Rothmans Inc. Delivers Higher Sales, Earnings and Cash Flow
in Fiscal 2006
Trading: TSX: ROC
TORONTO, May 19 /CNW/ - Rothmans Inc. today announced results for the
fourth quarter and full fiscal year ended March 31, 2006.
Rothmans' earnings for the year ended March 31, 2006 were $99.5 million,
or $1.47 basic earnings per share compared with $93.0 million, or $1.38 basic
earnings per share in fiscal 2005.
Sales at 60%-owned Rothmans, Benson & Hedges Inc., net of excise duty and
taxes, were $652.3 million compared with $636.8 million last year. The
$15.5 million increase in sales is a result of increased volumes of price
category cigarettes together with price increases across all product
categories, which more than compensated for volume declines in premium
cigarettes and fine cut products.
Investment income was $3.4 million compared with $4.2 million a year
earlier as a result of lower average cash balances following the payout of a
special dividend in the first quarter of fiscal 2006.
RBH's EBITDA margin was 44.8% for the year compared with 43.8% in the
prior year. The increase was due to a variety of factors, including increased
volumes of price category cigarettes, higher prices across all product
categories and reduced product input costs. These elements more than offset
reduced volumes in premium cigarettes and fine cut products and higher
manufacturing, sales, marketing and general administrative costs.
During the last three quarters of the fiscal year, the rate of decline in
reported industry sales volumes has accelerated. We believe this was caused by
increased sales of non-taxed or partially taxed contraband product.
For fiscal 2006, RBH's share of the total domestic composite market was
31.3%, up from 29.5% in 2005. Premium cigarette market share was 15.6%
compared with 15.5% a year earlier.
In the price category, RBH's total share increased to 47.4% compared with
46.3% in 2005. The cigarette price category segment was 44.4% compared with
41.5% in 2005. Share of the domestic fine cut market was 59.1% compared with
59.6% a year earlier.
Including the $1.50 per share special dividend, Rothmans Inc. paid
dividends of $182.7 million, or $2.70 per share, in fiscal 2006. This compares
with dividends of $70.9 million, or $1.05 per share, in 2005.
"Once again, Rothmans delivered improved financial results for the fiscal
year," said John Barnett, President and Chief Executive Officer of Rothmans
Inc. "The Company remains the leader in the growing price cigarette category
and maintains a solid financial position despite reduced industry
profitability. As a result of our strong performance and solid cash flow,
Rothmans paid a special dividend of $1.50 per share during the year, in
addition to the regular $1.20 per share dividend."
Fourth Quarter
Rothmans' earnings for the fourth quarter of fiscal 2006 were
$16.4 million, or $0.24 basic earnings per share, compared with $17.3 million,
or $0.26 basic earnings per share, in fiscal 2005.
Sales, net of excise duty and taxes, at Rothmans, Benson & Hedges, were
$144.1 million compared with $144.2 million a year earlier. Investment income
was $0.8 million compared with $1.3 million last year.
Seasonal trends in consumer purchasing patterns, with smoking
restrictions and weather causing variations between the summer and winter,
combined with accelerated declines in reported industry sales volumes are
believed to have reduced both earnings and sales volumes in the fourth quarter
of fiscal 2006.
RBH's EBITDA margin was 33.9% compared with 37.4% for the same period
last year. The decrease was due to reduced sales volumes affecting both RBH
and the reported industry and increases in various general and administrative
costs, partially offset by price increases across all product categories.
Outlook
"We anticipate continued growth in the cigarette price category in fiscal
2007, although at a slower rate than we have seen in recent years as the
category approaches maturity," said Mr. Barnett. "While we expect increasing
competitive challenges in the coming fiscal year, we are confident in our
ability to react quickly and effectively to ongoing changes in the tobacco
marketplace"
Dividend declared
The Board of Directors of Rothmans Inc. declared a quarterly dividend of
$0.30 per share payable on June 17, 2006 to shareholders of record at the
close of business on June 2, 2006.
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 19, 2006. 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 26 by calling 1-800-408-3053 and entering reservation
number 3185651. The recording can also be accessed through the investor
website.
Media are invited to listen to the call and to contact John McDonald 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 745 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.
To Our Shareholders
We are pleased to once again report another outstanding year at Rothmans
Inc. The Company's 60%-owned subsidiary Rothmans, Benson & Hedges Inc. (RBH)
delivered increased net sales, earnings and cash flow despite significant
declines in profitability and tobacco volumes experienced by the Canadian
tobacco industry. RBH's performance has resulted in a sizable increase in cash
paid to shareholders through dividends of $2.70 per share in fiscal 2006,
including a $1.50 per share special dividend paid in the first quarter,
compared with a regular annual dividend of $1.05 per share paid in fiscal
2005.
Maintenance of RBH's market share in the premium cigarette and fine cut
categories and manufacturer's price increases across all product categories
contributed to its superior performance during the year. However, the most
significant factor was that RBH remains the leader in the price cigarette
category which continued to grow this year at the expense of the premium and
fine cut market categories. While the growth in price category cigarette
volumes has slowed, and competition in this category has increased, we
continued to be pleased with the performance of RBH's Number 7, Canadian
Classics and Mark Ten brands.
During the last three quarters of the fiscal year, the rate of decline in
reported industry sales volumes accelerated. We believe that this was caused
by increased sales of non-taxed or partially taxed contraband product. While
the nature of the contraband market means it cannot be measured, recent media
reports appear to show a heightened level of audacity by contraband profiteers
as they flout the law in the practice of their trade. The establishment of a
growing and seemingly accepted contraband infrastructure is a cause for
concern. Wholesalers, retailers, governments and the public, as well as RBH,
are all negatively affected by the sale of contraband tobacco products.
A resolution to this growing issue is no doubt complex, requiring
adjustments in the structure of tobacco regulation and taxation. However, any
changes made in an effort to resolve the problem will be ineffective without
increased enforcement. The federal and provincial governments can control the
outcome - either a worsening problem or a fundamental solution. We believe
that disregard for the unfettered expansion of contraband has adverse
consequences for governments' revenue and health objectives. Rothmans and RBH
are keenly interested in supporting government initiatives that will lead back
to a Canadian tobacco market served by regulated tax-paid product.
Another Year of Strong Results
RBH increased net sales in fiscal 2006 by $15.5 million or 2.4% to
$652.3 million, as a result of increased volumes in the cigarette price
category and higher prices, which more than offset volume declines in premium
cigarette and fine cut products. The payment of a special dividend of $1.50
per share during the first quarter of the fiscal year led to lower average
balances of cash and short-term investments and a decrease in investment
income to $3.4 million.
Operating costs of $363.5 million were consistent with the prior year as
increases in certain general and administrative expenses were offset by lower
variable costs resulting from slightly lower volumes shipped.
Net earnings increased by 7.0% to $99.5 million from $93.0 million in the
prior year. Basic earnings per share rose to $1.47 in the year from $1.38 in
fiscal 2005. On a fully diluted basis, earnings per share increased to $1.45
from $1.37.
As in fiscal 2005, the first six months of fiscal 2006 were stronger than
the last six months. Seasonality and accelerating declines in reported
industry sales volumes, during the second half of the year, are believed to
have caused these results.
Overall, Rothmans Inc. has once again increased its level of
profitability, which translates to solid cash flow that is ultimately paid out
to the Company's shareholders through dividends. As this report was being
completed, our regular annualized dividend of $1.20 per share represented a
dividend yield of approximately 5.4%.
The Company's financial position continues to be strong. Even with a high
level of earnings returned to shareholders through regular dividend
distributions, Rothmans Inc. continues to hold cash and short-term investments
equivalent to approximately $1.25 per share as at March 31, 2006.
We continue to believe that further consolidation in the worldwide
tobacco industry is likely, and that further consolidation, should it occur,
may result in acquisition opportunities that would be attractive to Rothmans
Inc. We monitor these trends and opportunities and regularly assess our
position with the ultimate goal of securing an accretive opportunity that will
increase shareholder value.
RBH Continues to Increase Market Share and Profitability
Rothmans Inc.'s increased profitability is directly attributable to the
solid performance of Rothmans Benson & Hedges, which increased its share of
the total reported domestic tobacco market to 31.3% versus 29.5% in the
previous year. This increase in share reflects RBH's success in the cigarette
price category, through its Number 7, Canadian Classics and Mark Ten
trade-marks which continued to have leading performance.
Statistics Canada data indicates that the decline in total reported
domestic sales volume accelerated to 8.1% year over year from an average
annual decline rate of 5.3% for the five previous years. We believe unreported
sales of contraband product are contributing to the increased rate of decline.
Within this decline in industry volumes, the product mix has continued to
shift with many consumers leaving their traditional premium brands for
contraband or cigarette price category products. From a 33% share of the total
tobacco market in fiscal 2005, price category cigarettes increased to almost
40% this past year. Premium cigarette shipments were 50% of the total market
in fiscal 2006, down from about 55% the previous year. Shipments of fine cut
products declined to 10% from nearly 12% in fiscal 2005.
EBITDA margin in the fourth quarter of 2006 was 33.9% compared with 37.4%
in the same period of fiscal 2005. This reflects reduced unit volumes
affecting both RBH and the industry and increases in various general and
administrative costs, partially offset by price increases across all product
categories. Despite the challenging market, RBH continued to successfully
pursue its strategies and increased its EBITDA margin to 44.8% in fiscal 2006
from 43.8% in the previous year.
