a r r e t n o F 6 0 0 2 t r o p e r l a u n n A
F o n t e r r a A nnual report 2 0 0 6
a r r e t n o F 6 0 0 2 t r o p e r l a u n n A
F o n t e r r a A nnual report 2 0 0 6 Total number of shareholders (supply numbers) at 31 May 31 at numbers) Total(supply shareholders of number TotalReturn Shareholder Payout to Contribution ValueAdd Price Milk Commodity Fonterra Gap Price Milk Price Milk Commodity Historical kg/ MS) per (NZD Payout Shareholder Overseas (000’s)Overseas (000’s)Zealand New Ingredients and other revenue from outside of the Group the of outside fromrevenue other and Ingredients rate Fonterra’sconversion NZD/USD average year the throughout Ingredients Group the of outside fromrevenue Consumer Net Interest Bearing Debt (NZD millions) (NZD Debt Bearing Interest Net Shareholders’Funds,including minority interests millions)(NZD millions) Total(NZD Employed Assets surplus operating Segment Inter-GroupEliminations Consumer T Sta Fair O A millions) (N ZD Revenue millions) (NZ D surplus operating Segment T millions) (NZD minorities after Surplus/( Deficit) Net ebt to debt plus equity ratio equity plus debt to Debt C 7 6 5 4 3 2 1
otal Staff otal otal apital apital verage perating perating Represents earnings before interest and tax calculated on the basis of the historical CMP and adjusted for non recurring items. recurring non for adjusted and CMP historical the of basis the on calculated tax and interest before earnings Represents currency foreign net converted has place. in Fonterra cover that hedge rate the the on is based rate Dollars conversion NZ into average The receipts valuer. season. the independent for the rates by spot set daily range the the of within average from the is determined rate valuations exchange Average subsequent Board; Fonterra the by set value nominal a was price Share Value Fair Initial been not have Comparatives price. 34. milk page refer commodity methodology, Fonterra refined and the price using milk restated commodity Historical of calculation the to made were refinements methodology 2005/06 In 2005/06. and 2004/05 2003/04, 2002/03, in used that to methodology different Applying and over operations, its of all from Fonterra by milk suppliers’ supplied. to milk of capital) of value the cost the above (including added value the of year.measure a is formation Fonterra’s Payout in to systems Contribution reporting Add Group’s Value the The of structure the to due available not is season 2001/02 the for information comparative Certain ff V Revenue alue Share alue
E mployed Spot NZD/US E mployed (000’s)Employed mployed P er ) set for the next season next the for set (NZD) Price R f eturn ormance 6 Exchange s Fo NTERRA 2 ate applying Rate 6 7
– S – EA S ON 2005/06 2005/06 in review in 2005/06 11,286 13,001 13,080 52.1%
4 3,790 9,211 5,600 5,145 9.6% (0.23) 5.80 0.48 3.62 3.85 4.10 0.66 11.0 17.4 0.68 985 (28) 288 725 6.4 – 2004/05 11,680 12,323 11,812 17.2% 46.9% 3,775 8,548 4,334 4,911 (0.23)
5.44 0.45 4.14 4.37 4.59 11.6 18.6 0.61 0.69 191 823 (43) 265 601 7.0 2003/04 12,144 11,830 11,112 11.0% 45.7%
