3rd Quarter Report
Nine Months Ended
December 31, 2005
Trading: TSX: ROC
TORONTO, Feb. 3 /CNW/ - Rothmans Inc. today announced its results for the
third quarter of fiscal 2006, ended December 31, 2005.
Rothmans' earnings for the third quarter of fiscal 2006 were
$23.3 million, or $0.34 basic earnings per share, compared with $25.4 million
or $0.38 basic earnings per share in the third quarter of fiscal 2005. For the
first nine months of this fiscal year, Rothmans' earnings were $83.1 million
or $1.23 per share, compared with $75.7 million or $1.12 per share in the
first nine months of the prior year.
Sales, net of excise duty and taxes, at 60%-owned subsidiary Rothmans,
Benson & Hedges Inc. decreased to $157.4 million in the most recent quarter
compared with $164.1 million in the third quarter of fiscal 2005. Sales for
the first nine months of this fiscal year were $508.2 million versus
$492.6 million for the same period a year earlier.
RBH's recent quarter EBITDA margin was 43.8% compared with 50.1% in the
prior quarter and 45.7% in the quarter ended December 31, 2004. These EBITDA
margin decreases were primarily the result of lower premium cigarette and fine
cut volumes sold, only partially offset by increased volumes of price category
cigarettes, higher prices across all product categories and reduced material
costs.
RBH's share of the total domestic composite market was 31.4% for the
quarter ended December 31, 2005, compared with 31.1% in the previous quarter
and 30.6% in the third quarter of fiscal 2005. Premium cigarette share was
15.9%, compared with 15.6% in the previous quarter and 15.8% during the third
quarter of last year. RBH's share of the domestic price cigarette category of
43.5% compared with 44.1% and 42.8% in the prior quarter and third quarter of
fiscal 2005. In the fine cut market, RBH's share was 58.6%, down from 59.2% in
the prior quarter and 59.4% in the third quarter of fiscal 2005. RBH's share
of the total domestic price category was 46.3%, compared with 47.0% in both
the prior quarter and third quarter of fiscal 2005.
Outlook
"Variations in consumer consumption and wholesale buying patterns
continue to result in quarter to quarter volatility. The presence of
contraband product in the market caused by the high tax environment is
expected to continue to adversely affect legitimate industry stakeholders
including RBH," said John Barnett, President and Chief Executive Officer of
Rothmans Inc. and RBH. "In addition, smoking bans appear to have introduced a
higher degree of seasonality than previously experienced. Despite these
factors and the moderation in growth of the cigarette price category, we
believe that RBH continues to be well positioned in a challenging
environment."
The foregoing contains forward-looking statements about the Company's
outlook. Reference should be made to "Forward Looking Statements" as set out
in the Management's Discussion and Analysis section of this release.
Dividend declared
The Board of Directors of Rothmans Inc. declared a quarterly dividend of
$0.30 per share payable on March 17, 2006 to shareholders of record at the
close of business on March 3, 2006.
Analyst Conference Call and Webcast
Rothmans Inc. management will hold a conference call with analysts to
discuss the third quarter results at 8:30 a.m. Toronto time on Friday,
February 3, 2006. To listen to the conference call, shareholders are invited
to call 1-866-898-9626 or (416) 340-2216.
The call will also be webcast through the Company's investor website,
www.rothmansinc.ca. At the completion of the conference call, a recording will
be available until February 10, 2006 by calling 1-800-408-3053 and entering
reservation number 3173652. The recording can also be accessed through the
investor website.
About Rothmans Inc.
Rothmans Inc. is a widely held, publicly traded Canadian company that
participates in the Canadian tobacco industry through 60%-owned Rothmans,
Benson & Hedges Inc., Canada's second largest tobacco company. RBH currently
employs approximately 780 people at its head office in Toronto, its sales
offices across Canada and its manufacturing facilities in Brampton, Ontario
and Quebec City, Quebec where it has been operating for over 100 years.
Rothmans is Canada's only publicly traded company with interests exclusively
in the tobacco industry and is listed on the Toronto Stock Exchange under the
symbol ROC.
Management's Discussion and Analysis
of Financial Results for December 31, 2005
------------------------------------------
Management's Discussion and Analysis of Financial Condition and Results
of Operations "MD&A", provides shareholders with a review of significant
developments in the Company's financial performance in the fiscal quarter and
nine months ended December 31, 2005, 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 financial statements for the
period ended December 31, 2005, the MD&A and unaudited financial statements of
the Company for the quarters ended June 30, 2005 and September 30, 2005, the
annual MD&A contained in the 2005 Annual Report, and the audited annual
consolidated financial statements of the Company for the year ended March 31,
2005.
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 financial statements.
