Earnings Transcript for VCT.L - Q2 Fiscal Year 2022

Operator: Welcome to the Victrex Half Year Results 2022. Throughout the call, all participants will be in listen-only mode and afterwards there will be a question-and-answer session. Just to remind you this conference is being recorded. Today, I am pleased to present Jakob Sigurdsson, CEO. Please begin your meeting.

Jakob Sigurdsson: Thank you. Good morning. And welcome, everybody, to Victrex’s half results presentation for the financial year 2022. I am Jakob Sigurdsson; Richard Armitage, our CFO; and Martin Court, our Chief Commercial Officer also here today; also Andrew Hanson, Ahead of IR. As you may know, this is Richard’s last outing as a CFO for Victrex. Before he leaves us at the end of this month to join Morgan Advanced Materials and I’d like to take the opportunity to thank him for the excellent contributions to Victrex and a very pleasant and constructive collaboration throughout his tenure with the company and wish him well in his future endeavors. We also have a number of investors that are joining us by the phone as well, and before we start, maybe first a couple of housekeeping points. The slide presentation is on our website, www.victrexplc.com under the Investor tab and by clicking on Reports and Presentations. We will call out the slide numbers as we are speaking. And secondly, we will have a Q&A at the end and I will open up the room first and then we will take questions from those of you that are on the call. So turning to slide three, I thought it might be useful to summarize our purpose again. It is what drives everything we do actually attracts. Our purpose is to bring transformational and sustainable solutions to our customers and support how they can overcome their material challenges and bring a positive impact to society and the environment. We look to offer sustainable products, and remember that we set out a clear target to increase our sustainable product revenue from -- to 70% by 2030 from where they are at about 50% right now. Environmentally, well, firstly, we have a clear net zero goal. We are signed up to the SBTi. And we will be increasing disclosure of our ESG goals going forward and how we are progressing towards those. Social responsibility, safety is a key plank here, where zero accidents and incidents culture and we have a great record on stem as well on supporting local communities, as well as building a more diverse workforce. In summary, this is how we focus our ESG goals aligned to the UN Sustainable Development Goals. You will be hearing more from Victrex over the months and years ahead on this aspect. Moving to slide four, and the highlights, for the half, well, we have seen a strong demand, despite the tough comparatives with the same period in FY 2021 and we pleased to see 8% volume growth in what was a record first half, if we exclude the years where we saw the consumer electronics contracts business contributing to our results. This includes double-digit growth in electronics, Energy and Industrial and value-added resellers. In medical, we are pleased to see 12% growth in revenues, although some of this period, we still saw an Omicron impact on surgeries. So we think there’s more to go here. Profit were up 3% underlying or 10% in constant currency. Richard will summarize the financial update shortly. But it’s worth noting that the gross margin including the impact of cost inflation and currency would have improved closer towards a target of the high 50s close to 60s. Thanks to better operating efficiency and the utilization of our assets. On inflation, we are taking strong actions to recover inflation through price and operational improvements to offset inflation in the first half and this initial phase is delivering on plan, even if the timing of all price increases does not benefit us through all of the first half. On our additional price recovery is well advanced for the second half and we will update on progress later in the year. Mega programs some further progress here, which I will summarize later on. Before I hand it over to Richard, I would like to highlight some further progress on our ESG strategy with 100% renewable electricity from a U.K.-based sites right now and over 95% globally. Victrex has also joined Apple’s Clean Energy Supplier program and we are established a new Board Committee, our Corporate Responsibility Committee, which will have oversight over progress here. With sustainable products supporting light-weighting and faster and more efficient manufacturing in industries like Aerospace and Automotive, and clinical benefits in medical, we do have a quantifiable example of the positive environmental and social benefits that our products bring. I will now hand it over to Richard for the financial summary. Richard?

