Zotefoams plc (ZTF) Earnings Call Transcript & Summary

Yes, we can. So I just popped your camera. So if you want to go ahead, that was just to conserve that bandwidth.

Right. So yes, Europe, Continental Europe, we've seen 6% volume increase there and 23% overall growth. Obviously, the difference between volume and values substantially price. In Europe, we had a bit of a currency headwind as the euro weakened in the period. In the U.K., slight volume decline, which was mainly due to availability of specialty materials in the period and again, a very strong sales value increase with pricing increases. And then finally, in North America, a 13% volume increase has translated into 47% sales growth, although we have benefited there and in Asia, which isn't shown separately because of the relative size from a stronger dollar in the period. The key really on getting that profitability is managing the difference between the price that we charge and our cost base. And as I said, our prices have gone up kind of sequentially over the period with a number of different price increases in different markets over the 6 months or so. Where we are now is we seem to have caught up price increases or prices currently reflect our cost base. We're not seeing inflation really happening right now in most of our input costs. I think it has happened and it's been, as I said, quite severe in some cases. But we're now actually seeing polymer prices moderate and come off a little bit. We're seeing some of the rest of the inflation definitely damped down. So it's not really at the forefront of our mind as much as it has been other than potentially energy, as I said. So what you actually see is that you see that in 2021, in the second half -- or the first half, we did okay, 5% profit margin is not great, it's below our long-term average, and we need to improve that. But in the second half, we actually lost money in the segment because of the rapidly increasing polymer prices. In the first half of this year, we have got a grip of that. We've got a grip of the pricing, and I think we're now well positioned. And I think one of the key things is looking at what happened over the 6 months is we saw about a 6% improvement in our gross margin from going into the year to the June numbers. And most of that's been through polyolefin pricing. And so -- we're now at a point where that pricing is in a good position looking forward. If I move on to the high performance products, slightly different position in the cost space where the raw material prices have not been -- the inflation in raw materials has not been as high as in polyolefin. There have been some there. And our growth in footwear sales up 18%. And other sales, [indiscernible] was up 70% and [ T-FIT ] has really been driven by -- more by volume with a little bit of help from currency. So the pricing has been there a little bit in right across these things, but it's mostly underlying activity. In footwear, where we have an exclusive deal with Nike. We're pretty close to them. We are performing well. I'm very pleased at how Nike is taking our product and turning it into some very interesting market products for the running market, starts growing very well. Aviation, a few years ago, it was a very significant part of our business and growing very strongly. And then sort of pre-COVID -- just around COVID, it just collapsed. So it's not only now starting to recover. We see the second half being much better but up 69% from a very low base. It's very encouraging because it is one of our high-margin products, and that's one of the things that's buoyed the segment margin in the period up with sales up 21%. We've had a segment profit margin up 66% and the segment profit percentage up to 27%. Almost all of our HPP product is sold in U.S. dollars. So we're having some help with the dollar there. And without that dollar movement, segment margin would have been about at 23.5%. The other thing that makes up our HPP business is T-FIT. That's technical insulation products used in biotech, pharma and we're pushing into food and dairy now. A lot of that market is in China and India where COVID is very much still a factor. And in fact, during the period, we were forced to close down our manufacturing facility that takes sheets of foam from the U.K. and turns them into the tube insulation parts. In China, because of government restrictions around COVID. So despite the 2 main markets being heavily influenced by COVID and a factory shutdown, we managed to grow sales by 8%. And we see better momentum there going into the second half. On MuCell, revenues were up a bit. I mean, we -- sorry, that's showing up a bit. We're actually down a bit, why that percentage number there wrong. But our focus in MuCell is really not about licensing our technology to existing products to make them a bit better and take a license fee. Our focus really now has moved to ReZorce, mono-material packaging technology, which is a specific application that we believe offers a much better opportunity for us in the long term. It is high risk because it's a completely new development in an established market, but also potentially very high reward because the market is very big. It's struggling with the incumbent technologies to meet sustainability targets, and