9. INDUSTRY, INNOVATION, AND INFRASTRUCTURE

Edited Transcript of VCT.L earnings conference call or presentation 11-May-20 8:30am GMT – Yahoo Finance

Impact team
Written by Impact team

Edited Transcript of VCT.L earnings conference call or presentation 11-May-20 8:30am GMT  Yahoo Finance

Half Year 2020 Victrex PLC Earnings Call

Thornton Cleveleys May 12, 2020 (Thomson StreetEvents) — Edited Transcript of Victrex PLC earnings conference call or presentation Monday, May 11, 2020 at 8:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Jakob O. Sigurdsson

Victrex plc – CEO & Executive Director

* Martin L. Court

Victrex plc – Chief Commercial Officer of Industrial & Medical Divisions and Executive Director

* Richard J. Armitage

Victrex plc – CFO, Group Finance Director & Director

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Conference Call Participants

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* Adam Robert Collins

Liberum Capital Limited, Research Division – Analyst

* Andrew Gregory Stott

UBS Investment Bank, Research Division – MD and Research Analyst

* Charles L. Webb

Morgan Stanley, Research Division – Equity Analyst

* Chetan Udeshi

JP Morgan Chase & Co, Research Division – Research Analyst

* Dominic Convey

Peel Hunt LLP, Research Division – Analyst

* James Alexander Stewart

Barclays Bank PLC, Research Division – Chemicals Analyst

* Jaroslaw Marek Pominkiewicz

Jefferies LLC, Research Division – Equity Analyst

* Kevin Christopher Fogarty

Numis Securities Limited, Research Division – Analyst

* Sebastian Christian Bray

Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst

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Presentation

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Operator [1]

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Hello to all, and welcome to the Victrex interim results announcement for May 2020. (Operator Instructions) Just to remind you, this conference call is being recorded.

Today, I’m pleased to present Jakob Sigurdsson, the CEO; Martin Court, the CCO; and Richard Armitage, CFO. Please go ahead with your meeting, sir.

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Jakob O. Sigurdsson, Victrex plc – CEO & Executive Director [2]

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So good morning, everyone. Welcome to Victrex’ interim results presentation. It is our first virtual meeting. But hopefully, it will be almost as good as being in person. I’m joined today by the full executive team. Richard and Martin will be involved at the end of the presentation for Q&A as well as Andrew Hanson, our IR Director.

Now if we move up to Slide 3 in the presentation pack. The key message today is that we did see solid growth in the first half of the year. But we are now seeing emerging COVID-19-related headwinds for the second half. While the outlook is uncertain, we are unable to provide detailed guidance today, but we will provide indication of the market trends that we are seeing. And I would like to add that we firmly believe in our investment case and long-term opportunities and consider ourselves in an extremely strong position to weather the current storm.

If we now flip to Slide 4 and talk specifically about COVID-19. Part of the period that we are reporting on now was dominated and continues to be dominated by COVID-19, so I want to summarize our actions here first. As always, the safety and well-being of our people remains the highest priority. Right now, over 80% of our global employees are working from home, even after returning to work in China and Korea, with those offices now being open again. In these regions, we’ve also restarted customer meetings, but are adhering to appropriate guidelines, as you would expect.

In Germany and the U.S., our offices are in the phase of restarting, but we will navigate those returns very cautiously. As it relates to our U.K.-based operations, we have had no impact on our polymer production in the country. We have reduced operating levels to be more in tune with anticipated demand, while supplementing supply of our stock this year. And then clearly, our key priority has to be and has been to make sure that we don’t let our customers down, and I’m pleased to say that we’ve had delivery statistics that’s close to between 95% and 100% during and throughout the period.

Also pleased to mention a range of things that Victrex has done to support. We’ve taken care of several thousand PPE donations globally. Employees have been volunteering to help in a number of different situations. And we’ve even gone so far as using 3D-printed masks and distributed them as well. We have been a supplier of a number of different [curriculum] for different life-sustaining applications, ventilators being one of them. And clearly, with the chemicals classified as both an essential and critical industry in the U.K. and life-sustaining in the U.S., all of our plants have been operating throughout the period.

Richard will come back and talk about the financial position in summary. But I think in summary, I would say that we have taken a number of cost-reduction and cash-conservation measures to help us manage the challenge of COVID-19. We have deferred our U.K. debottlenecking project and also deferred our interim dividend. We believe that’s a prudent way to our approach the situation. We also removed all accruals for bonus for the year. We have appropriate debt facilities that we are ready to draw on if need be, although we don’t necessarily see that being necessary in the near future. To also point out that we significantly reduced both CapEx and OpEx throughout the period.

If we now move to Slide 5 for the highlights. Overall, as I said, a solid growth, mainly driven by our performance in Auto and Medical, the stable performance in the period or during the period in aero and Electronics. Good volume growth of 5% in the first half and 4% in the second quarter despite tougher comparatives. Profit before tax was stable despite the top line growth, largely as a result of under-recovered overhead from lower production, higher costs associated with special-grade campaigns and some production for a parts program ahead of revenue.

We do feel pleased to see the strength of the mega-programme pipeline remaining strong. Progress in aero brackets, next generation of Spine and Magma. Whilst we raised our capital and OpEx spend, we will tailor investments to long-term opportunities. Our Chinese joint venture is moving ahead according to plan, and we’re expecting around GBP 7 million of capital cost there for the year.

I think it’s quite important to emphasize the strength of our balance sheet in these tough times. It is strong and healthy with a healthy net cash position and appropriate facilities to draw on, whether we see a need to do so. So our inventory position has also helped us to navigate the situation. It was driven by Brexit needs in the beginning, and then we anticipated to leverage that for the debottlenecking of [PP1] that was about to start right now. But clearly, we’ve been able to leverage that to make sure that we can service our customers at the level that they are used to.

I’ll now hand it over to Richard for more details on the numbers.

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Richard J. Armitage, Victrex plc – CFO, Group Finance Director & Director [3]

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Thank you, Jakob. Good morning, everybody. So moving on to Chart 6. Here, you’ve got the headlines for the first half. We are very pleased to report a solid trading performance with sales volumes up 5% to 1,992 tonnes. The principal driver was Automotive, which showed a good recovery from the weak performance in the prior year, along with the associated impact on our Value Added Resellers, which grew by 8%. Aerospace & Electronics was stable, but we do see a decline of 11% in Energy, reflecting the emerging weakness in this sector.

Revenue grew by 4% to GBP 151.5 million or by 3% on a constant currency basis. This included growth in Medical revenue of 6%, reflecting double-digit growth in Asia and good progress in CMF, which also saw double-digit growth. Gross profit declined by 1% to GBP 86.8 million or by 6% on a constant currency basis, reflecting a decline in gross margin of 270 basis points to 57.3%. This was primarily driven by lower production volumes, which I will explain in more detail shortly.

Overheads reduced by nearly GBP 1 million due to currency, with underlying overheads flat year-on-year. We continue to treat acquisition-related expenditure as exceptional, with GBP 2.2 million (sic) [GBP 2.1 million] incurred in relation to our Chinese joint venture. Our underlying profit before tax was stable compared to last year and in line with our expectations. Our effective tax rate of 17.6% was higher than our expected long-run average of 12% to 13% due to the delay in the reduction of the U.K. corporation tax rate announced by the government in March which has impacted on our deferred tax balances.

As we come into the second half, we’ve had another solid month in April but have seen some weakness emerge in our forward-order book during May. As previously communicated in our preclose update, we are unable to provide detailed guidance on full year expectations given the significant macro and end-market uncertainty. Given this uncertain outlook, the Board has decided to defer the interim dividend at this point in consideration for all of our stakeholders. The timing of any payments will depend on an assessment of macro and end-market conditions over the coming months.

