Trading: TSE: ROC
TORONTO, May 16 /CNW/ - Rothmans Inc. today announced results for the fourth quarter and fiscal year ended March 31, 2008.
Rothmans' earnings for the year were $117.6C million or $1.73 per basic share compared with $99.8 million or $1.47 per basic share in fiscal 2007.
Sales at 60%-owned subsidiary Rothmans, Benson & Hedges Inc., net of excise duty and taxes, for the 2008 fiscal year were $670.6 million compared with $618.6 million in fiscal 2007.
Investment income of $12.2 million for fiscal 2008 was $3.1 million higher than fiscal 2007, due to the higher average cash balance held and a higher rate of return experienced during the year.
RBH's EBITDA margin was 50.9% for the year, compared with 47.6% in fiscal 2007. The increase was principally due to price increases across all product categories partially offset by volume shifts into lower-priced tiers of the cigarette price category and higher general and administrative expenses, including incentive plan costs and slightly higher spending on retail trade programs.
RBH shipped a total of 10.7 billion equivalent sticks into the domestic market during fiscal 2008, representing a 0.2% increase compared to fiscal 2007, due mainly to increased shipments of RBH price category cigarettes offsetting declines in both premium cigarette and fine cut shipments. While RBH has continued to demonstrate strong volumetric and financial performance in the face of a declining market, the reduction in overall industry profitability and the apparent growing presence of contraband product in the Canadian market are expected to continue to present significant challenges for RBH for the foreseeable future.
During fiscal 2008, the Company paid dividends of $88.5 million, versus $81.6 million in fiscal 2007. The fiscal 2008 regular dividend was $1.30 per share compared to $1.20 in fiscal 2007.
"RBH has continued to perform very well, having maintained total domestic sales volumes and increasing earnings by almost 18% compared to fiscal 2007," said John Barnett, President and Chief Executive Officer of Rothmans Inc. and RBH. "Year over year, we have grown domestic cigarette market share by 1.2 share points according to the Nielsen Company which, given our volume performance, indicates continued declines in industry tax-paid volumes sold."
Fourth Quarter
Rothmans' earnings for the fourth quarter of fiscal 2008 were $21.0 million or $0.31 basic earnings per share. This compares with earnings of $18.0 million or $0.27 basic earnings per share in the fourth quarter of fiscal 2007.
Sales, net of excise duty and taxes, at RBH were $142.7 million in the fourth quarter compared with $136.8 million in the same period in fiscal 2007.
RBH's EBITDA margin was 43.4% in the quarter compared with 39.4% in the same period of fiscal 2007, and compared to 49.8% in the third quarter of fiscal 2008. The year-over-year increase in EBITDA margin compared to the fourth quarter of fiscal 2007 is predominantly due to price increases across all product categories partially offset by lower shipment volumes and higher sales and marketing costs. The recent quarter EBITDA margin decrease compared to the third quarter of 2008 was principally due to the effect of lower shipment volumes.
Outlook
"The industry continues to be impacted by declining volumes overall and increased competition, particularly in the cigarette price category. In addition, illegal and untaxed products continue to have a negative effect on all industry participants," said Mr. Barnett. "With our new entrants into the premium cigarette category and our well established price cigarette category brands, RBH will continue to compete vigorously in this changing market."
Dividend Declared
The Board of Directors of Rothmans Inc. declared a quarterly dividend of $0.35 per share payable on June 17, 2008 to shareholders of record at the close of business on June 3, 2008.
Analyst Conference Call and Webcast
Rothmans Inc. management will hold a conference call with analysts to discuss the fourth quarter and full year results at 8:30 a.m. Toronto time on Friday, May 16, 2008. 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 May 24, 2008 by calling 1-800-408-3053 and entering reservation number 3261299. 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 750 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 fiscal year and three months ended March 31, 2008
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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 year and fiscal quarter ended March 31, 2008 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 year ended March 31, 2008. 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 May 15, 2008.
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.
Disclosure and Internal Controls
With respect to disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Company's disclosure controls and procedures as of March 31, 2008. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that such disclosure controls and procedures were effective as of March 31, 2008 in providing reasonable assurance that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities.
During the Company's most recent interim period, there were no changes in the Company's internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.
Forward Looking Statements
Certain statements contained in this MD&A and other sections of this document (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 May 15, 2008.
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, including the results of ongoing investigations; product liability claims; increases in the levels of contraband product in the market; increased competition and competitor initiatives; the variability in the rate of growth in the cigarette price category; continued declines in consumption of tobacco products; RBH's ability to continue to implement price increases; fluctuating wholesaler and consumer purchasing patterns; changes in government taxation policy; changes in government legislation and regulation including, but not limited to, legislation banning the display of tobacco products in retail stores and new requirements to apply federal excise duty paid stamps on tobacco products; 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 RBH's "earnings before interest, income taxes, depreciation and amortization" as a percentage of "sales, net of excise duty and taxes".
EBITDA margin provides a measure allowing period-to-period comparisons of the core RBH operating performance before the impact of changes in capital structure, interest, income taxes and capital spending and does not include income from investments or the expenses related to operating Rothmans Inc. as a public company. 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 March 31, 2008, and "prior quarter" refers to the three months ended December 31, 2007. "Fiscal 2008" or "recent fiscal year" refers to the fiscal year ended March 31, 2008 and other similar references to a fiscal year (e.g., fiscal 2007) refer to the fiscal year then ended on March 31 (e.g., March 31, 2007).
"The three major suppliers of tobacco products" 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. "Super premium" refers to tailor-made cigarettes sold at above premium retail prices. "Premium cigarettes" refers to tailor-made cigarettes sold at premium retail prices, "cigarette price category" refers to cigarettes sold at less- than-premium retail prices and "price category" refers to the combination of the cigarette price category and the fine cut category (loose tobacco and pre- portioned tobacco sticks). "Carton" refers to a selling unit containing 200 cigarettes or stick equivalents. "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. "Dark markets" refer to provincial jurisdictions where the display of tobacco products by retailers is banned by government regulation. "CTMC" refers to the Canadian Tobacco Manufacturers Council.
New Accounting Pronouncements
As required by the Canadian Institute of Chartered Accountants ("CICA"), on April 1, 2007, the Company adopted CICA Handbook Section 3855 "Financial Instruments - Recognition and Measurement", Section 3861 "Financial Instruments - Disclosure and Presentation" and Section 1530 "Comprehensive Income".
Sections 3855 and 3861 prescribe when a financial asset, financial liability, or non-financial derivative is to be recognized on the balance sheet, and at what amount. These sections also specify how financial instrument gains and losses are to be presented. The prospective adoption of these new standards resulted in changes in the accounting and presentation for financial instruments as well as the recognition of certain transitional adjustments that have been recorded in opening retained earnings as described in note 2. As required by the implementation of these new standards, the comparative consolidated financial statements have not been restated.
CICA Handbook Section 1530, "Comprehensive Income," introduces a new requirement to temporarily present certain gains and losses outside net income in other comprehensive income or loss. The Company determined that for the year ended March 31, 2008 there were no gains or losses that would be recorded in other comprehensive income or loss. Refer to note 2 for more details.
The implementation of these Handbook requirements did not have a material impact on the financial results of the Company.
The Company implemented the following three new accounting disclosure standards effective for the quarter and year ended March 31, 2008 in advance of the required implementation date.
CICA Handbook Section 1535 "Capital Disclosures" requires that an entity disclose information that enables users of its financial statements to evaluate an entity's objectives, policies and processes for managing capital, including disclosures of any externally imposed capital requirements and the consequences of non-compliance. This section applies to interim and annual financial statements relating to fiscal years beginning on or after October 1, 2007 (note 4).
The new Sections 3862 and 3863 replace Handbook Section 3861 "Financial Instruments - Disclosure and Presentation," revising and enhancing its disclosure requirements, and carrying forward unchanged its presentation requirements. These new sections place increased emphasis on disclosures about the nature and extent of risks arising from financial instruments and how the entity manages those risks. Sections 3862 and 3863 apply to interim and annual financial statements for fiscal years beginning on or after October 1, 2007 (note 3).
The following is the new accounting standard the Company will adopt effective April 1, 2008. Management is evaluating the standard and its impact on the Company's consolidated financial statements.
The CICA Handbook Section 3031 "Inventories" prescribes the accounting treatment for inventories. Specifically, the section provides guidance relating to the accounting for inventories and revises and enhances the requirements for assigning costs to inventories. Section 3031 applies to interim and annual financial statements for fiscal years beginning on or after January 1, 2008.
Outstanding Shares
As at March 31, 2008, there were 68,095,608 common shares outstanding or 69,346,408 shares on a fully diluted basis when all exercisable options were included. See notes 10 and 11 to the unaudited consolidated financial statements.
Industry Volumes & Market Share Measurement
For the purpose of managing and evaluating its ongoing business, RBH continues to use various information sources, not all of which are nationally representative, including a proprietary wholesale volumetric reporting system, industry market share information purchased from the Nielsen Company "Nielsen" (a recognized market research company), selected retail data, consumer survey data, and information reported by Statistics Canada. The market share data reported in this annual report was obtained from Nielsen and measures sales of RBH cigarettes sold by selected retailers in the domestic market. RBH continues to evaluate the quality of fine cut market share information available for the purposes of external reporting. Nielsen uses a sampling approach to determine product market share for tobacco products sold at retail. This information, by its nature, is subject to sampling error and variability over a range that is not determinable. Management believes that market share information provided under this approach may be useful in reflecting market trends rather than providing an accurate absolute measure of market share at any particular point in time. Nielsen market share of retail sales cannot be meaningfully compared with market share of volumetric shipments sold to wholesalers which had been previously reported by the Company.
Company Overview, Core Business and Strategy
Rothmans participates in the Canadian tobacco industry through its 60% ownership interest in RBH. The remaining 40% of RBH is owned by FTR Holding S.A. of Switzerland, an affiliate of Philip Morris International, Inc. Rothmans is the only widely held Canadian public company with interests exclusively in the tobacco industry. Its shares are listed on the Toronto Stock Exchange under the symbol ROC. Rothmans' financial results reflect those of RBH after minority interest, plus income generated by the Company's cash reserves, less the costs associated with operating Rothmans as a public company.
RBH is the second largest supplier of tobacco products to the tax paid Canadian market and competes in all the significant categories of that market including premium cigarettes, price category cigarettes and fine cut. RBH also competes in the cigar, pipe tobacco, duty free and export categories which in aggregate represented approximately 7% of RBH's net sales revenues in the recent fiscal year.
RBH continuously evaluates its brand offerings and positioning within each market category against the opportunities presented by the marketplace. This process allows for adjustments to the execution of its brand strategy in order to best maximize performance. The adjustment in strategy can involve activities including changes in RBH's selling price to wholesalers, brand launches, brand line extensions, brand repositioning, brand acquisitions and merchandising initiatives. While RBH has continued to demonstrate strong volumetric and financial performance in the face of a declining market, the apparent growing presence of contraband product in the Canadian market is expected to continue to present significant challenges for RBH for the foreseeable future. Management continues to believe that RBH's culture, strategy, product depth, product positioning and business processes are important strengths that will need to be utilized in responding to the challenges inherent within its business.
The Company continues to believe that worldwide tobacco industry consolidation could present opportunities for Rothmans. While consolidation has occurred, Rothmans has not found any attractive complements to its existing business interest in RBH that meet the Company's objective of maximizing shareholder value at an acceptable level of risk. Rothmans will continue to assess potential opportunities with the objective of maximizing shareholder value; however, the opportunities going forward may be more limited than in the past.
Industry Overview
The Canadian tobacco market is composed principally of consumers who choose between tax-paid premium cigarettes, price category cigarettes, fine cut tobacco offerings and untaxed or partially taxed contraband tobacco products. There is also a smaller category of consumers who choose tax-paid pipe tobacco, cigars and specialty products. Premium and super premium cigarette consumers are principally served by the three majors, offering products in varying lengths, package formats and tobacco blend characteristics under a variety of trade-marks. The price category includes price category cigarettes and fine cut products. Price category cigarette consumers are offered tax-paid tailor-made cigarette products at less than premium pricing by the three majors and a number of regional manufacturers. Fine cut product offerings include loose tobacco, high-yield tobacco and a variety of pre- portioned tobacco stick products. This category offers a lower-priced, high- quality alternative to the consumer who is willing to assemble the product prior to consumption. Contraband products appear to be having an increasing impact on the Canadian tobacco marketplace. In fiscal 2008, consumers continued to move away from premium cigarette and fine cut products to either tax-paid price category cigarettes or contraband products principally in search of acceptable tobacco products at a reduced price.
RBH management believes that a number of factors affected overall industry shipments in fiscal 2008 including:
- Contraband - During the second quarter of fiscal 2008, the CTMC
released a study on the illicit usage of cigarettes in the Canadian
marketplace. This study indicated that 22% of the national cigarette
volume being purchased was contraband product; up from 16.5% found in
a similar study conducted a year earlier. 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 - The period between
April and September has demonstrated stronger 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.
- Fluctuations in wholesaler buying patterns - Swings in wholesaler
purchasing patterns motivated by the timing of tax increases, price
increases, manufacturer trade 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.
