Victrex plc (VCT) Earnings Call Transcript & Summary

Hello and welcome to the Victrex Interim Results May 2021. [Operator Instructions] And just to remind you: This conference call is being recorded. Today, I'm pleased to present Jakob Sigurdsson, CEO. Please go ahead with your meeting.

Thank you. Good morning and welcome to Victrex' 2021 half year results presentation. I'm Jakob Sigurdsson, the CEO of Victrex. And I'm joined here today by Richard Armitage, our CFO; Martin Court, our Chief Commercial Officer; and Andrew Hanson, our Head of IR. Whilst we're sorry we can't be with you in person today, for our full year results in December, we hope to be in a position to see you all in 3D given good progress on global vaccination rates in the fight against COVID. Before we start, just a couple of housekeeping points. The slide presentation is on our website at www.victrexplc.com, under the Investors tab. And by clicking on Reports & Presentations, you will find today's materials [ presented there ]. As we go through our presentation today, we'll call out the slide number as we are speaking to the messages on each and every one of them. So turning to Slide 3. Our key message today is that we're seeing improving end markets all across the board leading to first half volumes up 5%, including a record February and March. And indeed April looks to have set a record as well. We also saw a good sequential recovery with first half volumes up 39% versus the second half of 2020. And pleasingly, we're also seeing significant pipeline milestones being achieved, and I'll come back and pull out some of those when we look on our mega-programmes specifically. On Slide 4, speaking about COVID. We're also seeing a solid recovery from the impact of COVID. I'd like to spend a moment reminding you that, like any business, we've had to navigate COVID challenges [indiscernible] of our stakeholders, and we continue to do so. Firstly, our people continue to demonstrate high levels of resilience. I want to thank them for their continued impressive contribution and dedication. Over 75% of our global teams remained homeworking although we have signaled our intent to see a greater return to site for our U.K. team in July, subject to government guidelines. And obviously, our Chinese colleagues have been back on site for some time now. We took part in a COVID testing program for our business-critical employees. And we continue to support a variety of communities globally with [ time ], PPE and even recycled PEEK materials and components for masks. For our customers, we continue to be a part of many critical supply chains. And remember that chemicals was designated an essential industry by the U.K. government. And we're really pleased and proud to be able to report that our on-time and in-full delivery towards our customers had been over 98% throughout this period. Richard will cover more of our financial position, but I do want to highlight a couple of points. Firstly, we did implement a cost savings program that will benefit us to the tune of around GBP 10 million this year and support our operating leverage going forward. Secondly, our cash position has improved. We are pleased to be back to pre-COVID dividend levels. On Slide 5, if we look at the highlights. We saw strong end markets in Electronics, in Value Added Resellers and in Other Industrial [ and then, after, principally our ] Manufacturing & Engineering business where we have put additional sales resource in recent years to capture a range of manufacturing applications. And also to say that we saw sequential improvement in auto, up 68% versus the second half of 2020; and in Energy, which remains challenging but are seeing improvement from the trough levels of last year. Aerospace remains tough, with volumes down 40% year-on-year, but this end market is stable now. And we continue to see long-term opportunities, and indeed we note recent OEM commentary suggesting some recovery of but quite variable. Medical has improved from the loss of 2020 but, given the strong comparative in the first half of 2020, was down 16% in FY '21. This also impacted our sales mix. And consequently, group revenue was stable despite heavy volumes. Profits were offset by weaker mix, some continued effects from under-recovered overheads and bonus accruals, reflecting that the market anticipates modest growth on a full year basis. It's also pleasing to see sequential margin improvement, and Richard will cover the bits on this shortly. Our growth potential remains undiminished for the future, and indeed as we emerge from COVID, we also see the opportunity for several programs to show potentially greater progress. Particular highlights in this update includes some new business that we're closing on -- in on in the electronic vehicle space. Our PEEK Knee program now has 3 trial sites ongoing, and progress has been good, with more detailed updates to be presented in July, focused on the first implants. And in PEEK Gears, we now have an OEM ready to launch a program in Europe. This is a significant milestone for us [ on that ]. I'll come back and cover more of these opportunities later on but will now hand it over to Richard for the financial summary.

