H1 2018 Results

29 August 2018

IQE plc

H1 2018 Results

IQE extends global footprint in high growth 3D sensing markets through multiple VCSEL investments in H1 2018

Cardiff, UK. 29 August 2018: 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 unaudited half year results for the six months to 30 June 2018.

* Adjusted Measures: The Directors believe that the adjusted measures provide a more useful comparison of business trends and performance. Adjusted measures exclude exceptional items, share based payments and non-cash acquisition accounting charges as detailed in note 7.  The following highlights of the first half results is based on these adjusted profit measures, unless otherwise stated.

HIGHLIGHTS

Overview

• Sales growth at constant currency in all three primary markets with Wireless up 11%, Photonics up 30%, and InfraRed up 11% compared with H1 2017.

• Multiple H1 2018 investments in VCSEL qualification programs extending the global footprint for 3D sensing in consumer and other high growth applications

• Since period end, qualification of a further two major supply chain partners has been completed, with initial production for Android OEMs now commenced.

• Guidance re-confirms consensus forecasts range as H2 2018 ramp in VCSELS re-commences.

Finance

• Currency headwind, accelerated customer qualification programs and Newport Foundry pre-production costs results in drag on H1 2018 profits of approximately £3.5m.  Excluding these factors, Profit Before Tax would have increased by 14.4% to £11.1m (H1 2017: £9.7m).

• Wafer sales up 5.4% against H1 2017 and total revenue up 4.0% delivered against the currency headwind of approximately 10%.

• Currency headwinds were caused by the average underlying currency UK£:US$ FX rates fluctuating from 1.26 in H1 2017 to 1.38 in H1 2018.
• Revenue at constant currency from the largest photonics customer was flat H1 2018 on H1 2017 as inventory from the very successful and aggressive first mass market ramp of VCSEL epiwafers in H2 2017 was consumed in the supply chain. Other photonics customers were up 40% H1 2018 on H1 2017 in constant currency demonstrating the breadth and depth of photonics engagements.
• Photonics business unit increased to 25.8% of total wafer revenues (H1 2017: 21.9%).
• Wafers gross profit was flat at £17.1m (H1 2017 £17.2m) as wafers gross margin contracted by 140bps from 24.7% in H1 2017 to 23.3% in H1 2018.  Photonics gross profit margins were adversely impacted by Newport Foundry pre-production costs of £0.9m and low margin customer funded product development (primarily new VCSEL customers) reducing photonics margins by a further £0.6m.
• The Newport pre-production costs of £0.9m (H1 2017: nil) were incurred on recruitment, increased headcount and training and have secured the human capital required to support and deliver the team for a 24/7 operation of the Newport Foundry.
• Reported Profit before tax increased by £1.0m (18.9%) to £6.6m (H1 2017: £5.6m).  Forex headwind produced a drag on Reported Profit before tax of c. £2m.
• Conversion of operating profit £7.6m (H1 2017: £10.7m) into operating cash £7.6m (H1 2017: £11.2m) of 100% (H1 2017: 105%) after funding a £6.6m increase in working capital (H1 2017: £4.5m) as a consequence of an increase in both trade and other receivables and inventories since 31 Dec 2017.
  • Investment in capex and product development was £13.0m (H1 2017: £15.4m).  This was funded in H1 2018 through organic cash generation and from cash reserves following the November 2017 share placing.

• Net cash at the end of H1 2018 was £40.6m (h1 2017: net debt £41.9m)

Operational and Strategic

• Nature and extent of customer and research and development engagements by the Group’s two joint ventures continue to expand.

• The Newport, UK foundry construction and fit out is proceeding well.  Five reactors had been successfully installed by the end of H1 2018 and a further two have been delivered in August 2018, with three more scheduled for H2 to bring the total to ten reactors during H2 2018.  Commissioning and qualifications are ongoing and initial production is expected to commence in the latter part of H2 2018.

• Option exercised in March 2018 to acquire the cREO™ technology and IP portfolio from Translucent Inc for US$ 5m.

• Milestone first production order received for $250k of edge emitting DFB lasers using the Group’s NIL technology.

• Re-negotiated a long term supply contract with a tier 1 wireless customer through to September 2019, securing an extended range of products and increased share of their epi-wafer requirements.

• A healthy wireless business and VCSEL engagements with more than 20 chip companies for sensing, mobile, industrial and data communications demonstrates the breadth and depth of customer engagements across a range of technologies and applications and sets the scene for increasing revenue diversity and growth through H2 2018 and beyond.

• Head-hunters have been engaged in the recruitment of a CFO to replace Mr Phillip Rasmussen, following his tragic death while on holiday in Menorca on 1^st April 2018.  Initial shortlist interviewing is complete and final interviews are scheduled for early September 2018.