Forward Looking Statements
Certain statements contained in this MD&A and other sections of this
release (in particular the sections 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", "believes", "should" and
similar expressions are intended to 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 if management's
expectations or assumptions prove to be inaccurate. 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. Unless
otherwise indicated, forward-looking statements describe expectations as of
February 3, 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 taxation policy with respect to tobacco
products, legal proceedings and claims against the Company and RBH, changes in
consumer incidence and consumption of tobacco products, levels of contraband
and counterfeit products in the market, fluctuations in wholesaler buying
patterns, changes in market share for RBH's products, and other risks and
uncertainties described in the Company's regulatory filings.
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 2005 Annual Information Form (in
particular under "Legal Proceedings" and "Risk Factors") and 2005 Annual
Report 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 Company'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 December 31, 2005, and "prior
quarter" refers to the three months ended September 30, 2005. "Fiscal 2006"
refers to the fiscal year ending March 31, 2006 and other similar references
to a fiscal year (e.g., fiscal 2005) refers to the fiscal year then ended on
March 31 (e.g., March 31, 2005).
"The three major manufacturers" or "three majors" refer to RBH, Imperial
Tobacco Canada Limited (ITL), and JTI-MacDonald Corp. (JTI). "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 Company estimates and includes information reported by the three
major manufacturers and by other manufacturers.
Industry Overview
Total reported domestic sales volumes for all tobacco products decreased
9.3% and 7.3% in the quarter and nine months ended December 31, 2005 versus
the comparable periods in the prior fiscal year. Recent and prior quarter
industry volume declines have been greater than the 6.6% decline experienced
in fiscal 2005 and the 4.3% average annual decline rate experienced over the
preceding five years. At present, it is unclear whether this represents a
change in the long-term decline trend. Continued declines in consumer
incidence and consumption of tobacco products and the presence of contraband
and counterfeit products, likely due to the high tax environment, are
impacting sales volumes. The relative contributions of these factors to the
declines being experienced are, by their nature, not determinable.
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; and
- fluctuations in wholesaler buying patterns as a result of anticipated
tax and wholesale 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 comparisons in the future.
Total reported domestic premium cigarette volumes declined by 15.4% in
both the quarter and nine months ended December 31, 2005 versus the same
periods of the prior year. In the recent quarter, total reported domestic
price category volumes declined 2.6% compared with the same period of the
prior year, as lower fine cut volumes were only partially offset by higher
price category cigarette volumes. For the nine months ended December 31, 2005,
the total domestic price category volumes were 2.8% higher versus the same
period of the prior year.
RBH estimates that premium cigarettes represented 48.9% of total domestic
industry shipments in the recent quarter versus 50.8% in the quarter ended
September 30, 2005 and 52.4% in the quarter ended December 31, 2004. The price
category is estimated to have represented 51.1% of total domestic industry
shipments in the recent quarter, versus 49.2% in the quarter ended
September 30, 2005 and 47.6% in the quarter ended December 31, 2004. Fine cut
products are estimated to have represented 9.7% of the total domestic tobacco
market in the recent quarter versus 9.5% in the prior quarter and 12.0% in the
third quarter of last year. Price category cigarettes are estimated to have
represented 41.4% of the total domestic tobacco market in the recent quarter
versus 39.7% in the prior quarter and 35.6% in the third quarter of last year.
The high tax environment continues to influence the relative contribution of
the premium cigarette, price category cigarette and fine cut components of
total industry volumes.
Duty-free and export shipments of price category cigarettes shipped
almost exclusively by regional manufacturers were 1.2 billion and 2.8 billion
equivalent sticks in the recent quarter and nine months ended December 31,
2005, compared with 0.8 billion and 2.0 billion equivalent 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.
Effective February 1, 2006, the Province of Ontario increased tobacco
taxes on tobacco products by $1.25 on a per carton or equivalent basis.
Below is a comparative summary of domestic shipments of tobacco products
for the nine months ended December 31, 2005.
<<
Canadian Domestic Tobacco Shipments
(in billions of sticks and equivalents)
-------------------------------------------------------------------------
For the nine months ended December 31
-------------------------------------------------------------------------
2005 2004
Three Reported Three Reported
RBH Majors Industry RBH Majors Industry
-------------------------------------------------------------------------
Premium cigarettes 2.2 14.2 14.2 2.6 16.8 16.8
Price category
cigarettes 4.9 9.6 11.2 4.1 8.2 10.0
Fine cut 1.7 2.8 2.8 2.2 3.6 3.6
Total Price Category 6.6 12.4 14.0 6.3 11.8 13.6
-------------------------------------------------------------------------
Total 8.8 26.6 28.2 8.9 28.6 30.4
-------------------------------------------------------------------------
-------------------------------------------------------------------------
RBH Market Share
Premium cigarettes 15.7% 15.7% 15.6% 15.6%
Price category 53.2% 47.1% 53.2% 46.0%
Composite markets 33.1% 31.2% 31.1% 29.2%
Note:
1. 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 nine month period were:
premium cigarettes - 0.4 billion sticks in fiscal 2006, and
0.4 billion sticks in fiscal 2005; price category cigarettes -
2.8 billion sticks in fiscal 2006 and 2.0 billion sticks in fiscal
2005.