Richard Armitage: Thank you, Jakob, and thank you for the kind words. Good morning, everybody. I’d like to start with an overview of our results for the half year ended 31st of March. Demand has remained strong, helping us deliver 8% volume growth in the period, with particularly strong performances in Electronics and Energy and Industrial sales. The value added resellers continue to be robust at 970 tons in the period. Medical revenue continued to improve with growth of 11.6%, but this was slightly tempered by supply constraints in China. Overall, reported revenue grew by 6% to £160.1 million and by 9% on a constant currency basis, with a 4% increase in selling prices compared to the second half of 2021, driven by growth in medical. Gross profit grew by 4% to £85 million or by 8% on a constant currency basis with gross margin broadly stable at 53.1%. It is worth noting the gross margin benefited from operational improvements and better asset utilization. But this was offset by the impact of energy and raw material cost inflation, as well as currency. I will come on to talk about how we have been taking steps to mitigate this. Overheads increased by 6% on a pre-exceptional basis, which reflected wage inflation and some investments in growth related projects. Our bonus accrual is currently slightly lower than last year as a consequence of the high payout made in FY 2021. Our underlying profit before tax improved by 3% or 10% on a constant currency basis and adjusted earnings per share by 2%. Our effective tax rate was 14% having normalized following the prior year in which changes to U.K. corporation tax have impacted our deferred tax charge. We have started to implement an ERP replacement program that will be a critical step in allowing the business to develop digital tools in manufacturing and R&D and with our employees and customers. Costs amounted to £4.6 million in the period, which would previously have been treated as capital and which we are now treating as an exceptional P&L item in line with SAS accounting requirements. We expect this to cost circa £17 million and be expense over FY 2022 to FY 2024. We finished the half with cash of £45.7 million following payment of the final and special dividends in February, with dividend payments having totaled £83 million. The Board is pleased to recommend an interim dividend of £13.40 in line with last year. Turning to the underlying year-on-year movements in profit before tax in more detail, we can see the benefit of the continued recovery in industrial and a better performance in medical together contributing £6.2 million of profit growth. We have also benefited from substantial operational improvements in the half. We have spoken before of our intention to drive a broad program of activity aimed at progressively reducing our manufacturing costs, as well as our Scope 1 and Scope 2 emissions. This is starting to gain traction and taken together with a production volume some 45% higher than the prior year led to a benefit amounting to £8.7 million. This has been an important factor in helping us to mitigate the impact of inflation in the short-term. The impact of inflation in energy, material and freight costs amounted to £9.4 million. We have been particularly impacted by U.K. energy costs and by energy and wage inflation affecting our Asian material suppliers. I will come on to our progress in mitigating this which we are well placed to do. The accrual for our employee bonus scheme decreased by £1.6 million as consensus assumes a lower absolute level of profit growth versus the prior year. We continue to invest in a number of targeted growth programs, which resulted in a year on year increase of £2.3 million in overheads. Finally, the currency headwinds amounted to £3.2 million, which we expect to be slightly higher in the second half, with an expected £6 million to £8 million impact for the year as a whole. Turning to our average selling prices, we did see a sequential improvement by 4% to £0.71 per kilo, compared with the second half of 2021. This was driven by growth in medical, where revenue grew by 12%, with progressive improvements in both the U.S. and Asia. Compared with the first half of FY 2021, the recovery medical also resulted in a mix improvement amounting to around £0.01 per kilo, but this is offset by the impact of currency to leave average selling prices around £0.01 a kilo lower overall. As we noted at our prelim results and at our IMS in February, we have set out to mitigate a substantial part of the impact of inflation through selling price increases and we remain well placed to do this. We chose to follow contract renewal dates in the number of cases, which allowed us to start to increase prices in the second quarter. But we have also chosen to respect a number of longer term contracts in areas such as medical, which means some increases have not yet to take an effect. As a consequence, the benefit of selling price increases in the first half was not particularly material. Looking forward, we expect further selling price increases to mitigate a substantial proportion of the run rate of inflation in the second half, as expected. This would have the effect of increasing selling prices by around £3 per kilo to £4 per kilo, but there will be some offset from currency. We are also mindful of mix in the second half. On the one hand, we expect continued strong growth in industrial demand, particularly from the value-added resellers, and on the other hand, we are seeing some very short-term impact of the lockdowns in China affecting our ability to shipping medical products. We therefore do remain slightly cautious about selling prices in the near-term and for now we would expect a modest overall improvement in the second half. I will cover gross margin in more detail on this slide. You can clearly see the two principal drivers, whereby operation improvement is more than offsetting inflation as already explained. We also saw a slight mix improvement from growth in medical sales, but this was offset by a small impact on the currency headwind, and as a result, gross margin was relatively stable at 53.1%, compared with 53.9% in the prior year. It is worth remembering, now for this year and next year, the commissioning of our China manufacturing facility does create a small drag on margin, which we expect to start to reverse in FY 2024. That development, together with ongoing operational improvements and further recovery in medical does continue to present the opportunity for good margin improvement over the medium-term. As we have commented on previously, we still believe that these factors will allow for recovery towards the high 50s. For the near-term outlook, it is worth noting the moving parts we expect to see in the second half. Firstly as notice we are implementing price increases which in isolation would enhance on gross margin. However, this will be offset by slightly higher currency impact in the second half, along with the short-term mix effects I have referred to. It’s also worth noting that inflation of our raw material prices impacted us later than might have been expected, with the result that the impact for the year weighted roughly 60% the second half. Therefore, we do anticipate the gross margin in the second half maybe slightly lower than in the first, but subject to demand holding up and our price and efficiency actions landing as planned, we would expect margin improvement in FY 2023, showing progress towards medium-term targets. On our next chart I have shown our treatments 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 then the gain or loss on forward contracts is shown as a separate line item within gross profit. Comparing our first half with the prior year, we can see that sterling strengthened versus the U.S. dollar with the weighted average rates moving from $1.31 to $1.37, whilst versus the euro it remains steady at €1.14. This led to a £3 million headwind in the half after the impact of currency hedging. It is worth noting the expected effective U.S. dollar rate for the second half of $1.38, compared with $1.29 in the prior year and for the euro $1.17, compared to the $1.14. This therefore leads to a greater headwind in the second half and also negative impacts on gross margin percentage when compared with the first half as a consequence of our treatment of hedging benefits. Overall, we expect a headwind for the year is £6 million to £8 million with FY 2023 at the moment looking to be broadly neutral. I will touch briefly on China, we have continued to make very good progress. We remain on track for mechanical completion during our third quarter and commissioning in later in the year. There is a risk that the plan could be affected by lockdowns, but we have so far managed to avoid any material impact of those. Our target remains to have saleable products in FY 2023 and we will provide a further update at the end of this year. Our commercial opportunity continues to grow and remain sizable across a number of end markets in China. Our progress can be seen from the latest picture, we have achieved nearly 1.5 million project hours on site and safety performance continues to be strong with over 900,000 hours since the last miner safety event. Finally, we are pleased to report another good cash performance, despite our high capital expenditure, which was in line with expectations at £26.7 million. Our working capital outflow £21.9 million was a reflection of the timing of CapEx and the small inventory build primarily in raw materials. We have not suffered any material impact from the challenges currently being experienced on global supply chains, but we have increased our safety stocks have a number of important materials as a precaution. Our tax outflow was relatively low at £5.6 million. We do have borrowings of £9.3 million, which relate to a facility we have established in China to support investments in our assets there. Dividends amounted to £83 million, including £43 million for the special dividend, and as a result, our cash balance at the end of the period was £45.7 million, which includes £3.8 million ring-fenced in China. Looking forward, we expect CapEx of around £60 million for this year, possibly something similar next year as we conclude on China investment and also carry out some process improvements in the U.K. We should then see a step down in CapEx to the order of 10% of sales, which reflects an expectation that some additional CapEx will be needed as we progress towards our net zero goal. And thinking about our investment plans, our target remains to return the business to a 20% return on capital over the medium-term. We review our existing and new investments on a continuous basis to ensure that this can be achieved. Thank you very much and I will now hand back to Jakob.