we offer something which if successful and accepted, would certainly go a long way to hit or even absolutely meet the sustainability targets of a lot of potentially very large customers. So we are putting in additional resources into this, about GBP 0.6 million operating cost there, which is the movement in the bottom line that we see. In addition to that, there has been a capital expenditure in relation to both our pilot facility in Boston and also requirement under financial standards to capitalize some of our costs in relation to development here. So you can see the numbers disclosed about how much we spend. A couple of slides just quickly on sustainability. Firstly, on the ReZorce products, you can see cartons here, but we also are looking at pouches and other things. The commercial contact base is very solid. We're not looking for other potential new customers because we need to really focus on the development and pre-commercialization. Our key U.S. patent has been issued. That's a patent that was filed in multiple territories, but the U.S. was the first. And typically, what happens is if it's granted in the U.S., it gives a very strong indication for other territories. That was filed in 2019. There were other patents filed around the same time, also in 2020, right up to patents filed even a couple of weeks ago. So it's something that we are really focused on making it strongly IP-backed and getting the first patent through and issued is a real plus. The other major plus there is that we have taken our development product into a full-scale commercial line, a potential customer, very small volumes, but we have made and filled a carton on a commercial line. And the objective now is to move to higher volume trials where we could fully demonstrate the reliability and statistical -- have enough trials done to statistically validate what we're talking about in terms of sustainability and also sterilizable product. So we are progressing pouch in parallel. I'd say in parallel slightly behind the trial plan on the cartons deliberately, but it's progressing well also. And sustainability more generally, Zotefoams is a business which does use plastic. We make that to meet the functional environmental needs of our customers. We are really focused on long-term use and saving weight, saving energy, helping solve recycling challenges and having products which are robust enough to have that long-term lifespan. So we also internally are focused on how do we optimize our product portfolio to go where the market wants and how we save costs through polymer reduction, energy reduction, et cetera, which add to the sustainability argument of our manufacturing process. So there's a lot going on. It's a bit like the duck paddling furiously under water, and we sail serenely on, but there's a lot going on in sustainability. And I think we are pretty well placed actually from that perspective. We think that is really based on these 4 aspects. We've got a unique process that uses nitrogen. We use raw material a lot more efficiently. Performance per unit weight is better than the competition. And so ultimately, you can use less material. A lot of what we do focuses on emissions avoidance like thermal insulations, et cetera. And the new product development, not just ReZorce called out here, but other places, other products are -- sustainability and low-carbon future is a key component on deciding which products to develop and go to market with. So finally, where does that leave us? Well, I think a very successful first half. Sales up strongly, very effective pricing, good pull-through on the profit number and definitely progress on ReZorce with patent awards and trials. As we look forward, we expect further sales growth. A little bit help from the dollar, mainly, but that better pricing is now fully embedded going forward. We see our HPP business growing well. Aviation growing -- possibly some weakness in Continental Europe, which is partly because there's a seasonality to that business but Continental Europe and Germany, in particular, has been particularly hard hit with some of the energy costs and the impact of sanctions and the way the economy is balanced towards automotive, et cetera, they definitely got some challenges there. But other areas in polyolefin are busy right now. We actually have a pretty good quarter 3 order book, including Germany, actually. But -- so that's very encouraging. People are saying today, well, we're nervous, but we're not experiencing any downturn. That's the general message. So we are somewhat cautious in that because of the prevailing risks in the economy, input inflation is there. And it's difficult to see higher prices without some impact on demand. But we are mindful of those risks. However, we have guided the market to higher profit than the analyst consensus we're expecting. And the analysts are now kind of moving the numbers a little bit or at least 2 analysts that are available this week have. So the other slides here are not for presenting, just appendices that you'd be able to access if you have any -- there's a bit more detail about our operational processes and Board and shareholders, et cetera, in there. So if I can ask Paul to stop presenting, and we can -- we will, I think go through the Q&A, is that...

