<<
2nd Quarter Report
Six Months Ended
September 30, 2006
>>
Trading: TSX: ROC
TORONTO, Oct. 27 /CNW/ - Rothmans Inc. today announced its results for
the second quarter of fiscal 2007, which ended September 30, 2006.
Rothmans' earnings for the second quarter of fiscal 2007 were
$C28.3 million, or $0.42 basic earnings per share, compared with $30.1 million
or $0.44 basic earnings per share in the second quarter of fiscal 2006. For
the first six months of this fiscal year, Rothmans' earnings were $57.6
million or $0.85 per share, compared with $59.8 million or $0.88 per share in
the first half of the prior year.
Sales at 60%-owned subsidiary Rothmans, Benson & Hedges Inc., net of
excise duty and taxes, increased to $165.2(1) million in the most recent
quarter compared with $164.9(1) million in the second quarter of fiscal 2006.
Sales for the first six months of this fiscal year were $328.1(1) million
versus $329.5(1) million for the same period a year earlier.
During the three months ended September 30, 2006, total reported industry
domestic sales volumes for all tobacco products decreased 10.0% from a year
earlier. It is believed that the presence of contraband product contributed to
this decline, which continues to exceed the historical average rate
experienced by the industry. Total reported industry domestic sales volumes of
8.7 billion equivalent sticks in the most recent quarter were 2.1% lower than
in the prior quarter, but 14.9% higher than in the quarter ended March 31,
2006, reflecting normal industry seasonality.
RBH's EBITDA margin for the second quarter was 50.6%(1) compared with
52.6%(1) in the prior quarter and 53.1%(1) in the quarter ended September 30,
2005. Lower EBITDA margin was primarily due to the effect of lower shipment
volumes, higher product input, manufacturing, sales and marketing and general
administrative costs and volume shifts from mid-tier to the lower-priced tier
of the cigarette price category partially offset by price increases across all
product categories.
<<
-------------------------------------------------------------------------
(1) The above financial results reflect the adoption of EIC156
"Accounting By A Vendor For Consideration Given To A Customer" and
results for prior periods have been restated accordingly. For more
information see "New Accounting Pronouncement" in the accompanying
MD&A.
>>
RBH's share of the total domestic composite market was 32.6% for the
quarter ended September 30, 2006 compared with 31.5% and 31.1% for the three
months ended June 30, 2006 and September 30, 2005, respectively. Premium
cigarette share was 16.2%, up from 15.5% and 15.6% in the prior quarter and
year-earlier quarter. RBH's share of the domestic price cigarette category of
45.8% compared with 43.7% in the previous quarter and 44.1% in the quarter
ended September 30, 2005. In the fine cut market, RBH's share was 58.6%, up
from 58.2% in the prior quarter but lower than the 59.2% share in the
year-earlier quarter. RBH's share of the total domestic price category was
47.8%, compared with 46.1% in the prior quarter and 47.0% in the quarter ended
September 30, 2005.
"The success of RBH in building its share of the legitimate market in the
second quarter is unfortunately overshadowed by the continuing growth of
contraband product," said John Barnett, President and Chief Executive Officer
of Rothmans Inc. and RBH. "Illegal and untaxed products entering the market
are clearly having a negative effect on the Canadian tobacco industry,"
commented Mr. Barnett.
Dividend declared
The Board of Directors of Rothmans Inc. declared a quarterly dividend of
$0.30 per share payable on December 17, 2006 to shareholders of record at the
close of business on December 1, 2006.
Analyst Conference Call and Webcast
Rothmans Inc. management will hold a conference call with analysts to
discuss the second quarter results at 8:30 a.m. Toronto time on Friday,
October 27, 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 November 3rd by calling 1-800-408-3053 and entering
reservation number 3201396. The recording can also be accessed through the
investor website.
Media are invited to listen to the call and to contact Karen Bodirsky at
(416) 442-3660 for further information.
About Rothmans Inc.
Rothmans Inc. is a widely held, publicly traded Canadian company that
participates in the Canadian tobacco industry through 60%-owned Rothmans,
Benson & Hedges Inc., Canada's second largest tobacco company. RBH currently
employs 761 people at its head office in Toronto, its sales offices across
Canada and its manufacturing facilities in Brampton, Ontario and QuDebec City,
QuDebec where it has been operating for over 100 years. Rothmans is Canada's
only publicly traded company with interests exclusively in the tobacco
industry and is listed on the Toronto Stock Exchange under the symbol ROC.
Management's Discussion and Analysis
for the six months ended September 30, 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 quarter and
six months ended September 30, 2006 compared with the prior year. It also
discusses factors that could affect future performance. This MD&A should be
read in conjunction with the attached unaudited consolidated financial
statements for the period ended September 30, 2006, the annual MD&A contained
in the 2006 Annual Report and the audited annual consolidated financial
statements of the Company for the year ended March 31, 2006. The results
reported herein have been prepared in accordance with Canadian Generally
Accepted Accounting Principles (GAAP) and are presented in Canadian dollars.
This MD&A is current as of October 26, 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 unaudited consolidated financial statements.
