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Edited Transcript of VCT.L earnings conference call or presentation 13-May-19 8:30am GMT

Half Year 2019 Victrex PLC Earnings Call

London May 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Victrex PLC earnings conference call or presentation Monday, May 13, 2019 at 8:30:00am GMT

TEXT version of Transcript


Corporate Participants


* Jakob Sigurdsson

Victrex plc - Chief Executive

* Richard Armitage

Victrex plc - Group Finance Director

* Martin Court

Victrex plc - Executive Director Medical

* Tim Cooper

Victrex plc - Executive Director Industrial


Conference Call Participants


* Adam Collins

Liberum - Analyst

* Andrew Stott

UBS - Analyst

* Bast Chargee

Citi - Analyst

* Raghav Bardalai

Exane BNP Paribas - Analyst

* Alex Stewart

Barclays Capital - Analyst

* Mathew Hampshire-Waugh

Credit Suisse - Analyst

* Martin Evans

HSBC - Analyst

* Chetan Udeshi

JPMorgan - Analyst

* Thomas Beavers

Smart Views - Analyst




Jakob Sigurdsson, Victrex plc - Chief Executive [1]


So good morning, everyone, and welcome to Victrex's half-year results for 2019. Welcome to those that are listening on the phone as well. I'm joined by a full executive team today. Richard, Tim and Martin will be involved during the presentation and will obviously be all available for Q&A towards the end.

I think the key message today is not a surprise. We did have a softer first half, as expected. We faced a number of short-term headwinds. We're focused on improvement in the second half year, even if demand recovery will be at a bit slower rate than anticipated when we spoke together the last time. We expect improvement to be gradual and probably more back end weighted.

And consequently it will be a challenge for us to deliver a year-on-year growth in the second half, although the medium-term story remains attractive and the key value drivers that are underpinning our value proposition are unchanged.

Despite weaker trading we delivered progress on our mega programs, so our investment case remains strong. Growth is obviously the key attraction. But we're not just about our mega programs; the core business had good structural growth opportunities despite the short-term demand or the short-term softness in demand in certain sectors. And cash generation is obviously an additional traction for our business.

If we look at the highlights of our first half, so overall our core business was characterized by a challenging automotive market. A more muted industrial market in general and by year-on-year toughest comparatives in the consumer electronics. Group volumes were down 16% mainly driven by weaker auto; the associated impact on value added resellers; and, like I said before, a comparison with the consumer electronics contract that was on the books for the same period last year, but was not on the books for this year.

However, we did see an improving trend in the second quarter with Auto stabilizing. Auto was down 23% in the first quarter, down 5% in the second quarter. And in fact, January, as an example, was the second biggest market for automotive in history. But what we're dealing with is a very volatile, I think, demand situation where the supply chain is pretty much had from hand to mouth these days, which is maybe not surprising in the world of [twitsy tweets] ruling the economy.

We are pleased to see medical progressing well, continuing a stable trend that we have seen out throughout the last year with revenue up 1% and 2% in constant currency. If we then include the headwinds of cost inflation and weaker trading investment, underlying profits in constant currency fell 9%.

On a more positive note, we continue to make good progress on our mega programs. One major thing to announce here today, and we'll discuss that a little bit later in the presentation, is the signing of a new aerospace alliance with Airbus which deals with structural parts -- larger structural parts for future planes, structures in wings and fuselages and is obviously a great testimony of the global opportunities that we [find] within our business.

We are close to signing our second PEEK Gear contract with a large American OEM as well. We will touch a little bit on that. We probably will only see prototype orders for this year, but we're expecting it to give us a meaningful impact when we head into the next year.

Patient recruitment was also imminent for our knee program and that would be a major milestone for us when we get the first PEEK Knee into a patient's body. And we would expect to see that happen before the year-end.

And furthermore, we continue to invest in our market development activity, as indicated by the investments we made in Surface Generation and Bond 3D, securing further downstream manufacturing capability and market creation for PEEK.

A quick word on cash before I hand it over to Richard. Despite weaker trading we continue to see healthy cash generation and this will obviously support our investment for future growth. It also supports appropriate return for shareholders on a medium-term basis.

On investment we continue to review the multiple options and we'll give you a little bit more color on that as we go on. So we're looking at new options for polymer capacity, both built a non-built as well as opportunities for the bottlenecking at Hillhouse and we will come back a little bit more detail on that during Richard's presentation as well. So with that I will hand it over to Richard.


Richard Armitage, Victrex plc - Group Finance Director [2]


Let me just start with an overview of the results for the first half. So, our sales volumes declined 16%, which was a fall of 357 tonnes. Around 140 tonnes of that was due to the significant consumer electronics order that was substantially fulfilled in the prior year. Excluding that that would give an underlying decline of 10%.

The balance was primarily due to the weaknesses in the automotive and electronics markets that we commented on in the Q1 IMS and the associated impact on the value-added resellers, the bulk of whose volume also goes into the automotive and electronics markets.

We did see an improvement in the second quarter with the X consumer electronics volume decline improving from minus 13% to minus 8%. Notably we saw an improvement in our direct automotive sales with volumes closer to last year by the end of the quarter.

As noted in our statement, we do expect this improvement to continue gradually. But with the uncertainty being widely experienced in those two key industrial markets, it will now be challenging to achieve year-on-year growth in the second quarter compared to the prior year period.

Revenue declined by 13% to GBP145.7 million or by 12% on a constant currency basis. Gross profit declined by 18% to GBP87.4 million pounds or by 13% on a constant currency basis.

We have chosen to report two items as exceptional in nature. Firstly, we have made an estimated non-cash pension adjustment in relation to GMP equalization of GBP1.3 million; and secondly, we have incurred costs in excess of GBP1 million in acquisition-related expenditures. Excluding the exceptional costs our overheads declined by GBP10 million principally due to a lower accrual for our employee bonus scheme.

Our underlying constant currency profit before tax therefore declined by 9%. Earnings per share declined by 21% to 51.4 pence with an effective tax rate of 12% in line with last year. An interim dividend of 13.42 pence has been proposed, again in line with last year.

