IQE plc (IQE) Earnings Call Transcript & Summary

Thank you, and good morning, everyone, and welcome to our delayed full year 2019 results. My name is Drew Nelson. And with me on the call, I have Tim Pullen, the CFO. Obviously, these are unprecedented times, and we've had dramatic changes to the way we work, live and play. Fortunately, communications networks and in terms of devices and infrastructure has been a major factor in our ability to cope personally, corporately and nationally. And I'm happy to say IQE's products have been playing a major role in the communications networks. And we believe in the future, as 5G is rolled out, we will have an even more important role to play. So by way of introduction to the 2019 results, we've entitled the release position for short-term resilience and long-term growth. And as we go through the presentation, we will bring out the key themes that support that. Now we were all set to publish our results on the 24th of March. And in fact, we're just waiting for the sign-off from the auditors on the afternoon before when the FCA and FRC guidance came into play due to the general uncertainty created by coronavirus. And so we had to unfortunately postpone our results. And in place, we put out a trading update to keep the market abreast of what was happening. So at IQE, our principal concern has been and remains the health and safety of our staff and their families. What we did was, we set up a business continuity committee about 8 weeks ago. And that has been guiding the company's principles throughout this pandemic and keeping everybody as safe as they possibly can. So currently, all of our production sites around the globe remain operational. We've had -- we've implemented appropriate safety measures and operating with the support of national governments. And we're going to say that we've been deemed critical supplier in the U.S. We have been operating in Singapore and in Taiwan pretty much as normal. But we have to say that there still remains an increased risk of business disruption, whether it's because there's been no people to operate the equipment or whether we have supply chain issues, but to date, we haven't experienced any of that. So everything has been operating pretty much as normal. Clearly, all of our admin staff, so anybody who is not involved in direct manufacturing is working from home, and we've increased our communications dramatically to enable that. So that's worked out, I think, as well as we could possibly have expected. In terms of Q1 2020 trading, it's actually been slightly better than expectations, and the outlook for Q2 continues to remain positive at this point. However, given the situation, there's obviously an increased risk to near-term demand from a global recession, which is pretty much inevitable. And so we are not giving guidance at this point, as Tim will go on to explain. We disclosed our unaudited summary financials on the 24th of March in that trading update. Today, we disclosed the full audited results for 2019, and they are very much in line, as you would expect with the March trading update. Total debt facilities at GBP 57 million were put in place during 2019 to provide resilience and the positive trading update from Q1 means we've -- our net debt has reduced versus the reported 31st of December 2019 position of GBP 16 million. And I know that kind of thing is very important. Liquidity is a key issue for many investors today. The long standard in customs relationship with HSBC, our bank, with regular communications has been very good, and they've agreed to formally relax debt covenants tested at December '20 and June '21 to ensure continued access to credit in the event of a severe downside scenario, and we've modeled a number of different scenarios, which have allowed that debt covenant to be relaxed. Okay. So that's a quick introduction. I will hand now on to Tim, and he can take you through the numbers in much more detail. So over to you, Tim.