Thank you, Jakob. Good morning, everybody. So I'll be starting on Chart 6 with an overview of the results for the year ending 31st of March. We're pleased to report a solid recovery from the trough in the second half of last year, which has given us year-on-year sales volume growth of 5%. We have seen particularly strong growth in Electronics and general industrial [ whilst also noting ] volumes were in line with what had been a good performance for us last year. There was also a good rebound in Value Added Resellers, albeit that this may reflect a degree of supply chain restocking. Nonetheless, we feel we have returned to pre-COVID levels of trading overall. Aerospace, Energy and Medical remained subdued as a consequence of market conditions but have all shown some improvement from the second half of last year. Reported revenue was flat year-on-year but grew by 2% on a constant currency basis to GBP 150.9 million, reflecting the [indiscernible]. Gross profit declined by 6% to GBP 81.4 million or by 3% on a constant currency basis, reflecting a decline in gross margin of 340 basis points to 53.9%. As well as the weakness in Medical sales, margin has been impacted by currency and, as expected, by an under-recovery of manufacturing costs as we unwind our Brexit inventory. We did see a sequential improvement from 47.3% in the second half of FY '20. Overheads were slightly below prior year, [ with ] underlying savings of GBP 4 million offset by bonus accruals. Our underlying profit before tax reduced by 10%. Our effective tax rate of 13.2% remains in line with our expected long-run average, which has increased slightly to reflect the changes in U.K. corporation tax rates. We continue to benefit from the lower rates available during the U.K. Patent Box scheme. Looking forwards, we expect sales volume to be slightly lower in the second half, reflecting the supply chain restocking we think has taken place in the first. We would expect a small incremental improvement in gross margin as production volumes pick up, but we do also expect overheads to be some GBP 4 million to GBP 5 million higher as a result of bonus accruals and the resumption of forward business activity. Given our solid outlook, the Board is pleased to recommend an interim dividend of 13.42p. Moving on to Chart 7, we can see the underlying year-on-year movements in profit before tax in more detail. We can see the effect of our Medical sales, where revenue was down 16%, offsetting the benefit of higher industrial sales where revenue grew by 3%. Overhead savings were offset by the bonus accrual [ and then it's a ] small currency headwind. The main item to call out is once again the under-recovery of fixed manufacturing costs, which was the principal cause of the decline in PBT. Comparing to the second half of FY '20, our increase in sales volume of nearly 600 tonnes was partially fulfilled by consuming roughly 300 tonnes of finished goods inventory. Therefore, although manufacturing activity did start to pick up, we have only seen a partial reversal of the under-recovery, so far. We do expect a further improvement in the second half but with production volumes for the year still likely to be roughly 20% below [ the 2019 ] levels. Moving to pricing. Average selling price was GBP 72 per kilo, some 5% or GBP 4 per kilo lower than last year. Approximately 1/3 of this was due to currency. And the balance was due to the mixed effect of lower Medical sales and higher industrial sales, with our underlying pricing remaining stable. Looking forwards, we expect the recovery in Medical to be more gradual, and therefore we don't expect a material improvement in average selling price in the second half of this year. Gross margin declined from 57.3% to 53.9% year-on-year. Of the 340 basis point decline, under-recovery accounted for about 2/3, whilst mix and currency accounted for the rest. As expected, we did see an improvement of 660 basis points when compared with the second half of last year. This was principally driven by an improvement in the under-recovery of fixed costs combined with the benefits of [ cost savings ] resulting from our restructuring announced last year. Looking forwards, we expect a further small sequential improvement in the second half, assuming we'll start to see a recovery in Medical sales in the fourth quarter. Moving on to Chart 9, we're again showing a chart that is intended to show that our gross margin was impacted by market conditions last year and how it is starting to recover this year. The first part of the chart is the savings we showed in December, with gross margin of 60% in FY '19 declining to 47.3% in the second half of FY '20. The principal causes were underabsorption of overheads, inventory provisions and mix, as previously explained. During this half, we can then see some improvements in mix, with Medical sales having shown some sequential improvement [ from when leaning ] below the first half of last year. Roughly half of our GBP 10 million of annualized cost savings [ reflected ] manufacturing costs, the benefits of which to gross margin we can also see. The biggest effect, though, has been a partial reversal in the under-recovery of [indiscernible]. Looking forward, we do expect further improvements, with Medical sales expected to recover once elective procedures restart in full and production volumes recover to pre-COVID levels. The timing of these changes is uncertain, which is why we're only expecting a limited further improvement in gross margin in our second half this year. Moving on to Chart 10, I'm again showing our treatment of currency on the face of the P&L in line with IFRS 9. As before, the individual line items are recorded at a weighted average spot rate, while the gains and losses on all contracts are shown as a separate line item within gross profit. The loss on forward contracts showed a GBP 1.7 million improvement versus prior year. However, a slight strengthening in sterling from USD 1.27 to USD 1.31 and from EUR 1.12 to EUR 1.14 resulted in an overall currency headwind of GBP 2.6 million, in line with our expectations. Our expectation for FY '21 is for a further headwind in the second half, to get -- to give an impact of approximately GBP 3 million to GBP 4 million for the year as a whole. We do this -- on this point also I want to note the potential for further significant currency headwinds as we move into FY '22. We are 75% covered for the first half with an average effective rate for the U.S. dollar of 1.37 and euro of 1.14. If sterling remains at these levels, then we expect the headwind for the year to be of the order of GBP 10 million. I want to talk briefly on inventory. So as planned, we've moved quickly to unwind our Brexit's inventory. We reduced raw materials by about GBP 7 million and finished goods by 300 tonnes and GBP 10 million in the first half. This has contributed to a substantial working capital improvement. We do currently plan to deliver a further improvement in inventory over time. However, we have noted recent bottlenecks in global supply chains, which may lead us to increase raw material inventory [ as a result ] between now and [ year-end's portion ]. We would therefore expect year-end inventory to be roughly in line with or maybe slightly below where it was at the half year. [ We would like to ] note that our Brexit inventory served its purpose in supporting our customers and their supply chains, and we have so far avoided any impact from other supply challenges. Our customer service has been in excess of 98% for the year-to-date as a result. Apart from some minor transactional matters that still need to be resolved, we have no outstanding Brexit-related concerns, and we now consider the immediate challenges from Brexit closed. Moving on to our capital investment. I'm pleased to report that our China joint venture is still progressing to plan. Building and civil work is nearing completion, and we are preparing for installation of equipment and services. The commercial opportunity in China continues to strengthen. Our business there remained stable through 2020. And we have returned quickly to double-digit growth this year, with our range of opportunities expanding. We do expect the costs of the project to increase, as we are still having to rely on local engineering resources during the period of COVID disruption. We have also noticed significant inflation emerging in locally sourced materials. In addition, we're making a number of investments in commercially driven projects in support of our customers, and we expect our capital expenditure for this year to be of the order of GBP 50 million [ as a consequence ]. Around 2/3 of that will be expended in China. Finally, we are now making preparations to restart our debottlenecking program in the U.K., and we'll say more on this at the end of the year. [ Reporting this project ] during the last year has given us an opportunity to rephase the project by implementing it in a number of tranches over 3 years whilst also releasing capacity via a number of noncapital-related improvement projects. The end results in terms of capacity evolution will be the same but with a smoother capital expenditure profile that will be managed within the maintenance capital forecast for each year. Finally, closing on cash. We are pleased to report another good cash performance with operating cash conversion of 96% despite our relatively high capital expenditure which was in line with expectations at GBP 16.5 million. Our working capital improvement of GBP 4.2 million comprised an inventory reduction of GBP 17.5 million, offset by a mixed movement in receivables and payables of GBP 12.9 million driven by increased activity. There were no changes to underlying payment terms. Our tax outflow was low at GBP 0.9 million. No U.K. tax was paid in the first half due to overpayments made in FY '20. As a reminder: We had made 6 quarterly payments in FY '20 as a consequence [indiscernible] HMRC payment arrangements. I will also note here that the proposed change to the U.K. corporation tax rate, [ if granted by parliament ], will lead to a one-off deferred tax charge in the second half of approximately GBP 6.3 million, which will increase the effective tax rate for FY '21 by 7 to 8 percentage points and have a corresponding impact on adjusted EPS. We have reported a cash receipt of GBP 3.9 million from our acquisitions. This is simply a capital contribution from our JV partner in China. Our net cash at the end of the period was GBP 79.6 million. It should be noted that this includes GBP 16.6 million ring-fenced in our China JV, which leaves GBP 63 million available to the wider group. We will expect our year-end cash balance to be in the region of GBP 80 million to GBP 85 million but with some uncertainty remaining over the timing of capital [ outside ]. Thank you. And I will now hand back to Jakob.

