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Connect Group: Financial report for the first half 2010

Half year data:
Sales of EUR 62.8 million (against EUR 63.2 million in 2009) for the continuing contract manufacturing operations.
Loss of EUR 2.6 million for continuing operations (against EUR 0.8 million in 2009) for continuing operations.
Net loss of EUR 1.6 million for the entire group (against EUR 3.7 million losses in 2009 for the entire group).

Quarterly data:
Sales of EUR 30.6 million (against EUR 29.7 million in 2009) for the continuing contract manufacturing operations.
Loss of EUR 1.9 million (against EUR 0.4 million in 2009) for continuing operations.
Net loss of EUR 0.8 million for the entire group (against EUR 2.3 million loss in Q2 2009 for the entire group).
Management discussion and analysis of the results

Connect Group NV (Euronext Brussels: CONN) posts sales of EUR 62.8 million for the first half 2010  from its continuing contract manufacturing operations. The first half 2010 operating result from the continuing operations was EUR -1.06 million. This result in the second quarter is for the most part attributable to delayed sales due to shortages of components on the market and the resultant production setbacks.
Total net financial costs for the second half amounted to EUR 1.609 million (against EUR 1.038 million in 2009). This deterioration is due to changes in the exchange rate of the US dollar, the Romanian lei and the Czech crown, all of which had a negative impact on the financial costs.

The net result of the continuing operations amounted to a loss of EUR 2.684 million for the period, against the previous year’s EUR 0.812 million loss.

The net result of the group was positively impacted by proceeds of EUR 1.096 million from discontinued operations. In 2009, as part of the divestiture of the automation business (the discontinued operation), a provision was booked for a major outstanding receivable from an automation customer, where the risk remained with the Connect group following the sale of the business. The receipt of full payment of this receivable in June 2010 meant that the impairment charge was no longer needed. The income statement of the discontinued operation for the first six months of 2010 includes no net operating results since all operations in the period 1 January to 3 March 2010 were conducted on behalf of the purchaser. In 2009 the discontinued automation operation posted an operating loss of EUR 2.9 million for the 6-month period.

The net group result for the first half 2010 was a loss of EUR 1.588 million compared to the EUR 3.725 million loss incurred in 2009.
 
Orders at the end of Q2 2010 were up 20% to EUR 66 million against EUR 55 million at the end of 2009.

The 2nd quarter of 2010 sadly confirmed what we had already been seeing and mentioned in the 1st quarter. Pressure in the components market in the 1st quarter increased further in the 2nd quarter, having a very significant impact on our results.

Looking at the top line (sales), we see that despite increased orders we are failing to deliver due to a lack of a number of components. We estimate that without component shortages in the market we could have increased turnover by EUR 4 - 5 million with the manpower we have on board today. With material costs accounting for an average of 70 percent of turnover, this means that our results would have been EUR 1.2 - 1.5 million better in the first half.

The shortage of components is also affecting their prices. In addition, to reduce delivery delays components have to be purchased through brokers at higher prices. These cannot always be passed on to customers and we estimate the resulting impact of both to be around EUR 0.5 million for the first six months of this year.

Thirdly, the lack of these components is affecting production efficiency. Work has to be interrupted because of shortages and then restarted at a later time causing additional production downtime and additional adjustments to compensate for all this, meaning that despite lower than expected output we could not make any savings in staff costs.

These 3 factors are the most important reasons for the cost price of sales being significantly higher (90 percent) than last year (88 percent).

Due to the lack of certain components we are seeing an increase in stocks of the other components. Since production can only be started once all components are available, the lack of just one component (on average there are 200-250 per board) means not only that we cannot produce but also that all other components remain longer in stock. The consequence is that our stocks are 3 to 4 million too high, thereby causing additional financing costs.

For several months now we have been working with our major customers to place advance orders for critical components. The intention is to obtain better and longer forecast periods so that we can place orders with suppliers earlier. We expect that, beginning with the fourth quarter, the component availability problem will for the most part be under control ".

The increase in trade receivables was due both to the raising of the payment period for contracts with a major customer from 30 to 60 days (more than EUR 4 million impact on receivables) and the non-respect of payment conditions by a customer (EUR 3 million impact). Agreements have been reached with this customer to convert the outstanding amount to normal payment terms. No provisions have yet been made for this amount since the agreements reached with the customer mean that the amount is not yet deemed irrecoverable.

The EUR 2 million investment in the new SAP software was recorded in the balance sheet at the end of 2009 under the heading "work in progress" under tangible non-current assets (fixed assets), as full delivery had not yet taken place. At the start of 2010 the software went online, meaning that the investment was included under intangible non-current assets.

The risk assessment can be found in the Annual Report and is available on the Internet
(www.connectgroup.com).

The following represent the major risks for the company at present:

1. Component availability causing sales delays. If component availability remains the problem as it was in the first half, there will be sales delays.
 
2.  Currency Risk:
• The group buys a number of its components in dollar / yen. The accompanying exchange rate risk is only partially covered in the selling price.
• With production being done partly in Romania and the Czech Republic, any major fluctuations of their currencies against the Euro can impact costs.
• Since foreign currency requirements cannot be exactly timed, the group has decided not to hedge foreign currencies.

3. The group has a credit agreement with its bankers. If the imposed credit conditions are not met on 31 December 2010, the bankers may either terminate the credit agreement or tighten its conditions.

4. The group has a major EUR 3 million outstanding claim against a customer who is currently not adhering to payment conditions. Should the customer - despite the agreements recently reached – default on the payment, the group will have to post a EUR 3 million impairment charge on this claim.

No significant events have occurred after the balance sheet date.


Significant events in first half-year 2010

On 2 March 2010 the sale of the automation activity to its former founders, Huub Baren and Vladimir Dobosch was completed. The present figures no longer show the effects of the automation activity. For comparability purpose, the 2009 figures have been restated, with the automation activity shown as a discontinued activity.

On 27 April 2010 the Extraordinary General Meeting approved a EUR 5 million convertible subordinated bond under the following conditions: suspension of general preferential rights, a minimum investment of EUR 50,000, a term of 6 years, an interest rate of 6 percent payable semi-annually, and a twice-yearly conversion option (following publication of annual and half-yearly figures). The bonds will be convertible at the lower of: (i) 70% of the average highest independent bid price for a Connect Group share, in the central order book of Euronext, over the 30 trading days preceding the date of exercise and (ii) EUR 2.00
The issuance of this subordinated warrant loan in an amount of EUR 5,000,000 considerably improves the Connect Group’s financial standing. This improvement of both the equity and the cash position was necessary, following the divestment of the automation activity at the end of 2009.

On 21 June 2010 Connect Group announced a simplification of its group structure. After shedding its automation activity in early 2010, management has undertaken an analysis of the remaining operational and legal structure of the group and concluded that this could usefully be simplified.
Connect Group is made up of nine companies, five in Belgium and four abroad (Germany, Romania Netherlands and the Czech Republic. The reorganization affects the five Belgian Companies which will be reduced to two. The surface mounting facility in Ieper (Connectronics NV) will be merged into Connect Group NV (Group holding company and surface mounting activity in Poperinge). Management company Connect Group International NV will be merged into Connect Group NV (the cable activity in Belgium) and Connect Group Holding NV, which served only as an internal holding company, will be liquidated.
This simplification process starts in the second half of 2010 and will be taking place in stages. The first stage was carried out on August 9, 2010 with the merger of the companies Connectronics NV and Connect Group.

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