Forward Looking Statements
Certain statements contained in this MD&A and other sections of this
release (in particular the sections entitled "Outlook" and "Industry
Overview") 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 October 26, 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; increases in the levels of contraband product in the market; increased
competition and competitor initiatives; price category pressure on overall
cigarette margins and changes in market share for RBH's products; declining
consumer consumption and dependence on price increases; fluctuating wholesaler
and consumer purchasing patterns; changes in government taxation policy;
changes in legislation and regulation; new product standards; and dependence
on the domestic tobacco market.
The Company disclaims any obligation or intention to update or revise any
forward-looking statement, whether the result of new information, future
events or otherwise. Additional information concerning risks and uncertainties
affecting RBH's business and the Company and other factors that could cause
financial results to fluctuate is set forth below under "Risks and
Uncertainties" and "Outlook" and is contained in the Company's filings with
Canadian securities regulatory authorities, including the Company's Annual
Information Form (in particular under "Legal Proceedings" and "Risk Factors")
available on SEDAR at www.sedar.com or on the Company's website at
www.rothmansinc.ca
Terminology used in this MD&A
Throughout this MD&A, "GAAP" refers to Canadian Generally Accepted
Accounting Principles, "Rothmans" and "the Company" refer to Rothmans Inc.,
"RBH" refers to Rothmans, Benson & Hedges Inc., which is 60%-owned by Rothmans
Inc., and "EBITDA margin", a key measure of the RBH's operating performance,
refers to "earnings before interest, taxes, depreciation and amortization" as
a percentage of "sales, net of 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 September 30, 2006, and "prior
quarter" refers to the three months ended June 30, 2006. "Fiscal 2007" or
"recent fiscal year" refers to the fiscal year ending March 31, 2007 and other
similar references to a fiscal year (e.g., fiscal 2006) refer to the fiscal
year then ended on March 31 (e.g., March 31, 2006).
"The three major manufacturers" or "three majors" refers to RBH, Imperial
Tobacco Canada Limited (ITL) and JTI-MacDonald Corp. (JTI). "BAT" refers to
British American Tobacco p.l.c., the parent company of ITL. "Premium
cigarettes" refers to tailor-made cigarettes sold at premium retail prices,
"cigarette price category" refers to cigarettes sold at less-than-premium
prices and "price category" refers to the combination of the cigarette price
category and the fine cut category (loose tobacco and pre-proportioned tobacco
sticks). "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. "Domestic composite market" refers to all fully tax-paid
cigarettes and fine cut tobacco products sold into the Canadian market.
"Direct-to-Store Distribution" or "DSD" refers to a distribution model where a
tobacco manufacturer ships directly to retail accounts instead of through a
wholesale network.
New Accounting Pronouncements
In September 2005, the Emerging Issues Committee of the Canadian
Institute of Chartered Accountants issued Abstract 156 "Accounting By A Vendor
For Consideration Given To A Customer (Including a Reseller of the Vendor's
Products)" ("EIC 156"). This abstract applies to fiscal years beginning on or
after January 1, 2006. The abstract addresses the issue of whether
consideration provided by a vendor to a customer is an adjustment to the
selling prices of the vendor's products and therefore a reduction of revenue
or is a cost incurred by the vendor and therefore classified as cost or
expense. The implementation of this pronouncement has resulted in a
Consolidated Statement of Earnings reclassification which reduces operating
costs excluding amortization and sales, net of excise duty and taxes, by
$10.9 million and $21.6 million in the quarter and six months ended
September 30, 2006. For comparative purposes, the reclassification reducing
operating costs excluding amortization and sales, net of excise duty and taxes
was $11.4 million, $9.9 million, $12.4 million and $11.4 million in the first
through fourth quarters of fiscal 2006 respectively. This reclassification
impacts EBITDA margin but has no impact on the earnings or cash flows of
either period. Comparative prior period amounts have been reclassified to
reflect the adoption of this pronouncement. Additional information regarding
this change can be found in Note 2 "Change in Accounting Policy" in the
September 30, 2006 Notes to the Interim Consolidated Financial Statements
which accompany this MD&A.
Industry Overview
Total reported industry domestic sales volumes for all tobacco products
decreased 10.0% and 9.4% in the quarter and six months ended September 30,
2006 versus the comparable periods in the prior fiscal year. The continuing
growth of contraband product, along with historical declines in consumer
incidence and consumption, are believed to have contributed to this decline
which continues to exceed the historical average rate experienced by the
industry. Recent quarter total reported industry domestic sales volumes of
8.7 million equivalent sticks were 2.1% lower than in the prior quarter, but
14.9% higher than the quarter ended March 31, 2006, reflecting normal industry
seasonality.
A number of other factors have been affecting overall industry shipments
including:
<<
- Taxes - High taxes reflected in the selling price to the consumer
contribute to probable increases in the presence of contraband product
in the domestic market.
- Seasonal trends in consumer purchasing patterns - Over the past two
fiscal years, the period between April and September has demonstrated
stronger industry shipments than the period between October and March.
RBH management believes that smoking restrictions are causing consumer
consumption variations between the summer and winter seasons.
