Coats Regulatory News (COA)

Risk

Nature of Risk

Action/Mitigation

Employee defined benefit obligations - accounting impact and regular funding

The Group has a number of employee

defined benefit arrangements in place, the

most significant being:

> three UK pension schemes: Coats, Brunel

and Staveley; and

> the Coats North America plan.

The UK schemes can impact the Group on various levels. Given their size, and particularly that of the Coats Pension Plan, these schemes can have a material impact on the Group's reported results. Under IAS19 the Consolidated Income Statement includes an administrative charge and a finance cost relating to these schemes and variations in these charges can give rise to fluctuations in reported earnings. In addition, changes in the IAS19 accounting surpluses and deficits in the schemes impact the level of shareholders' funds.

When funding deficits arise this can have a cash flow impact. The net accounting and funding positions of these arrangements are particularly sensitive to real discount rates and the investment performance of any segregated assets.

Managing the funding position of the three UK pension schemes is the primary responsibility of their respective trustees. The strategy followed by each trustee targets the long term funding position of its scheme. Each has used corporate bonds to fund short term liabilities. Equities and other return-seeking assets are held for the longer term. These provide a natural hedge respectively for short term obligations and long term inflation risk. Coats has in place a short term inflation hedging programme. In addition, the trustees have implemented formal de-risking strategies with thresholds for switching return-seeking assets into bonds.

The 2012 funding valuation for the Coats UK Pension Plan was completed during 2013 and a scheme deficit of £215 million was agreed. As of November 2013 a 14 year recovery plan commenced and the rate of contributions increased from that date from £7 million per annum to £14 million per annum. In addition Coats plc agreed to provide the scheme with a parent company guarantee.

The Brunel scheme is in the process of completing its 2013 triennial valuation. There was no deficit in 2010 and, hence, there is currently no recovery plan. However, the Board expects a deficit and a recovery plan to result from the current exercise.

The Staveley scheme last had a triennial valuation as at 5 April 2011. The 2011 valuation resulted in a one-off payment of £5 million being made to the scheme in July 2012 and an eight-year recovery plan at an annualised rate of £1.3 million.

The triennial valuation processes for both the Brunel and Staveley schemes are on-going and have been delayed by tPR's investigations. The Company is engaged in discussions with the trustees of both schemes with a view to reaching agreement on the valuations in due course.

The Coats North America plan has a funding surplus and the investment strategy followed includes a matching asset pool which should substantially reduce the risk of a funding shortfall arising in the future.

Employee defined benefit

obligations - regulatory

investigation

As previously reported and described further in the Chairman's statement on pages 3 to 4, tPR is investigating the Group's three UK defined benefit pension schemes and has issued Warning Notices in relation to all three schemes.

The Board continues to actively engage with tPR's investigations and will continue to explore all options to try to resolve these matters balancing the interests of all stakeholders.

Treasury concentration risk

The completion of the asset realisation programme combined with the deferral of the return of capital to shareholders during tPR's investigations has resulted in a significant proportion of shareholder value being represented by cash.

The Board is cognisant of the potential for this to give rise to concentration risk. The Board is provided on a monthly basis with a report of cash balances by bank, jurisdiction and currency. In addition it regularly reviews these risks at Board meetings to ensure appropriate mitigating action is being taken.

Foreign currency exposure

Coats business' activities are primarily denominated in USD, although it has major asset bases in other currencies, including the Indian Rupee and the Brazilian Real.

Coats takes action to protect its anticipated transactional currency exposure but does not hedge its assets and liabilities.

Cash generated through the asset realisation programme is primarily held in GBP, USD and NZD. The GBP balance is held to cover known liabilities whereas the NZD and USD balances represent the currently surplus funds.

Given the investigation being carried out by tPR, the Board faces the potential of some as yet unquantified obligations to provide further financial support to the Group's UK pension schemes. The size and nature of these obligations will only be known once the process with the respective scheme trustees and tPR has been completed. Any hearing before the Determination Panel of tPR for all three schemes is unlikely before the second half of 2016 at the earliest. If all rights of appeal are pursued, this process would extend beyond this period.

This in turn means the Board is currently not able to determine with certainty the quantum of future returns, if any, to shareholders.

The Board regularly reviews its currency exposures and has taken steps to ensure transparent reporting to shareholders of the positions held.

Human resources

Shareholder value is heavily dependent on key individuals within the Group.

The Board has recognised the risk to delivery of the Company's strategy from key staff leaving during the process. It regularly reviews the appropriateness of its incentive and reward arrangements and has established retention and/or incentive plans to address this risk.

Coats

Given the simplification of the Company's business model, the Coats business now represents the major portion of the Group's business risk.

Coats faces a wide range of commercial and operational risks. Coats manages these risks through various structures, including its Internal Audit Function and Operational Risk Management Committee, comprising a broad mix of managers across the business, chaired by the Group Chief Executive.

The Head of Internal Audit attends meetings of and reports to the Board's Audit and Risk Committee. The key risk areas identified and managed through this process are described in more detail on pages 18-20.

Risk

Nature of Risk

Action/Mitigation

Strategy and strategic planning risks

Delivery of strategy

A lack of resource, poor project management, lack of skills or lack of acceptance in the market may result in not delivering growth projects. Consequently profitability goals are not achieved or the market multiple is materially below target.

Projects are managed by a dedicated team and sponsored by a member of the Coats Management Board or Industrial or Crafts Americas Leadership Teams. They are controlled by a Steering Committee and monitored financially.

The Board receives regular progress reports and sets targets for profitable sales.

Recruiting, maintaining

and motivating high-quality

staff

Not identifying and retaining key staff or improving their skills and knowledge may result in an inability to execute growth strategy.

HR policies cover reward and recognition, health and safety, talent management, skills assessment and development, performance management, succession planning and employee consultation.

An annual group-wide employee satisfaction survey flags any areas for concern which are then acted on.

An annual survey of pay and benefits ensures that terms and conditions of employment remain competitive.

Financial risks

Pension

Fluctuations in discount rates, investment values and returns, inflation and/or member longevity in the defined benefit pension arrangements result in funding burdens on the Group in the future.

Pension position and strategy is regularly reviewed by the Board.

Funded pension schemes are overseen by their trustees. Trustees are required to have the appropriate knowledge and understanding in this area and take professional and actuarial investment advice as necessary. Where appropriate independent professional trustees are appointed to schemes to provide additional expertise.

Coats and the trustees seek to de-risk the scheme through liability management and investment strategies to reduce the impact of fluctuations.

Treasury

An exposure to uncertainties in financial markets and the banking sector including foreign exchange, interest rate, credit and liquidity risks as well as the risk of bank failure.

Coats' policies cover all aspects of its Treasury operations, providing strict controls on managing risks and bank selection.

Coats may be unable to present itself as an attractive candidate for financing.

Compliance with the terms of Coats' senior bank facility agreements is actively monitored. There is regular contact with core relationship banks and alternative sources of finance have been identified. In 2015 debt facility was successfully refinanced and maturity extended to 2020.

Operational risks

Information Technology (IT)

Unauthorised access to Coats IT systems and data may result in the theft of data or the disruption of business processes.

Standard firewall capability is overseen by an external vendor. Coats' networks are actively monitored and multiple layers of password protection are used at device and application level. Communications with portable devices are encrypted.

Coats ensures all internal users have appropriate access rights and permissions for their roles.

An inability of Coats' IT network and systems to perform critical transactions and processes may result in business disruption.

Coats has sufficient network capacity and established IT systems in place with Group and Divisional IT teams to manage the IT risks.

Supplier dependency

If one or more major external suppliers is unable or unwilling to supply goods it may cause major disruption to the Coats supply chain that cannot be replaced in the shortterm, leading to lost contribution and longterm impact on customer relations.

Supplier relationships and external supply chains are monitored and managed, with multiple sourcing of materials and strategic inventories.

Regular supplier meetings include detailed discussions of market conditions and supply expectations. Risk is spread by dealing with more than one supplier on each key material and continual identification of new supply sources.

Global insurance programmes include supplier dependency cover.

Internal supply chain

Disproportionate reliance on critical internal supply chain nodes may have a significant impact on profitability in the event of disruption to any of them.

Manufacturing and supply chain function monitors and reviews internal supply chains, fire protection systems and creates and tests disaster recovery plans.

Rolling property risk surveys are conducted of all Coats critical supply chain nodes. The implementation of the risk reduction recommendations is actively monitored and where necessary capital expenditure is prioritised.

Global insurance programmes include property destruction and business interruption cover.

Customer dependency

Key Crafts customers reduce shelf space for a group of products which Coats supplies or engages in price negotiation, materially reducing the contribution earned by the business.

Strong commercial relationships are maintained with senior level management with direct access to final decision makers. Coats works to ensure a high degree of customer collaboration, communication and management attention to POS data and weekly replenishment levels. It provides a high level of service/stock availability.

Significant investment in pattern/design support, product promotions and consumer advertising undertaken to boost in-store footfall and sales growth. Strategic marketing has targeted craft consumer demographics, in-store buying behaviour and positive correlation to store sales in other categories.

Environmental

Non-compliance with internal environmental control procedures or local requirements (if these are stricter) leads to a serious pollution event having an adverse impact on operations and resulting in regulatory action being taken. This results in litigation, resultant damages and damage to reputation.

Management aims to achieve the highest practicable standards of environmental performance. All environmental issues are reported to the Group's Audit and Risk Committee and Management Board through a semi-annual Risk Questionnaire completed by all operating units.

All sites must comply with local legal requirements for effluent quality and volume and hold the relevant permit to discharge. Coats has 'Global Water Effluent Limits', a set of 15 parameters with the strictest limits of any local authority across three downstream categories.

Global insurance programme includes cover for 3rd Party property damage and injury or illness resulting from pollution of air, water or soil caused by a sudden or unforeseen incident.

Coats may be held responsible and accountable for clean-up/remediation costs of legacy environmental issues originating before it acquired those sites or after their disposal/closure.

Appropriate checks are undertaken on sites we are looking to acquire, and we conduct ongoing monitoring of current sites.

Every step appropriate is taken to ensure closed and/or sold sites are cleaned up.

Labour relations

Poor labour relations in critical manufacturing sites could result in disruption to business.

An annual Employee Engagement satisfaction survey is conducted and relevant strategies developed and implemented to address concerns.

In the event of disruption, Coats can move production to other sites.

Year ended 31 December

 2014

2013

£m

£m

Short-term employee benefits

1

1

Sales of goods

Purchases of goods

Other income

 2014

2013

 2014

2013

2014

2013

£m

£m

£m

£m

£m

£m

Joint ventures

4

4

29

28

2

3