Tomkins 20-F 2007
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FOR THE FISCAL YEAR ENDED: DECEMBER 30, 2006
COMMISSION FILE NUMBER: 0-17140
(Exact name of Registrant as specified in its charter)
(Jurisdiction of incorporation or organization)
East Putney House, 84 Upper Richmond Road
London SW15 2ST, United Kingdom
(Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Securities registered or to be registered pursuant to Section 12(g) of the Act
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act
Indicate the number of outstanding shares of each of the issuers classes of capital or common stock as at the close of the period covered by the Annual Report:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes ¨ No x
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark which financial statement item the Registrant has elected to follow: Item 17 ¨ Item 18 x
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
TABLE OF CONTENTS
In this Annual Report (the Annual Report) on Form 20-F for the fiscal year ended December 30, 2006 (fiscal 2006), all references to Tomkins, the Tomkins Group, the Group, the Company, we, us and our include Tomkins plc and its consolidated subsidiaries, unless the context otherwise requires.
The consolidated financial statements of Tomkins plc appearing in this Annual Report are presented in US dollars ($) and are prepared in accordance with accounting principles generally accepted in the United States of America (US GAAP).
In this Annual Report, references to US dollars, $, cents and c are to United States currency, references to pounds sterling, £, pence and p are to British currency, references to Canadian dollars are to Canadian currency, and Euros are to the currency of certain member states of the European Union.
Special Note Regarding Forward-Looking Statements
Pursuant to the meaning of forward-looking statements in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the Exchange Act), this Annual Report contains assumptions, anticipations, expectations and forecasts concerning the Companys future business plans, products, services, financial results, performance, future events and information relevant to our business, industries and operating environments. When used in this document, the words anticipate, believe, estimate, assume, could, should, expect and similar expressions, as they relate to the Company or its management, are intended to identify forward-looking statements. Such statements reflect the current views of management with respect to future events and are subject to certain risks, uncertainties and assumptions. The forward-looking statements contained herein represent a good-faith assessment of our future performance for which we believe there is a reasonable basis. Many factors could cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements, including, among others, adverse changes or uncertainties in general economic conditions in the markets we serve, regulatory developments adverse to us or difficulties we may face in maintaining necessary licenses or other governmental approvals, changes in the competitive position or introduction of new competitors or new competitive products, lack of acceptance of new products or services by the Companys targeted customers, changes in business strategy, any management level or large-scale employee turnover, any major disruption in production at our key facilities, adverse changes in foreign exchange rates, and acts of terrorism or war, and other risks described in Item 3D Key Information Risk factors. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated or expected.
These forward-looking statements represent our view only as of the date they are made, and we disclaim any obligation to update forward-looking statements contained herein, except as may be otherwise required by law.
Item 3. Key Information
A. Selected financial data
The selected financial data set out below as at and for the fiscal years ended December 30, 2006, December 31, 2005 (fiscal 2005), January 1, 2005 (fiscal 2004), January 3, 2004 (fiscal 2003), the eight-month transition period ended December 31, 2002 and for the fiscal year ended April 30, 2002 has been derived from the audited consolidated financial statements of the Company. The audited consolidated financial statements for fiscal 2006 have been included as Item 18 to this Form 20-F. The selected financial data set forth below should be read in conjunction with, and are qualified in their entirety by reference to, such consolidated financial statements and Notes thereto and Item 5 Operating and Financial Review and Prospects.
Consolidated income statement data
(1) (9) Refer to notes on page 5.
Consolidated balance sheet data
The Company has paid cash dividends on its Ordinary Shares, nominal value 5p per share (Ordinary Shares), in respect of every fiscal year since being first listed on the London Stock Exchange Limited (the London Stock Exchange) in 1950.
Dividends are paid to shareholders as of record dates that are fixed after consultation between the Company and the London Stock Exchange. For fiscal 2006, an interim dividend was declared by the Board of Directors (the Board) in August 2006 and was paid in November 2006. A final dividend was recommended by the Board following the end of fiscal 2006 and will, subject to approval by the shareholders at the Companys annual general meeting on June 13, 2007, be paid on June 27, 2007.
The table below sets forth the amounts of interim, final and total dividends paid in respect of each fiscal year indicated and the eight month transition period ended December 31, 2002. The amounts are shown in US cents per Ordinary Share and in US cents per American Depositary Share (ADS) - each ADS represents four Ordinary Shares. The interim and final dividends below have been translated from pounds sterling into US dollars at the noon buying rate on each of the respective payment dates.
The Company expects to continue to pay dividends in the future. The total amounts of future dividends will be determined by the Board and will depend on the Companys results of operations, cash flow, financial and economic conditions and other factors. Management expects dividend payments to follow the same pattern in future years and anticipates the weighting of these payments to be approximately 40 percent for the interim dividend and 60 percent for the final dividend. Cash dividends are paid by the Company in pounds sterling, and fluctuations in the exchange rate between pounds sterling and US dollars will affect the US dollar amounts received by holders of American Depository Receipts (ADRs) upon conversion by The Bank of New York (the Depositary) of such dividends. Moreover, fluctuations in the exchange rates between the pound sterling and the US dollar will affect the US dollar equivalents of the pound sterling price of the Ordinary Shares on the London Stock Exchange and, as a result, are likely to affect the market prices of the ADSs which are quoted in US dollars. For a discussion of the historic effects of exchange rate fluctuations on the Companys financial condition and results of operations, see Item 11 Quantitative and Qualitative Disclosures about Market Risk and Note 17 to the consolidated financial statements.
B. Capitalization and indebtedness
C. Reasons for the offer and use of proceeds
D. Risk factors
The Groups business is affected by a number of risk factors, not all of which are in Tomkins control. This section highlights specific areas where Tomkins is particularly sensitive to business risk. The Groups financial condition or results of operations could be materially and adversely affected by any of these risks. Additional risks not currently known to management, or risks that management currently regards as immaterial could also have a material adverse effect on the Groups financial condition or results of operations.
As a part of the Performance Management Framework of the Group, each business considers strategic, operational, commercial and financial risks and identifies risk mitigation actions. Business unit managers maintain Risk Profiles, including mitigation strategies, which are updated at least annually. Periodically, each business unit reviews the risk profile. Managements internal Risk and Assurance Services function performs a periodic risk assessment that is reviewed by senior management, who develop plans to mitigate significant identified risks. The findings and plans are presented to the Audit Committee. This framework provides a comprehensive list of key Group risk and control processes and allows the Board to assess the impact of those risks and the effectiveness of those processes. The Group has categorized its risks as those relating to:
Risk can be considered either as downside risk (the risk that something can go wrong and result in a financial loss or financial exposure for the Group) or as volatility risk (the risk associated with uncertainty, meaning there may be an opportunity for financial gain as well as potential for loss).
Risks relating to the markets within which the Group operates
There are a number of risks in the markets in which the Group operates which could have a material adverse effect on the Groups business, financial condition or results of operations:
Cyclical nature of markets The Groups operating results depend on the conditions of the markets in which it operates, particularly the automotive and construction markets, where demand is ultimately affected by consumer spending and consumer preferences. Trends in these markets can be difficult to predict. In fiscal 2006, approximately 18 percent of the Groups sales were to the automotive original equipment market. Because the production volumes of automotive original equipment manufacturers (OEMs) depend on general economic conditions and consumer spending levels, automotive production and sales can be highly cyclical. The volume of automotive production in the United States, the Groups principal geographic segment, has fluctuated, sometimes significantly, from year to year, and such fluctuations give rise to fluctuations in the demand for the Groups products. In fiscal 2006, approximately 29 percent of the Groups sales were to the residential construction and non-residential construction markets in the United States. The construction industry in the United States slowed in the second half of 2006 and is expected to continue facing challenges in 2007 with the National Association of Home Builders forecasting that housing starts in 2007 will be approximately 15 percent lower in the United States than they were in 2006. The timing of a recovery in US residential housing now seems unlikely to occur until sometime in 2008, with this end-market showing greater weakness in the first quarter than commentators had predicted.
Loss of market share by US vehicle manufacturers In recent years, General Motors, Ford and DaimlerChrysler (the Detroit Three) have seen a decline in their market share for vehicle sales, particularly in North America, with Asian automobile manufacturers increasing their market share. The automotive industry is characterized by overcapacity and fierce competition. In North America it is also affected by significant pension and healthcare liabilities. North American automobile manufacturers have recently announced production cuts for a number of platforms. Because a portion of the Groups business is derived from the Detroit Three, if this trend of Detroit Three market share loss continues and the Groups share of business with other vehicle manufacturers does not increase, the Groups business could be materially and adversely affected.
Improvement in vehicle component life The greater quality, performance and reliability of the components that the Group manufactures improves service life and could affect demand for the products the Group sells through the aftermarket business segment.
Regulatory environment The Group is subject to a variety of environmental regulations in the industries in which it operates, particularly relating to waste water discharges, air emissions, solid waste management and hazardous chemical disposal. Management cannot give assurance that the Group has been or will be at all times in complete compliance with all of these requirements, or that it will not incur material costs or liabilities in connection with these requirements.
Operations in foreign and emerging markets The Group operates in a number of geographic regions of the world, including emerging markets, and derives approximately 37 percent of its sales from markets outside the United States. Operations in foreign and emerging markets may subject the Group to the risks inherent in operating in such markets, such as economic and political instability, other disruption of markets, restrictive laws and actions of certain governments and difficulty in obtaining distribution and logistical resources. Should the Group fail to define and adequately execute its strategy in these markets effectively, it may not capitalize on growth opportunities that exist in these markets.
Risks relating to the competitive position of the Group and its businesses
There are a number of risks to the Groups competitive position that could have a material adverse effect on its business, financial condition or results of operations.
Industry consolidation may result in more powerful competitors and fewer customers Some of the Groups customers and some of its competitors in a number of markets, particularly in the automotive aftermarket, and to a lesser extent in the markets of the Air Systems Components group, are consolidating to achieve greater scale or market share. Such changes could affect the negotiating leverage of the Groups customers and their relationship with the Group. As the Groups customers become larger and more concentrated, they could exert pricing pressure on all suppliers, including the Group, which may materially and adversely affect the Groups margins.
Significance of revenues generated from the Detroit Three Approximately 16 percent of the Industrial and Automotive groups sales in fiscal 2006 came from direct sales to the Detroit Three. These customers have strong purchasing power as a result of high market concentration and the Groups reliance on them subjects it to potential pressures on its sale prices that may reduce the Groups profitability.
Price reductions by automotive customers Approximately 18 percent of the Groups sales are to OEMs. It is normal practice for such customers to seek reductions in their costs from their suppliers over the duration of any committed supply arrangement. To meet such requests for price reductions whilst maintaining profit margins, the Company has had to achieve corresponding cost savings in the business by strategic sourcing of raw materials and by improving production and manufacturing efficiencies. The Group may be unable to achieve such cost reductions in the future, which could result in lower margins or the loss of customers.
Increased competition from low-cost producers The Group increasingly faces competition from low-cost sources in the developing economies of the world, leading to potential loss of market share and/or reduced margins.
Increasing raw material and energy costs Steel, aluminum, oil based resins and energy are a significant part of the Groups costs. If costs of these raw materials and energy increase, the Group may be unable to sustain margins if it is unable to pass such increases on to its customers. During fiscal 2006, the price of certain base metals more than doubled which had a particular adverse impact on the Wiper Systems and Fluid Systems businesses, as we were not able to increase prices to offset the increase in costs.
Reliance on certain raw materials and suppliers of key components The Groups productive processes require that arrangements are in place to ensure continuity of supply of certain raw materials and components. Disruption due to lack of availability of raw material and energy supplies may adversely affect our ability to service our customers and may erode our margins.
Dependence on strong relationships with manufacturers representatives, distributors and wholesalers Deterioration in the relationships with manufacturers representatives, distributors and wholesalers or a change in the Groups products distribution channels could materially and adversely affect the Groups sales.
Product liability claims due to the nature of the Groups products The Group faces an inherent business risk of exposure to product liability claims. In the event that a failure of a product results in, or is alleged to result in, bodily injury, property damage or consequential loss, we could face significant liability.
Technological changes The markets for the Groups products and services are characterized by evolving industry standards and changing technology which may lead to commoditization of its products, allowing for low switching costs, increased pricing pressures and, potentially, loss of customers and reduced margins. Continual development of advanced technologies for new products and product enhancements is an important way in which the Group maintains acceptable pricing levels. If the Groups core products are displaced or made obsolete, the Group may lose customers, which would have an adverse effect on its results of operations.
Dependence on investment and divestment decisions If the Group were to make inappropriate investment and divestment decisions or fail to implement major projects, such as systems development, product development or plant closures, there may be destruction of value, returns below expectations and /or business interruption.
Dependence on human resources strategy If the Group were to lack a human resources strategy or was to execute that strategy ineffectively there may be an adverse impact on the achievement of managements long-term strategic objectives.
Dependence on the continued operation of the Groups manufacturing facilities While the Group is not heavily dependent on any single manufacturing facility, major disruptions at a number of the Groups manufacturing facilities, due to labor unrest, natural disasters or mechanical failure of the Groups facilities, could result in significant interruption of the Groups business and potential loss of customers and sales.
Capacity, reliability and security of the Groups computer hardware, software and telecommunications infrastructure The Group currently secures its networks by means of back up, hardware, virus protection and other measures, but any systems interruption could lead to a reduction in performance or loss of services. The Groups systems are vulnerable to damage or interruption caused by human error, network failure, natural disasters, sabotage, computer viruses and similar disruptive events. A breach of network security could result in loss of customers and reduced revenues.
Intellectual property rights The Groups proprietary technology is protected by patents and trade secrets which could be at risk if:
Work stoppages or other labor issues at our facilities or at our customers facilities Some of the Groups employees are members of labor unions. While the Group considers its relations with its employees and labor unions to be good, if the Group is unable to maintain these relations, there may be disputes and work stoppages that could affect production of the Groups products. Some of the Groups customers, particularly in the automotive industry, have highly unionized workforces and have been involved in major disputes in the past. If any of our customers experiences a work stoppage, that customer may halt or limit the purchase of the Groups products which could, in turn, force the Group to shut down its own production facilities supplying these products.
Certain financial risks could have a material adverse effect on the Groups business, financial condition or results of operations.
Pension plans The Group operates both defined benefit and defined contribution pension plans, the majority of which are in the United States and the United Kingdom. The schemes were in deficit by $259.8 million as at December 30, 2006. Deterioration in pension plan asset prices or changes to long-term interest rates could lead to an increase in the deficit or give rise to an additional funding requirement.
Cash flow from subsidiaries The Company is a holding company with no independent operations or significant assets other than investments in, and advances to, subsidiaries. Accordingly, it depends upon the receipt of sufficient funds from its subsidiaries to meet its obligations, including its ability to repay any amounts it borrows under the Euro Medium Term Note (EMTN) Program or to pay its dividends. The ability of the Group to access that cash flow may be limited in some circumstances.
Health care and workers compensation Healthcare and workers compensation are provided by certain subsidiaries to current and former employees in the United States. Healthcare costs in the United States are increasing at a faster rate than general cost inflation and these cost increases have to be absorbed in the business.
Tax cash outflows Tomkins operates within multiple tax jurisdictions and is subject to audit in those jurisdictions. These audits can involve complex issues, which may require an extended period of time for resolution. Although provision has been made for such issues the ultimate resolution may result in additional tax charges and cash outflows.
Funding growth The Group may require capital to expand its business, implement its strategic initiatives and remain competitive. At present, the Groups established sources of funding are through equity, corporate bond markets (through the EMTN Program), bank debt and cash flow from operations. Management believes that the sources of funding currently available will be sufficient to fund the Groups operations. If managements plans or assumptions regarding the funding requirements change, the Group may need to seek other sources of financing, such as additional lines of credit with commercial banks or vendors or public financing, or to renegotiate existing bank facilities. It is possible that additional funding may not be available or may be available but not on commercially acceptable terms.
Bondholders rights The Group has a EMTN Program under which Tomkins may issue bonds. The Groups bondholders have the right to require the Group to redeem its outstanding bonds, at par, in the event of a change of control of Tomkins plc and also in the event that the Groups credit rating falls below investment grade as a result of the Group making either acquisitions or disposals that comprise more than 25 percent of the Groups operating profit in a twelve calendar month period. The Group may not have sufficient funds to repurchase such notes as required.
Fluctuations in currency exchange rates The Group has manufacturing facilities in, and sells products to customers in, many countries worldwide. The principal currencies in which the Group trades are US dollars, Canadian dollars, Euros and pounds sterling. Currency exchange movements can give rise to the following risks:
Risks related to the securities market and ownership of ADSs and registered shares
Holders of ADSs may be restricted in their ability to exercise voting rights - Holders of ADSs will generally have the right under the deposit agreement to instruct the Depositary to exercise their voting rights for the registered shares represented by ADSs. At managements request, the Depositary will mail to holders of ADSs any notice of any shareholders meeting received from the Company together with information explaining how to instruct the Depositary to exercise the voting rights of the securities represented by ADSs. If the Depositary receives voting instructions for a holder of ADSs on a timely basis, it is obligated to endeavor to vote the securities representing the holders ADSs in accordance with those voting instructions. The ability of the Depositary to carry out voting instructions, however, may be limited by practical limitations, such as time zone differences and delays in mailing.
ADS holders may be unable to participate in rights offerings and similar transactions in the future - US securities laws may restrict the ability of US persons who hold ADSs to participate in certain rights offerings or share or warrant dividend alternatives which the Company may undertake in the future in the event that the Company does not register such offerings under the US securities laws and is unable to rely on an exemption from registration under these laws. If the Company issues any securities of this nature in the future, it may issue such securities to the Depositary for the ADSs, which may sell those securities for the benefit of the holders of the ADSs. Management cannot offer any assurance as to the value, if any, the Depositary would receive upon the sale of those securities.
Item 4. Information on the Company
A. History and development of the Company
Tomkins plc was incorporated in England in 1925, converted from a private company into a public company in March 1950 and re-registered as a public limited company in February 1982. The Companys Ordinary Shares are listed on the London Stock Exchange and have been listed on the New York Stock Exchange (the NYSE) in the form of ADSs evidenced by ADRs since February 1995. Prior to listing on the NYSE, the ADSs had been quoted on the Nasdaq National Market since November 1988. The Company is registered in England and Wales No. 203531 and operates under United Kingdom law. The Companys registered office is East Putney House, 84 Upper Richmond Road, London SW15 2ST (Telephone: +44 (0) 20 8871 4544) and its website is www.tomkins.co.uk.
Tomkins plc is the ultimate parent of a large number of subsidiaries that are organized into two business groups:
The Industrial and Automotive group manufactures a wide range of systems and components for the industrial and automotive markets through four operating segments, Power Transmission, Fluid Power, Fluid Systems and Other Industrial and Automotive. The group sells globally into the automotive original equipment market, the automotive aftermarket, the industrial original equipment market and the industrial aftermarket. Other markets include the recreational vehicle market and the manufactured housing market. Its brands include Gates, Dexter Axle, Trico and Schrader Electronics. Prior to fiscal 2006, an additional operating segment, Wiper Systems, was included in the Industrial and Automotive group. During fiscal 2006, Wiper Systems was classified as a discontinued operation and management expects that it will be sold during the fiscal year ending December 29, 2007 (fiscal 2007).
The Building Products group manufactures a wide range of air handling components, bathware, doors and windows and other building components for the residential and commercial construction industries through two business areas: Air Systems Components and Other Building Products. The groups principal markets are the residential, industrial and commercial construction markets. Other markets include the recreational vehicle and manufactured housing market.
The Group is geographically diverse, operating 138 manufacturing facilities, 41 distribution centers and two dedicated research and development centers in 21 different countries across the Americas, Europe, Asia, and Australia.
The Industrial and Automotive group operates in all 21 countries in which the Group operates, while the Building Products group is located in the United States, Canada, Mexico, the United Kingdom and Thailand. Overall, 75 percent of revenue in fiscal 2006 came from the United States, 14 percent from Europe, 8 percent from Asia and 3 percent from the rest of the world.
Group sales in fiscal 2006 were to the following end markets:
In fiscal 1984, Tomkins plc was a manufacturer and distributor of buckles and fasteners in the United Kingdom with net sales of $34.6 million. In the late 1980s, the Company made a number of acquisitions of engineering companies in both the United Kingdom and the United States. In 1992, the Group diversified into food manufacturing, with the acquisition of Ranks Hovis McDougall plc in the United Kingdom.
In fiscal 1996, the Group established the Industrial and Automotive group with the acquisition of The Gates Corporation for $1,160 million. This was satisfied by the issue of $633.4 million of 4.344 percent (net) redeemable convertible cumulative preference shares and $526.6 million of 5.56 percent (net) convertible cumulative preference shares. Stant Corporation was added to the Industrial and Automotive group in 1997 and ACD Tridon in 1999.
The redeemable convertible preference shares, issued as part consideration for the acquisition of The Gates Corporation, were redeemed in August 2003. During fiscal 2006, 74.4 percent of the convertible cumulative preference shares were converted into the Companys Ordinary Shares. As at December 30, 2006, the carrying amount of the convertible cumulative preference shares was $131.3 million.
Between 1999 and 2005 a number of add on acquisitions were made in the Industrial and Automotive and Building Products groups, the food manufacturing business was sold and a number of other divestments were made as part of a program to dispose of non-core businesses.
Principal acquisitions, disposals, and capital expenditures
This section should be read in conjunction with Item 5 Operating and Financial Review and Prospects and with Notes 4 and 5 to the consolidated financial statements presented under Item 18 Financial Statements.
Acquisitions and disposals
In fiscal 2006, the Industrial and Automotive group acquired a 60 percent interest in Gates Winhere LLC (which, through a wholly-owned subsidiary, acquired the business and assets of a water pump manufacturer in China) and ENZED Fleximak Ltd, a supplier of engineering, fabrication, testing and service operations for flexible fluid transfer products in the Arabian Gulf region. The Building Products group acquired Selkirk Americas L.P., a manufacturer of chimney, venting and air distribution products, Eastern Sheet Metal (ESM), a manufacturer of commercial heating, ventilation and air conditioning systems and Heat-Fab Inc, a US-based manufacturer of high efficiency residential and commercial venting systems. The Group also acquired a 20 percent interest in e-business and logistics services provider, CoLinx LLC, which paved the way for the launch of an online store for industrial power transmission products in January 2007.
No businesses were sold in fiscal 2006. Subsequent to the year-end, on February 23, 2007, the Company completed the sale of Lasco Fittings Inc., a manufacturer of injection-molded fittings that was included in the Building Products group.
In fiscal 2005, the Industrial and Automotive group acquired L.E. Technologies, a recreational vehicle frame manufacturer and Eifeler Maschinenbau GmbH (EMB), a manufacturer of high-performance hydraulic tube fittings, adapters and accessories. The Building Products group acquired Milcor Inc, a multi-brand manufacturer of building products and NRG Industries Inc., a multi brand manufacturer of commercial building accessories.
In fiscal 2005, the Industrial and Automotive group sold Unified Industries, Inc, the Air Springs division and the business and assets of the North American Curved Hose business. The Building Products group sold the business and assets of Gutter Helmet, part of the Hart & Cooley residential construction business.
In fiscal 2004, the Industrial and Automotive group acquired the polyurethane power transmission and motion control belt business, assets and liabilities of Mectrol Corporation.
In fiscal 2004, the Group completed its exit from the valves, taps and mixers business with the disposal of the business and assets of Hattersley Newman Hender, and Pegler. In addition, Mayfran International Inc. was sold. Each of these businesses was included in the Companys former Engineered & Construction Products group. In the Industrial and Automotive group, the sale of the European curved hose business in Nevers, France, was completed in November 2004 and the related closure of the European curved hose business in St Just, Spain was also completed in fiscal 2004.
Disposals in each of the above fiscal years were executed as part of managements program to dispose of all non-core businesses.
Due to the diverse nature of the business, there is no individual item of capital expenditure that has had a material impact on the position of the Company and no individually significant capital expenditure project that is currently in progress.
B. Business overview
Segment contribution to net sales and operating income
The contribution of each segment to the Companys net sales and operating income is set out below. The Companys businesses are grouped for management reporting purposes according to the nature of their products and services. The Groups operating segments are described later in this section.
