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Moody“s assigns rating to Pilkington“s proposed senior unsecured bond

On 11September 2001 Moody“s Investors Service assigned its Baa1 long-term debt rating to
UK manufacturers of flat and safety glass and glazing products for the building and automotive markets Pilki…

On 11September 2001 Moody“s Investors Service assigned its Baa1 long-term debt rating to UK manufacturers of flat and safety glass and glazing products for the building and automotive markets Pilkington plc“s (“Pilkington”) recently-announced senior unsecured Euro Bond. The Baa1 long-term debt-rating for Pilkington reflects the company“s technical expertise, its good geographic diversification with strong market positions, providing the basis for relative cash flow stability. The rating, however, also recognizes the pressure on the current operating performance of the company due to the cyclical down-turn in the building materials industry in selected markets (e.g. Germany), the dependency on the car makers (OEMs) exerting increasing price pressure, the sensitivity to energy prices as well as the joint ventures in higher-risk regions as Asia and Latin America. The rating outlook is stable. For the medium term Moody“s expects management to continue to focus on cost savings and further streamlining of the global organization. In a second stage, Pilkington may consider smaller acquisitions to complement its joint-venture strategy. The rating agency expects that any major acquisition – though not anticipated – will be funded with a prudent mix of debt and equity. Moody“s considers the company“s technological know-how as being a key driver of the group“s business. The company has research and development costs between GBP 30 million and GBP 40 million (i.e. roughly 2% of sales) and is involved in most major advances in glass technology. Moody“s views Pilkington“s technical expertise/reputation is essential as it enables the company to further develop its geographic diversification with strong market positions and good cash flow potential. Pilkington has over the last years significantly reduced its costs and increa sed efficiency to become one of the lowest cost producers. The actions included simplification of the group“s organization, overhead reduction, improvement in manufacturing efficiency and productivity as well as elimination of unprofitable businesses. Moody“s rating assumes that a large percentage of these target savings and operational improvements will continue to be realized. Nevertheless the company“s current situation is challenging, because the cyclical down-turn in selected markets creates the need to maintain the dynamics of the cost savings programme. In addition, the cost of energy and the ongoing price pressure from the OEM“s are expected to depress the company“s near-term profitability. The company has grown in recent years, in part through joint ventures and as sociated companies. Jointly-owned production facilities are used to share the risk of demand cyclicality of existing markets and of entering new markets with a high degree of country risk. An example is with Saint-Gobain in South America. In order to limit the size of the investment in emerging markets, the company leverages its technology. Funds received for constructing the facility and licensing the technology can later be applied to acquire a minority equity interest in the project, an example of this was Poland where Pilkington subsequently bought out the other partners. Pilkington group cash flow is expected to improve further, because of the cost-savings programme which should effect operational improvement. As a result, Moody“s anticipates the company to generate rising operating cash flow to improve debt coverage. Furthermore, capex contains substantial discretion ary elements and could be reduced without impairing the technical standards of the production facilities. This adds to Pilkington“s financial flexibility and supports a stable debt capacity. Pilkington management is comfortable with current debt levels, but these are expected to reduce during the course of the 2002 financial year and onwards as a result of the margin improvements in the absence of major acquisition opportunities. Moody“s expects retained cash flow/net debt to increase from about 20% to around 30% in 2003 – assuming no protracted downturn in economic activity from current levels across Europe and the US. As a rule, all of group long-term debt is raised at the parent level and then passed on to the subsidiaries via inter-company loans. By having a centrally financed group with central cash pooling, it is ensured that the parent has full control over the operating cash flow. Funding at business level is possible, however, it must offer a price advantage and be of a very short term nature. There may be exceptions, but these have to be centrally authorized. Currently most of the debt is situated at holding/finance co. level. – There are some GBP 200 million of debt at the US holding company. These borrowings are closer to the cash flow of the US operating companies. Since these are generating a low proportion of group cash flow, debt service at this level is in effect dependent on the parent cash flow. Hence, there is only very limited structural subordination for Pilkington plc. Going forward, Pilkington will access the capital markets via bond issue. This will be done at the holding/finance co. level and thus further reduce the extent of structural subordination.

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