DVO.L Regulatory News (DVO)

1 March 2016

Devro plc

RESULTS FOR THE YEAR ENDED 31 DECEMBER 2015

Devro plc ("Devro" or the "group"), one of the world's leading manufacturers of collagen products for the food industry, announces its results for the year ended 31 December 2015.

* Exceptional items: 2015 (£14.1m), 2014 (£23.9m) related to the three year transformation programme

2015 Results highlights

Peter Page, Chief Executive of Devro, commented

"2015 was a year of notable progress for Devro, with sales volumes growing in a number of key markets, the completion of two restructuring programmes resulting in substantial cost reductions, significant progress in our investment projects in the US and China and the acquisition of a specialist European collagen gel business.

 "Our transformation will complete in 2016, after which Devro will be well positioned to supply all our markets with competitive products from efficient manufacturing operations. The benefits from this transformation will begin to flow through to profits in 2016 and the long term growth prospects are strong."

Contacts

There will be a presentation today at 9.30am for investors and analysts at the offices of FTI Consulting, 200 Aldersgate, Aldersgate Street, London, EC1A 4HD. A live audio feed will be available to those unable to attend this meeting in person. To connect to the webcast facility, please go to the following link: http://view-w.tv/943-1289-16925/en approximately 10 minutes before the start of the briefing (9.20am). The presentation will also be available on the company's website. 

Chairman's Statement

We entered 2015 with three main areas of focus for the executive team: to develop our market position; to complete the restructuring of our operations in Scotland and Australia; and to maintain momentum on the implementation of our major investment projects in the USA and China.

In tough market conditions, overall volumes of casings sold increased, most notably in key markets such as Japan, North America and South East Asia, and many key accounts have been retained elsewhere in the face of strong competing offers. Sales of co-extrusion gel in North America continued to grow well and the acquisition of PV Industries has now firmly established Devro as the market leader for gel in Europe as well.

As part of our restructuring we took out capacity of older, less efficient technology at one of our factories in Scotland, which was an important step in aligning our product portfolio with market opportunities. In Australia we initiated the outsourcing of hide preparation operations. There was some disruption as we worked through the planned actions, but I am pleased to report that we have delivered annualised cost savings of £5.8 million, slightly ahead of the targeted amount.

In the USA and China we are undertaking two strategic investment projects to build new plants in these locations. It has been challenging to support two such significant projects in parallel, but we have made good progress this year and the projects remain on track for completion as planned in 2016.

Financial highlights

Operating profit before exceptional items was £33.3 million (2014: £30.3 million), representing 10% growth over 2014, primarily relating to the delivery of cost savings from the restructuring actions. Profits would have increased more had it not been for adverse foreign exchange movements of £2.1 million (2014: adverse of £4.3 million). Whilst I am pleased with the growth in profits, there is clearly more to do on sales and this will be an area of focus for 2016.

A more complete explanation of the financial performance for the year, including a breakdown of the £14.1 million of exceptional items, is set out in the Financial Review on pages 7 to 11.

Strategic investments

The construction and launch of the new plants in the USA and China are central to the transformation of the manufacturing footprint for the group.

The new factory in the USA will improve manufacturing efficiency by establishing an advanced technology production facility. This will enable us to largely decommission the existing plant, which has continued to underperform in 2015 as it reaches the end of its useful economic life.

As previously indicated we expect an additional contribution to annual operating profit of £8 million from this USA investment, with the benefits starting mid-2016. A key component of this improvement will be the decommissioning of the old production lines, and the realisation of the associated cost savings.

In China the new plant will establish a manufacturing presence in the world's largest collagen casing market, adding capacity to support future sales growth. The new factory continues to progress well, with construction now complete and commissioning of the newly-installed equipment due to commence in the first half of 2016. Demand for premium products has continued to increase in China during 2015, despite the overall market in China declining, reflecting the ongoing development and segmentation of the market.

Board

As announced last year, Simon Webb, Group Finance Director, will retire in March 2016. The Board sincerely thanks Simon for his significant contribution to the business over the past five years.

Rutger Helbing will join us as Group Finance Director on 4 April 2016.

