Group Chief Executive's Business Review

Paul Forman
Group Chief Executive

The Board is confident that the disposal of Bonar Floors will help Low & Bonar to meet its long-term strategic objective of creating a leading global performance materials business.

Overview

2008 has been a very significant year for Low & Bonar, encompassing unprecedented levels of strategic refocusing, raw material volatility and changes to the economic background. I am pleased to report that the Group has entered what will be very testing times — but also times of great opportunity — in good financial and strategic shape. In the course of this highly active year, the financial performance was equally satisfying — Group profit before tax from continuing operations (before amortisation and non-recurring items) grew to £16.0m on Group revenues of £335.2m, an increase of 54% over the 2007 figure restated to reflect the disposal of the Floors Division. Consequently, earnings per share from continuing operations before amortisation and non-recurring items increased 60% to 7.37p (2007: 4.62p). This growth was underpinned not only by the maiden contribution of MTX, acquired in January 2008, but also by a healthy growth in Divisional operating margins from 8.5% to 9.6%. Given that the majority of our profits are earned in euros, there was also a benefit from translating results from euros to sterling.

Key Themes of 2008

Strategic refocusing

Commencing with the completion of the acquisition of MTX in January 2008, there have been four events this year completing the move to a more strategically focused Group based on the technical textiles industry. MTX, a leading producer of technical coated fabrics based in Germany and the Czech Republic, was acquired on 3rd January 2008 for €163.0m. It produces PVC-coated materials for the transport, architectural, print and general industrial sectors and operates in a segment that offers distinct scaling opportunities.

Architecture textile manufactured from VALMEX® structure membrane.

Waterproof bituminous roofing membrane on Colback® reinforcement

Megawatti yacht built with Enka® -Fusion flow medium.

On 8th January 2008, we announced the acquisition of Westbond Ltd, a producer of fusion-bonded carpet tiles, for a total consideration of £10.9m. During our period of ownership, it performed in line with internal expectations and, as envisaged, proved highly complementary to our existing Tessera carpet tile business. Westbond was successfully integrated into our Floors Division within six months of the acquisition.

In April 2008, the Group established Bonar Emirates Technical Yarns Industries LLC (BETY), a joint venture company, to manufacture artificial grass yarns and carpet backing yarns based in Abu Dhabi. Through this initiative, the Group will be able to expand its existing European capacity in artificial grass yarn production to meet the expected high growth in demand for this product, and will have ready access to new markets in the Gulf and Middle East region. It will also provide access to lower input costs such as raw materials, energy and labour. We have treated BETY as a subsidiary in the Group accounts as we hold economic control.

In September 2008, the Company completed the sale of the Group’s Floors Division (including Westbond) at a value of £123.0m on a cash-free, debt-free basis. This was a very significant change to the Group’s profile: Bonar Floors had been a valuable and important part of Low & Bonar for over 30 years. In the last few years the business had grown substantially, both organically and through acquisition, built a strong management team and developed a clear strategy, whilst generating very good margins. Nonetheless, the Board was supportive of the disposal because it believed that not only did the offer represent good value for the Company and shareholders, but also that it freed up management resource and cash to invest in developing the Group further as a leading technical textiles business. The disposal also reduced significantly the Group’s debt levels. The Board is confident that the disposal of Bonar Floors will help Low & Bonar to meet its long-term strategic objective of creating a leading global performance materials business. The strategy will be discussed in more detail later in this section.

We consider one of the strategic strengths of the Group to be its diversity of geographies served and the variety of end-markets, ranging from civil engineering to leisure to horticulture.

Raw material volatility

2008 was particularly noteworthy for the unprecedented volatility in our key raw materials, oil-based polymers including polyethylene, polypropylene, PVC, nylon and polyester. This is important because the spend on raw materials is approximately half our total sales value, with oil-based polymers representing by far the largest item of raw material expenditure. Three factors are widely regarded as critical to influencing the cost of those raw materials: the supply level for each polymer; global demand for each; and the price of crude oil. All these factors have varied very significantly throughout the year, with new supply coming on stream from the Gulf region, demand growing and then weakening in line with global industrial health and the well-documented movements in the oil price. Whilst we believe that the quality of our products and services, the strength of our customer relationships and our strong market positions all help to manage the margin implications of such volatility, there is necessarily at least some impact in the short term. We have been able to compensate well through actions on other cost areas and grow operating margins in 2008 despite an overall negative impact from raw materials. The latter part of the year did indeed see some weakening from the historic high levels of August and September as the oil price and demand for individual polymers fell. We see no reason to assume that in the medium term this volatility will lessen, but are confident we can continue to maintain healthy margins as a consequence of the added value we provide to our customers and our leading market positions.