During fiscal 2008, there were a number of changes in tobacco tax rates. During the first quarter of fiscal 2008, the Province of Alberta raised its Provincial Tobacco Tax on cigarettes and fine cut products by $5.00 per carton, or equivalent stick basis. Effective January 1, 2008, the federal excise duty applicable to cigarettes, tobacco sticks and fine cut products was raised by $0.59, $0.55 and $0.39 respectively, on a per carton basis, in order to offset the effect of the 1% GST reduction. Effective February 27, 2008, the federal government increased the federal excise duty on the tobacco stick category to $85.00 per thousand sticks, the same level as for tailor-made cigarettes. Also announced February 26, 2008, but effective July 1, 2008, the federal government changed the application of federal excise duty on fine cut and pipe tobacco products to a "per 50 gram or fraction thereof contained in a package" basis. This change effectively introduces a "tax penalty" on fine cut products and pipe tobacco not packaged in multiples of 50 grams.
Subsequent to the fiscal year end, on April 24, 2008, the Province of Prince Edward Island raised its Provincial Tobacco Tax on cigarettes and tobacco stick products by $5.00 per carton or equivalent stick basis. The corresponding increase on fine cut products was $4.02.
Key Performance Drivers
The key performance drivers for RBH are:
- the incidence and consumption trends for tax-paid tobacco products in
the Canadian marketplace;
- the amount of industry sales volume being supplanted by contraband
tobacco products;
- manufacturer pricing by product category;
- market share of the industry; and
- opportunities to reduce costs.
RBH's revenue model and its associated strategies for increasing profitability and shareholder value are driven by the tobacco volume sold and the price charged for that volume. RBH uses a variety of data sources for management purposes to estimate volume in equivalent sticks by product category and market share by brand. Along with these metrics, RBH also uses margin per equivalent stick to track its key drivers.
Volume trends provide key strategic information on market developments leading to decisions on product launches, line extensions, and price increases that have driven volume growth, market share growth and increasing profitability over the past several years.
Tobacco consumption continues to be a significant socio-political issue, giving rise to significant pressures on manufacturers, tobacco product consumers, tobacco growers, retailers and wholesalers. The high tax load imposed on tobacco products has caused a diversion of some consumers away from tax-paid products and has led to the growth of a significant contraband market of non-tax paid and partially tax-paid products.
Industry participants are also subject to other factors affecting the volume of tobacco sold and consumed including: the legal and regulatory environment related to tobacco, federal and provincial tobacco taxation policies and escalating restrictions on where tobacco can be consumed. Suppliers of contraband product are not subject to the same legal, regulatory, and taxation constraints. RBH sells only legal tax-paid product, markets only to adults who choose to smoke, does not market to youth, does not encourage youth to smoke or non-smokers to take up smoking and does not discourage smokers from quitting.
RBH regularly monitors its pricing position against industry participants, by category. This position, along with product category margin, provides profitability information used to drive strategic pricing decisions as well as to support sales and marketing directions. Due to contraband's covert nature, RBH is unable to effectively monitor its position versus suppliers of non-tax paid or partially tax-paid product.
Results at Rothmans Benson & Hedges Inc.
RBH shipped a total of 10.7 billion and 2.3 billion equivalent sticks into the domestic market during fiscal 2008 and the quarter ended March 31, 2008 respectively, representing a 0.2% increase and 2.6% decrease compared to the same periods of the prior year. While increased shipments of RBH price category cigarettes more than offset declines in premium cigarette and fine cut shipments during fiscal 2008, they only partially offset these declines in the recent quarter compared with the same period of the prior fiscal year. Based on market share information provided by Nielsen, RBH's share of total domestic cigarettes sold by retailers increased to 32.8% in fiscal 2008, from 31.6% in fiscal 2007 on a rolling 12 month basis. Given RBH's volume performance in fiscal 2008 this trend is indicative of continued overall domestic, tax-paid cigarette volume erosion during the year.
Success in the premium category, which is a significant driver of profitability for RBH, remains dependent on the strength of RBH's portfolio of brands. Consumers buy premium cigarettes based on a number of factors including brand attributes and the consistent product quality that the manufacturer provides to the consumer. Brands within the tobacco industry have a long product cycle. In recognition of this, RBH continues to focus its marketing and sales efforts on the top six premium brands that account for approximately 90% of its premium cigarette sales. Over the last year, RBH continued to leverage its retail and wholesaler programs in support of those brands which are central to the targeted premium brand strategy. To supplement its premium brand strategy RBH launched a number of premium and super premium brands. In fiscal 2007, RBH launched the Carreras and ROOFTOP brands, followed by Benson & Hedges Superslims, Davidoff and Parliament in fiscal 2008. The super premium category offers the tobacco consumer brands, formats and tobacco blends that differ from traditional premium offerings and are often internationally recognized.
Regulatory constraints continue to limit RBH's ability to communicate with adult smokers. With dark markets already in place in British Columbia, Saskatchewan, Manitoba, Prince Edward Island, Nova Scotia, Nunavut and the Northwest Territories, and scheduled for implementation in 2008 for Ontario, Quebec and Alberta, RBH's strategy for long-term success in the premium cigarette category is to focus on growing brands by investing in retail availability programs.
The growth in the cigarette price category continued in fiscal 2008 as some premium cigarette consumers continued to switch to lower-priced alternatives. In the fourth quarter, RBH launched the Quebec Classique brand into the cigarette price category in Quebec. The brand initially competed in the mid tier of the cigarette price category and was repositioned to the lowest tier subsequent to year end.
RBH believes that its products are well positioned in all price tiers in the cigarette price category. The Accord brand has been positioned at the lowest price tier nationally and the Quebec Classique brand matches Accord in the lowest price tier in Quebec. At the new mid-price tier, depending on the region, RBH has positioned its Canadian Classics and Mark Ten brands. At the highest tier, the Number 7 brand continues to be offered nationally. In order to further strengthen its Number 7 and Canadian Classics trade-marks, RBH introduced new updated packaging during the fiscal year. The cigarette price category continues to evolve and RBH is committed to strategies that defend its significant market position. A number of factors continue to influence the overall growth of this product category including the brands being offered to consumers, their availability, price and the availability of contraband products.
The fine cut portion of the price category continues to be driven by a combination of price, innovative product offerings, price category cigarette offerings and the impact of contraband product. Although the erosion of overall fine cut volumes continued during the year, RBH continues to believe that fine cut remains a viable part of the price category by providing lower priced alternatives to tobacco consumers. RBH's leadership position in fine cut has been driven by innovation resulting in product offerings that are either easier to assemble or offer better value. The introduction in fiscal 2007 of a new "Premium Long Cut" product innovation that produces fine cut products with enhanced tobacco strand length continued to support RBH's leadership position in fiscal 2008. During fiscal 2008 RBH focused its attention in this category on ensuring appropriate product distribution and on Accord brand offerings that compete at the lowest price tier of the fine cut category. With the announced significant change in the federal excise duty regime as it applies to both the tobacco stick category and the fine cut category, RBH is currently evaluating its portfolio of product offerings to ensure its competitive position during and post implementation.
RBH's EBITDA margin was 50.9% and 43.4% in the fiscal year and quarter ended March 31, 2008 compared with 47.6% and 39.4% in the same periods of the prior fiscal year. The fiscal 2008 EBITDA margin increase was principally due to price increases across all product categories partially offset by volume shifts into lower-priced tiers of the cigarette price category and higher general and administrative expenses, including incentive plan costs and slightly higher spending on retail trade programs. The recent quarter EBITDA margin decrease from 49.8% in the prior quarter was principally due to the effect of lower shipment volumes. The increase in EBITDA margin from the fourth quarter of the prior year is predominantly due to price increases across all product categories partially offset by lower volumes shipped and higher sales and marketing costs.
In fiscal 2008, RBH implemented various price changes for its products. In December 2007, RBH decreased the price charged to wholesalers for its Accord brand price category cigarettes by $1.98 per carton in Quebec and Ontario. This price reduction, in response to competitive activity in the market, maintained RBH's commitment to remaining competitive in the lowest cigarette price tier, where price sensitivity is most prevalent.
During the second quarter, RBH increased its wholesale prices on Mark Ten and Canadian Classics price category brands by $1.00 per carton in Quebec and Ontario. During the quarter ended June 30, 2007, RBH increased the prices charged to wholesalers by $1.00 per carton for the Carreras, Davidoff and ROOFTOP premium brands, $1.50 per carton for all other premium brands and $1.00 per carton for all price category cigarettes other than the Accord brand. Prices on fine cut products, cigars and pipe tobacco were increased by varying amounts depending on format.
Effective July 30, 2007, RBH implemented changes to its wholesale distribution terms, moving from a 2% prompt payment discount to a fee-for- service model nationally with the exception of Newfoundland and Labrador where terms remain unchanged. This change in distribution terms has had no material impact on distribution costs incurred since the change in terms was implemented.
Subsequent to year end, RBH implemented a number of price changes for its products. The wholesale price for the Dunhill brand was increased by $5.20 per carton. Wholesale prices for all cigarette categories were increased by $1.00 per carton nationally, except for the Accord and Canadian Classics brands in the Atlantic region. The price for Quebec Classique was reduced by $5.97 per carton. Prices on fine cut products, tobacco sticks, cigars and pipe tobacco were increased by varying amounts depending on format.
Rothmans Inc. Financial Results
Basic earnings per share were $1.73 and $0.31 in the fiscal year and quarter ended March 31, 2008 versus $1.47 and $0.27 in the comparable periods of the prior year. RBH's sales, net of excise duty and taxes, of $670.6 million and $142.7 million for fiscal 2008 and the recent quarter were $52.0 million higher than fiscal year 2007 and $5.8 million higher than the quarter ended March 31, 2007. Increased volumes of RBH price category cigarettes, together with price increases across all product categories, more than compensated for volume declines in premium cigarettes and fine cut products in both periods.
Investment income of $12.2 million for fiscal 2008 was $3.1 million higher than fiscal 2007 due to the higher average cash, cash equivalents and short-term investment balances held and a higher rate of return experienced during the year.
Operating costs, which totaled $334.3 million and $82.0 million for the fiscal year and quarter ended March 31, 2008, were $6.6 million higher and $1.6 million lower than in the same periods of the prior fiscal year. Higher general and administrative expenditures including incentive plan costs contributed to the higher operating costs in the fiscal year. Recent quarter operating costs were slightly lower due to lower volumes and general and administrative costs, partially offset by higher sales and marketing costs.
RBH's amortization expense of $12.6 million for fiscal 2008 was $0.3 million higher than in the prior year. Net capital spending by RBH increased during fiscal 2008 to $13.6 million from $6.6 million in fiscal 2007 returning to a level that approximates amortization expense. In fiscal 2009, historical capital expenditures approximating depreciation and a requirement to comply with the federal government's new tax stamping regime are likely to increase capital spending to the $18 - $22 million range.
Income tax expense was $130.6 million and $23.3 million in the fiscal year and recent quarter ended March 31, 2008 resulting in an effective tax rate for the fiscal year to date of 40.0%. Due to various substantively enacted federal and provincial tax rate reductions, the Company expects its effective tax rate for fiscal 2009 to approximate 38.0%.
Rothmans Inc. Consolidated Financial Summary (Unaudited)
(in millions of dollars, except per share data)
Year ended March 31 2008 2007 2006
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Operations
Sales, net of excise duty and taxes 670.6 618.6 607.2
Cash flows from operations 240.4 204.1 183.4
Earnings before minority interest 195.5 165.8 165.7
Earnings and comprehensive earnings
for the year 117.6 99.8 99.5
Dividends paid 88.5 81.6 182.7
Financial position
Net working capital 273.0 248.6 213.0
Total assets 542.8 485.9 447.6
Total long-term liabilities 206.1 212.3 197.9
Shareholders' equity 164.2 134.2 113.9
Per common share
Earnings - basic 1.73 1.47 1.47
Earnings - diluted 1.72 1.46 1.45
Dividends paid 1.30(1) 1.20 2.70(2)
Shareholders' equity 2.41 1.97 1.68
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(1) At the second quarter of year 2008, the quarterly dividend increased
to $0.35 per share from $0.30 per share.
(2) 2006 dividends paid includes a special dividend of $1.50 per share.
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 $216.7 million in the fiscal year ended March 31, 2008 compared with $182.0 million in the prior 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 fiscal 2008, the Company paid dividends of $88.5 million, versus $81.6 million in fiscal 2007. At the end of the second quarter of fiscal 2008, the Company announced an increase in the regular quarterly dividend to $0.35 per share from $0.30 per share resulting in a total fiscal 2008 regular dividend of $1.30 per share compared to $1.20 per share in fiscal 2007.
Cash Resources
Cash, cash equivalents and short-term investments of $234.9 million at March 31, 2008 represented the consolidated cash resources of the Company versus $172.2 million at March 31, 2007. The increase in cash, cash equivalents and short-term investments is predominantly due to earnings from RBH, investing activities and normal quarterly fluctuations in RBH's working capital requirements. On a non-consolidated basis, Rothmans held cash, cash equivalents and short-term investments of $154.4 million at March 31, 2008 down slightly from $157.0 million at December 31, 2007 but up from $120.8 million at March 31, 2007. The year over year increase results from the payment of dividends by the Company and the timing of dividends paid by RBH while the decrease from the prior quarter was primarily due to higher dividends paid by the Company than were received from RBH during the recent quarter.
RBH currently has outstanding $150.0 million of senior unsecured bonds maturing on December 21, 2011 carrying a coupon rate of 5.552%. It is RBH's present intention to maintain this level of debt within its capital structure for the foreseeable future and not to enter into fixed or floating interest rate swaps (see note 9 to the unaudited consolidated financial statements for the fiscal year).
Contractual Obligations
The table below summarizes RBH's obligation to make future payments on long-term debt, lease obligations and other obligations as at March 31, 2008.
