Preliminary Prospectus Dated August 26, 1997

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2 This is a preliminary prospectus relating to these securities, a copy of which has been filed with the appropriate securities commission or similar regulatory authority in each of the provinces and territories of Canada but which has not yet become final for the purpose of a distribution or a distribution to the public. Information contained herein is subject to completion or amendment. These securities may not be sold nor may offers to buy be accepted in any of such provinces or territories prior to the time a receipt is obtained for the final prospectus from the appropriate securities commission or other regulatory authority of such province or territory. Preliminary Prospectus Dated August 26, 1997 This prospectus constitutes a public offering of these securities only in those jurisdictions where they may be lawfully offered for sale and therein only by persons permitted to sell such securities. No securities commission or similar authority in Canada has in any way passed upon the merits of the securities offered hereunder and any representation to the contrary is an offense. The securities offered hereunder have not been and will not be registered under the United States Securities Act of 1933, as amended, and, subject to certain exemptions, may not be offered or sold within the United States or to persons resident in the United States and this prospectus does not constitute an offer to sell or a solicitation of an offer to buy any of the securities offered hereby in the United States. See Plan of Distribution. Initial Public Offering SAPUTO GROUP INC. $ Common Shares There is currently no market through which the Common Shares offered hereby may be sold. This offering (the Offering ) consists of an offering to the public of common shares (the Common Shares ) of Saputo Group Inc. ( Saputo ). In the opinion of counsel, the Common Shares offered hereby will, at the date of issue, be eligible for investment under certain statutes. See Eligibility for Investment. The price at which the Common Shares are offered has been determined by negotiation between Saputo and CIBC Wood Gundy Securities Inc., Lévesque Beaubien Geoffrion Inc., RBC Dominion Securities Inc., Midland Walwyn Capital Inc. and Newcrest Capital Inc. (collectively, the Underwriters ). See Plan of Distribution. After giving effect to the Corporate Reorganization, this Offering and the Preferred Share Repurchase, the offering price of each Common Share offered hereby exceeds the pro-forma consolidated net tangible book value per Common Share as at June 30, 1997 by $, representing a dilution factor of %. See The Company, Preferred Share Repurchase and Dilution. There are certain risk factors that should be considered in connection with an investment in the Common Shares. See Risk Factors. Price: $ per Common Share Price to Underwriters Net Proceeds the Public Fee to Saputo (1) Per Common Share... $ $ $ Total (2)... $ $ $ (1) Before deducting expenses of this Offering estimated to be approximately $, which, together with the Underwriters fee, will be paid by Saputo out of its general funds. (2) Saputo has granted to the Underwriters an option (the Over-Allotment Option ), exercisable for a period of up to 60 days from the date of closing of the Offering, to purchase up to an additional Common Shares (representing % of the Common Shares offered hereby) on the terms and conditions set forth above to cover over-allotments and for market stabilization, if any. If the Underwriters exercise the Over-Allotment Option in full, the total price to the public will be $, the Underwriters fee will be $ and the net proceeds to Saputo will be $. See Plan of Distribution. This prospectus qualifies the distribution of the Over-Allotment Option to the Underwriters and the Common Shares issuable on the exercise thereof. Lévesque Beaubien Geoffrion Inc., a member of the underwriting group, is an indirect majority-owned subsidiary of a Canadian chartered bank which has extended credit facilities to Saputo. In addition, Mr. Emanuele (Lino) Saputo, President and Chief Executive Officer of Saputo, is a member of the board of directors of such bank. Lévesque Beaubien Geoffrion Inc. will not receive any benefit in connection with this Offering other than its portion of the Underwriters fee. See Plan of Distribution. The Underwriters, as principals, conditionally offer the Common Shares, subject to prior sale, if, as and when issued and sold by Saputo and delivered to and accepted by the Underwriters in accordance with the terms and conditions contained in the Underwriting Agreement referred to under Plan of Distribution and subject to the approval of certain legal matters on behalf of Saputo by Stikeman, Elliott and on behalf of the Underwriters by McCarthy Tétrault. Subscriptions for the Common Shares will be received subject to rejection or allotment in whole or in part and the right is reserved to close the subscription books at any time without notice. It is expected that definitive certificates evidencing the Common Shares will be available for delivery at the closing of this Offering, which will take place on, 1997 or at any other date which may be agreed upon, but not later than, 1997.