The Company prepares its home country consolidated financial statements in accordance International Financial Reporting Standards (IFRS) adopted for use in the European Union.
SFAS131 Disclosures about Segments of an Enterprise and Related Information requires segment information provided in financial statements to reflect the information that was provided to the chief operating decision maker for purposes of making decisions about allocating resources within the Company and assessing the performance of each segment. The chief operating decision maker bases such decisions chiefly on adjusted profit from operations which comprises profit from operations before restructuring initiatives (restructuring expenses and gains and losses on disposals and on the exit of businesses) and the amortization of intangible assets arising on acquisition determined in accordance with IFRS.
Accordingly, the segment information presented below is prepared in accordance with IFRS. The information provided to the chief operating decision maker is presented in pounds sterling. In the tables that follow, pound sterling amounts have been translated into US dollars at the average exchange rate for the fiscal year which was as follows: fiscal 2006 £=$1.8336; fiscal 2005 £=$1.8156; fiscal 2004 £=$1.8257.
Reconciliations of net sales determined in accordance with IFRS to net sales determined in accordance with US GAAP and of adjusted profit from operations to operating income from continuing operations determined in accordance with US GAAP are set out below. An explanation of the differences between these measures is set forth in Note 7 to the consolidated financial statements presented under Item 18 Financial Statements.
Reconciliation of segmental information to US GAAP
Analysis by geographical origin (US GAAP)
Industrial and Automotive
The Industrial and Automotive group has corporate offices in Denver, Colorado, Rochester Hills, Michigan and Toronto, Canada. It supplies industrial and automotive parts, components and systems, serving a wide variety of industries, including the industrial and automotive original equipment and replacement markets, transportation, agricultural, mining, forestry, construction, office equipment, computer, and the food processing and handling markets.
In total, the Industrial and Automotive group operates 79 manufacturing facilities and 33 distribution centers in 21 countries. It has businesses in North America, Europe, Asia, South America, Australia and the Middle East. Most of the manufacturing facilities are in the Americas, with 40 manufacturing facilities in Canada and the United States, seven in Mexico and a further five in South America. European operations include 15 manufacturing facilities and the Asian operations involve 12 facilities, seven of which are in China.
The Industrial and Automotive group has four operating segments: Power Transmission, Fluid Power, Fluid Systems and Other Industrial and Automotive. These segments include divisions integrated from the acquisitions of Gates, Stant, Schrader and Stackpole. Together, these segments employed on average 20,776 people around the world in fiscal 2006. Products are sold directly to industrial and automotive OEMs and, through a network of approximately 150,000 distributors, dealers and jobbers worldwide, to the industrial and automotive replacement markets.
Prior to fiscal 2006, an additional operating segment, Wiper Systems, was included in the Industrial and Automotive group. This segment operated under the Trico and Tridon brands, manufacturing automotive windshield wiping systems and systems components. During fiscal 2006, the Wiper Systems business was classified as a discontinued operation and management expects that it will be sold during fiscal 2007.
Power Transmission produces a comprehensive global product line ranging from synchronous belt and accessory belt drive systems for automotive applications to heavy-duty industrial belt drives. As a market leader in the power transmission industry, the Power Transmission segment provides a diverse product line encompassing V-belts, multi V-ribbed belts, synchronous belts, sheaves/sprockets, pulleys, tensioners, idlers, and crankshaft dampers and employs a variety of process and material technologies including rubber, polyurethane, and metals. A broad product line coupled with industry expertise allows this group to design, manufacture, market, and distribute complete power transmission systems to both OEM and replacement markets.
Power Transmission is globally integrated to standardize product and process technology, maximizing resource utilization across the Group. Product, material and enabling technology teams join forces in the development and commercialization of products and systems. Focusing on customer needs, the appropriate innovative technology is selected to create a sustainable competitive advantage in the market. Innovation, technology and product development are driven through three technical and product development centers located at Aachen, Germany, Seoul, Korea, and Nara, Japan, and a dedicated research and development center in Rochester Hills, Michigan. Each of these centers leads product development, engineering, and systems design with capabilities to focus on customer specific requirements.
Power Transmission supports and supplies customers on a global basis. Regional management in the Americas, Europe and Asia work to leverage the Groups market strengths from one area to another utilizing common processes and global product lines.
The Fluid Power segment is a manufacturer of engineered hose, fittings and accessories for hydraulic power transmission systems used in both mobile and stationary industrial equipment. The segment also manufactures industrial hose used to convey both liquids and bulk powder type materials, focused primarily in the petroleum, chemical and food/beverage sectors. The segment also produces a wide range of under-the-hood automotive, heavy duty truck and bus products used in engine cooling, power steering, braking, transmission and fuel system applications.
The Customer Solutions Center in Denver, Colorado has been established to promote customer focused innovation and global product development emphasizing integration of new products and design solutions into a value-added systems approach. The development of next generation products is focused on evolving the existing hose and connector product line into a full port-to-port sub-system capable of providing systems and design concepts that reduce leaks, warranty and assembly labor costs.
The segment has a global reach, serving customers in North America, South America, Europe, Asia and India. The acquisition of EMB in Germany has resulted in an expanded product range and geographic presence in Eastern Europe and Asia. Within Eastern Europe, India and China, restructuring has allowed Gates to focus and expand its efforts in these fast growing markets. Expansion plans being implemented over the next 12 to 24 months are expected to allow for localized supply of certain products within these regions.
The Fluid Systems segment, which comprises acquired businesses such as Stant Corporation and Schrader-Bridgeport International, is a designer, manufacturer and distributor of a broad range of automotive fluid conveyance and fluid management components and modules. Fluid Systems employs the latest technology in tire pressure monitoring components and fuel vapor management valves. Products are sold primarily for use as original equipment by manufacturers of cars and trucks and in the automotive replacement market as repair parts and accessories. Major customers include DaimlerChrysler, Ford, General Motors, Nissan, Renault and PSA, as well as a number of other major international OEMs. Fluid Systems products are also sold in wholesale and retail automotive parts and distribution outlets in North America, Europe and Latin America including the service departments of OEM dealers.
Through Schrader Electronics, the Fluid Systems segment is the technology leader in Remote Tire Pressure Monitoring Systems (RTPMS), a driver information and passenger security system that is economically and ergonomically integrated into vehicle electronic information systems. Fluid Systems also designs, manufactures and markets a variety of fuel vapor management valves and fuel, oil and radiator closure caps at its Stant Manufacturing Division. Stant complemented its existing fuel vapor management product offering in fiscal 2006 with the addition of carbon canisters and evaporative system integrity monitors for DaimlerChrysler. Standard-Thomson is a manufacturer of engine thermostats used in automotive cooling systems. Schrader-Bridgeport International provides a wide range of tire valve, hardware and specialty valve products worldwide. RTPMS, tire, and specialty valve products are sold under the Schrader-Bridgeport and Schrader Electronics trademarks. Closure cap and fuel management valve products are sold under the Stant, Lev-R-Vent and Pre-Vent trademarks. Engine thermostats are sold under the Stant, Weir-stat, and Superstat brand names. Many of these products are also sold to various private label customers bearing their own brand names.
Other Industrial and Automotive
Other Industrial and Automotive includes the trailer axles, materials handling and the aftermarket businesses.
Dexter Axle produces and markets its products primarily in the United States directly to OEMs and distributors. Dexters product line consists of a wide variety or trailer axles for the general utility, recreational vehicle, highway trailer and manufactured housing markets. Competition is based on price, quality, product performance and customer service.
Dexters trailer axles are available in capacities from 800 pounds to 30,000 pounds and specific trailer applications within its markets include horse and livestock trailers, equipment hauling trailers, enclosed cargo trailers, heavy hauling trailers, recreational vehicles, manufactured homes, portable equipment and highway trailers.
The Dexter Chassis Group (formerly LE Technologies) produces and markets its products in the United States directly to OEMs. The Dexter Chassis Group manufactures chassis and components for recreational vehicles and utility trailers, fabricated metal parts to commercial truck body builders, and high-end coatings for military and general industries. The Dexter Chassis Group provides engineering services for the products it builds based on its own designs or based on customers current designs. A complete line of recreational vehicle slide out rooms is currently offered as a value-added feature to the chassis.
Dearborn Mid-West Conveyor Company (Dearborn) designs, fabricates and installs overhead conveyor systems, inverted power and free conveyor systems, skillet systems, automatic electrified monorail systems, power roll conveyors and flat top conveyors for the automotive, commercial trucks, aircraft, appliance and heavy equipment industries; belt conveyors, stackers, hoppers, rotary plow feeders, belt feeders, barge/truck/rail loaders and unloaders and pipe conveyors for handling bulk materials servicing coal power generating plants, coal processing and cement manufacturing facilities; and various unit handling systems for parcel movement applications for the United States Postal Service, United Parcel Service and Fed-Ex. Dearborn is classified as a continuing operation under IFRS (and therefore for the purposes of the segment information provided in this Annual Report), but in fiscal 2006 it was classified as a discontinued operation under US GAAP. Management expects that Dearborn will be sold during fiscal 2007.
The Aftermarket business integrates the sales, marketing, distribution and manufacture of products destined for both the Industrial and Automotive original equipment and Aftermarket and sold under the Tridon, Ideal, Schrader, Plews Edelmann and numerous private brands. It designs and sells aftermarket automotive tools and fittings, power steering hose, transmission cooler lines, lubrication equipment, stainless and carbon steel hose clamps for both original equipment and parts applications.
The Aftermarket business also manufactures and distributes specialist components for the automotive industry. Schrader brand products include precision control valves and associated fluid conveyance and control modules for vehicle fluid system applications in fuel delivery, emission control, engine management, brake, steering, power transmission, coolant, air conditioning, windshield washing, PVC air hose, and ride control. Schrader, a leading brand of wheel valves for cars, medium
and heavy-duty trucks, agricultural vehicles and construction equipment, offers a full range of products, including tubeless tire valves, valves for inner tubes, cores, tubeless valves for large wheels and an assortment of specialty valves for virtually all global applications.
Wheel care products, air power pneumatic components and systems, and pressure-measuring devices are marketed to automotive channels worldwide. Wheel care products include Camel brand tire patch products, tools, chemicals and Schrader brand tire valves and cores. Air power systems include Amflo pneumatic couplers and plugs. Aftermarkets Syracuse brand of pressure-measuring devices is a recognized market standard in North America. The Aftermarket business supplies Amflo pneumatic accessories to the home improvement retailer segment.
The Building Products group manufactures a range of products for residential and commercial buildings, supplying both the new-build and refurbishment sectors. Its product portfolio comprises air systems components (manufacturing a wide range of components for the heating, ventilation and air conditioning markets, principally in North America), bathware (manufacturing a range of baths, shower cubicles and luxury whirlpools for the North American residential market), and doors and windows (manufacturing uPVC doors and windows for the residential and manufactured housing markets in North America).
The Building Products group operates 59 manufacturing facilities and eight distribution centers in five countries. 55 of the manufacturing facilities are in the United States, Mexico and Canada, with three in the United Kingdom and one in Thailand. The distribution centers are all based in the United States.
Air Systems Components
The Air Systems Components segments products are primarily sold throughout the United States, Canada, Mexico and the United Kingdom. Competition is based principally on price, quality, service and breadth of product line. Just under half of the segments sales pass through manufacturers representatives and approximately 35 percent are sold through wholesalers, principally in the residential market. The balance of sales is direct to OEMs, national accounts and retail customers.
Hart & Cooley and Selkirk supply the residential and light commercial markets in the United States, Canada and Mexico with grilles, registers and diffusers. They also produce flexible air duct, chimney and gas venting systems which are marketed primarily through wholesale distributors and retail customers.
Air Systems designs and manufactures diffusers, variable air volume terminal boxes (with or without fan power), grilles, registers and fan coils for use in heating, ventilating and air conditioning systems in industrial, institutional and commercial applications. Air Systems also produces a comprehensive line of centrifugal and axial fans for both commercial and industrial applications comprising power roof ventilators, inline duct fans, ceiling fans, cabinet fans, propeller roof and wall fans, and fan accessories. These products are sold primarily to manufacturers representatives for resale to contractors.
Ruskin produces and markets commercial and industrial air control dampers, fire and smoke dampers, architectural louvers, sound absorbers, and air measuring stations for use in air conditioning, heating, ventilating and pollution control systems contained in office buildings, hotels, shopping centers, power plants, paper mills and other manufacturing plants. Ruskin also manufactures and supplies fans and blowers for residential and commercial forced air heating systems and air conditioners. These products are sold directly to manufacturers of heating, ventilating and air conditioning equipment and to contractors and commercial users principally through manufacturers representatives. Ruskin Air Management, a United Kingdom business, markets its damper, louver, grille, register, diffuser and fan coil products principally in the United Kingdom and continental Europe. This business gives the company important access to these markets for its other air distribution products.
Other Building Products
Lasco Bathware designs, manufactures and markets single piece and multi-piece fiberglass and acrylic showers, tub/shower combinations, soaking bathtubs, air tubs and whirlpools used in residential (including manufactured) housing and some commercial construction. Included in the product line are assisted care showers and tub/shower combinations designed both for new construction and remodeling applications, to meet the needs of senior citizens and the special requirements of the disabled. Products are sold in the United States, primarily through wholesale distributors and retail home improvement channels. Products are also sold directly to builders who use the company installation services. Aquatic Industries, a division of Lasco Bathware, is a maker of up-market acrylic whirlpools, principally for the dealer/distributor market in the United States and also supplies standard and customized products for hotel and resort developments internationally.
Lasco Fittings manufactures plastic fittings used in agricultural irrigation, turf irrigation, water works, swimming pools and spas, for commercial and industrial applications as well as for residential plumbing. Lasco Fittings is classified as a continuing operation under IFRS (and therefore for the purposes of the segment information provided in the Annual Report), but in fiscal 2006 it was classified as a discontinued operation under US GAAP. Lasco Fittings was sold on February 23, 2007.
Philips Products is a US producer of vinyl windows and sliding glass doors for the residential markets, principally for use in new on-site construction. These products are sold primarily through distributors to the builders. Philips sells to the window distributors through a company sales organization and, in certain regions, through independent sales representatives. Philips has recently introduced a new residential window series with appealing architectural and functional attributes that is targeted towards both the new construction and the remodeling markets. Additionally, Philips has received Florida/coastal state building code and hurricane approvals for its current residential vinyl window products allowing for growth in these regional coastal markets.
Philips Products also produces aluminum and vinyl windows, doors and venting products for the manufactured housing, recreational vehicle and specialty trailer markets. The majority of these products are sold to OEMs of manufactured housing, recreational vehicles, and specialty trailers. These products are also sold to manufactured housing and recreational vehicle after-market distributors. Philips makes sales to these OEMs and after-market distributors through a company sales organization.
Raw Materials and Energy Supplies
The Group purchases a broad range of raw materials, components and products from around the world in connection with its activities. The ability of the Groups suppliers to meet performance and quality specifications and delivery schedules is important to its operations, but the Company is not dependent on any single source of supply for critical materials. In the past, the energy and materials required for the Groups manufacturing operations have been readily available. However, basic raw materials such as steel, aluminum, nickel, polymers and resins used in the production of the Groups products, can be subject to significant fluctuations in price. Where appropriate, the Group seeks to minimize the effect of fluctuations in prices of raw materials by entering into forward purchase contracts or options to fix the input cost of the raw material or product. During fiscal 2006, the price of certain base metals more than doubled which had an adverse impact on the Groups Fluid Systems and Wiper Systems businesses. Generally, the Group has secured sales price increases that have enabled it to pass the increased cost of raw materials on to its customers. Where possible, the Group continues to endeavor to obtain raw materials from lower-cost sources and to find suitable lower-cost substitutes.
Industrial and Automotive
Sales to Automotive OEMs do not tend to exhibit seasonal patterns. Sales into the aftermarket are generally stronger during the winter months reflecting higher levels of demand for replacement parts for vehicles during this period. Sales to Industrial OEMs are strongest from October to April for outdoor power equipment and from February to June for agricultural equipment.
In the Fluid Power OEM segment, moderate seasonality is primarily driven by consumer demand and crop-related seasonal activities. Production of construction equipment declines in the summer months followed by a resurgence of activity in the late fall, early winter and spring. Farm equipment production levels are driven by purchases prior to the relevant planting and harvesting seasons. The remaining markets served by the Fluid Power segment do not exhibit significant seasonal patterns.
Sales to the construction industry slow down in November and December before the Thanksgiving, Christmas and New Year holiday season and are generally stronger in the spring and summer months. Sales can also be affected regionally by severe weather. Heating product sales are more concentrated in the fall and cooling products in the spring.
Patents and Trademarks
Management believes that the Groups operations are not dependent to any significant degree upon any single or series of related patents or licenses, or any single commercial or financial contract. Management also believes that the Groups operations are also not dependent upon any single trademark or trade name, although trademarks and trade names are identified with a number of the Groups products and services and are of importance in the sale and marketing of such products and services.
The Companys subsidiaries are regulated by governmental authorities in a number of countries. Many of the products produced by the Companys subsidiaries are subject to governmental regulation regarding their production, sale, advertising, safety, labeling and raw materials. Management believes that the Companys subsidiaries have taken sufficient measures to comply with applicable local or national regulations.
Some of the regulations applicable to the Companys subsidiaries include regulations that would allow local, national or federal authorities to mandate product recalls, or provide for the seizure of products, as well as other sanctions. Management believes that the controls implemented by subsidiaries minimize the risk of the occurrence of such events and that such risks do not pose a material threat to the Company. It is standard practice for contracts with OEMs to limit compensation arising from product recalls to direct costs (recall notification and replacement). Warranty limitations and exclusions are printed on all customer-facing material.
The Company maintains worldwide insurance coverage for product liability claims and believes that its level of insurance coverage is adequate.
The Companys subsidiaries are subject to regulation under various and changing federal, state and local laws and regulations relating to the environment and to employee safety and health. These environmental laws and regulations govern the generation, storage, transportation, disposal and emission of various substances. Permits are required for operation of certain businesses carried out by the Companys subsidiaries (particularly air emission permits) and these permits are subject to renewal, modification and, in certain circumstances, revocation. Management believes that the Companys subsidiaries are in substantial compliance with laws and regulations which could allow regulatory authorities to compel (or seek reimbursement for) clean up of environmental contamination at its subsidiary-owned sites and at facilities where its waste is stored or disposed of.
C. Organizational structure
Tomkins plc is the parent of a large number of subsidiaries that are organized into two principal business groups managed through a Corporate Center. The Groups organizational structure is shown below (excluding the Wiper Systems operating segment that formed part of the Industrial & Automotive business group, but was classified as a discontinued operation during fiscal 2006). During fiscal 2006, Dearborn Mid-West Conveyor Company (that was included within the Other Industrial and Automotive operating segment) and Lasco Fittings Inc. (that was included within the Other Building Products operating segment) were also classified as discontinued operations.
A list of the Companys significant subsidiaries, including name, country of incorporation and proportion of ownership, is set forth in Exhibit 8.1.
D. Property, plant and equipment
The Groups principal executive offices are located in London, England. The Groups plants, warehouses and offices are located in various countries throughout the world, with a large number in North America. The Group owns many of these properties and continues to improve and replace properties when considered appropriate to meet the needs of its individual operations. There are no individually significant properties that were underutilized during fiscal 2006.
The net book value as at December 30, 2006 of the Groups property, plant and equipment was $1,397.2 million, of which $113.7 million represented property, plant and equipment located in the United Kingdom, $614.6 million located in the United States and $180.0 million located in Continental Europe, with the balance of $488.9 million in the rest of the world. At December 20, 2006, the Group operated 138 manufacturing facilities, 41 distribution centers and two dedicated research and development centers in 21 countries across the Americas, Europe, Asia, and Australia. Due to the diverse nature of the business, management believes that there is no individual fixed asset at December 30, 2006, the loss of which would have a material impact on the position of the Group as a whole. Similarly there are no plans to construct, expand or improve facilities that would, on completion or cancellation, significantly affect the Groups operations.
Item 5. Operating and Financial Review and Prospects
A. Operating results
Basis of preparation
The Companys consolidated financial statements presented under Item 18 Financial Statements are prepared in accordance with US GAAP. Accordingly, information presented below in respect of the Group as a whole is stated in accordance with US GAAP.
The Company prepares its home country consolidated financial statements in accordance with IFRS adopted for use in the European Union. SFAS131 Disclosures about Segments of an Enterprise and Related Information requires segment information provided in financial statements to reflect the information that was provided to the chief operating decision maker for the purpose of making decision about allocating resources within the Company and assessing the performance of each segment. The chief operating decision maker bases such decisions chiefly on adjusted profit from operations which represents profit from operations before restructuring initiatives (restructuring expenses and gains and losses on disposals and on the exit of businesses) and amortization of intangible assets arising acquisition determined in accordance with IFRS. Accordingly, information presented below in respect of the Companys operating segments is prepared in accordance with IFRS.
Reconciliations of net sales determined in accordance with IFRS to net sales determined in accordance with US GAAP and of adjusted profit from operations to operating income from continuing operations determined in accordance with US GAAP are forth in Item 4B Business Overview. An explanation of the differences between these measures is set forth in Note 7 to the consolidated financial statements presented under Item 18 Financial Statements.
Three-year summary (US GAAP)
During the last three fiscal years, the Companys net sales were $5,418.7 million in fiscal 2006, $5,108.9 million in fiscal 2005 and $4,688.0 million in fiscal 2004. Income from continuing operations before taxes, minority interest and equity in net income of associates was $493.8 million in fiscal 2006, $394.8 million in fiscal 2005 and $479.1 million in fiscal 2004.
Details of the acquisitions and disposals during fiscal 2006, fiscal 2005 and fiscal 2004 are set forth in the Principal acquisitions, disposals and capital expenditures section of Item 4A History and development of the Company.
Fiscal 2006 results compared with fiscal 2005 results
Group overview (US GAAP)
Net sales were $5,418.7 million for fiscal 2006, an increase of $309.8 million (6.1 percent) from sales of $5,108.9 million for fiscal 2005. Cost of sales increased from $3,619.9 million for fiscal 2005, which was 70.9 percent of net sales, to $3,905.0 million for fiscal 2006, which is 72.1 percent of net sales. Selling, general and administrative expenses increased by 5.4 percent to $1,049.9 million for fiscal 2006 from $996.3 million for fiscal 2005, representing 19.4 percent of net sales for fiscal 2006 and 19.5 percent of net sales for fiscal 2005.
Goodwill impairment tests were completed as at December 30, 2006 and December 31, 2005. There was no impairment recognized at either date.
During fiscal 2006 there were $24.6 million of restructuring costs expensed to the consolidated income statement compared with $9.1 million in fiscal 2005. Major restructuring projects during both fiscal 2006 and fiscal 2005 included costs related to the closure of Stackpoles pump components facility and the rationalization of production facilities within Air Systems Components. Additionally, in fiscal 2006, restructuring costs included the restructuring of Fluid Powers facility at St. Neots, United Kingdom and the transfer of its machining, coupling assembly and testing equipment operations to a new facility at Karvina, Czech Republic. Management has undertaken the various restructuring activities to streamline operations, consolidate and take advantage of available capacity and resources, and ultimately to achieve net cost reductions. Restructuring activities include efforts to integrate and rationalize the Groups businesses and to relocate manufacturing operations to lower cost markets.
On May 3, 2007, management announced that Stackpole is to be integrated into the Gates group to enable the Group to further exploit the available synergies from the combined technologies, products and market positions of Gates and Stackpole and leverage the global reach of the Gates business. As part of this restructuring, during the second quarter of fiscal 2007 management will carry out an assessment of the carrying value of certain assets of the Stackpole business, taking into account the outlook for its markets and customers.
Operating income from continuing operations was $439.2 million for fiscal 2006 compared with $483.6 million for fiscal 2005. Overall the Groups operating margin was 8.1 percent, compared with 9.5 percent for fiscal 2005.
Net interest expense for fiscal 2006 was $48.1 million compared with $24.4 million in fiscal 2005. This consisted of interest expense on bank loans, overdrafts, bills discounted, capital lease interest and other loans, partially offset by bank interest income. Other finance income was $102.7 million in fiscal 2006 compared with other finance expense of $65.2 million in fiscal 2005. Other finance income or expense represents fair value gains and losses arising on financial instruments held by the Company to hedge its translational exposures where either the economic hedging relationship does not qualify for hedge accounting or to the extent that there is deemed to be ineffectiveness in a qualifying hedging relationship.
