to profitability, given the operating leverage of the group, which is predominantly fixed cost base, but is a slight increase year-on-year due to the full year effects of Newport, which obviously came online during last year; and the consolidation of our Singapore facility that we bought back out of the joint venture. That then means that we're profitable at the adjusted level. There is a reported loss, which is the result of the impairment of certain patents and intangibles within the cREO portfolio. There we have a broad range of technologies that's applicable to really a wide range of future technologies, most notably, in particular, we still think that filters technology for 5G, but that's really concerned with the true high-frequency 5G, which is not yet rolled out and is still some years away, we think, from deployment. That means that the revenue stream we expect from cREO is further away than we first anticipated when we first bought the technology and will take some time to get there. And for that reason, we're exercising good investment discipline and not investing too broadly in the other patents and technologies within the portfolio. And as we have to do on a semi-annual basis, we've conducted an impairment review. And given that focus purely on the filters element of this portfolio and the timing of revenues, we've booked an impairment charge for the non-filters-related cREO patents and intangibles. Associated with that as well, we do then get an onerous provision for the minimum royalty payments that are payable to the third party from whom we bought the technology. And that's basically because the revenue streams are expected to occur later than those royalty payments. We still anticipate that cREO will be very relevant to future technologies, in particular, true high-frequency 5G, just happening later than we thought. Cash flow for the group has been very strong. That return to profitability has resulted in strong cash flow, 100% cash conversion from adjusted EBITDA. And that, together with our lower capital investment, results in a reduction of net debt. So that was GBP 16 million at the year-end, now GBP 7.4 million. Investment in property, plant and equipment has come right down to minimal maintenance level. We'll talk a bit more about that in just a moment. If we can go on to the next slide, which is our revenue segmentation. Wireless revenues, really strong performance here. So over 50% growth year-on-year after a challenging year in 2019. Here, we've seen a return to strength for our power amplifier business for handsets, but also for our infrastructure business, the antenna elements for 5G communications, particularly in Asia. In Photonics, over 20% growth. So really strong growth there as well. We've seen continued strength in 3D sensing. And notably, that supply chain has really matured with a very consistent level of production throughout this year. And the growth there really driven by content gain that we expect in the existing supply chain there. And we think that we still got the predominant share of that supply chain right now. So overall, 35% year-on-year growth. If we move on to the next slide. Capital expenditure, I mentioned, has come right down. So really, this is now just at maintenance levels of CapEx, so the investments we need to spend for end-of-life kit or health and safety reasons. And as you can see, that's just GBP 1.1 million in the half. And that follows the natural conclusion of our infrastructure phase of the capacity expansion that we completed in 2019, which gave us the facilities, the buildings and so on, such as the Newport foundry and the Taiwan -- expansion of the facility there, which means that we've got sufficient capacity in the group to underpin the kind of growth that we're seeing this year and more. Going forward, the investment will be very linear and linked to the revenue opportunity, having completed that infrastructure phase. So if we need to buy more tools, we will do to underpin the future revenue streams, but we'll do that selectively at particular sites for particular products. Now we've continued to invest in technology during the half, and Drew will talk later on about our strategy and progress we're making there. Here, we're exercising strong discipline around our portfolio and really are focusing our spend. So the magnitude of spend has come down, but the efficiency has gone up, which means that we're pursuing still the same breadth of portfolio in our technology development, and we've capitalized GBP 2.9 million during the half. On to the next slide, all of that culminates in the cash flow and net debt position. As I say, 100% conversion of adjusted EBITDA into adjusted operating cash. So strong performance, combined with that capital investment profile, that means that our net debt has come down. This puts us in a really strong position in what has been an unprecedented and uncertain environment. So strong liquidity with access to material debt facilities. As all companies now need to do during this environment required by the FRC and the audit firms, we've considered severe but plausible downside scenarios as they're now called by the audit firms. And that's the stress test, given the uncertainty of the external environment, what would happen to our business? And I'm very pleased to report that given the debt facility structure that we have, that even in those very severe but plausible cases, we could still access our debt. We don't have any issues with the covenants associated with that, which is part of that strong liquidity position that I'm describing there. In terms of balance sheet, if we move on to the next slide, I won't linger on this too much. I think the numbers here speak for themselves, given the story around intangibles, investments in assets and so on. We do have bank