Towards Effective Regulation
The health risks associated with smoking have been recognized and
acknowledged for a considerable period of time. It is clear that governments
have an important leadership role to play in continuing to make the public
aware of those risks as well as ensuring that youth do not have access to
tobacco products. Effective tobacco policy can be achieved through a
combination of rational laws, regulation, tax policy and enforcement. Policies
in any of these areas that fail to recognize consumer demand, political
realities, and the mechanics of contraband markets will leave enforcement as
the only option. Enforcement can only be achieved with the support of society,
the political will to use that support, and the allocation of significant
resources. Current tobacco policies restrict the marketplace, while providing
powerful economic incentives to ignore those restrictions. Constructive
dialogue among all market participants including governments, manufacturers,
distributors, retailers and consumers provides the best chance of identifying
and managing policy issues related to tobacco.
RBH has been a long-time proponent of dialogue and continues to seek
opportunities to work co-operatively with governments. However, governments
appear to view the landscape of reasonable regulation differently and RBH has
had only limited success in its continued efforts to create a rational and
inclusive dialogue with governments. Often it faces governments that do not
want and will not allow the type of dialogue needed to create and maintain
effective regulation. The result is regulation which does not meet the
legislative mandate, does not respect the rights of those affected, and
therefore often has unintended and counterproductive consequences.
Areas of continuing concern for RBH are tobacco taxation policy and the
lack of consistent enforcement of the laws and regulations set by governments.
Tobacco tax increases moderated during this last fiscal year, but with the
current high level of tax per carton there is a powerful economic incentive to
contraband profiteers. In Canada and in other parts of the world, high taxes
have been shown to create turmoil in the market, turmoil characterized by
smuggling, counterfeiting, illegal manufacturing, increased theft and other
criminal activities. While these activities add to enforcement costs and the
risks faced by the employees of manufacturers, wholesalers and retailers, they
also do nothing to further governments' stated policy objectives of reducing
consumption, enhancing tax revenues and restricting youth access to tobacco.
High taxes, in the absence of the ability and political will to enforce laws
and regulations, are a recipe for an escalating problem.
A Team Effort
Rothmans and RBH are fortunate to have a dedicated Board, a skilled
management team and a group of unionized and non-unionized employees all
working in concert to increase shareholder value. A unique culture has evolved
at RBH which has been crystallized within our TLC values: Teamwork, Leadership
and Commitment to Win. These simple yet powerful values demonstrate the
collective collegiality and drive that are brought by employees to build the
business in a very challenging and competitive market.
RBH was recognized this year as one of the 10 most respected corporate
cultures in Canada in a survey conducted by Canadian Business Magazine. This
recognition is a testament to the values the employees bring to RBH every day.
We thank our employees for their outstanding efforts over the last year in
once again producing strong results for the Company's shareholders.
We'd also like to thank the management team whose strategic and tactical
leadership has driven higher revenues and earnings in a difficult and changing
environment.
As always, we appreciate the knowledge and guidance of our Board of
Directors. Rothmans shareholders are well-served by a Board whose concern for
shareholder interests is reflected in the Company's continued high standing in
The Globe and Mail's annual ranking of corporate governance practices.
Finally, but most importantly, we thank you, our shareholders, for your
continuing support and we assure you of our dedication to continuing to
deliver strong financial performance and returns on your investment in
Rothmans Inc.
Joe Heffernan
Chairman of the Board
John Barnett
President and Chief Executive Officer
Management's Discussion and Analysis
for the fiscal year and three months ended March 31, 2006
---------------------------------------------------------
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, 2006 compared with the prior year. It also
discusses factors that could affect future performance. This MD&A should be
read in conjunction with the attached unaudited consolidated financial
statements for the year ended March 31, 2006. The results reported herein have
been prepared in accordance with Canadian Generally Accepted Accounting
Principles (GAAP) and are presented in Canadian dollars. This MD&A is current
as of May 18, 2006.
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 consolidated financial statements.
Report on Disclosure Controls and Procedures
For the financial year ended March 31, 2006, an evaluation of the
effectiveness of the Company's disclosure controls and procedures was carried
out under the supervision of, and with the participation of, the Company's
management, including the Chief Executive Officer and Chief Financial Officer.
Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the design and operation of these disclosure controls
and procedures were effective as of March 31, 2006 to provide reasonable
assurance that material information relating to the Company and its
consolidated subsidiaries would be made known to them by others within those
entities.
Forward Looking Statements
Certain statements contained in this MD&A and other sections of this
release (in particular the section entitled "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 18, 2006.
Factors that could cause the Company's actual results to differ
materially from the forward-looking statements contained herein include, but
are not limited to: government claims and potential claims; product liability
claims; price category pressure on overall cigarette margins and changes in
market share for RBH's products; declining consumer consumption and dependence
on price increases; increases in the levels of contraband and counterfeit
products in the market; changes in legislation and regulation; changes in
government taxation policy; new product standards; dependence on the domestic
tobacco market; fluctuating wholesaler and consumer purchasing patterns; and
competition.
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 is contained in the Company's filings with Canadian
securities regulatory authorities, including the Company's Annual Information
Form (in particular under "Legal Proceedings" and "Risk Factors") available on
SEDAR at www.sedar.com or on the Company's website at www.rothmansinc.ca.
Terminology used in this MD&A
Throughout this MD&A, "GAAP" refers to Canadian Generally Accepted
Accounting Principles, "Rothmans" and "the Company" refer to Rothmans Inc.,
"RBH" refers to Rothmans, Benson & Hedges Inc., which is 60%-owned by Rothmans
Inc., and "EBITDA margin", a key measure of the RBH's operating performance,
refers to "earnings before interest, taxes, depreciation and amortization" as
a percentage of "sales, net of duty and taxes". EBITDA margin provides a
metric allowing period-to-period comparisons of the core RBH operating
performance before the impact of changes in capital structure, taxes and
capital spending. EBITDA margin is a non-GAAP financial measure that does not
have any standardized meaning prescribed by GAAP. It is therefore unlikely to
be comparable to similar measures presented by other companies. The "recent
quarter" refers to the three months ended March 31, 2006, and "prior quarter"
refers to the three months ended December 31, 2005. "Fiscal 2006" or "recent
fiscal year" refers to the fiscal year ended March 31, 2006 and other similar
references to a fiscal year (e.g., fiscal 2005) refer to the fiscal year then
ended on March 31 (e.g., March 31, 2005).
"The three major manufacturers" or "three majors" refers to RBH, Imperial
Tobacco Canada Limited (ITL) and JTI-MacDonald Corp. (JTI). "BAT" refers to
British American Tobacco p.l.c., the parent company of ITL. "Premium
cigarettes" refers to tailor-made cigarettes sold at premium retail prices,
"cigarette price category" refers to cigarettes sold at less-than-premium
prices and "price category" refers to the combination of the cigarette price
category and the fine cut category (loose tobacco and pre-proportioned tobacco
sticks). "Reported industry" is based on information reported by Statistics
Canada and RBH estimates and includes, in addition to the information reported
by the three major manufacturers, information reported by smaller regional
manufacturers. "Dark markets" refer to provincial jurisdictions where the
display of tobacco products by retailers is banned by government regulation.
"Domestic composite market" refers to all fully tax-paid cigarettes and fine
cut tobacco products sold into the Canadian market.
Outstanding Shares
As at March 31, 2006, there were 67,855,608 common shares outstanding or
69,346,408 shares on a fully diluted basis. See notes 7 and 8 to the unaudited
consolidated financial statements.
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 Altria Group, 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 tobacco company in Canada with a 31.3% share of
the reported domestic composite market in the recent fiscal year and a leading
position in the price category. RBH competes in all categories of the Canadian
tobacco 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 compares its brand offerings and positioning within each
market category against the opportunities presented by the marketplace. This
process allows for adjustments to the tactical execution of its brand strategy
in order to best maximize performance. The adjustment in strategy can involve
activities including brand launches, brand line extension, brand repositioning
and brand acquisition. While RBH has been able to grow market share in the
face of a declining market, the reduction in overall industry profitability
and the increasing presence of contraband product in the Canadian market is
expected to present significant challenges in the coming fiscal year. While
future success is not assured, management believes 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.
Rothmans also continues to be interested in opportunities for growth
through an international tobacco acquisition. The Company's acquisition
strategy centres on the expectation that the trend of worldwide tobacco
industry consolidation will continue. This strategy is therefore dependent on
the timing of opportunities initiated by third parties. To date, the Company
has not found an opportunity that is an attractive complement to its existing
business interest in RBH. Rothmans will continue to assess potential
acquisitions and its overall acquisition strategy with the objective of
maximizing shareholder value.
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 cigarette consumers are
principally served by the three major manufacturers, 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. The move of consumers towards
tax-paid price category cigarettes continued at a declining rate during fiscal
2006 reflecting the already substantial move of consumers to this category
over the past few years. Fine cut product offerings include loose tobacco,
high-yield tobacco and a variety of pre-proportioned 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. In addition to
legal tax-paid products sold by the tobacco industry, contraband products
appear to be having an increasing impact on the Canadian tobacco marketplace.
Total reported industry domestic sales volumes for all tobacco products
decreased 8.1% and 10.8% in the fiscal year and quarter ended March 31, 2006
versus the comparable periods in the prior fiscal year. Recent quarter total
industry domestic sales volumes of 7.6 billion equivalent sticks were 13.4%
lower than in the prior quarter. Both normal seasonality and increases in the
presence of contraband product are believed to have contributed to the
decline. Industry declines in the four quarters of fiscal 2006 compared with
the same periods of the prior year, were 4.3%, 8.3%, 9.5% and 10.8%
respectively. In aggregate the decline experienced in fiscal 2006 is greater
than the 5.3% average decline rate in reported industry volumes experienced
over the preceding five years.
Duty-free and export shipments of cigarettes shipped almost exclusively
by regional manufacturers were 3.8 billion and 0.7 billion sticks in the
fiscal year and recent quarter ended March 31, 2006 compared with 2.7 billion
and 0.7 billion sticks in the same periods of the prior year. By their nature,
the impact of these sales on the domestic tobacco market is not estimable.