Changes to the economic background

We consider one of the strategic strengths of the Group to be its diversity of geographies served and the variety of end-markets, ranging from civil engineering to leisure to horticulture. We have been able to build on our strong positions in niche markets by acquiring businesses that take us into new or complementary sectors that are set for growth, driven by factors such as legislation and environmental concerns. This means that we have seen volume growth in the technical textiles industry generally, and in our businesses in particular, above that of GDP.

Nonetheless, changes to the overall economic environment do have a significant impact on short-term customer demand levels and we witnessed a clear weakening in overall demand from September onwards. However, we believe that, for the reasons outlined above, some of this impact can be mitigated and that indeed additional opportunities to gain market share will present themselves. We also believe that the trend growth rate in the industry of one to two times GDP should reassert itself over time.

Our twin emphasis on acting responsibly in our manufacturing processes and on new product developments continues, but at an increased rate.

Financial performance summary

Overall Group revenue from continuing operations increased by 59% to £335.2m (2007 (restated): £210.3m), of which £105.3m was the effect of the MTX acquisition. The ten month revenue from Bonar Floors was £96.0m, including Westbond, compared with a full 12-month figure of £101.5m in 2007.

Revenue from continuing operations was broadly flat when adjusting for foreign exchange benefits as positive growth in the first half of the year was offset by the decline in the later part of the year and by the expected cessation of a non-strategic toll manufacturing contract previously held by Colbond. Decisions were taken at times throughout the year to turn away specific revenue opportunities if management believed the debt risk outweighed the reward.

Excellent work on lowering unit production costs, allied to good management of product mix and control of overhead spend, meant that operating profit from continuing operations before amortisation and non-recurring items grew by 89% to £26.7m (2007 (restated): £14.1m). MTX, which has met the stretching internal financial expectations established at the time of acquisition, contributed £12.3m operating profit (before amortisation and non-recurring items) in its 11 months as part of the Group, and local operating profit from the remaining activities grew by a very heartening £1.9m, or 13%, despite the major escalation of raw material costs. It is encouraging to report that Divisional operating margins consequently increased from 8.5% to 9.6%.

Group profit before tax from continuing operations (before amortisation and non-recurring items) grew by 54% to £16.0m (2007 (restated): £10.4m). Net financing costs increased from £3.7m to £10.7m as a result of higher debt levels and increased bank margins. Operating non-recurring items were a net £1.4m charge, comprising a £2.3m charge in respect of the restructuring of MTX post-acquisition and a £0.9m profit on the disposal of surplus land. A non-operating non-recurring charge of £6.2m was incurred in respect of a potential funding deficit arising from the implementation of pensions equalisation (see note 5). Our pre-amortisation and non-recurring items tax rate remained unchanged at 29%. Earnings per share from continuing operations before amortisation and non-recurring items increased by 60% to 7.37p (2007 (restated): 4.62p).

Our year end net debt position of £104.5m (2007: £50.5m) is a reflection of the acquisition and disposal activities, the translation impact of debt primarily denominated in euros, and good operational cash flow benefiting from strong management of working capital.

The net debt/EBITDA ratio (for bank covenant purposes) for the year was 2.6 times versus a covenant of no more than 3.25 times and the interest cover covenant was 3.7 times versus a covenant of no less than 3.0 times.

Health and safety

The Board’s rigorous commitment to health and safety matters remains undiminished. All statistics and incidents are subject to close scrutiny by myself and the senior management team. I am pleased to report that this continued emphasis, underpinned by training and selective capital investment, has meant that yet again the accident statistics have shown considerable year-on-year improvement. We believe that our level of accidents is half that experienced by our benchmark industry sectors across Europe and are intent on improving that ratio further still. MTX has been fully integrated into our Health & Safety processes and we are confident that it too will show the same improving trend in 2009.