borrowings of GBP 25 million despite that lower net debt position as a result of the asset financing facility that we took out last year, which obviously results in a decent cash balance out in [indiscernible]. Moving on to the outlook slide. So looking forward. To date, we haven't provided any full year guidance, really due to the uncertainty of the environment that we've been operating in, in 2020, in this unprecedented and uncertain world that we're in at the moment, but we have obviously traded very well and partly as a result of our resilience as a business and we reacted to pressures in our facilities, but also the fact that demand has been strong in our industry. And similarly, our partners, our suppliers and our customers [ have been disrupted either ]. Those customers in particular have recently put out very bullish, I would say, trading statements with a degree of optimism looking forward. And I think that bodes well for us even though we typically have reasonably low visibility of the business. So we are now in a position to be able to share full year guidance, and we're setting that at, at least GBP 165 million for the full year. So that would be at least 18% growth. Now that would obviously be sequential rather than half on half, but there are some reasons that Q4 could be a bit rough than the earlier parts of the year. It's quite possible that the second half could be just as strong as the first, but there are a couple of swing factors. One of those is in the 5G infrastructure deployment that we've seen such strength in [ second half ] of this year. The changes in global markets keep coming, and that means that there could be sort of changes [indiscernible]. And as Drew referred to, the path to the 5G deployments is not necessarily going to be linear, so we may see some sort of phasing changes in that, and that could affect us in Q4 and into 2021. And also 3D sensing, so many of you will know that our 3D sensing product have got a large OEM product launch and it's later in the year. The timing of that launch and the effect of that launch will have an impact on the volume that we produce in Q4. So those are the 2 big swing factors around our revenue [ guidance ] to be above GBP 165 million, so that's the minimum we're targeting at this level. We expect to deliver at least mid-single-digits million pounds operating profit for FY '20, clearly with our operations scaling. And if we do go above GBP 165 million, then more profit will drop to the bottom line. And in terms of CapEx, as I say, it's going to be no more than GBP 10 million. It might be less than that. We'll invest in additional tools [ and new ] technologies if we feel confident in those revenue streams looking out to 2021 and beyond. Overall, looking into 2021 and beyond, we're not seeing any specific guidance at this point in time. We do think that the impacts of the external environment will be a major factor in how we trade next year. And that's both in terms of the economic conditions and in terms of the pandemic but also [ the end part of ] trade negotiations that are being made by a lot of countries in the world, and the technology ecosystem revolves around that. So a high degree of uncertainty. And -- but as you've seen today, IQE is a very resilient business [indiscernible] given our global footprint, we believe we can adapt to any world conditions even if they're disruptive as [ COVID-19 has been ]. So that's the outlook and our thoughts moving forward. I would like to hand back now to Drew, who will give us an update on our strategy.

Okay. Thank you, Tim. So this is an overview of the progress on our strategy. We are continuing to invest pretty heavily in the future of compound semis, and the strategic goal there is to leverage and expedite or expand our IT portfolio. We are continuing to develop a number of new products and targeting new market entry points. And one of the big goals is to continue to gain this at future integration and miniaturization, which is the trend of the semiconductor industry and has been forever. So a number of the technologies we're developing based on a silicon platform, combining compound semiconductors with silicon, and as Tim said earlier, the number of the cREO patents in that portfolio aim very much at that. The issue there has been one of just timing. In terms of progress, we have developed the full-service distributed feedback laser, which these are being introduced for high-speed data comms, for backhaul and for data centers. And we're using Nano-Imprint Lithography for this, which is -- has a big advantage over existing technologies, since it's much less expensive and has much higher throughput. We are sampling customers at the moment with that technology, both at 10G -- 10 gigabits and the 25 gigabits. In addition, we're also sampling high-speed detectors for optical networks at the same time. We are working on Quasi Photonic Crystals for VCSEL module integration. And the aim there is to overall reduce the cost of the 3D sensing unit so that this can penetrate other tiers of the handset marketplace, particularly in the Android space. Infrared lasers for environmental and health sensing and health monitoring. To date, most of our infrared products have been aimed at military applications, particularly in sensing and night vision, but we see a truly exciting opportunity for health monitoring, for wearables coming along in the next couple of years. And our R&D there has been very much in developing lasers that will allow the probing -- the noninvasive probing of blood cells in the blood in order to detect all sorts of different so-called impurities, but you can think of things like lactose and glucose and other things. In terms of 5G front-end module integration, we are continuing to invest in filters, as Tim said earlier, but also in switch technology. And