Employees

Devro's success is built upon the commitment of our employees. Supporting two major projects in parallel has tested this commitment and has significantly stretched our global resources. I have been impressed by the way our employees have stepped up and delivered at this critical time. On behalf of the whole Board, I would like to thank all of our employees for their contribution across our business.

2016 will be another important year as we complete the fundamental transformation of the manufacturing footprint of our business. To be successful we will again need to call upon the dedication and experience of our employees, but I am confident that the team will rise to the challenge.

I would like to take this opportunity to acknowledge the large number of employees leaving the business as part of the transition to more efficient manufacturing technology. I am very grateful for the professionalism they have demonstrated throughout the transformation and wish them well for the future.

Dividend

The Board is proposing to maintain the final dividend at 6.1p per share (2014: 6.1p) bringing the total for the year to 8.8p per share (2014: 8.8p). Subject to shareholder approval at the Annual General Meeting ("AGM") in April, the dividend will be paid on 13 May 2016, to those on the register at 29 March 2016.

Return on investments

With our transformation programme nearing completion we must now demonstrate a return on the £110 million in capital investments we have made over the past three years. 2016 will be the year in which we start to see this return reflected in our profits with the new plant in the USA completing in the first half. Additional profit growth will follow in 2017 from the new plant in China, enabling us to increase capacity and support further revenue growth.

2016 is an important year for Devro given the complexities of starting up two new factories, but with the detailed planning in place we are on course to develop into the most advanced collagen casings company in the world. Devro will then be well placed to benefit from a dynamic and expanding global market, to create long-term value for our shareholders.

Gerard Hoetmer

Chairman

Chief Executive's Review

Summary

2015 was a year of notable progress for Devro, with sales volumes growing in a number of key markets, the completion of two restructuring programmes resulting in substantial cost reductions, significant progress in our investment projects in the US and China and the acquisition of a specialist European collagen gel business.

Our three-year transformation programme, to ensure that the business has high-tech manufacturing assets capable of supplying future demand, progressed well and will complete in 2016.

Markets overview

Devro supplies collagen casings, films and gel to a worldwide market that has long-term volume growth averaging 3-4% per year. Growth comes from the global trend towards urban living and rising levels of disposable income, with related increases in protein consumption, as well as the expansion of high-tech food manufacturing processes, which tend to use collagen casings.

In 2015, many regions reported volume growth, with an estimated global increase of 3% excluding China. Growth areas include meat-based snacks in the USA, snacks and confectionery in Japan and rising consumption in several South East Asian markets. After several years of remarkable growth, the total market in China contracted in 2015 due to a combination of economic and industry factors, however the premium casings segment continued to grow. Production of meat products in Russia declined in the earlier part of the year, as a result of economic, political and currency issues.

Strategy

Devro's three-part strategy focuses on revenue growth, manufacturing efficiency and product differentiation. The business made good progress in all three elements during 2015.

Revenue growth

Devro's sales volumes grew 1% in 2015. Strong increases were reported for the first half of the year, which were partially offset in the second half by declines in some markets, in part related to local economic factors but also short-term capacity constraints linked to the transformation of our manufacturing footprint.

Sales volume growth remained strong in Japan (7%), particularly in the snack and confectionery sector. Volumes across South East Asia increased 13% as capacity from the recently-expanded Czech and Australian plants enabled higher levels of supply. Latin America sales volumes, excluding Brazil, increased 5% having benefited from the launch of recently developed products.

Growth continued in the major markets of Continental EU and North America, with both markets increasing sales volumes by 3%. Volumes were broadly maintained in the mature and established markets of the UK and Australia, as well as in China where Devro sales were moderately constrained in the short-term by available capacity.

Russia and surrounding markets were affected by the geopolitical and economic factors, leading to a 16% sales volume decrease for Devro. Sales to Brazil, where prices are generally lower, were constrained by supply.

Demand for collagen gel in the manufacturing of large volume brands in USA and Europe continues to grow as major food manufacturers make significant capital investments in co-extrusion technology to reduce operating costs.

Manufacturing efficiency

Input costs reduced in 2015, due to an improved market for hides and the benefits of lower energy costs passing through the global supply chain.

The Czech operation ran at full capacity, benefiting from the high levels of investment we have undertaken since 2005.