------------------------------------------------------------------------- Contractual Fiscal Fiscal Fiscal Obligations ($000's) 2009 2010 2011-2013 Total ------------------------------------------------------------------------- Long term debt - - 150,000 150,000 Operating leases 3,619 2,990 6,333 12,942 Purchase obligations 2,423 - - 2,423 ------------------------------------------------------------------------- Total contractual obligations 6,042 2,990 156,333 165,365 -------------------------------------------------------------------------
Non-Capital Resources
RBH's critical non-capital resources are its trade-marks, and the culture and values that characterize the organization. The continuing quality of product that RBH delivers to its consumers is a key factor in the strength of RBH's brands. RBH's culture and values are built upon a number of competencies that reflect teamwork, leadership and a commitment to win. RBH believes that its culture and values, which drive how the organization functions, are critical to its success.
Manufacturing Facilities
RBH's capital expenditure programs are focused on maintaining manufacturing flexibility and capacity at both the Quebec and Brampton plants.
Management Estimates
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. Other than as discussed below, there are no critical accounting estimates that require disclosure or discussion in this report.
Employee Future Benefits
RBH provides defined benefit pension plans, defined contribution pension plans and post-employment benefits to its employees. For the defined benefit pension plans and the post employment benefits, determination of the benefit obligation and associated expense is subject to significant actuarial assumptions including the discount rate, the expected return on plan assets, the projected rate of compensation increase, health care cost trend rates, and the demographic characteristics of RBH's employee base.
The discount rate is used in determining the present value of the benefit obligation at the fiscal year end. The discount rate is prescribed as the market rate of high quality fixed income investments with a term equivalent to the projected benefits to be paid under the plans. A lower discount rate increases the present value of the benefit obligation. A 25 basis point change in the discount rate applied to the plans would result in a change in the obligation liability of $5.4 million and maintain the benefit cost for fiscal 2008.
The expected return on plan assets assumption is based on plan asset allocations and the associated future estimates of the long-term investment returns. A 25 basis point change in the expected return on plan assets assumption would change the pension cost in fiscal 2008 by approximately $0.3 million.
Compensation Programs
RBH's compensation bonus programs are tiered by level of responsibility and involve all non-union employees. Bonuses are generated from these programs based on the achievement of pre-determined corporate market share, profitability and shareholder return targets, aligning the programs with the drivers of shareholder value. The Company is required to make estimates and assumptions of future financial and operating performance to estimate the ultimate amounts payable under these programs. Changes in estimates of future financial and operating performance could result in material adjustments to amounts recognized in the consolidated financial statements. Annual option grants as a part of executive compensation programs were discontinued effective fiscal 2006.
Litigation Contingent Liabilities
As discussed more fully in the Risks and Uncertainties section of this MD&A, the Company and RBH have been the subjects of various lawsuits, legal proceedings and investigations. Management is unable to determine the likelihood of loss or liability and is unable to meaningfully estimate the loss, if any, that might result and neither the Company nor RBH has accrued for potential losses or liabilities. However, the outcome of any contingency is uncertain. If determined adversely against the Company or RBH, these lawsuits, legal proceedings or investigations either individually or in the aggregate, could involve significant damages or payments which would have a significant adverse effect on the financial condition of the Company, and which the Company and RBH may not have the resources to satisfy.
Risks and Uncertainties
Regulatory Environment
Canada is one of the most regulated environments in the world for the marketing and sale of tobacco products. Restrictive legislation governing virtually all aspects of tobacco product sales and promotion has been imposed by federal, provincial and municipal governmental authorities in Canada.
The Tobacco Act (Canada) prohibits the direct or indirect promotion of tobacco products and bans sponsorships by tobacco product manufacturers. It also mandates the display of health warnings and information concerning constituents of the product on tobacco product packaging and requires prescribed information concerning tobacco products and their ingredients and emissions to be reported to Health Canada. In December 2002, the Quebec Superior Court dismissed the constitutional challenge of this legislation by the three major tobacco product suppliers. In August 2005, the Quebec Court of Appeal essentially upheld the decision of the lower court. The federal government obtained leave to appeal to the Supreme Court of Canada with respect to those sections of the legislation which had been struck down by the Court of Appeal, and the Supreme Court of Canada heard the appeal, as well as the cross appeal of the three major tobacco product suppliers, in February 2007. In June 2007, the Supreme Court of Canada issued its decision on the constitutionality of the legislation, allowing the appeals of the federal government and dismissing the cross appeals of the three major tobacco product suppliers. Essentially, the Supreme Court of Canada ruled that the legislative and regulatory provisions at issue, when properly interpreted, were constitutionally valid.
Legislation banning the display, promotion and advertising of tobacco products at retail stores is in effect in British Columbia, Saskatchewan, Manitoba, Prince Edward Island, Nova Scotia, Nunavut and the Northwest Territories, and will be in effect in Ontario and Quebec as of May 31, 2008. In Alberta, a retail display ban comes into effect on July 1, 2008. In March of this year, New Brunswick introduced legislation which, if passed, will ban the display, promotion and advertising of tobacco products in retail stores as of January 1, 2009. Health Canada is considering issuing federal regulations banning the display of tobacco products at retail outlets where they are sold. Regulations restricting or prohibiting smoking in the workplace and other environments are in place in many jurisdictions. Legislation enacted in Quebec as of May 31, 2006 prohibits the sale of tobacco products in such places as the grounds and buildings of colleges and universities, buildings intended mainly for the presentation of sports, recreational, cultural or artistic activities and pubs, taverns and bars.
Legislation enacted in British Columbia, New Brunswick, Newfoundland and Labrador, Nova Scotia, Manitoba and Saskatchewan allows the provincial government in its own right 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 smoking-related illnesses. In January 2001, the Province of British Columbia initiated a lawsuit in the Supreme Court of British Columbia against RBH, the Company and numerous other Canadian and international tobacco companies and various tobacco trade associations seeking unspecified damages in an amount to cover the costs that allegedly have been, or will be, incurred by the Government of British Columbia in providing health care benefits to British Columbia residents who have allegedly suffered smoking-related illnesses. The action was brought pursuant to the Tobacco Damages and Health Care Costs Recovery Act (British Columbia), which purports to facilitate individuals and the provincial government in suing tobacco manufacturers. This legislation was enacted in January 2001, following a successful challenge (decided in March 2000 by the Supreme Court of British Columbia) by a number of tobacco manufacturers of similar predecessor legislation enacted in 1998. RBH and other tobacco manufacturers challenged the validity of the new British Columbia legislation on constitutional grounds. In May 2004, the B.C. Court of Appeal, overturning a lower court decision, ruled that the legislation was constitutionally valid. RBH and other tobacco product manufacturers appealed this decision to the Supreme Court of Canada which dismissed the appeal in September 2005. The action in British Columbia is now proceeding, and the trial is currently scheduled for the fall of 2010. A motion brought by the federal government, seeking to strike out a third party notice which would make it a party to the lawsuit in British Columbia, was heard in March 2008. The motion was allowed in April 2008. The Canadian tobacco companies have filed notices of appeal. In March 2008, the Company and RBH were named as defendants, along with Imperial Tobacco Canada Limited, JTI-Macdonald Corp. and a number of international tobacco product manufacturers, in a lawsuit filed by the province of New Brunswick in the Court of Queen's Bench of New Brunswick. The action has been brought pursuant to the Tobacco Damages and Health Care Costs Recovery Act (New Brunswick). The lawsuit is based upon grounds which include alleged misrepresentations made by the defendants in respect of the hazards of tobacco products and seeks to recover unspecified damages for costs that are alleged by the Government of New Brunswick to have been incurred in providing health care benefits to New Brunswick residents who have allegedly suffered smoking-related illnesses. At this time, no action has been commenced against the tobacco manufacturers in any of the other provinces.
Regulations enacted under the Tobacco Act require all cigarettes manufactured in or imported into Canada as of October 1, 2005 to meet new reduced ignition propensity performance standards and reports on testing of cigarette brands against these new standards to be submitted to Health Canada on an annual basis.
In January 2008 Canada Revenue Agency ("CRA") announced that a federal tobacco stamping regime which would be applicable to all Canadian tobacco product manufacturers and importers was proposed to be implemented in the summer of 2008. The new regime would require prescribed stamps to be applied to tobacco products which indicate that applicable excise duty has been paid. In March 2008, CRA advised the manufacturers implementation would be delayed to allow all parties adequate time to prepare for the new stamping regime. Implementation is now scheduled for January 1, 2010. RBH is currently discussing these and other anti-contraband measures with government authorities. The cost associated with compliance with the new stamping requirements and other anti-contraband measures including necessary plant equipment upgrades cannot be determined by RBH until such time as details of the new requirements have been finalized.
Health Canada published a consultation document in 2004 soliciting comments on a proposal for new health-related information on tobacco product labels. It proposed, among other things, 48 new health warnings for tobacco packaging as well as new health information messages. Health Canada is also considering implementing regulations which would require the current toxic emissions statement on tobacco product packaging to be replaced by other information. A survey with respect to the costs of these proposed regulations was circulated to industry stakeholders in March 2006.
In August 2007, Health Canada introduced proposed regulations which would prohibit the use of "light" and "mild" descriptors, or variations of those terms, in connection with tobacco products and accessories. In November 2006, at the request of the Competition Bureau, RBH agreed to discontinue manufacturing and packaging tobacco products using "light" and "mild" descriptors in advance of Health Canada's anticipated regulations. This change in packaging has now been completed. Similar agreements were made with the other two major suppliers of tobacco products.
Restrictive legislation and regulations enacted by all levels of government have proliferated in recent years. This legislation limits RBH's ability to compete for market share as well as adds significant costs to RBH's operations in terms of both increased expenses and reduced operating efficiencies. If RBH is unable to effectively market its products and compete for market share, or if the costs of compliance with government legislation and regulation cannot be offset through increased selling prices for its products, RBH's sales and operating results will be adversely affected.
Legal Proceedings
Various lawsuits and legal proceedings 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. Since 1995, there has been an increase in the number of these lawsuits, which include government actions for recovery of health care costs allegedly incurred in respect of smoking-related illnesses. Two of these lawsuits have been authorized by the court to proceed as class actions and punitive damages are specifically pleaded in a number of cases in addition to compensatory and other damages.
The lawsuits that have been filed against the Company and RBH to date remain at an early stage and involve complicated and novel questions of law that may take several years to resolve. Although the precise scope of the class actions remains unclear, such actions will involve a large number of people, possibly ranging in the millions. If determined adversely against the Company or RBH, these lawsuits, 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 which the Company and RBH may not have the resources to satisfy.
The Company and RBH believe that they have good defences in the court proceedings with respect to the lawsuits which have been filed against them to date and deny the allegations therein. The Company and RBH intend to vigorously defend themselves in the court proceedings relating to those lawsuits.
In addition to the lawsuits commenced against the Company and RBH to date, RBH is currently the subject of an ongoing investigation by the RCMP relating to its sales of products exported from Canada in the period 1989- 1996. This investigation, of which RBH was notified in January 2002, is related to allegations that tobacco products manufactured and exported by RBH were illegally smuggled back into Canada during this period without payment of applicable excise and tobacco taxes and duties. Although no action has been commenced and no charges laid against the Company or RBH or any of their present or former employees, officers or directors, the Company and RBH believe that the RCMP and federal and provincial government authorities intend to lay charges or commence other legal proceedings involving the Company or RBH and certain of their employees, officers and directors relating to or arising from these allegations. Counsel for RBH is continuing to have discussions with government authorities with respect to this matter. RBH's business and the Company would be materially adversely affected in the event of an unfavourable outcome of current or future investigations, or in the event charges or other legal proceedings are brought against RBH or the Company.
Illegal smuggling of tobacco products into Canada occurred during the late 1980s and early 1990s coincident with the imposition by the federal and provincial governments of significant new taxes and duties on tobacco products. Such taxes and duties were, however, not imposed on tobacco products exported out of Canada. In February 1994, in an effort to curb the high level of smuggling of tobacco products into Canada, the federal and certain provincial governments reduced taxes to earlier levels. Exports of tobacco products by the major Canadian tobacco manufacturers, including RBH, increased significantly from 1991 to 1994. In February 2003 the RCMP filed criminal charges against another Canadian tobacco products manufacturer and certain of its related parties alleging violations of the Criminal Code (Canada) in connection with the sale and export of tobacco products during the early 1990's. In January 2006, a former executive of that company pled guilty to charges of defrauding the federal government of tax revenue and was sentenced to eight months house arrest in return for providing evidence against that company and certain of its executives. A preliminary hearing with respect to the other defendants concluded in 2006 and in May 2007 the Ontario Court of Justice ordered that company and its former chief executive officer to stand trial. Charges against six other executives were initially dismissed. The Crown sought judicial review of these dismissals and in February 2008 those dismissals were set aside by the Superior Court of Justice and the matter was remitted back to the preliminary inquiry judge for reconsideration. In August 2003, the Government of Canada initiated a civil lawsuit and in August 2004 the Minister of Revenue for the Province of Quebec initiated tax reassessment proceedings against this company and related parties seeking to recover taxes allegedly owing in connection with the sale of such exported products. In September 2004, this manufacturer was granted protection from creditors under the Companies Creditors' Arrangement Act (Canada) and a stay of the civil proceedings brought by the Government of Canada and the Minister of Revenue for the Province of Quebec. Since that time, claims aggregating approximately $10 billion have been made against that company relating to unpaid taxes and duties on that company's export sales of tobacco products during the early 1990's. In November 2004, representatives of the RCMP conducted a search of the largest Canadian tobacco products supplier as part of its investigation into sales of tobacco products exported from Canada.
