Saputo
Annual Report 2005

Plain-text annual report

CRAFTING OUR FUTURE 2 0 0 5 A N N U A L R E P O R T CUMULATIVE TOTAL RETURN SINCE MARCH 31, 2000 The following graph compares, on a yearly basis, the total cumulative shareholder return of $100 invested in the Saputo Common Shares with the S&P/TSX Composite Total Return Index of the TSX during the five fiscal years ending March 31, 2005. 0 0 1 $ = 0 0 0 2 , 1 3 h c r a M $300 $250 $200 $150 $100 $50 03/31/00 03/31/01 03/31/02 03/31/03 03/31/04 03/31/05 Saputo S&P/TSX Composite Total Return Index Revenues (in millions of dollars) 3,883.1 EBITDA(1) (in millions of dollars) 407.8 Net earnings (in millions of dollars) 232.1 2 . 0 7 5 , 3 1 . 8 9 3 , 3 3 . 3 0 4 8 . 2 5 3 4 . 2 1 2 7 . 3 7 1 Cash flow generated by operations (in millions of dollars) 276.5 6 . 7 8 2 5 . 3 2 2 2003 2004 2005 2003 2004 2005 2003 2004 2005 2003 2004 2005 All amounts in this report are in Canadian dollars, unless otherwise stated. Table of Contents 1 Highlights / 8 Message from the Chairman of the Board / 10 Message from the President and Chief Executive Officer 12 Corporate Management / 13 Saputo at a Glance / 14 Dairy Products Division (Canada) 14 Dairy Products Division (Argentina) / 16 Cheese Division (USA) / 17 Bakery Division 19 Management’s Analysis / 42 Consolidated Financial Statements / 45 Notes to the Consolidated Financial Statements 58 Social Responsibility / 60 Board of Directors / 61 Shareholder Information HIGHLIGHTS Years ended March 31 (in thousands of dollars, except per share amounts and ratios) 2005 2004 2003 Revenues Dairy Products Sector Canada and Other United States Grocery Products Sector Earnings before interest, income taxes, depreciation and amortization (EBITDA)(1) Dairy Products Sector Canada and Other United States Grocery Products Sector Net earnings Cash flows generated by operations Working capital Total assets Long-term debt (including current portion) Shareholders’ equity Per share Net earnings Basic Diluted Dividends declared Book value $ 2,415,541 1,308,735 3,724,276 158,793 $ 3,883,069 $ $ $ 244,161 137,043 381,204 26,555 407,759 232,145 276,485 $ $ 452,635 $ 2,133,072 $ 302,521 $ 1,315,850 $ $ $ $ 2.23 2.20 0.60 12.59 $ 2,161,852 1,240,954 3,402,806 167,384 $ 3,570,190 $ $ $ 209,855 160,887 370,742 32,515 403,257 212,365 287,572 $ $ 297,202 $ 2,069,548 $ 371,911 $ 1,156,829 $ $ $ $ 2.05 2.03 0.48 11.15 Financial ratios Interest bearing debt(2)/Shareholders’ equity Return on average shareholders’ equity 0.21 18.8 % 0.39 19.5 % $ 2,017,383 1,212,810 3,230,193 167,919 $ 3,398,112 $ $ $ 199,561 120,069 319,630 33,165 352,795 173,728 223,532 $ $ 269,326 $ 1,970,686 $ 521,135 $ 1,016,504 $ $ $ $ 1.68 1.66 0.40 9.83 0.53 18.1 % (1) Measurement of results not in accordance with generally accepted accounting principles The Company assesses its financial performance based on its EBITDA, this being earnings before interest, income taxes, depreciation and amortization. EBITDA is not a measurement of performance as defined by generally accepted accounting principles in Canada, and consequently may not be comparable to similar measurements presented by other companies. (2) Net of cash Transformation TO TRANSFORM is to change something from one form to another. Every day our employees demonstrate that not only do they know how to transform raw materials into cheese, yogurt or snack cakes, but also, and most impor tantly, that they have what it takes to transform challenges into opportunities. It was through this invaluable ability that the little family company transformed itself into a leader in its industry. Today, Saputo is the largest dairy processor and the largest snack cake manufacturer in Canada, one of the most important cheese producers in North America and the third largest dair y processor in Argentina. Recognizing the impor tant role that our employees play in our daily success, we consciously strive to create a working environment that is as stimulating as possible, where employees have the opportunity of transforming their jobs into continuously evolving careers. 2 0 0 5 A N N U A L R E P O R T / S A P U T O 3 Innovation TO INNOVATE is to introduce something new. Thanks to the daily contribution of our employees, innovation lies at the heart of the entrepreneurial culture that is our greatest source of pride. Passion is transmitted from generation to generation, at every level of the Company. Since the very beginning, we have always considered it a duty to of fer our customers the flexibility required to respond to their specif ic needs. This constant concern with innovation motivates us not only to create new products, but also to think continuously about new ways of improving our day- to-day activities. 2 0 0 5 A N N U A L R E P O R T / S A P U T O 5 Growth TO GROW is to become stronger, more numerous, more pervasive. At Saputo, we are f irmly committed to growth. In taking careful steps on consolidating our resources at every stage, we are getting closer to our goal of becoming a world-class dairy processor. Our employees are the driving force of this growth. Our commitment is to provide them with an environment conducive to self-fulfilment, in which they can develop along with the organization. In applying this winning recipe we have turned our Company into one that is traded publicly with sales of close to four billion dollars, a company that is now leaving its mark from one end of the Americas to the other. Saputo today has approximately 8,500 employees bringing their talents, skills and passion to its 46 plants and its distribution centres. Transform and innovate to grow 2 0 0 5 A N N U A L R E P O R T / S A P U T O 7 MESSAGE FROM THE CHAIRMAN OF THE BOARD As you know, I have been shouldering the responsibilities of Chairman of the Board for more than a year since Lino Saputo, Jr. has been appointed President and Chief Executive Officer. Before, I was overseeing the day-to-day operations of the Company. Today my new role has given me a different perspective. It has made me realize how much progress has been made in the Company that my family and I founded over 50 years ago. Saputo has grown at more than one level. As satisfied as I am with our financial results, which have enjoyed steady improvement since our founding, I am equally proud of the working environment we have succeeded in creating. The family spirit that prevails at our Company is the embodiment of our values and our business culture, and this remains the source of my greatest pride. Our business approach, although it may have evolved over the years, has remained fundamentally the same. At all levels of the Company, our actions are considered on a daily basis. As true and enthusiastic entrepreneurs, we take care to always act quickly and always in the best interests of our shareholders, our customers and our employees. I take pleasure in reporting the activities of the Board during the course of the past fiscal year. The Board of Directors is responsible for overseeing the stewardship of the Company affairs to ensure that its resources are managed so as to increase share value and create economic wealth. The Company believes in the importance of sound corporate governance and considers that the interest held by its majority shareholder ensures that its interests are in line with those of the other shareholders. The Company’s Board of Directors is composed of a majority of unrelated and independent directors and the two Board committees are composed solely of unrelated and independent directors. The positions of Chairman of the Board and President and Chief Executive Officer are separate and the Board also has a Lead Director whose responsibilities include holding quarterly meetings of the unrelated and independent directors. During the year, the Board of Directors and its committees fulfilled their mandates and oversaw the application of many policies and the new regulatory procedures adopted last year in light of requirements. In addition, consistent with the process adopted last fiscal year, we conducted our first formal evaluation of the performance of the Board of Directors, its committees and its directors. We also adopted a formal evaluation process of the performance of the President and Chief Executive Officer, which will be implemented this fiscal year. 8 2 0 0 5 A N N U A L R E P O R T / S A P U T O The Board is pleased with the corporate governance practices in place within the Company and continues to monitor changes in legislation and in market trends to determine whether additional measures should be implemented. Please refer to the Information Circular dated June 6, 2005 for additional information on Board and committee mandates and accomplishments as well as corporate governance practices. My thanks I wish to thank the members of the Board of Directors for their invaluable advice throughout the past fiscal year. Lastly, as you know so well, we are all one big family at Saputo. And at the heart of that family are about 8,500 men and women who devote themselves day after day to the success of our Company. The passion and the commitment that characterize their daily work remain for me the greatest source of pride, and once again I wish to extend my warmest thanks to them. In closing, my colleagues on the Board of Directors and I intend to carry on with the same efforts in fiscal 2006 to assist the Company in its growth. Secondly, my most heartfelt thanks go out to our customers and to the consumers of our products, who have appreciated us for over 50 years. We will continue to make good on the same promise of quality, in terms of both products and service, and at a competitive price. (signed) Lino Saputo Chairman of the Board 2 0 0 5 A N N U A L R E P O R T / S A P U T O 9 MESSAGE FROM THE PRESIDENT AND CHIEF EXECUTIVE OFFICER We are proud to present net earnings of $232.1 million for the fiscal year ended March 31, 2005, up 9.3% compared to last fiscal year. Total revenues for fiscal 2005 amounted to $3.883 billion, up 8.8% over the preceding fiscal year. Building on a very solid base supported by strong values and a defined corporate culture, I have had the privilege to take over the responsibilities as President and CEO on April 1, 2004, the very same year that marked our 50th anniversary. Our storied past and humble beginnings remind us every day, that the true pillars of our foundations are the men and women in our organization that remain the driving force behind our consistent progress. As the global dairy industry undergoes an evolution through consolidation, and with world consumption of dairy products growing at historical rates of one to two percent per year, our quest of becoming an increasingly important dairy player, remains unchanged. In the United States, we still remain active towards potential acquisitions of cheese operations. The industry is still fragmented and we believe that there are good opportunities for our Company. We will also continue to seek out opportunities in countries that could provide us a solid platform by which we would be able to increase our presence as a dairy player on a world-wide scale, very much as we have done in Argentina, our first foray outside of North America. It is very important for us to remain a company that is not spoiled by past success. Although we have posted strong financial results, prior to and since our entrance into the public domain, we cannot rest on our laurels. We cannot, and we will not, allow ourselves to become complacent. As such, our commitment to dairy products innovation is stronger than ever. Be it in diverse cheese and milk technologies, dairy solids enhancements, or by-products extensions, we will explore new avenues that further improve our product variety and manufacturing efficiencies, consistent with, and capitalizing on, the ever-changing desires of our customers and consumers. I recently established a team of individuals reporting directly to me whose mandate is to seek innovation at a quicker pace. Their support and commitment will allow our Company to become a leader in dairy initiatives and innovation. Notwithstanding, every individual business unit will maintain the focus on product quality, cost effectiveness, and commitment to service that continues to distinguish our Company from the rest. This being said, fiscal 2005 was another great year for Saputo. In our Dairy Products Division (Canada), we have worked towards the final stages of the integration of our two former Cheese and Milk divisions into one single unit. Both our cheese and milk activities have seen increases in their sales volumes. We also started to see the benefits from the rationalization project we undertook in this division. As well, after the fiscal year-end, we concluded the acquisition of the activities of Fromage Côté S.A. and Distributions Kingsey Inc., Québec-based companies specializing in both fresh curds and specialty cheeses. The specialty cheese category has seen interesting growth in fiscal 2005 and we expect that this trend will continue as consumers are increasingly looking for specialty products. In Argentina, we have successfully completed the integration of the division into Saputo’s systems and values. As we have mentioned during the last fiscal year, we invested significant capital in new technologies and equipment that will allow us to extend our product offering and improve our profitability. We also experienced growth in both our national and international sales. For us, Argentina is a significant step in our goal to become a world-class dairy processor. We are learning everyday and this knowledge is already bearing fruit and will continue to do so in the future. In the United States, our Cheese Division performed well considering the ever-changing and volatile market conditions. Overall, we experienced a decrease in our sales volumes, as the average block market per pound of cheese, as traded daily on the Chicago Mercantile Exchange (CME), was US$0.28 higher this fiscal year over the prior fiscal year. The majority of the volume decline was concentrated in commodity type cheeses where the industry struggled with over-capacity issues. Volumes in the string cheese, hard cheese and other cheese categories all experienced increases over the prior fiscal year. In order to capitalize on the string cheese popularity, we announced in May 2005, the acquisition of the activities of Schneider Cheese, Inc., a manufacturer of string cheese and cheese sticks under the Schneider brand name and other private labels. We see great opportunities in the United States both from internal growth, where innovation is a key factor, as well as growth through acquisitions. 1 0 2 0 0 5 A N N U A L R E P O R T / S A P U T O In the Bakery Division, we increased the base selling price for our economy- and family-size products, which resulted in a slight decrease in our sales volumes. Despite the volume decrease, we believe the decision was necessary to ensure the continued profitability of the division. This division evolves in a competitive industry where innovation drives most of the growth. We have made a commitment towards the development of this division. In that regard, we have initiated the introduction of products with reduced or no trans fat content, thus pursuing our leadership in the snack cake and cereal bar categories. For fiscal 2006, we intend to increase our revenues, EBITDA and net earnings. This increase will be through organic initiatives in each division supported through capital investments. In Argentina, we will solidify our position by dedicating specific capital investments to increase production capacity as well as to optimize our by-products derived from cheese manufacturing. For our Bakery Division, fiscal 2006 will mark the first year of our three-year investment plan for which we committed approximately $20 million in February 2004. This investment should be covered by additional profitability generated within the same three-year period. In addition, we are evaluating potential cheese operations acquisitions in the United States. Looking at all the projects we are working on at the beginning of fiscal 2006, I am reminded of all the possibilities and promise the future holds for our Company. Given our financial stability and strength, we control our destiny. In the coming year, we will make the appropriate decisions and take all necessary actions to continue our successful ways, which all stakeholders have been accustomed to for over half a century. Day after day, we are crafting our future. (signed) Lino Saputo, Jr. President and Chief Executive Officer 2 0 0 5 A N N U A L R E P O R T / S A P U T O 1 1 CORPORATE MANAGEMENT From lef t to right, in the back: Dino Dello Sbarba, President and Chief Operating Of f icer, Cheese Division (USA) Carmine De Somma, President and Chief Operating Of f icer, Dairy Products Division (Argentina) Randy Williamson, President and Chief Operating Of f icer, Dairy Products Division (Canada) Lino Saputo, Jr., President and Chief Executive Of f icer From lef t to right, in the front: Pierre Leroux, Executive Vice President, Human Resources and Corporate Af fairs Louis-Philippe Carrière, Executive Vice President, Finance and Administration 1 2 2 0 0 5 A N N U A L R E P O R T / S A P U T O SAPUTO AT A GLANCE Solid foundations, a commitment to excellence and dedication to growth are the keystones that have enabled Saputo to evolve as the largest dairy processor in Canada, one of the most important cheese producers in North America, the third largest dairy processor in Argentina and the largest snack cake manufacturer in Canada. Our products, manufactured in 46 plants that stretch from one end of the Americas to the other, are marketed under such well-known brand names as Saputo, Armstrong, Caron, Cayer, Kingsey, Dairyland, Baxter, Nutrilait, Stella, Frigo, Dragone, Treasure Cave, La Paulina, Ricrem and Vachon. Saputo Inc. is a public company whose shares are listed on the Toronto Stock Exchange under the symbol SAP. Propelled by the same sense of dedication that motivates our 8,500 employees to surpass themselves day after day, we will continue to successfully craft our future. CANADIAN AND OTHER DAIRY PRODUCTS SECTOR Revenues (%) per market segment Canadian Cheese Activities DAIRY PRODUCTS DIVISION (CANADA) 48 Retail 39 Foodservice 13 Industrial Revenues (%) per market segment Canadian Fluid Milk Activities 80 Retail 20 Foodservice Revenues (%) per geographic segment Dairy Products Division (Argentina) 56 International 44 Domestic Types of products Mozzarella, Cheddar, Fluid Milk, Butter, Blue, Bocconcini, Brick, Brie, Caciocavallo, Camembert, Colby, Cream, Flavoured Coffee Creamers, Sour Cream, Farmer, Feta, Friulano, String Cheese, Cottage Cheese, Goat Cheese, Havarti, Juices and Drinks, Milk Powder, Evaporated Milk, Lactose, Margarine, Monterey Jack, Munster, Parmesan, Pastorella, Whey Protein, Provolone, Ricotta, Romano, Swiss, Trecce, Dips, Tuma, Yogurt Sales • Diversified range of dairy products • Leader in supplying the pizzeria market • Wide variety of specialty cheeses Distribution • Direct delivery in all regions of Canada • The largest dairy product distribution infrastructure in Canada Activities • Producing 38% of all natural cheese manufactured in Canada • Processing 20% of all fluid milk in Canada • Excess production capacity of 18% for cheese activities • Excess production capacity of 31% for fluid milk activities DAIRY PRODUCTS DIVISION (ARGENTINA) Types of products Mozzarella, Parmesan, Milk Powder, Butter, Cheddar, Cream, Dulce de Leche (Caramelized Milk), Edam, Emmenthal, Gouda, Goya, Monterey Jack, Soft Cheeses, Swiss, UHT Milk, Prato, Reggianito Sales • Nearly 44% of sales are in the domestic market • Cheese and milk powder exported to over 30 countries Distribution Independent distribution network comprising 150 distributors in 9 branches Activities • Processing 5% of all milk in Argentina • Excess production capacity of 20% CANADIAN AND OTHER DAIRY PRODUCTS SECTOR Revenues (in millions of dollars) 2,415.5 EBITDA(1) (in millions of dollars) 244.2 9 . 