3,636 8,194 4,041 4,795 (0.20) 4.69 0.48 3.77 3.97 4.25 11.1 19.6 0.52 0.62 839 280 563 8.5 (4)
7 2002/03 12,562 12,474 10,746 16.7% 48.5% 4,587 7,887 4,388 4,665 (0.18) 4.38 0.47 3.16 3.34 3.63 10.8 19.8 0.48 0.51 257 817 404 407 9.0
6 2001/02 13,057 13,924 11,800 51.3% 3 5,583 8,341 4,718 4,485 5 (0.39)
3.85 0.22 5.06 5.45 5.33 20.0 0.44 0.43 (50) 599 N/a N/a N/a N/a N/a N/a
1 For more information see www.fonterra.com see information more For
USD per MT FOB Litres (million) USD per MT FOB 12,60 12,80 13,000 13,20 13,40 13,60 13,80 14,000 14,20 $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 1,00 1,50 2,00 2,50 3,00 Percent 1,00 1,50 2,00 2,50 3,00 50 10 12 14 16 18 20 50 40 60 80 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 MILK COLLECTION MILK PA *Oceania Export Series, Series, Export *Oceania AV FONTERRA THE ON RETURN Agriculture. of Department US Service, Marketing Agricultural Series, Export *Oceania AV YOUT 2001/0 2001/02 2001/0 2001/0 2001/0 ERAGE COMMODITY PRICES PRICES COMMODITY ERAGE PRICES COMMODITY ERAGE – NZD per kg/MS per NZD – 2 2 2 2 2002/0 2002/0 2002/03 2002/0 2002/0 – kg/MS and Litres collected Litres and kg/MS – A g ricultural Marketin ricultural 3 3 3 3 FA 2003/0 2003/04 2003/0 2003/0 2003/0 IR IR – USD per MT FOB* MT per USD – FOB* MT per USD – VA LUE SHAR LUE 4 4 4 4 g Service, US Department of of Department US Service, 2004/0 2004/05 2004/0 2004/0 2004/0 E – vs the NZX 50 Capital Inde Capital 50 NZX the vs – 5 5 5 5 2005/0 2005/06 2005/0 2005/0 2005/0 A g riculture. 6 6 6 6 RE 1,06 1,08 1,10 1,12 1,14 1,16 1,18 1,20 1,22
0 0 0 0 0 0 0 0 0 FONTERRA SHARE FONTERRA NZX 50 CAPI 50 NZX S x VA INDEX RETURN INDEX
Kg/MS (millions) ULT LUE RETURN LUE (MILLION CHEESE CHEESE BUTTER BUTTER LITRES kg/MS WM WM SM SM TA S S P P P P L ) AT
A
MT 000’s Average Kg/MS GLANCE 100,000 105,00 110,00 70,000 75,000 80,000 85,000 90,000 95,000 $1,000 $1,100 1,50 1,75 2,00 2,25 2,50 2,75 3,00 $500 $600 $700 $800 $900 0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0 0 0 0 0 0 0 0 0 Rate that Fonterra converts net foreign currency receipts into NZD based on hedge cover in place. in cover hedge on based NZD into receipts currency foreign net converts Fonterra that Rate FONTERRA INGREDIENTS INGREDIENTS A AND SHAREHOLDERS OPERA SEGMENT 2001/02 2001/0 2001/0 2001/0 0.44 2 2 2 ’S A ’S – Manufactured in NZ 000’ NZ in Manufactured – VERAGE NZD/USD CONVERSION RA CONVERSION NZD/USD VERAGE 2002/0 2002/0 2002/03 2002/0 TING SURPLU TING 0.48 3 3 3 VERAGE kg/M VERAGE 2003/04 2003/0 2003/0 2003/0 S 0.52 – NZD millions NZD – 4 4 4 S – NZ only NZ – s MT and T and MT s 2004/05 2004/0 2004/0 2004/0 0.61 TE 5 5 5 otal Ingredients sales 000’ sales Ingredients otal 2005/06 2005/0 2005/0 2005/0 0.66 6 6 6 9,50 10,000 10,500 11,000 11,500 12,000 12,500 13,000 13,500 DAIR 0 IN NEW ZEALAN NEW IN MANUF SALES VOLUME SALES Y INGREDIENT Y s MT s
INGREDIENT Number of Suppliers SUPPLIERS ACTURE AV ERAG TO kg/MS TA D D S E S L
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Insight Creative Limited. Auckland. New Zealand. 09/06 FOOP004. Primary Photography – John Crawford.