Results at Rothmans, Benson & Hedges Inc.
In the quarter ended December 31, 2005, RBH shipped a total of
2.8 billion equivalent sticks into the domestic market, a 6.9% decrease from
the comparable period of the prior year. For the nine months ended
December 31, 2005, RBH shipped a total of 8.8 billion equivalent sticks, a
0.9% decrease from the comparable period of the prior year. In contrast with
the first two quarters of this fiscal year, RBH's recent quarter cigarette
price category shipment growth only partially offset the factors driving
overall industry decline trends in the premium cigarette and fine cut
categories. RBH's share of the total domestic composite market of 31.4% for
the quarter ended December 31, 2005 was up from the 31.1% and 30.6% for the
three months ended September 30, 2005 and December 31, 2004 respectively.
RBH's premium cigarette volumes declined 14.9% in the recent quarter and
15.2% in the fiscal year to date as compared to the same periods in the prior
year. RBH's domestic market share of premium cigarettes was 15.9% in the
recent quarter ended December 31, 2005, a marginal improvement from 15.6% in
the quarter ended September 30, 2005, and 15.8% in the quarter ended
December 31, 2004.
Sales of RBH's price category cigarettes totaled 1.6 billion sticks in
the recent quarter and 4.9 billion sticks for the year to date, which
represented increases of 7.4% and 20.3% from shipments in the comparable
periods of fiscal 2005. The recent quarter share of the domestic cigarette
price category was 43.5% versus 44.1% in the prior quarter, and 42.8% in the
quarter ended December 31, 2004. RBH continues to experience solid performance
in the cigarette price category. A number of factors continue to influence the
overall growth of this product category including the brands being offered to
consumers, their availability and price.
Shipments of RBH fine cut products declined 28.0% in the recent quarter
and 23.5% in the fiscal year to date compared to the same periods in the prior
year. This decline primarily resulted from reduced consumer purchases of high
yield tobacco and pre-portioned stick products. RBH's share of the domestic
fine cut market was 58.6% in the recent quarter, down from 59.2% in the
quarter ended September 30, 2005, and 59.4% in the quarter ended December 31,
2004. During the recent quarter, RBH initiated a program of stock keeping unit
"SKU" rationalization within the fine cut category. When completed, RBH's fine
cut consumers will continue to be offered a wide range of products.
Combining the cigarette price category with the fine cut segment, RBH's
share of the total price category was 46.3% in the recent quarter, down from
47.0% in the quarters ended September 30, 2005 and December 31, 2004.
RBH's recent quarter EBITDA margin was 43.8% compared with 50.1% in the
prior quarter and 45.7% in the quarter ended December 31, 2004. These EBITDA
margin decreases were primarily the result of lower premium cigarette and fine
cut volumes sold, only partially offset by increased volumes of price category
cigarettes, higher prices across all product categories and reduced material
costs.
During the quarter ended December 31, 2004, RBH increased wholesale
selling prices on its Number 7 products by $2.00 per carton of 200 cigarettes
and its Canadian Classics and Mark Ten products by $0.50 per carton. In
addition, the price on cigars and fine cut products were increased by varying
amounts depending on format. 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.
Rothmans Inc. Financial Results
Basic earnings per share were $0.34 in the recent quarter and $1.23 for
the nine months ended December 31, 2005, compared with $0.38 and $1.12 in the
comparable periods of the prior year. Sales, net of excise duty and taxes,
were $6.7 million lower for the quarter, and $15.6 million higher for the nine
months, ended December 31, 2005 versus the comparable periods in the prior
year. Increased prices across all product categories and increased volumes of
price category cigarette shipments in the recent quarter versus the comparable
period of the prior year only partially offset decreases in sales resulting
from declines in both premium cigarette and fine cut volumes.
Investment income declined to $0.8 million in the recent quarter from
$1.2 million in the comparable period of the prior year. A special dividend of
$1.50 per share paid during the first quarter of fiscal 2006 reduced the
average cash balance held by the Company during the recent quarter versus the
comparable period of the prior year.
Operating costs were $0.7 million and $2.4 million lower in the recent
quarter and nine months ended December 31, 2005 versus the comparable periods
of the prior year. These operating cost reductions resulted from lower product
variable costs, reflecting lower shipment volumes, lower component costs of
materials used to manufacture finished goods and lower general administrative
costs, partially offset by higher sales and marketing costs.