Moving on to Chart 7, which shows the progression from [this year to last year]. We can see firstly that the underlying year-on-year movement in profit before tax. In more detail, we can see the benefit of higher volumes, together with a currency benefit of GBP 5 million as expected, but these are offset primarily by the impact of higher cost of sales.

We had planned during this period to focus production on building stocks of a number of short-run special-grade products in anticipation of the start of our debottlenecking program in the second half. This had the effect of reducing polymer production volumes, which were approximately 20% down year-on-year and also roughly 15% below the associated sales volume. This led to a significant overhead under-recovery, which is the principal driver of the increased cost of sales. Cost of sales also includes manufacturing costs associated with the buildup of production capacity for our parts businesses as well as an element of inflation.

Whilst we have chosen to delay the debottlenecking into financial year ’21, it is worth pointing out that this stock-up building program has given us substantial flexibility with which to manage through any impact of coronavirus. We have also seen a modest increase in our overhead investment behind growth programs. This also reflects an increase in costs in support of anticipated growth in our parts businesses. It is also worth noting that we have taken a deliberate decision to keep overheads flat coming into the year as a precaution against weak trading. This has put us in a good position to manage costs carefully as we prepare to manage the impact of coronavirus, with all discretionary costs currently constrained to those critical to directly supporting customer activity. We have already removed in excess of GBP 4 million from our budgeted overheads for the year, and we would expect to continue this approach for the foreseeable future.

So moving on to Chart 8 to look at price and margin in a little more detail. We can see that our average selling price was GBP 76 a kilo, some 1% lower than the same period last year and 5% below the second half of financial year ’19. This movement was due to mix, with growth in Industrial principally driven by the Value Added Resellers and Automotive, with Value Added Resellers at slightly lower than temporary selling prices. Our underlying pricing by segment was stable. I’ve noted already the decline in gross margin from 60% to 57.3%. The slight weakening in mix did account for around 1 percentage point of that decline, but as noted, the principal driver of the decline was the overhead under-recovery.

Although we are unable to provide guidance for full year expectations, we should note that our lower production rates during the lockdown period will have some degree of negative impact on (inaudible). As we enter financial year ’21, we would expect for our peak period of our production hasn’t changed (inaudible). We will provide more detail on this program and its associated accounting treatment later in the year. We continue to [deliver] our long-term growth opportunities (inaudible) but the timing (inaudible) on a normalized production run rate as is (inaudible) [duration of the coronavirus and act]. And we will review any necessary and further spend to manage our cost base as required.

Moving on to Chart 9. We’re again showing the [opportunities] of currency and [price throughout the year] (inaudible) IFRS 9. As before, we have (inaudible) expected. Our currency benefit year-on-year was in line with our expectations of GBP 5 million [in revenues] primarily driven by an effective U.S.-dollar exchange rate of $1.24 compared with $1.31 in the prior year. This was driven by (inaudible)…

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Operator [4]

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My apologies for interrupting, this is the operator. We seem to have lost audible sound quality from the speaker line. I will therefore pause the call for one moment while we reestablish the connection to improve the quality. We thank you all for your patience.

(technical difficulty)

Hello, and thank you, everyone, for your patience. We will now resume your call, and I’ll hand back to Richard. Thank you very much.

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Richard J. Armitage, Victrex plc – CFO, Group Finance Director & Director [5]

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Thank you for bearing with us, everybody. Apologies for the technical challenges. So I’m starting again on Chart 9, which is currency, showing the effect of currency according to IFRS 9. As before, the individual line items are recorded as a weighted average spot rate, and the gain or loss on forward contracts is shown as a separate line item within gross profit. Our currency benefit year-on-year was in line with our expectations of GBP 5 million primarily driven by an effective U.S.-dollar exchange rate of $1.24 compared with $1.31 in the prior year driven by forward contracts taken out through mid-2019.

Our expectation for financial year ’20 is for a total benefit of GBP 6 million to GBP 7 million, albeit that this is based on expected trading before any coronavirus impact. Based on current exchange rates, we would expect currency to be broadly neutral in financial year ’21. We did review our hedging policy during the half and concluded that any change in policy would not be in the interest of our investors, particularly during these uncertain times. We will continue to keep the efficacy of the policy under review.

If I can move on to Chart 10 on inventories. We’ve clearly seen an increase of nearly GBP 10 million compared with half 1 of 2019. This increase was almost entirely driven by an increase in raw materials and work in progress. This was partly to correct the shortfall versus safety stocks that we reported last year and partly in anticipation of the debottlenecking program. This included a substantial increase in the inventory of special grades with significantly higher unit values. Finished goods volumes remained flat year-on-year but had reduced by around 500 tonnes from September 2019. We had previously invested around GBP 20 million in finished goods inventory to provide a contingency against any Brexit-related disruption, and then concluded that we would keep it at that level until the end of the Brexit transition period. We, therefore, still have in excess of 12-odd weeks’ inventory outside the U.K. and our regional warehouses continue to function well.

It is worth noting again that this high level of inventory is serving us well as we prepare for possible coronavirus disruption. We have been able to maintain strong customer service levels despite having reduced manning at our key manufacturing sites to a minimum to minimize risk for our employees and expect to be able to continue to do that. We do acknowledge that we should not keep this level of inventory indefinitely, and we would expect to see some reduction during financial year ’21, assuming some degree of stability returns following any coronavirus impact.

I’ll also touch on debottlenecking on Chart 11. Capital investment. We are pleased to report that our China joint venture is progressing to plan. As a reminder, we are investing GBP 32 million in a new PEEK facility over 3 years in order to support our customers and our growth opportunities in the region. We are currently at the stage of having secured most of the necessary permits as well as having acquired the land, and we would expect to start construction around the middle of this year.

We have chosen to delay our debottlenecking plan to financial year ’21. In the first instance, this was due to challenges in relation to being able to fully carry out engineering activities during the lockdown as well as regarding availability of key equipment. However, the delay also contributes to our cash conservation measures, whilst we assess the impact of coronavirus on our trading. In this vein, we have also stopped expenditure on other new capital projects for the time being. As a result, we expect capital expenditure this year to fall to around GBP 20 million to GBP 25 million, which includes GBP 7 million for the China joint venture.

We do currently plan to continue with the debottlenecking project during financial year ’21 and would expect capital capacity and operational costs to be roughly as previously announced. This is likely to result in a higher level of CapEx than normal in financial year ’21 before returning to more normal levels by financial year ’22, as we would expect our capacity to put us in a good position to support our growth programs for a number of years thereafter.

Finally, on cash, Chart 11 (sic) [Chart 12]. We’re pleased to report a good cash performance in the first half with a recovery in cash conversion. Capital expenditure was in line with our expectations, and we made a further GBP 7.8 million in stage payments in relation to our investments in parts businesses. Following payment of an interim dividend of GBP 39.9 million, our cash outflow for the period was GBP 19.3 million. Our net cash at the end of the period was GBP 53.2 million. It should be noted that this includes GBP 9.5 million ring-fenced in our China JV, which leaves GBP 43 million available to the wider group.

Turning to our coronavirus contingency measures. We are planning and preparing for a number of scenarios in terms of the impacts on our customers’ demand and the timing and shape of the recovery in our end markets. This has included consideration of a sharp impact during our second half, followed by a recovery early in financial year ’21 as well as a more severe scenario that assumes continued impact into financial year ’21 before a gradual recovery through the year. We go into this period with an undrawn and committed revolving credit facility of GBP 20 million as well as an uncommitted accordion also of GBP 20 million. We may also consider establishing access to further facilities for which we believe we have a number of options. We, therefore, believe that we have sufficient capital, borrowing facilities and flexibility to be able to manage through these scenarios while continuing to invest for longer-term growth.