New Zealand Dollars (million) 10,500 11,00 11,50 12,000 12,500 13,000 13,500 14,000 14,500 0 0 TO 2001/0 TA 13,924 L REVENUE REVENUE L 2 2002/0 – NZD millions NZD – 12,474 3 2003/0 11,83 0 4 2004/0 12,323 5 2005/0 13,001 6 TO NZD MILLION NZD TA L REVENU L E S Total number of shareholders (supply numbers) at 31 May 31 at numbers) Total(supply shareholders of number TotalReturn Shareholder Payout to Contribution ValueAdd Price Milk Commodity Fonterra Gap Price Milk Price Milk Commodity Historical kg/ MS) per (NZD Payout Shareholder Overseas (000’s)Overseas (000’s)Zealand New Ingredients and other revenue from outside of the Group the of outside fromrevenue other and Ingredients rate Fonterra’sconversion NZD/USD average year the throughout Ingredients Group the of outside fromrevenue Consumer Net Interest Bearing Debt (NZD millions) (NZD Debt Bearing Interest Net Shareholders’Funds,including minority interests millions)(NZD millions) Total(NZD Employed Assets surplus operating Segment Inter-GroupEliminations Consumer T Sta Fair A O millions) (N ZD Revenue T millions) (NZ D surplus operating Segment millions) (NZD minorities after Surplus/( Deficit) Net ebt to debt plus equity ratio equity plus debt to Debt C 7 6 5 4 3 2 1
otal Staff otal otal apital apital verage perating perating Represents earnings before interest and tax calculated on the basis of the historical CMP and adjusted for non recurring items. recurring non for adjusted and CMP historical the of basis the on calculated tax and interest before earnings Represents currency foreign net converted has place. in Fonterra cover that hedge rate the the on is based rate Dollars conversion NZ into average The receipts valuer. season. the independent for the rates by spot set daily range the the of within average from the is determined rate valuations exchange Average subsequent Board; Fonterra the by set value nominal a was price Share Value Fair Initial been not have Comparatives price. 34. milk page refer commodity methodology, Fonterra refined and the price using milk restated commodity Historical of calculation the to made were refinements methodology 2005/06 In 2005/06. and 2004/05 2003/04, 2002/03, in used that to methodology different Applying and over operations, its of all from Fonterra by milk suppliers’ supplied. to milk of capital) of value the cost the above (including added value the of year.measure a is formation Fonterra’s Payout in to systems Contribution reporting Add Group’s Value the The of structure the to due available not is season 2001/02 the for information comparative Certain ff V Revenue alue Share alue
E mployed Spot NZD/US E mployed (000’s)Employed mployed P er ) set for the next season next the for set (NZD) Price R f eturn ormance 6 Exchange s Fo NTERRA 2 ate applying Rate 6 7
– S – EA S ON 2005/06 2005/06 in review in 2005/06 11,286 13,001 13,080 52.1%
4 3,790 9,211 5,600 5,145 9.6% (0.23) 5.80 0.48 3.62 3.85 4.10 0.66 11.0 17.4 0.68 985 (28) 288 725 6.4 – 2004/05 11,680 12,323 11,812 17.2% 46.9% 3,775 8,548 4,334 4,911 (0.23)
5.44 0.45 4.14 4.37 4.59 11.6 18.6 0.61 0.69 191 823 (43) 265 601 7.0 2003/04 12,144 11,830 11,112 11.0% 45.7%
3,636 8,194 4,041 4,795 (0.20) 4.69 0.48 3.77 3.97 4.25 11.1 19.6 0.52 0.62 839 280 563 8.5 (4)
7 2002/03 12,562 12,474 10,746 16.7% 48.5% 4,587 7,887 4,388 4,665 (0.18) 4.38 0.47 3.16 3.34 3.63 10.8 19.8 0.48 0.51 257 817 404 407 9.0
6 2001/02 13,057 13,924 11,800 51.3% 3 5,583 8,341 4,718 4,485 5 (0.39)
3.85 0.22 5.06 5.45 5.33 20.0 0.44 0.43 (50) 599 N/a N/a N/a N/a N/a N/a
1 For more information see www.fonterra.com see information more For
USD per MT FOB Litres (million) USD per MT FOB 12,60 12,80 13,000 13,20 13,40 13,60 13,80 14,000 14,20 $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 1,00 1,50 2,00 2,50 3,00 Percent 1,00 1,50 2,00 2,50 3,00 50 10 12 14 16 18 20 50 40 60 80 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 MILK COLLECTION MILK PA *Oceania Export Series, Series, Export *Oceania AV FONTERRA THE ON RETURN Agriculture. of Department US Service, Marketing Agricultural Series, Export *Oceania AV YOUT 2001/0 2001/02 2001/0 2001/0 2001/0 ERAGE COMMODITY PRICES PRICES COMMODITY ERAGE PRICES COMMODITY ERAGE – NZD per kg/MS per NZD – 2 2 2 2 2002/0 2002/0 2002/03 2002/0 2002/0 – kg/MS and Litres collected Litres and kg/MS – A g ricultural Marketin ricultural 3 3 3 3 FA 2003/0 2003/04 2003/0 2003/0 2003/0 IR IR – USD per MT FOB* MT per USD – FOB* MT per USD – VA LUE SHAR LUE 4 4 4 4 g Service, US Department of of Department US Service, 2004/0 2004/05 2004/0 2004/0 2004/0 E – vs the NZX 50 Capital Inde Capital 50 NZX the vs – 5 5 5 5 2005/0 2005/06 2005/0 2005/0 2005/0 A g riculture. 6 6 6 6 RE 1,06 1,08 1,10 1,12 1,14 1,16 1,18 1,20 1,22
