Van Houtte Inc. For the year ending April 3, 2004
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1 Van Houtte Inc. For the year ending April 3, 2004 TSX/S&P Industry Class = Annual Revenue = Canadian $328.4 million 2004 Year End Assets = Canadian $370.0 million Web Page (October, 2005) = Financial Reporting In Canada Survey Company Number 191
2 26 consolidated financial statements Management s Responsibility for Financial Statements THESE FINANCIAL statements have been prepared by management in conformity with Canadian generally accepted accounting principles and include amounts that are based on best estimates and judgments. Management of the Company and of its subsidiaries, in furtherance of the integrity and objectivity of the data in the financial statements, has developed and maintains systems of internal accounting controls and supports a program of internal audit. Management believes that these systems of internal accounting controls provide reasonable assurance that financial records are reliable and form a proper basis for the preparation of the financial statements and that assets are properly accounted for and safeguarded, and that the preparation and presentation of other financial information are consistent with the financial statements. The Board of Directors carries out its responsibility for the financial statements principally through its Audit Committee, consisting solely of outside directors. The Audit Committee reviews the Company s annual consolidated financial statements, and management s discussion and analysis and recommends them to the Board of Directors for approval. The Audit Committee meets with the Company s management, internal and external auditors to discuss internal controls over the financial reporting process, auditing matters and financial reporting issues and formulates the appropriate recommendations to the Board of Directors. The auditors appointed by the shareholders have full access to the Audit Committee, with and without management being present. These financial statements have been examined by the auditors appointed by the shareholders, KPMG LLP, chartered accountants, and their report is presented hereafter. Jean-Yves Monette President and Chief Executive Officer Gérard Geoffrion Executive Vice-President and Chief Financial Officer May 21, 2004 Auditors Report to the Shareholders WE HAVE AUDITED the consolidated balance sheets of Van Houtte Inc. as at April 3, 2004 and March 29, 2003 and the consolidated statements of earnings, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at April 3, 2004 and March 29, 2003 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles. Chartered Accountants Montreal, Canada May 21, 2004
3 Consolidated Statements of Earnings consolidated financial statements 27 Years ended April 3, 2004 and March 29, 2003 (In thousands of dollars, except for earnings per share data) Revenues $ 328,389 $ 316,768 Cost of goods sold and operating expenses 268, ,158 59,562 61,610 Depreciation and amortization 31,030 29,769 Financial expenses (Note 3) 4,860 5,378 Operating profit before the undernoted 23,672 26,463 Non-recurring charges (Note 4) 5,174 Income taxes (Note 5) 4,671 5,062 Earnings before the undernoted 19,001 16,227 Share in net earnings of companies subject to significant influence Non-controlling interest (476) (343) Net earnings from continuing operations 18,564 15,988 Discontinued operations (net of income taxes of $ 406) (Note 6) (1,260) Net earnings $ 18,564 $ 14,728 EARNINGS PER SHARE (Note 7) Basic From continuing operations $ 0.87 $ 0.74 From discontinued operations (0.06) Net earnings Diluted From continuing operations $ 0.86 $ 0.74 From discontinued operations (0.06) Net earnings Weighted average number of shares outstanding (in thousands) 21,428 21,517 Diluted weighted average number of shares (in thousands) 21,532 21,657 See accompanying notes to consolidated financial statements. Consolidated Statements of Retained Earnings Years ended April 3, 2004 and March 29, 2003 (In thousands of dollars) Retained earnings, beginning of year $ 86,184 $ 76,791 Net earnings 18,564 14, ,748 91,519 Dividends 4,719 4,308 Premium paid on redemption of subordinate voting shares (Note 14) 272 1,027 Retained earnings, end of year $ 99,757 $ 86,184 See accompanying notes to consolidated financial statements.