- Fluctuations in wholesaler and retailer buying patterns as a result of
ITL's implementation of a DSD strategy - Late in the quarter, ITL
began their implementation of a Direct-to-Store distribution model
which resulted in fluctuating buying patterns by both wholesalers and
retailers. Buying patterns by wholesalers and retailers are expected
to be erratic through the quarter ending December 31, 2006 as ITL's
new distribution model evolves. The effect of this change on the
Canadian tobacco industry and RBH's competitive positioning can not be
presently determined.
- Fluctuations in wholesaler buying patterns as a result of anticipated
tax and manufacturer price increases, manufacturer sales programs and
trade terms - Swings in wholesaler purchasing patterns motivated by
the timing of tax increases, price increases, manufacturer sales
programs, manufacturer trade terms and other factors are anticipated
to have a significant effect on quarter-to-quarter sales volumes.
- Continued declines in consumer consumption of tobacco products.
>>
The foregoing contains forward looking statements about the industry
outlook. Reference should be made to "Forward Looking Statements" set out at
the beginning of this MD&A.
Total reported domestic premium cigarette volumes declined by 14.8% and
15.2% in the recent quarter and six months ended September 30, 2006 compared
with the same period of the prior year. Total reported domestic price category
volumes declined 5.0% and 3.2% in the quarter and six months ended
September 30, 2006 compared with the same period of the prior year, due to
lower fine cut volumes.
RBH estimates that premium cigarettes represented 48.0% of the reported
Canadian domestic tobacco market in the recent quarter versus 47.8% in the
quarter ended June 30, 2006 and 50.8% in the quarter ended September 30, 2005.
The price category is estimated to have represented 52.0% of the reported
Canadian domestic tobacco market in the recent quarter, versus 52.2% in the
quarter ended June 30, 2006 and 49.2% in the quarter ended September 30, 2005.
Fine cut products are estimated to have represented 8.0% of the total reported
domestic tobacco market in the recent quarter versus 8.7% in the prior quarter
and 9.5% in the second quarter of last year. Price category cigarettes are
estimated to have represented 44.0% of the total reported domestic composite
tobacco market in the recent quarter versus 43.5% in the prior quarter and
39.7% in the second 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.
Effective July 1, 2006 the federal excise duty applicable to cigarettes,
tobacco sticks and fine cut products was raised by $0.56, $0.50 and $0.38
respectively on a per carton or equivalent stick basis, in order to offset the
effect of the 1% GST reduction.
Shown below is a comparative summary of domestic shipments of tobacco
products for the six months ended September 30, 2006 and September 30, 2005.
<<
Canadian Domestic Tobacco Shipments
(in billions of sticks and equivalents)
-------------------------------------------------------------------------
For the six months ended September 30
-------------------------------------------------------------------------
2006 2005
Three Reported Three Reported
RBH Majors Industry RBH Majors Industry
-------------------------------------------------------------------------
Premium cigarettes 1.3 8.4 8.4 1.5 10.0 10.0
Price category
Cigarettes 3.4 6.9 7.7 3.3 6.4 7.5
Fine cut 0.9 1.5 1.5 1.2 1.9 1.9
-------------------------------------------------
Total Price Category 4.3 8.4 9.2 4.5 8.3 9.4
-------------------------------------------------------------------------
Total 5.6 16.8 17.6 6.0 18.3 19.4
-------------------------------------------------------------------------
-------------------------------------------------------------------------
RBH Market Share
Premium cigarettes 15.8% 15.8% 15.6% 15.6%
Price category 51.4% 46.9% 53.9% 47.4%
Composite markets 33.5% 32.0% 33.0% 31.1%
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 six month period were: premium
cigarettes - 0.2 billion sticks in fiscal 2007 and in fiscal 2006;
price category cigarettes - 1.4 billion sticks in fiscal 2007 and
1.6 billion sticks in fiscal 2006.
>>
Results at Rothmans, Benson & Hedges Inc.
In the quarter ended September 30, 2006, RBH shipped a total of
2.8 billion equivalent sticks into the domestic market, a 5.6% decrease from
the comparable period of the prior year, with increases in price category
cigarette volumes only partially offsetting declines in premium and fine cut
volumes. For the six months ended September 30, 2006, RBH shipped a total of
5.6 billion equivalent sticks, a 6.7% decrease from the comparable period of
the prior year. RBH experienced a lower percentage volume decline in shipments
compared with the industry in both the quarter and six months ended
September 30, 2006. This relatively stronger performance is believed to be due
in part to the market disruption caused by ITL's implementation of its DSD
program which was announced in May and implemented late in the recent quarter.
RBH's share of the total domestic composite market was 32.6% for the quarter
ended September 30, 2006 compared with 31.5% and 31.1% for the three months
ended June 30, 2006 and September 30, 2005, respectively.
RBH's premium cigarette volumes declined 11.6% in the recent quarter and
13.8% in the fiscal year to date as compared to the same period in the prior
year. RBH's domestic market share of premium cigarettes was 16.2% in the
recent quarter compared with 15.5% and 15.6% in the prior quarter and the
three months ended September 30, 2005, respectively.