Thank you, Richard. And turning now to our industrial update on Slide 15. On Automotive, we did see good growth in new applications, and volumes were only down 4% due to a strong prior year. Volumes were up 68% against the second half of 2020. And remember that in the prior year we saw some benefits from the PFOA banned in Asia, which contributed to a strong comparison this year around. Our PEEK play continues to have a good opportunity in traditional platforms and increasingly in electric vehicles as well, not just through [ high query ] but also due to durability, faster processing of materials and good thermal and electrical resistance. We are seeing some minor impacts from the semicon shortage for auto, but this hasn't distracted our business in this end market and momentum still remains strong. In Aerospace, year-on-year down 40%. We have some improvements since the trough levels. If we look at the OEM forecast builds rates over the long term, however, Airbus, as an example, still forecasts around 36,000 new or replacement models by 2038. So only a 1% total reduction from their estimate pre-COVID levels. We do not, however -- we do note, however, that this end market remains challenging in the short term. 2023, 2024 is the expected date for air travel to return to pre-COVID levels, although long haul is expected to be the slowest one to recover. If we think about Victrex' exposure, we do have exposure across both major OEMs; and across platforms, platforms including the 737 MAX, the A320neo, the 787 and the Airbus A350. Our composite opportunities also remain intact. And remember that faster processing, reduced waste and recyclability are key drivers there beyond [ light-weighting ]. PEEK continues to have a good fit in Aerospace, and our sustainable credentials keep us optimistic for the long term. On Energy, it is up about 10%, primarily driven by improvement in Manufacturing & Engineering and the Other Industrial segment, [ with all tied to machining and ] manufacturing applications, yes. Manufacturing & Engineering was up 27%. Oil & Gas, however, was down 11%. While this end market remains challenging, the rig count has stabilized and starting to slowly increase. And our [ catalyst ] market is unchanged. PEEK offers lighter and durable solutions. We should also note that we continue to develop opportunities with applications in the renewables area. On Electronics, very strong, up 28% year-on-year. This is largely an Asian-based business for us, so we do see further opportunities as many of these geographies open up post COVID. Semicon remains a good subsegment here. And we have exposure, remember, both on the capital side as well as the OpEx side here. Finally, value-added reseller. This remains an important end market for us and is up 11% year-on-year. And this is clearly where we're working with long-standing relationships with processors, be it compounders or stock shape producers. Now if we ever so briefly move on to Slide 16 and new application growth, some examples of where our materials fit and the mega trends that support them. Homeworking and 5G have been a support for us in Electronics, along with home appliances. And we've got good exposure in many high-end brands by now. In Manufacturing & Engineering, manufacturing and machine applications to drive efficiency, and also within the food industry as metal contact is reduced and manufacturers look for materials that tick a number of boxes. In auto, the power remains a key focus area here, and we've still got a lot of for -- opportunities to go after. And we're seeing increased penetrations into classical applications like [ grade ] parts, bushings and bearings, seal rings, et cetera. And overall, our solutions are a broad player across all of the internal combustion engine, electric vehicles and hybrids. Turning to Slide 17, on e-mobility. We're now closing in on some new business within e-mobility where PEEK has a good fit. Remember that here is all about thermal management and [ PEEK insulated ] properties as well as our focus on higher voltage and higher performance requirements. FY '22 is expected to see the start of revenues building in this area. And remember that we now have a separate level on our bubble chart for this program. We expect to hear more on this going forward. The good news is that we're adding new development programs. And we're trying to commercialize the ones we have, multiple programs in place across Asia, Europe and the U.S. As a reminder, we have used as a benchmark that PEEK could have an opportunity of up to 100 grams per application per car from around the 9 grams average that we're at working today. Moving on to Gears on Slide 18. In Gears, it's worth remembering we already have 4 contracts in place and on the road by now, not just cars but also road mobility as well. And today, we have around 20 programs in place. FY '21 and -- to FY '23 is the main period when we start to see production for some of these opportunities, and we're focused on commercializing several of them at this very moment. The solution is light. It reduces noise vibration by about half, helps process [ the pan ] around 3x faster and is up to 70% lighter and thereby supporting CO2 reduction, overall a great opportunity for Gears across a number of applications. And an average gear solution is probably representing an opportunity between 15 to 20 grams per car. On Slide 19, on Magma, a quick word. Despite COVID, progress remains positive for the opportunity in Brazil. TechnipFMC declared last year that PEEK was a material of choice for the qualification program in Brazil. Victrex' role here is to support this through execution of the pipe and providing the composite [ plate ] that is subsequently welded onto the pipe with the technology developed by Magma. This year, we'll also see some revenues from smaller incremental programs. And you will further -- we'll have a further [ info ] on this later in the year. On Slide 20, Medical update. Medical has seen a more gradual recovery from COVID, reflecting the fact that elective surgeries have been postponed in many geographies. And the reemergence of surgery has been slower than most people anticipated mid last year. Latest surgeon data suggest that China will be back at pre-COVID levels of surgeries by the end of this quarter. U.S. is expected to be later in the year, and Europe may be even later than the U.S. Nevertheless, we've seen incremental improvement in Medical revenues, up 23% compared to the second half of 2020. We should also remember that the first half last year was very strong in Medical, where there were a lot of prebuying before lockdowns. Momentum is improving as we move through the second half, but it may remain a slower improvement despite, for example, April revenues [indiscernible] on the prior year. In Spine, our focus will therefore be on rebuilding revenues and also on areas like our HA Enhanced product, which was progressing well before COVID hit us. We also continue to develop our Porous PEEK opportunity and using the investment in Bond 3D to prototype [ some of these ] cases, which deliver both [ hold-in ] and bone ongrowth after surgery. If we turn to some of our other programs: Trauma, we announced a partnership with U.S.