4 28 consolidated financial statements Consolidated Balance Sheets April 3, 2004 and March 29, 2003 (In thousands of dollars) ASSETS Current assets: Cash $ 7,341 $ 9,148 Accounts receivable 36,396 33,652 Income taxes receivable 576 2,230 Inventories (Note 8) 26,775 24,402 Prepaid expenses 3,301 3,685 Future income taxes (Note 5) 1,859 1,585 76,248 74,702 Investments (Note 9) 18,128 19,479 Fixed assets (Note 10) 116, ,929 Goodwill (Note 11) 140, ,963 Other assets (Note 12) 7,315 5,398 Future income taxes (Note 5) 10,542 7,626 $ 369,977 $ 363,097 LIABILITIES AND SHAREHOLDERS EQUITY Current liabilities: Accounts payable and accrued liabilities $ 33,117 $ 29,101 Current portion of long-term debt (Note 13) 22,710 30,857 55,827 59,958 Long-term debt (Note 13) 84,796 83,226 Employee future benefits 1,562 2,775 Future income taxes (Note 5) 3,083 2,472 Non-controlling interest 5,622 2,425 Shareholders equity: Capital stock (Note 14) 127, ,229 Retained earnings 99,757 86,184 Currency translation adjustment (Note 15) (7,746) (1,172) 219, ,241 Commitments (Note 16) Contingencies (Note 17) See accompanying notes to consolidated financial statements. $ 369,977 $ 363,097 On behalf of the Board: Jean-Yves Monette, Director Robert Parizeau, Director
5 consolidated financial statements 29 Consolidated Statements of Cash Flows Years ended April 3, 2004 and March 29, 2003 (In thousands of dollars) CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings from continuing operations: $ 18,564 $ 15,988 Adjustments for: Depreciation of fixed assets 28,881 28,310 Amortization of other assets 2,149 1,459 Amortization of financial expenses Future income taxes (3,194) (400) Non-controlling interest Share in net earnings of companies subject to significant influence, net of dividends received of $81 in 2003 (39) (23) Write-down and write-off of fixed assets 2,911 Loss on disposal of investment and unit 1,740 (Gain) loss on disposal of fixed assets (91) 2 Gain on disposal of businesses (393) (85) Gain on foreign exchange (126) (182) 46,705 50,662 Net change in non-cash balances related to operations (Note 18) (1,141) (3,810) 45,564 46,852 CASH FLOWS FROM INVESTING ACTIVITIES: Business acquisitions (Note 19) (13,884) (5,024) Additions to fixed assets (23,116) (32,256) Proceeds from disposal of fixed assets 1,503 1,610 Proceeds from disposal of investment 1,504 Acquisitions of investments (1,139) (410) Increase in other assets (2,801) (2,216) (39,437) (36,792) CASH FLOWS FROM FINANCING ACTIVITIES: Issue of subordinate voting shares (Note 14) Redemption of subordinate voting shares for cancellation (Note 14) (710) (2,131) Increase in long-term debt 51 1,579 Dividends (4,719) (4,308) Dividends paid to non-controlling shareholders of subsidiaries (830) (551) (5,923) (4,916) Effect of exchange rate changes on cash denominated in foreign currency (2,011) (596) Effect of discontinued operations on cash and cash equivalents (148) Net (decrease) increase in cash (1,807) 4,400 Cash, beginning of year 9,148 4,748 Cash, end of year $ 7,341 $ 9,148 See accompanying notes to consolidated financial statements.
6 30 Notes to Consolidated Financial Statements Years ended April 3, 2004 and March 29, 2003 (Tabular amounts are expressed in thousands of dollars) VAN HOUTTE INC. is incorporated under the Canada Business Corporations Act. The Company is an important gourmet coffee roaster, marketer and distributor. It markets its gourmet coffees across Canada and the US through distribution channels that include coffee services, retail stores, café-bistros, on-line shopping and food service networks. 1 Changes in accounting policies The Company has made certain changes in accounting policies to conform to the new accounting standards issued and applicable to us. (a) NEW ACCOUNTING POLICIES Guarantees In February 2003, the Canadian Institute of Chartered Accountants ( CICA ) issued Accounting Guideline 14 ( AcG-14 ), Disclosure of Guarantees, which requires that certain disclosures be made by a guarantor about its obligations under guarantees in its interim and annual consolidated financial statements for interim periods beginning on or after January 1, A guarantee is a contract or an indemnification agreement that contingently requires the Company to make payments to the other party to the contract or agreement, based on changes in an underlying that is related to an asset, a liability or an equity security of the other party or based on a third party failure to perform under an obligating agreement. It could be also an indirect guarantee of the indebtedness of another party, even though the payment to the other party may not be based on changes in an underlying that is related to an asset, a liability or an equity of the other party. In the normal course of business, the Company enters into agreements containing features that meet the AcG-14 criteria for a guarantee including the following: Capital leases A subsidiary of the Company, VKI Technologies Inc., has guaranteed lease obligations to third parties by franchisees of its Filterfresh Coffee Service, Inc. subsidiary. As security for the guarantees provided, the Company has a lien on the franchisees licenses and assets. As at April 3, 2004, the Company guarantees a total of US$128,905 for lease obligations to third parties. The company also guarantees lease obligations to third parties for a total of US$170,285. In the opinion of management, the security for the guarantees provided is adequate. Directors and officers indemnification agreements The Company indemnifies its directors and officers, former directors and officers and individuals who act or who have acted at the Company s request to be a director or officer of an entity in which the Company is a shareholder or creditor, to the extent permitted by law, against any and all charges, costs, expenses, amounts paid in settlement or investigative damages incurred by the directors and officers as a result of any lawsuit, or any judicial, administrative or investigating proceeding in which the directors and officers are sued as a result of their service. These indemnification claims are subject to any statutory or other legal limitation period. The nature of the indemnification agreements prevents the Company from making a reasonable estimate of the maximum potential amount it could be required to pay to counterparties.