A number of other factors have been affecting overall industry shipments
including:
- High taxes and the potential for future taxation increases - High
taxes reflected in the selling price to the consumer contribute to
probable increases in the presence of contraband product in the
domestic market.
- Seasonal trends in consumer purchasing patterns - Over the past two
fiscal years, the period between April and September has demonstrated
stronger industry shipments than the period between October and
March. RBH management believes that smoking restrictions are causing
consumer consumption variations between the summer and winter
seasons.
- Fluctuations in wholesaler buying patterns as a result of anticipated
tax and manufacturer price increases, manufacturer sales programs and
trade terms - Swings in wholesaler purchasing patterns motivated by
the timing of tax increases, price increases, manufacturer sales
programs, manufacturer trade terms and other factors are anticipated
to have a significant effect on quarter-to-quarter sales volumes.
- Continued declines in consumer consumption of tobacco products.
In large part due to the continued growth of the cigarette price
category, total reported domestic premium cigarette volumes declined by 15.1%
and 14.0% in the fiscal year and quarter ended March 31, 2006 versus the same
periods of the prior year. RBH estimates that premium cigarettes represented
50.4% of total reported domestic industry shipments during fiscal 2006 versus
54.6% in fiscal 2005 and 50.0% in the recent quarter versus 51.9% in the
quarter ended March 31, 2005.
The price category continued its growth in the recent quarter, and
represented 49.6% of the reported Canadian domestic tobacco market in fiscal
2006 versus 45.4% in fiscal 2005 and 50.0% in the recent quarter versus 48.1%
in the quarter ended March 31, 2005. Fine cut products represented 9.9% of the
total reported domestic tobacco market in fiscal 2006 versus 12.0% in fiscal
2005 and 9.9% in the recent quarter versus 12.0% in the quarter ended
March 31, 2005. Price category cigarettes are estimated to have represented
39.7% of the total reported domestic composite market during fiscal 2006
versus 33.4% in fiscal 2005 and 40.1% in the recent quarter versus 36.1% in
the quarter ended March 31, 2005.
Two provinces increased taxes on tobacco products during fiscal 2006.
Effective February 1, 2006, the Province of Ontario increased tobacco taxes on
tobacco products by $1.25 on a per carton or equivalent basis. Effective
March 31, 2006, the Province of Newfoundland and Labrador raised taxes on
cigarettes and tobacco sticks by $2.00 on a per carton or equivalent stick
basis, and taxes on fine cut products by $10.00 on a per carton equivalent
basis.
Subsequent to the fiscal year end, the federal government announced that
effective July 1, 2006 it would be raising the federal excise duty applicable
to cigarettes, tobacco sticks and fine cut products by $0.56, $0.50 and $0.38
on a per carton or equivalent stick basis, in order to offset the effect of
the GST reduction.
Shown below is a comparative summary of domestic shipments of tobacco
products for the fiscal years ended March 31, 2006 and March 31, 2005.
<<
Canadian Domestic Tobacco Shipments
(in billions of sticks and equivalents)
-------------------------------------------------------------------------
For the year ended March 31
-------------------------------------------------------------------------
2006 2005
Three Reported Three Reported
RBH Majors Industry RBH Majors Industry
-------------------------------------------------------------------------
Premium cigarettes 2.8 18.0 18.0 3.3 21.3 21.3
Price category
Cigarettes 6.3 12.3 14.2 5.4 10.7 13.0
Fine cut 2.1 3.5 3.6 2.8 4.6 4.6
----------------------------------------------------
Total Price Category 8.4 15.8 17.7 8.2 15.3 17.6
-------------------------------------------------------------------------
Total 11.2 33.8 35.8 11.5 36.6 38.9
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For the year ended March 31
-------------------------------------------------------------------------
2006 2005
-------------------------------------------------------------------------
RBH Market Share
Premium cigarettes 15.6% 15.6% 15.5% 15.5%
Price category 53.2% 47.4% 53.3% 46.3%
Composite markets 33.2% 31.3% 31.4% 29.5%
This table includes information relating to domestic shipments only
(i.e., excluding duty-free and export sales). Reported industry
export and duty-free shipments for the fiscal year were: premium
cigarettes - 0.5 billion sticks in fiscal 2006 and in fiscal 2005;
price category cigarettes - 3.8 billion sticks in fiscal 2006 and
2.7 billion sticks in fiscal 2005.
Key Performance Drivers
The key performance drivers for RBH and, by extension Rothmans, 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 reported industry volume in
equivalent sticks by product category, market share by brand, and margin per
equivalent stick as the measures of 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, wholesalers and the hospitality
industry. The high tax load imposed on tobacco products is causing an apparent
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 also are 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 gross
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.
Rothmans Inc. Consolidated
Financial Summary (Unaudited)
(in millions of dollars,
except per share data)
2006 2005 2004
Year ended March 31 $ $ $
-------------------------------------------------------------------------
Operations
Sales, net of excise duty and taxes 652.3 636.8 620.1
Cash flows from operations 183.2 162.0 225.6
Earnings before minority interest 165.7 155.6 151.1
Earnings for the year 99.5 93.0 90.3
Dividends paid 182.7 70.9 54.6
Financial position
Net working capital 208.8 286.8 273.2
Total assets 449.1 528.5 496.8
Total long-term liabilities 193.7 186.3 183.5
Shareholders' equity 113.9 193.7 168.5
Per common share (x)
Earnings - basic 1.47 1.38 1.34
Earnings - diluted 1.45 1.37 1.34
Dividends paid 2.70(1) 1.05 0.8125
Shareholders' equity 1.68 2.87 2.51
(1) 2006 dividends paid includes special dividend of $1.50 per share.
(x) Prior years have been adjusted for the two-for-one stock split
effective March 4, 2005.
Results at Rothmans, Benson & Hedges Inc.
RBH shipped a total of 11.2 billion and 2.4 billion equivalent sticks
into the domestic market during fiscal 2006 and the quarter ended March 31,
2006, representing a 2.3% and 7.2% decrease compared to the same periods of
the prior year. In contrast to the first two quarters of fiscal 2006,
increased shipments of RBH price category cigarettes in the third and fourth
quarters of fiscal 2006 only partially offset declines in premium cigarette
and fine cut shipments leading to a decline in sales volumes for fiscal 2006
compared to fiscal 2005. RBH's share of the total domestic composite tobacco
market of 31.3% and 31.8% for the fiscal year and recent quarter ended
March 31, 2006 represented an increase from the 29.5% and 30.6% in the fiscal
year and quarter ended March 31, 2005. These increases reflect a relatively
smaller decline in volume shipped by RBH compared with the overall reported
industry volume declines.
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 94% of its premium cigarette sales. Over the last year, RBH
continued to leverage its retail, bar and wholesaler programs in support of
the Benson & Hedges, Craven A, Rothmans, Belvedere, Belmont Milds and Viscount
brands, which are central to the targeted premium brand strategy. Regulatory
constraints continue to limit RBH's ability to communicate with adult smokers.
With upcoming regulatory restrictions on tobacco in the bar environment, RBH
recently discontinued its bar program. With dark markets already in place in
Saskatchewan and Manitoba and scheduled for implementation over the next two
years in Prince Edward Island, Ontario and Quebec, RBH's strategy for
long-term success in the premium cigarette category is to focus on growing
brands by investing in retail availability programs.
RBH's premium cigarette volumes declined 14.8% in fiscal 2006 and 13.2%
in the recent quarter as compared to the same periods in the prior year. RBH's
domestic market share of premium cigarettes was 15.6% in fiscal 2006 versus
15.5% in fiscal 2005 and 15.3% in the recent quarter versus 15.2% in the
quarter ended March 31, 2005.
The growth in the cigarette price category continued in fiscal 2006 as
some premium cigarette consumers continued to switch to lower-priced
alternatives. RBH believes that its products are well positioned in the two
pricing tiers in this category based upon their performance to date. At the
lower price tier, depending on regional consumer preferences, RBH has
positioned its Canadian Classics and Mark Ten brands. At the mid-priced tier
the Number 7 brand continues to be offered nationally. In order to further
strengthen its Number 7, Canadian Classics and Mark Ten trade-marks, RBH has
continued to launch line extensions to provide consumers of price category
cigarettes with a wider choice of formats and product characteristics. The
price cigarette category continued to evolve throughout the recent fiscal year
with increasing competition emerging in the lower priced tier. RBH is
committed to strategies that defend its significant position in the cigarette
price category.
RBH sold 6.3 billion price category cigarettes in fiscal 2006 and
1.4 billion cigarettes in the recent quarter, representing increases of 16.8%
and 5.9% compared with the similar periods in fiscal 2005. These volumes
represent market shares of the domestic price cigarette category of 44.4% and
45.9% in the fiscal year and quarter ended March 31, 2006 versus 41.5% and
42.9% in the same periods of the previous fiscal year. The increase in RBH's
share of the cigarette price category experienced in fiscal 2006 reflects the
continued solid performance of its price cigarette brand offerings
particularly in the lower price tier. 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 impact on the category by contraband product. The emergence of
price category cigarettes and contraband product has led to erosion of overall
fine cut volumes, however 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. During fiscal 2006, RBH initiated a program of stock
keeping unit "SKU" rationalization within the fine cut category. Upon
completion, consumers will continue to be offered a wide range of RBH products
within the fine cut portion of the price category.
Shipments of RBH fine cut products declined 24.6% and 28.7% in the fiscal
year and quarter ended March 31, 2006 compared with the same periods of the
prior fiscal year. This decline resulted from consumers switching to
cigarettes from both pre-portioned stick products and high-yield products.