3 TABLE OF CONTENTS Page Page PROSPECTUS SUMMARY... 3 USE OF PROCEEDS THE COMPANY... 7 CAPITALIZATION General... 7 DESCRIPTION OF SHARE CAPITAL Corporate Reorganization... 7 DIVIDEND RECORD AND POLICY INDUSTRY OVERVIEW... 8 The Canadian Dairy Industry... 8 MANAGEMENT The United States Dairy Industry SHARE OPTION PLAN Future Trends PRINCIPAL SHAREHOLDERS BUSINESS OF THE COMPANY PREFERRED SHARE REPURCHASE Overview ESCROWED SHARES Corporate Strengths and Strategy PLAN OF DISTRIBUTION History Products DILUTION Production RISK FACTORS Markets PRIOR SALES Distribution MATERIAL CONTRACTS Competition LEGAL MATTERS Employee Relations AUDITORS The Montreal Impact F.C SELECTED COMBINED FINANCIAL REGISTRAR AND TRANSFER AGENT INFORMATION PURCHASERS STATUTORY RIGHTS SELECTED PRO-FORMA COMBINED FINANCIAL STATEMENTS.. 39 CONSOLIDATED FINANCIAL PRO-FORMA CONSOLIDATED INFORMATION FINANCIAL STATEMENTS MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL POSITION CERTIFICATE OF THE COMPANY AND RESULTS OF OPERATIONS CERTIFICATE OF THE UNDERWRITERS. 55 ELIGIBILITY FOR INVESTMENT In the opinion of Stikeman, Elliott, counsel to Saputo, and McCarthy Tétrault, counsel to the Underwriters, based on legislation in effect at the date hereof and subject to compliance with the prudent investment standards and general investment provisions and restrictions of the following statutes (and, where applicable, the regulations thereunder) and, in certain cases, subject to the satisfaction of additional requirements relating to investment policies and goals, without resorting to the so-called basket provisions, an investment in the Common Shares offered hereby will not, at the date of issue, be precluded under the following statutes: Insurance Companies Act (Canada); Supplemental Pension Plans Act (Quebec); Pension Benefits Standards Act, 1985 (Canada); Insurance Act (Ontario); Trust and Loan Companies Act (Canada); Loan and Trust Corporations Act (Ontario); An Act respecting insurance (Quebec), for an Pension Benefits Act (Ontario); insurer, as defined therein, incorporated Loan and Trust Corporations Act (Alberta); under the laws of the Province of Quebec, Financial Institutions Act (British Columbia); other than a guarantee fund corporation; The Pension Benefits Act (Manitoba); An Act respecting trust companies and savings The Trustee Act (Manitoba); companies (Quebec), for a trust company Pension Benefits Act (Nova Scotia); and or savings company, as defined therein, Trust and Loan Companies Act (Nova Scotia). which invests its own funds and funds received as deposits; In the opinion of such counsel, the Common Shares, at the date of issue, when listed on a prescribed exchange in Canada, will also be qualified investments for trusts governed by registered retirement savings plans, registered retirement income funds and deferred profit sharing plans under the Income Tax Act (Canada). 2

4 PROSPECTUS SUMMARY The following is summary information only and is qualified in its entirety by, and should be read in conjunction with, the more detailed information appearing elsewhere in this prospectus. As used in this prospectus, unless the context otherwise requires or indicates, the terms Saputo and Company mean Saputo Group Inc. together with its subsidiaries, or any one or more of them. SAPUTO GROUP INC. Overview Saputo produces and markets mozzarella, other Italian specialty cheeses and by-products such as butter, lactose and whey protein. Saputo also distributes fine imported cheeses and a large assortment of other nondairy products that complement its cheese distribution. In fiscal 1997, mozzarella represented approximately 80% of the Company s total cheese production and 58.3% of its total sales. During the same period, 75.9% of Saputo s sales were in Canada, 14.8% in the United States and 9.3% internationally. The Company operates six manufacturing facilities in Canada and two in the United States which produced an aggregate of 55.2 million kilograms of cheese in fiscal On July 31, 1997, the Company had 800 full-time employees and 162 parttime employees. Saputo has established itself as Canada s leading producer of mozzarella, with a share of approximately 34% of the Canadian mozzarella production. In Canada, Saputo services mainly through its own distribution network three distinct market segments: food service (principally pizzerias), retail and industrial. In the United States, Saputo markets its products mainly to the food service segment through independent non-exclusive distributors. Internationally, products are sold directly or through local distributors and sales agents. Saputo has a history of strong profitability and growth through internal development and acquisitions. From fiscal 1993 to fiscal 1997, sales increased from $336.7 million to $450.5 million, representing a compounded annual growth rate of 7.6%. Net earnings during this period increased from $24.1 million to $41.0 million, representing a compounded annual growth rate of 14.2%. Historically, Saputo s net profit margins have been above those of other major Canadian cheese producers. Saputo s net profit margin for fiscal 1997 was 9.1%. Corporate Strengths and Strategy The Company s goal is to maintain its leadership position in the Canadian mozzarella market and to continue its growth in the broader North American dairy industry through a disciplined expansion program. Saputo will pursue this goal by drawing from the following strengths: Product Quality: Saputo s growth is largely attributable to its commitment to product quality, enabling the Company to sell its products at a premium price to a loyal clientele which values consistent quality. Low-Cost Producer: The Company is a low-cost producer due largely to its ability to maximize the output of cheese and value-added by-products per litre of milk and to management s approach to cost control. Dominance of Canadian Pizzeria Market: The Company s dominance of the Canadian pizzeria market is the direct result of its ability to rapidly adapt its infrastructure to supply this market segment with mozzarella. Saputo s focus on this market resulted in the gradual development of its unique Canadian distribution network which provides the Company with a significant competitive advantage. Value-Added By-Products: The St-Hyacinthe plant provides the Company with the ability to process liquid whey into value-added by-products such as lactose, whey protein and dairy blends, most of which are sold internationally. Specialty Cheese Capability: The Company is an active participant in the Canadian specialty cheese market both as a manufacturer and as an importer-distributor. As specialty cheese imports become less and less subsidized from the country of origin, the Company believes that it can replace these premium priced imports with a domestic production that may command higher margins than the Company s present product line. IQF: The Company is the only Canadian cheese processor having an Individually Quick Frozen capability, a manufacturing process that allows for mozzarella and other cheeses to be frozen at their optimum performance point. 3