1 6 1 , 2 4 . 7 1 0 , 2 9 . 9 0 2 6 . 9 9 1 2003 2004 2005 2003 2004 2005 US DAIRY PRODUCTS SECTOR Sales volumes (%) per market segment 44 Foodservice 26 Industrial 30 Retail Revenues (in millions of dollars) 1,308.7 EBITDA(1) (in millions of dollars) 137.0 0 . 1 4 2 , 1 8 . 2 1 2 , 1 9 . 0 6 1 1 . 0 2 1 2003 2004 2005 2003 2004 2005 CHEESE DIVISION (USA) (2) Types of products Mozzarella, String Cheese, Asiago, Blue, Whey Protein Concentrate, Feta, Fontinella, Gorgonzola, Kasseri, Sweetened Condensed Milk, Eggnog, Condensed Whey, Whey Powder, Parmesan, Provolone, Ricotta, Romano, Swiss Sales • Large range of products and well-balanced sales segmentation Distribution • Independent regional and national distributors • 3 distribution centres: East, Midwest, West Activities • Producing 6% of all natural cheese manufactured in the United States • Excess production capacity of 10% (2) Crayola, Twistables, chevron, and serpentine are registered trademarks, smile design is a trade- mark of Binney & Smith. GROCERY PRODUCTS SECTOR Revenues (%) per market segment Mainly retail Revenues (in millions of dollars) 158.8 EBITDA(1) (in millions of dollars) 26.6 9 . 7 6 1 4 . 7 6 1 2 . 3 3 5 . 2 3 2003 2004 2005 2003 2004 2005 BAKERY DIVISION Types of products Snack Cakes, Tarts, Cereal Bars Sales • Largest snack cake manufacturer in Canada and one of the leaders in the cereal bar market in Québec Distribution • Direct-to-store delivery Activities • Dominant market share in all regions of Canada • Excess production capacity of 31% SAPUTO AT A GLANCE Revenues (in millions of dollars) 3,883.1 2 . 0 7 5 , 3 1 . 8 9 3 , 3 EBITDA(1) (in millions of dollars) 407.8 3 . 3 0 4 8 . 2 5 3 Net earnings (in millions of dollars) 232.1 4 . 2 1 2 7 . 3 7 1 2003 2004 2005 2003 2004 2005 2003 2004 2005 (1) Measurement of results not in accordance with generally accepted accounting principles The Company assesses its financial performance based on its EBITDA, this being earnings before interest, income taxes, depreciation and amortization. EBITDA is not a measurement of performance as defined by generally accepted accounting principles in Canada, and consequently may not be comparable to similar measurements presented by other companies. Number of employees per sector* Number of plants per sector Revenues (%) per sector 1,100 Grocery Products Sector 5,300 Canadian and Other Dairy Products Sector 1 Grocery Products Sector 30 Canadian and Other Dairy Products Sector 4 Grocery Products Sector 62 Canadian and Other Dairy Products Sector 2,100 US Dairy Products Sector *Approximate number Visit us at w w w. s a p u t o . c o m . 15 US Dairy Products Sector 34 US Dairy Products Sector MANAGEMENT’S ANALYSIS The goal of the present management report is to provide a better understanding of our activities and should be read while referring to our audited consolidated financial statements and the accompanying notes, which are prepared in accordance with Canadian Generally Accepted Accounting Principles. In addition to containing an analysis of the year ended March 31, 2005, this report addresses any material element to be considered between March 31, 2005 and June 6, 2005, the date on which this report was approved by the Board of Directors of Saputo Inc. (the "Company" or "Saputo"). Additional information about the Company, including the Annual Information Form for the year ended March 31, 2005, can be obtained on SEDAR at www.sedar.com. This disclosure document contains management’s analysis on forward-looking statements. Caution should be used in the interpretation of management’s analysis and statements, since management often makes reference to objectives and strategies that contain a certain element of risk and uncertainty. Due to the nature of our business, the risks and uncertainties associated with it could cause the results to differ materially from those stated in such forward-looking statements. GLOBAL OVERVIEW Fiscal 2005 marked Saputo’s first full year of operations as a major player in both the North and South American dairy industry. Saputo’s operations are carried out in 46 plants and numerous distribution centres across Canada, United States, and Argentina. Saputo is proud to employ approximately 8,500 employees whose efforts and dedication have enabled the Company to excel. Saputo is active in two sectors: dairy products, which accounts for 95.9% of consolidated revenues, and grocery products, with 4.1% of consolidated revenues. Saputo manufactures almost all of the products it commercializes. Our Dairy Products Sector consists of the following: Canadian and Other Dairy Products Sector and US Dairy Products Sector. The Canadian and Other Dairy Products Sector consists of our Dairy Products Division (Canada) and our Dairy Products Division (Argentina). The US Dairy Products Sector consists of our Cheese Division (USA). Saputo’s dairy products are available in all segments of the food market: retail, foodservice and industrial. Saputo is the largest dairy processor in Canada, among the top five in the United States and the third largest in Argentina. The foodservice segment accounts for 33% of total revenues within the Dairy Products Sector. Sales are made to distributors of both specialty cheeses and complete product lines as well as to restaurants and hotels under our own brand names and under various private labels. Through our Canadian distribution network, we also offer non-dairy products manufactured by third parties. We also produce dairy blends for fast-food chains. The industrial segment accounts for 16% of total revenues within the Dairy Products Sector. Sales are made to food processors that use our products as ingredients to manufacture their products. In Canada, we supply cheese to frozen pizza manufacturers while in the United States, we supply cheese to numerous large food manufacturers. Our Canadian and US cheese manufacturing facilities also produce by-products such as lactose, whey powder and whey protein. Through our Canadian industrial segment, we sell cheese, lactose, whey powder, ice cream mixes and whey protein to numerous international clients. Our Argentina facilities also supply many international clients primarily with milk powder and cheese. The retail segment accounts for 51% of total revenues within the Dairy Products Sector. Sales are made to supermarket chains, independent retailers, warehouse clubs and specialty cheese boutiques under our own brand names as well as under private labels. Products manufactured and sold in this segment include dairy products as well as non-dairy products such as non-dairy creamers, juices and drinks. Our Grocery Products Sector consists of our Bakery Division which manufactures and markets snack cakes, tarts and cereal bars. Our products are sold almost exclusively in the Canadian retail segment, through supermarket chains, independent retailers, and warehouse clubs. On a smaller scale, the Bakery Division is also present in the northeastern United States. Saputo is the largest snack cake manufacturer in Canada and a leader in Québec’s cereal bar market. 2 0 0 5 A N N U A L R E P O R T / S A P U T O 1 9 Revenues (% ) per market segment Dairy Products Sector 51 Retail 33 Foodservice 16 Industrial Financial Orientation Over the years, Saputo has been synonymous with financial stability and performance growth. This is due to the strong foundations instilled in every facility in Canada, United States, and more recently, Argentina. Our sound business model has enabled the Company to grow both organically and through acquisitions, while maintaining profit margins. Our goal of creating value for our employees and shareholders remains our most important objective. Our discipline and thorough approach has enabled us to achieve this goal. This approach is present in all facets of our business. From manufacturing to sales activities, Saputo employees’ belief in this approach is the cornerstone to the Company’s success. The Company continually monitors and questions financial results in order to ensure that optimal results are achieved. The strong financial stability of the Company is a result of such actions. In fiscal 2005, Saputo fully repaid the long-term debt relating to the Dairyworld acquisition (February 2001). Our balance sheet is stronger than ever. Our goal of becoming a world-class dairy processor remains intact. Whether it be via organic growth or future acquisitions, Saputo will continue to apply the same principles and methodologies that have proven to be successful. Elements to Consider when Reading Management’s Analysis for Fiscal 2005 During fiscal 2005, we experienced solid financial performance: • Net earnings totalled $232.1 million, up 9.3% • Earnings before interest, income taxes, depreciation and amortization (EBITDA)(1) totalled $407.8 million, up 1.1% • Revenues reached $3.883 billion, up 8.8% • Cash flows generated by operations of $276.5 million, slightly lower compared to last fiscal year The improved performance in fiscal 2005 is the result of increased volumes and savings achieved from rationalization activities undertaken in prior fiscal years in our Dairy Products Division (Canada), as well as the inclusion of a full year of results from our operations in Argentina compared to only 18 weeks in the previous fiscal year. The continued rise of the Canadian dollar affected fiscal 2005 results. During fiscal 2005, the appreciation of the Canadian dollar eroded approximately $3 million in net earnings, $8 million in EBITDA, and $70 million in revenues. In the United States, we were affected by a less favourable relationship between the average block market (2) per pound of cheese and the cost of milk as raw material. The higher average block market per pound of cheese in the United States had a positive effect of approximately $148 million on revenues. The overall average block market per pound of cheese of US$1.67 this fiscal year was higher compared to US$1.39 last fiscal year. This benefited the EBITDA this fiscal year by providing a better basis of absorption for our fixed costs, while a less favourable relationship between the average block market per pound of cheese and the cost of milk as raw material was observed this fiscal year compared to last fiscal year. With regards to inventories, we started the fiscal year with a block market per pound of cheese at US$2.09 and ended the year at US$1.62, causing an unfavourable impact on the realization of inventories. These combined factors had a negative impact of $29.7 million on EBITDA. The Company also benefited from a one-time tax reduction to adjust future tax balances, due to a reduction in US tax rates, thus increasing net earnings by $3.5 million. (1) Measurement of results not in accordance with generally accepted accounting principles The Company assesses its financial performance based on its EBITDA, this being earnings before interest, income taxes, depreciation and amortization. EBITDA is not a measurement of performance as defined by generally accepted accounting principles in Canada, and consequently may not be comparable to similar measurements presented by other companies. (2) “Average block market” is the average daily price of a 40 pound block of Cheddar cheese traded on the Chicago Mercantile Exchange (CME), used as the base price for the cheese. 2 0 2 0 0 5 A N N U A L R E P O R T / S A P U T O Selected Consolidated Financial Information Years ended March 31 (in thousands of dollars, except per share amounts and ratios) Statement of earnings data Revenues Dairy Products Sector Canada and Other United States Grocery Products Sector Cost of sales, selling and administrative expenses Dairy Products Sector Canada and Other United States Grocery Products Sector EBITDA Dairy Products Sector Canada and Other United States Grocery Products Sector EBITDA margin (%) Depreciation of fixed assets Dairy Products Sector Canada and Other United States Grocery Products Sector Operating income Dairy Products Sector Canada and Other United States Grocery Products Sector Interest on long-term debt Other interest, net of interest income Earnings before income taxes Income taxes Net earnings Net earnings margin (%) Net earnings per share Diluted net earnings per share Dividends declared per share 2005 2004 2003 $ 2,415,541 1,308,735 3,724,276 158,793 $ 3,883,069 $ 2,171,380 1,171,692 3,343,072 132,238 $ 3,475,310 $ $ 244,161 137,043 381,204 26,555 407,759 10.5% 29,743 31,175 60,918 5,147 66,065 214,418 105,868 320,286 21,408 341,694 28,026 1,064 312,604 80,459 232,145 6.0% 2.23 2.20 0.60 $ $ $ $ $ 2,161,852 1,240,954 3,402,806 167,384 $ 3,570,190 $ 1,951,997 1,080,067 3,032,064 134,869 $ 3,166,933 $ $ 209,855 160,887 370,742 32,515 403,257 11.3% 29,854 31,550 61,404 4,634 66,038 180,001 129,337 309,338 27,881 337,219 34,792 1,218 301,209 88,844 212,365 5.9% 2.05 2.03 0.48 $ $ $ $ $ 2,017,383 1,212,810 3,230,193 167,919 $ 3,398,112 $ 1,817,822 1,092,741 2,910,563 134,754 $ 3,045,317 $ $ 199,561 120,069 319,630 33,165 352,795 10.4% 29,697 35,704 65,401 5,488 70,889 169,864 84,365 254,229 27,677 281,906 43,672 (1,351) 239,585 65,857 173,728 5.1% 1.68 1.66 0.40 $ $ $ $ Balance sheet data Total assets Long-term debt (including current portion) Shareholders' equity Statement of cash flows data Cash flows generated by operations Amount of additions to fixed assets, net of proceeds on disposal $ 2,133,072 $ 302,521 $ 1,315,850 $ $ 276,485 76,345 $ 2,069,548 $ 371,911 $ 1,156,829 $ $ 287,572 84,520 $ 1,970,686 $ 521,135 $ 1,016,504 $ $ 223,532 66,531 2 0 0 5 A N N U A L R E P O R T / S A P U T O 2 1 Saputo’s consolidated revenues totalled $3.883 billion, an increase of $313.0 million or 8.8% compared to $3.570 billion posted in fiscal 2004. The increase is attributed to our Dairy Products Division (Canada), as a result of increased sales volumes and higher selling prices, along with the inclusion of a full year of activity from our Dairy Products Division (Argentina) compared to only 18 weeks in fiscal 2004. These two factors contributed approximately $254 million of additional revenues in fiscal 2005. Our US Dairy Products Sector benefited from a US$0.28 higher average block market per pound of cheese, increasing revenues by approximately $148 million compared to last fiscal year. However, the appreciation of the Canadian dollar eroded about $70 million in revenues. Furthermore, a 3% decrease in sales volumes in our US Dairy Products Sector negatively affected revenues. The Grocery Products Sector revenues were approximately $9 million or 5.1% lower compared to fiscal 2004. Earnings before interest, income taxes, depreciation and amortization amounted to $407.8 million, an increase of $4.5 million compared to $403.3 million in fiscal 2004. The increase is attributed to our Canadian and Other Dairy Products Sector. Increased sales volumes and the benefit of the rationalization activities undertaken in fiscal 2004 from our Dairy Products Division (Canada) combined with the benefit from a full year of results from our Dairy Products Division (Argentina) contributed approximately $34 million in additional EBITDA. Our US Dairy Products Sector EBITDA decreased by approximately $24 million in fiscal 2005. The overall average block market per pound of cheese of US$1.67 this fiscal year was higher compared to US$1.39 last fiscal year. This benefited the EBITDA this fiscal year by providing a better basis of absorption for our fixed costs, while a less favourable relationship between the average block market per pound of cheese and the cost of milk as raw material was observed this fiscal year compared to fiscal 2004. With regards to inventories, we started the fiscal year with a block market per pound of cheese at US$2.09 and ended the year at US$1.62, causing an unfavourable impact on the realization of inventories. These combined factors had a negative impact of $29.7 million on EBITDA. The appreciation of the Canadian dollar also eroded approximately $8 million of EBITDA in fiscal 2005. These factors offset an increase of approximately $12 million in our US Dairy Products Sector EBITDA generated by continued improvements in our manufacturing Net earnings (in millions of dollars) 232.1 4 . 2 1 2 7 . 3 7 1 processes, price increases implemented on fixed price items and better product mix within the retail segment. The EBITDA for our Grocery Products Sector decreased by $5.9 million in fiscal 2005 caused by the reduced revenues, additional pension charges as well as increased ingredient and labour costs. EBITDA margin decreased from 11.3% in fiscal 2004 to 10.5% in fiscal 2005, mainly as a result of reduced margins in our US Dairy Products Sector. The US Dairy Products Sector was affected negatively in terms of the relationship between the average block market per pound of cheese and the cost of milk as raw material, which decreased by US$0.063 per pound of cheese this fiscal year compared to fiscal 2004. Depreciation expense totalled $66.1 million, stable compared to $66.0 million for the last fiscal year. The increase attributed to the inclusion of a full year depreciation from our Argentina operations was offset by a decrease in our Cheese Division (USA) depreciation caused by the appreciation of the Canadian dollar. Net interest expense decreased to $29.1 million in fiscal 2005 from $36.0 million in fiscal 2004. The reduction is attributed to the decrease in interest on long-term debt following repayments made. The appreciation of the Canadian dollar also reduced the interest expense on our US dollar debt. Income taxes totalled $80.5 million for an effective tax rate of 25.7%, compared to 29.5% in fiscal 2004. The following two factors explain the change in the effective tax rate. Firstly, a greater portion of our taxable earnings was generated in Canada, which is subject to lower tax rates than the United States. Secondly, the Company benefited from a one-time tax reduction to adjust future tax balances, due to a reduction in US tax rates, thus reducing income taxes by $3.5 million. For the year ended March 31, 2005, net earnings amounted to $232.1 million, a 9.3% increase over $212.4 million in fiscal 2004. The appreciation of the Canadian dollar eroded net earnings by approximately $3 million, while the one-time tax adjustment added $3.5 million to net earnings. Excluding these two factors, net earnings would have risen by 9.0% compared to fiscal 2004. Diluted net earnings per share Dividends declared per share (in dollars) 2.20 0.60 3 0 . 2 6 6 . 1 0 4 . 0 8 4 . 