Turning to the year-on-year decline in profit before tax in more detail, we can see the impact of three principal movements. Firstly, the impact of lower sales, primarily in automotive and electronics as noted, accounted for GBP8.8 million of the declines. The conclusion of the consumer electronics contract accounted for a further GBP3.5 million.

We have then seen an impact of nearly GBP7 million from currency and inflation. As expected, this impact was first half weighted and we expect the year-on-year impact of currency and inflation in the second half to be broadly neutral.

Finally, you can see the significant impact of our employee bonus scheme for which no accrual has been made in the first half given the decline in profit.

Let me turn to pricing and margin in a little bit more detail. Our average selling price was GBP76.70 a kilo, some 4% higher than the same period last year. This was driven by a combination of the mix benefit of growth in medical combined with a decline in industrial as well as the lower volumes from consumer electronics contracts. Currency had a slightly negative effect. We would expect this to continue into our second half with only a slight weakening in mix as industrial volumes gradually recover.

Despite the higher average selling price margin declined by 3.8 percentage points to 60%. Around 3 percentage points is due to the adoption of IFRS 9, which I will come back to. That leaves an underlying decline of around 1% which principally reflects the impact of raw material and utility inflation.

As noted, we expect the combination of currency and inflation to be broadly neutral in the second half. We would expect a slight improvement in gross margin as production volumes reflect a gradual recovery in sales.

It's also worth commenting on the decline in medical gross margin percentage reported in our statement. About two-thirds of this decline was currency-related given the business' exposure to the US dollar, as well as a small increase in [toll] manufacturing costs.

While also looking at margin, I wanted briefly to address to address one of the most commonly asked questions about our strategy which relates to the impact of cost parts manufacturing on our margins. This chart gives and indicative picture based on our modeling of a representative industrial parts business.

You can see in the third column that we would expect the percentage gross margin on industrial parts manufacture to be lower than the current margin on polymer manufacturing. As we have noted before, this is more likely to be in the 40s than the 60s. Even when we add both elements together to give the end-to-end margin for the parts margin is still likely to be sub 50%.

However, we can see the cash margin per kilo increases dramatically and that is cash margin that we will not have access to without our Polymer & Parts strategy. Given our intention to pursue this strategy through a combination of own investments and partnerships, thereby keeping our capital investment at a reasonable level, I hope this chart gives some reassurance around the potential for this strategy both to give us access to margin streams not currently available to us and to keep our return on capital at a healthy level.

On our next chart I just wanted to show the impact of the move to IFRS 9 on our P&L given that this is the first reporting period following the change. As required by the standard, the individual line items are recorded as a weighted average spot rate. Because we hedge net cash flows we are then required to show the gain or loss on forward contracts as a separate line item which we are showing within gross profit.

The chart compares against the first half of FY18 stated at the rates that were effective at the time showing clearly the year-on-year currency headwinds of GBP5.1 million and that most of it falls in gross profit. It is worth noting again that this has had the effect of depressing reported gross margin by 3 percentage points. We have noted as usual a 5% currency sensitivity based on FY19 consensus profitability and ignoring the effect of hedging.

If I move on to cash, we generated cash flow from operating activities in the half of GBP32.5 million, which represents a cash conversion of 65%. This is lower than normal due to an increase in working capital of GBP27 million. This was caused by a Brexit-related stock build of GBP15 million and a reduction in bonus accrual of GBP12 million.

Capital expenditure was GBP9 million in the first half and we expect our spend for the year to be close to our guidance of circa GBP25 million. Together with payments in relation to the two investments we have previously announced of GBP6 million and dividends of GBP111 million, this led to a net cash outflow of GBP95 million.

In the second half two points are worthy of note. Firstly, in relation to Brexit, we did implement our readiness plan successfully and slightly exceeded our target of holding a minimum of eight weeks finished goods stock outside the UK by March 29. Given the continued uncertainty around Brexit, we don't anticipate reducing this in the balance of the year. But we clearly expect this to unwind in due course.

Secondly, we expect to make further stage payments in relation to our investments in the second half of the year of up to GBP10 million. Therefore based on higher inventory build, investments and weaker cash conversion, the prospects for a special dividend this year look less encouraging all be it that the midterm opportunity for shareholder returns remains attractive.

Finally, I would just like to touch on the progress of our capacity expansion plans. As previously noted, we are looking at various options to expand our polymer capacity. We have first identified an opportunity to debottleneck the Hillhouse polymer plant.

This is a very attractive option as it allows us to leverage our existing infrastructure in the first instance, add capacity at an attractive incremental cost, and delay for a short while a decision regarding a larger scale investment. We expect this to cost roughly GBP20 million over FY20 and FY21.

We should note that one impact of this project will be a need for an extended shutdown in FY20. This is one of the reasons we expect to hold high stocks going into FY20. And we should also note that the extended shutdown will have a small impact on our profit before tax.

We then continue to look at options for both a smaller incremental investment as well as a larger multiyear investment akin to our last major capacity expansion. If the latter is chosen it is unlikely that significant CapEx in relation to that option would start before FY21. Investment therefore remains our priority for the use of cash albeit that good opportunities remain for returns to shareholders in the medium-term. Thank you and I now hand back to Jakob.


Jakob Sigurdsson, Victrex plc - Chief Executive [3]


Thank you, Richard. We will now just go into a segmental update and we start with industrial. Automotive, as well-documented, not just by us but I think those serving the automotive industry in general these days, it has been a tough market in the short term. Volumes were down 13% in the half but are moving back to a stable performance. We were down roughly 23% in the first quarter, 5% in the second and it looks as if momentum is coming back.

Notably though, I think IHS has moved its annual forecast for yearly build rates down to a 0.9% decline in 2019 compared to 2018. But a point to note though is that I think there are some [who] assume that that volume shortfall has largely been baked in in the first calendar quarter.

So in our case, we have seen increased momentum throughout the second quarter, which is continuing into the third quarter of our financial year. But demand is well [attached], like I indicated in my opening words. And we are surely dealing here with a supply team that seems to be feeding almost hand to mouth, and we can see that in the volatility of orders.