5 Acquisition Record: The Company s historical growth is principally due to a series of acquisitions whose subsequent financial performance demonstrates the Company s turnaround and integration abilities. Experience in the United States: The Company has been operating in the United States for almost nine years. It has demonstrated its ability to operate in an unregulated dairy environment where it has achieved substantially the same manufacturing profit margins as those it has attained in Canada. Ready for Deregulation: As a low-cost producer with available production capacity, the Company is well positioned to compete and grow in a possible deregulated industry environment in Canada. SELECTED COMBINED FINANCIAL INFORMATION (1) The following table sets forth selected audited and unaudited combined financial information. This information has been derived from the audited and unaudited combined financial statements of the Company contained elsewhere in this prospectus and should be read in conjunction with such statements and the notes thereto and with the information appearing under Management s Discussion and Analysis of Financial Position and Results of Operations. For the three months ended June 30, For the years ended March 31, (unaudited) (audited) (in thousands of dollars, except percentages) Statement of earnings data Revenue , , , , , , ,664 Cost of sales, selling and administrative expenses... 98,887 89, , , , , ,574 EBITDA (2)... 18,690 17,497 71,667 64,884 63,365 51,017 44,090 EBITDA margin % 16.3% 15.9% 15.9% 15.8% 14.1% 13.1% Depreciation and amortization... 1,996 1,948 7,796 7,074 7,803 6,866 5,869 Interest (income)... (46) (48) ,211 1,496 1,653 Income taxes... 6,059 5,521 22,642 19,829 19,217 15,201 12,493 Net earnings... 10,681 10,076 40,998 37,273 35,134 27,454 24,075 Net margin % 9.4% 9.1% 9.1% 8.7% 7.6% 7.2% Statement of changes in financial position data Cash flow from operations (3)... 12,700 12,487 49,114 44,983 43,947 36,800 29,494 Net additions to fixed assets... 4,242 1,371 4,242 17,748 5,586 4,086 8,207 (1) Historical figures are the combined figures of Saputo and Jolina Holdings, Inc. On August 26, 1997, Saputo acquired from a company controlled by Mr. Emanuele (Lino) Saputo, the President and Chief Executive Officer of the Company, the control over all of the issued and outstanding shares of Jolina Holdings, Inc. Although Jolina Holdings, Inc., which owns all of the United States operations, was not a subsidiary of Saputo prior to such transaction, it has nonetheless always been managed as a division of Saputo. Therefore, Saputo will not incur any material integration expenses in connection therewith. (2) Earnings before interest, income tax, depreciation and amortization. (3) Before changes in non-cash operating working capital items. 4

6 SELECTED PRO-FORMA CONSOLIDATED FINANCIAL INFORMATION The following table sets forth actual combined financial information and pro-forma consolidated financial information after giving effect to the Corporate Reorganization, this Offering, the Preferred Share Repurchase and other adjustments resulting from the assumptions described in the notes to the pro-forma consolidated financial statements of the Company contained elsewhere in this prospectus and should be read in conjunction with such statements and notes thereto. For the twelve months ended June 30, 1997 Actual Pro-forma combined consolidated (unaudited) (in thousands of dollars, except as otherwise indicated) Statement of earnings data Revenue , ,426 Cost of sales, selling and administrative expenses , ,341 EBITDA... 72,860 73,085 EBITDA margin... 15,8% 15,7% Depreciation and amortization... 7,844 8,013 Interest ,214 Income taxes... 23,180 22,843 Net earnings... 41,603 41,015 Earnings per share (1)(2)... $ 1 As at June 30, 1997 Actual combined Pro-forma consolidated (unaudited) (in thousands of dollars) Balance sheet data Working capital... 36,390 16,161 Fixed assets... 78,322 83,826 Total assets , ,967 Total debt... 10,140 27,348 Shareholders equity ,302 93,258 (1) Earnings per share was calculated using 1 Common Shares, being 30,000,000 Common Shares outstanding after giving effect to the Corporate Reorganization described under The Company Corporate Reorganization and 1 Common Shares to be issued pursuant to this Offering. (2) Without taking into account the options to be granted under the Company s Share Option Plan and the exercise of any portion of the Over-Allotment Option granted by Saputo to the Underwriters. See Share Option Plan and Plan of Distribution. 5

7 THE OFFERING Issue: 1 Common Shares ( 1 Common Shares if the Over-Allotment Option is exercised in full). Offering Price: $ 1 per Common Share. Amount: $ 1 ($ 1 if the Over-Allotment Option is exercised in full). Preferred Share Repurchase: Use of Proceeds: Dividend Policy: Risk Factors: On August 25, 1997, the Company declared a special dividend to the Saputo Shareholders (as defined under Principal Shareholders ) payable by the issue of fully paid Series A Preferred Shares of the Company (the Preferred Shares ) having an aggregate redemption value equal to 90% of the gross proceeds of this Offering. Immediately after the closing of this Offering, the Preferred Shares will be redeemed and canceled by the Company, the whole transaction being herein referred to as the Preferred Share Repurchase. The gross proceeds of $1 million to be received by Saputo from this Offering will be used as follows: (i) $1 million, representing 90% of the gross proceeds of this Offering, to redeem and cancel all of the Preferred Shares held by the Saputo Shareholders, and (ii) $1 million, representing 10% of the gross proceeds of this Offering, to reimburse the promissory note issued by Saputo on August 26, 1997 in partial consideration of its acquisition of Jolina Holdings, Inc. See The Company Corporate Reorganization and Preferred Share Repurchase. The Underwriters fee and the expenses of issue estimated to be approximately $1 million will be paid by the Company using funds available under its existing credit facilities. The net proceeds resulting from the exercise of the Over- Allotment Option, if any, will be used to reduce amounts drawn on the existing credit facilities of Saputo. The Board of Directors of Saputo has established an initial policy of declaring quarterly cash dividends on the Common Shares in an amount of $ 1 per share representing a yearly dividend of $ 1 per share. The balance of its earnings will be reinvested to finance the growth of the Company s business. The Company s dividend policy will be reviewed from time to time by the Board of Directors and will depend on Saputo s financial condition, results of operations, capital requirements and such other factors as the Board of Directors, in its sole discretion, deems relevant. See Dividend Record and Policy. The purchase of Common Shares involves risks which should be carefully considered by prospective investors, including competition, regulatory considerations, tariff protection, the absence of a public trading market, the possibility of volatility and dilution, inherent operating risks, environmental issues and dependence upon key personnel. See Risk Factors. 6