7 notes to consolidated financial statements 31 1 Changes in accounting policies (continued) (a) NEW ACCOUNTING POLICIES (continued) Guarantees (continued) Directors and officers indemnification agreements (continued) The Company has purchased directors and officers liability insurance which carries a $75,000 deductible. No amount has been accrued in the consolidated balance sheet with respect to these indemnifications. To the knowledge of the Company, there is no such claim against directors and officers. Operating leases The Company has guaranteed lease obligations by its franchisees expiring between 2004 and If a franchisee defaults under its contractual obligation, the Company must, under certain conditions, compensate the lessor for the default. The maximum exposure in respect of these guarantees is $737,651. As at April 3, 2004, the Company has not recorded a liability associated with these guarantees, since it is not probable that a franchisee will default under the agreement. (b) STOCK-BASED COMPENSATION AND OTHER STOCK-BASED PAYMENTS On March 31, 2002, the Company prospectively adopted the new accounting recommendations published by the CICA relating to stock-based compensation and other stock-based payments made in exchange for goods and services. As per Section 3870 of the CICA Handbook, the Company has chosen to continue using the settlement value method to record stock options granted to senior executives and management. Under this method, no compensation expense is recorded for such stock options. Any cash consideration paid by these beneficiaries on exercise of stock options is credited to capital stock. 2 Significant accounting policies The consolidated financial statements are prepared in accordance with Canadian generally accepted accounting principles. (a) CONSOLIDATION AND LONG-TERM INVESTMENTS The consolidated financial statements include the accounts of Van Houtte Inc. and all its subsidiaries (the Company ). The major subsidiaries are Red Carpet Food Systems Inc., Selena Coffee Inc., Filterfresh Coffee Service, Inc., VKI Technologies Inc., Les Cafés Orient Express Ltée, Red Carpet Refreshment Systems Inc. and Selena Food Services Inc. Investments in joint ventures are accounted for using the proportionate consolidation method. Joint ventures represent a negligible portion of the Company s operations. Investments in companies subject to significant influence are accounted for by the equity method. Portfolio investments are recorded at cost and would be written down in the case of a permanent impairment. Investments in companies in which the Company believes it does not exercise a significant influence are classified as portfolio investments. (b) INVENTORIES Raw materials are stated at the lower of cost, based on the first in, first out method, and replacement value. Finished goods and work in process are stated at the lower of average cost and net realizable value. Raw materials purchased using commodity contracts are accounted for at the purchase price set out under the terms and conditions of these contracts.
8 32 notes to consolidated financial statements 2 Significant accounting policies (continued) (c) FIXED ASSETS Fixed assets are stated at cost, net of any investment tax credits which are accounted for when qualified expenditures are incurred. Interest expense and other direct costs relating to major capital projects are capitalized to the cost of fixed assets until the commercial production stage. Depreciation is calculated using the straight-line method over the following periods: Asset Buildings Coffee service equipment Vending equipment Machinery and equipment Furniture and computer equipment Automotive equipment Leasehold improvements Period 20 to 30 years 7 years 12 years 5 to 15 years 3 to 10 years 3 to 15 years Term of lease (d) GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill and intangible assets with indefinite useful lives are not amortized. Goodwill is tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test is carried out in two steps. In the first step, the carrying amount of the reporting unit is compared with its fair value. When the fair value of a reporting unit exceeds its carrying amount, then goodwill of the reporting unit is considered not to be impaired and the second step of the impairment test is not required. The second step is carried out when the carrying amount of a reporting unit exceeds its fair value, in which case the implied fair value of the reporting unit s goodwill is compared with its carrying amount to measure the amount of the impairment loss, if any. When the carrying amount of the reporting unit s goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized in an amount equal to the excess and is presented as a separate line item in the statement of earnings before extraordinary items and discontinued operations. Intangible assets acquired in business combinations which have an indefinite useful life, are also tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test compares the carrying amount of the intangible asset with its fair value, and an impairment loss is recognized in the statement of earnings for the excess of the carrying value over the fair value. Intangible assets with definite useful lives are amortized over their useful life. (e) OTHER ASSETS Deferred development costs, net of applicable research and development tax credits, represent costs incurred to develop new coffee brewing equipment, brewers and other. Deferred costs are amortized on a straight-line basis over three years. Patents and rights are recorded at cost and are amortized using the straight-line method over 17 years. The deferred financing costs related to long-term financing are amortized using the straight-line method over the term of the related long-term debt.