Dr Drew Nelson, IQE Chief Executive, said:

“IQE has taken the opportunity during H1 2018 to accelerate and expand its qualification activities for the fast growing VCSEL market for consumer applications, and is now successfully engaged with over 20 companies in this arena. Coupled with the installation, staffing and run up of the initial high volume production tools in our flagship Newport Epi-Foundry, these activities represent major steps forward in securing and further strengthening IQE’s leading position in the global supply of VCSEL wafers for multiple consumer and industrial 3D sensing applications. Although the costs of these investments have impacted first half profitability, we are confident they will be pivotal in delivering strong increases in revenue, margin expansion and profitability as 3D sensing is widely adopted in global mobile platforms and other large volume applications.”

“Each of our business sectors delivered strong top line growth at constant currency during the first half.  Reported wafer revenue increased 5.4% despite strong forex headwinds of ~10%.  Together with the renewal of our long term supply agreement with our largest tier 1 wireless customer and the manufacturing milestone reached with our first NIL edge emitting DFB laser production order, this demonstrates both the strength of our existing core business and the new opportunities that we are creating as we continue to bring our unique innovative material capabilities and associated nanoscale fabrication technologies to market.”

“As we transition our business model from being the global leading supplier of advanced semiconductor wafers to a global leader in advanced material solutions, we already see significant engagements for our other core technologies, including GaN on Silicon, cREO and QPC. We look forward to the rest of 2018 and in particular the further multi-customer ramp which is expected in 2019, with considerable anticipation.”

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.

GLOSSARY OF TERMS

VCSEL...............  Vertical Cavity Surface Emitting Laser
GaN.................... Gallium Nitride
RF......................  Radio Frequency
DFB....................  Distributed Feedback Laser
cREO(TM)............Crystalline Rare Earth Oxide

QPC………………Quasi Photonic Crystals

NIL………………  Nano Imprint Lithography

CONTACTS

IQE plc +44 (0) 29 2083 9400 
Godfrey Ainsworth

Drew Nelson 
Chris Meadows

Canaccord Genuity + 44 (0) 20 7523 8000 
Simon Bridges

Richard Andrews

Peel Hunt +44 (0) 20 7418 8900
Edward Knight

Nick Prowting

NOTE TO EDITORS

http://iqep.com

IQE is the leading global supplier of advanced semiconductor wafers that enable a diverse range of applications, supported by an innovative outsourced foundry services portfolio that allows the Group to provide a 'one stop shop' for the wafer needs of the world's leading semiconductor manufacturers.

IQE uses advanced crystal growth technology (epitaxy) to manufacture and supply bespoke semiconductor wafers '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 is unique in being able to supply wafers using all of the leading crystal growth technology platforms.

IQE's products are found in many leading-edge consumer, communication, computing and industrial applications, including a complete range of wafer products for the wireless industry, such as smartphones and wireless infrastructure, Wi-Fi, base stations, and satellite communications; optical communications, optical storage, printing, thermal imagers, leading-edge medical technologies, automotive and aerospace technologies, a variety of advanced silicon based systems and high efficiency concentrator photovoltaic (CPV) solar cells.

IQE operates multiple manufacturing and R&D facilities worldwide.

INTERIM RESULTS 2018

1. INDUSTRY BACKGROUND

Semiconductors in the form of both silicon and compound semiconductors, are at the heart of virtually all major industrial, consumer and communication systems. Without semiconductors, many devices and applications that we rely on in our everyday lives would simply not exist, yet these atomically engineered materials go largely unnoticed amongst the end user brands with which we are so familiar.

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. Compound Semiconductors are a key enabling technology that feed into multiple supply chains which in turn feed a wide range of market sectors including: aerospace, healthcare technologies, safety & security, big data and the Internet of Things (IoT), energy efficiency (generation and consumption), 3D sensing, robotics and automotive products.

IQE’s core business is the manufacture of compound semiconductor wafers or “epiwafers” using a process known as epitaxy, which is a nanotechnology that enables multiple atomic elements to be combined to produce materials that have far superior properties to silicon. These advanced semiconductors are termed 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.

IQE’s end product is a pure, crystalline, semiconductor wafer comprising many individual atomic layers, often utilising quantum technologies that uniquely define the wireless, photonic and electronic performance of our epiwafers which are then processed by our customers to produce the “chips” that are found in virtually all of today’s technology devices and gadgets.

2. IQE AND THE COMPOUND SEMICONDUCTOR SUPPLY CHAIN

The inflection in CS technology adoption is well under-way, with 2017 and the first half of 2018 marking the first time 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 epiwafer 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 is the global leader 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 IQE’s position as the global leader 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, 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.

IQE designs and fabricates compound semiconductor wafers, generating revenues primarily from selling bespoke wafers to its customers, who in turn fabricate these wafers into compound semiconductor chips such as wireless communication chips, laser devices, or advanced sensors for applications including 3D sensing and LIDAR. These chips are then incorporated into devices such as smartphones, base-stations, or other electronic systems and gadgets.

The Group also generates income from licensing IP to joint ventures, being related entities which are not controlled by IQE.  These joint ventures (“JVs”) were established with IQE’s partners to provide a bridge between academia and industry.  Our university partners are participating in these JVs to provide a cost effective route to commercialise their new technologies, whereas IQE and its industrial partner are using the JVs to seed future revenues by using their “right of first refusal” over the commercial supply for these new technologies.