8 THE COMPANY General The business of the Company commenced in Saputo Group Inc. was constituted by a Certificate of Amalgamation issued pursuant to the provisions of the Canada Business Corporations Act on July 1, The Company is the successor corporation to Placements Saputo Inc., Fonds Saputo Inc., Placements Sapco Inc. and Fonds Sapco Inc. The head office and principal place of business of the Company is located at 6869 Metropolitain Boulevard East, Saint-Leonard, Quebec, Canada, H1P 1X8. As used in this prospectus, unless the context otherwise requires or indicates, the terms Saputo and Company mean Saputo Group Inc. together with its subsidiaries, or any one or more of them. Corporate Reorganization On August 25, 1997, the Company amended its articles to (i) create an unlimited number of Common Shares and Preferred Shares issuable in series, (ii) create the Series A Preferred Shares and (iii) convert its previously issued shares into Common Shares (the Share Capital Reorganization ). Further to the Company s decision to proceed with the Offering, all dairy food operations owned by Mr. Emanuele (Lino) Saputo and members of his family which were not already held by the Company were regrouped within Saputo. Such operations included Jolina Holdings, Inc. which owns all of the United States operations and Crémerie des Trois-Rivières, Limitée, which operates in the fluid milk and ice cream market segments in Quebec. The control over all of the issued and outstanding shares of Jolina Holdings, Inc. was acquired by Saputo on August 26, 1997 in consideration of the issuance of 3,000,000 Common Shares and a non-interest bearing promissory note in an amount equal to 10% of the gross proceeds of this Offering. Although Jolina Holdings, Inc. was not a subsidiary of Saputo, it has nonetheless always been managed as a division of Saputo. Such regrouping of the dairy operations together with the Share Capital Reorganization are herein collectively referred to as the Corporate Reorganization. The following organizational chart illustrates the corporate structure of Saputo and its significant subsidiaries and their respective jurisdictions of incorporation. SAPUTO GROUP INC. (Canada) 100% 100% 100% 100% Saputo Cheese Limited (1) (Canada) Saputo Foods Limited (2) (Canada) Crémerie des Trois-Rivières, Limitée (3) (Quebec) Jolina Holdings, Inc. (4) Vermont (U.S.A.) Stella Foods Importing Inc. (Quebec) 100% 100% 100% 100% 100% 100% Fromages Caron Inc. (Quebec) The Montreal Impact F.C., LP (Quebec) Richmond Cheese Company Vermont (U.S.A.) Jolina Foods USA, Inc. Vermont (U.S.A.) Jefferson Cheese Mfg. Inc. Maryland (U.S.A.) (1) Production and distribution of dairy and other food products in the Province of Quebec. (2) Production and distribution of dairy and other food products in provinces other than Quebec. (3) Fluid milk and ice cream production and distribution in the Province of Quebec. Acquired on July 31, 1997 from a related company which acquired Crémerie des Trois-Rivières, Limitée on March 3, See note 12 to the combined financial statements of the Company. (4) Production and sale of dairy products in the United States. Jolina Holdings, Inc. is a wholly-owned subsidiary and sole asset of a whollyowned subsidiary of Saputo Group Inc. 7

9 INDUSTRY OVERVIEW The Canadian Dairy Industry Regulatory Environment The regulation of the content, composition, labeling, packaging, marketing and distribution of all food products in Canada is a shared responsibility between the federal and the provincial governments. The dairy industry is further governed by a series of federal and provincial regulations specific to the production, processing and distribution of milk and milk-related products. All applicable statutes, whether provincial or federal, permit plant inspections, product testing and other regulatory scrutiny. In Canada, all milk processing plants are subjected to regular inspection by federal authorities and are required to be registered under the Canada Agricultural Products Act. Provincial legislation also demands that milk processing plants be licensed, compelling them to comply with all provincial inspections and regulations. Milk Supply The Canadian dairy industry operates within a highly regulated environment. The Canadian Dairy Commission ( CDC ), a crown corporation, has been mandated by the federal government to implement Canada s national dairy policy which is predicated on shared jurisdictional powers between the federal and provincial governments. Fluid milk is regulated provincially, while industrial milk is regulated federally. Fluid milk refers to table milk or cream intended for consumption in fluid forms, whereas industrial milk is used for the manufacturing of all other dairy products, such as cheese, butter, ice cream and yogurt. According to CDC information, the fluid milk sector represents approximately 38.2% of raw milk delivered in Canada while the industrial milk sector represents approximately 61.8%. The principal means used by the CDC to implement the national dairy policy is the monitoring of a dairy supply management system. The key goal of supply management is to ensure stable revenues for dairy farmers while maintaining the production of sufficient volumes of industrial milk to satisfy the domestic Canadian consumer demand for dairy products as well as certain planned exports. This is essentially achieved by setting the support price that the dairy processors can receive for butter and skimmed milk powder and by controlling the supply of industrial milk. Dairy farmers also receive a direct federal subsidy which is set to be phased out over the course of the next five years commencing in February It is expected that the subsidy loss will be recovered through higher industrial milk prices. Every dairy year, the CDC calculates the national industrial milk production quantum based on anticipated domestic demand and certain planned exports. This quantum is then allocated according to the terms of the National Milk Marketing Plan, a federal/provincial agreement. This agreement stipulates, among other things, that Quebec s and Ontario s shares of the national industrial milk production quantum (the Market Sharing Quota ) are approximately 47.6% and 30.5% respectively. Once the industrial milk quantum is determined and allocated among the provinces, provincial marketing boards govern the production, pricing and marketing of milk within their own borders. Each provincial marketing board allocates the milk to dairy processors. Industrial milk is allocated according to a cascading system that classifies industrial milk into various classes of products to be manufactured. Priority of supply is given to the higher milk class, which also commands a higher milk price. Although there may be some provincial variations, quantities of milk in each class other than fluid milk are generally restricted in their growth. As a result, operating in a supply managed system means that a dairy processor can only achieve significant growth through acquisitions. Any attempt to grow internally is stymied by the plant quota which limits a dairy processor to a specific guaranteed volume. Conversely, since the Market Sharing Quota is based on historical and anticipated demand for dairy products, the risk of a processor losing an important part of its market share is very low. 8