The Company also monitors other legal proceedings and lawsuits affecting the industry in Canada and which are ongoing or have occurred in other jurisdictions. In Canada, these proceedings include an action against another Canadian tobacco product manufacturer for damages alleging that a tobacco product caused a fire resulting in injury and/or death of the plaintiffs and that the defendant was negligent in failing to sell a fire-safe cigarette and class action suits alleging that the use of the terms "light" and "mild" and other similar descriptors constitute deceptive and misleading representations and unfair trade practices. In other jurisdictions, including the United States and the European Union, these proceedings have included product liability claims relating to smoking and health, personal injury claims caused by environmental tobacco smoke, class action suits alleging that the use of descriptors such as "lights" and "ultra lights" constitutes deceptive and unfair trade practices, claims and investigations relating to allegations of illegal exports and imports of tobacco products and of unlawful pricing activities, a co-operation agreement relating to anti-contraband and anti- counterfeit efforts and settlements of health care recovery litigation. Settlement agreements reached in the other jurisdictions on these types of issues have involved significant monetary payments being made by tobacco product suppliers in those jurisdictions over an extended period of up to 20 years. Should tobacco product manufacturers in Canada enter into settlement arrangements or agreements of a similar nature in respect of any lawsuits, legal proceedings or investigations currently outstanding or those that may be brought in the future, significant monetary payments to third parties including government authorities in Canada may be required which could adversely affect the financial condition and earnings of such companies, including RBH and the Company should they be a party to such arrangements.
It is not possible, at the present time, to determine the likelihood of loss or liability or to meaningfully estimate the loss, if any, that might result from the lawsuits, legal proceedings and investigations, against the Company or RBH or any future lawsuit or legal proceeding that may be brought as a result of any pending or future investigation or claim against the Company or RBH. Lawsuits, legal proceedings and investigations are subject to many uncertainties, and it is possible that there will be adverse developments against the Company and RBH and that these cases and any potential future cases could be decided unfavourably against the Company or RBH. The Company and RBH may also decide to settle current or future lawsuits, legal proceedings or investigations if it is believed to be in the best interests of the Company or RBH. In certain circumstances, defendants in litigation proceedings may be required to post a bond while an unfavourable trial decision is under appeal. The amount of such a bond may be significant and beyond the financial resources of the defendant. An unfavourable outcome or settlement of pending legal proceedings or investigations against RBH or other tobacco product manufacturers could encourage the commencement of additional litigation, or investigations involving RBH or the Company. There have also been a number of adverse legislative, regulatory, political and other developments concerning cigarette smoking and the tobacco industry that have received widespread media attention. These circumstances may negatively affect the outcome of pending proceedings and investigations and may prompt the commencement of additional similar proceedings and investigations.
An unfavourable outcome or settlement of lawsuits, legal proceedings or investigations, pending and future, against the Company or RBH could involve significant damages or significant monetary payments that would have a significant adverse effect on the financial condition of the Company and RBH and which, in the case of an adverse judgment, the Company and RBH may not have the resources to satisfy.
Further information concerning the lawsuits, legal proceedings and investigations affecting the Company and RBH is contained in Note 16 to the unaudited consolidated financial statements which accompany this MD&A.
Tobacco Taxation
Federal and provincial tobacco tax increases in the early part of this decade raised the price of cigarettes to unprecedented levels. In several jurisdictions cigarette prices more than doubled during this short period of time. This policy has raised the demand for illicit product and increased the incentive for those that choose to violate Canadian law. In particular, the illegal sale of non tax-paid or partially taxed tobacco products emanating from Native reserves located in Ontario, Quebec and New York State has been reported as the major source of the contraband product distributed in Canada. A study commissioned by the CTMC released this year found that illicit product represents in excess of twenty percent of cigarettes consumed across Canada. In Ontario and Quebec this figure is estimated to exceed thirty percent.
RBH is the market leader in the fine cut segment and these products play an important role in providing a fully taxed alternative to price-sensitive smokers who might otherwise switch to contraband products. Traditionally, fine cut products have been taxed at lower rates than tailor-made cigarettes in recognition that personal manufacture is required. However, in February 2008, the federal government increased the excise duty rate on tobacco sticks to the equivalent cigarette rate. Tobacco sticks are now taxed on par with cigarettes in all but a few jurisdictions in Canada. With respect to roll-your-own fine cut products one province, Newfoundland and Labrador, has revised its tax policy to tax these products on an approximate cigarette yield basis. Other jurisdictions may also be considering a similar policy. Fine cut products, including tobacco sticks, provide a controlled alternative to contraband. Fine cut tobacco sales volumes are not growing at the expense of higher-taxed cigarette products. In fact, sales volumes are decreasing in this market segment at a higher rate than cigarette volume declines. The Company continues to believe that fine cut products can contribute to the control of contraband. However, the benefits derived from maintaining lower taxes on tobacco stick products have recently been eliminated. RBH believes that it is important to maintain a differentiated taxing structure for roll-your-own fine cut products.
RBH's sales volumes are negatively affected by the existence of illicit trade in tobacco products within Canada, and future tax increases will exacerbate the problem. As well, any shift in government policy to tax roll- your-own fine cut products at cigarette equivalents may make RBH's fine cut products less attractive to consumers. All of these factors could result in an adverse effect on sales volumes and on RBH's profitability, cash flows and financial condition.
New Product Standards
New product technologies continue to be of importance due to the political, social and legal focus on the health effects of tobacco products. Tobacco product manufacturers continue to seek ways to develop and commercialize new product technologies, which continue to offer adult smokers products that meet their taste expectations. While RBH will endeavour, where possible, to ensure that new product developments and new technologies for tobacco products will be available to it, there can be no guarantee that RBH will be successful in these efforts. Should one or more of its competitors acquire such technologies which are not available to RBH, it may be at a competitive disadvantage and its sales and results of operations may be adversely affected.
Competition
The tobacco industry is highly competitive. Certain of RBH's competitors in the tobacco industry have substantially greater financial resources than RBH or may have an inherently greater ability to operate on a lower-cost basis or implement production efficiencies. As a result, those competitors may be able to compete more aggressively than RBH, particularly in respect of retail merchandising arrangements and product selling margins.
The combined effect of significant tax increases implemented by federal and provincial governments together with manufacturers' price increases have resulted in substantial increases in the retail prices of tobacco products, particularly premium cigarettes. Over the past five years, RBH's premium brands have encountered significant increased competition from lower-priced cigarette products. Additional competition has also resulted from diversion into the domestic market of cigarettes intended for sale outside of Canada, the sale of counterfeit cigarettes by third parties and the sale of non or partially tax paid contraband product. As a result, the market share of premium cigarettes has decreased significantly, putting pressure on overall selling margins of the three major suppliers of tobacco products. If these competitive factors continue, sales of premium cigarettes, the most profitable category, may continue to shift to both the cigarette price category and contraband product. The impact on the sales and earnings of RBH will be dependent upon consumer buying patterns with respect to products offered through the contraband distribution network and in the cigarette price category by RBH and competing suppliers. Steps that RBH has taken or may take with respect to the cigarette price category may not continue to be successful. All of these factors could result in lower overall sales and margins for RBH and could have a significant adverse effect on the operations, cash flow and financial condition of RBH.
Risk Management
Corporate risks are managed by RBH at the functional level with the oversight of a Risk Management Committee employing an enterprise-wide risk management methodology. Risk management is a continuous process and RBH refines its crisis management and contingency plans from time to time. RBH adheres to certain standards, principles and operational practices in an effort to reduce risk exposure throughout the organization, and emphasizes risk management as a guiding objective for its operations.
Outlook
In fiscal 2008, it is believed that the presence of contraband remained a key factor in affecting both RBH and total tax-paid industry volumes. Continued availability of contraband product in the domestic market as a result of high tobacco tax rates across the country may cause further declines in tax-paid industry volumes in the future resulting in a negative impact on RBH's sales volumes.
Competition by each of the three major suppliers of tobacco products in the cigarette price category has led to substantial growth of that category in recent 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.
Looking ahead, Rothmans expects that a number of factors could affect its financial performance including:
- the success of efforts by the Company and RBH to defend themselves
against legal claims and investigations and the outcome or settlement
of such claims and investigations that are ongoing or may arise in
the future;
- increased levels of contraband product that may occur due to the high
tax environment;
- the impact of continued high levels of taxation on consumer
purchasing patterns;
- the variability in the rate of growth of the cigarette price category
and RBH's ability to successfully compete in that segment;
- price competition within the lowest price tier of the cigarette price
category;
- continued declines in the consumption of tobacco products;
- RBH's ability to continue to implement price increases for its
products;
- RBH's ability to compete successfully in the 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;
- the impact of continued restrictive legislation and regulations over
the sale of tobacco products including legislation banning the
display of tobacco products in retail stores;
- RBH's ability to maintain its leading position in the fine cut
segment;
- government tax policy regarding federal excise duty and Provincial
Tobacco Tax rates applicable to fine cut products; and
- RBH's continued success in maintaining or reducing costs, especially
in view of the potential for regulated changes to product and
packaging specifications, including health warnings and the proposed
new tobacco stamping regime recently announced by Canada Revenue
Agency.
Quarterly Unaudited Consolidated Financial Information
FISCAL 2008
Period ended (in
thousands of
dollars, except Total
per share data) Jun 30 Sep 30 Dec 31 Mar 31 Year
-------------------------------------------------------------------------
EARNINGS
Revenues:
Sales, net of excise
duty and taxes 177,431 179,672 170,822 142,669 670,594
Investment income 2,677 3,098 3,406 2,987 12,168
-------------------------------------------------
Total revenues 180,108 182,770 174,228 145,656 682,762
Costs:
Operating costs
excluding amortization 80,079 85,157 87,055 81,968 334,259
-------------------------------------------------
Earnings before interest,
income taxes,
amortization and
minority interest 100,029 97,613 87,173 63,688 348,503
Amortization 3,929 2,834 2,856 2,979 12,598
Interest expense
- Long-term debt 2,080 2,094 2,094 2,070 8,338
- Other 242 303 424 521 1,490
-------------------------------------------------
Earnings before income
taxes and minority
interest 93,778 92,382 81,799 58,118 326,077
Income taxes
- Current 36,996 36,766 32,038 28,329 134,129
- Future 498 196 838 (5,070) (3,538)
-------------------------------------------------
Total income taxes 37,494 36,962 32,876 23,259 130,591
-------------------------------------------------
Earnings before
minority interest 56,284 55,420 48,923 34,859 195,486
Minority interest 22,456 22,074 19,513 13,823 77,866
-------------------------------------------------
Earnings and
comprehensive earnings
for the period 33,828 33,346 29,410 21,036 117,620
-------------------------------------------------
-------------------------------------------------
Earnings per common
share
- Basic 0.50 0.49 0.43 0.31 1.73
-------------------------------------------------
-------------------------------------------------
- Diluted 0.49 0.49 0.43 0.31 1.72
-------------------------------------------------
-------------------------------------------------
RETAINED EARNINGS
Balance at beginning
of period 86,645 100,398 113,325 118,913 86,645
Transitional adjustment
on adoption of new
accounting policies 344 - - - 344
-------------------------------------------------
Balance at the beginning
of period as restated 86,989 100,398 113,325 118,913 86,989
Earnings and
comprehensive earnings
for the period 33,828 33,346 29,410 21,036 117,620
-------------------------------------------------
120,817 133,744 142,735 139,949 204,609
Dividends paid:
Common Shares -
(2008 - $1.30 per share) (20,419) (20,419) (23,822) (23,834) (88,494)
-------------------------------------------------
Balance at end of
period 100,398 113,325 118,913 116,115 116,115
-------------------------------------------------
Rothmans Inc. and subsidiary companies (unaudited)
Quarterly Unaudited Consolidated Financial Information
FISCAL 2007
Period ended (in
thousands of
dollars, except Total
per share data) Jun 30 Sep 30 Dec 31 Mar 31 Year
-------------------------------------------------------------------------
EARNINGS
Revenues:
Sales, net of excise
duty and taxes 162,886 165,237 153,606 136,830 618,559
Investment income 1,953 2,320 2,570 2,186 9,029
-------------------------------------------------
Total revenues 164,839 167,557 156,176 139,016 627,588
Costs:
Operating costs
excluding amortization 78,121 82,643 83,283 83,606 327,653
-------------------------------------------------
Earnings before
interest, income taxes,
amortization and
minority interest 86,718 84,914 72,893 55,410 299,935
Amortization 2,865 2,967 3,292 3,215 12,339
Interest expense (income)
- Long-term debt 2,080 2,095 2,094 2,059 8,328
- Other 3 (30) 22 66 61
-------------------------------------------------
Earnings before income
taxes and minority
interest 81,770 79,882 67,485 50,070 279,207
Income taxes
- Current 32,192 32,422 27,083 30,181 121,878
- Future 775 343 321 (9,895) (8,456)
-------------------------------------------------
