Saputo
Annual Report 2018

Plain-text annual report

S A P U T O 2 0 1 8 A N N U A L R E P O R T 2018 ANNUAL REPORT Saputo produces, markets, and distributes a wide array of dairy products of the utmost quality, including cheese, fluid milk, extended shelf-life milk and cream products, cultured products and dairy ingredients. Saputo is one of the top ten dairy processors in the world, the largest cheese manufacturer and the leading fluid milk and cream processor in Canada, the top dairy processor in Australia and the second largest in Argentina. In the USA, Saputo ranks among the top three cheese producers and is one of the largest producers of extended shelf-life and cultured dairy products. Our products are sold in several countries under well-known brand names such as Saputo, Alexis de Portneuf, Armstrong, COON, Cracker Barrel*, Dairyland, DairyStar, Devondale, Friendship Dairies, Frigo Cheese Heads, La Paulina, Milk2Go/Lait’s Go, Montchevre, Murray Goulburn Ingredients, Neilson, Nutrilait, Scotsburn*, Stella, Sungold, Treasure Cave and Woolwich Dairy. Saputo Inc. is a publicly traded company and its shares are listed on the Toronto Stock Exchange under the symbol “SAP”. * Trademark used under licence. FINANCIAL HIGHLIGHTS Fiscal years ended March 31 (in millions of CDN dollars) REVENUES ADJUSTED EBITDA* NET EARNINGS ADJUSTED NET EARNINGS* 2018 2017 2016 Fiscal 2018 Since 2016 CAGR(1) $11,542.5 $ 11,162.6 $ 10,991.5 +3.4% +2.5% $1,264.7 $ 1,289.5 $ 1,174.1 -1.9% +3.8% $852.5 $ 731.1 $ 601.4 +16.6% +19.1% $704.2 $ 731.1 $ 626.9 -3.7% +6.0% For the fiscal year ended March 31, 2018 SECTOR NUMBER OF PLANTS** NUMBER OF EMPLOYEES** % OF TOTAL REVENUES Canada Sector USA Sector International Sector 21 26 12 5,400 6,100 3,500 35% 53% 12% Products sold in over 40 countries 59 plants Approx. 15,000 employees SEGMENT % OF TOTAL REVENUES CLIENTELE RETAIL FOODSERVICE 49% 39% Sales are made to supermarket chains, mass-merchandisers, convenience stores, independent retailers, warehouse clubs and specialty cheese boutiques under company-owned or customer brand names. Sales are made to broadline distributors, as well as to restaurants and hotels, under company-owned or customer brand names. INDUSTRIAL 12% Sales are made to food processors using Saputo’s products as ingredients to manufacture their products. * Non-IFRS measures described in the “Glossary” section on page 36 of the Management’s Discussion and Analysis. ** Taking into account the Murray Goulburn Acquisition completed on May 1, 2018, excluding the Koroit divestiture. (1) CAGR, Compound Annual Growth Rate is defined as the year over year growth rate over a specified amount of time. THE SAPUTO PROMISE The Saputo Promise is our commitment to live up to the values on which our business was founded in 1954. It consists of 7 Pillars, that form the backbone of our approach to social, environmental and economic performance. As a global leader in dairy processing, we have a responsibility to demonstrate good corporate citizenship in everything we do. We believe the future is created by what we do today. And our promise is to never stop building the future we believe in. Here’s a summary of what we achieved under our Promise in FY2018. Saputo workshops reinforce best practices in animal care and handling Between September and November 2017, we held workshops at three locations in Argentina to educate dairy farmers on ways to mitigate pain during disbudding, while also highlighting the benefits of implementing proper animal care. Together with our local primary production teams as well as APROCAL, a nationally recognized leader in supply management, we succeeded in securing over 400 individuals to take part in various educational seminars including farm owners, students, operators, and professionals in the field, and equipped them with the tools and knowledge they need to create a healthier future for their animals as well as their dairy farming business. Visit our case study section on www.saputo.com/our-promise to learn more. In FY2018 energy consumption increased by approx. 6% per ton of product, as compared to FY2017, due to an increase in production of more energy-intensive products, such as powder and cheese. (1) Total Recordable Incident Frequency (2) Global Food Safety Initiative We reduced TRIF(1) by approx. 3% in FY2018, as compared to FY2017. As at March 31, 2018, 94% of our plants were certified to GFSI(2) standards. OUR 7 PILLARS FOOD QUALITY AND SAFETY OUR PEOPLE BUSINESS ETHICS RESPONSIBLE SOURCING ENVIRONMENT NUTRITION AND HEALTHY LIVING COMMUNITY Our FY2018 Saputo Promise Fact Sheet – including further details on our non-financial performance- will be published in August 2018. We reached 2.1 million people through our partnerships and programs promoting a healthy lifestyle. By the end of FY2018, the average tenure of our employees was 10 years. We continued to promote the importance of behaving ethically by providing further training on our Code of Ethics, and ensuring it is a formal part of the onboarding process for all new employees. Milk2Go Now with Less Sugar Between January 2016 and December 2017, after several trials, adjustments, and consumer testing, our product development team gradually reformulated our original Milk2Go Flavours (chocolate, strawberry, banana and vanilla), which are now made with less sugar. On top of reducing sugar by 4 grams, our chocolate- flavoured Milk2Go is now the first Milk2Go formulation to have successfully transitioned to a ‘clean label’, with zero artificial colour or flavouring. Visit our case study section on www.saputo.com/our-promise to learn more. This has been another year of continued growth for Saputo as we strengthened our global business and affirmed our position as one of the leading dairy processors in the world. MESSAGE FROM THE CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER LINO A. SAPUTO, JR. On August 1, 2017, I became Chairman of the Board, in addition to my duties as Chief Executive Officer, following the retirement of my father Emanuele (Lino) who devoted 62 years of his life to building Saputo into a global dairy processor. I remain inspired by his vision and am committed to continuing his legacy of growing the Company while preserving the core values and traditions he made integral to its success. In addition, all members of the Board’s two committees – the Audit Committee and the Corporate Governance and Human Resources Committee – are independent directors. The Board is committed to good corporate governance as stated in the Company’s Management Proxy Circular dated June 7, 2018. I invite you to refer to this document to learn more about our governance practices and Board members. I want to thank all directors for their leadership and oversight this year. The Board of Directors is comprised of eight independent directors and two non-independent directors: myself and Louis-Philippe Carrière, who was elected to the Board on August 1, 2017 upon his retirement as the Company’s Chief Financial Officer and Secretary and who continues to act as Senior Advisor to Saputo. After each Board meeting, the independent directors, led by a Lead Director, meet without the non-independent directors. Profitability enhancement and shareholder value creation are cornerstones of the Company’s objectives and remain a focus of the Board of Directors. In fiscal 2018, the Board reviewed Saputo’s dividend policy and increased the quarterly dividend from $0.15 per share to $0.16 per share, representing a 6.7% increase. Since our IPO in 1997, we have grown significantly, both organically and through a series of strategic acquisitions, and now count approximately 15,000 employees worldwide. Our revenues have increased to $11.5 billion in fiscal 2018, our adjusted EBITDA* to $1.3 billion, and our adjusted net earnings* to $704.2 million. Canada. As we look to fiscal 2019, we expect to be in a position to complete the previously announced acquisition of the activities of Shepherd Gourmet Dairy (Ontario) Inc. in June 2018, which will enable our Dairy Division (Canada) to increase its presence in specialty cheese and expand its yogurt offering in Canada. A solid balance sheet offers us the flexibility to seek further acquisition opportunities, such as the two we completed in the United States in fiscal 2018 – the extended shelf-life (“ESL”) dairy product activities of Southeast Milk, Inc. (“SMI”), and Betin, Inc., doing business as Montchevre (“Montchevre”) – as well as the now completed acquisition of the activities of Murray Goulburn Co-Operative Co. Limited (“Murray Goulburn”) in Australia. Our growth has outpaced market trends as we regularly adjust and adapt to changes in a highly competitive landscape. We continue to invest in and modernize our plants to further improve overall efficiencies and raw material optimization across all divisions. The implementation of our new enterprise resource planning (“ERP”) system is progressing as planned, with successful implementations in Argentina and Australia. The implementation within the Dairy Foods Division (USA) will be completed in fiscal 2019 while the Cheese Division (USA) has started its preparation activities with completion expected in fiscal 2020. Finally, implementation in the Dairy Division (Canada) will begin in fiscal 2020. While ERP has been impacting our short-term results as planned, we are confident it will support our future growth for decades to come. In Canada, we worked to maintain our leadership position by focusing on cost reductions, operating efficiencies and promoting our retail brands, including the Saputo cheese brand we relaunched in fiscal 2017. We successfully completed the modernization of our Saint-Hyacinthe (Québec) plant to expand our ESL and aseptic product offering capabilities and capacity. We also initiated capital projects to leverage best practices for our manufacturing and warehouse, delivery and logistics platforms across Our USA Sector delivered higher sales volumes in fiscal 2018 resulting in increased revenues. While some administrative expenses increased in order to enable us to support future growth, we also faced higher warehousing and logistical costs related to additional storage expenses and higher transportation costs. Furthermore, new regulations impacted our shipping and delivery expenses. With the completion of the Montchevre acquisition, our Cheese Division (USA) broadened its presence in specialty cheese in the United States. We completed the modernization of our state-of-the-art blue cheese plant in Almena (Wisconsin) where we began manufacturing and packaging activities. We will also close our Fond du Lac (Wisconsin) plant in the first quarter of fiscal 2019, the production of which has already been amalgamated with that of the Almena plant. The Dairy Foods Division (USA) continued to build strategic relationships with existing and new customers. We introduced innovative new products and maintained our focus on driving efficiencies and optimizing our supply network for raw materials and delivered products. The acquisition of the ESL dairy product activities of SMI, based in Plant City (Florida), strengthened our national network and added capacity for continued growth. The International Sector saw further improvements in market conditions, but the cycle of supply and demand continued to create volatility in input and selling prices. We increased our milk intake and continued to pursue sales volume growth in existing markets, as well as to develop additional international markets. * Non-IFRS measures described in the “Glossary” section on page 36 of the Management’s Discussion and Analysis. Our Dairy Division (Argentina) enjoyed a strong presence in the domestic market and focused on cheese volume development in supermarkets and among distributors. Upgrades at the plant level were made this year to improve line productivity and increase manufacturing capacity to meet higher sales volumes in both the domestic and export markets, which increased revenues for the division. The most significant regulatory development in the United States in fiscal 2018 was the enactment of the “Tax Cuts and Jobs Act”, also known as tax reform, in December 2017. This translated into a notable one-time benefit for Saputo to adjust for future tax balances and current fiscal year provisions and a reduction in our U.S. federal income tax rate going forward. In our Dairy Division (Australia), we completed cheese and whey plant upgrades at our Allansford (Victoria) facility and continued to build solid relationships with farmer suppliers and customers as milk intake exceeded one billion litres for the first time. Going forward, the recently completed acquisition of Murray Goulburn will greatly expand our capacity in Australia and our ability to pursue additional export markets as we continue to invest in our Australian platform and contribute to the ongoing development of its domestic and international business. On the regulatory front, the Comprehensive Economic and Trade Agreement (CETA) between Canada and the European Union (“EU”) came into effect on September 21, 2017, giving EU cheeses increased access to the Canadian market. We have been advised of our Tariff Rate Quota allocation under this agreement and are prepared and well positioned to face this regulatory change. The Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), which includes Canada, Australia and nine other Pacific nations – but not the United States – was signed on March 8, 2018. This agreement will have an as-yet undetermined impact on our quotas in Canada and on dairy pricing domestically as new access is granted to the Canadian market, but it also provides us with new export opportunities from countries where we have a presence to other ratifying countries through our international platform. Meanwhile, it is still uncertain what, if any, changes there will be to the North American Free Trade Agreement (NAFTA) between Canada, the United States and Mexico. As several significant gaps related to key areas of interest for the various parties persist, it remains unclear whether an agreement can be reached prior to the end of fiscal 2019. Regardless of the outcome, we intend to adapt swiftly to any revised regulatory environment in North America. Looking ahead, I believe in our foundations, our infrastructure and our executive team to continue delivering strong results. I also want to thank our employees for ensuring Saputo provides quality products and service to our customers, consumers and business partners wherever they are in the world. Our positive financial and operational performance is the result of our employees executing on our strategies and business plans while staying true to the values that underpin all our initiatives. That is why I look to the future with great optimism, confident the Company will continue to face the challenges and capitalize on the opportunities within the global dairy industry. LINO A. SAPUTO, JR. Chairman of the Board and Chief Executive Officer Saputo Inc. MANAGEMENT’S DISCUSSION AND ANALYSIS — CONSOLIDATED FINANCIAL STATEMENTS 2018 June 7, 2018 TABLE OF CONTENTS Canada Sector USA Sector International Sector Liquidity, financial and capital resources Contractual obligations Balance sheet Guarantees Related party transactions Accounting standards MANAGEMENT’S DISCUSSION AND ANALYSIS Non-IFRS measures Caution regarding forward-looking statements Selected financial information Financial orientation Financial information Elements to consider when reading management’s discussion and analysis Outlook Consolidated results Information by sector 3 3 3 4 5 5 7 8 9 11 13 15 18 20 22 22 23 23 23 23 Critical accounting policies and use of accounting estimates 25 Effect of new accounting standards, interpretations and amendments not yet implemented Considerations for the implementation of IFRS 9 and IFRS 15 27 Effect of new accounting standards, interpretation and amendments adopted during the year 28 28 31 31 31 32 34 35 36 37 44 Risks and uncertainties Disclosure controls and procedures Internal controls over financial reporting Sensitivity analysis of interest rate and us currency fluctuations Quarterly financial information Analysis of earnings for the year ended March 31, 2017 compared to March 31, 2016 Measurement of results not in accordance with international financial reporting standards Glossary CONSOLIDATED FINANCIAL STATEMENTS NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS MANAGEMENT’S DISCUSSION AND ANALYSIS The goal of the management report is to analyze the results of, and the financial position for, the year ended March 31, 2018. It should be read while referring to the audited consolidated financial statements and accompanying notes. The accounting policies of Saputo Inc. (Company or Saputo) for financial years ended March 31, 2018, 2017 and 2016 are in accordance with International Financial Reporting Standards (IFRS). All dollar amounts are in Canadian dollars, unless otherwise indicated. This report takes into account material elements between March 31, 2018 and June 7, 2018, the date on which this report was approved by Saputo’s Board of Directors. The information in this MD&A is being presented as of March 31, 2018, unless otherwise specified. Additional information about the Company, including the annual information form for the year ended March 31, 2018, can be obtained on SEDAR at www.sedar.com. NON-IFRS MEASURES The Company reports its financial results in accordance with IFRS. However, in this MD&A, the following non- IFRS measures are used by the Company: adjusted EBITDA; adjusted net earnings; and adjusted net earnings per share. These measures are defined in the “Glossary” section on page 36 of this Management’s Discussion and Analysis. Refer to ‘‘Measurement of Results not in Accordance with International Financial Reporting Standards’’ on page 35 of this Management’s Discussion and Analysis for the reconciliations to IFRS measures. Management of the Company believes that these non-IFRS measures provide useful information to investors regarding the Company’s financial condition and results of operations as they provide key metrics of its performance. These non- IFRS measures are not recognized under IFRS, do not have any standardized meaning prescribed under IFRS and may differ from similar computations as reported by other issuers, and accordingly may not be comparable. These measures should not be viewed as a substitute for the related financial information prepared in accordance with IFRS. CAUTION REGARDING FORWARD-LOOKING STATEMENTS This report contains forward-looking statements within the meaning of applicable securities laws. These statements are based, among other things, on Saputo’s assumptions, expectations, estimates, objectives, plans and intentions as of the date hereof regarding projected revenues and expenses, the economic, industry, competitive and regulatory environments in which the Company operates or which could affect its activities, its ability to attract and retain customers and consumers, as well as the availability and cost of milk and other raw materials and energy supplies, its operating costs and the pricing of its finished products on the various markets in which it carries on business. These forward-looking statements include, among others, statements with respect to the Company’s short and medium term objectives, outlook, business projects and strategies to achieve those objectives, as well as statements with respect to the Company’s beliefs, plans, objectives and expectations. The words “may”, “should”, “will”, “would”, “believe”, “plan”, “expect”, “intend”, “anticipate”, “estimate”, “foresee”, “objective”, “continue”, “propose” or “target”, or the negative of these terms or variations of them, the use of conditional or future tense or words and expressions of similar nature, are intended to identify forward-looking statements. By their nature, forward-looking statements are subject to a number of inherent risks and uncertainties. Actual results could differ materially from the conclusion, forecast or projection stated in such forward-looking statements. As a result, the Company cannot guarantee that any forward-looking statements will materialize. Assumptions, expectations and estimates made in the preparation of forward-looking statements and risks that could cause actual results to differ materially from current expectations are discussed in the Company’s materials filed with the Canadian securities regulatory authorities from time to time, including the “Risks and Uncertainties” section of this Management’s Discussion and Analysis. Forward-looking statements are based on Management’s current estimates, expectations and assumptions, which Management believes are reasonable as of the date hereof, and, accordingly, are subject to changes after such date. You should not place undue importance on forward-looking statements and should not rely upon this information as of any other date. To the extent any forward-looking statement in this document constitutes financial outlook, within the meaning of applicable securities laws, such information is intended to provide shareholders with information regarding the Company, including its assessment of future financial plans, and may not be appropriate for other purposes. Financial outlook, as with forward- looking information generally, is based on current estimates, expectations and assumptions and is subject to inherent risks and uncertainties and other factors. Except as required under applicable securities legislation, Saputo does not undertake to update or revise these forward- looking statements, whether written or verbal, that may be made from time to time by itself or on its behalf, whether as a result of new information, future events or otherwise. ANNUAL REPORT 2018 - 3 - SELECTED FINANCIAL INFORMATION Years ended March 31 (in millions of CDN dollars, except per share amounts and ratios) Revenues Adjusted EBITDA* Adjusted EBITDA margin* Net earnings Net earnings margin Adjusted net earnings* Adjusted net earnings margin* PER SHARE DATA Net earnings per share Diluted net earnings per share Dividends declared per share Book value BALANCE SHEET DATA Working capital Total assets Net debt** Total non-current financial liabilities Equity FINANCIAL RATIOS Net debt / Equity Net debt-to-adjusted EBITDA* Adjusted return on average equity** Earnings coverage ratio** STATEMENT OF CASH FLOWS DATA Net cash generated from operations Amount of additions to property, plant and equipment, intangible assets, net of proceeds on disposal Business acquisitions Dividends 2018 2017 2016 11,542.5 11,162.6 10,991.5 1,264.7 11.0 % 1,289.5 11.6 % 1,174.1 10.7 % 852.5 7.4 % 704.2 6.1 % 731.1 6.5 % 731.1 6.5 % 601.4 5.5 % 626.9 5.7 % 2.21 2.18 0.64 12.38 1,129.6 8,003.0 1,496.4 1,432.6 4,797.7 0.31 1.18 18.3 % 20.83 809.1 337.4 385.1 243.5 1.86 1.84 0.60 11.19 1,187.1 7,596.6 1,343.3 1,504.5 4,322.9 0.31 1.04 20.7 % 25.83 1,073.6 316.7 - 228.3 1.53 1.51 0.54 10.37 819.0 7,172.3 1,467.1 1,208.3 4,069.8 0.36 1.25 19.2 % 13.36 849.8 226.3 214.9 210.0 * Non-IFRS measures described in the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. ** Refer to the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. ANNUAL REPORT 2018 - 4 - FINANCIAL ORIENTATION Saputo’s primary objective is the creation of shareholder value through profitability enhancement and long-term growth. The Company maintains its focus on cost management and operational efficiency to remain a strong operator and a disciplined financial manager while navigating a competitive and challenging dairy industry. Saputo is also focused on organic growth and growth through acquisitions in order to develop new markets and expand existing ones in addition to reinforcing its presence in emerging markets. The Company remains proactive in evaluating possible acquisitions and potential growth markets. Saputo benefits from a solid balance sheet and capital structure, supplemented by a high level of cash generated by operations. Saputo’s financial flexibility allows growth through targeted acquisitions and enables the Company to overcome possible economic challenges. In fiscal 2018, the Company completed some strategic acquisitions, continued to invest in capital projects, and increased its dividend. FINANCIAL INFORMATION (in millions of CDN dollars) STATEMENT OF EARNINGS Revenues Canada USA International Operating costs excluding depreciation, amortization, acquisition and restructuring costs Canada USA International Adjusted EBITDA* Canada USA International For the three-month periods ended March 31 2017 2018 For the years ended March 31 2017 2018 980.9 1,435.1 328.4 2,744.4 872.2 1306.8 303.1 2,482.7 108.1 128.3 25.3 261.7 959.8 1,486.5 273.5 2,719.8 855.7 1336.0 244.0 2,435.7 104.1 150.5 29.5 284.1 4,069.9 6,132.8 1,339.8 11,542.5 3,594.0 5,483.4 1,200.4 10,277.8 475.9 649.4 139.4 1,264.7 4,060.2 6,003.3 1,099.1 11,162.6 3,607.1 5,269.1 996.9 9,873.1 453.1 734.2 102.2 1,289.5 Adjusted EBITDA margin 9.5% 10.4% 11.0% 11.6% Depreciation and amortization Canada USA International Acquisition and restructuring costs Interest on long-term debt Other financial charges Earnings before incomes taxes Income taxes Net earnings Net earnings margin 14.5 42.3 7.9 64.7 1.2 8.3 4.6 182.9 52.9 130.0 4.7% 14.8 34.8 7.3 56.9 - 8.3 0.8 218.1 52.9 165.2 6.1% 55.9 138.4 32.0 226.3 40.6 33.8 14.1 949.9 97.4 852.5 7.4% 58.0 123.4 25.9 207.3 - 36.9 5.0 1,040.3 309.2 731.1 6.5% * Non-IFRS measure described in the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. ANNUAL REPORT 2018 - 5 -  (in millions of CDN dollars, except per share amounts and ratios) Net earnings Acquisition and restructuring costs (net of income taxes) US Tax Reform** Adjusted net earnings* For the three-month periods ended March 31 For the years ended March 31 2018 130.0 5.3 - 135.3 2017 165.2 - - 165.2 2018 852.5 30.6 (178.9) 704.2 2017 731.1 - - 731.1 Adjusted net earnings margin* 4.9% 6.1% 6.1% 6.5% PER SHARE DATA Net earnings per share Diluted net earnings per share Adjusted net earnings per share* Adjusted diluted net earnings per share* 0.34 0.33 0.35 0.35 0.42 0.42 0.42 0.42 2.21 2.18 1.82 1.80 1.86 1.84 1.86 1.84 * Non-IFRS measures described in the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. ** Refer to the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. ANNUAL REPORT 2018 - 6 - ELEMENTS TO CONSIDER WHEN READING MANAGEMENT’S DISCUSSION AND ANALYSIS Fourth Quarter 2018: • Net earnings totalled $130.0 million, down 21.3%, as compared to the same quarter last fiscal year. • Adjusted net earnings* totalled $135.3 million, down 18.1%, as compared to the same quarter last fiscal year. • Earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs (adjusted EBITDA*) totalled $261.7 million, down $22.4 million or 7.9%, as compared to the same quarter last fiscal year. • Revenues reached $2.745 billion, up 0.9%, as compared to the same quarter last fiscal year. • Net cash generated from operations totalled $317.9 million, up 56.7%, as compared to the same quarter last fiscal year. • Consolidated revenues increased due to higher sales volumes in all sectors. The fluctuation of the average block market** per pound of cheese and the average butter market** price per pound and lower international selling prices of dairy ingredients negatively impacted revenues. • The combination of a higher cost of milk as raw material and lower selling prices in the export markets, including inventory write-downs, negatively impacted consolidated adjusted EBITDA by approximately $33 million. • Higher warehousing and logistical expenses related to higher transportation costs, as well as higher Enterprise Resource Planning (ERP) expenses negatively impacted adjusted EBITDA by approximately $15 million and $10 million, respectively. • In the USA, market factors** also negatively impacted adjusted EBITDA by approximately $3 million, as compared to the same quarter last fiscal year. However, higher sales volumes positively impacted adjusted EBITDA. • The fluctuation of the Canadian dollar versus foreign currencies had a negative impact on revenues of approximately $93 million, as compared to the same quarter last fiscal year. This fluctuation negatively impacted adjusted EBITDA by approximately $5 million, as compared to the same quarter last fiscal year. • On May 1, 2018, the Company completed the acquisition of the activities of Murray Goulburn Co-Operative Co. Limited (Murray Goulburn or MG), based in Australia (Murray Goulburn Acquisition). • On May 23, 2018, the Company announced that it had entered into an agreement to acquire the activities of Shepherd Gourmet Dairy (Ontario) Inc. (Shepherd Gourmet Acquisition) located in St. Marys, Ontario (Canada) for a purchase price of $100 million. The transaction is expected to close in June 2018. • The Board of Directors approved a dividend of $0.16 per share payable on June 28, 2018 to common shareholders of record on June 19, 2018. Fiscal 2018: • Net earnings totalled $852.5 million, up 16.6%, as compared to last fiscal year. • Adjusted net earnings totalled $704.2 million, down 3.7%, as compared to last fiscal year. • Adjusted EBITDA totalled $1.265 billion, down $24.8 million or 1.9%, as compared to last fiscal year. • Revenues reached $11.543 billion, up 3.4%, as compared to last fiscal year. • Net cash generated from operations totalled $809.1 million, down 24.6%, as compared to last fiscal year. • Consolidated revenues increased due to higher sales volumes in all sectors. The fluctuation of the average block market per pound of cheese and the average butter market price per pound resulted in an increase of revenues of approximately $97 million, while higher international selling prices of cheese and dairy ingredients increased revenues by approximately $90 million and impacted adjusted EBITDA favourably. • Higher warehousing and logistical expenses related to higher transportation costs of approximately $30 million and ERP expenses of approximately $32 million negatively impacted consolidated adjusted EBITDA. • In the USA, market factors also negatively impacted adjusted EBITDA by approximately $25 million, as compared to last fiscal year. These decreases were partially offset by higher selling prices in both domestic and export markets and higher sales volumes. • As a result of decreases in certain market selling prices, inventory was written down by approximately $17 million, as compared to approximately $4 million last fiscal year. • The fluctuation of the Canadian dollar versus foreign currencies had a negative impact on revenues of approximately $211 million, as compared to last fiscal year. This fluctuation negatively impacted adjusted EBITDA by approximately $18 million, as compared to last fiscal year. • The acquisitions of the extended shelf-life dairy product activities of Southeast Milk, Inc. (SMI Acquisition) and Betin, Inc., doing business as Montchevre (Montchevre Acquisition), were completed on September 29, 2017 and December 12, 2017, respectively. ________________________ ∗ Non-IFRS measures described in the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. ** Refer to the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. ANNUAL REPORT 2018 - 7 - OUTLOOK Throughout fiscal 2018, the Company continued to strategically invest in capital projects, materialize acquisitions, expand its activities in existing markets and increase its dividend. In fiscal 2019, the strategic Murray Goulburn Acquisition, combined with our existing Australian platform allowed the Company to become the leading dairy processor in Australia. The Murray Goulburn Acquisition will provide opportunities in both domestic and export markets. In fiscal 2019, we will focus on integrating MG’s operations and maximizing the asset base in addition to aligning it with our Company’s operating model and business approach. Additionally, the SMI Acquisition and the Montchevre Acquisition integrations will continue in the USA, maximizing network infrastructure and distribution as well as increasing our presence in the specialty cheese category in the USA. The Company also benefits from a solid balance sheet and capital structure, supplemented by a high level of cash generated by operations. This financial flexibility allows the Company to continue to grow through targeted acquisitions and organically through strategic capital investments. Profitability enhancement and shareholder value creation remain the cornerstones of the Company’s objectives. The Company has a long-standing commitment to manufacture quality products and will remain focused on operational efficiencies. We intend to continue expanding and modernizing our plants, with investments in equipment and processes designed to increase efficiency. The Company tends to spend amounts of capital to a level which is equivalent to its depreciation and amortization expense, without considering capital expenditure amounts for strategic projects, such as plant capacity increases, capital expenditures necessary to build new infrastructure for rationalization programs, or the Company’s ERP initiative. In fiscal 2019, the Company intends to spend $310.7 million in capital in addition to an amount of $54.8 million allocated for the continued implementation of the ERP initiative. Refer to the section entitled ‘‘Capital Expenditures’’ in the Annual Information Form of the Company dated June 7, 2018 for additional information on the Company’s capital expenditure plan. The Company will pursue planning, designing and implementation activities for the migration to a new ERP system. The implementation is progressing as planned. The new ERP system has been successfully implemented in Argentina and Australia. In fiscal 2019, the Company expects to complete the system implementation in the Dairy Foods Division (USA). Afterwards, the Company will proceed with the implementation in the Cheese Division (USA), which is expected in fiscal 2020. Implementation in the Dairy Division (Canada) will begin in fiscal 2020. ANNUAL REPORT 2018 - 8 - CONSOLIDATED RESULTS Consolidated selected factors positively (negatively) affecting adjusted EBITDA and earnings before income taxes (in millions of CDN dollars) For the three-month periods ended March 31 2017 2018 For the years ended March 31 2017 2018 Market factors*,1 Inventory write-down Foreign currency exchange1 * Refer to the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. 