Income tax expense in fiscal 2006 was $63.3 million after the release of provisions for uncertain tax positions of $92.7 million, which compared with the income tax expense for fiscal 2005 of $61.3 million, after the release of provisions for uncertain tax positions of $106.6 million. The Group recognizes provisions in respect of uncertain tax positions whereby additional current tax may become payable in future periods following the audit by the tax authorities of previously filed tax returns. Provisions for uncertain tax positions are based upon managements assessment of the likely outcome of issues associated with assumed
permanent differences, interest that may be applied to temporary differences and the possible disallowance of tax credits and penalties. Provisions for uncertain tax positions are reviewed regularly and are adjusted to reflect events such as the expiry of limitation periods for assessing tax, administrative guidance given by the tax authorities and court decisions. As at December 30, 2006, the Group recognized a provision for uncertain tax positions amounting to $71.0 million. It is possible that the final outcome of these matters may differ from managements estimates.
Minority interest in net income was $19.0 million in fiscal 2006, compared with $16.4 million for fiscal 2005. Minority interests in the Companys subsidiaries are set forth in Note 2B to the consolidated financial statements presented under Item 18 Financial Statements.
The loss from discontinued operations in fiscal 2006 was $202.2 million, compared with a loss of $6.9 million in fiscal 2005. In fiscal 2006, the loss from discontinued operations included an impairment loss of $211.0 million on assets classified as held for sale of which $167.0 million related to goodwill, and $44.0 million related to property, plant and equipment. In fiscal 2005, an impairment loss of $9.6 million on property classified as held for sale was included in the loss from discontinued operations. The Group recognized a gain on disposal of discontinued operations of $39.7 million in fiscal 2006 compared with a gain of $1.6 million in fiscal 2005.
In fiscal 2006, dividends of $9.9 million were payable to convertible cumulative preference shareholders compared with $29.1 million in fiscal 2005. The Groups net income attributable to common shareholders for fiscal 2006 was $241.8 million, a decrease of 14.8 percent from $283.9 million for fiscal 2005.
Operating segment overview (IFRS)
Industrial and Automotive
In the Industrial and Automotive group, net sales and adjusted profit from operations for fiscal 2006 were up by 5.8 percent and down by 0.4 percent respectively compared to fiscal 2005. After adjusting for the effect of exchange, acquisitions and disposals, underlying net sales increased by 5.9 percent due principally to higher volumes. Underlying adjusted profit from operations decreased by 0.4 percent because the increase in net sales was outweighed by the effect of higher raw material prices and selling and distribution costs. Reflecting these changes, operating margin fell slightly from 11.8 percent in fiscal 2005 to 11.1 percent in fiscal 2006.
Demand from automotive OEMs in North America, which amounts to 9.2 percent of the Groups total sales (2005: 12.0 percent), was weaker than anticipated through most of fiscal 2006 as the Detroit Three continued to lose market share to the Asian manufacturers. Overall, the automotive aftermarket remained steady in the United States in fiscal 2006, despite some monthly fluctuations caused by a combination of weather, oil prices and customer consolidation and de-stocking. In Europe and in Asia the Companys aftermarket business grew in the developing regions.
Chinas growing importance for the Industrial and Automotive group was reflected in a 46.1 percent increase in sales during the year, albeit from a relatively small base, which contributed to an overall sales increase in Asia of 11.5 percent. Europe also performed well, with sales up 12.4 percent, driven by expansion into Eastern Europe.
The number of facilities based in low-cost regions now represents about a third of the Groups facilities, and this has given the business a better cost base and a stronger position in high growth regions with local customers.
During fiscal 2006, the Industrial and Automotive group acquired ENZED Fleximak Ltd., and a 60 percent interest in Gates Winhere LLC. In total, the net sales added by these businesses was approximately $6 million. In addition, the Company acquired a 20 percent interest in an e-business and logistics services provider, CoLinx LLC, which has paved the way for the launch of Gates online store for industrial power transmission products in January 2007.
During fiscal 2006, the Wiper Systems segment was identified as non-core to the Groups future operations and was classified as a discontinued operation. The business completed the restructuring of the Pontypool facility in Wales during the year and production moved to facilities in China and Mexico, leaving a small distribution facility for the United Kingdom and European aftermarket. Management expects that the business will be sold during fiscal 2007.
In fiscal 2006, 14 percent of Industrial and Automotive sales came from products launched in the past five years.
Power Transmission (Net sales: fiscal 2006 $1,851.3 million; fiscal 2005 $1,761.0 million)
Power Transmission sales grew by 5.1 percent and adjusted profit from operations increased by 10.0 percent, driven by expansion into Asia. Sales in the region grew strongly due to new business awards with automotive customers such as Chery and Brilliance in China and Hyundai in Korea. Hyundai has sizeable global growth targets and became the Groups biggest customer in Asia during fiscal 2006. Strong economic growth in China also resulted in increased opportunities to supply belts for white goods and for electrical products such as printers and photocopiers. Power Transmission sales in Asia now represent approximately 6.6 percent of total Group sales.
In Eastern Europe, there was good progress in the automotive aftermarket business and a sales office in Russia was opened during fiscal 2006 to assist with future expansion.
Successful product introductions such as the new Micro-V® XF belt for the automotive aftermarket and the CabRunner Integrated power system in Asia, Europe and South America have bolstered sales. At Stackpole, which as discussed in the Group Overview is expected to be integrated into the Gates group, the product launches for variable vane technology oil pumps and carrier systems for the new six-speed transmission programs continue to be on track and new business development has progressed well, with Gates being awarded an important first contract for variable vane oil pumps in Europe, using Stackpole technology. Stackpole has also started a development program with a Korean OEM, as part of its strategy to grow outside its existing market place and with new customers.
These gains were offset by weak sales in North America in the automotive OE market due to the severe cutbacks at the Detroit Three. This affected Stackpoles performance, which was also hampered by higher raw material costs from the sharp increases in the cost of certain base metals. The Pump Components facility in Ontario, Canada was closed in fiscal 2006 with production transferred to the recently constructed facility in Ancaster, Canada.
The automotive OE market will continue to be a challenging environment. The focus is on developing products that can respond to the growing demands of fuel efficiency and reduced environmental impact. With Stackpoles technology, the Group is well positioned to benefit from the move in the US automotive OE market to six-speed automatic transmission, which is forecast to become the standard by 2010.
The industrial OE and industrial OE markets showed steady growth in North America in fiscal 2006. The industrial markets offer significant opportunities to replace current power transmission applications with new technologies and materials. Innovation in material technology will also play an important role in winning this new business, and the Group is making significant advances in materials such as nano-composites, carbon cord and engineered fabrics.
Fluid Power (Net sales: fiscal 2006 $703.7 million; fiscal 2005 $650.0 million)
Fluid Power saw higher sales driven by strength in the European industrial markets and the full year contribution from EMB that was acquired in July 2005. There was good progress in India and South East Asia, with double-digit growth led by new awards and expansion into new industry segments. Sales in Asia of Fluid Power products now represent approximately 0.5 percent of total Group sales. In North America, sales of hydraulic OE softened during the second half of the year with the major construction OE manufacturers slowing their order rate.
The Quick-lok® family of products have attracted customer interest due to the leak-preventing technology and consequent warranty cost reductions for customers. New awards with revenue of approximately $15 million are to be launched in fiscal 2007 in both North America and Europe.
The Groups focus is to build the competitiveness of the Fluid power segment outside of North America, with relocation of production to low-cost areas and expansion in Asia. Construction started on a new facility in Chennai, India where there is significant quotation activity with local customers, and the initial transfer of hydraulic operations from the United Kingdom to the facility at Karvina, Czech Republic is now complete. Capacity has been increased at the Karvina plant to address growing demand for hydraulic equipment in Eastern Europe.
Fluid Systems (Net sales: fiscal 2006 $430.5 million; fiscal 2005 $418.1 million)
The Fluid Systems segment experienced a combination of weaker automotive OE volumes in North America due to lower customer demand, deferred revenues due to the delay in the TREAD Act, and rising raw material prices. This contributed to the decline in adjusted profits from operations from $31.0 million in fiscal 2005 to $20.2 million in fiscal 2006. This decline was somewhat mitigated by the significant ramp-up in production at Schrader Electronics that started in September 2006 and has continued successfully during the final quarter of the year. Production volumes are now double the level seen at the start of fiscal 2006.
The business won its first award of a RTPMS motorcycle contract with BMW and the development of the latest snap-in valve sensor and Wireless Auto Location technology has secured the award of approximately $165 million of new business with a major OE manufacturer in Europe and North America. Schraders RTPMS technology will be fitted to all of this particular customers vehicles for model years 2009 to 2011 inclusive. Fluid Systems is expanding its sensor technology into the area of fuel level sensors, which has attracted interest from customers, with several demonstration vehicle tests already underway.
Other industrial and automotive (Net sales: fiscal 2006 $981.7 million; fiscal 2005 $919.4 million)
In Other Industrial and Automotive, the Dexter Axle business experienced a difficult market environment with pricing pressure and some competition from offshore components imported from Asia. In fiscal 2005, Dexter had benefited from additional volume associated with the US Federal Emergency Management Agency demand following the hurricanes in the United States, which did not recur in fiscal 2006. Dearborn Mid-West saw increased sales in the year, with good volumes from its higher-margin bulk handling business. The mix of work changed as awards on the automotive side of the business were impacted by the difficulties at the Detroit Three. Dearborn has been identified as a non-core business and management expects that it will be sold during fiscal 2007. Dearborn is a discontinued operation under US GAAP but is classified as a continuing operation under IFRS.
Plews showed an improved performance during fiscal 2006, benefiting from some product initiatives that were implemented in fiscal 2005. Ideal continued to look to expand its business in high growth regions following the opening of a new facility at Suzhou, China. Ideal was impacted by sharp increases in the price of certain base metals, particularly nickel.
During fiscal 2006, Winhere, a manufacturer of automotive water pumps in China, was acquired and this has given Gates access to supply the large North American water pump market using a low-cost production source that has already resulted in new awards. The acquisition of Fleximak, a distributor and fabricator of flexible fluid transfer products, has provided Gates with an established infrastructure in the Middle East with which to accelerate its market penetration of Fluid Power and Power Transmission products.
During fiscal 2006, sales in Building Products increased by 9.8 percent to $1,762.1 million (fiscal 2005: $1,604.6 million) and adjusted profit from operations increased by 7.6 percent to $153.6 million (fiscal 2005: $142.7 million). The improved performance relates to the healthy non-residential construction market and the positive contribution from acquisitions made in the year, although much of the progress was offset by the significant weakness in the residential construction market during the second half of fiscal 2006. After adjusting for the effect of exchange, acquisitions and disposals, underlying net sales increased by 2.9 percent reflecting higher sales prices that outweighed the effect of lower volumes. Underlying adjusted profit from operations decreased by 1.1% because the increase in net sales was outweighed by the effect of higher raw material prices. Reflecting these changes, the operating margin declined slightly from 8.9 percent in fiscal 2005 to 8.7 percent in fiscal 2006.
The residential new-build market in North America weakened slightly during the first half of fiscal 2006 from the record level seen in fiscal 2005, then experienced a sharp and sudden decline in the latter half of August and September. Demand has since remained weak, with excess housing inventory levels in the supply chain. For fiscal 2007, the National Association of Home Builders has forecast that housing starts will be 15.4 percent lower in the United States than in fiscal 2006. New building permits issued in December 2006 stood at 1.596 million, almost 25 percent lower than in December 2005.
The non-residential construction market experienced solid growth in fiscal 2006 and within the commercial segment, the hotels and offices sector showed good growth. External forecasts indicate continued growth in fiscal 2007 of 2.2 percent compared to 1.4 percent in fiscal 2006.
The focus for all businesses in the Building Products group will be to control costs during a period of weaker sales volumes in the residential market, ensuring that production can be adjusted to meet ongoing variations in customer demand and that discretionary costs are reduced.
In fiscal 2006, 10.6 percent of Building Products sales came from products launched in the past five years.
Air Systems Components (Net sales: fiscal 2006 $1,070.6 million; fiscal 2005 $881.3 million)
Sales and adjusted profit from operations increased due to a healthy non-residential construction market, higher pricing levels on certain products and strong contributions from acquisitions. The order book and backlog remain at a healthy level for the non-residential market. The performance of the Hart & Cooley business was adversely impacted by the weakness in the residential market.
The acquisition of Selkirk, in March 2006, increased the existing product range and provided a well-established market presence in the Canadian market. The addition of Heat-Fab and Eastern Sheet Metal, in October 2006, added further product lines. These three bolt-on acquisitions helped to consolidate the Groups market position and strengthen relationships with the major distributor customers. The acquisitions contributed $127.4 million to the Air Systems Components groups sales for fiscal 2006.
The rationalization of production facilities continued, with the decision to close the Holland, Michigan facility in fiscal 2007 and transfer operations to a low-cost facility in Mexico.
The businesses are developing energy-smart products in response to the market drive for greener buildings. Examples include control dampers that reduce energy usage through tighter sealing capability and fans that are both quieter and more efficient than existing models.
Other Building Products (Net sales: fiscal 2006 $691.5 million; fiscal 2005 $723.3 million)
Both Lasco Bathware and Philips Doors and Windows experienced weaker sales during fiscal 2006, due to the slowdown in the residential construction market.
Lasco Bathware saw strong sales of its new FreedomLine range of assisted care products that are targeted at the ageing population in the United States, providing them with barrier-free bathing products. Despite the weak residential marketplace, sales of FreedomLine achieved double-digit growth as a new range of shower products was introduced to meet growing demand.
In the first half of fiscal 2006, Lasco introduced new robotics technology at its fiberglass manufacturing plant in Moapa, Nevada. The new technology provides an automated spray deposition process that significantly improves material transfer efficiencies, resulting in greater product quality and consistency, as well as a reduction in overspray waste. It plans to adopt this technology in all of its plants over the next three to five years.
Lasco Fittings has been identified as a non-core business and management expects that it will be sold during fiscal 2007. Lasco Fittings is a discontinued operation under US GAAP but is classified as a continuing operation under IFRS.
The Philips doors and windows business continued its new product development program in fiscal 2006, with its hurricane-resistant window opening up good potential in the new-build market in regions susceptible to hurricanes.
Fiscal 2005 results compared with fiscal 2004 results
Group overview (US GAAP)
Net sales were $5,108.9 million for fiscal 2005, an increase of $420.9 million (9.0 percent) from sales of $4,688.0 million for fiscal 2004. Cost of sales increased from $3,254.3 million for fiscal 2004, which was 69.4 percent of net sales, to $3,619.9 million for fiscal 2005, which is 70.9 percent of net sales. Selling, general and administrative expenses increased by 4.8 percent to $996.3 million for fiscal 2005 from $950.7 million for fiscal 2004, representing 19.5 percent of net sales for fiscal 2005 and 20.3 percent of net sales for fiscal 2004.
SFAS123(R) Share-based Payments was adopted using the modified prospective method with an effective date of January 2, 2005, whereby the standard was applied prospectively to the unvested portion of awards that were outstanding as at January 1, 2005 and all awards granted, modified or settled on or after January 2, 2005. Prior to adopting SFAS123(R), the Group accounted for share-based compensation using the intrinsic value method prescribed in APB25 Accounting for Stock Issued to Employees. The financial statements for the year ended January 1, 2005 were not restated to reflect the adoption of SFAS123(R). The compensation expense in respect of share-based compensation plans recognized in income was $16.5 million for fiscal 2005 compared with $6.6 million in fiscal 2004.
Goodwill impairment tests were completed as at December 31, 2005 and January 1, 2005. There was no impairment recognized at either date.
During fiscal 2005, there were $9.1 million of restructuring expenses charged to the consolidated income statement compared with $25.2 million in fiscal 2004. During fiscal 2005, major restructuring projects included the closure of Stackpoles Pump Components Division (PCD) facility, the transfer of the manufacturing of the Wiper Systems facility in Pontypool, United Kingdom to more cost competitive locations and the rationalization of production facilities at Air Systems Components. Management undertook various restructuring activities to streamline operations, and consolidate and take advantage of available capacity and resources in order to achieve net cost reductions. Restructuring activities included efforts to integrate and rationalize the Groups businesses and to relocate manufacturing operations to lower cost markets.
Operating income from continuing operations was $483.6 million for fiscal 2005, compared with $457.8 million for fiscal 2004. Overall the Groups operating margin was 9.5 percent, compared with 9.8 percent for fiscal 2004.
Net interest expense for fiscal 2005 was $24.4 million compared with $22.7 million in fiscal 2004. This consisted of interest expense on bank loans, overdrafts, bills discounted, capital lease interest and other loans, partially offset by bank interest income. Other finance expense was $65.2 million compared with other finance income of $44.0 million in fiscal 2004. Other finance income or expense represented fair value gains and losses arising on financial instruments held by the Company to hedge its translational exposures where either the economic hedging relationship did not qualify for hedge accounting or to the extent that there was deemed to be ineffectiveness in a qualifying hedging relationship.
Income tax expense in fiscal 2005 was $61.3 million, after the release of provisions for uncertain tax positions of $106.6 million, which compared with the income tax expense for fiscal 2004 of $101.3 million, after the release of provisions of $27.4 million following the closure of a number of previously open tax years. The Group recognized provisions in respect of uncertain tax positions whereby additional current tax may become payable in future periods following the audit by the tax authorities of previously filed tax returns. Provisions for uncertain tax positions were based upon managements assessment of the likely outcome of issues associated with assumed permanent differences and interest that may be applied to temporary differences, and the possible disallowance of tax credits and penalties. As at December 30, 2005, the Group recognized a provision for uncertain tax positions amounting to $162.9 million.
Minority interest in net income was $16.4 million in fiscal 2005, compared with $15.2 million for fiscal 2004. Minority interests in the Companys subsidiaries are set forth in Note 2B to the consolidated financial statements presented under Item 18 Financial Statements.
The loss from discontinued operations in fiscal 2005 was $6.9 million, compared with an income from discontinued operations of $3.2 million in fiscal 2004. The Group recognized a gain on disposal of discontinued operations of $1.6 million in fiscal 2005 compared with a gain of $11.0 million in fiscal 2004.
In fiscal 2005, dividends of $29.1 million were payable to convertible cumulative preference shareholders compared with $28.5 million in fiscal 2004. The Groups net income attributable to common shareholders for fiscal 2005 was $283.9 million, a decrease of 18.7 percent from $349.2 million for fiscal 2004.
Operating segment overview (IFRS)
Industrial and Automotive
In the Industrial and Automotive group, net sales and adjusted profit from operations for fiscal 2005 were up by 6.5 percent and 0.1 percent respectively compared to fiscal 2004. After adjusting for the effect of exchange, acquisitions and disposals, underlying net sales and adjusted profit from operations increased by 2.4 percent and decreased by 7.0 percent respectively. The growth in sales was mainly due to increased volumes.
The lower automotive production volumes in the North American automotive OE market generally, and particularly at General Motors and Ford, had an impact on sales volumes and margins. The group also had to contend with the delay in the TREAD Act that pushed back a significant number of RTPMS orders until the second half of 2006, and in the third quarter of 2005 the two hurricanes in the gulf coast region of the United States temporarily disrupted the supply chain and caused a spike in raw material prices.
The Industrial and Automotive group completed the acquisitions of L.E. Technologies and EMB in fiscal 2005, with the Mectrol business being acquired at the end of fiscal 2004. In total, the annualized sales added by these businesses was approximately $160 million.
In fiscal 2005, automotive OE represented 21.1 percent of the Groups total sales (fiscal 2004: 25.1 percent) and North American automotive OE represented 12.0 percent of total sales (fiscal 2004: 14.4 percent).
Power Transmission (Net sales: fiscal 2005 $1,761.0 million; fiscal 2004 $1,668.1 million)
Power Transmission sales grew by 5.6 percent due to good underlying growth in industrial markets and automotive aftermarket, offsetting the lower automotive OE volumes. The Mectrol industrial belt business, acquired in December 2004, made a strong contribution during fiscal 2005 and targeted a number of new applications for its products in markets such as food processing and print and paper processing.
Automotive OE sales were impacted throughout fiscal 2005 by production cuts, especially at General Motors and Ford. The business took action to address this, and in fiscal 2005 won new business orders in Asia of approximately $30.0 million with Hyundai, Toyota and SAIC, and new business orders in Europe of approximately $22.0 million with Renault/Nissan, PSA/Peugeot, VW and Fiat. The business continued to expand in China, with sales ahead by 17.2 percent, and secured an award from Chery Automotive for Excellent Technical Co-operation.
Automotive aftermarket sales increased by 4.3 percent, with particular strength in Europe where sales increased by 13.2 percent. The business in Europe benefited from the launch of the new Micro-V® XF belt and, in North America, Power Transmission won a key contract to supply tensioners to CARQUEST. The business continued to look at expansion opportunities in high-growth markets such as Russia and the Middle East, and during the year won a Supplier of the year award in Russia from AD International, a large Pan European organization, for the quality of its order fulfillment.
At Stackpole, the profitability of the business suffered from the lower automotive OE production volumes. The Company took action during the year to contain costs and implement profit protection plans and, in February 2006, announced the closure of the PCD facility.
Fluid Power (Net sales: fiscal 2005 $650.0 million; fiscal 2004 $591.0 million)
The Fluid Power segment performed strongly in fiscal 2005, with sales increasing by 10.0 percent. In North America, the business capitalized on the strength in industrial production with the result that sales of both hydraulic OE and industrial aftermarket products increased significantly. Sales in the automotive aftermarket were also strong in the fourth quarter of fiscal 2005. The balance of the sales growth was provided by contributions from Europe and from India, where a new facility was opened at Faridabad. The EMB business that was acquired in July 2005 was integrated and positively contributed in the second half of fiscal 2005. The development of new products continued and the Quick-Lok family of products was introduced at the start of fiscal 2005. This product was well received by customers, with several new contracts awarded for fiscal 2006 and fiscal 2007. The new Customer Solutions Center in Denver was opened in the second quarter of fiscal 2005.
Fluid Systems (Net sales: fiscal 2005 $418.1 million; fiscal 2004 $416.3 million)
The performance of the Fluid Systems segment was in line with fiscal 2004, but was impacted by the delay in the TREAD Act and lower automotive OE volumes. At the start of the year, Schrader Electronics had expected a significant ramp-up in volumes of RTPMS due to the requirements of the TREAD Act, but this was delayed. The management at Schrader Electronics took swift action during the year to limit the impact on profit from the reduced volumes and was also successful in winning several new contracts for its snap-in sensor technology to supply General Motors, DaimlerChrysler, PSA/Peugeot, Subaru and Nissan.
The Stant operation showed good year-on-year performance as sales of new valve products rose and a spike in demand for locking fuel caps occurred in the final quarter of fiscal 2005. The balance of the Fluid Systems segment was held back by lower automotive OE volumes.
Fluid Systems opened two new facilities in fiscal 2005. Stant commenced production at a plant in Karvina, Czech Republic and Schrader-Bridgeport completed a 36,000 square feet valve-manufacturing facility in Suzhou, China. There were significant start-up costs incurred during the year as production levels picked up and extra capacity was added to the plants.
Other industrial and automotive (Net sales: fiscal 2005 $919.4 million; fiscal 2004 $845.8 million)
Sales and adjusted profit from operations in fiscal 2005 were significantly ahead of fiscal 2004. Dexter recovered from lower volumes in the first quarter of the year to deliver a strong performance assisted by sales relating to the US Federal Emergency Management Agency in the final quarter of the year. The acquisition of the L.E. Technologies business in March 2005 added to the product offering.
The Dearborn Mid-West business performed well, while Ideal and Plews were both impacted by higher raw material costs for brass and PVC that were difficult to pass on to customers. The Ideal business opened its plant in Suzhou, China in the third quarter of fiscal 2005.