0 2003 2004 2005 2003 2004 2005 2 2 2 0 0 5 A N N U A L R E P O R T / S A P U T O INFORMATION BY SECTOR Canadian and Other Dairy Products Sector specialty products will continue and we are dedicating our energies and resources in such a way as to capitalize on opportunities in the current market. The sector consists of our Dairy Products Division (Canada) and our Dairy Products Division (Argentina). Revenues (Canadian and Other Dairy Products Sector) Our sales in the retail segment grew at the same pace as our overall volumes, notably in Québec with our specialty and string cheeses. The retail segment accounts for 48% of the revenues in our Canadian cheese activities, the same as the previous fiscal year. Revenues of the Canadian and Other Dairy Products Sector amounted to $2.416 billion, an increase of $254 million or 11.7% over the $2.162 billion in revenues for the previous fiscal year. Of the $254 million increase in revenues in fiscal 2005, approximately 58% or $148 million stems from our Dairy Products Division (Canada), representing a 7% increase over last fiscal year. The remainder of approximately $106 million is attributed to our Dairy Products Division (Argentina), which contributed a full year to the revenues in fiscal 2005 compared to only 18 weeks in fiscal 2004. Relating to the $148 million increase in revenues from our Dairy Products Division (Canada), approximately $49 million relate to higher selling prices as a result of the increase in the cost of milk as raw material. The rest is mainly related to volume growth in our cheese, yogurt, cream and juice categories compared to the previous fiscal year. Saputo is the leader in cheese production in Canada, with about 38% of all the natural cheese manufactured in the country. On the fluid milk side, Saputo’s production accounts for approximately 20% of the Canadian total, while in Argentina the Company ranks third among dairy processors. As for our Canadian cheese activities, our volumes showed a good increase for fiscal 2005, driven by sales of specialty cheeses that continued to grow. This fiscal year the specialty cheese sales volumes rose by almost 10%. We are paying special attention to this category by focusing on promotions and by continuing to support our brands. We believe that consumer interest for these Our cheese marketing activities focused on building strong national brands, and driving sales of higher margin specialty cheeses. In Canada, our flagship cheese brands include Saputo, Cheese Heads, Armstrong, Cayer and Caron. All of these brands received significant advertising and promotional support in fiscal 2005. This included the use of television, print and radio advertising at both the regional and national levels. One of our most successful television campaigns aired in the first quarter in the Québec market, and reinforced Saputo as a leader of Italian cheeses. We also utilized a wide variety of promotional vehicles to support our cheese brands, including in-pack promotions, demos, coupons and promotions customized for specific grocery banners. We launched a number of new cheese products in fiscal 2005, focusing on Italian, Canadian and French specialty cheeses. Our specialty products continue to be recognized for outstanding quality. For example, Cayer Bleubry was the Blue Cheese Category Champion at the 2004 Canadian Cheese Grand Prix. Moreover, eight of our cheeses finished first in their respective categories at the British Empire Cheese Competition held in Ontario in November 2004. We maintained our predominance in the foodservice segment. Sales growth in the segment is the result of the addition of new clients during the course of the fiscal year and higher selling prices caused by the increase in the cost of milk as raw material. This segment accounts for 39% of the revenues in the Canadian cheese activities, same as the previous fiscal year. In fiscal 2005, we increased our specialty cheese market share in this segment. We are pursuing opportunities in specialty cheeses through our national accounts. Revenues (% ) per market segment Dairy Products Division (Canada) 62 Retail 31 Foodservice 7 Industrial Revenues (in millions of dollars) Canadian and Other Dairy Products Sector 2,415.5 9 . 1 6 1 , 2 4 . 7 1 0 , 2 2003 2004 2005 2 0 0 5 A N N U A L R E P O R T / S A P U T O 2 3 At close to 13% of revenues from our Canadian cheese activities, our industrial segment consists of cheese and by-product sales. The increase in our revenues is attributed to more favourable prices on the international by-product market and to the additional sales of skim milk powder, since we serve as a processor of last resort for all excess milk in the three most western Canadian provinces. Our Canadian fluid milk activities enjoyed a slight volume increase over fiscal 2004. The bulk of the increase in revenues is derived from the production and commercialization of Sunny Delight(3) drinks under license for the total Canadian market. This commercialization began in the final quarter of last fiscal year, and we therefore benefited from a full year’s contribution to revenues in fiscal 2005. Our fluid milk and cream market share has remained relatively stable in the Canadian provinces, with the exception of Québec and Ontario, where we are continuing to increase our presence. Breakdown of our revenues remains stable between the retail segment (80%) and the foodservice segment (20%). Our milk marketing resources are deployed in order to maximize our profitability. More precisely, our value-added products such as our yogurts, non-dairy creamers, functional milks and flavoured milks received significant advertising and promotional support. Some examples of such products include Milk 2 Go / Lait’s Go, Dairyland Plus / Nutrilait Plus, Dairyland yogurts and International Delight(3) non-dairy creamers. We continue to focus on product innovation to enhance our reputation as a market leader and to drive incremental revenue and profit. For example, Dairyland Cottage Cheese Combos was launched in the first quarter of fiscal 2005 and is the first and only flavoured single-serve cottage cheese available in Canada. Similarly, Dairyland Li’l Ones Yogurt, launched in the fourth quarter of fiscal 2005, is the first Canadian yogurt specifically formulated for babies and toddlers. In fiscal 2005, we continued with our vending-machine program, with over 500 machines in service across Canada. We intend to pursue the growth potential and increase the number of vending- machines throughout Canada into appropriate locations. The dairy products market in Canada is both stable and competitive. No trend was observed in the market that would necessitate alternate ways of managing either our prices, rebates or discounts. In Argentina, our activities continue to develop at an interesting pace. Revenues from these activities for fiscal 2005 amounted to $150.3 million, surpassing the revenue trend for the division at the acquisition date. Strong product demand from the international market has allowed us to grow our export revenues throughout the fiscal year. Our domestic market also benefited from strong local conditions. These factors were the major contributors allowing the division to achieve the fiscal 2005 revenues. (3) Trademarks used under license. 2 4 2 0 0 5 A N N U A L R E P O R T / S A P U T O Revenues (% ) per geographic segment Dairy Products Division (Argentina) 56 International 44 Domestic EBITDA (Canadian and Other Dairy Products Sector) At March 31, 2005, our earnings before interest, income taxes, depreciation and amortization (EBITDA) totalled $244.2 million, as compared to $209.9 million a year earlier, an increase of $34.3 million or 16.3%. The EBITDA margin in this sector climbed from 9.7% in the previous fiscal year to 10.1% in fiscal 2005. Our Argentina activities throughout the fiscal year have continued to improve their EBITDA margins, although inferior to comparable Canadian activities. Included in our EBITDA for fiscal 2005 is a $2.6 million gain on disposal of fixed assets held for sale. The increase in the EBITDA is attributed to several factors. In fiscal 2005, we worked on further consolidating our manufacturing operations in response to the rationalization measures implemented during fiscal 2004. Important changes were implemented so that we would be in a position to secure the savings that were anticipated from those rationalization measures. These savings began to materialize in the second quarter, and amounted to roughly $5 million for fiscal 2005. We have improved our operational efficiencies and expect to generate annual savings of approximately $7 million. Fiscal 2004 EBITDA included rationalization expenses of $7.8 million. In addition, the increase in our cheese volumes contributed to the EBITDA. Furthermore, serving as a processor of last resort for all excess milk in the three most western Canadian provinces, we had access to milk surpluses that enabled us to increase our sales volumes of skim milk powder, which contributed to the results but do not generate the same EBITDA margins as our cheese revenues. Also our EBITDA benefited from a full year’s contribution of Sunny Delight(3) drinks, which began commercialization in the final quarter of last fiscal year. Finally, during fiscal 2005 the market for by-products, although volatile, had a favourable impact of $1.3 million compared with fiscal 2004. Despite the delay in the realization of savings relative to certain rationalization measures, the Canadian and Other Dairy Products Sector performed well. The progress made in sales volumes of our cheeses, juices, yogurts and flavoured milks enabled the sector to EBITDA (in millions of dollars) Canadian and Other Dairy Products Sector 244.2 9 . 9 0 2 6 . 9 9 1 2003 2004 2005 strongly position the Company in the Canadian market. We believe there are other opportunities for growth in the market, especially in Québec and in Ontario, where we have a relatively small presence. Furthermore, the merger of the former Cheese and Milk divisions (Canada) into a single operating unit, enabled us to identify certain opportunities that should generate additional savings both in administrative terms and at the logistics, transportation and distribution levels. We are currently working on taking full advantage of every targeted opportunity. Outlook (Canadian and Other Dairy Products Sector) The consumer excitement over specialty cheeses observed in fiscals 2004 and 2005 prompted us to redefine the positioning of those products in our operations. We plan to take advantage of that consumer enthusiasm by increasing our marketing support through redefining our packaging and brand names among other things. Our manufacturing processes being stable, reliable and efficient, we believe that we are in a position to expand the Company through this developing niche. The recent acquisition of the activities of Fromage Côté S.A and Distributions Kingsey Inc. will complement our specialty cheese business and provide opportunities for growth. The acquisition will add approximately $110 million to revenues. The purchase price was $52.9 million on a debt-free basis. We will, in the coming fiscal year, prepare an action plan covering all aspects of this operation. As for our Canadian fluid milk activities, we will be concentrating on developing our customer base, with our juice, yogurt and flavoured milk products generating more favourable EBITDA margins. At the same time, our manufacturing efficiency remains a priority and we will continue to be a low-cost processor. We are also carrying on with our vending-machine program as well as with our efforts to increase our market share in Québec and in Ontario. During fiscal 2005, certain fixed asset investments were completed in our Dairy Products Division (Canada) in relation to plant capacity. These capital investments started in fiscal 2004. Taking into consideration that sales volumes have increased both in the cheese and fluid milk activities, our excess production capacity went from 20% to 18% in our Canadian cheese activities and from 32% to 31% in our fluid milk activities. For our Argentina activities, great progress has been made this current fiscal year. We were successful in integrating the Saputo systems and values. Capital investments have been made with the installation of new technologies and equipment that will allow us to extend our product offering and improve our profitability. We are committed in the following fiscal year to continue the capital investments required to make this division a success. We plan to add $30 million of capital investments for our Argentina operations in fiscal 2006. This will allow the Company to manage its by-products and take full advantage of the opportunities, on both the international and domestic markets. 2 0 0 5 A N N U A L R E P O R T / S A P U T O 2 5 US Dairy Products Sector Our Cheese Division (USA) performed well under difficult conditions in fiscal 2005. Although the division experienced a more favourable average block market per pound of cheese, it was negatively affected by the relationship between the average block market per pound of cheese and the cost of milk as raw material. In fiscal 2005, we were able to maintain a good balance among our three market segments: retail, foodservice and industrial. Revenues (US Dairy Products Sector) Fiscal 2005 revenues totalled $1.309 billion, an increase of $68 million or 5.5% over the $1.241 billion in revenues attained in fiscal 2004. The higher average block market per pound of cheese this fiscal year had a positive impact of $148 million on the revenues we generated in the United States. The average block market per pound of cheese during fiscal 2005 was US$1.67, a US$0.28 increase over the average US$1.39 in fiscal 2004. The high market at the end of fiscal 2004 along with early price increases implemented on fixed price items took their toll on overall volumes in fiscal 2005. Overall sales volumes declined by 3.0% for the fiscal year. Most of the decline took place within the fiscal 2005 second quarter following the effect of a high block market along with price increases. The majority of the volume decline was concentrated in commodity type cheeses where the industry struggled with over-capacity issues. Retail volumes suffered slightly in light of the higher prices during the fiscal year. On the other hand, volumes in the string cheese, hard cheese and other specialty cheese categories all experienced increases over the previous fiscal year. The appreciation of the Canadian dollar throughout the fiscal year negatively affected revenues by approximately $70 million. We market our products in three market segments: retail, foodservice and industrial. Our pricing, rebating and discounting practices in all three segments were unchanged throughout the fiscal year. The retail segment accounts for 30% of our total sales volume in the United States, same as the previous fiscal year. In the last fiscal year, we concentrated our marketing efforts on supporting our brands with distinctive promotions to increase market share in several highly competitive retail cheese categories. Frigo Cheese Heads remains the number one brand of string cheese in the United States. This brand is supported with consumer promotion, utilizing on-pack offers, coupon distribution, and Web and print advertising. In the summer we offered the Crayola Twistables(4) crayon promotion and followed up in the fall with a Simpsons(5) promotion. Several new line extensions were introduced to take advantage of consumer trends within the cheese category such as Frigo Cheese Heads Snack Sticks containing mild Cheddar and Colby jack stick cheeses to complement our Cheese Heads line. Stella Shaved Parmesan Deli Cups were introduced in a format that helps satisfy consumers’ desires for a restaurant-quality dining experience at home, as salads topped with shaved Parmesan have been featured on many restaurant menus. We also launched a line extension of flavoured fetas under the Treasure Cave brand including tomato and basil, garden herb and reduced fat. Feta cheese consumption continues to grow and new flavours broaden consumer trial and repeat purchasing. Our marketing efforts were recognized at the International Dairy Foods Association 2005 Achieving Excellence Awards by winning Best Overall Promotion, Best Overall Website, Best New Cheese Product, Best Cheese Package Redesign, and Best Cheese Package Design. Sales volumes (% ) per market segment US Dairy Products Sector 44 Foodservice 30 Retail 26 Industrial Revenues (in millions of dollars) US Dairy Products Sector 1,308.7 0 . 1 4 2 , 1 8 . 2 1 2 , 1 2003 2004 2005 (4) Crayola, Twistables, chevron, and serpentine are registered trademarks, smile design is a trademark of Binney & Smith. (5) THE SIMPSONSTM & ©2004 Twentieth Century Fox Film Corporation. All Rights Reserved. 2 6 2 0 0 5 A N N U A L R E P O R T / S A P U T O The foodservice segment accounts for 44% of our total sales volume in the United States, a slight increase compared to last fiscal year. We experienced volume growth in this segment due to the quality of our products, the quality of our customer service, and the quality of our people at every level throughout the organization. During the fiscal year we concentrated on national accounts and were successful in landing new customers in that channel. At the same time, we worked hand in hand with our distributors to enhance their sales. The industrial segment represents 26% of our total sales volume in the United States, a slight decrease compared to last fiscal year. Market volatility and excess production capacity in the industry inhibited our ability to meet our volume growth targets for this segment. The price-sensitive, large industrial customer typical to this segment is an attractive target for companies looking to fill idle capacity quickly. In the short run, we do not sacrifice profitability for the sake of market share. In the longer term however, we work to develop more effective formulations that meet larger customers’ expectations for product performance and price. Products in the industrial segment also include whey by-products, sweetened condensed milk and eggnog. Prices of by-products in the international market rebounded in fiscal 2005. EBITDA (US Dairy Products Sector) During fiscal 2005, earnings before interest, income taxes, depreciation and amortization totalled $137.0 million, a $23.9 million or 14.9% decrease compared to $160.9 million posted in fiscal 2004. Fiscal 2005 was a volatile year. The overall average block market per pound of cheese of US$1.67 this fiscal year was higher compared to US$1.39 last fiscal year. This benefited the EBITDA this fiscal year by providing a better basis of absorption for our fixed costs, while a less favourable relationship between the average block market per pound of cheese and the cost of milk as raw material was observed this fiscal year compared to last fiscal year. Fiscal 2004 started with a block market per pound of cheese of US$1.08 and ended with US$2.09, setting the stage for major declines from that peak and extreme volatility in fiscal 2005 which ended the year at US$1.62. The margin is compressed in a declining market because the milk cost follows the block market on a delayed basis. In theory, these are timing differences which balance out over time. There is no guarantee however, that the balancing will occur within any particular fiscal year. Moreover, the balancing depends on volume remaining relatively constant throughout the period. With regards to inventories, we started the fiscal year with a block market per pound of cheese at US$2.09 and ended the year at US$1.62, causing an unfavourable impact on the realization of inventories. These combined factors had a negative impact of $29.7 million on EBITDA. Prices of by-products on the international markets rebounded in fiscal 2005, generating a positive impact on EBITDA of $1.4 million. However, the appreciation of the Canadian dollar created a shortfall in EBITDA of $7.6 million. These factors offset an increase of approximately $12 million in our EBITDA generated by continued improvements in our manufacturing processes, price increases implemented on fixed price items and better product mix within the retail segment. Outlook (US Dairy Products Sector) US Dairy Product Sector continues to produce quality products that meet the needs of our clientele. During the past fiscal year, we are particularly proud to have increased our sales in specialty and branded products such as string cheeses, Parmesan cheeses, Asiago cheese and others. This is a testimony to the continuous quality of products and services provided by Saputo people from plant floor right up to the customer’s location. We are looking forward to the upcoming fiscal year with optimism as we are poised to launch several new products to complement our Frigo Cheese Heads line, our specialty Stella hard and blue cheeses. We also embrace the new fiscal year with a mandate to be innovative at every level. First at the operations level as we will apply innovative processes and techniques to diminish the impact of raw material and overhead cost increases, then at the marketing level with innovative promotions, product creation and packaging, and EBITDA (in millions of dollars) US Dairy Products Sector 137.0 9 . 