1 As compared to same quarter of previous fiscal year for the three-month periods; as compared to the previous fiscal year for the years ended (25) (17) (18) (10) (2) (4) (3) (11) (5) (4) (4) 13 March 31. Consolidated revenues for the fourth quarter of fiscal 2018 totalled $2.745 billion, an increase of approximately $25 million or 0.9%, as compared to $2.720 billion for the same quarter last fiscal year. Higher sales volumes, as well as the inclusion of revenues derived from the SMI Acquisition and the Montchevre Acquisition, increased revenues by approximately $53 million, as compared to the same quarter last fiscal year. A lower average block market per pound of cheese, partially offset by a higher average butter market price per pound, decreased revenues by approximately $29 million as compared to the same quarter last fiscal year. Also, lower international selling prices of dairy ingredients negatively impacted revenues. Moreover, the fluctuation of the Canadian dollar versus foreign currencies decreased revenues by approximately $93 million. Consolidated revenues totalled $11.543 billion in fiscal 2018, an increase of approximately $380 million or 3.4% in comparison to $11.163 billion in fiscal 2017. Higher sales volumes and higher selling prices of cheese and dairy ingredients in both domestic and export markets increased revenues, as compared to last fiscal year. The fluctuation of the average butter market price per pound and the average block market per pound of cheese increased revenues by approximately $97 million. Additionally, the inclusion of revenues from the SMI Acquisition and the Montchevre Acquisition positively impacted revenues by approximately $78 million. Conversely, the fluctuation of the Canadian dollar versus foreign currencies decreased revenues by approximately $211 million. Consolidated adjusted EBITDA for the fourth quarter of fiscal 2018 totalled $261.7 million, a decrease of $22.4 million or 7.9% in comparison to $284.1 million for the same quarter last fiscal year. The combination of a higher cost of milk as raw material and lower selling prices in the export markets, including inventory write-downs, decreased adjusted EBITDA by approximately $33 million. Furthermore, higher warehousing and logistical costs related to additional external storage expenses and higher transportation costs of approximately $15 million, as well as higher administrative expenses to support future growth, mainly due to the ERP initiative, of approximately $10 million decreased adjusted EBITDA. In the USA, market factors negatively impacted adjusted EBITDA by approximately $3 million. These decreases were partially offset by higher sales volumes, operational efficiencies through raw material optimization, as well as the positive impact derived from the SMI Acquisition and the Montchevre Acquisition. Lastly, the fluctuation of the Canadian dollar versus foreign currencies had an unfavourable impact on adjusted EBITDA of approximately $5 million, as compared to the same quarter last fiscal year. Consolidated adjusted EBITDA in fiscal 2018 totalled $1.265 billion, a decrease of approximately $25 million or 1.9%, as compared to $1.290 billion in fiscal 2017. Higher warehousing and logistical costs related to additional external storage expenses and higher transportation costs of approximately $30 million, as well as higher ERP expenses of approximately $32 million decreased adjusted EBITDA, as compared to last fiscal year. Additionally, in the USA, market factors decreased adjusted EBITDA by approximately $25 million. As a result of the decrease in certain market selling prices, inventory was written down by approximately $17 million during fiscal 2018, as compared to approximately $4 million for last fiscal year. These decreases were partially offset by operational efficiencies through raw material optimization and higher international selling prices of cheese and dairy ingredients. Higher sales volumes and a favourable product mix, as well as the inclusion of the SMI Acquisition and the Montchevre Acquisition positively impacted adjusted EBITDA. Finally, the fluctuation of the Canadian dollar versus foreign currencies had an unfavourable impact on adjusted EBITDA of approximately $18 million, as compared to last fiscal year. The consolidated adjusted EBITDA margin decreased to 11.0% in fiscal 2018, as compared to 11.6% in fiscal 2017, resulting mainly due to lower adjusted EBITDA in the USA Sector as compared to the prior fiscal year. ANNUAL REPORT 2018 - 9 - Depreciation and amortization for the fourth quarter of fiscal 2018 totalled $64.7 million, an increase of $7.8 million, in comparison to $56.9 million for the same quarter last fiscal year. In fiscal 2018, depreciation and amortization expenses amounted to $226.3 million, an increase of $19.0 million, as compared to $207.3 million for fiscal 2017. These increases are mainly attributed to additions to property, plant and equipment and intangibles related to the ERP initiative, increasing the depreciable base, as well as the additional depreciation and amortization expenses related to the SMI Acquisition and the Montchevre Acquisition. Acquisition costs and restructuring costs amounted to $1.2 million and $40.6 million respectively for the three- month period ended March 31, 2018 and fiscal 2018. Acquisition costs are related to the SMI Acquisition, the Montchevre Acquisition and the Murray Goulburn Acquisition. In connection with the restructuring costs relating to a plant closure in Fond du Lac, Wisconsin, the Company incurred $23.1 million in severance and closure costs and $10.6 million in impairment charges to property, plant and equipment. Net interest expense for the three-month period ended March 31, 2018 and fiscal 2018 increased by $3.8 million and $6.0 million respectively, in comparison to the same periods last fiscal year. These increases are mainly attributed to higher bank loans denominated in Argentine peso, which bear higher interest rates, and financing for the SMI Acquisition and the Montchevre Acquisition. Income taxes for the three-month period ended March 31, 2018 and 2017 totalled $52.9 million, reflecting an effective tax rate of 28.9%, as compared to 24.3% for the same quarter last fiscal year. In fiscal 2018, income taxes totalled $97.4 million, compared to $309.2 million in fiscal 2017, reflecting an effective tax rate of 10.3%, compared to 29.7% last fiscal year. During the fiscal year, the Company recorded an income tax benefit of $178.9 million to adjust for future tax balances of $169.2 million and current fiscal year provisions of $9.7 million, due to the reduction of the US federal tax rate. Excluding the benefit of the US federal tax rate reduction, income tax expense in fiscal 2018 would have totalled $276.3 million, reflecting an effective tax rate of 29.1% compared to 29.7% for the previous fiscal year. This reduction is mainly due to an income tax recovery of $8.3 million following a positive settlement in a tax file. The income tax rate varies and could increase or decrease based on the amount and source of taxable income, amendments to tax legislations and income tax rates, changes in assumptions, as well as estimates used for tax assets and liabilities by the Company and its affiliates. Net earnings for the three-month period ended March 31, 2018 totalled $130.0 million, a decrease of $35.2 million or 21.3% in comparison to $165.2 million for the same quarter last fiscal year. In fiscal 2018, net earnings totalled $852.5 million, an increase of $121.4 million or 16.6%, as compared to $731.1 million last fiscal year. The variations in net earnings are due to the above-mentioned factors. Adjusted net earnings totalled $135.3 million for the three-month period ended March 31, 2018, as compared to $165.2 million for the same quarter last fiscal year. In fiscal 2018, adjusted net earnings, totalled $704.2 million, as compared to $731.1 million last fiscal year. These decreases are due to the above-mentioned factors. ANNUAL REPORT 2018 - 10 - INFORMATION BY SECTOR For fiscal 2018, the Canada Sector includes national and export revenues of ingredients manufactured in Canada. The USA Sector includes national ingredient revenues, and export ingredient and cheese revenues of products manufactured in the USA. For fiscal 2017, these figures were presented in the Dairy Ingredients Division as part of the International Sector. Accordingly, certain prior year’s figures have been reclassified to conform to the current presentation. CANADA SECTOR (in millions of CDN dollars) Fiscal years Revenues Adjusted EBITDA* 2018 2017 Q4 980.9 108.1 Q3 Q2 1,057.2 1,032.6 127.9 122.9 Q1 999.2 117.0 Q4 959.8 104.1 Q3 Q2 1,059.0 1,044.3 116.9 119.8 Q1 997.1 112.3 * Non-IFRS measure described in the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. The Canada Sector consists of the Dairy Division (Canada). USA SECTOR (in millions of CDN dollars) Fiscal years 2018 2017 Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Revenues 1,435.1 1,591.3 1,528.1 1,578.3 1,486.5 1,593.8 1,532.0 1,391.0 Adjusted EBITDA* 128.3 153.9 170.7 196.5 150.5 200.1 196.1 187.5 * Non-IFRS measure described in the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. Selected factors positively (negatively) affecting adjusted EBITDA and earnings before income taxes (in millions of CDN dollars) Fiscal years Market factors*,1 Inventory write-down US currency exchange1 Q4 (3) (7) (6) 2018 Q3 (19) - (9) Q2 Q1 (6) - (7) 3 - 8 Q4 (10) - (7) 2017 Q3 (3) - - Q2 20 - - Q1 (11) - 8 * Refer to the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. 1 As compared to same quarter of previous fiscal year. Other pertinent information (in US dollars, except for average exchange rate) Fiscal years Closing block price per pound of cheese* Average block market per pound of cheese* Closing butter market price per pound* Average butter market price per pound* Average whey powder market price per pound* Spread* US average exchange rate to Canadian dollar1 * Refer to the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. 1 Based on Bank of Canada published information. Q4 1.530 1.524 2.215 2.160 0.241 0.148 1.268 2018 Q3 1.540 1.627 2.208 2.254 0.310 0.072 1.270 Q2 1.735 1.660 2.315 2.568 0.403 0.066 1.256 Q1 1.525 1.575 2.643 2.312 0.465 0.039 1.344 2017 Q4 1.520 1.580 2.108 2.177 0.482 0.011 1.324 The USA Sector consists of the Cheese Division (USA) and the Dairy Foods Division (USA). ANNUAL REPORT 2018 - 11 - INTERNATIONAL SECTOR (in millions of CDN dollars) Fiscal years Revenues Adjusted EBITDA* Q4 328.4 25.3 2018 Q3 373.3 36.2 Q2 323.5 36.2 Q1 314.6 41.7 Q4 273.5 29.5 2017 Q3 313.3 29.6 Q2 269.0 24.7 Q1 243.3 18.4 * Non-IFRS measure described in the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. Selected factors positively (negatively) affecting adjusted EBITDA and earnings before income taxes (in millions of CDN dollars) Fiscal years Inventory write-down Foreign currency exchange1 Q4 (4) 2 2018 Q3 (2) (4) Q2 (3) (1) Q1 (1) 1 Q4 (2) (1) 2017 Q3 - 4 Q2 (1) 1 Q1 (1) 3 1 As compared to same quarter of previous fiscal year. The International Sector consists of the Dairy Division (Argentina) and the Dairy Division (Australia). ANNUAL REPORT 2018 - 12 - CANADA SECTOR (in millions of CDN dollars) Revenues Adjusted EBITDA* For the three-month periods ended March 31 2017 2018 980.9 108.1 959.8 104.1 For the years ended March 31 2017 4,060.2 453.1 2018 4,069.9 475.9 * Non-IFRS measure described in the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. The Canada Sector consists of the Dairy Division (Canada). Revenues For the fourth quarter of fiscal 2018, revenues for the Canada Sector totalled $980.9 million, an increase of approximately $21 million or 2.2%, as compared to $959.8 million for the same quarter last fiscal year. While sales volumes have remained relatively stable, the increase in revenues is mainly due to a favourable product mix partially offset by lower selling prices of ingredients sold in the export market. Revenues from the Canada Sector in fiscal 2018 totalled $4.070 billion, an increase of approximately $10 million or 0.2% in comparison to $4.060 billion in fiscal 2017. The increase is due to a favourable product mix, higher selling prices related to the increase in the cost of milk as raw material partially offset by lower selling prices of ingredients sold in the export market and lower sales volumes of juices, a product category the Company exited. The Sector manufactures approximately 32% of all Canadian natural cheeses. Saputo’s market share of total fluid milk and cream in Canada is approximately 37%. Saputo is the largest cheese manufacturer and the leading fluid milk and cream processor in Canada. In fiscal 2018, cheese, butter, value-added milk and cream per capita consumption increased, while fluid milk decreased, as compared to the previous fiscal year. The retail segment of the Dairy Division (Canada) represented approximately 62% of revenues following continued demand for dairy products. The Division continued to support its leading national brands, Dairyland, Saputo, Armstrong and Milk2Go, through various customer and consumer marketing activities, such as themed trade promotions at various retailers and through social media vehicles like our brands’ websites and Influencers. Additionally, the retail segment continued to focus on communicating the new image of Saputo and increasing the exposure of specialty cheeses across Canada, namely, Alexis de Portneuf, Woolwich and DuVillage 1860, through expanded distribution and inspirational consumer marketing support. We also continued to build consumer preference for our products and notably launched our new brand image for Milk2Go along with reintroducing the products that are now manufactured with our new state-of-the-art manufacturing equipment, in Saint-Hyacinthe, Quebec, using aseptic filling technology. Dairy utilization through menu inspiration in the foodservice segment represented approximately 35% of revenues in the Dairy Division (Canada). The Company’s focus is to support customers such as distributors, restaurant chains and pizzerias by providing quality products that perform to their expectations. Saputo strives to be the supplier partner of choice by offering high quality service and support such as data driven foodservice insights to enhance operator knowledge. We also continue to invest in foodservice product innovation to meet evolving consumer needs. The Company invests in the foodservice industry through partnerships with various culinary colleges, thereby investing in future generations that will contribute to a strong and healthy industry. The industrial segment represented approximately 3% of revenues in the Dairy Division (Canada). ANNUAL REPORT 2018 - 13 - Adjusted EBITDA For the fourth quarter of fiscal 2018, adjusted EBITDA for the Canada Sector totalled $108.1 million, an increase of $4.0 million or 3.8%, as compared to $104.1 million for the same quarter last fiscal year. Operational efficiencies through raw material optimization and a favourable product mix positively impacted adjusted EBITDA. This increase was partially offset by lower international selling prices of dairy ingredients and higher warehousing and logistical costs related to additional external storage expenses. Adjusted EBITDA in fiscal 2018 totalled $475.9 million, an increase of $22.8 million or 5.0%, as compared to $453.1 million in fiscal 2017. Operational efficiencies through raw material optimization, as well as lower administrative expenses, including the impact of phasing the ERP deployment activities, positively impacted adjusted EBITDA, as compared to the same quarter last fiscal year. This increase was partially offset by lower international selling prices of dairy ingredients, higher warehousing and logistical costs related to additional external storage expenses, as well as lower sales volumes of juices, a product category the Company exited. The fluctuation of the Canadian dollar versus foreign currencies had a negative impact on adjusted EBITDA of approximately $1 million. Outlook We will continue to focus on reviewing overall activities to improve operational efficiency, in order to mitigate downward margin pressures, low growth and competitive market conditions. The Dairy Division (Canada) will undertake capital projects aimed at increasing efficiencies and maximizing its manufacturing footprint in order to maintain its leadership position. The Division also intends to capture market opportunities from the redesign of the Saputo brand and reaffirm its engagement to consumers from coast-to-coast as their preferred and trusted cheese brand through various promotions, advertising and innovative packaging. As part of the Company’s capital expenditure plan, we intend to build a new facility for approximately $240 million, over the next three years, in Port-Coquitlam, British Columbia to better serve the market in Western Canada and benefit from a state-of-the-art facility to be commissioned in fiscal 2021. Consequently, the Company has entered into an agreement to sell its existing facility in Burnaby, British Columbia, which sale is expected to be completed in fiscal 2019, for an amount of $218 million, and will enter into a lease agreement for that same facility until the construction of the new facility is completed. We expect to be in a position to complete the Shepherd Gourmet Acquisition in June 2018 and then proceed with the integration of the activities. The acquisition will enable the Dairy Division (Canada) to increase its presence in specialty cheese and expand its yogurt offering in Canada. The transaction remains subject to customary conditions. The Dairy Division (Canada) will begin its preparation activities in fiscal 2019 in anticipation of its upcoming ERP system implementation in fiscal 2020. ANNUAL REPORT 2018 - 14 - USA SECTOR (in millions of CDN dollars) For the three-month periods ended March 31 2017 2018 For the years ended March 31 2017 2018 Revenues Adjusted EBITDA* * Non-IFRS measure described in the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. 1,435.1 128.3 1,486.5 150.5 6,132.8 649.4 6,003.3 734.2 Selected factors positively (negatively) affecting adjusted EBITDA and earnings before income taxes (in millions of CDN dollars) For the three-month periods ended March 31 2017 2018 For the years ended March 31 2017 2018 Market factors*,1 Inventory write-down US currency exchange1 * Refer to the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. 1 As compared to same quarter of previous fiscal year for the three-month periods; as compared to the previous fiscal year for the year ended March (10) - (7) (25) (7) (14) (3) (7) (6) (4) - 1 31. Other pertinent information (in US dollars, except for average exchange rate) Block market price* Opening Closing Average Butter market price* Opening Closing Average Average whey powder market price* Spread* US average exchange rate to Canadian dollar1 For the three-month periods ended March 31 2017 2018 1.540 1.530 1.524 2.208 2.215 2.160 0.241 0.148 1.268 1.660 1.520 1.580 2.268 2.108 2.177 0.482 0.011 1.324 For the years ended March 31 2017 1.460 1.520 1.605 1.955 2.108 2.112 0.350 0.092 1.312 2018 1.520 1.530 1.597 2.108 2.215 2.324 0.357 0.081 1.288 * Refer to the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. 1 Based on Bank of Canada published information. The USA Sector consists of the Cheese Division (USA) and the Dairy Foods Division (USA). Revenues For the three-month period ended March 31, 2018, revenues for the USA Sector totalled $1.435 billion, a decrease of approximately $52 million or 3.5%, as compared to $1.487 billion for the same quarter last fiscal year. The combined effect of the fluctuation of the average block market per pound of cheese and the average butter market price per pound decreased revenues by approximately $29 million, as compared to the same quarter last fiscal year. Lower selling prices in the international cheese and dairy ingredient market also negatively impacted revenues during the quarter. Higher sales volumes, as well as the inclusion of revenues of approximately $53 million derived from the SMI Acquisition and the Montchevre Acquisition positively impacted revenues. The fluctuation of the Canadian dollar versus the US dollar decreased revenues by approximately $63 million. ANNUAL REPORT 2018 - 15 - In fiscal 2018, revenues for the USA Sector totalled $6.133 billion, an increase of approximately $130 million or 2.2% in comparison to $6.003 billion for last fiscal year. The combined effect of the fluctuation of the average butter market price per pound and the average block market per pound of cheese, as compared to last fiscal year, increased revenues by approximately $97 million. Additionally, higher sales volumes, as well as higher selling prices in the international cheese and dairy ingredient market positively impacted revenues. The inclusion of revenues derived from the SMI Acquisition and the Montchevre Acquisition positively impacted revenues by approximately $78 million, while the fluctuation of the Canadian dollar versus the US dollar decreased revenues by approximately $133 million. The retail segment contributed approximately 44% of total USA Sector revenues. Two of its retail brands maintained their #1 market share positions. Frigo Cheese Heads continued to lead the string cheese brand category in the USA market and Treasure Cave continued to lead the crumbled blue cheese category. The Cheese Division (USA) continued to support these leading retail brands through promotional activities and trade incentives in fiscal 2018. Strengthening its position in the snacking category, the Cheese Division (USA) relaunched its Frigo Cheese Heads brand, unifying all its packaging under a new look and feel, while extending several flavors in its core line-up. A new line of products geared towards the convenience channel was also launched under this brand. The Dairy Foods Division (USA) continues to outpace market growth in core categories, including ESL creams/creamers and cultured products. The growth is driven by strong relationships with key customers, positive trends in private label, and targeted customer solutions, such as quality programs, formula updates and innovation. The foodservice segment contributed approximately 49% of total revenues. In fiscal 2018, the Cheese Division (USA) continued to focus on driving this segment through national pizza chains and through key national and independent restaurant chains. In addition to focusing on growing its share of the cheese market, the Division also sought to increase specialty cheese sales. The foodservice sales and marketing team executed various operator, distributor and broker initiative programs targeted at driving incremental sales. The foodservice segment for the Dairy Foods Division (USA) consists of two main customer segments: chain restaurants and broadline distributors. Distribution gains and menu innovation are driving the chain restaurant segment with its core portfolio of ice cream mix and bulk-size ESL dairy products. A focus on private label dairy products is driving growth for broadline distributors in core categories, such as ESL cream/creamers and sour cream. The industrial segment includes cheese sales and accounted for approximately 7% of revenues. Adjusted EBITDA For the three-month period ended March 31, 2018, adjusted EBITDA for the USA Sector totalled $128.3 million, a decrease of $22.2 million or 14.8%, as compared to $150.5 million for the same quarter last fiscal year. Contributing to the adjusted EBITDA decrease were higher warehousing and logistical expenses due to increased transportation costs, which amounted to approximately $12 million, as well as higher administrative expenses, mainly due to the ERP initiative. This decrease was partially offset by higher sales volumes and additional adjusted EBITDA derived from the inclusion of the SMI Acquisition and the Montchevre Acquisition. The variation in the average block market per pound of cheese during the quarter versus the same quarter last fiscal year had an unfavourable impact on both the realization of inventories and on the absorption of fixed costs. A lower dairy ingredient market had a negative effect on adjusted EBITDA. However, the relation between the average block market per pound of cheese and the cost of milk as raw material was favourable. These combined market factors, including unfavourable margins associated with a fluctuation of butter market prices, negatively impacted adjusted EBITDA by approximately $3 million, as compared to the same quarter last fiscal year. As a result of decreases in certain market selling prices, inventory was written down by approximately $7 million. The fluctuation of the Canadian dollar versus the US dollar had a negative impact on adjusted EBITDA of approximately $6 million. In fiscal 2018, adjusted EBITDA totalled $649.4 million, a decrease of $84.8 million or 11.5%, as compared to $734.2 million for last fiscal year. The variation in the average block market per pound of cheese in fiscal 2018, as compared to last year, resulted in an unfavourable realization of inventories. Also, the relation between the average block market per pound of cheese and the cost of milk as raw material was unfavourable. However, a higher dairy ingredient market had a positive effect on adjusted EBITDA. These combined market factors, including unfavourable margins associated with a fluctuation of butter market prices, negatively impacted adjusted EBITDA by approximately $25 million, as compared to last fiscal year. Contributing to the adjusted EBITDA decrease were higher administrative expenses, mainly due to the ERP initiative, as well as higher warehouse and logistical costs due to higher transportation costs, which amounted to approximately $20 million. Also, additional costs related to the start-up of a newly constructed blue cheese facility in Almena, Wisconsin decreased adjusted EBITDA. As a result of decreases in certain market selling prices, inventory was written down by approximately $7 million. These decreases were partially offset by higher sales volumes and a favourable product mix, as well as the inclusion of adjusted EBITDA derived from the SMI Acquisition and the Montchevre Acquisition. The weakening of the Canadian dollar versus the US dollar had a negative impact on adjusted EBITDA of approximately $14 million. ANNUAL REPORT 2018 - 16 - Outlook The Cheese Division (USA) is focused on increasing operational efficiencies and controlling costs in order to mitigate the negative impact on adjusted EBITDA of the dairy commodity markets. During the upcoming quarters, the Division will benefit from the additional blue cheese manufacturing capabilities in its newly constructed facility in Almena, Wisconsin. This capital expenditure project allows the Division to strengthen its position within the blue cheese category. Also, the Cheese Division (USA) will pursue growth of cheese export sales volumes to the extent USA milk pricing is competitive with world prices. The Division will close its cheese manufacturing facility in Fond du Lac, Wisconsin in the first quarter of fiscal 2019. In an effort to pursue additional efficiencies and decrease costs while strengthening its market presence, the production has been transferred into the Company’s facility in Almena, Wisconsin. The Division will focus on the integration of the Montchevre Acquisition which enables the Cheese Division (USA) to broaden its presence in specialty cheeses in the USA. The Dairy Foods Division (USA) continues to focus on optimization and maximizing investments in its existing network in order to benefit from new capabilities in production, enable future growth, meet customer demand and bring new products to market. The Division has integrated the SMI Acquisition and will focus on maximizing its network infrastructure and distribution. The Division will keep investing to support production capabilities and strengthen its competitive cost position. More specifically, the Dairy Foods Division (USA) will focus on targeted capital expenditures aimed at increasing production capacity. The dairy ingredient markets were depressed through the fourth quarter of fiscal 2018 and these prices are anticipated to remain low throughout the first half of fiscal 2019, which will continue to put downward pressure on the USA Sector’s margins. The implementation of the ERP system continues to progress. The implementation within the Dairy Foods Division (USA) will be completed in fiscal 2019 while the Cheese Division (USA) has started its preparation activities and implementation is expected to be completed in fiscal 2020. ANNUAL REPORT 2018 - 17 - INTERNATIONAL SECTOR (in millions of CDN dollars) For the three-month periods ended March 31 2017 2018 For the years ended March 31 2017 2018 Revenues Adjusted EBITDA* * Non-IFRS measure described in the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. 