During fiscal 2005, sales in Building Products increased by 11.0 percent to $1,604.6 million (2004: $1,445.6 million) and adjusted profit from operations increased by 11.2 percent to $142.7 million (2004: $128.3 million). This was achieved through positive contributions from acquisitions, price increases made to offset higher material costs, successful new product introductions, and the continued strength in the residential housing market. After adjusting sales for acquisitions and disposals there was an underlying increase of 8.9%, which is explained below. The operating margin in the Building Products group remained at 8.9 percent.
Air Systems Components (Net sales: fiscal 2005 $881.3 million; fiscal 2004 $772.3 million)
Sales were up by 14.1 percent on fiscal 2004. Of the total increase of $109.0 million, $58.1 million arose from acquisitions and of the remaining increase of $50.9 million (6.6 percent), 83 percent was due to volume and 17 percent was due to price increases. The Hart & Cooley business capitalized on the continued strength in the US residential housing market and, in January 2005, acquired Milcor. This business was fully integrated during fiscal 2005 and made a strong contribution to sales and profit. It presented opportunities for cross-selling of products with Hart & Cooley and for sourcing low-cost materials from its manufacturing operation in China.
Despite the slow non-residential market, the order intake level remained healthy and benefited from both new product introductions and new customer wins. In the third quarter, Ruskin successfully completed the acquisition of NRG Industries Inc.
There were a number of plant rationalizations during the year, with the closure of the Tabor City and Englewood facilities and the transfer of production to other facilities in the business. Ruskin commenced production at its new facility in Monterrey, Mexico. Operating margins in fiscal 2005 were impacted by costs associated with the plant rationalizations.
Other Building Products (Net sales: fiscal 2005 $723.3 million; fiscal 2004 $673.3 million)
A strong performance in the second half of fiscal 2005 resulted in full-year sales being ahead by 7.4 percent compared to fiscal 2004. The total increase of $50 million was after a reduction of $25.8 million due to disposals. The remaining underlying increase of $75.8 million (11.7 percent) was due to a combination of volume and price variances. Lasco Bathware achieved strong sales growth and double-digit operating margins before restructuring initiatives, driven by the record level of housing starts in the US residential market and the successful launch of several new products, such as the Contours range of luxury whirlpools and showers.
Lasco Fittings achieved year-on-year improvements in sales and profit, with higher volumes from new product introductions and market share gains. New product sales accounted for over 30 percent of the growth in sales in fiscal 2005. The business experienced significant pricing pressure in fiscal 2005 from the increased cost of PVC, but was able to implement a series of price increases.
The Philips Doors and Windows business had a positive fourth quarter and full-year sales increased compared to fiscal 2004. The operating margin in the business was impacted by a bad-debt write-off of $1.9 million in the first quarter of fiscal 2005.
Effect of Inflation
Management does not believe that inflation has had a material effect on the Companys financial condition or results of operations during fiscal 2006, fiscal 2005 or fiscal 2004.
Effect of Foreign Currency
For further discussion see Item 11 Quantitative and Qualitative Disclosures about Market Risk and Note 17 to the consolidated financial statements presented under Item 18 Financial Statements.
Critical Accounting Estimates
Details of the Groups significant accounting policies are set out in Note 2 to the Companys consolidated financial statements presented under Item 18 Financial Statements.
When applying the Groups accounting polices, management must make assumptions and estimates concerning the future that affect the carrying amounts of assets and liabilities at the balance sheet date, the disclosure of contingencies that existed at the balance sheet date and the amounts of revenue and expenses recognized during the accounting period. Management makes these assumptions and estimates based on factors such as historical experience, the observance of trends in the industries in which the Group operates and information available from the Groups customers and other outside sources. Due to the inherent uncertainty involved in making assumptions and estimates, actual outcomes could differ from those assumptions and estimates. An analysis of the key sources of estimation uncertainty at the balance sheet date that have a significant risk of causing a material adjustment to the carrying amounts of the Groups assets and liabilities within the next fiscal year is provided below.
Pension and other post-retirement benefits
Post-retirement benefits comprise pension benefits provided to employees throughout the world and other benefits, mainly healthcare, provided to certain employees in North America. The plans are structured to accord with local conditions and practices in each country and include defined contribution and defined benefit plans.
The Group accounts for its post-retirement benefit plans in accordance with SFAS87, Employers Accounting for Pensions, SFAS88 Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits and SFAS106, Employers Accounting for Postretirement Benefits other than Pensions. The principle underlying these accounting standards is that the cost of providing these benefits is recognized in income over the service lives of the participating employees.
For defined contribution plans, the cost of providing the benefits represents the Groups contributions to the plans and is recognized in income in the period in which the contributions fall due.
For defined benefit plans, the cost of providing the benefits is determined based on actuarial valuations of each of the plans that are carried out annually by independent qualified actuaries at a date not more than three months before the Companys fiscal year-end. Plan assets (if any) are measured at a fair value. Benefit obligations are measured using the projected unit credit method.
It is estimated that a 0.5 percent decrease in the expected rate of return on plan assets would have the following impact.
The net periodic cost comprises the service cost, the interest cost, the expected return on plan assets (if any), and the amortization of the prior service cost, the actuarial gain or loss and any unrecognized obligation or asset that existed on initial application by the Group of SFAS87 and SFAS106. The service cost represents the present value of benefits attributed to services rendered by employees during the period. The interest cost represents the increase in the projected benefit obligation (which is the present value of accrued benefits including assumed future salary increases) due to the passage of time. The discount rate used reflects the rates available on high-quality fixed-income debt instruments at the date of the plan valuation. Prior service costs resulting from plan amendments are recognized on a straight-line basis over the remaining service lives of participating employees.
Actuarial valuations are dependent on assumptions about the future that are made by management on the advice of independent qualified actuaries. If actual experience differs from these assumptions, there could be a material change in the amounts recognized by the Group in respect of defined benefit plans in the next financial year.
It is estimated that a 0.5 percent decrease in the discount rate would have the following impact on the projected benefit obligation and on the components of expense that are affected by a discount rate change.
Actuarial gains and losses represent differences between the expected and actual returns on the plan assets, gains and losses on the plan liabilities and the effect of changes in actuarial assumptions. The Group uses the so-called corridor approach whereby to the extent that cumulative actuarial gains and losses exceed 10 percent of the greater of the market related value of the plan assets and the projected benefit obligation at the beginning of the fiscal year, they are amortized to income over the average remaining service lives of participating employees. Gains and losses on settlements and curtailments are generally recognized in income in the period in which the curtailment or settlement occurs.
As at December 31, 2005, the defined benefit obligation recognized in the Groups consolidated statement of financial position comprised the net total for each plan of the fair value of the plan assets (if any) less the projected benefit obligation adjusted for the unrecognized net prior service cost or credit, the unrecognized net actuarial gain or loss and the unrecognized net transition asset or obligation. An additional liability was recognized to the extent that the accumulated benefit obligation (the projected benefit obligation without allowance for future salary increases) exceeded the fair value of the plan assets. Where an additional minimum liability was recognized, an intangible asset was recognized up to the amount of any unrecognized prior service cost and any unrecognized transition obligation. Any amount not recognized as an intangible asset was reported in other comprehensive income.
Effective December 30, 2006, the Group adopted the recognition provisions of SFAS158 Employers Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements no. 87, 88, 106, and 132(R). Accordingly, the Groups consolidated statement of financial position as at December 30, 2006 includes the net total for each plan of the fair value of the plan assets (if any) less the projected benefit obligation.
As at December 30, 2006, the previously unrecognized net prior service cost, the unrecognized net actuarial loss and the unrecognized net transition obligation were recognized and it became no longer necessary to recognize the minimum pension liability and the related intangible asset.
SFAS158 does not change the basis of determining the net periodic benefit cost that is recognized in the Groups consolidated statement of income. From fiscal 2007 onwards, prior service costs or credits and actuarial gains or losses that arise in the year but are not recognized as components of the net periodic benefit cost will be recognized as a component of other comprehensive income. Amounts recognized in accumulated other comprehensive income in respect of prior service costs or credits, actuarial gains or losses and the net transition asset or obligation will be adjusted as they are recognized as components of the net periodic benefit cost.
Impairment of Long-Lived Assets
Goodwill, intangible assets and property, plant and equipment are tested for impairment whenever events or circumstances indicate that their carrying amounts might be impaired. Such events and circumstances include the effects of restructurings and new product development initiated by management. Additionally, goodwill is subject to an annual impairment test.
Long-lived assets to be held and used, including intangible assets, are reviewed for impairment when events or circumstances indicate that the carrying amount of the asset or asset group may not be recoverable. The carrying value of a long-lived asset or asset group is considered to be impaired when the undiscounted expected future cash flows from the asset or asset group are less than its carrying amount. In that event, an impairment loss is recognized to the extent that the carrying amount of the asset or asset group exceeds its fair value. Fair value is determined based on quoted market prices, where available, or is estimated as the present value of the expected future cash flows from the asset or asset group discounted at a rate commensurate with the risk involved.
At the time of the business combination to which it relates, goodwill is allocated to one or more reporting units. Goodwill is tested at least annually for impairment. Firstly, to identify potential impairment of the goodwill, the fair value of the reporting unit to which the goodwill is allocated is compared with its carrying amount. Fair value is determined based on quoted market prices, where available, or is estimated as the present value of the expected future cash flows from the reporting unit discounted at a rate commensurate with the risk involved. Management bases such estimations on assumptions such as the future growth in sales volumes, future changes in selling prices, and expected changes in material prices, salaries and other costs. The discount rates used are based on current market interest rates. Secondly, if the carrying amount of the reporting unit, including the goodwill, exceeds its fair value, the goodwill is tested for impairment based on its implied fair value. The implied fair value of goodwill represents the excess of the fair value of the reporting unit over the fair value of its identifiable assets, liabilities and contingent liabilities at the date of the impairment test. An impairment loss is recognized if and to the extent that the carrying amount of the goodwill exceeds its implied fair value.
As at December 30, 2006, the aggregate carrying amount of goodwill, intangible assets and property, plant and equipment was $3,304.4 million. Impairment losses may be recognized on these assets within the next fiscal year if changes are necessary to the assumptions underlying the estimated future cash flows of income-generating units or if there are changes in market interest rates that affect the discount rates that are applied to those cash flows.
Assets held for sale
Assets that are classified as held for sale are measured at the lower of their carrying amount and fair value less costs to sell.
As at December 30, 2006, the carrying value of assets held for sale was $184.6 million. Impairment losses may be recognized in the next financial year if the amounts realized on the sale of these assets differs from managements estimates.
Inventories are stated at the lower of cost or market, with due allowance for any excess, obsolete or slow moving items based on managements review of on-hand inventories compared to historical and estimated future sales and usage profiles.
Cost represents the expenditure incurred in bringing inventories to their existing location and condition, which may include the cost of raw materials, direct labor costs, other direct costs and related production overheads. Cost is generally determined on a first in, first out (FIFO) basis, but the cost of certain inventories is determined on a last in, first out (LIFO) basis. As at December 30, 2006, inventories whose cost was determined on a LIFO basis represented 33 percent (December 31, 2005: 35 percent) of the total carrying amount of inventories. As at December 30, 2006, the replacement cost of inventories whose cost was determined on a LIFO basis exceeded their carrying values by $20.9 million (December 31, 2005: $14.2 million). Management considers current assessments of future demand, market conditions and new product development initiatives and impair inventory on the basis of these estimations. As at December 30, 2006, the carrying value of inventories was $753.4 million, net of allowances of $39.6 million. Impairment losses may be recognized on inventory within the next financial year if management needs to revise its estimates in response to changing circumstances.
The Group uses derivative financial instruments, principally foreign currency swaps, forward foreign currency contracts and interest rate swaps, to reduce its exposure to exchange rate and interest rate movements. The Group does not hold or issue derivatives for speculative or trading purposes.
Derivative financial instruments are recognized as assets and liabilities measured at their fair values at the balance sheet date. Foreign currency derivatives are valued by discounting the applicable cash flows at prevailing market interest rates. Interest rate derivatives are valued by discounting the applicable cash flows at prevailing market interest rates. Changes in their fair values are recognized in income and this is likely to cause volatility in situations where the carrying amount of the hedged item is either not adjusted to reflect fair value changes arising from the hedged risk or is so adjusted but that adjustment is not recognized in income. Provided the conditions specified by SFAS133 Accounting for Derivative Instruments and Hedging Activities are met, hedge accounting is used to mitigate this volatility.
Prior to fiscal 2005, the Group chose not to apply the hedge accounting provisions of SFAS133. During fiscal 2005, management reviewed its policy towards hedge accounting and decided to use hedge accounting in certain circumstances. With effect from fiscal 2005, the Group does not generally apply hedge accounting to transactional foreign currency hedging relationships, such as hedges of forecast or committed transactions. It does, however, apply hedge accounting to translational foreign currency hedging relationships and to hedges of its interest rate exposures where it is permissible to do so under SFAS133.
Derivatives embedded in non-derivative host contracts are recognized separately as derivative financial instruments when their risks and characteristics are not closely related to those of the host contract and the host contract is not stated at its fair value with changes in its fair value recognized in the income statement.
The fair value of derivative financial instruments continually changes in response to changes in prevailing market conditions and net income may be affected by changes in the fair values of derivatives where hedge accounting cannot be applied or, to the extent there is deemed to be hedge ineffectiveness in a qualifying hedging relationship.
Provision is made for claims for compensation for injuries sustained by the Groups employees while at work. The Groups liability for claims made but not fully settled is calculated on an actuarial basis by a third party administrator. Historical data trends are used to estimate the liability for unreported incidents. As at December 30, 2006, the workers compensation provision amounted to $37.2 million. Further provision may be necessary within the next fiscal year if the actual cost of settling claims exceeds managements estimates.
Provision is made for the estimated cost of known environmental remediation obligations in relation to the Groups current and former manufacturing facilities. Cost estimates include the expenditure expected to be incurred in the initial remediation effort and, where appropriate, in the long-term monitoring of the relevant sites. For each remediation project, management monitors the costs incurred to date against expected total costs to complete and operates procedures to identify possible remediation obligations that are presently unknown. As at December 30, 2006, the provision for environmental remediation costs amounted to $7.6 million. Further provision may be necessary within the next financial year if actual remediation costs exceed expected costs, new remediation obligations are identified or there are changes in the circumstances determining the Groups legal or constructive remediation obligations.
Provision is made for warranty claims on various products depending on specific market expectations and the type of product. These estimates are established using historical information on the nature, frequency and average cost of warranty claims. Provision is made for the cost of product recalls if management considers it probable that it will be necessary to recall a specific product and the amount can be reasonably estimated. As at December 30, 2006 and December 31, 2005, the Groups product warranty liability was $11.4 million and $10.7 million respectively. Further provision may be necessary within the next fiscal year if actual claims experience differs from managements estimates.
Share-based compensation is provided to employees under the Companys share option, bonus and other share award schemes. The Group adopted SFAS123(R) Share-based Payment using the modified prospective method with an effective date of January 2, 2005, whereby the standard was applied prospectively to the unvested portion of awards that were outstanding as at January 1, 2005 and all awards granted, modified or settled on or after January 2, 2005. Accordingly, the compensation expense recognized in fiscal 2006 and fiscal 2005 was based on the fair value of the awards, where appropriate measured using an option-pricing model. In measuring the fair value of the awards, management is required to make a number of assumptions, the most significant of which are expected volatility and the expected life of the awards. Expected volatility was determined based on the historical volatility of the market price of the Companys Ordinary Shares over the shorter of the expected life of the awards and the period since the beginning of the Companys fiscal year ended April 30, 2002 when, following a period of significant demerger activity, the Company was refocused on its remaining core businesses. Adjustments have been made to the expected life to reflect the effects of non-transferability, exercise restrictions and behavioral considerations, where available based on historical experience of similar awards.
For equity-settled awards, the fair value is determined at the date of grant and is not subsequently remeasured unless the conditions on which the award was granted are modified. For liability awards, the fair value is determined at the date of grant and is remeasured at each balance sheet date until the liability is settled. Generally, the compensation expense is recognized on a straight-line basis over the vesting period. Adjustments are made to reflect expected and actual forfeitures during the vesting period due to failure to satisfy service conditions or non-market performance conditions.
Prior to adopting SFAS123(R), the Group accounted for stock based compensation in accordance with APB25 Accounting for Stock Issued to Employees, whereby the compensation expense was based on the intrinsic value of the unvested awards determined at the measurement date. The measurement date was the first date on which both the number of shares that were subject to the award and the option or purchase price, if any, was known. Adjustments for forfeitures were made to the compensation expense in the period in which they occurred.
The Groups consolidated financial statements for fiscal 2004 have not been restated to reflect the adoption of SFAS123(R).
Current tax is the amount of tax payable or recoverable in respect of the taxable profit or loss for the period. Taxable profit differs from accounting profit because it excludes items of income or expense recognized for accounting purposes that are either not taxable or deductible for tax purposes or are taxable or deductible in other periods. Current tax is calculated using tax rates that have been enacted at the balance sheet date.
The Group operates within multiple tax jurisdictions and management is required to exercise significant judgment in determining the provision for income taxes. Estimation is required of taxable profit to determine the Groups current tax liability. The Group recognizes provisions in respect of uncertain tax positions whereby additional current tax may become payable in future periods following the audit by the tax authorities of previously filed tax returns. Provisions for uncertain tax positions are based upon managements assessment of the likely outcome of issues associated with assumed permanent differences, interest that may be applied to temporary differences, the possible disallowance of tax credits and penalties and are classified as current liabilities. Provisions for uncertain tax positions are reviewed regularly and are adjusted to reflect events such as the expiry of limitation periods for assessing tax, administrative guidance given by the tax authorities and court decisions. As at December 30, 2006, the Group recognized a provision for uncertain tax positions amounting to $71.0 million. It is possible that the final outcome of these uncertain tax positions may differ from managements estimates.
Deferred tax is tax expected to be payable or recoverable on differences between the carrying amount of an asset or a liability and its tax base used in the computation of taxable profit. Deferred tax is accounted for using the liability method, whereby deferred tax assets and liabilities are generally recognized for all temporary differences based on enacted tax rates. Deferred tax assets are reduced through the establishment of a valuation allowance at such time as, based on available evidence, it is more likely than not that the deferred tax asset will not be realized. As at December 30, 2006, the Group recognized net deferred tax assets amounting to $63.2 million. It is possible that the deferred tax assets actually recoverable may differ from the amounts recognized if actual taxable profits differ from managements estimates.
Deferred tax is provided on temporary differences arising on investments in foreign subsidiaries, except where the Company intends, and is able, to reinvest such amounts indefinitely. As at December 30, 2006, deferred tax liabilities were not recognized on the undistributed profits of foreign subsidiaries amounting to $3,937.1 million. Deferred tax will need to be provided on these amounts if circumstances change and management no longer intends, or is no longer able, to reinvest these amounts indefinitely.
Tax assets and liabilities are offset when there is a legally enforceable right to set off current tax assets against current tax liabilities and when they relate to income taxes levied by the same taxation authority and management intends to settle its current tax assets and liabilities on a net basis.
Recently issued accounting pronouncements
A. Pronouncements adopted during the year
The following accounting pronouncements that are relevant to the Groups operations were adopted during fiscal 2006:
SFAS151 Inventory Costs an amendment of ARB No. 43, Chapter 4
SFAS151 clarifies that, in determining the cost of inventory, fixed production overheads should be allocated based on the normal capacity of the production facilities (such that abnormal idle facility expenses are expensed) and other items such as abnormal freight, handling costs and amounts of wasted materials should be expensed. The Group has applied SFAS151 to inventory costs incurred on or after January 1, 2006. The adoption of SFAS151 had no effect on the Groups results or financial position.
SFAS154 Accounting Changes and Error Corrections
SFAS154 requires retrospective application to the financial statements of prior periods to reflect changes in accounting principle and redefines the term restatement as the revising of previously issued financial statements to reflect the correction of an error. Under SFAS154, a change of accounting principle is applied as at the beginning of the first period presented as if that principle had always been used. The cumulative effect of the change is reflected in the carrying value of assets and liabilities as at the beginning of the first period presented and the offsetting adjustments are recorded to opening retained earnings. Except where a change of accounting principle arises from the adoption of an accounting pronouncement that requires otherwise, the Group has adopted SFAS154 in respect of changes of accounting principle and corrections of errors that are made on or after January 1, 2006. The adoption of SFAS154 had no effect on the Groups results or financial position.
SFAS158 Employers Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements no. 87, 88, 106, and 132(R)
SFAS158 contains provisions relating to the recognition and measurement of assets and liabilities associated with defined benefit pension and other post-retirement plans. Effective December 30, 2006, the Group adopted the recognition provisions of SFAS158 under which it is required to recognize the overfunded or underfunded status of a defined benefit post-retirement plan (other than a multi-employer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. An analysis of the effect on the Groups financial position of adopting the recognition provisions of SFAS158 is set forth in Note 2 of the Companys consolidated financial statements presented under in Item 18 Financial Statements.
B. Pronouncements not yet adopted
The following accounting pronouncements are relevant to the Groups operations but were not mandatory for fiscal 2006:
SFAS157 Fair Value Measurements
SFAS157 provides guidance on how to measure the fair value of assets and liabilities and introduces additional disclosures concerning fair value measurements. SFAS157 applies whenever other accounting standards require or permit assets or liabilities to be measured at fair value. It does not extend the use of fair value measurement in financial statements.
SFAS157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants independent of the reporting entity. It requires that fair value should be based on the assumptions market participants would use when pricing the asset or liability. It establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data, for example, the reporting entitys own data.
The Group will adopt SFAS157 prospectively from the beginning of fiscal 2008.
SFAS158 Employers Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements no. 87, 88, 106, and 132(R)
The Group has not yet adopted the measurement provisions of SFAS158. Management is currently permitted to measure the funded status of the Groups defined benefit post-retirement plans at a date not more than 90 days prior to the fiscal year-end date (in fiscal 2006, for example, the measurement date was September 30). SFAS158 will require that the funded status of the plans be measured as at the Companys fiscal year-end date. The Group will adopt the measurement provisions of SFAS158 in fiscal 2008.
SFAS159 The Fair Value Option for Financial Assets and Financial Liabilities: Including an Amendment to FASB Statement No. 115
SFAS159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS159 provides entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The Company will adopt SFAS159 prospectively from the beginning of fiscal 2008, but management does not currently intend to apply the fair value option to any of the Groups eligible financial assets and financial liabilities.
FIN48 Accounting for Uncertainty in Income Taxes
FIN48 clarifies the accounting for uncertain tax positions under SFAS109 Accounting for Income Taxes. An uncertain tax position is a position taken by the Group in a previously filed tax return, or a position that it expects to take in a tax return that has not yet been filed that may be subject to examination by the relevant taxing authority. FIN48 requires that an uncertain tax position shall be recognized only when it is more likely than not that the position will be sustained on examination and, if recognized, it should be measured as the largest amount of tax benefit that is greater than 50 percent likely to be realized on settlement with the relevant taxing authority. FIN48 also requires the Group to provide certain disclosures in relation to tax benefits that are not recognized in the financial statements.
The Group will adopt FIN48 prospectively from the beginning of fiscal 2007. Management has not yet concluded its assessment of the effect of the adoption of FIN48 on the Groups financial position.
B. Liquidity and capital resources
Treasury responsibilities and philosophy
The primary responsibilities of the central treasury function are to procure the Groups capital resources, maintain an efficient capital structure, and manage the Groups liquidity, foreign exchange, interest rate, insurance and pensions risks on a Group-wide basis.
The central treasury function operates within strict policies and guidelines approved by the Board. Compliance with these policies and guidelines is monitored through the regular reporting of treasury activities.
A key element of managements treasury philosophy is that funding, interest rate and currency risk decisions and the location of cash and debt balances should be determined independently from each other. For example, the Groups debt requirements are met by raising funds in the most favorable markets, with the desired currency profile of net debt being achieved by entering into foreign exchange contracts where necessary. Similarly, the desired interest rate maturity of net debt is achieved by taking account of all debt and cash balances together with any foreign exchange transactions used to manage the currency profile of net debt. Management operates systems to ensure that all relevant assets and liabilities are taken into account on a Group-wide basis when making these decisions. Management believes this portfolio approach to financial risk management enables the Groups activities in these areas to be carried out effectively and efficiently and with a high degree of visibility.