Total income taxes 32,967 32,765 27,404 20,286 113,422
-------------------------------------------------
Earnings before
minority interest 48,803 47,117 40,081 29,784 165,785
Minority interest 19,532 18,800 15,954 11,737 66,023
-------------------------------------------------
Earnings and
comprehensive earnings
for the period 29,271 28,317 24,127 18,047 99,762
-------------------------------------------------
-------------------------------------------------
Earnings per common share
- Basic 0.43 0.42 0.35 0.27 1.47
-------------------------------------------------
-------------------------------------------------
- Diluted 0.43 0.41 0.35 0.26 1.46
-------------------------------------------------
-------------------------------------------------
RETAINED EARNINGS
Balance at beginning
of period 68,513 77,379 85,292 89,009 68,513
Earnings and
comprehensive earnings
for the period 29,271 28,317 24,127 18,047 99,762
-------------------------------------------------
97,784 105,696 109,419 107,056 168,275
Dividends paid:
Common Shares -
(2007 - $1.20 per share) (20,405) (20,404) (20,410) (20,411) (81,630)
-------------------------------------------------
Balance at end of
period 77,379 85,292 89,009 86,645 86,645
-------------------------------------------------
-------------------------------------------------
Rothmans Inc. and subsidiary companies (unaudited)
Unaudited Consolidated Statements of Earnings,
Comprehensive Earnings and Retained Earnings
Year ended March 31 (in thousands
of dollars, except per share data) 2008 2007 2006
-------------------------------------------------------------------------
EARNINGS
Revenues:
Sales, net of excise duty and taxes 670,594 618,559 607,165
Investment income 12,168 9,029 5,291
-----------------------------
Total revenues 682,762 627,588 612,456
Costs:
Operating costs excluding amortization 334,259 327,653 318,439
-----------------------------
Earnings before interest, income taxes,
amortization and minority interest 348,503 299,935 294,017
Amortization 12,598 12,339 10,663
Interest expense
- Long-term debt (note 9) 8,338 8,328 8,328
- Other 1,490 61 197
-----------------------------
Earnings before income taxes and
minority interest 326,077 279,207 274,829
Income taxes (note 13)
- Current 134,129 121,878 106,584
- Future (3,538) (8,456) 2,530
-----------------------------
Total income taxes 130,591 113,422 109,114
-----------------------------
Earnings before minority interest 195,486 165,785 165,715
Minority interest 77,866 66,023 66,251
-----------------------------
Earnings and comprehensive earnings
for the year 117,620 99,762 99,464
-----------------------------
-----------------------------
Earnings per common share (notes 5 and 10)
- Basic 1.73 1.47 1.47
-----------------------------
-----------------------------
- Diluted 1.72 1.46 1.45
-----------------------------
-----------------------------
RETAINED EARNINGS
Balance at beginning of year 86,645 68,513 151,734
Transitional adjustment on adoption of
new accounting policies (note 2) 344 - -
-----------------------------
Balance at beginning of year as restated 86,989 68,513 151,734
Earnings and comprehensive earnings
for the year 117,620 99,762 99,464
-----------------------------
204,609 168,275 251,198
Dividends paid:
Common Shares
(2008 - $1.30 per share, 2007 - $1.20,
2006 - $2.70(x)) (88,494) (81,630) (182,685)
-----------------------------
Balance at end of year 116,115 86,645 68,513
-----------------------------
(x) Includes a special dividend of $1.50 per share paid on June 17, 2005
Rothmans Inc. and subsidiary companies (unaudited)
Unaudited Consolidated Balance Sheets
March 31 (in thousands of dollars) 2008 2007 2006
-------------------------------------------------------------------------
ASSETS
Current Assets
Cash and cash equivalents 110,127 75,228 48,364
Short-term investments 124,766 96,987 81,867
Accounts receivable 3,561 8,851 10,319
Inventories (note 7) 193,693 201,637 206,433
Prepaid expenses 1,765 1,969 1,835
Future income taxes (note 13) 11,616 3,418 -
-----------------------------
Total current assets 445,528 388,090 348,818
Property, plant and equipment (note 8) 72,475 71,023 76,298
Future income taxes (note 13) 6,327 11,339 6,301
Prepaid pension benefit cost (note 12) 17,251 12,958 13,295
Long-term debt deferred financing charges
(note 2) - 1,102 1,332
Other assets 1,263 1,415 1,555
-----------------------------
542,844 485,927 447,599
-----------------------------
-----------------------------
LIABILITIES
Current Liabilities
Accounts payable and accrued liabilities 64,902 38,067 38,402
Excise and other taxes payable 74,228 69,471 66,204
Dividend payable to minority shareholder
of subsidiary company - - 10,761
Income taxes payable 33,405 31,939 20,437
-----------------------------
Total current liabilities 172,535 139,477 135,804
Other long-term liabilities 10,996 17,735 6,615
Other employee future benefits (note 12) 37,418 35,915 33,444
Long-term debt (note 9) 148,966 149,794 149,751
Minority interest in subsidiary company 8,724 8,828 8,125
-----------------------------
378,639 351,749 333,739
-----------------------------
Contingencies (note 16)
SHAREHOLDERS' EQUITY
Capital stock (notes 10 and 11) 48,090 47,533 45,347
Retained earnings 116,115 86,645 68,513
-----------------------------
Total shareholders' equity 164,205 134,178 113,860
-----------------------------
542,844 485,927 447,599
-----------------------------
-----------------------------
Rothmans Inc. and subsidiary companies (unaudited)
Unaudited Consolidated Statements of Cash Flows
Year Ended March 31 (in thousands of dollars) 2008 2007 2006
-------------------------------------------------------------------------
Cash provided by (used in):
OPERATING ACTIVITIES
Earnings for the year 117,620 99,762 99,464
Adjusted for non-cash items:
Amortization of property, plant
and equipment 12,598 12,066 10,390
Amortization of financing charges
and bond discount - 273 273
Non-cash interest expense 1,452 - -
Minority interest 77,866 66,023 66,251
Future income taxes (recovery) (3,538) (8,456) 2,530
Loss (gain) on disposal of property,
plant & equipment (405) (217) 44
Defined & other employee future
benefits expense 8,701 8,756 5,014
Defined & other employee future benefits
funding (11,491) (5,948) (6,359)
Long-term incentive plan 15,909 11,120 4,448
-----------------------------
218,712 183,379 182,055
Changes in non-cash operating
working capital (note 6) 21,728 20,704 1,391
-----------------------------
240,440 204,083 183,446
-----------------------------
INVESTING ACTIVITIES
Additions to property, plant &
equipment, net (13,645) (6,574) (17,583)
Proceeds on disposal (purchase) of
short-term investments, net (25,984) (15,120) 86,873
-----------------------------
(39,629) (21,694) 69,290
-----------------------------
FINANCING ACTIVITIES
Dividends paid
By the Company (88,494) (81,630) (182,685)
By a subsidiary company to
minority shareholder (78,200) (76,081) (48,315)
Proceeds on issuance of common shares 557 2,186 3,373
-----------------------------
(166,137) (155,525) (227,627)
-----------------------------
Increase in cash and cash equivalents 34,674 26,864 25,109
Cash and cash equivalents at beginning
of year, after adjustment (note 2) 75,453 48,364 23,255
-----------------------------
Cash and cash equivalents at end of year 110,127 75,228 48,364
-----------------------------
-----------------------------
Supplementary disclosures (note 6)
Rothmans Inc. and subsidiary companies (unaudited)
Notes to Unaudited Consolidated Financial Statements
(Tabular amounts are in thousands of dollars, except for share and per
share data or as otherwise indicated)
1. Summary of significant accounting policies
The consolidated financial statements of Rothmans Inc. (the Company) are
prepared in accordance with Canadian generally accepted accounting
principles.
a) Principles of consolidation
The consolidated financial statements include the accounts of the Company
and all subsidiaries including its 60% owned subsidiary, Rothmans, Benson
& Hedges Inc. (RBH).
b) Use of Estimates
The preparation of consolidated financial statements in conformity with
Canadian generally accepted accounting principles 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 may undertake in the future, actual results
could differ from those estimates.
c) Revenue Recognition
Sales of products are recognized upon the transfer of risks and rewards
of ownership to the customer, which occurs upon delivery and when
ultimate collection is reasonably assured. Sales are reported net of
excise duty and taxes, discounts, allowances and returns. The Company
also deducts from sales consideration provided to customers and
retailers. The Company does not have any unusual credit terms or rights
of return or refunds that would affect revenue recognition.
d) Inventories
Inventories are stated at the lower of cost and net realizable value.
Cost is determined by the first-in, first-out (FIFO) method for all
inventories.
e) Property, Plant and Equipment
Property, plant and equipment are recorded at cost and adjusted to fair
market value when the carrying amount is higher than the sum of
undiscounted future cash flows. Amortization is provided on a straight-
line basis over the estimated service lives of the assets, which are as
follows for the principal asset categories:
Land improvements.............................................. 10 years
Buildings...................................................... 30 years
Machinery and equipment........................................ 10 years
Computer equipment.............................................. 3 years
Motor vehicles.................................................. 5 years
Leasehold improvements............ term of lease, not to exceed 10 years
f) Employee Future Benefits
The cost of pension benefits earned by employees covered under defined
benefit plans is determined using the projected benefit method pro-rated
on service, and is charged to expense as services are rendered.
Adjustments arising from plan amendments, changes in assumptions and
experience gains and losses are amortized on a straight-line basis over
the estimated average remaining service lives of the employee groups,
using the corridor approach. Defined benefit pension plan assets are
valued at fair market value. The cost of post-employment benefits other
than pensions is recognized on an accrual basis over the working lives of
employees.
g) Income Taxes
Future income taxes are provided for using the liability method whereby
future income taxes are recognized for the expected future income tax
consequences of all significant temporary differences between the tax and
consolidated financial statement bases of assets and liabilities.
Future income tax assets are recognized only to the extent that, in the
opinion of management, it is more likely than not that the future income
tax assets will be realized. Future income tax assets and liabilities are
adjusted for the effects of changes in tax laws and rates on the date of
enactment or substantive enactment.
h) Marketing
Marketing costs, including those related to the introduction of new
brands, are charged against earnings during the year in which they are
incurred.
i) Earnings Per Common Share (EPS)
Basic EPS is calculated by dividing the earnings by the weighted average
of the common shares outstanding during the year. Diluted EPS is
calculated using the treasury stock method of calculating earnings per
share amounts whereby any proceeds from the exercise of stock options or
other dilutive instruments are assumed to be used to purchase common
shares at the average market price during the year.
j) Stock-Based Compensation Plans
The Company has stock-based compensation plans as described in note 11.
The Company expenses the fair value of stock options over the vesting
period. The amount paid by employees on exercising stock options is
credited to share capital. The Company's contributions under the employee
share purchase plan are charged to earnings as purchases are made.
k) Cash and Cash Equivalents
Cash and cash equivalents are comprised of cash and short-term deposits
with original maturities of three months or less.
2. Change in accounting policies
Effective April 1, 2007, the Company adopted The Canadian Institute of
Chartered Accountants ("CICA") Handbook Section 1530, "Comprehensive
Income", Section 3855, "Financial Instruments - Recognition and
Measurement" and Section 3861, "Financial Instruments - Disclosure and
Presentation." The prospective adoption of these new standards resulted
in changes in the measurement, recognition and presentation for financial
instruments. As a result of adopting these standards, certain
transitional adjustments have been recorded in opening retained earnings
as described below. There was no change resulting from the adoption of
these standards that required the Company to record other comprehensive
income. The principal changes in the accounting for financial instruments
due to the adoption of these accounting standards are described below. As
required by the standards, the comparative consolidated financial
statements have not been restated.
(a) Section 3855 "Financial Instruments - Recognition and Measurement"
Section 3861 "Financial Instruments - Disclosure and Presentation"
Under the new standards, financial assets and financial liabilities are
initially recognized at fair value and their subsequent measurements are
dependent on their classification as described below. Their
classification depends on the purpose, for which the financial
instruments were acquired or issued, their characteristics and the
Company's designation of such instruments. The standards require that all
financial assets be classified either as held-for-trading ("HFT"),
available-for-sale ("AFS"), held-to-maturity ("HTM"), loans and
receivables or other liabilities. The standards require that all
financial assets, including all derivatives be measured at fair value
with the exception of loans and receivables, assets classified as HTM and
AFS financial assets that do not have quoted market prices in an active
market.
Classification of Financial Instruments
The following is a summary of the assets and liabilities the Company
evaluated and elected to apply to its significant categories of financial
instruments outstanding as of April 1, 2007:
Cash Designated as held-for-trading
Cash equivalents and short-term
investments Designated as held-to-maturity
Accounts receivable Loans and receivables
Accounts payable and accrued liabilities Other liabilities
Other long-term liabilities Other liabilities
Long-term debt Other liabilities
Held-For-Trading
HFT financial assets are financial assets typically acquired for resale
prior to maturity. They are measured at fair value at the balance sheet
date. Interest earned and accrued is included in investment income. The
Company designated cash as HFT and it is measured at fair value as at the
consolidated balance sheet date.
Held-To-Maturity
HTM financial assets are non-derivative financial assets with fixed or
determinable payments and a fixed maturity when the Company has the
intention and the ability to hold these financial assets to maturity.
These financial assets are measured at amortized cost. Short-term
investments in debt securities are classified as HTM and are accounted
for at amortized cost. As at the consolidated balance sheet date,
interest income receivable of $0.1 million and $2.2 million was included
in cash and cash equivalents and short-term investments, respectively.
Available-For-Sale
AFS financial assets are those non-derivative financial assets that are
designated as AFS financial assets, or that are not classified as loans
and receivables, HTM investments or HFT financial assets. AFS financial
assets are carried at fair value with unrealized gains and losses to be
included in other comprehensive income until realized when the cumulative
gain or loss is recognized in earnings. The Company has not designated
any financial assets as AFS.
Loans and Receivables
Loans and receivables are accounted for at amortized cost.
Other Liabilities
Other liabilities are accounted for at amortized cost. Other long-term
liabilities are initially recognized at fair value and subsequently
accounted for at amortized cost. The transitional adjustment reducing
other long-term liabilities amounted to $0.9 million at the date of
adoption.