Thank you very much. And I will now hand back to Jakob.

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Jakob O. Sigurdsson, Victrex plc – CEO & Executive Director [6]

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So thank you, Richard. If we now touch on the key markets and the performance for the half year and move on to Slide 14. On the Automotive side, again, a slightly favorable comparative. We did see a 16% volume growth in the half through the benefit of new applications. And we also benefited from the PFOA ban in parts of Asia. That meant that we did see some business brought forward, particularly in Japan.

In Gears, we qualified our new program to commence testing with a Tier 1 supplier. So all in all, we now have 15 gear ongoing with SOPs in 2021 and 2022. Gears, remember, will also have a play in the electric vehicle world. It’s not just across the internal combustion engine. So we’re optimistic here about the midterm prospects. In electric vehicles, we have actually started a number of trials during the period, sort of underpinning our entry and hopes for opportunities in this ever-emerging segment. Main applications areas include wire coatings and remember that these are for the next generation of large-scale battery and electric-vehicle programs where higher voltage and faster charging rates are — become of importance.

If I move now on to Aerospace. There, we’ve really seen a tale of 2 quarters. A good start of the year in the first quarter, but then we saw the impact of the 737 MAX grounding from Q2 and onwards. Remember that we have around 100 kgs on each 737 MAX currently. Overall, we did see a stable performance over the period and further progress in our composites programs. So despite the near-term challenges, we are positive our long-term qualification-based development activities associated with loaded brackets and structural aerospace composites will continue. Remember that manufacturing of thermoplastic composite means less scrap, up to 30% improvement in manufacturing time and brings with it a possibility to recycle as well.

We’ll touch on this in the next slide about eVTOLs, electrical vehicle take-off and landing platforms, is an area we’re pursuing. And several key players have secured significant additional funding recently. And additionally, all major work streams for the Airbus program continue to make steady progress. Airbus have also sort of requested Victrex to supply (inaudible) to a Tier 1 supplier for a demonstrator part, which is very encouraging. So whilst we do see headwinds here in the short term, probably remaining with us for a couple of years at least, the long-term prospects are looking quite bright and might help us actually fill some of the gaps that we otherwise might have experienced.

On Energy, that market has been a tough one for us for the year. Oil & Gas and Energy is down around 11% in the first half. Anybody that has followed that market obviously understands the reason why, with the significant drop in oil prices in 2020, and rig count as well has gone down 50% since February, according to the reviews. We continue to explore all opportunities outside of oil and gas, for example, some (inaudible) primarily even focusing on wear components.

And on Magma, the TechnipFMC qualification program continues to progress. And Magma have been manufacturing parts for the purpose of qualification for the project down in Brazil. Our part in that has been to help the execution of the 6-inch qualification pipe and obviously making the UD tape that we then laser weld it onto pipe. We’ll come on to that in 2 slides’ time.

The Industrial part of this segment was actually in growth mode through the period, so Manufacturing & Engineering, which basically tracks our sales into food applications and other smaller industrial applications, but is reported under Energy, so 4% growth during the first half of the year.

Moving to Electronics. Stable performance in the first half year. Volumes slightly down. Semicon was a bit weaker than expected, but was offset by a good performance in Small Space Acoustics films, where we actually launched a new grade of film this year called DBX. This has been getting great feedback and enhances the quality and the acoustics of micro speakers, in particular. Quite a number of IP that goes into the manufacturing of these films. So this has been quite a beneficial boost for us during an otherwise challenging period in Electronics.

Finally, in Industrial, speaking about Value Added Resellers, a good first half with volumes up 5%, reflecting that Automotive is one of the largest markets supplied by the Value Added Resellers. So we see an improvement here. The supply chain was relatively dry going into the first half of the year, but we’re also seeing some customers wanting to ensure that they are stocked for the restart of the economies.

So if we now move to Slide 15. Ever so briefly on Aerospace loaded brackets. We continue to invest in downstream applications as a part of our mega-programmes, and to create markets for PAEK and to create the pool and catalyst for the adoption of PAEK in critical applications. Our TxV aero composite facility in Rhode Island has been operational for around a year now, a bespoke manufacturing with a lot of intellectual property as well being generated. We started producing composites part for qualification. We then got some commercial orders. These include seat pans for 2 major global airlines, seat pan using key composites of a greater durability and faster manufacturing times. We did acquire the remaining equity in TxV earlier this year, and that amounted to an investment of around GBP 3 million.

Despite some of the caution on midterm prospects for Aerospace, now post-COVID-19, one of the new areas we’re looking at is eVTOL or electrical vertical take-off and landing platforms. Very interesting opportunities for us in there, both for cargo and passengers. And we’re working with a number of key players in the industry. And it’s pleasant and pleasing to see that many of those players have been securing new rounds of funding in recent quarters. Boeing has talked quite a bit about this market and estimated its worth to be around $21 billion in 2035 through intercity transport drones and cargo carriers. And it’s clear that composites will have a key role here due to light-weighting and the ease of manufacture.

I will then move on to Magma, which is on Slide 16. A brief recap on the proposition we’re working on here, with both Magma and TechnipFMC. Really sort of 2 sets of opportunity based around hybrid flexible pipe and then the composite riser. Both opportunities are based on Magma m-pipe, where Victrex extrudes the PEEK pipe, makes the composite tape, then Magma then manufactures the final m-pipe. The hybrid-pipe solution is designed to reduce the heavy steel layer used in using a composite pipe with a high corrosion resistance with less permeability and obviously less weight. So whilst the m-pipe alone is around 90% lighter than steel in water, the hybrid pipe, including some steel armor, weighs around 60%, which obviously has a lot of statements and benefits associated with it.

If we move on to Slide 17, it’s further discusses Magma. So as always, Magma will communicate the latest update, but some good progress is being made on the qualification time. Initial testing completed and the qualification for Technip is also done. And some ways, testing is over a 1,000 bar pressure. And just to put it in perspective, that’s around 500x the pressure that is in a car tire. So very demanding situations that our materials are being placed under and passing so far. The next stage then, post qualifications, is industrialization of the hybrid pipe, adding the steel armoring with layers over the durable plastic composite pipe. And Petrobras, the field operator, is working towards late 2021 as a time line for full qualification and approval with a pilot pipeline operation, which opens up then the timing and the delivery for commercial quantities in late 2022 based on our current plans.

So moving on to Slide 18 and into Medical. We do see continued growth with revenues up 6% and 4% in constant terms. Growth is coming from non-Spine and HA Enhanced, which I will talk about separately. Non-Spine areas include Arthroscopy and Cranio Maxillo Facial applications, which is basically PEEK used in skull surgery. Another strong month with over 40% revenue growth in that specific segment. And this is now approaching a GBP 5 million business for us on an annual basis, which is clearly sizable. Spine itself was stable. We do continue to see some challenge from titanium, even though the PEEK market share seems to be stabilizing at around 63%.

Asia Medical growth remains very strong, up 10%, after an 80% revenue increase in FY ’19. Obviously, we’re mindful that the industry data suggests over 80% of elective surgery will be deferred in calendar quarter 2 for the year. And we are clearly assessing the impact of both the contraction and the length of that contraction in different areas of the world.

In Trauma, we continue to build relationship with OEMs and collaborations with those. Remember that Trauma plates are based on PEEK composites. And then the benefit of using PEEK is the improvement in union rates, which is 100% using PEEK and around 75% using titanium over a different period of time. We’re also actively exploring some collaborations in Asia specific to Trauma, and we’re looking to build on the good growth we’re seeing over there.

