IQE plc (IQE) Earnings Call Transcript

Good day, and welcome to IQE Results Conference call. My name is Breslyn. I'll be your coordinator for today's event. Please note, this call is being recorded. And I will now hand you over to your host, Americo, to begin today's conference. Please go ahead, sir. Thank you.

Thank you. Thank you. Good morning, good afternoon, good evening, everybody. Thank you for some of you who are joining us live, and I want to thank those who would be watching us on video after this session. We have important information this morning to share with you mainly 2 topics on the agenda. One is our 2022 results. And as you are all aware, last night, we have announced a GBP 30 million placement. We will take you through the details of that operation as well. So I want to thank you very much for being with us today. Before we get into the details, I would like to reflect a little bit on my first year as CEO of IQE. As you will remember, I joined early 2022. It has been a very, very exciting year and a lot has happened. So let's take a moment and look at the year in overview. I spent the first half of the year, understanding the business and going into a lot of detail with our customers and partners. That led us to a refresh strategy that we have announced in November. And it is a very important strategy for us. It is the right strategy. Throughout my conversation with the market players and customers, I have got a great validation that the strategy is sound and very, very good for our future. To be able to capture the growth of the market, we have announced a strategy mainly around 2 key pillars. One is maintaining our positions into connect and sense and diversify into growth markets. With the strategy, we have begun the transformation of the business, starting with the commercial engine that is absolutely critical for us to position the company for growth. If the commercial engine comes with customer engagement, as I said, it is important to reshape our relationship and be market-led and customer-centric. That led us to several key announcements in the year with long-term strategic partnership with key customers. Putting all that together, we have said -- we have seen a great execution of the business performance throughout the year. We have delivered a great performance given the market conditions for some of you who are following our industry. You have seen the softness in the market that we will talk about as well. And we have been driving our cost to the right position, improving our product mix and being fiscally disciplined to deliver an improved margin. Talking about the industry softness for some of you, as I said, who are tracking the sector, it is an industry-wide downturn that we are experiencing. It isn't unique to IQE. So we're going to have to navigate for that softness. And I think most industry experts are placing this downturn to be a temporary downturn, focused mainly in the last part of 2022 and 2023. Therefore, we are taking the right measures to be able to manage our business through our downturn with a very laser focus on implementing our strategy, which is the right one for the growth of the business. Now when we look at the short-term challenges of the industry, we would -- obviously, there's many factors that combine into this downturn, but it is, by far, caused by the high level of inventory that we see in the sector. And that level of inventory has been highlighted by many in the industry and can be traced back to the extended lockdown following the pandemic. Allowing us to navigate this challenging operating environment is one of the reasons for embarking in the fundraising that we announced yesterday afternoon. The GBP 30 million will ensure that we can meet our near-term liquidity requirement and deliver a sustainable balance sheet. It also gives us sufficient headroom in case this macro environment would persist into second half. As you know, our current forecast is to recover into second half, but in case that recovery doesn't materialize, we want to make sure that we have the balance sheet that allow us to navigate that as well. And most exciting for me is that this placement will allow us to accelerate our strategy of diversification into GaN business, specifically for power electronics and see our position into microLED market, which is the next big market in the compound space. We all know those 2 markets are high-value, high-growth market and are at the core of our strategy moving forward. Now if we take a step back and we look at the industry as a whole, it is important to keep in mind that despite the downturn that we see, which is not new to the industry, right? This is an industry that has gone through cycles on a regular basis, even though this time it's exacerbated by the COVID and its consequences, we can't lose sight to the fact that this industry has always been a growing industry over the long period of time. And it is forecast to double over the next 10 years. When you look at on the slide, we are currently at the right dot, which is a little deep, but contemplating to growth that's ahead of us from today to 2030, we