328.4 25.3 273.5 29.5 1,339.8 139.4 1,099.1 102.2 Selected factors positively (negatively) affecting adjusted EBITDA and earnings before income taxes (in millions of CDN dollars) For the three-month periods ended March 31 2017 2018 For the years ended ended March 31 2017 2018 Inventory write-down US currency exchange1 1 As compared to same quarter of previous fiscal year for the three-month periods; as compared to the previous fiscal year for the years ended March 31. (10) (2) (4) 7 (4) 2 (2) (1) The International Sector consists of the Dairy Division (Argentina) and the Dairy Division (Australia). Revenues For the three-month period ended March 31, 2018, revenues for the International Sector totalled $328.4 million, an increase of $54.9 million or 20.1%, as compared to $273.5 million for the same quarter last fiscal year. Higher sales volumes in both domestic and export markets increased revenues. Additionally, despite lower prices in the export market, higher selling prices in the domestic market and the fluctuation of the Argentine peso versus the US dollar increased revenues, as compared to the same quarter last fiscal year. The fluctuation of the Canadian dollar versus the foreign currencies used in the International Sector had a negative impact on revenues of approximately $30 million, as compared to the same quarter last fiscal year. In fiscal 2018, revenues for the International Sector totalled $1.340 billion, an increase of approximately $241 million or 21.9% in comparison to $1.099 billion last fiscal year. Higher selling prices in both the domestic and export markets, as well as the fluctuation of the Argentine peso versus the US dollar in the export market increased revenues, as compared to last fiscal year. Despite an unfavourable product mix, higher export sales volumes, as well as increased sales volumes in the domestic market of the Dairy Division (Argentina), increased revenues. The fluctuation of the Canadian dollar versus the foreign currencies used in the International Sector had a negative impact on revenues of approximately $78 million, as compared to last fiscal year. Adjusted EBITDA For the three-month period ended March 31, 2018, adjusted EBITDA for the International Sector totalled $25.3 million, a decrease of $4.2 million or 14.2%, as compared to $29.5 million for the same quarter last fiscal year. Lower selling prices in the export market and a higher cost of milk as raw material, including inventory write-downs, negatively impacted adjusted EBITDA by approximately $26 million. This decrease was partially offset by higher sales volumes and lower administrative expenses mainly due to higher ERP expenses during the same quarter last fiscal year. The fluctuation of the Canadian dollar versus foreign currencies had a positive impact on adjusted EBITDA of approximately $2 million. In fiscal 2018, adjusted EBITDA for the International Sector totalled $139.4 million, an increase of $37.2 million or 36.4%, as compared to $102.2 million last fiscal year. Higher sales volumes and higher selling prices in both the domestic and export markets positively impacted adjusted EBITDA. This increase was partially offset by higher warehousing and logistical expenses, in comparison to last fiscal year. As a result of the decrease in certain market selling prices, inventory was written down by approximately $10 million during the fiscal year, as compared to approximately $4 million last fiscal year. The fluctuation of the Canadian dollar versus foreign currencies had a negative impact on adjusted EBITDA of approximately $2 million. ANNUAL REPORT 2018 - 18 - Outlook On May 1, 2018, the Company completed the Murray Goulburn Acquisition, which will add to and complement the activities of its Dairy Division (Australia). By acquiring a well-established industry player, the Company reinforces its commitment to strengthen its presence in the Australian market. The Company intends to grow milk intake, review Murray Goulburn operations and focus on maximizing the network at its disposal. MG produces a full range of high- quality dairy foods, including fluid milk, milk powder, cheese, butter and dairy beverages, as well as a range of dairy ingredient and nutritional products, such as infant formula. MG supplies the retail and foodservice industries globally with its flagship Devondale, Liddells and Murray Goulburn Ingredients brands. Saputo intends to continue to pursue growth, invest in its Australian platform, and contribute to the ongoing development of its domestic and international business. The Company has also initiated a sale process for the Koroit dairy plant, based in Victoria, Australia, acquired from MG, such divestiture being required pursuant to the undertaking entered into with the Australian Competition and Consumer Commission in connection with the Murray Goulburn Acquisition. The International Sector will continue to pursue sales volumes growth in existing markets, as well as develop additional international markets. The Sector will continue to evaluate overall activities to improve efficiencies and aim to maximize its operational flexibility to mitigate volatility in market conditions. As volatility in dairy markets remains, we do not expect a significant recovery in the international cheese and dairy ingredient prices in the first half of fiscal 2019. As such, we will continue to focus on controlling costs and increasing operational efficiencies in order to mitigate their impact on adjusted EBITDA. ANNUAL REPORT 2018 - 19 - LIQUIDITY, FINANCIAL AND CAPITAL RESOURCES The intent of this section is to provide insight into the cash and capital management strategies and how they drive operational objectives, as well as to provide details on how the Company manages its liquidity risk to meet its financial obligations as they come due. The majority of the Company’s liquidity needs are funded from cash generated by operations. Principally, these funds are used for capital spending, dividends, debt repayments, business acquisitions and share repurchases. The Company also has bank credit facilities available for general corporate purposes. The Company’s cash flows are summarized in the following table: (in millions of CDN dollars) Cash generated from operating activities Net cash generated from operating activities Cash used for investing activities Cash used for financing activities (Decrease) increase in cash and cash equivalents For the three-month periods ended March 31 2017 2018 358.1 317.9 (90.4) (228.9) (1.4) 263.5 202.9 (100.4) (277.6) (175.1) For the years ended March 31 2017 1,325.7 1,073.6 (317.8) (679.8) 76.0 2018 1,155.8 809.1 (722.9) (204.1) (117.9) For the three-month period ended March 31, 2018, cash generated from operating activities amounted to $358.1 million in comparison to $263.5 million for the same quarter last fiscal year, an increase of $94.6 million. In fiscal 2018, cash generated from operating activities amounted to $1.156 billion in comparison to $1.326 billion last fiscal year, a decrease of $169.9 million. Net cash generated from operating activities for the three-month period ended March 31, 2018, amounted to $317.9 million in comparison to $202.9 million for the same quarter last fiscal year. The increase of $115.0 million is due to changes in non-cash operating working capital items of $118.5 million driven by the fluctuation in accounts receivable, inventories, as well as payables in line with the fluctuation of market prices and a decrease of income tax paid of $23.2 million. This increase was offset by a decrease in adjusted EBITDA of $22.4 million and additional interest paid of $2.8 million. In fiscal 2018, net cash generated from operating activities amounted to $809.1 million in comparison to $1.074 billion last fiscal year. The decrease of $264.5 million is due to changes in non-cash operating working capital items of $117.6 million driven by the fluctuation in accounts receivable, inventories, as well as payables in line with the fluctuation of market prices, a decrease in adjusted EBITDA of $24.8 million, an increase of $90.0 million and $4.6 million in income tax paid and interest paid, respectively. Investing activities for the three-month period ended March 31, 2018 were mainly comprised of $14.7 million disbursed for post-closing purchase price adjustments for the Montchevre Acquisition, additions to property, plant and equipment of $65.3 million and intangibles related to the ERP initiative of $10.7 million. In fiscal 2018, investing activities consisted mainly of the SMI Acquisition and the Montchevre Acquisition totalling $385.1 million, additions to property, plant and equipment of $277.8 million and additions to intangibles of $66.2 million related to the ERP initiative. Of these additions, 37% went into the replacement of property, plant and equipment and 63% to implement new technologies and to expand and increase certain manufacturing capacities. Financing activities for the three-month period ended March 31, 2018 consisted mainly of a decrease in bank loans of $173.6 million and issued shares as part of the stock option plan for $7.6 million. Finally, the Company paid $61.9 million in dividends. Financing activities in fiscal 2018 consisted mainly of an increase in bank loans of $129.6 million due to the Montchevre Acquisition and the net reimbursement of $100.0 million in long-term debt resulting from the issuance of $300.0 million medium term notes, which was used in addition to cash on hand to repay $400.0 million from an unsecured bank term loan. In addition, shares were issued as part of the stock option plan for $41.0 million. Finally, the Company repurchased share capital for $29.0 million and paid $243.5 million in dividends. ANNUAL REPORT 2018 - 20 - Liquidity Cash and cash equivalents, cash flows generated from operations, and the availability to draw against existing bank credit facilities are expected to enable the Company to meet its liquidity requirements over at least the next twelve-months. The Company does not foresee any difficulty in securing financing beyond what is currently available through existing arrangements to fund possible acquisitions. (in millions of CDN dollars, except ratio) Fiscal years Current assets Current liabilities Working capital Working capital ratio 2018 2,422.4 1,292.8 1,129.6 1.87 2017 2,380.5 1,193.4 1,187.1 1.99 The working capital ratio is an indication of the Company’s ability to cover short-term liabilities with short-term assets, without having excess dormant assets. The decrease in the working capital ratio is mainly attributed to higher bank loans due to the financing for the SMI Acquisition and Betin Acquisition. Capital management The Company’s capital strategy requires a well-balanced financing structure in order to maintain the flexibility required to implement growth initiatives, while allowing it to pursue disciplined capital investments and maximize shareholder value. The Company targets a long-term leverage of approximately 2.0 times net debt to adjusted EBITDA. From time to time, the Company may deviate from its long-term leverage target to pursue acquisitions and other strategic opportunities. Should such a scenario arise, the Company expects to deleverage over a reasonable period of time in order to seek to maintain its investment grade ratings. (in millions of CDN dollars, except ratio and number of shares and options) Fiscal years Long-term debt Bank loans Cash and cash equivalents Net debt** Adjusted EBITDA* Net debt-to-Adjusted EBITDA* Number of common shares Number of stock options 2018 1,425.3 193.3 122.2 1,496.4 1,264.7 1.18 387,407,403 19,510,123 2017 1,500.0 93.8 250.5 1,343.3 1,289.5 1.04 386,234,311 17,850,014 * Non-IFRS measures described in the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. ** Refer to the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. As at March 31, 2018, the Company had $122.2 million of cash and cash equivalents and available bank credit facilities of approximately $985 million, $193.3 million of which were drawn. See Note 9 to the consolidated financial statements for details of the Company’s bank loans. During fiscal 2018, the Company issued $300 million medium term notes under its medium term note program (the MTN Program). The net proceeds in the amount of $298.9 million were used to repay indebtedness under the Company’s non- revolving term facility. Under its MTN Program, the Company filed a short form base shelf prospectus qualifying an offering of MTNs for distribution to the public over a 25-month period, expiring in January 2019. In connection with the Murray Goulburn Acquisition, the Company entered into a new credit agreement on December 21, 2017 providing for a non-revolving term facility in the aggregate amount of $1.280 billion (the Acquisition Facility). On May 1, 2018, the facility had been drawn in full. Share capital authorized by the Company is comprised of an unlimited number of common shares. The common shares are voting and participating. As at May 29, 2018, 387,697,959 common shares and 23,669,527 stock options were outstanding. Normal course issuer bids Under the normal course issuer bid (Bid) covering the period between November 17, 2016 and November 16, 2017, the Company repurchased 6,580,880 common shares at prices ranging from $43.42 to $48.71 per share, for an aggregate consideration of approximately $301.1 million. ANNUAL REPORT 2018 - 21 - In November 2017, the Company renewed its normal course issuer bid (New Bid) to purchase up to 8,000,000 common shares, which represented approximately 2% of its issued and outstanding common shares, over a 12-month period beginning on November 17, 2017 and ending on November 16, 2018. No shares were purchased under the New Bid. During the fiscal year ended March 31, 2018, the Company purchased 654,900 common shares at prices ranging from $43.42 to $44.99 per share, under the Bids for an aggregate consideration of approximately $29.0 million (9,185,080 common shares at prices ranging from $35.74 to $48.71 per share for the fiscal year ended March 31, 2017 for an aggregate consideration of approximately $404.1 million). CONTRACTUAL OBLIGATIONS The Company manages and continually monitors its commitments and contractual obligations to ensure that these can be met with funding provided by operations and capital structure optimization. The Company’s contractual obligations consist of commitments to repay certain long-term debts in addition to leases of premises, equipment and rolling stock as well as purchase obligations for capital expenditures to which the Company is committed. Note 10 to the consolidated financial statements describes the Company’s commitment to repay long-term debt, and Note 18 to the consolidated financial statements describes its lease commitments. (in millions of CDN dollars) Less than 1 year 1–2 years 2–3 years 3–4 years 4–5 years More than 5 years March 31, 2018 Long-term debt Leases Purchase obligations 4.4 520.9 - 300.0 300.0 300.0 29.1 24.6 20.0 15.8 14.2 27.1 1,425.3 130.8 91.8 - - - - - 91.8 March 31, 2017 Long-term debt Leases Purchase obligations Total 125.3 545.5 20.0 315.8 314.2 327.1 - - 900.0 - 300.0 300.0 30.6 25.3 21.0 16.9 13.3 37.2 1,647.9 1,500.0 144.3 Total 119.5 25.3 921.0 16.9 313.3 337.2 1,733.2 88.9 - - - - - 88.9 Long-term debt As described in Note 10 to the consolidated financial statements, the Company’s long-term debt is comprised of unsecured bank term loan facilities of $200.0 million (US$157.0 million), maturing in December 2019, which bear interest at lenders’ prime rates plus a maximum of 1.00%, or bankers’ acceptance rates plus 0.80%, up to a maximum of 2.00%, depending on the Company credit ratings. Long-term debt is also comprised of four series of $300.0 million of medium term notes for a total of $1.200 billion, with annual interest rates varying from 1.94% to 2.83% and maturity ranging from November 2019 to November 2023. In connection with the Murray Goulburn Acquisition, the Company entered into the Acquisition Facility which consists of three tranches: a 1-year tranche of $400.0 million; a 3-year tranche of $300.0 million; and a 5-year tranche of $580.0 million (AU$600.0 million). On May 1, 2018, the facility had been drawn in full. Minimum payments on operating leases The Company has long-term operating leases for premises, equipment and rolling stock. BALANCE SHEET The main balance sheet items as at March 31, 2018 varied mainly due to the strengthening of the Canadian dollar versus the US dollar, Australian dollar and the Argentine peso, as well as the inclusion of the SMI Acquisition and the Montchevre Acquisition in comparison to March 31, 2017. The conversion rate of the USA operations’ balance sheet items in US currency was CDN$1.2900 per US dollar as at March 31, 2018, compared to CDN$1.3318 per US dollar as at March 31, 2017. The conversion rate of the Argentinian operations’ balance sheet items in Argentinian currency was CDN$0.0640 per Argentine peso as at March 31, 2018, compared to CDN$0.0866 per Argentine peso as at March 31, 2017. The conversion rate of the Australian operations’ balance sheet items in Australian currency was CDN$0.9914 per Australian dollar as at March 31, 2018, compared to CDN$1.0157 per Australian dollar as at March 31, 2017. The strengthening of the Canadian dollar versus the US dollar, the Australian dollar and the Argentine peso resulted in lower values recorded for the balance sheet items of the foreign operations. ANNUAL REPORT 2018 - 22 - The net cash (cash and cash equivalents less bank loans) position increased from positive $156.7 million as at March 31, 2017, to negative $71.1 million as at March 31, 2018, mainly resulting from the decrease of net cash due to the SMI Acquisition and the Montchevre Acquisition. The change in foreign currency translation adjustment recorded in other comprehensive income varied mainly due to the weakening of the US dollar. 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 warranties and for future claims for certain liabilities. The terms of these indemnification provisions vary in duration. See Note 18 to the consolidated financial statements that discuss the Company’s guarantees. RELATED PARTY TRANSACTIONS In the normal course of business, the Company receives services from and provides goods to companies subject to control or significant influence through ownership by its principal shareholder. These goods and services are of an immaterial amount and compensated by a consideration equal to their fair value, comparable to similar arms’ length transactions. The services that are received consist mainly of travel, publicity, lodging, office space rental and management services. The goods that are provided consist mainly of dairy products. Transactions with key management personnel (Management defines key management personnel as all the executive officers who have responsibility and authority for controlling, overseeing and planning the activities of the Company, as well as the Company’s Directors) are also considered related party transactions and consist of short-term employee benefits, post- employment benefits, stock-based compensation and payments under the deferred share unit plan. Refer to Note 19 to the consolidated financial statements for further information on related party transactions. ACCOUNTING STANDARDS CRITICAL ACCOUNTING POLICIES AND USE OF ACCOUNTING ESTIMATES The preparation of the Company’s financial statements requires Management to make certain judgements and estimates about transactions and carrying values that are fulfilled at a future date. Judgements and estimates are subject to fluctuations due to changes in internal and/or external factors and are continuously monitored by Management. A discussion of the judgements and estimates that could have a material effect on the financial statements is provided below. Income Taxes The Company is subject to income taxes in numerous jurisdictions. Significant judgement is required in determining the consolidated provision for income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. The Company recognizes liabilities for anticipated tax audit issues based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters differs from the amounts that were initially recorded, such differences will impact the results for the reporting period and the respective current income tax and deferred income tax provisions in the reporting period in which such determination is made. Deferred Income Taxes The Company follows the liability method of accounting for deferred income taxes. Deferred income tax assets and liabilities are measured using enacted or substantively 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. Deferred tax assets are reviewed at each reporting date and are reduced to the extent that it is no longer probable that the related tax benefit will be realized. Canadian, USA and international tax rules and regulations are subject to interpretation and require judgement on the part of the Company that may be challenged by taxation authorities. The Company believes that it has adequately provided for deferred 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. ANNUAL REPORT 2018 - 23 - Goodwill, Intangible Assets and Business Combinations Goodwill, trademarks and customer relationships have principally arisen as a result of business combinations. The acquisition method, which also requires significant estimates and judgements, is used to account for these business combinations. As part of the allocation process in a business combination, estimated fair values are assigned to the net assets acquired, including trademarks and customer relationships. These estimates are based on forecasts of future cash flows, estimates of economic fluctuations and an estimated discount rate. The excess of the purchase price over the estimated fair value of the net assets acquired is then assigned to goodwill. In the event that actual net assets fair values are different from estimates, the amounts allocated to the net assets, and specifically to trademarks and customer relationships, could differ from what is currently reported. This would then have a pervasive impact on the carrying value of goodwill. Differences in estimated fair values would also have an impact on the amortization of definite life intangibles. Property, Plant and Equipment Critical judgement is necessary in the selection and application of accounting policies and useful lives as well as the determination of which components are significant and how they are allocated. Management has determined that the use of the straight-line method of amortization is the most appropriate as its facilities are operating at a similar output potential on a year to year basis, which indicates that production is constant (please refer to the estimated useful lives table for further details on the useful lives of productive assets). It is Management’s best estimate that the useful lives and policies adopted adequately reflect the flow of resources and the economic benefits required and derived in the use and servicing of these long-lived productive assets. Impairment of Assets Significant estimates and judgements are required in testing goodwill, intangible assets and other long-lived assets for impairment. Management uses estimates or exercises judgement in assessing indicators of impairment, defining a CGU, forecasting future cash flows and in determining other key assumptions such as discount rates and earnings multipliers used for assessing fair value (less costs of disposal) or value in use. Estimates made for goodwill and intangible assets can be found in Note 7. Other long-lived assets are tested only when indicators of impairment are present. Employee Future Benefits The Company is the sponsor to both defined benefit and defined contribution plans, which provide pension and other post-employment benefits to its employees. Several estimates and assumptions are required with regards to the determination of the defined benefit expense and its related obligation, such as the discount rate used in determining the carrying value of the obligation and the interest income on plan assets, the expected health care cost trend rate, the expected mortality rate, expected salary increase, etc. Actual results will normally differ from expectations. These gains or losses are presented in the consolidated statements of comprehensive income. ANNUAL REPORT 2018 - 24 - EFFECT OF NEW ACCOUNTING STANDARDS, INTERPRETATIONS AND AMENDMENTS NOT YET IMPLEMENTED The International Accounting Standards Board (IASB) made revisions as part of its continuing improvements project. Below is a summary of the relevant standards affected and a discussion of the amendments. The following standards, amendments to standards and an interpretation have been issued and are applicable to the Company for its annual periods beginning on and after April 1, 2018, with an earlier application permitted: IFRS 2, Share-Based Payment In June 2016, the IASB issued an amendment to clarify how to account for certain types of share-based payment transactions. The amendments provide requirements on the accounting for: the effects of vesting and non-vesting conditions on the measurement of cash-settled share-based payments, share-based payment transactions with a net settlement feature for withholding tax obligations and a modification to the terms and conditions of a share-based payment that changes the classification of the transaction from cash-settled to equity-settled. IFRS 9, Financial Instruments In July 2014, the IASB issued the final version of IFRS 9, Financial Instruments with the goal of replacing IAS 39, Financial Instruments: Recognition and Measurement. The new standard addresses the classification and measurement of financial assets and liabilities, provides a new impairment model for the recognition of expected credit losses and provides a new hedge accounting model. Refer to the section “Considerations for the implementation of IFRS 9 and IFRS 15” of this note for more information. IFRS 15, Revenue from Contracts with Customers The IASB issued IFRS 15, Revenue from Contracts with Customers with its goal to provide a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. This new standard will supersede current revenue recognition guidance in IAS 18, Revenue, IAS 11, Construction Contracts and IFRIC 13, Customer Loyalty Programmes. The objective of this standard is to provide a five-step approach to revenue recognition that includes identifying contracts with customers, identifying performance obligations, determining transaction prices, allocating transaction prices to performance obligations and recognizing revenue when performance obligations are satisfied. In certain instances, transfer of assets that