Despite the challenges short-term, the structural growth opportunity remains intact and, as I said, the increased momentum is really the base for our future outlook. Sure enough statistical focusing does not help you much in an environment like this one. So we are very much basing our outlook on what we are hearing from our customer base with certain overlays and [judgmental] costs to be made on that. But we are navigating cautiously given the volatility of the sector.

Remember we are focused on breaking the chassis and transmission area so we are focused on the powertrain of the car on our next generation of product years. We continue to make progress, as I said before, and we are close to having signed the second major development agreement with a major American supplier and hope to be able to report on that at least at the latest in our next earnings release.

Working hard on electrical vehicles as well and it's worth remembering that we have a play across both. We are not just all about the combustion -- internal combustion engine, but we believe there is huge opportunity for PEEK in electric vehicles as we move forward to a more demanding situation.

On aerospace, much tougher year-on-year comparative in the first half, but good underlying growth that should be reflected in our H2 numbers. And we do expect growth there in the second half of the year. To note, as an example, we do have good volumes on the 787 Dreamliner. You may have seen that Boeing is announcing an increase in production rate there from 12 to 14 planes a month, as an example, and we have good penetration there along with a number of other different opportunities.

The key for us here is to drive forward the use of thermoplastic composites. We have already 250 grade which has been getting great initial traction and performs very well against other alternative technologies. I will cover a little bit in more detail later our progress on loaded brackets, but we have commissioned a facility in Rhode Island already and it is starting to supply prototype parts and the order book there is shaping up nicely.

Moving on to energy, stable conditions there in the first half, reflecting weaker industrial business offset by growth in both oil and gas. So the oil and gas part of our segment is up 9% in the first half. Oil has remained steady of around $70 a barrel, roughly, and it looks like OPEC is tightening its supply support activity. Rig count remains relatively flat but our overall outlook there, and we see it today, are promising on the energy side.

On Magma, we have seen a softer year so far after securing the meaningful revenue there for last year, but we would expect further opportunities in FY20 on the back of a number of projects that Magma is working on. (Inaudible) already been investing ahead of the Libra project in Brazil, so that bodes obviously well for Magma and therefore ourselves as well as a supplier of both pipe and tape into those opportunities.

As I said on Manufacturing & Engineering area, we saw a slower start of the year, but continue to work on the projects in the food area. And that's where we launched our new Victrex FG food product grade suite of products, which has been getting good initial traction and should start to reflect in the numbers as we go into the second half.

On the electronics, this is an area where we obviously saw a significant decline in the first half. As we signaled to the first half, it was a much tougher comparative because of the well-documented and mentioned large consumer electronics order. But we are more than that in electronics.

But the other areas that are key to us here, the semiconductor area has had some challenges as of late. And you know and have seen the well-documented outlook there which moves us to a cautious outlook and has obviously resulted in results for electronics so far this year.

Although we see good opportunities for growth and we did see good growth in our Home Appliances segment. And we are also looking for a non-consumer -- a non-smartphone consumer opportunity to kick in in the latter part of the year that we didn't see the benefit of in the first half of the year.

Finally, on value-added resellers, they in many ways reflect the underlying business as well. So they were down in the first half in volumes by 15%, reflecting that automotive is one of the bigger segments that they serve. And (inaudible) electronics are also big segments of theirs, so that's coming through in their numbers as well. And they are big suppliers to the general industrial markets as well which have remained muted. So we see a similar impact on their business as we see actually on our business directly.

Now I short update on the mega programs. On the industrial side we continue to invest downstream as part of our mega programs and market development activities. Our TxV Aero Composites joint venture in Rhode Island is now operational, bespoke manufacturing with quite a bit of intellectual property associated with it.

We have started producing composite parts for qualification purposes. We already have some prototypes with a major US airline and have the opportunity to deliver meaningful revenue on the aggregate in 2020. We have prequalified our AE 250 composite grade, which is getting great reception competing against alternative technologies. And in the specific applications we are focusing on seat pans, structural parts, door brackets and loadbearing brackets along with a few other applications.

On the new development alliance with Airbus, this is obviously a great milestone for us. I'm very pleased to finalize this with Airbus and this alliance is a part of the Clean Sky 2 program -- supports the use of composites in general.

The aerospace industry is looking at ways to build planes faster and that's not surprising given the backlog that each of the major OEMs as an example have. I think each of them is operating with backlogs for single aisle planes for close to nine years. And this is one way of ensuring faster build rates.

This is clearly something that we have high expectations towards. But I should point out that we shouldn't expect business from this last opportunity until in the time frame 2025-2027. But it does signify and confirm the last future potential that is embedded in the various areas of our business.

Moving on to medical, our spine offering has continued the stable performance seen during 2018, despite being in a mature phase of the lifecycle. Overall medical was 1% ahead in revenue and 2% ahead in constant currency. Growth has been coming from spine but also from other areas like arthroscopy and cranial maxillofacial use of PEEK in skull surgeries.

In HA-Enhanced, our next generation product for spine, we see an improvement compared to last year, so pushing towards GBP2 million in revenue this year. We have over 10,000 patient implants already using HA. And remember that this specific product offers better bone on growth compared to its predecessors.

We also have a new application use based on HA, Nvision secured FDA approval for their hammertoe device using HA-Enhanced. So we are managing to expand our application opportunities above and beyond spine, as an example. In general HA-Enhanced supports better bone on growth and fusion across the joint and has been shown to be better with this device.

Going forward in medical three things we need to focus on. Clearly increased innovation in HA-Enhanced is a great example of that, building up a position in emerging markets, we've seen significant growth in Asia and clearly the new platforms in dental, in trauma and in knee will feature strongly as we go forward.

On dental specifically, it remains a good proposition, proven clinical evidence that our PEEK products lower infection rates, peri implantitis rates are roughly 1% using PEEK after five years versus 10% for titanium. We also launched a new Oyster White product over the winter offering alternative colors given the aesthetics of the dental industry they are key.

