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Directors' Report for the 6 months ended 31 December 2010

The Directors of Cavalier Corporation are pleased to report an unaudited profit after tax for the six months to 31 December 2010 of $8.5 million, an increase of 22% on the $7.0 million the previous year.

This result is a particularly pleasing one especially given the lingering effects of the global financial crisis, particularly in New Zealand where activity levels remained subdued and were lower than those experienced in the previous financial year. On the other hand, trading conditions in Australia continued to improve.

Group revenue for the six months was $117 million, an increase of 3% on the $113 million the previous year, with increased Australian-based revenue more than offsetting the reduced revenue in New Zealand. As a result, revenue in Australia now accounts for 60% of the total revenue of the Group, compared with 52% in the previous comparable period.

Return on average shareholders' equity for the six months was 18.5% and earnings per share was 25.1 cents (both annualised) - compared with 15.9% and 20.8 cents respectively the previous year - on the back of the improved financial performance.

Financial Performance

Financial Position

Shareholders' equity at 31 December 2010 stood at $92.9 million, which is an improvement of $3.7 million on the $89.2 million a year ago and $1.4 million on the $91.5 million at 30 June 2010.

At the same time, total assets employed at 31 December 2010 were $198 million, compared with $188 million a year ago and $191 million at 30 June 2010 - mainly because of the additional inventories required to support the Group's current levels of activity.

Shareholders' equity accounted for 47% of total assets employed at balance date, compared with 48% a year ago and at 30 June 2010.

Net interest-bearing debt at balance date stood at $59.5 million and net interest-bearing debt to equity ratio was 39:61. These can be compared with $57.3 million and 39:61 respectively the previous year and $49.8 million and 35:65 respectively six months ago.

The Group's financial position remains strong, and it continues to be well-positioned to withstand the difficult operating environment in New Zealand and to grow shareholder value.

Segment Reviews

Carpet Business

Our carpet business comprises broadloom carpets and carpet tiles, and whilst some of its products can be found elsewhere in the world, New Zealand and Australia continue to remain the main markets by far.

In the six month period to 31 December 2010, our carpet business produced earnings before interest and tax (EBIT) of $13.4 million on revenue of $108.3 million, compared with EBIT of $10.1 million on revenue of $103.6 million the previous year, an increase of 33% and 5% respectively on the previous comparable period.

As a result, EBIT as a percentage of revenue improved to 12.4% in this latest six month period, compared with 9.7% in the previous comparable period. This improvement can be attributed to a 33% increase in carpet tile production and sales in Australia and the favourable NZD:AUD exchange rate on our Australian dollar receivables.

In the period under review, we experienced contrasting market conditions in our main markets in New Zealand and Australia.

In New Zealand, market conditions remained soft as households continued to adapt to the post global financial crisis era with concern and caution - with debt reduction the primary focus and very little discretionary spending coming through, particularly in the big-ticket consumer durables. Home refurbishments and new building starts were also at historical lows. All these combined reduced the demand for carpet in residential applications to the lowest level seen in recent years. Similarly, the commercial sector was also quiet.

However, we enjoyed much better market conditions in Australia where residential building activity levels remained high. Demand for residential carpet was strong, especially in the higher-end of the market where our premium brands are well represented. Commercial activity was also strong even though this was confined mainly to refurbishment work. Our carpet tile operation in Australia stood out in the six month period as it continued to perform very strongly on the back of its "design-led" focus and "solution-based" approach.

Australian-based sales were up 19% on the previous year during the six months, whilst New Zealand sales were down 15%, highlighting the extent of the underlying differences between the two markets at the present time.

Wool Business

Our wool business comprises the Elco Direct wool acquisition operation and our 50% interest in commission wool scourer, Cavalier Wool Holdings Limited (CWH).

EBIT for Elco Direct is $216,000 for the six months to 31 December 2010 on revenue of $13.4 million, compared with EBIT of $270,000 on revenue of $12.0 million the previous year.

Cavalier's share of the tax paid earnings of CWH for the six months to 31 December 2010 is $819,000, compared with $1.4 million the previous year.

Whilst the results from our wool operations are substantially down on the previous comparable period, much of that can be attributed to the very wet spring and the consequent disruption to shearing and the flow of wool from the farm gate to the scours.

Acquisition of Radford Yarn Technologies Business

The Directors advise that Cavalier has entered into a conditional agreement to purchase a 75% interest in the Radford Yarn Technologies business ("Radford Yarns").

The agreement is subject to various operational conditions being fulfilled within the next 10 business days at which time the parties will proceed to settlement.

Christchurch-based Radford Yarns was founded in 1992 by two of its current director-shareholders, Edward (Woody) Radford and Joseph (Jack) Radford. Set up initially as a manufacturer of apparel and other novel and exotic yarns, it has grown to become a highly-respected world-class producer of premium felted wool yarns which are sold to high-end rug and carpet makers around the world, including Cavalier's broadloom carpet operation, Cavalier Bremworth.

In 2009, Radford Yarns was accorded the Best Technical Yarn Award at Domotex Hanover, Europe's main flooring trade show, and Radford Yarns continues to lead the world in felted yarn technology.