Jakob Sigurdsson: So, thank you, Richard. And now turning to the industrial update on slide 13. Firstly, we have started now to report again our material annualized revenue number. Remember this is a measure of the health of our core business application pipeline and is based on the potential of all targets delivery. I am pleased to say that we saw 6% growth in the core application pipeline versus the first half of the year, with much of our annualized revenue now of around £300 million. Looking at our end markets then, firstly, in automotive, whilst most peers -- like most peers, we saw the impact on the semiconductor chip challenges in the second half of 2021. We are seeing more recent improvement and in Q2, we saw a sequential growth of 13% over Q1. So we are seeing a better short-term picture for Auto, though this will remain patchy over the year, for sure. We have seen forecasts for the overall production in the automotive industry being revised down as of late. I think the expectation, in general is that the output will be flat year-on-year, with some greater growth next year. But as I said, Q2 was a good one, much better than Q1, the demand has been quite volatile as you might imagine. On a half-on-half basis volume were down 8% altogether, though. This does reflect the worst impact of Semicon from last year on some of our new programs. However, I will come back to talk about our E-mobility in a second. For peak years, the pipeline remains healthy and we are seeing some growth in what we call resin plus business where we help design the application of IPs in the development, but the manufacturing is supported by partners. Resin plus effectively means that Victrex gets the pool through on demand for a polymer to support gear sales and remember that peak years sold over £1 million last year and for FY 2022 we expect modest growth above this level. In Aerospace, last week, I was with an Aerospace team at the JC Composites Show in Paris. We saw a great recognition for composites program there and we have seen a steady sales of our composite based parts for prototypes, some of which were on show in Paris in the form of large structural pieces, bulkheads, ribs and other very large parts of the plane. As a recap, we have a number of programs with our major OEM, including the well published one via Airbus, the Clean Sky 2 program, the main product, which is gaining traction in the Aerospace industry for us is our AE250 low-melt PEEK polymer. Remember that this offers faster processing benefits for the processors, the cycle times reduced by at least 25% and we also have an AE250 composites tape form, in polymer form and obviously in parts as well, with a good range of qualifications right now. Also, AE250 offers good sustainability benefits with good recyclability. And obviously, PEEKs ability to be molded means less scrap in the whole value chain. In our Aerospace business, we have seen a steady improvement deliver 4% growth year-on-year. It’s steady recovery. But it’s fair to say that we have seen greater activity levels and interest over the last six months or so. So whilst we have seen a significant impact on the business in the short-term, we are starting to see a slow but secure ascent now that build rates are starting to pick up again, particularly with Airbus getting close to it their pre-COVID levels, maybe 10% to 15% short of where they were pre-COVID. In Energy and Industrial 14% growth, which was supported by high activity levels in Energy, which was up 23%. The Industrial part of this segment includes applications for food processing, robotics, and the like, and other general industrial applications. If we then look at the Energy part, most of this business for us remains as onshore oil and gas, whether that be the U.S. or the Middle East, but we are making progress in other alternative technologies, also including hydrogen, wind and carbon capture applications. For Magma, I will come back and talk about that separately a little bit later. Turning to Electronics, further progress here, with 8% volume growth, despite smartphone shipments being down over the same period by approximately 11%, but Semicon demand remains very healthy and we have a strong play in Semicon, as you know, with both CapEx and the OpEx side being strong benefiting our business also. Finally, value-added resellers, a very strong performance, despite tough comparatives, volumes up 14%, and remember that value-adds largely correlates with many other end markets, particularly Energy and Industrial, Automotive and Electronics. We continue to work very closely with our customers to gain insight on their order books to allow us to optimize the supply chains between us and to develop new applications for OEMs and mutually support growth. So a very pleasing performance here and the order book in the large area remains healthy right now as we speak. If we now move on to slide 14, on E-mobility. Firstly, some good news on E-mobility. We talked about development programs we have been building over the last couple of years, we now have a healthy double-digit pipeline of the next-generation of high voltage application programs for the motor and some battery opportunities as well. Pleasingly two of these are now at SOP and will start I think to see E-mobility revenues building from this year onwards. Our application areas are focused around insulation be it against heat or electricity. Remember that PEEK offers excellent thermal insulation and the dielectric properties are conducive for use in high voltage application. And we know, for example, that there is also sustainability from using PEEK versus animal in coating wire as an example, it has processed benefit at times and also helps to reduce solvent emissions from the incumbent processes. One of the new business wins is replacing polyamide to this. So this is a great example of PEEK being chosen for a combination of properties actually and more to come here, but good news and we look forward to seeing revenue built here from next year onwards. If we move on to Magma on slide 15. Recently we had a presentation to the Victrex word from some of the senior TechnipFMC leaders. As you know, Victrex’s equity was acquired by TechnipFMC and they are putting significant capital time and resources now into scaling up in Brazil, including building a new facility there. Bid programs are currently out to tender and it’s down to Technip to update on the outcomes of those, but safe to say that we are quite optimistic on the progress here. Using a hybrid flexible pipe with steel armoring surrounding the PEEK core offers 50% weight savings compared to metal flexibles and is also a free hanging solution. The core on the slide is from TechnipFMC, they regard the hybrid pipe as the most cost effective riser solution for Brazil, less need for buoyancy boats, less need for offshore welding, given the solution is manufactured onshore as an example. For Victrex, remember that the pipe is based on Victrex PEEK and Victrex composite tape, with all the