Thank you, Drew, and good morning, everyone. So on Slide 5, we have a summary of our financials. As Drew said, these are now are fully audited financials for FY 2019. And here, you can see the figures that we've previously released in our March 24 trading update, and as Drew says, these numbers are in line with that position. Really, the new information in this release is the reported numbers, both at the operating loss level, GBP 18.8 million, and the loss after tax of GBP 35.1 million. And I'll come on shortly to explain some of the exceptional items that are behind those figures that are largely noncash adjustments. So on Slide 6, to recap our P&L performance that we reported on the 24th of March. Our revenue was down 10% in 2019, largely as a result of the geopolitical situation which changed global markets. And as we've always said, that was disruptive to us in the short term whilst IQE remains well placed to adapt in the medium to long term, given our geographic footprint. And we're already seeing some evidence of that in 2020 as we'll come on to talk about in the outlook section. But down 10% in 2019, and really, the year-on-year shortfall can be explained by 2 key customers. The reduction in revenues from one of our indium phosphide customers that we talked about at the half year point in our trading update in June. And also our biggest wireless customer where they were really affected by those changes in the global markets and also depleted inventory during 2019. Now IQE is a highly operationally geared company, as you know. So that means that we have a largely fixed cost base and having invested in extra capacity in 2019 we have that reduction in revenues and in volumes. And that, of course, means that we have a profitability challenge in that scenario. So adjusted EBITDA of GBP 16 million and an operating loss of GBP 5 million as reported back in March. Moving on to Slide 7. And here, you can see our CapEx, cash flow and net debt position. The CapEx of GBP 32 million was at the lower end of the guidance of GBP 30 million to GBP 40 million. And that continued really our investment in the extra capacity for the group. And really completed what we call the infrastructure phase of the capacity expansion. So those expansions in Newport with the construction of our Mega Foundry, which is fully built to house 100 tools. We've got 10 in there at the moment with sufficient capacity expansion capability to handle significant growth. 40% extra capacity in Taiwan, where we produce wireless power amplifier products for handsets. And the consolidation of our gallium nitride material capability for 5G infrastructure in Massachusetts. In terms of operating cash flow, we have 100% conversion of adjusted EBITDA into adjusted operating cash flow, underlining the cash generation potential of the underlying business, excluding those investments, and the investment -- why would that operating cash flow net out at a net debt position of GBP 16 million? And that was really the reason that we put in place those credit facilities during the year, GBP 57 million, as Drew highlighted. So if we move on to Slide 8, this explains some of the new information in these full year results over and above what we released in March. And this here walk explains how we get from the adjusted operating loss of GBP 4.7 million to the reported loss after tax of GBP 35 million. So a number of adjustments here. One is the exceptional legal costs associated with a confidential legal case that's been ongoing, and that's been reported for some time. A complicated case, but one that's been found entirely in IQE's favor during the arbitration hearing. So a really good outcome for the company, demonstrating that we will defend our patent portfolio, and we've had success in doing so. The court case is ongoing, and we expect that the costs associated with that will be significantly less than we have incurred to date. It's not as expensive as going through the arbitration process, but still there are some legal challenges that the other side may put forward. The legal advice that we have is that we should be very confident in the outturn position. But at the moment, there is no material impact on the group from a positive perspective. As well as those legal costs, we've incurred a number of noncash balance sheet write-downs, including the impairment of CSC preference shares, and this comes in 2 parts. One is the GBP 4.1 million expected credit loss. When we profiled the revenue profile of CSC, which is our joint venture with Cardiff University. What we're seeing is that revenues are lower in the near term. So shifting to the right and lower overall in magnitude. The rationale of the joint venture with Cardiff University, as many know, is to bridge that gap between academia and industry to work in that space to help bring new products and innovations into mass production that IQE would then mass manufacture. And that's had a lot of success. But the magnitude of that versus our business plan is lower. And in the context of the Brexit environment, which is not topical right now, but of course, it's still in the background, that has a big effect on access to funding as we depart from the European Union in the U.K. So when we profile that forward, we get this expected credit loss and moving the returns to perhaps a more long-term nature also give us what's called a loss absorption charge under IAS 28. So it gets a bit technical but essentially, we're writing down the 8 million of preference shares based on the expected returns from that joint venture. We're also impairing some of our intangible assets. And I think this is really the demonstration of strong governance with our new product introduction process. None of these are revenue earnings so are not things that you'll be familiar with from our product road map, but we're exercising good discipline and stopping things before we spend too much in things that are less likely to be commercialized in the future. So some write-down of GBP 2 million of investments and GBP 0.7 million of patents. And in addition, we're transforming our IT systems to help with the scalability and profitability of the group. So we have some write-downs and there are some legacy IT developments that we've done in the past as well. Those things, combined with some other minor items, things like restructuring, which, as you might expect, we did a bit of in 2019 because of the volume environment. And also the U.S. tax write-downs that we talked about back in our half year results last year, bridges between that operating loss and the loss after tax of GBP 35 million. If there is any further detail, you would like on that, there are some slides in the appendix, which go into some of the more complex accounting matters around some of those issues. But we'll move on now to the business update. And for that, I'll pass back to Drew Nelson.

