The Tenon Group

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February 2009

Current Market Conditions

Current operating and market conditions for us are quite unprecedented, and our expectation is that the international credit crisis will continue to have an impact on our business throughout 2009. Limited access to mortgage credit has to date been a significant dampener on housing activity in North America, with housing foreclosure activity rising dramatically in calendar 2008. This has contributed to an over-supply of new and existing homes for sale, which has seen a resultant reduction in house price – which in turn has fuelled more foreclosures as those homeowners with high housing debt see the equity in their homes eliminated.

In addition, we find ourselves in an environment where the traditional counter-cyclicality of remodelling spend with new house construction has not occurred. For the first time, significant declines in both market segments have occurred. Historically, remodelling spend has tracked at relatively constant and consistent levels, with steady growth that has survived the “downs” of the new housing cycles. As Tenon’s key driver is remodelling spend, it is that decline that has impacted us most. This is perhaps best indicated by the Big Box building retailers same store previous comparable period % sales figures– where the data has now been tracking negative for nine successive quarters.

Outlook

There is no doubt that we will be operating in extremely tough market conditions for the remainder of fiscal 2009, with this next six months perhaps proving to be the most difficult for our sector in this cycle. Clearly, the unknown for us relates to the extent of slow-down the US economy will sustain across this next period, with the greatest risk being to unemployment levels and the impact that will have on retail sales and resultant manufacturing activity across the country. Having said that, there are some positives on the horizon, such as an improving availability of mortgage credit for qualified borrowers, an increase in housing affordability resulting from the house price declines that occurred in calendar 2007 and 2008, a significantly lower interest rate environment and potentially a housing stimulus package as part of the Federal Government’s overall fiscal stimulus package. Taking all factors into account, the most likely outcome is for a “flattish” second-half earnings performance for Tenon compared with the first-half result reviewed in this report. Beyond this immediate period we believe the longer-term outlook for the Company remains strong. In summary, Tenon:

• Has built an enviable strategic position – in its chosen categories, it holds the #1 or #2 vendor/market position;
• Is almost exclusively a niche, specialty player – with our exposure being to high-value products used primarily in the remodelling and renovation markets;
• Operates a unique blend of manufacturing and distribution activities – which provide key points of leverage in the supply chain and good earnings diversification; and
• Has a strong long-term growth profile – by way of example, the store count growth that Empire has achieved with Lowe’s over the past four years. Despite current market conditions, Lowe’s is still anticipating further new store growth, albeit at a reduced rate. As long as Empire continues to provide the high level of service and commitment that Lowe’s demands, then it should participate accordingly in Lowe’s organic growth.

Quite aside from organic growth is the growth that product and category expansion through these powerful “Big Box” home-improvement retailers can offer. As we have discussed previously in our reports to Shareholders, Tenon has now moved into the “outdoor” segment with the launch of the Armour Wood® and LIFESPAN® brands. The overall importance and relevance of this new segment is that the exterior trim and sidings market is some ten times the size of Tenon’s traditional interior mouldings category,

and wood-based products have only scratched the surface of this opportunity. It will be the introduction of new wood-modification technology (refer Sneek Bridge photo) that will allow much higher growth of wood products into this segment in future. Tenon plans on taking a leadership role in developments in this segment, and we hope to report on these developments later in the year.

In addition to structurally positioning Tenon for growth, it is worth confirming that the longer-term macroeconomic conditions for future success in our business activities remain strong – with, in particular, positive household formation statistics and an aging housing-stock both being positive supporting indicators of strong future performance when the market recovers from its current low level of activity.

In the immediate environment, however, we remain focused on achieving incremental sales and cost-out opportunities to underpin our operating earnings at the bottom of the cycle. We will also continue our tight control of working capital and capital expenditure to ensure we meet our debt-reduction goals, whilst maintaining our best-in-class service and commitment to our customers. At the same time, we will be looking widely at a number of ways to strategically advance the Company – from product and market growth opportunities right through to participation in sector rationalisation activity where it is sensible for us to do so. This latter activity might require Tenon to establish a more flexible bank funding facility – if this can be achieved, then for the strategic reasons outlined above we believe Tenon would be well placed to participate in focused sector restructuring activity.

This photo shows the Akkerwinde bridge over the A7 motorway in Sneek, the Netherlands.

The bridge was constructed in 2008, using laminated beams up to 40m in length, made from Accoya® timber. This is a modified wood manufactured by Titan Wood from high-grade FSC certified Pinus radiata supplied by Tenon, who worked with Titan Wood on the project.