Tomkins 6-K 2005
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
Report of Foreign Issuer
Pursuant to rule 13a-16 or 15d-16 of
the Securities Exchange Act of 1934
File No. 0-17140
For the month of April 2005
(Translation of registrants name into English)
East Putney House, 84 Upper Richmond Road,
London SW15 2ST, United Kingdom
(Address of principal executive offices)
Indicate by check mark whether the registrant files or will file annual reports under cover Form 20-F or Form 40-F:
Form 20 x Form 40-F ¨
Indicate by check mark whether the registrant by furnishing the information contained in this form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934:
Yes ¨ No x
This document may contain forward-looking statements within the meaning of Section 27A of the U.S. Securities Act of 1933 and Section 21E of the U.S. Securities Exchange Act of 1934 (the Exchange Act). When used in this document, the words anticipate, believe, estimate, assume, could, should, expect and similar expressions, as they relate to Tomkins or its management, are intended to identify such forward-looking statements. Such statements are based on managements good faith assumptions, anticipations, expectations and forecasts concerning Tomkins future business plans, products, services, financial results, performance and future events and on information relevant to our businesses, industries and operating environments. Such forward-looking statements are subject to certain risks and uncertainties that could cause the actual results, performance or achievements of Tomkins to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements. Such risks and uncertainties, include, among others, adverse changes or uncertainties in general economic conditions in the markets we serve, changes in laws or regulatory developments adverse to
us (including environmental-related laws or regulations), 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, reduced demand for our products, loss of key customers or lack of acceptance of new products or services by Tomkins targeted customers, difficulties in controlling our costs in correlation with the prices charged to our customers, increases in the cost of raw materials, difficulties in obtaining sufficient levels of supplies or equipment in a timely or cost-effective manner, loss of key distributors, product liability claims, inability to preserve proprietary interests in intellectual property, changes in business strategy, any management level or large-scale employee turnover, any major disruption in production at our key facilities, difficulties in raising sufficient capital on favourable terms, adverse changes in foreign exchange rates, embargoes, acts of terrorism or war, and various other 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. For more discussion of the risks affecting us, please refer to Item 3.D. in our latest Annual Report on Form 20-F filed with the U.S. Securities and Exchange Commission.
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.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Tomkins is a world-class global engineering and manufacturing group with market and technical leadership across its three businesses;
Industrial & Automotive, Air Systems Components and Engineered & Construction Products.
In this Annual Review, the term underlying indicates that the amount has been adjusted for the effects of currency translation, and acquisitions and disposals; in the case of operating profits, the amount is also stated before goodwill amortisation and operating exceptional items. Some figures and ratios mentioned are not readily available from the financial information and details of how these figures and ratios have been arrived at are set out in the Operating and financial review and on page 51.
This Annual Review does not contain sufficient information to allow as full an understanding of the results of and state of affairs of the Group, and of its policies and arrangements concerning Directors remuneration, as would be provided by the Directors Report and Accounts approved by the Board on 23 February 2005 on which the independent auditors have issued an unqualified opinion. Shareholders requiring the Directors Report and Accounts for current and future years should contact the Company or its registrars.
Commentary on the results compares audited results for the 364 day period from 4 January 2004 to 1 January 2005 (2004) with audited results for the 368 day period from 1 January 2003 to 3 January 2004 (2003).
Financial highlights Sales
Operating profit before goodwill amortisation
Total dividends per share
Tomkins delivered a strong performance in 2004;
our focus on business excellence produced positive operating and financial results.
OPERATING PROFIT *
PROFIT BEFORE TAX
BASIC EARNINGS PER SHARE **
NET SALES UNDER US GAAP
OPERATING INCOME UNDER US GAAP
Highlights of the year
Our performance in 2004
reflects the momentum building
in the Group as a result of our
targeted growth strategy and
business excellence initiatives.
2004 in perspective
2004 was a good year for Tomkins. Each of our business units delivered solid performance with the Group achieving good volume growth and double-digit operating profit growth. This performance demonstrates the momentum building in the Group as a result of the business excellence initiatives and targeted growth strategy implemented since 2002.
Strong underlying results
The global economy grew by around 5 per cent in 2004, with our major market, the United States, averaging GDP growth of around 4.5 per cent. Against this backdrop, we achieved reported sales of £2,980.3 million (2003: £3,150.4 million) and operating profit (before operating exceptional items and goodwill amortisation) of £278.1 million (2003: £271.8 million). On an underlying basis, this represents growth of 5.7 per cent and 12.8 per cent respectively.
The translation effect of the weaker US dollar reduced reported sterling sales and operating profit (before operating exceptional items and goodwill amortisation) by £265.7 million (8.4 per cent) and £27.0 million (9.9 per cent) respectively.
The Groups operating margin, before operating exceptional items and goodwill amortisation, increased from 8.6 per cent in 2003 to 9.3 per cent in 2004. Operating profit before goodwill amortisation increased to £260.6 million from £235.9 million in 2003.
Cash flow was strong with the Group generating £333.9 million during the year from operating activities. Net debt reduced to £244.5 million (2003: £264.7 million).
Basic earnings per share before exceptional items and goodwill amortisation increased 20.1 per cent to 22.55 pence (2003: 18.78 pence) and basic earnings per share were 20.37 pence (2003: 18.53 pence).
Raw material costs increased at unprecedented rates in 2004. We mitigated much of the impact through efficiency improvements and price increases, limiting the net impact to £18.0 million, which was slightly higher than anticipated at the end of the third quarter. In 2005 we do not expect to see the same rapid increases in input costs, but where prices do rise, we will implement measures to alleviate the negative impact on the Group.
The Board has recommended a final dividend of 7.77 pence per ordinary share, which, together with the interim dividend of 4.83 pence per ordinary share paid on 12 November 2004, brings the total dividends for the year to 12.60 pence per ordinary share, an increase of 5.0 per cent.
The final dividend, if approved at the Annual General Meeting, will be paid on 26 May 2005 to shareholders on the register at 22 April 2005. The Board has decided to offer the Dividend Reinvestment Plan in respect of this final dividend.
It is our aim to maintain the highest standards of corporate governance, disclosure levels and transparency in reporting. As a foreign private issuer listed on the New York Stock Exchange, the Group is subject to the provisions of the Sarbanes-Oxley Act of 2002 (the Act). Over the course of the year, considerable time and emphasis were placed on preparation for compliance with Section 404 of the Act. When adopted, Section 404 will require certifications by management regarding the effectiveness of internal controls over financial reporting and will require our external auditors to express an opinion on our assertions regarding such internal controls. We believe these measures will further strengthen the internal control framework of the Group.
On behalf of shareholders and the Board, I would like to acknowledge the dedication of Tomkins people across all our operations whose hard work and support have been instrumental in achieving the progress made in 2004.
The outlook for our markets in 2005, together with wider macro-economic indicators, remains largely positive. Although we anticipate that our first quarter results for 2005 will be broadly in line with the strong first quarter of 2004, we expect to make underlying progress in 2005 as a whole. Our focus on improving operational performance, together with our strategy of investing for organic growth supplemented by strategic acquisitions, will continue to deliver value for Tomkins shareholders in 2005.
Tomkins delivered an improved performance in 2004 despite the dual impact of escalating raw material costs and the weakness of the US dollar. This sustained progress reflects the benefits of measures taken over recent years to improve efficiency and reduce costs as well as the targeted growth strategy executed by the Group. The progress achieved in 2004 is reflected in the Boards recommendation to increase the final dividend by 5.0 per cent.
We are focusing on the three business areas that have the potential to deliver the greatest growth in value.
Chief Executives statement contents
Our primary business objective is to achieve long-term sustainable growth in shareholder value at Tomkins through the strategic development of our businesses. We are focusing on the growth of three business areas in particular (Powertrain, Air Systems Components and Industrial & Automotive Aftermarket), underpinned by select key initiatives which are applied across the Group.
Product development and technology leading growth in Powertrain
Tomkins Powertrain business made further progress in 2004 as the Original Equipment Manufacturer (OEM) outsourcing trend continued. Through Gates and Stackpole we have significant engineering and development capability and, critically, a worldwide presence, as demonstrated by the award of a C $48 million (£21.1 million) contract to supply the Chinese components. It is our prime focus to develop powertrain technology that responds to the main issues prevailing today; tightening emissions regulations, fuel economy requirements and safety legislation. One example of this is our stop-start technology which went into production on the Citroën C3 in 2004. This innovative technology reduces emissions and generates significant fuel savings. Stop-start is currently being tested on urban delivery vehicles, generating fuel savings of up to 20 per cent. We are optimistic of further success with this product. We are also moving
Powertrain a market worth $138 billion by 2010.
We focus our passion for Powertrain on the right technology innovation, an open ear to customers, and a drive to market with a business model that provides sustainable advantage over our competition whilst providing value-creation for our shareholders.
President, Power Transmission North America
KEY DRIVERS FOR GROWTH: POWERTRAIN MARKET
STRATEGIES FOR GROWTH: POWERTRAIN
Through our Gates and Stackpole companies, we manufacture a range of powertrain components, modules and systems for original equipment and aftermarkets.
In 2002, only 20 per cent of the powertrain market was outsourced to third party suppliers such as Tomkins. However, there is a trend towards outsourcing as OEMs look to reduce their costs and share risks. Our differentiated technology enables them to do so.
Powertrain innovations are not limited to the automotive area; the technology is applicable to multiple end-markets. There is an increasing number of industrial applications for powertrain products, for instance in mobile farm equipment, as customers demand similar performance characteristics and fuel efficiency.
Continued product innovation to respond to emissions, fuel economy, performance and safety requirements.
OUTSOURCED MARKET GROWING AT A 21% COMPOUND ANNUAL RATE BETWEEN 2002 AND 2010
up the value chain by providing engine and transmission oil pumps and precision powdered metal gears, as well as entire carrier systems and modules to help OEMs achieve ways of reducing cost and assembly time.
Powertrain innovations are not limited to the automotive area; the technology is applicable to multiple end-markets. One example is our accessory drive tensioner, originally developed for the automotive OEM market, but which has now been extended to aftermarket, heavy-duty truck, industrial OEM and marine applications.
In December 2004 we acquired Mectrol Corporation, a manufacturer of polyurethane timing belts for the industrial market with a turnover of approximately $25 million (£13.7 million). This acquisition brings a new technology to the business and extends both our product and customer base. By making use of our worldwide distribution capability, we plan to accelerate its growth through deeper penetration of all global markets.
Repositioning of Air Systems Components
We are pleased with the strong performance of the Air Systems Components (ASC) business this year and optimistic about its prospects for 2005. The major market in which it operates, the non-residential construction market, is forecast to improve this year for the first time since 2000. We are especially well positioned in the fastest-growing segment of this market, office buildings, which is forecast by Dodge to grow in excess of 7 per cent per annum for the next three years.
Over the last three years, we have invested a considerable amount of time rationalising the cost base of ASC. We have closed 14 manufacturing facilities and implemented lean manufacturing techniques throughout the business unit.
As a result, production capacity at the remaining facilities is greater than that before the closure of the facilities, significantly increasing our operational gearing and improving our returns.
Organic growth in ASC will be supplemented by bolt-on acquisitions either to widen our product line or to expand geographically. In January 2005 we announced the acquisition of Milcor Inc., a multi-brand manufacturer of building products, selling to the US residential and commercial construction markets. Milcors annual sales are approximately $47 million (£25.7 million). This acquisition consolidates our market leadership, expands our product offering into contiguous areas and provides us with a strategically important manufacturing capability in China.
Differentiation of capabilities in the Industrial & Automotive Aftermarket
The performance of our aftermarket business in 2004 was mixed. We saw strong growth on the industrial side, driven by good replacement demand in the agricultural and construction equipment markets, but the automotive market proved more challenging. We attribute the slowness to temporary events and we are optimistic that the automotive aftermarket will return to its normal growth profile in 2005.
Our strategy to grow in the aftermarket involves expanding our product lines and services as well as developing new channels to market and expanding overseas. To this end, we have been growing our aftermarket business in China with strong results. Our underlying sales in China rose by 16.7 per cent in 2004. Our growth strategy in China is to continue supplying high quality products, develop and protect our brands, leverage a strong national distribution network and educate the market by providing sales support and training. In Europe, the block exemption has opened up opportunities such as the Original Equipment Service market and we are well positioned to take advantage of these opportunities going forward.
Product and process innovation is key to sustain and enhance our competitive positions in our markets and ultimately maintain market leadership. In 2004, new products developed in the previous three years accounted for 9.3 per cent of our sales. In 2005 we will continue to focus on innovation and aim to grow our new product sales. In terms of business efficiency, we generated £25.4 million of operating cost savings during the year as a result of implementing lean manufacturing across our facilities. In addition to these savings, we have also freed up considerable floor space and manufacturing capacity. The application of these techniques is an ongoing process and we believe that we will generate further cost savings and improve efficiency in 2005.
Geographic expansion into higher growth markets
Our objective is to establish sustainable positions in higher growth markets. During the course of the year we continued the construction of six new production facilities across three continents. We increased our sourcing of raw materials and components from low-cost jurisdictions. Our underlying sales to Asia were up by 17.1 per cent. In 2005 we expect to launch successfully our new facilities in China, Northern Ireland, Canada and the Czech Republic and we will continue to direct investment to China and India as well as other high-growth markets.