RBH's share of the domestic fine cut market was 59.1% and 57.9% in fiscal 2006
and the recent quarter compared with 59.6% and 59.5% in the same periods of
the previous fiscal year. Combining the cigarette price category with the fine
cut segment, RBH's share of the total price category was 47.4% and 48.2% in
the fiscal year and quarter ended March 31, 2006 compared with 46.3% and 47.1%
in the same periods of the prior fiscal year.
Consistent with the decline in total reported domestic industry sales
volumes, RBH's total domestic shipments in the recent quarter were 2.4 billion
equivalent sticks, a decrease of 12.6% compared to the prior quarter. Both
normal seasonality and increases in the presence of contraband product are
believed to have contributed to the lower volumes which were experienced
across all product categories.
RBH's EBITDA margin was 44.8% and 33.9% in the fiscal year and quarter
ended March 31, 2006 compared with 43.8% and 37.4% in the same periods of the
prior fiscal year. The fiscal 2006 EBITDA margin increase was principally due
to increased volumes of price category cigarettes, higher prices across all
product categories and lower product input costs (which more than offset
reduced premium cigarette and fine cut volumes), higher manufacturing, sales,
marketing and general administrative costs. The recent quarter EBITDA margin
decrease was principally due to lower premium cigarette and fine cut volumes
and increased general and administrative costs.
RBH increased prices twice during fiscal 2006. Early in the quarter ended
June 30, 2005, RBH increased the price charged to wholesalers for its premium
cigarettes and Number 7 cigarettes by $0.80 per carton. Prices on Canadian
Classics and Mark Ten were increased by $0.40 per carton and prices on fine
cut products were increased by varying amounts depending on format. In
February 2006, RBH increased wholesale selling prices on its premium cigarette
products by $1.50 per carton and its Number 7, Canadian Classics and Mark Ten
prices by $1.00 per carton. Prices on fine cut products did not change.
Rothmans Inc. Financial Results
Basic earnings per share were $1.47 and $0.24 in the fiscal year and
quarter ended March 31, 2006 versus $1.38 and $0.26 in the comparable periods
of the prior year. RBH's sales, net of excise duty and taxes, of
$652.3 million and $144.1 million for fiscal 2006 and the recent quarter were
$15.5 million higher than fiscal year 2005 but $0.1 million lower than the
quarter ended March 31, 2005. 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 during fiscal 2006, but were insufficient to do so in the recent
quarter.
Investment income of $3.4 million for fiscal 2006 was $0.8 million lower
than fiscal 2005 due to lower average cash balances.
Operating costs, which totaled $363.5 million and $95.6 million for the
fiscal year and quarter ended March 31, 2006, were $0.9 million and
$4.0 million higher than the same periods of the prior fiscal year. During the
fiscal year, RBH experienced lower variable costs due to lower shipment
volumes and lower product input costs, including a favourable impact due to
the change in the Canadian-US dollar exchange rate, compared with fiscal 2005.
These decreases were more than offset by higher manufacturing, sales and
marketing and general administrative expenditures compared with fiscal 2005.
Recent quarter operating costs were higher compared with the same period in
the prior year primarily due to higher general and administrative costs.
RBH's amortization expense of $10.7 million for fiscal 2006 was
relatively consistent compared with the prior year. Capital spending by RBH
decreased during fiscal 2006 to $17.6 million from $21.7 million in fiscal
2005 due to the timing of certain capital improvements. RBH continues to
invest in its production infrastructure in support of requirements driven
predominantly by the growth of the cigarette price category. Capital
expenditures in fiscal 2007 are anticipated to be consistent with the
investments made in fiscal 2006.
Income tax expense was $109.1 million and $17.9 million in the fiscal
year and recent quarter ended March 31, 2006 resulting in an effective tax
rate for the fiscal year to date of 39.7%. The Company expects its effective
tax rate for fiscal 2007 to be 40.2%.
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
$177.5 million in the fiscal year ended March 31, 2006 compared with
$168.3 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 2006, the Company paid dividends of $182.7 million, versus
$70.9 million in fiscal 2005. The fiscal 2006 dividend comprised $1.20 in
regular dividends and a $1.50 special dividend.
Cash Resources
Cash and short-term investments of $130.2 million at March 31, 2006
represented the consolidated cash resources of the Company versus
$192.0 million at March 31, 2005. The decrease in cash and short-term
investments is predominantly due to the payment by the Company of a $1.50 per
share special dividend during the first quarter of fiscal 2006, and normal
quarterly fluctuations in RBH's working capital requirements, partially offset
by earnings from RBH's operations. In order to provide additional working
capital for normal operations, RBH reduced its normal quarterly dividend for
the prior quarter. The recent quarter dividend from RBH reflects historical
practice and it is not currently anticipated that it will be necessary for RBH
to reduce its dividends in future quarters in order to fund working capital
requirements. On a non-consolidated basis, Rothmans held cash and short-term
investments of $85.0 million at March 31, 2006, a decrease from $192.0 million
at March 31, 2005. This decrease results from the payment of dividends by the
Company and the timing of dividends paid by RBH.
RBH currently has outstanding $150 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 6 to the unaudited consolidated financial statements for
the fiscal year.)
Effective January 3, 2006 RBH changed the early payment discount provided
to its domestic wholesale customers, matching the terms currently being
provided by ITL. This change resulted in accounts receivable declining to
$11.8 million as at March 31, 2006 versus $32.1 million as at March 31, 2005.
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, 2006.
-------------------------------------------------------------------------
Contractual
Obligations Fiscal Fiscal Fiscal Subsequent
($000's) 2007 2008 2009-2011 to 2011 Total
-------------------------------------------------------------------------
Long term debt - - 150,000 - 150,000
Operating leases 3,808 2,909 8,132 1,352 16,201
Purchase
obligations 7,033 - - - 7,033
-------------------------------------------------------------------------
Total contractual
obligations 10,841 2,909 158,132 1,352 173,234
-------------------------------------------------------------------------
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
Traditionally, RBH's level of capital expenditure approximated
amortization expense and focused on maintaining the manufacturing flexibility
and capacity at both the Quebec City and Brampton plants. Capital expenditures
in fiscal 2006 were $17.6 million to support the increased demand for price
category cigarettes and requirements to continue fine cut product innovation.
Management expects fiscal 2007 capital expenditures to be consistent with
fiscal 2006, before returning to traditional levels in fiscal 2008.
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 and
profitability targets, aligning the programs with the drivers of shareholder
value. In the prior fiscal year, executive compensation also included stock
option grants from the Company to executives and a select group of other key
employees. Annual option grants as a part of executive compensation programs
were discontinued effective fiscal 2006.
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 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
expected benefit cost of $0.1 million and obligation liability of $5.4 million
for fiscal 2006.
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 expected pension cost in fiscal 2006 by
approximately $0.3 million.
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 legal actions,
proceedings and claims. Based on the stage of those proceedings, management is
unable to meaningfully estimate the loss, if any, that might result from those
claims and neither the Company nor RBH has accrued for potential losses.
However, the outcome of any litigation is uncertain. If successful, these
claims, either individually or in the aggregate, could involve significant
damages which would have a significant adverse effect on the financial
condition of the Company, and the Company and RBH may not have the resources
to satisfy such claims.
New Accounting Pronouncements
In September 2005, the Emerging Issues Committee of the Canadian
Institute of Chartered Accountants issued Abstract 156 "Accounting By A Vendor
For Consideration Given To A Customer (Including a Reseller of the Vendor's
Products)". This abstract applies to fiscal years beginning on or after
January 1, 2006 and accordingly, will be adopted by the Company in the first
quarter of its fiscal year ending March 31, 2007. The abstract addresses the
issue of whether consideration provided by a vendor to a customer is an
adjustment to the selling prices of the vendor's products and therefore a
reduction of revenue or is a cost incurred by the vendor and therefore
classified as cost or expense. Management is currently evaluating the impact
of this accounting pronouncement on the Company's financial statements.
A new accounting standard, CICA Handbook Section 3855 "Financial
Instruments - Recognition and Measurement" was recently issued. This standard
prescribes when a financial asset, financial liability, or non-financial
derivative is to be recognized on the balance sheet, and at what amount. It
also specifies how financial instrument gains and losses are to be presented.
Section 3855 applies to interim and annual financial statements relating to a
fiscal year ending on or after October 1, 2006. The Company plans to adopt
this standard for its fiscal year ending March 2008. Management is currently
evaluating the standard and its impact on the Company's financial statements.
CICA Handbook Section 1530, "Comprehensive Income," introduces a new
requirement to temporarily present certain gains and losses outside net
income. This standard applies to interim and annual financial statements
relating to fiscal years beginning on or after October 1, 2006. The Company
will adopt this standard for its 2008 fiscal year. Financial Statements of
prior periods are required to be restated for certain comprehensive income
items. The Company is currently evaluating this standard and the impact of
this new accounting pronouncement on the Company's financial statements.
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 manufacturers. The manufacturers' appeal of this decision was
heard by the Quebec Court of Appeal in December 2004 and in August 2005 the
Quebec Court of Appeal upheld the validity of most of the legislation. The
federal government sought 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 has agreed to hear the
appeal, as well as the cross appeal of the manufacturers.
Legislation enacted in Saskatchewan prohibits the display of tobacco
products and any advertising or promotion of tobacco products in any location,
including retail stores, to which persons under the age of 18 have access.
Similar legislation banning the display of tobacco products has been enacted
in Manitoba, and Prince Edward Island will be banning the display of tobacco
products as of June 1, 2006. Legislation enacted in Quebec will, as of May 31,
2006, prohibit 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. In Ontario, legislation has been enacted which will,
as of May 31, 2006, restrict the manner in which tobacco products may be
displayed at locations where the product is sold. Effective May 31, 2008, the
display of tobacco products in Quebec and Ontario will be prohibited.