Maintaining our environmental responsibilities

Our twin emphasis on acting responsibly in our manufacturing processes and on new product developments continues, but at an increased rate. Operationally, we have successfully developed capabilities to reuse post-industrial polymer waste and are utilising this capacity wherever possible. Waste reduction programmes in all sites have the dual benefit of reducing our production unit costs and also improving our environmental footprint. Equally, we are actively engaged in programmes targeting reductions in usage rates across packaging, electricity and other utilities. Our products themselves are increasingly focused on aspects of environmental responsibility, such as the benefits of reducing water consumption and lower chemical usage from artificial grass. We have launched, amongst others, “green” roof products, 100% recycled carpet backings and a product for motorway central reservations that consumes exhaust emissions. Work continues on innovations in areas like biodegradable options for specific end-markets.

Employees

As has been discussed, 2008 witnessed an increased level of change across the Group compared to the already very high levels of the last few years. Our global dimension is exemplified by the fact that our 14 factories (including the Middle East site under construction) are located in nine countries across three continents and this provides great opportunities for the beneficial sharing of ideas and approaches. I have been encouraged by the positive way our colleagues have embraced the transformation that has occurred within Low & Bonar over the last 12 months and responded to the more demanding trading environment. Regrettable but necessary decisions have been required to ensure our cost base is adjusted appropriately and the commitment of all those working for Low & Bonar to building the Group has remained excellent.

Strategy, key strengths and 2008 performance review

The principal activities are in the international manufacturing and supply of performance materials known as technical textiles. The global technical textile industry comprises, inter alia, fibres, yarns and woven fabrics serving diverse markets for a wide range of niche industrial applications.

Strategy and key strengths

Strategy

The Group’s objective is to become a global leader in the manufacture and supply of performance materials, based primarily on technical textiles, for strategically attractive niche markets. The Group is focused on becoming a global performance materials business, based primarily, but not exclusively, on technical textiles, which aims to provide distinct and sustained added value to its customers’ businesses. The Company believes that pursuing this strategy, backed by a stable management team, will result in higher returns and above-market growth rates. It is the Company’s belief that a material increase in scale through the adoption of this strategy will give benefits in purchasing capability, utilisation of commercial infrastructure, scope to invest in state-of-the-art production equipment and shared knowledge and depth of pocket in research and development.

The Group’s strategy is to develop a portfolio of leading global positions in carefully chosen niche markets and to realise purchasing, production and cross-selling synergies as appropriate. Cost and quality leadership is sought through constant process redesign and improvement. The Company believes that organic expansion will be achieved through further product innovation in all areas, geographic expansion and operational process improvement. This strategy for organic growth may be complemented by acquisitions in segments that are consistent with this strategy or which provide geographic expansion of the Group’s core activities.

Lixhe port area (Belgium) — using more than 20,000m² of Bontec.

Specialist architectural coated fabric used at Aintree Racecourse.

Tarpaulin used on a wagon train.

The Company believes that organic expansion will be achieved through further product innovation in all areas, geographic expansion and operational process improvement.

Key Strengths

The Directors believe that the Group has a number of key strengths that assist in underpinning its financial performance. These strengths include

i) Leading market positions in the markets in which it operates

The acquisition strategy of the last five years has focused on building leading market positions in the niche markets in which the Group operates by either: (a) building on existing market positions, as was the case in the acquisitions of Xirion, a producer and supplier of artificial grass yarns, and Geo-Tipptex, a manufacturer of non-woven geotextiles; or (b) acquiring businesses that have leading market positions in new markets, as was the case with the acquisitions of the non-woven business of Colbond and the technical coated fabrics business of MTX. The Directors believe that this acquisition strategy enables the Group to maintain strong operating margins.

ii) Customer diversity reducing over-reliance on one specific country or end market