Okay. Thank you, Tim. So if we can move to Slide 10. It's entitled, resilient in the context of short term uncertainty. And I think we've been able to demonstrate that resilience through our trading performance in Q1 and also the outlook for Q2. And this is because IQE is very much a critical part of the global technology supply chain, particularly with regard to communications, as I alluded to at the beginning, whether it's handsets, whether it's infrastructure, or fiber optic communications or data centers, we have products which really sit at the heart of all of those applications. So in terms of underlying demand, the opportunities are being driven by 5G and connected devices. We saw confidence in the supply chains evident in January as companies, as our customers began to build products for 5G launches later in the year. And we've seen March 2020 revenue and Q1 revenue 2020, slightly ahead of what our internal expectations were at the beginning of the year. In terms of manufacturing, our global manufacturing operations have been operating as normal. Critical infrastructure supply status was given to all of our operations in the 4 states we operate in the U.S. No restrictions on manufacturing in the U.K. And in fact, we've been encouraged to continue to manufacture. And in Taiwan and Singapore, they've been operating normally as they've been currently unaffected. Taiwan, in fact, has only had, I think, 400 and something cases of COVID in total since the start of the pandemic, so they've managed to cope remarkably well. In terms of the global footprint, we have multisite operations across 3 continents. So as supply chains have become more localized, we've been able to cater for that very strongly. None of our competitors have any kind of geographical diversity. So the fact that we have operations in the 3 major continents here has been a major benefit to the group. Input supplies are dual or multisourced, where possible. So we haven't experienced any shortages of raw materials. And government advice and guidance has been implemented in each region to protect our staff and maintain our operations as directed by our business continuity committee, I mentioned at the beginning. OEMs continue to pursue product road maps, as evidenced by recent launches. There is speculation about launches later in the year being delayed somewhat. But from what we can see, it's -- the delays are a matter of weeks as opposed to a number of months. Businesses and consumers depending on mobile communications has been driven by a time of social distancing and self isolation. And this has led to a massive increase in the use of -- for working of social networking and so the communications infrastructure and communication devices have really played a critical role in keeping everybody together, keeping the economy moving as best it can. And I'm happy to say IQE has played a major role in that. One thing we see moving forward is governments are likely to pursue 5G rollouts as part of the economic stimulus and driven by this new way of working and living and playing. We've seen this already in China. There's been a massive stimulus package for 5G there, and we're beginning to benefit a little bit from that. And we believe that will be the case in other major regions of the world as well. So moving on to Slide 11. We believe also we are very well positioned to scale the business. We made not only significant operational progress in 2019, but we completed the infrastructure phase of major buildouts in Newport and our mega facility in Newport, also in gallium nitride capacity in Massachusetts to capitalize on the forthcoming 5G infrastructure deployments. And also in Taiwan, we increased our capacity for wireless products by approximately 40%. And we have continued to qualify new customers in Newport. It's in full production on a significant number of tools right now for 3D sensing applications. And we've also continued to push forward on our new product developments, which are really directed principally at 5G. So in terms of wireless front end, in terms of high-efficiency power amplifiers, new switches, high-efficiency switches and high-efficiency filters, we're continuing to push forward on all of those fronts. The high-efficiency Power Amplifier's already in the market, and we have some integrated products, which we introduced at the beginning of this year, which are now finding significant demand. We continue to push forward on full-service distributed feedback lasers and avalanche photodiodes, which are the devices used for high-capacity networks. Fiber optic networks at both 10G and 25G speeds. We continue to work on our dilute nitride products for -- under the OLED screen and for LiDAR and high-power applications for VCSELs. And so we continue to invest significantly in our product development as we really believe the company is very well positioned for 5G rollouts and all that entails. During the year, we've also evolved the Board structure and executive management to support our growth ambitions. We've introduced an executive management board consisting of 6 individuals: myself, Tim, the heads of the Wireless and Photonics business units, the CEO and the CTO, and that's working very effectively, and we've increased the number of people on the Board. Finally, we've also increased our credit facilities to support navigation of the challenging market conditions that we do foresee ahead of us, but we've tried to position the company in the best possible position to be able to withstand any of that. So moving on to Slide 12. In terms of the technology road map, in the short term, it's very much focused on 5G infrastructure rollout, 5G base stations and small cell installations. And the 2 key products we