Passionate People. Passionate about Food MAPLE LEAF FOODS INC ANNUAL REPORT

Transcription

1 M A P L E L E A F F O O D S I N C A n n u a l R e p o r t Passionate People Passionate about Food MAPLE LEAF FOODS INC ANNUAL REPORT

2 C O R P O R A T E P R O F I L E Maple Leaf Foods is a Canadian success story with growing global reach. Our roots in the flour business date back to a small-town mill in 1836, our meat processing business back to the 1860s, and our bakery business to the amalgamation of five separate companies in Rich in history, Maple Leaf Foods entered our current growth phase in 1995 when McCain Capital Corporation pooled our expertise in the food business with the financial resources of Ontario Teachers Pension Plan Board. Today, Maple Leaf Foods employs approximately 24,000 people, exports to nearly 80 countries, and operates in Canada, the United States, the United Kingdom, Europe, Southeast Asia and Mexico. Our Meat Products and Agribusiness operations are strategically linked to produce high quality meat products, minimize underlying commodity market exposure, and maximize earnings. They include animal nutrition, hog production, fresh value-added pork and poultry products, processed meats and home meal solutions, global sales and trading, and rendering operations. Table of Contents 1 Financial Highlights 2 Operations Overview 3 Segmented Operating Results 5 Letter from the Chairman 6 Letter to Fellow Shareholders 14 Financials Our Bakery operations are concentrated in North America and the United Kingdom. We are the Canadian market leader in premium nutrition fresh bakery products, such as whole grain and organic breads. We are also a major North American supplier of frozen ready-to-bake, par-baked and pre-baked breads, rolls and specialty bakery items, in addition to fresh pasta and sauces. In the U.K., we operate three plants, including one of the largest bagel plants in the world, servicing the fast growing U.K. and European markets. Our value creation strategy is supported by our flagship brands which are growing well above industry averages Maple Leaf and Schneiders in the meat category and Dempster s in the bakery category. They each deliver a promise to consumers: leadership in food safety, quality and taste, and nutrition. Behind our products and our many brands are our passionate people, and their passion for food.

3 F I N A N C I A L H I G H L I G H T S For years ended December 31 (In millions of Canadian dollars, except share information) Consolidated results Sales $ 6,463 $ 6,365 $ 5,042 $ 5,076 $ 4,775 Earnings from operations (i) Net earnings Return on assets employed (ii) 8.2% 8.9% 6.4% 9.2% 7.6% Financial position Net assets employed (iii) $ 2,256 $ 2,105 $ 1,561 $ 1,430 $ 1,387 Shareholders equity Net borrowings 1,063 1, Per share Net earnings $ 0.74 $ 0.90 $ 0.27 $ 0.71 $ 0.55 Dividends Book value Number of shares (millions) Weighted average Outstanding at December (i) Before restructuring costs (2003 and 2005). (ii) After tax, but before interest, calculated on average month-end net assets employed. Before restructuring costs (2003 and 2005). (iii) Total assets, less cash, future tax assets and non-interest bearing liabilities. SALES BY GROUP DOMESTIC VS. INTERNATIONAL SALES TOTAL ASSETS BY GROUP OPERATING EARNINGS BEFORE RESTRUCTURING COSTS 66.6% Meat Products 12.6% Agribusiness 20.8% Bakery Products 72.9% Domestic 13.9% U.S. 13.2% Other International 48.6% Meat Products 20.0% Agribusiness 9.6% Non-allocated 21.8% Bakery Products 38.7% Agribusiness 38.5% Bakery Products 22.8% Meat Products 1