Sales of RBH's price category cigarettes totaled 1.8 billion in the
recent quarter and 3.4 billion for the year to date, which represented an
increase of 3.3% and 3.4% compared with the same periods in the prior year.
The recent quarter share of the domestic cigarette price category was 45.8%
versus 43.7% in the prior quarter, and 44.1% in the quarter ended
September 30, 2005. RBH continues to experience solid performance in the
cigarette price category. A number of factors continue to influence this
product category including the brands being offered to consumers, their
availability and price, and the availability and price of contraband product.
Shipments of RBH fine cut products declined 24.8% in the recent quarter
and 26.2% in the fiscal year to date compared with the same periods in the
prior fiscal year. This decline was a result of consumers switching to
cigarettes from both pre-portioned stick products and high-yield products.
RBH's share of the domestic fine cut market was 58.6% in the recent quarter,
up from 58.2% in the quarter ended June 30, 2006, but down from 59.2% in the
quarter ended September 30, 2005. Combining the cigarette price category with
the fine cut segment, RBH's share of the total price category was 47.8% in the
recent quarter, up from 46.1% and 47.0% in the quarters ended June 30, 2006
and September 30, 2005, respectively.
After reflecting the adoption of EIC156, RBH's recent quarter EBITDA
margin was 50.6% compared with 52.6% in the quarter ended June 30, 2006. For
comparative purposes the reflection of EIC156 has resulted in restated EBITDA
margins of 52.3%, 53.1%, 47.8% and 36.9% for quarters one through four of
fiscal 2006. The restated EBITDA margin for the fiscal year ended March 31,
2006 was 48.1%. The recent quarter ended September 30, 2006 EBITDA margin
performance compared with the same period of the prior year was predominantly
due to lower shipment volumes, higher product input, manufacturing, sales and
marketing and general and administrative costs and volume shifts from the
mid-tier to the lower priced tier of the cigarette price category partially
offset by the impact of price increases across all product categories.
Rothmans Inc. Financial Results
Basic earnings per share were $0.42 in the recent quarter and $0.85 for
the six months ended September 30, 2006 compared with $0.44 and $0.88 in the
comparable periods of the prior year. After reflecting the adoption of EIC156,
RBH's sales, net of excise duty and taxes, were $0.3 million higher for the
quarter ended September 30, 2006 and $1.4 million lower for the six months
ended September 30, 2006 compared with the same periods of the prior year.
Increased volumes of RBH price category cigarettes together with price
increases, more than compensated for volume declines in premium cigarettes and
fine cut products during the recent quarter, but only partially compensated
for these volume declines in the six months ended September 30, 2006.
Investment income increased to $1.2 million in the recent quarter from
$0.7 million in the comparable period of the prior year mainly due to the
higher average cash balance held during the quarter ended September 30, 2006.
After reflecting the adoption of EIC156, operating costs were
$4.7 million and $3.2 million higher in the recent quarter and six months
ended September 30, 2006 compared with the same periods of the prior year.
Higher product input, manufacturing, sales and marketing, and general and
administrative costs during the recent quarter were only partially offset by
the impact of lower volumes sold in both the quarter and six months ended
September 30, 2006.
Income tax expense was $32.8 million in the recent quarter and
$65.7 million in the fiscal year to date, resulting in effective tax rates of
41.0% and 40.7% respectively. This compares with effective tax rates of 39.7%
in both of the comparable periods of the prior fiscal year. The increase in
the effective tax rate represents an additional expense of $1.1 million and
$1.6 million in the recent quarter and six months ended September 30, 2006.
Based on a recent evaluation, the Company now expects its effective tax rate
for fiscal 2007 to be 40.7%.
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
$51.3 million in the recent quarter and $100.7 million in the six months ended
September 30, 2006 compared with $54.7 million and $104.4 million in the same
periods of the prior fiscal year. RBH's ability to generate cash from
operations is generally sufficient to fund the day-to-day financing needs of
RBH's business. It is anticipated that additional funds, should they be
required, would be obtained through short-term bank borrowings.
During the recent quarter, the Company paid dividends of $20.4 million,
representing a dividend of $0.30 per share.
Cash Resources
Cash and short-term investments of $182.6 million at September 30, 2006
represented the consolidated cash resources of the Company versus
$130.2 million at March 31, 2006. The increase in cash and short-term
investments is predominantly due to earnings from RBH's operations and normal
quarterly fluctuations in RBH's working capital requirements. On a
non-consolidated basis, Rothmans held cash and cash equivalents of $121.3
million at September 30, 2006, an increase from $85.0 million at March 31,
2006. This increase resulted from dividends paid by RBH partially offset by
the payment of dividends by the Company.
Critical Accounting Estimates
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts reported
in the consolidated financial statements and accompanying notes. Although
these estimates are based on management's best knowledge of current events and
actions that the Company and RBH may undertake in the future, actual results
could differ from these estimates. 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, and the expected
return on plan assets remain as described in the annual MD&A for the year
ended March 31, 2006.