But we have to admit that progress in dental has been slower than anticipated. It is a fragmented market and we will need to sign up additional partners and we have actually done that above and beyond Straumann to facilitate for the penetration there.

Trauma, they are pleased that we are progressing a partnership with one of the top five players in the industry. Trauma plates are already in the body, by the way, but driving market adoption is obviously key for us. And that's why we need to work with medical device companies to further penetration and speed adoption.

On knee, we are now just about to start recruiting patients for the clinical trials. It will be run through two Italian hospitals with all the protocols having been approved. And as I said in my introductory words, we expect to have a PEEK Knee in the human body before the end of this financial year. It is an 18-month program and, as I said, we are working with two Italian hospitals and the size of the trial is around 30 patients, which will be recruited through those.

Ever so briefly on the value proposition in knee. As I said, patient recruitment is imminent. It is a sizable opportunity, around a $6 billion global market. PEEK offers simplicity and speed of manufacture, but the knee made out of PEEK is also lighter, it doesn't become cold, it doesn't rattle.

And when you put that in the context of the fact that one in five patients is unhappy with the outcome of procedures with cobalt chrome knees there's clearly a problem to be solved and a strong value proposition that is embedded in what we have to offer here. But clearly we cannot answer the question of technical viability until we run the clinical trial, but stay tuned to follow the progress of that.

Now moving on to the ever so famous bubble chart. A few moves on these this time around. Gear moves closer to the northwest of the chart, reflecting that our second major supply agreement is imminent which with a large American OEM, building on our German agreement signed last year.

Sufficient to say this is a much larger opportunity and will get us a long way into double-digit revenues out of the gears franchise, so I expectations there for us. Already have prototype orders but would expect the final production orders to arrive on our desk shortly.

On aerospace loaded brackets, as I told you before, completed the commissioning of a facility and decided to make parts. So we are moving that further to the west on the chart.

Dental, as I covered, has been slower than anticipated, but we are mitigating that by signing up a greater number of partners. Still a good proposition with a high probability of success.

You notice the new entrant there. We've included a new bubble there for primary and secondary structures like fuselage and wings, whilst we don't expect meaningful revenues from that in the next five years.

Ever so briefly, just to look at the milestones on the mega programs in a different way. I'm not going to go into each of these in detail, but sufficient to say on Magma, the progress with Technip with an eye on the Libra field in Brazil is processing well. But there's also other opportunities there associated with Equinor and with a couple of well containment companies that are identified there as well.

On HA-Enhanced we've touched on what's happening there already in 10,000 patients. We've seen GBP2 million in revenues hopefully this year, but also finding its way into other applications.

On dental we've already signed up a couple of other distribution partners in Asti and Umbra, above and beyond the agreement that we had with Straumann and would expect to roll out a similar model to other players as we go forward.

Gears, we talked about the second major OEM contract. Shouldn't forget to mention the fact that our site has been IATF16949 qualified as well. And here we're probably looking at the opportunity in our portfolio that in the shortest amount of time will get us to double-digit revenues.

Trauma, we talked about that, where we're working with one of the top five players in the industry with five plates party agreed for launch. Aero brackets, touched on the commissioning of TxV. In knee we are looking with great excitement towards getting the first knee implant into the patient before the end of the financial year.

As a part of investing for growth, we are pleased to announce two acquisitions or two minority stakes which will support our continued delivery of our mega programs and our market development activity. Surface Generation is one of them.

They have a state-of-the-art compression molding and injection molding capability whereby they are able to control the temperature both heating and cooling in the mold in quite a unique way, which opens up the opportunity to make parts that [here too] were difficult to make via these technologies. So we have taken a small equity stake in Surface Generation to facilitate development -- market development with PEEK using this technology.

With Bond 3D this will support our additive manufacturing development or the capability in 3-D printing with a particular focus on the medical market and Martin will be able to add more color to that later on. As we said last year, we expect to make small investments in the 3-D printing space building out the ecosystem that is needed to enable the delivery of PEEK in 3-D printed parts. This builds on the partnership we have with the University of Exeter and Airbus.

As you've seen us do in the past, we have acquired stakes in Kleiss gears and Zyex fibers as well as in TxV and Magma, and that has really allowed us to accelerate our product development and market adaptation, or off-peak in certain application areas. And we said that we will do more this -- more of the same and maybe on a slightly larger scale. And I think both Bond and Surface Generation are sort of a testimony to that.

Ever so briefly then on the outlook for H2 2019, on the aerospace side, we remain optimistic on aerospace, which will be facing a better comparative in the second half of the year than it had in the first half of the year. And as we continue to deliver good growth and supportive trends, although rig count is relatively flat but oil price has remained relatively high.

So we are relatively optimistic on energy, medical spine, despite low growth has shown continuing improvement over the last 12 months and we would expect that to continue for the remainder of the year. On medical new markets encouragement from non-spine areas, obviously, although the dental market has been a bit slower than we expected, but overall outlook on medical is relatively optimistic.

We do have a cautious outlook, however, on the automotive side. Whilst we expect a better H2 sequentially in the industrial market, auto is gradually improving. But we stay cautious until we see prolonged improvement. Remember volumes were down 5% in Q2 after a 23% decline in Q1. It looks as if we are approaching last year's run rate, but given the uncertain outlook we cannot take that as a given.

However, obviously China plays a big role in the automotive market these days. And I think with the income tax adjustments in China and the further VAT adjustments taking effect on April 1, and potentially other things on the horizon that should stimulate demand, hopefully the assumptions for a relatively mild recovery are sustainable.

Electronics certainly an easier comparison for us in the second half, but visibility for our non-smartphone consumer device is limited. Semicon forecasts are bearish. Year to date perhaps spending is down 14% as an example. Smartphone sales are forecast to improve 2% roughly as we go into the second half of the calendar year. But again, visibility is relatively low at this stage, so we remain very cautious on the outlook in electronics. We would expect some growth in Home Appliances, but this remains a relatively small part of the group.