0 6 1 1 . 0 2 1 2003 2004 2005 2 0 0 5 A N N U A L R E P O R T / S A P U T O 2 7 at the sales level to enhance service to our clients and finally, internally, to continually improve the training of our employees. The recent acquisition of the activities of Schneider Cheese, Inc. in May 2005 will further increase our presence in the string cheese category. These assets will complement our current cheese- making activities in the United States. The acquisition will add approximately US$40 million to revenues. The purchase price was US$24.4 million on a debt-free basis. During fiscal 2006, we will prepare an action plan covering all aspects of this operation in order to bring added-value to its activities. During fiscal 2005, we completed projects that increased our capacity in certain manufacturing locations and enhanced the production capabilities of our specialty plants for greater efficiency and quality so that we can remain competitive despite rising energy, ingredients and other manufacturing costs. In the upcoming fiscal year, we will continue to evaluate our operations and will accordingly invest in projects that will enhance our profitability and better serve the needs of our clients. We are currently running at 90% capacity after having completed the investment projects. If necessary, we could add additional manufacturing capacity to our plants with minimal capital investments. Once again in fiscal 2005, the fluctuations in the pricing of dairy products on the Chicago Mercantile Exchange (CME) significantly affected the results of our Cheese Division (USA). As mentioned in prior fiscal years, base prices are set according to daily transactions conducted at the CME. The CME acts as an auction market for certain commodity products where brokers represent buyers and sellers. Cheese is bought and sold on a daily basis, whereas butter is traded three days a week. The prices established at the end of a session serve as the reference price for most cheese and butter sales made in the United States. The CME market for Cheddar cheese blocks began fiscal 2005 at US$2.09, ranged from a low of US$1.36 to a high of US$2.20 during fiscal 2005, and closed at US$1.62 at March 31, 2005. These fluctuations in the cheese block market have had a significant effect on the results of our Cheese Division (USA). To remain successful, we must continually monitor the cheese block market and react accordingly. We are sensitive to the situation and we will actively search for permanent solutions that could provide more stability. For a second consecutive fiscal year, the appreciation of the Canadian dollar negatively affected our results in fiscal 2005. It is extremely difficult to predict fluctuations in the US or Canadian currencies as exchange rates can be affected by many factors. 2 8 2 0 0 5 A N N U A L R E P O R T / S A P U T O Grocery Products Sector The Grocery Products Sector consists of the Bakery Division and accounts for 4.1% of the Company’s revenues. Revenues (Grocery Products Sector) Revenues from the Grocery Products Sector totalled $158.8 million for the fiscal year ended March 31, 2005, down $8.6 million in comparison with the previous fiscal year. During fiscal 2005, sales volumes also fell by 4.9% in comparison with the previous fiscal year. The decrease in volume is attributable to several factors. In the third quarter of fiscal 2005, we took over the distribution network in the Maritimes, which was previously operated by a third party. Although a positive step, it had a slight downward effect on our revenues due to the transition period. In addition, the arrival of Easter in April 2004 and March 2005 this fiscal year, has negatively affected our revenues twice, since this is traditionally a slower period for us. Finally, on February 7, 2005, we increased the base selling price for our economy- and family-size products, which affected some of our volumes. Throughout the fiscal year, we were active in supporting our brand names. The category in which we operate requires innovation and new features on a regular and a seasonal basis. New products were introduced for the Christmas and Easter holiday periods, namely Brownies Dominoël, Ah Caramel! Black Forest, Mini 1/2 Moon Strawberry-Vanilla and the Ah Caramel! Easter Eggs. Other items targeting younger consumers, like Dynamite brand cakes, were introduced as permanent products. With the aim of offering our customers the products they seek, we introduced at the end of fiscal 2005 the new trans-fat-free Hop&Go! line, backed by an advertising campaign on television and magazines which started at the beginning of fiscal 2006. Our leader brands Jos. Louis, Ah Caramel!, 1/2 Moon and Brownies are now offered either in a trans-fat-reduced or trans-fat-free formula. In Canada, despite an increasingly competitive market, the division was able to retain its market share. With regards to the US market, there was no material fluctuation in sales during the fiscal year. The introduction of our products to this market remains a small-scale undertaking, proceeding a step at a time and in well defined areas. EBITDA (Grocery Products Sector) EBITDA for the fiscal year ended March 31, 2005, amounted to $26.6 million, a drop of $5.9 million from that of the previous fiscal year. The EBITDA profit margin dipped from 19.4% in fiscal 2004 to 16.7% in fiscal 2005. Several elements account for these declines. Firstly, the drop in revenues in fiscal 2005 compared to fiscal 2004, as mentioned in the revenues section above, created a reduction in EBITDA. Secondly, compared to the same period last fiscal year, we were subject to certain manufacturing cost increases during fiscal 2005, including increases in raw material and packaging costs, as well as labour costs. Moreover, as mentioned in our fiscal 2004 annual report, the division incurred additional expenses during fiscal 2005 related to the pension plan of approximately $2.3 million as compared to fiscal 2004. Throughout fiscal 2004 and fiscal 2005, fixed-asset investments have enabled us to improve our production efficiency by switching to the use of robotization in certain operations. These increased efficiencies, however, were not sufficient to preserve our EBITDA margin. Outlook (Grocery Products Sector) Fiscal 2005 has turned out to be a highly constructive year, enabling the Bakery Division to identify the various market growth potentials in Canada. In order to offset the impact of various cost increases, we announced an increase in the base price of our family- and economy-size products. Even if in the short term, this price increase had an effect on our sales volumes, we are confident that the sales volumes will resume to normal levels. We already practice Revenues (in millions of dollars) Grocery Products Sector 158.8 9 . 7 6 1 4 . 7 6 1 EBITDA (in millions of dollars) Grocery Products Sector 26.6 2 . 3 3 5 . 2 3 2003 2004 2005 2003 2004 2005 2 0 0 5 A N N U A L R E P O R T / S A P U T O 2 9 daily raw-material supply management, and we are subject to, like any manufacturer, increases in raw-material costs such as packaging and labour costs. Contrary to past practices, the revision of our selling prices will take place annually to ensure that the division can continue to grow. We took over our Maritime distribution network to have greater control of market penetration, which incidentally will be receiving in fiscal 2006 additional marketing investments to support the re- launching of our Hop&Go! brand. The snack cake, cereal bar and tart categories experienced somewhat difficult times in fiscal 2005 with the emergence of the trans-fat concern. In our position as leader, we were quick to introduce different products that responded to this new reality. We will be increasing our efforts in the upcoming fiscal year to expand our product offering at this level. The efforts from our research and development activities will support the division in order to market products that will meet consumer demands. As a way of expanding our business, we developed over fiscal 2005 certain products for the in-store bakery and foodservice segments, and we will over fiscal 2006 present our products to the market. We believe growth possibilities in those segments are realistic. In the United States, we are exploring other avenues to sell our products through co-packing arrangements for whom we would manufacture products for US customers. The result of these initiatives will enable us to make better use of the excess capacity of our plant, which totals about 31%. Fixed- asset investments anticipated for fiscal 2006 will be in support of our development efforts. Even though we operate in an industry referred to as one of indulgence, we remain convinced that consumers will continue to treat themselves. Our responsibility as leader in the snack-cake category in Canada will be to contribute to the growth of the entire category while never losing sight of consumer concerns regarding healthy eating. As mentioned in our fiscal 2004 annual report, we took the decision to retain the Bakery Division and to invest approximately $20 million over the next three years for the development and the redeployment of its brands. In fiscal 2005, we took further steps to consolidate our position and strengthen the division through different initiatives. Fiscal 2006 will be the first of the three-year plan for which the investments will be covered by additional profitability generated within the same three years. LIQUIDITY Cash generated by operating activities before changes in non-cash working capital items totalled $305.3 million for fiscal 2005, slightly higher compared to the $301.3 million for fiscal 2004. During fiscal 2005, non-cash operating working capital items used $28.8 million, compared to a usage of $13.7 million in fiscal 2004. The increased usage is the result of increased inventory values at our Dairy Products Division (Canada) and our Cheese Division (USA). The increase in our Canadian operations is attributed to an increase of approximately 8% in the cost of milk as raw material. Our Cheese Division (USA) inventory increase is attributed to a combination of higher inventory volumes and the increased inventory cost in line with the higher average block market per pound of cheese in fiscal 2005. In investing activities, the Company added $81.8 million in fixed assets, of which nearly 35% went into the replacement of fixed assets. The remaining funds were used to implement new technologies, as well as to expand and increase certain manufacturing capacities. The total of fixed asset spending compares favourably to our original budget of $80 million. The Company also disposed of unused assets in fiscal 2005 for total proceeds of $5.4 million, mostly in our Dairy Products Division (Canada). As for financing activities, the Company repaid approximately $44 million of long-term debt. With this long-term debt repayment, the Company fully repaid the Canadian long-term debt under its initial contractual obligations of February 2001 governing loans issued as part of the acquisition of Dairyworld. The Company also repaid $68.8 million of bank loans. For fiscal 2005, the Company issued shares for a cash consideration of $13.5 million as part of the Stock Option Plan, and paid out $59.5 million in dividends. FINANCIAL RESOURCES At March 31, 2005, the Company’s working capital stood at $452.6 million, an increase of $155.4 million over the $297.2 million at the end of the previous fiscal year. The increase is attributed mostly to the complete repayment of the current portion of long-term debt and the significant reduction of outstanding bank loans as well as the increased cash positions as at March 31, 2005, resulting from the strong cash flows generated by the Company in fiscal 2005. Our interest bearing debt-to-equity ratio has also improved significantly, from 0.39 as at March 31, 2004 to 0.21 as at March 31, 2005. The Company’s financial condition continues to improve. As operations continue to generate positive cash flows, we do not foresee any additional working capital requirements. 3 0 2 0 0 5 A N N U A L R E P O R T / S A P U T O SHARE CAPITAL INFORMATION Share capital authorized by the Company is comprised of an unlimited number of common and preferred shares. The common shares are voting and participating. The preferred shares can be issued in one or more series, and the terms and privileges of each class must be determined at the time of their creation. Issued as at Authorized March 31, 2005 Issued as at June 1, 2005 Common shares Preferred shares Stock options Unlimited Unlimited 104,527,282 104,625,499 None 5,551,832 None 4,797,915 OFF-BALANCE SHEET ARRANGEMENTS For all of its operations, the Company has certain off-balance sheet arrangements, consisting primarily of leasing certain premises as well as certain lease agreements for equipment and rolling stock. These agreements are recorded as operating leases. Future minimum lease payments as at March 31, 2005 totalled $38.9 million. The Company does not use derivative financial instruments for speculation. Saputo uses certain derivative financial instruments in specific situations. In the normal course of business, our Canadian operation imports certain products and our management of foreign exchange risk occasionally leads us to make certain foreign currency purchases in euros, of which the total amount as at March 31, 2005 was 1,200,000 euros. The Company periodically enters into forward contracts to protect itself against price fluctuations on certain commodities when it has secured a commitment to sell a finished product. As at March 31, 2005, the fair value of these contracts is $0.9 million. The Company’s exposure to the derivative financial instruments used is not affected by changing economic conditions, since these instruments are generally held until maturity. Notes 16 and 17 to the consolidated financial statements describe the Company’s off-balance sheet arrangements. For fiscal 2006, we foresee making about $100 million in additions to fixed assets, with approximately $60 million earmarked for new technology and added manufacturing capacity. The remainder will be devoted to replacing certain fixed assets. The increase in fixed asset additions is due to the continuing investment in our Argentina operations along with strategic investments planned for our Dairy Products Division (Canada). The Company expects fixed- asset depreciation expense in the amount of approximately $70 million. All funds required for the additions to fixed assets will be generated from Company operations. As at March 31, 2005, the Company had no significant commitments related to fixed- asset acquisitions. The Company currently has at its disposal bank credit facilities of $234 million, $15.1 million of which are drawn. The Company also has $41.5 million of cash on hand. Should the need arise, the Company can make additional financing arrangements to pursue growth through acquisitions. BALANCE SHEET In comparison to March 31, 2004, the main balance sheet items at March 31, 2005 varied due to the appreciation of the Canadian dollar versus both the US dollar and the Argentina peso. The conversion rate of our US operation’s balance sheet items in US currency was CND$1.2096 per US dollar as at March 31, 2005, compared to CND$1.3113 per US dollar as at March 31, 2004. The conversion rate of our Argentina operation’s balance sheet items in Argentina pesos was CND$0.4135 per Argentina peso as at March 31, 2005, compared to CND$0.4570 per Argentina peso as at March 31, 2004. The increased Canadian dollar results in lower values recorded for the balance sheet items of our foreign operations. From an operations perspective, as at March 31, 2005, our inventory levels were approximately $32 million higher than levels from the previous fiscal year. The inventory increase is attributed to our Dairy Products Division (Canada), resulting principally from an increase of approximately 8% in the cost of milk as raw material, and our Cheese Division (USA), due to a combination of higher inventory volumes and the increased inventory cost in line with the higher average block market per pound of cheese in fiscal 2005. In fiscal 2006, our objective is to reduce our inventory by approximately $35 million. As at March 31, 2005, the amount of current portion of long-term debt has been eliminated following repayments made throughout the fiscal year. Income taxes payable increased from $26.0 million at March 31, 2004 to $67.4 million at March 31, 2005. The increase is the result of tax planning initiatives undertaken by the Company that deferred various tax payments. The change in foreign currency translation adjustment listed under shareholders’ equity is determined on the basis of the change in foreign exchange rates. The Company’s total assets stood at $2.133 billion as at March 31, 2005, compared to $2.070 billion as at March 31, 2004. 