IQE differentiates itself from its competitors through technology leadership, economies of scale, and multiple site manufacturing for security of supply. This has enabled IQE to develop a strong leadership position, where it is recognised globally as the market leader, with an estimated 55% share of the wireless market and an unparalleled breadth of materials technologies.

Whilst both the silicon and the compound semiconductor industry sectors 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.

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.

IQE is leveraging the strength and depth of its IP portfolio to transition its business model from a “materials solutions company”, where we develop bespoke wafer solutions to customer defined specification, to an “innovative enabler” where IQE provides innovative material solutions to chip designers, enabling them to develop new chip designs which push the boundaries of performance 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 is 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 higher levels of integration of the FEM on a single chip.  This would be highly disruptive. An 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 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.   So again, with its cREO technology, IQE has a route to much higher levels of integration of these technologies. This again would be highly disruptive as it would result in the potential for 3D sensing solutions with more functionality on single chipsets resulting in more efficient, smaller footprint products at much lower costs of production.

3. RESULTS

The Group’s results are reported after a number of one-off items and non-cash accounting charges. In aggregate, these resulted in a net charge after tax of £2.1m in H1 2018 (H1 2017: £1.6m charge). These items are fully detailed in note 7 in order to assist with an assessment of the Group’s underlying business performance. The following commentary on the first half results is based on these adjusted profit measures.

First half revenues increased by 4.0% to £73.4m (H1 2017: £70.6m).  Wafer sales of £73.4m were up 5.4% against H1 2017.  This reflects increased sales in each of the Group’s primary markets achieved against a currency headwind of approximately 10%.  In constant currency, Wireless sales were up 11%, Photonics sales up 30% and InfraRed sales up 11%.  There was no license income from joint ventures (H1 2017: £0.95m). Reported photonics revenues grew by £3.7m (24%) to £18.9m (H1 2017: £15.2m) and accounted for 26% of IQE’s wafer sales in H1 2018, up from 22% in H1 2017. This remains IQE’s most rapidly growing business segment.

Wireless inventory channels, depleted as a consequence of the rapid ramp of VCSELs in H2 2017, were partially replenished during H1 2018 and photonics capacity was directed to satisfy more than twenty VCSEL chip manufacturer engagements in order to significantly broaden IQE’s global reach in the rapidly growing 3D sensing markets.

Wafers gross profit was flat at £17.1m (H1 2017 £17.2m) as wafers gross margin contracted by 140bps from 24.7% in H1 2017 to 23.3% in H1 2018.  Photonics gross profit margins were adversely impacted by Newport Foundry pre-production costs of £0.9m and low margin customer funded product development (primarily new VCSEL customers) reducing photonics margins by a further £0.6m.

Segment operating profit, detailed in note 6, was £7.6m (H1 2017: £9.7m).  Segment operating margins were 10.4% (H1 2017: 13.8%).  Wireless operating profit margins were 13.9% (H1 2017: 15.6%) and reduced as a consequence of reactor conversion costs relating to switching reactors from Photonics to Wireless production during H1 2018. Photonics 25.8% (H1 2017: 41.6%), reduced as a consequence of the high level of low margin photonics customer qualifications undertaken in H1 2018 and the pre-production costs which were expensed in relation to the new Newport Foundry.  Taking into account the Newport Foundry pre-production costs and the investment in qualification programmes for new VCSEL customers, the underlying photonics operating profit was £6.4m (H1 2017: £6.3m) at an operating profit margin of 33.4% (H1 2017: 41.6%).  Central corporate costs were flat at £4.5m (H1 2017: £4.5m). Photonics margins will return to 35% for H2 2018 as the production efficiencies of the ramp in output are realised.

Conversion of operating profit £7.6m (H1 2017: £10.7m) into operating cash £7.6m (H1 2017: £11.2m) of 100% (H1 2017: 105%) after funding £6.6m in working capital increase (H1 2017: £4.5m).  Investment in capex and product development was £13.0m (H1 2017: £15.4m), including £6.4m (H1 2017: £9.4m) in capitalised research and development expenditure relating to VCSELs, GaN, cREO and dilute nitride developments and £6.3m (H1 2017: £5.8m) in property plant and equipment associated predominantly with the new Newport Foundry.  This was funded in H1 2018 through organic cash generation and from surplus cash reserves arising following the November 2017 share placing.

Reported Profit before tax increased by £1.0m (18.9%) to £6.6m (H1 2017: £5.6m).  Reported profits before tax in H1 2018 were depressed by approximately £3.5m; approximately. £2m as a consequence of the impact of the forex headwind compared with H1 2017 and £1.5m relating to the Newport Foundry pre-production costs and VCSEL qualifications referred to above.