Litigation Contingent Liabilities
As discussed in the annual MD&A for the year ended March 31, 2006, the
Company and RBH have been the subjects of various legal actions, proceedings
and claims. Based on the stage of those proceedings, management is unable to
meaningfully estimate the liability, if any, that might result from those
claims and neither the Company nor RBH has accrued for potential liabilities.
However, the outcome of any litigation is uncertain. If successful, these
claims, either individually or in the aggregate, could involve significant
damages which would have a significant adverse effect on the financial
condition of the Company, and the Company and RBH may not have the resources
to satisfy such claims.
Risks and Uncertainties
Various legal actions, proceedings and claims arising out of the sale,
distribution, manufacture, development, advertising and marketing of tobacco
products are pending, have been threatened or may be instituted against the
Company and RBH. These actions, claims and proceedings, both pending and
threatened, are described in Note 12 to the audited annual consolidated
financial statements of the Company for the year ended March 31, 2006. Other
than as described below, there have been no developments of a material nature
during the fiscal year to date concerning these matters.
On June 13, 2006, Manitoba passed the Tobacco Damages and Health Care
Costs Recovery Act. The legislation, which is modeled on the British Columbia
legislation, purports to allow the provincial government to bring an action
against tobacco product manufacturers for the recovery of health care costs
that allegedly have been or will be incurred by the Province in respect of
alleged tobacco related diseases. No action has been commenced under this
legislation.
On June 22, 2006, the Tobacco Damages and Health Care Costs Recovery Act
in New Brunswick received royal assent. The legislation is similar to that of
British Columbia. No action has been commenced under this legislation.
In September 2006, the British Columbia Court of Appeal ruled that the
Company and certain international tobacco companies who are named as
defendants in the lawsuit initiated by the Province of British Columbia to
recover health care costs should remain in the lawsuit. These defendants,
including the Company, had argued that the Province did not have jurisdiction
over them as they do not do business in British Columbia. The companies are
considering whether or not to seek leave to appeal the decision to the Supreme
Court of Canada.
In late September 2006 RBH received a complaint from ITL and one of its
affiliates alleging RBH's ROOFTOP product packaging infringed their rights in
respect of the MARLBORO trade-mark registration in Canada. RBH and Philip
Morris Products S.A. ("PMPSA"), the owner of the ROOFTOP design in Canada,
have commenced an action in the Federal Court seeking a declaration that the
use of the ROOFTOP design in association with RBH's cigarette products does
not infringe upon any rights which ITL or its affiliate may have in respect of
the MARLBORO trade-mark registration in Canada. In their statement of defence,
ITL and its affiliate have counterclaimed against RBH and PMPSA seeking, among
other things, a declaration that the ROOFTOP packaging infringes their
trade-mark rights, a permanent injunction restraining the sale and
distribution of cigarettes in association with the ROOFTOP packaging in Canada
as well as unspecified damages or an accounting of profits, at their election.
RBH and PMPSA deny the allegations contained in ITL's claim, and intend to
defend themselves vigorously.
Additional information concerning legal matters affecting the Company and
RBH are contained in the Company's filings with securities regulatory
authorities including the Company's 2006 Annual Report and 2006 Annual
Information Form (in particular under "Legal Proceedings") which can be
accessed at www.sedar.com or on the Company's website at www.rothmansinc.ca.
During the third quarter of fiscal 2006, ITL announced the move of its
Canadian production facilities to Mexico resulting in the planned closure of
its Canadian production facilities. This move appears consistent with BAT's
stated strategy of rationalizing its worldwide production facilities to
improve efficiencies. Late during the recent quarter, ITL began the
implementation of its DSD strategy. It is currently too early to determine the
competitive impact of these initiatives.
Outlook
The following contains forward-looking statements about the Company's
outlook. Reference should be made to "Forward Looking Statements" set out at
the beginning of this MD&A.
Looking ahead, Rothmans expects that a number of factors could affect its
financial performance including:
<<
- the success of efforts by RBH and the industry to defend themselves
against government, product liability and other claims, and to operate
within the regulatory environment;
- continued high levels of contraband product in the market due to the
onerous tax environment;
- a lower rate of growth in the cigarette price category and RBH's
ability to successfully compete in that segment;
- the impact of continued high levels of taxation on consumer purchasing
patterns;
- continued declines in the consumption of tobacco products;
- RBH's ability to continue to implement price increases for its
products;
- the impact of RBH's efforts to stabilize its cigarette market share in
the declining premium cigarette category;
- the continued volatility in the cigarette market as a result of the
evolution of the Canadian cigarette price category, varying wholesaler
purchasing patterns and seasonal fluctuations in smoker consumption;
- RBH's ability to maintain its leading position in the fine cut
segment;
- government tax policy regarding the differentiation in tax rates
applicable to fine cut products in comparison to tailor-made
cigarettes; and
- RBH's continued success at maintaining or reducing costs, especially
in view of the potential for regulated changes to product
specifications.
>>
It is believed that the presence of contraband is a key factor in the
increased decline rate in the total reported industry sales volumes which
continues to exceed historical levels. Continued availability of contraband
product in the domestic market as a result of high tobacco tax rates across
the country may increase the decline rate in reported industry volumes further
in the future resulting in a negative impact on RBH's sales volumes.