2 0 0 5 A N N U A L R E P O R T / S A P U T O 3 1 GUARANTEES From time to time, the Company enters into agreements in the normal course of its business, such as service arrangements and leases, and in connection with business or asset acquisitions or disposals, agreements, which by nature may provide for indemnification to third parties. These indemnification provisions may be in connection with breach of representations and guarantees and for future claims for certain liabilities, including liabilities related to tax and environmental issues. The terms of these indemnification provisions vary in duration. Note 16 to the consolidated financial statements discusses the Company’s guarantees. CONTRACTUAL OBLIGATIONS ACCOUNTING STANDARDS Applied Standards Disposal of Long-Lived Assets and Discontinued Operations Section 3475 of the Canadian Institute of Chartered Accountants (CICA) Handbook, Disposal of Long-Lived Assets and Discontinued Operations, established standards for the recognition, measurement, presentation and disclosure of long-lived assets. It also establishes standards for the presentation and disclosure of discontinued operations, whether or not they include long-lived assets. The requirements apply to disposal activities initiated, following the Company’s commitment to pursue a plan, effective May 1, 2003. The Company prospectively adopted these new recommendations effective in fiscal 2004, which had no significant impact on the Company’s consolidated financial statements. The Company’s contractual obligations consist of commitments to repay its long-term debt as well as certain leases of premises, equipment and rolling stock. Asset Retirement Obligations Note 7 describes the Company’s commitment to repay long-term debt, and Note 16 describes its lease commitments. (in thousands of dollars) 2006 2007 2008 2009 2010 Subsequent years Total Long-term debt - 36,388 21 - 205,632 60,480 302,521 Minimum lease 9,886 8,322 6,113 5,066 4,064 5,424 38,875 TOTAL 9,886 44,710 6,134 5,066 209,696 65,904 341,396 Section 3110 of the CICA Handbook, Asset Retirement Obligations, requires the recognition of liabilities for legal obligations, whether they are of a legal, prescribed, contractual or other nature, and normally when these obligations arise. The liability’s fair value is initially measured and the related costs are capitalized in the carrying amount of the fixed asset in question. The asset retirement cost is amortized in the income statement using a systematic and rational method. The Company prospectively adopted these new recommendations effective April 1, 2004, which had no significant impact on the Company’s consolidated financial statements. Hedging Relationships RELATED PARTY TRANSACTIONS In the normal course of business, the Company receives and provides goods and services from and to companies subject to significant influence by its principal shareholder. These goods and services of an immaterial amount are compensated by a counterpart equal to the fair market value. The CICA Accounting Guideline AcG-13, Hedging Relationships, specifies the circumstances in which hedge accounting is appropriate, and it examines in particular the identification, documentation, designation and effectiveness of hedge accounting, as well as the discontinuance of hedge accounting. The Company prospectively adopted these new recommendations effective April 1, 2004, which had no significant impact on the Company’s consolidated financial statements. Employee Future Benefits Section 3461 of the CICA Handbook, Employee Future Benefits, expanded the disclosure requirements for these plans on both annual and financial statements. The Company prospectively adopted these new recommendations effective April 1, 2004. interim 3 2 2 0 0 5 A N N U A L R E P O R T / S A P U T O Accounting by a Customer for Certain Consideration Received from a Vendor Portfolio Investment The CICA Emerging Issues Committee EIC-144, Accounting by a Customer for Certain Consideration Received from a Vendor, provides guidance on how a customer of a vendor's products should account for cash consideration received from a vendor. The Company retroactively adopted this new recommendation effective July 1, 2004, which had no significant impact on the Company's consolidated financial statements. The portfolio investment is recorded at cost. The Company carries out an annual valuation to ensure that the fair value of the investment is not lower than the carrying amount. To calculate an estimated fair value, the Company uses the company’s EBITDA by applying to it a multiple based on comparable industry standards. If the portfolio investment undergoes a decline in value that is permanent, its carrying amount would be written down to account for this decline in value. Consolidation of Variable Interest Entities Goodwill The accounting standards require that goodwill no longer be amortized, and that an impairment test be performed annually or more frequently when events occur or circumstances arise that could indicate a reduction in its fair value. To determine any decline in value, each of the respective accounting units are required to undergo an assessment. The Company’s assessments are based on multiples for Saputo and for the industry. These multiples are applied to EBITDA and net assets. Should the calculated value be lower than the book value, a write-down would be taken. The Company has performed the impairment test, no write-down was necessary. Stock Based Compensation The Company uses the fair value based method to expense stock based compensation. With this method, the Company records a compensation cost over the vesting period of the options granted. The expected useful life of options used for calculating the fair value of options is based on management’s experience and judgment. Trademarks Impairment testing has to be performed on all trademarks annually. Estimated future cash flows to be derived from the trademarks are discounted to the present using current market rates. The discounted cash flow is compared to the carrying value of the trademarks. Should the discounted cash flow be lower than the book value, a write-down would be taken. The Company has performed the impairment test, no write-down was necessary. The CICA Accounting Guideline AcG-15, Consolidation of Variable Interest Entities, requires enterprises to identify Variable Interest Entities in which they have an interest, to determine if they are the primary beneficiary of such entities, and, if so, to consolidate them. The Company prospectively adopted this new recommendation effective January 1, 2005, which had no impact on the Company's consolidated financial statements. Future Standards The CICA issued in April 2005 new accounting standards for recognition, measurement and disclosure of financial instruments, hedges and comprehensive income. The new requirements are all to be applied at the same time and are effective for interim and annual financial statements relating to fiscal years beginning on or after October 1, 2006. The Company is presently assessing the impact of the new recommendations on the consolidated financial statements. CRITICAL ACCOUNTING POLICIES AND USE OF ACCOUNTING ESTIMATES in The preparation of consolidated financial statements accordance with generally accepted accounting principles requires management to make estimates. These estimates are established on the basis of previous fiscal years and management’s best judgment. Management continually reviews these estimates. Actual results may differ from those estimates. The following section establishes the main estimates used in preparing the consolidated financial statements of Saputo Inc. Fixed Assets In order to allocate the cost of fixed assets over their useful lives, estimates of the duration of their useful lives must be carried out. The cost of each fixed asset will then be attributed over the duration of its useful life and amortized year after year on this basis. 2 0 0 5 A N N U A L R E P O R T / S A P U T O 3 3 Sensitivity Analysis Pension Plans and Other Employee Future Benefits (in thousands of dollars) Anticipated rate of return on assets Effect of an increase of 1% Effect of a decrease of 1% Discount rate Effect of an increase of 1% Effect of a decrease of 1% Assumed growth rate of overall healthcare costs Effect of an increase of 1% Effect of a decrease of 1% Pension Plans The Company offers and participates in defined contribution pension plans of which close to 82% of its active employees are members. The net pension expenditure under these types of plans is generally equal to the contributions made by the employer. The Company also participates in defined benefit pension plans of which the remaining active employees are members. The cost of these pension benefits earned by employees is actuarially determined using the projected benefit method prorated on services and using management’s assumptions bearing on, among other things, the discount rate, expected return on plan assets, rates of compensation increase and the retirement age of employees. All of these estimates and assessments are formulated with the help of external consultants. The discount rate is determined on the basis of the effective rates of return on high-quality long-term corporate bonds, as required by the adjusted standard, to account for the duration of plan liability. The rate was downwardly adjusted last fiscal year from 6.25% to 6%, effective December 31, 2004. We expect that this adjustment will increase our expense during fiscal 2006 by approximately $0.5 million. We established the expected average return on invested assets at 7.9% given the type and combination of these assets. This rate has been revised to 7.3% for fiscal 2006. This assumption is deemed reasonable and is supported by our external consultants. We expect that this adjustment will increase our expense during fiscal 2006 by approximately $1 million. The compensation growth rate was set at 3.5% over the long term, taking into consideration estimated future inflation rates. Pension plans Other employee future benefits Accrued benefit obligations N/A N/A (18,434) 20,699 N/A N/A Net expense (1,697) 1,697 (1,669) 1,893 N/A N/A Accrued benefit obligations Net expense N/A N/A (2,274) 2,783 2,439 (2,075) N/A N/A (563) 395 224 (186) The Company also offers a post-retirement medical benefit program. For the purposes of assessing costs related to this program, the hypothetical annual growth rate of medical costs was set at between 5.5% and 7.0% for fiscal 2006 and, based on the assumptions used, these rates should gradually decline to reach 5.0% in fiscal 2010 and subsequent fiscal years. Any change in these assumptions or any plan experience that differs from the expected entails actuarial gains or losses with respect to expected results. If these gains or losses exceed 10 % of the maximum of the asset or liability of the plans, they are amortized over the expected average remaining service life of the group of employees participating in the plans, in compliance with CICA recommendations. The above table presents a sensitivity analysis of the key economic assumptions used to measure the impact on defined-benefit pension obligations, on other employee future benefit obligations and on net expenditure. This sensitivity analysis must be used with caution, as its results are hypothetical, and variations in each of the key assumptions could turn out not to be linear. The sensitivity analysis should be read in conjunction with Note 15 of the Consolidated Financial Statements. The sensitivity of each key variable has been calculated independently of the others. The measurement date of pension plan assets and liabilities is December 31 of each fiscal year. Pension plan assets are held by several independent trusts, and the average composition of the overall portfolio as at December 31, 2004 was 4% in cash and short-term investments, 47% in bonds and 49% in shares of Canadian, US and foreign companies. In the long term, we do not expect any major change to this asset allocation. In comparison to December 31, 2003, the average composition was 2% in cash and short-term investments, 44% in bonds and 54% in shares. 3 4 2 0 0 5 A N N U A L R E P O R T / S A P U T O For defined-benefit plans, actuarial valuations were performed as at December 2002 and 2003, covering all obligations with respect to this type of plan. In light of these valuations, a solvency deficiency of 20 million was posted on December 31, 2003. This deficiency is primarily due to an increase in plan liabilities resulting from a sharp decline in the discount rate prescribed by provincial legislation on pension plans, and from insufficient asset returns at the time of the evaluation. In accordance with this provincial legislation, an additional contribution is required for the next five years to pay off this deficiency. An additional payment of $6.1 million was made in fiscal 2005 ($4.6 million for fiscal 2004). The additional payment required for fiscal 2006 will be $6 million. The next evaluation for certain pension plans is scheduled for December 2005. Future Income Taxes The Company follows the liability method of accounting for income taxes. Deferred income tax assets and liabilities are measured using enacted or substantially enacted income tax rates expected to apply to taxable income in the years in which temporary differences are expected to be recovered or settled. As a result, a projection of taxable income is required for those years, as well as an assumption of the ultimate recovery or settlement period for temporary differences. The projection of future taxable income is based on management’s best estimates and may vary from actual taxable income. On an annual basis, the Company assesses its need to establish a valuation allowance for its deferred income tax assets. Canadian, US and international tax rules and regulations are subject to interpretation and require judgment on the part of the Company that may be challenged by the taxation authorities. The Company believes that it has adequately provided for future tax obligations that may result from current facts and circumstances. Temporary differences and income tax rates could change due to fiscal budget changes and/or changes in income tax laws. RISKS AND UNCERTAINTIES Product Liability Saputo’s operations are subject to certain dangers and risks of liability faced by all food processors, such as the potential contamination of ingredients or products by bacteria or other external agents that may accidentally be introduced into products or packaging. Saputo has quality control procedures in place within its operations to reduce such risks and has never experienced any material contamination problems with its products. However, the occurrence of such a problem could result in a costly product recall and serious damage to Saputo’s reputation for product quality. We maintain product liability and other insurance coverage that we believe to be generally in accordance with the market practice in the industry. Supply of Raw Materials Saputo purchases raw materials that may represent up to 85% of the cost of products. It processes raw materials into the form of finished edible products intended for resale to a broad range of consumers. Thus, variations in the price of foodstuffs can influence Company results upwards or downwards, and the effect of any increase of foodstuff prices on results depends on the ability of the company to transfer those increases to its customers, and this in the context of a competitive market. US and International Markets The price of milk as raw material and the price of our cheese products in the United States and Argentina and by-products on international markets are based on market supply and demand forces. The prices are tied to numerous factors, such as the health of the economy and supply and demand levels for dairy products in the industry. Price fluctuations may affect the Company’s results. The effect of such fluctuations on our results will depend on our ability to implement mechanisms to reduce them. 2 0 0 5 A N N U A L R E P O R T / S A P U T O 3 5 Competition Financial Risk Exposures The food processing industry in North America is extremely competitive. Saputo participates in this industry primarily through its dairy operations. The Canadian dairy industry is highly competitive and is comprised of three major competitors, including Saputo. In the United States and Argentina, Saputo competes in the dairy industry on a national basis with several regional and national competitors. Our performance will be dependent on our ability to continue to offer quality products at competitive prices, and this applies to all the countries in which we operate. Saputo has financial risk exposure to varying degrees relating to the foreign currency of our United States and Argentina operations. Approximately 34% and 4% of our sales are realized in the United States and Argentina, respectively. However, the cash flows from these operations act as a natural hedge against exchange risk. Cash flows from the United States also constitute a natural hedge against the exchange risk related to debt expressed in US dollars. At March 31, 2005, Saputo’s long-term debt was made up of the US senior notes only, which are at a fixed rate throughout their term. Consolidation of Clientele Regulatory Considerations During the last few years, we have seen important consolidation in the food industry in all market segments. Given that we serve these segments, the consolidation within the industry resulted in a decrease in the number of clients and an increase in the relative importance of some clients. Our ability to continue to service our clients in all the markets that we serve will depend on the quality of our products, services and the prices of our products. Environment The production and distribution of food products are subject to federal, state, provincial and local laws, rules, regulations and policies and to international trade agreements, all of which provide a framework for Saputo’s operations. The impact of new laws and regulations, stricter enforcement or interpretations or changes to enacted laws and regulations will depend on our ability to adapt and comply. We are currently in compliance with all important government laws and regulations and maintain all important permits and licenses in connection with our operations. Saputo’s business and operations are subject to environmental laws and regulations. We believe that our operations are in compliance, in all material aspects, with such environmental laws and regulations, except as disclosed in our Annual Information Form dated June 1, 2005 for the fiscal year ended March 31, 2005. Any new environmental laws or regulations or more vigorous regulatory enforcement policies could have a material adverse effect on the financial position of Saputo and could require significant additional expenditures to achieve or maintain compliance. Growth by Acquisitions The Company intends to grow both organically and through acquisitions. Based on past experience, a significant portion of this growth will likely occur through acquisitions. The ability to properly evaluate the fair value of the businesses being acquired, to successfully integrate them into the Company’s operations and realize the expected profit and returns are inherent risks related to acquisitions. Consumer Trends Demand for our products is subject to changes in consumer trends. These changes may affect the Company’s earnings. In order to constantly adapt to these changes, the Company innovates and develops new products. 3 6 2 0 0 5 A N N U A L R E P O R T / S A P U T O Tariff Protection Dairy-producing industries are still partially protected from imports by tariff-rate quotas which permit a specific volume of imports at a reduced or zero tariff and impose significant tariffs for greater quantities of imports. There is no guarantee that political decisions or amendments to international trade agreements will not, at some time in the future, result in the removal of tariff protection in the dairy market, resulting in increased competition. Our performance will be dependent on our ability to continue to offer quality products at competitive prices. CONTROLS AND PROCEDURES The Chief Executive Officer and the Chief Financial Officer together with management, after evaluating the effectiveness of the Company’s disclosure controls and procedures as of March 31, 2005, have concluded that the Company’s disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company and its consolidated subsidiaries would have been known to them. SENSITIVITY ANALYSIS OF INTEREST RATE AND THE US CURRENCY FLUCTUATIONS The portion of the long-term debt covered by fixed interest rate equals 100%. The used portion of the bank credit facility is subject to interest rate fluctuations, and was not being protected as of March 31, 2005. A 1% change in the interest rate would lead to a change in net earnings of approximately $0.110 million, based on the $15.1 million in bank loans as of March 31, 2005. fluctuations may affect earnings. Canadian-US currency Appreciation of the Canadian dollar compared to the US dollar would have a negative impact on earnings. Conversely, a decrease in the Canadian dollar would have a positive impact on earnings. During the fiscal year ended March 31, 2005, the average US dollar conversion was based on CND$1.00 for US$0.78. A fluctuation of CND$0.01 would have resulted in a change of approximately $0.7 million in net earnings, $1.9 million in EBITDA and $17.9 million in revenues. MEASUREMENT OF RESULTS NOT IN ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES Earnings before interest, income taxes, depreciation and amortization (EBITDA) is not a measurement of performance as defined by Canadian generally accepted accounting principles, and consequently may not be comparable to similar measurements presented by other companies. The Company assesses its financial performance based on its EBITDA. (in thousands of dollars) Operating income Depreciation of fixed assets EBITDA (in thousands of dollars) Operating income Depreciation of fixed assets EBITDA $ Canada & Other 214,418 29,743 244,161 $ Dairy Products United States $ 105,868 31,175 137,043 $ Canada & Other $ 180,001 29,854 $ 209,855 Dairy Products United States $ 129,337 31,550 $ 160,887 2005 TOTAL $ 320,286 60,918 $ 381,204 2004 TOTAL $ 309,338 61,404 $ 370,742 Grocery Products 21,408 5,147 26,555 Grocery Products 27,881 4,634 32,515 $ $ $ $ TOTAL $ 341,694 66,065 407,759 $ $ TOTAL 337,219 66,038 $ 403,257 2 0 0 5 A N N U A L R E P O R T / S A P U T O 3 7 The 2004 and 2005 quarterly financial information has not been reviewed by an external auditor. 