again, the thrust there is to try and develop something which is eventually truly integratable on a silicon platform. And so our focus on cREO development has been very much on the filters. In terms of scaling up the business for growth, we have invested pretty heavily over the last couple of years in capacity expansion at the Newport mega foundry in Massachusetts for gallium nitride and also in Taiwan in Hsinchu for Wireless. You've seen from the CapEx, big reduction in CapEx in the first half that, that infrastructure build's come to an end. So we're in a very good position now in terms of capacity. We can add additional tools as demand requires. And so as Tim mentioned, it will be a very linear CapEx spend versus demand moving forward in the future. We are continuing to qualify a number of new customers in strategic markets. And we've also been spending quite a bit of time enhancing our management control systems and processes to enable this mass production, and Keith Anderson, our COO, has been spearheading that effort. In terms of the progress, as I mentioned, the CapEx is significantly reduced. And I also mentioned earlier the closure of IQE's Pennsylvania, US site by 2024. And that will be consolidating the MBE footprint onto one site in North America. In terms of expanding cash flows and margins. Clearly, the strategic goal there is to get superior unit economics from better yields and economies of scale. Customer and market diversification is a key part of that strategy. And we've moved over the last few years to become a material solutions provider rather than just a pure epi-wafer supplier. And in terms of progress. Site utilization has significantly improved on the FY 2019 levels. We've returned to profitability, as you would have seen from the numbers. And we're generating strong operating cash flow to date in 2020, and we expect that to continue in the second half. So in terms of our technology road map. In the short term, the focus is very much on 5G infrastructure rollout with 5G base stations utilizing gallium nitride on silicon carbide. 5G handsets. We've already introduced high-efficiency power amplifiers and a more fully integrated power amplifier and switch called BiHEMT. So that's getting very strong traction, particularly for 5G handsets. Truly, the backhaul and data centers is -- there's also big requirements for expansion there, particularly at higher speeds. And so as I mentioned earlier, 10G and 25G DFBs and detectors. APDs stands for Avalanche Photo Detectors, it's a very advanced detector. And then in 3D sensing, we continue to see very strong traction there. It's obviously widely remit that there will be world-facing cameras introduced in the autumn time. And so we expect significant content gain as a result of that, and we believe we're extremely well positioned to benefit strongly from that. In the medium term, the trend is very much -- the 5G rollout cycle in terms of infrastructure and handsets, but there are a number of advanced sensing applications which we see as being particularly exciting as well. I mentioned already wearables and consumer devices, where we've developed a range of long-wavelength lasers, which are very appropriate for that market. We see in the 3D sensing a move towards longer wavelength, a sensing, which will allow the sensors to be put beneath the OLED screen. And that's a very strong trend and requirement in the industry. We are extremely well positioned there, having developed some material called dilute nitrides, which allows us to put longer-wavelength lasers on a gallium arsenide substrate, and we are very much the world leaders in that. We've got some really good results in the first half of 2020. So we could imagine that coming to market in the next 18 months to 2 years. And then we've been developing Quasi Photonic Crystals for module integration. And then in the longer term, environmental and health monitoring, given the current trend, very powerful trend towards personal health care, personal monitoring and the detection and monitoring of chronic illnesses, we think this is a very rich area for our technologies. LiDAR for our autonomous drive vehicles. Obviously, IoT with connected devices will continue to expand very rapidly. And then efficient power and smart grids is another area where our products are very much at the fore. So with that, here's just an example of the kind of applications of compound semiconductors in 5G, whether it's for the base stations or the small cells, using gallium nitride, BiHEMT for switching and low-noise amplifiers. And then in the backhaul, data center market, indium phosphide lasers and detectors. And then in the handset itself, you can see that a whole range of different applications for compound semis ranging from VCSELs for time-of-flight world-facing cameras, structured light, camera autofocus and proximity sensing and flood illuminators. And then there's a whole range of different products for the wireless front end from power amplifiers to BiHEMT to pHEMTs and bulk acoustic wave RF filters. So you can see a growing and very rich content for compound semiconductors, which we have targeted many of our development programs and production. So in summary, we've been able to deliver record revenues in the first half of 2020 despite of an unprecedented and uncertain environment. That's resulted in a return to profitability with strong cash generation and liquidity. We continue to make good progress on our technology developments. And although there are some risks and delay to 5G deployments due to global market factors, we believe the multiyear 5G mega replacement cycle will transform the way we live and work. And our technologies, we believe, are very much at the heart of this transformation. So with that, thank you, everybody, for attending today's meeting.