CLS Holdings

This was a year of numerous achievements for the Group, both at the core property operating level and with the range and depth of our financing arrangements. We have also achieved the highest total shareholder return amongst our peer group since the downturn began in 2008, producing 64.9% over four years, and 11.1% in 2011.

The effect of these achievements would have been even greater had they not been impacted to a degree by the difficulties at the broader macroeconomic level, in particular with the Eurozone during the second half of the year. Profit after tax was £38.8 million (2010: £60.1 million), earnings per share on an EPRA basis were 64.9 pence (2010: 42.5 pence) and EPRA net asset value rose to 983.1 pence (2010: 952.9 pence).

At the start of 2011, few were predicting that long-term interest rates would plummet, banks would face another round of stress tests, the United States and France would lose their AAA rating, or a potential break-up of the Eurozone which would require companies to start contingency planning. Politicians in Europe have failed to take decisive action that would restore confidence to markets and provide a platform for growth.

However, I am pleased to report that we have been responding with considered tenacity: the vacancy rate has been reduced to our lowest level for over 10 years; we have made property acquisitions in London; we have started building the two pre-let schemes in Germany; and we have submitted plans for two developments in central London for the medium-term.

The benefits of our strategy of diversification remain clear: we operate across four countries, we have a solid customer base of some 400 tenants and we are financed by 20 banks. Over the long term, this spread of risk has been an important aspect of the Group’s outperformance. I would stress that our direct exposure to the Eurozone is in its two strongest economies, Germany and France.

During the year the investment property portfolio grew in local currency terms, on a like-for-like basis, by 2.1%. The value of the London properties grew by 2.7%, France by 1.9%, Germany by 1.0% and Sweden by 1.5%. Acquisitions totalled £7.2 million, being primarily two office buildings in Hounslow, London. The total portfolio valuation at the year end rose to £902.1 million, notwithstanding a negative currency impact of £13.7 million.

Our core investment proposition remains solid: to generate attractive cash returns, using the difference between our net initial yield of 7.0% and our reduced cost of debt of 4.1%. This spread of 290 basis points is, we believe, one of the largest of the listed property sector. The fact that 65% of our rents are indexed is also very valuable at a time of higher inflation and this, together with our asset management initiatives, has been an important part of the overall valuation movement.

We continue to maintain very low vacancy levels, reduced yet further to just 3.9% from 4.3% last year. This was due to the strong emphasis on our in-house asset and property management across all our regions, enabling us to attract and retain tenants as our customers by understanding their needs and ensuring the properties are well maintained, and refurbished when required. Tenant demand is stable and enquiries are based on genuine need, often at short notice and based on companies growing. With no speculative office development activity in our markets, we are continuing to see signs that rents have stabilised with some upward pressure emerging. Tenants want well-managed space, and this is a key differentiator for us.

Our core rental income is secure, with 40% paid by Government tenants, 29% paid by major corporations and a weighted average lease length of 7.7 years, or 6.6 years to first break.

In considering new investments we remain very selective on property type and pricing because it is likely that there will continue to be good opportunities for some time ahead as lenders deal with their distressed loan books.

Our two pre-let developments in Germany totalling 7,042 sq m have progressed well: Gräfelfing was completed successfully in February 2012, and the E.ON building at Landshut will be ready in late summer. The planning applications for our two significant mixed-use schemes in Vauxhall – Spring Mews (20,800 sq m) and Vauxhall Square (154,000 sq m) – were submitted in December and we will be working closely with the local authority during 2012 on both of these applications.

Catena, the Swedish listed property company in which the Group owns 29.9%, submitted a planning application for a 150,000 sq m mixed use scheme at the Stora Frösunda site in Solna, a decision on which is expected in the first half of 2012.

Since the year end the Group has made an opportunistic investment in Sweden in Cood Investments AB, a residential property company specialising in holiday cottages and cabins on vacation sites, paying £4.1 million for a 16.6% stake. In 2011, Cood made a profit after tax in excess of £5.0 million.

Profit after tax of £38.8 million (2010: £60.1 million), was reduced by adverse changes in the value of long term interest rate swaps and a lower increase in the value of investment properties than in 2010. EPRA earnings per share, which exclude such revaluation movements to provide a measure of the underlying operating performance, rose to 64.9 pence per share (2010: 42.5 pence).

Net assets rose to £367.5 million, up by £10.3 million in the year after distributions to shareholders of £11.8 million, and EPRA net assets per share rose to 983.1 pence (2010: 952.9 pence). Basic net assets per share increased by 6.6% to 817.5 pence (2010: 766.7 pence).

