Full-year 2017 results
20 March 2018
Record financial results reflect the adoption of IQE’s VCSEL technology in mass market applications and broadening IP portfolio sets the Group for continuing diversification and growth.
IQE plc (AIM: IQE, “IQE” or the “Group”), the leading global supplier of advanced wafer products and wafer services to the semiconductor industry, announces its final results for the year ended 31 December 2017.
|£’ Million (except EPS)
|Adjusted1 Operating Profit
|Adjusted1 Profit Before Tax
|Adjusted1 Fully Diluted EPS2
|Cash generated from operations
|Net funds / (debt)
- 1. Non-GAAP adjusted measures have been presented as detailed in note 4
- 2. Fully diluted EPS for 2016 restated from 3.0p to 2.9p as detailed in note 1
- 3. Capital Investment represents cash invested in tangible and intangible assets, including assets acquired under finance lease of £6.6m (2016 : £nil), and excludes consideration paid for acquisitions of £nil (2016: £11.3m)
- Continued revenue diversification with strong growth in high margin product lines
- Record financial results reflect the adoption of IQE’s VCSEL technology in mass market consumer applications in H2 of 2017
- Photonics sales up 109% to £47.6m for the full year, with H2 2017 sales up more than 160% over prior year H2.
- The strong ramp of VCSEL sales during H2 represents a unique achievement in the industry, as IQE leveraged its expertise of mass market wireless supply to the significantly more complex VCSEL materials system.
- Operational gearing of the business supports strong profit and cash generation
- Wafer sales up 21% to £152.6m, propelling adjusted operating profit from wafer sales up 58% to £24.5m
- Strong conversion of adjusted operating profit into operating cash of 113% (PY:102%)
- Excellent progress with our investments in capacity, and our growth and diversification strategy
- Capital investment increased to £34.8m to address near term and forseeable growth opportunities (PY £19.1m)
- Net funds of £45.6m (PY: Net debt £39.5m), reflects new equity raised of £95m (gross) in November 2017 to fund ongoing capacity expansion in 2018 to meet rising demand as VCSEL adoption broadens
- New ‘Mega Foundry’ in Newport, South Wales in progress with plan to house up to 100 tools, creating a facility with unparalleled capacity and economies of scale in the industry. The first 5 tools are now in-situ and on track for production in H2 2018 as expected, and a further 5 tools are scheduled for installation and commission by end Q3. Preparation is underway to acquire at least a further 10 tools within the next 12-18 months as demand requires.
- IQE’s expanding portfolio of intellectual property, including over 180 patents, is enabling the group to differentiate itself in the marketplace, and strengthen its business model by not only being the global leader of choice in the supply of advanced semiconductor wafers, but increasingly able to provide comprehensive “advanced materials solutions” providing chip designers with a new “toolkit” to develop chips which push the boundaries of performance, enable higher levels of integration, and reduce the barriers of cost.
- Excellent progress with technology development including demonstration of key enabling technology for high performance wireless filters, cREO for integration of CS materials technologies on silicon, and Quasi Photonic Crystals and Nano-Imprint Lithography for a wide range of optical technologies including DFB lasers, integrated 3D sensing solutions and silicon photonics applications.
- Broadening Customer engagements across multiple business sectors
- VCSEL ramp initially supplied under a number of multi-year contracts. Market engagement has continued to broaden to multiple Tier 1 OEM’s, targeting mass market ramps over the next 12 to 18 months.
- Qualifications in progress with IQE’s GaN on Silicon technology for base station and other high power RF applications, providing route to accelerate wireless growth
- Customer interactions broadening for InfraRed. Now working with major OEM and device companies in developing InfraRed products for mass market consumer applications.
- Continued good progress by IQE’s Joint Ventures in the UK and Singapore. Significantly expanding external customer engagements and improving financial performance reflect the achievement of key milestones for these early-stage businesses.
- Continued growth in 2018 driven by expansion of existing business and qualifications of new business streams
- Photonics revenue expected to grow c.35% to 60% in 2018, based on expansion of products currently in production and the completion of ongoing qualifications . The introduction of new technologies and additional market opportunities provide potential for yet higher growth rates.
- Wireless revenue expected to grow up to c.5% in 2018; SMI inventories expected to replenish in 2018, with potential for revenue expansion as GaN products make stronger contribution
- InfraRed revenue expected to grow c. 5% to 15% in 2018, with customer engagement broadening
- Potential for strong growth in 2019 and beyond
- Increasing VCSEL adoption for 3D sensing expected to accelerate across multiple smartphone OEMs, introduction of world facing 3D technology, and first deployment of LIDAR and several other high volume sensing applications
- Increasing deployment of InP for high speed FTTX and datacentre applications
- Increasing CS content in 5G communication systems and increasing adoption of GaN for base stations and other high power RF applications, including consumer driven opportunities
- Increasing use of Infrared products in mass market consumer applications
- Revenues from both Power switching and non terrestrial solar markets
- Adoption of IQEs broad IP portfolio into multiple commercial applications utilising cREO, NanoImprint Lithography (NIL) and Quasi Photonic Crystal (QPC) technologies
- Multiple qualifications in progress with DFB laser products.
- Expected Compound Annual Growth Rates over the next 3 to 5 years, based on current products, in the ranges of: Wireless up to 10%; Photonics 40-60%; and InfraRed of 5-15%. Potential for higher growth with new product introductions.
Dr Drew Nelson, IQE Chief Executive, said:
“IQE delivered outstanding performance in 2017. Wafer revenues were up 21%, propelling adjusted operating profit from wafer sales up 58%. This reflects the high operational gearing in our business, and a more profitable sales mix.
“Photonics continues to be the star performer with 109% year on year growth in sales, and H2 sales up more than 160% over prior year H2. This substantial growth is largely being driven by VCSEL products for mass market consumer applications that ramped through H2 of 2017. The depth and breadth of customer engagements in Photonics provides a solid platform for continuing strong growth with several new product launches forecast over the next 12-18 months for multiple OEMs.
