IQE plc (IQEPF) Q4 2023 Earnings Call Transcript

IQE plc (OTCPK:IQEPF) Q4 2023 Earnings Conference Call April 10, 2024 4:00 AM ET

Company Participants

Americo Lemos - CEO
Jutta Meier - CFO

Conference Call Participants

Harvey Robinson - Panmure Gordon
John Karidis - Deutsche Numis

Operator

Good morning and welcome to IQE's Full Year Results Presentation.

I'll now hand the call over to Chief Executive Officer, Americo Lemos; and Chief Financial Officer, Jutta Meier. Please go ahead.

Americo Lemos

Thank you. Good morning, everyone. I am delighted to be here with our new CFO, Jutta Meier, who joined us earlier this year. Before we get into today's results, I wanted to touch based on the earthquake that hit Taiwan on April 3. As you know, we have operations in Taiwan, and I'm really pleased to say that all our colleagues, and their families are safe, and our operations are unaffected. But nonetheless, our thoughts are with the people of Taiwan, during this difficult time.

Now, let's turn our attention to our 2023 results. You would all agree that 2023 was an incredibly challenging year for everyone, as headlines indicate. With difficult macroeconomic backdrop, including high cost of living crisis, and persistent high inflation pretty much across the globe.

In terms of geopolitics, we also saw countries flex their muscle, to control supply chain and sometimes core materials. Export restrictions put on compound materials in China related to gallium, germanium and graphite. This indeed added further tension in the global ecosystem supply chain that was already under pressure from the pandemic. The semiconductor industry as a whole was not immune to the downturn either.

We did see high level of inventory across the industry, which led to a deeper, but cyclical downturn that had been anticipated, by many in the industry. As a result, we at IQE felt the knock on impact from our customers, who continue to grapple with these numerous challenges.

Despite all these challenging conditions though, I'm really pleased to say that we have delivered resilient performance in line with expectations, none of which would have been possible without the commitment and hard work of all our colleagues, employees around the world. So thank you for your value contribution to IQE and thanks to our customers.

During this challenging year, IQE made good progress, with implementing a number of cost saving initiatives, which puts us in good position to capitalize on the recovery in the second half.

Let's now take a closer look at how 2023 shaped up, and the H1 versus H2 performances of the business. What's clear is that 2023 was a tale of two halves. During H1, as documented, we were still supporting our customers through the downturn, as they addressed the buildup in inventory, which led to a reduction in customer orders and global utilizations.

Despite this tremendous challenging environment, we work closely with our customers and successfully navigate this period. When we spoke to you at the half year, we reported £52 million revenue that was down, compared to corresponding period in 2022. Even though this was a significant reduction in the context of the industry wide downturn, this was in line with what our peer group experienced.

It's important to note that when we spoke to you at the half year, we also forecast a recovery in the second half, double-digit growth versus first half. And I'm happy to report that we saw this materialize, as we successfully grew revenue in H2 by 21% versus H1. In the second half, we have seen inventory level reducing, in some end markets such as smartphones.

We have also diversified our customer base, and our product base into wireless market. We ramped up new products in photonics such as our new VCSEL 3D sensing product that is with the Tier 1 OEM handset. And we have begun to bear the fruits of our strategy of maintaining our core business, while diversifying into new high growth market such as GaN our electronics, which we will talk about in more detail later on.

But first, let me update you on the progress we have made on the key priorities, we presented at the half year. Priority number one, has been to manage the temporary downturn. Number two, was investing for growth, and number three was continually improving our profitability. All of these underpinned by a range of ESG initiatives, to deliver a more resilient business.

Let me take you through each of these in turn. We've already covered a lot of the macro elements. So, I would like to highlight the fact that during the first half downturn, we took measures to strengthen our balance sheet, improve our working capital, and put in place a number of operational improvements, all of which Jutta will talk to later on. As expected, to cope with the downturn, we took a prudent approach to cost savings.

While retaining our ability to invest for business recovery and future growth, which brings me on to the next point. We continue to expand our customer base in all end markets. In wireless, we have secured multiple design wins with Tier 1 customers, serving the Android ecosystem through our partnership with AWSC in Taiwan.