Recurring interest cover for the year was a comfortable 2.6 times. The Group’s net debt as a proportion of adjusted net assets was a consistent 128% (2010: 122%), and the overall property loan to value was 62.5% (2010: 63.5%).

The Group’s business model has long been to ring-fence debt on individual properties, and this continues to serve us well. We have an active relationship with 20 banks, and are delighted to have added two new lenders this year, Saar LB and Santander. We value the strong relationships that we enjoy with our banks and the mutual benefits they provide.

We have increased and strengthened the Group’s financing arrangements during 2011. In total we have refinanced £113.2 million of existing debt and raised a further £33.0 million. In May we issued the Group’s first corporate bond, a SEK 300 million issue in Sweden, which has been listed on the NASDAQ OMX in Stockholm. This five year, unrated, unsecured bond has a coupon of 375 basis points above STIBOR and is testament to the Group’s innovative approach to financing.

This success in raising new finance is encouraging in a climate where a number of banks are closing for new business. We typically approach ten to fifteen banks when seeking new finance, and are keen to explore a wide range of financing options.

The year saw an unusually steep reduction in long-term interest rates – the sterling 15-year swap rate fell by over 150 basis points, its largest annual downward move for over 12 years – and this impacted some of our hedging arrangements. The Group had long-term swaps, covering 22.9% of our debt at the start of the year, and we expected to retain these as a long-term hedge at an average interest rate of 5.74%. However, the exceptional fall in rates increased the liabilities on these swaps by £14.2 million during the year, and to provide more flexibility in the Group’s financing we chose to close out a swap with a nominal amount of £83.5 million at a cost of £24.2 million. At the end of 2011 we had swaps in place with a nominal amount of £50 million, for which there was a liability in the balance sheet of £9.1 million.

The positive effect of cancelling the swap, which was due to run until 2026, has been the fall in our weighted average cost of debt to 4.1% (2010: 4.3%) and we expect an interest cost saving in the next three years of over £10.7 million in aggregate and breaking even after seven years.

Since the year end, we have gained credit committee approval to refinance two loans, totalling £89.1 million, including our largest asset, Spring Gardens in London. These two new loans will increase the weighted average loan length from 4.4 years to 5.1 years.

Our balance sheet is strong, with cash and liquid resources of £140 million available for investment. We continue to use corporate bonds to generate higher returns than cash. At the year end, the Group held a portfolio of 39 different bonds with a value of £85.1 million which produced an annual coupon of 10.2%. Since first investing in them towards the end of 2008, the corporate bonds have generated a return of £19.8 million, or 32.8% on average cost. Since the year end, the bonds have risen in value by £8.2 million.

During the year, the Group increased its focus on energy efficiency and sustainability, and recruited a full time Sustainability Manager. We now have good base data to measure our success in reducing energy consumption and emissions, and in lowering costs for our customers and the Group. The new £2.3 million geothermal energy facility at Vänerparken in Sweden is complete and operating, and early results are in line with the projected savings of over 80% in consumption and emissions.

As Executive Chairman it is my responsibility to ensure that the Board operates efficiently and effectively, and upholds high standards of corporate governance appropriate for a company of our size. I believe that the decisions taken by the Board and the resulting performance of the Company against its peers is indicative of the fact that we are doing things right.

The steps we have taken this year to change the Board and the composition of its Committees, Board processes and executive remuneration align the Company more closely to the provisions of the UK Corporate Governance Code and introduce greater levels of accountability and transparency to the operation and effectiveness of the Board. This underpins our commitment to good governance for the benefit of all shareholders.

In April 2011, we distributed £7.2 million by way of our traditional tender offer buy-back of shares, and a further £4.4 million in September. The Board proposes to distribute £7.9 million in April using the tender offer buy-back method, at a rate of 1 in 42 shares at 735 pence per share. A circular setting out the details will be sent to shareholders with the Report and Accounts.

For economies to grow, businesses and investors need to have confidence to invest and a reasonable supply of credit. Politicians must deliver the basic platform for this to occur, which, in the current climate, means a credible solution to the Eurozone crisis. Until this happens, there will continue to be significant uncertainty and risk in the system.

However, the Group is solidly placed, with a strong balance sheet, a very healthy cash flow, and a high level of liquid resources for investment when we see the right opportunities. We continue to attract new tenants, maintain low vacancy and progress added value development plans, and, therefore, I am optimistic that we can continue to deliver for shareholders.

Sten Mortstedt
Executive Chairman
5 March 2012