So if we sum it up, it was a weaker half one as we expected, although second quarter showed some signs of improvement with automotive starting to stabilize. We also saw a continuation of the improving trend in medical where revenues were ahead for the first half, including growth in HA-Enhanced. Early actions that we took late last year and early on in our financial year to improve manufacturing efficiency and reduce costs are also starting to take effect.

Looking forward to the second half, headwinds in the form of currency and cost inflation will probably be neutral and incremental operating investment will be limited. We will also benefit from low bonus accruals. However, with some of our key industrial markets remaining weak, our base assumption is that improvement will be gradual and backend weighted.

Overall our expectations are that it will now be challenging to achieve a year-on-year growth in the second half compared to the prior year period. We remain well-placed for the medium- to long-term with strong structural growth opportunities. I think our underlying value proposition for the markets we serve is unchanged.

We're going through a cyclical downturn right now, but it doesn't change the fundamentals and the fundamental attractiveness of our portfolio as a whole. Healthy new product pipeline and highly cost generated business model should obviously be an attraction as well going forward.

That sort of concludes the formal part of the presentation and we'll now open it up for Q&A. (Operator Instructions).


Questions and Answers


Adam Collins, Liberum - Analyst [1]


Good morning, it's Adam Collins from Liberum. I had a couple questions please. You've given some indications of the year-over-year impacts from 4X bonus accruals, raw materials and so on. I wondered if you could do that in terms of the sequential FX. So what do you think will be the additional impetus in the second half compared to the first half from bonus accruals, FX and raw materials?

And perhaps while we're on that subject, you also alluded in the statements to potentially better volume contributions. And I think you've done that in terms of home appliance, new non-smartphones and aero phasing. Can you just give us a sense of what the additional momentum might be from that? I think you said Home Appliance is a relatively small program but you've got three things going on there.

And then just on the investment progress, you talked about debottlenecking in 2020. Would you be able to give us a sense of this -- and I though it's early -- on what the capacity potential is of that? What would be the magnitude of the down time and also the safety stocking?


Richard Armitage, Victrex plc - Group Finance Director [2]


I think if I do the first and third of those, so the sequential impact of bonus FX and raw materials, so if the combination of FX and raw material inflation had a year-on-year impact in the first half of just under GBP7 million, the year-on-year impact in the second half will be neutral. And that's a small upside on currency, there's a small downside on inflation given roughly balancing out -- if that helps for that one.

In terms of bonus, so again in the second half given the consensus around profit growth we would not be anticipating making an accrual for employee bonus compared with last year. In round numbers that takes out about GBP4 million. So a year-on-year decline of GBP4 million.

We have continued our investment in front-end sales, technical service and R&D costs, but at a slower rate than we had anticipated constraining our costs in the current environment and that would be about plus GBP2 million. So GBP4 million down, GBP2 million up gives you a feel for where we expect to be I think on that one.

Debottlenecking, so as I said, this really is a very attractive way to progress. So we are anticipating a capital investment of up to GBP20 million. We have indicated in the statement that actually what this does is help the Hillhouse plant to get to its nameplate capacity of 7,150 tonnes.

And we said before that the effective capacity where we are at the moment is probably around 6,200 tonnes. So that's giving you a feel that it's up to about 1,000 tonnes, which if you then go back to my previous major capacity expansion for powder plant three indicates that this is a substantially better incremental capital cost per tonne.


Adam Collins, Liberum - Analyst [3]


(Inaudible - microphone inaccessible)?


Richard Armitage, Victrex plc - Group Finance Director [4]


The downtime is going to be phased, so it's a little bit hard to describe it in a way of just a discrete period of time. It has the potential to impact about 20% of our production. And therefore it you can see that if we are coming into the year with an increased inventory initially driven by Brexit, you can see maybe GBP5 million to GBP10 million coming off that during the course of the year.


Andrew Stott, UBS - Analyst [5]


Andrew Stott, UBS. Can I just stay with the CapEx issue or theme? I just wonder if you could step back and tell us about the Board discussions, why the debottleneck all of a sudden? Are we to think that the growth CapEx you've talked about for the last 12 months to 18 months is potentially up in the air now and it may not go ahead for the foreseeable future? Or are you pretty keen to still progress from 2021 onwards?

And then can I get specific guidance on CapEx for this year and next year on the basis of the debottlenecking? Because I don't think I see that in the press release.

And then finally, coming back to Adam's question on downtime, so is there any way to net that on an overhead basis? Or is it still in the planning phase and you just can't whittle it down? I think, Richard, you said a small impact for 2020. I just want to know what small is.


Richard Armitage, Victrex plc - Group Finance Director [6]


So, in a way I wouldn't read too much into the debottlenecking. I think it's no more than in the course of looking at a number of options. It became immediately apparent that actually there was a debottlenecking opportunity. And therefore it's a fairly economically driven discussion that says if you can add lower-cost incremental capacity in a relatively short term by debottlenecking, why wouldn't you?

That does allow us to push out any potential further large-scale capacity decision for a while and that's helpful, one, in terms of cash flow. But also as time evolves the product mix may change somewhat. Technology may evolve and it just gives us more time to get that decision right. So, it is not indicate a reduction in appetite to make further capacity investments beyond the debottlenecking at all. It is I think just pointing to a better way of sequencing it.

In terms of the impact on CapEx, we've indicated that our sort of normal or, if you will, maintenance level of CapEx is around 6% of sales or GBP25 million; that guidance is still good. We do indeed this year expect to be at about GBP25 million-ish. This would add GBP20 million or up to GBP20 million probably over two years. The exact phasing of that has yet to be determined.


Andrew Stott, UBS - Analyst [7]


(Inaudible - microphone inaccessible)?


Richard Armitage, Victrex plc - Group Finance Director [8]


Yes. In terms of the impact on the P&L, I did indeed say small. I think notwithstanding the impact of the debottlenecking in FY20, we should still be expecting PBT growth in mid-single digits.


Jakob Sigurdsson, Victrex plc - Chief Executive [9]


I think if I may add a little more color to this one. I think you have seen us talk about GBP25 million to GBP35 million an ongoing CapEx. So to put it simply, the added expense associated with debottlenecking would actually fit within that bracket.