Regulations restricting or prohibiting smoking in the workplace and other
environments are in place in many municipal jurisdictions.
Legislation enacted in British Columbia, Newfoundland and Labrador, Nova
Scotia and Ontario purports to allow 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. New Brunswick
and Manitoba have both introduced bills modeled on the legislation in British
Columbia. RBH and other tobacco manufacturers challenged the validity of the
British Columbia legislation on constitutional grounds. 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 in British Columbia is now
proceeding.
As of October 1, 2005, new regulations enacted under the Tobacco Act
require all cigarettes manufactured in or imported into Canada to meet new
reduced ignition propensity performance standards and reports on testing of
cigarette brands against these new standards are to be submitted to Health
Canada on an annual basis.
Health Canada is working on proposed regulations which would prohibit the
use of "light" and "mild" descriptors, or variations of those terms, in
connection with tobacco products and accessories. It is also working on
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. There is also an ongoing regulatory investigation
by the Competition Bureau relating to the use of the terms "light" and "mild"
as descriptors on tobacco products.
In 2004, Health Canada published a consultation document which solicited
comments on a proposal for new health-related information on tobacco product
labels. Among other things, 48 new health warnings were proposed for tobacco
packaging as well as new health information messages.
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 legal actions, proceedings and claims arising out of the sale,
distribution, manufacture, development, advertising and marketing of tobacco
products are pending, have been threatened or may be instituted against the
Company and RBH. Since 1995, there has been an increase in the number of these
claims, which include government actions for recovery of health care costs
allegedly incurred in respect of smoking-related illnesses. Two of these legal
actions 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.
These claims remain at an early stage and involve complicated and novel
questions of law that may take several years to resolve. Based on the stage of
these proceedings, the Company is unable to meaningfully estimate the amount
or range of loss, if any, that might result from these claims. 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 successful,
these claims, either individually or in the aggregate, could involve
significant damages, which would have a significant adverse effect on the
financial condition of the Company, and the Company and RBH may not have the
resources to satisfy such claims. RBH is currently the subject of an ongoing
investigation by the RCMP relating to its business records and sales of
products exported from Canada in the period 1989-1996. Although no action has
been commenced against the Company or RBH and the Company believes that RBH's
operations were properly conducted at all times, the Company cannot predict
the outcome of any such investigation or whether additional investigations may
be commenced, and it is possible that RBH's business could be materially
affected by an unfavourable outcome of current or future investigations.
The Company and RBH believe that they have good defences to these claims
and proceedings and intend to vigorously defend themselves. The outcome of
litigation is however uncertain and those claims could be decided unfavourably
against RBH and the Company. The Company and RBH may also decide to enter into
settlement discussions if they believe it is in their best interests.
Further information concerning the claims and proceedings affecting the
Company and RBH is contained in note 12 to the unaudited consolidated
financial statements of the Company.
In addition to these claims and investigations, the Company monitors
other legal proceedings and claims 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 U.S. and the European
Union, these proceedings include 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" constitute 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 manufacturers in those jurisdictions
over an extended period of up to 20 years. To date, no such settlement
agreements have been entered into in Canada. Should tobacco product
manufacturers in Canada, enter into arrangements or agreements of a similar
nature in respect of any claims, 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 to predict the outcome of legal claims, pending and
future, against the Company or RBH. Legal proceedings are subject to many
uncertainties and it is possible that there will be adverse developments in
the claims and investigations pending against the Company and RBH and that
these and any potential future cases could be decided unfavourably or settled.
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
claims involving RBH or the Company. There has 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 may prompt the commencement of additional similar proceedings.
Tobacco Taxation
Following the tax roll-back in 1994, tobacco tax increases introduced in
the years 1995 to 2001, while frequent in number and well in excess of
inflation, were generally moderate in size. This policy of moderation was
abandoned in 2001 when federal, and especially, provincial tobacco tax rates
began to increase dramatically to current unprecedented levels. Very high
tobacco taxes lead to significant increases in the size of the non tax-paid or
partially taxed tobacco product market. The presence of contraband product in
the domestic tobacco market appears to have substantially increased in recent
years. In fact, the Canada Revenue Agency (the "CRA") has confirmed in a
Discussion Paper released in 2005 that "significant taxation of tobacco
products and the potential for profit act as powerful incentives for
contraband activity which results in substantial revenue losses at both the
federal and provincial levels, and undermines government health initiatives,
which form part of the basis for high excise duties and provincial taxes on
tobacco products". The CRA also noted that "Canada is clearly a target for
offshore contraband tobacco products". RBH concurs with the statements made by
the CRA and has been cooperatively working with enforcement officials to
address the foreign source counterfeiting problem.
Most governments appear to have acknowledged that tobacco tax increases
in recent years have been excessive and have led to unintended consequences.
As a result, only Ontario and Newfoundland and Labrador increased cigarette
taxes during the fiscal year by $1.25 and $2.00 per carton, respectively.
Taxes on other tobacco product categories were also increased in the two
provinces.
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. However, both
tobacco stick and high-yield roll-your-own products have been targeted by
anti-smoking groups for increased taxes. One province, Newfoundland and
Labrador, has revised its tax policy to tax roll-your-own fine cut 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 firmly believes that fine cut products
can contribute to the control of contraband and it is important that
governments recognize this and maintain differentiated taxing structures.
RBH's sales volumes are negatively affected by the existence of illicit
trade in tobacco products within Canada, and unreasonable future tax increases
will exacerbate the problem. As well, any shift in government policy to tax
fine cut products at cigarette equivalents may make RBH's products less
attractive to consumers. This could result in an adverse effect on sales
volumes and on RBH's profitability, cash flows and financial condition.
New Product Standards
New government regulations, which became effective in October 2005,
establish fire safety standards for tobacco products and require tobacco
products sold in Canada to meet specified reduced ignition propensity
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 manufacturing 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.
During the third quarter of fiscal 2006, ITL announced the move of their
Canadian production to Mexico resulting in the planned closure of their
Canadian production facilities. This move appears consistent with BAT's stated
strategy of rationalizing its worldwide production facilities to improve
efficiencies. Subsequent to the year end, ITL also announced that beginning in
late August 2006, it will be changing its distribution process to permit
direct sales and distribution of its products to retail outlets. It is
currently too early to determine the impact of these initiatives.
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 price 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-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 manufacturers. If these competitive factors continue, sales of
premium cigarettes, the most profitable category, may continue to shift to the
cigarette price category. The impact on the sales and earnings of RBH will be
dependent upon consumer buying patterns with respect to products offered in
the cigarette price category by RBH and competing manufacturers. 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
continues to refine its crisis management and contingency plans. 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
Looking ahead, Rothmans expects that a number of factors could affect its
financial performance including:
- the success of efforts by RBH and the industry to defend themselves
against product liability, government and other claims, and to
operate within the regulatory environment;
- increased levels of counterfeit and other contraband product that may
occur due to the increasingly onerous tax environment;
- a lower rate of growth in the cigarette price category and RBH's
ability to successfully compete in that segment;
- the impact of continued high levels of taxation on consumer
purchasing patterns;
- continued declines in the consumption of tobacco products;
- RBH's ability to continue to implement price increases for its
products;
- the impact of RBH's efforts to stabilize its cigarette market share
in the declining premium cigarette category;
- the continued volatility in the cigarette market as a result of the
evolution of the Canadian cigarette price category, varying
wholesaler purchasing patterns, seasonal fluctuations in smoker
consumption;
- RBH's ability to maintain its leading position in the fine cut
segment;
- government tax policy regarding the differentiation in tax rates
applicable to fine cut products in comparison to tailor-made
cigarettes; and
- RBH's continued success at maintaining or reducing costs, especially
in view of the potential for regulated changes to product
specifications.
In fiscal 2006 it is believed that the increasing presence of contraband
was a key factor in the increased decline rate in total reported industry
sales volumes. Domestic industry volume declines during the four quarters of
fiscal 2006 compared with the same periods of the prior year were 4.3%, 8.3%,
9.5% and 10.8% respectively, leading to an overall decline of 8.1% for fiscal
2006 compared to fiscal 2005. Continued growth in the availability of
contraband products in the domestic market as a result of high tobacco tax
rates across the country may increase the decline rate in reported industry
volumes further in the future resulting in a negative impact on RBH's sales
volumes.
RBH domestic price cigarette category volumes grew by 16.8% in fiscal
2006 and 5.9% in the recent quarter compared to the comparable periods in the
prior fiscal year. Price category cigarettes are estimated to have represented
44.0% of total reported industry domestic cigarette sales volumes in fiscal
2006, an increase from 38.0% in fiscal 2005. While it is expected that the
cigarette price category will continue to grow, it is expected that the rate
of growth will be less than seen in recent years as the category approaches
maturity.