In the photonic markets, we have ramped up our new VCSEL 3D sensing with a Tier 1 handset OEM. And in addition to expanding our customer base in wireless and photonics, we are diversifying into high-value markets, with our GaN power strategy. And indeed our investment in new capacity, with the purchase of four additional GaN reactors.

As we said before, we offer our customers, an unmatched global footprint that provides a secure and resilient supply chain, which is critical in today's geopolitical world. We have strengthened this position, by deploying our GaN capacity both in the U.S. and in the U.K. It's an important point to make, because we are in the position to rapidly scale our capacity in the U.S. in the U.K. in line with demand, to serve our customers close to the end market.

Another measure we are taking for the long-term, is the continuous improvement in our profitability. Throughout our global footprint, we have taken steps to standardize and centralize our operations to improve cost and efficiency.

We have also accelerated the consolidation of our MBE infrastructure into North Carolina, which will become our Center of Excellence for MBE product, by closing the Pennsylvania site ahead of schedule. Looking ahead, we continue to work with our customers to optimize our global footprint while continually offering a secure and resilient supply.

Let's now talk about the progress we have made with ESG, which underpins everything we do. It's a vast and complex topic, so we are focusing on climate-related risk, reducing emissions and lowering our carbon footprint, all through our commitment to the Task Force on Climate Financial Disclosures and our Science-Based Targets.

More fundamentally, our biggest contribution will come from the very product we are set to build in GaN power, which is so effective at reducing power consumption. This will help the world achieve its net zero ambitions. 2023 also saw us strengthen and improve the diversity of our leadership team and the Board of Directors.

Today, when my Chairman looks at his Board, he sees 50-50 split between male and female around the boardroom table, something we are really proud of. We talk about strengthening and diversifying the team, and I'm absolutely delighted to welcome Jutta Meier, who brings industry expertise in abundance, especially in the semiconductor foundry business.

Just before I pass over to Jutta, I would like to take a moment to acknowledge the hard work of Neil Rummings, who acted as Interim CFO in 2023 during the search process. Thank you for your contribution over the course of the year.

And now let me pass it to Jutta Meier. Thank you.

Jutta Meier

Thank you, Americo. It's great to be here.

It has been a long journey, a journey which actually started when I was bitten by the semiconductor virus about 25 years ago, joining AMD in Dresden, Germany. That journey then led me on to Silicon Valley with GlobalFoundries, and then later Intel, and now back again in Europe with IQE.

I'm very excited to be here and part of the team at IQE. And even though, I've not yet hit the 90-day mark, what I've seen so far, either from my daily interactions, or the visits to the sites, has left me really impressed. From meeting Mark at the security hut at the gate of our Newport facility, through to Lindley, who showed me the clean room facility in North Carolina.

The enthusiasm, warmth, and knowledge of all of the colleagues I have met so far, our leading technology, customer pipeline, and the market opportunities, have all given me enormous confidence in what we can achieve in the future.

Let's go into the numbers, which you know have been impacted, by the macro backdrop. 2023 has been incredibly difficult for the entire semiconductor industry, and IQE hasn't been immune to that development. Our reported revenue at £115 million, has decreased by 31% versus 2022. However, it is consistent with expectations.

It reflects the challenging market dynamics experienced in the first half, as previously reported, but also includes a gradual recovery in market dynamics and customer demand in Q4, 2023. As Americo also mentioned, I will go into more detail into the story of the second half later.

The adjusted EBITDA came in at £4.3 million, coming in above the expected forecast for the year, which we are pleased to report, given the market backdrop. However, this result is still in stark contrast, to the EBITDA level achieved in 2022. The semiconductor industry its investment and therefore fixed cost heavy.

The significant reduction in consumer volumes, as witnessed in 2023, has led to an underutilization of our manufacturing capacity, and adversely impacted profitability in reaction to the downturn. And to counteract the underutilization impact, we've implemented decisive actions to manage costs, and create a leaner and healthier company. I will go into more detail on the actions taken later.

Adding non-cash depreciation and amortization charges of £24.5 million lead to an adjusted EBIT loss of £20.2 million. Despite the challenging trading conditions, we were able to keep the adjusted operating cash flow of £15.7 million at the same level as in 2022, mainly driven by strong working capital management implemented across the group, with an inflow of £10.9 million.

