Peter Page
Peter Page
Chief Executive

Chief Executive's Review

2015 was a year of notable progress for Devro.

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

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 USA 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 shortterm 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 the 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 from 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 highercost locations in the USA, the 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 dualrunning 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 B.V., 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