have there are gallium nitride on silicon and gallium nitride on silicon carbide, and we're seeing fairly robust demand, particularly for gallium nitride on silicon carbide. I mentioned a few minutes ago, the high-speed data coms, 10G and 25G DFBs, Asian market wireless demand for Power Amplifiers as the supply chains become more localized, has been a big driver of our business in Taiwan. And there is also continued 3D sensing proliferation. Recently some devices with world-facing cameras for the LiDAR have been introduced into the marketplace, and we believe that will be a significant trend moving forward, increasing our content in mobile platforms. In the medium term, 5G infrastructure rollout will continue apace, and that will also include millimeter wave small cell networks, which we have other products like pHEMTs for and that will also involve high-speed lasers and protectors for backhaul and fronthaul networks. We see a big opportunity for us, for the company in 5G handsets. I mentioned filters, high-efficiency Power Amplifiers and integrated Power Amplifiers, switch devices called the BiHEMT, which we've already introduced and continued 3D sensing proliferation. And then in the longer term, we see products for environmental and health monitoring becoming very, very significant. Health monitoring, in particular, given the emphasis that COVID's placed on personal health and personal health monitoring. Obviously, autonomous drive vehicles and LiDAR will become a major theme. Connected devices, the Internet of Things will be a huge proliferation of devices which are all interconnected. And then smart grids will also be a major part of our future network environment. So we are, as a company, I think, particularly well placed to satisfy these various areas. And then on Slide 13, we just illustrate here that compound semiconductors are now beginning to be implemented in every major theme, whether it's connectivity or sensing or LiDAR or health care or big data or smart grids. Compound semiconductors are involved in pretty much all of these. The integration of compound semiconductors with silicon devices, we see as a very powerful trend, and we obviously have material solutions to enable that. And they're beginning to get significant traction. So overall, I think IQE is positioned not only for short-term resilience, but also very well positioned for the way the world will develop as we come out the other side of COVID-19. So with that, let me pass back to Tim to finish off by giving you some comments on the outlook for the rest of this year and beyond. Over to you, Tim.

Thank you, Drew. So let's look forward to the next year or so. Obviously, we're in a situation, which is incredibly difficult and challenging. So we're all interested in how we're managing through that. So I'd like to talk a bit about IQE's response to the pandemic and also talk a bit about the outlook for the year ahead. Clearly, the way we all live our lives has changed for now and the pandemic is having a huge effect on the health of people around the world, but also on economies and businesses. We created our business continuity committee, some weeks back now, as Drew mentioned, to really oversee our response to this. And we think about this according to 3 main categories of response. Firstly and primarily protecting our people. As Drew mentioned, that's our utmost priority at this time, making sure that our people and their families stay safe. Secondly, maintaining our operations and ensuring that the business can continue during this difficult period. And thirdly, ensuring the liquidity of the group to ensure that we have access to sufficient financing to guard against potential downside scenarios, recognizing that we are operating in an environment of unprecedented uncertainty. So let's take each one of those in turn. If we turn to Slide 16, first of all, protecting our people, as I say, was our first priority in the response to this. And as a global organization, we've really heeded the advice of national governments, state governments and world organizations, in implementing the appropriate policies and procedures to protect our staff. Clearly, those have been dynamic over time, and we expect them to remain so. The world is currently in lockdown in many regions. And as we come out of that, the approaches of different governments will be different and will ensure that we're implementing the practices and policies that ensure that we comply, keep our people safe in all of the regions that we work in. To date, that's included things like ensuring people are working from home where they can, increasing the cleaning regimes in our facilities and a shift segregation planning to make sure that we keep people separate. What's really important during this period has been the communications with our staff, and we've always said that you can't overcommunicate with your staff right now. So frequent communications and using many media channels to make sure that the information is getting out to our staff and the people remain engaged and motivated during this period. We're certainly maintaining operations on Slide 17. As Drew mentioned, we've been designated as a critical infrastructure supplier in the U.S., and that's in all 4 states in which we operate. The Department for Homeland Security actually state that suppliers, such as ourselves, have a special responsibility to maintain normal work schedules. No restrictions on manufacturing in the U.K. either. And recently, the U.K. Business Secretary stated that manufacturing is a critical part of our economy. So we expect that to continue. Similarly, manufacturing is being supported in Taiwan, which has been less affected by the virus, but also in Singapore, even where