Now going to the results in more detail covering the segmental revenue. Our Wireless segment represents roughly 47% of our overall revenue. It represents IQE's long legacy and connect wireless technology in applications ranging from smartphones to 5G infrastructure, enabling the smart connected devices, enhancing efficiencies and functionality.

The main accomplishments in 2023 cover partnerships with an Asia-based foundry to supply Tier 1 Android smartphone OEMs. It also covers the increased engagement with leading U.S. wireless customers, with sampling and product qualifications. The launch of our industry first 6-inch indium phosphide laser platform for AI in data center applications, was another accomplishment in 2023.

Our wireless revenue was £53.9 million, a 29% reduction year-over-year, reflecting a decline in wireless gallium arsenide epi-wafer cells and a weakness in GaN epi-wafer cells for 5G infrastructure. This reduction has been driven, by the softness in the broader smartphone handset market and buildup of inventory and supply chains.

Now covering our Photonics segment, representing 51% of our overall revenue. As a leader in cutting edge sensing technology, IQE is committed to maintaining technology leadership in advanced sensing technologies, enabling applications in fields such as autonomous vehicles, healthcare, 3D facial recognition, security and environmental monitoring for enhanced decision making and situational awareness.

Main accomplishments in 2023 are multi-year strategic agreement, with a global Tier 1 consumer electronic OEM, for the development of next generation 3D sensing applications, as well as an R&D partnership with global market leaders for next generation products.

The photonics revenue came in at £59.1 million, down 33% year-over-year, primarily reflecting the softness in the handset market and a slowdown in Asian telecom infrastructure. Partially offset, by strong performance in aerospace and security markets for infrared related products.

Lastly, our CMOS segment, representing roughly 2% of our overall revenue, is focused on the integration of compound semiconductors on silicon. Revenue came in at £2.3 million, down 18% year-over-year, due to elevated inventory levels in the consumer supply chain, caused by weaker demand in consumer goods.

When we spoke to you regarding the first half results, we forecasted a recovery projecting double-digit growth in second half, compared to first half. Inventory depletion as well as the results of our diversification strategy, led to an increase of revenue by 22%. One particular example driving that increase is the partnership with a major Taiwanese foundry, who delivers wireless products to leading China cellular and Wi-Fi suppliers for growing Chinese and Indian Android smartphone market.

That provides optimism for improvement in the latter part of 2023, and into 2024. The increase in revenue can be also seen in our EBITDA numbers, which improved significantly, and that is driven by improved capacity utilization, impact of cost mitigation actions, and value realization from sales through of aged working capital balances.

In turn, the operating cash flow reflects the impact of these cost mitigation actions, and tight working capital management. Our cash flow, CapEx, and net debt positions reflect the financial discipline in light of the challenging environment.

Our adjusted operating cash flow of £15.7 million reflects a strong working capital management implemented across the group, mainly driven by a reduction in inventory levels, careful inventory management, and lower trading volumes, coupled with a reduction in trade and other receivables, successful cash collection, and lower trading volumes.

Investment in intangibles. Even though it's down £1.6 million, IQE maintained investment on a combination of intellectual property, IQE's multi-year strategic IT transformation program, in a constrained funding environment.

Our CapEx expenditure increased by £2.7 million to a total of £12.2 million in 2023. This investment reflects a growth in the growing capacity, to meet demand and reflects our overall growth strategy, with capital expenditure across the global footprint to supply future growth opportunities.

The net debt position reflects a reduction of £13 million year-over-year, which is now reflecting a net debt position of £2.2 million, mainly driven by the successful equity fund raise.

I will now take you through a detail of the net debt position. This view consolidates the items I covered earlier, providing a summary of the net debt buildup. Specifically, I wanted to pull out insights of the adjustment items to complete the view.

The adjustment items of £5.7 million reflect costs associated with the group's wide restructuring program, insight decommissioning costs, associated with the consolidation of the group's MBE manufacturing facilities. It also covers adjustments relating to share-based payments, recruitment costs, and severance. Beyond that, the underlying items have already been discussed.