Details of corporate bonds and EMTN program
The Group operates a EMTN Program. The initial bond under the program in December 2001 was for £150 million with a ten-year maturity and was issued at a coupon of 8 percent.
In September 2003, a further £250 million bond with a twelve-year maturity at a coupon of 6.125 percent was issued. The proceeds of this bond issue were used to finance the early redemption of the convertible cumulative preference shares, which took place in August 2003.
In December 2001, long-term credit ratings with Moodys and Standard & Poors were established. The ratings, which cover the EMTN Program, have remained unchanged since that date at Baa2 and BBB respectively. The Group also has a short-term rating of P-2 with Moodys. It is managements aim to manage the Groups capital structure to preserve these ratings.
Committed bank borrowing facilities mainly comprise a multi-currency revolving credit facility of £400 million, the maturity of which was extended in August 2005, from February 2009 to August 2010.
Borrowing facilities are monitored against forecast requirements and timely action is taken to put in place, renew or replace credit lines. Managements policy is to reduce financing risk by diversifying funding sources and by staggering the maturity of borrowings.
During fiscal 2006, there was a net decrease in cash and cash equivalents of $58.7 million.
Net cash provided by operating activities was $514.2 million, $140.9 million higher than in fiscal 2005. Net cash used in investing activities was $390.6 million, $37.5 million higher than in fiscal 2005 due principally to lower proceeds on the sale of discontinued operations and reduced net expenditure on property plant and equipment. Net cash used in financing activities in fiscal 2006 was $182.0 million which compared with net cash provided by financing activities of $25.0 million in fiscal 2005, the difference of $207.0 million being due largely to amounts drawn down on bank loans and higher dividend payments. During fiscal 2006, the Groups net draw-down on bank loans (principally against the multi-currency revolving credit facility) was $51.2 million, compared with a net draw-down of $247.5 million in fiscal 2005. Dividend payments to the Companys shareholders were $229.9 million in fiscal 2006, compared with $206.3 million in fiscal 2005.
At December 30, 2006 and December 31, 2005, total debt was $1,130.1 million and $975.3 million respectively. Net debt, a non-GAAP measure defined as total debt less cash, cash equivalents, and restricted cash, at those dates was $784.4 million and $569.7 million respectively. The analysis of total debt and a reconciliation of total debt to net debt at carrying value are provided in the table below.
Management believes net debt provides useful information regarding the level of the Groups indebtedness by reflecting the amount of indebtedness assuming cash balances are used to repay debt.
Levels of borrowings and seasonality
During fiscal 2006, gross and net debt increased, with gross debt of $1,130.1 million and net debt of $784.4 million on December 30, 2006 (2005: $975.3 million and $569.7 million respectively). The peak level of net debt during the year was $879.9 million. As the majority of the Groups debt is denominated in currencies other than pounds sterling, reported net debt decreased by $76.3 million as a result of the weakening of the US dollar ($62.2 million) and other currencies ($14.1 million) during the period.
The Group operates in a wide range of markets and geographic locations and as a result the seasonality of its borrowing requirements is low. Underlying cyclicality before capital expenditure is driven principally by the timing of ordinary and convertible cumulative preference dividends and interest payments.
Funding requirements for investment commitments and authorizations
At December 30, 2006, the Group had surplus cash balances in excess of the operational needs of the Groups businesses. Accordingly, the Groups present policy is to fund new investments, firstly from existing cash resources and then from borrowings sourced centrally by Tomkins Finance. It is managements intention to maintain surplus un-drawn borrowing facilities sufficient to enable the credit ratings to be maintained and to enable the Group to manage its liquidity through the operating and investment cycle. A regular dialogue is maintained with the rating agencies, and the potential impact on the credit rating is taken into consideration when making capital allocation decisions.
Current versus prospective liquidity
At December 30, 2006, the committed 2010 £400 million multi-currency revolving credit facility was drawn by $285.4 million and there was a further $18.1 million of fully-drawn capital leases. The Group had a further $500.7 million of other, mainly uncommitted credit facilities, of which $62.2 million was drawn for cash and $169.1 million was utilized through the issuance of bank guarantees and standby letters of credit. Total headroom under the facilities was $767.0 million in addition to cash balances of $345.7 million. Total committed borrowing headroom under the Groups credit facilities as of December 30, 2006 was $266.3 million, in addition to cash balances.
It is the Groups policy to retain sufficient liquidity throughout the capital expenditure cycle to maintain its financial flexibility and to preserve its investment grade credit rating. Management does not anticipate any material long-term deterioration in the overall liquidity position in the foreseeable future and considers that available working capital is sufficient for the Groups requirements.
Maximizing returns on cash balances
The Groups central treasury function is responsible for maximizing the return on surplus cash balances within liquidity and counterparty credit constraints imposed by the Tomkins Board-approved liquid funds policy. This is done, where practical, by controlling directly all surplus cash balances and pooling arrangements on an ongoing basis and by reviewing the efficiency of all other cash balances across the Group on a weekly basis. At December 30, 2006, $185.3 million of cash was under the direct control of the Companys central treasury function.
The Groups weighted average cost of debt at December 30, 2006 was 7.0 percent (2005: 6.5 percent). The net interest charge for fiscal 2006 of $48.1 million was $24.5 million higher than the charge for fiscal 2005. Fair value gains arising on derivative hedging instruments of $102.7 million (2005: losses of $65.2 million) have been recognized under other finance income in accordance with US GAAP.
At December 30, 2006, the Groups total cash and investments were $345.7 million. Of this amount, $155.2 million was invested in short-term deposits by the treasury department, $9.8 million of cash was held in the Groups captive insurance company, Tomkins Insurance Limited, $60.7 million of cash was held in the Groups Asian Unitta companies and $120.0 million of cash was held in centrally controlled pooling arrangements and with local operating companies. $266.4 million of the cash (including restricted cash and before interest accruals) was interest earning. The Groups policy is to apply funds from one part of the Group to meet the obligations of another part wherever possible, to ensure maximum efficiency of the Groups funds. No material restrictions apply that limit the application of this policy. It is anticipated that surplus cash in excess of that required for operating purposes held in operating companies will be repatriated or reinvested in new investments during fiscal 2007.
At December 30, 2006, the Group had $169.1 million of bank and insurance company issued bonds, guarantees and standby letters of credit in issue. These were issued primarily in favor of insurance companies to cover potential workers compensation claims in the United States in the course of normal business, in addition to other contractual counterparties for operational purposes. Annual operating lease rentals were $45.7 million in fiscal 2006 (fiscal 2005: $37.6 million).
The Group is subject to covenants, representations and warranties commonly associated with investment grade borrowings on the committed 2010 £400 million multi-currency revolving credit facility, and the £150 million 2011 bond and £250 million 2015 bond issued under the EMTN Program.
The Group is subject to two financial covenants under the committed 2010 £400 million multi-currency revolving credit facility. The ratio of net debt to consolidated EBITDA must not exceed 2.5 times and the ratio of consolidated profit from operations to consolidated net interest charge must not be less than 3.0 times. Throughout fiscal 2006, the Group has operated comfortably within these limits. These financial covenants are calculated by applying UK GAAP extant as at December 31, 2002.
C. Research and development, patents and licenses, etc.
Applied research and development is important to the Groups manufacturing businesses. The Group maintains development centers in Japan, Europe and the United States. Businesses within the Group are encouraged to review their products regularly and to develop them in accordance with perceived market trends. The Groups expenditure on research and development was $96.8 million in fiscal 2006, (fiscal 2005: $85.5 million, fiscal 2004: $93.7 million).
D. Trend information
With approximately 37 percent of the Groups primary sales derived from outside the United States, any changes in the value of the US dollar against other currencies is likely to effect reported earnings in US dollars.
The overall outlook for the Groups markets in fiscal 2007 is that they will be difficult, with the timing of recovery in trading conditions in some of the North American end-markets uncertain.
In fiscal 2006, the global automotive aftermarket (18.6 percent of Group sales in fiscal 2006) experienced a slight fall in sales, predominantly due to lower levels of demand from the Groups customers, together with the translation effect of the weaker US dollar. In Europe and in Asia, the aftermarket business grew in the developing regions, with this trend expected to continue in fiscal 2007.
The demand from automotive OE customers in North America, which amounted to 9.2 percent of the Groups total sales in fiscal 2006, was weaker than anticipated through most of fiscal 2006 as the Detroit Three manufacturers continued to lose market share to the Asian manufacturers. China, India and Eastern Europe have been the fastest growing regions while there is still overcapacity in North America and Europe. The Company is well positioned to benefit from the move to six-speed automatic transmission in the United States market, which is forecast to become the standard by 2010.
The industrial OE market (13.4 percent of total sales in fiscal 2006) showed reasonable growth in North America in fiscal 2006. External forecasts indicate this market may slow in the United States in fiscal 2007, but remain robust in other regions. The industrial aftermarket (12.0 percent of total sales in fiscal 2006) showed good growth in North America in fiscal 2006. This market tends to follow the OE market fairly closely and may experience a gradual slowdown in fiscal 2007. In both markets there is a growing demand for white goods in Asia and Eastern Europe with new technologies replacing existing applications.
The residential new-build market in North America weakened slightly during the first half of fiscal 2006 from the record level seen in fiscal 2005, then experienced a sharp and sudden decline in the latter half of August and in September 2006. Demand has since remained weak, with excess housing inventory levels in the supply chain. The non-residential construction market (15.8 percent of global sales) experienced solid growth in fiscal 2006 and within the commercial segment, the hotels and offices sector showed good growth. External forecasts from Dodge, an industry forecasting service, indicate continued growth in fiscal 2007 at a slightly reduced level compared to fiscal 2006.
For 2007, the National Association of Home Builders has forecast that housing starts will be 15.4% lower in the United States than 2006. New building permits issued in December 2006 stood at 1.596 million, almost 25% lower than in December 2005. In addition house builders are expected to reduce their current inventory levels, which are running well above normal levels, before construction levels can pick up again. The timing of a recovery in US residential housing now seems unlikely to occur until sometime in 2008, with this end-market showing greater weakness in the first quarter than commentators had predicted. The commercial construction market is predicted to grow more slowly in 2007 following a strong year in 2006, with figures from Dodge predicting an overall growth rate of 2.2%.
The focus for all businesses in the Building Products group will be to control costs during a period of weaker sales volumes in the residential market, ensuring that production can be adjusted to meet ongoing variations in customer demand and that discretionary costs are reduced.
The Group results for the first quarter of fiscal 2007 reflect the greater than expected weakness in the US residential housing market and lower demand from automotive original equipment customers in North America.
There were good performances during the quarter in the Fluid Power business, Power Transmission in Europe and Asia, in Fluid Systems helped by the continued ramp-up of sales of the Groups remote tire pressure monitoring product, and the non-residential business of Air Systems Components.
The Group continued to build its position in China and India where the Gates business saw strong sales growth and worked on development opportunities with key customers in the region. In Air Systems Components the Group has entered into an agreement to form a joint venture with an Indian business partner to supply into the fast growing Indian Heating Ventilation and Air Conditioning market.
See also Item 5A Operating and financial review and prospects - Operating results and Item 4B Information on the Company Business overview.
E. Off-balance sheet arrangements
Management does not believe that the Company has any material off-balance sheet arrangements.
F. Tabular disclosure of contractual obligations
Contractual obligations and commercial commitments
The Companys consolidated contractual obligations and commercial commitments are summarized in the following table which includes aggregate information about the Companys contractual obligations as at December 30, 2006 and the periods in which payments are due. Amounts in respect of operating leases and purchase obligations are items that the Company is obligated to pay in the future, but they are not required to be included on the consolidated balance sheet.
G. Safe Harbor
See special note regarding forward-looking statements.
Item 6. Directors, Senior Management and Employees
A. Directors and senior management
The Directors and executive officers of Tomkins plc as at April 13, 2007 are as follows:
James Nicol was appointed Chief Executive on February 18, 2002. He was formerly President and Chief Operating Officer of Magna International Inc., the Canadian automotive parts company. He joined Magna in 1987 as Vice President, Special Projects, following a career as a commercial lawyer. He left in 1992 to set up TRIAM Automotive Inc. and returned to Magna as Vice-Chairman when Magna acquired TRIAM in 1998.
Ken Lever was appointed Chief Financial Officer on November 1, 1999. He is a non-executive director of iSOFT Group plc. He is a Chartered Accountant and Chairman of the Hundred Group Financial Reporting Committee. He has held executive directorships at Albright and Wilson plc, Alfred McAlpine PLC and Corton Beach plc and was a partner at Arthur Andersen.
David Newlands was appointed a non-executive Director of the Company in August 1999, and became Chairman in June 2000. He is non-executive Chairman of KESA Electricals plc and PayPoint plc, and a director of a number of other companies. He was formerly finance director of The General Electric Company p.l.c., Chairman of Britax International plc and Deputy Chairman of Standard Life Assurance.
Sir Brian Pitman was appointed a non-executive Director of the Company in June 2000. He is also a non-executive director of the Carphone Warehouse Group PLC, Singapore Airlines Limited, Virgin Atlantic Airways Limited and ITV plc, and is a senior adviser to Morgan Stanley. He retired in April 2001 from Lloyds TSB Group plc where he was Chief Executive for 13 years and Chairman for four years. He was also non-executive Chairman of Next Group plc from 1998 until May 2002. Sir Brian will retire as a Director of the Company at the conclusion of the Annual General Meeting on June 13, 2007.
Richard Gillingwater was appointed a non-executive Director of the Company in December 2005. He has recently been appointed Dean of Cass Business School in the City of London. He previously held senior appointments in Government and the City of London, as Chairman of the Shareholder Executive, the body responsible for the Governments shareholdings in major public-owned businesses, and at CSFB, BZW and Kleinwort after qualifying as a solicitor with Lovell White Durrant.
Jack Keenan was appointed a non-executive Director of the Company in November 2001. He is presently a non-executive director of Marks and Spencer Group plc and is the patron of the Centre for International Business and Management at Cambridge University. Previously he was Chairman of Kraft International, Chief Executive of Guinness United Distillers & Vintners Limited and an executive director of Diageo plc until he retired in October 2001. Mr. Keenan will retire as a Director of the Company at the conclusion of the Annual General Meeting on June 13, 2007.
David Richardson was appointed a non-executive Director of the Company in March 2006. He is currently Chairman of Sports Direct International plc, a non-executive director of the Restaurant Group PLC, Serco Group plc, Dairy Crest Group plc, Forth Ports PLC and until recently he was a Chairman of De Vere Group plc. He held a number of senior financial management and strategic planning positions in Whitbread PLC from 1983 to 2005 becoming Group Finance Director in 2001. Prior to his time at Whitbread, he had worked for ICL plc and Touche Ross & Co. (now Deloitte & Touche LLP).
Struan Robertson was appointed a non-executive Director of the Company in December 2005. He is currently a non-executive Director of Forth Ports PLC, Henderson TR Pacific Investment Trust plc, International Power plc and Salamander Energy plc. He was Group Chief Executive of Wates Group Limited between 2000 and 2004, having previously spent 25 years with BP plc in a number of senior positions. He was the Senior Independent Director at WS Atkins plc from 2000 to 2005.
R. Bell was appointed President of The Gates Rubber Company on May 27, 2002, in addition to his role as Group President Worldwide Power Transmission Division. He came to Gates with the Uniroyal acquisition in 1986 and has held management positions in Asia and Europe prior to moving to the United States in 1996. During May 2007 it was announced that Richard Bell has been appointed to the role of Chief Operating Officer Industrial & Automotive.
D.J. Carroll was appointed Executive Vice President on July 1, 2003 and has executive responsibilities for four business units within the Group. He joined the Group from Magna International Inc. where he had operated in various sales and planning roles since 1984 becoming Executive Vice President, Marketing and Corporate Planning in 2002.
W.M. Jones joined the Group with the acquisition of Philips Industries in 1990. Having spent 10 years with General Motors he joined Philips Industries in 1979 becoming President Dexter Axle Company in 1985. He has had executive responsibility for both Dexter Axle Company and Philips Products Inc. since 1996 and has also taken on responsibility for Lasco Fittings.
T.J. OHalloran became President Building Products in January 2007 having been Group President Air Systems Components Division since 1999. He has had twenty-two years experience with Tomkins in the Building Products group, including his roles as President of Air Systems Components Limited Partners and President of Ruskin. During May 2007 it was announced that Terry OHalloran has been appointed to the role of Chief Operating Officer Building Products.
G.S. Pappayliou was appointed General Counsel on April 9, 2003. He joined the Group in August 1990 with the acquisition of Philips Industries. Thereafter he served as the General Counsel of Tomkins Industries and later as the Groups General Counsel North America.
N.C. Porter was appointed Company Secretary on August 1, 2002. Previously he was Company Secretary at Marconi plc and before that at its predecessor, The General Electric Company p.l.c.
M.P. Woryk was appointed Vice President Human Resources on May 1, 2006. She joined the Group in October 1993 and prior to her current appointment served as Assistant General Counsel.
J.W. Zimmerman was appointed Vice President Corporate Development in July 1999. He is a Chartered Accountant in South Africa. Previously he was a Principal at Braxton Associates in Canada and a Senior Manager at Deloitte & Touche in South Africa.
David Richardson was appointed as a non-executive Director of the Company on March 1, 2006. Following the substantial reduction in the interests of the Gates family in the Company on March, 9 2006, Marshall Wallach resigned as a non-executive Director of the Company with effect from May 1, 2006. Norman Broadhurst and Ken Minton retired as non-executive Directors of the Company at the conclusion of the Annual General Meeting on May 22, 2006.
Executive officer changes
M.T. Swain, previously Executive Vice-President Human Resources, announced his retirement effective June 30, 2006 and was replaced by M.P. Woryk.
There are no family relationships between any Director or executive officer and any other Director or executive officer or any arrangement or understanding between any Director or executive officer and any other person pursuant to which such Director or executive officer was so elected or appointed.
The Articles of Association of the Company provide that, unless otherwise determined by the shareholders at a general meeting, the number of Directors will not be less than two or more than fifteen. Directors may be appointed by the shareholders at a general meeting or by the Board itself, provided that any Director appointed by the Board is required to retire from office (but is eligible to stand for re-appointment by the shareholders) at the annual general meeting of the Company following his appointment. At every annual general meeting, not less than one-third of the Directors are required to retire from office and are eligible to stand for re-appointment at such meeting. Subject to the provisions of the Companies Act 1985, the Board may from time to time appoint one or more Directors to an executive office on such terms and for such period as it may determine. No Director or executive officer has a service contract with the Company of more than two years duration.
This section to shareholders sets out the membership of the Remuneration Committee and the names of the advisers who provided services to the Remuneration Committee during the fiscal 2006. The policies that have been followed by the Remuneration Committee during the year in determining the elements of executive remuneration are also set out, together with the policies and principles to be followed by the Committee over the next two years.
The Board keeps under review the terms of reference for the Remuneration Committee, which are based on current best practice contained in the model terms of reference set out in the Guidance Note produced by the Institute of Chartered Secretaries and Administrators. The principal responsibility of the Committee is to determine the framework or broad policy for the Companys executive remuneration and the remuneration of the Chairman of the Board, for approval by the Board. The remuneration of non-executive Directors is a matter for the Board itself. The terms of reference of the Remuneration Committee can be found under Governance in the Responsibilities area on the Companys website, www.tomkins.co.uk. In addition, the Company takes full account of the guidelines published by the Association of British Insurers and the National Association of Pension Funds.
Details of the emoluments, bonuses, benefits-in-kind, incentive arrangements (including share options and other long-term incentives), pensions and service contracts applicable to each Director who served during fiscal 2006 are given in this section.
Membership of the Remuneration Committee and Advisers
The Remuneration Committee is made up exclusively of non-executive Directors whom the Board determined to be independent, as each was found to be free from any material business or other relationship with the Company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the Company). Accordingly, the Board believes that there are no such relationships that could materially interfere with the exercise of their independent judgment. Messrs. Gillingwater and Keenan served on the Remuneration Committee throughout the year and David Newlands was appointed to the Remuneration Committee on July 28, 2006. Ken Minton and Norman Broadhurst ceased to be members of the Remuneration Committee upon their retirement from the Board on May 22, 2006.
The members of the Remuneration Committee as at December 30, 2006 were:
R.D. Gillingwater (Chairman)
There were no other changes to the membership of the Committee during the year.
The Remuneration Committee consults with the Chief Executive concerning matters of executive remuneration. The Remuneration Committee also appointed and received advice from external advisers, PA Consulting Group, concerning the Companys 2006 Performance Share Plan. PA Consulting Group also provided consulting services during the year in respect of business process, technology and strategy. Mercer Human Resource Consulting provided advice to Tomkins in respect of the placement and operation of life assurance benefits for Executive Directors and provided professional advice to the trustees of the pension schemes of Tomkins and some of its subsidiaries in respect of their respective pension arrangements. Other than those consulting services mentioned above, PA Consulting Group and Mercer Human Resources Consulting had no connections with the Company.
Statement of Companys policy on Directors remuneration
The policies operated by the Company during the year and those to be applied over the next two years, are set out below:
The Companys policy on executive remuneration is that the Remuneration Committee and the Board should each satisfy itself that executives, including executive Directors, are fairly rewarded for their individual contributions to the Groups performance. The Remuneration Committee has sought to ensure that executive Directors receive a level of remuneration that is appropriate to their scale of responsibility and performance and which will attract, motivate and retain individuals of the necessary caliber. The only pensionable element of executive Directors remuneration is basic salary. This policy applies whether or not an executive Director is a member of the Tomkins Retirement Benefits Plan or has a personal pension arrangement.
Annual remuneration for executives
The Board recognizes that one of its key objectives is to grow the value of the business for the benefit of shareholders and that such growth is strongly related, amongst other things, to the degree of entrepreneurial spirit in the Group. To create the necessary entrepreneurial impetus within an organization, compensation arrangements are required which are similar to those that an owner of a business would seek.
This has led to the adoption of a remuneration policy under which the levels of total remuneration are set to attract, retain and motivate executives. Remuneration is provided through a combination of base salaries at median level or below and annual bonuses that have a direct and proportionate link to total value created for shareholders. This provides the incentive for executives to act like owners of the business. The Remuneration Committee and the Board believe that this policy more closely aligns the interests of shareholders and management whereby executives only receive substantial rewards when they have created high value in the business.
Over time and subject to the achievement of value-creating performance targets, this policy is likely to lead to a realignment of the component parts of total executive remuneration, so that a greater part of the total package received by executives is made up of incentive pay with the remainder coming from base salaries at the median level or below. The performance targets for the Companys Annual Bonus Incentive Plan and 2006 Performance Share Plan ensure that a substantial proportion of total remuneration is directly related to actual measurable performance.
Non-executive Directors fees and Chairmans remuneration
The executive Directors review the fees of non-executive Directors, who play no part in determining their own remuneration. The Chairmans remuneration is determined by the Remuneration Committee and is approved by the Board. The Chairman takes no part in the discussions and decisions relating to his own remuneration. Review of non-executive Directors fees and the Chairmans remuneration takes place every two years.
The Companys policy on Directors service contracts is that service contracts and letters of appointment for executive Directors normally provide for notice periods of no longer than 12 months. On appointment, a longer notice period may apply, but this will reduce over time to the normal 12 months notice period. Notwithstanding the provisions in an executive Directors service contract or letter of appointment concerning termination payments, the Company will seek to reduce any compensation that may be payable to reflect the departing Directors obligation to mitigate loss.
The Companys policy on external appointments is that, with the approval of the Chairman of the Board, executive Directors are permitted to hold appointments outside the Company. Any fees payable in connection with such appointments are normally retained by Directors unless otherwise agreed.
Long-term incentives and share options
The Company has operated a number of share-based long-term incentive schemes in the past but, following a review of executive remuneration, the Remuneration Committee and Board expect the number of plans and schemes to reduce over time as they lapse and are not renewed or replaced. As reported in fiscal 2005, the Remuneration Committee and the Board decided not to continue with an executive share option scheme beyond May 9, 2005, the date on which the Companys Executive Share Option Schemes lapsed. Following further consideration, the Board decided, with shareholder approval, to introduce a new share scheme, The Tomkins 2006 Performance Share Plan.
The Company operates an employee savings related share option scheme, the Tomkins 2005 Sharesave Scheme, which applies to all United Kingdom employees.