“We continue to expand capacity to meet forecast increases in demand, as well as driving throughput and yield improvements to release latent capacity and drive margin expansion in our existing business. Progress on the new foundry has progressed exceptionally well, with the first 5 five tools already installed and with further expansion scheduled for Q3 and beyond. This is an incredible achievement given that the initial building works only began in September 2017.
“Armed with an unparalleled breadth of IP and patent coverage, our business model is evolving from being the global leading supplier of advanced semiconductor wafers, to becoming a globally leading ‘advanced materials solutions’ company where our unique innovative materials and associated nanoscale fabrication technologies provide a route for our customers to push the boundaries of chip performance, extend semiconductor integration capabilities and thereby reduce the cost barriers to broad consumer adoption.”
“The Board looks forward to the future with a high degree of anticipation and confidence”
The information contained within this announcement is deemed to constitute inside information as stipulated under the Market Abuse Regulations (EU) No. 596/2014. Upon the publication of this announcement, this inside information is now considered to be in the public domain.
IQE plc +44 (0) 29 2083 9400
Canaccord Genuity + 44 (0) 20 7523 8000
Henry Fitzgerald O'Connor
Peel Hunt +44 (0) 20 7418 8900
NOTE TO EDITORS
IQE is the leading global supplier of advanced semiconductor wafers with products that cover a diverse range of applications. The Group's outsourced foundry services provide a 'one stop shop' for the wafer needs of the world's leading semiconductor manufacturers.
IQE uses advanced epitaxial growth technology platforms to manufacture and supply advanced semiconductor 'epi-wafers' to the major chip manufacturing companies, who then use these wafers to make the chips which form the key components of virtually all high technology systems.
IQE's products are found in many consumer, communication, computing, mobility and industrial applications. IQE's epi-wafers enable a wide range of wireless/RF, photonics, infrared, power, solar, advanced electronics and sensor technologies.
IQE operates multiple manufacturing and R&D facilities across Europe, Asia and the USA.
Since 1988, IQE has pioneered the development of compound semiconductor (CS) materials technology. From its origins in fibre optic communications, the group has progressively expanded its product range and intellectual property (IP) portfolio across a broad range of advanced semiconductor materials. In celebrating its 30th anniversary in 2018, IQE can reflect on the unparalleled breadth and depth of its IP portfolio, and its track record of delivering its complex atomically engineered wafers consistently and repeatedly in mass market, with the precision and quality needed by its customers to achieve high yielding low cost chips. It is this pedigree that has enabled IQE to build its market leadership and is positioning the group to exploit the inflection that is now taking place in the market for CS materials.
The evolution of semiconductor technology
There is little doubt that semiconductor materials have significantly changed the way we work, live and socialise. Silicon has been the backbone of the electronics revolution since the early 1960s, largely by virtue of the continuous miniaturisation of chips (“Moore’s Law”) which has led to an exponential increase in performance and reduction in cost. However, Moore’s Law has reached the point of diminishing returns, which is where epitaxy and compound semiconductors are playing an increasingly important role.
Silicon is only one of several semiconducting elements. Indeed, many of the other semiconducting elements have far superior properties to silicon. Epitaxy is a nanotechnology which enables these elements to be combined to produce materials which have far superior properties to silicon. These advanced semiconductors are called Compound Semiconductors (CS). Specifically, epitaxy is the atomic engineering of highly uniform crystals of these elements at a nanoscale. These advanced CS materials can then be converted into chips which in turn exceed the performance capabilities of silicon chips, especially in terms of their optical, radio-frequency and electronic properties.
For the last decade, compound semiconductors based on combinations of gallium and arsenic (gallium arsenide or GaAs) have dominated some of the critical communication components in smartphones thanks to their high-speed wireless communication properties, thereby enabling the smartphone revolution. Similarly, optical communication (enabling internet connectivity), and LEDs (the lighting revolution) have only been possible through atomically engineering elements such as gallium, arsenic, indium, phosphorous, aluminium and nitrogen using epitaxy.
Whilst the silicon and compound semiconductor industries have evolved independently, it is widely acknowledged that the future of the semiconductor industry is to combine the advanced properties of compound semiconductors with the low cost of silicon production to create a high performance - low cost hybrid technology which has the best of both worlds. This hybrid technology requires the adoption of highly complex epitaxial techniques to produce layers of compound semiconductors on a base silicon material. IQE has been a pioneer in this space over more than a decade, and through many development programmes and collaborations it has built a powerful portfolio of IP including patents and trade secrets. With its strong pedigree in innovation and high-volume manufacturing, IQE is uniquely positioned to develop and commercialise its expertise.
The inflection in CS technology adoption has already begun, with 2017 marking the first year when laser technology was adopted in mass consumer markets, following the mass adoption of power amplifiers (PAs) for wireless communications using compound semiconductors, and Light Emitting Diodes (LEDs), which are also wholly based on compound semiconductor technology. The adoption of CS lasers in mass consumer applications has been facilitated by the complex epi wafer technology behind Vertical Cavity Surface Emitting Lasers (VCSELs), which has enabled for the first time a CS laser at a cost point which enables mass consumer adoption. IQE are the global leaders in VCSEL epi wafer technology and production, having first established the technology over 25 years ago, and since developed it to mass production, building on IQEs global leadership position in the production of power amplifier wafers. It is this leadership which led to a more than doubling of our Photonics revenues in 2017, and established IQE with an estimated market share of over 90% for mass consumer VCSEL production. Combined with continuing growth in our other markets, 2017 was a record year for the Group in financial performance terms, and with significant investment in new product development and the building of an ever more comprehensive IP portfolio, the Group is poised for continuing strong growth as it evolves its business model from being the leading global advanced semiconductor wafer supplier to the leading global advanced materials solution provider.
In addition to reporting GAAP profit measures, the Group also provides additional non-GAAP profit measures. Full details of these adjusted measures are provided in note 4. In addition, the prior year financial results have been restated, as detailed in note 1.