they have had a second wave of some outbreaks at the moment. Manufacturing continues there, obviously, with the appropriate measures to keep staff safe. IQE is what I would term a low people intensity business. And those of you that will have visited our facilities know that actually, there are a few people needed to actually run the operations. So really, we're better able to implement the kind of social distancing measures required in the current environment than many other industries. Nonetheless, we're not operating with any complacency, and we have a lot of operational monitoring in place to check that we have the appropriate skills in place with each shift and that we can respond appropriately to any situations as they arise. Thirdly, we've been ensuring liquidity on Slide 18. And this is important because as we look forward, there is this level of uncertainty. We don't know how a global economic recession will affect the markets that IQE serves. We'd already put in place the GBP 57 million of debt facilities in 2019, really because of the challenging geopolitical context that we faced then. We have a very good relationship with our bankers, HSBC, who are incredibly supportive of us. And based on that relationship, we've agreed to relax the debt covenant test at both December 2020 and June 2021. Now we don't disclose the exact nature of those covenant tests. Those are commercially confident between ourselves and HSBC. But what we've done is look at severe and plausible downside scenario. That's the terminology that the financial reporting council are encouraging firms to use and to look at to really test how bad could things get in a severe plausible scenario. And we've done that and put in place that covenant realization, which means that we won't breach the covenant even in that severe plausible scenario. It's not to say that's what we think will happen. But obviously, we do have to consider the downside at the moment, and that ensures that we get continued access to those credit facilities of GBP 57 million, should we need them. Obviously, during this time, we're focusing a lot on cash preservation, working capital management and so on. And as mentioned, our capital expenditure is coming right down naturally at the end of the infrastructure phase of the capacity expansion. So let's think about the outlook. And on Slide 19, there's a qualitative assessment here of the drivers really for IQE. As Drew mentioned, we're not going to give specific guidance for the full year 2020 because things are just too uncertain if we think about the economic demands in future months. But I wanted to set out here some of the negative and positive demand drivers that we see. Clearly, on the negative side, an economic recession could lead to reductions in consumer and business spending, which could affect the markets in which we serve. And there is possible disruption to supply chains in many of the types of markets that we serve, be it handsets, 5G infrastructure or the military markets. And that disruption, I think, will remain a risk as we go through future months. In terms of positive demand drivers though, there evidently are some for this particular sector. IQE is not operating in a sector that's had to shut down completely during this period. We're still operating and from what we've seen is that handset makers have continued to launch phones to continue with their product road maps. And that's a really good sign as we continue through the year. And we're certainly seeing that some of the manufacturing that we're doing now is connected with product launches that we expect to happen later in the year. As Drew mentioned, there's an unprecedented level of use of mobile phones and communications devices right now in this period of self isolation, social distancing and so on. So actually, there is an argument to say that the handset market may fare better even in the recession than some other industries. What we do certainly see is that governments will push 5G infrastructure rollouts as a way to stimulate their economies post exiting this crisis. And there's some evidence of this already in Asia. And we expect that the military market will be very resilient as well to an economic recession for reasons of national security and also economic stimulus again. Obviously, quantifying these is difficult at this point in time. But as you can see, there are both positive and negative demand drivers. So when we consider the financial outlook, if we turn to Slide 20, what we're saying at the moment is given the unprecedented levels of uncertainty, we're not going to give explicit guidance for an outturn for 2020. We are trading well at the moment. As we've mentioned, Q1 slightly above our expectations and Q2 looks positive. We'll continue to invest during this time, albeit at lower levels in terms of property, plants and equipment. And so under GBP 10 million of CapEx there. But we'll invest a similar amount in our research and development intangibles in 2020 that we have in previous years. So just under GBP 10 million there is the guidance as well. That's really important, as Drew described. We've got lots of future opportunity at IQE in terms of technology. And so we want to make sure that we continue to develop that road map. And clearly, we'll continue to monitor this situation very closely. The situation concerning the pandemic itself, levels of economic activity and specific market intelligence, and we'll keep the markets updated as things change. So that concludes our presentation for today. Thank you for listening. And as you can see, IQE remains well positioned to be resilient in the short term but also set ourselves up for -- to tackle that exciting future opportunity that remains for us.