Principal risks and uncertainties

“During the year we created the position of Chief Risk and Control Officer for the Group.”

Risk can be considered either as downside risk (the risk that something can go wrong and result in a financial loss or financial exposure for the Group), or volatility risk (the risk associated with uncertainty, meaning there may be an opportunity for financial gain as well as potential for loss).

This document contains certain forward-looking statements, which involve risk and uncertainty as they relate to future events and circumstances. Tomkins operates globally in varied markets and is affected by a number of risks inherent in its activities, not all of which are within its control. This section highlights specific areas where we are particularly sensitive to business risk. Our financial condition or results of operations could be materially adversely affected by any of these risks. Additional risks not currently known to us, or risks that we currently regard as immaterial, could also have a material adverse effect on our financial condition or the results of operations.

As part of the Performance Management Framework of the Group, each business considers strategic, operational, commercial, and financial risks and identifies risk mitigation actions. Business unit managers maintain Risk Profiles, including mitigation strategies, which are updated at least annually. Periodically, each business unit is subject to a review, facilitated by the office of the Group’s Chief Risk and Control Officer, to validate the business unit’s Risk Profile. A review of risks and exposures in each business is also performed quarterly as part of the Business Review process.

At the Group level, the Chief Risk and Control Officer performs a quarterly risk assessment, with the likelihood of the identified risks occurring and their potential financial impact considered by the Group’s senior management. Mitigating actions are identified for each risk and the effects of these actions are also reviewed and monitored quarterly for the most significant risks. At least annually, the risk assessment and management’s response plans are independently considered by the Group Internal Audit (IA) function. The Group Risk Profile and management’s responses to those risks are then formally presented to the Audit Committee of the Board of Directors accompanied by IA’s evaluation of risk response.

The principal risks and uncertainties faced by the Group, which could cause the Group’s actual results to vary materially from historic and expected results, are set out below:

– Operating in global markets subjects the Group to risks associated with changes in economic conditions. The current economic malaise centred on US credit markets may spread globally, dampen demand, increase price pressure, reduce margins and accelerate customer consolidation. These pricing pressures and declining demand risks are particularly acute in our housing, commercial construction and automotive markets. As discussed more fully elsewhere in this document, the Group’s businesses have responded aggressively to mitigate these risks, principally through plant rationalisations, lean and other cost base reduction initiatives, strategic sourcing programmes, and development of non-traditional market and adjacent space expansion plans. However, a prolonged dampening of demand could have an adverse effect on the Group’s financial results.

– The Group’s businesses compete globally for key manufacturing inputs and they may be adversely affected should the availability of certain raw materials, energy or other key components be disrupted by rising demand from rapidly developing economies. The purchasing policies and practices of the Group’s businesses seek to address this risk through multiple source strategies, joint procurement initiatives where practicable, and expanded geographic diversity in buying.

– Elsewhere in this document the Group’s recent activities and plans with regard to restructuring, rationalisation, investments and acquisitions are discussed. These represent important steps in the implementation of our plans for each business to expand in attractive markets and improve its competitive position through improved manufacturing efficiencies and reductions in its cost base. However, generating the expected returns from these activities and investment decisions, particularly those involving relocations to low-cost countries with elevated risk of political instability, and investment in non-traditional markets, involve higher levels of execution risk. Poor or failed implementation of these plans could have a significant adverse impact on the Group’s results. The Group replies to this risk with a thorough Investment Project Proposal (IPP) process which involves, among other things, return sensitivity modelling and specific project risk identification and action plans. Major project and IPP progress is also monitored quarterly as part of the regular Business Reviews. With regard to acquisitions, a rigorous, prescribed due diligence approach with an experienced team, combined with formal 100 day integration plans, is employed.

– The automotive industry is affected by macro-economic conditions driven by changing consumer demand and preferences. The Group’s exposure to the continuing fortunes of General Motors, Ford and Chrysler and the penetration challenges presented by the new US domestic manufacturers may result in lost market share and/or lower profitability. This risk has been addressed through the continuous monitoring of our financial exposure to these customers, ongoing but focused/disciplined investment in support of these customers’ more competitive platforms, particularly those addressing green concerns through fuel efficiency and emissions, and our emphasis on Industrial and Aftermarket expansion to diversify our customer base.

– The inability to sustain margins due to increasing costs of raw materials, energy and other inputs which we are unable to pass on to customers, represents another significant risk to the Group. Management’s response to this risk involves, among other things, the aforementioned lean and strategic manufacturing initiatives, multiple source and geographically diverse procurement policies, strategic customer pricing reviews, and expanded investment in low-cost countries, the latter principally to counter the competitive threat from low-cost producers in Central and Eastern Asia.

– If the Group is unable to timely identify, attract and retain excellent management and executive talent, it may not be able to effectively implement its business strategy, or it may experience delays in the development of, or face difficulty in selling, its products and services. Tomkins believes its future success depends in large measure on its ability to retain and develop its existing management talent. To that end we employ a number of tactics such as formalised succession planning, management internships, competitive compensation schemes which align manager and shareholder interests, periodic 360 degree performance evaluations, and bespoke management training through Tomkins College, the Group’s executive development programme presented in league with the highly regarded Indiana University School of Business in the US. These initiatives, along with the successful execution of the Group’s strategic plan, are viewed as the main attractions for external management talent.

– The nature of the Group’s products mean that we face an inherent risk of product liability claims if failure results in any claim for injury or consequential loss. Fewer suppliers due to vendor consolidation and a less qualified offshore supplier base increase the likelihood of receiving inbound defective materials. This increases the risk of product failure and resultant liability claims. The businesses in the Group seek to mitigate this risk by employing thorough qualification procedures for new suppliers, implementing rigorous quality programmes in our plants, particularly for inbound materials, and making strategic exits from particularly litigious markets.

– Exposure to the US dollar presents significant risk to the Group. Translation of much of the Group’s businesses, which employ the US dollar as the functional currency, impacts the perception of the Group’s underlying financial strength as the dollar weakens against sterling, the Group’s reporting currency. Additionally, genuine economic risk is heightened on cross-border transactions denominated in US dollars as the world’s major currencies strengthen against it. The Group closely monitors all cross-border positions and hedges as appropriate on all currency exposures to address the latter risk and will be adopting the US dollar as its reporting currency and will redenominate its share capital in 2008 to address the translation issue. Operationally, the Group has a number of initiatives in place to capitalise on its substantial US manufacturing base and the export opportunity presented by the recent weak US dollar.

– Tomkins operates in highly competitive markets and the failure to deliver products within acceptable timeframes could have an adverse effect on the business. Customer driven reductions in lead times, carrier consolidation, reduced capacity from driver shortages, fuel availability/cost, and longer supply chains concomitant sourcing from low-cost countries all may impact service levels resulting in lost share or missed opportunities. Additionally, short lead time horizons in many of our businesses exposed to the US consumer can impair forecasting accuracy. This may result in the inability to predict abrupt changes in our US driven end markets. The Group’s businesses continue to monitor order backlog, intake and lead indicators, while optimising inventory stocking levels, refining forecasting techniques and maintaining close customer contact to mitigate these risks.