4 O P E R A T I O N S O V E R V I E W P R O T E I N V A L U E C H A I N Feed Maple Leaf Animal Nutrition Hog Production Elite Swine Processing, Marketing & Distribution Maple Leaf Consumer Foods Maple Leaf Fresh Foods Maple Leaf Global Foods By- Products Rothsay M E A T P R O D U C T S MAPLE LEAF CONSUMER FOODS Supported by our flagship brands Maple Leaf and Schneiders and a family of strong regional brands, Maple Leaf Consumer Foods is Canada s leading producer of premium quality processed meat and home meal solutions. Products include refrigerated fully cooked roasts, frozen meat products, bacon, ham, wieners, deli and canned meats, single serve entrées and hand-held meat and pastry products. Plants: 24, Distribution Centres: 7 MAPLE LEAF FRESH FOODS Maple Leaf Fresh Foods is Canada s leading multi-species fresh meat company, producing premium quality, fresh and frozen value-added pork, chicken, and turkey products. Brands include Maple Leaf Prime Naturally*, Maple Leaf Fresh Grill!, Maple Leaf Fresh Roast!, Maple Leaf Prime Turkey, Mitchell s Gourmet Foods and Maple Leaf Medallion Naturally. Plants: 12, Hatcheries: 3 MAPLE LEAF GLOBAL FOODS Canada s largest exporter of agri-food products, supported by global offices in key markets, including Southeast Asia, Europe and Mexico. Operations include the marketing, distribution and trading of value-added protein, bakery and agri-food products, including pork products, seafood, grain and soy products, pre-cooked meat and poultry products, french fries, bakery products and pet food. Plants: 2, Trading Offices: 8 A G R I B U S I N E S S ELITE SWINE The Company s hog management operations are an important component of Maple Leaf s quality control and Vertical Co-ordination strategy, supplying approximately 20% of Maple Leaf Fresh Foods pork requirements. With 130,000 sows under management, Elite Swine is the largest hog producer in Canada and the seventh largest production system in North America. MAPLE LEAF ANIMAL NUTRITION Canada s leading animal nutrition organization, supported by leading trusted brands Shur-Gain in Eastern Canada and Landmark Feeds in Western Canada and excellence in research and development. The business provides animal nutrition products and services, including swine, dairy and beef cattle, poultry, aquaculture, equine and pet food. Feed Mills: 18, Retail Sales Centres: 13, Hatcheries: 3, Research Facilities: 3 ROTHSAY Canada s largest recycler of animal by-products into value-added products, including animal feed, amino acid supplements, biodiesel and other industrial uses. Rothsay provides an essential service for its customers and other Maple Leaf operations by responsibly managing and recapturing the value of inedible by-products. Plants: 6 B A K E R Y P R O D U C T S FRESH BAKERY The leading Canadian producer and distributor of fresh baked products including breads, rolls, bagels and artisan breads with brands such as Dempster s, POM, Ben s, McGavin s and Healthy Way. Dempster s is the national brand leader in higher nutrition, whole grain products. The Company also manufactures a variety of fresh and filled fresh pasta and sauces under the Olivieri brand, distributing to customers across North America. Plants: 24, Distribution Centres: 12 * Canada s leading brand of chicken FROZEN BAKERY A leading North American producer and distributor of frozen unbaked, par-baked and fully baked breads, rolls and bagels and artisan breads for retail and foodservice customers, and a U.K.-based producer of bagels and specialty breads for the U.K. and European markets. Brands include Grace Baking, California Goldminer and the Wholesome Harvest line of premium nutrition products, in addition to the New York Bagel brand in the U.K. Plants: 12 For detailed information on these operations, visit 2

5 S E G M E N T E D O P E R A T I N G R E S U L T S P R O T E I N V A L U E C H A I N (In millions of Canadian dollars) % change Meat Products Group Sales $ 4,300 $ 4,127 4 % Earnings from operations before restructuring costs (13)% Total assets 1,550 1,463 6 % Agribusiness Group Sales $ 817 $ 925 (12)% Earnings from operations before restructuring costs % Total assets % TOTAL PROTEIN VALUE CHAIN (In millions of Canadian dollars) % change Sales $ 5,117 $ 5,052 1 % Earnings from operations before restructuring costs (3)% Total assets 2,190 2,066 6 % The Meat Products Group includes Consumer Foods, Fresh Foods and Global Foods operations. The Agribusiness Group comprises Animal Nutrition, hog production and rendering operations. B A K E R Y P R O D U C T S G R O U P TOTAL BAKERY PRODUCTS GROUP (In millions of Canadian dollars) % change Sales $ 1,346 $ 1,313 3 % Earnings from operations before restructuring costs % Total assets (1)% The Bakery Products Group is comprised of Maple Leaf Foods 87.5% ownership in Canada Bread Company, Limited, a leading producer and distributor of fresh and frozen bakery products and fresh pasta and sauces, with operations across Canada, the United States and the United Kingdom.

6 Our independent directors have had highly successful careers as leaders in business, academia and public service. Because of this, they add significant perspective and oversight into how management shapes strategy and manages the business. From left to right: Purdy Crawford Michael McCain Chaviva Hosek Jim Hankinson Scott McCain Diane McGarry Bob Stewart Jeffrey Gandz Ted Newall Bob Hiller Gord Ritchie Don Loadman

7 L E T T E R F R O M T H E C H A I R M A N G. Wallace F. McCain Chairman Delivering long-term shareholder value is seldom a straight line of profit gains. Implementing the right strategy to achieve high financial returns in a diversified global food company means growth often happens in expansive bursts. It may come in the form of large acquisitions that expand our global presence, or exciting new product innovations that transform the marketplace. Great companies are premised on such intensity. The alignment of growth ambitions with shareholder value involves serious equity commitments by directors and managers. Our two largest shareholders McCain Capital Corporation and Ontario Teachers Pension Plan Board own approximately 70 percent of the Company. The 10 independent directors on our 13-member board have also pledged a substantial amount as an investment in our future. An important distinction is that all shareholders don t necessarily share the same interests, because investment horizons are different. Our Board and management team are managing this Company for long-term value creation. Shareholders, current and prospective, should keep this top of mind as you make investment decisions and measure our success. We operate in a complex environment with multiple stakeholders government, communities, unions and industry groups to name a few. On this basis, shareholders need a Board well experienced in value creation, but also who bring a diversity of experience to the Company s management. Our independent directors have had highly successful careers as leaders in business, academia and public service. Because of this, they add significant perspective and oversight into how management shapes strategy and manages the business. We are always looking for ways to better engage directors in the business and with our people. Last year, we introduced an innovative new program called Board Connect, where directors spend a day shadowing a senior operations manager. This allows them to garner first hand insights into our business and engage directly with our people. One director enjoyed a day in the life of a sales executive, another organizing fresh pork shipments across the border, while a third participated with the Consumer Foods management team in their annual budget process. This program will continue in Building corporate greatness means dramatic changes in the next few years as we step with increased boldness onto the world stage. Your Board will assess these and all our major business decisions with a shareholder lens; ensuring long-term value creation is supported each step of the way. Sincerely, G. Wallace F. McCain, Chairman 5