Income tax expense was $25.7 million in the quarter and $91.2 million in
the fiscal year to date, resulting in an effective tax rate for the fiscal
year to date of 39.7%. The Company expects its effective tax rate for the
fiscal year to approximate 39.7%.
Liquidity and Capital Resources
Cash flow
RBH's operations generate significant cash resources. These are
sufficient to fund interest payments on RBH's long-term debt, capital
expenditures and dividends to its shareholders. The dividends received by
Rothmans Inc. are 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
$42.2 million in the recent quarter and $146.6 million in the fiscal year to
date versus $47.3 million and $137.4 million in the comparable periods of 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 the quarter, the Company paid dividends of $20.4 million,
representing a dividend of $0.30 per share.
Cash resources
Cash and short-term investments of $182.8 million represented the
consolidated cash resources of the Company versus $192.0 million at March 31,
2005. This decrease in cash and short-term investments is predominantly due to
the payment by the Company of a $1.50 per share special dividend made 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 recent quarter.
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 Inc. held cash and
short-term investments of $94.0 million at December 31, 2005, 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.
Effective January 3, 2006 RBH changed the early payment discount provided
to its domestic wholesale customers, matching the terms currently being
provided by ITL. On average, this change is expected to reduce RBH's accounts
receivable balance and therefore non-cash operating working capital
requirements by approximately $25 million.
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 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
The actuarial assumptions used to determine the benefit obligation and
associated expense of RBH's various defined benefit pension plans were not
adjusted in the recent quarter. Therefore, the discount rate, or the expected
return on plan assets remain as described in the annual MD&A for the year
ended March 31, 2005. A recent valuation of the post employment benefits has
resulted in certain changes in actuarial assumptions. The impact of these
changes on the benefit obligations and associated expense was not material.
Litigation Contingent Liabilities
As discussed in the annual MD&A for the year ended March 31, 2005, based
on management's best estimates, neither the Company nor RBH has accrued for
potential losses regarding the various legal actions, proceedings and claims
to which they are subject. If successful, these claims, either individually or
in aggregate, could involve significant damages which could exceed the
resources of the Company and RBH.
Risks and Uncertainties
Various legal actions, proceedings and claims arising out of the sale,
distribution, manufacture, development, advertising and marketing of tobacco
products are pending, have been threatened or may be instituted against the
Company and RBH. These actions, claims and proceedings, both pending and
threatened, are described in Note 13 to the audited annual consolidated
financial statements of the Company for the year ended March 31, 2005. Except
as described below, there have been no developments of a material nature
during the fiscal year to date concerning these matters.
In September 2005, the Supreme Court of Canada dismissed the
constitutional challenge of the Tobacco Damages and Health Care Costs Recovery
Act (British Columbia) ("BC Act") brought by RBH and other Canadian and
foreign tobacco product manufacturers. To date, no substantive court hearings
have been held regarding the merits of the Province's claim as the action had
been stayed pending the outcome of the constitutional challenge. The Supreme
Court decision lifted the stay of the Province's action. While the rules that
will be applicable to the B.C. action will, as a result of the Province's
legislation, be more favourable to the Province than those which would have
applied in the absence of the legislation, RBH believes that it continues to
have good defenses to the Province's claim and intends to bring before the
court, all evidence that supports its position. In the decision, the Supreme
Court left open novel and complex legal issues which all but ensure many years
of complex litigation.
In September 2005, two claims were filed in the Province of Quebec
against RBH, Imperial Tobacco Limited and JTI-Macdonald Corp. As previously
disclosed, the Quebec Superior Court had authorized these two claims to
proceed as class actions in February 2005. The first claim, filed on behalf of
a class of persons residing in Quebec who allegedly are or have been addicted
to the nicotine contained in cigarettes manufactured by the respondents, seeks
$17.8 billion in damages. The other claim, filed on behalf of a class of
persons residing in Quebec 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 in the group, seeks $5 billion in damages. RBH
intends to vigorously defend itself and denies the allegations contained in
the claims, which include allegations of failure to warn, addiction, nicotine
manipulation, advertising directed at young people, false advertising and
inadequate warnings.
In Nova Scotia, the Tobacco Damages and Health-care Costs Recovery Act
was passed into law. The legislation, which is modeled on the BC Act, 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. The Bill received royal assent on December 8, 2005. No actions have
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 BC Act, 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. The Bill received second reading on
December 9, 2005.
The outcome of any litigation is uncertain and, if successful, these
claims 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.