qualifications built into the program. We also have a support and services agreement with TechnipFMC. As it relates to timing, the focus for FY 2022 remains the qualification programs and manufacturing test based pipes. Technip are then looking to be ready for scale up in 2023 in the latter half of last year and are committing capital and resources to do this on a significant scale. So, overall, it’s fair to say that we remain very pleased with the progress on Magma. Moving on to Medical on slide 16. Very pleasing performance here with revenues up 12% as surgeries began to return in greater numbers. We saw growth in all regions. Although, Asia saw a record growth performance in the first half, as economies there opened up faster than elsewhere and we saw 38% growth in Asia. Spine remained in growth but was offset by the Omicron impact in the U.S. in late 2021. Pleasingly, we are seeing sequential progress in the calendar year-to-date within the U.S. In non-Spine, good progress with 25% growth and non-Spine now bigger than Spine, as we grow across all segments, particularly in trauma, but also in cardio and drug delivery applications. Looking forward, as Richard had noticed -- noted, China lockdowns I want to watch for Medical, given access into China supply chain right now, as I am sure you are all aware of. But, overall, pleasing progress in Medical is clearly an area that we expect to see good growth over the coming years, and obviously, that will support mix to a great extent. Now move on to Knee. Knee has one program and has moved faster than our expectations over the past 12 months. We are now halfway through a patient’s recruitment with 15 patients implanted with PEEK based Knees across Belgium and India, and three patients are beyond the 12 month states without any complications. As I said, none of these patients have needed any intervention. So this bodes well for the trial as a whole. Our next steps with our partner Maxx Orthopedics is to complete the trial for the 30 patients. We are also looking at establishing a trial site in the U.S. in the second half and recently I visited a major top five orthopedic company and we are hoping to close on additional partnership very shortly. The demand pool and interest levels from major orthopedic companies has increased since a clinical trial started as you might imagine, and in summary, excellent progress, a great opportunity. Remember that Knee, the global market for Knee is at least $10 billion on an annual basis, and probably, a $1 billion addressable opportunity for Victrex. To put it in perspective, at this day, at today, roughly 13.5% of the population is over 60. In 2050, it’s predicted that that’s going to be around 22% and I think with an aging population and a more active population, this opportunity is only going to grow. We are looking ahead to completion of the first patients early next year in a clinical trial, and hopefully, we can start the commercialization soon thereafter. I will go briefly on the bubble chart on slide 18. The main movers here are gears. As I said, we are anticipating growth on the £1 million revenue from last year. Thanks to both parts and resin plus based revenue. We are expecting not to be significantly larger this year and E-mobility, we have secured new business wins, which will already start contributing revenue towards the end of this year. Overall, our growth pipeline remain strong, with a broad portfolio of programs. The specific milestones for each of these mega programs are shown in the appendix to this presentation. On slide 19, again on ESG, as I said, at the start of the presentation, we have a strong ESG profile and a great story to tell in terms of how our products can help us to reduce Co2 emissions through light weighting, with quantifiable benefits in the likes of aerospace and automotive. In terms of our net zero ambition, we are looking at alternative fuels and alternative processes and technologies as a way to deliver our 2030 net zero goal. This will be complemented by the likes of renewable efficiency, which I talked about earlier. We are now more than 95% renewable electricity for our global footprint and 100% for U.K. sites. But the big way for us to close the gap we will be reducing -- gap we will be reducing the climate impact for our own operations. And you may have seen us lobbying for access to hydrogen as one example. And indeed, we have been building links to other partners to see if this can be done for our main U.K. manufacturing assets, particularly those in the northwest. As the chart shows, if you model your own business growth, without any mitigation, our mission would accelerate significantly, which is why we are setting out the ways, we can get to a net zero goals in quite a clear way. We will update you more on this, as we move forward. On the outlook to finish off, we remain positive about volume growth going into the second half, even if we are mindful of the changing economic environment. If you look at the end markets, Electronics, Energy and Medical, we remain positive on the outlook for all of those, the Semicon market is still seeing very healthy demand. Oil prices that are at high levels right now and are likely to remain high, obviously bodes well for our Energy business and highly correlated with our performance in that area. And activity levels in Medical with returning surgeries give us a reason to be optimistic about the prospects there. On Aerospace and Automotive, you heard me talk about Aerospace, we are seeing a steady ascent there and I think that’s something that we expect to continue. And with Automotive, it will remain volatile, between now and the end of the year for I think well documented reasons that you all follow very well. So on slide 31, to wrap up, we are focused on volume improvement in the second half, which should look better than the first half, and consensus volume of 4500 tons. So I think we will definitely come in quite a bit higher than that. We have clear plans progressing to mitigate additional inflation that we have seen recently and it is piecing their operational improvement would have seen good margin progression, we are not for the significant in fact -- impact or the inflationary impact, which we are focused on recovering, as Richard talked about in his part. Overall, we are focused on a good year-on-year growth. Our core business is in excellent shape. We have grown the core over the period of COVID and it coming -- it’s coming out of COVID stronger than it ever was before. So I think we have short-term growth opportunities around the core and they will stay with us going forward as well. But we are also getting closer in time to where the mega programs will start to significantly add to our topline, as evidenced by the comments that I mentioned relating to Magma in particular and E-mobility also. And last but not least, our ESG credentials are growing and we have a clear plan to progress us towards our net zero goals. So thank you all for listening and I will now hand it over to Q&A.