2005 Quarterly Financial Information Consolidated Statement of Earnings (in thousands of dollars, except per share amounts) Statement of earnings data Revenues Cost of sales, selling and administration expenses Earnings before interest, income taxes, depreciation and amortization Margin % Depreciation of fixed assets Operating income Interest on long-term debt Other interest Earnings before income taxes Income taxes Net earnings Net margin % Per share Net earnings Basic Diluted 2004 Quarterly Financial Information Consolidated Statement of Earnings (in thousands of dollars, except per share amounts) Statement of earnings data Revenues Cost of sales, selling and administration expenses Earnings before interest, income taxes, depreciation and amortization Margin % Depreciation of fixed assets Operating income Interest on long-term debt Other interest Earnings before income taxes Income taxes Net earnings Net margin % Per share Net earnings Basic Diluted 3 8 2 0 0 5 A N N U A L R E P O R T / S A P U T O 1st 2nd 3rd 4th Quarter (unaudited) Quarter (unaudited) Quarter (unaudited) Quarter (unaudited) Fiscal 2005 (audited) $ 1,018,900 911,882 $ 1,005,109 904,209 $ 942,235 845,711 $ 916,825 813,508 $3,883,069 3,475,310 107,018 100,900 96,524 103,317 407,759 10.5% 10.0% 10.2% 11.3% 10.5% 17,043 89,975 7,870 467 81,638 23,348 58,290 5.7% 0.56 0.55 $ $ $ 16,689 84,211 7,404 426 76,381 20,513 55,868 5.6% 0.54 0.53 $ $ $ 16,138 80,386 6,439 170 73,777 15,507 58,270 6.2% 0.56 0.55 $ $ $ $ $ $ 16,195 87,122 6,313 1 80,808 21,091 59,717 66,065 341,694 28,026 1,064 312,604 80,459 $ 232,145 6.5% 6.0% 0.57 0.57 $ $ 2.23 2.20 1st Quarter (unaudited) 2nd Quarter (unaudited) 3rd Quarter (unaudited) 4th Quarter (unaudited) Fiscal 2004 (audited) $ 816,783 726,118 $ 915,540 804,658 $ 892,010 796,949 $ 945,857 839,208 $ 3,570,190 3,166,933 90,665 110,882 95,061 106,649 403,257 11.1% 12.1% 10.7% 11.3% 11.3% 16,542 74,123 9,598 15 64,510 18,450 46,060 5.6% 0.45 0.44 $ $ $ 16,436 94,446 8,971 416 85,059 26,858 58,201 6.4% 0.56 0.56 $ $ $ 16,252 78,809 8,223 272 70,314 20,276 50,038 5.6% 0.48 0.47 $ $ $ $ $ $ 16,808 89,841 8,000 515 81,326 23,260 58,066 66,038 337,219 34,792 1,218 301,209 88,844 $ 212,365 6.1% 5.9% 0.56 0.56 $ $ 2.05 2.03 SUMMARY OF THE FOURTH QUARTER RESULTS ENDED MARCH 31, 2005 Revenues for the quarter ended March 31, 2005 totalled $916.8 million, a decrease of 3.1% compared to $945.9 million for the same quarter last fiscal year. The decrease is attributed to our US Dairy Products Sector and our Grocery Products Sector. The main contributor to the decrease in revenues in the US Dairy Products Sector this quarter compared to the same quarter last fiscal year, was the appreciation of the Canadian dollar, which eroded approximately $24 million in revenues. This was partially offset by a higher average block market per pound of cheese, which increased revenues by $15 million. The Grocery Products Sector experienced reduced revenues of approximately $7 million due, among other things, to the Easter Holidays, which traditionally is a slow period for the division. The fourth quarter of fiscal 2005 included the Easter Holiday, which was not the case in fiscal 2004. In addition, on February 7, 2005, we increased the base selling price for our economy- and family-sized products, which affected some of our volumes. Revenues from our Canadian and Other Dairy Products Sector were slightly lower in comparison to the same period last fiscal year, mainly due to lower volumes in our Canadian cheese activities. Earnings before interest, income taxes, depreciation and amortization (EBITDA) for the fourth quarter of fiscal 2005 totalled $103.3 million, a $3.3 million decrease from the same period last fiscal year. EBITDA from our US Dairy Products Sector decreased by approximately $13 million compared to the corresponding period last fiscal year. The appreciation of the Canadian dollar along with an unfavourable relationship between the average block market per pound of cheese and the cost of milk as raw material were the driving factors behind the decrease. The Grocery Products Sector EBITDA decreased by approximately $2 million as a result of reduced revenues, and additional pension, raw material, packaging and labour costs. The EBITDA of our Canadian and Other Dairy Products Sector increased by approximately $12 million in comparison to the corresponding period last fiscal year. The increase is attributed to the benefits derived from rationalization activities undertaken in the prior fiscal year, for which fiscal 2004 fourth quarter included $2.7 million in rationalization expenses, increased sales volumes specifically in our specialty cheese category, more interesting margins achieved in our Argentina operations, and a gain on sales of assets held for sale in the amount of $2.6 million. Compared to the same quarter last fiscal year, depreciation expense decreased by $0.6 million to $16.2 million. Interest expense decreased to $6.3 million compared to $8.5 million for the corresponding period last fiscal year, as a result of long-term debt repayments made throughout the year. The effective tax rate for the current quarter was 26.1% compared to 28.6% for the same quarter last fiscal year. The lower rate is the result of higher income being generated in jurisdictions with lower tax rates compared to the same quarter last fiscal year. During the quarter, the Company added $22.0 million in fixed assets and received proceeds of $4.6 million from the sale of certain fixed assets. The Company also repaid $19.5 million in bank loans, issued shares for a cash consideration of $2.7 million as part of the Stock Option Plan, and paid out $15.7 million in dividends to its shareholders. For the same period, the Company generated cash flows of $79.5 million from operations, similar to the cash generated from operations for the corresponding period last fiscal year. Net earnings reached $59.7 million, an increase of $1.6 million from the same quarter in fiscal 2004. QUARTERLY FINANCIAL INFORMATION During fiscal 2005, certain specific circumstances affected the quarterly changes in revenues and earnings before interest, income taxes, depreciation and amortization compared to fiscal 2004. First, the average block market per pound of cheese on the US market was higher during all quarters, increasing both revenues and EBITDA. However, the relationship between the average block market per pound of cheese and the cost of milk as raw material was unfavourable for the last three quarters of fiscal 2005 in comparison to fiscal 2004, having a negative affect on EBITDA. The Canadian dollar was also stronger during all quarters of fiscal 2005 compared to the same periods in fiscal 2004, thus reducing both revenues and EBITDA throughout the fiscal year. Our Canadian operations continued to grow gradually from quarter to quarter in fiscal 2005. Fiscal 2005 also includes a full year of results from our Argentina operations compared to 18 weeks for fiscal 2004. Finally, our Grocery Products Sector incurred additional pension costs of approximately $0.5 million in each of the first three quarters of fiscal 2005 and $0.8 million in the fourth quarter of fiscal 2005. Quarterly earnings directly reflect the effects of the previously mentioned items. ANALYSIS OF EARNINGS FOR THE YEAR ENDED MARCH 31, 2004 COMPARED TO MARCH 31, 2003 Saputo’s consolidated revenues amounted to $3.570 billion in fiscal 2004, up 5.1% compared to $3.398 billion posted in fiscal 2003. Although the Company’s sales volume grew in Canada – and even more so in the United States where sales volumes rose nearly 5.9%, the rise of the Canadian dollar in fiscal 2004 as compared to fiscal 2003 created a shortfall in revenues of nearly $182 million. The average block market per pound of cheese on the US market, 21% higher than in 2003, increased revenues by about $138 million. In addition, the acquisition in Argentina contributed approximately $44 million to revenues between November 28, 2003 and March 31, 2004. 2 0 0 5 A N N U A L R E P O R T / S A P U T O 3 9 Earnings before interest, income taxes, depreciation and amortization (EBITDA) stood at $403.3 million, a 14.3% increase compared to $352.8 million in fiscal 2003. EBITDA margins increased from 10.4% in fiscal 2003 to 11.3% in fiscal 2004. The strong cheese block market condition in the United States in fiscal 2004 drove up EBITDA by approximately $36.9 million. Major increases in sales volumes in the Unites States, combined with our improved operational efficiency, helped grow EBITDA in our US Dairy Products Sector by about $27.7 million. However, the rise of the Canadian dollar unfavourably affected EBITDA by about $23.8 million. In Canada, sales growth as well as our improved operations strengthened EBITDA by about $10 million in fiscal 2004, despite the fact that the dairy by-product market, combined with the appreciation of the Canadian dollar, had an unfavourable impact of about $2 million on dairy by-product exports. The Company incurred, throughout fiscal 2004, some $7.8 million in rationalization costs when it closed certain manufacturing facilities. The Bakery Division’s EBITDA remained relatively stable. Depreciation expense totalled $66.0 million in fiscal 2004, down $4.9 million from fiscal 2003. The expense in fiscal 2004 included a write-down of fixed assets of approximately $1 million following the shutdown of plants during the same fiscal year. The decline in this expense is mainly attributable to the rise in the Canadian dollar in fiscal 2004 compared to fiscal 2003. Net interest expense amounted to $36.0 million in fiscal 2004, down $6.3 million compared to fiscal 2003. Nearly half of this decline is attributed to the reduction of interest resulting from ongoing payments of long-tern debt. The other portion of this decline owes to the effect the rise of the Canadian dollar has had on interest charges for debt in US dollars. Income taxes were $88.8 million in fiscal 2004, for an effective tax rate of 29.5% compared to 27.5% in 2003. The higher rate is mainly attributable to the fact that, in fiscal 2004, a greater portion of our taxable earnings were generated in the United States, which were subject to higher tax rates than those in Canada. For the fiscal year ended March 31, 2004, net earnings totalled $212.4 million, a 22.3% increase over 2003’s net earnings of $173.7 million. A higher Canadian dollar, compared to fiscal 2003, eroded net earnings by $9.2 million for fiscal 2004, and rationalization expenses consumed another $5.6 million. Excluding these two factors, net earnings would have risen by 30.8% compared to fiscal 2003. OUTLOOK Although no business acquisitions were made during the fiscal year, we nonetheless realized growth, and we did so on several levels. It was essentially organic growth that enabled us to generate a return on equity of 18.8%. Our vision for our development embodies a number of components: organic growth, consolidation of our position in current markets, growth by acquisitions, and preparing our future by tailoring our plans accordingly. Each of our divisions has set itself precise objectives for fiscal 2006, all of which should result in increased revenues, EBITDA, cash flow generated and consolidated net earnings. We are mainly relying on organic growth and improvement in our procedures and our efficiency to achieve continuous growth in our overall profitability. During fiscal 2005, we started working on the acquisition of two businesses, which were announced during the early months of fiscal 2006. Certainly the Company’s larger-scale growth will be by way of acquisitions, and we will continue to toil steadily in that direction. At all levels, our growth will not take place at the expense of our profitability. Our financial position is excellent, and provides us with considerable flexibility in our future development for the 2006 fiscal year as well as for the coming years. Our destiny is ours alone to shape. 4 0 2 0 0 5 A N N U A L R E P O R T / S A P U T O MANAGEMENT’S STATEMENT OF RESPONSIBILITY FOR FINANCIAL REPORTING Management is responsible for the preparation and presentation of the consolidated financial statements and the financial information presented in this annual report. This responsibility includes the selection of accounting policies and practices and making judgments and estimates necessary to prepare the consolidated financial statements in accordance with generally accepted accounting principles. Management has also prepared the financial information presented elsewhere in this annual report and has ensured that it is consistent with the consolidated financial statements. Management maintains systems of internal control designed to provide reasonable assurance that assets are safeguarded and that relevant and reliable financial information is being produced. The Board of Directors is responsible for ensuring that management fulfills its responsibilities for financial reporting and is responsible for reviewing and approving the consolidated financial statements. The Board of Directors carries out this responsibility principally through its Audit Committee, which is comprised solely of independent directors. The Audit Committee meets periodically with management and the external auditors to discuss internal controls, auditing matters and financial reporting issues. It also reviews the annual report, the consolidated financial statements and the external auditors’ report. The Audit Committee recommends the external auditors for appointment by the shareholders. The external auditors have unrestricted access to the Audit Committee. The consolidated financial statements have been audited by the external auditors Deloitte & Touche LLP, whose report follows. (signed) Lino Saputo, Jr. President and Chief Executive Officer (signed) Louis-Philippe Carrière, CA Executive Vice President, Finance and Administration, and Secretary AUDITORS' REPORT TO THE SHAREHOLDERS OF SAPUTO INC. We have audited the consolidated balance sheets of Saputo Inc. as at March 31, 2005 and 2004 and the consolidated statements of earnings, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at March 31, 2005 and 2004 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles. (signed) Deloitte & Touche LLP Chartered Accountants Laval, Québec May 27, 2005 2 0 0 5 A N N U A L R E P O R T / S A P U T O 4 1 CONSOLIDATED STATEMENTS OF EARNINGS Years ended March 31 (in thousands of dollars, except per share amounts) Revenues Cost of sales, selling and administrative expenses Earnings before interest, depreciation and income taxes Depreciation of fixed assets (Note 3) Operating income Interest on long-term debt Other interest (Note 11) Earnings before income taxes Income taxes (Note 12) Net earnings Earnings per share (Note 13) Net earnings Basic Diluted 2005 2004 $ 3,883,069 3,475,310 407,759 66,065 341,694 28,026 1,064 312,604 80,459 232,145 $ $ 3,570,190 3,166,933 403,257 66,038 337,219 34,792 1,218 301,209 88,844 212,365 $ $ $ 2.23 2.20 $ $ 2.05 2.03 CONSOLIDATED STATEMENTS OF RETAINED EARNINGS Years ended March 31 (in thousands of dollars) Retained earnings, beginning of year Net earnings Dividends Retained earnings, end of year 2005 2004 $ $ 711,371 232,145 (59,462) 884,054 $ $ 546,667 212,365 (47,661) 711,371 4 2 2 0 0 5 A N N U A L R E P O R T / S A P U T O CONSOLIDATED BALANCE SHEETS As at March 31 (in thousands of dollars) ASSETS Current assets Cash Receivables Inventories Income taxes Future income taxes Prepaid expenses and other assets Portfolio investment (Note 2) Fixed assets (Note 3) Goodwill (Note 4) Trademarks (Note 4) Other assets (Note 5) Future income taxes LIABILITIES Current liabilities Bank loans (Note 6) Accounts payable and accrued liabilities Income taxes Future income taxes Current portion of long-term debt (Note 7) Long-term debt (Note 7) Other liabilities (Note 8) Future income taxes SHAREHOLDERS’ EQUITY Share capital (Note 9) Contributed surplus (Note 10) Retained earnings Foreign currency translation adjustment On behalf of the Board (signed) (signed) Lino Saputo, Director Louis A. Tanguay, Director 2005 2004 $ 41,477 299,828 452,814 14,381 10,711 16,795 836,006 53,991 648,584 507,200 24,054 53,437 9,800 $ 2,133,072 $ 15,083 291,197 67,438 9,653 - 383,371 302,521 19,139 112,191 817,222 483,896 8,095 884,054 (60,195) 1,315,850 $ 2,133,072 $ 7,874 287,012 420,660 9,348 14,877 13,838 753,609 53,991 661,183 524,856 26,076 46,422 3,411 $ 2,069,548 $ 82,367 295,124 26,020 8,927 43,969 456,407 327,942 13,941 114,429 912,719 469,262 4,411 711,371 (28,215) 1,156,829 $ 2,069,548 2 0 0 5 A N N U A L R E P O R T / S A P U T O 4 3 CONSOLIDATED STATEMENTS OF CASH FLOWS 2005 2004 $ 232,145 $ 212,365 4,774 66,065 (2,576) 4,860 305,268 (28,783) 276,485 - - (81,786) 5,441 (7,278) (83,623) (68,844) (43,965) 13,544 442 (59,462) (158,285) 34,577 (974) 7,874 41,477 27,565 37,896 $ $ $ 2,936 66,038 (680) 20,630 301,289 (13,717) 287,572 (99,994) 2,000 (90,446) 5,926 (4,677) (187,191) 63,945 (110,099) 4,931 4 (47,661) (88,880) 11,501 (2,391) (1,236) 7,874 33,889 70,095 $ $ $ Years ended March 31 (in thousands of dollars) Cash flows related to the following activities: Operating Net earnings Items not affecting cash Stock based compensation Depreciation of fixed assets Gain on disposal of fixed assets Future income taxes Changes in non-cash operating working capital items Investing Business acquisitions (Note 14) Portfolio investment Additions to fixed assets Proceeds on disposal of fixed assets Other assets Financing Bank loans Repayment of long-term debt Issuance of share capital for a cash consideration Employee future benefits Dividends Increase in cash Effect of exchange rate changes on cash Cash (bank overdraft), beginning of year Cash, end of year Supplemental information Interest paid Income taxes paid 4 4 2 0 0 5 A N N U A L R E P O R T / S A P U T O NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended March 31 (tabular amounts are in thousands of dollars except information on options) 1 . S I G N I F I C A N T A C C O U N T I N G P O L I C I E S The financial statements have been prepared in accordance with generally accepted accounting principles used in Canada and include the following significant accounting policies: Use of estimates In the course of the preparation of financial statements in conformity with generally accepted accounting principles, management must make estimates such as the useful life and depreciation of fixed assets, the valuation of goodwill, portfolio investments, trademarks and future income taxes and certain actuarial and economic assumptions used in determining defined benefit pension costs, accrued pension benefits obligation