can only be excited about the longer term of this industry. It is also important to keep in mind that the industry has shifted from design to manufacturing of semiconductor becoming more and more critical as we have seen on the chip shortage that we experienced. I believe for the first time, we have seen the cost of not having wafers or chips in the industry. Therefore, many governments around the world or companies are increasing focus and investment into the manufacturing of semiconductor product and compound is very, very good -- is very well positioned to capture that level of focus and investment. Across the world, we see that in Asia, we see it in the U.S. with CHIPS Act, we see it in Europe, and we look forward to the U.K. announcing also it is semiconductor strategy in support in the industry, and we really hope that semiconductor manufacturing would be at the core of such a strategy. So IQE is aligning itself with these trends, and now our global footprint would allow us to capitalize on that growth while we are accelerating the growth into power electronics and future microLED markets. Now the trillion dollar is overall semiconductor market, if I zoom into the compound space, it is a sector that is forecasted to grow even faster than the overall industry. And when I look at the specific epitaxy wafers, which is where IQE plays, the growth is even higher, 22% projected growth for epi wafers. So based on our strategy that we outlined end of last year, we are positioning the company to really capture and address the total market of GBP 4.6 billion. That means we are positioning ourselves not only to address the outsourced market, but also to serve very large customers that today are maybe doing their own epitaxy, and we would like to be the strategic partner of choice of the global market moving forward. We have a strategy to do that, and the strategy is really in 2 ways: one, we maintain our strong position into wireless and sensing for which IQE is known to be the leader. And we leverage our technology leadership, our customer relationship, our global footprint to scale into new growth markets, which are power electronics and microLED display. We have at IQE 3 key advantages to be able to implement such a strategy. First, we have the most advanced technology portfolio when it comes to epitaxy with 5 mature platforms in volume production. Secondly, we have a global footprint which put us unique. As I said, we are the only global pure-play manufacturer. In today's geopolitical world, having a global footprint is one of the key strategic advantage of any semiconductor manufacturing. We can deliver a secure and resilient supply chain in the ecosystem by manufacturing products seamlessly in the U.S., in Europe and in Taiwan. Third, we have the ability to scale to serve the global market and large customers without the need to create a new fab. We can deliver 3x the wafer output within our 4 walls, which is a very key advantage in terms of time to market and customer supply security that would allow us to deliver our strategy. Those 3 key strategic advantages positioned IQE to capture not only the current outsourced market, as I said. But in our conversation with customers, it is the key value proposition for them to be able to serve their global customer base. Now to our focus, as I said, is implementing our strategy while we navigate our temporary downturn and the successful equity raise allow us to do exactly that. Now let me quickly run through the details. We were very pleased to see how strong the takeup was. It really reflects the commitment of our shareholders to the business and the recognition of the growth opportunity ahead for IQE who main reasons why this placement is so important, as I said earlier. Firstly, in terms of liquidity and deleveraging, we need additional liquidity in the second half of this year because of the temporary downturn that the overall industry has experienced, not just IQE. And we have agreed with our bank partner on resolving -- on revolving credit facility for us moving forward. That gives us sufficient headroom that we need if the economic downturn we have to persist in the second half of 2023. In addition to the better balance sheet, it allows us to accelerate our diversification strategy. We have forecast CapEx investment of approximately GBP 15 million this year -- this year and next. And it is important for the investment to be disciplined while we position the company for growth. That's why we are focused on investing on the most attractive growth area and that growth area is focused on GaN to serve the growing power electronic market. And we also need to see the microLED market where we see a lot of interest from key customers. We have a diverse and rich customer pipeline for both of these markets. Obviously, we would also work with customers to fund the capacity when it comes to volume ramp to be able to deliver our commitment during the Capital Market Day of 3x revenue in the next 5 years. But first, let's look at the financial performance of 2022. I will hand it over to Tim and then come back to you with some closing thoughts.