10 International Trade (Canada) Imports. The Department of Foreign Affairs and International Trade administers Canada s cheese import quotas. These quotas are divided into European Union and non-european Union sources. This results from Canada s obligation to the European Union to import 66.0% of the approximately 20.4 million kilograms of cheese that Canada is committed to import annually under the World Trade Organization ( WTO ) Agreement on Agriculture. Imports within this minimum access commitment are subject to low rates of duty while imports over this amount are subject to significantly higher tariffs. Over-access tariffs for cheese currently stand at 267.3% of invoiced value. Exports. All dairy export activities must be submitted for consideration by the CDC. The issuance of a permit to the exporter under the agreement amongst provinces for international cheese exports is particularly important since it entitles the cheese processor to a price discount given by the local milk boards on the milk purchases required for the manufacturing of the products to be exported. This allows Canadian processors to be competitive in world markets as Canadian milk prices are higher than the average world industrial milk price. Since Canada s dairy policy s objective is to balance the supply and demand of milk, export activities are limited. Notwithstanding the foregoing and in view of the increasing importance of the dairy world market, various provincial dairy boards have established or are attempting to establish an optional export program whereby both the farmer, through his board, and the processor commit themselves to a specific volume that would not be calculated as part of Canada s domestic requirement. The Company intends to take advantage of the optional export program should it deem the potential return to be adequate. Canadian Market The dairy processing industry makes a major contribution to the Canadian economy with shipments valued at over $7.5 billion in Second only to meat processing, the dairy processing sector accounted for over 13.7% of the estimated value of all food and beverage processing sales in From August 1, 1995 to July 31, 1996, approximately 78.0 million hectolitres of milk were processed in Canada for sale to the fluid and industrial milk markets. Of the 278 dairy plants in Canada in 1994, 159 processed primarily industrial milk and 119 processed fluid milk. Significant rationalization is occurring in the processing sector as plants strive to achieve the greater efficiencies and economies of scale required to remain competitive in increasingly global markets. The following table indicates the production volumes of selected dairy products manufactured in Canada in Canadian Production Volumes of Selected Dairy Products in 1996 (1) (in thousands) Cheddar ,543 kg Yogurt ,090 kg Specialty cheeses (2) ,959 kg Milk powder... 64,336 kg Cottage cheese... 22,583 kg Concentrated milk... 95,989 kg Butter... 93,404 kg Fluid milk... 2,647,261 litres Ice cream and other ice cream Cream ,180 litres products ,556 litres (1) Source: 1996 Dairy Market Review of Agriculture and Agri-Food Canada. (2) Includes mozzarella. 9

11 Production of mozzarella accounts for an important portion of the Canadian production volumes of specialty cheeses as demonstrated by the table below. Canadian Production Volumes of Specialty Cheeses and Mozzarella (1) (in thousands of kilograms) Specialty cheeses , , , , ,104 Mozzarella , , ,691 99,186 93,513 (1) Source: 1996 Dairy Market Review of Agriculture and Agri-Food Canada. The United States Dairy Industry Regulatory Environment In the United States, the production of all food products is subject to extensive federal, state and local government regulations regarding the advertising, quality, packaging, labeling and safety. All food plants are subject to regulation and inspection by agencies such as the Food and Drug Administration ( FDA ) and the United States Department of Agriculture ( USDA ). State and local government agencies work with the federal government to ensure the safety of food produced within their jurisdictions. State and local government agencies also enforce environmental compliance. Milk Supply In the United States, there are two grades of milk: Grade A, which is used for fluid milk, and Grade B, which is used exclusively to manufacture dairy products. United States dairy programs influence the production and marketing of milk and milk products through the operation of the Commodity Credit Corporation ( CCC ), a federal agency. CCC buys butter, non-fat dry milk and cheese at below market support prices. Such products are either sold domestically or internationally. The CCC does not however directly support dairy farmers, nor does it establish a target return for farmers. In most cases, milk prices are set monthly based on the average milk price paid for Grade B milk in Minnesota-Wisconsin, updated by a product price formula known as the Basic Formula Price which takes into account weekly cheese price surveys conducted by the National Agriculture Statistics Service. Wholesale pricing for the bulk of the United States cheese production is established by Cheddar Cheese trades on the Chicago Mercantile Exchange. Cheddar trades once a week on Thursdays. The last trade on this day establishes the market price for the following week. Processors usually charge a premium over the established market price. A dairy processing plant is not limited in terms of the quantity of milk it can receive and is free to negotiate its milk supply with whomever it chooses. Independent processors usually negotiate with local cooperatives for the necessary milk quantities and are charged a price which reflects the current month s milk price plus a negotiated handling charge. International Trade (United States) Imports. Another key component of the United States dairy program is import restrictions. Most United States cheese import quotas are country and product specific. Under the terms of the WTO Agreement on Agriculture, the United States agreed to import, at a lower tariff rate, approximately 127,400 metric tons of cheese in Tariffs for cheese in excess of the quota are prohibitive. Entry for dairy products made with sheep, goat and buffalo milk do not require a license nor are they subject to a United States duty. The same is true for a few other products including brie cheese. Exports. The United States is not a significant exporter of dairy products. In 1995, United States export activity accounted for 2.4% of worldwide dairy products trade estimated at C$29.1 billion. 10