Continued launches into the cigarette price category and price
competition by each of the three major manufacturers have led to significant
growth of that category over the past three fiscal years, and there continues
to be a significant degree of variability in the underlying business trends,
making it difficult to accurately estimate the impact on consumer purchasing
patterns.
<<
Interim Consolidated Statements of Earnings and Retained Earnings
Three months ended Six months ended
(In thousands of dollars, September 30 September 30
except per share amounts) 2006 2005(x) 2006 2005(x)
-------------------------------------------------------------------------
EARNINGS
Revenues:
Sales, net of excise duty and
taxes (note 2) 165,237 164,903 328,123 329,518
Investment income 1,201 651 2,161 1,775
------------------------------------------
Total revenues 166,438 165,554 330,284 331,293
Costs:
Operating costs excluding
amortization (note 2) 82,643 77,959 160,764 157,530
------------------------------------------
Earnings before interest,
taxes, amortization and
minority interest (note 2) 83,795 87,595 169,520 173,763
Amortization 2,967 2,646 5,832 5,163
Interest expense (income)
- Long-term debt 2,095 2,093 4,175 4,175
- Other (1,149) (384) (2,139) (721)
------------------------------------------
Earnings before income taxes
and minority interest 79,882 83,240 161,652 165,146
Income taxes
- Current 32,422 32,536 64,614 64,450
- Future 343 512 1,118 1,114
------------------------------------------
Total income taxes 32,765 33,048 65,732 65,564
------------------------------------------
Earnings before minority
interest 47,117 50,192 95,920 99,582
Minority interest 18,800 20,087 38,332 39,824
------------------------------------------
Earnings for the period 28,317 30,105 57,588 59,758
------------------------------------------
------------------------------------------
Earnings per common share
(note 3)
- Basic 0.42 0.44 0.85 0.88
------------------------------------------
------------------------------------------
- Diluted Diluted 0.41 0.44 0.84 0.87
------------------------------------------
------------------------------------------
RETAINED EARNINGS
Balance at beginning of period 77,379 59,757 68,513 151,734
Earnings for the period 28,317 30,105 57,588 59,758
------------------------------------------
105,696 89,862 126,101 211,492
Dividends paid:
Common Shares - (20,404) (20,344) (40,809) (141,974)
(Q2 2007 - $0.30 per share;
Q2 2006 - $0.30 per share)
------------------------------------------
Balance at end of period 85,292 69,518 85,292 69,518
------------------------------------------
------------------------------------------
(x) Restated - See note 2
Rothmans Inc. and subsidiary companies (unaudited)
Interim Consolidated Balance Sheets
As at As at
September 30 March 31
(In thousands of dollars) 2006 2006
-------------------------------------------------------------------------
ASSETS
Current Assets
Cash and cash equivalents 182,581 48,364
Short-term investments - 81,867
Accounts receivable 10,625 10,319
Inventories 181,575 206,433
Prepaid expenses 2,757 1,835
--------------------
Total current assets 377,538 348,818
Property, plant and equipment 76,054 76,298
Future income taxes 5,183 6,301
Prepaid pension benefit cost 15,835 13,295
Other assets 2,662 2,887
--------------------
477,272 447,599
--------------------
--------------------
LIABILITIES
Current Liabilities
Accounts payable and accrued liabilities 41,774 42,618
Excise and other taxes payable 86,524 66,204
Dividend payable to minority shareholder of
subsidiary company - 10,761
Income taxes payable 21,643 20,437
--------------------
Total current liabilities 149,941 140,020
Other long-term liabilities 2,743 2,399
Other employee future benefits 33,947 33,444
Long-term debt 149,772 149,751
Minority interest in subsidiary company 8,217 8,125
--------------------
344,620 333,739
--------------------
SHAREHOLDERS' EQUITY
Capital stock (note 4) 47,360 45,347
Retained earnings 85,292 68,513
--------------------
Total shareholders' equity 132,652 113,860
--------------------
477,272 447,599
--------------------
--------------------
Rothmans Inc. and subsidiary companies (unaudited)
Interim Consolidated Statements of Cash Flows
Three months ended Six months ended
September 30 September 30
(In thousands of dollars) 2006 2005 2006 2005
-------------------------------------------------------------------------
Cash provided by (used in):
OPERATING ACTIVITIES
Earnings for the period 28,317 30,105 57,588 59,758
Adjusted for non-cash items:
Amortization 2,967 2,646 5,832 5,163
Minority interest 18,800 20,087 38,332 39,824
Future income taxes 343 512 1,118 1,114
Loss (gain) on sale of
property, plant & equipment - (9) 2 (9)
Defined & other employee
future benefits expense 1,570 1,949 2,842 3,702
Defined & other employee
future benefits funding (659) (462) (4,879) (5,356)
------------------------------------------
51,338 54,828 100,835 104,196
Changes in non-cash operating
working capital 39,821 3,902 44,422 (7,166)
------------------------------------------
91,159 58,730 145,257 97,030
------------------------------------------
INVESTING ACTIVITIES
Additions to property, plant
& equipment, net (4,126) (4,412) (5,454) (8,715)
Sale of short-term investments - - 81,867 168,740
------------------------------------------
(4,126) (4,412) 76,413 160,025
------------------------------------------
FINANCING ACTIVITIES
Dividends paid -
By the Company (20,404) (20,344) (40,809) (141,974)
By a subsidiary company to
minority shareholder (19,360) (1,435) (49,001) (20,395)
Proceeds on issuance of common
shares 58 3,243 2,013 3,243
Proceeds on (repayment of)
notes payable - (13,500) - -
Proceeds on (repayment of)
other long-term liabilities 272 (77) 344 139
------------------------------------------
(39,434) (32,113) (87,453) (158,987)
------------------------------------------
Increase in cash and cash
equivalents 47,599 22,205 134,217 98,068