-based In2Bones to use PEEK in both higher and lower extremity applications, a good news to support our U.S. [ access ], for sure. In Asia, we're collaborating with a number of players in China, for example. And China, for example, supports many of these. Trauma itself is up 21% versus the first half of 2020, and this also includes [ skull plates ] for craniomaxillofacial applications. In Dental, very good [indiscernible] evidence that COVID has been a disruptor in this segment [ as well as in others ]. We know that other players are also continuing [ to find option ] challenging here. Adoption will need to be through industry partners. Our role will be to support the clinical evidence. And remember that PEEK has a much lower infection rate than titanium [ and in fact ] with less than 1% infection rate compared to 10% with metal-based one, based on 5 year-data. And on Knee, I'll come on to this on the next slide but very pleased with the progress here. And as you will also see, it has moved ahead in our bubble chart. So moving on to Knee on Slide 21. Here remember that we are working with our partner Maxx Orthopedics across 3 clinical trial sites now in Belgium, in India and in Italy. The original trial has restarted in Italy, and then 2 new sites have been added. Maxx will be providing an update in July, which we expect we will also cover in our IMS call after our third quarter results and report progress on the first implants. Remember this would be the first PEEK Knee implant ever in the human body. It is an attractive market 6 billion in overall global size, a very sizable opportunity obviously and particularly in the context of dissatisfaction rate with metal knees is rather high. From Victrex' perspective, we had IP here and knowhow in place. And we also have initial manufacturing capability ready here as well. This trial will run for 2 years, at which point any modifications to the product will be made before we commercialize this on a broader scale. Over 30 patients are involved. And we look forward to update you further later in the year, as I said before. And there will be 2 or 3 points in the 2-year trial when we can provide [ stage and gate ] updates. On Slide 22, on medical strategy overall, very briefly. We believe we have a very strong medical strategy and pipeline both in Spine but also in non-Spine. It's worth noting that, the first half, our non-Spine business is now 46% of divisional revenues, great progress if you consider the fact that Spine was over 75% of revenues less than 10 years ago. So we're growing in the likes of [ pharma and ] orthopedics and more broadly. You can also see on the slide CMF plates and also emerging applications like in heart applications. In summary, we are diversifying our Medical business to position ourselves for broad-based growth in non-Spine and also geographically mostly -- and mainly in Asia. Slide 22 (sic) [ 23 ], a quick word on the bubble chart. Firstly, we continue to see little evidence of material slowdown in these programs through COVID, although for me, it should be mentioned that this program is now running around a year later than our anticipated time line. There's good progress now since the restart of clinical trial. The main movers on the charts are e-mobility, reflecting some upcoming new business. Dental remains challenging for us and have moved back in timing even if the clinical data is strong. Aerospace revenues will remain subdued for these mega-programmes in the near term, but it's worth nothing the niche nature of our composite offering. And initial commercial revenues keeps the program fully intact. In the Aerospace Structures program, you have seen we've been supplying prototype casts for some of the OEM programs, which will start in prototype revenues already this year. On Slide 23 (sic) [ 24 ], key milestones. I'm not going to dwell on each and every one of those, but it gives you a sense of the milestones we are hitting and the focus areas for the remainder of year. We're targeting meaningful revenues in Gears this year. In aerospace structure, we have a chance of delivering close to GBP 1 million of revenue as we secure prototype business here in spite of a tough industrial environment there. On the outlook, on Slide 24 (sic) [ 25 ], a brief word. We're optimistic on Automotive, where we have seen a return to growth in recent months. Electronics is up 28% in the first half with a favorable comparative in the second half. We think there is room for further progress here. Medical side, we're also optimistic here, and this should support mix in H2 but late in H2. And this will be more gradual, initially in China and Asia and then U.S. surgery later this year and Europe probably a little bit behind that, but from here on, we see a definite positive trend upwards. Remember that U.S. is still over 50% of revenue for the Medical division. On Energy, we're neutral on that, although we should note that Other Industrial is a part of this. And we anticipate seeing continued growth here in line with global indicators. And on Aerospace, stable but subdued, and we remain neutral here on this end market for the remainder of the year. On Slide 26, one point that I do want to [ enter ] is the significant growth potential from the fact that our products are aligned to global mega trends and the benefits that it can offer to our customers. PEEK remains lighter than metals and offers [ ourselves innovative metal ] replacement and light-weighting. It has good recyclability properties. We've seen tests on PEEK that show no degradation or reduction in property after reuse over 10 times. PEEK will -- also offers faster processing, around 1/3 faster than injection moldings, rather than complex [indiscernible] machining practices. And don't forget that PEEK also has great mechanical strength, durability and chemical resistance. And it is bioinert with now over 13 million patent implants based on our fleet. Overall, our product premium not only will have social benefits. We can support CO2 reduction in aero and auto and clinics will benefit in Medical. So post-COVID, we think we're well positioned and aligned with global mega trends -- the mega trends. On Slide 27, summary, for FY '21. We are comfortable with the current market expectations of PBT at around EUR 81 million, but there may yet be some upside and we would like to reserve judgment on that for another few months until we see a better picture of momentum in the second half. We think we see some restocking in the first half. And therefore, we do think full year profit might be first half-weighted. We're seeing continued momentum within April, and April actually proved to be a record month for us compared to previous Aprils. And May is tracking well ahead of last year. The mid- to long-term outlook also remains strong. Cash generation is improving, and the cost savings implemented will support our longer-term operating leverage. Our ESG agenda is strong. And as I said, we have products fit for the post-COVID world and aligned to mega trends. Our growth pipeline is also strong, and we're seeing milestones being delivered as we seek greater commercialization and faster commercialization of these opportunities. So we've got a strong investment case and a sustainable recovery to report on. We feel comfortable and pleased with the past half and are quite confident even if we are cautious on the outlook for the immediate future. Thank you, and I'll now open it up for questions from the audience on the call.