12 Most export activity is conducted through the Dairy Export Incentive Program which allocates subsidized export volumes to specific countries thereby enabling exporters to bid for export assistance for dairy products destined to these countries. United States Market In 1995, there was an estimated 489 cheese processing plants in the United States producing 3.2 billion kilograms of cheese for an estimated aggregate value of US$21.8 billion. Of the 3.2 billion kilograms of cheese produced in 1995, cheddar accounted for 34.9% of this total or 1.1 billion kilograms and Italian cheeses, as a whole, contributed 38.1% or 1.2 billion kilograms. Mozzarella alone accounted for approximately 950 million kilograms of total cheese production, representing 79.3% of Italian cheeses and 30.2% of all cheeses produced in The following table indicates the production volumes of Italian cheeses and Mozzarella in the United States from 1992 to United States Production Volumes of Italian Cheeses and Mozzarella (1) 1996 (2) (in thousands of kilograms) Italian cheeses... 1,251,036 1,198,414 1,191,010 1,131,507 1,137,883 Mozzarella... 1,012, , , , ,181 (1) Source: USDA (2) Source: Preliminary estimate USDA. Future Trends The rationalization trend which began several years ago in both the American and Canadian dairy industries is, in the Company s opinion, set to continue due to a more intense competitive environment caused by an increased presence of multinationals in the North American dairy industry. This evolving competitive environment will necessarily force regional processors to either adapt, sell or merge with other industry participants. Well-capitalized industry consolidators should take advantage of this rationalization trend to make strategic acquisitions. Canada s supply management system of its dairy industry may also come under pressure from internal and external sources. Internally, provincial governments risk being questioned for maintaining a system which artificially limits the economic activity of the dairy processing sector in their jurisdictions. In the opinion of the Company, provincial governments have already shown some openness towards a less rigid control of this sector of economic activity. Internationally, some of Canada s trade partners, particularly the United States, have expressed their opposition to Canada s system and are expected to continue to apply pressure, and this despite Canada s recent North American Free Trade Agreement panel victory. At present, the United States and New Zealand are threatening to bring Canada s dairy supply management system before the scrutiny of a WTO panel. Should this challenge materialize and be successful, Canada s dairy markets could be opened to direct American and international competition. Management is of the opinion that, should this occur, the Company is well positioned to take advantage of this deregulation as demonstrated by its financial performance in the United States deregulated environment. In 2001, a new round of tariff reduction negotiations is set to begin under the auspices of the WTO. It is anticipated that over quota tariffs for agricultural products will be subject to reductions. As long as Canada s supply management system remains in place, no significant growth can be achieved by Canadian producers other than through acquisitions. The recent consolidation that took place in the Canadian dairy industry has, however, greatly reduced the number of companies that can be acquired. In the United States, where plant quotas do not exist, increased market share can be achieved either by acquisition or by further utilizing existing facilities. It is management s intention to pursue both avenues while recognizing that acquisitions will provide for faster growth. 11