Consolidated revenues were up 16% to £154.5m. Wafer sales, which represented 99% (2016: 95%) of revenues, were up 21% (2016: up 19%) reflecting continuing organic growth. License income, which represented 1% (2016: 5%) of revenues reduced from £6.7m to £1.9m as expected, reflecting that 2016 included a significant portion of up front license fees. Growth in underlying demand was accompanied by a currency tailwind of c. 5% (2016: c. 11%). This similarly affects costs, which are also largely denominated in foreign currency.
The growth in wafer sales was largely driven by Photonics, where sales were up 109% to £47.6m. This was primarily driven by the adoption of IQE’s VCSEL technology in a mass market consumer application which ramped strongly in H2. Indeed, Photonics sales in H2 were up more than 160% over H2 2016. InfraRed sales also enjoyed double digit growth, with sales up 14% to £12.0m. Wireless sales were broadly flat at £91.6m (2016: £91.3m), affected by a £3m managed reduction of SMI inventories to focus capacity on the ramp in Photonics. The SMI inventories are expected to replenish in 2018. Finally, CMOS++ sales were flat at £1.4m (2016: £1.4m).
As a consequence of these growth rates, wafer sales continued to diversify, with Wireless accounting for 60% (2016: 72%), Photonics 31% (2016: 18%), InfraRed 8% (2016: 8%), and CMOS++ 1% (2016:1 %).
Gross profit increased from £34.2m to £38.6m. Excluding license income, which has a 100% margin, the gross margin on wafer sales increased from 21.8% to 24.1%. Adjusted gross margin, which excludes the charge for share based payments, increased from £36.4m to £43.6m, reflecting an improvement in the adjusted gross margin on wafer sales from 23.6% to 27.4%. This improvement in margins primarily reflects the benefit of a favourable sales mix with a greater proportion of higher margin Photonics sales in 2017 over 2016.
As expected, other income reduced from £2.3m in 2016 to £nil. The gain in 2016 related to the release of the remaining balance of contingent deferred consideration relating to a previous acquisition. This gain did not relate to underlying trade and hence was excluded from adjusted earnings in 2016.
Selling, general and administrative (“SG&A”) expenses increased from £16.6m to £21.6m. Adjusted SG&A, which excludes charges for share based payment, the amortisation of acquired intangibles, and non-cash rent increased from £14.2m to £17.3m. In addition to investing for growth, the increase includes the impact of inflation, foreign exchange, and an increase in amortisation.
Operating profit decreased from £19.8m to £17.0m, reflecting the adjustments noted above, whilst adjusted operating profit increased from £22.1m to £26.4m. The increase in adjusted profits reflect a 58% increase in wafer related profits from £15.5m to £24.5m partially offset by the £4.8m reduction in license income.
The segmental analysis in note 3, reflects the adjusted operating margins for the primary segments (before central corporate support costs): Wireless c.15%, Photonics ~38% and InfraRed ~27%. In the current environment we believe that these represent sustainable margins, and hence provide the opportunity for future margin expansion through continuing diversification of revenues. Central corporate support costs are expected to grow approximately 5-10% reflecting a combination of inflation and business growth.
Finance costs increased from £1.5m to £2.1m. Adjusted finance costs, which exclude imputed interest associated with the discounting, increased from £1.5m to £2.0m. This underlying increase in cash interest reflects an increase in borrowings to finance capacity expansion and the impact of foreign exchange. The borrowings were repaid in full prior to year end from the proceeds of the equity fund raising.
The charge for taxation increased from £0.3m to £0.4m. Adjusted tax, which excludes the tax affect associated with the non-GAAP adjustments, was a credit of £0.5m (2016: credit £0.1m), reflecting the benefit of deferred tax asset recognised less taxes paid relating to 2017. The cash payment of taxes increased from £0.8m to £5.8m due to the settlement of US taxes relating to prior years as detailed in note 1. Cash taxes are expected to remain at approximately £1m to £2m for the near future, whilst the effective rate is expected to be approximately 15% to 20% reflecting the deferred tax charge associated with the utilisation of tax losses.
Cash invested decreased from £30.3m in 2016 to £28.2m in 2017. The reduction reflects that in 2016 the group made the final payment of deferred consideration (£11.3m) in respect of the Kopin acquisition. Excluding this, the group increased its investment from £19.1m to £28.2m, namely: capital expenditure up £0.3m to £11.3m; investment in product development up £8.2m to £14.5m; and investment in intangible assets up £0.6m to £2.4m.
The capital expenditure of £11.3m reflects cash paid directly to equipment suppliers. In addition, the group financed £6.6m of capital expenditure via finance lease where the bank settled the purchase cost directly with the equipment suppliers. This finance lease was settled prior to the year end (and title to the equipment passed to the group), and hence the cash flow is classified as part of the repayment of borrowings. Aggregating these amounts, the total cash invested in equipment was £17.9m.
The group increased its investment in product development from £6.3m to £14.5m. IQE is developing products to address a wide range of end market applications within its business segments. Although there are “families” of products such as VCSEL’s, EEL’s, and HBT’s, each product is developed bespoke to the customers individual specification. IQE does not produce any commodity or “off the shelf” products. The year on year increase in investment, was largely due to the development of the VCSEL technology which ramped into mass market through H2.
The investment in intangible assets includes the purchase of patents from third parties, the cost of patenting internally generated IP, and software. The year on year increase includes the purchase of a portfolio of 54 patents relating to Quasi Photonics Crystals reported in December 2017.
In November 2017, the group issued 67.9 million new ordinary shares, raising gross proceeds of approximately £95 million. This fund raise was primarily to finance a capacity expansion programme to deliver the scale needed to capture multiple high growth market opportunities, and in particular the continuing increase in demand for VCSELs. In addition, the fund raising is enabling the acceleration of product development. Part of the proceeds from the share issue was applied to repay outstanding borrowings in order to save interest charges.
