IQE came out swinging on Monday, after its credibility was sent through the floor – along with its share price – by a scathing attack from a short-selling outfit on Friday.
The report, released by ShadowFall Capital & Research on Friday, alleged that the booming British chipmaker was reliant on two joint ventures for the bulk of its profits – one based in IQE's hometown of Cardiff, and one in Singapore.

ShadowFall – which is run by former research analyst Matt Earl – said that 42% of the company's 2015 profits and 30% of its 2016 profits came from the two ventures.

It also alleged that IQE's relationship with the ventures was a “somewhat circular state of affairs”, with the only customer appearing to be IQE itself.

IQE's shares rocketed in 2017, almost quintupling between January and November, on unconfirmed reports the company's products were inside the new Apple iPhone X.

They then began a slow slide amid rumours Apple was facing disappointing sales figures for the new-generation smartphone, before falling 3.3% in the wake of ShadowFall's attack on Friday.

The short seller pointed out that losses had been backing up at the ventrues, which could make for a convenient situation “where IQE books the profits and the joint ventures retain the losses”.

But on Monday, IQE said the allegations contained within the report were “without merit”, and provided a misleading analysis of the company's financial position.

It said the central thesis of the report was a “fundamental misrepresentation” of the profit and cash generation of IQE, especially with respect to its joint venture agreements.

“IQE would like to directly address the key themes in the report, correct any misinformation that might arise from the report's inaccuracies and assure shareholders that IQE holds itself to the highest standards of corporate governance, transparency and integrity.”

“It is also important to note that ShadowFall states that it holds a short position in IQE and so will duly profit from any near-term reduction in IQE's share price, caused by the allegations in the report.

“ShadowFall made no attempt to review its report with IQE prior to its publication.”

IQE said its joint ventures in Singapore and Cardiff formed an “important part” of its strategy, had independent third-party shareholders and were governed by standalone boards, separate management teams and joint venture agreements.

As a member of the joint ventures, IQE participated in those boards, but said it does not have control, with the joint ventures also independently audited.

“The creation of the joint venture in Cardiff was the first cornerstone entity in the development of a globally recognised UK compound semiconductor cluster (CS Connected), which is seeking to create and sustain over 2,000 high skilled, well paid manufacturing jobs for the local and UK economy.

“This is already making a significant impact in the local economy, including saving 500 jobs in Newport Wafer Fab, which had been scheduled for closure by its previous owner, the creation of a UK Government-funded Compound Semiconductor Applications Catapult, and a number of major technology development programmes between Cardiff University, the joint venture, IQE and a number of major OEMs in South Wales.”

IQE explained that its trade with the joint ventures was “clearly reported” in the notes to its annual reports and financial statements.

The nature of the trade was IQE subcontracting certain external customer contracts through the joint ventures.

“By acting as an anchor customer, IQE is providing the joint ventures with initial business to limit their start up losses in their early years of operation.

“By agreement with its joint venture partners, these transactions are undertaken at cost, and hence this does not impact IQE's cost of production or increase its profits,” the company said.

“The joint ventures have subsequently been successful with new business wins, some of which have been contracted directly with new customers in 2017 with no direct involvement of IQE.”

License income from joint ventures had been reported in detail by the company in regulatory announcements and in its annual reports and financial statements, it claimed.

In those reports, IQE said it had made it “clear” that license income from joint ventures was front-loaded, reflecting the creation of their initial capability to serve commercial contracts.

As noted in its most recent trading update, IQE's license income from joint ventures would be less than £2m in 2017.

“The only profits that IQE has earned from the joint ventures is a book profit on the initial contribution on fixed assets in the setup of the Cardiff joint venture, and through the licensing of its intellectual property to both joint ventures.

“In the case of the Cardiff joint venture (CSC), the consideration for intellectual property licensing has been a combination of cash and receivable long-term loans.”

IQE said that both sources of consideration had been “clearly stated” in IQE's annual reports and financial statements.

“The revenue that the joint venture generates from IQE meets the cash cost of the joint venture's operation, at no financial gain or loss to IQE.

“The EBITDA loss of the joint venture in 2016 was £0.7m, representing the cost of its own management, business development, and administration.

“The joint venture also has non-cash charges for amortisation of its intellectual property license and a depreciation of assets which gives a net loss of £4.4m.”

IQE's board said that was detailed in its annual reports, adding that the ShadowFall report implied that the company had used the joint venture to 'hide' costs of IQE's own business, “which is inaccurate”.

In the case of the Singapore joint venture (CSDC), to support that business through its start up years, IQE said it licensed intellectual property and leased surplus molecular beam epitaxy (MBE) capacity to the joint venture on a contingent basis.

It said those charges only become payable by the joint venture to IQE to the extent that the joint venture generates surplus cash in each year.

“As required by International Financial Reporting Standards, the joint venture fully reflects these costs in its own accounts, whereas IQE only accounts for this as income when it has been received in cash.

“Excluding these contingent charges, the Singapore joint venture generated cash of approximately £2m from its operations in 2016, and hence paid approximately £2m of license income to IQE in that year.”

In order to reduce overall set up costs, IQE said it also contributed certain fixed assets to the Cardiff joint venture in return for its equity stake.

That was undertaken at market value, as determined by an independent professional valuer mutually agreed by the joint venture partners.

Cardiff University match-funded that value in cash, in return for its equity stake in the joint venture.

Similarly, the board said the valuation of the intellectual property was validated by an independent accounting firm in a report to the joint venture board.

“The difference between IQE's EBITDA and its free cash generation can be readily identified from IQE's annual reports and financial statements, namely investment in R&D and capital expenditure, and an acquisition in 2012 which was paid for through an earnout,” the board explained when it came to its books.

In 2012, IQE acquired the MBE epi-wafer manufacturing unit of RF Micro Devices, with the acquisition consideration being settled through a trade discount on sales by IQE to RFMD for a fixed period of four years.

In accordance with IFRS, that discount was classified as part of working capital.

IQE said that was described in its annual reports and financial statements, and detailed in the notes to the cash flow statement.

“Had the company financed this acquisition through debt or equity finance, the payment to acquire this business would have been excluded from the calculation of the free cash generation.

“As previously reported, this discount period ended in 2016.

“IQE now fully owns the acquired facility in North Carolina – original cost $110m – and RFMD, now Qorvo, remains a key customer for IQE.”

Looking ahead, as stated in its pre-close statement on 20 December, IQE expected full year revenue to be ahead of market expectations, and to be not less than £150m for the year to 31 December.

“Wafer sales are on track to deliver strong double-digit growth in 2017 and to continue to diversify, while annual growth in Photonics is also expected to achieve triple-digit growth,” the board explained.

“The company remains confident in its outlook for 2018 and beyond.”

IQE said it was scheduled to report its full year results for 2017 on 20 March, and would provide forward-looking guidance at that time.


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