Pre-tax adjusted items were £1.0m (H1 2017: £4.1m).  The tax charge on the adjusted items was £1.1m (H1 2017: tax credit £2.5m) leaving adjusted items net of tax of £2.1m (H1 2017: £1.6m). These items are fully detailed in note 7 and include the cost of employee share based payments, exceptional share based payment costs from accelerated vesting of options and insurance income both relating to the death in service of Mr Phillip Rasmussen and legal fees relating to an ongoing patent dispute defence.

The tax charge on adjusted profits was £1.4m (H1 2017: tax credit £0.3m) reflecting an effective tax rate of 18% (H1 2017: -2.7%), FY2017: 2.9%)  The tax rate increase primarily reflects recognition of £2.2m tax losses in H1 2017 (H1 2018: £nil, FY 2017 £4.0m), see note 8 for further details.  The reported effective tax rate of 37.3% (H1 2017; -49.8%. FY 2017: 2.9%) reflects the tax effect on exceptional items as detailed in note 7 in addition to the underlying tax charge.

The Group has approximately £110m (H1 2017: 115m) of accumulated tax losses which represent a potential reduction in future tax payable of £22m (H1 2017: £33m), the reduction being a consequence of the reduction announced in Dec 2017 in US tax rates from 35% to 21%.

Adjusted profit after tax reduced £3.7m to £6.2m (H1 2017: £9.9m), which combined with an increase of 11.3% in the weighted average number of fully diluted shares in H1 2018 to 807.8m shares (H1 2017: 725.6m shares) resulted in a 43.7% decrease in adjusted fully diluted EPS from 1.37p to 0.76p.

After exceptional charges of £2.1m (H1 2017: £1.6m), the Reported Profit after Tax decreased from £6.2m (H1 2017: £9.9m) to £4.2m (H1 2017: £8.4m).

The Group’s net cash at 30 June 2018 was £40.6m (30 June 2017: net debt £41.9m) a decrease of £5.0m since the prior year end (31 Dec 2017: £45.6m).  The reversal in the 12 months to 30 June 2018 was a result of the successful placing completed in November 2017, raising in excess of £90m to repay debt and fund capacity expansion.

Balance sheet net assets at 30 June 2018 were £301m (H1 2017: £192m) an increase of £109m since H1 2017 and £9.9m since 31 Dec 2017.

4. VISION AND STRATEGY

Compound semiconductors continue to play an increasingly important role in the electronics industry as their advanced properties exceed the performance limitations of silicon semiconductors. Through continuing innovation, compound semiconductor technologies are now achieving the cost-performance thresholds that is accelerating their adoption on many fronts.  Moreover, as the technology continues through this inflection point of mass adoption, it is approaching a paradigm shift with the emergence of “Compound Semiconductor on Silicon” technology (CS-on-Si).

IQE’s vision is to maintain and grow our established position as the leading global provider of advanced semiconductor materials – the global “go to” compound semiconductor materials specialist in the electronics industry.

To realise this vision requires the ability to deliver “enabling technology”, which meets the price points needed for adoption, and which can be delivered reliably, on-time, every-time with the ability to scale rapidly.  IQE has positioned itself well for this challenge, having built the broadest portfolio of materials IP in the industry, and developed a unique platform for a secure low cost supply. Moreover, IQE has developed a reputation to match – for excellence and reliability.

5. MARKETS

IQE has developed a market facing organisational structure, based around its 6 key markets: Wireless, Photonics, Infrared, Solar, Power, and CMOS++. The emerging markets of Solar and Power control are not yet significant enough to be separated in our segmental reporting.

Wireless

Compound Semiconductors play an essential role in high speed wireless communications 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.

Despite slower growth in smartphone sales in recent years, the relentless increase in data traffic continues to drive the need for more sophisticated wireless chip solutions in handsets. There is little doubt that the world will become increasingly more connected with advances in areas such as connected and autonomous vehicles (AVs) driving demand for 5G communications. IQE sees the acceleration of the roll-out of 5G infrastructures around the world as a significant upside potential for its wireless business as this transition will require much more complex material technologies.

Current 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 increasingly 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 our lead customer, IQE has developed a high performance low cost solution (GaN on Silicon) to accelerate the displacement of LDMOS.  Our lead customer 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 Bulk Acoustic Wave (BAW) filters.  Although the primary materials technology for BAW 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 is currently prototyping the key technologies for the realisation of much higher cystalline quality AlN wafer product and is actively 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 up to 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;
• adoption of GaN on Silicon technology for base stations; and
• the transition to 5G communications, requiring more advanced CS materials and adoption of high quality CS materials solutions enabled by cREO for wireless filters.

The Group also announced in July 2018 that it had re-negotiated a long term supply contract with a tier 1 wireless customer through to September 2019, securing an extended range of products and increased share of their epiwafer requirements.

Photonics

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 spaces.

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.

There is little doubt that sensing technologies, from 3D sensing 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 6 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.

Alongside our growing VCSEL business, 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 and received our first milestone production order during H1 2018 for DFB lasers made using our proprietary NIL process.

InfraRed

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.