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Chetan Udeshi of JPMorgan. Please go ahead. Your line is open.

Chetan Udeshi: Yeah. Hi. Thanks, morning. A bit more direct question to start with, and Jakob, you were referring to upside to full year 2022 consensus volumes. If I do my math that would suggest that the volumes in 2022 should be probably close to 10% higher than what you guys did in 2018, which was sort of last year peak before the slowdown and COVID, et cetera. But then when I look at the PBT consensus, we are still talking about something which is down almost 25% versus that level and I was just calculating that’s about £30 million lower out of that £5 million is FX. I mean, I -- my question is, we can see a lot of focus on growth, which is great. But is there a sort of more relaxed approach on earnings to achieve that growth now or is that not the case? Because I guess the concern is that, we are seeing growth on volumes, but not on earnings and at what point do we start to question that, that incremental growth is not resulting the same contribution to the bottomline, if you will?

Jakob Sigurdsson: Chetan, good morning. I will take that. So, first on your volume assessment, I certainly think you are in the right ballpark. If you took 2018 volume, took out the large Electronics contracts and then went up by about 8% to 10%, you are in roughly the right area. But there have been significant moving parts on earnings. And the biggest would be currency, which over that period is going to been of the order of £14 million to £15 million, then inflation, which actually is probably even slightly higher than that, so somewhere between sort of £15 million to £20 million over that period. So you very quickly understand why the current rate of earnings might be lower. And then I think, thirdly, we have got to bear in mind that we have made a number of investments in Parts businesses, and in China, all of which are progressing towards a desired rate of profitability, but are not there yet and they have represented a drag on gross margin. So I don’t think there is any let up in the focus on earnings at all. But we have been in a period with some fairly unprecedented economic movements, which we are in the process of managing our way through. We have deliberately invested in downstream activities, which are focused on expanding the markets for PEEK and if we didn’t do that, we wouldn’t have the future growth opportunities versus those currently face. And that’s therefore how we find ourselves where we are and we have signaled that our target for gross margin that remains in the high 50s and our return on capital employed target remains 20% and we are very focused on a very regular basis on how to return to those targets.

Chetan Udeshi: Understood. And maybe if I can follow up on the question-- the comment around the core pipeline, can you -- can I ask, how should we read this number, because it says mature analyzed revenue of £303 million. I mean, the run rate of revenue today is 3.30 [ph]. So how should we read that commentary around pipeline and what it means for future growth, because I am a bit confused how to read that specific number?

Richard Armitage: Yeah. So, Chetan, I will take that. So that’s our assessment of what that pipeline could deliver at maturity. There’s obviously an element of risk associated in there as well, which is why that number looks so high. So there’s an element of average risk adjust that as well. So but it’s the present the scale of the sorts of spaces in which we are seeing new opportunity to use PEEK in the core business, where there are many people sort of approaching us about new opportunities, us finding new opportunities to use PEEK inside the core.

Chetan Udeshi: And is this all incremental to existing revenue or is this including some of the programs, which are in current revenue base, because otherwise, we are talking about almost doubling of revenue, right, if all of these pipeline were to materialize?

Richard Armitage: Yeah. There will be a mixture of cannibalization in there as we see different opportunities come through replacing some of our products in there. But it doesn’t include any of the mega program revenue, that’s separate.

Chetan Udeshi: Understood. Thank you.

Operator: Thank you. [Operator Instructions] And that next person is Charlie Webb from Morgan Stanley. Please go ahead. Your line is open.

Charlie Webb: Yeah. Good morning, gentlemen. Thanks for taking the questions. First off, can you just share your latest views on the cost buckets, as we think the kind of year-on-year positives and negatives, FY 2022 versus FY 2021. Obviously, lots of moving parts, inflation continues to run high, just if you could clarify the various bits and pieces within that, as we think of the bridge would be very helpful? And then just secondly on pricing, you kind of mentioned some parts, you are pushing pricing albeit, it’s on the safe to bit of a bit of a lag to come through other parts, unlikely to push it through given the kind of a longer term nature of the contract. So just trying to understand what portion of the business, have you been pushing pricing. What order of magnitude and any chance that we are going to see kind of surcharges from you to tackle some of this near term inflation? Thanks.

Richard Armitage: So Charlie, good morning I will start from that one. So we indicated in the first half the impact in inflation was around £9 million. I have indicated that sort of roughly, the impact for the year is roughly 40%, first half 60% second half. So that’s a pretty clear indicator that we expect the impact for the year to be a little over £20 million. And that is about two-thirds energy, one-third materials, if that helps. Nothing is always worth noting in our case, that primarily material inflation is not commodities, as other chemical businesses might see them. This is more to do with us buying intermediates, particularly from Asia. And if some of those are on long-term contracts, where we have been able to manage -- the extent to which those increases affect us in the short term, which is why some of that inflation hasn’t landed until a little bit later in our financial year. So that gives you an idea of the shape of the inflation. I think what we have indicated around pricing is, this is not a commodity business, as we said before. We have predominantly in our customer base, very long-term relationships contracts covering the vast majority of our business. And we have felt it prudent to respect those contracts, to address pricing -- increases as those contracts have become due for renewal. That did give the opportunity for price increases to be put in place during our second quarter, mainly taking effect towards the end of the quarter or early in the third. And has meant that there are a number of areas where we have customers on longer term contracts, where we are not yet ready to increase prices, so there is more to come. Therefore, we have not implemented surcharges of any material degree. We think for us, this is the right, this is the right approach we are a high value business. And a very important point is that as things progress, we would expect those prices to be pretty sticky. So in other words, we would expect to be sustaining those price increases for the longer term. So it’s a different mechanic, don’t particularly want to be precise as to exactly how much of that raw material -- and energy inflation, we will recover. But the point I made is that if you take the second half run rate of inflation, we expect it to be recovering on a run rate basis, a very substantial part of it.

Charlie Webb: Very helpful. And may if I could just have -- squeeze one more in just on the demand side. You seem pretty constructive on the demand outlook as we are today, looking at the order books. Are there any signs of any nervousness from any customers in any end markets, it’s just obviously, we hear a lot about the consumer and the pressures that we are facing and others are facing around the world. So just wondering if any of that is kind of materialising in any discussions you are having with customers at this stage, or is it -- or just talk and for now, the numbers just -- and the orders just keep ticking on in?