0 0 0 0 0 0 0 0 0 FONTERRA SHARE FONTERRA NZX 50 CAPI 50 NZX S x VA INDEX RETURN INDEX
Kg/MS (millions) ULT LUE RETURN LUE (MILLION CHEESE CHEESE BUTTER BUTTER LITRES kg/MS WM WM SM SM TA S S P P P P L ) AT
A
MT 000’s Average Kg/MS GLANCE 100,000 105,00 110,00 70,000 75,000 80,000 85,000 90,000 95,000 $1,000 $1,100 1,50 1,75 2,00 2,25 2,50 2,75 3,00 $500 $600 $700 $800 $900 0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0 0 0 0 0 0 0 0 0 Rate that Fonterra converts net foreign currency receipts into NZD based on hedge cover in place. in cover hedge on based NZD into receipts currency foreign net converts Fonterra that Rate FONTERRA INGREDIENTS INGREDIENTS A AND SHAREHOLDERS OPERA SEGMENT 2001/02 2001/0 2001/0 2001/0 0.44 2 2 2 ’S A ’S – Manufactured in NZ 000’ NZ in Manufactured – VERAGE NZD/USD CONVERSION RA CONVERSION NZD/USD VERAGE 2002/0 2002/0 2002/03 2002/0 TING SURPLU TING 0.48 3 3 3 VERAGE kg/M VERAGE 2003/04 2003/0 2003/0 2003/0 S 0.52 – NZD millions NZD – 4 4 4 S – NZ only NZ – s MT and T and MT s 2004/05 2004/0 2004/0 2004/0 0.61 TE 5 5 5 otal Ingredients sales 000’ sales Ingredients otal 2005/06 2005/0 2005/0 2005/0 0.66 6 6 6 9,50 10,000 10,500 11,000 11,500 12,000 12,500 13,000 13,500 DAIR 0 IN NEW ZEALAN NEW IN MANUF SALES VOLUME SALES Y INGREDIENT Y s MT s
INGREDIENT Number of Suppliers SUPPLIERS ACTURE AV ERAG TO kg/MS TA D D S E S L
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Insight Creative Limited. Auckland. New Zealand. 09/06 FOOP004. Primary Photography – John Crawford.
New Zealand Dollars (million) 10,500 11,00 11,50 12,000 12,500 13,000 13,500 14,000 14,500 0 0 TO 2001/0 TA 13,924 L REVENUE REVENUE L 2 2002/0 – NZD millions NZD – 12,474 3 2003/0 11,83 0 4 2004/0 12,323 5 2005/0 13,001 6 TO NZD MILLION NZD TA L REVENU L E S Dairy for life > BUILDING ON NATURE’S GOODNESS blue skies,greengrass,clearwater A LIFEWHICHSTARTS WITHSUNSHINE, and healthycows…
> ENHANCING LONG TERM HEALTH + VITALITY because nomatterwhatgenerationwebelongto, we wanttogetthemostoutofeveryday… A LIFETHAT’S VITAL, ACTIVEANDHEALTHY,
> CREATING STRONG TIES between families,generations,customers, communities andtheworldaroundus… A LIFERICHINRELATIONSHIPS,
A LIFE WHERE CAN-DO ISN’T AN ADJECTIVE, but a verb, because that’s the way we’ve always been. MAKING THINGS HAPPEN THE “KIWI” WAY
>
Dairy is our life’s work. We cannot think of anything more rewarding. In an age where you need a chemistry degree to understand some food labels, milk is pure milk, designed by nature to provide all the building blocks for a healthy life. Dairy has never gone out of style. It is not hard to understand why. It has never failed to meet our needs, even as they change and become more sophisticated. For our great grandparents, it was simple nutrition, served chilled in a glass. Today, we marvel at the precision with which dairy can deliver the levels of health we seek at every age, whether it be in strong bones, healthy digestion, higher immunity or lower weight. How did we get from simple to sophisticated? We said “thanks” to nature for giving us something wonderful to work with, then we set about figuring out how to make it even better. On the way, “what can we do with dairy?” has become “can-do” with dairy. It’s this knowledge that sets us apart. Dairy has provided an enduring way of life, which has seen farming heritages built up and passed down through the generations. Year after year, farmers have worked with the land and their herds to bring dairy to successive families of consumers, customers and communities. Dairy is all we do. We think that’s quite enough to be thinking about. By thinking solely about dairy, we’ve become experts in our favourite topic, starting on the land and ending in the best place of all, the tastebuds. Because let’s not forget that while dairy is good in nutrition, it’s absolutely great in taste. CONTENTS
Season in Review tables IFC Less complexity, more productivity 26 Dairy for life 01 Global manufacturing view leverages expertise 28 Chairman’s Review 14 Encouraging sustainable and profitable growth 30 CEO’s Review 20 Performance measures 34 Adding value to commodities 22 Governance 38 Exceeding sales and profit targets 24 Financial Information 49 > HENRY VAN DER HEYDEN - CHAIRMAN Our life’s ambition: To Lead in Dairy.