In Knee, a pause in the clinical trial due to the issues in Italy — due to COVID-19 issues in Italy has been undertaken. We probably would, by now, have the first patient with a PEEK-based knee if it hadn’t been for COVID- 19, but now we’re sort of more looking towards the fourth calendar quarter of the year to see that significant milestone. We are also exploring all the geographies for trials for Knee, which include all the European countries and/or countries in Asia with a possibility to fast-track the program.

If we now move on to Slide 19, which speaks to HA Enhanced. Really pleasing to see the further progress in HA Enhanced with revenues up 92% in the half. Strong clinical evidence obviously backing up our position here with 74% of patients fused within 6 months. For titanium, it’s less than 50% over the same period, as an example. Clearly, COVID-19 may impact company’s product launches that will impact FY ’20 revenues. But the U.S.- and Asia-based submissions already in for FY ’21, the opportunity to capitalize on any deferrals of procedures might be helpful, so HA Enhanced bone-on growth, but good progress also in Porous PEEK, which supports bone-in growth. And that’s where we’re seeing our investment in Bond 3D actually starting to deliver a very interesting set of prototypes that can enhance our position here. 3D-printed titanium growth continues here. So Porous PEEK gives us a good proposition, albeit 2 to 3 years away from commercialization.

Now if we move to Slide 20 in the pack and speak a little bit about non-Spine. We’ve seen further progress in CMF in Asia, although we might have been seeing some forward buying in March, in particular, adding to the growth in the first half. If you remember from our last presentation, CMF has shown good clinical outcomes using skull plates with PEEK, and 1 study showed a 25% improvement in brain function compared to the existing standard of care.

In ventilators, we already have some business here, but we have clearly capitalized on the need for ventilators in recent times, where many people and companies that are not in making ventilators in the past have changed their manufacturing setup to be able to meet demands for ventilators because of COVID-19. And finally, other areas of non-Spine would include heart pumps. And finally, as a material in total, artificial hearts.

Overall, I think we can gain a high single digit of millions of revenues from non-Spine this year in the medium-term — and in the medium term. And as I mentioned before, CMF is already delivering us in excess of around GBP 5 million per year.

Moving to Slide 21 now. On the bubble chart, movers, Aerospace loaded bracket. And we completed our TxV parts facility in the U.S., and it’s supplying parts on a commercial basis. As a consequence, meaningful revenue has moved to the left, so within the next 2 to 3 years. In Gears, we signaled in December the last program we said in the December has been rescoped, as we’ve talked about. But we are still working on a number of programs with the same OEMs and altogether have 15 programs on the books right now with SOPs in the years 2021 to 2023.

So good medium-term opportunity. Trauma also moved forward as we enter more collaborations. On aerospace structures, this principally represents the average deal for working on larger composite parts and wings and fuel-cell assets. And we actually would have similar opportunities with Boeing, too, but these are clearly much further out in time. However, we are now getting some prototype revenue coming through associated with restructural parts opportunities. And in fact, we have recently supplied a composite tape to a tier player for a demonstrator program as a part of the Airbus projects. Already mentioned Knee, clearly a huge opportunity for us, but has been pushed out because of the COVID-19 crisis.

Slide 22, both milestones for H1 and what we’re expecting as progress for the remainder of FY 2020. We won’t go into that in detail, but this is a useful reference for you as far as what we’ve achieved so far and what we expect to achieve for the remainder of the year.

Slide 23. On sustainability, ever so briefly. We have been working on enhancing the sustainability agenda. We already have a very good story. Our materials do support carbon dioxide reduction trends, particularly in Aerospace and Automotive. Our polymers also offer recyclability potential. And we have a good external recognition for agenda, including from being in the FTSE Russell Green Revenues Index as an example. So we are working on enhancing our sustainability goals and communications, and we’ll report to you in greater detail on that towards the end of the year. But we wanted to give you a little bit of a heads-up on that.

Now if we move on to Slide 24 and the outlook. Currently, we’re not providing guidance for the remainder of FY ’20 given the highly uncertain outlook. But I will summarize some of the trends in these markets.

On Electronics, the latest view from various surveys that are tracking the semicon industry suggests that some of the CapEx programs in semicons will go ahead post COVID-19. Gartner forecasts revenue in semicon to be down 1% in 2020, and that’s a change from the previous estimates where they were expecting 5% growth in the sector for the year. We do have some encouraging indications, though, from the memory-based revenues. But overall, as a consequence for the balance of things in the segment, we remain neutral in our position on the market.

On Medical, whilst we know that expectation of 80% decline in elective procedures in calendar quarter 2 of the year in both Europe and the U.S., China does offer some encouragement. Chinese surgeons expect procedures to gradually ramp up to 100% by September. And overall, procedures in China are expected to decline mid-teens compared to 2019 levels. We also note some of our materials going into life-sustaining devices, so decline might be modest. So we remain neutral on the outlook in Medical.

Yes, in Aerospace. Now looks like a very challenging segment on a 2-year view. Deliveries by volume in Aerospace are forecast to be down 20% this year, around 5% next year and become more stable in the year 2022. We also note comments around the fact that about half of the backlog could be canceled. This is according to CompositesWorld. But composites can help to improve throughput and production speeds and the long-term programs we are on continue to progress well. And we’ve also identified other opportunities, as I spoke about, related to eVTOLs.

On Automotive, IHS forecasts a decline now of 22% for car build this year or 18 million less cars produced. But the EV standards look set to stay, and that offers clearly an opportunity for us as well. And clearly, don’t forget the fact that we’re also getting share against metal in traditional applications.

On Energy, obviously quite a challenge here with rig count down 50% in the last 8 weeks and oil price down between 50% and 70% since the start of 2020. Magma can help to reduce installation costs and existing programs continue to plan at this stage, but there are reason to be cautious in our outlook as it relates to Energy.

Moving on to Slide 25, and so the overall summary. Again, a solid first half, but emerging headwinds in the second half from COVID-19. We have taken a range of actions so far, including deferring CapEx and deferring our interim dividend. It’s not that we’re not in a position to pay it, but we do think that it’s prudent given the uncertainty prevailing to defer that for a decision in months to come.

We do have a strong financial position and appropriate facilities to draw on if need be. And our medium-term opportunities remain strong. And overall, we won’t be providing guidance given the uncertain outlook. I should say, though, that we did see a solid April and a reasonable start of May. But we are expecting headwinds to start to have an impact on the order book going forward.

Our range of scenarios does reflect a contraction in auto and in aero in particular. But during our stress testing, we see that we’re well equipped to deal with that. We’ve also modeled in scenarios like Richard spoke about before, which would not see an improvement in the first half of 2021, but we will be able to withstand that without any major issues from a financial perspective.

We will come back to you in July for IMS, if not before, and update you on our latest set of information as it relates to the demand and the situation in our results.

Thank you. And for now, over to Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Alex Stewart at Barclays.

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James Alexander Stewart, Barclays Bank PLC, Research Division – Chemicals Analyst [2]

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Richard, your line broke up when you were talking about the gross margin expectations, with likely lower volumes in the second half. Could you just quickly go through that again and tell us what you expect for gross margin in the second half and then maybe into 2021? I think you made a comment on it, I just couldn’t hear it.

Secondly, you talked about the PFOA compounds prebuy in your fiscal Q1. Can you confirm whether — this is in auto. Can you confirm whether that continued into the second quarter as well? I think at the time, you indicated it would be isolated in fiscal Q1, but it sounds like maybe that was dragged into Q2. And then finally, if any way you could possibly quantify the impact that you’re seeing in the order book to give us some idea of how volumes or expected demand are likely to react would be extremely useful.

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Richard J. Armitage, Victrex plc – CFO, Group Finance Director & Director [3]

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Alex, yes, sorry about the breakup. So in the first half, our production volumes were about 20% down year-on-year. That accounted for most of the cost of sale increase through overhead under-recovery. Then we haven’t quantified what that would do in the second half. But clearly, we’re anticipating that if the coronavirus situation does impact on demand, we may need to keep production levels at a lower level, so there could be an impact on gross margin. But at the moment, can’t quantify how much.