are not related to the entity’s ordinary activities will also be required to follow some of the recognition and measurement requirements of the new model. The standard also expands current disclosure requirements. In April 2016, the IASB amended IFRS 15 to comprise clarifications of the guidance on identifying performance obligations, accounting for licenses of intellectual property and the principal versus agent assessment (gross versus net revenue presentation). The amendment includes additional practical expedients related to transition to the new revenue standard. With regards to identifying performance obligations, the amendments clarify how to determine when promises in a contract are ‘distinct’ goods or services and, therefore, should be accounted for separately. The amendments to licensing guidance clarify when revenue from a license of intellectual property should be recognized ‘over time’ and when it should be recognized at a ‘point in time’. With regards to the principal versus agent assessment, the amendments clarify that the principal in an arrangement controls a good or service before it is transferred to a customer. Refer to the section “Considerations for the implementation of IFRS 9 and IFRS 15” of this note for more information. IAS 40, Investment Property In December 2016, the IASB issued an amendment to IAS 40 clarifying when assets are transferred to, or from, investment properties. The amendment clarified that to transfer to, or from, investment properties there must be a change in use. To conclude if a property has changed use there should be an assessment of whether the property meets the definition. This change must be supported by evidence. This amendment may be applied prospectively or retrospectively. IFRIC 22, Foreign Currency Transactions and Advance Consideration In December 2016, the IASB issued IFRIC 22 which provides an interpretation on how to determine the date of the transaction when applying the standard on foreign currency transactions, IAS 21. The interpretation applies where an entity pays or receives consideration in advance for foreign currency-denominated contracts. The date of the transaction determines the exchange rate to be used on initial recognition of the related asset, expense or income. This interpretation provides guidance for when a single payment or receipt is made, as well as for situations where multiple payments or receipts are made and aims to reduce diversity in practice. Except as disclosed in ‘‘Considerations for the implementations of IFRS 9 and IFRS 15’’, the adoption of these standards, amendments and interpretation will not have a significant impact on the Company’s financial statements. ANNUAL REPORT 2018 - 25 - EFFECT OF NEW ACCOUNTING STANDARDS, INTERPRETATIONS AND AMENDMENTS NOT YET IMPLEMENTED (CONT’D) The following standards have been issued and are applicable to the Company for its annual periods beginning on April 1, 2019 and thereafter, with an earlier application permitted for entities that have also adopted IFRS 15: IFRS 16, Leases In January 2016, the IASB published a new standard, IFRS 16 ‘‘Leases’’, which will replace IAS 17 ‘‘Leases’’. The new standard will eliminate the distinction between operating and finance leases and will bring most leases on the balance sheet for lessees, except with respect to lease that meet limited exception criteria. For lessors, the accounting remains mostly unchanged and the distinction between operating and finance leases is retained. The following standards, amendments to standards and interpretations have been issued and are applicable to the Company for its annual periods beginning on and after April 1, 2019, with an earlier application permitted: IFRS 3, Business Combinations In December 2017, the IASB issued an amendment to IFRS 3 to clarify that when an entity obtains control of a business that is a joint operation, it remeasures previously held interests in that business. IFRS 9, Financial Instruments In October 2017, the IASB further amended IFRS 9 to allow financial assets with a prepayment option that could result in the option’s holder receiving compensation for early termination to meet the solely payments of principal and interest condition if specified criteria are met. IFRS 11, Joint Arrangements In December 2017, the IASB issued an amendment to IFRS 11 to clarify that when an entity obtains joint control of a business that is a joint operation, the entity does not remeasure previously held interests in that business. IAS 19, Employee Benefits In February 2018, the IASB issued an amendment to IAS 19 to specify how an entity shall determine pension expenses when changes to a pension plan occur. When an amendment, curtailment or settlement to a plan takes place, IAS 19 requires an entity to remeasure its net defined benefit liability or asset. The amendments require an entity to use the updated assumptions from this remeasurement to determine the current service cost and net interest for the remainder of the reporting period after the change to the plan. In addition, amendments have been included to clarify the effect of a plan amendment, curtailment or settlement on the requirements regarding the asset ceiling. IAS 23, Borrowing Costs In December 2017, the IASB issued an amendment to IAS 23 clarifying that if any specific borrowing remains outstanding after the related asset is ready for its intended use or sale, it becomes part of the funds that an entity borrows generally when calculating the capitalization rate on general borrowings. IAS 28, Investments in Associates In October 2017, the IASB issued an amendment to IAS 28 to clarify that an entity should apply IFRS 9 to long-term interests in an associate or joint venture that form part of the net investment in the associate or joint venture but to which the equity method is not applied. IFRIC 23, Uncertainty Over Income Tax Treatments In June 2017, the IFRS Interpretations Committee issued IFRIC 23 which clarifies how the recognition and measurement requirements of IAS 12, Income Taxes, are applied where there is uncertainty over income tax treatments. Management is currently assessing the impact of the adoption of these standards, amendments and interpretation on the Company’s financial statements. ANNUAL REPORT 2018 - 26 - CONSIDERATIONS FOR THE IMPLEMENTATION OF IFRS 9 AND IFRS 15 IFRS 9 and IFRS 15 are required to be applied for annual reporting periods beginning on April 1, 2018. The Company will not be early adopting IFRS 9 or IFRS 15. The Company will adopt IFRS 9 and IFRS 15 in fiscal 2019. IFRS 9 is applicable retrospectively in accordance with IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, subject to certain exemptions and exceptions. In general, the main impacts of adopting IFRS 9 are expected to be on classification and measurement of financial assets, the introduction of a new impairment model based on expected losses (rather than incurred loss as per IAS 39, Financial Instruments: Recognition and Measurement), hedge accounting and significant additional disclosure requirements. The Company evaluated the impact of this standard. The Company’s analysis did not identify any differences that would significantly change the classification and measurement of its financial instruments. The Company expects to apply the simplified approach and record lifetime expected losses on all trade receivables. IFRS 9 will require the Company to ensure that hedge accounting relationships are aligned with the Company’s risk management objectives and strategy and to apply a more qualitative and forward-looking approach to assessing hedge effectiveness. The Company completed these changes to its internal documentation to meet the requirements of IFRS 9. The Company evaluated the impact of the new standard on the consolidated financial statements and it does not have a significant impact. IFRS 15 can be applied using one of the following two methods: retrospectively to each prior reporting period presented in accordance with IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, or retrospectively with the cumulative effect of applying IFRS 15 recognized at the date of initial application. The Company decided to use the second method as its transition method as prescribed under IFRS 15. The Company has reviewed standard purchase orders, invoices, shipping terms and significant contracts with customers including discount arrangements. The Company has quantified the impact of IFRS 15 and has determined these changes do not have a material impact on its consolidated financial statements. The following items represent the main areas where differences were identified on transition to IFRS 15: • Presentation of the shipping and handling activities will be considered principal and will be presented on a gross basis. The Company’s current accounting treatment has not resulted in any material differences. • Revenues will be recognized at a point in time when control of the asset is transferred to the customer, generally upon shipment of products. The Company’s current accounting treatment has not resulted in any material differences. • Some contracts with customers provide incentive programs, including discounts, promotions, advertising allowances, and other volume-based incentives. Such incentives give rise to variable considerations, which are also estimated at contract inception. IFRS 15 has not resulted in any material differences to the current estimation methodologies or the timing of the recognition of estimates and the Company’s current accounting treatment. The Company does not expect to record any adjustment in the opening retained earnings as of the transition date since the impact is not material. In addition to ensuring that the accounting and disclosure requirements of IFRS 15 are met, we continue to address any systems and process changes necessary to compile the information and meet the recognition and disclosure requirements of the standards. The Company will not be required to materially change its business process and controls to support this transition. The Company will provide additional disclosure as required by the new standard starting from the first quarter of fiscal year 2019 onwards. In addition to the new disclosure requirements under IFRS 15, the Company will also disclose the amount by which each financial statement line item is affected in the reporting period by the application of IFRS 15 as compared with the previous standards. ANNUAL REPORT 2018 - 27 - EFFECT OF NEW ACCOUNTING STANDARDS, INTERPRETATIONS AND AMENDMENTS ADOPTED DURING THE PERIOD The following amendments to existing standards were adopted by the Company on April 1, 2017: IAS 7, Statement of Cash Flows IAS 7 has been amended to provide additional presentation related to the changes in liabilities arising from financing activities such as: (i) changes from financing cash flows; (ii) changes arising from obtaining or losing control of subsidiaries or other businesses; (iii) the effect of changes in foreign exchange rates; (iv) changes in fair values; and (v) other changes. This amendment did not significantly impact the Company’s financial statements for the year ended March 31, 2018. IAS 12, Income taxes IAS 12 has been amended to provide clarification on the requirements relating to the recognition of deferred tax assets for unrealized losses on debt instruments measured at fair value. This amendment did not significantly impact the Company’s financial statements for the year ended March 31, 2018. RISKS AND UNCERTAINTIES The main risks and uncertainties the Company is exposed to are presented hereafter. The Board of Directors (the Board) delegated to the Audit Committee the responsibility to study and evaluate the risk factors inherent to the Company and ensure that appropriate measures are in place to enable Management to identify and manage these risk factors effectively. The Audit Committee receives regular reports from Management on these matters. In this regard, the Audit Committee and the Board have adopted and implemented certain policies and procedures which are reviewed at least annually. An annual detailed presentation on all risk factors identified, as well as periodic presentations, are made by Management to the Audit Committee and, as required, to the Board. While risk management is part of the Company’s transactional, operational and strategic decisions, as well as the Company’s overall management approach, risk management does not guarantee that events or circumstances will not occur which could negatively affect the Company’s financial condition and performance. 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 be introduced into products or packaging. The occurrence of such a problem could result in a costly product recall and serious damage to Saputo’s reputation for product quality. 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 customers. Availability of raw materials as well as variations in the price of foodstuffs can therefore influence the Company’s results upwards or downwards, and the effect of any increase of foodstuff prices on results depends on the Company’s ability to transfer those increases to its customers and this, in the context of a competitive market. USA and international markets The price of milk as raw material and the price of our products in the USA, Argentina and Australia, as well as in 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 results will depend on the Company’s ability to implement mechanisms to reduce them. Competition The food processing industry is extremely competitive. The Canadian dairy industry is highly competitive and is comprised of three major competitors, including Saputo. In the USA, Argentina and Australia, Saputo competes in the dairy industry on a national basis with several regional, national and multinational competitors. Saputo also competes in the dairy industry internationally. The Company’s performance in all the countries in which it does business will be dependent on its ability to continue to offer quality products at competitive prices. ANNUAL REPORT 2018 - 28 - Consolidation of clientele During the last few years, there has been important consolidation in the food industry in all market segments. Given that Saputo serves these segments, the consolidation within the industry has resulted in a decrease in the number of customers and an increase in the relative importance of some customers. One customer represented more than 10% of total consolidated revenues for fiscal 2018, with 10.44%. The Company’s ability to continue to service its customers in all the markets that it serves will depend on the quality of its products and services as well as price. 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 considers that it has low exposure to concentration of credit risk with respect to accounts receivable from customers due to its large and diverse customer base operating in three segments, retail, foodservice and industrial, and its geographic diversity. There are no accounts receivable from any individual customer that exceeded 10% of the total balance of accounts receivable as at March 31, 2018. The allowance for bad debts and accounts receivable due is reviewed regularly by Management. The Company updates its estimate of the allowance for doubtful accounts based on the evaluation of the recoverability of accounts receivable balances of each customer taking into consideration historic collection trends of past due accounts. Supplier concentration The Company purchases goods and services from a limited number of suppliers as a result of consolidation within the industries in which these suppliers operate in North America and other major markets. Furthermore, issues with suppliers regarding pricing or performance of the goods and services they supply or the inability of suppliers to supply the required volumes of such goods and services in a timely manner could impact the Company’s financial condition and performance. Any such impact will depend on the effectiveness of the Company’s contingency plan. Unanticipated business disruption Major events, such as systems and equipment failure, health pandemics and natural disasters, could lead to unanticipated business disruption of any or certain of the Company’s manufacturing facilities. The effect would be more significant if the Company’s larger manufacturing facilities are affected, in which case, the failure to find alternative suppliers or to replace lost production capacity in a timely manner could negatively affect the Company’s financial condition and performance. Economic environment The Company’s operations could be affected by the economic context should the unemployment level, interest rates or inflation reach levels that influence consumer trends and consequently, impact the Company’s sales and profitability. Environment Saputo’s business and operations are subject to environmental laws and regulations, including those relating to permitting requirements, wastewater discharges, air emissions (greenhouse gases and other), releases of hazardous substances and remediation of contaminated sites. The Company believes that its operations are in compliance, in all material respects, with such environmental laws and regulations, except as disclosed in the Annual Information Form dated June 7, 2018 for the fiscal year ended March 31, 2018. Compliance with these laws and regulations requires that the Company continue to incur operating and maintenance costs and capital expenditures, including to control potential impacts of its operations on local communities. Future events such as changes in environmental laws and regulations or more vigorous regulatory enforcement policies could have a material adverse effect on the financial position of Saputo and could require additional expenditures to achieve or maintain compliance. Information systems The Company relies upon information technology applications and systems for its business and the reporting of its results. These applications and systems are subject to an increasing number of constantly evolving cyber threats which are becoming more sophisticated. The Company is mainly exposed to risks relating to confidentiality, data integrity and business disruptions. Therefore, any unavailability or failure, due to security incidents or otherwise, may impede or slow down production, delay or taint certain decisions and result in financial losses for the Company. In addition, any unauthorised access to information systems, proprietary, sensitive or confidential information or malicious use could compromise the Company’s data integrity or result in disclosure or loss of data which may have adverse effects on the Company’s activities, results, and reputation, including loss of revenues due to a disruption of the business, diminished competitive advantage, litigation or other legal procedures, or liability for failure to comply with privacy and information security laws. Although the Company has measures to reduce the likelihood of disruptions to its information technology applications and systems, and to identify and respond to and manage cybersecurity incidents, there is no assurance that any of these measures will be successful. Also, the Company is currently undertaking technology initiatives regarding an ERP system. There is no guarantee that the implementation of the ERP system will not disrupt or reduce the efficiency of the Company’s operations. ANNUAL REPORT 2018 - 29 - Human resources Saputo’s success depends on its ability to identify, attract and retain qualified individuals and to execute appropriate succession planning for Management and key personnel. Although the Company believes that it has good relationships with its employees and a significant number of the Company’s workforce is unionized, a lengthy strike or work stoppage could impact the Company’s operations and performance. The Company’s operations are also subject to health and safety risks as well as laws and regulations in this regard. Notwithstanding Saputo’s existing health and safety systems, serious injury or death of any employee could have a serious impact on Saputo’s reputation and require the Company to incur compliance costs. Growth by acquisitions The Company plans to grow both organically and through acquisitions. Historically, the Company has grown through acquisitions and should reasonably and in large part rely on new acquisitions to pursue its growth. The ability to properly evaluate the fair value of the businesses being acquired, to properly devote the time and human resources required to successfully integrate their activities with those of the Company as well as the capability to realize synergies, improvements and the expected profit and to achieve anticipated returns constitute inherent risks related to acquisitions. In connection with acquisitions made by the Company, there may be liabilities and contingencies that the Company discovered after closing, or was unable to quantify in the due diligence conducted prior to closing of an acquisition and which could have a negative effect on the Company’s business, and financial condition and performance. Consumer trends Demand for the Company’s products is subject to changes in consumer trends. These changes may affect earnings. The impact of these changes will depend on the Company’s ability to innovate and develop new products. Intellectual property As the Company is involved in the production, sale and distribution of food products, it relies on brand recognition and loyalty from its clientele in addition to relying on the quality of its products. Also, as innovation forms part of the Company’s growth strategy, its research and development teams develop new technologies, products and process optimization methods. The Company therefore takes measures to protect, maintain and enforce its intellectual property. Any infringement to its intellectual property could damage its value and limit the Company’s ability to compete. In addition, Saputo may have to engage in litigation in order to protect its rights which could result in significant costs. Financial risk exposures Saputo has financial risk exposure to varying degrees relating to the currency of each of the countries where it operates. In fiscal 2018, approximately 35% of sales were realized in Canada, 53% in the USA, and 12% internationally. Cash flows from operations in each of the countries where Saputo operates act as a natural hedge against the exchange risks related to debt denominated in such countries’ currency. The level of the financial risk exposure related to currency will depend on its ability to maintain this natural hedge or any other protection mechanism. Interest rate and access to capital market Saputo’s interest bearing debt is subject to interest rate fluctuations. The impact on the Company’s results will depend on its ability to maintain mechanisms to protect against such interest rate fluctuations. The Company’s growth is driven mainly by acquisitions and is dependent on access to liquidity in the capital market. Legislative, regulatory, normative and political considerations The Company is subject to local, provincial, state, federal and international laws, regulations, rules and policies as well as to social, economic and political contexts prevailing in places where Saputo conducts its activities. Consequently, the modification or change of any of these elements may have an unfavourable impact on Saputo’s results and operations and may require that important expenses be made in order to adapt or comply. More specifically, 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 the Company’s ability to adapt, comply and mitigate. Saputo is currently in compliance in all material respects with all applicable laws and regulations and maintains all material permits and licenses in connection with its operations. 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 result in the removal of tariff protection in the dairy market, resulting in increased competition. The Company’s performance will be dependent on its ability to continue to offer quality products at competitive prices. ANNUAL REPORT 2018 - 30 - DISCLOSURE CONTROLS AND PROCEDURES The Chief Executive Officer (CEO) and the Chief Financial Officer (CFO) are responsible for establishing and maintaining disclosure controls and procedures. The Company’s disclosure controls and procedures are designed to provide reasonable assurance that material information relating to the Company is made known to Management in a timely manner to allow the information required to be disclosed under securities legislation to be recorded, processed, summarized and reported within the time periods specified in securities legislation. The CEO and the CFO, along with Management, after evaluating the effectiveness of the Company’s disclosure controls and procedures as at March 31, 2018, have concluded that the Company’s disclosure controls and procedures were effective. INTERNAL CONTROL OVER FINANCIAL REPORTING The CEO and the CFO are responsible for establishing and maintaining internal control over financial reporting. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS. The CEO and the CFO, along with Management, evaluated the effectiveness of the Company’s internal control over financial reporting as at March 31, 2018, in accordance with the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, the CEO and the CFO, along with Management, have concluded that the Company’s internal control over financial reporting was effective. There were no changes in the Company’s internal control over financial reporting that occurred during the period beginning on January 1, 2018 and ended on March 31, 2018, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. SENSITIVITY ANALYSIS OF INTEREST RATE AND US CURRENCY FLUCTUATIONS The debt subject to interest rate fluctuations was $393.3 million as at March 31, 2018 and consisted of $193.3 million of bank loans and $200.0 million bank term loan facilities. A 1% change in the interest rate would lead to a change in net earnings of approximately $2.8 million. Canadian and US currency fluctuations may affect net earnings. Appreciation of the Canadian dollar compared to the US dollar would have a negative impact on net earnings. Conversely, a decrease in the Canadian dollar compared to the US dollar would have a positive impact on net earnings. During the fiscal year ended March 31, 2018, the average US dollar conversion was based on CDN$1.00 for US$0.776. A fluctuation of CDN$0.10 of the Canadian dollar would have resulted in a change of approximately $32.0 million in net earnings, $50.4 million in adjusted EBITDA and $478.0 million in revenues. ANNUAL REPORT 2018 - 31 - QUARTERLY FINANCIAL INFORMATION 2018 quarterly financial information – consolidated statement of earnings (in millions of CDN dollars, except per share amounts and ratios) Q4 Q3 Q2 Q1 Fiscal 2018 Statement of earnings Revenues Operating costs excluding depreciation, amortization, 2,744.4 3,021.8 2,884.2 2,892.1 11,542.5 acquisition and restructuring costs 2,482.7 2,703.8 2,554.4 2,536.9 10,277.8 Earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs Margin Depreciation and amortization Acquisition and restructuring costs Interest on long-term debt Other financial charges Earnings before income taxes Income taxes Net earnings Net margin Acquisition and restructuring costs (net of income taxes) US Tax Reform** Adjusted net earnings* Adjusted net earnings margin* 261.7 9.5% 318.0 10.5% 329.8 11.4% 355.2 12.3% 1,264.7 11.0% 64.7 1.2 8.3 4.6 182.9 52.9 130.0 56.1 39.1 8.6 4.0 210.2 (126.8) 337.0 51.8 0.3 9.1 3.4 265.2 80.0 185.2 53.7 - 7.8 2.1 291.6 91.3 200.3 226.3 40.6 33.8 14.1 949.9 97.4 852.5 4.7% 11.2% 6.4% 6.9% 7.4% 5.3 - 135.3 25.1 (178.9) 183.2 0.2 - 185.4 - - 200.3 30.6 (178.9) 704.2 4.9% 6.1% 6.4% 6.9% 6.1% Per Share Net earnings Basic Diluted Adjusted net earnings* Basic Diluted 0.34 0.33 0.35 0.35 0.87 0.86 0.47 0.47 0.48 0.47 0.48 0.47 0.52 0.51 0.52 0.51 2.21 2.18 1.82 1.80 Earnings coverage ratio** 20.83 23.34 26.69 28.51 * Non-IFRS measures described in the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. ** Refer to the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. Selected factors positively (negatively) affecting adjusted EBITDA and earnings before income taxes (in millions of CDN dollars) Fiscal year Market factors*,1 Inventory write-down Q4 (3) (11) 2018 Q3 (19) (2) Q2 (6) (3) Q1 3 (1) Foreign currency exchange1,2 * Refer to the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. 