So let me move on to the next slide. Cash is king. This is something that has been following me throughout my career, and is still a term that I'd love to use. With that in mind, for 2023, the successful £30 million equity fund raise, the refinancing of the £35 million multi-currency revolving credit facilities provided by HSBC, coupled with significant cost reductions and cash preservation actions, provided IQE with the necessary liquidity, to navigate the semiconductor market downturn, and allow for the continued investment in our growth diversification strategy.

However, this basis needs to be preserved and optimized. And here are some of the things that we have done, and we continue to do in order to do so. Headcount restructuring in 2023, resulted in a 10% reduction of our overall workforce, whilst keeping key talent to support our overall growth.

Asset optimization included idling of certain manufacturing assets and reactors, to optimize manufacturing capacity aligning with our lower volumes, and that's also reduced our cost base. We also sold excess tools, resulting from site consolidation. The non-labor cost reductions covered all areas, including manufacturing, SG&A, by driving things as second source supplies and reduction of discretionary spending.

Our working capital optimization efforts are continued, even though we did see great results already in 2023. These initiatives are not just a one-off reaction to industry downturn, but will rather become a part of IQE's DNA, to continuously drive for margin improvements, as we continue on our path for profitability. To add structure and transparency to these efforts, we are implementing a transformation office driving cross-functional alignment. These initiatives give us a strong trajectory into 2024.

With that, I'd like to go into 2024 outlook. In short, with inventory levels beginning to normalize and our diversification strategy gaining traction, we are projecting the recovery initiated in second half 2023, to continue into 2024. As a proof point of this recovery, I am pleased to report that IQE's Q1 trading is in line with Board expectations. This also gives us the confidence to confirm that revenue and adjusted EBITDA for 2024 are expected to be within the range of analysts' forecast for the year.

With that, let me hand over to Americo, to cover the 2024 strategy.

Americo Lemos

Thank you, Jutta. Thank you very much for the details on the numbers.

So, in this next section, we'll take a closer look at what the future holds for IQE. First, let's take a step back and look at how the environment we are operating in today has changed. As explained by Jutta, we expect growth in 2024, but what gives me this confidence, is these three key points.

Firstly, it's well documented that the industry is expecting a return to growth in 2024. I was at the GSA CEO Summit in December in California, alongside a number of CEOs in the industry. During this meeting, there was a consensus in the room that, we have bottom already and that growth is coming. Obviously, not all end markets will have the same level of recovery. Nevertheless, we could see the optimism.

The second factor that gives me confidence, is the unprecedented level of investment being poured into semiconductor manufacturing. Looking back in 2022 and 2023, we have seen the years, where we have announced semiconductor strategies and governments have launched funding schemes.

Since the beginning of this year, these strategies have been implemented and billions of dollars have been deployed and granted for capacity investment. This is very positive as we see most of the capital going towards semiconductor manufacturing with the goal to build a secure and resilient supply chain, which is the core of what IQE is doing. Therefore, we are engaged with several governments, where we do business who align with their strategies, and develop public-private partnership to develop our capacity.

Finally, there are two key growth engines for the future. The interconnected work, which is being powered by AI and the decarbonization of the globe with a focus on electric vehicles market.

Let me take you through how IQE can capitalize on these tracks. The key takeaway here, is that if we look at the AI ecosystem, IQE technology is actually present across the whole spectrum from the palm of your hand, to a network that transports the data to the data centers themselves. This is a growth opportunity for IQE as every new device comes on stream, it's going to require two key capabilities.

One, connectivity. The second one, sensing. Both of which are central to our product set and technology roadmap. Especially, we enable sensing and connectivity in smartphones and automotive segments. In the infrastructure space, we have a long history of GaN, RF, or 5G networks and looking ahead, as we are well positioned to enable the next generation of high-speed connectivity.

As generic applications such as ChatGPT and the like, put tremendous demand on data centers, we announced an industry-first photonic solution for our 6-inch indium phosphide high-speed laser platform, offering the best economy of scale in the market, to enable a more efficient data transfer. As AI network demands more and more power, this is at odd, with the global push to deliver net zero.

That's why our GaN power platform is an essential solution, to deliver that demand for more power in a more sustainable way. This is why we are confident in our strategy to maintain our core business, while diversifying into new growing end market like GaN for automotive markets. And we remain confident in the future of the business.

