Operations Europe

Europe

Market

The European division is managed through three geographic areas with senior management allocated responsibility for each. These areas are UK including Ireland, France and Central Europe. The latter is responsible for the division's operations in Austria, Belgium, the Czech Republic, Denmark, Hungary, Italy, Luxembourg, the Netherlands and Switzerland.

Wolseley UK is managed through brands such as Hire Center, Plumb Center and Build Center. These brands allow focus on specific market groups of customers while being supported by the common logistics and operations infrastructure of Wolseley UK.

Europe in total represents a market estimated to be 450 million people and is experiencing the following demographic factors, all of which present market opportunities for Wolseley:

• Falling birth rates leading to less new build but more repair, maintenance and improvement work.
• Longer life expectancies and increasing divorce rates leading to an increase in apartment accommodation compared to family homes.
• An increasing number of high incomes resulting in more demand for second homes.
• Skill shortages leading to a more migrant population and an increased use of offsite fabrication.
• Increasing consumerism producing new routes to market, for example, the Internet.

These changes often represent shifts of activity within segments rather than shifts into segments where the division does not have a presence. Nevertheless the Group does employ a flexible business model which allows it to react quickly to market changes.

The European division continues to seek opportunities to expand into other geographic areas such as Spain and other parts of Eastern Europe. The Group will be present in the growing Nordic region following completion of the acquisition of DT Group.

Market size

Europe revenue and market share

Management has estimated market sizes through evaluating the building materials suppliers' total market if all products were channelled through the distribution network. Management's best estimate of both Wolseley's activity in each market and the total size of these markets are set out below:

An analysis of the estimated total market opportunity in Europe, including those territories where at 31 July 2006 Wolseley had no presence, is set out below:

Note: Wolseley's small existing operation in Denmark has been excluded from this analysis.

Demand in the European markets is driven by activity in a number of key market sectors:

• the residential market analysed between new construction and repairs, maintenance and improvements;
• the non-residential market analysed between new construction and repairs, maintenance and improvements; and
• the civil infrastructure market.

The division's split of business by each of these key drivers is given below:

European % of divisional revenue

The division has more activity generated from residential compared to non-residential and civil infrastructure work, however the actions underway both through acquisitions and enhancement of business diversity, continue to broaden the business base.

Significant opportunities are available to broaden the division's reach both geographically and also in terms of market segment. The acquisition of DT Group represents a significant step in this regard. Its annual revenue in its last financial year was £1.6 billion.

Divisional performance

Europe revenue

All of the continental European operations with the exception of the Czech Republic, which had marginally lower revenue, increased revenue and most achieved profit improvements in the year to 31 July 2006 despite markets in construction that showed very little growth. The results benefited from the effect of acquisitions but were adversely impacted by the fall in Brossette's profits due to its restructuring and lower profitability in Austria.

Reported revenue for the European division increased by 11.1% from £4,637 million to £5,150 million, of which 2.8% was from organic growth. Growth due to acquisitions accounted for £382 million (8.2%) of revenue. Trading profit, after European central costs, increased 2.9% from £307 million to £316 million. European central costs rose by £3 million to £7 million due to the planned expansion of the European infrastructure to drive future growth and profit initiatives.

The overall divisional trading margin, after European central costs, fell from 6.6% to 6.1% primarily due to the lower trading margins in Brossette, Austria and the UK and the effect of acquisitions. Margin improvements were achieved in PBM (France), Manzardo (Italy), Cesaro (Czech Republic), Electro Oil (Denmark) and Wasco (Netherlands).

In the year, a further net 375 branches were added to the European network, giving a total of 2,861 locations (2005: 2,486).

UK and Ireland

Wolseley UK's performance held up well against a UK building materials market which is estimated to be around 4-5% down on the prior period. Whilst the fundamentals of the UK economy remained positive, with relatively low interest rates and low unemployment, repairs, maintenance and improvement ("RMI") spending slowed in the first half of the financial year in response to weaker consumer confidence, but sales trends started to show a gradual improvement in the final quarter. Government spending remained a relative bright spot, although there have been noticeable delays in planned social housing expenditure.

Revenue and Trading profit- UK and Ireland

Against this more challenging background, Wolseley UK, which includes Ireland, recorded a 14.4% increase in revenue to £2,690 million (2005: £2,351 million). Organic growth of 2.1% outperformed the market generally, with Bathstore, the retail bathroom offering and Heatmerchants and Brooks, the Irish businesses, performing particularly well, producing double-digit organic revenue growth.

Wolseley UK's trading profit increased by 9.9% on the prior year mainly as a result of the acquisitions of William Wilson, Encon, AC Electrical and Brandon Hire, all of which have outperformed expectations at the time of acquisition. Although the gross margin improved, the trading margin fell slightly from 7.8% to 7.5%. This was the result of the ongoing investment in the business to increase the management resource, improve supply chain and logistics and expand the branch opening programme. These investments provide a platform for future growth in both the traditional brand areas as well as those recently entered.