The Group has established six market facing Business Units along market lines, to address it primary markets: IQE Wireless, IQE Photonics, IQE InfraRed, and IQE CMOS++, and its emerging market : IQE Solar and IQE Power.
Each Business Unit has a clear product and customer focus, but continues to benefit from the production and technology synergies of the whole Group. The emerging markets of Solar and Power are in pre-production and hence are not yet significant enough to be separated in our segmental reporting.
Compound Semiconductors play an essential role in high speed wireless communication and have been an enabling technology for mass market applications such as smartphones and WiFi. IQE is market leader with an estimated 55%-60% share of this global market. Wireless accounted for approximately 60% of IQE’s wafer sales in 2017 (2016: 72%)
Following the launch of the iPhone in 2007 this market enjoyed several years of double digit organic growth, as the launch of new handsets were usually met with a “feeding frenzy” of consumers eager to secure the latest model. However, market growth has cooled since 2013 as the innovation cycle struggled to keep apace. In fact, according to industry analyst IDC, overall smartphone shipments during the year remained flat at 1.47 billion units (2016: 1.47 billion units). This represents a core and stable part of IQE’s business.
Despite the lack of growth in smartphone sales, the relentless increase in data traffic continues to drive the need for more sophisticated wireless chip solutions in handsets. This is driving the market towards 5G communication, which IQE sees as a significant upside potential for its wireless business as this transition will require much more complex material technologies.
Infrastructure applications such as base stations, radar and CATV are a small but rapidly growing part of IQE’s wireless segment. This is becoming an increasing important part of IQE’s business as the superior performance of this CS technology continues to replace the incumbent silicon LDMOS technology. Indeed, in partnership with MACOM Technologies Inc., IQE has developed a high performance low cost solution (GaN on Silicon) to accelerate the displacement of LDMOS. Indeed, MACOM is in the process of qualifying this technology downstream and concluded a high volume chip fabrication partnership in late 2017, in anticipation of a production ramp on completion of these qualifications.
The fastest growing segment of the wireless chip market over the past few years has been for high performance filters. Although the primary materials technology for filters (aluminium nitride, or AlN) is made from compound semiconductor elements, the wafers have been fabricated using a less sophisticated process called sputtering, reflecting that producing a more sophisticated single crystal epitaxial solution has been a significant IP challenge. IQE overcame these hurdles in late 2017, and prototyped the key technologies for the realisation of much higher cystalline quality AlN wafers. We are now engaged with multiple customers who see this advance as a potentially disruptive solution.
Wireless continues to be a significant and stable business for the group and is expected to grow at a rate of upto 5% in the near term. Furthermore, this division has several exciting developments which provide routes for a return to double digit growth, including:
- Innovation in smartphone hardware, including the adoption of advanced photonics sensors;
- The adoption of GaN on Silicon technology for base stations;
- The transition to 5G communications, requiring more advanced CS materials;
- The adoption of high quality CS materials solutions enabled by cREO for wireless filters.
Photonics refers to devices that emit or detect light, such as advanced laser and sensors. They enable a wide range of end markets in the communications, consumer, and industrial space. This segment accounted for 31% of IQE’s wafer sales in 2017, up from 18% in 2016. This is IQE’s most rapidly growing segment.
There are two critical technologies in this segment:
- Vertical Cavity Surface Emitting Lasers (“VCSELs”) - the key enabling technology behind a number of high growth markets including 3D sensing, data communications, data centres, gesture recognition, health, cosmetics, illumination and heating applications. IQE is the market leader for outsourced VCSEL materials, which has been achieved by virtue of its technology leadership. This includes the demonstration of VCSELs with record speeds, efficiencies and temperature performance. In addition, with its 6” wafer capability IQE has been successful at enabling its customers to reduce significantly the unit cost of chips which is further accelerating the adoption of this technology.
- Indium Phosphide (“InP”) – this technology enables fibre to the premises (“FTTX”). The continued development of this technology to achieve higher performance at lower costs, plus the explosive growth in data traffic is leading to the extension of the fibre optic network “to the premises” – also known as “the last mile”. IQE has developed advanced laser technologies with differentiated IP which underpins our high growth expectations for this business.
Photonics sales increased by 109% year-on-year, with H2 sales up more than 160% over prior year H2. This reflects a strong ramp of VCSEL’s into a mass market consumer application through the second half of 2018. This was a unique achievement within the industry, as IQE leveraged its expertise of mass market supply to rapidly ramp the supply of this complex photonics material into unprecedented volumes. The supply of materials into this ramp was delivered under multiple multi-year contracts.
There is little doubt that sensing technologies, from facial recognition, to gesture recognition and LIDAR, will represent a major growth area in the near term and extending into the future. Some analysts have referred to this as the start of a “super cycle”. Indeed, this is reflected in the breadth of product development programmes in which IQE is engaged, and which now span multiple Tier 1 OEM’s (directly and via chip customers) who are targeting mass market ramps in 3D sensing applications over the next 12 to 18 months.
However, VCSELs have many more applications beyond sensing, including fibre optics for data centres, industrial heating, and machine vision to name a few. IQE has built a strong technical lead in this market, which combined with its unparalleled track record for mass market delivery, positions IQE well for continuing strong growth.
Whilst VCSEL has been the star of the show, our InP business continues to perform well. This market is being driven by the need for higher speed, higher capacity fibre optic systems to address continuing growth in data traffic. As a result, more sophisticated materials solutions are becoming critical to achieve higher levels of performance. To address this evolving market, IQE has developed novel technologies which enable higher performance with lower cost of manufacture. This includes an innovative solution for Distributed Feedback Lasers (DFB’s) for high speed FTTX chips. We are engaged in qualifications with several customers for this technology, which are expected to ramp into production in over the next 6-12 months.
The Photonics business is expected to grow at a rate of 35%-60% in the near term based on products currently in production. The introduction of new technologies provide potential for higher growth rates, and therefore we will highlight new technologies as these reach commercial adoption.