1 As compared to same quarter of previous fiscal year. 2 Foreign currency exchange includes effect on adjusted EBITDA of conversion of US dollars, Australian dollars and Argentine pesos to Canadian dollars. (14) (8) (5) 9 ANNUAL REPORT 2018 - 32 - 2017 quarterly financial information – consolidated statement of earnings (in millions of CDN dollars, except per share amounts and ratios) Q4 Q3 Q2 Q1 Fiscal 2017 Statement of earnings Revenues Operating costs excluding depreciation, amortization, 2,719.8 2,966.1 2,845.3 2,631.4 11,162.6 acquisition and restructuring costs 2,435.7 2,619.5 2,504.7 2,313.2 9,873.1 Earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs Margin Depreciation and amortization Acquisition and restructuring costs Interest on long-term debt Other financial charges Earnings before income taxes Income taxes Net earnings Net margin Acquisition and restructuring costs (net of income taxes) Adjusted net earnings* Adjusted net earnings margin* Per Share Net earnings Basic Diluted Adjusted net earnings* Basic Diluted 284.1 10.4% 346.6 11.7% 340.6 12.0% 318.2 12.1% 1,289.5 11.6% 56.9 - 8.3 0.8 218.1 52.9 165.2 50.9 - 9.2 0.6 285.9 88.5 197.4 50.2 - 8.7 1.6 280.1 88.3 191.8 49.3 - 10.7 2.0 256.2 79.5 176.7 207.3 - 36.9 5.0 1,040.3 309.2 731.1 6.1% 6.7% 6.7% 6.7% 6.5% - 165.2 - 197.4 - 191.8 - 176.7 - 731.1 6.1% 6.7% 6.7% 6.7% 6.5% 0.42 0.42 0.42 0.42 0.50 0.49 0.50 0.49 0.49 0.48 0.49 0.48 0.45 0.44 0.45 0.44 1.86 1.84 1.86 1.84 Earnings coverage ratio** 25.83 22.54 18.34 15.02 * Non-IFRS measures described in the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. ** Refer to the ‘‘Glossary’’ section on page 36 of this Management’s Discussion and Analysis. ANNUAL REPORT 2018 - 33 - ANALYSIS OF EARNINGS FOR THE YEAR ENDED MARCH 31, 2017 COMPARED TO MARCH 31, 2016 Consolidated revenues totalled $11.163 billion in fiscal 2017, an increase of $171.1 million or 1.6%, compared to $10.992 billion in fiscal 2016. The increase is mainly due to higher sales volumes and a favourable product mix, as well as higher selling prices related to the increase of the cost of milk as raw material in the Canada Sector and the International Sector. Revenues increased due to higher international selling prices of cheese and dairy ingredients, as compared to fiscal 2016 and the inclusion of revenues from the companies forming Woolwich Dairy (Woolwich Acquisition) for the full fiscal year. The fluctuation of the average block market per pound of cheese, combined with the fluctuation of the average butter market price, decreased revenues by approximately $5 million. Finally, the fluctuation of the Canadian dollar versus foreign currencies decreased revenues by approximately $145 million, mainly due to the weakening of the Argentine peso. Consolidated earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs (adjusted EBITDA) amounted to $1.290 billion in fiscal 2017, an increase of $115.4 million or 9.8% compared to $1.174 billion for fiscal 2016. The increase is due to higher sales volumes, a favourable product mix, lower warehousing and logistical costs, as well as lower ingredients costs. Additionally, higher international selling prices of cheese and dairy ingredients positively impacted adjusted EBITDA. This increase was partially offset by higher administrative expenses, mainly due to the ERP initiative, as well as sales and marketing expenses. In the USA, market factors negatively impacted adjusted EBITDA by approximately $4 million. As a result of the decrease in certain market selling prices, inventory was written down by approximately $4 million, as compared to approximately $18 million for fiscal 2016. Finally, the fluctuation of the Canadian dollar versus foreign currencies had a positive impact on adjusted EBITDA of approximately $13 million, as compared to fiscal 2016. The consolidated adjusted EBITDA margin increased to 11.6% in fiscal 2017, as compared to 10.7% in fiscal 2016, resulting mainly from a higher adjusted EBITDA in the USA Sector as compared to fiscal 2016. Depreciation and amortization totalled $207.3 million in fiscal 2017, an increase of $8.7 million, compared to $198.6 million in fiscal 2016. This increase is mainly attributed to the fluctuation of the Canadian dollar versus foreign currencies, as well as additions to property, plant and equipment, increasing the depreciable base. In fiscal 2016, the Company incurred acquisition costs relating to business acquisitions totalling $3.0 million ($2.4 million after tax), as well as restructuring costs in relation to plant closures announced in March 2016 in Canada totalling $31.2 million ($23.1 million after tax). As part of the restructuring costs for fiscal 2016, the Company incurred $5.5 million in severance costs and $25.7 million in impairment charges to property, plant and equipment. In fiscal 2017, no acquisition or restructuring costs were incurred by the Company. Net interest expense amounted to $41.9 million in fiscal 2017, compared to $70.4 million in fiscal 2016. This decrease is mainly attributed to a lower level of long-term debt, lower interest rates and lower bank loans denominated in Argentine peso which bear high interest rates. Income taxes totalled $309.2 million in fiscal 2017, compared to $269.5 million in fiscal 2016, for an effective tax rate of 29.7% in fiscal 2017, as compared to 30.9% for fiscal 2016. The decrease of the fiscal 2017 effective tax rate is mainly due to the recognition of previously unrecognized deferred tax assets. The income tax rate varies and could increase or decrease based on the amount of taxable income derived and from which source, any amendments to tax laws and income tax rates and changes in assumptions and estimates used for tax assets and liabilities by the Company and its affiliates. Net earnings for fiscal 2017 amounted to $731.1 million, an increase of $129.7 million or 21.6%, as compared to $601.4 million in fiscal 2016. This increase is due to the factors mentioned above. Adjusted net earnings for fiscal 2017 amounted to $731.1 million, an increase of $104.2 million or 16.6%, as compared to $626.9 million in fiscal 2016. This increase is due to the factors mentioned above, without considering acquisition and restructuring costs. ANNUAL REPORT 2018 - 34 - MEASUREMENT OF RESULTS NOT IN ACCORDANCE WITH INTERNATIONAL FINANCIAL REPORTING STANDARDS In certain instances, the Company makes references to terms in evaluating financial performance measures, such as adjusted EBITDA, adjusted net earnings and adjusted net earnings per share, that hold no standardized meaning under IFRS. These non-IFRS measurements are therefore not likely to be comparable to similarly titled or described measures in use by other publicly traded companies nor do they indicate that excluded items are non-recurring. The Company uses earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs (adjusted EBITDA) as a performance measure as it is a common industry measure and reflects the ongoing profitability of the Company’s consolidated business operations. Adjusted net earnings is defined by the Company as net earnings prior to the inclusion of acquisition and restructuring costs, net of applicable income taxes, if any. Adjusted net earnings per share is defined as adjusted net earnings per basic and diluted common share. The most comparable IFRS financial measures to the ones used by the Company are earnings before income taxes, as well as net earnings and net earnings per share (basic and diluted). Adjusted EBITDA, adjusted net earnings and adjusted net earnings per share, as used by Management, provide precision and comparability with regards to the Company’s ongoing operation. They also provide readers with a representation of the activities considered of relevance to the Company’s financial performance through the inclusion of additional financial information that can be used to identify trends or additional disclosures that provide information into the manner in which the Company operates. Non-IFRS measures also provide comparability to the Company’s prior year results. The definitions provided above are used in the context of the results and activities for the year ended March 31, 2018. They are subject to change based on future transactions and as deemed necessary by Management in order to provide a better understanding and comparability of future results and activities of the Company. A reconciliation of earnings before income taxes, net earnings and net earnings per share to adjusted EBITDA, adjusted net earnings and adjusted net earnings per share for the three-month periods and the fiscal years in which Management has presented this measure is provided below. (in millions of CDN dollars) Earnings before income taxes Other financial charges Interest on long-term debt Acquisition and restructuring costs Depreciation and amortization Adjusted EBITDA For the three-month periods ended March 31 2017 2018 182.9 4.6 8.3 1.2 64.7 261.7 218.1 0.8 8.3 - 56.9 284.1 For the years ended March 31 2017 1040.3 5.0 36.9 - 207.3 1,289.5 2018 949.9 14.1 33.8 40.6 226.3 1,264.7 (in millions of CDN dollars, except per share amounts) For the three-month periods ended March 31 2018 Per Share Basic Diluted 0.34 0.01 0.35 0.33 0.01 0.35 Total 130.0 5.3 135.3 Total 165.2 - 165.2 2017 Per Share Basic 0.42 - 0.42 Diluted 0.42 - 0.42 Net earnings Acquisition and restructuring costs1 Adjusted net earnings 1 Net of income taxes (in millions of CDN dollars, except per share amounts) For the years ended March 31 2018 Per Share Basic Diluted 2.21 0.08 (0.46) 1.82 2.18 0.08 (0.46) 1.80 Total 727.8 - - 727.8 2017 Per Share Basic Diluted 1.86 - - 1.86 1.84 - - 1.84 Total 852.5 30.6 (178.9) 704.2 Net earnings Acquisition and restructuring costs1 US Tax Reform Adjusted net earnings 1 Net of income taxes ANNUAL REPORT 2018 - 35 - GLOSSARY Adjusted EBITDA "Adjusted EBITDA" means earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs. Adjusted EBITDA margin "Adjusted EBITDA margin" is defined as adjusted net earnings expressed as a percentage of net revenues. Adjusted net earnings "Adjusted net earnings" means net earnings prior to the inclusion of acquisition and restructuring costs, net of applicable income taxes. Adjusted net earnings margin "Adjusted net earnings margin" is defined as adjusted net earnings expressed as a percentage of net revenues. Adjusted net earnings per share "Adjusted net earnings per share" (basic and diluted) means adjusted net earnings per basic and diluted common share. Adjusted return on average equity "Adjusted return on average equity" means adjusted net earnings divided by average total equity not considering the effect of annual fluctuations in foreign currency translation. Average block market "Average block market" means the average daily price of a 40 pound block of cheddar traded on the Chicago Mercantile Exchange (CME), used as the base price for cheese. Average butter market "Average butter market" means the average daily price for Grade AA Butter traded on the CME, used as the base price for butter. Average whey powder market price "Average whey powder market price" means the average daily price for extra grade dry whey published on the Dairy Market News. Earnings coverage ratio "Earnings coverage ratio" means net earnings (before interest on long-term debt and other financial charges and income taxes) for the applicable period divided by interest on long-term debt and other financial charges for the applicable period for the trailing twelve-months. Closing block price "Closing block price" means the price of a 40 pound block of cheddar traded on the CME on the last business day of the fiscal year. Closing butter market price "Closing butter market price" means the price of Grade AA Butter traded on the CME, on the last business day of each fiscal year. Market factors Market factors include, for the USA Sector, the average block market per pound of cheese and its effect on the absorption of fixed costs and on the realization of inventories, the effect of the relationship between the average block market per pound of cheese and the cost of milk as raw material, the market pricing impact related to sales of dairy ingredients, as well as the impact of the average butter market price related to dairy food products. Net debt Net debt means long-term debt and bank loans, including the current portion thereof, net of cash and cash equivalents. Net debt-to-adjusted EBITDA "Net debt-to-adjusted EBITDA" means net debt divided by our trailing twelve-months adjusted EBITDA financial liabilities, consisting of long-term debt and bank loans, including current portions, net of cash and cash equivalents. Spread "Spread" means the average block market per pound of cheese less the result of the average cost per hundredweight of Class III and/or Class 4b milk price divided by 10 in the USA market. US Tax reform "US Tax Reform" means the enactment of the ‘‘Tax Cuts and Jobs Act’’ on December 22, 2017. ANNUAL REPORT 2018 - 36 - CONSOLIDATED FINANCIAL STATEMENTS 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 International Financial Reporting Standards. 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 independent auditors to discuss internal controls, auditing matters and financial reporting issues. It also reviews the annual report, the consolidated financial statements and the independent auditors’ report. The Audit Committee recommends the independent auditors for appointment by the shareholders. The independent auditors have unrestricted access to the Audit Committee. The consolidated financial statements have been audited by the independent auditors Deloitte LLP, whose report follows. (signed) Lino A. Saputo, Jr. Lino A. Saputo, Jr. Chairman of the Board and Chief Executive Officer (signed) Maxime Therrien Maxime Therrien, CPA, CA Chief Financial Officer and Secretary June 7, 2018 ANNUAL REPORT 2018 - 37 - INDEPENDENT AUDITOR’S REPORT To the shareholders of Saputo Inc. We have audited the accompanying consolidated financial statements of Saputo Inc., which comprise the consolidated balance sheets as at March 31, 2018 and March 31, 2017, and the consolidated statements of earnings, consolidated statements of comprehensive income, consolidated statements of equity and consolidated statements of cash flows for the years then ended, and a summary of significant accounting policies and other explanatory information. Management’s Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with International Financial Reporting Standards, and for such internal control as Management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor’s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of Saputo Inc. as at March 31, 2018 and March 31, 2017, and its financial performance and its cash flows for the years then ended in accordance with International Financial Reporting Standards. /s/ Deloitte LLP 1 June 7, 2018 Montréal, Québec ____________________ 1 CPA auditor, CA, public accountancy permit No. A114871 ANNUAL REPORT 2018 - 38 - CONSOLIDATED STATEMENTS OF EARNINGS (in millions of CDN dollars, except per share amounts) Years ended March 31 Revenues Operating costs excluding depreciation, amortization, acquisition and restructuring costs (Note 5) Earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs Depreciation and amortization (Notes 6 and 7) Acquisition and restructuring costs (Note 22) Interest on long-term debt Other financial charges (Note 13) Earnings before income taxes Income taxes (Note 14) Net earnings Net earnings per share (Note 15) Basic Diluted 2018 2017 $ 11,542.5 $ 11,162.6 10,277.8 9,873.1 1,264.7 226.3 40.6 33.8 14.1 949.9 97.4 $ 852.5 $ 1,289.5 207.3 - 36.9 5.0 1,040.3 309.2 731.1 $ $ 2.21 2.18 $ $ 1.86 1.84 The accompanying notes are an integral part of these consolidated financial statements. ANNUAL REPORT 2018 - 39 - CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in millions of CDN dollars) Years ended March 31 Net earnings Other comprehensive income: Items that may be reclassified to net earnings: Exchange differences arising from foreign currency translation Net unrealized gains on cash flow hedges1 (Note 20) Reclassification of gains on cash flow hedges to net earnings2 Items that will not be reclassified to net earnings: Actuarial losses3 (Note 17) Other comprehensive income Total comprehensive income 1 Net of income taxes of $2.0 (2017 – $1.1). 2 Net of income taxes of $2.8 (2017 – $1.7). 3 Net of income taxes of $1.1 (2017 – $1.4). 2018 2017 $ 852.5 $ 731.1 (168.2) 6.0 (6.8) (169.0) (4.1) (4.1) (173.1) $ 679.4 $ 104.2 0.6 (3.6) 101.2 (3.1) (3.1) 98.1 829.2 The accompanying notes are an integral part of these consolidated financial statements. ANNUAL REPORT 2018 - 40 - - - - - - - - - - - - - - - - CONSOLIDATED STATEMENTS OF EQUITY (in millions of CDN dollars, except common shares) For the year ended March 31, 2018 Share capital Reserves Common Shares Amount Foreign Currency Translation Cash Flow Hedges Stock Option Plan Total Reserves Retained Earnings Total Non- Controlling Interest Total Equity Balance, beginning of year 386,234,311 $ 871.1 $ 717.8 $ (3.0) $ 97.9 $ 812.7 $ 2,639.1 $ 4,322.9 $ - $ 4,322.9 Net earnings Other comprehensive income Total comprehensive income Dividends declared Stock option plan (Note 12) Shares issued under stock option plan Amount transferred from reserves to share capital upon exercise of options Excess tax benefit that results from the excess of the deductible amount over the compensation cost recognized Shares repurchased and cancelled - - - - - - - - 1,827,992 41.0 - 8.2 - - (654,900) (1.4) - (168.2) - (0.8) - - - (169.0) 852.5 (4.1) 852.5 (173.1) 679.4 (243.5) 24.1 - - - - 24.1 - - 24.1 - (243.5) - - 41.0 - (8.2) (8.2) - - - - 2.8 - 2.8 - - 2.8 (27.6) (29.0) - - - - - - - - - 852.5 (173.1) 679.4 (243.5) 24.1 41.0 - 2.8 (29.0) Balance, end of year 387,407,403 $ 918.9 $ 549.6 $ (3.8) $ 116.6 $ 662.4 $ 3,216.4 $ 4,797.7 $ - $ 4,797.7 For the year ended March 31, 2017 Share capital Reserves Common Shares Amount Foreign Currency Translation Cash Flow Hedges Stock Option Plan Total Reserves Retained Earnings Total Non- Controlling Interest Total Equity Balance, beginning of year 392,520,687 $ 821.0 $ 613.6 $ 82.1 $ 695.7 $ Net earnings Other comprehensive income Total comprehensive income Additional non-controlling interests arising from issuance of additional shares Acquisition of the remaining interest in a subsidiary (net of taxes of $40.2) Dividends declared Stock option plan (Note 12) Shares issued under stock option plan Amount transferred from reserves to share capital upon exercise of options Excess tax benefit that results from the excess of the deductible amount over the compensation cost recognized Shares repurchased and cancelled - - - - - - - - - - - - 2,898,704 57.6 - 12.7 - - (9,185,080) (20.2) - $ - - - - - - 104.2 (3.0) - - 2,485.1 $ 727.8 4,001.8 $ 727.8 - 101.2 (3.1) 98.1 825.9 68.0 $ 3.3 4,069.8 731.1 - 3.3 98.1 829.2 - - - - 16.3 16.3 - - 22.0 - - - 22.0 - 41.5 (228.3) - 41.5 (228.3) 22.0 - 57.6 - (12.7) (12.7) - - - - 6.5 - 6.5 - 6.5 - (383.9) (404.1) (87.6) - - - - - - (46.1) (228.3) 22.0 57.6 - 6.5 (404.1) Balance, end of year 386,234,311 $ 871.1 $ 717.8 $ (3.0) $ 97.9 $ 812.7 $ 2,639.1 $ 4,322.9 $ - $ 4,322.9 The accompanying notes are an integral part of these consolidated financial statements. ANNUAL REPORT 2018 - 41 - CONSOLIDATED BALANCE SHEETS (in millions of CDN dollars) As at ASSETS Current assets Cash and cash equivalents Receivables Inventories (Note 4) Income taxes receivable (Note 14) Prepaid expenses and other assets Property, plant and equipment (Note 6) Goodwill (Note 7) Intangible assets (Note 7) Other assets (Note 8) Deferred income taxes (Note 14) Total assets LIABILITIES Current liabilities Bank loans (Note 9) Accounts payable and accrued liabilities Income taxes payable (Note 14) Current portion of long-term debt (Note 10) Long-term debt (Note 10) Other liabilities (Note 11) Deferred income taxes (Note 14) Total liabilities EQUITY Share capital (Note 12) Reserves Retained earnings Total equity Total liabilities and equity March 31, 2018 March 31, 2017 $ $ $ $ $ $ 122.2 $ 944.9 1,234.5 52.0 68.8 2,422.4 2,220.0 2,417.3 823.1 85.7 34.5 8,003.0 $ 193.3 $ 1,068.6 26.5 4.4 1,292.8 1,420.9 66.7 424.9 3,205.3 $ 918.9 662.4 3,216.4 4,797.7 $ 8,003.0 $ 250.5 863.2 1,172.5 15.0 79.3 2,380.5 2,165.5 2,240.5 662.3 99.7 48.1 7,596.6 93.8 1,008.3 91.3 - 1,193.4 1,500.0 68.9 511.4 3,273.7 871.1 812.7 2,639.1 4,322.9 7,596.6 The accompanying notes are an integral part of these consolidated financial statements. On behalf of the Board, (signed) Lino A. Saputo, Jr. Lino A. Saputo, Jr. Chairman of the Board and Chief Executive Officer (signed) Tony Meti Tony Meti Director ANNUAL REPORT 2018 - 42 - CONSOLIDATED STATEMENTS OF CASH FLOWS (in millions of CDN dollars) Years ended March 31 Cash flows related to the following activities: Operating Net earnings Adjustments for: Stock-based compensation Interest and other financial charges Income tax expense Depreciation and amortization Gain on disposal of property, plant and equipment Impairment charges related to plant closure Share of joint venture earnings, net of dividends received Underfunding of employee plans in excess of costs Changes in non-cash operating working capital items Cash generated from operating activities Interest and other financial charges paid Income taxes paid Net cash generated from operating activities Investing Business acquisitions Additions to property, plant and equipment Additions to intangible assets Proceeds on disposal of property, plant and equipment Other Financing Bank loans Proceeds from issuance of long-term debt Repayment of long-term debt Issuance of share capital Repurchase of share capital Dividends Acquisition of the remaining interest in a subsidiary Additional non-controlling interest arising from issuance of additional shares 2018 2017 $ 852.5 $ 731.1 34.3 47.9 97.4 226.3 (0.7) 10.6 0.9 1.8 1,271.0 (115.2) 1,155.8 (47.4) (299.3) 809.1 (385.1) (277.8) (66.2) 6.6 (0.4) (722.9) 129.6 300.0 (402.2) 41.0 (29.0) (243.5) - - (204.1) 34.0 41.9 309.2 207.3 (2.0) - (1.1) 2.9 1,323.3 2.4 1,325.7 (42.8) (209.3) 1,073.6 - (236.7) (84.7) 4.7 (1.1) (317.8) (82.1) 600.0 (552.2) 57.6 (404.1) (228.3) (87.0) 16.3 (679.8) 76.0 164.3 10.2 250.5 (Decrease) increase in cash and cash equivalents Cash and cash equivalents, beginning of year Effect of exchange rate changes on cash and cash equivalents Cash and cash equivalents, end of year (117.9) 250.5 (10.4) 122.2 $ $ The accompanying notes are an integral part of these consolidated financial statements. ANNUAL REPORT 2018 - 43 - NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended March 31, 2018 and 2017 (Tabular amounts are in millions of CDN dollars except information on options, units and shares.) NOTE 1 CORPORATE INFORMATION Saputo Inc. (the Company) is a publicly traded company incorporated and domiciled in Canada. The Company’s shares are listed on the Toronto Stock Exchange under the symbol “SAP.” The Company produces, markets and distributes a wide array of dairy products from Canada, the United States, Argentina and Australia. The address of the Company’s head office is 6869, Metropolitain Blvd. East, Montréal, Québec, Canada, H1P 1X8. The consolidated financial statements (financial statements) of the Company for the year ended March 31, 2018 comprise the financial results of the Company and its subsidiaries. The financial statements for the year ended March 31, 2018 have been authorized for issuance by the Board of Directors on June 7, 2018. NOTE 2 BASIS OF PRESENTATION STATEMENT OF COMPLIANCE The consolidated annual financial statements of the Company have been prepared in accordance with International Financial Reporting Standards (IFRS). BASIS OF MEASUREMENT The Company’s financial statements have been prepared on a going concern basis and applied based on the historical cost principle except for certain assets and liabilities as described in the significant accounting policies section. FUNCTIONAL AND PRESENTATION CURRENCY The Company’s financial statements are presented in Canadian dollars, which is also the consolidated entity’s functional currency. All financial information has been rounded to the nearest million unless stated otherwise. NOTE 3 SIGNIFICANT ACCOUNTING POLICIES CONSOLIDATED FINANCIAL STATEMENTS The consolidated financial statements include the accounts of the Company and entities under its control. Control exists when an entity is exposed, or has rights, to variable returns from its involvement with investees and has the ability to affect those returns through its power over them. All intercompany transactions and balances have been eliminated. Investments over which the Company has effective control are consolidated. The operating results of acquired businesses, from their respective acquisition dates, are included in the consolidated statements of earnings. CASH AND CASH EQUIVALENTS Cash and cash equivalents consist primarily of cash and short-term investments having an initial maturity of three months or less at the time of acquisition. INVENTORIES Finished goods, raw materials and work in process are valued at the lower of cost and net realizable value, cost being determined under the first in, first out method. ANNUAL REPORT 2018 - 44 - NOTE 3 SIGNIFICANT ACCOUNTING POLICIES (CONT’D) PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are stated at cost less accumulated depreciation and any impairment losses and are depreciated using the straight-line method over their estimated useful lives as described below: Buildings Furniture, machinery and equipment Rolling stock Assets under finance lease 15 to 40 years 3 to 20 years 5 to 10 years based on estimated kilometers traveled Shorter of term of lease or estimated useful life Where components of an item of building or furniture, machinery and equipment are individually significant, they are accounted for separately within the categories described above. Assets held for sale are recorded at the lower of their carrying amount or fair value less costs to sell, and no depreciation is recorded. Assets under construction are not depreciated. Borrowing costs are capitalized to qualifying property, plant and equipment where the period of construction of those assets takes a substantial period of time to get ready for their intended use. Borrowing costs, if incurred, are added to the cost of those assets until such time as the assets are substantially ready for their intended use. For the purposes of impairment testing, property, plant and equipment are tested at the cash-generating unit (CGU) level. Write-downs are included in “depreciation and amortization” presented on the consolidated statements of earnings. GOODWILL AND INTANGIBLE ASSETS Goodwill represents the excess of the consideration transferred in a given acquisition over the fair value of the identifiable net assets acquired and is initially recorded at that value. Goodwill is subsequently carried at cost less any impairment. Intangible assets include trademarks, customer relationships and software that is not an integral part of the related hardware. Intangible assets are initially recorded at their transaction fair values. Indefinite life intangibles are subsequently carried at cost less any impairment losses. Definite life intangible assets are subsequently carried at cost less accumulated amortization and less impairment losses, if any. Goodwill and trademarks are not amortized as they are considered to be indefinite life intangible assets. However they are tested for impairment annually or more frequently if events or changes in circumstances indicate that the assets might be impaired. When testing goodwill and indefinite life intangible assets for impairment, the carrying values of the CGU’s or group of CGU’s including goodwill are compared with their respective recoverable amounts (higher of fair value less costs of disposal and value in use) and an impairment loss, if any, is recognized for the excess. Customer relationships and software are considered to be definite life intangible assets and are amortized using the straight-line method over their useful lives which vary from 5 to 15 years and are reviewed for indicators of impairment prior to each reporting period. Refer to “Impairment Testing of Cash-Generating Units” in Note 7 for a discussion of the CGU levels at which goodwill and intangible assets are tested. IMPAIRMENT OF OTHER LONG-LIVED ASSETS Other long-lived assets are subject to an “indicators of impairment” test at each reporting period. In the event of an indication of impairment, the asset or group of assets (referred to as CGU’s), for which identifiable cash flows that are largely independent of the cash inflows from other assets or group of assets exist, are tested for impairment. An impairment loss is recorded in net earnings when the carrying value exceeds the recoverable amount. The recoverable amount is defined as the greater of fair value less costs of disposal and value in use. BUSINESS COMBINATIONS The Company accounts for its business combinations using the acquisition method of accounting. Under this method, the Company allocates the purchase price to tangible and intangible assets acquired and liabilities assumed based on estimated fair values at the date of acquisition, with the excess of the purchase price amount allocated to goodwill. Significant debt issuance costs directly related to the funding of business acquisitions are included in the carrying value of the debt and are amortized over the related debt term using the effective interest rate method. Acquisition costs are expensed as incurred. ANNUAL REPORT 2018 - 45 - NOTE 3 SIGNIFICANT ACCOUNTING POLICIES (CONT’D) EMPLOYEE FUTURE BENEFITS The cost of defined benefit pension and other post-retirement benefits is actuarially determined annually on March 31 using the projected benefit method prorated based on years of service and using Management’s best estimates of rates of compensation increases, retirement ages of employees and expected health care costs. Current service costs and interest on obligations offset by interest income on plan assets are expensed in the year. Actuarial gains or losses, the effect of an adjustment, if any, on the maximum amount recognized as an asset and the impact of the minimum funding requirements, are recorded in other comprehensive income (loss) and immediately recognized in retained earnings without subsequent reclassification to the consolidated statements of earnings. The net pension expenditure under defined contribution pension plans is generally equal to the contributions made by the employer. REVENUE RECOGNITION The Company recognizes revenue when the title and risk of loss are transferred to customers, price is determinable, collection is reasonably assured and when persuasive evidence of an arrangement exists. Revenues are recorded net of sales incentives including volume rebates. FOREIGN CURRENCY TRANSLATION The Company’s functional currency is the Canadian dollar. Accordingly, the balance sheet accounts of foreign operations are translated into Canadian dollars using the exchange rates at the balance sheet dates and statements of earnings accounts are translated into Canadian dollars using the average monthly exchange rates in effect during the periods. The foreign currency translation adjustment (CTA) reserve presented in the consolidated statements of comprehensive income and the consolidated statements of equity, represents accumulated foreign currency gains (losses) on the Company’s net investments in companies operating outside Canada. The