The new national distribution centre ("DC") in Royal Leamington Spa, which is located alongside Wolseley UK's new headquarters, commenced deliveries to branches in August 2006. The regional DC, in the north west, is scheduled to open in Autumn 2007. These investments and the current initiatives to centralise control of transport and branch inventory management should enhance customer service, improve efficiency and support continued growth in the business.

During the year, 288 net new locations were added in the UK and Ireland, including 262 branches added as a result of acquisitions, taking the total number of branches for Wolseley UK to 1,858 (2005: 1,570 branches).

France

In France, government tax incentives continued to underpin growth in the new residential market, but RMI, representing approximately two-thirds of revenue for both Brossette and PBM, continued to show only marginal improvement against the background of little growth in the overall economy, weak consumer confidence and persistent high levels of unemployment.

Revenue and Trading profit- France

Wolseley's French operations, which since May have been managed through one central team, generated revenue up 4.8% to €2,515 million (2005: €2,399 million), including organic growth of 2.1%. Trading profit for France was down to €132 million (2005: €143 million) with a trading margin of 5.3% (2005: 6.0%) as a result of the lower level of profitability in Brossette.

PBM achieved an increase in revenue of 6.8% in local currency, almost half of which was organic growth. The sales trends in PBM improved in the second half and this upward momentum is expected to continue. Gross margin was down slightly. PBM's branch numbers increased by 57 during the year to 347 branches including the opening of 8 new satellites and 12 hire locations. The underlying trading profit, excluding the previously announced €11.5 million (£8 million) wood import duties rebate, showed an improvement, as did the underlying trading margin.

Local currency revenue in Brossette was 1.8% up on the prior year. Trading profit was significantly lower, before taking account of the previously announced €7.6 million (£5 million) fine from the French Competition Authorities relating to matters which took place more than ten years ago. Brossette's results reflect the ongoing reorganisation of the district, branch and management structures and the move to centralisation of purchasing and logistics, all of which are designed to enhance customer service and facilitate future expansion. In order to accelerate the changes being made at Brossette a number of management and employee changes were made during the year with associated one-off severance costs of approximately €3.5 million.

PBM is expanding the number of joint sites with Brossette, continuing to cross-sell each others' products in their respective branches and exploiting opportunities to create purchasing synergies and indirect cost savings in cooperation with other Group companies.

Central Europe

The Group's other continental European operations enjoyed generally good results despite broadly flat markets. Revenue in Central Europe was up by 14.6% to £735 million (2005: £642 million), reflecting organic growth of 7.4% and the benefit of acquisitions. Trading profit was up 3.9% to £31 million (2005: £30 million).

Revenue and Trading profit- Central Europe

Tobler, in Switzerland, had another record year with revenue up 17.8% to more than CHF300 million for the first time, including 10.1% organic growth. Despite competitive market conditions exerting some pressure on prices and a change in the business mix to lower margin products, its trading margin improved.

In the Netherlands, Wasco continued to make good progress expanding its product range into sanitaryware, developing its offering to the more profitable RMI market and focusing on cost control. It achieved organic revenue growth of 16.1% and trading profit improved by 57.0%. In Luxembourg, CFM's revenue increased by 3.6% although trading profit was down, reflecting an increasingly competitive market. Centratec, the Belgian business acquired in October 2005, performed in line with expectations and is now working with Wasco and CFM to achieve improvements in sourcing, logistics and inventory management.

ÖAG, in Austria, increased revenue by 2.7% although trading profit fell due to continued competitive pressure on prices as a consequence of difficult housing and RMI markets and business restructuring. In Hungary and the Czech Republic, local market conditions remained difficult but Wolseley Hungary achieved strong organic revenue growth and Cesaro in the Czech Republic improved profits.

In Italy, Manzardo increased revenue by 21.4% compared to the prior year, including 6.7% organic growth in a flat market and the incremental effect of Iser Zauli acquired in January 2005. The branch opening programme of the past few years continued to benefit Manzardo's revenue growth. Trading profit rose 13% reflecting the costs of branch openings and preparations for the DC opening. Four new branches were opened during the year. Progress on the €20 million new central DC in northern Italy continues and the first branch deliveries are expected to commence before the end of 2006, with other branches being rolled out over the following 12 to 18 months.

Further progress was made during the year to manage the businesses in a more integrated way across Europe. The focus was on sharing best practice in areas such as branch format and product/service offerings, rationalising the product and supplier base, improving the supply chain and sourcing from low cost countries. All of these initiatives are designed to enable the Group to benefit from cross-border synergies and accelerate growth in Europe.