[Operator Instructions] Just while the team take a few moments to review those questions submitted there. I'd like to remind you the recording of the presentation, along with a copy of the slides and the published Q&A can be accessed via your investor dashboard. David, Gary, perhaps before we go into those questions submitted during today's meeting. We did have a pre-submitted question, which reads as follows: HPP firms have compounded over 20% per annum since 2004 and such a strong rate of growth expected over the coming 5 years. Obviously, it's a much bigger part of the business than perhaps it was in 2004, but any further comments, that would be great.

Yes. I'm glad 20%, so was done the math, 20% compound growth is pretty great by anyone's means, obviously, very strongly driven by the success in footwear. And actually, aviation was running at a 20-odd percent compound growth until it wasn't. So I think we expect -- looking forward, we expect aviation to come back reasonably strongly in the second half this year and into '23, but probably not until 2024 to reach where it has been. I think the opportunity to grow very strongly with Nike rest on us being able to break into other categories at Nike. And I think they've done very, very well in running. But we are premium product in a premium market. And therefore, there's only so much business in there that we can reasonably get. So I think -- we're very happy to continue to innovate and keep that business and see some growth. But if we're going to get something else from Nike, it's going to be outside that particular category. I think looking at other opportunities within HPP, there certainly are other opportunities. And one of the things that I've learned over the years is that until we've actually got it, don't count your chickens because a lot of the markets we are in are highly technical. We require a lot of testing of the materials. And if you're successful, it can go very well, but it does take a while. So I would say that we've got a pipeline of very interesting opportunities in HPP. But at this point, I can't point to one thing and say that's going to be the next driver for growth over the next 5 years. But certainly, we've got quite a large number of things which would contribute to that. I wouldn't pull one of them out specifically. And I think you need to look to analysts' forecasts, if you want views on even 2 years out, 3 years out on specific product line to markets, we tend not to lead the market that way. So hopefully, that's somewhat helpful. But I hope you also do appreciate that certain questions are asked in a way that we [indiscernible] them directly. We're simply not allowed to make these types of forecasts.

That's great. May I ask you both just to click on that Q&A tab just out of the top, where appropriate to do so. Just read out the question and give your response, that would be wonderful.