Acquisition of value-enhancing businesses
During 2004, we reviewed many opportunities but found the market highly competitive and willing to pay prices that exceeded what we concluded was fair value. However, we have
Air Systems Components having the strongest brands in the industry.
We will continue to consolidate our number one position in the market and grow organically through new product development and expansion into new markets and geographical areas.
KEY DRIVERS FOR GROWTH: AIR SYSTEMS COMPONENTS
STRATEGIES FOR GROWTH: AIR SYSTEMS COMPONENTS
Tomkins Air Systems Components businesses manufacture components used in Heating, Ventilation & Air Conditioning systems in the residential and non-residential construction markets.
AIR SYSTEMS COMPONENTS OVERVIEW
Following a period of manufacturing rationalisation and the roll-out of lean manufacturing techniques across the group, we have increased our level of open capacity and significantly improved our operational gearing. This positions us well to take advantage of the recovery in ASCs main market, non-residential construction, which is forecast to grow by 5 per cent in 2005, following four years of decline.
Continue to drive organic growth through geographic and product line expansion, supplemented by acquisitions to consolidate our number one market position.
completed three important smaller acquisitions, one in the industrial power transmission market, one in the air systems market and one in the recreational vehicle market. All businesses meet our target of double-digit operating margins and we expect them to grow within Tomkins. We will continue to assess opportunities as they arise and we are optimistic that we will conclude further transactions in 2005.
We also continuously review our businesses to determine whether they create value or have the potential to do so. Where this is not the case, we take action to dispose of or exit these businesses. We completed the exit from two non-core automotive businesses, specifically our European automotive curved hose business and in February 2005 we disposed of our AirSprings business. We also completed the disposal of Unified Industries after the year-end. Other divestments in 2004 included Mayfran, Dexters wheels and rims business and the Valves, Taps & Mixers business.
We have achieved significant progress with manufacturing excellence by, among other things, applying the principles of lean manufacturing and Six Sigma. Business Excellence at Tomkins is an initiative to ensure we achieve excellence in all aspects of our business as we strive to create dynamic growth in economic value. Details of Business Excellence at Tomkins are set out on pages 10 to 11.
Tomkins people are fundamental to the achievement of long-term growth in the economic value of the Group. Our human resources (HR) strategy is designed to support the key themes of the overall Tomkins business strategy. Tomkins HR function operates on a decentralised basis with the majority of our HR staff located at the business unit level where they can be most effective. This reflects our belief that localised HR teams, operating under common principles, are best equipped to deal with the varying business cultures, operating structures and geographic locations that exist across the Group.
At the corporate level our emphasis is on identifying and developing emerging talent, broadening training opportunities, performance management and succession planning. We also directly manage the incentive plan for our top managers, thus ensuring that this key element of remuneration is wholly consistent with shareholders interests.
The Groups operating and financial performance in 2004 demonstrates the benefits of our focus on business excellence and provides confidence that we can continue to grow profitably in the future, even before the benefits of any future acquisitions. Our continued strong cash generation, combined with ongoing strategic initiatives including product and process innovation and expansion into higher growth markets, should deliver continued growth in shareholder value in 2005.
Aftermarket having the widest distribution network.
Our strategy to grow in the aftermarket involves expanding our product line and services, as well as developing new channels to market and expanding overseas into high-growth areas.
Group President, Worldwide Aftermarket
OPPORTUNITIES FOR GROWTH: AFTERMARKET
STRATEGIES FOR GROWTH: AFTERMARKET
Our aftermarket businesses manufacture products for the automotive aftermarket and industrial replacement markets around the world.
The aftermarket is a large and steadily growing market. We are well positioned, owning the number one or two brands for the products we supply and offering a full product line. We are the leader in cataloguing, have a strong distribution network and operate the largest independent salesforce in the industry.
We aim to expand our market leadership in North America and develop market presence in Europe and Asia. Growth will also come from expanding our product line and services, as well as developing new distribution channels.
UNDERLYING AFTERMARKET GROWTH
SOURCE: 2004/2005 AAIA FACTBOOK; MEMA; AASA 2003
Annual Review 2004
Business Excellence at Tomkins
The overall objective of Business Excellence at Tomkins is to achieve continued dynamic growth in economic value for our shareholders.
FIG.1.1 BUILDING BLOCKS OF VALUE
Business Excellence at Tomkins is directly linked to the concept of 10-10-10 and bonusable profit. 10-10-10 requires each one of our businesses to focus on achieving 10 per cent growth, 10 per cent after-tax return on invested capital and 10 per cent return on sales. Bonusable profit is a measure of economic profit and is defined as profit after tax and a charge for cost of capital. Our business managers are incentivised using the bonusable profit metric.
Two important components of the framework of Business Excellence at Tomkins are:
The Building Blocks of Value (Fig.1.1)
As shown in figure 1.1 Business Excellence at Tomkins requires each of our businesses to ensure they have in place the building blocks of value, which are:
The building blocks of value focus on the importance of achieving sustainable growth in after-tax cash flows over time.
The pre-tax cash flows are directly impacted by the competitive strategies pursued by our businesses and the pursuit of excellence in all areas of our business.
The pre-tax cash flows in our business are driven by:
The after-tax cash flows reflect the effective tax rates of the businesses and the Group as a whole. The Group takes a proactive approach to tax management through the overall financial strategy managed by the Group Tax and Treasury functions (see Operating and financial review).
FIG.1.2 THE PERFORMANCE MANAGEMENT SYSTEM
Performance Management System (Fig:1.2)
Delivery of growth in value is achieved through our performance management system.
This encourages value-based decision making at all levels and is designed to improve strategic and operational decisions to ensure long-term creation of value for our shareholders. The business processes within the framework ensure delivery of growth in value.
The framework is based on performance measurement, resource allocation and remuneration and incentives. We measure our performance using both accounting and economic metrics. Our ultimate test of value creation is the improvement in economic return over time. Our resource allocation process ensures we invest in those areas that will create economic value. We operate a rigorous approach to the evaluation of investment projects and acquisitions and we distinguish between sustaining and growth investments. Our remuneration and incentive schemes are based on aligning the interests of all our senior managers with our shareholders.
The business processes within the Tomkins Performance Management System ensure the delivery of growth in value.
Risk management: Each business identifies and assesses the key strategic, operational, commercial and financial risks affecting the achievement of their objectives. We also identify the risk management processes to mitigate key business risks to an acceptable level. In addition, at the Corporate Centre we consider those risks to the Group strategic objectives that may not be identified and managed at the individual business level.
Business strategy review: Each business is required to produce a financial and strategic position assessment taking into account the current and future market environment and competitive positions of the business with specific consideration given to strategic risk. We review the strategy with each business and the Board is presented with a summary of the plans.
Financial plans: Each business prepares financial plans in a defined format that include financial consideration of the identified risks. At the Corporate Centre we review the financial plans and a summary is presented to the Board.
Approval of investment projects: All significant capital expenditures are subject to a formal capital authorisation approval process, which takes into account operational, financial and technical risks. For significant capital projects a post-investment analysis is completed to facilitate continuous improvement to the capital planning process. Proposed acquisitions are subject to a rigorous due diligence process considering all areas of financial, legal, environmental and business risk.
Quarterly business reviews: We perform extensive reviews with each business covering current and projected financial results, the progress of key operating and strategic initiatives, the risks affecting their achievement and the actions being taken by the business units management to manage the risks and achieve their objectives. The reviews are heavily focused on the building blocks of value.
Reporting, analysis and forecasts: All our businesses are required to report monthly on financial performance and to reassess their forecasts for the current year on a rolling 18 months time horizon.
Financial strategy: The overall objective of the financial strategy is to ensure procurement of funds at an optimal cost so as to achieve an appropriate weighted average cost of capital and to ensure that the tax cash cost of the Group is optimised.
Corporate strategy: The corporate strategy provides an overall direction for the Group taking into account the value-creating opportunities provided by the businesses. It includes a top-down assessment of the Groups intrinsic value based on an understanding of future projected operating cash flows and investment requirements.
Our markets as a whole performed well in 2004.
Underlying sales increased by 2.3 per cent.
On a global basis automotive production increased by 5.2 per cent compared to 2003, with a total of 60 million passenger cars and light trucks being manufactured. On a regional basis, North American production was down a modest 0.7 per cent while Western Europe increased by 1.7 per cent. Production in China continued to show strong growth, up 10.8 per cent. However, at over 25 per cent growth year-on-year, India and Brazil demonstrated some of the best improvements.
Looking ahead to 2005, CSM Auto is forecasting another positive year, with global production expected to increase by 3.3 per cent. 17.5 per cent growth in production is expected in China, and Western Europe is predicted to be marginally ahead of 2004 with a 0.6 per cent increase. North America is forecast to be modestly ahead of 2004 with a 0.5 per cent increase although production is likely to be weighted towards the second half of the year.
Underlying sales increased by 1.5 per cent.
The automotive aftermarket in North America in 2004 was adversely affected by several factors including: hurricanes in South Eastern United States which caused significant disruption; higher fuel prices which caused deferrals of spending on automobile maintenance; and consolidation in the retail customer base which caused a temporary slow-down in sales due to destocking of combined warehouses. The automotive aftermarket should return to a normal growth rate in 2005.
Underlying sales increased 15.9 per cent.
In 2004 the market continued to show strong year-on-year growth in North America, South America and Europe.
The outlook for our markets in 2005, together with wider macro-economic factors, remains broadly positive.
Total industrial production, as measured by the US Federal Reserve, was 4.4 per cent higher compared to 2003, with particularly strong growth in the construction, agriculture and mining sectors. Economic activity in the manufacturing sector grew in December 2004 for the nineteenth consecutive month. Strong industrial demand continues to be driven by improved consumer spending, inventory restocking, increased exports stimulated by the lower US dollar, and the demand created for industrial equipment in developing markets like China. Strong growth is forecast to continue in industrial markets through 2005.
GLOBAL AUTOMOTIVE PRODUCTION
OUTLOOK (UNITS MILLIONS)
NORTH AMERICAN INDUSTRIAL
Underlying sales increased 11.5 per cent.
The industrial aftermarket also performed strongly in 2004. The first half of the year saw high levels of inventory replenishment by US distributors followed by continued strong demand in the second half. Volumes are expected to remain strong into 2005.
Underlying sales increased 7.3 per cent.
The US residential construction market exhibited strong growth in 2004 despite initial concerns at the beginning of the year that it would decline. Housing starts were up 5.7 per cent and completions were up 9.9 per cent in the year. A good backlog of unused house building permits provides reassurance on housing start activity in 2005. The latest forecast from the National Association of Home Builders for 2005 is that housing starts will be 3.3 per cent lower than 2004 as a result of higher mortgage rates, but still at historically high levels.
Underlying sales increased 5.4 per cent.
The US non-residential construction market, measured in square footage terms, finished the year 0.5 per cent ahead of 2003. This was the first increase since the market peaked in 2000. It appears that the market hit its low point of the cycle at mid-year and has begun a slow recovery. The latest Dodge forecast projects an increase of approximately 5 per cent in 2005 compared to 2004.
Underlying sales increased 14.1 per cent.
The industrial and utility trailer market performed strongly in 2004 and expectations are for the market to remain buoyant in 2005.
Underlying sales increased 20.9 per cent.
Sales of recreational vehicles in 2004 increased 15.4 per cent over 2003. Expectations for 2005 are for a slight slowdown in this market.
Underlying sales increased 1.1 per cent.
Shipments of manufactured homes for the year were down 0.1 per cent, but showed recovery through the latter part of the year. From September onwards, monthly shipments of manufactured homes exceeded the previous year. Expectations are for an improvement in 2005.
The remaining 1.3 per cent of Group sales relates to other markets, including bulk and postal handling.
NORTH AMERICAN RESIDENTIAL
HOUSING STARTS (UNITS 000s)
SQUARE FOOTAGE (SQ. FT. 000s)
The Group operates three business units:
Industrial & Automotive, Air Systems Components and Engineered & Construction Products.
Tomkins management assesses the underlying performance of its businesses by adjusting UK Generally Accepted Accounting Principles (GAAP) statutory results to exclude items it considers to be exceptional or non-operational in nature. These adjusted measures are described as underlying. In the case of underlying sales, the statutory result is adjusted for the effects of currency translation and acquisitions and disposals; in the case of profits, the amount is also stated before goodwill amortisation and operating exceptional items. To provide more meaningful discussion of business performance in this operating and financial review, management has focused on the underlying results of the business. Some figures and ratios mentioned within the following discussion are not readily available from the financial information and details of how these figures and ratios have been arrived at are set out on pages 32 to 33 and page 51.
Tomkins plc is an international engineering business, listed on the London (ticker TOMK) and New York (ticker TKS) stock exchanges, with a turnover of approximately £3.0 billion and operating profit (before operating exceptional items and goodwill amortisation) of £278.1 million in 2004.
The Company is the ultimate parent of a large number of subsidiaries that are organised into three separate business segments; Industrial & Automotive, Air Systems Components and Engineered & Construction Products. All three businesses enjoy strong market positions and technical leadership and own some of the best-known brands in their respective markets.