13 BUSINESS OF THE COMPANY Overview Saputo produces and markets mozzarella, other Italian specialty cheeses and by-products such as butter, lactose and whey protein. Saputo also distributes fine imported cheeses and a large assortment of other nondairy products that complement its cheese distribution. In fiscal 1997, mozzarella represented approximately 80% of the Company s total cheese production and 58.3% of its total sales. During the same period, 75.9% of Saputo s sales were in Canada, 14.8% in the United States and 9.3% internationally. The Company operates six manufacturing facilities in Canada and two in the United States which produced an aggregate of 55.2 million kilograms of cheese in fiscal On July 31, 1997, the Company had 800 full-time employees and 162 part-time employees. Saputo has established itself as Canada s leading producer of mozzarella, with a share of approximately 34% of the Canadian mozzarella production. In Canada, Saputo services mainly through its own distribution network three distinct market segments: food service (principally pizzerias), retail and industrial. In the United States, Saputo markets its products mainly to the food service segment through independent non-exclusive distributors. Internationally, products are sold through direct sales, local distributors and sales agents. Saputo has a strong history of profitability and growth through internal development and acquisitions. From fiscal 1993 to fiscal 1997, sales increased from $336.7 million to $450.5 million, representing a compounded annual growth rate of 7.6%. Net earnings during this period increased from $24.1 million to $41.0 million, representing a compounded annual growth rate of 14.2%. Historically, Saputo s net profit margins have been above those of other major Canadian cheese producers. Saputo s net profit margin for fiscal 1997 was 9.1%. Corporate Strengths and Strategy The Company s goal is to maintain its leadership position in the Canadian mozzarella market and to continue its growth in the broader North American dairy industry through a disciplined expansion program. Saputo will pursue this goal by drawing from the following strengths: Product Quality: Saputo s growth is largely attributable to its commitment to product quality, enabling the Company to sell its products at a premium price to a loyal clientele which values consistent quality. Low-Cost Producer: The Company is a low-cost producer due largely to its ability to maximize the output of cheese and value-added by-products per litre of milk and to management s approach to cost control. Dominance of Canadian Pizzeria Market: The Company s dominance of the Canadian pizzeria market is the direct result of its ability to rapidly adapt its infrastructure to supply this market segment with mozzarella. Saputo s focus on this market resulted in the gradual development of its unique Canadian distribution network which provides the Company with a significant competitive advantage. Value-Added By-Products: The St-Hyacinthe plant provides the Company with the ability to process liquid whey into value-added by-products such as lactose, whey protein and dairy blends, most of which are sold internationally. Specialty Cheese Capability: The Company is an active participant in the Canadian specialty cheese market both as a manufacturer and as an importer-distributor. As cheese imports become less and less subsidized from the country of origin, the Company believes that it can replace these premium priced imports with a domestic production that may command higher margins than the Company s present product line. IQF: The Company is the only Canadian cheese processor having an Individually Quick Frozen ( IQF ) capability, a manufacturing process that allows for mozzarella and other cheeses to be frozen at their optimum performance point. Acquisition Record: The Company s historical growth is principally due to a series of acquisitions whose subsequent financial performance demonstrates the Company s turnaround and integration abilities. 12

14 Experience in the United States: The Company has been operating in the United States for almost nine years. It has demonstrated its ability to operate in an unregulated dairy environment where it has achieved substantially the same manufacturing profit margins as those it has attained in Canada. Ready for Deregulation: As a low-cost producer with available production capacity, the Company is well positioned to compete and grow in a possible deregulated industry environment in Canada. History Mr. Emanuele (Lino) Saputo, the President and Chief Executive Officer of Saputo, started the Company with his parents in 1954, producing quality cheeses for the Italian community of Montreal. In the late 1950 s, the Company s first major production facility was constructed in the Montreal St. Michel district. In the 1960 s, Saputo grew significantly as demand for its products increased both in Montreal and in new markets, such as other regions of Quebec, Ontario and the Maritimes. In the 1970 s, Saputo acquired several production operations and developed its national distribution network, positioning itself, in Canada, as the leading producer of mozzarella, principally to the food service market segment. In 1981, the Company built a cheese plant in Mont-Laurier, Quebec and acquired a cheese plant in Cookstown, Ontario. In 1984, Saputo acquired a plant in St-Hyacinthe, Quebec which processes liquid whey, a by-product of its cheese production operations, into value-added products such as lactose and whey protein. Since 1984, Saputo has continued its growth in Canada by acquiring small to medium-sized cheese manufacturers, food distributors and manufacturers of other dairy products located in various parts of Canada. In 1988, the Company entered the United States market by acquiring a cheese manufacturing plant located in Richmond, Vermont and the Jefferson cheese plant now located in Hancock, Maryland. In 1996, Saputo acquired Fromages Caron Inc., a distributor of fine imported cheeses, then located in Beloeil, Quebec. In March 1997, a company controlled by Mr. Emanuele (Lino) Saputo acquired Crémerie des Trois-Rivières, Limitée which had sales of $18.0 million. On July 31, 1997, Crémerie des Trois-Rivières, Limitée became a wholly-owned subsidiary of Saputo. With this acquisition, the Company entered the fluid milk and ice cream markets, two segments of the dairy industry it had not previously explored. Products In Canada, the Company produces and markets nationally a wide variety of quality cheeses. It also produces a number of products derived from its cheese production including butter, lactose and whey protein. The Company s distribution network also distributes fine imported cheeses and a large assortment of third party manufactured non-dairy products that complement its cheese distribution to the food service industry, especially pizzerias. On a smaller scale, the Company recently started to produce fluid milk and ice cream. In the United States, the Company produces exclusively mozzarella and provolone leaving to independent distributors the distribution of its cheeses. The Company does not import any cheese in the United States, except for some limited quantities originating from its Canadian operations. The following table shows the Company s segmentation of sales by product category for fiscal 1997: Segmentation of Sales by Product Category in Fiscal 1997 Sales Percentage of total sales (in thousands of dollars) Mozzarella , Other manufactured cheeses... 78, Butter... 21, By-products... 21, Imported cheeses... 14, Non-dairy products... 52, Total ,