The Directors believe that the Group benefits from having limited exposure to any specific geographic market and through serving a wide range of end-markets. In 2008, the Group’s sales by destination amounted to approximately 5.5% to the United Kingdom, 70.5% to continental Europe, 15.7% to North America and 8.3% to the rest of the World, primarily Asia. The end-markets are themselves diverse, with products finding their way into, inter alia, markets such as the civil engineering, carpet tile manufacture, horticulture, artificial sports pitches, building construction and large-scale outdoor advertising media sectors.

iii) A growing investment in new product development

The Group places great significance on innovation as a means of developing new products to satisfy customer demands. Colbond, for example, has research and development facilities in the Netherlands and in the United States comprising 5% of its employees and has recently added to its capabilities to support the Yarns business. Sales from products introduced within the last 12 months have increased to almost 20% of the total. Specific examples of recent innovation include “F2F”, a unique double-sided backing product for carpet tiles that enables customers to reduce
inventory and set-up times, and technical coated fabrics specifically designed for the storage of biogas. Our Fabrics business has launched a new range of products to support its horticultural customers and a new “Cool Grass” product has been developed by the Yarns business which
lowers the surface temperature of a sports pitch by up to 15 ºC.

iv) The Group has a clearly demonstrated ability to execute and add value to acquisitions

The Group has completed seven acquisitions and joint ventures in technical textiles in the last five years, across Europe, North America, the Middle East and China. These investments have
ranged in size from £3.0m to €163.0m and have built on existing businesses or added new businesses to the Group. The Directors believe that these acquisitions have created value, both financially and strategically, within the Group. MTX has, for example, generated €26.7m
of operating cash flow in the period to 30th November 2008, and Geo-Tipptex achieved record sales in the last quarter of 2008.

v) The Group has a strong management team which has delivered significant financial improvement

In the year ended 30th November 2002, before the current management team joined the Group, the relevant part of Low & Bonar, Yarns & Fabrics, generated divisional operating profit of approximately
£2.6m on sales of £44.3m, representing an operating margin before central costs of 5.9%, based on figures derived using UK GAAP. In the year ended 30th November 2008, the sales of the
Technical Textiles Division were £335.2m, divisional operating profit before amortisation and non-recurring items was £32.1m and the operating margin before central costs was 9.6%, based on
figures derived using IFRS. This growth in margins was achieved at a time when average raw material costs have doubled approximately.

vi) Many of the markets served have positive long-term trend growth

A number of structural factors determine the underlying growth of the market served by the Group, other than those purely associated with macroeconomic trends: the level of global investment
in infrastructure; the rate of change in commercial use from broadloom carpets to carpet tiles; the installation of artificial grass sports pitches; the use of artificial grass for landscaping applications; the use of coated fabrics for permanent and semi-permanent structures; and the importance of yield
improvement and energy reduction in horticulture. The overall technical textiles industry is believed to have been growing in volume above underlying GDP over the last five years due to substitution and new market development factors. Whilst overall economic activity is one factor in determining the growth rates of the Group’s various markets, there are many other determinants, including those stated above, which taken together the Directors believe should sustain strong growth rates
in core markets over the long term.

2008 Performance review

Highlights

• Successful acquisition of MTX
• Cost control and operational productivity compensate for lower H2 sales
• Rate of product innovation increased
• Volatile raw material environment successfully mitigated
• Operating margin increased to almost 10%

Despite a slower final quarter, 2008 proved a satisfying year financially and operationally. The biggest event was the acquisition of MTX, our technical coated fabrics business, and its subsequent integration and I am pleased to report that results to date are marginally higher than the stretching internal expectations that were set at the time of acquisition.

Technical Coated Fabrics

MTX operates from two factories in Germany and one in the Czech Republic and a network of overseas sales offices. The main products are truck side tarpaulins, larger fabrics for outdoor advertising applications, permanent and semi-permanent structures, and various other specialist applications including the marine, pool and outdoor leisure sectors. Market demand is influenced by underlying economic drivers such as the number and replacement pattern of commercial vehicles in Europe, outdoor media expenditure, architectural trends and product substitution. The market is estimated to be worth approximately £2bn globally and hence offers significant scope for our further growth.