Transaction Costs
Transaction costs related to HTM financial assets and liabilities and
other liabilities are netted against the carrying value of the liability
and then amortized over the expected life of the instrument using the
effective interest method. The deferred financing charges relating to the
Company's long-term debt issue were reclassified to the carrying value of
the long-term debt at the date of adoption.
Embedded Derivatives
Derivatives embedded in other financial instruments or contracts are
separated from their host contracts and accounted for as derivatives when
their economic characteristics and risks are not closely related to those
of the host contract. Embedded derivatives are measured at fair value
with changes in fair value recognized in earnings. The Company does not
currently have any outstanding contracts with embedded derivatives.
Determination of Fair Value
The fair value of a financial instrument is the amount of consideration
that would be agreed between two or more parties. The fair value of a
financial instrument on initial recognition is the transaction amount
given or received. Subsequent to initial recognition, the fair values of
financial instruments that are quoted in active markets are based on bid
prices for financial assets held and offer prices for financial
liabilities. When independent prices are not available, the fair values
are determined using valuation techniques using observable market data of
similar instruments, discounted cash flow analysis and other valuation
techniques commonly used by market participants. A number of factors such
as bid-offer spread and credit profile are taken into account, as
appropriate, when values are calculated using valuation techniques.
(b) Section 1530 "Comprehensive Income"
The Company determined that as at the date of adoption and for the year
ended March 31, 2008 there were no gains or losses that would be recorded
in other comprehensive income or loss.
Transitional Adjustments
The impact of adopting these standards as at April 1, 2007 is as follows:
As at As at
March 31, April 1,
2007 Adjustment 2007
--------- ---------- --------
Assets
Cash and cash equivalents 75,228 225 75,453
Short-term investments 96,987 1,795 98,782
Accounts receivable 8,851 (2,020) 6,831
Long-term debt deferred financing charges 1,102 (1,102) -
Future income taxes - long-term 11,339 (352) 10,987
Liabilities
Other long-term liabilities 17,735 (926) 16,809
Long-term debt 149,794 (1,102) 148,692
Minority interest 8,828 230 9,058
Shareholders' Equity
Retained earnings 86,645 344 86,989
Effective January 1, 2008, the Company early adopted the new accounting
standards for Capital Disclosures (CICA Handbook Section 1535). Under
Section 1535, the Company has disclosed its objectives, policies and
procedures for managing capital, including disclosures of any externally
imposed capital requirements and the consequences of non-compliance. This
standard did not affect the Company's consolidated results or financial
position (see note 4).
Effective January 1, 2008, the Company early adopted the new accounting
standards for Financial Instruments-Disclosure and presentation (CICA
Handbook Sections 3862 and 3863). Sections 3862 and 3863 replace Handbook
Section 3861, Financial Instruments-Disclosure and Presentation, revising
and enhancing its disclosure requirements, and carrying forward unchanged
its presentation requirements. These new sections place increased
emphasis on disclosures about the nature and extent of risks arising from
financial instruments and how the entity manages those risks. This
standard did not affect the Company's consolidated results or financial
position (see note 3).
The following is the new accounting standard the Company will adopt
effective April 1, 2008. Management is evaluating the standard and its
impact on the Company's consolidated financial statements.
The CICA Handbook Section 3031 "Inventories" prescribes the accounting
treatment for inventories. Specifically, the section provides guidance
relating to the accounting for inventories and revises and enhances the
requirements for assigning costs to inventories. Section 3031 applies to
interim and annual financial statements for fiscal years beginning on or
after January 1, 2008.
3. Financial Instruments
Financial instruments consist of cash, cash equivalents, short-term
investments, accounts receivable, accounts payable and accrued
liabilities, excise tax and other taxes payable, other long-term
liabilities and long-term debt.
Fair Value of Financial Instruments
Financial instruments are initially recognized at fair value and
subsequent treatment depends on management's designation and intentions.
The fair value of a financial instrument is the amount of consideration
that would be agreed upon in an arm's length transaction between
knowledgeable, willing parties who are under no compulsion to act. When
independent prices are not available, fair values are determined by using
valuation techniques that refer to observable market data.
Financial Instruments Designated as Held-For-Trading
Cash includes deposits held on call with a Canadian chartered bank and is
designated as held-for-trading. The carrying value of cash approximates
fair value as it is immediately available for use.
Cash equivalents are investments with a maturity of three months or less
from the date of purchase and are designated as held-for-trading. They
are assets typically acquired for resale prior to maturity. The carrying
amount, which includes interest earned and accrued in investment income,
approximates the fair market value due to the short-term nature of
investments.
Financial Instruments Designated as Held-To-Maturity
Short-term investments have a maturity from three months to a year from
the date of purchase and are classified as held-to-maturity. Short-term
investments are initially recorded at fair value and subsequently
measured at amortized cost. The carrying amount includes interest earned
and accrued in investment income. The fair value of short-term
investments is subject to changes in interest rates and is determined by
a valuation method using mid-market closing rate of the balance sheet
date for investments with similar terms.
Financial Instruments Designated as Loans and Receivables
Accounts receivable are classified as loans and receivables. Their
carrying value approximates fair value due to their short-term nature.
Financial Instruments Designated as Other Liabilities
Accounts payable and accrued liabilities largely consist of trade
payables, the current portion of the long-term incentive program accrual
and the short-term incentive program accrual. Due to the short-term
nature of the trade accounts payable and accruals, the carrying value
approximates the fair value.
Other long-term liabilities are classified as other liabilities and their
fair value is determined using a valuation technique by discounted cash
flow analysis based on current market rates for loans and investments
with similar terms, conditions and maturities.
Long-term debt is comprised of senior unsecured bonds carrying a fixed
coupon rate of 5.552% and matures on December 21, 2011. The fair value of
the debt is subject to changes in interest rates and other market prices.
The fair value of the debt was based on a valuation technique using
observable market data such as market spread and the price of similar
instruments.
The following provides a comparison of carrying and fair values for each
classification of financial instruments as at March 31, 2008:
March 31, 2008
Carrying Fair
Amount Value
----------------------
Financial instruments designated as
held-for-trading:
Cash and cash equivalents 110,127 110,127
Financial instruments designated as held-to-maturity:
Short-term investments 124,766 124,811
Loans and receivables:
Accounts receivable 3,561 3,561
Other liabilities:
Accounts payable and accrued liabilities 64,902 64,926
Other long-term liabilities 10,996 11,024
Long-term debt 148,966 148,390
----------------------
224,864 224,340
----------------------
No prior year figures were provided as they are not comparable as the
accounting policies differ significantly from the policies adopted in the
current year.
Credit Risk
The credit risk is a risk of loss associated with a counterparty's
inability or failure to discharge its obligations. The Company is exposed
to credit risk in its cash, cash equivalents, short-term investments and
accounts receivable.
The Company's cash is deposited with a Canadian chartered bank and
therefore management believes the risk of loss to be remote.
Cash equivalents and short-term investments are held through various
institutions, mainly in Canadian banker's acceptances and Canadian
corporations' commercial papers. Cash equivalents are investments with a
maturity of three months or less from the date of purchase. Short-term
investments have a maturity from three months to a year from the date of
purchase. The Company's maximum credit risk exposure as at March 31, 2008
was $234.9 million which is comprised of cash, cash equivalents and
short-term investments. The Company's credit risk on cash, cash
equivalents and short-term investments is low as the investments are
readily convertible into a known amount of cash and are subject to
minimal risk of changes in value.
The Company's credit risk with respect to accounts receivable is limited
and managed by evaluating the customer's creditworthiness and financial
strength before commencing trade and during the business relations. The
Company sets a credit limit for each customer, reviews accounts
receivable aging daily, monitor cash collections and routinely reviews
the customers' financial statements. As at March 31, 2008, there were no
past due accounts receivable amounts or allowances for doubtful accounts.
Liquidity Risk
Liquidity risk is the risk that the Company may encounter difficulties in
meeting obligations associated with financial liabilities and
commitments.
The Company manages liquidity risk through its investment policy and cash
flow planning. Excess cash is invested only in high-grade investment
securities and the grade rating the Company uses is that of Dominion Bond
Rating Service (DBRS) or a comparable recognized rating agency. The
investments are placed with varying terms to maturity to effectively meet
the required expenditures for continuing operations.
The Company also manages this risk by regularly monitoring compliance
with the long-term debt financial covenants. The Company is subject to
certain financial covenants with which they were in compliance as at
March 31, 2008. Breach of these covenants could result in the debt
becoming due on demand.
RBH's operations generate cash resources to fund its operations, pay
interest payments on RBH's long-term debt 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. The table below summarizes the payment schedule
for the financial liabilities as at March 31, 2008:
Years
subsequent
Fiscal Fiscal Fiscal Fiscal to Fiscal
2009 2010 2011 2012 2012 Total
----------------------------------------------------------
Accounts payable
and accrued
liabilities 64,902 - - - - 64,902
Other long-term
liabilities - 4,997 1,283 - 4,716 10,996
Long-term
debt(x) - - - 148,966 - 148,966
----------------------------------------------------------
64,902 4,997 1,283 148,966 4,716 224,864
----------------------------------------------------------
(x) Represents a carrying amount reflecting debt of $150 million less the
unamortized debt issue costs.
The non-cash interest expense on other liabilities, excluding long-term
debt, amounted to $1.2 million during fiscal year 2008 and long-term debt
interest expense totalled $8.3 million. The interest income on cash
equivalents and short-term investments in the fiscal year 2008 amounted
to $12.2 million.
Market Risk
Market risk is the risk that the fair value or future cash flows of a
financial instrument will fluctuate as a result of changes in market
prices. Market risk is comprised of three types of risk: interest rate,
currency and share price.
a) Interest Rate Risk
Interest rate risk arises as the fair value of future cash flows
fluctuates due to changes in market interest rates. The Company has
limited exposure to interest rate risk through its cash equivalents,
short-term investments, accrued liabilities and other long-term
liabilities.
b) Foreign Currency Risk
Foreign currency risk is the risk that the fair value or future cash
flows of a financial instrument will fluctuate as a result of changes in
foreign exchange rates.
A portion of the Company's expenditures are incurred in US dollars and
euros. A change in the currency exchange rate between the Canadian dollar
relative to the US dollar and euro would have an effect on the results of
the Company's operations, financial position or cash flows. The Company
does not hedge its exposure to currency fluctuations.
As at March 31, 2008, the Company was exposed to currency risk mainly
through its cash and accounts payable denominated in US dollars. As at
March 31, 2008, the Company had cash and accounts payable in US dollars
of $0.9 million and $0.9 million, respectively. The Company had no
exposure to euro denominated accounts payable at the balance sheet date.
c) Share Price Risk
The other long-term liabilities consist of accruals related to the long-
term incentive plan and the deferred share unit plan (DSU plan). The DSU
plan is intended to permit non-executive directors of the Company to
defer receipt of all or a portion of their annual retainer and attendance
fees until termination of Board service in the Company. The valuation of
the long-term liabilities uses the Company's share value as one of the
factors in its calculation, therefore a change in the Company's market
price impacts the results of operations, financial position or cash
flows.
Sensitivity Analysis
Section 3862 requires disclosure of sensitivity analysis that is intended
to illustrate the sensitivity of the Company's financial position,
performance and fair value of cash flows associated with the Company's
financial instruments to changes in market variables such as foreign
exchange rates, share price and interest rates. The sensitivity analysis
provided discloses the effect on profit or loss assuming that a
reasonably possible change in the relevant risk variable has occurred at
March 31, 2008 and has been applied to the risk exposures in existence at
that date. The reasonably possible changes in market variables used in
the sensitivity analysis were determined based on implied volatilities
where available, or historical data.
The sensitivity analysis has been prepared based on March 31, 2008
balances and on the basis that the balances are all constant. Excluded
from this analysis are all non-financial assets and liabilities that are
not classified as financial instruments under Section 3855 and financial
instruments not carried at fair value or denominated in a foreign
currency in the consolidated financial statements.
The sensitivity analysis provided is hypothetical and should be used with
caution as these estimated impacts may differ from the actual impacts the
Company may experience. Changes in fair values or cash flows based on a
variation in a market variable cannot be extrapolated because the
relationship between the change in a market variable and the change in
fair value or cash flows may not be linear. In addition, the effect of a
change in a particular market variable on fair values or cash flows is
calculated without considering interrelationships between the various
market rates or mitigating actions that would be taken by the Company.
Based on the above discussions, the following table summarizes the
effects of risk exposure as at March 31, 2008:
----------------------------------------------------
Interest Foreign
Carrying risk currency risk Price risk
value ----------------------------------------
($000) +1% -1% +5% -5% +5% -5%
----------------------------------------------------
Financial Assets
----------------------------------------------------
Cash and cash
equivalents:
----------------------------------------------------
Cash denominated in
foreign currency 769 8 (8) 47 (47) - -
----------------------------------------------------
Cash & cash
equivalents in
Canadian dollars 109,358 29 (29) - - - -
----------------------------------------------------
Short-term
investments 124,766 486 (486) - - - -
----------------------------------------------------
Financial Liabilities
----------------------------------------------------
Accounts payable
and accrued
liabilities(1):
----------------------------------------------------
Accrued incentive
plan 31,824 (78) 78 - - 469 (469)
----------------------------------------------------
Amount denominated in
foreign currency(2) 892 - - 45 (45) - -
----------------------------------------------------
Other long-term
liabilities:
----------------------------------------------------
Accrued incentive
plan 6,280 (89) 89 - - 171 (171)
----------------------------------------------------
Deferred share
unit plan 4,716 - - - - 236 (236)
----------------------------------------------------
(1) The carrying value excludes the Canadian dollar denominated accounts
payable and accrued liabilities of $32.2 million.