Beyond defence, the InfraRed division has been successful in broadening its 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 sun’s 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 and UAVs, where the higher efficiency has a dramatic cost benefit on payload. Product qualifications are underway with leading UAV/satellite manufacturers, paving the way for commercial revenues, therefore we will highlight new technologies as these reach commercial adoption.

Power

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.

CMOS++

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.

JOINT VENTURES

Compound Semiconductor Centre Limited (“CSC”)

The CSC is a joint venture, jointly controlled by the parties with equal voting rights, between the Company and Cardiff University as a centre of excellence for the development and commercialisation of advanced semiconductor products using MOCVD.  During H1 2018, the CSC expanded funded Collaborative Research and Development (“CRD”) project activity, and realised its first third party commercial manufacturing revenues.

The CRD strategy has built on its successes of 2017 (Techworks Research Collaboration Award, Economic Impact title: 2017 Business and Education Partnerships Award, shortlisted for the Times Higher Education awards: Knowledge Exchange Initiative of the Year). A total of nine CRD projects are underway, with a value of £5.4m across all partners and total funding of approximately £1.3m to the CSC, with a typical project duration of two years. The projects have resulted in formal product development partnerships with five multinationals, four mid-size companies, four SMEs and three additional academic partners in critical areas such as next generation Optical Communications, Quantum Technologies, novel Power and RF components and applications of Compound Semiconductors in Healthcare and Cosmetic applications.

Routes to commercial income streams are now maturing and the first commercial orders driven by outcomes from the CRD projects were delivered in H1 2018. The percentage of non-IQE revenue received by the Centre is increasing steadily, and expected to be in the range of 15-20% for full year 2018.

A second phase capital expansion focussed on the installation of new cleanroom and a GaN MOCVD reactor designed for Cardiff University research activity was initiated in October 2017 and completed in April 2018. The CSC has welcomed the Cardiff University research team on site at St Mellons, and is working closely to qualify the new reactor and increase collaboration on a wide range of commercially relevant research topics.

The CSC management look forward to progressing several key areas in H2 2018 including delivery of further exploitable outcomes of the CRD programme, diversification of the research roadmap and wider industry engagement to develop the commercial revenue pipeline.

Compound Semiconductor Development Centre (“CSDC”)

The CSDC is joint venture between the Company, WIN Semiconductors Corp. and Nangyang Technological University in Singapore. The entity is jointly controlled by the shareholders who have equal shares of the voting rights. The CSDC is a centre of excellence in Asia for the development and commercialisation of advanced semiconductor products using MBE.  The joint venture is engaged in a number of early stage qualifications for new customers in China.

Twelve new Chinese customer engagements were initiated in H1 2018 for fifteen separate product qualifications including five for wireless pHEMTs and seven for photonics products. The Chinese Government announced the formation of the China National Integrated Circuit Industry Investment Fund (“CNICIIF”) in 2014 to provide funding support of US$ 21.8bn (RMB 138.7bn) for start-up semiconductor businesses and research and development and the CSDC’s engagements provide an excellent opportunity to build relationships with emerging key players.  Following the recent move, subsequently reversed, by the US Government to ban the sale of US technology to China ZTE Corp., and the growing tensions in the US and China’s trade and economic relations, China is reported to have sought to accelerate its efforts to gain semiconductor self-sufficiency by increasing funding to the successor of the CNICIIF to US$ 47bn.

The CSDC is well placed, as is the Company’s business in Taiwan, to service the requirements of the Chinese market should other supply routes become difficult or expensive.

Revenue from the joint venture is only recognised to the extent that it generates surplus cash.

6. CURRENT TRADING AND OUTLOOK

The Group is strongly positioned to deliver healthy profit growth and cash generation in the coming periods built on the firm foundations of technology and market leadership combined with a growing pipeline of high growth opportunities.

The VCSEL wafer ramp for H2 2018 for existing 3D consumer applications commenced as expected at the end of H1 2018, and since the period end, the first production for new 3D sensing customers has also started. At this time, the Group has customer forecast demand to meet consensus revenue, with a 40:60 revenue split for H1/H2 2018.  This exaggerated seasonality, when compared with our historic wireless splits, is driven by OEM product launches expected in late Q3 2018 and the demand from other qualified chip manufacturers for new entrant OEMs in the fast-developing 3D sensing VCSEL market which are expected to start in late 2018 and ramp strongly through 2019.

The Group will invest approximately £6m in expanding GaN capacity in its facility in Taunton, MA in order to transition and combine its GaN activities from its NJ plant, providing a strong position for the upcoming wide ranging 5G deployment of GaN solutions. This investment will commence in H2 2018 and be completed by H1 2019. The GaN facility in Somerset, NJ will close in December 2018 as the transfer of its business to Taunton is completed.  The consolidation of GaN production capacity is expected to save approximately £1.5m in 2019, after allowing for severance and decommissioning costs, and approximately £3m per annum thereafter.