Jakob Sigurdsson: Yes. I think the way we are approaching it Charlie is, the only certainty and sure enough, the order book for us, looks very healthy as it -- looks towards the end of the year. But I think everybody and anybody in business these days has to make sure that this -- the ship is to sail through a potential storm as we had, let’s say, into the fourth quarter of this calendar year and into the next one, I mean we are seeing GDP forecasts being revised downwards in all of the major economies. We are also seeing interest rates rising again, even if they are not really high by historical standards by any means. So I think, there are some clouds on the horizon that anybody in business needs to be mindful of, and be ready to deal with, should they actually pan out. And I can certainly say that, that our team is ready to tackle those. To delays to conversations with customers, it’s interesting these days, that while everybody’s keeping their eyes on the long-term horizon that I was describing, that is uncertain. If we look at our vast customers, their order books are full. Their lead times are actually quite long. So the demand situation is healthy, and they have not been able to recover their level of safety stocks, during this past 12 months to 18 months of recovery past COVID so they are basically running flat out all of them. If I look at the automotive sector, as I said before, we are looking to see sort of a flat level of production for 2022 compared to 2021. But there is still a belief in a catch up in 2023 and onwards. And we are expecting sort of a healthy outturn for automotive between now and the end of the year and probably going to see a second half that was better than the first. Aerospace on a slow, but I think secure upward trend there is need for investment in the newer planes. I think actually, we might see some of the older planes retired faster in the face of rising energy prices, where fuel efficiency light-weighting and efficient motors count for more than they ever did before. I think there is a healthy underpinning for steady growth on the aerospace side. And Electronics, as I alluded to good signs from the Semicon sector of the business, consumer electronics, might be faced with some difficulties, with higher inflation, for sure. And we have seen a contraction in smart devices over the recent horizon. But I think overall with our exposure to Semicon, that underpins our optimism for between now and the end of the year. And clearly medical, we have still room for improvement given that, most countries are not at pre-COVID levels as is it relates to the number of elective procedures that are being performed. And I am saying that though, with the caveat of the situation in China, because I don’t think we have seen the full impact of the lockdown in China yet. And it’s likely to be a cascade of closures throughout different provinces if they stick to the zero-COVID policy. And that will definitely provide for some supply chain and logistical challenges to what to say the least. So I think, very optimistic based on the demand for the short-term and between now and the end of the financial year. Certainly a lot of favorable macro-economic drivers, but also worrying signs that we need to be mindful of so it’s a balanced picture, as you would expect.

Charlie Webb: All right. Thank you very much.

Jakob Sigurdsson: Thanks, Charlie.

Operator: Thank you. And we have further third person during the queue that’s Kevin Fogarty at Numis. Please go ahead. Your line is open.

Kevin Fogarty: Thank you very much. And thank you for the presentation. I just had a question really on the inventory levels? I think I picked up in the presentation. You haven’t seen sort of material kind of supply constraints, that safety stocks have been increasing? I just wondered sort of what they are -- reflecting there. Do you think that the risk of supply constraints is increasing here? And just if you could give us a feel for what’s sort of level of investment this might require, as we look for the sort of full year. Are we seeing a kind of step up in terms of the sort of inventory investment you think you need in second half of the year?

Richard Armitage: Yes. It’s a good question. So the increase in inventory has been driven by two things. So firstly, raw materials and intermediates that was about £5 million. And then actually, the balance of it was the, if you will the effect of inflation. So in other words, we see inflation come through in the period, a certain amount of that is held in stock given how relatively high stock levels. And so that was the balance. We haven’t had any material impact of supply chain issues. Certainly, we have seen bottlenecks for instance, in Chinese ports -- equally Japan, which could maybe cause some disruption, but we worked our way through those. So in fact, this is really just more of a precautionary approach. Given this at the moment, supply chains are a little bit unstable around the world, I think we would probably want to do a little bit more. So you could see a few more million pounds going into inventory, as assuming these kind of, conditions continue for a while, but that would be about the extent so I think.

Jakob Sigurdsson: And if I may sort of expand on a little bit, we are a critical part of our customers business, given the nature of our product, given the specifications, and given, our reliability here. And reliability as a supplier is easy for us. We have navigated COVID, incredibly well delivered with way over 90% delivery on time in full, it’s not been without challenges but we have stuck to that. We are a -- even if we were highly sort of technically and scientifically based business, we are also a high service level business. And that, relates to both reliability as a supplier, but also as it relates to tech service and helping our customers. So manufacturing challenges hit the product in the appropriate way into formulations for different applications so it’s not just about the technology, it’s very much about the service as well. And we are very much driven by the commitment of not leaving our customers hanging high and dry. And we have, I think gotten great accolades for our performance, both during the COVID period not least in the period of recovery as well, when demand recovered at a very fast pace, and is running at a very fast pace, even as we speak today, with low sort of supply chain challenges that needs to be managed on a day-to-day basis. So that’s likely to -- lead to the outcome that Richard was describing in a quantitative way. But qualitatively, this is a part of our strategy absolutely fundamental part of our strategy to be the reliable partner, both on logistics, supply availability, and technical service.

Kevin Fogarty: Okay. That’s helpful.

Jakob Sigurdsson: Market for PEEK so…

Kevin Fogarty: Go ahead. Okay. So we should sort of read it as it sort of measures and steps to ensure you don’t have any sort of supply issues effectively. And you can keep that continuity of supply going?

Jakob Sigurdsson: Exactly. And naturally, given the challenges in the supply chain, this will lead to increase in safety stock levels for both raw materials and products. And Richard has quantified that.

Kevin Fogarty: That’s helpful. Thank you for that.

Richard Armitage: Yes. Can we just point out that this is the phase that we will take questions in the room at this point?

Jakob Sigurdsson: Yes. We are just emptying the line on the phone. And then we will turn to the room in the reverse order, actually, that we had planned.

Operator: Thank you. There are no further questions on the phone at this time. So please, go ahead.

Henry Carver: Brilliant. Thanks, guys, Henry Carver from Peel Hunt. Just one slightly in relation to the last few queries and just thinking about the stocking levels that, customers across the business, but predominantly VAR. Is there a sense that some of the volume growth coming through at the moment, being that strong is kind of over ordering on there, and just because of the general kind of supply chain, panic situation not quite panic, but and if that is the case, how should we look at that over the next six to 12 months do you think?