9 notes to consolidated financial statements 33 2 Significant accounting policies (continued) (e) OTHER ASSETS (continued) Other assets, which include start-up costs, are amortized over a period ranging from 3 to 10 years. Management reviews periodically the value and amortization period of other assets. A permanent decline, if such be the case, will be determined based on future undiscounted cash flows. (f) INCOME TAXES The Company follows the asset and liability method of accounting for income taxes. Under this method, future income tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases. Future income tax assets and liabilities are measured using enacted or substantively enacted tax rates expected to apply when the assets are realized or the liabilities settled. Future income tax assets are recognized and, if realization is not considered more likely than not a valuation allowance is provided. The effect on future income tax assets and liabilities of a change in tax rates is recognized in income in the period that substantive enactment or enactment occurs. (g) EMPLOYEE FUTURE BENEFITS The Company accrues the estimated cost of the contractual termination benefits, when it is probable that employees will be entitled to benefits and the amount can be reasonably estimated. (h) FOREIGN CURRENCY TRANSLATION Net assets of self-sustaining foreign operations are translated using the current rate method. Adjustments arising from this translation are deferred and recorded as a separate item under shareholders equity and are included in income only when a reduction in the net investment in these foreign operations is realized. Gains or losses on foreign currency balances or transactions that are designated as hedges of a net investment in self-sustaining foreign operations are offset against exchange losses or gains included in the Currency translation adjustment account included in shareholders equity. Other foreign currency transactions entered into by the Company are translated using the temporal method. Translation gains and losses are included in the statement of earnings. (i) DERIVATIVE FINANCIAL INSTRUMENTS The Company uses various derivative financial instruments to manage its exposure to fluctuations in interest rates, foreign currency exchange rates and commodity pricing. The Company does not hold or use any derivative instruments for speculative trading purposes. The Company documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives to specific assets and liabilities or to specific firm commitments or forecasted transactions. The Company enters into interest rate swaps in order to manage the impact of fluctuating interest rates on its long-term debt. These swap agreements require the periodic exchange of payments without the exchange of the notional principal amount on which the payments are based. The Company designates its interest rate swap agreements as hedges of the underlying debt. Interest expense on the debt is adjusted to include the payments made or received under the interest rate swaps.
10 34 notes to consolidated financial statements 2 Significant accounting policies (continued) (i) DERIVATIVE FINANCIAL INSTRUMENTS (continued) Realized and unrealized gains or losses associated with derivative instruments, which have been terminated or cease to be effective prior to maturity, are deferred under other current or non-current assets or liabilities on the balance sheet and recognized in earnings in the period in which the underlying hedged transaction is recognized. In the event a designated hedged item is sold, extinguished or matures prior to the termination of the related derivative instrument, any realized or unrealized gain or loss on such derivative instrument is recognized in earnings. (j) REVENUE RECOGNITION Revenue is recognized when goods are delivered or when services are provided. (k) USE OF ESTIMATES The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, related amounts of revenues and expenses and disclosure of contingent assets and liabilities. Significant areas requiring the use of management estimates relate to the determination of the useful life of assets for amortization and evaluation of net recoverable amounts, the determination of the fair value of portfolio investments, the determination of the fair value of assets acquired and liabilities assumed in business combinations, implied fair value of goodwill, provisions for income taxes and determination of future income tax assets and liabilities and the determination of the fair value of financial instruments. Actual results could differ from those estimates. 3 Financial expenses Interest on long-term debt $ 4,382 $ 4,779 Amortization of financial expenses $ 4,860 $ 5,378 4 Non-recurring charges Write-off of fixed assets (i) $ $ 2,911 Loss on disposal of investments and of a business unit (i) 1,740 Other restructuring charges 523 $ $ 5,174 (i) In 2003, to reflect the new organizational structure and the integration of its Canadian operations, the Company wrote off certain assets related to the integration of its information management systems and the divestiture of a marginal non-strategic unit.