In summary, IQE has experienced, obviously like any in the industry, a severe downturn in the first half, but we did return to growth in the second half as we forecasted. And we expect such growth to continue in this current year of 2024. We took actions to manage our cost, to be fiscally responsible, to strengthen our balance sheet, while continuously improving our margins.

We have made tremendous progress in diversification of our customer base, our product mix, and we have secured not only GaN additional capacity in multiple geographies, but we have also secured customer design wins, and begin sampling to automotive customers. And we remain very well positioned, to capture the growth opportunities in this industry, with key strategic advantages.

We have a very complete technology roadmap for compound materials. We have scale, to support large customers, demanding customers, and we have a global footprint that allow us, to deliver a secure and resilient supply chain. And IQE today, is the only pure-play, large-scale manufacturer of epitaxial wafers from compounds. So we are well positioned and I'm really optimistic, with the changes we made in the executive team and the Board and our customers pipeline. And I look forward, to speaking with you very soon.

Now let's open it up for questions. Thank you.

Question-and-Answer Session

Operator

Thank you very much, Mr. Lemos. [Operator Instructions] Our very first question from audio is coming from Harvey Robinson calling from Panmure Gordon. Please go ahead.

Harvey Robinson

Good morning, guys. Just a couple of questions from me. Just in terms of, you've obviously made some progress diversifying away from your lead customer in wireless. Clearly, back at your Capital Markets Day, you talked about it. I have some opportunity. I think obviously related to that, is the large wafer sizes. Could you just dig a bit deeper into where we are on your potential outsourcing contract if possible? I know it's commercially sensitive, but - if you could give me some guidance on that, that'd be helpful. And the second question really is, as you talk about, I might miss exactly what you said, but you talk about some of this potential funding, you're seeing three geographies or geographical regions, if you like. When do you think you might get some potential non-dilutive funding?

Americo Lemos

Thank you. Thank you, Harvey. Good questions. On the diversification of wafer size, as we stated, we are diversifying into GaN, gallium nitride for power electronics, which is a growth market for us at 8-inch. I know today the high volume production is at 6, so there isn't really much of 8-inch. So we are at the forefront here. And we have invested in 2023, yet the necessary capacity to do technology and customer early engagement, and new product introductions.

So as I said, we have invested, which was a very good first step after the strategy. We are deploying that capacity into geographies at the same time, to really engage in full - with multiple customers at the early stage of the development. So, we are very confident. And there are really three types of customers that, we are engaged with. We obviously serve the foundries at 8-inch.

We also engage with Fabless and some of the IDM/OEMs. So, we are working on all fronts and I'm very happy to see that large companies now are joining the show, so to speak, in GaN-on-Silicon. In recent announcement, I think GlobalFoundries did highlight that they are going to come into the market, as a foundry - for GaN-on-Silicon. Orders have announced migration to an 8-inch.

So this is very positive, because it all requires epitaxy where the value is really in GaN on silicon. And we are very well positioned to serve the global market. The second question you had was around funding, or government engagement. So as you said, we have a global footprint. So, we are really engaged with all government where we do business. And in the U.K., I'm part of the Advisory Committee for the semiconductor strategy, which is good.

We are working hard to put in place policies to address the skill set gap. As we said, we are also working with local universities, and the U.K. is also funding early stage companies. Orders like in the U.S., we are obviously working with the CHIPS office to increase our capacity in the United States, which is very, very important. So, we are diverse and we're going to work, where it is for our shareholders.

Harvey Robinson

Thank you.

Operator

Thank you, sir. [Operator Instructions] We do have another audio question coming at this time. It will be coming from John Karidis calling from Deutsche Numis. Please go ahead, sir.

John Karidis

Thank you. And thanks for pronouncing my surname correctly. Thanks very much, everyone. Good morning. Americo, could you talk a little bit more about the potential of your renewed partnership with AWSC? I'm keen to sort of figure out, what you've achieved already, but also what the potential is from this point onwards? Thank you.

Americo Lemos

Thank you, John. Yes, this is a very important partnership. As I said, our strategy is really to diversify our customer base, and our product mix. So in wireless, we have been very strong. We remain very, very strong. We have served an ecosystem in the U.S. that is very successful. Now, what we are doing is to taking that position of leadership, and expanding into new markets.