Okay. Thank you, Americo, and thank you all for joining the call today. I'm going to take you through the preliminary financial results for FY '22. So a really resilient performance from IQE in a softening market for FY '22. And as we previously updated in our trading update, we were expecting 8% revenue growth on a reported basis. We came in just above that, as you can see, with 9% reported growth, which is approximately flat year-on-year on a constant currency basis. So a solid performance in a softening environment. In terms of our profitability, we delivered savings in line with our efficiency objectives, which meant that we have a reported adjusted EBITDA margin of 14%, which is slightly above the prior year, 12%. In terms of the bottom line profitability, this is affected by a goodwill impairment, a noncash write-down of the wireless business units goodwill. And this is really formulaic related to the current operating environment of the group being based on a cash flow NPV obviously, with a soft period in the first years of that NPV, which gives us this formulaic write-down, which is, of course, noncash. On an adjusted basis, the LBIT of the group is GBP 3.6 million. Operating cash flow was solid, but affected slightly by adverse working capital movements in the year with a performance of [ GBP 8.9 million ] delivered during the year. So let's break the performance down in terms of our segments, starting with our wireless business unit, which started to experience the softening in Q4 last year. If we break that down into the 2 key material systems, we have Gallium Arsenide, which is the power amplifier material in mobile handsets. And we have gallium nitride, which is the high-performance, high-efficiency material used in 5G communications. So if we take Gallium Arsenide, first of all, this is most affected by the industry downturn being related to smartphone handsets, which, of course, we've seen large inventory buildups in predominantly in the Android space. And so here, we're down 25% year-on-year on a reported basis, 32% on a constant currency basis. That was partly offset by the gallium nitride infrastructure materials business. Here, we saw strength in the Aerospace & Security segments, up 59% on a reported basis and 43% on a constant currency basis. So overall, we've got wireless business unit down 18% year-on-year on a constant currency basis. Now this was offset substantially by the Photonics business unit. So really here, the IQE portfolio working well to provide resilience in this environment. Photonics up 18% on a constant currency basis. And when we break that down, we can see that VCSELs were very strong. These are our Vertical-Cavity Surface-Emitting Lasers used in the 3D sensing components of smartphone handsets. That part of the business, up 29% on a reported basis, which is 17% on a constant currency basis. And here, we diversified our customer base and are now delivering to 2 out of 3 of the key chip vendors within the key premium smartphone handset chain. We also had strength in infrared, which is our advanced sensing materials business, delivering into the Aerospace & Security sector. That was also up 17% on a constant currency basis. And we also saw a resurgence in indium phosphide, which is the material used in the fiber optic networks of datacoms here, up 21% on a constant currency basis. So just rounding off then our segments. Our smaller segment is CMOS++. This is our silicon epitaxy business, which is important to the future integration of compound semiconductors on silicon. And here, roughly around GBP 3 million is the size of the business again in 2022. Let's move to our CapEx and investments. Here, we saw really disciplined control being exercised in FY '22 in the context of the market softening. So down just over 1/3 on a year-on-year basis at GBP 9.4 million for property, plant and equipment CapEx. But we continue to invest in our R&D development, remaining at the forefront of innovation is an important thing for us, and so GBP 3.8 million invested in intangibles for development. We also invested in our systems and processes to scale the business as we target our 3x growth over 5 years and our improvement in margins to over 30% EBITDA as set out in our Capital Markets Day, investment in consistent, scalable, repeatable systems across our global footprint. It's really important to us GBP 4.7 million invested in the year. In terms of cash flow, that then results in GBP 15.7 million of adjusted net operating cash flow. And at the end of the year, we had GBP 11.6 million of cash and equivalents in the bank. The net debt figure at the end of last year was GBP 15.2 million. Just like to go into a bit more detail on the EBITDA bridge to set out the movement in profitability. So this takes us from our adjusted EBITDA in constant currency. It takes us down to the reported after-tax loss. The key movements here really are the depreciation and amortization of the group of over GBP 25 million. The impairment of goodwill previously referenced. This is a noncash write-down in the wireless business segment of GBP 62.7 million. We've also got the impairment of development costs related to distributed feedback lasers. This is actually something we announced in last year's annual results, but the actual accounting impact of this happened in FY '22. So we're repeating here. We've got some restructuring costs flowing through here that relate to the group's global site optimization program. This is the closure of the Singapore site that was subscale. That was completed on time in the middle of 2022. And we're on track as well with the closure of our Pennsylvania site by 2024 and the consolidation of that part of the business into our North Carolina site. So with a few other movements that gets us down to the reported after-tax loss of GBP 74.5 million. Let's move on to our current trading and outlook. And as Americo has set out, we are at the moment and going through a period of industry downturn that is temporary and is not unique to IQE, is really part of the broad industry outlook at the moment. Here, we can see that we do expect our revenues to be lower in the first half. We're expecting between GBP 50 million and GBP 56 million on a reported basis due to the industry downturn for the first half of 2023. And we're still expecting that, that will return to year-on-year growth during the second half of 2023. In this context, we have strengthened our balance sheet, has set out, and that allows us to diversify into the high-growth markets of power and display through expanding our GaN capacity, which is the relevant technology to both and our strategy has been to improve our balance sheet to do that. And really, there are 3 aspects of how we've done that. So the first is to take all appropriate measures as a management team to recognize the environment that we're operating in. We've reduced our labor cost by about 10% for the full year for 2023, whilst maintaining all of the critical skills and capabilities that we have in IQE to help us grow out of the downturn. In total, we've reduced our overheads by about 7% on a forecast basis called the year. And that's despite inflationary pressures in several cost categories, such as utilities and the bulk gases we use in production. We've taken measures to reduce travel and all discretionary spend. We've reduced our core CapEx spend on maintenance, health and safety items and committed expenditure. And we've rephased some of our IT transformation that I've talked about today to preserve cash, whilst we continue to deliver, albeit slightly slower to make sure that we recognize the environment that we're in. We've also got some commercial options that we've exercised, which include the tool sales and renegotiation of certain commercial agreements. So we've taken adequate necessary steps for ourselves as a management team in the environment. We've also then worked with our relationship bank, HSBC to agree new terms and extend our credit facility with them. So this is a $35 million revolving credit facility with a tenor to May 26. We have covenants agreed with the bank, but also some alleviations to those, which enable us to navigate with safety through this environment. And we also have then completed our successful launch of this equity raise that we announced yesterday. And that means that we're raising a further GBP 30 million by the placing, which includes direct participation of GBP 2.5 million, and there's an additional 3 million Rex retail offering to existing shareholders in addition to the GBP 30 million. These 3 steps really strengthened the balance sheet of the group and give us the best possible position to navigate through the current environment, maintain our liquidity as a group, enable us to continue investing in our diversification strategy and leave us very much on track to execute the strategy that we set out last year at the Capital Markets Day. I'll now hand you back to Americo, who is going to finish with closing remarks before we move to Q&A.