Quarterly Unaudited Consolidated Financial Information
FISCAL 2006
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 $ 175,991 $ 174,759 $ 157,410 $ 144,111 $ 652,271
Investment income 1,124 651 767 809 3,351
------------------------------------------------------
Total revenues 177,115 175,410 158,177 144,920 655,622
Costs:
Operating costs
excluding
amortization 90,947 87,815 89,151 95,632 363,545
------------------------------------------------------
Earnings before
interest, taxes
and amortization 86,168 87,595 69,026 49,288 292,077
Amortization 2,517 2,646 2,599 2,901 10,663
Interest expense
(income)
- Long-term debt 2,082 2,093 2,094 2,059 8,328
- Other (337) (384) (342) (680) (1,743)
------------------------------------------------------
Earnings before
income taxes and
minority interest 81,906 83,240 64,675 45,008 274,829
Income taxes
- Current 31,914 32,536 25,348 16,786 106,584
- Future 602 512 336 1,080 2,530
------------------------------------------------------
Total income taxes 32,516 33,048 25,684 17,866 109,114
------------------------------------------------------
Earnings before
minority interest 49,390 50,192 38,991 27,142 165,715
Minority interest 19,737 20,087 15,665 10,762 66,251
------------------------------------------------------
Earnings for the
period $ 29,653 $ 30,105 $ 23,326 $ 16,380 $ 99,464
------------------------------------------------------
------------------------------------------------------
Earnings per
common share
- Basic $ 0.44 $ 0.44 $ 0.34 $ 0.24 $ 1.47
------------------------------------------------------
------------------------------------------------------
- Diluted $ 0.43 $ 0.44 $ 0.34 $ 0.23 $ 1.45
------------------------------------------------------
------------------------------------------------------
RETAINED EARNINGS
Balance at
beginning of
period $ 151,734 $ 59,757 $ 69,518 $ 72,490 $ 151,734
Earnings for the
period 29,653 30,105 23,326 16,380 99,464
------------------------------------------------------
181,387 89,862 92,844 88,870 251,198
Dividends paid:
Common Shares -
(2006 - $2.70 per
share)(x) (121,630) (20,344) (20,354) (20,357) (182,685)
------------------------------------------------------
Balance at end
of period $ 59,757 $ 69,518 $ 72,490 $ 68,513 $ 68,513
------------------------------------------------------
------------------------------------------------------
(x) Includes special dividend of $1.50 per share paid on June 17, 2005
Rothmans Inc. and subsidiary companies (unaudited)
Quarterly Consolidated Financial Information
FISCAL 2005
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 $ 161,805 $ 166,669 $ 164,110 $ 144,187 $ 636,771
Investment income 884 912 1,181 1,252 4,229
------------------------------------------------------
Total revenues 162,689 167,581 165,291 145,439 641,000
Costs:
Operating costs
excluding
amortization 90,613 90,245 90,190 91,593 362,641
------------------------------------------------------
Earnings before
interest, taxes
and amortization 72,076 77,336 75,101 53,846 278,359
Amortization 2,127 2,195 2,598 2,654 9,574
Interest expense
(income)
- Long-term debt 1,937 1,954 1,983 3,084 8,958
- Other (334) (418) (488) (278) (1,518)
------------------------------------------------------
Earnings before
income taxes and
minority interest 68,346 73,605 71,008 48,386 261,345
Income taxes
- Current 27,480 29,002 28,149 21,958 106,589
- Future 476 656 485 (2,455) (838)
------------------------------------------------------
Total income taxes 27,956 29,658 28,634 19,503 105,751
------------------------------------------------------
Earnings before
minority interest 40,390 43,947 42,374 28,883 155,594
Minority interest 16,548 17,540 16,931 11,578 62,597
------------------------------------------------------
Earnings for
the period $ 23,842 $ 26,407 $ 25,443 $ 17,305 $ 92,997
------------------------------------------------------
------------------------------------------------------
Earnings per
common share
- Basic $ 0.35 $ 0.39 $ 0.38 $ 0.26 $ 1.38
------------------------------------------------------
------------------------------------------------------
- Diluted $ 0.35 $ 0.39 $ 0.37 $ 0.25 $ 1.37
------------------------------------------------------
------------------------------------------------------
RETAINED EARNINGS
Balance at
beginning of
period $ 129,628 $ 136,622 $ 146,143 $ 154,700 $ 129,628
Earnings for the
period 23,842 26,407 25,443 17,305 92,997
------------------------------------------------------
153,470 163,029 171,586 172,005 222,625
Dividends paid:
Common Shares -
(2005 - $1.05
per share) (16,848) (16,886) (16,886) (20,271) (70,891)
------------------------------------------------------
Balance at end
of period $ 136,622 $ 146,143 $ 154,700 $ 151,734 $ 151,734
------------------------------------------------------
------------------------------------------------------
Rothmans Inc. and subsidiary companies
Unaudited Consolidated Statements of Earnings and Retained Earnings
Year ended March 31 (in thousands
of dollars, except per share data) 2006 2005 2004
-------------------------------------------------------------------------
EARNINGS
Revenues:
Sales, net of excise duty and taxes $ 652,271 $ 636,771 $ 620,104
Investment income 3,351 4,229 3,839
-----------------------------------
Total revenues 655,622 641,000 623,943
Costs:
Operating costs excluding
amortization 363,545 362,641 355,861
-----------------------------------
Earnings before interest,
taxes and amortization 292,077 278,359 268,082
Amortization (notes 5 and 6) 10,663 9,574 9,880
Interest expense (income)
- Long-term debt (note 6) 8,328 8,958 7,973
- Other (1,743) (1,518) (2,454)
-----------------------------------
Earnings before income taxes
and minority interest 274,829 261,345 252,683
Income taxes (note 10)
- Current 106,584 106,589 105,762
- Future 2,530 (838) (4,177)
-----------------------------------
Total income taxes 109,114 105,751 101,585
-----------------------------------
Earnings before minority interest 165,715 155,594 151,098
Minority interest 66,251 62,597 60,821
-----------------------------------
Earnings for the year $ 99,464 $ 92,997 $ 90,277
-----------------------------------
-----------------------------------
Earnings per common share
(notes 3 and 7)
- Basic $ 1.47 $ 1.38 $ 1.34
-----------------------------------
-----------------------------------
- Diluted $ 1.45 $ 1.37 $ 1.34
-----------------------------------
-----------------------------------
RETAINED EARNINGS
Balance at beginning of year $ 151,734 $ 129,628 $ 93,969
Earnings for the year 99,464 92,997 90,277
-----------------------------------
251,198 222,625 184,246
Dividends paid:
Common Shares (2006 - $2.70 per
share(x), 2005 - $1.05,
2004 - $0.8125) (182,685) (70,891) (54,618)
-----------------------------------
Balance at end of year $ 68,513 $ 151,734 $ 129,628
-----------------------------------
-----------------------------------
(x) Includes 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) 2006 2005 2004
-------------------------------------------------------------------------
ASSETS
Current Assets
Cash and cash equivalents $ 48,364 $ 23,255 $ 46,978
Short-term investments 81,867 168,740 137,929
Accounts receivable 11,795 32,119 31,993
Inventories (note 4) 206,433 209,819 198,941
Prepaid expenses 1,835 1,322 2,123
-----------------------------------
Total current assets 350,294 435,255 417,964
Property, plant and equipment
(note 5) 76,298 69,149 56,292
Future income taxes (note 10) 6,301 8,831 7,993
Prepaid pension benefit cost (note 9) 13,295 12,003 11,738
Other assets 2,887 3,290 2,770
-----------------------------------
$ 449,075 $ 528,528 $ 496,757
-----------------------------------
-----------------------------------
LIABILITIES
Current Liabilities
Accounts payable and accrued
liabilities $ 42,618 $ 47,445 $ 37,021
Excise and other taxes payable 67,680 79,578 77,587
Dividend payable to minority
shareholder of subsidiary company 10,761 - -
Income taxes payable 20,437 21,475 30,178
-----------------------------------
Total current liabilities 141,496 148,498 144,786
Other long-term liabilities 2,399 2,167 1,468
Other employee future benefits
(note 9) 33,444 33,497 30,439
Long-term debt (note 6) 149,751 149,708 150,000
Minority interest in subsidiary
company 8,125 950 1,567
-----------------------------------
335,215 334,820 328,260
-----------------------------------
SHAREHOLDERS' EQUITY
Capital stock (notes 7 and 8) 45,347 41,974 38,869
Retained earnings 68,513 151,734 129,628
-----------------------------------
Total shareholders' equity 113,860 193,708 168,497
-----------------------------------
$ 449,075 $ 528,528 $ 496,757
-----------------------------------
-----------------------------------
Unaudited Consolidated Statements of Cash Flows
Year Ended March 31 (in
thousands of dollars) 2006 2005 2004
-------------------------------------------------------------------------
Cash provided by (used in):
OPERATING ACTIVITIES
Earnings for the year $ 99,464 $ 92,997 $ 90,277
Adjusted for non-cash items
Amortization (notes 5 and 6) 10,663 9,574 9,880
Minority interest 66,251 62,597 60,821
Future income taxes 2,530 (838) (4,177)
Loss on disposal of property,
plant & equipment 44 150 388
Defined & other employee future
benefits expense 5,014 7,681 8,240
Defined & other employee future
benefits funding (6,359) (4,888) (2,145)
Share option compensation cost - 1,030 1,092
-----------------------------------
177,607 168,303 164,376
Changes in non-cash operating
working capital 5,607 (6,281) 61,184
-----------------------------------
183,214 162,022 225,560
-----------------------------------
INVESTING ACTIVITIES
Additions to property, plant &
equipment, net (17,583) (21,666) (11,621)
Proceeds on disposal (purchase)
of short-term investments 86,873 (30,811) (55,841)
-----------------------------------
69,290 (52,477) (67,462)
-----------------------------------
FINANCING ACTIVITIES
Dividends paid
By the Company (182,685) (70,891) (54,618)
By a subsidiary company to
minority shareholder (48,315) (63,214) (69,138)
Proceeds on issuance of bond - 149,697 -
Repayment of long-term debt - (150,000) -
Payment of financing charges
on issuance of bond - (1,634) -
Proceeds on issuance of common shares 3,373 2,075 1,209
Repayment of bank indebtedness - - (20,447)
Proceeds on other long-term
liabilities 232 699 692
-----------------------------------
(227,395) (133,268) (142,302)
-----------------------------------
Increase (decrease) in cash
and cash equivalents 25,109 (23,723) 15,796
Cash and cash equivalents at
beginning of year 23,255 46,978 31,182
-----------------------------------
Cash and cash equivalents at
end of year $ 48,364 $ 23,255 $ 46,978
-----------------------------------
-----------------------------------
SUPPLEMENTARY DISCLOSURES
Income taxes paid $ 106,953 $ 115,185 $ 92,534
Interest paid
- Long-term debt 8,328 5,480 7,921
- Other 347 232 171
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 on the historical cost basis 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) 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.
d) 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 3 to 10 years
Motor vehicles 5 years
Leasehold improvements term of lease, not to exceed 10 years
e) 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,
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 using fair market value. The cost of post-employment benefits
other than pensions is recognized on an accrual basis over the working
lives of employees.
f) Future income taxes
Future income tax assets and liabilities are recorded on the difference
between the accounting carrying values of balance sheet assets and
liabilities and the tax cost basis of these assets and liabilities based
on substantively enacted tax laws and rates.