I should also point out that the projects we're looking at are new sites for a new manufacturing facility, that project will still go on. But I think the opportunity that we have identified obviously allows for us to push that a little bit further out, which is obviously a good thing. And the cost per kilogram, if you wish, of our debottlenecking unit of capacity is obviously significantly lower than from new capacity.

So it is obviously very pleasing for us to have identified this and it would be smart for us to pursue it. And obviously the longer we can push out the larger investment the better. But to emphasize Richard's point, our interest in that remains and we continue to progress the project that is associated with that.


Bast Chargee, Citi - Analyst [10]


[Bast Chargee] from Citi. Just a bit of clarification on the full-year guidance. On the [2 HSA] it's going to be challenging. Could you just help us quantify is that base case or is that best case scenario in terms of reaching flat year on year?

And then just on the -- I'm going back to slide 8, you talk about the absolute margin opportunity. Could you comment on the return on capital employed and the capital intensity of the growth into the parts and how it compares to the (inaudible)?


Richard Armitage, Victrex plc - Group Finance Director [11]


So I think on both of those, so -- yes, flat growth I think would be probably the best case. Again, principally related to the uncertainty in automotive and electronics and the volatility we are seeing right now.

The point on return on capital is -- whilst these plans have yet to evolve we are not seeing any particular evolution of our plans that would involve group (inaudible) on capital falling below 20%. And indeed over time it should be enhanced because the capital intensity of those downstream applications, when we are taking a gander at both our own investments and working in partnerships, is not too high. So, a key point for us, sustain return on capital at at least 20% and potentially enhances (inaudible).


Raghav Bardalai, Exane BNP Paribas - Analyst [12]


Hi. It is Raghav from Exane. Can I just ask quickly on the dental outlook? You talk about midterm growth potential, but I think the comments from Straumann were a bit more cautious recently. I think their exact words, they are trying to stay away consciously from some of the PEEK products.

I would just like to hear your thoughts on where things stand there. And is your confidence coming from other suppliers not experiencing those issues or now you are changing the material? Any help much appreciated.

And then on auto, just a clarification. Can you just clarify what percentage of volume you are selling to electric vehicles, if any at all? And maybe do gears have a potential role to play in that as well or is that technology not applicable? Thanks.


Jakob Sigurdsson, Victrex plc - Chief Executive [13]


I think on medicals (inaudible) market. So I think we need to look carefully at what was said by the Straumann CEO in that call. He was talking about implants and PEEK is being experimented with implants, but we are not working in implants; we are working on the frame that goes on top of the implant.

Straumann are, amongst others, being very successful with that from a clinical perspective and I think it's easy to get confused about that. So what he was talking about was it being problematic at the moment in implants and not in the prosthetic frame. So, all our figures are based on us being successful in the prosthetic frame and not in the implant space at the moment.

So we remain confident that the medium-term position is very strong, that the clinical evidence is continuing to grow and patient comments are -- remain excellent there in terms of the performance of the product.


Raghav Bardalai, Exane BNP Paribas - Analyst [14]


And take auto as well?


Richard Armitage, Victrex plc - Group Finance Director [15]


Yes, so on e-mobility, I think we talked about this in the past, that there are a few areas that we've identified where we think PEEK has a particular play there and insulation at high-voltage being one of them. So we continue to work in that space.

But also if we look at gears, then if anything we expect to see more gears in an electric cars than there are in a traditional car, particularly in the actuator space. And that's something that we think we have a place to play in electric vehicles as well.


Alex Stewart, Barclays Capital - Analyst [16]


It's Alex here from Barclays. If the worst case scenario happens and we crash out of the European Union at some point, have you thought about what impact that would have on your business and your distribution costs, whether that would be passed on to the consumer or whether you would bear some of that cost? We obviously hope that doesn't happen, but any idea would be great.


Jakob Sigurdsson, Victrex plc - Chief Executive [17]


Yes, I think this very much featured into our whole Brexit strategy and Brexit evaluation -- and we did get to pressure test that as it got closer to March 29 and then April something. So I think the key impact there would be potential tariffs placed on our exports from the UK into Europe, determined by the WTU -- WTO to the tune of around 6%.

Now having said that, there is a possibility there to file for an extension to those given the fact that we are the only European manufacturer of PEEK. Now that process could take between I think 9 or 12 months roughly. So the question then is what happens in the interim. And that remains to be seen, whether that is passed on or not. And that obviously depends on a number of factors, not competitive situations the least.


Alex Stewart, Barclays Capital - Analyst [18]


Have you started having the conversation with your customer about whether you would pass that on or whether you would absorb the cost? I mean you probably haven't had specific contract discussions, but any sort of idea?


Jakob Sigurdsson, Victrex plc - Chief Executive [19]


No, we have not had any significant discussions on that yet and it has not really come up.


Mathew Hampshire-Waugh, Credit Suisse - Analyst [20]


Hi, it is Mathew Hampshire-Waugh from Credit Suisse. Can I just get an update on the Magma lever opportunity, where you are now, potential volume opportunity in let's say five years' time if you get onto the risers, etc.? How you think the timing is going to work and does this define your major investment plans?


Jakob Sigurdsson, Victrex plc - Chief Executive [21]




Martin Court, Victrex plc - Executive Director Medical [22]


So, I guess we have to be careful that Magma should comment on what they think about the long-term future there. But certainly if you look at what Technip are aspiring to do in those fields, then you're talking hundreds of tonnes of PEEK for one phase of the field. So yes, it does weigh into us thinking of what we do in terms of future capacity.


Alex Stewart, Barclays Capital - Analyst [23]


Where are you now and how quickly could that come about if it goes to plan?


Martin Court, Victrex plc - Executive Director Medical [24]


So the -- Petrobras are already asking people to quote for phases of that deployment. The first phase was won by Technip on metal, which is a bit of a strange one for them because they are the leaders in flexibles. They are clearly very enthusiastic to move to a flexible solution that works in that environment as fast as possible.

