Letter to the shareholders

In the 2018 financial year, the Arbonia Group was affected by various trends. The company recorded stable organic growth and an encouraging increase in profitability. In the second half of the year, momentum declined as expected, as a result of macroeconomic and industry-specific developments in major markets, but also on account of internal challenges, such as the relocation of wood/aluminium window production from Switzerland to eastern Germany.

In 2018, Arbonia increased Group revenue by 10.3% compared to the previous year to CHF 1 374.0 million (previous year: CHF 1 245.6 million). The activities of the Vasco Group, which were consolidated on 1 June 2018, contributed with CHF 58.8 million to Arbonia's growth. EBITDA increased by 8.5% and reached CHF 130.5 million with special effects (previous year: CHF 120.3 million). In adjusted terms, Arbonia increased its EBITDA by 13.6% from CHF 101.3 million to CHF 115.1 million. Considerably higher depreciations in the reporting year meant that EBIT did not rise, resulting in Arbonia achieving a level of CHF 61.0 million (previous year: CHF 61.3 million). Excluding special effects, EBIT reached CHF 47.8 million (CHF 42.6 million in the previous year), equating to a 12.4% increase. Arbonia achieved a company result of CHF 46.0 million. In the previous year, this figure was CHF 46.4 million.

The continued strengthening of Arbonia's financial footing over recent years means that it is able to offer shareholders a dividend for the 2018 financial year for the first time since the 2013 financial year.

Market environment

In the reporting year, Germany was the largest sales market followed by Switzerland, Poland, Italy and France. Arbonia attained around 80% of its annual revenue in these core markets.

Concerns over interest rates and the economy, the escalating trade dispute between the USA and China, the continuing uncertainty surrounding Brexit and Italy's national debt dampened the mood in the global economy, particularly in the second half of 2018. These uncertainties also influenced the forecasts issued in relation to the construction industry. In the reporting year, Arbonia battled against rising raw material prices, including for aluminium, steel and glass, as well as an increase in labour costs, particularly in Central and Eastern Europe.

In Germany, development of the construction industry remained stable, though the lack of skilled workers and sites for construction has been curbing the boom experienced in the new construction sector for some time now. The shortage of skilled construction workers led to a preference for new construction, which further restricted the more profitable renovations business in the reporting year. The effects of the general pessimistic economic outlook, however, were also felt in 2018. Lower incoming orders in the industry led to a drop in commercial expenditure on buildings.

In Switzerland, capacity remained stable. However, the large amount of new construction activity seen in recent years, driven by low interest rates, has led to imbalances on the property market. The increasing number of income properties remaining vacant is leading to increased competition, with pressure on rents. This development is also making energy efficiency refurbishments less attractive, as such renovations increase the value of the property. Overall, the risk that new residential construction in Switzerland will experience an even greater correction than has long since been expected is looking increasingly likely. In contrast, however, the office building sector recorded healthy growth.

In Eastern Europe, Arbonia's most significant market, Poland, continued to experience pleasing growth. However, a lack of skilled workers presented challenges and became an even more exacerbated issue – as did unsatisfactory productivity levels, which were well below the EU average. The negative effects of the lack of skilled workers and increasing wages on economic development have already been felt in Slovakia and the Czech Republic, where Arbonia also has production sites.

In Italy, 2018 was characterised by ongoing political instability and the country's dramatic budget dispute with the EU. These problems led to a general air of uncertainty in the economy, credit risks and postponements to investments, as well as stagnating consumption and the country ultimately falling into recession.

Growth in France slowed, especially in the second half of the year, and real earnings only registered a slight increase. The protests held by the "yellow vest" movement, which flared up towards the end of the year, also brought political uncertainty and further subdued the economy. This also had a negative impact on the mood of building contractors. Expectations for new construction business and energy efficiency refurbishments are therefore low in the sector for 2019.

General activities of the Arbonia Group

In the 2018 financial year, Arbonia implemented further strategic measures which enabled it to strengthen its profile as well as its industrial and financial basis for long-term business growth. The former Building Technology Division was split up at the start of 2018; since then, its market segments have been represented by the two new, independent divisions of HVAC (Heating, Ventilation and Air Conditioning) and Sanitary Equipment. Also in January, Arbonia successfully completed the sale of the profile systems business unit, which had been initiated at the end of 2017, thus focusing the Doors Division on its business with interior doors. The Arbonia Group now consists of four divisions: HVAC, Sanitary Equipment, Windows and Doors.