The Company reviews the value of its future income tax assets and
liabilities quarterly and records adjustments, as necessary, to reflect
the realizable amounts of its future income tax assets and liabilities.
The Company expects that it will realize its future income tax assets and
liabilities in the normal course of operations.
g) Marketing
Marketing costs, including those related to the introduction of new
brands, are charged against earnings during the year in which they are
incurred.
h) Earnings per common share
The Company uses 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.
i) Stock-based compensation plans
The Company has stock-based compensation plans as described in note 8.
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.
j) Cash and cash equivalents
Cash and cash equivalents are comprised of cash and short-term deposits
with original maturities of three months or less.
k) Interest rate swaps
Interest rate swaps are used to change the interest rate on a portion of
the outstanding debt from floating rate to fixed rate. This type of
interest rate swap involves the receipt of floating rate amounts in
exchange for fixed rate interest payments based on an underlying notional
principal amount over the life of the swap agreement.
l) Financial instruments
The fair values of short-term investments, accounts receivable, other
receivables, deposits, accounts payable and accrued liabilities as
recorded in the consolidated balance sheets approximate their carrying
amounts due to the short-term maturities of these instruments.
The fair value of the Company's bonds, with a coupon rate of 5.552% and
maturity date of December 21, 2011, approximates its carrying value as
the terms and conditions of the borrowing arrangements are comparable to
current market terms and conditions for similar loans. Fair value has
been calculated using the future cash flows (principal and interest) of
the actual outstanding debt instrument, discounted at the current market
rate available to the Company for similar instruments.
2. Changes in accounting policies
Effective April 1, 2004 the Company adopted The Canadian Institute of
Chartered Accountants (CICA) Guideline 13 "Hedging Relationships" which
establishes certain conditions when hedge accounting may be applied. The
relevant hedging relationship will be subject to an effectiveness test on
a regular basis for reasonable assurance that it is and will continue to
be effective. Under these rules, any derivative instrument that does not
qualify for hedge accounting will be recorded at the market value
applicable if the instrument was sold at the period end date, and any
losses or gains would be recognized in earnings. During the applicable
fiscal year, the Company applied the test established by the CICA and the
instrument was deemed to be effective, qualifying it for hedge
accounting. Effective March 31, 2005, the Company no longer uses the
derivative instrument related to its long-term debt, as detailed in
note 6.
3. Earnings per share
Earnings per common share is calculated based on a weighted average
number of 67,745,422 (2005 - 67,491,827, 2004 - 67,219,412) shares
outstanding. Diluted earnings per common share is calculated based on
68,385,047 (2005 - 67,871,711, 2004 - 67,377,788) common shares
outstanding, the dilution being due to the exercise of common share
options.
4. Inventories
2006 2005 2004
$ $ $
-----------------------------------
Leaf tobacco 95,542 88,249 82,501
Finished goods 88,839 99,995 95,870
Packaging material and other 22,052 21,575 20,570
-----------------------------------
206,433 209,819 198,941
-----------------------------------
-----------------------------------
5. Property, plant and equipment
2006 2005 2004
$ $ $
-----------------------------------
Cost
Land and land improvements 1,499 1,499 1,501
Buildings 24,155 24,269 23,781
Machinery and equipment 182,946 168,509 149,213
Motor vehicles 1,014 1,007 998
Leasehold improvements 2,860 2,752 2,682
-----------------------------------
212,474 198,036 178,175
Less: Accumulated amortization 136,176 128,887 121,883
-----------------------------------
76,298 69,149 56,292
-----------------------------------
-----------------------------------
2006 2005 2004
$ $ $
-----------------------------------
Accumulated amortization
Land improvements 141 137 135
Buildings 14,043 13,383 12,890
Machinery and equipment 118,965 112,510 106,134
Motor vehicles 992 982 998
Leasehold improvements 2,035 1,875 1,726
-----------------------------------
136,176 128,887 121,883
-----------------------------------
-----------------------------------
For the year ended March 31, 2006, a total amortization expense of
$10.4 million (2005 - 8.7 million, 2004 - $9.6 million) was recorded.
6. Long-term debt
On September 27, 2001, RBH reorganized its capital structure by reducing
its share capital by $150.0 million and distributed that amount to its
shareholders. This distribution was funded through a $150.0 million,
five-year, unsecured, floating rate, term loan entered into with a
Canadian bank syndicate, which could be prepaid in whole or in part at
any time at the option of RBH with the principal coming due on
September 28, 2006. During the fiscal year 2005, RBH fully repaid the
floating rate credit facility by issuing a total of $150.0 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 their principal is repayable
in full at maturity without amortization. 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 EBITDA ratio of 3.0 times
on a consolidated basis. RBH has the right to repay the bonds at anytime
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 (2005 - $0.8 million, 2004 -
nil) was expensed during fiscal year 2006, ending the year with
approximately $1.3 million of unamortized financing costs remaining.
Discounts of $303,000 on the bonds are also being amortized over the term
of the bonds and a total of $43,000 (2005 - $11,000, 2004 - nil) was
expensed as at March 31, 2006.
The following table details the interest rate swaps and rates of interest
as at the consolidated balance sheet dates.
2006 2005 2004
$ $ $
-----------------------------------
Notional amount Nil Nil 75,000
Weighted average floating rate N/A N/A 4.6650%
Weighted average fixed rate N/A N/A 5.9525%
7. Capital stock
Authorized
An unlimited number of common shares
Issued
67,855,608 (2005 - 67,572,008, 2004 - 67,351,208) common shares
2006 2005 2004
$ $ $
-----------------------------------
Balance - April 1 41,974 38,869 36,568
Issuance of shares 3,373 2,075 1,209
Contributed surplus (note 8) - 1,030 1,092
-----------------------------------
Balance - March 31 45,347 41,974 38,869
-----------------------------------
-----------------------------------
During fiscal year 2006, a total of 283,600 (2005 - 220,800, 2004 -
189,000) shares were issued due to the exercise of stock options.
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.
8. 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 vested 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.
The fair value of each option grant was estimated on the date of grant
using the Binomial option pricing model with the following assumptions:
2006 2005 2004
---------------------------------
Risk-free interest rate (%) N/A 4.25(x) 3.90(x)
Dividend yield (%) N/A 5.20 5.20
Expected lives (years) N/A 6 6
Volatility (%) N/A 22.00 26.50
(x) The risk-free interest rate is the yield for a six-year Government of
Canada bond on the date of grant.
A summary of the status of the Company's employee share option plan as at
March 31, 2006, 2005 and 2004, and changes during the years ending on
those dates is presented below:
2006 2005 2004
---------------------------------------------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
price price price
Options Shares $ Shares $ Shares $
-------------------------------------------------------------------------
Outstanding -
Beginning
of year 1,774,400 14.325 1,556,800 13.281 1,235,400 13.006
Granted - - 438,400 16.620 510,400 12.320
Exercised 283,600 14.448 220,800 11.518 189,000 8.892
Forfeited - - - - - -
Outstanding -
End of year 1,490,800 14.301 1,774,400 14.325 1,556,800 13.281
---------------------------------------------------------
---------------------------------------------------------
Options
exercisable
at year-end 1,490,800 14.301 1,774,400 14.325 1,428,468 13.025
---------------------------------------------------------
---------------------------------------------------------
Weighted average
fair value of
options granted
during the year N/A 2.35 2.14
-------- -------- --------
-------- -------- --------
Under the share option plan, as at March 31, 2006, 181,800 (2005 -
181,800, 2004 - 620,200) common shares were issuable. Given the limited
number of common shares available for issuance under the option plan, the
annual grant of options was discontinued effective fiscal year 2006. No
options were forfeited in fiscal 2006.
The following table summarizes information about share options
outstanding as at March 31, 2006:
Weighted
average
Exercise remaining
price Number contractual Number
$ outstanding life exercisable
-------------------------------------------------------------------------
8.825(1) 18,000 4.3 18,000
11.500(1) 154,000 5.1 154,000
12.320(2) 398,200 6.2 398,200
14.080(1) 261,400 5.5 261,400
16.125(1) 306,000 5.4 306,000
16.620(2) 353,200 7.4 353,200
------------ ------------
1,490,800 1,490,800
------------ ------------
------------ ------------
(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 dividend 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. Contributed funds are utilized to
purchase the Company's shares on the open market. Dividends earned on
shares held in the plan are reinvested through the purchase of additional
shares of the Company. The Company also pays for all fees and transaction
costs associated with the purchases.
During fiscal year 2006, a total of 101,626 (2005 - 88,291, 2004 -
104,062) shares of the Company were purchased under the provisions of
this plan.
9. Employee future benefits
The Company provides pension (including both defined benefit and
contribution plans), post-employment, and post-retirement benefits, which
in aggregate are considered employee future benefits. 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, 2006. The most recent actuarial valuations
for the various defined benefit plans were as of April 1, 2004 and
December 31, 2005. Valuations are carried out both annually and
biannually depending on the plan. The last actuarial valuation for other
benefits was as at April, 2005 to account for the costs of the plan for
the fiscal year ending March 31, 2006.