The Companys retirement benefit plan was closed to new members in April 2002 and, since that time, the Companys policy has been that new employees, including executive Directors and senior executives, will receive a payment from the Company to enable them to make contributions to retirement benefit schemes of their choice on behalf of themselves and their dependants. No change to this policy is expected over the next two years. The normal retirement age of the executive Directors is 60.
Basic salary, fees, bonuses and benefits in kind for fiscal 2006
Having taken into consideration comparative remuneration data, the contribution made by the Chairman to the Companys affairs, the time he devotes to the Companys business, and the extra responsibilities placed upon him arising from the changes in corporate governance requirements in the United Kingdom and the United States, the Remuneration Committee recommended to the Board that his remuneration should be increased from $321,000 to $339,000 plus 2,000 Ordinary Shares in the Company per annum, with effect from January 1, 2006. These recommendations were approved by the Board.
Non-executive Directors fees
The executive Directors reviewed the fees paid to non-executive Directors and having taken into consideration comparative remuneration data, the contribution made by individual non-executive Directors to the Companys affairs, the time they devote to the Companys business, and the extra responsibilities placed upon them arising from the changes in corporate governance requirements in the United Kingdom and the United States, approved an increase in the basic annual fee to $78,000 plus 2,000 Ordinary Shares in the Company per annum with effect from January 1, 2006. No changes to the level of Remuneration Committee fees were made. In recognition of his duties as Senior Independent Director, Sir Brian Pitmans fees were increased by $27,500 per annum with effect from January 1, 2006.
The following table shows emoluments paid or payable to all Directors and all executive officers of the Company as a group for fiscal 2006.
Annual Bonus Incentive Plan
The executive Directors and senior executives participate in the Companys Annual Bonus Incentive Plan (the Plan). Each participant in the Plan receives a percentage of bonusable profit of the business for which he or she has responsibility. Bonusable profit is based on operating profit less a charge for tax, certain exceptional items, and a charge for invested capital, and is based upon IFRS. The objective of the Plan is to reward the senior executives for increasing the overall value created in the business, based on the margin of the after-tax return on invested capital in excess of the weighted average cost of capital. Accordingly, bonusable profit may increase at a faster rate than operating profit where the margin of the return over the cost of capital increases. This aligns the interests of management and shareholders. In arriving at bonusable profit, adjustments may be made for restructuring charges relating to strategic manufacturing initiatives to match the costs of the strategic manufacturing initiatives to the benefits over a period of up to three years. The charge for taxation reflects the ongoing charge for tax excluding any benefit from exceptional adjustments to tax provisions. The charge for invested capital is based on applying the estimated weighted average cost of capital to the average invested capital in the Group. The estimated weighted average cost of capital takes into account the capital structure of the Group and the costs associated with each element of capital. The method of calculation has been agreed by the Remuneration Committee and is subject to review each year. The invested capital is based on the book value of assets in the Group, excluding goodwill relating to acquisitions made prior to December 30, 1999. The cost of capital used in the calculation of bonusable profit for the year under review was 7.95 percent.
The Remuneration Committee carries out a detailed review of the computations involved and ensures that the rules are applied consistently. Furthermore, the independent auditors are asked to perform agreed-upon procedures on behalf of the Remuneration Committee on the calculations which underlie the computation of the bonusable profit. The incentive bonus of the executive directors is based on a percentage of the bonusable profit of the Group which, for the year ended December 30, 2006, was $204.1 million (December 31, 2005: $224.6 million). James Nicol received the sum of $2.4 million (December 31, 2005: $2.7 million) and Ken Lever received the sum of $1.1 million (December 31, 2005: $1.3 million). Although there is no limit to the bonusable profit on which bonuses are calculated, inordinate growth in bonusable profit in any one year is unlikely to arise due to the nature of the Groups business.
The bonus awards are payable to senior participants, including executive Directors, as four-sevenths in cash, one-seventh in bonus shares and two-sevenths in deferred shares. The bonus awards payable to the remaining participants are as three-quarters in cash, one-twelfth in bonus shares and one-sixth in deferred shares. The bonus is paid at the end of June, September and December based on 75 percent of the bonus earned to the end of the previous quarter, with the balance of the full entitlement to the bonus for the calendar year paid at the end of March following the calendar year-end.
Bonus shares are restricted and vest only after a period of three years from the initial bonus award. Dividends are paid on the bonus shares. Deferred shares are awarded at the time of the initial bonus award but the vesting of the shares is conditional on continued employment with the Group for three years after the award. Dividends are not paid on the deferred shares until they have vested.
As a condition of continued participation in the Plan, senior participants, including executive Directors, are required to hold shares with a market value equivalent to one years total after-tax remuneration including bonus, based on an average of the previous three years. Remaining participants are required to hold shares with a market value equivalent to one-half of one years total after-tax remuneration including bonus, based on an average of the previous three years. Increases in annual base salary of all participants, including executive Directors, are restricted to the equivalent rate of increase in the Retail Prices Index (in the United Kingdom) or equivalent index in the country in which a participant works. The restrictions on the increases in salary, together with the growth in bonus, assuming increases in bonusable profit, will result in the incentive pay element of remuneration increasing over time. The share awards will increase the investment each of the participants, including executive Directors, has in the Ordinary Shares in the Company.
The Tomkins 2006 Performance Share Plan
The Tomkins 2006 Performance Share Plan (the PSP) is a long-term incentive plan. The purpose of the PSP is two-fold. First, to provide a share-based long-term incentive arrangement for senior executives that more closely aligns the interests of executives with shareholders. Secondly, the PSP is in substitution of the Companys legal obligation to the Chief Executive to provide annual grants of options, which had previously been satisfied by the Executive Share Option Scheme that lapsed in May 2005. The Remuneration Committee considered the alternatives and, with the agreement of the Chief Executive and the assistance of PA Consulting Group, devised a plan that achieves those aims. The PSP will provide rewards in future years only if shareholders have seen value created over the preceding three years. The Remuneration Committee and Board believe that
this creates a better alignment between executive reward and the creation of shareholder value than a standard executive share option scheme. The PSP has four key features: (i) the performance baseline is established which is equal to the cost of equity and if the total shareholder return (comprising dividends and increase in the share price) over three years does not exceed the cost of equity over the same three-year period, no award of shares will be made; (ii) the award of shares will be proportional to the degree of performance over the baseline; (iii) there is a cap on the quantum of share awards; and (iv) subject to performance, awards will be made at the end of each three-year performance period. During the year, the following maximum awards of Ordinary Shares in the Company were made to James Nicol and Ken Lever under the PSP:
The Tomkins Executive Share Option Scheme No. 3 (ESOS 3) and The Tomkins Executive Share Option Scheme No. 4 (ESOS 4)
ESOS 3 and ESOS 4 lapsed for grant purposes on May 9, 2005 and the Remuneration Committee and the Board decided not to continue with an executive share option scheme beyond that date.
ESOS 3 was an HM Revenue and Customs-approved scheme. ESOS 4 was not approved by HM Revenue and Customs. The options under both schemes mature after three years. All outstanding ESOS 4 options were granted to participants within the limit of four times their annual earnings. The performance condition for all outstanding options under ESOS 3 and ESOS 4 requires that the growth in the Groups earnings per share must exceed the growth in the UK Retail Prices Index by an average of 2 percent per annum over a three-year period before an option can be exercised, which was in accordance with contemporary practice when the schemes were introduced in 1995.
The Tomkins 2005 Sharesave Scheme (Sharesave)
Sharesave is a standard HM Revenue and Customs-approved savings related share option scheme, which is open to employees who are resident for tax purposes in the United Kingdom. It offers eligible employees the option to buy Ordinary Shares in Tomkins plc after a period of three, five or seven years funded from the proceeds of a savings contract to which employees may contribute up to £250 per month.
The Tomkins Share Matching Scheme (SMS)
Awards which had been made under a now expired scheme known as The Tomkins Restricted Share Plan and which had vested, were eligible for matching awards for the same number of shares under the SMS. Such awards could be for up to two conditional share matching awards vesting a further two years and four years respectively after the end of the original restricted period. The final commitment to grant an SMS award was made during the year and the SMS is therefore now closed for grant purposes. With shareholder approval, this share scheme was introduced in 1996 with no performance conditions attached and accordingly it does not comply with Schedule A of the Combined Code.
The interests of the Directors in Ordinary Shares in the Company held within the SMS that are yet to vest and yet to be included in Directors remuneration were as follows:
The value of entitlements held under the SMS for current Directors as at December 30, 2006 was $7,300 (December 31, 2005: $9,000). No shares were awarded to Directors during fiscal 2006 (fiscal 2005: 1,809, K Lever with a market value of $9,000 when the closing MMQ for a share was 290.00p).
During fiscal 2006, no shares vested under the SMS (fiscal 2005: 1,809 at 289.02 pence per share, market value $9,000, in respect of Ken Lever). As at December 30, 2006, 3,618 shares were required to be retained by Ken Lever to allow the SMS award in the above table to vest in the relevant vesting period (December 31, 2005: 3,618 shares required to be retained by Ken Lever). No other current Director was required to retain shares in this respect as at December 30, 2006.
Deferred Matching Share Purchase Plan
This has now lapsed. It was specifically and solely introduced for James Nicol as part of the incentive package to attract him to the Company. No benefit was paid during fiscal 2006 (fiscal 2005: 1,015,228 shares vested, taken as a cash payment of $7.6 million).
Tomkins Premium Priced Option
This was an option specifically and solely granted to James Nicol as part of the incentive package on his joining the Company. It consists of a nontransferable option to acquire 5,076,142 shares. The exercise price was 197 pence per share in respect of 2,538,072 shares (A option shares), 276 pence per share in respect of 1,522,842 shares (B option shares) and 345 pence per share in respect of 1,015,228 shares (C option shares). The options have all vested and will lapse on February 11, 2012 or earlier in certain circumstances.
This is an option specifically and solely granted to James Nicol on February 11, 2002 as part of the incentive package to attract him to the Company. It consists of a non-transferable option to acquire 1,522,842 shares at 197p per share, which can be exercised on or after February 18, 2005 provided the rate of increase of earnings per share over any three-year period is equal to or greater than the rate of increase of the UK Retail Prices Index plus 9 percent. This performance condition has been met and the option has been exercised in respect of 972,842 shares. The option will lapse on February 11, 2012 or earlier in certain circumstances.
The Tomkins Savings Related Share Option Scheme No. 2 (SAYE 2)
SAYE 2 was a standard HM Revenue and Customs-approved savings related share option scheme open to employees resident for tax purposes in the United Kingdom, which lapsed for the purpose of new grants on May 9, 2005.
James Nicol and Ken Lever are not entitled to any retirement benefits defined in terms of final or average salary but they receive a payment at an annual rate of 37.5 percent of their basic salary to enable them to make contributions to retirement benefit schemes of their choice on behalf of themselves and their dependants. For fiscal 2006, this amounted to $583,000 (fiscal 2005: $548,000) for James Nicol, and $280,000 (fiscal 2005: $263,000) for Ken Lever. At the time he joined the Company, Ken Lever was given the option to elect at any time to become a member of the Tomkins Retirement Benefits Plan or any other replacement pension scheme nominated by the Company, but did not do so during fiscal 2006. The normal retirement age of the executive Directors is 60.
A summary of the service contract or letter of appointment of each of the Directors is as follows:
James Nicol Chief Executive Officer
The Company and James Nicol entered into a contract dated February 11, 2002 which set out the terms and conditions under which he joined the Company as Chief Executive Officer on February 18, 2002. The contract remains in force until terminated by either party giving notice of not less than twelve months.
Ken Lever Finance Director
On November 1, 1999, Ken Lever and the Company entered into a Memorandum which set out the terms and conditions of employment under which Ken Lever joined the Company as Finance Director on that date. The terms of the Memorandum remain in force until terminated by either party giving notice of 51 weeks.
None of the non-executive Directors has a service contract with the Company, their terms of engagement being set out in a letter of appointment. Ordinarily, non-executive Directors serve for a period of two years but, subject to agreement with the Board, a non-executive Director can be re-appointed for a further term of three years. The appointment of non-executive Directors may be terminated before the conclusion of their two-year term by, and at the discretion of, either party upon two weeks written notice. In the case of David Newlands, the appointment is for a term of three years and may be terminated at any time by either party serving written notice upon the other, such notice to take effect from the date of receipt thereof. None of the non-executive Directors is entitled to compensation for loss of office. The dates from which the respective letters of appointment are effective are as follows: Richard Gillingwater December 20, 2005; Jack Keenan November 1, 2005; David Newlands February 18, 2004; Sir Brian Pitman June 30, 2004; David Richardson March 1, 2006; and Struan Robertson December 20, 2005
Payments made to and interests of former Directors
No payments were made to former Directors during fiscal 2006 (fiscal 2005: $nil).
Sums paid to third parties in respect of a Directors services
During fiscal 2006, no amounts were paid to third parties in respect of a Directors services to any company within the Group (fiscal 2005: $nil).
Sums received by executive Directors from other external directorships
On June 21, 2005, Ken Lever was appointed as a non-executive director of iSoft plc and during fiscal 2006 he received non-executive directors fees of $110,000 (fiscal 2005: $56,000 from iSoft Group plc and $37,000 from Vega Group plc where he served as a non-executive director from January 1 to September 8, 2005 before leaving the board). In both cases Ken Lever retained the fees. James Nicol holds no external directorships.
C. Board practices
The Board of Directors
The Company is controlled through the Board. The Boards main roles are to create value for shareholders, to provide leadership of the Company, to approve the Companys strategic objectives, to ensure that the necessary financial and other resources are made available to the management to enable them to meet those objectives and to operate within a framework of effective controls which enables the assessment and management of principal business risks. The Board, which has reserved certain specific matters to itself for decision (as set out in a Schedule of Reserved Matters and updated in 2006), is responsible for approving overall Group strategy and financial policy, acquisition and divestment policy and major capital expenditure projects. It also appoints and removes members of the Board and Board Committees, and reviews recommendations of the Audit Committee, Remuneration Committee and Nomination Committee and the appointment of the independent auditors and the financial performance and operation of each of the Companys businesses.
The Board sets the standards and values of the Company and much of this has been embodied in the Companys Code of Conduct and Ethics and Human Rights Policy which can be found on the Companys website (www.tomkins.co.uk). The Code of Conduct and Ethics applies to all Directors, officers and employees, including the principal executive, financial and accounting officers, as required by section 406 of the US Sarbanes-Oxley Act of 2002 (the SOX Act), the related rules of the US
Securities and Exchange Commission (the SEC) and the rules of the NYSE. The Code contains provisions (Reporting of Violations) under which employees can report violations of company policy or any applicable law, rule or regulation, including those of the SEC. Employees in the United States have the added protection of section 806 of the SOX Act, which prohibits the discrimination by a company or others against an employee where such violations are reported. The current procedure, which is set out in the Groups Code of Conduct and Ethics, provides for information to be given anonymously or by named employees under conditions of confidentiality. Those employees who come forward and give their name are assured that they will receive the full protection of section 806 and no retaliation will take place. This is of particular importance since 54 percent of the Groups employees are based in the United States. Furthermore, the Company ensures that the principles are applied in other jurisdictions, subject to compliance with local employment and other laws. For further information regarding the Code of Conduct and Ethics, refer to Item 16B Code of Ethics.
The Board has delegated to the Chief Executive responsibility for the day-to-day management of the Group subject to certain financial limits above which Board approval is required. The delegated authority includes such matters as operations, acquisitions and divestitures, investments, capital expenditure, borrowing facilities and foreign currency transactions.
The Board comprises a non-executive Chairman, five additional non-executive Directors and two executive Directors who together, with their different financial, commercial, technical and operational expertise and cultures, bring with them a wide range of experience to the Company.
The Board has determined that David Newlands, Richard Gillingwater, Jack Keenan, Sir Brian Pitman, David Richardson and Struan Robertson are independent, as they are independent of the Companys executive management and free from any material business or other relationship with the Company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the Company). In December 2000, at the request of the Board, the non-executive Chairman, David Newlands, temporarily assumed certain executive responsibilities until the recruitment of James Nicol as Chief Executive in February 2002. It is the Boards view that this short-term arrangement did not affect Mr. Newlands independence. Accordingly, the Board believes that there are no such relationships that could materially interfere with the exercise of their independent judgment.
Non-executive Directors are normally appointed for a minimum period of two years, which is renewable by agreement with the Board and is subject to approval by shareholders at the Annual General Meeting. The terms and conditions of appointment of non-executive Directors are available for inspection at the Companys registered office during normal business hours on weekdays and will also be available for inspection at the place of the Annual General Meeting from 15 minutes before the meeting until it ends. The Combined Code recommends the appointment of a Senior Independent Director and Sir Brian Pitman served in this capacity during fiscal 2006.
The role of the non-executive Directors is to:
They meet together from time to time in the absence of management and the Chairman normally presides over such meetings.
On appointment, non-executive Directors receive a range of information about the Group, including its strategy, structure, geographical spread of operations, financial position, markets, products, technologies and people, as well as their legal responsibilities as a Director and, where appropriate, any training that is necessary for them to carry out their duties effectively. An induction program is available which aims to provide an understanding of the Group as a whole, including its strategy, structure, geographical spread of operations, financial position, markets, products, technologies and people, as well as their legal responsibilities as a Director. The Board and its Committees receive, in a timely manner, detailed information concerning the matters to be discussed to enable them to make informed decisions. The Directors have access to the advice and services of the Company Secretary, whose removal may be effected only with the approval of the Board, and can obtain independent professional advice at the Companys expense in furtherance of their duties, if required.
The Board ordinarily meets not less than five times a year, and will hold additional meetings when circumstances require. During fiscal 2006, the Board met on five occasions. Between meetings, the Chairman and Chief Executive update the non-executive Directors on current matters and there is frequent contact to progress the affairs of the Company. With the encouragement of the Chief Executive, the non-executive Directors have regular contact with senior management through their presentations at Board meetings, at strategic reviews and on other occasions.
Attendance by each individual Director at Board and Committee meetings held during fiscal 2006 is set out in the table below.
n/a = not applicable (where a Director is not a member of a Committee).
David Newlands was appointed to the Remuneration Committee on July 28, 2006. David Richardson joined the Board on March 1, 2006 and was unable to attend one Board meeting and one Audit Committee meeting due to a prior engagement arranged before he was appointed. During fiscal 2006, other Directors attended meetings of the Audit Committee, Remuneration Committee, Nomination Committee and Health, Safety and Environment Committee by invitation. Details of those attendances are not included in the above table. On the rare occasion when a Director cannot attend a meeting, he will normally, prior to the meeting, make his views on the agenda items known to the Chairman or, in respect of Committee meetings, to the chairman of the respective Committee.
At the Companys forthcoming Annual General Meeting, and in accordance with the Companys Articles of Association, David Newlands, Jack Keenan and Sir Brian Pitman, as the longest serving Directors, will retire from the Board and David Newlands will seek reappointment. Details of David Newlands terms of appointment can be found in the section on Non-executive Directors under Service Contracts above.
Chairman and Chief Executive
There is a clear division of responsibility between the Chairman and the Chief Executive, with neither having unfettered powers of decision with respect to substantial matters. The Chairman is responsible for running the Board and ensures that all Directors receive sufficient relevant information on financial, business and corporate matters to enable them to participate effectively in Board decisions. In advance of each meeting, the Board is provided with comprehensive briefing papers on items under consideration.
The Chairman, David Newlands, is also Chairman of Kesa Electricals plc and PayPoint plc. Whilst these are important appointments, the Board believes that the Chairman continues to be able to carry out his duties and responsibilities effectively for the Company.
The Chief Executives primary role is the running of the Companys businesses and the development and implementation of strategy. The non-executive directors have the opportunity to meet with the Chairman and with the Chief Executive periodically, either together or separately, to consider and discuss a wide range of matters affecting the Company, its business, strategy and other matters.
The Board has established a number of Committees and receives reports of their proceedings. Each Committee has its own delegated authority as defined in its terms of reference, which are reviewed periodically by the Board. The Board believes that its Committees written terms of reference conform to best corporate governance practice. The terms of reference for all Board Committees can be found on the Companys website, www.tomkins.co.uk (under Responsibilities Governance), or a copy can be obtained by application to the Company Secretary at the Companys registered office.
The Board appoints the chairmen and members of all Board Committees upon the recommendation of the Nomination Committee. The Company Secretary is Secretary to all Board Committees. The principal Committees, their membership and a brief description of their duties are set out below.
D.H. Richardson (appointed on March 1, 2006 and became Chairman on May 22, 2006), R.D. Gillingwater, J.M.J. Keenan
Terms of reference
The Committees terms of reference, a copy of which can be found under Governance in the Responsibilities area of the Companys website, are reviewed from time to time and approved by the Board. They are based on the model terms of reference set out in the Guidance Note produced by the Institute of Chartered Secretaries and Administrators and take account of the requirements of the SOX Act and the Guidance Notes set out in Sir Robert Smiths Report published in January 2003. The terms of reference cover membership and appointment, meetings, duties and responsibilities, authority and a number of other matters.
Membership and appointment
The Audit Committee comprises three independent non-executive Directors: David Richardson who was appointed to the Committee on March 1, 2006 and became Chairman on May 22, 2006; Jack Keenan, who was appointed in November 2001; and Richard Gillingwater, who was appointed in December 2005. Norman Broadhurst and Ken Minton ceased to be members of the Audit Committee upon their retirement from the Board on May 22, 2006. The Board has determined that all three members of the Audit Committee are independent for the purposes of the Combined Code and rule 10A.3(b)(1) under the Exchange Act and section 303A of the NYSEs Listed Company Manual. The members bring wide-ranging financial, commercial and management experience to the work of the Audit Committee.
The Chairman of the Audit Committee, David Richardson, is a Chartered Accountant (FCA), having previously held a number of senior financial management and strategic planning positions in Whitbread plc from 1983 to 2005 (in the United Kingdom and United States), becoming Group Finance Director in 2001. Prior to 1983, he held financial positions in ICL plc and Touche Ross & Co. (now Deloitte & Touche LLP). In accordance with section 407 of the SOX Act, the Board has determined that David Richardson is an audit committee financial expert as that term is defined under the rules of the SEC, having significant, relevant and up-to-date United Kingdom and United States financial and accounting knowledge and experience.
The Audit Committee meets at least four times a year and on other occasions when circumstances require. The quorum for a meeting of the Audit Committee is two members. The Finance Director and representatives from the independent auditor and the internal auditor attend meetings under a standing invitation. The Chairman of the Board, the Chief Executive and other Directors are able to attend meetings of the Audit Committee under the practice that any Director may attend any meeting of a Board Committee provided that they have no conflict of interest in respect of business to be discussed. It is usual practice for the Chief Executive to attend meetings of the Audit Committee. Other finance and business risk executives attend meetings and the Company Secretary is Secretary to the Audit Committee. The Audit Committee Chairman reports regularly to the Board on its activities. Four meetings were held during fiscal 2006.
Work of the Committee
The Audit Committee has established an agenda framework which it believes is vital for maintaining an appropriate focus on its objectives. The agenda sets out all of the operational duties and responsibilities outlined in the Audit Committees terms of reference and is based on four regular meetings, in February, April, July and October, which coincide with the announcement of the Groups quarterly results prepared in accordance with IFRS. The areas covered by the agenda framework are as follows:
The audit plan and scope sets out details of the areas to be covered and how the audit is to be conducted. The Chairman of the Audit Committee meets periodically with the independent auditors to discuss progress on the audit and any major points that arise, and has the opportunity to assess the effectiveness of the process. The Audit Committee is also able to assess the effectiveness of the auditors and the audit process through reports made to the Audit Committee by the independent auditors.
