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Directors' Report for the six months ended 31 December 2007

Financial Performance

Financial Position

The Group accounts to 31 December 2007 were prepared under NZ IFRS (New Zealand equivalents to International Financial Report Standards) for the first time. As first-time adopters of NZ IFRS, the Group is required to establish a new opening position as at 1 July 2006, the start of our comparative periods, and to restate the previous year’s comparatives using the new reporting standards.

A reconciliation of these restatements can be found in the notes to the accounts. The most significant impact is the increase in the carrying value of land and buildings at 1 July 2006 by $11.4 million.

Equity as at 31 December 2007 stood at $75 million and represented 44% of the total assets of the Group. This is an improvement on the 42% as at 30 June 2007.

Over the last six months, fixed assets increased by $0.9 million due to capital spends in excess of depreciation, whilst current assets decreased by $6.6 million in line with seasonal fluctuations in trading activities.

Cash Flows

Net cash inflow from operating activities was $16.0 million, an improvement of $2.9 million on the same period last year.

Net cash outflow from investing activities was $9.1 million, with $4.2 million for fixed assets purchased and $4.9 million for the other 50% of the Timaru wool scour acquired at the end of April last year.

Operations

Carpet Business

For the six months to December 2007, our carpet business produced operating revenue of $90 million, up 11% on the comparable period’s $81 million.

Profit (before interest and tax) was $15 million, an increase of 3% on the previous period.

Our carpet business comprises broadloom carpets and carpet tiles with their main markets in Australasia.

Carpet tiles performed strongly, with the continuation of favourable market conditions in commercial flooring on both sides of the Tasman. The substantial improvements made over the years, together with operational excellence, have enabled us to capitalise on the opportunities currently prevailing.

The operating revenue for carpet tiles was $26 million for the period, which was up 24% on the previous comparable period. Profit (before tax and interest) of $4.3 million was also up by a substantial 65%.

Market conditions for broadloom carpets were mixed. In Australia, our sales in residential carpets continued to benefit from the upward momentum of the previous year. We enjoyed good volume increases in both the premium and mid-market segments.

We found the New Zealand market conditions not as conducive as those in Australia and there was some pressure in the premium end of the residential market. Despite this, we managed an overall volume increase in New Zealand, which was pleasing in light of the market conditions that prevailed.

Broadloom carpet’s operating revenue was up 7% at $63 million. Profit (before tax and interest) was down 10% on the previous period as a result of margin and costs pressures and a stronger NZD:AUD exchange rate.

Wool Business

Wool scouring and wool buying are the operations within our wool business.

Operating revenue for the six months to December 2007 was $22 million, up 18% on the same period last year. This increase was due, in the main, to the operating revenue from the wool scour at Timaru, which was previously not recognised in the accounts (and therefore not in the comparatives) because it was accounted for as an associate up until April 2007, when we acquired the remaining 50%.

Profit (before interest and tax) was up $0.5 million for the same reason.

Our wool business was affected by the lower volume of wool available for scouring due to the drought in the East Coast of the North Island last year. At the same time, we saw a switch by some wool growers to alternative uses for their land as a result of the declining returns from wool.

Norman Ellison Carpet

The Company completed the purchase of its 70% interest in Norman Ellison Carpets on 7 February 2008. The purchase, which was effective from 1 February 2008, will enable the Group to grow its market share in New Zealand and Australia and to enhance its earnings performance.

The Norman Ellison purchase was transacted through a new company incorporated for the purpose. To help fund Cavalier’s capital contribution of $5.6 million, being its 70% share of the capital of the new company, Cavalier issued, on 8 February 2008, 1.59 million shares (or 2.42% of the then total number of shares on issue) to the shareholders of the Norman Ellison business for a total cash consideration of $5.1 million.

As advised previously, we expect the Norman Ellison business to generate, in its first full financial year, a turnover of $60 million and EBITD (earnings before interest, tax and depreciation) of $6.5 million, with Cavalier’s share being 70% of that.

Whilst there will be five months of earnings from this business in Cavalier’s June 2008 financial year results, the Directors caution that it will not be possible to simply pro-rata the expected future earnings of this business into the Group results to June 2008.

A number of operational issues will have to be attended to before the business can achieve the earnings target. At this stage, it is anticipated that it will take us until the end of June 2008 to sufficiently bed down the operation and be in a position to fully realise the earnings and synergies identified.

Microbial Technologies

The Directors decided, after balance date, to cease funding the Microbial research project with effect from 31 March 2008.

This means that apart from the closure costs consequent upon the termination of the project, there should be no further research costs after that date. The total costs, being research costs and the other costs to bring the project to closure, have been estimated at $0.5 million for the second half of this financial year. On this basis, the cost of the Microbial research project for the year to 30 June 2008 is expected to be similar to the previous year.

However, Group earnings for the financial year 2009, and beyond, should benefit from the discontinuation of funding for this project.

The Company is currently in discussions with the partner-scientists involved in the project with the aim of securing a royalty agreement in the event that its intellectual property is used in commercial applications in future.

Outlook

The overall outlook for the carpet business is mildly positive, with growth in Australia helping to offset some of the softer conditions expected in the residential market in New Zealand. In addition, we will have the Norman Ellison business on board for the first time.

With regards to our wool business, we expect the current low wool prices to continue to dampen activity in this segment and anticipate operating conditions similar to those experienced in the first half of this financial year.

As previously advised, our budget for the June 2008 financial year, which excludes any contribution from the Norman Ellison business, is for a 5% increase in earnings. We are ahead of the same period last year after the first half, but not enough for us to change the year’s budget as there are still many uncertainties ahead of us.

On the basis of a 5% increase in earnings from our existing operations, and after incorporating our share of the Norman Ellison business for the five months to June 2008, our earnings outlook for the June 2008 financial year is for a 7% increase on the previous year (after tax and minorities).

Dividends

The policy of paying dividends three times a year continues.

The Directors have declared a fully imputed second interim dividend for the year ending 30 June 2008 of 6 cents per ordinary share, an increase of 0.5 cent on the second interim dividend for the previous year.

This second interim dividend will be paid on Friday, 14 March 2008. The share register will close at 5 p.m. on Friday, 7 March 2008 for the purpose of determining entitlement to the dividend and will reopen on Monday, 10 March 2008.

Non-resident shareholders will also be receiving a supplementary dividend of 1.0588 cents per share together with their second interim dividend.

For and on behalf of the Board of Directors

W K Chung
Managing Director

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