We all know, the decoupling with China means there's going to be local supplier in the China space, and we are going after that market. So, we have announced a partnership with AWSC and Lansus this morning. There are many more in the pipeline, and AWSC has been and continues to be a very strong partner. We do epitaxy, they do devices, and we go to market together.

So, we expect to basically continue to expand our wireless business. And frankly, even if the unit is not growing, we are taking shares, so we are very optimistic. That has been part of our recovery and part of our growth this year, as - on top of what we are doing in other products like GaN.

John Karidis

Great. Thank you.

Operator

Thank you very much, Mr. Karidis. As we have no further audio questions. I'd like to turn the call over to the management team for webcast questions. Thank you.

Jutta Meier

Thank you very much. I will now start asking the webcast questions. The first question comes from [Kai Korschelt] from Canaccord Genuity. And you didn't reiterate your 2027 guidance of $650 million in revenues, and you see the mid-term outlook. Apple volumes in 5G, are not really growing anymore. What will drive your growth beyond the current inventory rebuild?

Americo Lemos

Good question. I'm not going to reiterate 2027 targets every year so, but I'll give you - an idea on where we are. This is still our target. And obviously, we published these targets in 2022 before the sector downturn. But if you look at what we did in 2023, as we managed the temporary downturn, we have really beginning to implement our strategy. We have secured, the funding necessary to invest in GaN capacity.

And we deploy that GaN capacity in a very optimal way with two sites, two continents to deliver a secure supply chain to our customers, where when they qualify a site, we can scale, okay. That's the fastest way to pass through revenue. And we have engaged the customers, and we have sample waivers. So, I think one would say we have made significant progress on our diversification strategy.

And we have a number of levers for growth. It is not just the current smartphone volume, as I said. We are working hard to capture market share from competition. We are working to diversify our product base. We are working, to develop public-private partnership to accelerate our funding. So all of that are really, really positive for IQE. And when we look at, again, as I said in my previous remark.

The amount of funding going into semiconductor manufacturing, it is just unprecedented. And the fact that now big players are coming to the compound manufacturing is very positive for IQE, because we are extremely well positioned in terms of epitaxy know-how and the infrastructure necessary, to deploy a secure and supply chain in the industry.

So of course, we still have four years to go for 2027. And we are in an industry that is booming. We have key mega trend that are driving innovation that all require compound as much as they do require silicon. So when you look at early data, there is about $4 billion to $5 billion EPI market by 2027. And as a market leader, I don't think our target is totally unreasonable. We are putting the right steps already in 2023 and continue into 2024. So we are optimistic, towards those targets.

Jutta Meier

Thank you very much, Americo. The second question is also directed at Americo. You mentioned AI products. When do you envisage large revenues from AI-related products? Is 2024 too early?

Americo Lemos

So AI is a big topic as such. And as I tried to explain, we serve the AI ecosystem in multiple different ways, from sensing on the handset, or connected devices to photonics in the data centers, to the power of GaN that would help the whole system, becomes more resilient and sustainable. So we are seeing revenue, or where we assume that some of the smartphone, becomes AI engines towards the GaN. So it's a progression. And we do not quantify an AI business as such, but we do serve the ecosystem as a whole.

Jutta Meier

Thank you very much, Americo. Next question. As you've appointed a new VP of Government Affairs. And to what extent are - your expectations for IQE gaining a meaningful growth, from government in the future?

Americo Lemos

Good question. Yes, having an executive dedicated to that was absolutely critical for me. And Rina has joined us from the SIA, where she had a very, very key role of shaping out what we saw in the U.S. So obviously her focus is global. But first and foremost, we are heavily engaged with the CHIPS office in the U.S.

As you know, we have been in the U.S. operating for a long time. We are a key part of the U.S. national security ecosystem. And we are working closely with them. At this point, the fund that have been released, by the U.S. in particular have gone to defense companies.

And then by and large to large silicon fabs. We have yet to get funding deployed. But given what happened, I expect this to accelerate ahead of the November election in the U.S. So I'm pretty optimistic.

Jutta Meier

Thank you so much, Americo. I'm afraid that's all we have time for in terms of questions this morning. Thank you all very much for your time.