Sure. So we have 3 or 4 pre-submitted questions. The first one is, how does the ReZorce liquid packaging system compete with both the 2 and 3 layers existing systems? How is progress going on ReZorce pipe alternative? And have you decided on the strategy of either licensing production? Okay. That's 1 question. Most of it packed in there -- so the ReZorce technology is designed to compete with multi-material systems. Whether those are 2 or 3 or 5 layers doesn't really matter. The point is that they've got 2 or more different materials that give -- combined would give the packaging properties. And combining those 2 materials or more materials together, gives you something which is very difficult to recycle. And so we've got this mono-material. It does the job of the multi-material systems, and we believe we can compete both on performance and we're looking at the economic costs, but it's pretty difficult right now because we've seen a lot of inflation in different parts of the system and trying to figure out exactly what the underlying relative economics are on each of these things is a bit tricky. But it certainly looks promising for both carton and pouch and some of the other things. Pouch is progressing. We have 2 trials lined up for pouch, but those are some months behind in terms of the progress where we are in carton. And we haven't yet decided on a particular strategy for commercialization, whether that's manufacturing and licensing or regional or global or whatever. What we have said is we've reached the point now where we feel that a partner would be appropriate because it's a big market out there, big opportunity. And we think that together with someone else who is more specialist in these markets, we are bringing the technology, we're bringing the opportunity, but execution, I think we feel would be better alongside somebody. So that's something that we've specifically said in the statement. Next question is that how is HP capacity holding up? We [ must ] soon need to make a decision on the new HP capacity, assuming a 2-year lead time for autoclaves and growth over the last 2 years. If new capacity is required, where will the equipment be located? So by HP capacity, I think the question means the high-pressure autoclaves. We invested in 2 large high-pressure autoclaves not that long ago in North America. And at that time, we reported that we had increased overall group capacity by 60%. So we've still got some room in that capacity expansion. So we have no immediate plans to invest in additional capacity of that sort at the moment. If we were, we've got 2 places we could put it, either in North America, we could increase capacity there by 50% on the existing infrastructure. Or in Poland, which has been designed as the first stage investment that we've already made, and that we already have, obviously, land, buildings and a lot of the infrastructure there for that. So that's something that we will consider. We do a 5-year plan every year. Capacity investments is always part of that. And so if that changes, it would be good news because it means the growth expectations in the business are high. But at the moment, no flagging of that investment. Next question, have we seen a big upsurge in military packaging in the last 6 months, and do we see good growth opportunities? We have seen, I think, upsurge in all military activity, including protective vests, sleeping mats, backpacks as well as packaging. So -- and I guess military supplies are being depleted at a quick rate at the moment compared to historical numbers and people reassessing what they actually need. So we have seen quite a lot of activity in that. Nothing in the first half really moved the dial significantly. And we are in discussions with quite a lot of people over the next. But I think probably that's something that contracts being looked at now are probably going to make more of a difference in 2023 than 2022. So next question. Do we have plans in place to cope with a possible energy crisis this coming winter? There are 2 types of energy crisis. One is price -- and yes, we do. And the other one is shutting off energy supply. There's no indication at all that that's going to happen. And so I think we are -- at the moment, given what we know, we're in a good place. Next question, what visibility do you have on future Nike orders? And how is the '23 Nike order book looking? The way we work with Nike is that we work with their footwear group who share long-term forecast with us. And those long-term forecasts get turned into actual shoe models. For each shoe model, we know how much foam they need per pair. And when the design goes final, they will give us the forecasts for those. So we've got reasonably good forward visibility out a reasonable time for -- 18 months or so, talk about that. But those are not orders. The orders come when the product gets sold in the market and Nike pulls additional products through the footwear factories. The correlation between the long-term forecast and the pull-through tends to be pretty good. They know what they're doing. So you do get month-to-month variability. You do get shoe-to-shoe variability. So they say we're going to sell so many units of product X and so many of product y, and they might not get that exactly right. But on average, they're very, very good at knowing what's happening. And I would say the forecast that we have had historically have been pretty accurate. So we've got that visibility, but we don't have an official order book for 2023. Okay. Next question. Can you talk about future catalysts for growth, new launches, et cetera, for HPP? I think I've probably covered that. So I go on to the next question. There was a mention of a surcharge earlier in the presentation, can you expand on this? We have a number of price increases put through on polyolefin products over the period. In some areas, some jurisdictions, the last price increase was put in as a price surcharge because we felt that polymer prices really wouldn't stay up there, but would remain volatile and the energy prices were moving up. So we've said to customers, look, this last price increase may move up or it may move down a little bit over the period depending on our input costs. Previous price increases were less price increases there it is, that's it. So if we see a lot of volatility in polymer and energy, we may end up adjusting those. I think the best way to think about it is that you kind of protect the margin, but there's no upside. Does that make sense? So if our costs go down a little bit, we'll give some back. Of course, go up a bit, we'll ask for a little bit more from our customers. But I think the reality is there won't be much movement in those surcharges at all given the way that little polymer prices seem to be coming down a little bit, it looks like energy is going up quite significantly, and I mean they [ each are ] out. Next question, how big do you think ReZorce could be? As a product line, it's very difficult to say. It really is. The carton market alone, 1% of the carton market is about GBP 100 million. And that's excluding pouches. 1% of the pouch market is about GBP 100 million as well, I think, maybe a bit more. So -- it's all about penetration. And I think when you're talking about markets that big, you're going to find big [ sways of ] them that actually your product isn't quite right for or at least not initially, we might iterate and innovate into there. But you're also going to find [ pouches ] of it that you're perfect for. So it's very, very difficult sitting here today saying, give me a number on those. But what I will say is, if it is successful technically and commercially, it would make a lot of sense that it was much bigger than the Zotefoams Group today. So I hope you can understand where I'm sitting there. [ Christie ], where do we think AZOTE margin should be in a normal market? Okay, that's half a question, [ Chris ]. And the [ reason ] it's half the question is that we've got an investment cycle. So for example, we've invested a lot of money in Poland deliberately to give us what is a large facility that's currently underutilized to give us growth options. And the cost of that would naturally or do naturally dilute the margin in the short term, the percentage margin. Hopefully, we can still make it profitability, you can make it the investment makes sense, but you are going to dilute your margin. And that's -- so it depends what part of the investment cycle we're at. But certainly, AZOTE margins of 5% are too low, and I think historically, Gary, we're probably looking in the 10% to 15% maybe...

When we were really tight just before we put the capacity and we hit 17%, but that really is at the far other end.