11 notes to consolidated financial statements 35 5 Income taxes Income tax expenses are detailed as follows: Current $ 7,865 $ 5,462 Future (3,194) (400) The following table reconciles the statutory tax rate with the effective tax rate: $ 4,671 $ 5,062 Combined statutory tax rate 33.2 % 35.3 % Losses recovered at a rate higher than the statutory rate (1.0) (1.4) Manufacturing and processing deduction 0.2 (1.0) Adjustment to future income tax assets and liabilities for enacted changes in tax laws and rates (1.1) 0.5 Foreign tax rate variance (8.5) (11.8) Other items (3.1) 2.2 Effective tax rate 19.7 % 23.8 % The tax effects of temporary differences that give rise to a significant portion of the future tax assets and future tax liabilities are as follows: FUTURE INCOME TAX ASSETS - CURRENT: Employee future benefits $ 624 $ 115 Reserve deductible next year 1,235 1,470 1,859 1,585 FUTURE INCOME TAX ASSETS - NON-CURRENT: Tax losses carried forward 16,954 11,853 Employee future benefits 893 Differences between book and tax bases of fixed assets 1,676 1,750 Differences between book and tax bases of other assets Total future income tax assets - non-current 18,765 14,639 FUTURE INCOME TAX LIABILITIES - NON-CURRENT: Differences between book and tax bases of fixed assets 4,301 4,884 Differences between book and tax bases of other assets 7,005 4,601 Total future income tax liabilities 11,306 9,485 Net future income tax assets $ 9,318 $ 6,739
12 36 notes to consolidated financial statements 5 Income taxes (continued) These future tax assets and liabilities are presented as follows in the consolidated balance sheet: FUTURE INCOME TAX ASSETS: Current $ 1,859 $ 1,585 Long-term 10,542 7,626 12,401 9,211 Future income tax liabilities 3,083 2,472 Net future income tax assets $ 9,318 $ 6,739 The Company has not recognized a future tax liability for the undistributed earnings of its subsidiaries in 2004 and in prior years because the Company does not expect those unremitted earnings to reverse and become taxable to the Company in the foreseeable future. A future tax liability will be recognized when the Company expects that it will recover these undistributed earnings in a taxable manner. As at April 3, 2004, the Company had non-capital losses to carry forward of $46,600,000 originating mainly from U.S. subsidiaries and capital losses to carry forward of $1,644,000 without expiry dates. These non-capital losses are available to reduce the taxable income of future years and expire at different dates from 2007 to The future tax asset related to these operating losses has been recorded in the financial statements. 6 Discontinued operations On March 19, 2003, pursuant to a sale and purchase agreement, Van Houtte Inc. sold all its outstanding shares of Fairfield, representing a 60% equity interest, for a cash consideration of $1. Consequently, the European market segment is considered a discontinued operation and accordingly the results of operations and the cash flows of 2003 were adjusted in order to isolate the effect of this discontinued operation. Fairfield s operating results were then presented separately from the beginning of 2002 until March 19, 2003, the disposal date. The following table provides additional financial information related to the discontinued operation for the year ended March 29, 2003: Condensed Consolidated Statement of Earnings Revenues $ 1,379 Loss before non-controlling interest $ 923 Non-controlling interest (369) Loss of the discontinued operation 554 Loss on disposal, net of income taxes of $ Net loss from the discontinued operation $ 1,260
13 notes to consolidated financial statements 37 7 Earnings per share Basic earnings per share is calculated by dividing the net earnings attributable to the common shareholders by the weighted average daily number of common shares outstanding during the year. Diluted earnings per share is calculated by dividing the net earnings attributable to the common shareholders by the weighted average number of common shares outstanding restated to take into account the potential dilutive impact of the exercise of the stock options under the treasury stock method. (in thousands) (in thousands) Weighted average number of outstanding common shares 21,428 21,517 Potential dilutive impact Weighted average number of common and dilutive common shares 21,532 21, Inventories Raw materials $ 10,685 $ 7,558 Work in process Finished goods 15,433 16,152 $ 26,775 $ 24,402 Investments Shares in companies subject to significant influence, voting and participating, at equity value $ 383 $ 2,708 Advances to companies subject to significant influence and to minority shareholders, with various interest rates and payment terms 2,325 1,351 Portfolio investment 15,420 15,420 $ 18,128 $ 19,479 Fixed assets 2004 Accumulated Net book Cost depreciation value Land $ 1,571 $ $ 1,571 Buildings 14,893 4,628 10,265 Coffee service equipment and vending equipment 145,138 74,300 70,838 Machinery and equipment 40,269 22,907 17,362 Furniture, computer equipment and leasehold improvements 26,839 17,170 9,669 Automotive equipment 17,247 9,989 7,258 $ 245,957 $ 128,994 $ 116,963