Thank you, Tim. Thank you very much for the details. As we said, despite this short-term weakness in the market, we are positioning the company to be resilient to not only navigate sort of downturn, but also implement our strategy for growth. And we have a very, very strong platform to do that. We are now building long-term agreements that recognize the pivotal role of manufacturing that we play in the semiconductor industry. The market, as I said, is set for a period of very high growth rate, particularly in the area where we diversify into with power electronics and labor microLED and being the only pure-play manufacturer for global footprint. We are really well positioned to be able to play a vital role in this industry and becoming the champion of compound epitaxy manufacturer. So we are very dedicated. We are very focused, and we are improving our organizations, our business models and our balance sheet to be able to do that. Now let's open it up for Q&A. We welcome questions here.

[Operator Instructions] We will take our first question from Damindu Jayaweera from Peel Hunt.

Firstly, congratulations for being on the front foot. Americo, I wanted to ask you a question on the GaN opportunity. When you kind of look at -- I was looking at the Infineon's acquisition of GaN Systems and going through that deck. Obviously, they align with the view you guys have about the GaN power opportunity specifically. It was interesting to see they talk about their internal capacity for epitaxy. So does that mean that in GaN, right here right now, a lot of the epitaxy is still insourced and there is very little outsourcing? And is that the opportunity you see on a go-forward basis?

Thank you for the question. I think that acquisition highlighted how critical GaN power electronics is for the market. We have to understand that some of the energy crisis or climate issues can only be addressed at the technology revolution level. So GaN is one of those as well as silicon carbide in different segment of the market. So we believe that the GaN ecosystem is really prone to a pure-play outsourcing model like we see in the silicon world because you have an ecosystem of fabless that needs manufacturing capabilities and companies who are manufacturing their own epitaxy today, would have the opportunity to come work with IQE, right? We are positioning ourselves to deliver a resilient supply chain and capacity that will allow them to scale even faster than otherwise. When I look at the geopolitics and some of the supply chain requirements, will allow IQE to deliver product very close to customers for the global market. So we have a very large pipeline of customers that we are engaged with to be able to do exactly that, right? We want to be able to give optionalities to customers who are doing their own epitaxy today so that it is at the end of the day, more valuable to come scale with IQE that continue to in-source such growth of GaN system because there is a fantastic growth in that sector that is not yet addressed as we speak, right? On top of that, the fabless ecosystem that we believe will proliferate would also give us opportunity to strengthen our position in that market. So we are looking at a dual strategy, right? Capital market that is insourced today from IDMs and also serve the global fabless ecosystem.