15 Mozzarella The Company s major product is mozzarella which represented 79.7% of the total volume of cheese manufactured by the Company and 58.3% of all sales in fiscal Used mainly as an ingredient in the preparation of various foods, especially pizza, mozzarella has always been at the centre of the Company s operations. The Company has grown to become the dominant producer in Canada s mozzarella market with a production share of approximately 34%. In Canada and in the United States, there are two processes to manufacture mozzarella. The first is the Italian type process, also known as pasta filata, which requires that, after coagulation, the curd be cooked at temperatures varying between 65 and 74 degrees Celsius (between 150 and 165 degrees Fahrenheit), thereby increasing the stretchability of the cheese and giving it that string-like attribute that is particular to pasta filata mozzarella. The other is the American type process which requires that the coagulated curd be vacuumed pressed. Although the Company produces both types, the majority of its Canadian mozzarella production and the totality of its American production utilize the Italian type process. Other Manufactured Cheeses Specialty Cheeses. In Canada, the Company produces an Italian specialty cheese line that includes ricotta, provolone, friulano, tuma, cacino, trecce, caciocavallo, bocconcini and a variety of parmesan cheese blends while in the United States, Saputo also produces provolone. With the recent completion of the specialty plant in St-Leonard, Quebec, the Company intends to further expand its share of this market segment with the introduction of new high margin specialty cheeses, some of which are presently imported from Europe and sold at premium prices. Furthermore, the specialty plant is equipped to produce string cheese for institutional and retail clients. In recent years, this product has gained popularity as a snack food. Cheddar and Other Pressed Cheeses. In Canada, the Company also manufactures a more traditional North American product line which includes cheddar, brick, colby, farmer, munster, edam, monterey jack and other cheese varieties belonging to the pressed cheese family. Process Cheese. The Company s Canadian operations also produce process cheese, a product that is widely consumed in Canada. The Company sells this product both to institutional and food service clients which buy in bulk sizes and to retailers which buy individually wrapped slices. Other Dairy Products Butter. In Canada, the Company produces butter from fat skimmed off the milk used in its cheese manufacturing process. Butter is a necessary by-product of the Company s cheese production since different types of cheeses use different percentages of fat. The butter manufactured by the Company is distributed to restaurants and retail stores under the Saputo brand name and is packaged pursuant to private label arrangements with certain key customers. The Company also sells small quantities of its butter production to the Canadian Dairy Commission which, in turn, sells it on the international market. When advantageous, the Company also sells its excess fat to other manufacturers who use it in the production of butter or ice cream. Fluid Milk and Ice Cream. The recent acquisition of Crémerie des Trois-Rivières, Limitée marks the Company s entry into the fluid milk and ice cream markets. It is the Company s intention to broaden its understanding of the fluid milk and ice cream production processes and market segments and to apply, where possible, its low-cost manufacturing expertise to such processes. This should increase the profitability of this business and allow the Company to slowly grow its share of the Quebec fluid milk and ice cream markets. At present, the operations are marginally profitable but management is confident about the potential profitability of these product lines and is committed to make further investments as long as the profitability of this plant is consistent with the Company s expectations. 14

16 By-Products: Lactose, Whey Protein, Whey Powder and Dairy Blends Liquid whey is a by-product of the Company s cheese production which represents approximately 90% of total milk composition, leaving the remaining ten percent as the basis for cheese production. Utilizing liquid whey from its operations and from third party facilities, the Company s St-Hyacinthe facility extracts solids from liquid whey and processes these solids into lactose, whey protein and whey powder. Lactose, which is commonly found in infant formulas and dry soup mixes, is sold primarily on the international market. Saputo produces more than 10,000 tons of lactose per year and is the only producer of lactose in Canada. Whey protein is used in the formulations of ice cream, caramel and yogurt and may also be used as animal feed. It is sold both domestically and internationally. In its St-Hyacinthe facility, the Company also produces numerous blends of dairy product powders which clients use as substitutes for higher priced ingredients in their specific product formulations. Whey powder results from the drying of liquid whey and is used in various product formulations, including bread. The resulting by-product of lactose and whey protein production, known as mother liquor, is also sold by the Company as animal feed. All of the Company s Canadian and United States plants send liquid whey by truck to the St-Hyacinthe facility for processing, with the exception of the facility in Souris, Manitoba. Because of the distance between the Souris plant and the St-Hyacinthe plant, the liquid whey emanating from the Souris plant is dried on site. The process in place is different than the one in St-Hyacinthe and the resulting product, commonly referred to as popcorn whey, has less value and is sold as animal feed. Imported Cheeses As a holder of a cheese import allocation, the Company is active in this market segment. The Company does not have sufficient quotas to satisfy demand for imported cheeses. Accordingly, it enters into agreements with existing quota holders. In the United States, the Company does not hold any import quotas. It does, however, import some very limited quantities of cheese originating from its Canadian operations through arrangements made with authorized American licence holders. Non-Dairy Products In Canada, the Company s sales force distributes a wide variety of other products sourced from domestic and international suppliers. This line of products includes pasta, vegetable oils, margarine, spices, flour, various meats, tomato sauce, pizza boxes, olives, pineapples and shortening. The nationwide distribution of these complementary products is exclusively used to enhance the sale of the Company s cheeses by offering clients, especially pizzerias, the advantage of dealing with one supplier offering a full range of products. Most of these products are sold under the Saputo label. Production Manufacturing Process The production of cheese is predicated on the coagulating property of milk. In its simplest terms, the manufacturing process of cheese is as follows: milk is received, skimmed and pasteurized. Excess fat is sent for butter production. The skimmed milk is then sent to a vat and cooked. Rennet is added to facilitate coagulation. Upon coagulation, whey separates from the cheese curds and both products are channeled to a draining station where the cheesemaker awaits the proper ph level. Whey is then removed from the draining station. If it is a pressed cheese, the cheese curd is sent for moulding and vacuum pressing. If it is a pasta-filata cheese, it is sent to a cooker that heats the curd. Once cooked, the Italian type mozzarella is moulded and kept in a brine solution until packed. Whey is transported to the St-Hyacinthe plant where it is processed into lactose, whey protein and whey powder. Please refer to the diagram appearing on the next page for an illustration of the Company s manufacturing process. 15

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