The businesses operate in a variety of end-markets, supplying both the original equipment and aftermarket/replacement markets. This diversity provides the Group with a natural resilience to a downturn in any one particular market. The chart below sets out the Groups sales to end-markets.
The Group is also geographically diverse, operating 131 manufacturing facilities and eight research and development facilities in 18 different countries across the Americas, Europe, Asia, and Australia.
SALES TO END-MARKETS
The Industrial & Automotive business operates in all 18 countries. Air Systems Components is located in the United States, the UK and Thailand, while Engineered & Construction Products is entirely based in the United States. Overall, 67.4 per cent of revenue comes from the US, 15.2 per cent from Europe and 17.4 per cent from the rest of the world.
The Industrial & Automotive group represented 65 per cent of Tomkins sales in 2004 and 64 per cent of operating profit*. Air Systems Components, the smallest of the three segments, accounted for 14 per cent of sales and 16 per cent of operating profit*. The remaining 21 per cent of sales and 20 per cent of operating profit* were contributed by Engineered & Construction Products.
The contribution each business group makes to sales, operating profit* and operating cash flow, as well as net operating assets and employees by business group are shown in the pie charts below.
NET OPERATING ASSETS
OUR GLOBAL PRESENCE: GEOGRAPHICAL SALES SPLIT
Industrial & Automotive is made up of five principal business areas:
The Industrial & Automotive group manufactures a wide range of systems and components for the industrial and automotive markets.
Manufactures components and systems used in the automotive engine accessory drive belt and timing belt systems, components and assemblies used in automotive transmission systems, oil pumps and a range of belt products used in industrial applications.
Manufactures hoses, connectors and port-to-port systems used in hydraulics and other liquid transfer systems used in mobile equipment, principally in the mining, agriculture and construction industries.
Manufactures caps, closures and valves for use in automotive fuel systems, engine thermostats and tyre valves including remote tyre pressure monitoring systems.
Manufactures windscreen wiper systems and components for the automotive industry.
Aftermarket manufactured products
Manufactures a number of products and accessories used in automotive and industrial markets including hose clamps, power steering hose assemblies and air and lubrication products.
Sales by business unit and product category are shown on the following charts:
SALES BY BUSINESS UNIT
SALES BY PRODUCT CATEGORY
The principal markets for Industrial & Automotive are the Automotive Original Equipment Market (AOE), the Automotive Aftermarket (AM), the Industrial Original Equipment market (IOE), the Industrial Replacement market (IAM) and the Original Equipment Service market (OES). Each of the sub groups within Industrial & Automotive has a different mix of business across the major sectors.
The Industrial & Automotive business group operates in the Americas, Europe, Asia and Australia.
INDUSTRIAL & AUTOMOTIVE KEY STATISTICS
The sales by geographic region within each major market for each of the businesses within Industrial & Automotive is shown in the following charts:
SALES BY GEOGRAPHIC REGION
The market shares for the major product groups in each business area are as follows:
MARKET SHARE BY PRODUCT
MAJOR CUSTOMERS IN INDUSTRIAL & AUTOMOTIVE
The largest customer accounts for 11.3 per cent of the sales in Industrial & Automotive and the top ten customers account for 42.8 per cent. Sales to the three largest automotive original equipment manufacturers account for 25.3 per cent.
The principal raw material purchases are steel, polymers and machined components.
Key drivers impacting the performance of Industrial & Automotive
Industrial & Automotive sales are linked directly or indirectly to consumer spending in the various economies of the world. Consumer spending will affect demand for new automotive vehicles and also impact the spending on vehicle maintenance and automotive replacement parts. Consumer spending is affected by interest rates and taxation rates in an economy.
Inventory or stock levels of vehicles or parts will impact demand for our products. If stock levels reduce overall in the distribution channel then sales of our products will be negatively affected.
New automotive volumes are driven by disposable income, the relative price of the vehicle and population growth. Volumes in developing countries will grow at a faster rate than in mature economies.
The longer-term demand for aftermarket products is driven by the number of vehicles on the road, the age of the vehicle, miles travelled and the average cost of vehicle repair.
Industrial production levels will drive demand for our industrial products in Industrial & Automotive. Capital spending by the major manufacturers of mobile equipment used in the construction, agricultural and mining sectors will directly impact our business as well as levels of demand in a number of other industries such as white goods and electronic equipment. Stock levels in the distribution channel affect our sales of products into the industrial replacement market.
Air Systems Components is a manufacturer of air handling components in North America supplying the heating, ventilation and air conditioning market.
Products include fans, grilles, registers, diffusers, variable air volume units, fan coils and terminal units for residential and commercial applications and dampers for commercial and industrial use.
Residential products are sold under the brand names of Hart & Cooley, Milcor and American Metal Products and the industrial and commercial products are sold under the brand names of Titus, Ruskin, Krueger and Actionair.
Sales by each business unit and by product category are shown in the charts opposite.
The Air Systems Components business operates principally in North America, with around 4 per cent of sales in Europe and Asia.
The products are sold through a variety of manufacturers representatives, wholesalers, distributors and retailers. No customer accounts for more than 3 per cent of sales in either of its markets.
The principal raw material purchases are steel and aluminium.
Key drivers impacting the performance of Air Systems Components
Air Systems Components sales are linked directly or indirectly to consumer spending in the United States due to the significance of the new home market and the home re-modelling market. Consumer spending will drive demand for residential housing and is affected by interest rates and taxation rates in the economy.
New home construction is measured by the number of units completed.
The longer-term trend of new home building is linked to the balance of demand and supply, which is affected by demographics and
affordability and is related to disposable income and interest rates.
Remodelling sales are affected by the age of the housing stock and the age and disposable income of the occupants of the home.
The non-residential construction market is driven by rental rates, occupancy rates, the level of employment in the economy and by industrial production trends.
SALES BY BUSINESS UNIT
SALES BY PRODUCT CATEGORY
SALES BY END-MARKET
MARKET SHARE BY PRODUCT GROUP
Engineered & Construction Products is made up of five separate business areas:
The Engineered & Construction Products group manufactures products for a variety of end-markets in the United States primarily related to building, construction, truck and trailer and automotive industries.
We manufacture non-dynamic axles for the industrial utility trailer market, sold through distributors to trailer manufacturers under the Dexter brand.
Under the Lasco brand, we manufacture acrylic and fibreglass reinforced panel baths and shower cubicles, sold through distributors and the retail market.
Under the Lasco brand, we manufacture PVC pipe fittings for pressure water applications and drain, waste and vent applications, sold through dealers and distributors.
Doors and Windows
The Philips brand manufactures uPVC doors and windows for the residential and manufactured homes market, sold through national distribution arrangements.
Trading as Dearborn Mid-West, we design, manufacture and install material handling systems used in the automotive, postal and bulk materials markets.
Each of the business areas has a strong branded product offering and low cost manufacturing base.
The principal raw material purchases are steel, PVC resin and gelcoat.
Key drivers impacting the performance of Engineered & Construction Products
There are a number of different factors driving demand in each of the principal markets.
Residential construction the principal factors impacting the market are discussed in the overview of the Air Systems Components business on page 18.
Manufactured housing demand for manufactured homes is affected by availability of finance, interest rates, disposable income and the availability of conventional housing at affordable prices.
Industrial utility trailer demand is affected by the general level of industrial and construction activity and by expenditure on trailers for leisure pursuits.
Automotive and industrial demand is driven by investment by the automotive original equipment manufacturers and by industrial production levels generally.
SALES BY BUSINESS UNIT
SALES BY PRODUCT CATEGORY
SALES BY BY END-MARKET
MARKET SHARE BY PRODUCT GROUP
Sales and operating profit
In 2004, sales were £2,980.3 million (2003: £3,150.4 million) and operating profit (before operating exceptional items and goodwill amortisation) was £278.1 million (2003: £271.8 million). Operating profit from continuing operations before goodwill amortisation was £260.5 million (2003: £246.0 million).
Around 65 per cent of our business is denominated in US dollars and as a consequence, the weakening of the US dollar during 2004 had a negative translation impact on our reported turnover and operating profit when converted into sterling. For 2004, our US dollar financial results were translated at an average rate of £1=$1.83 compared with £1=$1.63 in 2003.
This represents a 12.3 per cent reduction in the average sterling to US dollar exchange rate. The weakness of the US dollar adversely affected our reported sales and operating profit (before operating exceptional items and goodwill amortisation) by £265.7 million and £27.0 million respectively.
During 2004 our continuing major investment in strategic manufacturing initiatives resulted in certain abnormal costs. These strategic initiatives are aimed at improving the cost base of the Group. However, the costs can distort reported performance and so they are separately identified as operating exceptional items. They amounted to £17.5 million during the year.
OPERATING PERFORMANCE INDICATORS
FINANCIAL PERFORMANCE INDICATORS
INDUSTRIAL & AUTOMOTIVE
Acquisitions and disposals can also distort the view of the change in performance from one year to the next and so we regard it as helpful to show their impact on sales and operating profit separately. The charts below pull out the impact of currency translation, operating exceptional items and acquisitions and disposals to present a view of the underlying performance of Tomkins.
On an underlying basis, sales grew 5.7 per cent and operating profit before goodwill amortisation by 12.8 per cent, as set out in section 14 on page 32.
Overall our reported operating margin before operating exceptional items and goodwill amortisation was 9.3 per cent. This compares with 8.6 per cent in 2003. The operating margin before operating exceptional items and goodwill amortisation for each of the business units was as follows: Industrial & Automotive, 10.1 per cent (2003: 9.6 per cent);
Air Systems Components, 11.2 per cent (2003: 9.4 per cent); and Engineered & Construction Products, 9.5 per cent (2003: 8.8 per cent).
Industrial & Automotive
The Industrial & Automotive group achieved sales of £1,932.9 million (2003: £1,977.2 million) and operating profit (before operating exceptional items and goodwill amortisation) of £195.3 million (2003: £189.9 million). On an underlying basis, this represents increases of 4.3 per cent and 11.4 per cent respectively.
On a global basis the groups automotive original equipment (OE) sales were up by 2.3 per cent and industrial OE sales rose by an impressive 12.7 per cent. All regions performed well with sales up year-on-year. Aftermarket sales were up 5.3 per cent on a global basis, with automotive replacement up by 1.9 per cent despite some weakness in North America. Industrial replacement was ahead by 11.5 per cent, driven by strong demand from North America in particular. Aftermarket sales in Asia were particularly strong, up 33.3 per cent year-on-year.
Powertrain sales grew by 2.9 per cent and operating profit by 5.6 per cent on an underlying basis. All areas contributed to the increase with the exception of North America, which was down 2.5 per cent, impacted by lower OE demand. Asia performed strongly with sales up by 17.8 per cent. Europe was ahead by 3.7 per cent, driven in particular by good automotive OE demand.
Key developments during the year included the first sales of our Electro-mechanical Drive system (stop-start technology) on the new Citroën C3 vehicle in France. Availability is expected to widen this year and trials of the technology on urban delivery vehicles are currently underway. Sales of the newly launched Fleetrunner heavy-duty belts and the Eliminator belts were encouraging. In December 2004, we completed the acquisition of Mectrol, a US and German-based manufacturer of polyurethane timing belts. The company has been integrated into the industrial belts business of Gates. The transaction benefits include a new unique product portfolio for Gates, access to new markets and customers, and multiple avenues for growth.
Stackpoles sales declined 5.0 per cent in 2004, impacted by declining production volumes at one of its key customers, resulting in lower margins. However, significant business, amounting to C$98 million (£42.7 million), was awarded during the year. This new business mainly relates to the 2006 to 2008 production years. Near-booked business ended the year at C$102 million (£44.1 million) while new product development activity continued to progress in an impressive way. New programmes under development at the year-end totalled C$124 million (£53.7 million).
The construction of the two new Stackpole facilities in Canada and the extension of a third site progressed well and production has now started at all sites. The full volume launch at the Carrier Systems facility will occur in March 2005. The Powder Metal group will launch 46 new part numbers on 18 different platforms in 2005. The launch of the Engineered Products facility is going well, with management expecting full operational
OPERATING PROFIT* BRIDGE
AIR SYSTEMS COMPONENTS
efficiency for the oil pump cells in February 2005. Despite the difficult financial performance and expectations of weaker first quarter automotive production in 2005, Stackpole remains on track to achieve its strategic objectives of double-digit growth and operating margins driven by technology and innovation.
Fluid Powers underlying sales were up 16.1 per cent, driven by robust global demand especially in the construction and agricultural equipment markets. All regions outperformed last year, with strong sales and operating profit growth coming from North America and Europe as well as significant operational improvement in Europe. Global sales to industrial OEMs were up 24.8 per cent although fluid power sales to automotive OEMs were lower by 1.2 per cent. The new Technical Centre in Denver (CO) was completed at the end of the year. New product development initiatives progressed with the Quick-Lok family of products gaining success in the industrial OE marketplace.
In July 2003, we announced the phased exit from the European automotive curved hose business. During 2004 we completed the closure of the St Just facility and the sale of the business in Nevers.
Fluid Systems had a very successful year, with underlying sales and operating profit exceeding the previous year by 10.4 per cent and 14.9 per cent respectively. A strong operating profit performance was achieved by Stant, Schrader Electronics and Schrader France, slightly offset by weaker results at Schrader Brazil and Standard-Thomson.