The businesses in Scotland and Australia both completed substantial restructuring projects to reduce overhead costs whilst at the same time maintaining full operating activities. This proved challenging, particularly in the first half, but over the course of the year annualised cost savings of £5.8 million were successfully realised, slightly ahead of expectations.

Over the three years 2014-2016 Devro has been restructuring its manufacturing operations worldwide in order to have lower cost capacity located to supply both established and emerging markets with competitive products. From a total of 2,200 employees in 2014, 350 roles in higher-cost locations in the USA, UK and Australia have become redundant, whilst 180 roles have been created at a new plant in China. This change reflects the scale of the cost reduction and reorganisation that has been undertaken at the same time that capacity is being increased.

In the USA construction and commissioning of the new £50 million plant in South Carolina is now approaching completion. The old USA plant saw its last full year of production in 2015. The permanent shutdown of the old, inefficient capacity commenced in December 2015, and will complete in the first half of 2016, as customers are transferred to enhanced products from the USA and Europe. Once the dual-running of the old and new capacity ceases during 2016, the expected annual cost saving of £8 million will start to be realised.

In China, construction of a £60 million new plant in Jiangsu province was completed. Commissioning will run through the first half of 2016, with commercial production due to commence during the second half. This plant represents the first stage of an investment to supply directly into the world's largest market for collagen casings.

Start-up of the new plants involves a large amount of specialist input and fine-tuning to achieve efficient output. In view of the scale of both projects, this will require significant input from all parts of the business during 2016.

Product differentiation

Effective research and development is key to product differentiation. During 2015 the priority for development was to ensure that products coming from the new capacity will be effective replacements of predecessors and, where possible, will provide enhanced performance to customers.

A single group research team is now established, with appropriate expertise recruited and a range of collaborative external research projects now starting to extend knowledge and opportunities.

The acquisition of PV Industries BV, a specialist European collagen gel business, has provided Devro with access to a strong technical skills base and an innovative and developing product portfolio. This will further strengthen our ability to differentiate our products and enhance value for customers.

Outlook

For current trading, some markets are positive and providing good opportunities for growth, whilst others face continuing economic and political pressures that limit demand. In China, Devro continues to pursue the strategy of supplying differentiated products for the premium sector, which is growing, whereas in the standard casings sector there has been a contraction in volumes recently along with high levels of availability leading to price erosion.

For Devro in 2016, it is the timely and efficient commissioning of our new plants that will most significantly contribute to improved profitability and, whilst we anticipate inevitable challenges in this phase, we are confident in the ability of our local management teams to reach successful conclusions.

Our transformation will complete in 2016, after which Devro will be well positioned to supply all of our markets with competitive products from efficient manufacturing operations. The benefits from this transformation will begin to flow through to profits in 2016 and the long term growth prospects are strong.

Peter Page

Chief Executive

Financial review

Revenue

Sales volumes in 2015 grew 0.9% for Devro. Volumes of edible casings grew strongly in North America, Japan and South East Asia. Political and economic volatility in Russia and surrounding markets contributed to volumes declining in these markets and were partly responsible for holding back overall group sales growth, particularly in the second half. Sales in Brazil, where prices are generally lower, were constrained by supply resulting in a year on year decline in volumes in this region.

There was also an extra week of trading in the first half of the year, due to changes in the manufacturing calendar, and consequently a week less trading in the second half. This contributed to the movement in trading volumes between the two halves. Adjusting for this, underlying growth would have been 2% in the first half and a decline of 1% in the second half.

Sales of gel continue to grow well in the USA, as customers transition from cellulose applications to collagen co-extrusion. The acquisition of PV Industries BV ("PVI"), which was completed in October 2015, has helped to expand the group's expertise in this area as well as our sales into Europe.

Year on year growth in revenue can be analysed as follows:

Revenue, excluding the impact of foreign exchange, grew by 1.2% in 2015, predominantly as a result of improved volumes, particularly in Japan, North America and South East Asia. The acquisition of PVI contributed 0.4% of the revenue growth from gel sales in Europe.

Pricing was relatively neutral during the year with a small positive mix effect which reflects the geographical split of sales. Pricing in China remains competitive, which underlines the importance of focussing on the premium segment.