change in the unrealized gains (losses) on translation of the financial statements of foreign operations for the periods presented resulted mainly from the fluctuation 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 balance sheet dates for monetary assets and liabilities, and at the prevailing exchange rates at the time of transactions for income and expenses. Non-monetary items are translated at the historical exchange rates. Gains or losses resulting from this translation are included in operating costs. STOCK-BASED COMPENSATION The Company offers an equity settled stock option plan to certain employees within the organization pursuant to which options are granted over a five-year vesting period with a ten-year expiration term. The fair value of each instalment of an award is determined separately and recognized over the vesting period. When stock options are exercised, any consideration paid by employees and the related compensation expense recorded as a stock option plan reserve are credited to share capital. The Company allocates deferred share units (DSU) to eligible Directors of the Company which are based on the market value of the Company’s common shares. DSUs are granted on a quarterly basis, vest upon award and entitle Directors to receive a cash payment for the value of the DSUs they hold following cessation of functions as a Director of the Company. The Company recognizes an expense in its consolidated statements of earnings and a liability in its consolidated balance sheets for each grant. The liability and related expense is subsequently re-measured at each reporting period. The Company offers performance share units (PSU) to senior management which are based on the market value of the Company’s common shares. The PSU plan is non-dilutive and is settled in cash. These awards are considered cash-settled share-based payment awards. A liability is recognized for the employment service received and is measured initially, on the grant date, at the fair value of the liability. The liability is then subsequently remeasured at each reporting period with any change in value recorded in net earnings. The compensation expense is recognized over the three-year performance cycle. JOINT VENTURES Joint ventures are accounted for using the equity method and represent those entities in which the Company exercises joint control over and for which it is exposed to variable returns from its involvement in the arrangement. Joint control is the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control. ANNUAL REPORT 2018 - 46 - NOTE 3 SIGNIFICANT ACCOUNTING POLICIES (CONT’D) INCOME TAXES Income tax expense represents the sum of current and deferred income tax and is recognized in the consolidated statements of earnings with the exception of items that are recognized in the consolidated statements of comprehensive income or directly in equity. Current income taxes are determined in relation to taxable earnings for the year and incorporate any adjustments to current taxes payable in respect of previous years. The Company follows the liability method of accounting for income taxes. Under this method, deferred income tax assets and liabilities are determined based on temporary differences between the carrying amount of an asset or liability in the consolidated balance sheets and its tax basis. They are measured using the enacted or substantively enacted tax rates that are expected to apply when the asset is realized or the liability is settled. A deferred income tax asset is recognized to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be used. FINANCIAL INSTRUMENTS Financial assets and liabilities are initially measured at fair value. Subsequently, financial instruments classified as financial assets available for sale, held for trading and derivative financial instruments, part of a hedging relationship or not, continue to be measured at fair value on the balance sheet at each reporting date, whereas other financial instruments are measured at amortized cost using the effective interest method. The Company has made the following classifications: - Cash and cash equivalents are classified as loans and receivables and are subsequently measured at amortized cost. - Receivables are classified as loans and receivables and are subsequently measured at amortized cost. - Other assets that meet the definition of a financial asset are classified as loans and receivables and are subsequently measured at amortized cost. - Bank loans, accounts payable and accrued liabilities, other liabilities and long-term debt are classified as other liabilities and are measured at amortized cost, with the exception of the liability related to DSUs and PSUs which is measured at the fair value of common shares on the balance sheet dates. Certain derivative instruments are utilized by the Company to manage exposure to variations in interest rate payments and to manage foreign exchange rate risks, including foreign exchange forward contracts, currency swaps and interest rate swaps. Derivatives are initially recognized at fair value at the date the derivative contracts and currency swaps are entered into and are subsequently remeasured to their fair value at the end of each reporting period. The resulting gain or loss is immediately recognized in net earnings unless the derivative is designated as a hedging instrument. HEDGING The Company designates certain financial instruments as cash flow hedges. At the inception of the hedging relationship, the Company formally documents its risk management objective, strategy, term, nature of risk being hedged and identifies both the hedged item and hedging instrument. For derivatives instruments designated as cash flow hedges, the change in fair value related to the effective portion of the hedge is recognized in other comprehensive income (loss), and the accumulated amount is presented as a hedging reserve in the consolidated statement of equity. Any ineffective portion is immediately recognized in net earnings. Gains or losses from cash flow hedges included in other components of equity are reclassified to net income, when the hedging instrument has come due or is settled, as an offset to the losses or gains recognized on the underlying hedged items. The Company formally assesses at inception and quarterly thereafter, the effectiveness of the hedging instruments ability to offset variations in the cash flow risks associated with the hedged item. Where a hedging relationship is no longer effective, hedge accounting is discontinued and any subsequent change in the fair value of the hedging instrument is recognized in net earnings. NON-CONTROLLING INTEREST Non-controlling interests represent equity interest in acquired subsidiaries by third parties. The non-controlling shareholders claim on net assets of the subsidiary is presented as a component within equity. Any share purchases from non-controlling interests after the Company obtains control of a division are treated as transactions with equity owners of the Company. Net earnings and each component of other comprehensive income are attributed to both the owners of the Company and to the non-controlling interest. ANNUAL REPORT 2018 - 47 - NOTE 3 SIGNIFICANT ACCOUNTING POLICIES (CONT’D) FAIR VALUE HIERARCHY All financial instruments measured at fair value are categorized into one of three hierarchy levels, described below, for disclosure purposes. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Each level reflects the inputs used to measure the fair values of assets and liabilities: Level 1 – Inputs are unadjusted quoted prices of identical instruments in active markets. Level 2 – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 – One or more significant inputs used in a valuation technique are not based on observable market data in determining fair values of the instruments. Determination of fair value and the resulting hierarchy requires the use of observable market data whenever available. The classification of a financial instrument in the hierarchy is based upon the lowest level of input that is significant to the measurement of fair value. USE OF ESTIMATES AND JUDGEMENTS IN THE APPLICATION OF ACCOUNTING POLICIES The preparation of the Company’s financial statements requires Management to make certain judgements and estimates about transactions and carrying values that are fulfilled at a future date. Judgements and estimates are subject to fluctuations due to changes in internal and/or external factors and are continuously monitored by Management. A discussion of the judgements and estimates that could have a material effect on the financial statements is provided below. SIGNIFICANT ESTIMATES AND JUDGEMENTS Income Taxes The Company is subject to income taxes in numerous jurisdictions. Significant judgement is required in determining the consolidated provision for income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. The Company recognizes liabilities for anticipated tax audit issues based on estimates of whether additional taxes will be due. Where the final tax outcome of these matters differs from the amounts that were initially recorded, such differences will impact the results for the reporting period and the respective current income tax and deferred income tax provisions in the reporting period in which such determination is made. Deferred Income Taxes The Company follows the liability method of accounting for deferred income taxes. Deferred income tax assets and liabilities are measured using enacted or substantively 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. Deferred tax assets are reviewed at each reporting date and are reduced to the extent that it is no longer probable that the related tax benefit will be realized. Canadian, US and international tax rules and regulations are subject to interpretation and require judgement on the part of the Company that may be challenged by taxation authorities. The Company believes that it has adequately provided for deferred 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. Goodwill, Intangible Assets and Business Combinations Goodwill, trademarks and customer relationships have principally arisen as a result of business combinations. The acquisition method, which also requires significant estimates and judgements, is used to account for these business combinations. As part of the allocation process in a business combination, estimated fair values are assigned to the net assets acquired, including trademarks and customer relationships. These estimates are based on forecasts of future cash flows, estimates of economic fluctuations and an estimated discount rate. The excess of the purchase price over the estimated fair value of the net assets acquired is then assigned to goodwill. In the event that actual net assets fair values are different from estimates, the amounts allocated to the net assets, and specifically to trademarks and customer relationships, could differ from what is currently reported. This would then have a pervasive impact on the carrying value of goodwill. Differences in estimated fair values would also have an impact on the amortization of definite life intangibles. ANNUAL REPORT 2018 - 48 - NOTE 3 SIGNIFICANT ACCOUNTING POLICIES (CONT’D) Property, Plant and Equipment Critical judgement is necessary in the selection and application of accounting policies and useful lives as well as the determination of which components are significant and how they are allocated. Management has determined that the use of the straight-line method of amortization is the most appropriate as its facilities are operating at a similar output potential on a year to year basis, which indicates that production is constant (please refer to the estimated useful lives table for further details on the useful lives of productive assets). It is Management’s best estimate that the useful lives and policies adopted adequately reflect the flow of resources and the economic benefits required and derived in the use and servicing of these long-lived productive assets. Impairment of Assets Significant estimates and judgements are required in testing goodwill, intangible assets and other long-lived assets for impairment. Management uses estimates or exercises judgement in assessing indicators of impairment, defining a CGU, forecasting future cash flows and in determining other key assumptions such as discount rates and earnings multipliers used for assessing fair value (less costs of disposal) or value in use. Estimates made for goodwill and intangible assets can be found in Note 7. Other long-lived assets are tested only when indicators of impairment are present. Employee Future Benefits The Company is the sponsor to both defined benefit and defined contribution plans, which provide pension and other post-employment benefits to its employees. Several estimates and assumptions are required with regards to the determination of the defined benefit expense and its related obligation, such as the discount rate used in determining the carrying value of the obligation and the interest income on plan assets, the expected health care cost trend rate, the expected mortality rate, expected salary increase, etc. Actual results will normally differ from expectations. These gains or losses are presented in the consolidated statements of comprehensive income. EFFECT OF NEW ACCOUNTING STANDARDS, INTERPRETATIONS AND AMENDMENTS NOT YET IMPLEMENTED The International Accounting Standards Board (IASB) made revisions as part of its continuing improvements project. Below is a summary of the relevant standards affected and a discussion of the amendments. The following standards, amendments to standards and interpretations have been issued and are applicable to the Company for its annual periods beginning on and after April 1, 2018, with an earlier application permitted: IFRS 2, Share-Based Payment In June 2016, the IASB issued an amendment to clarify how to account for certain types of share-based payment transactions. The amendments provide requirements on the accounting for: the effects of vesting and non-vesting conditions on the measurement of cash-settled share-based payments, share-based payment transactions with a net settlement feature for withholding tax obligations and a modification to the terms and conditions of a share-based payment that changes the classification of the transaction from cash-settled to equity-settled. IFRS 9, Financial Instruments In July 2014, the IASB issued the final version of IFRS 9, Financial Instruments with the goal of replacing IAS 39, Financial Instruments: Recognition and Measurement. The new standard addresses the classification and measurement of financial assets and liabilities, provides a new impairment model for the recognition of expected credit losses and provides a new hedge accounting model. Refer to the section “Considerations for the implementation of IFRS 9 and IFRS 15” of this note for more information. IFRS 15, Revenue from Contracts with Customers The IASB issued IFRS 15, Revenue from Contracts with Customers with its goal to provide a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers. This new standard will supersede current revenue recognition guidance in IAS 18, Revenue, IAS 11, Construction Contracts and IFRIC 13, Customer Loyalty Programmes. The objective of this standard is to provide a five-step approach to revenue recognition that includes identifying contracts with customers, identifying performance obligations, determining transaction prices, allocating transaction prices to performance obligations and recognizing revenue when performance obligations are satisfied. In certain instances, transfer of assets that are not related to the entity’s ordinary activities will also be required to follow some of the recognition and measurement requirements of the new model. The standard also expands current disclosure requirements. ANNUAL REPORT 2018 - 49 - NOTE 3 SIGNIFICANT ACCOUNTING POLICIES (CONT’D) In April 2016, the IASB amended IFRS 15 to comprise clarifications of the guidance on identifying performance obligations, accounting for licenses of intellectual property and the principal versus agent assessment (gross versus net revenue presentation). The amendment includes additional practical expedients related to transition to the new revenue standard. With regards to identifying performance obligations, the amendments clarify how to determine when promises in a contract are ‘distinct’ goods or services and, therefore, should be accounted for separately. The amendments to licensing guidance clarify when revenue from a license of intellectual property should be recognized ‘over time’ and when it should be recognized at a ‘point in time’. With regards to the principal versus agent assessment, the amendments clarify that the principal in an arrangement controls a good or service before it is transferred to a customer. Refer to the section “Considerations for the implementation of IFRS 9 and IFRS 15” of this note for more information. IAS 40, Investment Property In December 2016, the IASB issued an amendment to IAS 40 clarifying when assets are transferred to, or from, investment properties. The amendment clarified that to transfer to, or from, investment properties there must be a change in use. To conclude if a property has changed use there should be an assessment of whether the property meets the definition. This change must be supported by evidence. This amendment may be applied prospectively or retrospectively. IFRIC 22, Foreign Currency Transactions and Advance Consideration In December 2016, the IASB issued IFRIC 22 which provides an interpretation on how to determine the date of the transaction when applying the standard on foreign currency transactions, IAS 21. The interpretation applies where an entity pays or receives consideration in advance for foreign currency-denominated contracts. The date of the transaction determines the exchange rate to be used on initial recognition of the related asset, expense or income. This interpretation provides guidance for when a single payment or receipt is made, as well as for situations where multiple payments or receipts are made and aims to reduce diversity in practice. Except as disclosed in ‘‘Considerations for the implementations of IFRS 9 and IFRS 15’’, the adoption of these standards, amendments and interpretation will not have a significant impact on the Company’s financial statements. The following standard has been issued and is applicable to the Company for its annual periods beginning on April 1, 2019 and thereafter, with an earlier application permitted for entities that have also adopted IFRS 15: IFRS 16, Leases In January 2016, the IASB published a new standard, IFRS 16 ‘‘Leases’’, which will replace IAS 17 ‘‘Leases’’. The new standard will eliminate the distinction between operating and finance leases and will bring most leases on the balance sheet for lessees, except with respect to lease that meet limited exception criteria. For lessors, the accounting remains mostly unchanged and the distinction between operating and finance leases is retained. The following standards, amendments to standards and interpretations have been issued and are applicable to the Company for its annual periods beginning on and after April 1, 2019, with an earlier application permitted: IFRS 3, Business Combinations In December 2017, the IASB issued an amendment to IFRS 3 to clarify that when an entity obtains control of a business that is a joint operation, it remeasures previously held interests in that business. IFRS 9, Financial Instruments In October 2017, the IASB further amended IFRS 9 to allow financial assets with a prepayment option that could result in the option’s holder receiving compensation for early termination to meet the solely payments of principal and interest condition if specified criteria are met. IFRS 11, Joint Arrangements In December 2017, the IASB issued an amendment to IFRS 11 to clarify that when an entity obtains joint control of a business that is a joint operation, the entity does not remeasure previously held interests in that business. ANNUAL REPORT 2018 - 50 - NOTE 3 SIGNIFICANT ACCOUNTING POLICIES (CONT’D) IAS 19, Employee Benefits In February 2018, the IASB issued an amendment to IAS 19 to specify how an entity shall determine pension expenses when changes to a pension plan occur. When an amendment, curtailment or settlement to a plan takes place, IAS 19 requires an entity to remeasure its net defined benefit liability or asset. The amendments require an entity to use the updated assumptions from this remeasurement to determine the current service cost and net interest for the remainder of the reporting period after the change to the plan. In addition, amendments have been included to clarify the effect of a plan amendment, curtailment or settlement on the requirements regarding the asset ceiling. IAS 23, Borrowing Costs In December 2017, the IASB issued an amendment to IAS 23 clarifying that if any specific borrowing remains outstanding after the related asset is ready for its intended use or sale, it becomes part of the funds that an entity borrows generally when calculating the capitalization rate on general borrowings. IAS 28, Investments in Associates In October 2017, the IASB issued an amendment to IAS 28 to clarify that an entity should apply IFRS 9 to long-term interests in an associate or joint venture that form part of the net investment in the associate or joint venture but to which the equity method is not applied. IFRIC 23, Uncertainty Over Income Tax Treatments In June 2017, the IFRS Interpretations Committee issued IFRIC 23 which clarifies how the recognition and measurement requirements of IAS 12, Income Taxes, are applied where there is uncertainty over income tax treatments. Management is currently assessing the impact of the adoption of these standards, amendments and interpretation on the Company’s financial statements. CONSIDERATIONS FOR THE IMPLEMENTATION OF IFRS 9 AND IFRS 15 IFRS 9 and IFRS 15 are required to be applied for annual reporting periods beginning on April 1, 2018. The Company will not be early adopting IFRS 9 or IFRS 15. The Company will adopt IFRS 9 and IFRS 15 in fiscal 2019. IFRS 9 is applicable retrospectively in accordance with IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, subject to certain exemptions and exceptions. In general, the main impacts of adopting IFRS 9 are expected to be on classification and measurement of financial assets, the introduction of a new impairment model based on expected losses (rather than incurred loss as per IAS 39, Financial Instruments: Recognition and Measurement), hedge accounting and significant additional disclosure requirements. The Company evaluated the impact of this standard. The Company’s analysis did not identify any differences that would significantly change the classification and measurement of its financial instruments. The Company expects to apply the simplified approach and record lifetime expected losses on all trade receivables. IFRS 9 will require the Company to ensure that hedge accounting relationships are aligned with the Company’s risk management objectives and strategy and to apply a more qualitative and forward-looking approach to assessing hedge effectiveness. The Company completed these changes to its internal documentation to meet the requirements of IFRS 9. The Company evaluated the impact of the new standard on the consolidated financial statements and it does not have a significant impact. IFRS 15 can be applied using one of the following two methods: retrospectively to each prior reporting period presented in accordance with IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors, or retrospectively with the cumulative effect of applying IFRS 15 recognized at the date of initial application. The Company decided to use the second method as its transition method as prescribed under IFRS 15. ANNUAL REPORT 2018 - 51 - NOTE 3 SIGNIFICANT ACCOUNTING POLICIES (CONT’D) The Company has reviewed standard purchase orders, invoices, shipping terms and significant contracts with customers including discount arrangements. The Company has quantified the impact of IFRS 15 and has determined these changes do not have a material impact on its consolidated financial statements. The following items represent the main areas where differences were identified on transition to IFRS 15: • Presentation of the shipping and handling activities will be considered principal and will be presented on a gross basis. The Company’s current accounting treatment has not resulted in any material differences. • Revenues will be recognized at a point in time when control of the asset is transferred to the customer, generally upon shipment of products. The Company’s current accounting treatment has not resulted in any material differences. • Some contracts with customers provide incentive programs, including discounts, promotions, advertising allowances, and other volume-based incentives. Such incentives give rise to variable considerations, which are also estimated at contract inception. IFRS 15 has not resulted in any material differences to the current estimation methodologies or the timing of the recognition of estimates and the Company’s current accounting treatment. The Company does not expect to record any adjustment in the opening retained earnings as of the transition date since the impact is not material. In addition to ensuring that the accounting and disclosure requirements of IFRS 15 are met, we continue to address any systems and process changes necessary to compile the information and meet the recognition and disclosure requirements of the standards. The Company will not be required to materially change its business process and controls to support this transition. The Company will provide additional disclosure as required by the new standard starting from the first quarter of fiscal year 2019 onwards. In addition to the new disclosure requirements under IFRS 15, the Company will also disclose the amount by which each financial statement line item is affected in the reporting period by the application of IFRS 15 as compared with the previous standards. NEW ACCOUNTING STANDARDS ADOPTED DURING THE YEAR The following amendments to existing standards were adopted by the Company on April 1, 2017: IAS 7, Statement of Cash Flows IAS 7 has been amended to provide additional presentation related to the changes in liabilities arising from financing activities such as: (i) changes from financing cash flows; (ii) changes arising from obtaining or losing control of subsidiaries or other businesses; (iii) the effect of changes in foreign exchange rates; (iv) changes in fair values; and (v) other changes. This amendment did not significantly impact the Company’s financial statements for the year ended March 31, 2018. IAS 12, Income taxes IAS 12 has been amended to provide clarification on the requirements relating to the recognition of deferred tax assets for unrealized losses on debt instruments measured at fair value. This amendment did not significantly impact the Company’s financial statements for the year ended March 31, 2018. ANNUAL REPORT 2018 - 52 - NOTE 4 INVENTORIES Finished goods Raw materials, work in progress and supplies Total March 31, 2018 March 31, 2017 $ $ $ 835.2 399.3 783.0 389.5 1,234.5 $ 1,172.5 The amount of inventories recognized as an expense in operating costs for the year ended March 31, 2018 is $9,175.1 million ($8,876.1 million for the year ended March 31, 2017). During fiscal 2018, a write-down of $16.9 million ($4.1 million at March 31, 2017) was included as an expense in “Operating costs excluding depreciation, amortization, acquisition and restructuring costs” under the caption “Changes in inventories of finished goods and work in process” presented in Note 5. NOTE 5 OPERATING COSTS EXCLUDING DEPRECIATION, AMORTIZATION, ACQUISITION AND RESTRUCTURING COSTS Changes in inventories of finished goods and work in process Raw materials and consumables used Foreign exchange loss (gain) Employee benefits expense Selling costs Other general and administrative costs $ 2018 (56.5) $ 8,018.0 2.7 1,314.1 429.1 570.4 Total $ 10,277.8 $ Certain prior year’s figures have been reclassified to conform to the current presentation. 