Felting, which is achieved by subjecting woollen slivers to axial forces as they are drawn through a temperature-controlled felting liquor, allows for a wide range of yarn styles and types to be produced that cannot be replicated using conventional yarn spinning methods. As a result, these unique-looking yarns are able to support the highly distinctive wool carpets which are particularly well suited for the premium end of the market.

The proposed transaction will be effected through a new company set up to acquire the assets, intellectual property and goodwill of Radford Yarns. Cavalier has agreed to subscribe for a 75% shareholding in the new company whilst the current management team (including founders, Woody and Jack Radford) will take up the remaining 25%.

The new company will have net operating assets of around $7 million, $6.5 million being the assets acquired in the original purchase and the balance being the increase in working capital required to support the business. Paid-up capital of the new company will be $3.4 million, with $850,000 of that coming from the Radford Yarns senior management for their 25% share in the new company and the balance funded by Cavalier from borrowings.

The purchase of Radford Yarns is a very positive and symbiotic initiative and will allow:

• Radford Yarns to continue to maximise the market potential of this unique technology within its existing and established customer base; and
• Cavalier Bremworth to not only expand its iconic "Bremworth Collection" range (which now boasts four felted products, with more under development) and underpin its product differentiation strategy into the foreseeable future, but also access new market segments in Australia, North Asia and North America.

The intention is for Radford Yarns to continue to retain its own identity in the market place (through continuity in management, sales representation, sales people and brands) with the positives from the proposed transaction coming from the synergies that will naturally arise from this acquisition - from product development through to manufacturing and marketing across Radford Yarns and Cavalier Bremworth.

In its first full year, the new company is expected to have a turnover of $7 million and EBITD (earnings before interest, tax and depreciation) of $1 million. However, the more significant benefits will come from within Cavalier Bremworth.

The Directors will update shareholders as soon as the agreement is able to be declared unconditional and the parties can proceed to settlement.

Commerce Commission Application by CWH

The Directors also advise that CWH recently lodged an application with the Commerce Commission for authorisation to effect a transaction which will involve CWH acquiring control of the wool scouring business of New Zealand Wool Services International Limited in order to bring about further rationalisation of the New Zealand wool scouring industry.

CWH has played a key role in the rationalisation of the industry over many years - more recently, when it was involved in the acquisition and successful rationalisation of the scours owned by Godfrey Hirst NZ Limited in April 2009 - and sees this latest initiative as strengthening New Zealand's competitiveness in wool scouring internationally.

The Directors will update shareholders as matters unfold over the coming months.

Earnings Outlook

The earnings outlook for the Group for the 2011 financial year is for after-tax earnings to be in the range of $15.8 to $17.5 million which is equivalent to the previous year's earnings (normalised) of $16.6 million plus or minus 5%. This is unchanged from the outlook presented to shareholders at the Annual Meeting on 15 November 2010.

In arriving at this outlook, we anticipate market conditions in New Zealand and Australia to be similar to those experienced in the first half of this financial year. We do not see much upside in New Zealand, with the high level of unemployment and the lack of confidence unlikely to spur any meaningful growth in the economy, in household spending and in home refurbishments or new-builds. At the same time, we are not expecting to see any slow-down in building activity levels in Australia.

The eventual rebuild of Christchurch following last September's earthquake should see a lift in demand for our carpet, especially as our brands are well represented with the group home builders there. In the meantime, building activity in the region is virtually at a standstill and will not pick up again until the after-shocks die down.

We are also expecting a lift in demand for carpet in flood-ravaged Queensland over the next 12 months.

With regards to our wool business, we expect the current shortage of wool to continue for the remainder of the season which will impact negatively on our scour earnings. But farmers would be heartened by the current high wool price which can only be positive for the industry in the long run and encourage the much-needed lift in wool production.

The flip side to the high wool price - which is now at a record 20 year high - will, of course, be the impact that will have on our broadloom carpet business where wool is a significant raw material. However, we are confident that we can manage our way through this, like any other increase in raw material prices.

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 2011 of 4 cents per share, unchanged on the equivalent for the previous year.

This, together with the first interim dividend of 3 cents per share paid in December 2010, brings the total interim dividend (fully imputed) to 7 cents per share, also unchanged on the previous year's total interim dividend.

This second interim dividend will be paid on Friday, 25 March 2011. The share register will close at 5 p.m. on Friday, 11 March 2011 for the purpose of determining entitlement to the dividend and will reopen on Monday, 14 March 2011.

Non-resident shareholders will also be receiving a supplementary dividend of 0.7059 cents per share together with their second interim dividend.

The Cavalier Corporation Limited Dividend Reinvestment Plan which allows shareholders to receive shares in the Company in lieu of dividends will apply to the second interim dividend. Shareholders wishing to participate and who have not previously notified the Company's Share Registrar must do so before 5 p.m. on Friday, 11 March 2011. A copy of the Participation Notice can be obtained from the Company's Share Registrar.

The Directors advise that the price for determining the number of shares to be issued in lieu of this dividend will be the volume weighted average sale price of all price-setting trades on the NZX over the five trading days from Monday, 14 March 2011 to Friday, 18 March 2011 without any discount.

For and on behalf of the Board of Directors,

A M James
Chairman
W K Chung
Managing Director

18 February 2011

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