Schrader Electronics delivered a strong performance and expectations are for further growth in 2005 and beyond, following proposed changes to the TREAD Act ruling in the US, which, it is expected, will require all new vehicles sold in the US to be equipped with a tyre pressure monitoring system by 2007. New business awarded during the year amounted to £67 million. In order to meet increased levels of demand, the new production facility at Carrickfergus in Northern Ireland commenced production in late January 2005. Customer acceptance of the Snap In sensor design continues to grow, with business of over 6 million sensors already awarded for 2008. New product research is opening up new non-automotive applications.
Schrader-Bridgeports 36,000 square feet valve-manufacturing facility in China was completed in January 2005. The start-up of the new Stant plant in Karvina, Czech Republic, has also progressed well. Production will commence at the end of the first quarter 2005. The development activity for Stants new Carbon Canister advanced, with the product being newly engineered for two new platforms in 2005.
2004 was a disappointing year for the Wiper Systems business, with sales declining 2.4 per cent on the back of a tough OE environment and lower aftermarket demand. Rising input costs also affected profitability. While Trico was successful in increasing prices in the aftermarket, the automotive OEMs continued to reject steel-related price increases from the supply base. Aftermarket demand started to improve in December of 2004 and has shown continued strength into January of this year. Our new Beam Blade was successfully launched at an industry show. It was selected as one of the twelve best new products in the show and is doing very well in the market place.
Tricos Asian strategy, for both the aftermarket and OEM business, continues to take shape. A production location in Suzhou, China has been selected and we are now progressing plans for the construction of a 70,000 square feet facility. Initial production is scheduled in the fourth quarter of 2005.
In October 2004 we announced our intention to exit our small Gates AirSprings business. This exit was completed in February 2005 with the sale of the assets to Vibracoustic NA, L.P.
The net impact of increases in raw material costs absorbed by the Industrial & Automotive business group amounted to around £6.1 million for the year. Savings from lean manufacturing totalled £19.3 million in 2004.
CAPITAL EXPENDITURE AND DEPRECIATION
ENGINEERED & CONSTRUCTION PRODUCTS
Air Systems Components
Air Systems Components performed strongly in 2004, with sales up by 5.3 per cent and operating profit ahead by 24.9 per cent on an underlying basis. The non-residential construction market saw the first signs of a recovery with square footage built in the US slightly ahead of the prior year. We outperformed this market, with sales growing by 3.7 per cent on 2003. Our sales to the residential construction market rose by 8.4 per cent, supported by strong demand.
Several new products such as the Fantom IQ, duct access doors from Hart & Cooley and a new Ruskin damper for marine applications were successfully launched during 2004. Significant new business wins included Titus products destined for the University of Nebraska and the Hearst headquarters in New York as well as a large contract for Ruskins industrial tunnel dampers and acoustic silencers for the New York City Transit system.
Ruskin announced plans to build a new manufacturing facility in Monterrey, Mexico. Manufacturing is expected to commence mid-2005.
In January 2005, we completed the acquisition of Milcor Inc. The company is a multi-brand manufacturer of building and roofing products, selling to the US residential and commercial construction markets. Milcors annual sales are approximately $47 million (£25.7 million). It will be integrated into our residential business, Hart & Cooley.
Business efficiency measures continued, with Hart & Cooley completing the closure of its Monessen (PA) facility and transferring production of duct accessories to Huntsville (AL). Savings generated from lean manufacturing amounted to £4.6 million in 2004.
The net impact of rising raw material costs amounted to approximately £4.2 million for the year.
Engineered & Construction Products
The Engineered & Construction Products group achieved sales of £624.4 million (2003: £725.3 million) and operating profit (before operating exceptional items and goodwill amortisation) of £59.3 million (2003: £63.6 million). On an underlying basis, this represents increases of 10.5 per cent and 4.4 per cent respectively.
Demand for Dexters axles was particularly strong in 2004 across all its end-markets. Hurricanes in the South East of the United States tempered demand in the third quarter, however, sales increased in the fourth quarter as replacement demand grew. In June 2004, the business disposed of its steel wheels and rims business. A project to expand capacity at its Elkhart (IN) facility got underway during the year. This additional capacity will allow Dexter to meet demand for rubber torsion axles.
In March 2005, we acquired L.E. Technologies, a company that manufactures recreational vehicle (RV) frames, trailers and fabricated metal components. The acquisition will allow Dexter Axle to expand into the RV frame business, a market which is adjacent to Dexters current markets. It also provides sales, manufacturing and purchasing synergies, in addition to accessing a new customer base. L.E. Technologies employs over 490 people in Southern Michigan and Northern Indiana and generated approximately $85.6 million (£46.8 million) of revenue in 2004.
We disposed of two businesses in the Material Handling group. Mayfran was sold in June and we completed the disposal of Unified Industries on 2 January 2005. The remaining material handling business, Dearborn Mid-West, saw a pick-up in demand, especially from automotive programmes and finished the year with a healthy order book.
Lasco Bathware saw its volumes increasing as its new Home Depot contract commenced at the half-year. New product development activities continued to gain momentum. The acrylic modular shower, incorporating a body shower, steam unit and seat, that was introduced at the Kitchen and Bath Show was launched formally at the Builders Show in January 2005. Lascos efforts to grow acrylic sales continued to show results with acrylic sales for the year increasing by around 15 per cent.
OPERATING EXCEPTIONAL ITEMS
Lasco Fittings showed year-on-year improvements in sales, but suffered the effects of substantial increases in the cost of its major raw material. An investment project for large-diameter pipe fittings was initiated in the third quarter. This will enable Lasco to penetrate new markets such as water reclamation and aquaculture. Initial production commenced towards the end of the year with volumes ramping up in January 2005.
Philips saw continued development of its share of the residential doors and windows market, with sales to this market up 5.1 per cent.
The net impact of raw material price increases on the business group, in particular steel and oil-based chemical derivatives, was approximately £7.7 million for the year. Savings from lean manufacturing totalled £1.5 million in 2004.
Events impacting our financial performance and position
a. Raw materials
The net impact of increases in raw material costs absorbed by the Group in 2004 was £18.0 million.
b. Operating exceptional items
The operating exceptional items are set out in the table above. These are costs relating to strategic manufacturing initiatives, which are charged in arriving at operating profit, but which are abnormal in nature in that they relate to costs associated with major restructuring initiatives of the Group.
Restructuring costs tend to be a continuing feature of manufacturing and in the future you may expect annual recurring costs of the order of £10 million. We will continue to charge these costs against operating profit as we have done in the past but will separately identify them if significant.
c. Non-operating exceptional items
The sale of the European curved hose business in Nevers, France, was completed on 17 November 2004. There was a loss on disposal of the business of £2.1 million. The closure of the European curved hose business in St Just, Spain was also completed in the year with costs of £16.2 million. Provisions amounting to £29.6 million for exit from these businesses were reversed in the year.
On 30 January 2004 and 31 January 2004 respectively, the business and assets of Hattersley Newman Hender Limited and Pegler Limited were sold for a combined consideration, before costs, of £13.0 million of which £5.8 million is deferred. Further net proceeds of £0.6 million were received after related closure costs and the disposal of the vacant site. There was a loss on disposal of the businesses of £72.9 million, including £51.4 million of recycled goodwill, of which £72.9 million was provided in the year ended 3 January 2004.
On 1 June 2004, Mayfran International Inc. was sold for a total consideration of $12.7 million (£6.9 million) of which $4.2 million (£2.3 million) was deferred. There was a loss on sale of £19.0 million, including £13.1 million of recycled goodwill.
On 10 June 2004, the wheels and rims business of Dexter Axle was sold for a total consideration of $10.9 million (£6.0 million) of which $1.8 million (£1.1 million) remains deferred at the year-end. There was a gain on sale of £3.1 million.
Costs on prior year disposals resulted in losses of £0.9 million being recognised in 2004. Deferred consideration, net of these costs, resulted in additional proceeds of £1.3 million being received during the year and £0.5 million was received in advance relating to the post year-end disposal of Unified Industries Inc.
Further details on non-operating exceptional items can be found in the notes to the Directors Report and Accounts, a separate report to shareholders.
The net interest expense for the year was £15.1 million (2003: £8.4 million). Higher interest costs largely reflected the impact of the redemption of the redeemable convertible cumulative preference shares in August 2003.
Earnings per share
We have presented basic earnings per share before and after amortisation of goodwill and non-operating exceptional items. Before amortisation of goodwill and non-operating exceptional items, basic earnings per share was 22.55 pence compared with 18.78 pence in 2003. After goodwill and non-operating exceptional items, earnings per share was 20.37 pence compared to 18.53 pence in 2003.
The dividends to our preference shareholders are dollar denominated and in the year, the sterling equivalent was £15.6 million (2003: £28.9 million). Preference dividend payments have reduced as a result of the
TOTAL RECOGNISED GAINS AND LOSSES
redemption of the redeemable preference shares and due to the weakening of the US dollar.
The dividends to holders of ordinary shares for the year were £97.3 million (2003: £92.8 million). This represents dividend cover, before goodwill amortisation and non-operating exceptional items, of 1.8 times (2003: 1.6 times). Cash cover was 1.2 times (2003: 1.5 times). Cash cover is based on cash flow after interest, tax and preference dividends (free cash flow to equity) compared to ordinary dividends paid.
The cash movement for the year is summarised in the above table. The chart below shows the movement in free cash flow to equity.
Operating cash flow is stated after £20.1 million of restructuring costs and £10.0 million of capital expenditure associated with the various restructuring costs.
During the year, capital expenditure was £157.7 million representing 1.4 times depreciation and an increase of 11.8 per cent over 2003. The major capital expenditure projects were the capacity expansion at Stackpole, new facilities in China and systems development expenditure at Gates.
Capital expenditure before disposals is expected to be around £160 million in 2005.
Additional efforts were made in the final quarter to end the year with a good working capital performance. For the year as a whole the Groups working capital measure, average working capital as a percentage of moving annual total sales, was 13.5 per cent compared to 13.4 per cent in 2003.
Total recognised gains and losses
The adjacent table shows the statement of total recognised gains and losses.
Funding for sustaining investment and investment for organic growth is met initially from internally generated cash flow (cash flow after interest, tax and preference dividends). The resulting net cash flow available for equity holders, together with debt finance available within the debt capacity of the Group, will determine the funding for acquisitions and distribution policy. The debt capacity of the Group is determined by our objective to maintain a stable capital structure and the Groups investment grade debt rating.
We aim to grow the dividend steadily and progressively in line with the overall long-term cash generation of the Group. When the Group generates surplus cash and existing investment needs are met, then the economics of share repurchases or special dividends
to shareholders will be examined.
We assess the accounting return on capital invested in our businesses in two ways.
BRIDGE OF FREE CASH FLOW TO EQUITY(1)
Return on net operating assets is a pre-tax measure of the return on the book value of capital employed in the businesses and represents a measure of the financial productivity of the cash invested in the operating assets of the business.
Return on invested capital is an after-tax measure of the return on the invested capital employed in the business taking into account the goodwill associated with the acquisition of the business and represents a measure of the financial return on the total financial investment in the business.
The charts below set out the return on average invested capital and the return on average net operating assets for each business and the Group.
Cash flow metrics
We assess the cash flow performance of each of our businesses based on the percentage of operating profit (before operating exceptional items) converted to operating cash flow (cash conversion). The cash conversion for each of the business groups and for the Group as a whole is shown below.
To track the economic performance of the Group we look at cash added value and economic return.
Cash added value is an absolute measure of value created based on after-tax EBITDA less sustaining investment and a charge for cost of capital. The charge for cost of capital is based on the weighted average cost of capital applied to the average book value of investment in the business including goodwill associated with acquisitions.
The economic return is based on cash added value expressed as a percentage of the average book value of investment.
The trends of cash added value and economic return are used to assess the allocation of capital over the long-term.
Weighted average cost of capital
The weighted average cost of capital is the weighted average by value of the after-tax costs of each of the elements of the Groups capital structure.
The cost of equity is calculated using the capital asset pricing model with the risk-free rate based on a ten-year sterling government bond rate, an equity beta of one and an equity market risk premium of 4 per cent. The value of equity is the current market value of the ordinary shares of Tomkins.
The cost of debt comprises both the cost of the perpetual preference shares and the cost of the Groups net debt after tax at a normalised tax rate of 30 per cent. The value of net debt used is the actual current sterling value of the Groups net debt. The value of the preference shares is the current sterling equivalent nominal value of the preference shares.
A graph showing the weighted average cost of capital during the year is shown on page 27.
Applied research and development is important to the Companys manufacturing businesses. The Company does not have a Group-wide research and development programme, although it maintains development centres in Japan, Europe and the United States. Companies within the Group are encouraged to review their products regularly and to develop them in accordance with perceived market trends. The Companys measured expenditure on research and development was £51.3 million in 2004 (2003: £58.6 million). Research and development expenditure is expensed in the period in which it is incurred.
Our medium-term aim is to maintain an appropriate mix of equity and debt to ensure an efficient capital structure consistent with our desired investment grade financial profile. Our debt capacity is assessed within this aim. Our long-term debt finance requirements are also defined within these parameters and with an understanding of our future financial needs for capital investments, acquisitions and dividends.