2017 (88.3) 7,768.1 (4.3) 1,268.9 404.2 524.5 9,873.1 ANNUAL REPORT 2018 - 53 - NOTE 6 PROPERTY, PLANT AND EQUIPMENT Furniture, machinery and Land Buildings equipment Rolling stock Held for Lease sale Total For the year ended March 31, 2018 Cost As at March 31, 2017 $ Business acquisitions (Note 16) Additions Disposals Transfers Foreign currency adjustments 69.2 $ 854.9 $ 2,638.3 $ 16.9 $ - $ - $ 3,579.3 2.4 0.2 (0.8) (5.2) 20.6 83.3 (11.5) (17.8) 3.4 193.6 (85.2) (0.1) 1.0 0.7 (0.4) - (0.8) (23.0) (71.5) (0.5) 28.7 - - - 0.9 - - - 23.1 56.1 277.8 (97.9) - - (94.9) As at March 31, 2018 $ 65.0 $ 906.5 $ 2,678.5 $ 17.7 $ 29.6 $ 23.1 $ 3,720.4 Accumulated depreciation As at March 31, 2017 Depreciation Disposals Transfers Impairment charges related to plant closure Foreign currency adjustments As at March 31, 2018 $ - - - - - - - 290.5 33.0 (8.6) (8.8) 6.1 (8.8) 1,115.9 166.1 (83.1) - 4.5 (25.2) $ 303.4 $ 1,178.2 $ 7.4 1.9 (0.3) - - (0.1) 8.9 $ - 1.1 - - - - - - - 8.8 1,413.8 202.1 (92.0) - - - 10.6 (34.1) 1.1 $ 8.8 $ 1,500.4 Net book value at March 31, 2018 $ 65.0 $ 603.1 $ 1,500.3 $ 8.8 $ 28.5 $ 14.3 $ 2,220.0 Furniture, machinery and Land Buildings equipment $ 68.2 0.4 (0.2) $ 818.4 29.5 (4.5) $ 2,438.0 205.0 (46.7) 0.8 69.2 $ 11.5 854.9 $ 42.0 2,638.3 $ - - - - - 256.3 34.3 (3.5) 991.7 153.4 (45.4) 3.4 16.2 $ 290.5 $ 1,115.9 $ For the year ended March 31, 2017 Rolling stock Lease Held for sale Total 17.5 $ 1.8 (2.7) 0.3 16.9 $ 8.1 1.7 (2.5) 0.1 7.4 $ - - - - - - - - - $ $ $ - - - - - - - - - $ 3,342.1 236.7 (54.1) 54.6 $ 3,579.3 1,256.1 189.4 (51.4) 19.7 $ 1,413.8 Cost As at March 31, 2016 $ Additions Disposals Foreign currency adjustments As at March 31, 2017 $ Accumulated depreciation As at March 31, 2016 Depreciation Disposals Foreign currency adjustments As at March 31, 2017 $ Net book value at March 31, 2017 $ 69.2 $ 564.4 $ 1,522.4 $ 9.5 $ - $ - $ 2,165.5 The net book value of property, plant and equipment under construction amounts to $109.1 million as at March 31, 2018 ($190.6 million as at March 31, 2017), and consists mainly of machinery and equipment. The assets held for sale relate mainly to land and building in Canada as a result of the closure of certain facilities and have been recorded at the lower of carrying value and fair value less costs to sell. There were no assets held for sale as of March 31, 2017. ANNUAL REPORT 2018 - 54 - NOTE 7 GOODWILL AND INTANGIBLE ASSETS Indefinite Life Definite Life For the year ended March 31, 2018 Goodwill Trademarks Customer relationships1 Software2 Total Intangible Assets Cost As at March 31, 2017 $ Business acquisitions (Note 16) Additions Foreign currency adjustments $ 2,240.5 233.8 - (57.0) As at March 31, 2018 $ 2,417.3 $ Accumulated Amortization As at March 31, 2017 Amortization Foreign currency adjustments As at March 31, 2018 $ - - - - 354.7 $ 81.7 - (2.9) 433.5 $ - - - Net book value at March 31, 2018 $ 2,417.3 $ 433.5 $ $ - $ $ 260.1 49.9 - (6.3) $ 135.9 - 66.2 (6.5) 303.7 $ 195.6 $ 87.2 17.7 (2.4) 102.5 $ 201.2 $ 1.2 6.5 (0.5) 7.2 $ 188.4 $ 750.7 131.6 66.2 (15.7) 932.8 88.4 24.2 (2.9) 109.7 823.1 Indefinite Life Definite Life For the year ended March 31, 2017 Goodwill Trademarks Customer relationships1 Software2 Total Intangible Assets Cost As at March 31, 2016 Additions Foreign currency adjustments $ $ 2,194.1 - 46.4 As at March 31, 2017 $ 2,240.5 $ Accumulated Amortization As at March 31, 2016 Amortization Foreign currency adjustments As at March 31, 2017 $ - - - - 351.9 $ - 2.8 354.7 $ - - - $ 255.8 - 4.3 $ 48.6 84.7 2.6 260.1 $ 135.9 $ 69.3 16.7 1.2 - 1.2 - 656.3 84.7 9.7 750.7 69.3 17.9 1.2 88.4 $ - $ 87.2 $ 1.2 $ Net book value at March 31, 2017 $ 2,240.5 $ 354.7 $ 172.9 $ 134.7 $ 662.3 1 Customer relationships are amortized straight-line over a period of 15 years. 2 None of the additions were internally generated. IMPAIRMENT TESTING OF CASH-GENERATING UNITS Goodwill In determining whether goodwill is impaired, the Company is required to estimate the recoverable amount of CGUs or groups of CGUs to which goodwill is allocated. Management considers the sectors below to be CGUs or groups of CGUs as they represent the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows form other assets or groups of assets. The Company reports its operations under three geographic sectors. The Canada Sector consists of the Dairy Division (Canada). The USA Sector includes the Cheese Division (USA) and the Dairy Foods Division (USA). Finally, the International Sector combines the Dairy Division (Argentina) and the Dairy Division (Australia). ANNUAL REPORT 2018 - 55 - NOTE 7 GOODWILL AND INTANGIBLE ASSETS (CONT’D) As of April 1, 2017, the Canada Sector includes national and export revenues of ingredients manufactured in Canada. The USA Sector includes national ingredient revenues, and export ingredient and cheese revenues of products manufactured in the USA. The goodwill related to Dairy Ingredients Division was reclassified to the Canada Division and the Cheese Division (USA). Prior to April 1, 2017, these figures were presented in the Dairy Ingredients Division as part of the International Sector. Accordingly, certain prior year’s figures have been reclassified to conform to the current presentation. Goodwill has been allocated to each CGU or group of CGUs as follows: Allocation of goodwill Canada USA Cheese Division (USA) Dairy Foods Division (USA) International Dairy Division (Australia) Dairy Division (Argentina) March 31, 2018 $ 323.2 $ March 31, 2017 323.2 1,247.3 617.3 219.6 9.9 2,417.3 $ 1,068.6 613.6 224.9 10.2 2,240.5 $ Recoverable amounts for Dairy Division (Canada), Cheese Division (USA) and Dairy Foods Division (USA) have been estimated using an earnings multiplier valuation model (fair value less costs of disposal). The key assumptions used in these models consist mainly of earnings multipliers for market comparables that are applied to the results of each CGU or group of CGUs tested. Recoverable amounts for Dairy Division (Australia) and Dairy Division (Argentina) have been estimated using a discounted cash flow (value in use) model based on the following key assumptions: • Cash flows: Cash flow forecasts for a given CGU are based on earnings before interest, income taxes, depreciation and amortization and are adjusted for a growth rate and income tax rates. The cash flow forecast does not exceed a period of five years with a terminal value calculated as a perpetuity in the final year. Terminal growth rate: Management uses a terminal growth rate to adjust its forecasted cash flows based on expected increases in inflation and revenue for the CGU. • • Discount rate: Cash flows are discounted using pre-tax discount rates. The Company performed its annual impairment test and in all cases the recoverable amounts exceeded their respective carrying values including goodwill. As at January 31, 2018 and 2017, goodwill was not considered to be impaired. Trademarks Trademarks are included in the following CGU or group of CGUs: Allocation of trademarks Neilson – Dairy Division (Canada) Other March 31, 2018 $ March 31, 2017 223.2 131.5 354.7 223.2 $ 210.3 433.5 $ $ For purposes of trademarks impairment testing, recoverable amounts of the CGU or group of CGUs to which they belong have been estimated using discounted cash flows (value in use) based on the following key assumptions: • Cash flows: Cash flow forecasts for a given trademark are based on earnings before interest, income taxes, depreciation and amortization and are adjusted for a growth rate and income tax rates. The cash flow forecast does not exceed a period of five years with a terminal value calculated as a perpetuity in the final year. Terminal growth rate: Management uses a terminal growth rate to adjust its forecasted cash flows based on expected increases in inflation and revenue for the products under trademark. • • Discount rate: Cash flows are discounted using pre-tax discount rates. The Company tested its trademarks for impairment using value in use (discounted cash flows) to establish recoverable amounts. The recoverable amounts for each trademark and other intangibles not subject to amortization were then compared to their carrying values. In all circumstances, the recoverable amounts exceeded carrying values and therefore no impairment losses were necessary. For definite life intangibles subject to amortization, no indicators of impairment were present for fiscal 2018 and 2017. ANNUAL REPORT 2018 - 56 - NOTE 8 OTHER ASSETS Joint ventures Other March 31, 2018 March 31, 2017 $ $ $ 47.9 37.8 85.7 $ 50.8 48.9 99.7 The Company has two joint ventures in Australia, for which it holds a 50% and 49% interest, respectively. In both joint ventures, the terms of the contracts require unanimous consent of all parties in order to direct the significant operations of the ventures. The joint ventures have a June 30th year end and are accounted for under the equity method. The Company recognized $7.3 million in net earnings, representing its share of earnings in the joint ventures for the year ended March 31, 2018 ($11.4 million for the year ended March 31, 2017). Dividends received from the joint ventures amounted to $8.2 million for the year ended March 31, 2018 ($10.3 million for the year ended March 31, 2017). NOTE 9 BANK LOANS The Company has available bank credit facilities providing for unsecured bank loans as follows: Credit Facilities North America-USA North America-Canada Argentina Argentina Australia Australia Maturity December 20221 December 20221 Yearly2 Yearly3 Yearly4 Yearly5 Available for use Amount drawn Canadian Currency Equivalent 387.0 258.0 117.4 100.5 24.8 96.8 984.5 Base Currency March 31, 2018 March 31, 2017 $ 300.0 USD 200.0 USD 91.0 USD 1,570 ARS 25.0 AUD 75.0 USD $ 71.0 - 41.3 42.2 7.9 30.9 $ 193.3 $ - - 46.2 23.9 - 23.7 93.8 1 Bears monthly interest at rates ranging from lender’s prime rates plus a maximum of 1.00% or LIBOR or banker’s acceptance rate plus 0.80% up to a maximum of 2.00% depending on the Company credit ratings. 2 Bear monthly interest at local rate and can be drawn in USD. 3 Bear monthly interest at local rate and can be drawn in ARS. 4 Bear monthly interest at Australian Bank Bill Rate plus 0.85%. 5 Bear monthly interest at LIBOR or Australian Bank Bill Rate plus 0.75% and can be drawn in AUD or USD. ANNUAL REPORT 2018 - 57 - NOTE 10 LONG-TERM DEBT Unsecured bank term loan facilities Obtained December 2012 and due in December 2019 ($850 million)1 200.0 600.0 March 31, 2018 March 31, 2017 Unsecured senior notes2 2.65%, issued in November 2014 and due in November 2019 (Series 1) 2.20%, issued in June 2016 and due in June 2021 (Series 2) 2.83%, issued in November 2016 and due in November 2023 (Series 3) 1.94%, issued in June 2017 and due in June 2022 (Series 4) Finance lease obligations Current portion Principal repayments are as follows: Less than 1 year 1-2 years 2-3 years 3-4 years 4-5 years More than 5 years 300.0 300.0 300.0 300.0 25.3 1,425.3 4.4 $ 1,420.9 $ $ 4.4 520.9 - 300.0 300.0 300.0 300.0 300.0 300.0 - - 1,500.0 - 1,500.0 - - 900.0 - 300.0 300.0 $ $ $ 1 Bears monthly interest at rates ranging from lender’s prime plus a maximum of 1.00% or LIBOR or bankers’ acceptance rates plus 0.80% up to a maximum of 2.00%, depending on the Company credit ratings, and can be drawn in CAD or USD. Effective February 4, 2013, the Company entered into an interest rate swap to fix its rate, which matured on December 30, 2016. As at March 31, 2017 interest rate on $452.9 million of the facility was fixed at 1.58% plus appropriate spread. As at March, 31 2018, US$157.0 million was drawn and its foreign currency risk was offset with a cross currency swap. Interest payments are semi-annual. 2 $ 1,425.3 $ 1,500.0 On June 12, 2017, the Company issued $300.0 million Series 4 medium term notes with an annual interest rate of 1.94% payable in equal semi-annual instalments, maturing on June 13, 2022, pursuant to its medium term note program expiring in January 2019. On December 21, 2017, the Company entered into a new credit agreement providing for a non-revolving term facility in the aggregate amount of $1.28 billion (the “Acquisition Facility”), consisting of three tranches: a 1-year tranche of $400.0 million; a 3-year tranche of $300.0 million; and a 5-year tranche of $580.0 million (AU$600.0 million), which was available to finance the acquisition of the business of Murray Goulburn Co-Operative Co. Limited (Note 25). On May 1, 2018, the facility had been drawn in full. NOTE 11 OTHER LIABILITIES Employee benefits (Note 17) Derivative financial liabilities (Note 20) Performance share unit liabilities and related fringe benefits Other March 31, 2018 March 31, 2017 $ $ 33.1 $ 11.7 18.5 3.4 66.7 $ 38.8 4.5 21.3 4.3 68.9 ANNUAL REPORT 2018 - 58 - NOTE 12 SHARE CAPITAL AUTHORIZED The authorized share capital of the Company consists of an unlimited number of common shares. The common shares are voting and participating. ISSUED 387,407,403 common shares (386,234,311 common shares in 2017) $ 918.9 $ 871.1 March 31, 2018 March 31, 2017 During the year ended March 31, 2018, 1,827,992 common shares (2,898,704 in 2017) were issued for an amount of $41.0 million ($57.6 million in 2017) pursuant to the share option plan. For the year ended March 31, 2018, the amount transferred from stock option plan reserve was $8.2 million ($12.7 million in 2017). Pursuant to the normal course issuer bid which began on November 17, 2016, and expired on November 16, 2017, as amended, the Company was authorized to repurchase for cancellation up to 12,000,000 of its common shares. Under the normal course issuer bid that became effective on November 17, 2017, and expiring on November 16, 2018, the Company is authorized to repurchase, for cancellation purposes, up to 8,000,000 of its common shares. During the year ended March 31, 2018, the Company repurchased 654,900 common shares, at prices ranging from $43.42 to $44.99 per share, relating to the normal course issuer bids. The excess of the purchase price over the carrying value of the shares in the amount of $27.6 million was charged to retained earnings. SHARE OPTION PLAN The Company has an equity settled share option plan to allow for the purchase of common shares by key employees and officers of the Company. The total number of common shares which may be issued pursuant to this plan cannot exceed 45,698,394 common shares. As at March 31, 2018, 24,360,279 common shares are available for future grants under this plan and 19,510,123 common shares are underlying options outstanding. During fiscal 2018, a total of 1,827,992 common shares were issued following the exercise of options. Options may be exercised at a price not less than the weighted average market price for the five trading days immediately preceding the date of grant. The options vest at 20% per year and expire ten years from the grant date. Options issued and outstanding as at year end are as follows: Granting period 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Exercise price $ 11.55 $ 13.91 $ 10.70 $ 14.66 $ 21.61 $ 21.48 $ 25.55 $ 27.74 $ 35.08 $ 41.40 $ 46.29 March 31, 2018 March 31, 2017 Number of options Number of exercisable options Number of options Number of exercisable options - 62,600 652,202 853,430 838,875 1,684,832 2,174,840 2,734,958 2,699,555 3,986,625 3,822,206 19,510,123 - 62,600 652,202 853,430 838,875 1,684,832 1,589,320 1,430,240 949,431 769,556 - 8,830,486 3,668 423,697 800,662 939,584 942,295 1,981,526 2,521,165 3,149,368 2,981,402 4,106,647 - 17,850,014 3,668 423,697 800,662 939,584 942,295 1,364,064 1,237,025 1,016,224 526,006 - - 7,253,225 ANNUAL REPORT 2018 - 59 - NOTE 12 SHARE CAPITAL (CONT’D) Changes in the number of outstanding options are as follows: Balance, beginning of year Options granted Options exercised Options cancelled Balance, end of year 2018 2017 Number of options 17,850,014 3,908,023 (1,827,992) (419,922) 19,510,123 Weighted average exercise price $ $ $ $ $ 29.00 46.29 22.41 35.07 32.95 Number of options 16,903,824 4,218,934 (2,898,704) (374,040) 17,850,014 Weighted average exercise price $ $ $ $ $ 24.41 41.40 19.87 32.30 29.00 The exercise price of the options granted in fiscal 2018 is $46.29, which corresponds to the weighted average market price for the five trading days immediately preceding the date of grant ($41.40 in fiscal 2017). The weighted average fair value of options granted in fiscal 2018 was estimated at $7.68 per option ($6.94 in fiscal 2017), using the Black Scholes option pricing model with the following assumptions: March 31, 2018 March 31, 2017 Weighted average: Risk-free interest rate Expected life of options Volatility1 Dividend rate 1 The expected volatility is based on the historic share price volatility over a period similar to the life of the options. 18.89% 1.26% 1.10% 5.4 years 0.81 % 5.4 years 20.01 % 1.34 % A compensation expense of $24.1 million ($20.8 million net of taxes) relating to stock options was recorded in the statement of earnings for the year ended March 31, 2018 and $22.0 million ($18.7 million net of taxes) was recorded for the year ended March 31, 2017. Options to purchase 4,536,208 common shares at a price of $41.02 per share were granted on April 1, 2018. DEFERRED SHARE UNIT PLAN FOR DIRECTORS For fiscal 2018, a new fee structure for Directors was adopted. Under this structure, all eligible Directors of the Company are allocated an annual retainer payable 50% in DSUs and 50% in cash or DSUs, at the election of the Director. Until the ownership threshold is met by the Director, the Director must receive the entire compensation in DSUs. The number of DSUs granted quarterly to each Director is determined based on the market value of the Company’s common shares at the date of each grant. When they cease to be a Director of the Company, a cash payment equal to the market value of the accumulated DSUs will be disbursed. The liability relating to these units is adjusted by taking the number of units outstanding multiplied by the market value of common shares at the Company’s year-end. The Company includes the cost of the DSU plan in “Operating costs excluding depreciation, amortization, acquisition and restructuring costs”. Balance, beginning of year Annual retainer Dividends reinvested Payment to directors Variation due to change in stock price Balance, end of year 2018 2017 Units 367,918 48,782 4,794 (126,864) - 294,630 Liability $ 17.6 2.1 0.2 (5.6) (2.1) Units 374,956 49,026 4,688 (60,752) - $ 12.2 367,918 Liability $ 16.3 2.2 0.2 (2.6) 1.5 $ 17.6 The Company enters into equity forward contracts in order to mitigate the compensation costs associated with its DSU plan. As at March 31, 2018, the Company had equity forward contracts on 320,000 common shares (320,000 as of March 31, 2017) with a notional value of $13.9 million ($14.6 million as of March 31, 2017). The net compensation expense related to the DSU plan was $2.2 million for the year ended March 31, 2018 ($2.8 million for March 31, 2017), including the effect of the equity forward contracts. Certain prior years’ figures have been reclassified to conform to the current year’s presentation. ANNUAL REPORT 2018 - 60 - NOTE 12 SHARE CAPITAL (CONT’D) PERFORMANCE SHARE UNIT PLAN The Company offers senior management a performance share unit (PSU) plan to form part of long-term incentive compensation, together with other plans discussed within this report. The PSU plan is non-dilutive and is settled in cash only. Under the PSU plan, each performance cycle shall consist of three fiscal years of the Company. At the time of the grant of a PSU, the Company determines the performance criteria which must be met. Following completion of a three- year performance cycle, the PSUs for which the performance criteria have been achieved will vest and the value that will be paid out is the price of the common shares at such time, multiplied by the number of PSUs for which the performance criteria have been achieved. The amount potentially payable to eligible employees is recognized as a payable and is revised at each reporting period. The expense is included in employee benefits under the “Operating costs excluding depreciation, amortization, acquisition and restructuring costs” caption. Balance, beginning of year Annual grant Cancelled Payment Balance, end of year 2018 Units 814,571 263,637 (6,592) (299,909) 771,707 2017 Units 705,721 255,975 (15,738) (131,387) 814,571 As at March 31, 2018, a long-term obligation related to PSUs of $15.5 million was recorded ($17.7 million as at March 31, 2017) in addition to $10.9 million that was recorded in short-term liabilities ($13.6 million as at March 31, 2017). On April 1, 2018, 298,819 PSUs were granted at a price of $41.02 per unit ($46.29 in 2017). The Company enters into equity forward contracts in order to mitigate the compensation costs associated with its PSU plan. As at March 31, 2018, the Company had equity forward contracts on 770,000 common shares (700,000 as of March 31, 2017) with a notional value of $32.9 million ($27.1 million as of March 31, 2017). The net compensation expense related to PSUs was $11.3 million for the year ended March 31, 2018 ($10.0 million for the year ended March 31, 2017), including the effect of the equity forward contracts. NOTE 13 OTHER FINANCIAL CHARGES Finance costs Finance income $ $ 2018 17.4 $ (3.3) 14.1 $ 2017 8.0 (3.0) 5.0 ANNUAL REPORT 2018 - 61 - NOTE 14 INCOME TAXES On December 22, 2017, the United States (US) enacted the “Tax Cuts and Jobs Act” which has been commonly referred to as US tax reform. A significant change under this reform is the reduction of the US Federal tax rate from 35.0% to 21.0%, effective January 1, 2018. This change resulted in the Company recording an income tax benefit of $178.9 million to adjust for future tax balances of $169.2 million and current fiscal year provisions of $9.7 million. These benefits are estimated based on the Company’s initial analysis of the “Tax Cuts and Jobs Act”. Given the complexity of this act, these estimates are subject to adjustment when further guidance becomes available. The reduction of the effective tax rate is also due to an income tax benefit of $8.3 million following a positive settlement in a tax litigation file. Income tax expense is comprised of the following: Current tax expense Deferred tax recovery Income tax expense $ $ 2018 198.0 $ (100.6) 97.4 $ 2017 264.9 44.3 309.2 RECONCILIATION OF THE EFFECTIVE TAX RATE The effective income tax rate was 10.4% in 2018 (29.7% in 2017). The Company’s income tax expense differs from the one calculated by applying Canadian statutory rates for the following reasons: Earnings before tax Income taxes, calculated using Canadian statutory income tax rates of 26.4% (26.6% in 2017) Adjustments resulting from the following: Effect of tax rates for foreign subsidiaries and other deductions Changes in tax laws and rates Benefit arising from investment in subsidiaries Manufacturing and processing deduction Stock-based compensation Recognition of previously unrecognized deferred tax assets Adjustments in respect of prior years and other $ 2018 949.9 $ 250.4 2017 1,040.3 276.2 29.5 (163.4) (12.8) (9.5) 3.9 - (0.7) 66.4 - (14.3) (13.4) 3.6 (8.3) (1.0) Income tax expense $ 97.4 $ 309.2 During the year, as a result of a reduction in the Canadian corporation tax rate, the statutory tax rate has decreased by approximately 0.2%. INCOME TAX RECOGNIZED IN OTHER COMPREHENSIVE INCOME Income tax on items recognized in other comprehensive income in 2018 and 2017 were as follows: Deferred tax benefit on actuarial losses on employee benefit obligations Deferred tax benefit on cash flow hedge Total income tax recognized in other comprehensive income 2018 2017 $ $ 1.1 $ 0.8 1.9 $ 1.4 0.6 2.0 ANNUAL REPORT 2018 - 62 - NOTE 14 INCOME TAXES (CONT’D) INCOME TAX RECOGNIZED IN EQUITY Income tax on items recognized in equity in 2018 and 2017 were as follows: Excess tax benefit that results from the excess of the deductible amount over the stock-based compensation recognized in net earnings Total income tax recognized in equity CURRENT TAX ASSETS AND LIABILITIES Income taxes receivable Income taxes payable Income taxes payable (net) DEFERRED TAX BALANCES Deferred tax assets Deferred tax liabilities Deferred tax liabilities (net) 2018 2017 2.8 $ 2.8 $ 6.5 6.5 2018 $ 52.0 (26.5) 25.5 $ 2018 $ 34.5 (424.9) (390.4) $ 2017 15.0 (91.3) (76.3) 2017 48.1 (511.4) (463.3) $ $ $ $ $ $ DEFERRED TAX ASSETS AND LIABILITIES The movement of deferred tax assets and liabilities are shown below: Deferred tax asset Deferred tax liabilities Accounts payable and accrued liabilities Income tax losses Net assets of pension plans Total Inventories Property, plant and equipment Other Total For the year ended March 31, 2018 $ 56.8 $ 15.4 $ 9.9 $ 82.1 $ 8.5 $ 323.7 $ 213.2 $ 545.4 (8.6) (8.7) (2.8) (20.1) (10.3) (70.4) (40.0) (120.7) - - (2.5) - - (0.3) 1.1 - (0.1) 1.1 - (2.9) - - - - (0.6) (11.7) (0.8) 51.0 (12.0) (0.8) 51.0 (24.3) Balance, beginning of the year Charged/credited to net earnings Charged/credited to other comprehensive income Acquisitions Translation and other Balance, end of the year $ 45.7 $ 6.4 $ 8.1 $ 60.2 $ (2.4) $ 241.6 $ 211.4 $ 450.6 Deferred tax asset Deferred tax liabilities Accounts payable and accrued liabilities Income tax losses Net assets of pension plans Total Inventories Property, plant and equipment Other Total For the year ended March 31, 2017 $ 50.4 $ 7.2 $ 7.4 $ 65.0 $ 11.8 $ 327.0 $ 178.9 $ 517.7 5.7 8.8 1.0 15.5 3.7 12.0 44.1 59.8 - - 0.7 - - (0.6) 1.4 - 0.1 1.4 - 0.2 - (7.4) 0.4 - (22.1) 6.8 (0.6) (10.7) 1.5 (0.6) (40.2) 8.7 Balance, beginning of the year Charged/credited to net earnings Charged/credited to other comprehensive income Acquisitions Translation and other Balance, end of the year $ 56.8 $ 15.4 $ 9.9 $ 82.1 $ 8.5 $ 323.7 $ 213.2 $ 545.4 ANNUAL REPORT 2018 - 63 - NOTE 15 NET EARNINGS PER SHARE Net earnings Non-controlling interest Net earnings attributable to shareholders of Saputo Inc. Weighted average number of common shares outstanding Dilutive options Weighted average diluted number of common shares outstanding Basic net earnings per share Diluted net earnings per share $ $ 2018 852.5 $ - 852.5 $ 2017 731.1 3.3 727.8 386,561,315 4,610,594 390,972,159 5,053,793 391,171,909 396,025,952 $ $ 2.21 $ 2.18 $ 1.86 1.84 When calculating diluted net earnings per share for the year ended March 31, 2018, 3,822,206 options (no options for the year ended March 31, 2017) were excluded from the calculation because their exercise price is higher than the average market value for the year. Shares purchased under the normal course issuer bid were excluded from the calculation of net earnings per share as of the date of purchase. NOTE 16 BUSINESS ACQUISITIONS BETIN, INC. On December 12, 2017, the Company completed the acquisition of Betin, Inc., doing business as Montchevre (Betin or Montchevre). The purchase price of $348.1 million, on a debt free basis, was paid in cash. Montchevre manufactured, marketed and distributed goat cheese in the USA, mainly under the Montchevre brand. Its activities are conducted at one manufacturing facility located in Belmont, Wisconsin (USA). For the year ended on June 30, 2017, Montchevre generated annual revenues of approximately $150 million. Recognized goodwill reflects the value assigned to expected future synergies and an assembled workforce within the Cheese Division (USA) CGU. EXTENDED SHELF-LIFE (ESL) DAIRY PRODUCT ACTIVITIES OF SOUTHEAST MILK, INC. (SMI) On September 29, 2017, the Company acquired the ESL dairy product activities of SMI. The purchase price of $63.6 million, on a debt free basis, included cash consideration of $37.0 million. Its activities are conducted at one manufacturing facility located in Plant City, Florida (USA). For the year ended on June 30, 2017, the ESL dairy product activities of SMI generated annual revenues of approximately $59 million. Recognized goodwill reflects the value assigned to expected future synergies and an assembled workforce within the Dairy Foods Division (USA) CGU. The purchase price was allocated to the identifiable assets acquired and liabilities assumed based on the fair values presented below. Assets acquired Liabilities assumed Working capital Property, plant and equipment Goodwill Intangibles Finance lease obligations Deferred income taxes $ Betin 38.4 $ 17.5 211.6 131.6 - (51.0) SMI 2.8 $ 38.6 22.2 - (26.6) - 2018 Total 41.2 56.1 233.8 131.6 (26.6) (51.0) Net assets acquired and total consideration paid in cash $ 348.1 $ 37.0 $ 385.1 ANNUAL REPORT 2018 - 64 - NOTE 17 EMPLOYEE POST-EMPLOYMENT BENEFITS PLANS The Company sponsors various post-employment benefit plans. These include pension plans, both defined contribution and defined benefit plans, and other post-employment benefits. Post-employment benefit plans are classified as either defined contribution plans or defined benefit plans. DEFINED CONTRIBUTION PLANS The Company offers and participates in defined contribution pension plans of which 99% of its active employees are members. The net pension expense under these types of plans is generally equal to the contributions made by the employer and constitutes an expense for the year in which they are due. For fiscal 2018, the defined contribution expenses for the Company amounted to $47.8 million compared to $45.7 million for fiscal 2017. The Company expects to contribute approximately $49.2 million to its defined contribution plans for fiscal 2019. DEFINED BENEFIT PLANS The Company participates in defined benefit pension plans in which the remaining active employees are members. Under the terms of the defined benefit pension plans, pensions are based on years of service and the retirement benefits are equal to 2% of the average eligible earnings of the last employment years multiplied by years of credited service. The registered pension plans must comply with statutory funding requirements in the province or state in which they are registered. Funding valuations are required on an annual or triennial basis, depending on the jurisdiction, and employer contributions must include amortization payments for any deficit, over a period of 5 to 15 years. Contribution holidays are allowed and subject to certain thresholds. Other non-registered pension plans and benefits other than pension are not subject to any minimum funding requirements. The cost of these pension benefits earned by employees is actuarially determined using the projected benefits method prorated on services and using a discount rate based on high quality corporate bonds and Management’s assumptions bearing on, among other things, rates of compensation increase and retirement age of employees. All of these estimates and assessments are formulated with the help of external consultants. The plan assets and benefit obligations were valued as at March 31 with the assistance of the Company’s external actuaries. The Company also offers complementary retirement benefits programs, such as health insurance, life insurance and dental plans to eligible employees and retired employees. The Company expects to contribute approximately $4.9 million to its defined benefit plans in 2019. The Company’s net liability for post-employment benefit plans comprises the following: March 31, 2018 March 31, 2017 Present value of funded obligation Fair value of assets Present value of net obligations for funded plans Present value of unfunded obligations Present value of net obligations Asset ceiling test Accrued pension/benefit cost as at March 31 $ $ 72.2 67.0 5.2 27.1 32.3 0.8 33.1 Employee benefit amounts on the balance sheet as net liability $ 33.1 $ The changes in the present value of the defined benefit obligations are as follows: 70.4 64.9 5.5 32.4 37.9 0.9 38.8 38.8 Defined benefit obligation, beginning of year Current service costs Interest cost Actuarial losses (gains) from change in experience Actuarial losses (gains) from change in economic assumptions Actuarial losses (gains) from change in demographic assumptions Effects of settlement1 Exchange differences Benefits paid March 31, 2018 March 31, 2017 $ $ 102.8 5.0 3.6 2.2 2.8 0.4 (1.2) (0.3) (16.0) 87.6 5.8 3.6 0.6 5.1 2.1 - 0.3 (2.3) Defined benefit obligation, end of year $ 99.3 $ 102.8 ANNUAL REPORT 2018 - 65 - NOTE 17 EMPLOYEE POST-EMPLOYMENT BENEFITS PLANS (CONT’D) The changes in the fair value of plan assets are as follows: March 31, 2018 March 31, 2017 Fair value of plan assets, beginning of year Interest income on plan assets Return on plan assets, excluding interest income Administration costs Contributions by employer Effects of settlement1 Exchange differences Benefits paid $ $ 64.9 2.5 - (0.3) 17.6 (1.6) (0.1) (16.0) Fair value of plan assets, end of year 1 Annuities were purchased to release the plan from its liability with regards to retirees. $ 67.0 $ 57.1 2.4 3.6 (0.3) 4.4 - - (2.3) 64.9 Actual return on plans assets amounted to a gain of $2.2 million in fiscal 2018 compared to a loss of $5.6 million in fiscal year 2017. The fair value of plan assets, which do not include assets of the Company, consist of the following: Bonds Equity instruments Cash and short–term investments March 31, 201 8 March 31, 2017 48 % 45 % 7 % 100 % 50 % 43 % 7 % 100 % The expenses recognized below are included in "Operating costs excluding depreciation, amortization, acquisition and restructuring costs" within employee benefits expense (refer to Note 5) and are detailed as follows: March 31, 2018 March 31, 2017 Employer current service cost $ 5.0 $ Effect of settlement Administration costs Interest costs Interest income on plan assets Defined benefits plans expense 0.5 0.3 3.6 (2.5) $ 6.9 $ 5.8 - 0.3 3.6 (2.4) 7.3 The Company recognizes actuarial gains and losses in the period in which they occur, for all its defined benefit plans. These actuarial gains and losses are recognized in other comprehensive income and are presented below: Net gains (losses) during the year Effect of the asset ceiling test Amount recognized in other comprehensive income March 31, 2018 March 31, 2017 $ $ $ (5.4) 0.2 (5.2) $ (4.3) (0.2) (4.5) Weighted average assumptions used in computing the benefit obligations at the balance sheet date are as follows: March 31, 2017 March 31, 2018 Discount rate Duration of the obligation Future salary increases Mortality table 3.59% 18.13 3.00% 3.77% 18.58 3.00% 2014 Private Sector Canadian Pensioners’ Mortality Table, projected generationally using Scale CPM-B 2014 Private Sector Canadian Pensioners’ Mortality Table, projected generationally using Scale CPM-B The impact of an increase and a decrease of 1% on the discount rate would be $14.9 million and $17.8 million respectively. Also, an increase or a decrease of 1% on the future salary assumptions would be approximately $3.2 million on the obligation and a 10% increase in life expectancy would represent approximately $1.4 million. ANNUAL REPORT 2018 - 66 - NOTE 17 EMPLOYEE POST-EMPLOYMENT BENEFITS PLANS (CONT’D) Weighted average assumptions used in computing the net periodic pension cost for the year are as follows: Discount rate Future salary increases Mortality table March 31, 2018 March 31, 2017 3.77% 3.00% 4.10% 3.00% 2014 Private Sector Canadian Pensioners’ Mortality Table, projected generationally using Scale CPM-B 2014 Private Sector Canadian Pensioners’ Mortality Table, projected generationally using Scale CPM-B For measurement purposes, a 3.0% to 7.0% annual rate of increase was used for health, life insurance and dental plan costs for the fiscal years 2018 and 2017. Assumed medical cost trend rates have an effect on the amounts recognized in profit or loss. A one percentage point change in the assumed medical cost trend rates would have marginal impact on cost and obligations. NOTE 18 COMMITMENTS AND CONTINGENCIES COMMITMENTS The table and paragraphs below show the future minimum payments for our contractual commitments that are not recognized as liabilities for the next fiscal years: Less than 1 year 1-2 years 2-3 years 3-4 years 4-5 years More than 5 years Leases Purchase obligations1 $ $ 29.1 $ 24.6 20.0 15.8 14.2 27.1 130.8 $ 91.8 $ - - - - - 91.8 $ Total 120.9 24.6 20.0 15.8 14.2 27.1 222.6 1 Purchase obligations are the contractual obligations for capital expenditures to which the Company is committed. The Company carries on some of its operations in leased premises and has also entered into lease agreements for equipment and rolling stock. The Company guaranteed to certain lessors a portion of the residual value of certain leased assets with respect to operations which mature until 2017. If the market value of leased assets, at the end of the respective operating lease term, is inferior to the guaranteed residual value, the Company is obligated to indemnify the lessors, specific to certain conditions, for the shortfall up to a maximum value. The Company believes that the potential indemnification will not have a significant effect on the financial statements. CLAIMS The Company is a defendant to certain claims arising from the normal course of its business. The Company is also a defendant in certain claims and/or assessments from tax authorities in various jurisdictions. The Company believes that the final resolution of these claims and/or assessments will not have a material adverse effect on its earnings or financial position. INDEMNIFICATIONS The Company from time to time offers indemnifications to third parties in the normal course of its business, in connection with business or asset acquisitions or disposals. These indemnification provisions may be in connection with breach of representations and warranties, and for future claims for certain liabilities. The terms of these indemnification provisions vary in duration. At March 31, 2018, given that the nature and amount of such indemnifications depend on future events, the Company is unable to reasonably estimate its maximum potential liability under these agreements. The Company has not made any significant indemnification payments in the past, and as at March 31, 2018 and March 31, 2017, the Company has not recorded any significant liabilities associated with these indemnifications. ANNUAL REPORT 2018 - 67 - NOTE 19 RELATED PARTY TRANSACTIONS The Company receives services from and provides goods to companies subject to control or significant influence through ownership by its principal shareholder. These transactions, which are not significant to the Company’s financial position or financial results, are made in the normal course of business and have been recorded at the fair value, consistent with market values for similar transactions. The services that are received consist mainly of travel, publicity, lodging, office space rental and management services. The goods that are provided consist mainly of dairy products. Transactions with key management personnel (short-term employee benefits, post-employment benefits, stock-based compensation and payments under the DSU plan) are also considered related party transactions. Management defines key management personnel as all the executive officers who have responsibility and authority for controlling, overseeing and planning the activities of the Company, as well as the Company’s Directors. Transactions with related parties are as follows: Entities subject to control or significant influence through ownership by its principal shareholder $ Key management personnel Directors Executive officers 2018 6.3 $ 2.6 28.1 $ 37.0 $ 2017 4.5 3.1 31.1 38.7 Dairy products provided by the Company were the following: 2018 2017 Entities subject to control or significant influence through ownership by its principal shareholder $ 0.3 $ 0.3 Outstanding receivables and accounts payable and accrued liabilities for the transactions above are the following: Entities subject to control or significant influence through ownership by its principal shareholder $ 0.1 $ 0.1 $ 0.5 $ 0.1 Receivables Accounts payable and accrued liabilities March 31, 2018 March 31, 2017 March 31, 2018 March 31, 2017 Key management personnel Directors Executive officers - - - - 12.2 27.8 $ 0.1 $ 0.1 $ 40.5 $ 17.6 42.7 60.4 The amounts payable to the Directors consist entirely of balances payable under the Company’s DSU plan. Refer to Note 12 for further details. The amounts payable to executive officers consist of short-term employee benefits, share- based awards and post-retirement benefits. ANNUAL REPORT 2018 - 68 - NOTE 19 RELATED PARTY TRANSACTIONS (CONT’D) KEY MANAGEMENT PERSONNEL COMPENSATION The compensation expense for transactions with the Company’s key management personnel, including annual fees of the executive Chairman, consists of the following: Directors Cash-settled payments Stock-based compensation Executive officers Short-term employee benefits Post-employment benefits Stock-based compensation Total compensation 2018 2017 0.3 $ 2.3 2.6 $ 13.5 3.5 11.1 28.1 $ 0.7 2.4 3.1 17.6 3.4 10.1 31.1 30.7 $ 34.2 $ $ $ $ SUBSIDIARIES All the Company’s subsidiaries are wholly owned. The following information summarizes the Company’s significant subsidiaries which produce a wide array of dairy products including cheese, fluid milk, extended shelf-life milk and cream products, cultured products and dairy ingredients: Saputo Cheese USA Inc. Saputo Dairy Products Canada G.P. Saputo Dairy Foods USA, LLC Warrnambool Cheese and Butter Factory Company Holdings Limited Molfino Hermanos S.A. 100.00% 100.00% 100.00% 100.00% 100.00% Percentage Owned Location USA Canada USA Australia Argentina NOTE 20 FINANCIAL INSTRUMENTS In the normal course of business, the Company uses various financial instruments which by their nature involve risk, including credit risk, liquidity risk, interest rate risk, foreign exchange risk and price risk (including commodity price risk). These financial instruments are subject to normal credit conditions, financial controls and risk management and monitoring strategies. Occasionally, the Company may enter into derivative financial instrument transactions in order to mitigate or hedge risks in accordance with risk management strategies. The Company does not enter into these arrangements for speculative purposes. CREDIT RISK Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash equivalents and receivables. Cash equivalents consist mainly of short-term investments. The Company has deposited these cash equivalents in reputable financial institutions. The Company also offers credit to its customers in the normal course of business for trade receivables. Credit valuations are performed on a regular basis and reported results take into account allowances for potential bad debts. Due to its large and diverse customer base and its geographic diversity, the Company has low exposure to credit risk concentration with respect to customer’s receivables. There are no receivables from any individual customer that exceeded 10% of the total balance of receivables as at March 31, 2018 and March 31, 2017. However, one customer represented more than 10% of total consolidated revenues for the year ended March 31, 2018 with 10.4% (one customer with 10.6% in 2017). ANNUAL REPORT 2018 - 69 - NOTE 20 FINANCIAL INSTRUMENTS (CONT’D) Allowance for doubtful accounts and past due receivables are reviewed by Management at each balance sheet date. The Company updates its estimate of the allowance for doubtful accounts based on the evaluation of the recoverability of receivable balances from each customer taking into account historic collection trends of past due accounts. Receivables are written off once determined not to be collectible. The accounts receivable from our export sales benefit from payment terms that are longer than our standard payment terms applicable to domestic sales. The amount of the allowance for doubtful accounts is sufficient to cover the carrying amount of receivables considered past due and at risk. The amount of the loss is recognized in the statement of earnings within operating costs. Subsequent recoveries of amounts previously written off are credited against operating costs in the statement of earnings. However, Management does not believe that these allowances are significant. LIQUIDITY RISK Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due. The Company manages liquidity risk through the management of its capital structure and financial leverage, as outlined in Note 21 relating to capital disclosures. It also manages liquidity risk by continuously monitoring actual and projected cash flows. The Board of Directors reviews and approves the Company’s operating and capital budgets, as well as any material transactions out of the normal course of business. Contractual maturities for the significant financial liabilities as at March 31, 2018 are as follow: accounts payable and accrued liabilities, bank loans and long-term debt. All items included in accounts payable and accrued liabilities are less than one year. For maturities on bank loans and the long-term debt, please refer to Note 9 and Note 10 respectively. INTEREST RATE RISK The Company is exposed to interest rate risks through its financial obligations that bear variable interest rates. Bank loans and unsecured bank term loans facilities bear interest at fluctuating rates and thereby expose the Company to interest rate risk on cash flows associated to interest payments. The senior notes bear interest at fixed rates and, as a result, no interest rate risk exists on these cash flows. During last fiscal year, the cash flow hedges of interest rate risk were assessed to be highly effective and a loss of $2.1 million (net of tax of $0.7 million) was automatically transferred in the statement of earnings at the settlement date. For the fiscal year ended March 31, 2018, the interest expense on long-term debt totalled $33.8 million ($36.9 million in fiscal 2017). The interest accrued as at March 31, 2018 was $9.7 million ($8.3 million as at March 31, 2017). As at March 31, 2018, the net amount exposed to short-term rates fluctuations was approximately $271.1 million. Based on this exposure, an assumed 1% increase in the interest rate would have an unfavourable impact of approximately $1.9 million on net earnings with an equal but opposite effect for an assumed 1% decrease. ANNUAL REPORT 2018 - 70 - NOTE 20 FINANCIAL INSTRUMENTS (CONT’D) FOREIGN EXCHANGE RISK The Company operates internationally and is exposed to foreign exchange risk resulting from various foreign currency transactions. Foreign exchange transaction risk arises primarily from future commercial transactions that are denominated in a currency that is not the functional currency of the Company’s business unit that is party to the transaction, as well as the unsecured bank term loan facilities that can be drawn in US dollars. The Company entered into forward exchange contracts to sell US dollars and buy Australian dollars in order to mitigate market fluctuations in the USD/AUD exchange rates on receivables. During the fiscal year, the cash flow hedges were highly effective and accordingly, the Company recognized an unrealized gain of $2.8 million (net of tax of $1.2 million) in other comprehensive income (and an associated asset) as a result. A gain of $6.0 million (net of tax of $2.6 million) was reclassified to net earnings during fiscal 2018 related to these forward exchange contracts. These cash flow hedges were also deemed to be highly effective on March 31, 2017 and an unrealized gain of $3.5 million (net of tax of $1.5 million), was recorded, during last fiscal year, in other comprehensive income. A gain of $5.6 million (net of tax of $2.4) was reclassified to net earnings during fiscal 2017 related to these forward exchange contracts. During last fiscal year, the Company entered into forward exchange contracts in order to offset market fluctuations in the USD/CAD exchange rates for the US dollars intercompany financing. This intercompany financing from our US to Canada divisions for the foreign exchange hedge will settle in November 2019 for US$250.0 million. This cash flow hedges were highly effective and accordingly, the Company recognized an unrealized loss of $2.9 million (net of tax of $0.4 million) in other comprehensive income. During fiscal 2018, a loss of $0.8 million (net of tax of $0.1 million) in other comprehensive income was reclassified to net earnings related to this forward exchange contracts. The Company is mainly exposed to US dollar fluctuations. The following table details the Company’s sensitivity to a CDN$0.10 weakening of the Canadian dollar against the US dollar on net earnings and comprehensive income. For a CDN$0.10 appreciation of the Canadian dollar against the US dollar, there would be an equal and opposite impact on net earnings and comprehensive income. Change in net earnings Change in comprehensive income $ $ 2018 32.0 $ 281.2 $ 2017 24.3 249.1 COMMODITY PRICE RISK In certain instances, the Company enters into futures contracts to hedge against fluctuations in the price of commodities. Outstanding contracts as at the balance sheet date had a negative fair value of approximately $1.9 million (negative fair value of approximately $1.5 million at March 31, 2017). The Company applies hedge accounting for certain of these transactions. During the fiscal year, these hedges (designated as cash flow hedges) were assessed to be highly effective and accordingly, an unrealized gain of $0.6 million (net of tax of $0.4 million) was recorded in other comprehensive income. The gains recorded in the statement of comprehensive income are transferred to the statement of net earnings when the related inventory is ultimately sold. These hedges (designated as cash flow hedges) were assessed to be highly effective and accordingly, an unrealized gain of $0.2 million (net of tax of $0.1 million) was recorded, during last fiscal year, in other comprehensive income. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company has determined that the fair value of its financial assets and financial liabilities with short-term maturities approximates their carrying value. These financial instruments include cash and cash equivalents, receivables, bank loans, accounts payable and accrued liabilities. The table below shows the fair value and the carrying value of other financial instruments as at March 31, 2018 and March 31, 2017. Since estimates are used to determine fair value, they must not be interpreted as being realizable in the event of a settlement of the instruments. ANNUAL REPORT 2018 - 71 - NOTE 20 FINANCIAL INSTRUMENTS (CONT’D) Cash flow hedges Commodity derivatives (Level 2) Foreign exchange derivatives (Level 2) Derivatives not designated in a formal hedging relationship Equity forward contracts (Level 2) Commodity derivatives (Level 2) Long-term debt (Level 2) $ March 31, 2018 March 31, 2017 Fair value Carrying value Fair value Carrying value $ (1.4) $ (8.7) (1.4) $ (8.7) (1.6) $ 3.2 (1.6) 3.2 (1.4) (0.5) 1,410.0 $ (1.4) (0.5) 1,425.3 $ 5.1 0.1 1,520.5 $ 5.1 0.1 1,500.0 The following table summarizes the financial instruments measured at fair value in the consolidated balance sheet as at March 31, 2018 and March 31, 2017, classified using the fair value hierarchy described in Note 3. March 31, 2018 Commodity futures contracts Foreign exchange contracts Equity forward contracts March 31, 2017 Commodity futures contracts Foreign exchange contracts Equity forward contracts $ $ $ $ Level 1 Level 2 Level 3 - $ - - - $ (1.9) $ (8.7) (1.4) (12.0) $ - $ - - - $ Level 1 Level 2 Level 3 $ - - - $ (1.5) 3.2 5.1 6.8 $ - $ - - - $ Total (1.9) (8.7) (1.4) (12.0) Total (1.5) 3.2 5.1 6.8 For the years ended March 31, 2018 and 2017, there were no changes in valuation techniques and in inputs used in the fair value measurements and there were no transfers between the levels of the fair value hierarchy. Fair values of other assets, long-term debt and derivative financial instruments are determined using discounted cash flow models based on market inputs prevailing at the balance sheet date and are also obtained from financial institutions. Where applicable, these models use market-based observable inputs including interest-rate-yield curves, volatility of certain prices or rates and credit spreads. If market based observable inputs are not available, judgement is used to develop assumptions used to determine fair values. The fair value estimates are significantly affected by assumptions including the amount and timing of estimated future cash flows and discount rates. The Company’s derivatives transactions are accounted for on a fair value basis. NOTE 21 CAPITAL DISCLOSURES The Company’s objective in managing capital is to ensure sufficient liquidity to pursue its growth strategies and undertake selective acquisitions, while at the same time taking a conservative approach towards financial leverage and management of financial risk. An additional objective includes a target for long-term leverage of 2.0 times net debt to earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs. From time to time, the Company may deviate from its long-term leverage target to pursue acquisitions and other strategic opportunities. Should such a scenario arise, the Company expects to deleverage over a reasonable period of time in order to seek to maintain its investment grade ratings. Also, the Company seeks to provide an adequate return to its shareholders. The Company believes that the purchases of its own shares may, under appropriate circumstances, be a responsible use of its capital. ANNUAL REPORT 2018 - 72 - NOTE 21 CAPITAL DISCLOSURES (CONT’D) The Company’s capital is composed of net debt and equity. Net debt consists of long-term debt and bank loans, net of cash and cash equivalents. The Company’s primary use of capital is to finance acquisitions. The primary measure used by the Company to monitor its financial leverage is its ratio of net debt to earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs. The net debt-to-earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs ratios as at March 31, 2018 and March 31, 2017 are as follows: Bank loans Long-term debt, including current portion Cash and cash equivalents Net debt Earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs Net debt-to-earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs $ $ 2018 $ 193.3 $ 1,425.3 (122.2) 1,496.4 $ 2017 93.8 1,500.0 (250.5) 1,343.3 1,264.7 $ 1,289.5 1.18 1.04 The Company has existing credit facilities which require a quarterly review of financial ratios and the Company is not in violation of any such ratio covenants as at March 31, 2018. The Company is not subject to capital requirements imposed by a regulator. NOTE 22 ACQUISITION AND RESTRUCTURING COSTS Acquisition and restructuring costs are summarized as follows: Restructuring costs Acquisition costs Total $ $ 2018 33.7 $ 6.9 40.6 $ 2017 - - - RESTRUCTURING COSTS In fiscal 2018, the Company announced the closure of one facility. The final closure will occur in June 2018. Costs associated with the closure recorded regarding restructuring activities are summarized in the table below: Write down of non-current assets Severance Total $ $ 2018 10.6 $ 23.1 33.7 $ 2017 - - - The write down of non-current assets, recorded in fiscal 2018, consists of impairment charges to property, plant and equipment to bring them to the lower of carrying value and recoverable amount. The total after tax costs for fiscal 2018 are $25.1 million. The restructuring costs recorded in fiscal 2018 represent estimated expenses required to restructure these operations. Liabilities related to severance expenditures have been grouped within current liabilities on the balance sheet. ACQUISITION COSTS In connection with the acquisitions of SMI and Betin (Note 16) as well as the acquisition of the business of Murray Goulburn Co-Operative Co. Limited (Note 25), the Company incurred acquisition costs of $6.9 million ($5.6 million after tax) in fiscal 2018. ANNUAL REPORT 2018 - 73 - NOTE 23 SEGMENTED INFORMATION The Company reports under three geographic sectors. The Canada Sector consists of the Dairy Division (Canada). The USA Sector consists of the Cheese Division (USA) and the Dairy Foods Division (USA). Finally, the International Sector consists of the Dairy Division (Argentina) and the Dairy Division (Australia). As of April 1, 2017, the Canada Sector includes national and export revenues of ingredients manufactured in Canada. The USA Sector includes national ingredient revenues, and export ingredient and cheese revenues of products manufactured in the USA. Prior to April 1, 2017, these figures were presented in the Dairy Ingredients Division as part of the International Sector. Accordingly, certain prior year’s figures have been reclassified to conform to the current presentation. These reportable sectors are managed separately as each sector represents a strategic business unit that offers different products and serves different markets. The Company measures geographic and sector performance based on earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs. Management has aggregated the Cheese Division (USA) and the Dairy Foods Division (USA) due to similarities in long- term average return and correlated market factors driving pricing strategies that affect the operations of both divisions. The divisions within the International Sector have been combined due to similarities in global market factors and production processes. The accounting policies of the sectors are the same as those described in Note 3 relating to significant accounting policies. INFORMATION ON REPORTABLE SECTORS Years ended March 31 Revenues Canada USA International Earnings before interest, income taxes, depreciation, amortization, acquisition and restructuring costs Canada USA International Depreciation and amortization Canada USA International Acquisition and restructuring costs Financial charges, net Earnings before income taxes Income taxes Net earnings 2018 2017 $ 4,069.9 $ 6,132.8 1,339.8 4,060.2 6,003.3 1,099.1 $ 11,542.5 $ 11,162.6 $ 475.9 $ 649.4 139.4 453.1 734.2 102.2 $ 1,264.7 $ 1,289.5 $ 55.9 $ 138.4 32.0 $ 226.3 $ 40.6 47.9 949.9 97.4 $ 852.5 $ 58.0 123.4 25.9 207.3 - 41.9 1,040.3 309.2 731.1 Certain prior year’s figures have been reclassified to conform to the current year’s presentation. ANNUAL REPORT 2018 - 74 - NOTE 23 SEGMENTED INFORMATION (CONT’D) GEOGRAPHIC INFORMATION Total assets Canada USA International Net book value of property, plant and equipment Canada USA International Total liabilities Canada USA International March 31, 2018 March 31, 2017 $ $ $ 2,061.8 $ 4,597.0 1,344.2 8,003.0 $ 592.3 $ 1,361.4 266.3 $ 2,220.0 $ $ $ 2,002.8 $ 818.1 384.4 3,205.3 $ 2,116.0 4,198.3 1,282.3 7,596.6 580.3 1,305.7 279.5 2,165.5 2,157.7 798.8 317.2 3,273.7 Certain prior year’s figures have been reclassified to conform to the current year’s presentation. NOTE 24 DIVIDENDS During the year ended March 31, 2018, the Company paid dividends totalling $243.5 million, or $0.64 per share ($228.3 million, or $0.60 per share for the year ended March 31, 2017). NOTE 25 SUBSEQUENT EVENTS ACQUISITION OF THE ACTIVITIES OF SHEPHERD GOURMET DAIRY (ONTARIO) INC. On May 23, 2018, the Company announced that it has entered into an agreement to acquire the activities of Shepherd Gourmet Dairy (Ontario) Inc. (“Shepherd Gourmet”). Its activities are conducted at one manufacturing facility located in St. Marys, Ontario (Canada). Shepherd Gourmet manufactures, markets and distributes a variety of specialty cheeses, yogurt, as well as Skyr Icelandic-style yogurt in Canada. The purchase price of $100 million, on a debt-free-basis, will be paid in cash from cash on hand and available credit facilities. For the twelve-month ended on April 30, 2018, Shepherd Gourmet generated revenues of approximately $57 million. The transaction is subject to customary conditions and is expected to close in June 2018. ACQUISITION OF THE BUSINESS OF MURRAY GOULBURN CO-OPERATIVE CO. LIMITED On May 1, 2018, the Company completed the acquisition of the business of Murray Goulburn Co-Operative Co. Limited (Murray Goulburn or MG), based in Australia. The MG acquisition will add to and complement the activities of the Dairy Division (Australia) and enable the Company to strengthen its presence in Australia. MG produces a full range of high-quality dairy foods, including fluid milk, milk powder, cheese, butter and dairy beverages, as well as a range of ingredient and nutritional products, such as infant formula. MG supplies the retail and foodservice industries globally with its flagship Devondale, Liddells and Murray Goulburn Ingredients brands. The purchase price for the transaction is $1.29 billion (AU$1.31 billion) on a debt-free basis and was financed through the Acquisition Facility (Note 10). For the trailing twelve-month period ended on December 31, 2017, MG had revenues of $2.42 billion (AU$2.43 billion). ANNUAL REPORT 2018 - 75 - CORPORATE HEADQUARTERS STOCK EXCHANGE DIVIDEND POLICY Saputo Inc. 6869 Métropolitain Blvd. East Montréal, QC Canada H1P 1X8 Telephone: 514-328-6662 www.saputo.com ANNUAL MEETING OF SHAREHOLDERS Tuesday, August 7, 2018, at 10 a.m. Laval Room, Hotel Sheraton Laval 2440 Autoroute des Laurentides Laval, QC Canada H7T 1X5 INVESTOR RELATIONS Sandy Vassiadis Telephone: 1-514-328-3141 1-866-648-5902 Email: investors@saputo.com Toronto Stock Exchange Symbol: SAP TRANSFER AGENT Computershare Trust Company of Canada 1500, boul. Robert-Bourassa, Suite 700, Montréal, QC Canada H3A 3S8 Telephone: 514-982-7888 EXTERNAL AUDITORS Deloitte LLP Montréal, QC Canada Saputo Inc. declares quarterly cash dividends on common shares at $0.16 per share, representing a yearly dividend of $0.64 per share. The Board of Directors reviews the Company’s dividend policy from time to time, but at least once annually, based on financial condition, financial performance, capital requirements and such other factors as are deemed relevant by the Board in its sole discretion. SAPUTO.COM S A P U T O 2 0 1 8 A N N U A L R E P O R T 

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