In December 2005, the Canadian International Trade Tribunal (CITT) issued
a notice that it was commencing a global safeguard inquiry into the
importation into Canada of unmanufactured Virginia flue-cured leaf tobacco for
use in the manufacture of tobacco products. The inquiry, which stems from a
complaint brought by the Ontario Tobacco Growers, is to determine whether the
increased importation of such tobacco is of serious injury or threat to
domestic tobacco leaf growers. The hearing is scheduled to begin on May 1,
2006. RBH has filed notice of its intention to participate as a party. Should
the CITT make a determination of serious injury or threat thereof, the
Government of Canada may apply import safeguard measures, which would impact
the costs incurred by RBH for imported tobacco leaf. In fiscal 2005, RBH
purchased approximately 13% of its total tobacco leaf requirements from
foreign tobacco producers.
Additional information concerning legal matters affecting the Company and
RBH are contained in the Company's filings with securities regulatory
authorities including the Company's 2005 Annual Report and 2005 Annual
Information Form (in particular under "Legal Proceedings") which can be
accessed at www.sedar.com or on the Company's website at www.rothmansinc.ca.
Outlook
The following contains forward-looking statements about the Company's
outlook. Reference should be made to "Forward Looking Statements" set out at
the beginning of this MD&A.
Looking ahead, Rothmans expects that a number of factors will affect its
financial performance including:
- the success of efforts by RBH and the industry to defend themselves
against product liability and other claims, and to operate within the
regulatory environment;
- the lower rate of growth of 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;
- increased levels of counterfeit and other contraband product that may
occur due to the onerous tax environment;
- continued declines in the consumption of tobacco products;
- the continued volatility in the cigarette market as a result of a
number of factors including changes in brands and pricing in the
Canadian cigarette price category, varying wholesaler purchasing
patterns and seasonal trends in smoking consumption;
- the effectiveness of RBH's efforts to retain cigarette market share in
the declining premium cigarette category;
- RBH's ability to maintain its leading position in the fine cut
segment;
- RBH's ability to continue to implement price increases for its
products;
- 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.
It is believed that the increasing presence of contraband is a key factor
in the increased decline rate in the total reported industry sales volumes
which continues to exceed historical levels. 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 in the future which would have a negative impact on RBH's
sales volumes.
Continued launches into the cigarette price category and price
competition by each of the three major manufacturers have led to significant
growth of that category over the past two fiscal years, and there continues to
be a significant degree of variability in the underlying business trends,
making it difficult to accurately estimate the impact on consumer purchasing
patterns.
RBH's domestic price cigarette category volumes grew by 7.4% and 20.3% in
the quarter and nine months ended December 31, 2005 compared with the same
periods in the prior fiscal year. Price category cigarettes are estimated to
have represented 45.9% and 43.9% in the quarter and nine months ended
December 31, 2005 of total reported industry domestic cigarette sales volumes
compared with 40.4% and 37.1% in the quarter and nine months ended
December 2004. In the recent quarter, RBH's rate of price cigarette category
volume growth was not sufficient to offset declines in premium and fine cut
volumes. 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.
On October 1, 2005, federal regulations came into effect requiring that
all cigarettes manufactured or imported into Canada comply with standards
designed for reduced ignition propensity. RBH has contracted for the supply of
cigarette paper designed to meet the standard and now expects that this new
paper, together with testing, will increase costs by approximately $4 million
in the current fiscal year ending March 31, 2006. On an annualized basis,
costs are estimated to increase by $7 million per year. These more current
estimates of cost increases are less than those estimated in the annual MD&A.
It is also anticipated that seasonal fluctuations in smoker consumption
patterns may become more pronounced as indoor and workplace smoking bans and
restrictions become more widespread, leading to seasonal variations in
wholesale purchases.
Rothmans has a strong balance sheet with more than sufficient cash flow
and resources to service its long-term debt and meet its capital expenditure
requirements. The Company has demonstrated its commitment to increasing
shareholder returns, and is committed to exploring other potential investment
opportunities, in conjunction with RBH's continuing attention to its core
brand strategy.