Treasury responsibilities and philosophy
The primary responsibilities of the central treasury function are to procure the Groups capital resources and to maintain an efficient capital structure, together with management of the Groups liquidity, foreign exchange and interest rate 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 our treasury philosophy is that funding, interest rate and currency risk decisions and the location of cash and debt balances are determined independently from each other. For example, the Groups debt requirements are met by raising funds in the most favourable 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. We operate systems to ensure that all relevant assets and liabilities are taken into account on a Group-wide basis when making these decisions. This portfolio approach to financial risk management enables our activities in these areas to be carried out effectively and efficiently and with a high degree of visibility.
Details of corporate bonds and EMTN programme
We have a Euro Medium Term Note Programme under which Tomkins may issue bonds up to a total maximum principal amount of £750 million. Our initial bond under the programme in December 2001 was for £150 million with a ten-year maturity and was issued at a coupon of 8 per cent.
In September 2003 we issued a further £250 million bond with a twelve-year maturity at a coupon of 6.125 per cent. The proceeds of this bond issue were used to finance the early redemption of the redeemable convertible cumulative preference shares, which took place in August 2003.
RETURN ON AVERAGE NET
RETURN ON AVERAGE
In December 2001 we established long-term credit ratings with Moodys and S&P. Our ratings have remained unchanged since this date at Baa2 and BBB respectively and cover our Euro Medium Term Note Programme and £250 million bond issued by Tomkins Finance plc, a directly owned subsidiary of Tomkins plc that carries out all of the Groups central treasury activities, together with our £150 million bond issued by Tomkins plc. We also have a short-term rating of P-2 with Moodys. Our aim is to manage the Groups capital structure to preserve these ratings.
Maturity profile of borrowings and borrowing facilities
The maturity profile of our borrowing facilities is set out in the chart below.
Our committed bank borrowing facilities mainly comprise a multi-currency revolving credit facility of £400 million maturing in February 2009.
Borrowing facilities are monitored against forecast requirements and timely action is taken to put in place, renew or replace credit lines. Our policy is to reduce financing risk by diversifying our funding sources and by staggering the maturity of our borrowings.
Levels of borrowings and seasonality
During 2004 our gross and net borrowings remained stable, with gross and net debt of £434.8 million and £244.5 million on 1 January 2005 and £444.1 million and £264.7 million on 3 January 2004 respectively. The peak level of gross debt during the year was £460.3 million and the peak level of net debt during the year was £290.6 million.
We operate in a wide range of markets and geographic locations and as a result the seasonality of our borrowing requirements is low. Underlying cyclicality before capital expenditure is driven principally by the timing of our ordinary and preference dividends and interest payments.
Funding requirements for investment commitments and authorisations
At 1 January 2005 we had surplus cash balances in excess of those required to be held in the businesses for operational purposes. Accordingly, our present policy is to fund new investments firstly from existing cash resources and then from borrowings sourced centrally by Tomkins Finance plc. It is our intention to maintain surplus un-drawn borrowing facilities sufficient to enable our credit ratings to be maintained and to enable us to manage the Groups liquidity through the operating and investment cycle. We maintain a regular dialogue with the rating agencies and the potential impact on our credit rating is taken into consideration when making capital allocation decisions.
Current versus prospective liquidity
At 1 January 2005 our committed 2009 £400 million bank credit facility was un-drawn and we had a further £231.5 million of other, mainly uncommitted, credit facilities and finance leases, of which £15.9 million was drawn for cash and £66.5 million was utilised through the issuance of bank guarantees and standby letters of credit. Total headroom under the facilities was £540.6 million in addition to cash balances of £190.3 million. If all of our uncommitted credit facilities were to become unavailable, our total committed borrowing headroom would be £321.2 million, in addition to our cash balances.
It is our policy to retain sufficient liquidity throughout the capital expenditure cycle to maintain our financial flexibility and to preserve our investment grade credit rating.
Maximising returns on cash balances
Our central treasury function is responsible for maximising the return on surplus cash balances within liquidity and counterparty credit constraints imposed by our 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 1 January 2005, £123.9 million of cash was under the direct control of Group treasury.
Cost and location of debt
Our weighted average cost of debt at 1 January 2005 was 6.5 per cent (2003: 6.2 per cent). The rise in the cost of debt is primarily due to higher interest rates applying in the currencies in which our net debt is denominated at the end of 2004 compared to 2003.
The net interest charge for the year to 1 January 2005 of £15.1 million was £6.7 million higher than the charge for the previous year. This increase was principally due to additional interest costs from the redemption of the preference shares in August 2003 and the acquisition of Stackpole in July 2003 (£7.3 million), combined with the impact of fixing our US dollar interest rates for up to 5 years in August 2003 (£1.1 million), offset by lower underlying net debt throughout the year (£1.7 million).
At 1 January 2005, our total cash balances were £190.3 million. Of this amount £75.3 million was invested in short-term deposits by our treasury department, £21.1 million of cash was held in our captive insurance company, Tomkins Insurance Limited, £34.9 million of cash was held in our Asian Unitta companies and £59.0 million of cash was held in centrally controlled pooling arrangements and with local operating companies. £170.4 million of our cash was interest earning. Our policy is to apply
WEIGHTED AVERAGE COST OF CAPITAL
MATURITY PROFILE OF BORROWINGS
AND BORROWING FACILITIES
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 which 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 2005.
Cash flow and net debt
We do not anticipate any material long-term deterioration in our overall liquidity position in the foreseeable future.
Contractual obligations and financial commitments
At 1 January 2005, we had £66.5 million of bank and insurance company issued bonds, guarantees and standby letters of credit in issue. These were issued primarily in favour of insurance companies for the fronting of workers compensation claims in the US, in addition to other contractual counterparties for operational purposes. Our annual operating lease rentals were £21.4 million in 2004 (2003: £21.8 million).
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 our 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.
Our transaction exposures arise in currency pairs with the main currency pair exposures for the year ended 1 January 2005 being USD to MXN (£36.7 million), USD to GBP (£27.9 million), and GBP to EUR (£42.7 million). The total loss on major transaction exposures during the year as a result of the movement of average exchange rates from 2003 to 2004, was £0.6 million. The impact of our hedging activities during 2004 was a net loss of £0.1 million.
Foreign currency translation exposures
To the extent that Tomkins is funded by shareholders equity, overseas investments are not hedged. 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 net debt position comprises principally US dollars, Canadian dollars and Euros.
Dividends are funded by converting the foreign currency cash flows generated by overseas investments at the time of payment of the dividend. Interest payments on foreign currency net borrowings are funded with cash flows generated by the corresponding foreign currency investments.
We do not hedge foreign currency profit and loss translation exposures and we are subject to the risk of currency fluctuation. We estimate a movement of 10 per cent in the US dollar to sterling exchange rate has an impact on reported operating profits of around 7 to 8 per cent. This risk is partly offset to the extent that interest arises on foreign currency net borrowings.
Information on our use of derivatives and financial instruments is given in note 28 to the Directors Report and Accounts, a separate report to shareholders.
Interest rate risk management
Our central treasury function ensures that the interest rate profile desired by the Board is maintained and manages interest rate gaps in each currency in which the Group has an exposure. This is achieved by considering the portfolio of all of our interest bearing assets and liabilities across the Group. Our net desired interest rate profile in each currency is then managed by entering into interest rate swaps, options and forward rate agreements. At 1 January 2005, the interest rate maturity profile of our Canadian dollar, Euro and sterling net debt was less than 3 months.
The graph below shows our US dollar interest rate maturity profile as at 1 January 2005.
We are subject to covenants, representations and warranties commonly associated with investment grade borrowings on our £400 million committed 2009 bank facility, our £150 million 2011 bond and our £250 million 2015 bond.
We are subject to two financial covenants under our £400 million committed bank facility. The ratio of net debt to consolidated EBITDA must not exceed 2.5 times and the ratio of consolidated operating profit to consolidated net interest charge must not be less than 3.0 times. Throughout 2004 we have been comfortably within these limits. These financial covenants are calculated by applying UK GAAP frozen as at 31 December 2002 and are therefore unaffected by accounting changes associated with the transition to International Financial Reporting Standards.
The overall objective of the Group tax function is to efficiently plan and manage the tax affairs
NET CASH INFLOW FROM OPERATING ACTIVITIES
US DOLLAR INTEREST RATE MATURITY PROFILE
of the Group within the various local tax jurisdictions of the world so as to achieve the lowest tax cash cost consistent with compliance with the local tax regulations.
The net tax charge and the net cash tax cost as a percentage of operating profit for the period 2002 through to 2004 are shown in the chart below.
The effective tax rate for the year was 19.0 per cent. A total charge of £57.5 million represented an effective rate of 25.7 per cent on profit before tax. This was before a release of £15.0 million which reduced the total tax charge. The reduction in the provision arose as a result of the closure of a number of previously open tax years. The percentage net tax cash cost was 17.8 per cent.
Generally the charge for taxation is affected by the varying tax rates in different jurisdictions applied to taxable profits and the mix of those profits, by the rules impacting deductibility of certain costs, such as finance costs, and by the rules relating to double taxation relief.
Although we have been successful in minimising the cash tax cost of the Group the increasing focus of taxation authorities around the world on the tax affairs of multinational corporations is likely to lead to a gradual increase in cash tax costs over time.
We take a prudent approach to the management of the Groups tax affairs and provisions are set to cover any tax exposures the Group may have.
The asset values and the discount rates of the liabilities are based on the financial markets existing at our financial year-end and the present value of scheme liabilities for the Groups defined benefit plans exceeded the market value of scheme assets by £138.2 million (2003: £148.2 million). After adjusting for unrecoverable surpluses and after the recognition of the related deferred tax asset, the net pension liability reduces to £97.8 million (2003: £103.7 million). Under FRS 17 this deficit would have to be included in the balance sheet.
The reduction in the under-funded status of the plans is primarily due to the impact of a more favourable asset return environment and an increase in the market value of scheme assets.
Cash contributions to the defined benefit schemes in 2004 were £19.4 million (2003: £24.3 million) and £19.6 million was charged to the profit and loss account (2003: £19.1 million). We estimate cash contributions to the defined benefit schemes in 2005 will be £36 million, an increase of £17 million on 2004.
The total charge to the profit and loss account, including defined contribution schemes, was £45.9 million (2003: £47.9 million). At 1 January 2005, pension related assets of £28.2 million (2003: £25.3 million) and pension related liabilities of £55.3 million (2003: £53.4 million) were included in debtors and creditors respectively.
Tomkins continues to address the pension deficit, which was largely created by the negative equity returns of 2000-2002, through a combination of active investment management, adequate funding levels and proper oversight of pension benefits. Although the equity positions of many UK-based pension schemes were reduced during 2004 in favour of a greater allocation to fixed income, the pension assets participated in the strong equity market returns of 2003 and 2004 contributing to the reduction of the deficits. We are confident that continued funding at reasonable and sustainable levels, in addition to continued reallocation of assets and reduction of overall portfolio risk, will result in Tomkins meeting its obligations to the pensioners.
Factors driving deficits
The primary factors that continue to contribute to the pension deficits can be summarised as low interest rates and improving longevity estimates of our scheme members:
Pensions funding strategy
The Company remains committed to responsibly funding pensions. In the UK, this means satisfying the funding agreements made with the Trustees of the schemes in order to eliminate deficits over a reasonable period of time. In the US, funding objectives generally seek to avoid PBGC (Pension Benefit Guaranty Corporation) variable rate premiums, accelerated funding charges mandated by ERISA (Employee Retirement Income Act of 1974) and remain above the ERISA required minimum funding levels. Accordingly most plans are funded on the basis of reaching or exceeding 90 per cent funded on a current liability basis.
Pensions investment strategy
Tomkins continues to manage all pension scheme assets in a broadly diversified portfolio balancing fixed income with equity assets. The assets have enjoyed a slight performance premium due to an allocation to active managers with specific investment mandates, including international and emerging market equities. Although we have been satisfied with the investment performance, the Company is investigating additional strategies to extend the duration of the fixed income portfolio to more closely match the pension liabilities as well as overlay interest rate hedging techniques to reduce overall portfolio risk and volatility of future funding.
Critical accounting policies
Our significant accounting policies are more fully described in the notes to the consolidated financial statements (see the Directors Report and Accounts, a separate report to shareholders). Certain of our
TAX CHARGE AND CASH TAX COST
accounting policies require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, terms of existing contracts, our observance of trends in the industry, information provided by our customers and information available from other outside sources, as appropriate. Our significant accounting policies include:
Pension and other post retirement benefits
The determination of our obligation and expense for pension and other post retirement benefits is dependent on our selection of certain assumptions used by actuaries in calculating such amounts. Those assumptions, which are reviewed annually by the Company, are described in Note 26 to the consolidated financial statements (see the Directors Report and Accounts, a separate report to shareholders) and include, among others, the discount rate, expected long-term rate of return on plan assets and rates of increase in compensation, healthcare costs and other economic and demographic factors.
Tomkins operates pension plans throughout the world. Over 60 per cent of Tomkins employees are either in the UK or in the US. In the UK the majority of plans is based on final pensionable salary and there is a small number of defined contribution plans. A number of defined benefit plans is operated by a number of the Groups US subsidiaries. However, defined contribution plans, which include profit sharing plans, cover most of Tomkins US employees. Both defined benefit and defined contribution plans are operated for employees in the rest of the world.