I think secondly on PFOA, that was mainly in the first quarter, a small amount in the second quarter, but essentially that was a first quarter item. Then third point?

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Jakob O. Sigurdsson, Victrex plc – CEO & Executive Director [4]

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The third point, Alex, was?

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James Alexander Stewart, Barclays Bank PLC, Research Division – Chemicals Analyst [5]

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The third point whether you could give us some sort of quantification of how your order books have reacted or perhaps how much orders were down would be really useful.

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Jakob O. Sigurdsson, Victrex plc – CEO & Executive Director [6]

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Yes. I think May — April, actually, was quite robust for us and close to be in line with what we saw last year. May has started well also. But I would also say there that under all normal set of circumstances, we would be happy with the situation of the order book in May, have 6 billing days into it. However, I would, in no way, encourage anybody to extrapolate from those 2 data points in May given how uncertain and volatile the situation seems to be. So we’re expecting to have to navigate this quite cautiously from here onwards. But as it relates to April, robust; May, so far, 6 billing days in, roughly looking relatively good. But I wouldn’t necessarily extrapolate based on those 6 data points for May towards the end of the month.

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James Alexander Stewart, Barclays Bank PLC, Research Division – Chemicals Analyst [7]

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That’s really kind. Does that mean that you don’t yet have a sense of how the end of May deliveries or June deliveries will play out from what you can tell in the order book?

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Jakob O. Sigurdsson, Victrex plc – CEO & Executive Director [8]

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Yes. But basically, we’ve got a good set of statistics that tell us that depending on how full the order book is at the beginning of every month is a good predictor of how the month will end. Now that’s a prediction mechanism that would work well under any normal set of circumstances, but we’re far from being in any normal set of circumstances right now, and that’s why I wouldn’t be wanting to extrapolate from those kind of statistics right now.

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Operator [9]

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Our next question comes from the line of Charlie Webb of Morgan Stanley.

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Charles L. Webb, Morgan Stanley, Research Division – Equity Analyst [10]

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Just a couple for me. Firstly, just trying to understand the decision to defer the interim dividend. I understand you talk about a prudent approach. I’m just wondering why it didn’t make sense to release or try to release some of the working capital that you built up over the last couple of years. Clearly, inventories — inventory days are much higher than average, so why wouldn’t you unwind some of that more aggressively this year to support liquidity cash flow as opposed to, let’s say, cutting — or deferring, sorry, the interim dividend. So just trying to understand the decision process there.

And then secondly, just around mega-programmes and thinking about COVID-19. Does COVID-19 structurally change how you think about certain end markets and opportunities for some of these mega-programmes? In particular, thinking about Aerospace. I was interested to see your Aerospace kind of opportunity shift more near term on your bubble chart given the kind of challenges facing the aerospace industry and what we’re hearing out of Boeing, Airbus from their communication. So just understanding how these things are changing, how you view them given COVID-19. I guess, Magma, as well oil and gas, I guess another event where we’ve seen obviously a meaningful correction in CapEx and demand for oil, how that’s going to play out over the next 5 years. Has that changed and how do you think about it would be helpful.

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Jakob O. Sigurdsson, Victrex plc – CEO & Executive Director [11]

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Yes. So on the deferral of the dividend, it’s not because we can’t pay it right now. We could. But we do feel that given the uncertainty, we should navigate cautiously here, and there’s a matter of prudency in our mind to postpone it.

And as it relates to the question of whether we couldn’t cover it with dipping down into inventories, that would be a very fair assumption under all normal set of circumstances. But let’s not forget that we do play a critical role in many critical applications in our customer base. So we wanted to make sure that we will be able to supply them under a broad set of circumstances, and let’s not forget either that we might have an impending Brexit hitting us relatively soon or towards the end of the year. And it was for that purpose that the inventory was built, and there is still a need to have a mitigating set of actions to deal with any potential ramifications of that. So these positions of inventories were built out up in the regions, in Central Europe, in Asia and in the U.S., to help us navigate through uncertain times. And we’re choosing to leverage those now for COVID-19 contingencies, and we would expect to maintain similar amounts of inventories as well as should there, for instance, be a hard Brexit following the emergence from COVID. So I’m sure you can appreciate that in these uncertain times, it’s prudent to make sure that we navigate with enough coverage to make sure that we don’t leave our customers hanging dry.

With comments on the mega-programmes, I’ll hand it over to Martin. Clearly, it is impacting the way we think about our strategy. But I think I can say that when we go over the programs one by one, the strategic overlay associated or derived from implications of COVID-19 mostly reinforcing the strength of our value proposition for all of those. Martin, if you want to comment a bit further.

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Martin L. Court, Victrex plc – Chief Commercial Officer of Industrial & Medical Divisions and Executive Director [12]

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Yes. Thanks, Jakob. Yes. So Charlie, I think that it’s absolutely right, to think about how we see the mega-programmes impacted by COVID. The main thing for us is to look at what mega trends that the — each of those mega-programmes serve, and I think you called out a couple where there’s clearly a potential for some disruption there. But if we take Magma first, then Magna still, we believe and the rest of the supply chain believe, gives access to actually lower cost production through some of the benefits around the flexible pipe. But particularly, we’re seeing very strong ongoing commitment from the Brazilian field to get this product qualified because they see it as a key part of making them the most cost-effective source. Clearly, the demand picture there is a difficult one to call, and we’re seeing very depressed demand there. But actually, I think a lot of the shale guys will end up be — to be really struggling in this sort of environment. So it may be they’re actually the lowest-cost producers from deep sea will end up in a stronger position.

On Aerospace then, there’s lots to talk actually about redesigning of planes and having new structures, which I think plays really well into thermoplastics because the thermoplastics bring a set of benefits that the current materials don’t do, particularly around making more complicated parts to allow suite of assembly.

So in those 2 areas, I think there’s — there’ll be mixed impacts, but I think the projects still stay viable. All the medical ones are still in line with people needing particular help as they grow older and people are not accepting the limitations of age anymore, so I think we think those will stay in place. And then if we look at the final one around the Gears program. And actually, we’ve always said that electrification or traditional combustion engines still require PEEK Gears, and we’re working in all 3 spaces there, so in hybrid, in standard traditional combustion engine and in full electric. So I think we keep monitoring. There will be some adjustments here in terms of the priorities, which is why you’re talking about eVTOL as an early way of adopting some of these technologies as the airframe builders decide what happens next. But we’re confident that they still stay very relevant to the global position.

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Charles L. Webb, Morgan Stanley, Research Division – Equity Analyst [13]

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If I could just quickly follow up on the inventory. On a normalized basis, what do you believe your stock days should be for this business? Because if I look historically, it’s not quite doubled, but it’s not far off doubled into this period. And I understand the higher uncertainty. I’m just trying to understand what is required for a business like Victrex on a normal basis relative to today? And yes, just to get a better gauge on that.

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Richard J. Armitage, Victrex plc – CFO, Group Finance Director & Director [14]

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I think, Charlie, for now, one of the things we’ve done over the last couple of years is to improve our internal planning processes. So over time, we are expecting to run with considerably lower inventories, although we probably haven’t quantified exactly where those will get to. I think the first thing to think about is that we put in GBP 20 million of inventory triggered by the Brexit planning. And our first step, over time, is going to be to reduce that. Where we go beyond there, we’ll communicate in due course.