The Group will also invest approximately £15m in additional wireless capacity at its plant in Hsinchu, Taiwan.  This project will commence in September 2018 and will complete in H1 2019, increasing capacity there by 40%. With this investment the Company will be able to avoid the costs of converting and reconverting reactors from Wireless to Photonics and back again which have totalled approximately £3m in the last 18 months in costs and lost opportunity and provide additional capacity for the continued growth of the Group’s wireless business.

These investments will enable the Group to better balance its production capabilities, provide capacity to fulfil market growth expectations and reduce costs, improving efficiency to underpin margin expansion. Updated guidance on capital investment is detailed below.

The Board remain confident of achieving current market expectations at current £:US$ exchange rates.

GUIDANCE

IQE provides the following updated guidance for the 2018 financial year, initial guidance for FY 2019 and over a 3-5 year horizon.

Dr Drew Nelson, OBE, DSc, FREng, FLSW

President & Chief Executive Officer

29 August 2018

Adjusted basic and diluted earnings per share is presented in Note 9.

* This may be subsequently reclassified to the income statement when it becomes realised.

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

1. REPORTING ENTITY

IQE plc is a public limited company incorporated in the United Kingdom under the Companies Act 2006. The Company is domiciled in the United Kingdom and is quoted on AIM.

These condensed consolidated interim financial statements (‘interim financial statements’) as at and for the six months ended 30 June 2018 comprise the Company and its Subsidiaries (together referred to as ‘the Group’). The principal activities of the Group are the development, manufacture and sale of advanced semiconductor materials.

1. BASIS OF PREPARATION

These interim financial statements have been prepared in accordance with IAS 34 ‘Interim Financial Reporting’, and should be read in conjunction with the Group’s last annual consolidated financial statements as at and for the year ended 31 December 2017 which were approved by the Board of Directors on 20 March 2018 and were delivered to the Registrar of Companies. The report of the auditors on those financial statements was unqualified, did not contain an emphasis of matter paragraph and did not contain any statement under section 498 of the Companies Act 2006.

The interim financial statements do not include all of the information required for a complete set of IFRS financial statements and do not constitute statutory accounts within the meaning of section 434 of the Companies Act 2006. However, selected explanatory notes are included to explain events and transactions that are significant to an understanding of the changes in the Group’s financial position and performance since the last annual financial statements.

This is the first set of the Group’s financial statements where IFRS 15 and IFRS 9 have been applied. Changes to significant accounting policies are described in Note 4.

Comparative information in the interim financial statements as at and for the year ended 31 December 2017 has been taken from the published audited financial statements as at and for the year ended 31 December 2017 and restated to reflect the implementation of the new accounting standard, IFRS 15, which is effective for annual periods beginning on or after 1 January 2018. All other periods presented are unaudited.

The financial information contained in these interim financial statements has been reviewed by the Company’s auditor in accordance with ISRE 2410 however this does not constitute an audit.

The interim financial statements were approved by the Board of Directors and the Audit Committee on 29 August 2018.

1. USE OF JUDGEMENTS AND ESTIMATES

In preparing these interim financial statements, management has made judgements and estimates that affect the application of accounting policies and the reported amounts of assets and liabilities, income and expense. Actual results may differ from these estimates.

The significant judgements made by management in applying the Group’s accounting policies and the key sources of estimation uncertainty were the same as those described in the last annual financial statements, except for new significant judgements and key sources of estimation uncertainty related to the application of IFRS 15, which is described in Note 4.

1. CHANGES IN SIGNIFICANT ACCOUNTING POLICIES

The accounting policies adopted are consistent with those of the annual financial statements for the year ended 31 December 2017, as described in those financial statements on pages 91 to 99, except for the impact of the implementation of IFRS 15 ‘Revenue from contracts with customers’.

Recent accounting developments

In preparing the interim financial statements the Group has adopted the following Standards, amendments and interpretations which are effective for 2018 and will be adopted for the year ended 31 December 2018:

• Annual improvements 2014-2016 cycle
• Amendment to IFRS 2, ‘Share based payments’ to clarify the classification and measurement of certain share based payment transactions
• IFRS 9 ‘Financial instruments’
• IFRS 15 ‘Revenue from contracts with customers’

The adoption of these standards and amendments has not had a material impact on the interim financial statements, except for IFRS 15, Revenue from contracts with customers’.

1. CHANGES IN SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Change in accounting policy – IFRS 15 ‘Revenue from contracts with customers’

IFRS15, ‘Revenue from contracts with customers’ deals with revenue recognition and establishes principles for reporting useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Revenue is recognised when a customer obtains control of a good or service and thus has the ability to direct the use and obtain the benefits from the good or service.

The standard replaces IAS 18 ‘Revenue’ and IAS 11 ‘Construction Contracts’, and related interpretations and is effective for annual periods beginning on or after 1 January 2018.

The group has implemented the requirements of IFRS 15, ‘Revenue from contracts with customers’ from 1 January 2018 and restated its comparative financial information contained in these interim financial statements for the six months ended 30 June 2017 and the twelve months ended 31 December 2017 accordingly.