I think [Lee] being clear that they made an investment in Magma to accelerate that and they continue to drive that program with us and with Magma as hard as they can. And it's all about qualification with Petrobras and confidence in the technology in that application and the quicker they get there the better for them.


Unidentified Analyst [25]


A question about non-spinal growth in medical. You mentioned a couple of areas that I know you've done historically but haven't been that progressive, craniofacial ultrascopic, as growing. Would you be able to comment on that? And also not clear on the hammertoe and how that works. Maybe you could expand on that.


Jakob Sigurdsson, Victrex plc - Chief Executive [26]


Yes, so let's talk about CMF first. So, you'll notice in the statement there's really strong growth in Asia this year. A lot of that is around what's going on with CMF -- PEEK being deployed in CMF there, as a result of a recent study that showed that cerebral activity when using PEEK it instead of using metal for CMF plates was significantly enhanced. So that's driving a new interest in CMF there from the point of view of its clinical benefits, which is something that is a new study that came out of [Batten] a year ago.

On arthroscopy then, again, we stayed focused on arthroscopy but that's just about growth of procedures as people become more demanding of their bodies as they get older. And so, that means there's a lot more sports medicine type procedure that's coming through now.

On hammertoe, then it's a very specific type of ankle surgery and it really is using the osseointegration effect of HA just to get a stronger anchor system in there. So, it's something that was one of those things which came a bit serendipitously, so it's just using the osseointegration capability. It's not something that will end up being a big segment for us. It's just an interesting application for the technology.


Martin Evans, HSBC - Analyst [27]


Martin Evans, HSBC. Just to go back maybe to the guidance and visibility and jump back a little bit back to December when you were obviously more optimistic than you are now. Was it simply that at that point, because you say your guidance is basically led by your customers, that they were giving you more optimistic visibility in terms of order books and so on? And that that's obviously deteriorated over the last month or two? Or is it maybe essentially that you were a little bit too optimistic at the time about the outlook for autos, electronics and so on?


Jakob Sigurdsson, Victrex plc - Chief Executive [28]


Monday morning quarterbacking is always easy. But to your point, I think we did put forward our best estimates at the time. And we clearly recognized that we were in a volatile territory. Sure enough, as I said before, you don't use statistical forecasting mechanisms at that point in time, but you very much base your assumptions on what you are hearing from your customer base, number one.

As it relates to the underlying demand, you build it on timing of specific product launches as well -- and/or product discontinuations, either/or, and you try to aggregate these and put an override or based on macroeconomic indicators that you see. This is no new science as such.

And as a consequence of that work throughout the year we came up with our guidance towards the end of last year. And that was really guidance that we gave with the best of our abilities. Sure enough now we have seen how things progressed. Shortly after we came out with our guidance or just about that. We had a very strong January and a very strong start of February. Then demand went very flat for the remainder of it. And it's this volatility that makes it inherently very difficult to project the outlook obviously.

So, I've given you an insight into our mechanics of thinking when we put those together. And given the volatility we're probably taking a bit more cautious outlook now and have escalated our cautiousness based on the volatilities that have been demonstrated in the time in between. So I think it's a natural evolution of how things have progressed since we came out with our guidance towards the end of last year.


Martin Evans, HSBC - Analyst [29]


Do you have an average visibility in terms of your order book? Are we looking at a month or two?


Jakob Sigurdsson, Victrex plc - Chief Executive [30]


No, I mean when we are looking at our books right now we do see orders already into August. But then what happens in reality is that your order book may be shaping up nicely in the beginning of the month and then, depending on the end demand, people are then pushing out orders. And we've seen that happen on a number of occasions.

So we start the month with a very healthy book, but as it progressive towards the middle or then towards the end you see customers asking to delay orders. I think that's what I am also referring to when I talk about our supply chain, particularly in the general industrial sector, on the automotive as well, a supply team that is working hand to mouth.

I think this whole supply chain is nervous because of this world of twitchy twittering by world leaders. And therefore it is progressing very carefully with relatively low inventories and they are staying pretty nimble. And given the price of our material it's expensive to have it sitting on your shelf for longer than it absolutely has to be.

And sure enough we are known for very good service levels, so people know they can get short-term delivery times from us. And that is certainly a part of our value proposition that we won't be changing. We are there for our customers when they need us and that may exacerbate a little bit the volatility in terms of demand that comes to us.


Chetan Udeshi, JPMorgan - Analyst [31]


Hi, Chetan from JPMorgan. Just two questions. One is given this this weaker demand environment, are you seeing any structural change in the competitive dynamics between different PEEK suppliers or PEEK versus substitute products?

And the second question is there's a lot of focus on the bubbles than there has ever been, but what is the underlying growth in the business without those bubbles? Say just normal GDP environment, what is the underlying growth, do you think, in the business without those bubbles?


Jakob Sigurdsson, Victrex plc - Chief Executive [32]


So on structural changes, no, I don't think we're seeing structural change as a consequence of this. But I do think that we see actually similar kinds of effect with all of those supplying specialty polymers for the industry's that actually we are serving as well. So in many ways I think that dealing with similar kinds of demand situations, but as a structural change as a consequence of it, no, I don't think we can see that.

Is there a battle between different polymer technologies? Always. PEEK is relatively highly priced. We have been careful to select segments and to target segments where we have something special to offer that others can't. And that's probably been the source of our ability to maintain margins over a long time.

When you talk about the bubbles and the underlying growth, what's in the bubbles right now is insignificant in terms of current revenues, a very small fraction of what we do, but obviously it has huge value associated with it as we go forward.

If you want to get a benchmark of the resilience of the core business, the best way to look at that is to roll back in time four years in 2015 when we had roughly 1,000 tonnes of this last contract on our books. Now that has since then gone down to 200 tonnes in financial year 2018. It would be close to zero this year, but yet we have grown throughout the period.

That basically tells you, well, the underlying core business has made up for that shortfall, has filled that void. And that is basically a testimony to the fact that PEEK is continuing to find new applications to penetrate where people are willing to adopt PEEK in spite of a relatively high price, mainly to replace metal actually, very often driven by light weighting requirements, combined with all the other attributes of PEEK.