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Jakob O. Sigurdsson, Victrex plc – CEO & Executive Director [15]

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And also briefly, Charlie, on the dividend question as well, I think it’s also important to state that we will be looking at that over the next few months as well and revisiting the potential timing of us paying a dividend or the interim dividend. And as you can imagine, under circumstances like we’re currently in, any additional data points on demand in different sectors is obviously valuable, and then that is why we’re taking this cautionary measure. But with more data, we’ll be able to make more informed decisions. And then that will factor in to our decision on when and if to pay the interim dividend.

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Operator [16]

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Our next question comes from the line of Adam Colmins — sorry, Adam Collins of Liberum.

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Adam Robert Collins, Liberum Capital Limited, Research Division – Analyst [17]

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I had 3 questions, please. Firstly, on the solid April. To what extent was that because Solvay’s India capacity looks to have been down for pretty much all of the month during the Indian lockdown? And to what extent was that helped by ventilator sales? So some color on the significance of those 2 things. And to what extent is that an ongoing feature?

Second question is on your aftermarket exposure. It sounds like this aftermarket can be helpful, and that sells into replacement markets. I don’t think that’s a big constituent for you. But could you have a go at helping us understand how big aftermarket sales are in Transport and Energy?

And then just on sort of similar lines, just for scoping. You’ve got a sizable amount of sales, of course, coming from VARs. I understand the biggest segment there is Other Industrial. Could you help us understand what the main applications are in Other industrial for VARs? And then maybe just on a wider basis, could you help us understand the main end market exposures across VARs?

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Jakob O. Sigurdsson, Victrex plc – CEO & Executive Director [18]

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So I think if we start about — start talking about April. Adam, I could not comment on the situation with our competitor out of India. It’s certainly a possibility that we might have seen some impact from that. And it could be said that looking at the channels that materials are going into and what kinds of materials that will support that, but I really couldn’t comment on the amount that is associated or might be associated with that.

Ventilators, relatively sort of small, volume-wise, and measured in not 2-digit figures, but some and very positive impact in March predominantly and going into April as well but not a material impact in terms of volume.

Aftermarket replacement. If you think about it, what our products go into primarily in the auto side and on the energy side, as an example, is bushings and bearings and braking parts and the like. So there is quite a bit of aftermarket in that. In our business, for instance, on the Energy side and the correlation that it has with the rig count is largely based on money that is spent on maintenance and keeping rigs working. So there is a considerable aftermarket there above and beyond what we’ve seen in terms of new production, and this is actually worth keeping in mind when we’re looking at Automotive, in particular.

On VARs. Actually VARs do sell quite a bit into Automotive as well, so the same logic would apply there as it relates to aftermarket demand. But they’re also brought in all kinds of general applications, whether it’s PEEK parts that goes into machines in food manufacturing or conveyor belts, so what have you, but a substantial part of their business as well, which is a sundry of different kinds of industries that sometimes they themselves necessarily don’t have a good visibility through because, remember, they will sell their products in the forms of rods and sheets, if we’re talking about the stock shape manufacturers and then the compounders, which will be supplying compounds, so PEEK with other sort of performance-enhancing additives, if you wish, through a number of what is a very convoluted and fragmented chain of end processors that then supply to the tiers. So it’s difficult to stipulate specifically how that gets up. But if we said that it was primarily auto, general industry and somewhat energy actually, then I think that would capture the picture. And if you talk about the compounders, you’re going into some — actually consumer electronics as well, which is a sizable part of what the compounders are selling into.

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Adam Robert Collins, Liberum Capital Limited, Research Division – Analyst [19]

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Okay. Maybe just a couple of clarification points. So on VARs, aerospace is relatively small. Is that correct?

And then on ventilators, is that going into Other industrial or Electronics in terms of the volume shipped?

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Jakob O. Sigurdsson, Victrex plc – CEO & Executive Director [20]

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Ventilators is captured for us in Other Industrials, and Other Industrial included the Energy segment. So it’s a little bit of a tree there that you have to trace down, Adam, I’m afraid. But what we call Manufacturing & Engineering for general industry is reported under Energy. And as I mentioned in my presentation, that saw actually good growth over the period and particularly in the second quarter, and ventilators clearly had an impact.

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Operator [21]

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Our next question comes from the line of Sebastian Bray of Berenberg Bank.

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Sebastian Christian Bray, Joh. Berenberg, Gossler & Co. KG, Research Division – Analyst [22]

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I would have 2, please. The first is on the margin impact of the debottlenecking project in the U.K. How’s the guided profitability impact of high single-digit GBP million, in fact, shifted into 2021? Or was it already experienced in the current fiscal year?

The second question is a more conceptual one. The average selling price at Victrex has not shifted much since 2011, 2012 at about GBP 76 per kilogram. But the gross margin, even allowing for the temporary effects in the half year 2020, is down by about 7%. What are the drivers for this? And what does the group see as a long-term achievable gross margin?

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Richard J. Armitage, Victrex plc – CFO, Group Finance Director & Director [23]

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Sebastian, so I think the point on the margin impact of debottlenecking is this. So very, very roughly, we had anticipated a little bit less than half of the high single-digit impact to be in the first half of the year because it was because we were manufacturing the special grades and short-run campaigns which did reduce our production volume by about 20% year-on-year, and we have anticipated that this lower half in the second half of the year. So assuming that as we go ahead as planned in financial year ’21, we could anticipate some kind of impact also in financial year ’21, probably a little more than half of what we hadn’t anticipated in total. But I think we do have to be very aware that coronavirus will probably have some degree of effect. So to the extent that production is below what it would have been in the second half of this year, we would expect some kind of impact from that. It could well be that there is also some degree of hangover into financial year ’21. So sorry, I can’t be more precise. But hopefully, that gives you a feeling for the shape of how that was going to evolve.

I think, on average, selling price, broadly, the driver, I think, is one of mix. So over that period, we will have seen proportionately a bigger growth in Industrial. And that, I think, is probably the main driver as to what has reduced gross margin. Also, bear in mind that we have started investing in past businesses, which are starting to produce revenues relatively recently, so there is quite an investment there, probably a little bit of inflation as well over that period. So I think it’s probably those 3 drivers.

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Operator [24]

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Our next question comes from the line of Andrew Stott of UBS.

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Andrew Gregory Stott, UBS Investment Bank, Research Division – MD and Research Analyst [25]

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I had a couple of things I wanted to explore, please. First of all was Capex, both in the U.K. and China. Start with the U.K. Is there a discussion at the moment about scaling back the 1,000-tonne debottleneck? Or is that sort of hardwired in? If it is hardwired given all the uncertainty on demand, could you explain why it is 1,000 tonnes that it has to be? Second one, China. Have you seen any delays to your planning process for the investment in China?

And then probably a question for Martin. On the mega-programmes, I’m interested in an update on the PEEK Gears, in particular. So the re-scoping of the U.S. contract — sorry, the U.S. OEM you talked about. I just wondered if you could update us on that.

I’m sorry, I said 2 questions. I just wanted to steal a third, but it’s a follow-on from Charlie’s question earlier on the call. The point about inventory-to-sales is important to me because it’s hard to model, and I get the fact you’re investing ahead of this peculiar time with Brexit and of course now the situation of volumes falling. But is the message that you won’t go back to the early 20s on the inventory-to-sales ratio? I just want to be clear on that. So thinking about not next year, but the midterm, is it just impossible to get back to the early 20s? And if so, why?

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Richard J. Armitage, Victrex plc – CFO, Group Finance Director & Director [26]

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Andrew, let me deal, I think, with CapEx and inventory and then pass to Martin. Firstly, CapEx in the U.K., debottlenecking. At the moment, we do intend to carry that out starting in the first half of the next financial year. The 1,000 tonnes or thereabouts is probably still about right, and that’s really about effective use of capital, looking at the configuration of our polymer plants and thinking about how best to debottleneck it. That gets very cost-effective capacity. So yes, we have confidence in our long-term growth plans, and we would anticipate with progressing would roughly be the current plan.