One area of focus in the reporting year concerned bolstering the HVAC Division from a strategic and an industrial perspective. In May, Arbonia announced the acquisition of the Belgian Vasco Group, the market leader for radiators in the Benelux countries, which has production plants in Belgium, the Netherlands and Poland. This enabled the division to add regionally established brands to its portfolio, expand its geographical presence in western Europe and helped it to consolidate its position in the radiator industry. In the autumn, Arbonia acquired Tecna, its former HVAC distribution partner for the Iberian Peninsula, boosting its direct business.

In 2018, Arbonia pursued its strategic goal of aligning its property ownership with operational needs by selling three properties in Switzerland. During the first half of the year, it sold the window production property in Villeneuve (CH). With retroactive effect from 1 October, the company sold an industrial property in Dietlikon (CH) which it had not been using since it withdrew from the kitchen business in 2014. In December, Arbonia sold a plot of undeveloped land at its headquarters in Arbon (CH). All properties were purchased by property development companies. Arbonia is using the substantial proceeds from these divestments to finance its general business operations.

In order to secure solid medium to long-term financing of the Arbonia Group by means of an additional source, a bonded loan was issued in April 2018. Due to strong demand for the bonds with terms of 5, 7 and 10 years, the volume was able to be increased from the original EUR 75 million to EUR 125 million.

In the reporting year, Arbonia invested a total of CHF 136.0 million. Further investment projects worth CHF ~100 million are planned for 2019.

In order to ensure continuity at senior management level, the Board of Directors of Arbonia AG appointed Daniel Wüest as its Chief Financial Officer (CFO) and member of Group Management in December 2018. He will assume responsibility for Corporate Finance from Felix Bodmer on 12 April 2019, the date of the Annual General Meeting. A Swiss national, Daniel Wüest (born 1970) is an economist specialising in finance and banking. He has a proven international track record and has been familiar with the Arbonia Group for many years on account of his former work as a consultant.

Strategies and developments in the divisions

In 2015, Arbonia launched a comprehensive programme to achieve financial and strategic goals by the end of 2018. Key measures included the relocation of the production footprint and focusing on divisional strategies. In order to build on the solid foundations it enjoys today, Arbonia has defined four strategic approaches for the entire industrial business:

Detailed information is provided in addition to the following overview in the separate division chapters from page 18.

As of 1 January 2018, the HVAC Division (Heating, Ventilation and Air Conditioning) has been an independent part of the former Building Technology Division. It is therefore reporting its own key figures for a complete financial year for the first time. The division pursues two key strategic goals:

1. To adapt its product portfolio and market presence in line the growing number of products/services and markets

2. To play a leading role in the consolidation of the European radiator market and in doing so to expand both regionally and in terms of the portfolio it offers.

The division made an important step towards achieving these goals with the acquisition of the Belgian Vasco Group in May 2018. In the HVAC business, Vasco expanded Arbonia's market presence in western European countries and deepened vertical integration, as it produces pipes for underfloor heating itself. For several years, radiators have represented over 90% of the division's overall revenue, with steel panel radiators in the DACH region accounting for over 65%. In 2018, despite consolidated growth, radiators only accounted for under 65% of overall revenue, less than 40% of this being steel panel radiators, which are largely being sold in emerging markets such as Eastern Europe and Russia. However, a significant proportion of the division's consolidated revenue growth in 2018 was in the product segment of heat pumps, floor heating, convectors, and air-conditioning and ventilation technology, which is set to account for 40 – 50% of revenue in the future.

By making considerable investments, Arbonia has in recent years also modernised its production facilities in the German town of Plattling in order to improve both quality and supply availability. To centralise its expertise in competence centres and to further increase its competitiveness, the HVAC Division is intending to focus its production here and on other highly automated locations. In the Russian town of Stupino, the construction of a new radiator production plant, which was started in 2018, is on track; the plant is set to be put into operation in spring 2019.

The Sanitary Equipment Division, which was also formed on 1 January 2018 from the former Building Technology Division, further adapted and standardised its processes at the Plattling location in Germany during the reporting year, following the relocation of the Koralle brand's production facilities to the site in the previous year. The targeted increase in production efficiency was achieved by the end of the reporting year. Nevertheless, the division battled against losses from excessive retail concentration of the Kermi and Koralle brands in Germany. Difficult market conditions in France were also cause for concern and brought about a general downtrading of sales activities, meaning that the division, along with its distribution partner, was forced to accept losses. A whole host of measures are being evaluated or have already been implemented to take important steps which will enable Arbonia to set the course for its production, product development, sales and services activities in 2019.