In addition to the items considered by the Audit Committee under the agenda framework, during fiscal 2006 other important issues considered included regular reviews of the internal control systems and the statement to be made in the Directors Report in respect of internal controls, Group risk profile, Group tax reports, updates on compliance with the Combined Code, review of tax services provided by the independent auditors, Form 20-F and update of IT systems. Amendments to the Statement of Policy on the pre-approval of audit, audit-related, tax and other services provided by the independent auditors were made. Confidential meetings with representatives of the independent audit and internal audit functions took place during the year in the absence of executives. Considerable time and emphasis continued to be placed by the Audit Committee on compliance with section 404 of the SOX Act and detailed progress reports were received by the Audit Committee at each of its meetings, including an update of the Sarbanes-Oxley Project Risk Profile. This was the focus of attention of the Risk and Assurance Services and internal audit function during the first half of fiscal 2006. In the second half of fiscal 2006, Risk and Assurance Services resources were transitioned towards internal audit reviews, with an appropriate amount of resources applied to Sarbanes-Oxley and internal audit responsibilities. The Audit Committee received reports on the implementation of the Oracle IT project in Gates during fiscal 2006.
Risk and Assurance Services internal audit function is actively engaged in the business risk assessment processes in the Groups businesses and also provides guidance and assistance in the development of risk mitigation plans. Each quarter, the Audit Committee receives a summary of reviews of the businesses risk management processes and any significant related financial exposures are highlighted. The risk assessment process and risk mitigation plans are an important part of the development of business strategies. Business risks are considered at the quarterly reviews with the businesses, where all of the major strategic, operational, compliance and financial risks are discussed. During the year, Ms Shawn Tebben left the Group and on January 1, 2007, Mr. Joseph Montoya was appointed Vice-President Risk and Assurance Services for the Group in her place. There were no matters Ms Tebben drew to the attention of the Audit Committee concerning her departure from the Company.
In determining its policy on the extent of non-audit services provided by the independent auditors, the Audit Committee has taken account of the rules of the SEC which regulate and, in certain circumstances, prohibit the provision of, certain types of non-audit services by the independent auditors. Non-audit services are ordinarily put out to tender and require the approval of the Chairman of the Audit Committee. During the year, specific projects requiring tax services were the subject of a tender process and in a number of cases the work was not awarded to the firm of the independent auditors. In those cases where the work was awarded to the independent auditors, it was concluded that the firm of the independent auditors was best placed to supply such tax services in a cost-effective manner due to the experience and qualifications of the individuals providing such services, the independent auditors knowledge of the Company and its tax affairs and that the best interests of the Company were served by engaging the firm of the independent auditors. The previous adoption of certain other rules by the Audit Committee, including those relating to audit partner rotation, relevant ethical guidance issued by the professional bodies in the Consultative Committee of Accountancy Bodies (in particular that the independent auditors should not audit their own firms
work, make management decisions for the Company, create a mutuality of interest nor be put in the position of advocate for the Company), when taken together provide adequate protection of auditor independence. All fees proposed by the independent auditors must be reported to and approved by the Audit Committee or, between meetings, the Chairman of the Audit Committee. Details of fees paid to the Companys independent auditors, Deloitte & Touche LLP, are set forth in Item 16C Principal accountant fees and services.
The Companys practice, in accordance with the UK Companies Act and the Combined Code, in relation to the appointment and termination of the independent auditors, involves a recommendation from the Audit Committee to the Board, which will then make a recommendation to shareholders in general meeting. This differs from the procedure in the United States, where the independent auditors are accountable to the Audit Committee, which has the authority to appoint or dismiss the independent auditors without reference to shareholders.
With the approval of the Board, the Audit Committee has established guidelines for the recruitment of employees or former employees of the independent auditors. The Group will not engage, on a part-time or full-time basis, any person who is or was an employee of the Companys independent auditors, where that person has worked on the Groups audit either as a principal or partner at any time during a period of not less than three years prior to the proposed date of joining the Group. Certain less stringent conditions apply to other employees or former employees of the independent auditors.
A whistle blowing procedure has been established for the confidential and anonymous submission by employees of concerns regarding accounting, internal controls or auditing matters, in accordance with the requirements of section 301 of the SOX Act. Should a call be received on the dedicated telephone line, the Vice-President, Risk and Assurance Services would immediately report to the Chairman of the Audit Committee all concerns raised. A course of action is agreed and a report is prepared for review at the next meeting of the Audit Committee, including details of actions taken to deal with the matters raised. The Chairman of the Audit Committee will report all cases of whistle blowing to the Audit Committee and the Board. The Companys Code of Conduct and Ethics includes the whistle blowing procedure. Calls to the designated telephone number, as well as direct contacts with management, are made from time to time, but no issues material to the Company were dealt with by the Audit Committee during fiscal 2006.
Shareholders are given the opportunity at the Annual General Meeting to ask the Chairman of the Audit Committee questions on this report and any other related matters.
R.D. Gillingwater (Chairman), J.M.J. Keenan, D.B. Newlands (appointed July 28, 2006)
The Remuneration Committee, which meets at least twice a year, is made up exclusively of non-executive Directors whom the Board determined to be independent, as each was found to be free from any material business or other relationship with the Company (either directly or as a partner, shareholder or officer of an organization that has a relationship with the Company). Accordingly, the Board believes that there are no such relationships that could materially interfere with the exercise of their independent judgment. Richard Gillingwater and Jack Keenan served on the Remuneration Committee throughout the year and Ken Minton and Norman Broadhurst ceased to be members of the Remuneration Committee upon their retirement from the Board on May 22, 2006.
In June 2006, the Financial Reporting Council published an updated version of the Combined Code on Corporate Governance that, amongst other things, included a provision that permitted a company chairman to sit on the Remuneration Committee if considered independent on appointment. The Board was satisfied that the Chairman of the Board was independent and upon the recommendation of the Nomination Committee, the Board appointed David Newlands as a member of the Remuneration Committee in July 2006. There were no other changes to the membership of the Remuneration Committee during fiscal 2006.
The Board keeps under review the terms of reference for the Remuneration Committee, which are based on current best practice contained in the model terms of reference set out in the Guidance Note produced by the Institute of Chartered Secretaries and Administrators. The principal responsibility of the Remuneration Committee is to determine the framework or broad policy for the Companys executive remuneration and the remuneration of the Chairman of the Board, for approval by the Board. No executive Director takes part in any discussion or decision concerning his own remuneration. The remuneration of Non-Executive Directors is a matter for the Board itself. The Remuneration Committee takes independent advice from consultants as and when required. The terms of reference of the Remuneration Committee can be found under Governance in the Responsibilities area on the Companys website, www.tomkins.co.uk.
D.B. Newlands (Chairman), Sir Brian Pitman, R.D. Gillingwater, J.M.J. Keenan, D.D.S Robertson, D.H. Richardson (appointed on March 1, 2006)
The Nomination Committee makes recommendations to the Board on all proposed appointments of Directors through a formal and transparent procedure. The Nomination Committee meets as and when required. Ken Minton and Norman Broadhurst ceased to be members of the Nomination Committee upon their retirement from the Board on May 22, 2006 and Marshall Wallach ceased to be a member of the Nomination Committee following his resignation from the Board on May 1, 2006.
In accordance with the Companys Articles of Association, Directors are subject to reappointment at the Annual General Meeting immediately following the date of their appointment, and thereafter they must seek reappointment no more than three years from the date they were last reappointed. The Nomination Committee recommends to the Board the names of the Directors who are to seek reappointment at the Annual General Meeting in accordance with the Companys Articles of Association.
During the year, one new Board appointment was made. The Nomination Committee was central to the recruitment process, including the appointment of professional advisers and conducting interviews with potential candidates.
Health, Safety and Environment Committee
D.D.S. Robertson (Chairman), J. Nicol
The Health, Safety and Environment Committee meets at least three times a year. The Health, Safety and Environment Committee is chaired by an independent non-executive Director and its membership includes the Chief Executive. Ken Minton and Marshall Wallach ceased to be members of the Health, Safety and Environment Committee following their respective retirement and resignation from the Board on May 22, 2006 and May 1, 2006 respectively.
The principal role of the Health, Safety and Environment Committee is to determine, on behalf of the Board, the framework or broad policy and objectives in the areas of health, safety and the environment (HSE) and propose any amendments to existing policies for approval by the Board. It also reviews managements performance in the achievement of HSE objectives and reviews HSE reports produced by business units for compliance with all local health, safety and environmental codes of practice, legislation and relevant industry practice.
More details of the work of the Health, Safety and Environment Committee can be found in the Corporate Responsibility Report to shareholders available on the Companys website www.tomkins.co.uk.
D.B. Newlands (Chairman), J. Nicol, K. Lever
The Disclosure Committee meets as and when required for the purpose of, inter alia, reviewing and approving for release all price-sensitive information relating to the Company and compliance with the Disclosure and Transparency Rules of the Financial Services Authority.
General Purposes Committee
J. Nicol, K. Lever, E.H. Lewzey, J.E. Middleton, N.C. Porter, K.A. Sullivan, N.P. Wilkinson
The General Purposes Committee meets as and when required. It comprises executive Directors and senior executives and the quorum requires the presence of at least one executive Director. The General Purposes Committee deals principally with day-to-day matters of a routine nature and matters delegated to it by the Board.
Board, Committee and Chairman Evaluations
Under the direction of the Senior Independent Director, Sir Brian Pitman, evaluations of the effectiveness of the Board, its Committees and Chairman were conducted during fiscal 2006. The evaluation processes continued with the same approach as the previous year which drew on the experiences of the previous evaluations of the Board and its Committees and concentrated on six key elements:
Board and Committee
The fourth Board performance evaluation took place during fiscal 2006, which continued the processes developed in the first three years. The overall view of the Directors was that the Board continues to function well, supported by high-quality papers, presentations and reporting, with some minor areas where improvement can be achieved. Each of these areas has been considered by the Board and arrangements have been made to address the matters raised.
The third Board Committee performance evaluation reinforced the positive messages that were highlighted in the first two evaluations. The Committees were led by strong and experienced members who were well informed. There were a small number of suggestions on improving particular aspects of the work of the Committees, including the distribution of minutes to all Directors and, overall, the Directors continue to believe that the Committees function well.
For the evaluation of the Chairman, the more formal approach adopted last year continued, including completion of a questionnaire that sought views across a broad range of the Chairmans responsibilities. The Directors continued to be very positive about the role performed by the Chairman and his leadership of the Board. The Senior Independent Director, Sir Brian Pitman, discussed with the Chairman a small number of matters which were raised during the evaluation process.
Comparison of Corporate Governance
The Company has placed on its website a general summary of the significant ways in which the Companys corporate governance differs from that followed by domestic US companies under the NYSEs listing standards, as required by section 303A.11 of the NYSEs Listed Company Manual.
The number of employees at period end within each of the Groups business groups was as follows:
During fiscal 2006, 56 percent of the Groups total employees were located in the United States, 16 percent in Mexico, 7 percent in Continental Europe, 5 percent in the United Kingdom, and 16 percent in the Rest of the world (the geographical location of employees in fiscal 2006 is broadly consistent with fiscal 2005). In fiscal 2004, 55 percent of the Groups employees were located in the United States, 16 percent in Mexico, 7 percent in the United Kingdom, 8 percent in Continental Europe and 14 percent in the rest of the world. There have been no significant work stoppages or labor disputes involving the Groups employees in any of the last five years.
Each company in the Group is encouraged to implement comprehensive employment policies designed to motivate employees and to determine ways in which their knowledge and skills can best contribute towards the Companys success. Schemes are introduced to ensure that loyalty and performance are properly rewarded. Some of the Groups employees are members of labor unions and over many years the Group has been able to maintain successful relationships with the unions and employment organizations. Management believes that it has a good relationship with the Groups employees.
Employee involvement and communication programs continue to be developed and are designed to provide equal opportunity to all, irrespective of sex, race, religion or color. Each company in the Group endeavors to provide equality of opportunity in recruiting, training, promoting and developing the careers of disabled persons.
E. Share ownership
As at April 13, 2007, the Directors of the Company, and the Directors and officers of the Company as a group owned the number of Ordinary Shares and the percentage of such total number of shares outstanding on such date as set forth below.
The executive Directors, as potential beneficiaries, are technically deemed to have an interest in all Ordinary Shares held by or in which the trustees of the Tomkins Employee Share Trust (the Trust) are interested. The table includes, however, only those Trust shares which are specifically allocated to the individual Director under the terms of the Annual Bonus Incentive Plan and the SMS.
Share options are outstanding under the following share option schemes (which are described under Compensation above):
Non-executive Directors are not eligible to receive awards of share options.
Movements in Directors Share Options during the year:
The table below details the weighted average price each Director would have had to pay to exercise his options and how much they were worth in monetary terms at the year-end and prior year-end.
The mid-market price of a Tomkins share as at December 30, 2006 was 245.75 pence with a range during the year January 1, 2006 to December 30, 2006 of 229.75 pence to 345.75 pence. Options included in the above table at December 30, 2006 relate to the Tomkins Executive Share Option Scheme No. 4 (James Nicol 3,775,486 shares, Ken Lever 450,000 shares), the Tomkins Savings Related Share Option Scheme No. 2 (both 8,014 shares) and, in the case of James Nicol, the Premium Price Option (5,076,142 shares) and the Ongoing Option (550,000 shares).
Directors options over Ordinary Shares as at April 13, 2007 were:
At April 13, 2007 options, including options granted to Directors and officers, to subscribe for 18,689,628 Ordinary Shares were outstanding under the Companys executive share option schemes at prices ranging from 170.5 pence to 345 pence. At that date, options over 13,521,098 of those shares were exercisable. The exercise dates for the options range from April 13, 2006 to November 28, 2014.
At April 13, 2007 options, including options granted to Directors and officers, to subscribe for 1,402,280 Ordinary Shares were outstanding under the Companys SAYE 2 option scheme at prices ranging from 204.00 pence to 269.40 pence. At that date, no options were exercisable. The exercise dates for the options range from June 1, 2009 to November 30, 2013.
No options were outstanding in the name of any former Director as at April 13, 2007.
Long-term incentive plans
As at April 13, 2007 the Trustees held 11,320 Ordinary Shares on behalf of 11 participants including Directors and officers under the Share Matching Scheme. 11,320 Ordinary Shares allocated on December 29, 2005 will be released on December 30, 2007 if not forfeited or vested before those dates. In addition, 4,436,244 Ordinary shares were held in treasury or by the trustees on April 13, 2007, to satisfy current and future awards under the Annual Bonus Incentive Plan.
Employee Share Plans
Employees who are resident for tax purposes in the United Kingdom are encouraged to acquire an interest in Ordinary Shares in the Company through participation in the Tomkins 2005 Sharesave Scheme.
Item 7. Major Shareholders and Related Party Transactions
A. Major shareholders
The Companys issued share capital as at December 30, 2006 consisted of 858,209,522 Ordinary Shares, nominal value 5p per share, and 2,625,138 US dollar denominated Convertible Cumulative Preference Shares, nominal value $50 per share (the Perpetual Convertible Shares).
As at April 13, 2007, 858,414,616 Ordinary Shares and 2,617,400 Perpetual Convertible Shares were outstanding. As at that date, 775,159 Ordinary Shares were held by 79 registered holders with a registered address in the United States; 63,395 ADRs were held by 145 registered holders with a registered address in the United States; and 2,606,832 Perpetual Convertible Shares were held by 15 registered holders with a registered address in the United States. Since certain of the Ordinary Shares and ADRs were held by brokers and nominees, the number of record holders in the United States may not be representative of the number of beneficial holders or of where the beneficial holders are resident.
The Perpetual Convertible Shares are convertible at any time at the shareholders option into fully paid Ordinary Shares at a rate of 9.77 Ordinary Shares per Perpetual Convertible Share. Since July 29, 2006 the Company has had the option to redeem at any time all or any of the issued and outstanding Perpetual Convertible Shares.
At the date of issue, the conversion terms of the Perpetual Convertible Shares were equivalent to a price of 334 pence per Ordinary Share.
Upon liquidation of the Company or otherwise (other than on redemption or repurchase of shares), the assets of the Company available to shareholders will be applied first in repaying the capital paid-up or credited as paid-up in respect of the Perpetual Convertible Shares together with all arrears and accruals of dividends to the holders of the Perpetual Convertible Shares and any other classes of shares ranking pari passu as to capital with the Perpetual Convertible Shares.
Until such time as the shares are converted or redeemed, the Perpetual Convertible Shares have a right to receive dividends, at an annual rate of 5.560 percent, in preference to the holders of the Ordinary Shares.
The holders of the Perpetual Convertible Shares are entitled to vote at a general meeting of the Company on the following basis:
Except as set forth above with respect to holders of Perpetual Convertible Shares, shareholders of the Company do not have different voting rights.
To the Companys knowledge, no person or entity other than those shown below is the owner of more than 5 percent of its outstanding Ordinary Shares, nor is the Company directly or indirectly owned or controlled by any corporation, by any government or by any other natural or legal person or persons, severally or jointly.
Major shareholders at April 4, 2007
Significant changes in shareholders owning more than 5 percent of the Ordinary Share capital of the Company over the past three years are as follows:
There are no arrangements currently known to the Company that would result in a change in control of the Company.
B. Related party transactions
Dongfeng-Fuji-Thomson Thermostat Co Ltd
Dongfeng-Fuji-Thomson Thermostat Co Ltd (Dongfeng-Fuji-Thomson) is an associate in which the Company has a 32 percent interest. During the period, Standard-Thomson Corporation (Standard-Thomson), a wholly owned subsidiary, purchased thermostats and thermostat components from Dongfeng-Fuji-Thomson amounting to $1,892,558 (fiscal 2005: $1,104,979). Also during the period, Standard-Thomson sold thermostat components to Dongfeng-Fuji-Thomson amounting to $50,857 (fiscal 2005: $72,682). As at December 30, 2006, there was a nil balance outstanding in respect of these transactions (December 31, 2005: $nil).
Ideal International SA
Ideal International SA (Ideal International) is an associate in which the Company has a 40 percent interest. During the period, Ideal, a wholly-owned subsidiary, sold parts and other items and provided technical assistance to Ideal International amounting to $424,614 (fiscal 2005: $251,279). As at December 30, 2006, $239,710 was receivable from Ideal International in respect of these transactions (December 31, 2005: $181,467).
During the period, the Group purchased aviation services under an agreement with IGC, LLC and GForce Aviation, LLC. IGC, LLC is wholly-owned by the Gates family, certain of whom have an interest in the Companys Perpetual Convertible Shares. The agreement was entered into on an arms-length basis and the services provided are used strictly for corporate travel to the Companys diverse locations within North America and only if there is no convenient lower cost alternative available to the Companys employees. The agreement permits the Company to purchase an unlimited number of aircraft flying hours at the rate of $2,700 per flying hour, plus $1,500 per day for crew, plus $2,100 per month to cover insurance costs. During fiscal 2006, the Company recognized an expense of $98,900 (fiscal 2005: $147,870) in respect of these services. As at December 30, 2006, $15,999 was payable to IGC, LLC in respect of these transactions (December 31, 2005: $2,100).
Lu Hai Rubber Metal Company Ltd
Lead-Pro Industrial Ltd is the minority shareholder in the Companys 60 percent owned subsidiary, Schrader-Lu Hai Rubber Metal (Kunshan) Co Ltd (Schrader-Lu Hai). During the period, Schrader-Lu Hai incurred fees for materials processing services provided by Lu Hai Rubber Metal Company Ltd, a subsidiary of Lead-Pro Industrial Ltd, amounting to $234,063 (fiscal 2005: $204,250). As at December 30, 2006, there was a nil balance outstanding in respect of these transactions (December 31, 2005: $nil).
Nitta Corporation (Nitta) is the minority shareholder in the Companys 51 percent owned subsidiary, Gates Unitta Asia Company Ltd (Gates Unitta). During the period, a number of transactions took place between these companies in the ordinary course of business. Sales of automotive and industrial products by Gates Unitta to Nitta amounted to $46,561,083 (fiscal 2005: $42,415,546). Gates Unitta incurred sales commission due to Nitta amounting to $4,337,518 (fiscal 2005: $4,032,774), purchased raw materials from Nitta amounting to $33,609,008 (fiscal 2005: $35,084,916), incurred rent payable to Nitta amounting to $7,355,202 (fiscal 2005: $7,616,954) and incurred fees for administrative services provided by Nitta amounting to $7,301,674 (fiscal 2005: $8,298,114). As at December 30, 2006, the net amount receivable from Nitta Corporation in respect of these transactions was $461,547 (December 31, 2005: $459,840). Nitta is also the minority shareholder in the Companys 51 percent owned subsidiary, Gates Korea Company Ltd (Gates Korea). During the period, Gates Korea purchased raw materials from Nitta amounting to $3,510,908 (fiscal 2005: $3,483,730). As at December 30, 2006, $849,161 was payable to Nitta in respect of these transactions (December 31, 2005: $844,528).
Pyung Hwa CMB Co Ltd
Pyung Hwa CMB Co Ltd (Pyung Hwa) is an associate in which the Company has a 21 percent interest. During the period, Gates Korea Company Ltd, a 51 percent owned subsidiary, purchased raw materials from Pyung Hwa amounting to $8,222,799 (fiscal 2005: $8,412,091). As at December 30, 2006, $2,011,138 was payable to Pyung Hwa in respect of these transactions (December 31, 2005: $2,330,424).
Winhere Auto Part Manufacturing Co Ltd
Dexon Investments Limited (Dexon) is the minority shareholder in the Companys 60 percent owned subsidiary, Winhere LLC, that was incorporated during fiscal 2006. On July 19, 2006, Winhere LLC, through its wholly-owned subsidiary, Gates Winhere Automotive Pump Products (Yantai) Co Ltd (Gates Winhere), acquired the business and assets of the water pump manufacturing operations of Winhere Auto Part Manufacturing Co Ltd (Winhere), a fellow subsidiary of Dexon, for $8.7 million in cash. During the period since the acquisition, sales by Gates Winhere to Winhere amounted to $1,574,864 and Gates Winhere incurred rent payable to Winhere amounting to $59,570. As at December 30, 2006, there was a nil balance outstanding in respect of these transactions.
There are no further transactions or proposed transactions with related parties that are material to the Company or to a related party.
C. Interests of experts and counsel
Item 8. Financial Information
A. Consolidated statements and other financial information
See Item 18 Financial Statements.
The group is, from time to time, party to legal proceedings and claims, which arise in the ordinary course of the business. The Directors do not anticipate that the outcome of any of the above proceedings and claims, either individually or in aggregate, will have a material adverse effect upon the groups financial position.
See Item 3A Key Information Selected financial information.
B. Significant changes
For a description of significant changes occurring since December 30, 2006, see Note 30 to the consolidated financial statements forming Item 18 Financial Statements.
Item 9. The Offer and Listing
A. Offer and listing details
The high and low closing prices of the ADSs on the NYSE for the periods indicated are set forth below.
The following table sets forth, for the fiscal periods indicated, the closing high and low middle market quotations for the Companys Ordinary Shares on the London Stock Exchange. The table does not reflect trading after the daily official close of the London Stock Exchange for which no official quotations exist.
The Perpetual Convertible Shares are registered shares but are not traded on any exchange.
B. Plan of distribution
The principal trading market for the Companys Ordinary Shares is the London Stock Exchange.
ADSs, each representing four Ordinary Shares and evidenced by ADRs, have been issued pursuant to a sponsored ADR program, with The Bank of New York as depositary. The Companys ADSs are listed on the NYSE, under the symbol TKS.
D. Selling shareholders
F. Expenses of the issue
Item 10. Additional Information
A. Share Capital
B. Memorandum and Articles of Association
The rights of the shareholders are set forth in the Memorandum and Articles of Association (together, the Articles) of the Company and are provided by applicable English law. The following summary of key provisions of the Articles is qualified in its entirety by reference to the Articles filed as an exhibit hereto.
The Company is incorporated in England and registered at Companies House under company number 203531. The main objects and purposes of the Company, set forth in Articles 4(a) to (c), are as follows:
Board of Directors
The Articles provide for a minimum of two and a maximum of 15 Directors. At every annual general meeting, no less than one-third of the Directors are required to retire from office and are eligible to stand for re-appointment at such meeting. Subject to the provisions of the Companies Act, the Board may from time to time appoint one or more Directors to an executive office on such terms and for such period as it may determine. No Director or executive officer has a service contract with the Company for more than two years duration.
A Director who has disclosed to the Board that he or she has an interest in any transaction or arrangement with the Company, may participate in such transaction or arrangement, but may not vote in respect of any such transaction. A Director may not be counted in the quorum of a meeting in relation to any resolution on which he is barred from voting.