8 L E T T E R T O F E L L O W S H A R E H O L D E R S Michael H. McCain President and Chief Executive Officer We accomplished a great deal in 2005 as we implemented structural changes throughout the organization and increased operating earnings by 17% in the first nine months compared with the prior year. Unfortunately that momentum slowed in the fourth quarter due to a sharp rise in energy costs, an unexpected drop in the yen, and higher timing related advertising and promotion costs. The net result for 2005 compared with the prior year was as follows: Sales increased by 2% to $6.5 billion Earnings from operations also increased by 3% to $263 1 million Earnings per share declined to $ from $0.90 Cash flow from operating activities increased by 10% to $260 million Capital expenditures decreased to $152 million from $157 million Return on net assets declined to 8.2% 1 from 8.9% Share price closed the year at $15.20, up 1.5%, outperforming the S&P Food Products Index by 7% Operating earnings in our Meat Products Group declined by 13% to $60 million for the year. The main cause was an industry-wide contraction in commodity processor margins approximately 30% in pork and 41% in poultry versus the prior year. We offset these negative underlying influences in three ways. First, our Vertical Co-ordination strategy to minimize commodity influences on our earnings is working. We effectively own 20% of our hog supply and this natural hedge against high hog prices offsets a substantial portion of the commodity processor margin decline. Second, we added value to our commodity products through gains in processing, innovation, and better sales and marketing execution. Finally, our brand focused, consumer-oriented, fresh bread and consumer packaged meats and meals businesses both performed brilliantly as a result of brand marketing and sales effectiveness, operational improvements, and lower raw material costs. Higher hog prices were the main reason why our Agribusiness Group s operating profits increased by 3% to $102 million. This improvement more than offset the costs of commissioning a new high-efficiency feed mill in Atlantic Canada. We also completed construction of the first commercial 1 Before restructuring costs (please refer to Management s Discussion and Analysis) 6

9 L E T T E R T O F E L L O W S H A R E H O L D E R S biodiesel plant in Canada, employing a proprietary process developed at Maple Leaf Foods to convert tallow into a valuable renewable fuel source. The Agribusiness Group plays a vital role in our value chain strategy by delivering stable earnings, providing virtually all animal feed requirements to our poultry producers and hog production business, and converting inedible animal by-products into earnings streams through our rendering operations. Our Bakery Products Group, which reflects our We like this business very much and will continue to acquire Canada Bread shares at the right price, although we have no overt strategy to buy out the remaining shares. Maple Leaf continues to be a strong cash generator, with $260 million in operating cash flow in We invested $152 million in capital for the year, which supported the construction of a highefficiency feed mill in Eastern Canada, a biodiesel plant in Quebec and environmental upgrades in 87.5% ownership of our rendering business. Canada Bread, recorded MUCH OF 2005 WAS DEVOTED We ended the year with another very strong TO BUILDING A STRONGER a strong balance sheet, year, capitalizing on ORGANIZATION THAT WILL CREATE LASTING LONG-TERM reflected in a Net acquisitions and mergers completed several years SHAREHOLDER VALUE. Debt/EBITDA ratio of 2.6x and a commitment ago. Operating earnings grew by 14% to $101 million, driven largely by our fresh bakery operations. The Group faced the challenges of higher energy and distribution costs and the start-up costs of a large bagel plant in the U.K. The portfolio benefit of being in the bakery business cannot be overstressed as there are excellent synergies between the protein and bakery businesses. to maintaining investment grade credit quality. Our long-term compound annual growth rate in earnings per share since 1995 is 10.4% versus our goal of 15%, and our return on net assets was 8.2% in 2005, versus our target of 11.5%. S I M P L I F Y I N G O U R S T R U C T U R E Much of 2005 was devoted to building a stronger organization that will support lasting long-term RONA Long-Term Financial Targets: EPS CAGR > 15% RONA 11.5% EPS RONA Earnings Per Share (1) EPS CAGR: 10.4% 10% 9% 8% 7% 6% 5% 4% 3% 2% % % (1) Before restructuring costs 7

10 L E T T E R T O F E L L O W S H A R E H O L D E R S shareholder value. We began 2005 with 14 independent operating companies, plus several ancillary business units. We finished the year with 10 streamlined operating companies. All consumer foods businesses, including Schneider Foods, Maple Leaf Consumer Foods and Larsen Packers, were merged as Maple Leaf Consumer Foods. Our fresh pork and poultry operations were consolidated as Maple Leaf Fresh Foods. In the Agribusiness Group, Shur-Gain and Landmark Feeds were combined as Maple Leaf Animal Nutrition. Our international trading business was reorganized as Maple Leaf Global Foods, and is expanding beyond its core strength in trading to increase geographic and value-added product diversification. These types of mergers always put strain on an organization. Supported by the discipline and methodology of Six Sigma, they were accomplished with professionalism and stability, ensuring we always kept our customers needs first. The task of aligning our core processes and completing very complex organizational change will continue in This simpler organizational structure will deliver operational efficiencies and enable us to more effectively leverage the competitive advantages of our national scope, strong brands and product diversity. O U R F O U N D A T I O N S The enduring feature of our Company is our deep conviction in the long-term benefit of investing in people and disciplines, specifically our Leadership Edge and Six Sigma programs. In 2005, we expanded that commitment by investing over 8,400 person days in leadership values and skills development through the Maple Leaf Leadership Academy and Six Sigma training programs. Our team of 130 Six Sigma Black Belt professionals manage a portfolio of what is now more than 570 projects. We know from long experience that safe plants are well run plants. We are pleased to report that we recorded our fifth consecutive year of doubledigit improvement in health and safety measures. In 2005, our lost time accident frequency rate improved by a remarkable 38%. F O U R T H Q U A R T E R C H A L L E N G E S Our fourth quarter results dampened a year of strong operating performance due to three factors. First, we faced unprecedented rapid increases in energy costs, with more than 40% of oil and gas cost increases occurring in Q4. This is a large cost From left to right: Wayne Johnson, Brock Furlong, Lynda Kuhn, Doug Dodds 8