Because it's not just enough to be light weight, a lot of polymers are light weight. But when you combine it with a need for chemical resistance, wear resistance, biocompatibility, heat resistance, lack of thermal and electrical conductivity, you have a very strong value proposition given the drivers that most of our industries are facing or demands that most of our industries are facing these days. Did it capture your --? Martin again.


Martin Evans, HSBC - Analyst [33]


Maybe just a question on electric vehicles that were mentioned earlier and your potential role in that. So, can you just clarify where you see PEEK in this what will be a huge market? And are you currently selling material to the OEMs for electric vehicle manufacture?


Martin Court, Victrex plc - Executive Director Medical [34]


So, PEEK is already well deployed in the insulation part of electric motor and that's been in place for some time, even in hybrid vehicles that is there. I think there are several areas where people are investigating the potential use of PEEK in electric vehicles at the moment. Some of those being in gears, some of those being around the power pack. But the whole design is in such a state of flux at the moment that nobody really knows what their electric vehicle is actually going to look like.

So, there's a lot more conversation about what voltage the powertrain will be based on, what the mechanism of adding or taking the battery in and out of the vehicle, how it will charge. I think in the and, until they get through whether they can deliver solid-state battery technology into that space it's going to be really hard to know how that works out.

So, we are focusing more on the things that they know. So, we know they are going to need insulation for electric motors and they are going to increase the voltage and we think PEEK becomes more relevant the higher the voltage. And then also the fact that there will be less moving parts but a lot more gears and actuators. So, yes, we are in collaboration with OEMs, we are working with our tiers to deliver things and there are -- our PEEK has been used in some of those solutions, yes.


Jakob Sigurdsson, Victrex plc - Chief Executive [35]


Are there any further questions here? Before we move to questions from the phone maybe, if there are any, are there any questions from the phone?


Operator [36]


(Operator Instructions). [Thomas Beavers], [Smart Views].


Thomas Beavers, Smart Views - Analyst [37]


I have two questions please; first on dental. I wonder if you could give us more color there in terms of the issues and what the barriers to greater traction in that market are.

Secondly, on gears, just wondering on the first supply agreement with the German OEM, can you give us any more color there as to how business is going there? Whether you are likely to expand your business with that OEM? Thank you.


Martin Court, Victrex plc - Executive Director Medical [38]


So, maybe let's talk about dental first. So, on dental we've said I think for some time that the big challenge here is not about the credibility or the value of the clinical outcome. And we've talked in this room about people being very upset when their dentist tried to take away their PEEK prosthetic and replace it with a metal prosthetic. So that still stays in place.

But we also talked about the fact that it's quite a fragmented market and so penetrating that market is quite difficult. The fact that we had agreed to work closely with Straumann we hoped would allow us to deal more effectively with the fragmentation in the market. It's making an impact but not as fast an impact or as much impact as we'd hoped.

We continue to work with Straumann. And recently at the two major dental shows annually, at Chicago Dental and IDS, have made joint inputs there. We are getting good reaction, it's just the pickup in a market that is difficult. And I think a lot of this is because dentists tend to be single people and have grown their businesses and they are quite risk-averse. So getting a level of confidence into that industry space is quite hard.


Jakob Sigurdsson, Victrex plc - Chief Executive [39]


And then on gears --.


Martin Court, Victrex plc - Executive Director Medical [40]


So, on gears, yes, we do expect further business with that German OEM. The application we talked about at the time, it was a small application. That application is going well. There are vehicles using -- being driven with that technology deployed. And that's clearly giving them more confidence to think of other opportunities to use PEEK in other spaces there.


Operator [41]


(Operator Instructions). And there are no further questions from the phone.


Jakob Sigurdsson, Victrex plc - Chief Executive [42]


So just before we leave, I want to recognize the fact that Tim has been really instrumental here in executing on our alliance with Airbus. So, before we leave, if you can give us a little bit more color on how it's progressed and how you see it progressing and what is behind that.


Tim Cooper, Victrex plc - Executive Director Industrial [43]


So just quickly on the aerospace piece, I think -- so we've been talking for years about confidence -- in terms of plastic confidence in aerospace and the alliance that we've talked about now and there's sort of similar activity with the large OEM just in terms of how they are now taking thermoplastic companies more seriously. They've invested people, which is always a good sign. Both the big OEMs have got large and growing groups of thermoplastic composite engineers.

And I think our opportunity has come through a couple of things. First of all the AU 250 that Jakob mentioned is a version of PAEK that we actually develop for the aerospace industry. And the lower melting point that it has enables processes to run it on equipment that you could already run PPS on. So it enables you to bring in a higher performing product on the assets that are already there in the market.

It also has brought this ability for us to do over molding. So over molding standard PEEK on the AE 250. And that opens up all sorts of design opportunities that haven't been available previously for the airframe designers. So I think that has been a key thing.

I think the other thing -- and it actually is linked to the Magma work that we've been doing, but as part of getting the Magma project to where it is, a few years back we decided that we would make the composite unit directional tape ourselves, because the quality standards that Magma were looking for weren't being met by the existing pre-preg supply chain.

And we got very good at it and we are now able to put into the area OEMs the best quality PEEK tape on the marketplace. And that sort of set the standards for the other pre-preggers who will -- we do work with and will work with and will come into market. But we've actually been able to demonstrate that we've got quite a special differentiated offering with this AE 250.

And I think that was a big attraction for Airbus getting us on board. And as I say, we're having similar conversations -- there are joint development projects potential with Boeing as well. So, it's just a good example of -- we talked in the past about product leadership and what it can do for us. And I think that's really what drove that alliance coming together.


Jakob Sigurdsson, Victrex plc - Chief Executive [44]


Perfect, thanks. Any further questions? All right, thanks for you that came and joined us this morning, whether it was on the phone or over here. And I look forward to seeing you again shortly. Thank you.


Operator [45]


This now concludes the conference call. Thank you all for attending. You may now disconnect your lines.