Jakob Sigurdsson: Yes. I think there’s bound to be some element of that in all supply chains around the world these days. You have heard this phrase, companies moving from just in time to just in case and some comments on the sort of global macro-economic level, saying that, that there will be a lot more localization going forward as well, because people are not as willing to be reliant on long-term or long supply chains, actually and we will try to be more independent on that. I think in our case, we have worked quite closely, particularly with the virus as of late to synchronise our demand assumptions, to the effect that our order book probably with a never has extended as far out into the future. So that’s basically saying we are mirroring their demand on our supply plans as well. So that leads me to believe that there’s probably less of an impact in the short-term from overbuying, if you wish, then the otherwise would have been. There is less of hoarding with that constituency than you might have seen in the past number one. So I think that -- definitely a point. So I think we have benefited from that synchronisation, we worked extremely well together on the downturn. And when the sharp upturn came along, I think we use that opportunity to get closer to their plan as a supply chain people than we have ever been before. So I think our demand picture as it relates to their demand is -- clearer than it’s ever been and likely to result in lower overbuying. Now, they are still running flat out themselves, as I said before, so they have not been able to build up their inventories. But I do think that it’s a fair assumption that some of their customers will definitely building a higher level of safety stock than then they have had in the past. I am not sure there is hoarding of material, but there’s bound to be some increase in safety stocks across all supply chains in the world, based on the uncertainty that all of us are very much aware of. So there will be some element of that for sure. But then you can go look at the flip side off and look at the macro-economic drivers as we sort of tried to talk through it, high energy prices, high demand for Semicon. So there is very high and demand for the end product also. So there’s no absolute answer, of course. But I do think that in our numbers there might be less reflection of hoarding that it might have been in prior years, primarily because of the synchronisation of demand assumptions and then the fact that our immediate customers are running flat out still.

Henry Carver: Thanks.

David Farrell: Hi. Thanks. David Farrell from Jefferies. Question about China and can you just kind of remind us when that starts up? Are they all incremental volumes, and give us some sense of the ramp up phase, how many years that will take and to what degree that will be the drag on margins until it turns profitable? Thanks.

Richard Armitage: Sure. So we are expecting commissioning to take place during the balance of this calendar year. We have noted a little bit of caution around the current lockdown situation, but I have to say we haven’t actually been impacted materially by that so far. So hopefully, we will carry on as planned. That means we get into commercial volumes during 2023, there has to be a certain number of product certification processes. The regulatory environment in China is at least as demanding as elsewhere in the world. So, we probably don’t see an easing of that impact on gross margin until 2024. The demand is definitely there. I think the way to look at it is that the output from the plant would be substantially incremental. So we are making a different grade of peak to advance that we would predominantly supply at the moment. So that opens up different and new opportunities to us. And frankly, every time we look at the market, there are more and more opportunities there we measure a pipeline that keeps on getting bigger. So hopefully that gives you an idea of the shape of how that is going to evolve.

David Farrell: Yes. Perfect. Thanks.

Unidentified Analyst: Hello. Good morning. Andrea Emmanuel [ph] from Berenberg. One question on the U.K. debottlenecking and can you quantify maybe what would be the structural cost savings from this investment when it’s completed?

Jakob Sigurdsson: I think it’s, we wouldn’t give out the exact number here. But the driver is twofold. On one hand, it’s productivity improvements. But you could also look at this as cheap CapEx investment as well, giving us relatively inexpensive capacity increments by debottlenecking the plant? And related to the first one on productivity, a part of it, it also related to our ESG strategy, to make sure that our facilities are efficient as possible from an environmental and safety perspective. So we have talked about it before that that, the size of it, what was the initial total size of it that was broken down the capital of debottlenecking.

Richard Armitage: So we have spoken previously of the order of £15 million.

Jakob Sigurdsson: Right that was initially anticipated to be done in one year. Now we are seeing a better way to actually execute it. So we are executing that over a number of years actually, but it does these two things. Part of it you have already seen in some of the numbers that Richard was presenting earlier on productivity and how that’s mitigated cost increases. So that had a productivity impact. But the other part of it, it also helps us need capacity and needs -- growing needs for volumes going forward in a probably more balanced way than to have to go for large scale investments like we did with PP3 [ph] in 2015 or so when we went with new capacity to the tune of around 3000 tons in one swoop for about £100 million at the time, £100 million at the time. I think of productivity gains, this being as a source of productivity gains, and ESG efficiency. And secondly, a more balanced way to get capacity on stream through less expensive waste, if you wish.

Sam Perry: Hello. Sam Perry from Credit Suisse. Just a question on Magma it’s made it’s meaningful revenue of £1 million to £2 million, but on the Mega program chart it’s always indicated as sort of £50 million-ish revenue -- there about. And it’s had meaningful revenue delivered for a while. So how do we think about the ramp up to the £50 million-ish or there about? Is that something that continues to get pushed out?

Jakob Sigurdsson: No. This one is actually a very simple one. And that is that, we have seen meaningful revenue for a while through qualification material being sold. And so that sort of defines the level of revenue from Magma to-date and until you start to see a deployment in Brazil. So we will probably see some increased revenues from qualifications in the near term, but they will be of similar orders of magnitude. But then when it ramps up for risers, in the Libra field, that’s when you see the real kicker and you will start to see some of that coming in 2024, through the rest of this decade, essentially.

Richard Armitage: Yes. Sam then the journey towards £50 million is still secure in that project. But it’s all dependent on techniques ability to deploy they are putting in significant resources to deploy in a particular field where you can’t get access without this technology. So I think that -- it’s about timing, but I think the revenue is still.