11 L E T T E R T O F E L L O W S H A R E H O L D E R S line that affects each of our business units either directly in the case of manufacturing and distribution or indirectly in higher ingredient, packaging and overhead costs. We are confident that we will be able to pass these cost increases on in our pricing, although there is a lag effect, category by category, as we plug into natural re-pricing rhythms with our customers. Second, the yen declined 16% against the Canadian dollar in the quarter compared to the first six months of 2005, consumption returned to more normal levels after two robust years. We believe that both of these factors are short term. Meanwhile, we have made headway in diversifying our international markets for premium quality pork, although there is still lots of opportunity to better balance our important Japanese business with other markets. Third, advertising and promotional costs to support product launches and brand building were higher due to timing related costs that are expected to yield returns causing margin pressure on our Japanese pork exports, which are priced DESPITE THESE SHORT-TERM CHALLENGES, THE FOUNDATIONS OF THE BUSINESS CONTINUE TO GET STRONGER WITH in market share and brand leadership. Despite these shortterm in yen. While this should EACH PASSING YEAR. challenges, the normalize over the foundations of the medium term, it accounted for a significant portion of the fourth quarter earnings decline. Japan is important to our fresh pork strategy and is a great, though inconsistent market from quarter to quarter. In Q4 we experienced the downside of this curve, although our results in Japan for the full year were satisfactory. Compounding the currency impact, the Japanese market finished the year with unusually business continue to get stronger with each passing year. We have aggressive growth targets and, as significant shareholders, take a longer-term view to wealth creation. The Maple Leaf story will never be a straight line of rising profits. While we seek steady earnings growth, we do not manage the business quarter to quarter. Our commitment to long-term shareholder value creation is resolute. high frozen pork inventories, as domestic From left to right: Rick Young, Rocco Cappuccitti, Kevin Golding, Jerry Vergeer, Bruce Miyashita 9

12 L E T T E R T O F E L L O W S H A R E H O L D E R S V A L U E C R E A T I O N S T R A T E G I E S A N D O P P O R T U N I T I E S The food business provides enormous opportunities for companies that understand and achieve the necessary balance between rigorously controlling costs and growing the top line profitably through innovation and adding value. At Maple Leaf Foods, seven strategic elements form the blueprint for wealth creation and govern all key business decisions. Each is underpinned with specific medium-term initiatives: Add value for our customers Add value to our products Invest in leading market shares Build our brands Innovate Drive costs out Diversify globally We are continuously seeking to move our customer relationships from transactional to strong enterprise partnerships by developing deep insights into their needs and tailoring our relationship to plug into each of their unique strategies. Our value-added product focus spans the Company, from innovation in feed formulation to new bakery product technology such as FroBake in our bakery business. Market share leadership is critical in this industry to establish stable market conduct and achieve high plant efficiencies. We will not compete in a market that we cannot lead and we have leading market shares in all our businesses. We are brand equity builders, and we use innovation as a key brand building platform. Driving costs out of our business model is essential to success, supported by Six Sigma methodology and insights, appropriate capital investments, consolidation of supply chains into larger scale facilities, and application of standardized processes throughout our business structure. We expect longer-term value creation will be driven by global diversification, which offers excellent opportunities in both protein and bakery. Applying these strategic principles, there are four major value creation opportunities in the mid-term, in addition to our many other initiatives. The first is to complete the merger between Schneider Foods and Maple Leaf and realize the synergies that result from having leading brands and market shares in Canadian packaged consumer meats and meals. The second is to grow margins in our fresh meat businesses by adding value to commodity products through service and value-added processing. The third is harvesting our investment in the frozen and U.K. bakery From left to right: Barry McLean, Randy Powell, Michael Detlefsen, Annalisa King 10