At the time of the MTX acquisition, a detailed set of plans was developed to ensure sales, profit margins and cash flow were optimised. This initiative has progressed well to date despite the trailer market being adversely impacted by the economic environment in the latter half of the year. The business has significantly reduced its working capital, sustained good operating margins and implemented many of the Group processes relating to financial and operational control. Looking ahead, opportunities exist to optimise manufacturing productivity and working capital efficiency still further as well as to expand its geographic presence and to increase the rate of innovation and hence sales growth. The diverse geographic nature of its sales network is proving an asset to our other businesses, as well as its expertise in coating technology.

Performance Technical Textiles

(i) Technical Fabrics
The Technical Fabrics business produces and supplies woven and non-woven geotextiles, agrotextiles and other industrial textiles; it also supplies specialist fibres added to concrete, primarily in the civil engineering industry. It manufactures from factories in Belgium, Hungary and China. The European business continued its track record of growth in sales and profit, delivering record margins. A particular highlight of the year was the very good performance of Geo-Tipptex, the Hungarian manufacturer of non-woven geotextiles used in civil engineering that was acquired in 2006. This business has benefited from the increase and upgrading of its production capacity in 2007, enabling it to improve margins and product quality. Elsewhere, the businesses serving the civil engineering market and horticulture markets for groundcovers fared well and retain leading positions across Europe. Encouragingly for the future, the focus of the management team on enhancing its new product pipeline is starting to bear fruit with the proportion of sales from new products gaining steadily throughout the year, such as specialist applications like cherry cloth, Phormidrain and mushroom mats. It is also making good headway in less developed, higher growth geographic markets — most notably the Gulf region. Our Chinese joint venture experienced unprecedentedly high levels of raw material cost escalation as well as market softening from their Chinese customers supplying product into Europe and North America. Nonetheless, the long-term potential remains undoubted and we are using expertise from across the Group to bring standards of production and financial performance to a consistently high level.

(ii) Bi-component non-wovens and three-dimensional mats
Colbond sells non-woven speciality fabrics as backing for carpet tiles, higher end automotive applications and for roofing membranes. It also produces three-dimensional mats used as flow media and separation media in civil engineering and composites amongst others. The business performed well to maintain its profit despite being the one business with some exposure both to the automotive and residential housing market, which proved difficult throughout 2008.

Excellent levels of product innovation enabled sales to grow elsewhere, with sales into the civil engineering, general industrial and US carpet tile sectors all performing notably well. As importantly, the production teams on both sides of the Atlantic made great strides in productivity improvements and achieved reductions of over 10% for certain core products. Additionally, the completion of a new warehouse in July 2008 has started to improve service and reduce cost. Like Fabrics, it saw significant growth in sales from products recently introduced and looks set to maintain this trend. Entry into new end-markets is also being strenuously targeted and is likely to produce tangible benefits in 2009. Sales initiatives into growth markets like “green” buildings and composites have been prioritised further given their greater underlying resilience in the current economic environment and their long-term growth potential. In the broader context, Colbond’s R&D capability remains a core strength that much of the business calls upon to good effect and it leads the way in many aspects of health, safety and environmental practice. Its safety record is pre-eminent within the Group and is clear best practice.

(iii) Technical Yarns
Bonar Technical Yarns manufactures and supplies a range of high-specification synthetic yarns for use in the production of synthetic sport and landscaping surfaces as well as in woven Axminster and Wilton carpets. The key development in this business in 2008 was the establishment of a joint venture in Abu Dhabi. The production facility is expected to commence production of grass yarn in the second half of 2009 and will add to the existing European production capacity in Scotland and Belgium. As well as bringing access to lower production costs it is situated close to one of the expected growth markets for both sports and landscape applications. 2008 saw Yarns face the highest raw material price increases across the Group and a lot of good work on raw material and direct labour efficiency ensured that this negative effect was broadly mitigated. Underlying sales volume growth was achieved and new customers were obtained globally but further progress needs to be made for the business to achieve its profit potential. Encouragingly, significant growth in new product development output has been achieved and the business is in better underlying shape than it has been for a long time, due to a lot of hard work across all facets of the business.

Paul Forman
Group Chief Executive
19th February 2009