Textile & Washroom Services

MARKET CONDITIONS

The markets throughout Europe remained challenging in 2006 reflecting the continued decline of the traditional industrial base as manufacturing moves to lower cost countries. There is also some overcapacity in the continental European markets which impacted our ability to increase prices despite cost pressures (fuel, labour and costs relating to the more stringent legislation and regulations in the areas of health and safety and the environment).

2006 REVIEW

The Textiles and Washroom Services division had a difficult year with adjusted operating profit down 18.7% in the full year on broadly flat revenue. The UK business, which accounts for 15% of divisional revenue, is being fundamentally restructured and tough market conditions in the major countries in western Europe have had a significant adverse effect on margins.

The UK business underwent a number of fundamental changes in the year to address some deep-seated operational issues. Although impacting on performance in 2006, these changes will create a platformfor the development of a much stronger and more profitable business going forward. The loss-making linen and workwear activities were closed on 30 April 2006. The structure of the remaining washroom business was completely overhauled as the two legacy washroom businesses were integrated, a process which could not commence until linen and workwear had been separated out. At the start of the year the combined business had operated from 50 branches. By year end, this had transitioned to 25 multi-service centres with some key functions previously carried out at branch level being transferred to centralised customer handling and back office facilities. The action taken in the UK business in 2006 will reduce its cost base by £3 million per annum and the restructuring is expected to be completed by the end of 2007. The one-off costs incurred in the UK in 2006 were £5.1 million. Inevitably, such a high level of change negatively affected performance of the UK business. In particular, a high level of terminations was recorded in the second and third quarters from washroom customers who had previously also taken linen and workwear services, although this began to stabilise in the fourth quarter. As a result, revenue declined by 5.7% in the UK compared with the prior year and adjusted operating profit fell by £13.8 million.

In France, the industrial sector of the textiles business BTB was reorganised whereby processing is run centrally whilst profit and loss responsibility remains at branch level. The reorganisation aims to develop a more coherent approach to plant investment and capacity utilisation and a more active and professional sales management. However, the difficult market environment of soft demand and aggressive competition prevented the business from realising the full benefits of the structural change in 2006. Consequently although revenue in France grew by 1.3% in 2006, adjusted operating profit fell by 15.9%. During 2006, BTB received a formal complaint from the French Competition Council alleging that certain activities in a period between 1997 and 2002 infringed French competition law. After taking appropriate legal advice, the group has made a provision in respect of the possible regulatory fine to be imposed by the French authorities. While the provision represents our best estimate of the total liability that may arise, it is possible that the ultimate liability may be different from the amount of the provision currently recorded. The total amount of the provision is not disclosed to avoid prejudicing the group’s position in this matter.

Revenue in the Netherlands fell by 3.1% compared with last year because strong competitive pressure in the second half of 2005 and first half of 2006 resulted in a net loss of portfolio. Our ability to control costs due to greater route density in this market limited the impact of lower revenue on adjusted operating profit, which declined by 3.6%.

In Germany, revenue increased by 3.4% in 2006. However adjusted operating profit was 7.1% lower as a result of continuing losses in the hospital services business and cost inflation in excess of the price increases we could achieve in the market. A plant review programme commenced during the year reflecting our desire to exit low margin activities in the south of Germany. It is anticipated that this will be completed by the fourth quarter of 2007. The estimated saving is £2.0 million per year which will be achieved in 2008.

Revenue increased in the division’s business in Belgium by 1.2% over last year but again higher costs resulted in a decline in adjusted operating profit of 2.6%.

Most of the division’s smaller European businesses recorded higher revenue in 2006, including strong double digit growth in Austria, Spain, Finland, Portugal and the Czech Republic and mid to high single digit growth in Denmark and Switzerland. Operating profit came under pressure due to rising costs – principally investment in sales and service capacity – and competitive pressure with only Austria, Portugal, Switzerland and Spain making progress against last year.

The integration of the two legacy washroom businesses moved ahead during 2006 in the majority of the European markets. As well as creating a more efficient structure and improving service performance, the aims of the integration include selling the full range of washroom services and mats to all markets.

A number of capital investment programmes commenced in Europe in 2006 for completion in 2007 which will either upgrade existing facilities or provide market entry. These include Amstetten in Austria, Lokeren in Belgium, Brie-Comte Robert in France and Prague in the Czech Republic. The total investment associated with these projects is estimated to be £24 million, of which £10 million was spent in 2006 with the balance to follow in 2007.

2007 PREVIEW

2007 is an important year for the division and it is vital that progress is made in a number of key areas. These include improved cost recovery and higher productivity and efficiency throughout the division. We will explore cross-border structures to improve customer service and reduce costs in processing, service and management activities. At the same time, we will monitor developments in the wider market and evaluate opportunities to protect and/or create value as they arise.

The changes in the UK will be completed by the end of the year. By then, the business will be operating from its final 20 locations; it will have modern, efficient processing plants using new technology; the centralised back office facilities will be running at full strength, as will the new Oracle systems. The branch cost base will have reduced by £3 million. Overall, we anticipate improved customer retention rates and higher new business wins leading to higher organic revenue growth.

In France, there were positive trends in portfolio development at the end of 2006 which have continued into the early part of 2007.With this in mind, our aim in 2007 is to stabilise profits in the French business. Firstly, we must improve our ability to recover cost increases. In 2006, our costs rose by some 4% but price increases were less than 1%, a position which is clearly not sustainable. We are also aiming to improve sales productivity and continue to develop range selling, that is to say the number of products taken by each customer.

Elsewhere in continental Europe, cost recovery is also a high priority. In Germany, we expect to exit certain low margin activities in the south and also complete the washroom business integration. A pan-European plant and infrastructure review will be undertaken. We will be investing in new processing capacity in Belgium, France, Austria, the Czech Republic and Spain and looking for market entry in eastern European markets such as Poland.