13 L E T T E R T O F E L L O W S H A R E H O L D E R S businesses, where we feel we have significant of We Take Care gives consumers added opportunity to drive sales volume and earnings confidence through our commitment to food safety growth. The fourth is to reduce costs in our hog leadership. In the bakery category, Dempster s leads production operations and restore competitiveness the premium nutrition whole grain bakery market, with the U.S. industry. supported by the newly launched brand position M E G A - B R A N D S ; M E G A F U T U R E The equity in a brand accrues benefits to brand owners for decades. Very few companies have a single mega-brand. In Canada, we are proud to have three leading food brands Schneiders, Maple Leaf and Dempster s. accomplishment of our sales and marketing teams. What keeps these brands fresh, hot and generating better returns? A time-tested recipe of brand strategy, brand support and lots of brand innovation. The Schneiders brand has penetrated the position of Taste The Difference Quality Makes deep into the Canadian awareness. Supported by European craftsmanship, heritage and top quality ingredients, the taste proposition continues to resonate with consumers. The Maple Leaf brand position Nourish Yourself. As one of Canada s leading national TV advertisers, we support these brands with continuous and creative breakthrough advertising. Brands drive market share leadership, and innovation drives brands. Consumers are always seeking something new They are among the top SCHNEIDERS, MAPLE LEAF AND from the brands they 25 brands in the country DEMPSTER S... ARE AMONG THE trust. O u r innovation TOP 25 BRANDS IN THE COUNTRY AND and growing well in excess of the average for this peer group a major GROWING WELL IN EXCESS OF THE AVERAGE FOR THIS PEER GROUP. platform keeps getting stronger and stronger. Recent examples include Maple Leaf Fully Cooked Roasts, Maple Leaf Fresh Grill! and Maple Leaf Fresh Roast!, all targeted to meet the needs of time-starved consumers. In the bakery category, early in 2006 we launched Dempster s Smart, a white bread made with all the benefits of whole grains and the first product of its kind in Canada. T H E N E X T C H A P T E R The last decade has been transformational. In many ways, that s just the end of the first chapter. From left to right: Rory McAlpine, Peter Smith, Maryanne Chantler, Pat Ressa Absent: Peter Maycock 11

14 L E T T E R T O F E L L O W S H A R E H O L D E R S Long-term we won t achieve our ambitious a culinary strategy in our Company, by improving shareholder return targets solely as a $6.5 billion Canadian protein and bakery company. We must take on bigger challenges and more well managed risks to achieve exceptional returns. We have defined the agenda for the next decade as follows. First, we always have and always will begin with our foundations Leadership Edge and Six Sigma. This is our past, our present and our future, but we are looking at both of these foundations through new prisms. We need to our new product development processes, by expanding our leadership in delivering convenience and nutrition, and by developing greater external relationships with innovation partners. We are building a culture that is passionate about food! Finally, significant investments outside Canada are imperative to expand our geographic reach in our core categories and realize our growth and financial goals. In 2005, our Board reviewed and accepted broad parameters for such take them deeper into the organization right to the front line to engage MAPLE LEAF PEOPLE ARE P ASSIONATE, COMMITTED PEOPLE WHO GET THINGS DONE, ARE OUTRAGEOUSLY TENACIOUS, AND WHO investments. However, there must be a visible, compelling value creation 100% of our people. ALWAYS KEEP THEIR EYE ON THE PRIZE. strategy behind our Second, we will take steps to strengthen fortress Canada to ensure it can profitably grow and sustain any competitive challenges. This will mean substantial increases in our capital spending to consolidate operations into mega-plants with world leading technology. There are opportunities to make such investments in each segment of our business. Third, we are stepping up our commitment to innovation, underpinning the mega-brands in our portfolio. We will do so by enhancing the role of investments. We will look for a convincing path to market/category leadership that fits well with our existing organization. We also must be in a state of readiness. We are not there yet, but we are getting ready. Our balance sheet is in excellent shape and we expect that by early 2007, the organizational mergers previously described will be largely complete. We are taking steps to enhance the global depth and readiness of our talent and we are assessing in detail the various market opportunities available to us. From left to right: Richard Lan, Scott McCain, Tom Muir, Michael Vels, Michael McCain 12

15 L E T T E R T O F E L L O W S H A R E H O L D E R S Over the longer-term, we are also proactively minimizing risk from disease by preparing ourselves for the potential outbreak of a global influenza pandemic. We pay close attention to the risk of avian influenza due to our industry affiliations. While we are primarily a processor and our business model is to not own poultry growing operations, we are taking steps with our employees and producer partners to reduce risk. The larger concern we all share is the threat of a pandemic in the human population. We cannot control this outcome, although we can take a leadership position in preparedness, which is exactly what we are doing both in our industry and inside our Company. P A S S I O N A T E P E O P L E ; P A S S I O N A T E A B O U T F O O D We continue to nurture and develop the greatest asset of this organization our people and their leadership capabilities, which defines our culture. Maple Leaf people are passionate, committed people who get things done, are outrageously tenacious, and who always keep their eye on the prize. It s an amazing place! Adding to this team are the newest members of our Executive Council, Annalisa King who leads our Vertical Co-ordination group, and Maryanne Chantler who heads up our Purchasing and Supply Chain group. Both Annalisa and Maryanne have a strong history in operating and finance roles at Maple Leaf and they continue to make outstanding contributions in their new responsibilities. Rory McAlpine, who has a diverse background in government and international trade, also recently joined Maple Leaf s senior leadership team, to lead and build our Government and Industry Relations program. We are entering 2006 with a great deal of confidence. Our underlying operating and financial fundamentals are strong and the talent we have across the organization, thousands of Maple Leaf Foods employees, is what will drive value creation. They are an amazing team, and on that basis you have invested well. Michael H. McCain President and Chief Executive Officer Richard A. Lan President and Chief Operating Officer, Bakery Products Group J. Scott McCain President and Chief Operating Officer, Agribusiness Group Tom P. Muir Executive Vice-President and Chief Development Officer Michael H. Vels Executive Vice-President and Chief Financial Officer 13