(2) The carrying value of amounts denominated in foreign currencies is
not indicative of the activity in the year as significant amounts of
services and goods denominated in foreign currency were purchased
during the year. Total purchases in foreign currency in the current
fiscal year amounted to $41.3 million and $20.6 million in US dollars
and euros, respectively. Assuming that all other variables remain
constant, a 5% depreciation or appreciation of the Canadian dollar
against the US dollar or euro would impact the Company's expenses by
$2.1 million and $1.0 million, respectively.
4. Management of Capital
The Company's objectives when managing capital are to (i) safeguard the
entity's ability to continue as a going concern in order to provide
returns for shareholders and benefits for other stakeholders; and (ii)
maintain a capital structure that provides financing options to the
Company when a financing or a refinancing need arises to ensure access to
capital on commercially reasonable terms, without exceeding its debt
capacity.
In the management of capital, the Company includes shareholders' equity,
minority interest and senior unsecured long-term debt in the definition
of capital.
The Company manages the capital structure by monitoring its operational
results against various financial scenarios prepared to reflect the
changes in market and economic conditions. In order to maintain or adjust
the capital structure, the Company may adjust the amount of dividends
paid to shareholders, return capital to shareholders, issue debt to
replace existing debt with similar or different characteristics, issue
new shares, buy back shares or adjust the amount of cash, cash
equivalents and short-term investment balances.
The Company is not subject to any capital requirements imposed by a
regulator.
There were no changes in the Company's capital management policies during
the period.
5. Earnings per share
Earnings per common share is calculated based on a weighted average
number of 68,064,362 (2007 - 68,001,480, 2006 - 67,745,422) shares
outstanding. Diluted earnings per common share is calculated based on
68,543,918 (2007 - 68,399,635, 2006 - 68,385,047) common shares
outstanding, the dilution being due to the issuance of common share
options.
6. Supplementary cash flow disclosures
a) Change in non-cash operating working capital:
2008 2007 2006
-----------------------------
Accounts receivable 3,270 1,468 19,733
Prepaid expenses 204 (134) (513)
Inventories 7,944 4,796 3,386
Other assets 152 140 173
Accounts payable and accrued liabilities 3,935 (335) (9,043)
Excise and other taxes payable 4,757 3,267 (11,307)
Income taxes payable 1,466 11,502 (1,038)
-----------------------------
21,728 20,704 1,391
-----------------------------
-----------------------------
b) Other:
2008 2007 2006
-----------------------------
Income taxes paid 132,643 110,517 106,953
Interest Paid:
- Long-term debt 8,328 8,328 8,328
- Other 139 188 347
7. Inventories
2008 2007 2006
-----------------------------
Leaf tobacco 79,907 86,267 95,542
Finished goods 92,021 93,698 88,839
Packaging material and other 21,765 21,672 22,052
-----------------------------
193,693 201,637 206,433
-----------------------------
-----------------------------
8. Property, plant and equipment
2008 2007 2006
-----------------------------
Cost
Land and land improvements 1,508 1,499 1,499
Buildings 26,048 25,120 24,155
Machinery and equipment 186,592 176,602 170,938
Computer equipment 12,875 11,782 12,008
Motor vehicles 1,018 1,014 1,014
Leasehold improvements 2,955 2,879 2,860
-----------------------------
230,996 218,896 212,474
Less: Accumulated amortization 158,521 147,873 136,176
-----------------------------
72,475 71,023 76,298
-----------------------------
-----------------------------
Accumulated amortization
Land improvements 150 145 141
Buildings 15,465 14,758 14,043
Machinery and equipment 128,753 120,309 110,777
Computer equipment 10,799 9,475 8,188
Motor vehicles 1,012 1,003 992
Leasehold improvements 2,342 2,183 2,035
-----------------------------
158,521 147,873 136,176
-----------------------------
-----------------------------
As at March 31, 2008, the cost of property, plant and equipment included
capital projects in progress of $3.4 million (2007 - $2.1 million, 2006 -
$12.6 million) for which no amortization was recorded.
9. Long-term debt
During fiscal 2005, RBH issued $150 million of senior unsecured bonds,
with a discount of $303,000 to their face value and carrying a coupon
rate of 5.552% payable semi-annually, through a private placement.
These bonds mature on December 21, 2011 and the principal is repayable in
full at maturity. The bonds are direct senior unsecured and
unsubordinated obligations of RBH ranking pari passu with all other
present and future senior unsecured and unsubordinated indebtedness of
RBH. Under this debt obligation, RBH is subject to certain covenants,
including a maximum debt to earnings before interest, taxes, depreciation
and amortization ratio of 3.0 times on a consolidated basis. RBH has the
right to repay the bonds at any time in whole or in part, subject to
certain "make-whole" provisions.
Financing costs related to this debt issue are being amortized over the
term of the bonds. A total of $0.2 million (2007 - $0.2 million, 2006 -
$0.2 million) was expensed during fiscal 2008, ending the year with
approximately $0.9 million of unamortized financing costs remaining. The
discount of $303,000 on the bonds is also being amortized over the term
of the bonds and a total of $43,000 (2007 - $43,000, 2006 - $43,000) was
expensed in fiscal 2008, ending the year with approximately $163,000
(2007 - $206,000, 2006 - $249,000) of the unamortized bond discount
remaining.
10. Capital stock
Authorized - An unlimited number of common shares
Issued - 68,095,608 (2007 - 68,038,008, 2006 - 67,855,608) common shares
2008 2007 2006
-----------------------------
Balance - April 1 47,533 45,347 41,974
Issuance of shares 557 2,186 3,373
-----------------------------
Balance - March 31 48,090 47,533 45,347
-----------------------------
-----------------------------
During fiscal year 2008, a total of 57,600 (2007 - 182,400, 2006 -
283,600) shares were issued due to the exercise of stock options.
The issuance of shares reflects net proceeds after the special dividend
payment upon the exercise of share options of $0.2 million (2007 -
$0.4 million, 2006 - $0.7 million).
On February 4, 2005, the Company declared a two-for-one stock split to be
effective by way of a stock dividend. The number of common shares
outstanding and all share related data were adjusted retroactively for
the stock split.
11. Stock-based compensation plans
The details of the Company's share option plan and employee share
purchase plan are as follows:
a) Share option plan
In March of 2000, the Board of Directors of the Company approved a share
option plan for the purpose of advancing the interests of the Company
through the attraction, motivation and retention of employees and
officers of the Company and RBH. This plan was subsequently approved by
the Company's shareholders at the annual general meeting in July 2000.
Under this plan, the Company could grant options to its employees for up
to 3.4 million common shares. The exercise price of each option equals
the market price of the Company's common shares as at the date of the
grant. Granted options vest in three equal amounts as the twenty-day
average trading price of the Company's shares exceeds thresholds of 10%,
20% and 30% above the option exercise price. Generally, vested options
may be exercised over a ten-year period from the date of grant. In
certain circumstances, upon exercise, optionees are also entitled to
receive an amount equal to the aggregate of all special dividends paid
since the date of the option grant.
Under the share option plan, as at March 31, 2008, 181,800 (2007 -
181,800, 2006 - 181,800) common shares were issuable. Given the limited
number of common shares available for issuance under the share option
plan, the annual grant of options was discontinued effective fiscal year
2006.
A summary of the status of the Company's employee share option plan as at
March 31, 2008, 2007 and 2006, and changes during the years ending on
those dates is presented below:
2008
----------------------------------
Weighted
average
exercise
Options Shares price Shares
-------------------------------------------------------------------------
Outstanding - Beginning of year 1,308,400 14.291 1,490,800
Exercised (57,600) 12.779 (182,400)
----------------------------------
Outstanding - End of year 1,250,800 14.360 1,308,400
----------------------------------
----------------------------------
Options exercisable at year end 1,250,800 14.360 1,308,400
----------------------------------
----------------------------------
2007 2006
----------------------------------
Weighted Weighted
average average
exercise exercise
Options price Shares price
-------------------------------------------------------------------------
Outstanding - Beginning of year 14.301 1,774,400 14.325
Exercised 14.378 (283,600) 14.448
----------------------------------
Outstanding - End of year 14.291 1,490,800 14.301
----------------------------------
----------------------------------
Options exercisable at year end 14.291 1,490,800 14.301
----------------------------------
----------------------------------
The following table summarizes information about share options
outstanding as at March 31, 2008:
Weighted
average
remaining
Exercise Number contractual Number
price outstanding life exercisable
$
-------------------------------------------------------------------------
8.825(1) 3,000 2.3 3,000
11.500(1) 136,000 3.1 136,000
12.320(2) 308,200 5.1 308,200
14.080(1) 261,400 3.6 261,400
16.125(1) 237,000 4.2 237,000
16.620(2) 305,200 6.1 305,200
------------- -------------
1,250,800 1,250,800
------------- -------------
------------- -------------
(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).
b) Employee share purchase plan
The Company has an employee share purchase plan in place to assist
employees in taking an ownership position in the Company. This plan
promotes employee participation in the business, and thus better aligns
their interests with the interests of shareholders. The plan allows every
employee to contribute between 1% to 5% of their base salary toward the
purchase of shares. The Company contributes 35% of each employee's
contributions up to $1,500 per annum per employee. Contributed funds are
utilized to purchase the Company's shares on the open market. The Company
also pays for all fees and transaction costs associated with the
purchases.
During the fiscal year 2008, a total of 72,708 (2007 - 74,210, 2006 -
101,626) shares of the Company were purchased under the provisions of
this plan. The Company expensed a total of $0.4 million (2007 -
$0.4 million, 2006 - $0.4 million) relating to this plan.
12. Employee future benefits
The Company provides defined benefit pension plans, defined contribution
pension plans, post-retirement and post-employment benefits to its
employees. Defined benefit pension obligations are funded with
independent trustees in accordance with legal requirements.
The defined benefit plan assets were determined using the market value of
plan assets as at March 31. The most recent actuarial valuations for the
various defined benefit plans were at April 1, 2006 and December 31, 2007
and valuations are carried out both annually and biannually depending on
the plan. The last actuarial valuation for other benefits was at April 1,
2005.
The table below provides plan information on the actuarially determined
benefit obligation, the status of plan assets and the net benefit plan
expense for the year:
2008 2007 2006
------------------------------------------------------------
Defined Defined Defined
benefit Other benefit Other benefit Other
pensions benefits pensions benefits pensions benefits
------------------------------------------------------------
Change in
benefit
obligation
Benefit
obligation -
Beginning
of year 166,213 43,351 151,359 41,675 137,641 42,656
Current service
cost 5,842 912 5,087 873 4,717 681
Interest cost 8,613 2,230 7,850 2,112 8,105 2,130
Cost for
retirement
window
adjustment 892 - 1,300 - - -
Actuarial
(gain) loss (10,058) (2,412) 10,535 1,004 9,383 (1,608)
Benefits paid (9,894) (2,309) (9,918) (2,313) (8,487) (2,184)
------------------------------------------------------------
Benefit
obligation -
End of year 161,608 41,772 166,213 43,351 151,359 41,675
------------------------------------------------------------
------------------------------------------------------------
Change in plan
assets
Fair value of
plan assets -
Beginning
of year 167,801 - 161,335 - 153,199 -
Return on
plan assets (1,331) - 12,749 - 12,448 -
Net employer
contributions 9,183 2,309 3,635 2,313 4,175 2,184
Benefits paid (9,894) (2,309) (9,918) (2,313) (8,487) (2,184)
------------------------------------------------------------
Fair value of
plan assets -
End of year 165,759 - 167,801 - 161,335 -
------------------------------------------------------------
------------------------------------------------------------
Plan status
Funded surplus
(deficit) 4,151 (41,772) 1,588 (43,351) 9,976 (41,675)
Unrecognized
loss 19,882 3,023 18,867 5,882 11,530 6,453
Unrecognized
transition
(asset)
liability (7,623) 1,331 (8,450) 1,554 (9,276) 1,778
Unrecognized
past service 841 - 953 - 1,065 -
------------------------------------------------------------
Prepaid
(accrued)
benefit cost 17,251 (37,418) 12,958 (35,915) 13,295 (33,444)
------------------------------------------------------------
------------------------------------------------------------
Included in the above prepaid defined benefit obligation and fair value
of plan assets are the following amounts in respect of plans that are not
fully funded:
2008 2007 2006
-----------------------------
Defined benefit pensions
Benefit obligation - End of year 121,184 42,800 36,168
Fair value of plan assets - End of year 118,591 33,226 30,339
-----------------------------
Funded deficit 2,593 9,574 5,829
-----------------------------
-----------------------------
As at March 31, 2008 approximately 43% (2007 - 50%, 2006 - 50%) of the
defined benefit pension plan assets were invested in equities, 42% (2007
- 37%, 2006 - 38%) in fixed income securities and 15% (2007 - 13%, 2006 -
12%) in cash and cash equivalents. The plan assets for the current fiscal
year included investments in the Company's shares of $0.4 million or 0.3%
of defined benefit plan assets (2007 - $0.5 million or 0.3%, 2006 -
$0.3 million or 0.2%).
The defined contribution plan assets as at March 31, 2008 were
$98.4 million (2007 - $103.4 million, 2006 - $95.2 million).