Jakob Sigurdsson: And then, I should also mentioned that there are other sort of emerging opportunities with flexible pipe, both related to hydrocarbons, but also related to renewables and then particularly in the area of hydrogen, and that’s probably something that we will be featuring more prominently, as we go forward as well.

Andrew Stott: Good morning, Andrew Stott from UBS. I had a couple questions I wanted to come back on the pricing issue. I just wonder what’s holding you back, like, what are the consequences of putting prices up because even your commodity peers, and they are not competitors, their peers are getting price increases of 20% plus?

Jakob Sigurdsson: Yes.

Andrew Stott: It feels as though it’s never easy getting price increases, but in this environment, it’s easy than the most. Why not put prices up or break contracts and put surcharges in what holds you back?

Jakob Sigurdsson: I mean, this is we have chosen to honor the contracts and we feel an implementing surcharges is a bit of a draconian measure. We have been growing our share, if we compare ourselves, or use your comparison of some of our peers that are probably, have a greater portfolio of commodities. It will be interesting to see how the price increases are split between commodity and speciality. And I guess you might be hearing a similar story there, we are not a commodity business. We know, what we mean to our customers and their customers, we do honor contracts. And it’s a reputation that you earn over a long time. And I am sure we will reap the benefits of it when the tide change is also. So it is a part of building the business and the health of the business for the long-term, even if you may suffer a quarter or two. And we know that our business, once we get it, it usually stays with it for long. So it is in these defining times, that your performance is really evaluated and assessed. And that’s how you can build a long-term franchise.

Richard Armitage: So, Andrew, I think there’s a really interesting dynamic with many of our customers, where if we are not careful we feel like -- what they feel like they are held to ransom. And we have to be really careful not to do that because we want them to continue to be with us on an ongoing basis. And if we overplay our hand in situations like this, it becomes really damaging to the relationship. So it’s how we balance those two.

Andrew Stott: Okay. That’s good. And the second question completes up on autos. You usually mentioned that your autos volumes for the half are down eight which, to me is similar to how global to production looked for the period. I would have expected more, because your loading per vehicle should be going up due to EV?

Jakob Sigurdsson: Yes.

Andrew Stott: So can you square that circle? Thanks.

Jakob Sigurdsson: So if we look at it, we were down half one and half one 7%, Richard, if we compare half one 2021 to half one 2022, 7%. I think we are going to look at probably a significant growth half two on half two remember -- there was quite a bit of suffering in the second half of last year Andy. And I think we will see a better second half this time around, we definitely see that we are increasing, our share of wallet as well. A few years ago, we might have been at around eight grams, we are probably above 10 right now. And I think, you are only going to see that number grow as you grow forward, it’s still difficult to compare numbers of manufacturers cars in a quarter, to our sales in a quarter, because there is quite a long supply chain between ourselves and when the car comes off the conveyor belt. But I do think, you should expect to see the long-term trends, they are still they will go in to a higher content per car. And if you remember, sort of our reference milestones, they went from eight, through to 10, penetrating existing applications, mainly associated with the ICE, up to around 20 as an opportunity with gears and up to 100 with E-mobility. And I think these are useful benchmarks that we feel quite comfortable with and still and I think are valid ones. If you then look at the content per car in an EV world where we might have a substantial part of the, of let’s say material associated with insulating wires and high -- performing high voltage motors, some of the things that will translate across in terms of bushings and bearings and actuators and things like that associated with battery materials and brake pads. I think, the obvious content in a car that has all of that is obviously measured in hundreds of grams if not more. But I think it’s still a useful figure to benchmark this average for the overall car produced. And we are definitely on the right trajectory there. But it’s very difficult to square on a quarter-to-quarter basis.

Richard Armitage: I think Andrew don’t forget the chip shortage has created a volatility. So the recovery after COVID has not been smooth. And also, initially probably a recovery that was faster than people expected. We certainly saw the benefit during our second half last year with very strong growth. And also, then the noise around the chip shortage was particularly acute. And roughly in our first quarter, so October to December that you have seen that come up again and as Jakob has anticipated we expected better second half. So there’s been quite an overlay from that market volatility.

Jakob Sigurdsson: Not to mention the Ukraine atrocity as well impacting German manufacturers, to the extent that some of them had to shut down for quite a considerable time also, so there’s all kinds of curveballs being thrown an impacting the demand pattern in this particular sector.

Rikin Patel: Rikin Patel from BNP. Just a quick follow-up on costs I think you booked 6% underlying overhead inflation in H1. Should we use that as a guide point for the second half? And then secondly, in the medical business, how much visibility do you actually have on the improving medical rates in the U.S., given the slowdown in the end of last year? Thanks.

Richard Armitage: So I will take the first one. So yes that’s probably about right for the second half, maybe even slightly higher, but I would use that kind of order of magnitude.

Jakob Sigurdsson: So on the visibility then of all industries, Medical is the one that is the most impacted by COVID, particularly if you are a non-elective surgery, which most -- which is where most of our business is, so there’s a mixture there of patient confidence of surgeon confidence and capacity to deal with non-elective with elective surgery on top of the non-elective procedure. So we keep pretty close measure on what’s going on with the particularly the spine market and we have seen stuttering progress. In the U.S., we saw very strong recovery in China. Now of course, the big question is what’s going to happen in China? We should also look at the fact that if we look at attaining versus peak and then we have been looking at that trend on an ongoing basis. And we continue to strive really vigorously to get a porous peak offering because we think that that’s the best surgical procedure option and where we continue to work towards getting FDA approval for that process. Once that’s in place, and I think we will see a really significant change there.

Jakob Sigurdsson: So I don’t think there are any more questions in the room. Are there any more questions online?

Operator: No. No further questions on the phone at this time.

Jakob Sigurdsson: So thanks, everybody for attending the call, whereas on the phone or here at JPMorgan and we look forward to speaking to you again once we talk about the third year -- the third quarter results. Thanks everybody.