Okay. Next question, surcharges was mentioned. Yes, we talked about that. Is that on top of the 20% price increases and 4% for all? And if so, was the risk of demand destruction? So the surcharges were put in very late in the period. So you don't really see them in the profitability numbers for the full period, but they're also designed to be reversible. And so if like everyone else in the market, if polymer prices drop, we will see our costs go down. Everyone else's cost going down. I think there will be a recognition of that and allowing the customers to participate in part of that at least. And so that's why we put them through surcharges. We are always very cautious and aware of pricing and demand destruction. So what we need to look at is what are the customers doing today. And by that, I mean, if the customer has got a contract that's got a few months to run, and you put up the prices, it's a lot of switching course for them to go and find another supplier for 2, 3, 4 months of a running contract, they'll just accept the price increases, run with lower profitability for a bit and then the next contract not use you. But you would see that until the next contract starts and you don't have the business. And so what we need to make sure is that the customers are specifying our product or talking to our salespeople about the products that are available and price is one part, availability is definitely another because that's not a given in today's market. And we are getting more than our fair share of the businesses around. That's the key. So it's not a perfect science. Customers don't always [ have ] complete transparency with us, but that's what we're trying to do. And I think we've got pretty good relationships with most of the customers. They recognize we're not trying to rip them off. They recognize that if you look at the second half of 2021 that we actually lost money in polyolefin business, and they can see that. We pointed that out to them. Like we can't do business like this. You can't do it. The prices need to go up. The whole industry is grappling with that. I think there is a risk, obviously, of, in any inflationary environment, when prices go up, demand has a risk. But -- and we are -- profitability is partly driven by pricing, partly driven by volume. And our teams have been told, get out there and find the areas where the volume's robust. I think one more comment on that is that our polyolefin products, we make some really, really good products that are lightweight. And if you can buy those, you see they're cheaper, they use less material, they're more environmentally friendly. And they do their job. And with not very much change in specification to your customer, you can go to your customer, the end customer or our customers can go to their customer and say, how about this product from Zotefoams that's lighter, uses less materials, it's cheaper. You want to get away from the majority of inflation, do this. And so we've been heavily promoting that with some success, and that's been not something the customers will be willing to do in the past. And so the beauty of that is we have the best cost base down at that point. The competitors cannot follow us down there. They cannot make these products. So if we can get the industry to switch to these lighter weight products, then we've got much more of a chance of hanging on to the business, and it is more cost-effective for the customer. So we're not just about price. We're about getting the right product to the job, and we've got a better offering in the market than other people, I think.

That was fantastic, David. I think you covered off every single question and Gary, that we've had through. And of course, if there are any further questions, the team will be able to review those and we'll publish responses where appropriate to do so. David, perhaps before redirecting investors to provide you with their feedback, which I know is particularly important. If I could just have a few closing comments.

Yes. Just to say that -- it's -- there's a lot of moving parts in the world today. I've been asked not just by this group, but by other shareholders and salespeople and brokers, et cetera, all kinds of questions. And what's coming through is a real appreciation that we're not a one-trick pony. We've got 4 or 5 or 6 different options for every scenario. And we're managing the business in a proactive and robust way. But everyone's got a different take on what the scenarios are going to be in the second half on demand and energy and what kinds of things. So we've got to believe in the value of active management. We've got a management team with a lot of experience. We're keeping our ear to the ground, we're keeping close to the customer. And if circumstances are different than we think, then we'll manage the business appropriately. I think we've done pretty well in the first half. It's great to see EPS up the half year better than it was at the full year last year, and it's great to give a profit upgrade at the half year, which is something we've not done for quite a few years. So I'm pleased with the progress, and I think we're well placed going forward. So thanks, Paul, and I thank [ all of you ] for attendance.

Thank you very much. David, Gary. Thanks for updating investors today. Can I please ask investors not to close the session as you'll be automatically redirected to provide your feedback in order the team can better understand your views and expectations? This will only take a moment to complete and will be gladly valued by the company. On behalf of the management team of Zotefoams plc, we'd like to thank you for attending today's presentation. That concludes today's session. Thank you, and good afternoon to you all.