The significant actuarial assumptions used to arrive at the net defined
benefit obligations are shown below:
2008 2007 2006
------------------------------------------------------------
Defined Defined Defined
benefit Other benefit Other benefit Other
pensions benefits pensions benefits pensions benefits
-------------------------------------------------------------------------
Weighted
average
assumptions
(%)
Discount
rate (%) 5.75 5.75 5.25 5.25 5.25 5.25
Expected return
on plan
assets (%) 7.00 - 7.00 - 7.00 -
Rate of
compensation
increase (%) 4.50 4.00 4.50 4.00 4.50 4.00
Beginning in 2007 the health care cost trend rate, mainly of prescription
drugs, was 9.0%, which is graded down by 0.5% each year until it reaches
4.5% in 2016. Total cash payments by the Company for all employee future
benefits for 2008 were $14.8 million (2007 - $9.3 million and 2006 -
$9.5 million)
The Company's defined benefit pension plan and other benefits expense is
as follows:
2008 2007 2006
------------------------------------------------------------
Defined Defined Defined
benefit Other benefit Other benefit Other
pensions benefits pensions benefits pensions benefits
------------------------------------------------------------
Current
service cost 5,842 912 5,087 873 4,717 681
Interest cost 8,613 2,230 7,850 2,112 8,105 2,130
Actual return
on plan
assets 1,331 - (12,749) - (12,448) -
Actuarial
(gains)
losses (10,058) (2,412) 10,535 1,004 9,383 (1,608)
------------------------------------------------------------
Costs arising
in the year 5,728 730 10,723 3,989 9,757 1,203
Difference
between costs
arising and
costs
recognized in
respect of
Return on plan
assets (11,597) - 2,930 - 3,023 -
Actuarial
loss (gain) 10,580 2,859 (10,267) 571 (9,182) 706
Transitional
obligation (826) 223 (826) 224 (827) 222
Past service
cost 112 - 112 - 112 -
Adjustment for
retirement
window 892 - 1,300 - - -
------------------------------------------------------------
Net expense
recognized 4,889 3,812 3,972 4,784 2,883 2,131
------------------------------------------------------------
------------------------------------------------------------
RBH's defined contribution pension plan expense for fiscal year 2008 was
$3.3 million (2007 - $3.4 million, 2006 - $3.1 million).
The following table shows the effect of a one-percentage point change in
assumed health costs:
1% 1%
increase decrease
-----------------------
Effect on other benefits - total service
and interest cost 564 (386)
Effect on other benefits - accrued benefit
obligation 5,671 (3,665)
13. Income taxes
The consolidated effective income tax rate is as follows:
2008 2007 2006
-----------------------------
Combined federal and provincial basic
rates (%) 32.9 33.3 33.0
Manufacturing and processing tax credits (%) (0.5) (0.5) (0.5)
Surtaxes and other (%) 7.6 7.8 7.2
-----------------------------
Effective income tax rate (%) 40.0 40.6 39.7
-----------------------------
-----------------------------
Future income tax assets and liabilities are recognized on temporary
differences between the financial and tax bases of existing assets and
liabilities as follows:
2008 2007 2006
-----------------------------
Future income tax assets
Deferred Compensation 13,908 8,987 -
Other employee future benefits 15,173 14,897 14,492
Other 948 551 247
-----------------------------
30,029 24,435 14,739
-----------------------------
Future income tax liabilities
Property, plant and equipment 5,637 4,515 2,896
Pension asset 6,449 5,163 5,542
-----------------------------
12,086 9,678 8,438
-----------------------------
Net future income tax asset 17,943 14,757 6,301
Less: Future income tax assets - current 11,616 3,418 -
-----------------------------
6,327 11,339 6,301
-----------------------------
-----------------------------
14. Commitments
In the normal course of business, the Company and its subsidiaries have
commitments in respect of capital expenditures, purchase of tobacco and
other obligations.
Commitments under operating lease obligations relate to fleet
automobiles, warehouses and offices. The following table summarizes the
payments due after March 31, 2008 for lease and other obligations:
2009 6,042
2010 2,990
2011 2,869
2012 2,498
2013 966
----------
15,365
----------
----------
15. Related party transactions
RBH is 40% owned by FTR Holding S.A. of Switzerland, an affiliate of
Philip Morris International, Inc. (PMI). PMI was 100% owned by Altria
Group, Inc. until March 28, 2008. RBH entered into various related party
transactions during the year with subsidiaries and affiliates of PMI
("related parties") that are measured at their exchange amounts.
In the ordinary course of business, RBH purchased various management
advisory services in the amount of $1.2 million (2007 - $1.2 million,
2006 - $1.3 million), tobacco blends, raw materials and marketing
materials totaling $3.3 million (2007 - $1.7 million, 2006 - nil) and had
sales of $3.0 million (2007 - $3.1 million, 2006 - $5.1 million) to
related parties. In fiscal 2007, RBH entered into a trademark license
agreement relating to the manufacture, distribution and sale of the
ROOFTOP brand in Canada. Total royalty expense for the year amounted to
$1.0 million (2007 - $0.7 million, 2006 - nil). The net receivable as at
March 31, 2008, due from related parties, was $0.2 million (2007 -
$0.5 million, 2006 - $0.7 million).
16. Litigation, claims and contingencies
The Company and RBH are subject to a number of lawsuits and legal
proceedings, investigations and legislation as described below:
- In February 2005, the Quebec Superior Court authorized two actions
brought by plaintiffs resident in the Province of Quebec to proceed
as class actions against RBH, Imperial Tobacco Limited and JTI-
Macdonald Corp. The court consolidated the two actions; one
representing a class consisting of certain persons residing in Quebec
who allegedly are or have been addicted to the nicotine contained in
cigarettes manufactured by the respondents which is seeking
$17.8 billion in damages, the other representing certain persons who
have allegedly suffered certain diseases as a result of smoking
cigarettes manufactured by the respondents, as well as the legal
heirs of deceased persons included in the group, which is seeking
$5 billion in damages. The claims include allegations of failure to
warn, addiction, nicotine manipulation, advertising directed at young
people, false advertising and inadequate warnings. The claimants are
seeking on behalf of themselves and each class member general and
exemplary damages to be assessed and the establishment of a fund with
the object of limiting cigarette consumption, supporting medical
research into tobacco linked illnesses and reimbursing the Province
of Quebec for certain health care costs incurred by it in treating
these illnesses. Statements of claim were filed by the plaintiffs and
oral examinations of the plaintiffs have commenced.
- RBH is currently the subject of an ongoing investigation by the RCMP
relating to its sales of products exported from Canada in the period
1989-1996. This investigation, of which RBH was notified in January
2002, is related to allegations that tobacco products manufactured
and exported by RBH were illegally smuggled back into Canada during
this period without payment of applicable excise and tobacco taxes
and duties. Although no action has been commenced and no charges laid
against the Company or RBH or any of their present or former
employees, officers or directors, the Company and RBH believe that
the RCMP and federal and provincial government authorities intend to
lay charges or commence other legal proceedings involving the Company
or RBH and certain of their employees, officers and directors
relating to or arising from these allegations.
Illegal smuggling of tobacco products into Canada occurred during the
late 1980s and early 1990s coincident with the imposition by the
federal and provincial governments of significant new taxes and
duties on tobacco products. Such taxes and duties were, however, not
imposed on tobacco products exported out of Canada. In February 1994,
in an effort to curb the high level of smuggling of tobacco products
into Canada, the federal and certain provincial governments reduced
taxes to earlier levels. Exports of tobacco products by the major
Canadian tobacco manufacturers, including RBH, increased
significantly from 1991 to 1994. In February 2003, the RCMP filed
criminal charges against another Canadian tobacco products
manufacturer and related parties alleging violations of the Criminal
Code (Canada) in connection with the sale and export of tobacco
products during the early 1990s. In January 2006, a former executive
of that company pled guilty to charges of defrauding the federal
government of tax revenue and was sentenced to eight months house
arrest in return for providing evidence against that company and
certain of its executives. A preliminary hearing with respect to the
other defendants concluded in 2006 and in May 2007 the Ontario Court
of Justice ordered that company and its former chief executive
officer to stand trial. Charges against six other executives were
initially dismissed. The Crown sought judicial review of these
dismissals and in February 2008 those dismissals were set aside by
the Superior Court of Justice and the matter was remitted back to the
preliminary inquiry judge for reconsideration. In August 2003, the
Government of Canada initiated a civil lawsuit and in August 2004 the
Minister of Revenue for the Province of Quebec initiated tax
reassessment proceedings against this company and related parties
seeking to recover taxes allegedly owing in connection with the sale
of such exported products. In September 2004, this manufacturer was
granted protection from creditors under the Companies Creditors'
Arrangement Act (Canada) and a stay of the civil proceedings brought
by the Government of Canada and the Minister of Revenue for the
Province of Quebec. Since that time, claims aggregating approximately
$10 billion have been made against that company relating to unpaid
taxes and duties on that company's export sales of tobacco products
during the early 1990's. In November 2004, representatives of the
RCMP conducted a search of the largest Canadian tobacco products
supplier as part of its investigation into sales of tobacco products
exported from Canada.
- In January 2001, the Province of British Columbia initiated a lawsuit
in the Supreme Court of British Columbia against RBH, the Company and
numerous other Canadian and international tobacco companies and
various tobacco trade associations seeking unspecified damages in an
amount to cover the costs that allegedly have been, or will be,
incurred by the Government of British Columbia in providing health
care benefits to British Columbia residents who have allegedly
suffered smoking-related illnesses. The action was brought pursuant
to the Tobacco Damages and Health Care Costs Recovery Act (British
Columbia), which purports to facilitate individuals and the
provincial government in suing tobacco manufacturers. This
legislation was enacted in January 2001, following a successful
challenge (decided in March 2000 by the Supreme Court of British
Columbia) by a number of tobacco manufacturers of similar predecessor
legislation enacted in 1998. RBH and other tobacco product
manufacturers challenged the constitutional validity of the new
legislation. However, in May 2004, the British Columbia Court of
Appeal, overturning a lower court decision, ruled that the
legislation was constitutionally valid. RBH and other tobacco product
manufacturers appealed this decision to the Supreme Court of Canada,
which dismissed the appeal in September 2005. The action is now
proceeding and the trial is currently scheduled for the fall of 2010.
A motion brought by the federal government, seeking to strike out a
third party notice which would make it a party to the lawsuit, was
heard in March 2008. The motion was allowed in April 2008. The
Canadian tobacco companies have filed notices of appeal.
- In March 2008, the Company and RBH were named as defendants, along
with Imperial Tobacco Canada Limited, JTI-Macdonald Corp. and a
number of international tobacco product manufacturers, in a lawsuit
filed by the province of New Brunswick in the Court of Queen's Bench
of New Brunswick. The action has been brought pursuant to the Tobacco
Damages and Health Care Costs Recovery Act (New Brunswick). The
lawsuit is based upon grounds which include alleged
misrepresentations made by the defendants in respect of the hazards
of tobacco products and seeks to recover unspecified damages for
costs that are alleged by the Government of New Brunswick to have
been incurred in providing health care benefits to New Brunswick
residents who have allegedly suffered smoking-related illnesses.
- In May 1997, a statement of claim was issued against RBH and Imperial
Tobacco Limited (ITL) by a single plaintiff, Mirjana Spasic, in the
Ontario Superior Court of Justice claiming damages in the amount of
$1,000,000, reimbursement for moneys expended on the purchase of the
defendants' cigarette products and aggravated, punitive and exemplary
damages. The claim is based upon allegations of negligent and
intentional acts, spoliation, negligent misrepresentation, deceit,
conspiracy, product liability and breaches of express and implied
warranty. The action is proceeding. RBH has filed its Statement of
Defence.
- In 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 defence, 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 counterclaim.
- In 2002, the Province of Newfoundland and Labrador enacted the
Tobacco Health Care Costs Recovery Act. This legislation allows the
provincial government to bring an action against tobacco product
manufacturers for recovery of health care costs that allegedly have
been or will be incurred by the Province in respect of alleged
smoking-related illnesses. The Province also announced that it had
retained a U.S. law firm to assist the Province in bringing a claim
against tobacco product manufacturers for recovery of these health
care costs. At this time, no action has been commenced under this
legislation.
- In December 2005, Nova Scotia passed the Tobacco Damages and Health-
care Costs Recovery Act. The legislation, which is modeled on the
British Columbia legislation, allows 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.
- In June 2006, the Manitoba government passed the Tobacco Damages and
Health Care Costs Recovery Act. The legislation is also similar to
that of British Columbia. No action has been commenced under this
legislation.
- In April 2007, the Saskatchewan government passed The Tobacco Damages
and Health Care Costs Recovery Act. The legislation is similar to
that of British Columbia. No action has been commenced under this
legislation.
The Company and RBH believe that they have good defenses in the court
proceedings with respect to the lawsuits which have been filed against
them to date and deny the allegations therein. The Company and RBH intend
to vigorously defend themselves in the court proceedings relating to
these lawsuits. All of the court proceedings in the lawsuits described
above remain at an early stage and management is not able to determine
the likelihood of loss or liability or make a meaningful estimate of the
loss which might be incurred, if any, and accordingly, neither the
Company or RBH has accrued for these contingent liabilities.
It is not possible at the present time to determine the likelihood of
loss or liability or meaningfully estimate the loss, if any, that might
result from lawsuits, legal proceedings or investigations, pending and
future, against the Company or RBH. Lawsuits, legal proceedings and
investigations are subject to many uncertainties, and it is possible that
there will be adverse developments against the Company and RBH or that
these cases and investigations, and any potential future cases and
investigations, could be decided unfavourably against the Company and
RBH. The Company and RBH may also decide to settle current or future
lawsuits, legal proceedings or investigations if it is believed to be in
the best interests of the Company and RBH. An unfavourable outcome or
settlement could involve significant damages or significant monetary
payments that would have a significant adverse effect on the financial
condition of the Company and RBH, and which, in the case of an adverse
judgment, the Company and RBH may not have the resources to satisfy.