I think China, there have been no delays to planning. It has gone remarkably well. We do intend to continue at the current pace. I think we’ll just hang out there a slight possibility of a very small amount of phasing because of the fact that, right now, we, at some point, need to get engineers into China, and we can’t. But nothing broadly will stop us carrying on, even if there’s a little bit of re-phasing of activity.

And finally, on inventory. I mean our intention here is to get inventory down over time to a level that we would be able to justify, assuming we’re following world-class standards of planning and manufacturing, and we haven’t quantified what that will be. So I think, as I said earlier, the best thing to anticipate is that, firstly, we take out the Brexit inventory, probably primarily over financial year ’21 and surely afterwards and then look for further opportunities to reduce inventory.

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Martin L. Court, Victrex plc – Chief Commercial Officer of Industrial & Medical Divisions and Executive Director [27]

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So, Andrew, on Gears, in general, I think that the automotive industry, as I guess we all know, finds itself in quite a difficult position to decide which platforms to develop, which ones to hold as they are and how to resolve challenges they have on existing platforms. In the program that we talked about with the re-scoping, it was in amongst the mix there of way to prioritize activity and way to think about different ways to solve a problem. They continue to see our solution as a very viable solution in that area and now just wrestling with the priorities about what to do next, really. We have quite a broad range because having 15 programs this early in this type of technology is quite unusual, but I think that signals how much the deployment is varied across all 3 types of major new platforms that are coming in.

And the OEM in question have a number of — as Jakob said, have a number of those other programs, clearly very convinced by the viability of the technology. It’s just about them wrestling with priorities about where to deploy their limited resources and how to make sure that they manage their innovation resources appropriately.

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Andrew Gregory Stott, UBS Investment Bank, Research Division – MD and Research Analyst [28]

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And can I just follow on? When you think about the 10 programs in Gears, are any of them linked to that one OEM? So is there a conditionality? Or are they totally separate?

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Martin L. Court, Victrex plc – Chief Commercial Officer of Industrial & Medical Divisions and Executive Director [29]

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So the programs are across a range of different OEMs. In terms of linking to that OEM, then I think there are a couple of other programs with that OEM. But the linkage is actually quite helpful because it means that they’ve derisked the technology. So clearly, it’s quite hard to have people wrestle with metal replacement in an engine. And you can understand that the first conversation you have with somebody around using PEEK in an engine, the engineers used to using metal find that hard. But we’ve got through that thinking process very successfully with the OEM in question, so linkage is quite helpful.

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Jakob O. Sigurdsson, Victrex plc – CEO & Executive Director [30]

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And maybe if I may weigh in on that just ever so briefly that, of the 15 programs that we have, there are several with this OEM that we were referring to specifically. But we do have programs with other OEMs in the U.S., with OEMs in Europe and with OEMs in each of China, Japan and Korea. So the 15 are actually spread across a number of different OEMS.

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Operator [31]

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Our next question comes from the line of Dominic Convey of Peel Hunt.

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Dominic Convey, Peel Hunt LLP, Research Division – Analyst [32]

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Just a few quick ones from me. Just around the group outlook slide, Slide 24. I guess really drilling into it, Auto has been remarkably robust to date given collapse in production through March and April. And Energy — elsewhere, there’s a sort of growing sense that, hopefully, with half the worst, then — and the sector is planning to resume production. So I just want to understand the context of your outlook there with regard to sort of cautious going through into the second half and how you might think about it in a sequential basis if production generally comes back through in the sort of Q3 calendar this year.

Secondly, on Medical. I got slightly lost around — between the 80% fall in elective surgery in Q2, which was presumably calendar Q2, and to where you then feel that there’ll be a neutral view on the remainder of this year.

And then finally, I don’t know whether it was the quality issue, as Richard was talking, but just a little bit of color around ASP. If we think about the outlook slide, as you give it on 24, what would your expectations be there for average selling price in H2 at the very least on a mix basis?

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Jakob O. Sigurdsson, Victrex plc – CEO & Executive Director [33]

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So if I take the first one on auto, Dom, and thanks for your questions. And then Martin, the Medical; and Richard, the ASP. So we’ll do a full team effort on your 3. I think we believe that we have not seen the full impact of the closures, for instance, in the European OEMs from sort of March onwards. And actually, Volkswagen just started production, again late April, are expecting to be at around 40% production rate around middle of May, as an example. So I think we will be seeing a slow ramp-up of production again. China, actually, I should mention, has sort of rebounded remarkably well so far. But I think there is one element, and that is your ability to produce. And then the second element that is a little bit difficult to assess these days is how is consumer confidence going to develop and evolve. And even if you can produce, how you’re going to be selling? And probably that is factored quite a bit into IHS’ forecast. And they are assuming that roughly 20% drop in production levels this year from around 88 million or whatever, down to close to 71 million and then sort of a slow recovery as you head into 2021. And that’s sort of very much sort of our assumptions as well or derived assumptions. Now factored into that is obviously the situation where we are actually substituting metal, so we should be growing at a bit faster rate than the market once it starts to recover. And clearly, the level of inventory in the supply chain that is serving the market will impact it as well. And the supply team was a bit dry towards the end of current year 2019. It is probably a bit healthier this time around, but I don’t think it has reached high levels by any stretch of the imagination. So when you factor into account all of these elements, we are expecting not maybe a V-shaped return, but a little bit more like a Nike sort of swoosh, if you wish. We’ve gone pretty far down, but then we’re sort of expecting to start growing again from the basis of 2020, which is going to be around 70 million cars. But we think we have yet to see a little bit of an impact from auto, at least in the next couple of quarters, and that’s why we’re cautious on the outlook there.

And clearly, I think we’re seeing, for a lack of a better word, right now, we’re seeing some interesting experiments taking place in the major industrialized countries like Germany these days and the U.S. And that is with the ease of social distancing measures, what is it going to mean for industrial output, number two; and what is it going to mean for the consumer psyche as well? So these 2 factors, I think, will be critical to watch in the next couple of months, at least, to see what it tells us about the recovery of end demand.

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Martin L. Court, Victrex plc – Chief Commercial Officer of Industrial & Medical Divisions and Executive Director [34]

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So on Medical, I think it’s a phasing issue. So we’ve already seen China pretty much through its stalling, and we’re seeing now people going back to do it, to take elective surgery. And actually, the indications are will be that towards the latter part of our year, we’re going to see additional volume there rather than reduced volume as the activity ramps up. And the U.S., it appears is going to start to return a bit quicker than maybe people thought. So I think people are going to start to be back and having elective procedures more quickly. So it’s — that whole thing about what our output — our outlook being neutral is looking at how we see the latter half of the year because of this phasing of recovery in Asia and being — the pretty strong recovery in Asia and then less reduction in Europe and the U.S. in the second half as people return to elective surgery.

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Richard J. Armitage, Victrex plc – CFO, Group Finance Director & Director [35]

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I think on average selling price, I mean, what we haven’t anticipated for the second half was a very

slight improvement on the first half being up to — 0 to about 1%. And a little bit reflecting what Martin said on Medical that, clearly, there will be some uncertainty out of that given the uncertainties in relation to COVID. But that’s certainly what our basic assumption was.

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Operator [36]

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Our next question comes from the line of Chetan Udeshi of JPMorgan.

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Chetan Udeshi, JP Morgan Chase & Co, Research Division – Research Analyst [37]

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Quick questions. Number one, can you just give us some sense of how your order book looks like, in general, not in terms of change, but how much of your orders are 2 weeks, 3 weeks? So just in terms of duration of the typical order book going into the next couple of months.