Operating profit

The movement in operating profit before exceptional items between 2014 and 2015 can be analysed as follows:

Restructuring savings

The planned cost reductions have been realised following the restructuring of operations in Scotland in 2014, as the group closes its older and less efficient capacity, alongside the outsourcing of hide preparation operations in Australia. Together these actions contributed £5.8 million of cost savings, which was slightly ahead of target.

Input costs

Input costs reduced £3.0 million during the year following a number of years of increases. The group benefited from lower raw material costs in the USA and Australia, alongside lower energy costs across all locations.

Manufacturing

Manufacturing was especially challenging in the existing USA factory, which is nearing the end of its useful life, ahead of the transition to the new manufacturing plant. The updated equipment in the new plant is currently being commissioned and is expected to be fully operational in the first half of 2016.

As both this investment project and the new manufacturing site in China are completed during 2016 overall manufacturing costs for the group will be further reduced.

Foreign exchange

Devro has operations around the world in multiple currencies. There was an adverse foreign exchange impact on the results of £2.1m which reflects the strengthening of sterling against most other key trading currencies of the group compared to 2014, particularly against the euro and Czech koruna.

Other movements

Other movements include inflation on wages and salaries.

Operating margin

We achieved an operating margin of 14.5%, compared with 13.0% in 2014, largely reflecting the cost savings achieved through the restructuring activities initiated in 2014.

Exceptional items

Exceptional items incurred during 2015 comprise incremental costs associated with the two investment projects to establish new plants in the USA and China, an adjustment to the decommissioning provision related to restructuring actions and costs related to the acquisition of PVI.

Investment projects exceptional items include staff retention costs and redundancy provisions, accelerated depreciation, incremental costs attributable to the transition to the new plant and decommissioning costs related to the assets being made redundant by the USA investment, together with project management costs, training costs and professional fees for the two projects.

The non-cash exceptional item of £1.4 million comprises accelerated depreciation and the write-off of raw materials which will not be usable once production has ceased at the existing USA factory.

2016 will be the final year of exceptional items associated with the three year transformation programme. Exceptional items in 2016 are expected to be at a similar level to those incurred in 2015, which reflects the start-up costs of the two new plants prior to full scale commercial production.

Capital investment

Devro is on track to invest £110 million on the two investment projects to build new factories in the USA and China. Of this total, £91 million has been invested up to the end of 2015, and a further £19 million will be invested in the first half of 2016. This is approximately £15 million higher than the amount originally planned for the two projects in order to provide additional functionality in both the USA and China plants to support future expansion, including investment in waste water treatment, product kitchens and the base infrastructure.

These two strategic projects are both on plan to commence commercial production in 2016.

Acquisition

The group acquired 100% of the shares in PV Industries BV ("PVI") on 5 October 2015. Based in the Netherlands, PVI is a leading manufacturer of high quality collagen gel products for the meat processing industry.

Cash consideration of €9.2 million (£6.8 million) was paid, with a further €0.2 million (£0.2 million) contingent consideration expected to be paid dependent upon revenues earned by PVI to the end of 2016. Including cash and debt acquired with PVI the acquisition increased group net debt by £8.8 million.

The fair value of net assets purchased (including net borrowings) was £3.9 million which included £2.1 million recognised as an intangible asset in respect of customer contracts and relationships. Additionally £3.1 million was recognised as goodwill.

Working capital and cash flow

Inventory levels fell through the year in a continuation of the trend from the second half of 2014, and contributed positively to the group's operating cash flow. £3 million of the increase in trade and other receivables related to payment of input taxes on equipment installed in our new plant in China, which will be recovered as sales and profits are generated from the new plant.

Operating cash flow, before capital expenditure and exceptional items, improved to £49.9 million (2014: £48.1 million), in line with operating profits.

Cash outflow from exceptional items was £15.5 million (2014: £6.5 million).

Financing and net debt

Key financial measures are as follows:

Net debt increased as expected during the year, principally due to expenditure on the group's two major investment projects which are expected to commence commercial production during 2016. Additionally net debt increased £8.8 million upon the acquisition of PVI in October 2015, and we negotiated a temporary increase in the key net debt / EBITDA covenant on our funding facility from 3 times to 3.25 times as a result. The covenant reverts to 3 times in September 2016.