Cash and cash equivalents
at beginning of period 134,982 99,118 48,364 23,255
------------------------------------------
Cash and cash equivalents
at end of period 182,581 121,323 182,581 121,323
------------------------------------------
------------------------------------------
SUPPLEMENTARY DISCLOSURES
Income taxes paid 23,481 23,283 63,576 62,307
Interest paid
- Long-term debt - - 4,164 4,164
- Other 20 47 41 75
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. The note disclosure in these interim
consolidated financial statements includes only material changes from
the disclosure found in the Company's annual consolidated financial
statements for the year ended March 31, 2006. Therefore, these
interim consolidated financial statements and notes should be read in
conjunction with those statements. These interim consolidated
financial statements follow the same accounting policies as the
Company's audited annual consolidated financial statements, except as
described in note 2.
2. Change in Accounting Policies
Effective April 1, 2006, the Company adopted the EIC156 "Accounting
A Vendor For Consideration Given To A Customer (Including a Reseller
of the Vendor's Products)" issued by the Emerging Issues Committee of
the Canadian Institute of Chartered Accountants. The abstract
addresses the issue of whether consideration provided by a vendor to
a customer is an adjustment to the selling prices of the products and
therefore a reduction of revenue, or is a cost incurred by the vendor
and thus classified as cost or expense. The Company evaluated its
selling costs and retroactively reclassified cash consideration given
to customers or resellers of products as an adjustment to the selling
prices to reduce net sales revenue. Sales, net of excise duty and
taxes, were reduced by $10.7 million of reclassified selling costs
for the recent quarter and $21.6 million for the fiscal year to date,
compared with $9.9 million and $21.2 million in the same periods of
prior fiscal year. There was no change in the net earnings for the
period from this reclassification.
3. Earnings per Share
Earnings per common share is calculated based on the weighted average
number of common shares outstanding, the dilution being due to issued
common share options.
Basic Diluted
---------------------------------------------------------------------
Six months ended:
September 30, 2006 67,972,277 68,363,645
September 30, 2005 67,641,898 68,355,294
Three months ended:
September 30, 2006 68,016,782 68,390,853
September 30, 2005 67,711,028 68,403,860
4. Capital Stock
Authorized: An unlimited number of common shares
Issued: 68,021,008 (March 31, 2006 - 67,855,608) common shares
September 30 March 31
(in thousands of dollars) 2006 2006
---------------------------------------------------------------------
Balance at beginning of period, April 1 45,347 41,974
Issuance of shares 2,013 3,373
---------------------------------------------------------------------
Balance at end of period 47,360 45,347
---------------------------------------------------------------------
---------------------------------------------------------------------
In the second quarter of fiscal 2007, a total of 5,400 (2006 -
270,600) shares were issued due to the exercise of stock options.
5. Share Option Plan
A summary of the status of the Company's employee stock option plan
as at the periods ended September 30, 2006 and September 30, 2005 and
changes during the periods ended on those dates are presented below:
---------------------------------------------------------------------
Three months ended September 30
---------------------------------------------------------------------
2006 2005
---------------------------------------------------------------------
Weighted Weighted
average average
exercise exercise
Options Shares price Shares price
---------------------------------------------------------------------
Outstanding at
beginning of period 1,330,800 14.270 1,774,400 14.325
Exercised 5,400 12.320 270,600 14.470
---------------------------------------------------------------------
---------------------------------------------------------------------
Outstanding at
end of period 1,325,400 14.278 1,503,800 14.299
---------------------------------------------------------------------
---------------------------------------------------------------------
Options exercisable
at period end 1,325,400 14.278 1,503,800 14.299
---------------------------------------------------------------------
---------------------------------------------------------------------
---------------------------------------------------------------------
Six months ended September 30
---------------------------------------------------------------------
2006 2005
---------------------------------------------------------------------
Weighted Weighted
average average
exercise exercise
Options Shares price Shares price
---------------------------------------------------------------------
Outstanding at
beginning of period 1,490,800 14.325 1,774,400 14.325
Exercised 165,400 14.488 270,600 14.470
---------------------------------------------------------------------
---------------------------------------------------------------------
Outstanding at
end of period 1,325,400 14.278 1,503,800 14.299
---------------------------------------------------------------------
---------------------------------------------------------------------
Options exercisable
at period end 1,325,400 14.278 1,503,800 14.299
---------------------------------------------------------------------
---------------------------------------------------------------------
Under the current share option plan as at September 30, 2006, a total
of 181,800 (2005 - 181,800) common shares were issuable. Given the
limited number of common shares available for issuance under the
Option Plan, the annual grant of options was discontinued effective
fiscal 2006. No options were forfeited during the period.