and pension plan assets, and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the revenues and expenses for the period. Actual results could differ from these estimates. Consolidated financial statements Investments over which the Company has effective control are consolidated. The interest in a joint venture (Note 14), that is jointly controlled is accounted for by the proportionate consolidation method. The operating results of acquired businesses, from their respective acquisition dates, are included in the consolidated statements of earnings. Inventories Finished goods and goods in process are valued at the lower of average cost and net realizable value. Raw materials are valued at the lower of cost and replacement value, cost being determined under the first-in, first-out method. Income taxes The Company follows the liability method of income tax allocation. Under this method, future income tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted or substantially enacted tax rates that will be in effect when the differences are expected to reverse. Future income tax assets are recognized only to the extent that, in the opinion of management, it is more likely than not that the future income tax asset will be realized. Fixed assets Fixed assets are stated at cost and are depreciated using the straight-line method over their estimated useful lives or by using the following methods: Buildings Furniture, machinery and equipment Rolling stock 20 years to 40 years 3 years to 15 years 5 years to 10 years or based on kilometers traveled Goodwill and trademarks Goodwill and trademarks are not amortized; however they are tested for impairment annually, or more frequently if events or changes in circumstances indicate that the assets might be impaired. The carrying values of goodwill and trademarks are compared with their respective fair values, and an impairment loss is recognized for the excess, if any. Employee future benefits The cost of pension and other post-retirement benefits earned by employees is actuarially determined using the projected benefit method prorated on services and using estimates of expected return on plan assets, rates of compensation increase, retirement ages of employees and expected health care costs and other post-retirement benefits. Current service costs are expensed in the year. In accordance with generally accepted accounting principles, past service costs and the excess of the net actuarial gains or losses related to defined benefit 2 0 0 5 A N N U A L R E P O R T / S A P U T O 4 5 1 . S I G N I F I C A N T A C C O U N T I N G P O L I C I E S ( c o n t ’ d ) pension plans over 10% of the greater of the benefit obligation or fair value of plan assets are amortized over the expected average remaining service period of active employees entitled to receive benefits under the plans. The Company uses five-year asset smoothing to determine the defined benefit pension costs. On January 1, 2000, the Company prospectively adopted the new employees future benefit accounting standards. It amortizes on a straight-line basis the transitional obligation over the expected average remaining service life of the employee groups for each of the plans at January 1, 2000. In the case where a plan restructuring entails both a plan curtailment and settlement of obligations from the plan, the curtailment is recorded before the settlement. Revenue recognition The Company recognizes revenue, net of sales incentives, upon shipment of goods when the title and risk of loss are transferred to customers. Foreign currency translation The balance sheet accounts of the self-sustaining companies operating in the United States and Argentina are translated into Canadian dollars using the exchange rates at the balance sheet dates. Statement of earnings accounts are translated into Canadian dollars using the average monthly exchange rates in effect during the fiscal years. The foreign currency translation adjustment account presented in shareholders’ equity represents accumulated foreign currency gains or losses on the Company’s net investments in self-sustaining companies operating in the United States and Argentina. The change in the foreign currency translation account during the year ended March 31, 2005 principally resulted from the increase in value of the Canadian dollar as compared to the US dollar. Foreign currency accounts of the Company and its subsidiaries are translated using the exchange rates at the end of the year for monetary assets and liabilities and the prevailing exchange rates at the time of transactions for income and expenses. Gains or losses resulting from this translation are included in the statement of earnings. Foreign currency gain Stock based compensation 2005 562 $ 2004 315 $ The fair value based method of accounting is used to expense stock based compensation awards. This method consists of recording compensation cost to earnings over the vesting period of options granted. When stock options are exercised, any consideration paid by employees and the related compensation expense recorded as contributed surplus are credited to share capital. New accounting standards On May 1, 2003, the Company adopted the new recommendations of the Canadian Institute of Chartered Accountants (CICA) regarding "Disposal of long-lived assets and discontinued operations", which establish standards for the recognition, measurement, presentation and disclosure of the disposal of long-lived assets and discontinued operations. This new standard was applied prospectively. (See Note 3 for the required disclosure) Effective April 1, 2004, the Company adopted the following new recommendations of the CICA regarding “Asset retirement obligations”, which requires the recognition of liabilities for legal obligations, whether they are of a legal, prescribed, contractual or other nature, and normally when these obligations arise; “Hedging relationships”, which specifies the circumstances in which hedge accounting is appropriate, and examines in particular the identification, documentation, designation and effectiveness of hedging relationships for the purpose of hedge accounting, as well as the discontinuance of hedge accounting; and “Employee future benefits”, which expands the disclosure requirements in both annual and interim financial statements. These new recommendations had no significant impact on the Company’s consolidated financial statements. Effective July 1, 2004, the Company adopted the following new recommendation of the CICA regarding “Accounting by a Customer for Certain Consideration Received from a Vendor”, which provides guidance on how a customer of a vendor's products should account for a cash consideration received from a vendor. This new recommendation had no significant impact on the Company's consolidated financial statements. Effective January 1, 2005, the Company adopted the following new recommendation of the CICA regarding “Consolidation of Variable Interest Entities”, which requires enterprises to identify variable interest entities in which they have an interest, to determine if they are the primary beneficiary of such entities, and, if so, to consolidate them. This new recommendation had no impact on the Company's consolidated financial statements. 4 6 2 0 0 5 A N N U A L R E P O R T / S A P U T O 2 . P O R T F O L I O I N V E S T M E N T 21% share capital interest in Dare Holdings Ltd. 2005 53,991 $ 2004 53,991 $ The portfolio investment is recorded at cost less the excess of dividends received over the Company's share in accumulated earnings. No dividends were received during fiscal 2005. The dividend of $2,000,000 received during fiscal 2004 was accounted for as a reduction of the cost of the investment. 3 . F I X E D A S S E T S Land Buildings Furniture, machinery and equipment Rolling stock Held for sale 2005 Accumulated depreciation - $ 53,657 290,014 5,378 - $ 349,049 Cost 27,872 246,887 707,965 11,817 3,092 997,633 $ $ $ Net book value 27,872 193,230 417,951 6,439 3,092 $ 648,584 $ Cost 33,932 253,394 677,945 10,714 3,622 $ 979,607 2004 Accumulated depreciation - $ 56,013 258,036 4,375 - $ 318,424 Net book value 33,932 197,381 419,909 6,339 3,622 661,183 $ $ During the year, a gain on disposal of fixed assets held for sale totalling $2,576,000 was recorded in cost of sales, selling and administrative expenses. These assets relate to the activities of the Canadian dairy products sector. During the year, a $6,000,000 write-down to fair value of certain machinery and equipment was recorded. This charge is included in depreciation of fixed assets. Fixed assets held for sale represent mainly machinery, equipment and buildings of the Canadian dairy products sector that will be disposed of as a result of certain plant closures. A $1,000,000 write-down to fair value of these assets was recorded in 2004. This charge is included in depreciation of fixed assets. The net book value of fixed assets under construction, that are not being amortized, amounts to $47,921,000 as at March 31, 2005 ($71,030,000 as at March 31, 2004). 4 . G O O D W I L L A N D T R A D E M A R K S Dairy products sector 2005 Grocery products sector Dairy products sector Total 2004 Grocery products sector Total Goodwill Balance, beginning of year Foreign currency translation adjustment Business acquisitions (Note 14) Balance, end of year $ 360,343 (17,656) - $ 342,687 $ 164,513 - - $ 164,513 $ 524,856 (17,656) - 507,200 $ $ 386,117 (27,123) 1,349 $ 360,343 $ 164,513 - - $ 164,513 $ 550,630 (27,123) 1,349 $ 524,856 Trademarks Balance, beginning of year Business acquisitions (Note 14) Foreign currency translation adjustment Balance, end of year $ $ 26,076 - (2,022) 24,054 $ $ - - - - $ $ 26,076 - (2,022) 24,054 $ $ - 27,330 (1,254) 26,076 $ $ - - - - $ $ - 27,330 (1,254) 26,076 2 0 0 5 A N N U A L R E P O R T / S A P U T O 4 7 5 . O T H E R A S S E T S Net accrued pension plan asset (Note 15) Other 6 . B A N K L O A N S 2005 45,505 7,932 53,437 $ $ 2004 37,517 8,905 46,422 $ $ The Company has available short-term bank credit facilities providing for bank loans up to a maximum of approximately $234,000,000. These bank loans are available in Canadian dollars or the equivalent in other currencies and bear interest at rates based on lenders' prime rates plus a maximum of 0.6% or LIBOR or bankers' acceptances rate plus 0.55% up to a maximum of 1.6%, depending on the interest- bearing debt to the earnings before interest, depreciation and amortization and income taxes ratio of the Company. 2005 - $ 2004 43,870 $ 36,288 205,632 60,480 121 302,521 - $ 302,521 $ 39,339 222,921 65,565 216 371,911 43,969 327,942 $ - 36,388 21 - 205,632 60,480 $ 302,521 2005 14,383 4,756 19,139 $ $ 2004 13,941 - 13,941 $ $ 7. L O N G - T E R M D E B T Term bank loan, repaid during year Senior notes 7.97%, due in November 2006 (US$30,000,000) 8.12%, due in November 2009 (US$170,000,000) 8.41%, due in November 2014 (US$50,000,000) Other loans, repayable up to 2008 Current portion Estimated principal payments required in future years are as follows: 2006 2007 2008 2009 2010 2011 and subsequent years 8 . O T H E R L I A B I L I T I E S Employee future benefits (Note 15) Other 4 8 2 0 0 5 A N N U A L R E P O R T / S A P U T O 9 . S H A R E C A P I TA L Authorized The authorized share capital of the Company consists of an unlimited number of common and preferred shares. The common shares are voting and participating. The preferred shares may be issued in one or more series, the terms and privileges of each series to be determined at the time of their creation. Issued 104,527,282 common shares (103,777,730 in 2004) 2005 2004 $ 483,896 $ 469,262 749,552 common shares (317,725 in 2004) for an amount of $13,544,000 ($4,931,000 in 2004) were issued during the year ended March 31, 2005 pursuant to the share option plan. For share options granted since April 1, 2002, the amount previously accounted for as an increase to contributed surplus was also transferred to share capital upon the exercise of options. For the year ended March 31, 2005, the amount transferred from contributed surplus was $1,090,000. Share option plan The Company established a share option plan to allow for the purchase of common shares by key employees, officers and directors of the Company. The total number of common shares which may be issued pursuant to this plan cannot exceed 14,000,000 common shares. Options may be exercised at a price equal to the closing quoted value of the shares on the day preceding the grant date. The options vest at 20% per year and expire ten years from the grant date. Options issued and outstanding as at the year-ends are as follows: Granting period 1998 1999 2000 2001 2002 2003 2004 2005 Exercise price 8.50 $ from $16.13 to $18.75 19.70 $ $ 13.50 from $19.00 to $23.00 30.35 $ 22.50 $ 33.05 $ 2005 2004 Number of options 77,420 160,602 272,403 582,608 814,073 815,518 1,174,625 900,666 4,797,915 Weighted average exercise price 8.50 $ 18.34 $ 19.70 $ 13.50 $ 19.09 $ 30.35 $ 22.50 $ 33.05 $ 23.62 $ Number of options 125,249 226,180 400,164 793,069 994,783 891,072 1,315,063 - 4,745,580 Weighted average exercise price 8.50 $ 18.28 $ 19.70 $ 13.50 $ 19.13 $ 30.35 $ 22.50 $ - 20.96 $ Options exercisable at end of year 1,778,646 $ 19.71 1,566,785 $ 18.12 Changes in the number of options are as follows: Balance at beginning of year Options granted Options exercised Options cancelled Balance at end of year 2005 Weighted average Number of exercise price options 20.96 $ 4,745,580 33.05 984,055 $ 18.07 (749,552) $ 28.01 (182,168) $ 23.62 $ 4,797,915 2004 Number of options 3,784,944 1,338,396 Weighted average exercise price 19.99 $ 22.50 $ 15.52 (317,725) $ 23.31 (60,035) $ 20.96 $ 4,745,580 2 0 0 5 A N N U A L R E P O R T / S A P U T O 4 9 9 . S H A R E C A P I TA L ( c o n t ’ d ) The fair value of share purchase options granted was estimated at $9.86 per option ($6.31 in 2004), using the Black-Scholes option pricing model with the following assumptions: Risk-free interest rate: Expected life of options: Volatility: Dividend rate: 2005 3.5% 61/2 years 28% 1.8% 2004 4.9% 71/2 years 27% 1.7% The exercise price of these options is $33.05 ($22.50 in 2004), which corresponds to the closing quoted value of the shares on the day preceding the grant date. A compensation expense of $4,774,000 ($4,173,000 after income taxes) relating to stock options was recorded in the statement of earnings for the year ended March 31, 2005 and $2,936,000 ($2,571,000 after income taxes) was recorded for the year ended March 31, 2004. The effect of this expense on basic and diluted earnings per share was $0.04 for the year ended March 31, 2005, and $0.025 for the year ended March 31, 2004. Options to purchase 914,952 common shares at a price of $36.15 were also granted on April 1, 2005. Deferred share units plan for directors Effective April 1, 2004, all eligible directors of the Company were allocated a fixed amount of deferred share units which were granted on a quarterly basis in accordance with the deferred share units plan. The directors have a choice to receive either cash or deferred units for their compensation. The number of units issued to each director is based on the market value of the Company’s common shares at each grant date. As directors cease their functions with the Company, a cash payment equal to the market value of the accumulated deferred share units will be disbursed. The number of units issued each year, multiplied by the market value of common shares at the Company’s year-end, is recorded as an expense by the Company. During the year ended March 31, 2005, the expense recorded for the deferred share units was $488,000. 2005 4,411 4,774 (1,090) 8,095 2005 1,568 (504) 1,064 $ $ $ $ $ $ $ $ 2004 1,475 2,936 - 4,411 2004 1,586 (368) 1,218 10 . C O N T R I B U T E D S U R P L U S Contributed surplus, beginning of year Stock based compensation Amount transferred to share capital Contributed surplus, end of year 11 . O T H E R I N T E R E S T Expense Income 5 0 2 0 0 5 A N N U A L R E P O R T / S A P U T O 1 2 . I N C O M E TA X E S The provision for income taxes is comprised of the following: Current income taxes Future income taxes 2005 75,599 4,860 80,459 2004 68,214 20,630 88,844 $ $ $ $ Reconciliation of income taxes, calculated using statutory Canadian income tax rates, to the income tax provision presented in the statement of earnings: Income taxes, calculated using Canadian statutory income tax rates Adjustments resulting from the following: Manufacturing and processing credit Effect of tax rates of American subsidiaries Changes in tax laws and rates Utilization of tax benefit not previously recognized Benefit arising from investment in subsidiaries Other Provision for income taxes 2005 97,212 2004 $ 101,454 $ (1,453) 4,593 (3,816) (2,381) (9,118) (4,578) 80,459 $ (4,483) 4,442 (1) (3,501) (9,819) 752 88,844 $ The tax effects of temporary differences that give rise to significant portions of the future tax asset and liability are as follows: Future income tax asset Accounts payable and accrued liabilities Income tax losses Other Future income tax liability Inventories Fixed assets Net assets of pension plans Other assets Portfolio investment Classified in the financial statements as: Current future income tax asset Long-term future income tax asset Current future income tax liability Long-term future income tax liability Net future income tax liability Potential tax benefits 2005 2004 $ $ 5,088 5,639 3,634 14,361 $ $ 5,773 2,915 2,306 10,994 $ 7,350 95,677 4,979 1,463 6,225 $ 115,694 $ 6,680 94,624 7,259 993 6,506 $ 116,062 $ $ 10,711 9,800 (9,653) (112,191) 14,877 3,411 (8,927) (114,429) $ (101,333) $ (105,068) As of March 31, 2005, the Company has income tax losses of approximately $60,857,000 which may be used to reduce future years' taxable income of its subsidiaries in Argentina. The benefits resulting from these tax losses have not been recognized in the accounts. These losses expire as follows: 2006 2007 2008 2009 $ $ $ $ 898,000 3,037,000 48,615,000 8,307,000 2 0 0 5 A N N U A L R E P O R T / S A P U T O 5 1 1 3 . E A R N I N G S P E R S H A R E Basic earnings per share have been calculated using the weighted average number of common shares outstanding during each fiscal year: 104,257,660 shares in 2005 (103,589,621 in 2004). Diluted earnings per share for the year ended March 31, 2005 have been calculated using 105,698,700 (104,817,272 in 2004) common shares by applying the treasury stock method. 14 . B U S I N E S S A C Q U I S I T I O N S The Company acquired on May 1, 2003 a 51% voting share interest in Gallo Protein 2003, LLC (a joint venture) for a cash consideration of $3,546,000, and acquired on May 23, 2003 the commercial activities of the Treasure Cave and Nauvoo brands for a cash consideration of $36,510,000. Relating to the Gallo Protein acquisition, the fair values attributed to the assets acquired were $812,000 to working capital, $1,385,000 to fixed assets, and $1,349,000 to goodwill. The fair values attributed to the assets acquired for the commercial activities of the Treasure Cave and Nauvoo brands were $5,361,000 to working capital, $3,819,000 to fixed assets and $27,330,000 to trademarks. Gallo Protein 2003, LLC operates in the United States and manufactures and markets whey protein isolates and related products from whey protein concentrate. The commercial activities of the Treasure Cave and Nauvoo brands are related to the manufacturing and commercialization of blue cheese in the United States. On November 28, 2003, the Company acquired 100% of the voting shares of Molfino Hermanos S.A. (Molfino). Molfino is a cheese and dairy products manufacturer operating in Argentina. Total acquisition costs for Molfino amounted to $66,162,000 including cash of $4,395,000 and related acquisition costs of $1,829,000 for a net consideration paid of $59,938,000. The fair values attributed to the assets acquired were $40,092,000 to fixed assets, $2,166,000 to other assets, and the remainder of $19,509,000 to working capital. The operating results of Molfino are included in the Canada and other dairy products sector. 