The group remained within its funding facilities which include the US$100 million US private placement that took place in the first half of 2014, and the £110 million revolving credit facility which was negotiated in December 2014 and will be in place until 2019.

Net debt / EBITDA ended the year at 2.6 times and is expected to peak in the first half of 2016 as the two investment projects are completed but will remain within the banking covenants.

ROCE reduced from 11.8% to 11.5% which reflects the significant investment programme currently being undertaken by the group.

Interest

The net interest cost for the year was lower than 2014. In addition to the interest charged to the income statement the group has capitalised interest of £2.7 million (2014: £0.6 million) reflecting the capital invested in the group's two major investment projects. As these projects are completed the capitalisation of interest will cease and the net interest cost will increase as a result.

The small increase in net finance cost on pensions over 2014 reflects the increase in the opening net pension liability.

Pension schemes

We operate a number of defined benefit schemes around the group, although all of these are now closed to new entrants. The net pension liabilities of these schemes can be analysed as follows:

The decrease in the pension liability during the year largely reflects the increase in scheme discount rates.

During the year discussions with trustees of the UK scheme were completed following the triennial valuation as at 31 March 2014, and as a result annual contributions to fund the deficit were increased by £1 million for the next 12 years.

Earnings per share

We have again presented an adjusted EPS that excludes the effects of exceptional items, to provide a better indication of our underlying performance. The increase in EPS reflects the group's higher operating profit before exceptional items.

Tax

The Group operates around the world and earns profits which are subject to tax at varying rates.

During the year, further investment incentives were obtained in the Czech Republic which helped to keep the underlying tax rates low in 2015.

Dividend

The Board is recommending an unchanged dividend in 2015.

Going concern

At 31 December 2015 the group was operating within the banking covenants related to its revolving credit facility and US private placement facilities. The group's detailed financial forecasts indicate that there is sufficient headroom in the facilities for the foreseeable future and that they can be repaid in line with the expected terms.

After making enquiries, the directors have a reasonable expectation that the group has adequate resources to continue in operation for the foreseeable future. For this reason, they continue to adopt the going concern basis in preparing the financial statements.

Simon Webb

Group Finance Director

Consolidated income statement (unaudited)

for the year ended 31 December 2015

All results relate to continuing operations.

Consolidated statement of comprehensive income (unaudited)

for the year ended 31 December 2015

Consolidated balance sheet (unaudited)

at 31 December 2015

Consolidated statement of changes in equity (unaudited) 

for the year ended 31 December 2015

Consolidated cash flow statement (unaudited)

for the year ended 31 December 2015

1. Financial information

The financial information set out above does not constitute the company's statutory accounts for the years ended 31 December 2015 or 2014.

The financial information for 2014 is derived from the statutory accounts for 2014 which have been delivered to the registrar of companies. The auditor has reported on the 2014 accounts; their report was (i) unqualified, (ii) did not include a reference to any matters to which the auditor drew attention by way of emphasis without qualifying their report and (iii) did not contain a statement under section 498 (2) or (3) of the Companies Act 2006.

The statutory accounts for 2015 will be finalised on the basis of the financial information presented by the directors in this preliminary announcement and will be delivered to the registrar of companies in due course.

2. Segment information

The chief operating decision maker has been identified as the Board. The Board reviews the group's financial results on a geographical segment basis with three identifiable operating segments:

· Americas: which includes North America and Latin America

· Asia - Pacific: which includes Australia, New Zealand, Japan, China and the rest of South East Asia

· Europe: which includes Continental Europe, UK, Ireland and Africa

The Board assesses the performance of the operating segments based on operating profit. This measurement basis excludes the effects of exceptional income and expenditure from the operating segments. The Board assesses the operating segments based on group profit for external sales in each region, rather than statutory profit for the region which also includes profit on intercompany sales.

Finance income and cost, and net finance cost on pensions, are not included in the segment results that are reviewed by the Board.

Information provided to the Board is consistent with that in the financial statements.

3. Operating profit

An additional £0.8m (2014:£1.6m) of development expenditure has been capitalised within intangible assets

4. Exceptional items

Exceptional charges included in operating profit were £14.1m (2014: £23.9m).