The ordinary remuneration of the Directors (other than a Managing Director or an Executive Director) may not exceed an aggregate amount of £250,000 per annum as the Board (or any duly authorized committee thereof) may from time to time determine or such greater amount as the Company may, upon the recommendation of the Board, from time to time by ordinary resolution determine, to be divided among them in such proportion and manner as the Directors may determine or, failing agreement, equally. Any Director who (by arrangement with the Board) performs or renders any special duties or services outside his ordinary duties as a Director may be awarded extra remuneration (in addition to fees or ordinary remuneration) by way of a lump sum or salary or commission or participation in profits or otherwise. Directors are required to hold at least 5,000 Ordinary Shares each.
The Board may exercise all the powers of the Company to borrow money, mortgage property and assets and issue debentures and other securities. The Articles require the Board to restrict aggregate borrowings of the Company to one and a half times the share capital of the Company plus capital reserves (calculated as set forth in the Articles).
Share Capital, Dividends and Voting Rights
The share capital of the Company is £79,258,211 divided into 1,585,164,220 Ordinary Shares, nominal value 5p per share and $696,000,000 divided into 13,920,000 US dollar denominated voting Convertible Cumulative Preference Shares, nominal value $50 per share. (Perpetual Convertible Shares).
Under Section 9 of the Companies Act, the Company may by special resolution at a general meeting of shareholders alter its Articles and thereby alter the rights of the shareholders of the Company. A special resolution is a resolution that can only be passed by a majority of no less than three-fourths of the shares entitled to vote that are voted. Whenever the share capital of the Company is divided into different classes of shares, the rights attached to any class may only be varied or abrogated either with the consent in writing of the holders of three-fourths of the issued shares of that class or with the sanction of an extraordinary resolution passed at a separate meeting of such holders. The Articles provide that the necessary quorum for a general meeting at which such an extraordinary general resolution may be passed is at least two persons holding or representing by proxy no less than one-third in nominal amount of the issued shares of that class.
The Perpetual Convertible Shares are entitled to be paid, in priority to any payment of dividend on any other class of shares, a fixed cumulative preferential dividend at a rate per annum per such share held fixed by the Board on issue of the shares, payable quarterly. Dividends are at the discretion of the Board. The Company in a general meeting of shareholders may declare dividends on the Ordinary Shares in its discretion by reference to an amount in pounds sterling or in a foreign currency, but dividends may not exceed the amount recommended by the Board. Dividends remaining unclaimed for 12 years after having been declared are forfeited and revert to the Company.
On a show of hands, each holder of Ordinary Shares or Perpetual Convertible Shares present at a general meeting of the Company is entitled to one vote. On a poll, the holders of Ordinary Shares are entitled to one vote per share, and the holders of the Perpetual Convertible Shares are entitled to one vote for every seven Ordinary Shares into which such Perpetual Convertible Shares are convertible. If two or more quarterly dividends on the Perpetual Convertible Shares are in arrears and there is a poll vote, the holders of the Perpetual Convertible Shares are entitled to one vote for every one Ordinary Share into which such Perpetual Convertible Shares are convertible. Cumulative voting is not permitted.
The liquidator on any winding-up of the Company, may, with the authority of an extraordinary resolution, divide among the shareholders in kind the whole or any part of the assets of the Company and for such purposes may set such value as he deems fair upon any one or more class or classes of property, and may determine how such division shall be carried out as between shareholders or classes of shareholders. On a return of assets on liquidation or otherwise (other than on a redemption or a repurchase), the assets of the Company available to shareholders shall be applied first in repaying to the holders of the Perpetual Convertible Shares all amounts paid up thereon together with all arrears and accruals of dividend to be calculated down to the relevant date and to be payable whether or not such dividend has become due and payable, in priority to any other class of shares.
Since July 26, 2006, the Company is entitled to redeem all or any Perpetual Convertible Shares upon written notice. In the case of any notice given for redemption of either class of such shares, the holders are entitled to opt for all of their remaining Perpetual Convertible Shares to be converted into Ordinary Shares. Upon redemption, all amounts paid up, plus all arrears and accruals of dividend down to the date of redemption are to be paid.
There are no provisions in the Articles discriminating against an existing or prospective holder of securities as a result of such shareholder owning a substantial number of shares.
The Company shall in each year hold a general meeting of shareholders within 15 months of the previous years annual general meeting of shareholders. The Board may call an extraordinary general meeting whenever it determines appropriate. In addition, members holding not less than one-tenth of the paid up share capital entitled to vote at a general meeting of the Company can require an extraordinary general meeting to be convened.
Only shareholders registered in accordance with the Articles may be recognized as valid shareholders. There are no other limitations on the rights to own securities.
There are no provisions in the Articles that would have the effect of delaying, deferring or preventing a change of control of the Company and that would operate only with respect to a merger, acquisition, or corporate restructuring involving the Company or any of its subsidiaries.
Disclosure of Ownership
There are no provisions in the Articles relating to the ownership threshold above which shareholder ownership must be disclosed. The Companies Act requires a shareholder to notify the Company in respect of a three percent holding subject to certain exemptions, and there is an additional obligation to notify the Company when a ten percent threshold is reached which is not subject to any exemptions.
Changes in Capital
There are no conditions imposed by the Articles governing changes in capital that are more stringent than those conditions that would be required by governing English law.
C. Material Contracts
D. Exchange controls
There is currently no UK law, decree or regulation that restricts the export or import of capital, including, but not limited to, UK foreign exchange controls, or that affects the remittance of dividends (except as otherwise set forth below, see Taxation) or other payments to holders of Ordinary Shares. There are no limitations under UK law or the Companys Memorandum and Articles of Association on the rights of persons who are neither residents nor nationals of the United Kingdom from freely holding, voting or transferring Ordinary Shares in the same manner as UK residents or nationals.
The following is a summary of the principal US federal income and UK tax consequences of the purchase, ownership and disposition of Ordinary Shares or ADSs by certain US Holders (as defined below) and not a complete analysis or listing of all of the possible tax consequences of such purchase, ownership or disposition. Furthermore, this summary does not address the tax consequences under state, local, or non-US or non-UK tax law of such purchase, ownership or disposition, or the US federal estate or gift tax consequences thereof. Certain US Holders with special status (e.g., banks and financial institutions, insurance companies, tax-exempt entities, dealers in securities, and traders in securities that mark-to-market) or in special tax situations (e.g., whose functional currency is not the US dollar, who hold their Ordinary Shares or ADSs as part of a straddle, appreciated financial position, hedge, conversion transaction or other integrated investment, who hold (directly, indirectly or through attribution) 10 percent or more of the voting power of the Companys stock, or who are subject to the alternative minimum tax) will be subject to special rules not described below. This summary is limited to US Holders that hold their Ordinary Shares or ADSs as capital assets and does not address the tax treatment of US Holders that are partnerships or pass-through entities that are not partnerships or the tax treatment of the holders of interests in such entities. The following summary of US federal income and UK tax consequences is not exhaustive of all possible tax considerations and should not be considered legal or tax advice. Prospective investors are therefore advised to consult their own tax advisors with respect to the tax consequences of the purchase, ownership and disposition of Ordinary Shares or ADSs, including specifically the consequences under state, local and tax laws.
This summary is based upon the Internal Revenue Code of 1986, as amended (the Code), Treasury regulations promulgated under the Code, the Convention Between the Government of the United States and the Government of the United Kingdom for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and Capital Gains dated July 24, 2001, as ratified on March 31, 2003 and amended (the Tax Convention), and administrative and judicial interpretations thereof, all as in effect as of the date of this Annual Report and all of which are subject to change, possibly with retroactive effect. Statements regarding UK tax laws and practices set out below are based on those UK laws and published
practices of HM Revenue & Customs as at the date of this Annual Report which UK laws and practices are subject to change, again with possibly retroactive effect. As used herein, a US Holder is a beneficial owner of Ordinary Shares or ADSs that, for United States federal tax purposes, is:
HM Revenue & Customs should treat US Holders of ADSs as the owners of the underlying Ordinary Shares for the purpose of the taxation of dividend payments under the Tax Convention. US Holders of ADSs are also treated as the owners of the underlying shares for the purposes of the Code.
Taxation of Dividends
The gross amount of distributions in respect of the Companys Ordinary Shares or ADSs will be included in the gross income of US Holders and treated as dividends to the extent of the Companys current and accumulated earnings and profits, as determined under US federal income tax principles. Such dividends will not qualify for the dividends received deduction available in certain circumstances to corporate holders. Distributions in excess of current and accumulated earnings and profits will be treated as a return of capital to the extent of a US Holders adjusted tax basis in the Ordinary Shares or ADSs and, thereafter, as capital gains.
For taxable years that begin before 2011, qualified dividend income (as defined below) paid by the Company generally will be taxable to non-corporate US Holders at the 15 percent reduced rate. For this purpose, except as described below, dividends paid by the Company will be qualified dividend income, and taxable at the reduced rate, if shares in the company are readily tradable on an established securities market in the United States, including NYSE and NASDAQ, or if the Company is eligible for benefits of a comprehensive income tax treaty with the United States which the Secretary of the Treasury has determined is satisfactory for this purpose and which includes a provision for the exchange of information. The Secretary of Treasury has determined that the Income Tax Convention qualifies as a comprehensive income tax treaty for this purpose. Dividends paid by a foreign corporation will not constitute qualified dividend income, however, if that corporation is treated, for the tax year in which the dividend is paid or the preceding tax year, as a Passive Foreign Investment Company (PFIC) for US federal income tax purposes. In addition, US Holders will be eligible for the reduced rate only if they have held the Ordinary Shares or ADSs for more than 60 days during the 121-day period beginning 60 days before the ex dividend date and satisfy certain other requirements.
US Holders will not be subject to UK withholding tax on any dividends paid in respect of Ordinary shares. Provided that dividends paid in respect of ADSs are treated as distributions for UK tax purposes, such dividends will not be subject to UK withholding tax.
Foreign Currency Dividends
For US federal income tax purposes, any dividend paid in foreign currency will be included in income in a US dollar amount equal to the US dollar value of such foreign currency calculated by reference to the exchange rate in effect on the day the dividends are actually or constructively received by the US Holders, regardless of whether the foreign currency is converted into US dollars at that time. US Holders will generally have a basis in the foreign currency equal to its US dollar value on the date of actual or constructive receipt. Any gain or loss realized by the US Holders on subsequent conversion or other disposition of the foreign currency will be treated as US source ordinary income or loss.
Passive Foreign Investment Company (PFIC) Status
The Company believes that it will not be considered a PFIC for US federal income tax purposes. However, since the Companys status as a PFIC depends on the composition of its income and assets and the market value of its assets from time to time, there can be no assurance that it will not be considered a PFIC in any taxable year.
US shareholders in a company classified as a PFIC have certain federal income tax consequences. In determining a companys PFIC status for a taxable year, two tests must be applied, as well as certain look-through rules. If 75 percent or more of a companys gross income (including the pro-rata gross income of any company in which such company is considered to own 25% or more of the stock by value) for the taxable year is passive, it is considered a PFIC. Alternatively, if 50 percent or more of its gross assets (including the pro-rata value of the assets of any company in which such company is considered to own 25% or more of the stock by value) during the taxable year, based on their average value, are either held for the production of or produce passive income, it is considered a PFIC. In this instance, passive income commonly includes dividends, interest, royalties, rents, annuities, gains from commodities and securities transactions, and the excess of gains over losses from the disposition of assets which produce passive income (unless the 25% look-through rules otherwise apply).
If the Company were treated as a PFIC in a taxable year, a US Holder may be subject to particular adverse tax consequences. The receipt of certain excess distributions, as well as the disposition of Ordinary Shares or ADSs, could trigger increased tax liability. Gain or excess distribution would be allocated among the tax years of the shareholders holding period from the time the entity was determined to be a PFIC. The portion allocable to prior years would be taxed at the highest marginal US federal tax rate and would be subject to an interest charge.
Certain elections may enable the shareholder in a PFIC to avoid some of these adverse tax consequences. Under the Qualified Electing Fund (QEF) election, a US shareholder is taxed currently on its share of the companys ordinary income. Under the mark-to-market election a US shareholder recognizes gains or losses each year for the difference between the fair market value and the adjusted basis of his or her shares. US Holders should consult their tax advisers for further details of the restrictions and coverage of each election and the potential tax consequences arising from the ownership and disposition of an interest in a PFIC.
Taxation of Capital Gains
Corporate US Holders that are resident in the United States and not resident in the United Kingdom for UK tax purposes will not generally be liable for UK corporation tax on capital gains realized on the sale or other disposal of Ordinary Shares or ADSs unless a specific Corporate US Holder carries on a trade in the United Kingdom through a permanent establishment and the Ordinary Shares or ADSs are or have been used, held or acquired for the purposes of such trade through such permanent establishment. Non-corporate US Holders that are resident in the United States and are neither resident nor ordinarily resident in the United Kingdom for UK tax purposes will not generally be liable for UK tax on capital gains realized on the sale or other disposal of Ordinary Shares or ADSs unless a specific non-corporate US Holder carries on a trade, profession or vocation in the United Kingdom through a branch or agency and the Ordinary Shares or ADSs are or have been used, held or acquired for the purposes of such trade, profession or vocation through such branch or agency. Notwithstanding the foregoing, an individual US Holder who is neither resident nor ordinarily resident in the United Kingdom for UK tax purposes for a period of less than five years, but who was previously resident or ordinarily resident in the United Kingdom, and who disposes of Ordinary Shares or ADSs during the period of non-residence may also be liable on returning to the United Kingdom for UK tax on capital gains despite the fact that the individual was not resident or ordinarily resident in the United Kingdom for UK tax purposes at the time of the disposal.
US Holders will generally recognize capital gain or loss for US federal income tax purposes upon the sale or other disposal of such US Holders Ordinary Shares or ADSs in an amount equal to the difference between the US dollar value of the amount realized on the sale or other disposal and the US Holders adjusted tax basis, determined in US dollars, in such Ordinary Shares or ADSs. Such gains or losses will be eligible for long-term capital gain or loss treatment if the Ordinary Shares or ADSs have been held for more than one year at the time of such sale or disposal. Long-term capital gains of individuals are eligible for reduced rates of taxation, with respect to taxable years beginning before 2011. The deductibility of capital losses is subject to limitations. In general, any gain or loss recognized by a US holder on the sale or other disposition of Ordinary Shares or ADSs will be US-source income or loss for purposes of US federal foreign tax credit limitation.
UK Inheritance Tax
Under the convention that entered into force on November 11, 1979 between the United States and the United Kingdom for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on estates of deceased persons and on gifts (the Estate and Gift Tax Convention), Ordinary Shares or ADSs will generally not be subject to UK inheritance tax upon an individuals death or on a transfer of the Ordinary Shares or ADSs during the individuals lifetime if it is held by an individual who is domiciled in the United States and is not treated as domiciled in the United Kingdom. In certain other cases where the individual is domiciled in the United States and is not treated as domiciled in the United Kingdom, the individual may be subject to UK inheritance tax. Also, an individual will be subject to UK inheritance tax in the exceptional case in which Ordinary Shares or ADSs are part of the business property of a UK permanent establishment or pertains to a fixed base of the individual in the United Kingdom used for the performance of independent personal services. In the unusual case where Ordinary Shares or ADSs are subject to both the UK inheritance tax and the US federal estate and gift tax, the Estate and Gift Tax Convention generally provides for a tax credit under the rules enumerated in the Estate and Gift Tax Convention.
UK Stamp Duty and Stamp Duty Reserve Tax (S.D.R.T.)
UK stamp duty or S.D.R.T. is not generally payable on the issuance of Ordinary Shares (except see below regarding the issue of Ordinary Shares to the custodian of the Depositary). The transfer of Ordinary Shares will generally give rise to a liability to UK stamp duty at the rate of 0.5 percent (rounded up to the next multiple of £5) of the amount or value of the consideration paid. S.D.R.T. is generally chargeable at the same rate on entering into an unconditional agreement to transfer Ordinary Shares (or upon a conditional agreement to transfer Ordinary Shares becoming unconditional). However, such S.D.R.T. is cancelled or repaid if the agreement is completed within six years of the date of the unconditional agreement (or the date on which the conditional agreement became unconditional) by a duly stamped transfer instrument. Where an instrument of transfer of Ordinary Shares is executed where there is no change of beneficial ownership it will generally be subject to UK fixed rate stamp duty of £5.
The issuance of Ordinary Shares to the custodian of the Depositary will generally give rise to an S.D.R.T. liability at 1.5 percent of the issue price. The transfer of Ordinary Shares to the custodian of the Depositary will generally give rise to either UK stamp duty at the rate of 1.5 percent of the value of the Ordinary Shares transferred (rounded up to the next multiple of £5), or, in the unlikely event that there is no transfer instrument on which UK stamp duty is chargeable, to S.D.R.T. at the rate of 1.5 percent of the value of the Ordinary Shares transferred.
In accordance with the terms of the Deposit Agreement, any tax or duty payable by the Depositary or the custodian of the Depositary on deposits of Ordinary Shares will be charged by the Depositary to the party to whom the ADSs are delivered against such deposits.
Following the issue or transfer of Ordinary Shares to the custodian of the Depositary, no S.D.R.T. will generally be payable on the issue of ADSs or on an agreement to transfer ADSs, nor should UK stamp duty be payable on a transfer of ADSs, provided, amongst other things, that the instrument of transfer is executed and retained outside the United Kingdom. A transfer of Ordinary Shares by the Depositary or its nominee to the relevant ADS holder when the ADS holder is not transferring beneficial ownership will attract UK fixed rate stamp duty of £5 but will generally not be liable to the 0.5 percent stamp duty charge or to the principal 0.5 percent S.D.R.T. charge.
US Backup Withholding and Information Reporting
Payments of dividends and other proceeds with respect to Ordinary Shares or ADSs made within the US by a US paying agent or other US intermediary will be reported to the IRS and to the US Holders as may be required under applicable regulations unless a specific US Holder is a corporation or otherwise establishes a basis for exemption. Backup withholding may apply to reportable payments if the US Holders fail to provide an accurate taxpayer identification number or otherwise fails to comply with, or establish an exemption from, such backup withholding requirements. The amount of any backup withholding from a payment to a US Holder will be allowed as a credit against his or her US federal income tax liability and any excess amounts will be refundable, if the US Holder provides the required information to the IRS. US Holders should consult their tax advisers as to their qualification for exemption from backup withholding and the procedure for obtaining an exemption.
F. Dividends and paying agents
G. Statement by experts
H. Documents on display
Tomkins is subject to the information requirements of the Exchange Act and in accordance therewith files reports and other information with the SEC. These reports and other information can be inspected and copied at the public reference facilities maintained by the SEC, 100 F Street, N.E., Washington, D.C. 20549, and at the SECs regional office at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You may request copies of all or a portion of these documents from the Public Reference Section of the SEC at 100 F Street, N.E., Washington, D.C. 20549, at prescribed rates. From August 2002, reports filed by the Company with the Commission are available on the Commissions website at www.sec.gov. As a foreign private issuer, Tomkins is exempt under the Exchange Act from, among other things, the rules prescribing the furnishing and content of proxy statements and the short-swing profit recovery provisions contained in Section 16 of the Exchange Act.
I. Subsidiary information
See Exhibit 8.1.
Item 11. Quantitative and Qualitative Disclosures about Market Risk
The financial risk management of the Group, which includes currency risk, interest rate risk and liquidity risk, is the responsibility of the Groups central treasury function, which operates within strict guidelines approved by the Board.
Derivative financial instruments are held to reduce exposure to foreign exchange risk and interest rate movements. None are held for speculative purposes.
Derivative financial instruments are recognized as assets and liabilities and measured at their fair values at the balance sheet date. Changes in their fair values are recognized in income and this may cause volatility in net income. Provided the conditions specified by SFAS133 Accounting for Derivative Instruments and Hedging Activities are met, hedge accounting is used to mitigate this volatility.
Prior to fiscal 2005, the Group chose not to apply the hedge accounting provisions of SFAS133. During fiscal 2005, management reviewed its policy towards hedge accounting and decided to use hedge accounting in certain circumstances. With effect from fiscal 2005, the Group does not generally apply hedge accounting to transactional foreign currency hedging relationships, such as hedges of forecast or committed transactions. It does, however, apply hedge accounting to translational foreign currency hedging relationships and to hedges of its interest rate exposures where this is permissible to do so under SFAS133.
Derivatives embedded in non-derivative host contracts are recognized separately as derivative financial instruments when their risks and characteristics are not closely related to those of the host contract and the host contract is not stated at its fair value with changes in its fair value recognized in the income statement.
Borrowing facilities are monitored against forecast requirements and timely action is taken to put in place, renew or replace credit lines. Managements policy is to reduce financing risk by diversifying the Groups funding sources and by staggering the maturity of its borrowings.
Foreign currency transaction exposures
The foreign currency transaction exposures in the business are protected with forward currency purchases and sales. These are put in place when foreign currency trading transactions are committed or when there is a high likelihood of such transactions arising. All foreign exchange contracts are carried out by the Groups central treasury function, except in cases where this is prohibited by local regulations. In these cases, local transactions are reported to central treasury on a systematic basis.
The Groups principal net currency transaction exposures arising during fiscal 2006 were US dollar to pounds sterling ($40.0 million), US dollar to Mexican peso ($39.1 million), and pound sterling to euro ($68.2 million). The impact of the movement in average exchange rates between fiscal 2005 and fiscal 2006 on the Groups transaction exposures was $0.4 million positive. Under the Groups foreign exchange transaction exposure policy, certain exposures are hedged. Compared to the average actual rates for the year, the effect of these hedging activities was a gain of $2.0 million.
Foreign currency translation exposures
The majority of the Groups activities are transacted in US dollars and the presentation currency used in the Groups consolidated financial statements is the US dollar. The Group is exposed to potential currency translation exposures in the balance sheet, income statement and cash flow arising from the translation into US dollars of income, expenses, assets, liabilities and cash flows denominated in foreign currencies. Management borrows in the currency that management considers most efficient it considers most efficient and uses derivative foreign currency contracts to ensure that the Groups net borrowings are generally retained in proportion to the currencies in which the Groups assets are denominated, to hedge the foreign currency translation exposure arising from the Groups overseas investments. The proportion of overseas investments effectively funded by shareholders equity is not hedged.
The following table shows the Groups foreign currency translation exposures taking into account the currency profile of the Groups net debt as adjusted to reflect of derivative foreign currency contracts held by the Group to manage its foreign currency translation exposures:
December 30, 2006
December 31, 2005
Interest payments on foreign currency net borrowings are funded with cash flows generated by the corresponding foreign currency investments. The main potential impact of a movement in the US dollar/pound sterling exchange rate movement is the effect on dividends. Much of the Groups cash flow is generated in US dollars from the cash flows generated by overseas investments, but dividends on Ordinary Shares are paid in pounds sterling by converting the foreign currency cash flows at the time of payment of the dividend.
Foreign currency net income translation exposures are not hedged and the reported results may be affected by the translation effect of currency fluctuations. Management estimates that a 10 percent change in the exchange rates between the US dollar and the functional currencies of the Groups subsidiaries would give rise to a change of approximately 4 percent in the Groups operating income from continuing operations.
Interest rate risk management
The central treasury function manages the Groups interest rate profile within the policy established by the Board. This is achieved by considering the portfolio of all of the Groups interest bearing assets and liabilities. The net desired interest rate profile in each currency is then managed by entering into interest rate swaps, options and forward rate agreements. At December 30, 2006, the interest rate maturity profile of the Canadian dollar, euro and pound sterling net debt was less than three months.
The graph below shows the Groups US dollar interest rate maturity profile as at December 30, 2006.
Interest and Exchange Rate Information
The tables below provide information as at December 30, 2006 and December 31, 2005, about the Groups financial instruments and derivative instruments that are sensitive to changes in interest rates and exchange rates. For borrowings, cash and deposits, the tables present principal cash flows, while for derivatives the tables present the notional amounts used to calculate payments to be exchanged under the contracts. Instruments shown as bearing interest at floating rates are instruments where the interest rate is reset periodically by reference to short term benchmark interest rates, such as LIBOR in the relevant currency. The information is presented in US dollars, with the instruments grouped by the actual currency in which their cash flows are denominated. All market risk sensitive instruments used by the Company are entered into for trading purposes.