Interim Consolidated Statements of Earnings and Retained Earnings
Three months ended Nine months ended
(In thousands of dollars, December 31 December 31
except per share amounts) 2005 2004 2005 2004
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EARNINGS
Revenues:
Sales, net of excise duty
and taxes $ 157,410 $ 164,110 $ 508,160 $ 492,584
Investment income 767 1,181 2,542 2,977
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Total revenues 158,177 165,291 510,702 495,561
Costs:
Operating costs excluding
amortization 89,516 90,190 268,632 271,048
-------------------------------------------
Earnings before interest,
taxes, amortization and
minority interest 68,661 75,101 242,070 224,513
Amortization 2,234 2,598 7,043 6,920
Interest expense (income)
- Long-term debt 2,094 1,983 6,269 5,874
- Other (342) (488) (1,063) (1,240)
-------------------------------------------
Earnings before income taxes
and minority interest 64,675 71,008 229,821 212,959
Income taxes
- Current 25,348 28,149 89,798 84,631
- Future 336 485 1,450 1,617
-------------------------------------------
Total income taxes 25,684 28,634 91,248 86,248
-------------------------------------------
Earnings before minority
interest 38,991 42,374 138,573 126,711
Minority interest 15,665 16,931 55,489 51,019
-------------------------------------------
Earnings for the period $ 23,326 $ 25,443 $ 83,084 $ 75,692
-------------------------------------------
-------------------------------------------
Earnings per common share
(note 2)
- Basic $ 0.34 $ 0.38 $ 1.23 $ 1.12
-------------------------------------------
-------------------------------------------
- Diluted $ 0.34 $ 0.37 $ 1.22 $ 1.12
-------------------------------------------
-------------------------------------------
RETAINED EARNINGS
Balance at beginning of
period $ 69,518 $ 146,143 $ 151,734 $ 129,628
Earnings for the period 23,326 25,443 83,084 75,692
-------------------------------------------
92,844 171,586 234,818 205,320
Dividends paid:
Common Shares - (20,354) (16,886) (162,328) (50,620)
(Q3 2005 - $0.30 per share)
(Q3 2004 - $0.25 per share)
-------------------------------------------
Balance at end of period $ 72,490 $ 154,700 $ 72,490 $ 154,700
-------------------------------------------
-------------------------------------------
Rothmans Inc. and subsidiary companies (unaudited)
Interim Consolidated Balance Sheets
As at As at
December 31 March 31
(In thousands of dollars) 2005 2005
-------------------------------------------------------------------------
ASSETS
Current Assets
Cash and cash equivalents $ 100,888 $ 23,255
Short-term investments 81,867 168,740
Accounts receivable 33,940 32,119
Inventories 190,781 209,819
Prepaid expenses 1,726 1,322
-------------------------
Total current assets 409,202 435,255
Property, plant and equipment 75,225 69,149
Future income taxes 7,381 8,831
Prepaid pension benefit cost 14,113 12,003
Other assets 2,950 3,290
-------------------------
$ 508,871 $ 528,528
-------------------------
-------------------------
LIABILITIES
Current Liabilities
Accounts payable and accrued liabilities $ 43,466 $ 47,445
Excise and other taxes payable 126,993 79,578
Income taxes payable 26,086 21,475
-------------------------
Total current liabilities 196,545 148,498
Other long-term liabilities 2,711 2,167
Other employee future benefits 33,958 33,497
Long-term debt 149,740 149,708
Minority interest in subsidiary company 8,125 950
-------------------------
391,079 334,820
-------------------------
SHAREHOLDERS' EQUITY
Capital stock (note 3) 45,302 41,974
Retained earnings 72,490 151,734
-------------------------
Total shareholders' equity 117,792 193,708
-------------------------
$ 508,871 $ 528,528
-------------------------
-------------------------
Rothmans Inc. and subsidiary companies (unaudited)
Interim Consolidated Statements of Cash Flows
Three months ended Nine months ended
December 31 December 31
(In thousands of dollars) 2005 2004 2005 2004
-------------------------------------------------------------------------
Cash provided by (used in):
OPERATING ACTIVITIES
Earnings for the period $ 23,326 $ 25,443 $ 83,084 $ 75,692
Adjusted for non-cash items:
Amortization 2,234 2,598 7,043 6,920
Minority interest 15,665 16,931 55,489 51,019
Future income taxes 336 485 1,450 1,617
Loss on sale of property,
plant & equipment 418 0 763 11
Defined & other employee future
benefits expense (note 5) 511 2,118 4,213 5,634
Defined & other employee future
benefits funding (506) (314) (5,862) (4,273)
Share option compensation cost - - - 1,030
-------------------------------------------
41,984 47,261 146,180 137,650
Changes in non-cash operating
working capital 64,362 (18,547) 57,196 2,321
-------------------------------------------
106,346 28,714 203,376 139,971
-------------------------------------------
INVESTING ACTIVITIES
Proceeds on sale of property,
plant & equipment - - 1 3
Additions to property, plant
& equipment (4,963) (7,106) (13,679) (14,160)
Sale (purchase) of short-term
investments (81,867) (168,740) 86,873 (30,811)
-------------------------------------------
(86,830) (175,846) 73,195 (44,968)
-------------------------------------------
FINANCING ACTIVITIES
Dividends paid -
By the Company (20,354) (16,886) (162,328) (50,620)
By a subsidiary company to
minority shareholder (20,087) (14,960) (40,482) (50,275)
Proceeds on bond issue - 97,000 - 97,000
Repayment of long-term debt - (97,000) - (97,000)
Deferred financing charges - (1,152) - (1,152)
Proceeds on issuance of common
shares 85 - 3,328 1,823
Proceeds on other long-term
liabilities 405 315 544 223
-------------------------------------------
(39,951) (32,683) (198,938) (100,001)
-------------------------------------------
Increase (decrease) in cash
and cash equivalents (20,435) (179,815) 77,633 (4,998)
Cash and cash equivalents at
beginning of period 121,323 221,795 23,255 46,978
-------------------------------------------
Cash and cash equivalents at
end of period $ 100,888 $ 41,980 $ 100,888 $ 41,980
-------------------------------------------
-------------------------------------------
SUPPLEMENTARY DISCLOSURES
Income taxes paid $ 22,393 $ 22,908 $ 84,700 $ 92,348
Interest paid
- Long-term debt 4,164 1,566 8,328 5,480
- Other 168 78 243 150
Rothmans Inc. and subsidiary companies (unaudited)
Notes to the Interim Consolidated Financial Statements (unaudited)
1. Summary of Significant Accounting Policies
The interim consolidated financial statements of Rothmans Inc. (the
"Company") have been prepared in accordance with Canadian generally
accepted accounting principles. These interim consolidated financial
statements do not contain all of the note disclosures found in the
Company's annual consolidated financial statements for the year ended
March 31, 2005. Therefore, these interim consolidated financial
statements and notes should be read in conjunction with those
statements. These interim consolidated financial statements follow
the same accounting policies as the Company's audited annual
consolidated financial statements.