14 38 notes to consolidated financial statements Fixed assets (continued) 2003 Accumulated Net book Cost depreciation value Land $ 1,571 $ $ 1,571 Buildings 14,827 4,150 10,677 Coffee service equipment and vending equipment 141,901 65,969 75,932 Machinery and equipment 37,602 19,142 18,460 Furniture, computer equipment and leasehold improvements 22,727 13,811 8,916 Automotive equipment 16,645 9,272 7,373 $ 235,273 $ 112,344 $ 122,929 Goodwill For the year ended April 3, 2004, the changes in the carrying amounts of goodwill are as follows: Canada United States Total Balance as at March 29, 2003 $ 73,370 $ 59,593 $ 132,963 Purchases (disposals) of business/shares of a subsidiary 1,652 13,085 14,737 Translation adjustments (6,919) (6,919) $ 75,022 $ 65,759 $ 140, Other assets 2004 Accumulated Net book Cost amortization value Patents and rights $ 918 $ 515 $ 403 Start-up costs 1, Deferred development costs 6,318 3,260 3,058 Deferred financing costs 1,889 1, Other assets 4,010 1,206 2,804 $ 14,298 $ 6,983 $ 7, Accumulated Net book Cost amortization value Patents and rights $ 664 $ 367 $ 297 Start-up costs 1, Deferred development costs 4,331 2,005 2,326 Deferred financing costs 1,953 1, Other assets 1, ,025 $ 9,706 $ 4,308 $ 5,398
15 notes to consolidated financial statements Long-term debt Revolving bank credit facility (i) $ 104,681 $ 108,617 Mortgage loan, 11.75%, repaid during the year 1,549 Due to non-controlling shareholders of subsidiaries (US$1,400,000), bearing interest at 12%, repaid during the year 2,049 Other 2,825 1, , ,083 Less current portion 22,710 30,857 $ 84,796 $ 83,226 (i) As at April 3, 2004, these borrowings were drawn on a bank credit facility of $150 million. The bank credit facility is composed of two tranches. The first tranche of $60 million is a 364-day revolving facility that can be extended on a yearly basis and the second tranche of $90 million is a three-year revolving facility maturing in October As at April 3, 2004, Cdn$22,000,000. was borrowed under the first tranche, and $82,682,000 (Cdn$33,000,000 and US$38,000,000) under the second tranche. The borrowed amounts of the first tranche are to be reimbursed in full in October 2007 at the latest or if the facility is not extended, while the borrowed amounts of the second tranche will be converted, in October 2005, into a two-year term loan repayable in eight quarterly installments beginning three months following the effective date of the term loan. The credit agreement governing this bank credit facility contains certain covenants, among which is the obligation to maintain certain financial ratios. The borrowed amounts bear interest at floating rates based on Bankers Acceptances or the bank prime rate. The bank credit facility is secured by all the assets of Van Houtte Inc. In accordance with the terms of various borrowing agreements and excluding any refinancing options, the Company will make the following repayments over the next few years: 2005 $ 22, , , ,
16 40 notes to consolidated financial statements 14 Capital stock AUTHORIZED: Unlimited number of multiple voting shares with voting rights of five votes per share, participating and without par value Unlimited number of subordinate voting shares with voting rights of one vote per share, participating and without par value Unlimited number of Classes A and B preferred shares, issuable only in series, non-voting and without par value ISSUED AND PAID: 5,300,000 multiple voting shares $ 353 $ ,130,481 subordinate voting shares (16,139,681 shares in 2003) 126, ,876 $ 127,076 $ 127,229 (a) SHARE ISSUE AND REPURCHASE 2004 During the year, 55,700 subordinate voting shares were redeemed for a cash consideration of $710,000. The excess of the price paid over the average cost of these shares as well as the redemption expenses of $272,000 were recorded as a reduction of retained earnings. During the year, 46,500 subordinate voting shares were issued upon the exercise of stock options, for a cash consideration of $284,675. (b) SHARE ISSUE AND REPURCHASE 2003 During the year, 140,500 subordinate voting shares were redeemed for a cash consideration of $2,131,000. The excess of the price paid over the average cost of these shares as well as the redemption expenses of $1,027,000 were recorded as a reduction of retained earnings. During the year, 44,200 subordinate voting shares were issued upon the exercise of stock options, for a cash consideration of $495,350. (c) STOCK OPTION PLAN Under a stock option plan, 1,650,000 subordinate voting shares are reserved for certain management employees of the Company. The exercise price of each option is determined based on the average of the daily high and low board lot trading prices of the Company s shares on the TSX stock exchange for the last five trading days for which there have been transactions immediately preceding the date on which the option is granted. Each option may be exercised during a period not exceeding ten years from the date it was granted.