[Operator Instructions] Our first question comes from the line of Charlie Webb from Morgan Stanley.

Just 2 for me. Just first on the outlook, just perhaps digging a little bit deeper. I mean it sounds like sequentially, everything is actually, if anything, perhaps accelerating, with strong April, strong May, yet you kind of reserve a more cautious view. So perhaps you can just help us understand what the potential -- what is the potential upside? What kind of magnitude are we talking about there? And/or alternatively, perhaps you can say in H1 what you thought was the contribution from those kind of stocking effects at a sales PBT level? I guess, either way, that kind of helps us to triangulate what kind of upside we're looking at for the second half -- the potential upside, sorry, and therefore, the full year. So just understanding that. And what would give you reason to be more cautious? As in what markets do you think have overheated or have had lots of stocking effects that might come off? Because it sounds like it's progressing well. And then just second question on EV. Obviously, you brought it forward on your kind of double charts in terms of a bigger opportunity. Can you just remind us, based on the business you're winning rather than probably the total opportunity, but the business that you're winning, how much more peak or not is in an EV versus an ICE today just in terms of the platforms and opportunities you have when you look at the like-for-like there? That would be very helpful.

So just on the first point, this question of restocking is an interesting one. I mean we think that broadly, supply chains are probably actually still relatively low in inventory, but there is little evidence that in some of the sales growth we've seen in the first half, particularly into the value-added resellers, there could be a little bit of restocking going on. So our expectation into the second is that the second half will be a little lower. I think maybe about 100 tonnes, something like that. But I have to stress we don't have great visibility through those channels. So that's a real estimate, if that helps. But at the moment, that's the way we're viewing it. What would we need to see change that we've got more confidence, I think firstly, in terms of Medical, we need to see elective surgeries picking up pretty firmly. And at the moment outside of Asia, there isn't a lot of evidence of that. So that's one indicator. And then I suppose an ongoing general steady improvement in performance and particularly perhaps and also signs that the chip shortage is not impacting us. It's those kind of signals, if that helps.

Yes. Maybe just one follow-up. I mean the 100 tonne difference second half versus first half, yes, I guess, kind of implied in the guidance is a somewhat more meaningful step-down in PBT H2 versus H1. And I guess, seasonally, second half is normally stronger than first half so just help me triangulate. What are we missing that kind of leads you to hold that more conservative view currently? Sorry, I don't mean to press it. It just -- it seems like -- it seems -- I'm just trying to get what the most realistic view is of the full year given where things are today, the 2 months you've had and what you see. I mean it does seem like a big sequential step-down.

Yes. I mean, firstly, there's that volume point which our margins is significant. I think secondly, I did point to overhead. So we're starting -- we've run lean for a year now. And we've got to restart and add further increases to some investments in growth activities. Travel and other such activity is going to pick up so we're anticipating an increase in overheads half-on-half coming all that of the order of GBP 4 million to GBP 5 million. And I think that also production volumes, whilst they are picking up, are still going to weigh on gross margin in the second half. So I think it's those things that are driving the caution, consensus was at about GBP 81 million. It's moving a little higher. We are comfortable with that. But nonetheless, because of those reasons, I cited we remain a little cautious about the second half.

And Charlie, if -- I'll take the one on electric vehicles. I think we're looking at opportunities across really, you would say, sort of 5 main pillars, if you wish. So it would be associated with e-motors, it will be associated with battery applications, thermal management broadly in the electric vehicle space, power electronics and then sort of applications that would translate over from the ICE, namely things that are associated with the chassis and braking systems as an example. So it's a -- across these 5 pillars, if you wish, we've used as a guiding figure that our penetration in cars -- passenger car today is probably around 9 grams per car roughly. We see potential to increasing that to 12 grams by expanding further in existing applications with broader adaptation of Gears. That opportunity grows to around 20 grams on average per car for us. And I think we're more and more convinced the more data points that we see. And when we look at the set of opportunities across the 5 pillars that I mentioned, that the opportunity in the EV world is getting somewhere close to 100 grams per car. And particularly looking to trends right now that are leading to more demanding situations where higher voltage, as an example, is increasingly being sought after.

That's helpful. Are these applications pure PEEK applications or are they kind of composite?

These applications that I referred to are all sort of pure PEEK applications, not composites.

And the next question comes from the line of Alex Stewart from Barclays.