IQE is a global leader in the supply of indium antimonide and gallium antimonide wafers for advanced infrared technology, primarily “see in the dark” defence applications. We are the technology leader with the launch of the industry’s first 150mm indium antimonide wafers, a major milestone in reducing the overall cost of chips to drive increasing adoption. This has enabled the business to secure several contract wins and drive sales growth. We expect this business to continue to grow between 5%-15% with its current product range.
Beyond defence, the InfraRed division has been successful in broadening is customer engagements into product development for mass market consumer applications. Indeed, we are now engaged with major OEM and device companies in developing InfraRed products for consumer applications including sensing. This provides potential for higher growth rates, and therefore we will highlight new technologies as these reach commercial adoption.
Advanced Solar (CPV)
Technologies which convert sunlight into electricity are also called PhotoVoltaics (or “PV”). The prevalent solar technology is based on silicon material, which typically achieves a conversion of between 15%-18% of the suns energy into electricity. IQE has been at the centre of developing solar materials using compound semiconductors, which can deliver much higher levels of efficiency. This technology, which is also known as Concentrating Photovoltaics, or “CPV”, can already deliver efficiencies in excess of 44%, and has a route map to much higher levels of efficiency. Although this offers a lower overall cost of energy generation in sunny territories, the challenge in mass adoption is in reducing the end system install costs, which has been hampered by global macroeconomics.
The terrestrial market remains an exciting market opportunity, but as a result of the shifting macroeconomics, focus has shifted to the space market, where these advanced materials are used to power satellites where the higher efficiency has a dramatic cost benefit on payload. Product qualifications are underway with leading satellite manufacturers, paving the way for commercial revenues, therefore we will highlight new technologies as these reach commercial adoption.
Gallium Nitride on Silicon (GaN on Si) is driving a technology shift in the multi-billion dollar power switching and LED markets. IQE has continued to push the technology boundaries and is making rapid progress both technically and in developing commercial relationships in the supply chain. The power switching market alone is approximately 3-4 times the size of the current wireless PA chip market, and represents a major growth opportunity for IQE. IQE’s patented technology, cREO, provides a significant competitive advantage in this space. We will highlight new technologies as these reach commercial adoption.
Future semiconductor technology architectures are moving strongly toward hybrid integrated chips using a combination of traditional CMOS based chips with Compound Semiconductor chips, all built on a silicon base wafer. This provides the market with the significant technical advantages of Compound Semiconductors at the cost point of silicon, and allows the CS industry to utilise the huge investment already made into large scale Silicon chip manufacturing. As a result, this greatly increases the available market for Compound Semiconductors. IQE has developed multiple routes to delivering this powerful new hybrid, and the addition of cREO and other IP provides unique solutions to achieving the end goal. IQE is involved in multiple programmes across the globe, which are developing the core technologies from which we expect highly significant revenue streams to emerge over the next 3-5 years.
IQE has built a strong leadership position in the market for CS materials. This leadership has been built around an unparalleled breadth of IP, in contrast to IQE’s competitors who operate within the constraints of their narrow IP portfolios and inferior research and development capabilities. Uniquely, this makes IQE a “one stop shop” for CS materials, at a time when the market is increasingly seeking multiple material solutions to meet expanding and diverse end markets. This represents a powerful competitive advantage for IQE in a market where qualification barriers are high, and microscopic variations in wafer crystals can have dramatic adverse operational and financial implications downstream.
The operational and financial risks associated with variations between wafers creates the second layer of IQE’s defensive moat. To provide context, every epitaxial tool has to be individually qualified in order to be released for production in any supply chain. This is because the complexity of the technology creates an inherent risk of microscopic variations between wafers in the same production run, as well as from run-to-run. These variations can have dramatic and costly implications downstream. Whilst there is a significant IP barrier in being able to produce these materials, there is an equally challenging IP barrier of controlling variations to be able to repeatedly and reliably produce high quality materials in high volume which enable high yields down stream. Accordingly, customers are “sticky”, which reflects why IQE had to use M&A to consolidate the wireless supply chain. Moreover, in simple terms, IQE has shipped more wafers in mass production that any other epi foundry, giving it an unparalleled pedigree in the mass market.
Finally, as the largest outsource epi foundry IQE has created a competitive advantage through specialism and scale. Achieving low cost chip production necessitates high quality wafers, because wafer defects translate into lost capacity and low yields for chip makers. As a materials specialist, IQE has developed the IP to make materials of the highest quality, and it has the accolades and market share to prove it. As the materials specialist with the largest scale it has inherent economies of scale, a feature which IQE is about to intensify with its new foundry which will house up to 100 tools. This is why the outsource model is prevalent in the more mature silicon industry, why the wireless market shifted from a horizontal to vertical model, and why the winner in the initial mass market ramp of VCSELs adopted an outsource strategy.
However, we are not resting on our laurels. IQE’s expanding portfolio of intellectual property, including over 180 patents, is enabling the group to differentiate itself in the marketplace, and strengthen its business model by not only being the global leader of choice in the supply of advanced semiconductor wafers, but increasingly able to provide comprehensive “advanced materials solutions” providing chip designers with a new “toolkit” to develop chips which push the boundaries of performance, enable higher levels of integration, and reduce the barriers of cost.
A couple of examples illustrate the power of this strategy:
- Wireless “Front End Modules” – The Front End Module (FEM) refers to the communications module in a smartphone. It is the FEM that performs all of the wireless communications. The FEM is made up of many individual chips, which can essentially be grouped into Filters (for filtering out undesired wireless frequencies), Switches (for high speed, high efficiency switches), and Power Amplifiers (for high efficiency amplification of wireless signals). Each of these three types of chips are made from different semiconductor materials technology. The sweet spot for IQE has historically been the Power Amplifier, but it has also developed the technologies for Switches (SOI) and for Filters (AlN). Armed with its patented cREO technology, IQE has a clear route to combining these three material systems on a single wafer, which paves the way for the complete integration of the FEM on a single chip. This would be highly disruptive. A FEM solution on a single chip would be more efficient, with a smaller footprint at a dramatically lower cost of production
- 3D sensing solutions – tear downs of the first 3D sensing solutions show a combination of advanced technologies in a complex module: a VCSEL light source, optical components, and silicon sensing components. Again, IQE has the underlying materials technologies for these components, and the benefit of several patents including Quasi Photonic Crystals and Nanoimprint Lithography for wafer level optics and diffractive optical elements. So again, with its advanced technology, IQE has a route to integrating many of these technologies on a single wafer. This would be highly disruptive as it would result in a 3D sensing solution on a single chip which would again be more efficient, with a smaller footprint at a dramatically lower cost of production.