And the second question I wanted to ask is, obviously, in people's minds who are probably not looking at the other peers in the value chain. They will question how do you kind of get back, what evidence you have for getting back to growth in the second half. Could you perhaps remind us what others in the ecosystem are talking about? Because I am aware what, for example, what you see in the WIN semis numbers or what you would see in the commentary from [ Carol ] or even the adjacencies like TSMC. It will be helpful to get some color of what you hear from the industry and what gives this country tends for return to growth in the second half?

Sure. Thank you very much for the question. Yes, we have obviously close relationship with several players in the ecosystem being our fabless customers, our foundry customers or, to some extent, also our substrate partners, right? So we scan the entire industry from U.S. to Taiwan to China and aligning with our customers on the inventory levels. So we already saw some news coming from the industry. You mentioned a few names here who have hinted that they already see recovery in this first half or early second half. So what we monitor is the inventory level. What I hope is, we're going to be aligned with our customers to make sure that we manage inventory level at the right way in the sense where we resume orders in the second half as we forecast, and we do not wait too long because if we do wait too long, we may go back to a situation where there's again shortage, right? If customers wait for too long until we deplete -- completed the inventory, we may be in the situation where we came from, we did not have enough wafer. So at the moment, consensus is that the inventory burnout weight is pretty good. We would see -- we already see in some cases, demand coming back, as highlighted by a few customers publicly or a few players in the industry, but we look at the inventory level by talking to our customers and other ecosystem players.

Thanks, Americo. Maybe the last question I wanted to ask was for Tim. If I look at consensus forecast out there for EBITDA, excluding the outliers, it seems people are forecasting just on the GBP 7 million adjusted EBITDA for FY '23. Just on rough math, the -- on that GBP 7 million overhead cost savings, it looks like that EBITDA number is moving to kind of GBP 12 million-ish level. I just wanted to clarify if that math is correct because then there is obviously the implication of the 150 million new shares and what it will do to the earnings outlook.

Yes, thank you. Your math is good. As always, we've taken a number of steps as set out in the presentation to tackle the cost base in advance of discussions with the bank and coming to shareholders, and it's a fair assumption thereof of the full year EBITDA that you make.

[Operator Instructions] we will move on to Balajee Tirupati from Citi.

Two from my side, if I may. Could you share color on different drivers within your first half outlook? And at this stage, while you expect a recovery in second half based on historically lower visibility, what will be the confidence level that you have, based on conversations with customers and also investing from some of the larger players, which is suggesting a potential push out of recovery in some of the end consumer markets? And then I have a follow-up question.

Okay. Thanks, Balajee. I'll tackle the first part of that question, then Americo, will give a bit more flavor on the customer and industry conversations that is happening. So the first half performance we said back in March that would be GBP 30 million lower than the prior year. Last year it was GBP 86 million, so that puts us at GBP 56 million. We're currently saying GBP 50 million to GBP 56 million, and that's based on a few remaining purchase orders that we need to close for the first half. And some potential capacity constraints in our infrared parts of the business were actually order flow is very strong related to a part of the industry that's obviously on a different cycle to things like the handset and so on. So it could be that some of that revenue shifts from the first half into the second half. If it does, we're not changing our full year view, but we're just giving the range of where that could outturn at between GBP 50 million and GBP 56 million. As Americo, I think it just sets out really around the second half, there are a number of players that are giving signals that green shoots are starting to appear at the end of the first half and into the second half. But Americo, anything further you'd say on that?

No. As I said earlier, we are monitoring the inventory level with our customers and foundry partners, Balajee, and we are hoping and hearing that the growth would resume in the second half. And if it happens to push out, I think we have created to raise the balance sheet that would allow us to navigate the downturn if it happens to expand into next year. But I have yet to hear from industry that this is an issue beyond 2023. I think the debate more -- the debate is more into at what phase of 2023, we see the growth coming back. I haven't heard yet being 2024. But we continue to monitor very carefully the situation in the inventory with customers.