I have 3 questions clarifying some points in your release. You said in the first half the bonus impact on allocated costs was offset by the cost savings. I think I read that correctly. And then you said that the bonus element was GBP 4 million in the first half, which implies that the cost savings is GBP 4 million on unallocated costs, and you talked about GBP 5 million in gross margins for the year. So does that mean you're going to hit your GBP 10 million run rate on cost savings this year? But if I've got that wrong, please do correct me. And then secondly, you said you saw currency gain in the gross margin in Medical in the first half. Can you just clarify what you mean by that and possibly the impact of it? I know there were some distortions at the end of last year, too, in Medical. Finally, your guidance on ASP. You're talking about fiscal '21 being modestly lower than fiscal '20. So let's say, GBP 76 a kilo. Your first half number was GBP 72. So are we looking at kind of 80 -- around GBP 80 for the second half? Can I just get your view on whether my maths and conclusion is correct? And a follow-up on that, my assumption is that the majority of that very significant sequential increase is just the return with Medical. Is that all aligned with what you're thinking?

Alex, your line was breaking a bit. I'm going to try and answer the questions but tell me if I missed something. So bonus offset by cost savings. So we did indicate about GBP 4 million in bonus accrual in the first half. It's likely to be roughly the same in the second. So that's one point. In terms of run rate of savings, we will achieve GBP 10 million in terms of underlying labor-related savings this year. About half of that is in manufacturing so it goes into gross margin, but that unfortunately gets buried by the under-recovery. The other half is in overheads, and we're definitely going to achieve that. I guess you could say the benefit of that is offset by the bonus accrual. And there is a lot of movements, but nonetheless, that saving is there. I think on selling price. So we, I think, are expecting to see a slight improvement in average selling price in the second half as Medical revenue is expected to pick up and therefore, we get the mix benefit. But I wasn't quite sure how you got to a figure of something like GBP 80. If we were GBP 72 in the first half, you could assume a slightly better than that in the second half. Maybe we'll get to GBP 73 or thereabout for the year as a whole.

Okay. Sorry, just to clarify that. You said in your statement that full year ASP will be modestly lower than FY 2020. So maybe my modestly lower is slightly different to your modestly lower because if you did GBP 76 per kilo in fiscal '20, I guess, what you're saying is that actually fiscal '21 will be more like kind of GBP 73, GBP 74 a kilo. Is that the conclusion?

Yes. Plus or minus something .

Okay. Fantastic. And then just, sorry, just to clarify on that bonus point. So if you're going to do GBP 10 million by the end of the year and GBP 5 million of that is in gross profit, then it obviously implies GBP 5 million in unallocated portion. But the statement implies you've already done GBP 4 million in the first half in the unallocated line, the sort of the corporate cost line. So does that mean you're going to get no incremental benefit in the second half? Or you're actually going to overshoot the GBP 10 million? I can't quite get those numbers to add up.

No. I can see your confusion, I think, Alex. So the total bonus accrual in the first half was GBP 4 million. We saw the same things from -- I said this program was just over GBP 4 million, but part of that sits within gross margin.

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

Can I start with future capacity? Two different questions here. Jakob, I think I heard you say the costs in China are going up so I wanted to explore that. If you could spell out specifically why and if you can scale what that means for CapEx and OpEx relative to previous guidance. Second question on this topic was the U.K. Still -- the debottleneck is still in pause as per the release. What do you need to see to come back to that decision? How close are we to seeing that actually reverse? So carry on, I've got 2 more. Or do you want to take those first?

Go ahead, Andrew.

I'll go ahead, okay. Second one was Magma. Maybe I'm wrong, but is Magma being pushed back? Because I had in my notes that you're expecting a decision by the end of this calendar year and I think you're now saying 2022. So I just want to check whether I was wrong in my note taking or not. And then is there any chance you can scale the EV contract for us? Obviously, the one you're close to signing.

Thanks, Andrew. I'll take the first one. So there are 2 inflationary impacts on the capital cost in China. The first is we've mostly -- we wanted to move [indiscernible] is the fact that we are working remotely. We've had to recruit quite a lot of local engineering resource. So that has an inflationary impact. And then what's emerging is some fairly rapid inflation in commodities, particularly steel. Now we're working through that right now. So I would prefer not to get into the specifics of how much that might cost us because we're in the middle of the negotiation. But what we are happy with is that our guidance for capital in total for this year will be of the order of GBP 50 million. That's a little higher than it was because I think previously, if you've seen, we're something in the range of GBP 40 million to GBP 50 million. But really, we're just coming out of the top end of that range.

So Richard, just to follow up on that, there might be some upside risk to CapEx guidance beyond this year. Is that the inference?

Yes, that's probably a reasonable assumption. We're still working through what plans we may have for next year. I can probably see that next year would be another year of moderately high CapEx probably still in the GBP 40 million to GBP 50 million kind of range. So you're right to anticipate that some of that will roll onto next year.

And then, Andrew, on debottlenecking at Hillhouse. As Richard mentioned in his overview, we are still planning to undertake that. We're going to do it in paces, however. So the overall capital investment is about the same as we've indicated before. But instead of being consumed in a year, it's likely to be spread out over 3 years. And it is a sensible thing for us to do along with other initiatives that are ongoing here to increase capacity through incremental improvements and changes. And given the growth rate that we've seen in the business over periods of highs and lows, then you've seen this business growing at upper single digits over its entire history. We've got every reason to believe that we'll continue to do so. And with mega programs starting to command volumes in years to come, then we feel it is a prudent thing to pursue. It's a relatively low cost per kilogram in terms of CapEx. So we'll continue with the bottlenecking of PP1, spread it over 3 years as opposed to doing in a single year before. And we'll be pursuing it with impacts sort of starting to show in FY '22. On the Magma side, Martin, I'll hand that over to you.