Chairman’s Review PAYOUT Our $4.10 per kg/MS payout delivers $5 billion to Fonterra closed the season with a final payout of our shareholders and the New Zealand economy, and $4.10 per kilogram of milksolids, up from our original includes a value add contribution of $578 million, forecast of $3.85 per kg/MS. The 25 cent difference or 48 cents per kg/MS. Our value add contribution comes down to achieving cost reductions worth more has increased by seven per cent on the prior year. than $130 million, the results of a good sales drive In addition to the $4.10 per kg/MS payout, our in the last quarter and progress in turning around shareholders this season will, on average, receive a Fonterra Brands. It was achieved in the face of a strong benefit equal to 14 cents per kg/MS, arising as a result dollar which gave us our highest ever average foreign of changes to our capital structure. The benefit varies exchange conversion rate of 66 cents. among shareholders.
While the payout is down on the previous season’s $4.10 per kg/MS with a 66 cent average exchange result of $4.59 per kg/MS, it is a satisfactory outcome, rate is a result farmers would never have expected given the environment, and we are now working flat in Fonterra’s early days. That result is grounds for out to continue to do better. confidence in the co-operative and we will always be focused on ensuring that our performance earns the The season certainly reminded us that dairy is always loyalty of shareholders. dependent on the weather. Our milk flows veered from being below-budget in mid-season to an autumn surge VALUE ADD CONTRIBUTION through our manufacturing sites. Our value add earnings have been challenged over the past few years. Each year in the last four, Fonterra’s The sales team did well in responding to the challenge, average conversion rate to the US dollar has weakened. achieving record fourth quarter sales. Their performance 14 As the significant majority of our value add earnings was a highlight, as was the achievement of our consumer are denominated in US dollars, that has reduced business in beating its sales and profit targets, despite our earnings in New Zealand dollars. In addition, high commodity prices. we have seen commodity prices increase from the The autumn milk surge meant our farmers achieved year before. record production of 1,210 million kg/MS, 4.3 per cent These higher prices inevitably squeeze our value add higher than the previous season and nearly one per earnings. In spite of these factors, we have kept cent up on the previous production record of 1,201 earnings roughly flat over the period. The seven per million kg/MS set in 2003/04. cent rise in value add earnings this year over last year is It was encouraging to see the strength and flexibility of a good result given the environment. A more detailed our supply chain and our ability to respond quickly to discussion of this is included in the performance changes in supply and market conditions. Achievements summary on page 35. include selling nearly 100,000 MT more in the last FONTERRA GLOBAL TRADE AND FONTERRA quarter than we did in the same period last season. INGREDIENTS That includes the first ever sale of more than 300,000 Sales by Fonterra’s Global Trade and Ingredients MT in a calendar month, achieved in May. businesses (formerly collectively called Fonterra We need more of this speed in the business. With Ingredients) were $663 million up at $9.2 billion, increasing competition, we need to be quicker at making driven primarily by higher sales volumes. Total revenues, decisions and getting the results of those decisions into including intersegment sales, were $10.6 billion. the market much faster. This will be something we will The business achieved an operating surplus, essentially be working on over the next 12 months. its EBIT, of $725 million, up $124 million or 21 per cent from last year, driven by increased sales and reflecting FINANCIAL REVIEW cost savings initiatives during the year. Our revenues, at $13 billion, were six per cent, or $678 million, up on the previous season. The increase is Higher sales of ingredients sourced from third parties primarily related to record ingredients sales volumes of made a significant contribution to revenues, with third 2.5 million MT, an increase of 207,000 MT, or nine per party sales revenues up to $2.3 billion compared to cent on the 2004/05 season. $1.8 billion in the prior year. These sales included a 85,000 MT increase in volumes by improved prices for protein and milk powders. from Australia, as well as higher skim milk powder It was a year in which average prices peaked at the exports from the US. The Australian volume growth beginning of the second quarter, then began to come included a 37,000 MT contribution as a result of off historical highs. Fonterra’s acquisition of Nestlé’s powdered milk plant in The higher average selling price, while positive for the Dennington, Victoria in the first quarter of 2006. This commodity business (Fonterra Global Trade), was felt in