Exceptional items comprise incremental costs that are directly related to the actions being taken to transform the business. During 2015 this principally comprises the two investment projects to establish new plants in the USA and China. Over the course of 2014 exceptional costs were also incurred in relation to the significant restructuring of existing operations, particularly in Scotland and Australia. The restructuring of operations in Scotland involved older, less efficient lines being permanently shut down and the restructuring in Australia related to the closure of the hide preparation plant.

(i) During 2015 costs have been incurred in the USA where the completion of the new plant will require significantly fewer operators compared with the existing less efficient operation. The redundancy programme was initially announced during 2014. During the year an extension to the programme was announced resulting in further redundancy costs and retention payments. Redundancy costs in 2014 principally related to the restructuring of operations in Scotland, where 130 roles were impacted, and the outsourcing of hide preparation operations in Australia.

(ii) Costs incurred related to training staff prior to the commencement of production, in the use of the group's latest technology that will be used in the new manufacturing facilities.

(iii) Costs related to the projects to establish new manufacturing plants in the USA and China, including project management, legal and professional fees, and other incremental costs incurred prior to the commencement of commercial production that are not eligible for capitalisation. The increased costs during 2015 are a reflection of the more advanced stages of the projects.

(iv) Accelerated depreciation charge incurred on assets that will be replaced earlier than their previously estimated useful economic lives due to the group's planned investment in the new USA plant. The 2014 charge also included amounts related to the restructuring actions in Scotland and Australia.

(v) Estimate of the costs that will be incurred to ensure the affected sites are made safe and that food hygiene and environmental standards are maintained, for which a constructive obligation exists at the balance sheet date. During 2014 an estimate was made relating to the removal of equipment that would no longer be used once the restructuring was complete in Scotland and Australia, and the new manufacturing plant is operational in the USA. Some costs have been settled during 2015 with the remainder expected to be settled over the next two years. The cost/(credit) recognised in 2015 reflects the latest estimate of the ultimate costs that will be incurred.

(vi) Estimate of the incremental UK pension liability recognised in 2014 that was expected to arise related to people leaving the business as part of the restructuring of operations in Scotland.

(vii) Costs (including professional fees) incurred in relation to the acquisition of PV Industries BV in October 2015.

(viii) Costs in 2015 relate to the write off of raw materials which are specific to the old manufacturing process in the USA and cannot be re-used. The costs incurred during 2014 related to the write-off of raw materials that were specific to some of the equipment being decommissioned in Scotland.

5. Earnings per share

Basic earnings per share is calculated by dividing the profit for the year attributable to owners of the parent of £14.6m (2014: £4.4m) by 166,928,534 (2014: 166,866,949) shares, being the weighted average number of shares in issue throughout the year.

Shares arising from the Performance Share Plan are only treated as dilutive where the effect is to reduce earnings per share. Diluted earnings per share is calculated by dividing the profit for the year attributable to ordinary shareholders of £14.6m (2014: £4.4m) by the average number of shares, including the effect of all dilutive potential shares, of 168,406,376 (2014: 167,899,401).

Earnings per share before exceptional items is calculated in order to eliminate the effect of exceptional items after tax in 2015 of £11.0m (2014: £18.5m) on the results. Basic earnings per share before exceptional items is calculated by dividing the profit attributable to ordinary shareholders before exceptional items, after attributable tax, of £25.6m (2014: £22.9m) by 166,928,534 (2014: 166,866,949) shares, being the weighted average number of shares in issue throughout the year.

6. Pension obligations

The group operates a number of pension schemes throughout the world. The major schemes are of the defined benefit type and, with the exception of Germany where book reserves are supported by insurance policies, the assets of the schemes are held in separate trustee-administered funds. The defined benefit schemes are closed to new entrants. The total pension obligation cost for the group was £7.5m (2014: £8.9m), of which £3.2m (2014: £3.0m) related to the overseas schemes. On the advice of the actuaries, cash contributions to the group's defined benefit schemes are expected to be £5.0m for the year ending 31 December 2016.

* As part of the changes to the United Kingdom plan agreed in 2010, future pensionable salary increases are capped at 1% per annum. No rate of increase in salaries has been assumed in respect of the USA plan as the plan is now frozen.

Net pension liabilities at 31 December 2015 were as follows:

Movements in the deficit during the year were as follows: