3rd Quarter Report
Nine Months Ended
December 31, 2006
Trading: TSX: ROC
TORONTO, Feb. 2 /CNW/ - Rothmans Inc. today announced stronger results for the third quarter of fiscal 2007, which ended December 31, 2006.
Rothmans' earnings for the third quarter of fiscal 2007 were $C24.1 million, or $0.35 basic earnings per share. This compares with $23.3 million or $0.34 basic earnings per share in the third quarter of fiscal 2006. For the first nine months of this fiscal year, Rothmans' earnings were $81.7 million or $1.20 per share, compared with $83.1 million or $1.23 per share in the first nine months of the prior year.
Sales at 60%-owned subsidiary Rothmans, Benson & Hedges Inc., net of excise duty and taxes, increased to $153.6 million in the most recent quarter compared with $145.0 million in the third quarter of fiscal 2006. Sales for the first nine months of this fiscal year were $481.7 million versus $474.5 million for the same period a year earlier.
During the three months ended December 31, 2006, RBH's total domestic sales volumes for all tobacco products decreased by only 3.1% from a year earlier. This represents a significant departure from the industry trend which was reported as a decline of 10% in the quarter ended September 30, 2006. While the continuing presence of contraband is believed to be adversely impacting the industry, RBH management believe that the Company's performance this quarter benefited from volatility in the market caused by the implementation by Imperial Tobacco Canada Limited (ITL) of its direct-to-store distribution system (DSD). Warmer weather than normally experienced in Canada through to the end of December may also have offset the normal effects of seasonality. Concurrent with the implementation of DSD, ITL discontinued providing sales data information to the Canadian Tobacco Manufacturers Council, of which RBH is a member. Therefore, RBH's management is unable to provide a meaningful estimate of industry sales volumes and industry market shares for the recent quarter.
RBH's EBITDA margin for the third quarter was 46.4% compared with 50.6% in the prior quarter and 47.8% in the quarter ended December 31, 2005. The lower EBITDA margin was predominantly due to the effect of lower shipment volumes, volume shifts to the lower-priced tier of the cigarette price category and higher general administrative expenses, partially offset by price increases across all product categories.
"RBH's stronger financial performance and the lower rate of decline in volumes sold in the third quarter are encouraging considering the challenges that we continue to face from significant contraband and competitive activities," said John Barnett, President and Chief Executive Officer of Rothmans Inc. and RBH. "In the absence of action by government, illegal and untaxed products will continue to have a negative effect on the Canadian tobacco industry," commented Mr. Barnett.
Financial results reported in this release reflect the adoption of EIC156 "Accounting By A Vendor For Consideration Given To A Customer" and results for prior periods have been restated accordingly. More information is available in the section "New Accounting Pronouncements" in the accompanying MD&A.
Dividend declared
The Board of Directors of Rothmans Inc. declared a quarterly dividend of $0.30 per share payable on March 17, 2007 to shareholders of record at the close of business on March 2, 2007. The dividend will constitute an "eligible dividend" for purposes of the enhanced dividend tax credit rules announced in the 2006 Federal Budget once such rules come into effect.
Analyst Conference Call and Webcast
Rothmans Inc. management will hold a conference call with analysts to discuss the third quarter results at 8:30 a.m. Toronto time on Friday, February 2, 2007. In order to listen to the conference call, shareholders are invited to call 1-866-898-9626 or 416-340-2216.
The call will also be webcast through the Company's investor website, www.rothmansinc.ca. At the completion of the conference call, a recording will be available until February 9, 2007 by calling 1-800-408-3053 and entering reservation number 3211884. The recording can also be accessed through the investor website.
Media are invited to listen to the call and to contact Karen Bodirsky at (416) 442-3660 for further information.
About Rothmans Inc.
Rothmans Inc. is a widely held, publicly traded Canadian company that participates in the Canadian tobacco industry through 60%-owned Rothmans, Benson & Hedges Inc., Canada's second largest tobacco company. RBH currently employs approximately 760 people at its head office in Toronto, its sales offices across Canada and its manufacturing facilities in Brampton, Ontario and Quebec City, Quebec where it has been operating for over 100 years. Rothmans is Canada's only publicly traded company with interests exclusively in the tobacco industry and is listed on the Toronto Stock Exchange under the symbol ROC.
Management's Discussion and Analysis
for the nine months ended December 31, 2006
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Management's Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, provides shareholders with a review of significant developments in the Company's financial performance in the fiscal quarter and nine months ended December 31, 2006 compared with the prior year. It also discusses factors that could affect future performance. This MD&A should be read in conjunction with the attached unaudited consolidated financial statements for the period ended December 31, 2006, the annual MD&A contained in the 2006 Annual Report and the audited annual consolidated financial statements of the Company for the year ended March 31, 2006. The results reported herein have been prepared in accordance with Canadian Generally Accepted Accounting Principles (GAAP) and are presented in Canadian dollars. This MD&A is current as of February 1, 2007.
Responsibility of Management and the Board of Directors
Management is responsible for the information disclosed in this MD&A and has in place the appropriate information systems, procedures and controls to ensure that information used internally by management and disclosed externally is materially complete and reliable. In addition, the Company's Audit Committee and Board of Directors provide an oversight role with respect to all public financial disclosures by the Company, and have reviewed and approved this MD&A and the accompanying unaudited consolidated financial statements.
Forward Looking Statements
Certain statements contained in this MD&A and other sections of this release (in particular the sections entitled "Industry Overview" and "Outlook") constitute "forward-looking statements" and express views as to future events, circumstances and trends relating to RBH's business and the Company. Words such as "plans", "intends", "outlook", "expects", "anticipates", "estimates", "believes", "should" and similar expressions may identify forward-looking statements. Forward-looking statements are based on management's current expectations and assumptions and entail various risks and uncertainties. There is no assurance that any forward-looking statement will materialize. Actual results may differ materially from these expectations and forward-looking statements, if known and unknown risks or uncertainties affect RBH's business or the Company, or if management's expectations or assumptions prove to be inaccurate. Unless otherwise indicated, forward-looking statements describe expectations as of February 1, 2007.
Factors that could cause the Company's actual results to differ materially from the forward-looking statements contained herein include, but are not limited to: government claims and potential claims; product liability claims; increases in the levels of contraband product in the market; increased competition and competitor initiatives; price category pressure on overall cigarette margins and changes in market share for RBH's products; declining consumer consumption and dependence on price increases; fluctuating wholesaler and consumer purchasing patterns; changes in government taxation policy; changes in legislation and regulation; new product standards; and dependence on the domestic tobacco market.
The Company disclaims any obligation or intention to update or revise any forward-looking statement, whether the result of new information, future events or otherwise. Additional information concerning risks and uncertainties affecting RBH's business and the Company and other factors that could cause financial results to fluctuate is set forth below under "Risks and Uncertainties" and "Outlook" and is contained in the Company's filings with Canadian securities regulatory authorities, including the Company's Annual Information Form (in particular under "Legal Proceedings" and "Risk Factors") available on SEDAR at www.sedar.com or on the Company's website at www.rothmansinc.ca.
Terminology used in this MD&A
Throughout this MD&A, "GAAP" refers to Canadian Generally Accepted Accounting Principles, "Rothmans" and "the Company" refer to Rothmans Inc., "RBH" refers to Rothmans, Benson & Hedges Inc., which is 60%-owned by Rothmans Inc., and "EBITDA margin", a key measure of the RBH's operating performance, refers to "earnings before interest, taxes, depreciation and amortization" as a percentage of "sales, net of excise duty and taxes". EBITDA margin provides a metric allowing period-to-period comparisons of the core RBH operating performance before the impact of changes in capital structure, taxes and capital spending. EBITDA margin is a non-GAAP financial measure that does not have any standardized meaning prescribed by GAAP. It is therefore unlikely to be comparable to similar measures presented by other companies. The "recent quarter" refers to the three months ended December 31, 2006, and "prior quarter" refers to the three months ended September 30, 2006. "Fiscal 2007" or "recent fiscal year" refers to the fiscal year ending March 31, 2007 and other similar references to a fiscal year (e.g., fiscal 2006) refer to the fiscal year then ended on March 31 (e.g., March 31, 2006).
"The three major manufacturers" or "three majors" refers to RBH, Imperial Tobacco Canada Limited (ITL) and JTI-MacDonald Corp. (JTI). "BAT" refers to British American Tobacco p.l.c., the parent company of ITL. "Premium cigarettes" refers to tailor-made cigarettes sold at premium retail prices, "cigarette price category" refers to cigarettes sold at less-than-premium prices and "price category" refers to the combination of the cigarette price category and the fine cut category (loose tobacco and pre-proportioned tobacco sticks). "Domestic composite market" refers to all fully tax-paid cigarettes and fine cut tobacco products sold into the Canadian market. "Direct-to-Store Distribution" or "DSD" refers to a distribution model where a tobacco manufacturer ships directly to retail accounts instead of through a wholesale network. "CTMC" refers to the Canadian Tobacco Manufacturers Council.
Industry Volumes & Market Share Measurement
Historically the three major manufacturers shared volumetric shipment information which was compiled through the CTMC. This information, combined with Statistics Canada information and other company estimates permitted the Company and RBH to assess overall industry volumes and category market shares on a quarterly basis. As of October 2006, concurrent with the implementation of DSD, ITL has discontinued providing sales data information to the CTMC. Therefore, RBH is unable to provide meaningful estimates on total tax paid industry volumes and category market share information. For the purpose of managing its ongoing business, RBH continues to use various information sources, not all of which are nationally representative, including a proprietary wholesale volumetric reporting system, selected retail data, consumer survey data, and information reported by Statistics Canada. RBH is assessing these, and other data sources for ongoing reporting purposes.
New Accounting Pronouncements
In September 2005, the Emerging Issues Committee of the Canadian Institute of Chartered Accountants issued Abstract 156 "Accounting By A Vendor For Consideration Given To A Customer (Including a Reseller of the Vendor's Products)" ("EIC 156"). This abstract applies to fiscal years beginning on or after January 1, 2006. The abstract addresses the issue of whether consideration provided by a vendor to a customer is an adjustment to the selling prices of the vendor's products and therefore a reduction of revenue or is a cost incurred by the vendor and therefore classified as cost or expense. The implementation of this pronouncement has resulted in a Consolidated Statement of Earnings reclassification which reduces operating costs excluding amortization and sales, net of excise duty and taxes, by $13.6 million and $35.2 million in the quarter and nine months ended December 31, 2006. For comparative purposes, the reclassification reducing operating costs excluding amortization and sales, net of excise duty and taxes was $11.4 million, $9.9 million, $12.4 million and $11.4 million in the first through fourth quarters of fiscal 2006 respectively. This reclassification impacts EBITDA margin but has no impact on the earnings or cash flows of either period. Comparative prior period amounts have been reclassified to reflect the adoption of this pronouncement. Additional information regarding this change can be found in Note 2 "Change in Accounting Policy" in the December 31, 2006 Notes to the Interim Consolidated Financial Statements (unaudited) which accompany this MD&A.
Industry Overview
As previously reported, total reported industry domestic sales volumes for all tobacco products decreased 10.0% and 9.4% in the quarter and six months ended September 30, 2006 versus the comparable periods in the prior fiscal year. The continuing growth of contraband product, along with historical declines in consumer incidence and consumption, were believed to have contributed to this decline which exceeded the historical average rate experienced by the industry.
A number of other factors have also been affecting overall industry shipments. Although a meaningful estimate of the recent quarter tax paid industry decline rate was not possible, RBH management believes that these factors remain in place. They include:
- Taxes - High taxes reflected in the selling price to the consumer
contribute to probable increases in the presence of contraband
product in the domestic market.
- Seasonal trends in consumer purchasing patterns - Over the past two
fiscal years, the period between April and September has demonstrated
stronger industry shipments than the period between October and
March. RBH management believes that smoking restrictions are causing
consumer consumption variations between the summer and winter
seasons. The impact of warmer than normal weather in a large part of
Canada during the period from October to December 2006 and its impact
on seasonal purchasing patterns from the tax paid industry are not
determinable in the context of other factors listed here.
- Fluctuations in wholesaler and retailer buying patterns as a result
of ITL's implementation of a DSD system - Late in the second quarter,
ITL began their implementation of a Direct-to-Store distribution
model which resulted in fluctuating buying patterns by both
wholesalers and retailers which appeared to continue through the
recent quarter. Volatility in the market caused by ITL's
implementation of this model appears to have had a positive impact on
RBH's volumes sold during the recent quarter. However, the long-term
effects of this change on the Canadian tobacco industry and RBH's
competitive positioning are still uncertain.
- Fluctuations in wholesaler buying patterns as a result of anticipated
tax and manufacturer price increases, manufacturer sales programs and
trade terms - Swings in wholesaler purchasing patterns motivated by
the timing of tax increases, price increases, manufacturer sales
programs, manufacturer trade terms and other factors are anticipated
to have a significant effect on quarter-to-quarter sales volumes.
- Continued declines in consumer consumption of tobacco products.
The foregoing contains forward looking statements about the industry outlook. Reference should be made to "Forward Looking Statements" set out at the beginning of this MD&A.
As previously reported, for the quarter ended September 30, 2006, RBH estimated that the premium cigarettes, price category cigarettes, and fine cut represented 48%, 44% and 8% respectively of the Canadian domestic tax paid industry. The high tax environment continues to influence the relative contribution of the premium cigarette, price category cigarette and fine cut components of total industry volumes. RBH believes that during the recent quarter, the industry continued to trend towards a higher contribution from the price cigarette category at the expense of the premium cigarette and fine cut categories.
To date there have been various changes in tobacco taxes. During the quarter ended September 30, 2006, the federal excise duty applicable to cigarettes, tobacco sticks and fine cut products was raised by $0.56, $0.50 and $0.38 respectively on a per carton or equivalent stick basis, in order to offset the effect of the 1% GST reduction. During the recent quarter the Province of Saskatchewan announced an increase in its provincial tobacco rates in order to offset a 2% reduction in its provincial sales tax rate and the Nunavut government announced a 34.6% increase in PTT on cigarettes and a 62.8% increase on fine cut products.
Results at Rothmans, Benson & Hedges Inc.
In the quarter ended December 31, 2006, RBH shipped a total of 2.7 billion equivalent sticks into the domestic market, a 3.1% decrease from the comparable period of the prior year, with increases in price category cigarette volumes only partially offsetting declines in premium and fine cut volumes. For the nine months ended December 31, 2006, RBH shipped a total of 8.3 billion equivalent sticks, a 5.6% decrease from the comparable period of the prior year. RBH experienced a lower percentage volume decline in shipments than would be indicated by the industry decline rates experienced during the first two fiscal quarters of this year. This performance is believed to be due in part to the market disruption caused by ITL's implementation of its DSD program late in the second quarter. Moderation in the seasonality effect, due to warmer than normal weather experienced in the majority of Canada during the recent quarter, may also have contributed to a moderation in RBH's volumetric decline rate.
RBH's recent quarter EBITDA margin was 46.4% compared with 50.6% in the prior quarter after reflecting the adoption of EIC156. For comparative purposes the adoption of EIC156 has resulted in restated EBITDA margins of 52.3%, 53.1%, 47.8% and 36.9% for quarters one through four of fiscal 2006. The restated EBITDA margin for the fiscal year ended March 31, 2006 was 48.1%. The lower recent quarter EBITDA margin compared with the prior quarter and the same period of the prior year was predominantly due to the effect of lower shipment volumes, volume shifts into the lower-priced tier of the cigarette price category and higher general administrative expenses, including incentive plan accruals, various benefit costs and the impact of foreign exchange, partially offset by price increases across all product categories.
In November 2006, RBH increased the price charged to wholesalers for its premium and price category cigarettes by $1.00 per carton. Prices on fine cut products, cigars and pipe tobacco were increased by varying amounts depending on format.
Subsequent to the end of the recent quarter, RBH launched its Accord brand nationally into the price cigarette category. The brand is anticipated to compete at a retail price below RBH's two existing price tiers within the cigarette price category.
Rothmans Inc. Financial Results
Basic earnings per share were $0.35 in the recent quarter and $1.20 for the nine months ended December 31, 2006 compared with $0.34 and $1.23 in the comparable periods of the prior year. After reflecting the adoption of EIC156, RBH's sales, net of excise duty and taxes, were $8.6 million higher for the quarter ended December 31, 2006 and $7.2 million higher for the nine months ended December 31, 2006 compared with the same periods of the prior year. Increased volumes of RBH price category cigarettes, together with price increases across all categories, more than compensated for volume declines in premium cigarettes and fine cut products during the recent quarter and in the nine months ended December 31, 2006.
Investment income increased to $1.3 million in the recent quarter from $0.8 million in the comparable period of the prior year due to the higher average cash balance held and a higher rate of return experienced during the quarter ended December 31, 2006.
After reflecting the adoption of EIC156, operating costs were $6.5 million and $9.8 million higher in the recent quarter and nine months ended December 31, 2006 compared with the same periods of the prior year. The increases are mainly attributable to higher general and administrative costs including incentive plan accruals, various benefit costs, and the impact of foreign exchange.
Income tax expense was $27.4 million in the recent quarter and $93.1 million in the fiscal year to date, resulting in an effective tax rate of 40.6% for both periods. This compares with effective tax rates of 39.7% in both of the comparable periods of the prior fiscal year. The increase in the effective tax rate represents an additional expense of $0.6 million and $2.2 million in the recent quarter and nine months ended December 31, 2006. The Company expects its effective tax rate for fiscal 2007 will be 40.6%.
Capability to Deliver Results
Cash Flow
RBH's operations generate significant cash resources. These are currently sufficient to fund interest payments on RBH's long-term debt, capital expenditures and dividends to its shareholders. Based on RBH's historical earnings levels, the dividends received by Rothmans from RBH are expected to be sufficient to fund its operations, pay dividends to its public shareholders and continue to accumulate cash reserves.
RBH's cash flow from operations before changes in working capital was $44.3 million in the recent quarter and $145.0 million in the nine months ended December 31, 2006 compared with $42.2 million and $146.6 million in the same periods of the prior fiscal year. RBH's ability to generate cash from operations is generally sufficient to fund the day-to-day financing needs of RBH's business. It is anticipated that additional funds, should they be required, would be obtained through short-term bank borrowings.
During the recent quarter, the Company paid dividends of $20.4 million, representing a dividend of $0.30 per share.
Cash Resources
Cash and short-term investments of $152.9 million at December 31, 2006 represented the consolidated cash resources of the Company versus $130.2 million at March 31, 2006. The increase in cash and short-term investments is predominantly due to earnings from RBH's operations and normal quarterly fluctuations in RBH's working capital requirements. On a non-consolidated basis, Rothmans held cash and cash equivalents of $126.6 million at December 31, 2006, an increase from $85.0 million at March 31, 2006. This increase resulted from dividends paid by RBH, and received by the Company, partially offset by the payment of dividends by the Company.
Critical Accounting Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Although these estimates are based on management's best knowledge of current events and actions that the Company and RBH may undertake in the future, actual results could differ from these estimates. Critical accounting estimates that require disclosure are discussed below.
Employee Future Benefits
The actuarial assumptions used to determine the benefit obligation and associated expense of RBH's various defined benefit pension plans were not adjusted in the recent quarter. Therefore, the discount rate, and the expected return on plan assets remain as described in the annual MD&A for the year ended March 31, 2006.
Litigation Contingent Liabilities
As discussed in the annual MD&A for the year ended March 31, 2006, the Company and RBH have been the subjects of various legal actions, proceedings and claims. Based on the stage of those proceedings, management is unable to meaningfully estimate the liability, if any, that might result from those claims and neither the Company nor RBH has accrued for potential liabilities. However, the outcome of any litigation is uncertain. If successful, these claims, either individually or in the aggregate, could involve significant damages which would have a significant adverse effect on the financial condition of the Company, and the Company and RBH may not have the resources to satisfy such claims.
Risks and Uncertainties
Various legal actions, proceedings and claims arising out of the sale, distribution, manufacture, development, advertising and marketing of tobacco products are pending, have been threatened or may be instituted against the Company and RBH. These actions, claims and proceedings, both pending and threatened, are described in Note 12 to the audited annual consolidated financial statements of the Company for the year ended March 31, 2006. Other than as described below, there have been no developments of a material nature during the fiscal year to date concerning these matters.
On June 13, 2006, Manitoba passed the Tobacco Damages and Health Care Costs Recovery Act. The legislation, which is modeled on the British Columbia legislation, purports to allow the provincial government to bring an action against tobacco product manufacturers for the recovery of health care costs that allegedly have been or will be incurred by the Province in respect of alleged tobacco related diseases. No action has been commenced under this legislation.
On June 22, 2006, the Tobacco Damages and Health Care Costs Recovery Act in New Brunswick received royal assent. The legislation is similar to that of British Columbia. No action has been commenced under this legislation, however the New Brunswick government announced in December that it had begun the process to hire a qualified law firm or consortium of law firms to represent the province. A request for proposals with a deadline of January 31, 2007 has been issued.
In November 2006, the government of Saskatchewan announced that it was introducing The Tobacco Damages and Health Care Costs Recovery Act. The legislation is similar to that of British Columbia. The Bill received second reading in December 2006.
In September 2006, the British Columbia Court of Appeal ruled that the Company and certain international tobacco companies who are named as defendants in the lawsuit initiated by the Province of British Columbia to recover health care costs should remain in the lawsuit. These defendants, including the Company, had argued that the Province did not have jurisdiction over them as they do not do business in British Columbia. The Company has determined not to appeal the decision.
In late September 2006, RBH received a complaint from ITL and one of its affiliates alleging that RBH's ROOFTOP product packaging infringed their rights in respect of the MARLBORO trade-mark registration in Canada. RBH and Philip Morris Products S.A. ("PMPSA"), the owner of the ROOFTOP design in Canada, commenced an action in the Federal Court seeking a declaration that the use of the ROOFTOP design in association with RBH's cigarette products does not infringe upon any rights which ITL or its affiliate may have in respect of the MARLBORO trade-mark registration in Canada. In their statement of defense, ITL and its affiliate have counterclaimed against RBH and PMPSA seeking, among other things, a declaration that the ROOFTOP packaging infringes their trade-mark rights, a permanent injunction restraining the sale and distribution of cigarettes in association with the ROOFTOP packaging in Canada as well as unspecified damages or an accounting of profits, at their election. RBH and PMPSA deny the allegations contained in ITL's claim, and are vigorously defending the counterclaim.
Additional information concerning legal matters affecting the Company and RBH are contained in the Company's filings with securities regulatory authorities including the Company's 2006 Annual Report and 2006 Annual Information Form (in particular under "Legal Proceedings") which can be accessed at www.sedar.com or on the Company's website at www.rothmansinc.ca.
ITL has now moved most of its production operations to Mexico. At the end of the prior quarter, ITL also began the implementation of its DSD system. It is difficult to assess the competitive impact of these initiatives at this time.
In November 2006, the government of Nova Scotia passed certain amendments to the Tobacco Access Act which, subject to proclamation, will come into effect as of March 31, 2007. The amendments will ban the display of tobacco products in establishments that permit entrance to persons under the age of nineteen. The federal government is considering adopting similar restrictions.
Outlook
The following contains forward-looking statements about the Company's outlook. Reference should be made to "Forward Looking Statements" set out at the beginning of this MD&A.
Looking ahead, Rothmans expects that a number of factors could affect its financial performance including:
- the success of efforts by RBH and the industry to defend themselves
against government, product liability and other claims, and to
operate within the regulatory environment;
- continued high levels of contraband product in the market due to the
onerous tax environment;
- the impact of ITL's direct-to-store distribution program and RBH's
ability to compete in the new environment;
- a lower rate of growth in the cigarette price category and RBH's
ability to successfully compete in that segment;
- the impact of continued high levels of taxation on consumer
purchasing patterns;
- continued declines in the consumption of tobacco products;
- RBH's ability to continue to implement price increases for its
products;
- the impact of RBH's efforts to stabilize its cigarette market share
in the declining premium cigarette category;
- the continued volatility in the cigarette market as a result of the
evolution of the Canadian cigarette price category, varying
wholesaler purchasing patterns and seasonal fluctuations in smoker
consumption;
- RBH's ability to maintain its leading position in the fine cut
segment;
- government tax policy regarding the differentiation in tax rates
applicable to fine cut products in comparison to tailor-made
cigarettes; and
- RBH's continued success at maintaining or reducing costs, especially
in view of the potential for regulated changes to product
specifications.
It is believed that the presence of contraband is a key factor in the decline rate in the total tax paid industry sales volumes. Continued availability of contraband product in the domestic market as a result of high tobacco tax rates across the country may increase the decline rate in tax paid industry volumes further in the future resulting in a negative impact on RBH's sales volumes.
Continued launches into the cigarette price category and price competition by each of the three major manufacturers have led to significant growth of that category over the past three fiscal years, and there continues to be a significant degree of variability in the underlying business trends, making it difficult to accurately estimate the impact on consumer purchasing patterns.
Over the past two fiscal years, the period between April and September has demonstrated stronger industry shipments than the period between October and March. This seasonality is likely due to smoking restrictions that are causing consumption variations between the summer and winter seasons. The impact of warmer than normal weather in a large part of Canada in the recent quarter on seasonal purchasing patterns on the tax paid industry is not determinable.
Interim Consolidated Statements of Earnings and Retained Earnings
Three months ended Nine months ended
(In thousands of dollars, December 31 December 31
except per share amounts) 2006 2005(x) 2006 2005(x)
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EARNINGS
Revenues:
Sales, net of excise duty
and taxes(note 2) 153,606 145,005 481,729 474,523
Investment income 1,286 767 3,447 2,542
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Total revenues 154,892 145,772 485,176 477,065
Costs:
Operating costs excluding
amortization(note 2) 83,283 76,746 244,047 234,276
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Earnings before interest,
taxes, amortization and
minority interest (note 2) 71,609 69,026 241,129 242,789
Amortization 3,292 2,599 9,124 7,762
Interest expense (income)
- Long-term debt 2,094 2,094 6,269 6,269
- Other (1,262) (342) (3,401) (1,063)
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Earnings before income taxes
and minority interest 67,485 64,675 229,137 229,821
Income taxes
- Current 27,083 25,348 91,697 89,798
- Future 321 336 1,439 1,450
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Total income taxes 27,404 25,684 93,136 91,248
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Earnings before minority
interest 40,081 38,991 136,001 138,573
Minority interest 15,954 15,665 54,286 55,489
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Earnings for the period 24,127 23,326 81,715 83,084
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Earnings per common share
(note 3)
- Basic 0.35 0.34 1.20 1.23
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- Diluted 0.35 0.34 1.19 1.22
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RETAINED EARNINGS
Balance at beginning of
period 85,292 69,518 68,513 151,734
Earnings for the period 24,127 23,326 81,715 83,084
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109,419 92,844 150,228 234,818
Dividends paid:
Common Shares - (20,410) (20,354) (61,219) (162,328)
(Q3 2007 - $0.30 per share;
Q3 2006-$0.30 per share)
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Balance at end of period 89,009 72,490 89,009 72,490
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(x) Restated - See note 2
Interim Consolidated Balance Sheets
As at As at
December 31 March 31
(In thousands of dollars) 2006 2006
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ASSETS
Current Assets
Cash and cash equivalents 55,953 48,364
Short-term investments 96,987 81,867
Accounts receivable 10,868 10,319
Inventories 201,324 206,433
Prepaid expenses 1,908 1,835
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Total current assets 367,040 348,818
Property, plant and equipment 73,898 76,298
Future income taxes 4,862 6,301
Prepaid pension benefit cost 15,093 13,295
Other assets 2,615 2,887
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463,508 447,599
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LIABILITIES
Current Liabilities
Accounts payable and accrued liabilities 46,288 42,618
Excise and other taxes payable 60,791 66,204
Dividend payable to minority shareholder
of subsidiary company - 10,761
Income taxes payable 25,670 20,437
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Total current liabilities 132,749 140,020
Other long-term liabilities 3,084 2,399
Other employee future benefits 34,229 33,444
Long-term debt 149,783 149,751
Minority interest in subsidiary company 7,211 8,125
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327,056 333,739
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SHAREHOLDERS' EQUITY
Capital stock(note 4) 47,443 45,347
Retained earnings 89,009 68,513
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Total shareholders' equity 136,452 113,860
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463,508 447,599
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Interim Consolidated Statements of Cash Flows
Three months ended Nine months ended
December 31 December 31
(In thousands of dollars) 2006 2005 2006 2005
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Cash provided by (used in):
OPERATING ACTIVITIES
Earnings for the period 24,127 23,326 81,715 83,084
Adjusted for non-cash items:
Amortization 3,292 2,599 9,124 7,762
Minority interest 15,954 15,665 54,286 55,489
Future income taxes 321 336 1,439 1,450
Loss (gain) on sale
of property, plant
& equipment (244) 53 (242) 44
Defined & other employee
future benefits expense 1,517 511 4,359 4,213
Defined & other employee
future benefits funding (493) (506) (5,372) (5,862)
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44,474 41,984 145,309 146,180
Changes in non-cash
operating working capital (36,346) 64,362 8,076 57,196
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8,128 106,346 153,385 203,376
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INVESTING ACTIVITIES
Additions to property,
plant & equipment, net (823) (4,963) (6,277) (13,678)
Sale (purchase) of
short-term investments (96,987) (81,867) (15,120) 86,873
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(97,810) (86,830) (21,397) 73,195
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FINANCING ACTIVITIES
Dividends paid -
By the Company (20,410) (20,354) (61,219) (162,328)
By a subsidiary company
to minority shareholder (16,960) (20,087) (65,961) (40,482)
Proceeds on issuance
of common shares 83 85 2,096 3,328
Increases in other
long-term liabilities 341 405 685 544
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(36,946) (39,951) (124,399) (198,938)
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Increase (decrease) in cash
and cash equivalents (126,628) (20,435) 7,589 77,633
Cash and cash equivalents
at beginning of period 182,581 121,323 48,364 23,255
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Cash and cash equivalents
at end of period 55,953 100,888 55,953 100,888
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SUPPLEMENTARY DISCLOSURES
Income taxes paid 23,055 22,393 86,631 84,700
Interest paid
- Long-term debt 4,164 4,164 8,328 8,328
- Other 41 168 82 243
Notes to the Interim Consolidated Financial Statements (unaudited)
1. Summary of Significant Accounting Policies
The interim consolidated financial statements of Rothmans Inc. (the
"Company") have been prepared in accordance with Canadian generally
accepted accounting principles. The note disclosure in these interim
consolidated financial statements includes only material changes from
the disclosure found in the Company's annual consolidated financial
statements for the year ended March 31, 2006. Therefore, these
interim consolidated financial statements and notes should be read in
conjunction with those statements. These interim consolidated
financial statements follow the same accounting policies as the
Company's audited annual consolidated financial statements, except as
described in note 2.
2. Change in Accounting Policy
Effective April 1, 2006, the Company adopted the Abstract 156
"Accounting By A Vendor For Consideration Given To A Customer
(Including a Reseller of the Vendor's Products)" issued by the
Emerging Issues Committee of the Canadian Institute of Chartered
Accountants. The abstract addresses the issue of whether
consideration provided by a vendor to a customer is an adjustment to
the selling prices of the products and therefore a reduction of
revenue, or is a cost incurred by the vendor and thus classified as
cost or expense. The Company evaluated its selling costs and
retroactively reclassified cash consideration given to customers or
resellers of products as an adjustment to the selling prices to
reduce net sales revenue. Sales, net of excise duty and taxes, were
reduced by $13.6 million of reclassified selling costs for the recent
quarter and $35.2 million for the fiscal year to date, compared with
$12.4 million and $33.6 million in the same periods of prior fiscal
year. There was no change in the net earnings for the period from
this reclassification.
3. Earnings per Share
Earnings per common share is calculated based on the weighted average
number of common shares outstanding, the dilution being due to issued
common share options.
Basic Diluted
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Nine months ended:
December 31, 2006 67,990,311 68,389,491
December 31, 2005 67,710,190 68,384,368
Three months ended:
December 31, 2006 68,026,183 68,440,143
December 31, 2005 67,846,032 68,440,721
4. Capital Stock
Authorized: An unlimited number of common shares
Issued: 68,032,008 (March 31, 2006 - 67,855,608) common shares
December 31 March 31
(in thousands of dollars) 2006 2006
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Balance at beginning of period, April 1 45,347 41,974
Issuance of shares 2,096 3,373
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Balance at end of period 47,443 45,347
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In the third quarter of fiscal 2007, a total of 11,000 (2006 - 7,000)
shares were issued due to the exercise of stock options.
5. Share Option Plan
A summary of the status of the Company's employee stock option plan
as at the periods ended December 31, 2006 and December 31, 2005 and
changes during the periods ending on those dates are presented below:
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Three months ended December 31
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2006 2005
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Weighted Weighted
average average
exercise exercise
Options Shares price Shares price
---------------------------------------------------------------------
Outstanding at beginning
of period 1,325,400 14.278 1,503,800 14.299
Exercised 11,000 11.500 7,000 16.125
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Outstanding at end of
period 1,314,400 14.301 1,496,800 14.290
---------------------------------------------------------------------
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Options exercisable at
period end 1,314,400 14.301 1,496,800 14.290
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Nine months ended December 31
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2006 2005
---------------------------------------------------------------------
Weighted Weighted
average average
exercise exercise
Options Shares price Shares price
---------------------------------------------------------------------
Outstanding at beginning
of period 1,490,800 14.301 1,774,400 14.325
Exercised 176,400 14.301 277,600 14.512
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Outstanding at end of
period 1,314,400 14.301 1,496,800 14.290
---------------------------------------------------------------------
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Options exercisable at
period end 1,314,400 14.301 1,496,800 14.290
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Under the current share option plan as at December 31, 2006, a total
of 181,800 (2006 - 181,800) common shares were issuable. Given the
limited number of common shares available for issuance under the
Option Plan, the annual grant of options was discontinued effective
fiscal 2006. No options were forfeited during the period.
The following table summarizes information about stock options
outstanding as at December 31, 2006:
Weighted average
Range of Number remaining Number
exercise price outstanding contractual life exercisable
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$8.825(1) 18,000 4.3 18,000
$11.500(1) 143,000 5.1 143,000
$12.320(2) 322,400 7.1 322,400
$14.080(1) 261,400 5.5 261,400
$16.125(1) 252,000 6.1 252,000
$16.620(2) 317,600 8.1 317,600
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1,314,400 1,314,400
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(1) Entitled upon exercise to a payment of $4.00 per share (amount
equal to special dividends paid since date of option grant).
(2) Entitled upon exercise to a payment of $1.50 per share (amount
equal to special dividends paid since date of option grant).
6. Employee Future Benefit Expenses
The Company's defined benefit pension plan and other benefits
expenses are as follows:
Three months ended Nine months ended
December 31 December 31
(in thousands of dollars) 2006 2005 2006 2005
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Defined benefit plan expenses
Pension benefit plans 679 816 1,842 2,136
Other benefits 838 (305) 2,517 2,077
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1,517 511 4,359 4,213
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The Company's defined contribution pension plan expenses in the three
and nine months ended December 31, 2006 were $0.8 million and
$2.6 million (three and nine months ended December 31, 2005 -
$0.8 million and $2.4 million).
7. Seasonality
Over the past two fiscal years, the period between April and
September has demonstrated stronger industry shipments than the
period between October and March. This seasonality is likely due to
smoking restrictions that are causing consumption variations between
the summer and winter seasons. The impact of warmer than normal
weather in a large part of Canada on seasonal purchasing patterns on
the tax paid industry is not determinable.
8. Litigation, Claims and Contingencies
The Company and Rothmans, Benson & Hedges Inc. ("RBH") are subject to
a number of claims and potential claims. The nature and extent of
these claims has been described in Note 12 of the annual consolidated
financial statements of the Company for the year ended March 31,
2006. Other than as described below, there have been no developments
of a material nature during the fiscal year to date concerning these
matters.
On June 13, 2006, Manitoba passed the Tobacco Damages and Health Care
Costs Recovery Act. The legislation, which is modeled on the British
Columbia legislation, purports to allow the provincial government to
bring an action against tobacco product manufacturers for the
recovery of health care costs that allegedly have been or will be
incurred by the Province in respect of alleged tobacco related
diseases. No action has been commenced under this legislation.
On June 22, 2006, the Tobacco Damages and Health Care Costs Recovery
Act in New Brunswick received royal assent. The legislation is
similar to that of British Columbia. No action has been commenced
under this legislation, however the New Brunswick government
announced in December that it had begun the process to hire a
qualified law firm or consortium of law firms to represent the
province. A request for proposals with a deadline of January 31,
2007 has been issued.
In November 2006, the government of Saskatchewan announced that it
was introducing The Tobacco Damages and Health Care Costs Recovery
Act. The legislation is similar to that of British Columbia. The
Bill received second reading in December 2006.
In September 2006, the British Columbia Court of Appeal ruled that
the Company and certain international tobacco companies who are named
as defendants in the lawsuit initiated by the Province of British
Columbia to recover health care costs should remain in the lawsuit.
These defendants, including the Company, had argued that the Province
did not have jurisdiction over them as they do not do business in
British Columbia. The Company has determined not to appeal the
decision.
In late September 2006, RBH received a complaint from ITL and one of
its affiliates alleging that RBH's ROOFTOP product packaging
infringed their rights in respect of the MARLBORO trade-mark
registration in Canada. RBH and Philip Morris Products S.A.
("PMPSA"), the owner of the ROOFTOP design in Canada, commenced an
action in the Federal Court seeking a declaration that the use of the
ROOFTOP design in association with RBH's cigarette products does not
infringe upon any rights which ITL or its affiliate may have in
respect of the MARLBORO trade-mark registration in Canada. In their
statement of defense, ITL and its affiliate have counterclaimed
against RBH and PMPSA seeking, among other things, a declaration that
the ROOFTOP packaging infringes their trade-mark rights, a permanent
injunction restraining the sale and distribution of cigarettes in
association with the ROOFTOP packaging in Canada as well as
unspecified damages or an accounting of profits, at their election.
RBH and PMPSA deny the allegations contained in ITL's claim, and are
vigorously defending the counterclaim.
Additional information concerning legal matters affecting the Company
and RBH are contained in the Company's filings with securities
regulatory authorities including the Company's 2006 Annual Report and
2006 Annual Information Form (in particular under "Legal
Proceedings") which can be accessed at www.sedar.com or on the
Company's website at www.rothmansinc.ca.
9. Comparative Figures
Certain comparative figures have been reclassified to conform to the
presentation adopted in the current year.