We disclose our pension and post retirement benefits in accordance with accounting principles generally accepted in the United Kingdom. We currently apply Statement of Standard Accounting Practice No. 24 Pension Costs, under which the cost of pension plans and other post-retirement benefits are charged to the profit and loss account so as to spread the costs over the employees working lives with the Group. Actual results that differ from our assumptions are accumulated and amortised over future periods and therefore, generally affect our recognised expense and recorded obligation in such future periods. While we believe that our assumptions are appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our pension and other post-retirement obligations and our future expense.
As permitted by the transitional arrangements of Financial Reporting Standard No. 17 Retirement benefits (FRS 17), Tomkins has elected to defer its implementation. The disclosures required under the transitional arrangements are set out in note 26 to the consolidated financial statements (see the Directors Report and Accounts, a separate report to shareholders).
Valuation of long-lived assets and investments
We periodically review the carrying value of our long-lived assets and investments for continued appropriateness and when events and changes in circumstances occur that would more likely than not reduce the fair value of the Companys reporting units below their carrying value. This review is based upon our projections of anticipated future cash flows. These valuation techniques are based on a number of estimates and assumptions, including the projected future operating results of the reporting unit, discount rate, long-term growth rate and appropriate market comparable. While we believe that our estimates of future cash flows are reasonable, different assumptions regarding such cash flows could materially affect our evaluations. The Companys assessments of impairment of long-lived assets, including goodwill and purchased intangible assets, and its periodic review of the remaining useful lives of its long-lived assets, are an integral part of the Companys ongoing strategic review of the business and operations, and are also performed in conjunction with the Companys periodic restructuring actions. Therefore future changes in the Companys strategy could impact the projected future operating results that are inherent in the Companys estimates of fair value resulting in impairments in the future. Additionally, other changes in the estimates and assumptions, including discount rate and expected long-term growth rate, which drive the valuation techniques employed to estimate the fair value of long-lived assets and goodwill, could change and, therefore, impact the assessments of impairment in the future.
We accrue for environmental liabilities based on estimates of known environmental remediation exposures. The liabilities include accruals for sites owned and formerly owned by Tomkins. Our cost estimates include remediation and the long-term monitoring of relevant sites and may be affected by changing determinations of what constitutes an environmental liability or an acceptable level of remediation. An ongoing monitoring and identification process is in place to assess how the activities with respect to the known exposures are progressing against the accrued cost estimates, as well as to identify other potential remediation sites that are presently unknown. Environmental provisions totalling £8.1 million were included in the consolidated balance sheet at 1 January 2005.
We reduce the carrying value of stock based on estimates of what is excess, slow moving and obsolete. In addition, we reduce the carrying value of stock whose carrying value is in excess of net realizable value. These write-downs are based on current assessments of future demand, market conditions and related management initiatives. We would be required to further reduce the carrying value of this stock if, in the future, we determined that the market conditions and actual demands were less favourable than those projected and as a result stock was overvalued. The subsequent write-down would be charged to the income statement at the time such determination was made. If, in the future, we determined that the stock write-downs were overstated and stock was undervalued, we would recognise the increase to earnings at the time the related stock was sold. However, historically actual results have not differed materially from managements estimates.
Our tax charge is based on the profit for the year and takes into account tax deferred due to timing differences between the treatment of certain items for tax and accounting purposes. We provide for
deferred tax in accordance with accounting principles generally accepted in the United Kingdom. Deferred tax is provided in full on all liabilities. Deferred tax assets are recognised to the extent it is regarded that it is more likely than not that there will be suitable profits from which the future reversal of the underlying timing differences can be deducted and for this purpose Tomkins considers only future periods for which forecasts are prepared.
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 we believe that adequate provision has been made for such issues, there is a possibility that the ultimate resolution of such issues could have an adverse effect on the earnings of the Company. Conversely, if these issues are resolved favourably in the future, the related provisions would be reduced, resulting in a positive impact on earnings.
With effect from the first quarter of 2005, Tomkins will present its results in accordance with International Financial Reporting Standards (IFRS). Consequently, the 2004 Directors Report and Accounts is the last to contain the Groups financial statements prepared in accordance with UK GAAP.
We have been preparing for the transition to IFRS since 2003. Our work is progressing well and we are currently finalising the restatement of our 2004 results in accordance with IFRS.
We will be holding a webcast briefing for investors ahead of our first quarter results announcement at which we will present our results for 2004 restated in accordance with IFRS. Details of how to access the presentation will be available on the Companys website, www.tomkins.co.uk, nearer the time.
During 2005, our quarterly results announcements will contain comparative information for 2004 restated in accordance with IFRS and reconciled to the amounts previously reported under UK GAAP.
We appreciate that there is uncertainty in the market concerning the impact of IFRS and would welcome any questions that investors may wish to ask as the picture unfolds. In the meantime, we provide below a summary of the significant differences between UK GAAP and IFRS that are relevant to Tomkins.
While the adoption of IFRS will have no impact on the underlying cash and economic performance of our business, our reported results are likely to be impacted by the volatility introduced by the required adoption of a fair value accounting model and changes in the format of the income statement.
We have decided not to revisit the accounting for past business combinations. As a result, the carrying amount of goodwill recognised under UK GAAP on past acquisitions will not be restated and goodwill that was written-off to reserves will no longer be recycled to the income statement in the event of the disposal of the acquired business.
Goodwill recognised on acquisitions will continue to be measured using fair valuation techniques, but we will be required to recognise separately certain acquired intangible assets that would have been subsumed within goodwill under UK GAAP.
Going forward, goodwill will no longer be amortised but will be subject to an annual impairment test.
Research and development costs
Under UK GAAP, research and development costs are written off to the income statement in the period in which they are incurred. Under IFRS, we will continue to write off all research costs but development costs relating to new or substantially improved products or processes must be capitalised as an intangible asset if certain conditions relating to the feasibility of the project are met.
Due to the nature of our businesses, most of the Groups development expenditure results in incremental improvements to existing products and processes and will not therefore qualify for capitalisation under IFRS.
Derivatives and hedge accounting
Going forward, the derivative financial instruments that the Group uses to manage its currency and interest rate exposures will be recognised as assets and liabilities stated at their fair values at the balance sheet date and changes in their fair values will be recognised in the income statement.
While it is possible to use so-called hedge accounting to mitigate the volatility in reported profit that may result, there may be circumstances where it may be not be possible for us to apply hedge accounting to our current hedging activities.
We are therefore likely to experience some volatility in our income statement arising from our hedging activities.
Under IFRS, the basis of accounting for retirement benefits is broadly similar to that required by FRS17 Retirement Benefits on which we provide transitional disclosures in notes 20 and 26 to the financial statements (see the Directors Report and Accounts, a separate report to shareholders).
Share based payments
Under UK GAAP, we measure the cost of employee share schemes based on the intrinsic value of the awards. Under IFRS, the cost must be based on the fair value of the awards. Due to the nature of our existing schemes and the relevant transitional provisions, we do not expect there to be a significant impact on our restated 2004 results.
Under UK GAAP the 5.560 per cent voting convertible cumulative preference shares are presented as non-equity shareholders funds. Under IFRS, the carrying value of these shares must be split for accounting purposes between a liability component, representing the present value of the obligation to pay dividends in perpetuity, and an equity component, representing the fair value of the holders option to convert into ordinary shares. Dividends payable on the shares will be presented as finance costs in the income statement, rather than as an appropriation of profit.
Convergence with US GAAP
For the benefit of US investors, we will continue also to present our results in accordance with US GAAP.
Generally, there are fewer differences between IFRS and US GAAP than there were between UK GAAP and US GAAP. Differences in important areas such
as business combinations, goodwill and intangible assets, employee share schemes and hedging activities, will largely be eliminated either immediately or gradually over time. However, some differences will remain and we will provide an analysis of them when we announce our 2004 results restated in accordance with IFRS.
Operating income from continuing operations under US GAAP in 2004 was $477.1 million, an increase of 23.7 per cent, compared to $385.6 million in 2003. Net income under US GAAP was $377.7 million in 2004, a decrease of 11.5 per cent, compared to $426.7 million in 2003.
The differences between operating income under US GAAP and UK GAAP arise from the treatment of restructuring costs, goodwill, intangible assets, inventory, pension costs and share options. Net income under US GAAP is subject to additional adjustments relating to the treatment of costs associated with exit or disposal activities, capitalised interest, derivatives and deferred tax.
Shareholders equity under US GAAP was $2,923.1 million at 1 January 2005, compared to $2,697.0 million at 3 January 2004. The adjustments from UK GAAP reflect the cumulative effect of adjustments noted above.
A reconciliation of the reported financial information prepared under UK and US GAAP is shown on page 53.
The Directors are confident, on the basis of current financial projections and facilities available, that the Company and the Group have adequate financial resources to continue in operation for the foreseeable future. For this reason, the Directors continue to adopt the going concern basis in preparing the financial statements.
DETAILED CHANGES IN UNDERLYING SALES AND OPERATING PROFIT
ANALYSIS OF MOVEMENT IN SALES AND OPERATING PROFIT FROM 2003 TO 2004
Board of Directors
Board of Directors
Non-executive Chairman. Aged 58.
Appointed to the Board in August 1999 and became Chairman in June 2000. He is Chairman of KESA Electricals plc, PayPoint plc, Deputy Chairman of The Standard Life Assurance Company and a director of a number of other companies. He was formerly Finance Director of The General Electric Company, p.l.c. and Chairman of Britax International plc.
Chief Executive Officer. Aged 51.
Appointed to the Board in February 2002. Former 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 successful 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.
Finance Director. Aged 51.
Appointed to the Board in November 1999. He is a non-executive director of Vega Group PLC. He is a Chartered Accountant and a member of the ICAEW Financial Reporting Committee 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 in Arthur Andersen.
Independent Non-executive Director. Aged 63.
Appointed to the Board in December 2000. He is currently Chairman of Chloride Group PLC and Freightliner Limited. He is also a non-executive director of Cattles plc, Old Mutual plc and United Utilities PLC. He was Group Finance Director of Railtrack PLC from 1994 to 2000.
Independent Non-executive Director. Aged 68.
Appointed to the Board in November 2001. He is presently a non-executive director of Marks and Spencer Group p.l.c. and The Body Shop International 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 Ltd and an executive director of Diageo plc until he retired in October 2001.
Independent Non-executive Director. Aged 68.
Appointed to the Board in December 2000. He is Executive Chairman of 4Imprint Group plc and a non-executive director of Solvay SA. He spent most of his career at Laporte plc where he was Managing Director for five years and then Chief Executive for ten years. Subsequently he was Executive Chairman of Arjo Wiggins Appleton PLC. He was also non-executive Chairman of John Mowlem & Company PLC and SGB Group Plc.
Senior Independent Non-executive Director. Aged 73.
Appointed to the Board in June 2000. He is a non-executive director of The Carphone Warehouse Group PLC, Singapore Airlines, Virgin Atlantic Airways Limited and ITV plc, and is a senior advisor to Morgan Stanley. He retired in April 2001 from Lloyds TSB Group plc where he was Chief Executive for 13 years and Chairman for 4 years. He was also non-executive Chairman of NEXT Group plc from 1998 until May 2002.
Non-executive Director. Aged 62.
Appointed to the Board in August 1999. He is President of Wallach Capital Advisors which is based in Denver, Colorado and advises the Gates family on its interests in the Groups perpetual preference shares and other investments.
It is the aim of Tomkins to achieve, over time, best-in-class social, environmental and ethical standards in all of its businesses.
The Board and management of Tomkins recognise the important part that the Group and its businesses play in the communities in which they operate, their responsibilities and their impact on social, ethical and environmental matters.
In recognising these responsibilities, Tomkins is mindful of its obligations to its shareholders, employees and customers to provide products and services that customers are prepared to buy, whilst continuing employment opportunities and providing an acceptable return to shareholders.
Within this framework, Tomkins has taken a number of initiatives that have advanced these principles. These include lean manufacturing which has seen, amongst other things, cost-savings through a reduction in the use of raw materials, levels of waste and use of energy, together with an improvement in health, safety and environmental performance in many of the Groups facilities. In the design, engineering and production of the Groups products, consideration is given to the environmental impact of the manufacture and use to which such products are put. The Board of Tomkins encourages such policies within its businesses.
This report sets out a summary of the work the Group has undertaken during the year consistent with the principle of continuous improvement, and highlights the main achievements.
Socially Responsible Investment
It is the aim of Tomkins to achieve, over time, best-in-class social, environmental and ethical (SEE) standards in all of its businesses, and progress continues to be made, particularly in the areas of health, safety and environment (HSE). In support of the Groups HSE policies and procedures, an HSE database is under development that will streamline the process for data collection, storage and reporting with multi-user access to track HSE performance as well as the ongoing HSE audit process. It will have two significant benefits: it will assist in expediting the resolution of outstanding audit findings, and will free-up skilled audit staff so they can conduct more on-site audits, at the same time as minimising the time spent on administrative functions.