Historically, the group’s IP was centred around trade secrets, so we inevitably monetised this IP through wafer sales. However, we’ve made no secret of our strategy to build an increasingly diverse IP portfolio including technologies which we could protect through patent. Naturally, over time this will lead to the commercialisation of our IP through new channels, including licensing. Initially realising license income through JV’s, we see many opportunities to expand our model to third party license streams over the next few years, and in due course for this to represent a significant part of our business.
Our progress in executing this strategy is clear. From only a handful of patents 10 years ago, we have successfully built a portfolio of advanced materials IP which sets us apart in our industry. Today, we have the benefit of over 180 patents, which we will continue to develop and expand both organically and inorganically. Indeed, we have created a virtuous circle with the critical mass for this model to be self-fulfilling and sustaining. We attract the best talent in our industry, which, combined with the best routes to commercialisation attracts the best technology development partners, and so the cycle continues. Add to this the progress being made by our JV’s, and the power of the CS Cluster (below) that is gathering momentum, and you begin to see how we are bringing our vision to life.
In November 2017, IQE announced the placing of 67.9 million new ordinary shares, raising gross proceeds of approximately £95 million. The fund raise was primarily to finance a capacity expansion programme to deliver the scale needed to capture multiple high growth market opportunities. Of immediate significance is the ramp in demand for VCSELs. In addition, the fund raising is enabling the acceleration of product development.
At the heart of the capacity expansion is the creation of a new foundry in Newport, South Wales. This ‘Mega Foundry’ will house up to 100 tools, creating a facility with unparalleled capacity and economies of scale in the industry. The first 5 tools are now in-situ and on track for production in H2 2018, a further 5 tools are scheduled for delivery in Q3. Preparation is underway to call off a further 10 tools within the next 12-18 months.
The establishment of the new foundry is being supported by the Cardiff City Region City Deal, which is funding the construction of the infrastructure. IQE is leasing the building under an 11 year lease, which has a 3 year rent free period and an option to purchase. This support has enabled IQE to focus its own investment on adding new tools, which requires upfront investment in both opex and capex. The lead time to get new tools into production is approximately 9-12 months, from which time a fully utilised tool making VCSELs has a payback of c. 1 year.
Future Strategy: Innovation through collaboration and building a highly defensible business model through IP leadership
Intellectual property relating to advanced materials is playing an increasingly important role in the evolution of the semiconductor industry, it is widely accepted that advanced materials are needed to overcome the challenges and realise the opportunities facing the electronics industry.
Technology leadership through IP has always been at the heart of IQE’s strategy. Indeed, as a pioneer of CS technology over the past 30 years, IQE has built an enviable global reputation in the industry for the breadth and depth of its materials technologies and capabilities. It is clear from IQE’s many engagements with leading universities, start-ups, leading chip makers and established global electronics giants, that IQE has succeeded in establishing itself as the ‘go to’ place for advanced materials, supporting its customers from research and development through to high-volume manufacturing. The growing strength of IQE’s IP is reflected in how its relationships within the supply chain have evolved. Historically, IQE was only engaged by the chip makers, whereas it now regularly engages directly with a number of Tier 1 OEMs.
It is well understood that collaboration is a powerful tool in accelerating innovation. The benefits are even greater when whole ecosystems “cluster” in the same location, breaking down the barriers created by geography and time zones. Indeed, Silicon Valley in California is a prime example of how the benefit of clustering can propel an industry to a global platform.
It is the benefits of collaboration and clustering that underpin IQE’s strategic rationale for the joint ventures in the UK and Singapore, and its highly successful Open Innovation Programme (openiqe.com). Moreover, IQE has been at the heart of creating the CS Cluster in South Wales, which is the first of its kind globally. This new cluster is accelerating research into novel technologies, product development and innovation. The CS cluster, which is branded as CSconnected, follows considerable high-level thinking across government, industry and academia, as well as significant private and public sector investment to establish top-class facilities and infrastructure to support activities along the technology development chain from blue-sky research to high-volume production.
The journey started in 2015, when Cardiff University announced an investment of around £75 million in the Institute of Compound Semiconductors (ICS). The announcement was followed by a joint venture between IQE Plc and Cardiff University to form the Compound Semiconductor Centre (CSC), allowing businesses and academics to demonstrate production-ready CS materials reducing time-to-market and cost. The facilities at the CSC are being complemented by new materials research, fabrication and testing at the ICS.
2016 saw the announcement by Innovate UK of a £50 million investment to establish the Compound Semiconductor Applications Catapult (CSAC), located in South East Wales; a world-class, open-access R&D facility to support businesses across the UK in exploiting novel CS technologies in key application areas.
In addition to IQE, other organisations in the region include Newport Wafer Fab (an open access chip foundry), and SPTS (Orbotech) who design, manufacture and support a range of wafer processing tools for the semiconductor and microelectronics industries. Downstream capabilities include Microsemi’s Advanced Packaging business, delivering novel solutions for miniaturised electronic circuits with wireless connectivity.
High-volume manufacturing is also certainly on the agenda for the cluster; in September 2017, IQE, Welsh and UK Governments and the Cardiff Capital Region City Deal ratified the development of the Compound Semiconductor Foundry in an historic signing ceremony.