17 notes to consolidated financial statements Capital stock (continued) (c) STOCK OPTION PLAN (continued) The following table provides details regarding changes to outstanding options for the years ended April 3, 2004 and March 29, 2003: Weighted Weighted average average Options exercise price Options exercise price Balance at beginning 1,181,674 $ ,230,599 $ Granted 243, , Cancelled (346,072) (325,238) Exercised (46,500) 6.12 (44,200) Balance at end of year 1,033,023 $ ,181,674 $ Vested options at end of year 714,515 $ ,367 $ The following table provides summary information regarding outstanding options as at April 3, 2004: Options outstanding Options exercisable Number of Weighted Weighted Weighted Range of outstanding average average Number average exercise options as at years to exercise exercisable as at exercise prices April 3, 2004 maturity price at April 3, 2004 price $ 5 to , $ ,000 $ to 10 9, , to , , to , , to , , to , , $ 5 to 30 1,033, $ ,515 $ During the year 2004, the Company granted 243,921 stock options to senior executives and management at a weighted average exercise price of $14.22 and cancelled 346,072 options, of which 61,561 were granted after March 31, 2002 at a weighted average exercise price of $ The weighted average fair value of stock options granted was $4.07 while that of cancelled options was $6.20. The fair value of each option granted was determined using the Black-Scholes option pricing model and the following weighted average assumptions: Risk-free interest rate 4.47% Expected life 5.2 years Expected volatility 27% Expected dividend yield 1.5%
18 42 notes to consolidated financial statements 14 Capital stock (continued) (c) STOCK OPTION PLAN (continued) If the stock options had been accounted for based on the fair value based method, pro forma net earnings and pro forma net earnings per share would have been as follows: As reported Pro forma Net earnings $ 18,564 $ 17,841 EARNINGS PER SHARE: Basic $ 0.87 $ 0.83 Diluted $ 0.86 $ 0.83 The pro forma figures omit the effect of stock options granted prior to March 31, Currency translation adjustment Balance at beginning $ (1,172) $ 2,605 Effect of exchange rate variation on translation of net assets of U.S. subsidiaries (6,574) (3,777) Balance at end $ (7,746) $ (1,172) Furthermore, gain (loss) on foreign exchange transactions recorded in the consolidated statement of earnings amounted to ($1,563,000) in 2004 and ($202,700) in Commitments The Company rents premises and equipment under operating leases which expire at various dates up to 2014 and for which gross rents total $26,750,000. Of this amount, a portion of $3,247,000 is assumed by the franchisees of the Company. Annual payments under these leases for the next five years are as follows: Gross Franchisees Net 2005 $ 6,605 $ 844 $ 5, , , , , , , , , Contingencies The Company is involved in various lawsuits and claims. Management is of the opinion that the resolution of these claims would have no material impact on the Company s financial position or results of operations.
19 notes to consolidated financial statements Additional information on cash flows OPERATING ACTIVITIES: Changes in non-cash operating working capital items: (Increase) decrease in the undernoted items: Accounts receivable $ (2,744) $ 4,198 Income taxes payable 1,655 (401) Inventories (2,372) (512) Prepaid expenses (Decrease) increase in the undernoted items: Accounts payable and accrued liabilities 2,865 (6,535) Employee future benefits (1,212) (903) Working capital acquired 283 (452) $ (1,141) $ (3,810) CASH PAYMENTS OF INTEREST AND INCOME TAXES WERE AS FOLLOWS: Cash interest payments $ 4,765 $ 5,174 Cash payments for income taxes $ 6,211 $ 4,979 Purchase of fixed assets financed by accounts payable $ 1,644 $ Business and asset acquisitions and disposals The business combinations are accounted for using the purchase method. Results of the businesses acquired are included from the date of the acquisition in the consolidated financial statements of the Company. (a) 2004 During the year, the Company acquired fifteen coffee service businesses, twelve in the United States and three in Canada, and sold six of its vending branches in Canada for a total net cash consideration of $13,884,000. The principal acquisitions of the year are: United States On March 30, 2003, concurrent with a partnership agreement of which the Company holds a 74% interest, the Company purchased the businesses of Coffee Time Inc. and Mocha Men West Inc.; On December 15, 2003, concurrent with a partnership agreement of which the Company holds a 56% interest, the Company purchased the business of Corporate Coffee System, LLC. On June 26, 2003, the Company acquired the remaining 75% ownership of Caffe Satisfaction LLC.