16 F I N A N C I A L S Financial Contents 15 Results of Operations 16 Operating Segments 17 Operating Review 17 Meat Products Group 18 Agribusiness Group 19 Bakery Products Group 20 Acquisitions 21 Capital Resources and Liquidity 23 Derivatives 24 Environment 24 Risk Factors 28 Critical Accounting Estimates 29 Changes in Accounting Policies 30 Recent Accounting Pronouncements 32 Summary of Quarterly Results 32 Forward-Looking Statements 34 Management s Statement of Responsibility 34 Auditors Report to the Shareholders 35 Consolidated Financial Statements 38 Notes to the Consolidated Financial Statements 58 Corporate Governance and Board of Directors 60 Senior Management and Officers 61 Corporate Information

17 M A N A G E M E N T S D I S C U S S I O N A N D A N A L Y S I S THE BUSINESS Maple Leaf Foods Inc. is a leading Canadian food processing company committed to delivering quality food products to consumers around the world. Headquartered in Toronto, Canada, the Company employs approximately 24,000 people at its operations across Canada and in the United States, Europe and Asia. EFFECT OF RESTRUCTURING AND OTHER ITEMS Except where noted, operating earnings, net earnings, earnings per share ( EPS ) and return on net assets ( RONA ) comparisons for 2005 exclude $13.2 million before tax ($8.3 million after-tax and minority interest) in restructuring costs incurred in the first quarter of Management believes that this is the most appropriate basis on which to evaluate operating results, as restructuring costs are not representative of continuing operations. Year-over-year and quarterly comparisons are also affected by the inclusion of an additional week of operations in the fourth quarter of 2004, which affect sales and earnings comparisons in the fourth quarter and full year. SELECTED FINANCIAL HIGHLIGHTS The following is a summary of audited financial information for the three years ended December 31, (In thousands of dollars except per share information) Sales $ 6,462,581 $ 6,364,983 $ 5,041,896 Operating earnings before restructuring costs 263, , ,428 Net earnings (i) 94, ,283 30,217 Net earnings before restructuring costs (i) 102, ,283 40,609 Total assets 3,189,780 3,038,133 2,148,721 Net debt 1,062,755 1,046, ,678 RONA (ii) 8.2% 8.9% 6.4% Per share EPS $ 0.74 $ 0.90 $ 0.27 EPS before restructuring costs $ 0.81 $ 0.90 $ 0.36 Cash dividends $ 0.16 $ 0.16 $ 0.16 (i) 2003 and 2004 restated in accordance with Note 2 to the Consolidated Financial Statements. (ii) This is not a recognized measure under Canadian Generally Accepted Accounting Principles. The calculation of RONA comprises taxaffected earnings before interest divided by average monthly net assets. Net assets are defined as total assets, less cash, future tax assets and non-interest bearing liabilities. These calculations and definitions may not be comparable to measures used by other companies. RESULTS OF OPERATIONS Operating results for 2005 reflected strong performance from most businesses and the full year contribution of Schneider Foods, purchased in April Earnings for the full year were affected by weaker results in the fourth quarter, due to a combination of factors, including higher energy costs, lower earnings from exports to Japan and higher advertising and promotional costs. Management is of the opinion that these are largely short-term factors which can be mitigated through price increases. The value-added businesses, particularly consumer products and fresh bakery, contributed strongly to earnings through a combination of new product innovation, operating improvements and lower raw material costs in the meat business earlier in the year. The Company also benefited from portfolio balance across the Protein Value Chain operations as weaker commodity processing margins and lower rendering earnings were partly offset by higher hog profits. Overall, changes in prices of 15

18 M A N A G E M E N T S D I S C U S S I O N A N D A N A L Y S I S commodities had a marginally negative impact on earnings for the full year. The following table outlines the change in some of the key indicators that affected the business and financial results. Annual Averages Change Pork Industry Processor Margins (USD per cwt) $ 1.55 $ 2.03 (23.7)% Poultry Industry Processor Margins (CAD per kg) $ 0.57 $ 0.97 (41.2)% Natural Gas (CAD / Gj) $ 8.25 $ % As noted above, in response to higher costs, particularly energy, price increases will be implemented in Sales for the year increased 2% to $6.5 billion, primarily due to the acquisition of Schneider Foods in April This increase in sales was partially offset by the inclusion of an additional week of operating results in the fourth quarter of 2004 and by lower commodity prices that affected sales in the Company s pork, poultry, feed and rendering businesses. Earnings from operations before restructuring costs increased 3% to $263.0 million for the year. Net earnings for the year before restructuring costs of $102.6 million ($0.81 per share), compared to $102.3 million ($0.90 per share) last year. Including restructuring costs, net earnings were $94.2 million ($0.74 per share). RONA declined to 8.2% from 8.9% in 2004, primarily due to the increase in assets resulting from the purchase of Schneider Foods. OPERATING SEGMENTS The combination of the Company s Meat Products Group and the Agribusiness Group comprises the Protein Value Chain operations, which are involved in producing animal protein products. The Meat Products and Agribusiness operations are highly interrelated and are strategically linked through the Company s Vertical Co-ordination business model. While each operation maintains a strong external customer focus, they are tightly coordinated to deliver superior performance where their operations intersect. Accordingly, it is more meaningful to review the combined results of the Protein Value Chain rather than each segment independently. The Meat Products Group comprises branded value-added prepared meat products; fresh, frozen and branded value-added pork products; fresh, frozen and branded value-added chicken and turkey products; and global food marketing, distribution and trading. The Agribusiness Group operations include research, development and supply of quality livestock nutrition products and services; pet food; swine production; and animal by-products recycling. The Bakery Products Group is comprised of Maple Leaf s 87.5% ownership in Canada Bread Company, Limited, a producer of fresh, frozen and branded valueadded bakery products, including frozen par-baked bakery products and specialty pasta and sauces. Maple Leaf Ownership of Canada Bread 90.0% 80.0% 70.0% 60.0%