The signing followed an agreement in May by the Cardiff Capital Region (CCR) Regional Cabinet to contribute £37.9 million from the CCR City Deal’s Wider Investment Fund towards the establishment of a state-of-the-art foundry for high-end production of compound semiconductors. The CCR City Deal seeks to position the region as the global leader in CS-enabled applications, which was initiated by a £12 million investment from the Welsh Government.
In addition, Cardiff University was awarded £10 million by the Engineering and Physical Sciences Research Council (EPSRC) to lead the EPSRC Manufacturing Hub in Future Compound Semiconductors that will combine and connect the UK research excellence in compound semiconductors, with translational facilities at the new CSAC Catapult to provide a pathway from research through to device and application testing and qualification.
A number of projects are already underway within the CSconnected cluster, such as improving VCSEL manufacturing efficiencies, nanoimprint lithography for laser diodes and enabling miniaturised atomic clocks using VCSEL pump sources, with both the latter projects worth over £1m.
The collaborative environment fosters strong working relationships to encourage sharing of knowledge and ideas. The organisations involved are enthusiastic about the future. CSconnected is open for business.
In addition to generating new IP through collaborative partnership, IQE continues to build on its already broad IP portfolio in areas such as cREO, whilst also acquiring strategic IP such as the purchase and assignment of a portfolio of patents relating to Quasi Photonic Crystal technologies from the Taiwan based Luxtaltek Corporation announced in December 2017
Current Trading and Outlook
The Group’s technology and market leadership, and its strong pipeline of high growth opportunities position it uniquely to capitalize on its high-growth potential over the coming years.
After a significant ramp in production during the second-half of 2017, the current financial year has started in line with expectations. The outlook for the full year and beyond is for continuing strong growth. The Board anticipates that the Group will increasingly benefit from the wealth of opportunities it has created during the past few years, and leverage the breadth and depth of its high level customer engagement. The powerful IP portfolio that has been established provides a unique platform for the evolution of the Group’s business model to being a leading global advanced semiconductor materials solution provider, and the Board looks forward to the future with great anticipation and confidence.
IQE provides the following guidance for the 2018 financial year, and a over a 3-5 year horizon:
Wafer revenue growth rates
Wireless CAGR: 0-10%
Photonics : 40-60%
Adjusted Operating Margins
(Key wafer segments)
Target Group Margin 25%+
Central costs growth
License income from JV
Effective tax rate ~15%
Cash tax £1-2m
Effective tax rate ~20%
Cash tax £1-2m
H1:H2 seasonality is currently expected to be ~40:60 for FY18, and is heavily influenced by the timing of OEM new product launches.
Dr Drew Nelson OBE, DSc, FREng, FLSW
President & Chief Executive Officer
20 March 2018
NOTES TO THE RESULTS
The company is a public limited company, admitted to trading on AIM, a market operated by The London Stock Exchange plc and incorporated and domiciled in England and Wales. The address of its registered office is Pascal Close, St Mellons, Cardiff, CF3 0LW.
1 BASIS OF PREPARATION
All figures are taken from the 2017 audited annual accounts which were approved by the directors on 20st March 2017, unless denoted as 'unaudited'. Comparative figures in the results for the year ended 31 December 2016 have been taken from the 2016 audited annual accounts, except for the following restated amounts:
In October 2017, the Group identified historical tax liabilities dating back to 2013 in a US subsidiary. The historical tax liabilities, interest and penalties have been quantified at £4,671,000 and the liability was settled in full in 2017 with the relevant US tax authority. The comparative information in the financial statements has been restated to reflect the tax liability as follows:
- The brought forward retained earnings at 1 January 2016 in the consolidated balance sheet and consolidated statement of changes in equity have been restated by £3,196,000 to reflect the historic tax liability relating to 2013, 2014 and 2015;
- Total comprehensive income for the year ended 31 December 2016 has been reduced by £1,475,000 historic tax liability of £748,000 relating to 2016 and an exchange loss on the outstanding balance of £727,000;
- Current liabilities in the consolidated balance sheet as at 31 December 2016 has been restated to include a current tax liability of £4,671,000 to reflect the cumulative historic tax liability.
The impact of the prior year restatement has been to reduce profit for the year in 2016 by £748,000, reduce brought forward reserves by £3,196,000 and reduce net assets by £4,671,000. The prior year restatement has no impact on the prior year cash flow as the tax liability was settled in 2017.
b) Financial assets
The Group classifies its preference share financial assets as debt instruments. Debt instruments are initially recognised at fair value and subsequently measured at amortised cost.
The debt instruments recognised in the balance sheet were originally recognised at cost, which was deemed to be a proxy for fair value. However, this did not discount the carrying value to reflect the forecast repayment profile of the debt.
The initial fair value of the debt instruments has been restated to reflect the impact of discounting on the debt cash flows. The fair value of the instrument at initial recognition has been recalculated by discounting the cash flows using a rate of 5.5%. This rate was determined by reference to comparable market transactions.
The impact of this restatement on the comparative information in the financial statements has been as follows:
- Brought forward retained earnings at 1 January 2016 in the consolidated balance sheet and consolidated statement of changes in equity has been restated by £1,281,000 to reflect the restated initial fair value of the instruments on initial recognition in 2015;
- The interest charge in the consolidated income statement for the year ended 31 December 2016 has been restated to include a credit of £170,000 to reflect the non-cash unwind of the discounting associated with the initial fair value recognition of the instrument.
The impact of the prior year restatement in the 2016 comparative financial information has been to reduce brought forward reserves by £1,281,000, increase profit for the year by £170,000 for the non-cash unwind of discount and reduce net assets by £1,111,000. The prior year restatement has no impact on cash flow.
c) Social security costs associated with outstanding share options
In 2016 the social security costs associated with outstanding share options was unrecorded and therefore the comparative information in the financial statement has been restated as follows:
- Profit for the year in the consolidated income statement has been restated by £839,000 to reflect the social security costs associated with outstanding share options;
- Other taxation and social security within trade and other payables has been restated by £839,000 to reflect the social security liability associated with outstanding share options.