Implementation of IFRS 15, ‘Revenue from contracts with customers’ has resulted in changes in the recognition of revenue in circumstances where the Group produces bespoke customer products with a guaranteed contractual right to payment. In these situations revenue is recognised on an ‘overtime’ basis earlier in the manufacturing process than was historically the case where revenue was typically recognised on delivery and acceptance of the goods by the customer.

The comparative financial information as at and for the six months ended 30 June 2017 has been restated to reflect the impact of this change in accounting policy. Brought forward retained earnings at 1 January 2017 in the balance sheet and statement of changes in equity have been restated by £191,000 and brought forward other reserves at 1 January 2017 in the balance sheet and statement of changes in equity have been restated for the impact of foreign exchange by £4,000. Revenue in the income statement for the six months ended 30 June 2017 has been restated to include a net credit of £192,000 and cost of sales has been restated to include an additional net charge of £85,000 with an associated reduction in inventory of £815,000, increase in accrued income of £1,101,000 and foreign exchange impact in other reserves of £16,000 recorded in the balance sheet. The adjustment has increased net assets at 30 June 2017 by £286,000.

The comparative financial information as at and for the twelve months ended 31 December 2017 has been restated to reflect the impact of this change in accounting policy. The opening adjustments described for the six month period ended 30 June 2017 remain consistent for the twelve month period ended 31 December 2017.   Revenue in the income statement for the twelve month period has been restated to include a net credit of £73,000 and cost of sales has been restated to include an additional net credit of £102,000 with an associated reduction in inventory of £663,000, increase in accrued income of £1,029,000 and foreign exchange impact in other reserves of £4,000 recorded in the balance sheet. The adjustment has increased net assets at 31 December 2017 by £366,000.

Prior year adjustments

The comparative information contained in the interim financial statements as at and for the six months ended 30 June 2017 has been restated to reflect certain prior year adjustments included in the financial statements as at and for the year ended 31 December 2017. The impact of these prior year adjustment on the comparative financial information for the six months ended 30 June 2017 is detailed below.

Taxation

In October 2017, the Group identified historical tax liabilities totalling £4,671,000 dating back to 2013 in a US subsidiary that were treated as a prior year adjustment in the financial statements for the year ended 31 December 2017.

The comparative financial information as at and for the six months ended 30 June 2017 has been restated to reflect the impact of this prior year adjustment. Brought forward retained earnings and other reserves at 1 January 2017 in the balance sheet and statement of changes in equity have been restated by £4,671,000 to reflect the historic tax liability. Other comprehensive income in the statement of changes in equity for the six months ended 30 June 2017 has been restated by £288,000 to reflect an exchange gain on the opening 1 January 2017 restated tax liability which has been restated in the 30 June 2017 balance sheet to £4,383,000.

Preference share debt

The Group classifies its preference share financial assets as debt instruments which were originally recognised at their nominal value. The initial fair value of the debt instruments was restated in the financial statements for the year ended 31 December 2017 using a market rate of interest of 5.5% which resulted in the recognition of a discounted asset value.

The comparative financial information as at and for the six months ended 30 June 2017 has been restated to reflect the impact of this prior year adjustment. Brought forward retained earnings at 1 January 2017 in the balance sheet and statement of changes in equity have been restated by £1,111,000 to reflect the initial fair value discount (net of discount unwind). The interest charge in the income statement for the six months ended 30 June 2017 has been restated to include a credit of £111,000 to reflect the non cash unwind of the discount and the financial asset represented by the debt instruments has been restated in the balance sheet to £7,000,000.

1. CHANGES IN SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Social security costs associated with outstanding LTIP and share option awards

Social security costs associated with outstanding LTIP and share option awards were unrecorded and restated as a prior year adjustment in the financial statements for the year ended 31 December 2017.

The comparative financial information as at and for the six months ended 30 June 2017 has been restated to reflect the impact of this prior year adjustment. Brought forward retained earnings at 1 January 2017 in the balance sheet and statement of changes in equity have been restated by £839,000 to reflect the recognition of social security liabilities on outstanding LTIP and share option awards. Operating profit in the income statement for the six months ended 30 June 2017 has been restated to include a charge of £1,381,000 to reflect an increase in the social security liability from the restated opening 1 January 2017 position whilst the tax credit in the income statement has been restated to include a deferred tax credit of £2,220,000 representing the related deferred tax asset.

The impact of the change in accounting policies and prior year adjustments on the comparative financial information for the six months ended 30 June 2017 and the twelve months ended 31 December 2017 is set out in the summarised income statements and balance sheets below.

1. CHANGES IN SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

1. PRINCIPAL RISKS AND UNCERTAINTIES

The principal risks and uncertainties impacting the Group are described on pages 28 to 36 of our 2017 Annual Report and remain unchanged at 30 June 2018.

They include: competition, technological change, health, safety and environment, human resourcing, natural disasters, financial liquidity, business interruption, customer concentration, legal compliance, loss of intellectual property, information technology failure and tax liability.