19 M A N A G E M E N T S D I S C U S S I O N A N D A N A L Y S I S OPERATING REVIEW The following table, which forms the basis of discussion in this document of the Company s results of operations, reflects operating earnings by business group before restructuring costs. Earnings from Operations ($ millions) Change 2003 Meat Products Group $ 59.9 $ 68.4 (13)% $ 24.3 Agribusiness Group % 69.9 Protein Value Chain (3)% 94.2 Bakery Products Group % 58.2 $ $ % $ Protein Value Chain Operations Protein Value Chain earnings for the year declined 3% due to industry-wide decreases in both pork and poultry processor margins, higher energy costs, higher costs in the Company s hog production operations and lower profits from rendering operations. These factors more than offset positive contributions from consumer products and lower feed costs. Meat Products Group Sales for the year were up 4% to $4.3 billion compared to $4.1 billion last year, due to the acquisition of Schneider Foods in April Offsetting this was the effect of lower commodity prices that reduced sales values. Earnings from operations for the year were $59.9 million, down from $68.5 million last year. The consumer products business, which is the combination of the Schneider Foods and the former Maple Leaf Consumer Foods operations, achieved excellent operating results driven by the full-year contribution of Schneider Foods, lower raw material costs and the contribution of higher margin products such as Maple Leaf Fully Cooked Roasts and Schneiders lunch kits. These strong results were partly offset in the fourth quarter by higher energy costs and timing of advertising and promotional spending to support brand positioning and new product launches. This business will implement price increases in 2006 to offset inflationary costs. The Schneider Foods merger has met expectations to date. In 2005, the two organizations were combined with the majority of systems integration to follow in This will yield future gains in procurement, supply chain, working capital and customer service. An integrated manufacturing strategy will be implemented Segmented Operating Earnings Meat Products Group Agribusiness Group Bakery Products Group Earnings from Operation ($ millions) (50)

20 M A N A G E M E N T S D I S C U S S I O N A N D A N A L Y S I S beginning in 2007, although some benefits from optimizing the manufacturing network will be realized in The acquisition of Schneider Foods has given the Company an effective balance between fresh primary processing and further processed products, resulting in a desirable mix of commodity-influenced and more stable value-added branded businesses. Over time, in most market conditions, management expects that this should result in higher margins and less volatile earnings, particularly when these results are combined with the counter-cyclical earnings of the Agribusiness Group. Earnings from fresh poultry operations declined sharply in 2005 due to lower industry-wide processor margins. These margins were at unusually high levels in 2004 due to a supply shortage related to avian influenza. The contribution from primary pork processing operations was down marginally compared to the prior year. In 2005, the North American pork processor spread was lower than 2004 and well below the fiveyear average. However, pork processing performance benefited from an improved value-added sales mix, increased manufacturing efficiencies and higher earnings from the Japanese pork market in the first three quarters of However, the fourth quarter was impacted by a 16% depreciation of the Japanese yen against the Canadian dollar compared to the first half of 2005, which resulted in a decline in the sales value and profitability of pork exports to Japan. In 2005, the Company announced that it will invest up to $110 million to construct a fresh pork processing plant in Saskatoon, Saskatchewan. The new plant will replace a 65-year-old plant in Saskatoon acquired as part of the purchase of Schneider Foods. The current facility provides over two-thirds of its production to other Maple Leaf value-added processing facilities in Saskatchewan. The new plant will increase production capacity from the current 17,500 to 20,000 hogs per week on a single shift, with the capability to process up to 40,000 on a double shift. Subject to Company and government approvals, the Province and the City have committed to infrastructure support that will affect the ultimate expenditure by the Company. Construction is expected to commence by mid-to-late 2006 with the plant commissioned 18 to 24 months later. Agribusiness Group Sales for the year declined 12% to $816.8 million from $924.9 million last year due to lower market prices for feed and rendered products, reflecting lower underlying commodity prices. Earnings from operations for the year increased 3% to $101.8 million from $98.7 million in Contributing to the earnings increase was an improvement in hog production margins driven primarily by lower prices for feed grains; however, this was partially offset by a 4% decline in hog prices compared to last year. The Company had effective ownership of 20% of the hogs it processed in the year. Although hog profits were higher, the Company s hog production operations underperformed in the face of a stronger Canadian dollar and higher operating costs. The Company has a number of initiatives underway to improve performance and reduce costs in this business. Earnings from the rendering operations for the year declined due to a reduction in export volumes and lower prices for finished products, compounded by rapidly rising energy costs. These factors overshadowed increased operating efficiencies due to a capital investment in environmental upgrades over the last number of years. In the fourth quarter, the Company commissioned a new commercial scale biodiesel plant in Quebec, which will provide an alternate higher value market for tallow. 18