Yes, Andrew. So we're making really good progress on the qualification work there with Technip, really strong discussions going on with Petrobras. But clearly, the oil and gas industry went through a really tough time from a capital availability point of view in the middle of the COVID period. So Petrobras were keen to make sure they continue with the qualification work even though there may be a slight delay in some of their deployments because of that. But they're driving really hard with the qualification. We're working very closely in a 3-way relationship with Technip and Petrobras, combined with Magma to drive that forward. And they still see it as the best solution for that problem.

And then I think your last, Andrew, was on the EV contract. And I'm just going to keep this brief this time around. I don't think we're ready to comment any further on that at this stage, but we're incredibly pleased to see the validation that is embedded in -- the validation of our value proposition for this space, and that sort of obviously further underpins our belief in what we have to offer in these kinds of applications. But I'm sure you will hear more about it in due time, so bear with us, please.

Okay. And just to seem that, fingers crossed, you get that signed, I guess, those revenues start to come through next year, FY '22?

We will start to see some elements of that starting to show up next year, yes.

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

I would have 2, please. The first is on pricing. This -- on an underlying basis for industrials, I think this has been the first half year for a while, if I'm not mistaken, where there was not any even moderate decline. Demand is pretty strong. Could the next few years prove the exception to the rule that prices are usually down 0.5% to 1% per year within the industrial PEEK applications? My second question is on the electric vehicles. I suspect you're not going to give much in the way of details about what these applications are. But more broadly, could you talk about the type of materials against which PEEK is competing for applications like slot liners and other EV-specific uses and the type of price point which the material is sitting at versus currently used solutions?

So I'm not entirely sure I particularly want to get into the business of predicting pricing. But I think as you noted, and just to be clear, in the majority of our business, our underlying pricing tends to remain very stable. We can see a little bit of erosion from time to time in the value-added resellers. In the first half of this year, pricing is stable. There is very little movement at all, which is good. Looking forward, we would aim to continue with our approach of focusing on service to our customers, making sure we continue to bring innovation, making sure we continue to make the right returns. So I'm not sure we would be seeing any change to our approach to our customers as a consequence of what's currently happening.

Martin, do you want to...

Yes. And Sebastian, on EV, this is an ever-changing picture in terms of the performance criteria so the question you asked is pretty tough to answer. So what I would say is that if you read over all the benefits that you see of PEEK in normal industrial applications, so things like high-temperature chemical resistance and abrasion resistance and ability to perform in tight spaces and lightweight, all of those things apply in the various elements of e-mobility. We continue to see the applications that we are being specified and evolved, and it's really hard to give you a point on pricing or on specifics because I think, actually, many of the e-machine builders and the e-vehicle builders are still working it out themselves, what's -- where things fit best. But what I can say is you can rely on the fact that the traditional principles of if PEEK fits there, it will fit on the basis of those very specific performance criteria.

If I may push on this, when you pitch for work in slot line as a rubber electrical insulation, what are type of materials that are currently sitting within those applications at the moment?

Well, if you think about, let's take wire, for instance, then that's broadly against enamel.

And the next question comes from the line of Rob Hales from Morningstar.

In Medical, you talk about the CMF and arthroscopy applications. You usually talk about Asia. So I'm wondering, are those markets -- what's the state of those markets in the U.S. and Europe right now? Are they material? And are they still growth markets there? And then your comments on kind of recruitment and retention. I was just wondering, you said you made some changes there. And I'm just wondering what led to that decision and it's no longer based on profit growth. So again, what is the kind of the performance it's based on now?

Martin, do you want to answer for the medical industry?

Yes. So on CMS, then we have seen very strong performance in Asia over the last 18 months really on the back of a study that I think we talked about previously, which showed that cognitive recovery was much better using PEEK rather than metal as the implant there. There is an application on a broad base globally, but it is more prevalent in China.

I think I'll -- let me just pick up on your points. I think you referred to recruitment and retention. I think you're probably referring to our slight change to the employee bonus scheme. So in summary , the old scheme was based purely on PBT growth. The -- and was almost uncapped. Now there was a cap to it, but it was so high that actually in Europe, there was strong PBT growth, the bonus accrual could be very large. But the problem was that this is a business that can be affected by market movements then there are years when the bonus kind of payout is a significant bonus. There are other years where there would be nothing paid out at all. And you then have to look at the history over the last 3 years to see how that has played out and how that actually can be demotivating for our staff. So we simply moved to a more normal bonus scheme based around achievement of a budget in any given year with a range around that budget. And with a cap on the scheme at the higher end, I think people saw the lower end. So that's all really aimed at achieving a more consistent bonus payout over time for our employees, and it's not aimed at reducing cost. It's not a cost saving measure.

The next question comes from the line of Rikin Patel from Exane BNPP.

Just one on Gears. Firstly, what is the max revenue potential of your 4 existing contracts? And how many of the 20 development contracts would you have to commercialize in order to generate high single-digit revenues or low double-digit revenues? And then secondly, just a follow-up on Hillhouse and debottlenecking over there. How much of that incremental capacity do you expect to be absorbed from the new volumes in your growth program?

I think it's difficult to pinpoint exactly what's going to be consumed by the mega programs. But if you look at the growth run rate in the business, and I think we're getting to a point right now where we are looking at the nucleus, if you will, that we had as a core business in 2018 that suffered by a mini recession, particularly in automotive and electronics in 2019. We're recovering from that when COVID hit. But I think right now, that nucleus is sort of starting to grow again. We have not lost business from that time with increased penetration into certain applications. So I think the nucleus that we've had in 2018 will be starting to grow again at the rates that we saw sort of preceding the recession in 2019 and 2020. So that's point #1. And then the biggest volume demand for mega programs in the near term, will be coming from Magma definitely and then probably Aerospace and Gears after that. And then out in '27, '28, from the structural parts programs that we currently have ongoing. Victrex has always had a history of investing ahead of demand. It is important for us to be able to keep with the spikes in demand. It underlines the need for reliability towards our customer base that very often relies on us as a single-source supplier and hence, the emphasis, as you've also seen throughout the COVID period, whereby we have delivered them at a rough -- well, around 98% are on time and in full. And we managed to do that also in the face of this quite substantial rise in demand over the recent months. So we do take our role quite seriously in that regard and therefore, are committed and convinced and comfortable with investing ahead of demand. I'll hand it over to Martin for Gears to comment on.