2. Earnings per Share
Earnings per common share is calculated based on the weighted average
number of common shares outstanding, the dilution being due to issued
common share options.
Basic Diluted
---------------------------------------------------------------------
Nine months ended:
December 31, 2005 67,710,190 68,384,368
December 31, 2004 67,471,186 67,809,879
Three months ended:
December 31, 2005 67,846,032 68,440,721
December 31, 2004 67,544,008 67,924,162
---------------------------------------------------------------------
3. Capital Stock
Authorized: An unlimited number of common shares
Issued: 67,849,608 (March 31, 2005 - 67,572,008) common shares
December 31 March 31
(in thousands of dollars) 2005 2005
---------------------------------------------------------------------
Balance at beginning of period, April 1 $ 41,974 $ 38,869
Issuance of shares 3,328 2,075
Contributed surplus (note 4) - 1,030
---------------------------------------------------------------------
Balance at end of period $ 45,302 $ 41,974
---------------------------------------------------------------------
---------------------------------------------------------------------
4. Stock Based Compensation Plan
The details of the Company's share option plan are as follows:
Share Option Plan
The annual grant of options was discontinued effective fiscal year
2006. In fiscal year 2005, the Company recognized $1.0 million of
stock-based compensation costs for options granted after March 31,
2005 based on the fair value method. The fair value of each option
grant was estimated on the date of grant using the Binomial option
pricing model with the following assumptions:
December 31 December 31
2005 2004
---------------------------------------------------------------------
Risk-free interest rate (%)(x) N/A 4.25
Expected dividend yield N/A 5.20
Option term (years) N/A 6
Expected volatility (%) N/A 22.0
---------------------------------------------------------------------
(x) The Risk-free interest rate is the yield for a 6-year Government
of Canada bond on the date of grant.
A summary of the status of the Company's employee stock option
plan as at the periods ended December 31, 2005 and December 31, 2004
and changes during the periods ending on those dates are presented
below:
---------------------------------------------------------------------
Three months ended December 31
---------------------------------------------------------------------
2005 2004(x)
---------------------------------------------------------------------
Weighted Weighted
average average
exercise exercise
Options Shares price ($) Shares price ($)
---------------------------------------------------------------------
Outstanding at beginning
of period 1,503,800 $14.299 1,802,400 $14.281
Granted - - - -
Exercised 7,000 $16.125 - -
---------------------------------------------------------------------
Outstanding at end of
period 1,496,800 $14.290 1,802,400 $14.281
---------------------------------------------------------------------
---------------------------------------------------------------------
Options exercisable at
period end 1,496,800 $14.290 1,510,134 $13.829
---------------------------------------------------------------------
---------------------------------------------------------------------
Weighted average fair
value of options granted
during the period N/A N/A
---------------------------------------------------------------------
---------------------------------------------------------------------
---------------------------------------------------------------------
Nine months ended December 31
---------------------------------------------------------------------
2005 2004(x)
---------------------------------------------------------------------
Weighted Weighted
average average
exercise exercise
Options Shares price ($) Shares price ($)
---------------------------------------------------------------------
Outstanding at beginning
of period 1,774,400 $14.325 1,556,800 $13.281
Granted - - 438,400 16.620
Exercised 277,600 $14.512 192,800 11.521
---------------------------------------------------------------------
Outstanding at end of
period 1,496,800 $14.290 1,802,400 $14.281
---------------------------------------------------------------------
---------------------------------------------------------------------
Options exercisable at
period end 1,496,800 $14.290 1,510,134 $13.829
---------------------------------------------------------------------
---------------------------------------------------------------------
Weighted average fair
value of options granted
during the period N/A 4.70
---------------------------------------------------------------------
---------------------------------------------------------------------
(x) Adjusted for the two-for-one stock split effective March 4, 2005
Given the limited number of common shares available for issuance
under the Option Plan, the annual grant of options was discontinued
effective fiscal 2006. No options were forfeited during the period.