1. SEGMENTAL INFORMATION

The comparative financial information for six months ended 30 June 2017 and 31 December 2017 have been restated.  Details of the restatement are set out in note 4.

1. ADJUSTED PROFIT MEASURES

The group’s results are reported after a number of adjusted items. The directors believe that the selected adjusted measures allow management and other stakeholders to better compare the performance of the Group between the current and prior year, without the effects of one-off or non-operational items and better reflects the normalised underlying earnings in the year. The tables below provide additional information to aid an understanding of the adjusted items and the impact on the Group’s performance.

The comparative financial information for six months ended 30 June 2017 and 31 December 2017 have been restated.  Details of the restatement are set out in note 4.

The nature of the adjusted items is as follows:

• Share based payments – the charge recorded in accordance with IFRS 2 ‘share based payment’ of which £1.0m (H1 2017: £2.3m, FY17 £5.0m) has been classified within cost of sales in gross profit and £0.5m (H1 2017: £1.1m, FY17 £2.5m) in selling, general and administrative expenses within 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 £0.3m (H1 2017: £0.7m, FY17 £1.4m) has been classified as selling general and administrative expenses within operating profit.
• Non-cash rent charge – The charge associated with rent free periods on leased property (New foundry in Newport) classified as selling, general and administrative expenses within operating profit in the prior period (H1 2017: £nil, FY17: £0.4m) has been included as part of the on-going commissioning cost of the foundry in H1 2018.

• Insurance income – This relates to the accrued insurance income receivable following the death of the Chief Financial Officer, Phillip Rasmussen, in April 2018.  Costs of £0.4m (H1 2017 and FY17: £nil) have been netted off the gross receivable of £2.1m (H1 2017 and FY17: £nil) which has been classified as other income within operating profit.

• Exceptional legal costs – This relates to the accrued legal fees incurred in respect of a patent dispute defence. Costs of £0.9m (H1 2017 and FY17: £nil) have been classified within selling, general and administrative expenses within operating profit.

• Discounting – This relates to the unwinding of the discounting on long term financial assets of £0.1m (H1 2017: £0.1m, FY17: £0.2m) and the unwinding of discounting on long term financial liabilities of £0.1m (H1 2017: £nil, FY17 £0.2m) and has been classified as finance costs within profit before tax.

• Change in US tax rate – This refers to a deferred tax charge of £7.0m in FY17 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.

The cash flow impact of adjustments in the first half of 2018 relates to the onerous lease rental payments which are offset by the unwinding of the onerous lease provision.

Certain items noted above are accounting estimates based on judgements, accordingly, the actual amounts may differ from these estimates.

Earnings before interest, tax, depreciation and amortisation (EBITDA) have been calculated as follows:

*Exceptional items impacting EBITDA include the following items: share based payments, profit and loss on disposal of fixed assets, non-cash lease charges, insurance income and one-off legal fees.

1. TAXATION

The tax charge assessed for the year is different to that resulting from applying the standard rate of corporation tax in the UK of 19.00% (2017: 19.25%).  The differences are explained below:

1. EARNINGS PER SHARE

1. EARNINGS PER SHARE (CONTINUED)

Basic earnings per share is calculated by dividing the profit attributable to ordinary shareholders by the weighted average number of ordinary shares during the period.

Diluted earnings per share is calculated by dividing the profit attributable to ordinary shareholders by the weighted average number of shares and ‘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 period. 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.

1. CASH GENERATED FROM OPERATIONS

1. ANALYSIS OF NET FUNDS / (DEBT)

Cash and cash equivalents include £3.8m held in escrow following the Group’s decision, announced on 16 March 2018, to exercise its exclusive option to acquire the cREO ™ technology and IP portfolio from Translucent Inc.  The Group has until 12 October to settle the outstanding purchase consideration either in cash or equity to the value of £3.8m.

1. PROVISIONS FOR OTHER LIABILITIES AND CHARGES

As part of the re-organisation and rationalisation of the Group’s facilities the Group ceased its manufacturing activities in Singapore and established the Compound Semiconductor Development Centre. The provision above represents the onerous lease obligation in respect of the Singapore property. This is expected to be utilised over the next two years. The provision has been discounted using a risk free rate of 2.5%.

1. SHARE CAPITAL

In the period to the 30 June 2018 4,749,808 (H1 2017: 7,516,861, FY17:12,602,907) ordinary shares were issued to satisfy employee share schemes.

1. RELATED PARTY TRANSACTIONS

The Group recognised revenue of £nil (H1 2017: £1.0m, FY17: £1.9m) and made purchases of £1.8m (H1 2017: £6.4m, FY17: £10.4m) from its joint venture in Singapore, the Compound Semiconductor Development Centre Private Limited.

The Group also made purchases of £3.8m (H1 2017: £3.3m, FY17: £6.1m) and recharged other costs of £1.6m (H1 2017: £1.4m, FY17: £4.5m) with its joint venture in the UK the Compound Semiconductor Centre Limited.