1 5 . E M P L O Y E E P E N S I O N A N D O T H E R B E N E F I T P L A N S The Company provides defined benefit and defined contribution pension plans as well as other benefit plans such as health insurance, life insurance and dental plans to eligible employees and retired employees. Under the terms of the defined benefit pension plans, pensions are based on years of service and the average salary of the last employment years or the career salary. Contributions are paid by employees and contributions by the Company are based on recommendations from independent actuaries. Actuarial valuations were performed as at December 2002 and 2003. The measurement date of pension plan assets and liabilities is December 31. The defined contribution pension plans entitle participating employees to an annual contribution giving right to a pension. Plan assets are principally comprised of shares of Canadian and foreign companies, mutual funds and fixed income investments. 5 2 2 0 0 5 A N N U A L R E P O R T / S A P U T O 1 5 . E M P L O Y E E P E N S I O N A N D O T H E R B E N E F I T P L A N S ( c o n t ’ d ) Financial position of the plans Changes in accrued benefits obligation Benefits obligation at beginning of year Current service cost Interest cost Benefits paid Actuarial losses (gains) Amendments and divestitures Foreign currency gain Benefits obligation at end of year Changes in fair value of plan assets Fair value of plan assets at beginning of year Actual return on plan assets Employer contributions Employee contributions Benefits paid Foreign currency loss Fair value of plan assets at end of year Deficit Unamortized actuarial losses Unamortized past service cost Adjustment to recognize obligation Unamortized transitional obligation Asset (liability) as at the measurement date Employer contributions made from the measurement date to the end of the year Net asset (liability) recognized in the balance sheet 2005 2004 Defined benefit pension plans $ $ 165,460 5,214 10,099 (12,962) 8,085 - (261) 175,635 152,730 13,584 9,175 1,170 (12,962) (210) 163,487 (12,148) 66,461 680 14 (11,059) 43,948 Other benefit plans 17,614 680 1,173 (1,175) 3,013 205 (924) 20,586 - - 1,046 129 (1,175) - - (20,586) 4,561 35 - 1,561 (14,429) Defined benefit pension plans $ $ 154,890 4,188 10,187 (11,767) 8,295 - (333) 165,460 142,145 15,914 5,548 1,129 (11,767) (239) 152,730 (12,730) 60,797 761 - (12,215) 36,613 Other benefit plans 20,683 914 1,216 (1,172) (826) (2,049) (1,152) 17,614 - - 1,061 111 (1,172) - - (17,614) 2,260 (344) - 1,757 (13,941) 1,557 45,505 46 (14,383) $ $ 904 37,517 - (13,941) $ $ All defined benefit pension plans present an accumulated benefits obligation in excess of plan assets. 2 0 0 5 A N N U A L R E P O R T / S A P U T O 5 3 1 5 . E M P L O Y E E P E N S I O N A N D O T H E R B E N E F I T P L A N S ( c o n t ’ d ) Employee benefit plans expense Defined benefit plans Employer current service cost Interest cost on benefits obligation Actual return on plan assets Actuarial losses (gain) Plan amendments Curtailment and settlement of plans Unadjusted benefits expense taking into account the long-term nature of the cost Difference between expected return and actual return on plan assets Difference between amortized past service costs and plan amendments for the year Difference between net actuarial loss recognized and actual actuarial loss on benefits obligation Transitional obligation amortization Defined benefit plans expense Defined contribution plans expense Total benefit plans expense 2005 2004 $ $ Pension plans 4,044 10,099 (13,584) 8,085 - 70 Other benefit plans 550 1,173 - 3,013 205 - $ $ Pension plans 3,058 10,187 (15,914) 8,295 - (1,146) Other benefit plans 584 1,216 - (826) - (2,049) 8,714 4,941 4,480 (1,075) 175 78 - 2,392 - (109) 91 1,999 (5,995) (1,155) 1,817 (2,779) 196 2,249 (7,614) (1,156) (1,807) 521 377 1,822 10,278 12,095 $ $ - 2,249 $ 8,712 6,905 $ - 1,822 For the year ended March 31, 2005, the Company’s total expense for all its employee benefits plans was $14,344, 000 ($8,727,000 in 2004) and the total Company contributions to the employee benefits plans was $20,499,000 ($15,321,000 in 2004). Weighted average assumptions To determine benefits obligation at end of year: Discount rate of obligation Rate of increase of future compensation expense To determine benefit plans expense: Discount rate of obligation Expected long-term rate of return on plan assets Rate of increase of future compensation expense 6.00% 3.50% 6.25% 7.90% 3.50% 6.00% 3.50% 6.25% N/A 3.50% 6.25% 3.50% 6.75% 7.90% 3.50% 6.25% 3.50% 6.75% N/A 3.50% For measurement purposes, a 5.5% to 7% annual rate of increase was used for health, life insurance and dental plan costs for the year 2006 and this rate is assumed to decrease gradually to 5% in 2010 and remain at that level thereafter. In comparison, during the previous year, a 5.5% to 7% annual rate was used for the year 2005 and that rate was assumed to decrease gradually to 5.3% in 2007. 5 4 2 0 0 5 A N N U A L R E P O R T / S A P U T O 16 . C O M M I T M E N T S A N D C O N T I N G E N C I E S The Company carries some of its operations in leased premises and has also entered into lease agreements for equipment and rolling stock. The minimum annual lease payments required are as follows: 2006 2007 2008 2009 2010 Subsequent years $ $ 9,886 8,322 6,113 5,066 4,064 5,424 38,875 The Company is defendant to certain claims arising from the normal course of its business. The Company believes that the final resolution of these claims will not have a material adverse effect on its earnings or financial position. The Company from time to time enters into agreements in the normal course of its business, such as service arrangements and leases, and in connection with business or asset acquisitions or dispositions, which agreements by their nature may provide for indemnifications of counterparties. These indemnification provisions may be in connection with breach of representations and warranties and for future claims for certain liabilities, including liabilities related to tax and environmental matters. The terms of these indemnification provisions vary in duration. Given the nature of such indemnifications, the Company is unable to reasonably estimate its maximum potential liability under these agreements. 17. F I N A N C I A L I N S T R U M E N T S A N D R I S K M A N A G E M E N T a) Fair value of financial instruments The fair value of cash, receivables, bank loans and accounts payable and accrued liabilities corresponds to their carrying value due to their short-term maturity. The fair value of long-term debt, estimated by discounting expected cash flows at rates currently offered to the Company for debts of the same remaining maturities and conditions, is $345,285,000 ($445,133,000 in 2004). b) Credit risk The Company grants credit to its customers in the normal course of business. Credit valuations are performed on a regular basis and the financial statements take into account an allowance for bad debts. The Company does not have any credit risk concentration. c) Interest rate risk The short-term bank credit facilities bear interest at fluctuating rates. The Company occasionally enters into interest swap contracts to hedge against exposures to increases in interest rates. As at March 31, 2005, the Company had no outstanding interest swap contracts. d) Currency risk In the normal course of Canadian operations, the Company enters into certain foreign currency transactions. The Company manages its currency risks by occasionally entering into foreign currency contracts. The Company had outstanding foreign currency contracts as at the balance sheet date for the purchase of 1,200,000 euros. The Company realizes approximately 34% and 4% of its sales in the United States and Argentina, respectively, and is therefore exposed to currency exchange fluctuations. The cash flows from US operations constitute a natural economic hedge against the exchange risk related to debt expressed in US dollars. e) Price commodities risk The Company occasionally enters into hedging contracts to hedge against fluctuations on the price of certain commodities. Outstanding contracts as at the balance sheet date had a fair value of $900,000. 2 0 0 5 A N N U A L R E P O R T / S A P U T O 5 5 1 8 . S E G M E N T E D I N F O R M AT I O N The dairy products sector principally includes the production and distribution of cheeses and fluid milk. The activities of this sector are carried out in Canada, Argentina and the United States. The grocery products sector consists of the production and marketing of snack cakes. Total assets of this sector include the portfolio investment. These operating sectors are managed separately because each sector represents a strategic business unit that offers different products and serves different markets. The Company measures performance based on geographic operating income and sector operating income on a stand-alone basis. The accounting policies of the sectors are the same as those described in Note 1 relating to significant accounting policies. The Company does not have any intersector sales. Information on operating sectors Revenues Dairy products Grocery products Earnings before interest, depreciation and income taxes Dairy products Grocery products Depreciation of fixed assets Dairy products Grocery products Operating income Dairy products Grocery products Interest Earnings before income taxes Income taxes Net earnings 2005 2004 Canada and other United States Total Canada and other United States Total $ 2,415,541 158,793 $ 2,574,334 $ 1,308,735 - $ 1,308,735 $ 3,724,276 158,793 $3,883,069 $ 2,161,852 167,384 $2,329,236 $ 1,240,954 - $ 1,240,954 $3,402,806 167,384 $ 3,570,190 $ 244,161 26,555 $ 270,716 $ $ 29,743 5,147 34,890 $ $ $ $ 137,043 - 137,043 $ 381,204 26,555 407,759 $ $ 209,855 32,515 $ 242,370 $ 160,887 - $ 160,887 $ 370,742 32,515 $ 403,257 31,175 - 31,175 $ $ 60,918 5,147 66,065 $ $ 29,854 4,634 34,488 $ $ 31,550 - 31,550 $ $ 61,404 4,634 66,038 $ 214,418 21,408 $ 235,826 $ 105,868 - $ 105,868 $ 320,286 21,408 341,694 $ 180,001 27,881 207,882 $ $ 129,337 - $ 129,337 $ 309,338 27,881 337,219 29,090 312,604 80,459 $ 232,145 36,010 301,209 88,844 $ 212,365 5 6 2 0 0 5 A N N U A L R E P O R T / S A P U T O 1 8 . S E G M E N T E D I N F O R M AT I O N ( c o n t ’ d ) Geographic information Revenues Dairy products Grocery products Total assets Dairy products Grocery products Net book value of fixed assets Dairy products Grocery products Additions to fixed assets Dairy products Grocery products Goodwill Dairy products Grocery products 2005 2004 Canada Argentina United States Total Canada Argentina United States Total $2,265,277 158,793 $2,424,070 $ 150,264 - $ 1,308,735 - $ 150,264 $ 1,308,735 $ 3,724,276 158,793 $3,883,069 $2,117,390 167,384 $2,284,774 $ 44,462 - $ 44,462 $ 1,240,954 - $ 1,240,954 $3,402,806 167,384 $ 3,570,190 $ 1,017,031 298,950 $1,315,981 $ 100,696 - $ 716,395 - $ 100,696 $ 716,395 $ 1,834,122 298,950 $ 2,133,072 $ 932,552 291,622 $1,224,174 $ 89,138 - $ 89,138 $ 756,236 - $ 756,236 $ 1,777,926 291,622 $2,069,548 $ 315,260 40,739 $ 355,999 $ $ 38,856 6,010 44,866 $ 132,698 164,513 $ 297,211 $ $ $ $ $ $ 51,601 $ 240,984 - $ 240,984 - 51,601 $ 607,845 40,739 $ 648,584 $ 305,134 39,876 $ 345,010 $ 41,805 - $ 41,805 $ 274,368 - $ 274,368 $ 621,307 39,876 661,183 $ 18,134 $ - 18,134 $ 18,786 - 18,786 $ $ 75,776 6,010 81,786 $ $ 63,713 5,123 68,836 - $ 209,989 - - - $ 209,989 $ 342,687 164,513 507,200 $ $ 132,698 164,513 $ 297,211 $ $ $ $ 315 - 315 $ $ 21,295 - 21,295 $ $ 85,323 5,123 90,446 - - - $ 227,645 - $ 227,645 $ 360,343 164,513 $ 524,856 1 9 . S U B S E Q U E N T E V E N T S On April 18, 2005 the Company acquired the activities of Fromage Coté S.A. and Distributions Kingsey Inc. (a cheese manufacturer operating in Canada) for a cash consideration of $52,900,000, subject to adjustments. The preliminary purchase price allocation is as follows; working capital: $10,900,000, fixed assets: $11,375,000 and intangible assets: $30,625,000. The final allocation of the purchase price will be completed in the next fiscal year. On May 27, 2005 the Company acquired the activities of Schneider Cheese, Inc. (a cheese manufacturer operating in the United States) for a cash consideration of US$24,400,000, subject to adjustments. The preliminary purchase price allocation is as follows; working capital: US$2,400,000, fixed assets: US$4,350,000 and intangible assets: US$17,650,000. The final allocation of the purchase price will be completed in the next fiscal year. 2 0 0 5 A N N U A L R E P O R T / S A P U T O 5 7 Social Responsibility Human capital, in society at large or within the confines of our own Company, is our most precious resource. This is the premise that underlies many of Saputo’s initiatives. One of those consists in providing our employees with a stimulating work and living environment in which they can achieve their potential and make a personal contribution to the success of the Company. Much more than a job, at Saputo, where an entrepreneurial approach and family spirit prevail and where promotion from within is the order of the day, employees are offered a career. That commitment towards our employees continues outside the Company, where employees are encouraged to involve themselves in helping out their communities that are close to their hearts. We are very much aware of the important contribution these activities make to society, and we back up our encouragement with financial investments or with product donations. Of the 8,500 employees in the Company today, many are actively involved in a variety of volunteer activities that range from marathons to raising funds to help victims of the December 2004 Tsunami, and volunteering their time on behalf of a favourite charitable institution. Sports and youth development are also essential activities for Saputo employees, with a great many of them devoting their time and energies to helping organizations geared to supporting the young. As a corporate citizen, Saputo contributes to many organizations and institutions. Causes and needs seem to grow steadily, and all of them with equally praiseworthy aims and goals. The Company builds on its leadership position in the food industry to benefit those organizations that foster good nutrition and promote health through proper eating habits. It is the Company’s desire to contribute to the essential daily nutrition of children at elementary schools. A healthy diet leads not just to better report cards but to a better quality of life, and thus Saputo continues with its involvement in the Club des petits déjeuners du Québec. Moreover, Saputo has expanded such participation to a national level by supporting the organization Breakfast for Learning. In close to 2,600 schools across Canada, approximately 260,000 students benefit from a school feeding program that allows them to start their day with the energy and the mental focus that will help them to succeed. Youth is also supported through contribution to the Make-A-Wish Foundation® of America in the United States, whose mission is to realize the wishes of children with life-threatening medical conditions. Saputo also donates a variety of foods to various food banks across Canada and the United States. Furthermore, Saputo supports a number of educational institutions and takes part in various research projects primarily having to do with the agro-food industry. Saputo contributes to the academic development of students through various university scholarship programs and by recognizing outstanding initiatives. Saputo’s support is also directed towards family and sports activities. Saputo helped feed the athletes and volunteers at the 41st Québec Games Finals, which took place in Saint-Hyacinthe in March 2005. The Company continues to back the Montréal Impact, a not-for-profit professionnal soccer team, as a major sponsor. Saputo’s involvement in soccer goes well beyond this particular professional team; for many years it has sponsored the Québec Soccer Federation as well as several soccer teams and technical clinics in a number of regions to promote physical activity. In this same perspective, Saputo continues to back the Fondation de l’athlète d’excellence du Québec, which by way of academic scholarships supports athletes from Québec and elsewhere in Canada who distinguish themselves on the national and international athletic scenes. These are just a few examples illustrating the deep-seated commitment of Saputo and its employees to the community and to the individuals, it’s most precious resource. 2 0 0 5 A N N U A L R E P O R T / S A P U T O 5 9 BOARD OF DIRECTORS From lef t to right, in the back: Pierre Bourgie, President and Chief Executive Of f icer, Société Financière Bourgie Inc. Louis A. Tanguay, Corporate Director Jean Gaulin, Corporate Director Frank A. Dottori, President and Chief Executive Of f icer, Tembec Inc. André Bérard, Corporate Director Lino Saputo, Chairman of the Board, Saputo Inc. From lef t to right, in the front: Caterina Monticciolo, CA, President, Julvest Capital Inc. Lucien Bouchard, Senior Partner, Davies Ward Phillips & Vineberg LLP Patricia Saputo, CA, FP, President, Pasa Holdings Inc. Lino Saputo, Jr., President and Chief Executive Of f icer, Saputo Inc. 6 0 2 0 0 5 A N N U A L R E P O R T / S A P U T O 6 0 2 0 0 5 A N N U A L R E P O R T / S A P U T O SHAREHOLDER INFORMATION Head Office Transfer Agent Saputo Inc. 6869 Métropolitain Blvd. East Saint-Léonard, Québec, Canada H1P 1X8 Telephone: 514.328.6662 • Fax: 514.328.3364 www.saputo.com National Bank Trust 1100 University Street, Suite 900 Montréal, Québec, Canada H3B 2G7 Telephone: 514.871.7171 or 1 800 341.1419 Fax: 514.871.7442 General Annual Meeting of Shareholders External Auditors Tuesday, August 2, 2005, at 11 a.m. Laval Room, Hotel Sheraton Laval 2440 Autoroute des Laurentides Laval, Québec, Canada H7T 1X5 Investor Relations Corporate Communications Telephone: 514.328.3377 • Fax: 514.328.3364 Email: investors@saputo.com Stock Exchange Toronto Symbol: SAP Deloitte & Touche LLP, Laval, Québec Dividend Policy Saputo Inc. declares quarterly cash dividends on common shares in an amount of $0.15 per share, representing a yearly dividend of $0.60 per share. The balance of corporate earnings is reinvested to finance the growth of the Company’s business. The Board of Directors may review the Company’s dividend policy from time to time based on financial position, operating results, capital requirements and such other factors as are deemed relevant by the Board in its sole discretion. Un exemplaire français vous sera expédié sur demande adressée à : Saputo inc. Communications corporatives 6869, boul. Métropolitain Est Saint-Léonard (Québec) Canada H1P 1X8 Téléphone : 514.328.3377 • Télécopieur : 514.328.3364 Courriel : investisseurs@saputo.com A special thank-you to our young artists from Breakfast for Learning for their superb drawings and to Gabrielle, member of the Club des petits déjeuners du Québec. Photography: Ronald Maisonneuve, Fernando E. Alvarez, Impact de Montréal/pépé, Jacques Sztuke Graphic design: www.dyade.com Printed in Canada This annual report is printed on elemental chlorine-free and acid-free Canadian paper. w w w. s a p u t o . c o m 

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