Second question is you talked about some scenario analysis, the stress testing, the numbers. I was wondering, what was the sort of worst-case assumptions that you took in terms of your scenario analysis? And can you give us a sense of what the output of that analysis was in terms of earnings or any some sort of metric that you might be able to share?

And last question is, in the current low oil price environment, we are actually seeing some of the pricing for some of the other polymers come down quite substantially. Is that a threat, you think, in terms of the PEEK growth into some of the end markets or more competition to PEEK from other polymers?

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Richard J. Armitage, Victrex plc – CFO, Group Finance Director & Director [38]

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Chetan, so let me start with the order book. I mean, in ordinary times, we have some degree of reliable visibility for 4 to 6 weeks. Normally, at this stage in the month, perhaps we would have some visibility of how June is looking. There is some of that still there, but I think we’re going to reemphasize the point that there are very unusual dynamics taking place in our end markets. So there is more uncertainty now than there would ordinarily be.

I mean on scenarios, and I will stress the point that we applied some scenarios for the purposes of stress testing. These are not forecasts and not what we think will happen, but we took a reasonably worst-case view as far as we could tell. And so we did 2 things. First of all, we thought about what, for instance, IHS is saying about automotive, which sort of points us to a 20% to 25% decline in light-vehicle sales globally this kind of year. And then we note, for instance, the automotive build rate — sorry, the aerospace build rates coming out of Boeing and Airbus, which point to — depending on where — how you measure it with something like a 25% to 30% decline this year with a slight further decline next year, and we took account of Energy. And then we sort of scaled that downside up. So actually, we applied downside volume cases in the range of 30% to 40% and actually nearer 40% than 30%. But then we did 2 things. We said what happens if that applies in this half, so the second half of our financial year, but then there is a recovery early in next year? And then in the second case, we said what happens actually if this kind of minus 30% to 40% range happens in 12 months, i.e. carried on through the first half of next year before seeing some gradual recovery in the second half of next year? And there were a whole bunch of [assumptions] from that, but I think the key takeaway was that, even in the worst case, we would see ourselves using our debt facility to a limited degree for a relatively short period of time, in other words, a number of months and not a lot longer. But of course, it’s based on a number of assumptions. But what that told us was that, given our current debt facilities, we do have the strength of the balance sheet to last through those reasonably pessimistic scenarios. We may also choose to take additional facilities, but that won’t necessarily be because we think we have to, but that will be more in the case that we have some concerns about the credit markets.

And then I think in terms of pricing, we have not seen any impact of coronavirus on that pricing or all those market dynamics. At the moment that’s our best view.

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Operator [39]

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Our next question comes from the line of Jarek Pominkiewicz of Jefferies.

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Jaroslaw Marek Pominkiewicz, Jefferies LLC, Research Division – Equity Analyst [40]

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I have 2, actually, for Richard. Number one would be lower oil prices and stable ASP. Will you see some benefit from lower raw material cost to gross OpEx from the second half of the year?

And question number two, a little bit, could you give me some clarity on the under absorbed overheads? I understand that the volumes produced were lower this year — in the first half of the year than volumes sold. But I supposed that in the run-up to the debottlenecking exercise, you’ll be producing more inventory. Will that have a mirror impact on gross margin? So potentially, gross margins could go up as a result of higher volumes produced? And two, when you actually come to the actual exercise, will you still — are you still planning to treat to circa GBP 9 million of under absorbed fixed costs as exceptional during that period?

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Richard J. Armitage, Victrex plc – CFO, Group Finance Director & Director [41]

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Thank you, Jarek. Those are good questions. I think on lower oil prices, always bear in mind that our raw material bill is a little over 10% of sales. So we are not as sensitive to commodity prices as most other chemical companies and certainly not to oil. So yes, there could be a little bit of a feedthrough, but we wouldn’t necessarily anticipate that it would be material to us.

I think on under absorbed overheads, I think the scenario you described, in one way, could be possible. But we really got to bear in mind that coronavirus could impact our production volumes over the next 6 months, so the period between now and when we would start the debottlenecking. So I would not be anticipating an increase in margin or a sort of back in the way that you described. On other occasions, it might well be the case, but I would not be assuming that on this occasion. I am going to reiterate that we have not given guidance over the next — the second half for that reason.

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Jaroslaw Marek Pominkiewicz, Jefferies LLC, Research Division – Equity Analyst [42]

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But if you wanted to isolate the — your kind of the impact of inventory product to the run-up of the debottlenecking. So I understand that your volumes could be dropped because of COVID, so that will have a negative impact. But there could be some positive impact from the inventory buildup, although that could — that might not completely offset or even not in a meaningful way offset the decline from lower volumes with the COVID.

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Richard J. Armitage, Victrex plc – CFO, Group Finance Director & Director [43]

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Again, theoretically, maybe, but we don’t want to get into predicting how these very uncertain dynamics will land. Bear in mind also that the outcome will vary depending on which sectors could be affected. That influences the grades we have to make, the order in which we have to make them. So trade, I just want to keep on stressing that there is uncertainty at the moment.

And I think treating as exceptional is a good question. We will certainly, when the time comes, bring out a full analysis of what the impact is. We do have to pause and think about the use of exceptional costs as a classification. I don’t think any of us on our Board are very keen on using them routinely. And we would acknowledge that if there is a dip in production in financial year ’21 and it follows a dip in production in financial year ’20 for different reasons perhaps, whether it is appropriate to call those exceptionals, I think might be questionable. Hence, my comment earlier on that we will review that and give more clarity around the accounting treatment around the end of the year.

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Operator [44]

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Our next question comes from the line of Kevin Fogarty of Numis Securities.

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Kevin Christopher Fogarty, Numis Securities Limited, Research Division – Analyst [45]

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A couple of clarification questions for Richard, please. Richard, obviously, your line deteriorated during your piece. I just wanted to clarify what it was you said on SG&A costs if we sort of ex out the sort of bonus accruals piece for this year. Just wanted to get a bit more of a handle on what you said there.

And just, I guess, given the drivers of the tax rate during H1, your full year assumptions in terms of effective tax rates, I guess have they changed at this point?

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Richard J. Armitage, Victrex plc – CFO, Group Finance Director & Director [46]

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Yes. Kevin, so on SG&A, the headline number is actually down by about GBP 1 million in the first half, but that is primarily driven by currency. So essentially, SG&A is flat. The point I additionally made was that we have taken action to constrain SG&A as one of our cash conservation measures, and that is basically involved us taking in excess of GBP 4 million as of our budgeted level of spend. That doesn’t represent a year-on-year saving as such, but it does mean we have cut back on a number of areas of expenditure as a precaution.

I think on tax, the first half line tax rate was impacted by deferred tax. So that was the delay in the implementation of the 17% U.K. corporation tax rate. That change was applied by the sort of management policies at the 31st of March that had the effect of putting up the headline rate of tax to 17.5%. Clearly, unless something else happens, that effect has now taken place. For the second half, we would expect to be down around the 13% kind of range. What that means for the full year will depend, clearly, on the phasing of profitability between the first and second half.

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Operator [47]

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And we have no further questions on the line, so I’ll hand back to our speakers for closing comments.

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Jakob O. Sigurdsson, Victrex plc – CEO & Executive Director [48]

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So thanks, everybody, again for joining us today. Again, solid performance in the first half, all the uncertainties that we’re well familiar with as it relates to the future outlook. But I want to leave you with the fact that we are in a strong position, a strong balance sheet, a number of interesting growth platforms as well, fundamental assumptions around, some of which might have actually strengthened during the COVID crisis.

So thanks again for joining us today, and we look forward to speaking to you again in July. Stay safe.

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Operator [49]

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This now concludes our call. Thank you for attending. Participants, you may disconnect your lines.

Source: finance.yahoo.com

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