21 M A N A G E M E N T S D I S C U S S I O N A N D A N A L Y S I S The animal nutrition operations continued to post steady results for the year. Bakery Products Group Sales increased by 3% to $1.3 billion, reflecting higher prices and continued growth in higher value whole grain and specialty products. Sales comparisons would have been stronger if not for the inclusion of an additional week of operating results in the fourth quarter of Earnings from operations for the year increased 14% to $101.3 million from $89.2 million in 2004 as price increases and a sales mix that is weighted towards health and well-being categories contributed to earnings in the first three quarters. Earnings, particularly in the fourth quarter, were negatively impacted by higher fuel, energy and other inflationary costs. Strong sales of branded whole grain, whole wheat and specialty fresh bakery products, higher prices, and Six Sigma driven operating improvements all contributed to strong earnings growth for the year. This offset the impact of rising fuel, energy and flour costs and increased advertising and promotional spending in the back half of the year. The Olivieri pasta and sauce business experienced year over year sales and volume growth reflecting a decline in the effect of low carbohydrate diets. The North American frozen business experienced significant increases in fuel, energy and related costs which offset the operational improvements in the year in freight and distribution. The U.K. bakery operations benefited from sales growth largely due to overall market growth of 18%. Full year margin growth in 2005 was more than offset by increased advertising expenditures to support the New York Bagel brand in the U.K., higher energy and flour costs and additional costs associated with commissioning a new bagel plant in Rotherham, England. Other Income Other income increased to $7.0 million, up from $2.7 million in The increase was due to substantially higher earnings from equity investments acquired as part of the Schneider Foods acquisition, insurance proceeds, and gains on fixed asset disposals that were partially offset by a loss on conversion of the convertible debenture in the first quarter of Restructuring Costs During the first quarter of 2005, the Company recorded $13.2 million in restructuring costs ($8.8 million after-tax) in respect of certain plant closures and operational restructuring for several of its businesses associated with the integration of Schneider Foods, the closure of the Company s bakery in Peterborough, England, and certain other operational restructuring items. Of the $13.2 million, $5.0 million represents the writedown of certain capital assets that were disposed of or that have become impaired as a result of restructuring and $8.2 million relates to provisions for employee terminations, facility exit costs, and other restructuring costs. Of the $8.2 million in provisions, $2.9 million was paid in The Company expects to complete the remaining major components of these restructuring plans in Furthermore, management continues to seek out efficiencies and further optimization opportunities. Any such rationalization initiatives undertaken in 2006 may result in charges to earnings and will be recorded in the quarter in which they occur and disclosed as restructuring costs. Interest Expense Interest expense for the year increased to $98.3 million compared to $89.8 million last year. In the fourth quarter of 2004, the Company refinanced a significant portion of its debt, replacing short-term, lower rate debt with longer-term, fixed rate 19

22 M A N A G E M E N T S D I S C U S S I O N A N D A N A L Y S I S notes that have higher interest rates than short-term floating debt and therefore contributed to higher average interest rates of 6.2% paid compared to last year (2004: 6.0%). A full year impact of the acquisition of Schneider Foods, partly offset by an equity issue in December 2004, also contributed to higher interest expense in the current year. At December 2005, 86% of indebtedness was not exposed to interest rate fluctuations. Income Taxes Income tax expense decreased to $51.3 million from $57.0 million in The Company s effective tax rate was 32.4% in 2005 compared to 33.7% in Components of the changes are provided in Note 18 to the Consolidated Financial Statements. ACQUISITIONS On April 5, 2004, the Company acquired Schneider Foods for cash consideration of $376.7 million, including transaction costs of $8.1 million and the assumption of Schneider Foods debt, for a total purchase price of approximately $500 million. Schneider Foods is one of Canada s largest producers of premium-branded quality food products, specializing in packaged processed meats, poultry and grocery products. The Company employs approximately 5,000 people at 20 facilities across Canada. As at June 30, 2005, the purchase price allocation (including fair values assigned to intangible assets, certain fixed assets, legal claims, long-term debt, pensions, post-retirement benefits and taxes) had been completed. Other costs of integration that cannot be allocated to the purchase price were charged to earnings as incurred. Goodwill resulting from the transaction is included in the total assets of the Meat Products Group. The acquisition of Schneider Foods transforms the Meat Products Group since it significantly increased the mix of value-added products and management anticipates this will result in higher margins and more stable cash flow and earnings. Schneider Foods and Maple Leaf Consumer Foods have highly complementary businesses and brands that provide for significant growth and cost reduction opportunities for the combined operations. In May 2005, the Company purchased the remaining 32% interest in a subsidiary of Schneider Foods, Cappola Food Inc., for net proceeds of approximately $3.6 million resulting in additional goodwill of approximately $1.5 million. TRANSACTIONS WITH RELATED PARTIES During 2004 and 2005, the Company completed a series of market and private agreement purchases of Canada Bread shares. As a result of these transactions, the ownership interest in Canada Bread increased from 84.7% at the beginning of 2004 to 87.5% as 225,300 (2004: 490,400) shares were purchased in The aggregate value of cash paid and shares issued to finance these transactions in 2004 and 2005 was $29.4 million and the allocation of these amounts to Capital Expenditures Meat Products Group Agribusiness Group Bakery Products Group Depreciation Capex($ millions)