20 44 notes to consolidated financial statements 19 Business and asset acquisitions and disposals (continued) (b) 2003 During the year, the Company acquired nine coffee service businesses, eight in the United States and one in Canada and sold five business units, three in the United States and two in Canada for a total cash consideration of $5,024,000. The acquisitions and disposals are summarized as follows: ASSETS ACQUIRED AND DISPOSED: Non-cash operating working capital $ 283 $ (452) Fixed assets 4,183 1,117 Other assets 1,831 Goodwill (i) 14,737 4,665 21,034 5,330 LIABILITIES ASSUMED: Long-term debt Non-controlling interest 4,070 Gain on disposal 393 Net assets acquired at fair value $ 16,022 $ 5,024 CONSIDERATION: Cash $ 13,884 $ 5,024 Portion of purchase price paid in a prior year 2,138 $ 16,022 $ 5,024 (i) Tax base of goodwill acquired $ 13,796 $ 3, Financial instruments (a) FAIR VALUE The carrying value of cash, accounts receivable, accounts payable and accrued liabilities approximates their fair value because of the near-term maturity of these instruments. The carrying value of the revolving term loan and other debt approximates its fair value, as the interest rates vary based on market rate. In 2003, the estimated fair value of mortgage loan and of the due to non-controlling shareholders of a subsidiary, calculated at the value of contractual future payments of principal and interest, discounted at the current market rate of interest available to the Company for the same type of debt instrument, was $3,768,000. The negative fair value of the interest rate swap is $1,884,907 ( $648,872). (b) MANAGEMENT OF INTEREST RISK The Company has entered into interest rate swaps to manage its interest rate exposure on a portion of the revolving bank credit. The Company is committed to exchange, at specific intervals, the difference between the fixed and floating interest rates calculated by reference to the notional amounts. As at April 3, 2004, the Company pays a fixed interest rate of 4.86% on a notional amount of $30,000,000 and receives a floating interest based on Bankers Acceptance having a three-month maturity. The swap will expire in July 2007.
21 notes to consolidated financial statements Financial instruments (continued) (b) MANAGEMENT OF INTEREST RISK (continued) The Company does not foresee any failure by the counterparties to these contracts as they are financially sound Canadian banks. (c) FOREIGN EXCHANGE RISK The Company makes several purchases in US dollars and enters into various types of foreign exchange forward contracts in order to manage its foreign exchange risk. The Company does not hold nor issue such financial instruments for trading purposes. As at April 3, 2004, there were forward exchange contracts outstanding for a notional amount of US$4,500,000. The negative fair value of the forward exchange contracts is $61,000. (d) CREDIT RISK The Company does not have a significant exposure to any individual customer nor counter-party. The Company reviews a new customer s credit history before extending credit and conducts regular reviews of its existing customers credit performance. An allowance for doubtful accounts is established based upon factors such as the credit risk for specific customers, historical trends and other information. (e) OTHER RISK The Company also has a significant exposure toward the fluctuation of the price of green coffee. The Company purchases, from time to time, coffee contracts on a public commodities market in order to manage its price risk. As at April 3, 2004, the Company had contracts for the purchase of green coffee having a positive fair value of $309,094 and as at March 29, 2003, the Company had contracts for the purchase of green coffee having a positive fair value of $678, Segmented information At the end of the first quarter of 2003, the Company changed its organizational structure. The new structure put in place reflects the Company s desire to integrate its Canadian operations and thus, be better poised to seize market opportunities and eliminate the duplication of activities and expenditures, while recognizing the respective uniqueness of the Canadian and American markets. Thus, all its Canadian distribution channels, coffee services and retail networks alike were consolidated within a single operating unit, which also includes all the Company s roasting operations. Another operating unit was created to encompass all of Van Houtte s US distribution channels. Consequently, segmented information is henceforth distinguished between Canada and the U.S., the Company s two main areas of business. These segments are managed separately, since they all require specific marketing strategies. The Company assesses the performance of each segment based on operating income before depreciation, amortization, financial expenses and non-recurring items. The accounting policies of each segment are identical to the accounting policies used for consolidated financial statements.
22 46 notes to consolidated financial statements 21 Segmented information (continued) Segment income includes income from sales to third parties and inter-segment sales. These sales are accounted for at prevailing market prices. BUSINESS SEGMENTS Revenues: Canada $ 237,857 $ 229,126 United States 90,773 88, , ,649 General corporate revenues and others 10,474 8,035 Intersegment (10,715) (8,916) $ 328,389 $ 316,768 Operating earnings before depreciation and amortization, financial expenses and non-recurring items: Canada $ 52,393 $ 50,691 United States 12,053 13,005 64,446 63,696 General corporate expenses (4,884) (2,086) $ 59,562 $ 61,610 Fixed assets and goodwill: Canada $ 140,363 $ 141,086 United States 94,739 92, , ,930 General corporate assets and intersegment and others 21,269 21,962 $ 256,371 $ 255,892 Additions to fixed assets and other assets: Canada $ 19,044 $ 23,580 United States 5,090 6,587 24,134 30,167 Other 2,795 3,700 $ 26,929 $ 33,867 Depreciation and amortization of fixed assets: Canada $ 19,462 $ 19,266 United States 8,454 8,173 27,916 27,439 Other $ 28,881 $ 28, Comparative figures Certain comparative figures have been reclassified to conform with the financial statement presentation adopted in the current year.
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