The following table summarizes information about stock options
outstanding as at December 31, 2005:
Weighted average
Range of Number remaining Number
exercise price outstanding contractual life exercisable
---------------------------------------------------------------------
$8.825(1) 18,000 5.3 18,000
$11.500(1) 160,000 6.1 160,000
$12.320(2) 398,200 8.1 398,200
$14.080(1) 261,400 6.5 261,400
$16.125(1) 306,000 7.1 306,000
$16.620(2) 353,200 9.1 353,200
---------------------------------------------------------------------
1,496,800 1,496,800
---------------------------------------------------------------------
(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.)
5. Employee Future Benefit Expenses
The Company's defined benefit pension plan and other benefits
expenses are as follows:
Three months ended Nine months ended
December 31 December 31
(in thousands of dollars) 2005 2004 2005 2004
---------------------------------------------------------------------
Defined benefit plan expenses
Pension benefit plans 816 705 2,136 1,803
Other benefits (305) 1,413 2,077 3,831
---------------------------------------------------------------------
511 2,118 4,213 5,634
---------------------------------------------------------------------
---------------------------------------------------------------------
The Company's defined contribution pension plan expenses in the
quarter and year to date for fiscal year 2006 were $771 (2004 - $749)
and $2,418 (2004 - $2,439) respectively.
6. Seasonality
Over the past two fiscal years, the period between April and
September has demonstrated stronger industry shipments than the
period between October and March. This seasonality is likely due to
smoking restrictions that are causing consumption variations between
the summer and winter seasons.
7. Litigation, Claims and Contingencies
Various legal actions, proceedings and claims arising out of the
sale, distribution, manufacture, development, advertising and
marketing of tobacco products are pending, have been threatened or
may be instituted against the Company and RBH. These actions, claims
and proceedings, both pending and threatened, are described in
Note 13 to the audited annual consolidated financial statements of
the Company for the year ended March 31, 2005. Except as described
below, there have been no developments of a material nature during
the fiscal year to date concerning these matters.
In September 2005, the Supreme Court of Canada dismissed the
constitutional challenge of the Tobacco Damages and Health Care Costs
Recovery Act (British Columbia) ("BC Act") brought by RBH and other
Canadian and foreign tobacco product manufacturers. To date, no
substantive court hearings have been held regarding the merits of the
Province's claim as the action had been stayed pending the outcome of
the constitutional challenge. The Supreme Court decision lifted the
stay of the Province's action. While the rules that will be
applicable to the B.C. action will, as a result of the Province's
legislation, be more favourable to the Province than those which
would have, applied in the absence of the legislation, RBH believes
that it continues to have good defenses to the Province's claim and
intends to bring before the court all evidence that supports its
position. In the decision, the Supreme Court left open novel and
complex legal issues which all but ensure many years of complex
litigation.
In September 2005, two claims were filed in the Province of Quebec
against RBH, Imperial Tobacco Limited and JTI-Macdonald Corp. As
previously disclosed, the Quebec Superior Court had authorized these
two claims to proceed as class actions in February 2005. The first
claim, filed on behalf of a class of persons residing in Quebec who
allegedly are or have been addicted to the nicotine contained in
cigarettes manufactured by the respondents, seeks $17.8 billion in
damages. The other claim, filed on behalf of a class of persons
residing in Quebec 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 in the group, seeks $5 billion
in damages. RBH intends to vigorously defend itself and denies the
allegations contained in the claims, which include allegations of
failure to warn, addiction, nicotine manipulation, advertising
directed at young people, false advertising and inadequate warnings.
In Nova Scotia, the Tobacco Damages and Health-care Costs Recovery
Act was passed into law. The legislation, which is modeled on the
BC Act, 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. The Bill
received royal assent on December 8, 2005. No actions have 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 BC Act, 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. The Bill received second reading on December 9, 2005.
The outcome of any litigation is uncertain and, if successful, these
claims 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.
Additional information concerning legal matters affecting the
Company and RBH are contained in the Company's filings with
securities regulatory authorities including the Company's 2005
Annual Report and 2005 Annual Information Form (in particular under
"Legal Proceedings") which can be accessed at www.sedar.com or on the
Company's website at www.rothmansinc.ca.
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