The impact of the prior year restatement in the 2016 comparative financial information has been to reduce profit for the year by £839,000, increase trade and other payables by £839,000 and reduce net assets by £839,000.
d) Segmental analysis disclosure
In the reported results for the 6 months ended 30 June 2017, as part of the groups ongoing improvements to the disclosures in its financial reports the group separately disclosed central corporate costs, which has previously been allocated by segment. The segmental analysis disclosure for 2016 has similarly been updated in this annual report. Central corporate costs include all head office and other corporate related support functions.
Restatement of the 2016 disclosure has no impact on profit for the year, net assets or cash flow.
This financial information has been prepared in accordance with the Companies Act 2006 applicable to companies reporting under International Financial Reporting Standards ("IFRS") as adopted by the European Union and IFRIC interpretations. The application of these standards and interpretations necessitates the use of estimates and judgements. This financial information is also prepared on a going concern basis under the historical cost convention except where fair value measurement is required by IFRS.
Certain statements in this announcement constitute forward-looking statements. Any statement in this announcement that is not a statement of historical fact including, without limitation, those regarding the Company's future expectations, operations, financial performance, financial condition and business is a forward-looking statement. Such forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially. These risks and uncertainties include, among other factors, changing economic, financial, business or other market conditions. These and other factors could adversely affect the outcome and financial effects of the plans and events described in this announcement and the Company undertakes no obligation to update its view of such risks and uncertainties or to update the forward-looking statements contained herein. Nothing in this announcement should be construed as a profit forecast.
These results will be announced to all shareholders on the London Stock Exchange and published on the Group's website on 20st March 2017. Copies will be available to members of the public upon application to the Company Secretary at Pascal Close, Cardiff, CF3 0LW.
2 ACCOUNTING POLICIES
The accounting policies adopted are set out in the annual financial statements for the year ended 31 December 2017, as described in those financial statements.
The financial information does not constitute statutory accounts within the meaning of sections 434(3) and 435(3) of the Companies Act 2006 or contain sufficient information to comply with the disclosure requirements of International Financial Reporting Standards (IFRS).
The Company’s auditors, KPMG LLP, have given an unqualified report on the consolidated financial statements for the year ended 31 December 2017. The auditor’s report did not include reference to any matters to which the auditors drew attention without qualifying their report and did not contain any statement under section 498 of the Companies Act 2006.
The consolidated financial statements will be filed with the Registrar of Companies, subject to their approval by the Company’s shareholders at the Company’s Annual General Meeting.
3 SEGMENTAL ANALYSIS
4 ADJUSTED PROFIT MEASURES
The Group’s results are reported after a number of imputed non-cash charges and non-recurring items. Therefore, we have provided additional information to aid an understanding of the Group’s performance.
The comparative financial information for the year ended 31 December 2016 has been restated. Details of the restatement are set out in note 1.
The adjusted items are analysed as follows, which shows the pre-tax amounts and their related tax effects :
The nature of these items is as follows :
- Change in US tax rate – This refers to a deferred tax charge of £7,003k (2016: £nil) relating to the impact of the change in US Federal tax rates from 35% to 21% and the associated reduction in value of the Group’s US deferred tax asset.
- Share based payments – The charge recorded in accordance with IFRS 2 ‘Share based payment’, of which £5,017k (2016: £1,920k) has been classified within cost of sales in gross profit,and £2,509k (2016: £961k) has been classified as selling, general and administrative expenses in operating profit.
- Amortisation of acquired intangibles – The amortisation of customer contract intangible assets which arose in respect of the fair value exercise in previous acquisitions. The charge of £1,429k (2016: £1,374k) has been classified as selling, general and administrative expenses within operating profit.
- Gain on release of deferred consideration – The gain in 2016 related to the release of the balance of a provision for deferred consideration. This gain was classified as other income in operating profit. The deferred consideration was settled in full in 2016.
- Non-cash rent charge – The charge associated with rent free periods on leased property of £385k (2016: £nil) (New foundry in Newport) has been classified as selling, general and administrative expenses within operating profit.
- Discounting - This relates to the discounting of long term financial assets of £235k (2016: £nil) and the unwinding of discounting of long term balances of £155k (2016: £26k), and has been classified as finance costs within profit before tax.
- Restructuring – the costs relating to restructuring and reorganisation activities which were concluded in 2016. An amount of £326k was classified as cost of sales in gross profit, and £52k was classified as selling, general and administrative expenses within operating profit
These adjustments were non-cash, other than the restructuring charge in 2016. The cash impact of adjustments in the consolidated cash flow statement represent the rental cost associated with an onerous property lease provision.
Adjusted EBITDA (Adjusted Earnings Before Interest, Tax, Depreciation and Amortisation) has been calculated as follows:
* Exceptional items impacting Adjusted EBITDA include the following items: non cash property lease charges associated with rent free periods, wireless business unit re-organisation costs, and the release of contingent deferred consideration.
5 EARNINGS PER SHARE
Basic earnings per share is calculated by dividing the profit attributable to ordinary shareholders by the weighted average number of ordinary shares in issue during the year.
Diluted earnings per share is calculated by dividing the profit attributable to ordinary shareholders by the weighted average number of shares and the dilutive effect of ‘in the money’ share options in issue. Share options are classified as ‘in the money’ if their exercise price is lower than the average share price for the year. As required by IAS 33, this calculation assumes that the proceeds receivable from the exercise of ‘in the money’ options would be used to purchase shares in the open market in order to reduce the number of new shares that would need to be issued.
The directors also present an adjusted earnings per share measure which eliminates certain non-cash items in order to provide a more meaningful underlying profit measure. The adjustments are detailed in note 4.
6 CASH GENERATED FROM OPERATIONS
7 ANALYSIS OF NET DEBT
Other non-cash movements includes an amount of £6.6 million in respect of assets purchased under finance lease. These lease were settled in full prior to the year end.