The Board regularly takes account of the significance of SEE matters and how these impact the Groups businesses and value. The Board ensures that appropriate and effective systems are in place to manage significant risks. This manifests itself in a number of ways. At the quarterly business reviews conducted by senior management, the significant risks facing each business are considered and strategies to mitigate these risks are discussed and agreed. Periodically, the Board receives a summary of the Group Risk Profile that sets out the most important risks facing the Group and its businesses, which may have an impact on the short, medium and long-term value of the Group. These risks cover a whole range of issues including pricing pressures, growth, investment, currency exposures, products, strategies for developing countries and any failure adequately to identify and manage significant environmental, health and safety issues. Each of the risks is assessed for its impact on profit and cash flow, the likelihood of its occurrence, and the scope for mitigation or reduction of the risk. The risks are kept under review until they are either wholly mitigated or no longer represent a significant risk to the Company and its short and long-term value.
Other important areas where SEE issues are taken into account include major capital expenditure proposals considered by the Board, where operating businesses are required to take account of, and report on, SEE matters where there is any potential impact. The Business Risk Assurance group has included in its overall business risk assurance
process specific requirements to examine and assess SEE matters in its list of responsibilities. The results of the work of the Business Risk Assurance group are reported quarterly to the Audit Committee, which, in turn, reports to the Board.
Code of Conduct and Ethics & Human Rights Policy
Tomkins Code of Conduct and Ethics (the Code) and Human Rights Policy form the basis on which uniform standards are applied across the Group in all countries where the Group operates.
Code of Conduct and Ethics
The Code sets out a series of policies and principles of conduct to be followed by all Tomkins companies and applies to all Directors, officers and employees, all of whom are expected to conduct Company business with integrity and in compliance with the laws of the countries in which they operate. The Code covers a number of important areas including competing fairly and complying with anti-trust and competition laws, employee health and safety laws and environmental laws. It also reaffirms Tomkins commitment to fair treatment of all employees, ethical and lawful behaviour and sets out some general principles, which are important in dealing with suppliers and customers, and with governments and government agencies. The Code emphasises the importance of employees protecting the Companys intellectual property. Any waivers to the Code require the approval of the Board and will be published on the Companys website. During the year, no waivers have been either sought or granted.
Tomkins Human Rights Policy has established a number of principles that are applied across the Group to all companies, no matter where they operate. These principles cover anti-discrimination, employee rights (in the areas of health and safety, wages and working hours), prohibition of child labour and social responsibility (covering environmental impact and community relations). Employees are expected to maintain the highest standards in conformity with the principles.
A copy of the full text of the Code (in several languages) and the Human Rights Policy can be found in the corporate governance area on Tomkins website or a printed copy is available by application to the Company Secretary at the Companys registered office. From time-to-time, the Board reviews the Code and Human Rights Policy to ensure that they reflect best practice. During the year, a paragraph was added to the Code setting out Tomkins whistleblowing procedure.
Senior management throughout the Group are required to confirm annually that they and their businesses have complied with the principles set out in both the Code and Human Rights Policy and to report any breaches. For 2004, no breaches were reported by any of the operating businesses. Adherence to the Code and the Human Rights Policy now forms part of the business risk assurance monitoring process. The Board does not believe that an independent external process of verification is required at this time, but will keep this under review.
Health, Safety and Environment
The priority and importance placed by the Board and management of Tomkins on HSE matters is driven by a belief and experience that our commercial success and HSE performance are compatible objectives. It was because of the importance placed on HSE matters that the Health, Safety and Environment Committee was formed by the Board in January 2003.
In recognising its responsibilities to its employees and the communities in which Tomkins operates, the Groups approach to health, safety and the environment is one of continuous improvement. Key to the maintenance of the standards the Group sets for itself is the work of the Health, Safety and Environment Committee of the Board and a supporting team of specialist professionals (HSE team) operating throughout the Group. They have been active in guiding operating businesses to achieve the highest internationally recognised standards including Occupational Health and Safety Assessment Series (OHSAS) 18001 and ISO 14001 or equivalent. The OHSAS standard has been created to allow companies to develop systematic controls relating to their health and safety risks and to seek external accreditation of the HSE management system.
Policy, Objectives and Compliance
The intention of Tomkins HSE policy is to provide a safe and healthy workplace for all employees and to minimise the impact of the Groups operations on the environment. We are committed to the highest HSE standards consistent with regulatory requirements and best management practices. The Groups businesses are required to operate their facilities consistent with this commitment. All employees have a part to play in that commitment and they are encouraged and expected to do so.
The Groups policies and objectives are translated by management into specific action plans for each operational site. All business groups are encouraged to set realistic HSE targets and objectives within their annual business plans in order to pursue a strategy based on continuous performance improvement. The HSE activities of individual businesses in the Group are monitored by the HSE team which carries out regular performance audits. The audit reports arising are provided to management who are responsible for correcting any deficiencies that come to light as a result of the audit and a summary is provided to the HSE Committee. At every quarterly business review with senior management, an analysis of incidents of industrial accident and environmental exposure is considered and discussed.
The Tomkins Annual Bonus Incentive Plan for management is focused on a sharing of a proportion of Group after-tax profits after deduction of a charge for the cost of capital. An intrinsic feature of the Groups ability to generate sustained value is the need to maintain high standards of HSE controls in all operating businesses worldwide. There is much evidence that actions to improve standards of HSE are frequently financially beneficial to the Group. Furthermore, high standards of HSE are often
paralleled by high standards of product quality control and customer service. For these reasons, the Board does not believe it is necessary to identify separately the performance on HSE matters as a specific criterion in determining bonus payments.
The Health, Safety and Environment Committee receives detailed quarterly reports from the HSE team on the current status of all matters which require attention, including a description of what action has been taken to address those matters and the timetable to completion. The adoption of international or comparable internal standards, tailored to the individual requirements of a growing number of operating businesses, increases the Committees confidence in the effectiveness and accuracy of the reporting systems and procedures.
Health, Safety and Environment Committee
The Committee plays a key role in the Groups HSE activities and is comprised of two non-executive Directors and the Chief Executive and normally meets at least four times a year. In 2004, there were meetings and inspections at Balsareny, Spain; Pontarlier, France; Siloam Springs, Arkansas; Toluca and Atlacomulco, Mexico. Meetings always take place at one of the Groups facilities and normally form part of a two-day programme during which the Committee will, where possible, visit more than one site. Site visits enable the Committee to gain an understanding at first hand of HSE activities of business units and the issues facing them. This process allows the Committee to maintain a strong and continuing overview of the way the Groups HSE policies and objectives are being implemented.
Amongst the Committees responsibilities is the determination on behalf of the Board of the framework or broad policy and objectives in the areas of HSE and to propose any amendments to existing policies and objectives for approval by the Board. The Committee has formal terms of reference which can be found in the Corporate Governance section of the Companys website. The Committee reports regularly to the Board on its activities, which assists the Board in making informed decisions about the businesses of the Group, particularly relating to any proposed new investment in manufacturing facilities and the HSE implications thereof. The quarterly reports received by the Committee also highlight current areas of HSE focus and improvement and any event or potential breach of regulatory requirements. Any potentially serious breach is communicated immediately to the Chief Executive and the Committee. This enables the Committee to monitor fully the compliance record of each business unit and ensure corrective action is taken in a timely manner. Of the environmental deficiencies found by regulators or discovered during audits in 2004, the substantial majority related to reporting deficiencies. On health and safety, the majority of the Occupational Safety and Health Administration (OSHA) citations and informal inquiries were resolved very quickly.
Tomkins places a great deal of importance on HSE matters in its acquisition processes. Where appropriate, external environmental advisers are employed to review and assess any environmental risks to which the Group could become exposed if an acquisition proceeded. In addition, a review is made of an acquisition candidates environmental management systems, relationships with regulatory officials and general level of respect and care shown for the environment. In the due diligence process, health and safety is also a key area for which a full review is undertaken including the level of compliance with all applicable laws and regulations. Environmental due diligence was performed at all acquired facilities during the year to ensure that no outstanding remedial obligations were assumed unless properly defined and reserved and that any compliance issues were properly identified prior to acquisition and addressed promptly. Where necessary, an indemnity is sought from the vendor to cover any potential liabilities, but it is possible that a potential acquisition would be rejected if the HSE risks were considered to be too high. Tomkins may require a vendor to undertake health, safety or environmental improvements before a transaction is concluded.
Work has continued during the year to build an integrated approach to the Groups HSE activities. This has been supported by the development of Tomkins HSE intranet website which is available to the Groups HSE community. It offers a wide range of information and assistance in many important areas including training. The HSE database mentioned earlier in this report is expected to be fully operational in the second half of 2005.
Two major HSE conferences were held during the year for Tomkins Group HSE professionals: one in Europe (Vaals, The Netherlands) and the other in North America (Nashville, Tennessee). They provided a forum in which experiences could be shared and issues of common interest could be discussed. The conferences also provided opportunities for training and bringing practitioners up to date with changes in HSE rules, regulations and laws. An Asian/Australian HSE meeting is also planned for 2005. Tomkins has continued to encourage operating businesses to seek accreditation to internationally accepted standards.
The emphasis on training continues to remain an HSE priority with a whole range of programmes provided to employees, from basic plant-based programmes to the more advanced training for HSE professionals.
Work has continued during the year to build an integrated approach to the Groups Health, Safety and Environment activities.
There were many notable health and safety achievements throughout the Group during the year, and the five summarised below are representative of those achievements:
A large number of awards were received by our operating businesses from local, regional and national organisations, reflecting the attainment and maintenance of high standards in health and safety throughout our facilities.
There are numerous examples throughout the Group where changes to processes can yield environmental, health and safety and financial benefits in one operation. As an example, changes to more efficient lighting installations with longer bulb life can improve plant lighting and also bring reductions in energy use and costs. These lighting units can also be disposed of as general refuse, unlike the metal halide fixtures which contain mercury and require a licensed waste hauler for disposal. A total of 19 of our facilities are working with third parties on lighting efficiency projects which have both an environmental and health and safety gain for the businesses.
Environment and Environmental Management Systems
At the end of 2004, 92 of the Groups 140 facilities had adopted an Environmental Management System (EMS), of which 65 facilities were ISO 14001 accredited (2003: 42). A further nine facilities are currently ISO certified but not registered. A further 18 facilities have alternative EMSs in place (these facilities have implemented fully functional EMSs that were not based on the ISO 14001 Outline but achieve similar results and are not intended for ISO certification); the remainder of the facilities (except those facilities opening or closing during 2005) are expected to achieve ISO 14001 Compliant Status in 2005 (these facilities are implementing an ISO 14001 EMS but have not undergone a formal registration audit).
There were a number of notable environmental achievements during the year where targets were either met or exceeded, and, by way of example, some are summarised below:
Tomkins recognises its responsibilities to the wider community in which businesses operate to provide balanced and targeted charitable assistance.
There are a number of continuous improvement projects run by operating businesses which continue to yield year-on-year gains in environmental and financial performance.
Targets: facts and figures
All of the businesses have established a range of HSE Key Performance Indicators (KPIs) within their current business plans to monitor and assess HSE and environmental performance on an ongoing basis. The Health, Safety and Environment Committee monitors the KPIs on a regular basis to ensure that HSE focus and continuous improvement in performance are being delivered by all business groups. Business risk assurance audits are conducted by Tomkins own professionals together with the site management teams, to ensure that processes and controls are in place to maintain compliance with Group policy and the applicable local and national HSE legislation. Examples of the KPIs used include incident/accident and severity rates, raw material wastage and energy consumption per applicable production unit, and compliance with Tomkins health, safety and environment policy and local environmental legislation.
Trends on accidents within Tomkins manufacturing plants and distribution facilities are measured using OSHA standards, since the majority of the Groups operations are based in North America. Taking Gates Corporation, which is broadly representative of the majority of the Tomkins Group, the accident rate and the resulting lost days, and the severity rate are tracked in all individual facilities. In 2004, as part of the Gates HSE Excellence Model, a target incident rate of 2.0 (meaning 2 reportable incidents per 100 workers) was set. The outturn for the incident rate for the year was 2.24 (2003: 3.68) a reduction of over 39 per cent during the year and marginally above the target. The target severity rate (average number of lost workdays per incident) is zero and for 2004 it was 24.32 (2003: 30.46) a reduction of over 20 per cent during the year and has continued to decline since 2001. Non-Gates businesses also experienced an improvement in these KPIs during the year. The results were affected by the performance of businesses acquired in recent years, but improvements in their performance are expected in the next few years.
At present, waste generation is measured in all Gates facilities as part of the HSE Excellence Model. In addition, this data is collected monthly for European, Asian & Australian operations, as well as the majority of North American operations. Over time, aggregation of such measurements will increase to cover more of the Group. However, there is no reason to believe that the results achieved in these regions are not indicative of the rest of the Tomkins Group. Actual tonnes of total waste and waste to landfill are tracked. Waste is defined as any goods being shipped off-site for either disposal or for other beneficial use besides the intended original end-product function, that is, any non-saleable good or product. Waste volume is then compared to net production volume (tonnes of good product manufactured and shipped to warehouse or to customers or, for distribution centres, tonnes of product shipped). Due to the significant amount of waste inherent in some production processes (e.g. grinding dust of belts, or swarf in hose coupling production), for the purpose of evaluation, waste indices are calculated as a percentage of net production. This enables performance to be benchmarked. The Total Waste Index is rated as tonnes of total waste per tonne of net production. The Landfill Waste Index is rated as tonnes of waste to landfill per tonne of net production. Indices calculated from the aggregated data for 2003 and 2004 show a total waste reduction of 5.9 per cent with a reduction in landfill waste of 30.1 per cent. Since land-filling is the worst method of waste disposal, the focus on reduction has been on this, while at the same time not losing sight of total waste reduction. The target is to show continuous year-on-year reduction of waste. Once the Group has waste as a KPI measurement worldwide, specific percentage improvement targets will be set. Energy consumption data is also aggregated for many operations of Gates, but no detailed analysis is yet available.