Yes. So on Gears, the projects that we have already commercialized, they're obviously early adopters, so smaller type programs. So I would guess that we'd say that they're less than GBP 1 million in those. But certain programs in the pipeline have potential to be greater than GBP 5 million. So a pretty normal way of the way these things build, where initially people put new technology into the market in a limited way. Once it's demonstrated, then are prepared to go for bigger and more significant programs. So we -- in that pipeline, there are several opportunities which can -- which could bring really material sales.

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

A couple of questions from my side, and the first one was just on Electronics. Just wanted to confirm there is nothing which is like one-off product in that number. I think from my memory, there was a couple of years back something like consumer device, 50 tonnes or so, which never recurred. Again, I'm just wanting to check nothing of that sort in the number that it disappears, let's say, in 3 months' time. And the second question was just coming back to the Medical and it's a 2-part question. First is your commentary of maybe subdued recovery in elective surgery is a bit out of sync with what we hear from some of the other medical device companies more recently, where they have seen actually a faster recovery. And just looking at the Medical gross margin, it's already back to the 88% level even though the high-value piece has still not recovered. So does it mean that the Medical product set across the board has that sort of same gross margin levels even if the value or ASP is different across some of these different medical applications?

Yes. Thanks, Chetan. I'll take the Electronics one, and then Martin will give you a market update on Medical, and Richard will take the margin question on Medical as well. On the Electronics side, it is a broad-based growth for us around the number of home appliances and acoustic applications along with semicon. So it's a mixture of these 3 and a pretty healthy outcome for all of them. So we all know that electronics have a relatively fast development cycle and a product life cycle as well. But I wouldn't consider annual goals as necessarily one-offs. But obviously, they will be subject to the fact that we're always operating at a faster truck speed here than we are in other markets. But as it relates to a definition of a one-off, I wouldn't say so. Richard, do you want to take the Medical market before Martin?

Yes. So this movement in Medical margin is actually a consequence of an unusual movement in the underlying currency dynamics and so I wouldn't necessarily focus exactly on it. If you think about the fact that we can look forward for 12 months on a margin basis, and then we got into the second half of last year and Medical revenue reduced quite sharply as a consequence of COVID, we found ourselves overhedged in U.S. dollars in relation to the Medical business. So -- and we then came into this year, and the hedges unwound and were favorable hedges. Then there is a favorable impact on the Medical gross margin from the unwounded hedges , and that actually pretty much accounts for the increase. And it's a one-off because normally, our hedging is reasonably accurate, and that one occurred because of the unusual circumstances around COVID in the second half of last year.

So Chetan, on our outlook for Medical. We clearly spoke over 50% of our business is in the U.S. and we remain cautious about that. We've been using a quite unusual way of looking at this by looking at what people are searching from the point of view of procedures, and it's something that's quite interesting when you look at the number of Google hits on elective surgery. You can make some projections about how confident people are to subject themselves to elective surgery. And we found that to be a quite helpful guide so far in terms of the way in which the U.S. market has recovered. So other people may be using different measures, and we're certainly seeing China back to usual. And we're obviously a bit cautious about what's going to go on in Europe given the way in which the coronavirus is affecting Europe at the moment. Clearly, with U.S. vaccination, you'd expect that the rates of elective surgery would recover, but we're still not thinking that's going to happen until the last calendar quarter.

Understood. Maybe if I can follow up with a slightly different question, which was, Jakob, you mentioned the pipeline activity is progressing. So given now that we are also in some sort of a macro recovery cycle, should we be seeing Victrex go closer to those numbers that you guys have talked about in terms of high single-digit growth prospects in the business in terms of volumes? Because clearly, I think at some point, one would argue that, that optimism on pipeline has to come through in terms of numbers.

I think we were trying to dissect what you said, Chetan, here amongst ourselves. Yes, I think overall, there's every reason to believe that Victrex should be returning back to the rate at which it was prior to the 2019, 2020 recessions, where the company has historically shown the CAGR of between 8% to 9%, so upper single digits. And I think we have a reason to believe that, that is a growth rate that should be expected from us.

The next question comes from the line of Martin Evans from HSBC.

Just a quick question back on Medical and long-term non-Spine potentially. You refer in the slides and also in the text to cardio and also specifically to one of your customers receiving approval, I think it said, for an artificial heart. I mean I appreciate this is presumably a very niche market. But maybe for Martin, could you give us a feel for PEEK's involvement in the cardio market and the very long-term potential as you see it?

Yes. Martin, this is a very specific application, where people who need heart replacements can be extended while they wait for a heart by having an external artificial heart. And when made of PEEK, it's proving to be very successful. So very early days. The early clinical trials are showing that somebody can be kept waiting for a replacement heart for up to 18 months with this particular device. But as you say, it's a pretty niche application. We are, as Jakob said earlier, looking at broadening what we do in non-Spine. We still remain focused on Spine with the Porous project, of course. But there are other areas, I think, where we'll see broader growth than in that very specific cardio space, Martin.

And we have one more question from Alex Stewart from Barclays.

Can I just clarify, Jakob, that comment you made on the midterm growth, 7% to 8% or high single digit, you're talking about volume growth there. Is that your aspiration for volume growth over the midterm rather than the EPS growth?

Yes. That's right, Alex.

And as there are no further questions, I'll hand it back to the speakers for closing remarks.

So thanks, everybody, for your participation today and the questions. We look forward to come back to you when we release our third quarter results in early July. Thanks, everybody.

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