The Windows Division is working towards becoming the European market leader in the windows sector. It is striving to gain a sustainable competitive advantage by consolidating manufacturing in Eastern European competence centres.

Relocation of production from the plant in Altstätten (CH) to the state-of-the-art wood competence centre in Langenwetzendorf (D), which started in 2017, involved a huge amount of work. Following considerable delays to the plant's ramp-up process, which were caused by a combination of factors including a shortage of skilled workers, a difficult training period with the Eastern European workforce and the fact that operations had to continue in parallel at the Swiss plant, Wertbau made huge strides in productivity in the summer and has been working at the desired level since November. The aim is to close the Altstätten (CH) production plant fully in 2019 and to only continue to run a service shop.

In the reporting year, the division strengthened its market position with new products, particularly involving vinyl and vinyl/aluminium. The pioneering product platform for wood/aluminium windows, which was launched in the previous year and operates across companies and markets, has continued to demonstrate its worth. In Switzerland, the division was able to gain market shares as a result. In 2018, the vinyl competence centre in Pravenec (SK) commenced series production of insulating glass at a state-of-the-art facility, allowing it to shorten production lead times, enhance quality and decrease dependency on local suppliers. What's more, standardising profile and fitting systems has reduced both costs and complexity.

At the end of 2016, Arbonia significantly strengthened its Doors Division with the acquisition of the Looser Group. This market-leading provider of interior doors was a perfect addition to Arbonia's doors business, both in terms of the products it offers and its production facilities. The Looser Group's doors companies were incorporated promptly in 2017 and the division focuses on the interior doors business. Proof that this strategic step was the right one and that it was implemented effectively can be seen in the pleasing business activities recorded in the reporting year and the fact that encouraging order volumes are already in place for the start of 2019. As in the previous year, the production plants in Germany and Poland were operating at the limits of their capacity and are now being modernised and extended. In Poland, the foundations for a new door production facility have already been laid and a new warehouse has been put into operation.

In Switzerland, demand for interior doors from the Prüm brand developed very positively. Business with the specialist trade in Switzerland gained momentum as a result of the merger, benefitting both functional doors from RWD Schlatter and standard doors from Prüm.

From a strategic perspective, Arbonia is aiming to assume a leading role in relation to the rapidly advancing digitisation of the property industry ("prop tech") and consequently has acquired shares in the Berlin-based (D) PropTech company KIWI.KI GmbH. KIWI and the Doors Division have jointly developed the "SmartDOOR", a door enhanced with digital access technology from KIWI which cannot be seen from the outside. Housing providers can use this digital access system to digitise their key management and at the same time provide their tenants with increased comfort. Managers and owners can manage access rights online in real time and therefore no longer have to meet tenants in person to hand over keys.

Outlook

In recent months, the IMF and various economic research institutes have issued negative statements regarding the global economic outlook. Trade conflicts, the current uncertainty surrounding the United Kingdom's exit from the EU, Italy's national debt, and the prospect of an end to expansionary monetary policy are presented as the known risks. A number of forecasts are indicating that there could be an end to almost ten years of continuous growth.

In the reporting year, there were already signs that the favourable development of the construction industry and demand is set to weaken in 2019 on account of the problems stated, such as capacity limits, a lack of skilled workers and further increases to labour costs. It is our assumption that – following an accelerated period of recovery up until 2017 – the construction industry may lose some momentum in the medium term and construction volumes may decline to varying degrees depending on the market compared against the previous year.

Acknowledgements

Despite establishing solid industrial and financial foundations, Arbonia continues to operate in a highly competitive industry. Our customers come to expect a lot from us in terms of the product quality of our renowned brands as well as our efficiency and value for money. Parallel to this, requirements in relation to cooperation within the Group are continuing to increase: production facility relocations, acquisitions and market expansion mean that our cultural diversity is growing. All these developments placed huge demands on Arbonia's employees and managers in the 2018 financial year. On behalf of the Board of Directors and Group Management, we would like to thank all those involved for their outstanding dedication. We would also like to thank our customers and suppliers and most notably you, our dear shareholders, for your trust.

Alexander von Witzleben

Chairman of the Board of Directors

Felix Bodmer

CFO