Tomkins has well-established guidelines that determine the nature of organisations to which support is given. Tomkins recognises its responsibilities to the wider community in which its businesses operate to provide balanced and targeted charitable assistance. The charities given assistance cover a wide range of activities including health and welfare, education, civic and community projects, culture and the arts. Tomkins prefers to spread its charitable giving over many smaller local charities that usually do not have
the organisation, structure or resources to compete with the marketing skills of the larger high-profile charitable bodies. Each year donations are made to hundreds of charities. Tomkins makes further donations through advertising, sponsorship, products for prizes and volunteers or other in-kind support.
In the UK, applications are normally made to Tomkins corporate office in London. Requests for donations are made from a variety of charities and Tomkins tries to respond positively to as many requests as possible, provided they come from small local charities and are registered with the Charities Commission.
In the US most requests for support are made locally and donations can be made in a number of ways. The Tomkins Foundation makes matching gifts, foundation gifts and contributions to United Way, an external charitable organisation that distributes funds to charities. Tomkins US subsidiary companies also make donations to United Way. In addition to their charitable giving activities, the businesses also run a range of initiatives for the benefit of local communities. These include allowing employees time off to participate in community activities and other charitable support. With the co-operation of certain of Tomkins US companies, some local charities will designate a casual day for a cause, whereby companies allow their employees to dress casually, to enable funds to be raised for charity. Similar charitable initiatives have taken place in Europe, Asia and Australia. Examples of the many organisations to which help was provided during the year include the American Heart Association, the American Cancer Society and the Museum of Nature and Science. At the plant level, donations were also made to March of Dimes (an organisation that helps prevent birth defects and infant mortality) and support was given to Drug Awareness Resistance Education (DARE) programmes which aim to keep children off drugs and Relay for Life Walk for Cancer. Some US businesses use their industrial and commercial expertise to support charities, and Habitat for Humanity receives the support of Lasco Fittings (a lead sponsor) and Philips Products, who donate doors and windows.
There was widespread company and employee support in many countries for giving blood and in the US this was done in co-operation with local Red Cross organisations. Free influenza immunisation is offered by many of our businesses to employees.
In response to the Asian tsunami disaster in December 2004, which had such a devastating effect on many countries in the Indian Ocean area, Tomkins decided that it would match donations made by employees up to a total of US$1 million. The Group will donate the sums raised to a panel of charities closely associated with the ongoing relief efforts.
Total charitable donations during the year are shown in the Directors Report and Accounts, a separate report to shareholders.
No donations were made to any organisation in which any of the independent non-executive Directors serves in an executive capacity.
It is Tomkins practice not to use shareholders funds for the purpose of making political donations either in the form of cash donations or other in-kind benefits and consequently we have not sought shareholder approval to make such donations.
ACCIDENT INCIDENT RATE
ACCIDENT SEVERITY RATE
The Board promotes the highest standards of corporate governance within the Company through its support and application of the Principles of Good Governance set out in Section 1 of the Combined Code.
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, 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 auditor 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.
There is a clear division of responsibility between the Chairman and the Chief Executive Officer, 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.
The Chief Executive Officers primary role is the running of the Companys businesses and the development and implementation of strategy.
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 terms of reference for all Board Committees can be found on the Companys website 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 principal Committees and a brief description of their terms of reference and their duties are as follows:
Details of the Audit Committee and its work can be found on page 46.
The Remuneration Committee, which meets at least twice a year and on other occasions when circumstances require, comprises independent non-executive Directors and has responsibility for determining Company policy on executive remuneration for approval by the Board. It also determines specific remuneration packages and compensation packages on employment or early termination of office for each of the executive Directors of the Company. The Committee takes independent advice from consultants as and when required. All decisions of the Remuneration Committee in respect of remuneration packages of executive Directors are referred to the Board. No executive Director takes part in any discussion or decision concerning his own remuneration.
The Nomination Committee makes recommendations to the Board on all proposed appointments of Directors through a formal and transparent procedure.
Health, Safety and Environment Committee
The Health, Safety and Environment Committees principal role 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 health, safety and environmental local codes of practice, legislation and relevant industry practice.
General Purposes Committee
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 Committee deals principally with day-to-day matters of a routine nature and matters delegated to it by the Board.
Under the direction of the Chairman, evaluations of the effectiveness of the Board, its Committees and individual Directors were conducted during the year. The evaluation processes built on the experiences of the previous years Board evaluation and concentrated on six key elements: (i) the optimum mix of skills and knowledge amongst the Directors; (ii) clarity of goals and processes; (iii) tailoring the evaluation to the specific circumstances of Tomkins; (iv) the culture of candour that encourages constructive evaluation; (v) regular reviews of assessment criteria; and (vi) full disclosure of procedures and criteria to the Board.
The results of the second Board evaluation were that progress continues to be made in improving the effectiveness of the Board and that a number
Summary Directors report
of small changes to processes and procedures may improve performance even further.
This was the first year that a formal evaluation of Board Committees has taken place. The Committees evaluated were the Audit Committee, the Remuneration Committee and the Nomination Committee. Suggestions were made in respect of improvements to reports to the Audit Committee (eg corporate governance) and to the Remuneration Committee (eg the latest developments in executive remuneration).
Individual evaluations of both the executive and non-executive Directors were conducted by the Chairman. The performance of the Chairman is ordinarily reviewed annually by the Board in his absence, led by the senior independent Director.
The Summary remuneration committee report sets out a summary of the Companys remuneration policy and related information.
The Board, through the Operating and financial review, seeks to provide a detailed understanding of each business of the Group. In conjunction with the Chairmans statement, the Chief Executives statement, the Overview of principal markets and the Summary Directors report, the Board seeks to present a balanced and understandable assessment of the Companys position and prospects.
The above statements are included within this Annual Review.
The Company places a high degree of importance on maintaining good relationships and communications with both institutional and private investors and ensures that shareholders are kept informed of significant Company developments.
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 New York Stock Exchanges listing standards, as required by section 303A.11.
Tomkins is a world-class global engineering and manufacturing group with market and technical leadership across its three businesses: Industrial & Automotive, Air Systems Components and Engineered & Construction Products.
Results and dividends
The summary audited financial statements for the year ended 1 January 2005 are set out on pages 48 to 50. Profit attributable to shareholders is £172.6 million (2003: £171.8 million).
A review of the businesses, activities and future developments of the Company and its subsidiaries is given on pages 2 to 33 and should be read as part of this report.
The Directors recommend an ordinary final dividend of 7.77 pence per ordinary share, to be paid on 26 May 2005 to ordinary shareholders on the register as at the close of business on 22 April 2005. Together with the ordinary interim dividend of 4.83 pence per share paid on 12 November 2004, this makes a total dividend for the year of 12.60 pence (2003: 12.0 pence).
A list of the Directors of the Company at the year-end appears on page 35.
The Annual Review was approved by the Board on 23 February 2005 and signed on its behalf by
N C Porter, Secretary
Membership of the Remuneration Committee and Advisers (unaudited information)
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 organisation 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 judgement. Members of the Committee who served throughout the year were:
K J Minton (Chairman)
N N Broadhurst
J M J Keenan
There were no changes to the membership of the Committee during the year.
Statement of Companys policy on Directors remuneration (unaudited information)
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 calibre. 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.
The Board recognises 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. In order to create the necessary entrepreneurial impetus within an organisation, 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 in order to attract, retain and motivate executives, and 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 more closely aligns the interests of shareholders and management whereby executives only receive substantial rewards when they have created high value in the business.
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 twelve months. On appointment, a longer notice period may apply, but this will reduce over time to the normal twelve months notice period.
Performance graph (unaudited information)
The graph set out below plots Total Shareholder Return on a holding in the Companys shares for each of the past five years ended 31 December, measured against the performance of the FTSE Engineering and Machinery Index. This index was chosen because its major constituents are, like Tomkins, moderately diversified engineering groups with a significant manufacturing presence outside the home UK market.
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. 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.
Retirement benefits (audited information)
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 per cent 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 the year ended 1 January 2005, this amounted to £300,000 (year to 3 January 2004 £293,000) for James Nicol, and £144,000 (year to 3 January 2004 £141,000) for Ken Lever.
TOTAL SHAREHOLDER RETURN
ELEMENTS OF REMUNERATION (AUDITED INFORMATION)
During the year no Director exercised any options and accordingly no gains or losses were made on exercise (year to 3 January 2004 nil).
Membership, appointment and experience
The Audit Committee comprises three independent non-executive Directors who have served on the Committee throughout the year. The members of the Committee are Norman Broadhurst, who was appointed to the Committee, as Chairman, in December 2000, Kenneth Minton, who was also appointed in December 2000 and Jack Keenan, who was appointed in November 2001. No limitation on the term of office is specified for members of any of Tomkins Board Committees.
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 US Securities Exchange Act of 1934 and section 303A of the New York Stock Exchanges Listed Company Manual.
The Audit Committee meets at least four times a year and on other occasions when circumstances require. The quorum for a meeting of the Committee is two members. The Finance Director and representatives from the independent auditor and the internal auditor attend meetings under a standing invitation.
Work of the Committee
The Committee has established an agenda framework which sets out all of the operational duties and responsibilities outlined in the Committees terms of reference. The areas covered are Corporate Governance, Business Risk and Internal Audit, confidential sessions with the Audit Committee in the absence of Directors and Company executives, Financial Reporting and Independent Audit. The Chairman of the Audit Committee meets periodically with the Independent Auditor to discuss progress on the audit and the major points to arise, and has the opportunity to assess the effectiveness of the process. The Committee is also able to assess the effectiveness of the process through reports made to the Committee by the Independent Auditor.
During 2004 other important issues considered included regular reviews of the internal control systems, Group risk profile, Group tax reports, the rules governing the employment of present and former employees of the independent auditor, audit partner rotation, whistleblowing procedures, updates on compliance with the Combined Code, review of tax services provided by the independent auditor and update of IT systems.
There is a close liaison with the Business Risk Assurance and Internal Audit function which 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. Business Risk Assurance is considered at the quarterly reviews with the businesses where all of the major risks are discussed.
In determining its policy on the extent of non-audit services provided by the independent auditor, the Committee has taken account of the rules of the US Securities and Exchange Commission which regulate and, in certain circumstances, prohibit the provision of certain types of non-audit services by the independent auditor. Non-audit services are ordinarily put out to tender and require the approval of the Chairman of the Audit Committee above certain levels. 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 auditor. Certain other rules were considered and adopted by the Committee during the year and the Committee believes that, taken together, the adoption of these rules and regulations provides adequate protection of auditor independence. All fees proposed by the independent auditor must be reported to the Audit Committee and prior approval is required from the Chairman of the Audit Committee for any projects above specified limits. With the approval of the Board, the Committee has established guidelines for the recruitment of employees or former employees of the independent auditor.
During the year, the Committee and the Board approved the whistleblowing procedure 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 Sarbanes-Oxley Act of 2002. No reports were received by the Committee during the year.
Shareholders are given the opportunity at the Annual General Meeting to ask the Chairman of the Committee questions on this report and any other related matter.
To the members of Tomkins plc
We have examined the Annual Review which comprises the summary Directors report, summary remuneration report, profit and loss account, balance sheet and cash flow statement.
This report is made solely to the Companys members, as a body, in accordance with section 251 of the Companies Act 1985. Our work has been undertaken so that we might state to the Companys members those matters we are required to state to them in an auditors report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Companys members as a body, for our audit work, for this report, for our audit report, or for the opinions we have formed.
Respective responsibilities of Directors and auditors
The Directors are responsible for preparing the Annual Review in accordance with applicable United Kingdom law. Our responsibility is to report to you our opinion on the consistency of the Annual Review with the full annual accounts, the Directors report and the remuneration committee report, and its compliance with the relevant requirements of section 251 of the Companies Act 1985 and the regulations made thereunder. We also read the other information contained in the Annual Review as described in the contents section, and consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the Annual Review.
Basis of opinion
We conducted our work in accordance with bulletin 1999/6 The Auditors Statement on the Summary Financial Statement issued by the Auditing Practices Board for use in the United Kingdom.
In our opinion, the Annual Review is consistent with the full annual accounts, the Directors report and the remuneration committee report of Tomkins plc for the year ended 1 January 2005 and complies with the applicable requirements of section 251 of the Companies Act 1985, and the regulations made thereunder. We have not considered the effects of any events between the date on which we signed our report on the annual accounts, 23 February 2005, and the date of this statement.
Deloitte & Touche LLP
Chartered Accountants and Registered Auditors
18 March 2005
Consolidated profit and loss account
Consolidated cash flow statement
Reconciliation of net cash flow to movement in net debt
Annual Review 2004 | 49
Consolidated balance sheet
FOR THE YEAR ENDED 1 JANUARY 2005