The following table summarizes information about stock options
outstanding as at September 30, 2006:
Weighted
average
remaining
Number contractual Number
Range of exercise price outstanding life exercisable
---------------------------------------------------------------------
$8.825 (1) 18,000 4.3 18,000
$11.500 (1) 154,000 5.1 154,000
$12.320 (2) 322,400 7.1 322,400
$14.080 (1) 261,400 5.5 261,400
$16.125 (1) 252,000 6.1 252,000
$16.620 (2) 317,600 8.1 317,600
---------------------------------------------------------------------
1,325,400 1,325,400
---------------------------------------------------------------------
(1) Entitled upon exercise to a payment of $4.00 per share (amount
equal to special dividends paid since date of option grant).
(2) Entitled upon exercise to a payment of $1.50 per share (amount
equal to special dividends paid since date of option grant).
6. Employee Future Benefit Expenses
The Company's defined benefit pension plan and other benefits
expenses are as follows:
Three months ended Six months ended
September 30 September 30
(in thousands of dollars) 2006 2005 2006 2005
---------------------------------------------------------------------
Defined benefit plan expenses
Pension benefit plans 730 759 1,163 1,320
Other benefits 840 1,190 1,679 2,382
---------------------------------------------------------------------
1,570 1,949 2,842 3,702
---------------------------------------------------------------------
---------------------------------------------------------------------
The Company's defined contribution pension plan expenses in the
quarter and year-to-date for fiscal year 2007 were $0.8 million and
$1.8 million, compared with $0.7 million and $1.6 million in the same
periods of prior fiscal year.
7. Seasonality
Over the past two fiscal years, the period between April and
September has demonstrated stronger industry shipments than the
period between October and March. This seasonality is likely due to
smoking restrictions that are causing consumption variations between
summer and winter seasons.
8. Litigation, Claims and Contingencies
The Company and Rothman, Benson & Hedges Inc. ("RBH") are subject to
a number of claims and potential claims. The nature and extent of
these claims has been described in Note 12 of the annual consolidated
financial statements of the Company for the year ended March 31,
2006. Other than as described below, there have been no developments
of a material nature during the fiscal year to date concerning these
matters.
On June 13, 2006, Manitoba passed the Tobacco Damages and Health Care
Costs Recovery Act. The legislation, which is modeled on the British
Columbia legislation, purports to allow the provincial government to
bring an action against tobacco product manufacturers for the
recovery of health care costs that allegedly have been or will be
incurred by the Province in respect of alleged tobacco related
diseases. No action has been commenced under this legislation.
On June 22, 2006, the Tobacco Damages and Health Care Costs Recovery
Act in New Brunswick received royal assent. The legislation is
similar to that of British Columbia. No action has been commenced
under this legislation.
In September 2006, the British Columbia Court of Appeal ruled that
the Company and certain international tobacco companies who are named
as defendants in the lawsuit initiated by the Province of British
Columbia to recover health care costs should remain in the lawsuit.
These defendants, including the Company, had argued that the Province
did not have jurisdiction over them as they do not do business in
British Columbia. The companies are considering whether or not to
seek leave to appeal the decision to the Supreme Court of Canada.
In late September 2006 RBH received a complaint from ITL and one of
its affiliates alleging RBH's ROOFTOP product packaging infringed
their rights in respect of the MARLBORO trade-mark registration in
Canada. RBH and Philip Morris Products S.A. ("PMPSA"), the owner of
the ROOFTOP design in Canada, have commenced an action in the Federal
Court seeking a declaration that the use of the ROOFTOP design in
association with RBH's cigarette products does not infringe upon any
rights which ITL or its affiliate may have in respect of the
MARLBORO trade-mark registration in Canada. In their statement of
defence, ITL and its affiliate have counterclaimed against RBH and
PMPSA seeking, among other things, a declaration that the ROOFTOP
packaging infringes their trade-mark rights, a permanent injunction
restraining the sale and distribution of cigarettes in association
with the ROOFTOP packaging in Canada as well as unspecified damages
or an accounting of profits, at their election. RBH and PMPSA deny
the allegations contained in ITL's claim, and intend to defend
themselves vigorously.
As discussed in the annual MD&A for the year ended March 31, 2006,
the Company and RBH have been the subjects of various legal actions,
proceedings and claims. Based on the stage of those proceedings,
management is unable to meaningfully estimate the liability, if any,
that might result from those claims and neither the Company nor RBH
has accrued for potential liabilities. However, the outcome of any
litigation is uncertain. If successful, these claims, either
individually or in the aggregate, could involve significant damages
which would have a significant adverse effect on the financial
condition of the Company, and the Company and RBH may not have the
resources to satisfy such claims.
9. Comparative Figures
Certain comparative figures have been reclassified to conform to the
presentation adopted in the current year.
>>