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.
2006 2005 2004
Defined Defined Defined
benefit Other benefit Other benefit Other
pensions benefits pensions benefits pensions benefits
$ $ $ $ $ $
------------------------------------------------------
Change in benefit
obligation
Benefit obligation -
beginning of year 137,641 42,656 134,464 41,060 125,045 35,160
Current service
cost 4,717 681 4,222 1,717 3,832 1,333
Interest cost 8,105 2,130 7,914 2,406 8,213 2,354
Actuarial (gain)
loss 9,383 (1,608) (693) (341) 6,504 4,605
Benefits paid (8,487) (2,184) (8,266) (2,186) (9,130) (2,392)
------------------------------------------------------
Benefit obligation -
end of year 151,359 41,675 137,641 42,656 134,464 41,060
------------------------------------------------------
------------------------------------------------------
Change in plan
assets
Fair value of plan
assets - beginning
of year 153,199 - 145,514 - 130,503 -
Return on plan
assets 12,448 - 13,249 - 24,388 -
Net employer
contributions 4,175 2,184 2,702 2,186 (247) 2,392
Benefits paid (8,487) (2,184) (8,266) (2,186) (9,130) (2,392)
------------------------------------------------------
Fair value of
plan assets -
end of year 161,335 - 153,199 - 145,514 -
------------------------------------------------------
------------------------------------------------------
Plan status
Funded surplus
(deficit) 9,976 (41,675) 15,558 (42,656) 11,050 (41,060)
Unrecognized loss 11,530 6,453 5,371 7,159 10,321 7,825
Unrecognized
transition (asset)
liability (9,276) 1,778 (10,103) 2,000 (10,922) 2,796
Unrecognized
past service 1,065 - 1,177 - 1,289 -
------------------------------------------------------
Prepaid (accrued)
benefit cost 13,295 (33,444) 12,003 (33,497) 11,738 (30,439)
------------------------------------------------------
Included in the above prepaid defined benefit obligation and fair value
of plan assets are the following amounts in respect of one plan that is
not fully funded:
2006 2005 2004
$ $ $
-----------------------------------
Defined benefit pensions
Benefit obligation - End of year 36,168 33,330 34,870
Fair value of plan assets - End of year 30,339 27,177 24,070
-----------------------------------
Funded deficit 5,829 6,153 10,800
-----------------------------------
-----------------------------------
As at March 31, 2006, approximately 50% (2005 - 49%, 2004 - 49%) of the
defined benefit pension plan assets were invested in equities, 28%
(2005 - 38%, 2004 - 41%) in fixed income securities, and 22% (2005 - 13%,
2004 - 10%) in cash and cash equivalents. The plan assets for the current
fiscal year included investments in the Company's shares of $0.3 million
or 0.2% of total plan assets (2005 - $0.4 million or 0.3%, 2004 -
$0.3 million or 0.2%).
The defined contribution plan assets as at March 31, 2006 were
$95.2 million (2005 - $82.1 million, 2004 - $72.4 million).
The significant actuarial assumptions used to arrive at the net defined
benefit obligations are shown below:
2006 2005 2004
------------------ ----------------- -----------------
Defined Defined Defined
benefit Other benefit Other benefit Other
pensions benefits pensions benefits pensions benefits
% % % % % %
------------------------------------------------------
Weighted average
assumptions
Discount rate 5.25 5.25 6.00 6.00 6.75 6.00
Expected return
on plan assets 7.00 - 7.00 - 7.00 -
Rate of compensation
increase 4.50 4.00 4.50 5.00 5.00 5.00
Beginning in 2005 the health care cost, mainly of prescription drugs,
trend rate was 10.0% which is graded down by 0.5% each year for twelve
years until it reaches 4.5% in 2016.
Total cash payments by the Company for all employee future benefits for
2006 was $9.5 million (2005 - $8.1 million and 2004 - $5.2 million)
The Company's and RBH's defined benefit pension plan and other benefits
expense are as follows:
2006 2005 2004
------------------ ----------------- -----------------
Defined Defined Defined
benefit Other benefit Other benefit Other
pensions benefits pensions benefits pensions benefits
$ $ $ $ $ $
------------------------------------------------------
Current service
cost 4,717 681 4,222 1,717 3,832 1,333
Interest cost 8,105 2,130 7,914 2,406 8,213 2,354
Actual return on
plan assets (12,448) - (13,249) - (24,388) -
Amortization of
plan (gains)
losses 9,383 (1,608) (693) (341) 6,504 4,605
------------------------------------------------------
Costs arising in
the year 9,757 1,203 (1,806) 3,782 (5,839) 8,292
Difference between
costs arising and
costs recognized
in respect of:
Return on plan
assets 3,023 - 4,249 - 16,312 -
Actuarial loss
(gain) (9,182) 706 701 667 (6,553) (4,060)
Transitional
obligation (827) 222 (819) 795 (819) 795
Past service cost 112 - 112 - 112 -
------------------------------------------------------
Net expense
recognized 2,883 2,131 2,437 5,244 3,213 5,027
------------------------------------------------------
------------------------------------------------------
RBH's defined contribution pension plan expense for fiscal year 2006 was
$3.1 million (2005 - $3.2 million, 2004 - $3.1 million). The following
table shows the effect of a one-percentage point change in assumed health
care costs:
1% 1%
increase decrease
$ $
------------------------
Effect on other benefits - total service
and interest cost 453 (354)
Effect on other benefits - accrued
benefit obligation 5,435 (4,330)
10. Income taxes
The consolidated effective income tax rate is as follows:
2006 2005 2004
% % %
-----------------------------------
Combined federal and provincial
basic rates 33.0 33.2 34.2
Manufacturing and processing
tax credits (0.5) (0.5) (1.3)
Surtaxes and other 7.2 7.8 7.3
-----------------------------------
Effective income tax rate 39.7 40.5 40.2
-----------------------------------
-----------------------------------
Future income tax assets and liabilities are recognized on temporary
differences between the financial and tax bases of existing assets and
liabilities as follows:
2006 2005 2004
$ $ $
-----------------------------------
Future income tax assets
Other employee future benefits 14,492 14,425 12,896
Other 247 270 265
-----------------------------------
14,739 14,695 13,161
-----------------------------------
Future income tax liabilities
Property, plant and equipment 2,896 844 308
Pension asset 5,542 5,020 4,860
-----------------------------------
8,438 5,864 5,168
-----------------------------------
Net future income tax assets 6,301 8,831 7,993
-----------------------------------
-----------------------------------
11. 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, 2006 for lease and other obligations:
$
----------
2007 10,841
2008 2,909
2009 2,830
2010 2,744
2011 2,558
Years subsequent to 2011 1,352
----------
23,234
----------
----------
12. Litigation, Claims and Contingencies
The Company and RBH are subject to a number of claims and potential
claims as described below:
- In February 2005, the QuDebec Superior Court authorized two claims
brought by plaintiffs resident in the Province of QuDebec 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 QuDebec
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 QuDebec 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.
- In January 2002, representatives of the Royal Canadian Mounted Police
(RCMP) conducted a search of RBH's business premises in connection
with an investigation into RBH's business records and sales of
products exported from Canada in the period 1989-1996. 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 increased significantly from 1991 to 1994.
Although no action has been commenced and no charges laid against the
Company or RBH or any of its present or former employees, officers or
directors, the RCMP and the federal and provincial governments may be
considering commencing actions or laying charges alleging smuggling
of tobacco products. 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 this 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 other company and certain of its
executives. A preliminary hearing with respect to the other
defendants is expected to be concluded during 2006. 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 manufacturer 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. In November 2004, representatives
of the RCMP conducted a search of the largest Canadian tobacco
products manufacturer as part of its investigations into sales of
tobacco products exported from Canada. The former federal Minister of
Justice previously stated that if the Government of Canada believes
that it has sufficient evidence to move against any company, it will
do so.
- 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.
- In October 2002, the Province of Newfoundland and Labrador commenced
a reference case in the Newfoundland Court of Appeal seeking a
determination as to whether the Tobacco Health Care Costs Recovery
Act (Newfoundland) enacted in 2002 (but yet to be proclaimed in
force) is constitutional. This legislation purports to allow 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. The Province later announced that it was withdrawing its
reference case and would await the decision of the Supreme Court of
Canada in the British Columbia action before proceeding with its
claim. At this time, no action has been commenced.
- 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, purports to allow the provincial
government to bring an action against tobacco product manufacturers
for the recovery of health care costs that allegedly have been or
will be incurred by the Province in respect of alleged tobacco
related diseases. No action has been commenced under this
legislation.
- In December 2005, the New Brunswick government introduced the Tobacco
Damages and Health Care Costs Recovery Act. The Bill, which is also
modeled on the British Columbia legislation, purports to allow the
Province 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. The Bill has received second reading.
- In March 2006, the Manitoba government introduced proposed health
care costs recovery legislation similar to that of British Columbia,
Newfoundland and Labrador, Nova Scotia and New Brunswick.
- In May 1997, a statement of claim was issued against RBH and Imperial
Tobacco Limited 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
Defense and will continue to defend the case.
The Company and RBH deny the allegations in the claims, pending and
threatened, described above and intend to vigorously defend the actions. All
of these claims and potential claims remain at an early stage and an estimate
of the loss, which might be suffered, if any, cannot be determined. The
outcome of any litigation is uncertain. If successful, these claims, either
individually or in the aggregate, could involve significant damages which
would have a significant adverse effect on the financial condition of the
Company, and the Company and RBH may not have the resources to satisfy such
claims.
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