contribution shows the potential we have in Australia Fonterra Brands and in our Fonterra Ingredients value and while, overall, our performance there is not yet add business, increasing raw material costs. Their ability where we want it to be, progress is being made. to offset higher input costs with increased prices during Sales conditions globally proved difficult early in the year the year meant the impact was mitigated and this was with a slowdown mid-season when customers delayed an important factor in Fonterra Brands’ exceeding its purchases for a number of reasons. This forced us to sales and profit targets for the year. carry higher inventories through the middle of the year. COSTS Record volumes sold in the final quarter reduced our Record milk flows, record manufacturing totals and inventories back to normal levels. Sales growth was record sales volumes are reflected in Fonterra’s higher achieved across all major markets, including the United total cost of goods sold for the season of $10.8 billion States, our largest market. compared to the previous season’s $10.2 billion. Also Cost of goods sold in Fonterra Global Trade and reflected in the increase in total costs of goods sold are Fonterra Ingredients was $9.1 billion compared with higher third party volumes of 116,000 MT and higher $8.5 billion in the prior year. The increase reflects energy costs. higher third party volumes and higher volumes of milk Other expenses, including interest costs, increased to being paid for in New Zealand. $2.1 billion compared to $1.9 billion. These included FONTERRA BRANDS restructuring costs of $57 million, higher interest costs Fonterra Brands exceeded its sales and profit targets, of $95 million, higher advertising and promotional despite paying its highest commodity prices in five spending by Fonterra Brands, $26 million relating to years. Fonterra Brands achieved 9.3 per cent organic the premium on redemption of Fonterra capital notes growth, a result which exceeded that of previous and increases in storage and distribution costs relating 15 seasons by a good margin. to higher inventory levels during the year. These higher costs have been offset by cost improvements of more The business’ operating revenue, excluding intersegment than $130 million, with more savings forecast over sales, gains on the sale of investments and other one- the next three seasons. The costs incurred through off items, was $192 million ahead at $3.7 billion, restructuring and the redemption of capital notes will compared to $3.5 billion in the prior year. result in lower costs for future seasons.
Fonterra Brands increased sales, improved selling prices Fonterra’s total net interest bearing debt at the end of ™ and benefited from acquisitions such as Anchor and the year was $5.6 billion compared to $4.3 billion as ™ Fresh ‘n Fruity in New Zealand. It also achieved net a result of funding for mergers and acquisitions; new growth of 15 per cent in Fonterra Foodservices sales. property, plant and equipment; higher trade receivables; Fonterra Brands’ operating surplus, essentially its EBIT, and the impact of a depreciating New Zealand currency was $288 million, up nine per cent, or $23 million from on foreign denominated debt. This, along with the last year, reflecting the increased operating revenues general increase in interest rates, contributed to higher 2006 and higher returns from our Power Brands. net interest costs in the year of $350 million compared 2006 to $260 million in the 2004/05 year. Fonterra Brands’ cost of goods sold, at $2.6 billion, compared favourably with the $2.5 billion of the prior The late surge in sales in particular had a significant year given continued increases in the commodity prices impact on our working capital, resulting in higher ANNUAL REPORT which represent its main input costs. trade receivables, $575 million higher than last year. ANNUAL REPORT Post year end we expect to drive working capital During the capital structure discussions we made down to more normal levels as we receive payment for a commitment to provide shareholders with more the strong fourth quarter sales and from sales of the FONTERRA FONTERRA information on Fonterra Brands’ performance. More carryover inventory. analysis is provided on page 37. Our debt to debt-plus-equity ratio is 52.1 per cent. PRICES While this is outside the 45-50 per cent range set by Over the full year, average selling prices across the the Board, the Board is comfortable with this position full range of products were 2.4 per cent higher than and our current ratio still represents a strong balance the prior season at US$2,640 per MT, driven mainly sheet going forward. CASH FLOW There is no reason why the same methodologies should The higher working capital demands were reflected not be applied to a co-operative. in our operating cash flows with an outflow of $232 Our shareholders can look back on a record of steady million recorded compared to an inflow of $228 million growth in the value of their investment with an average in the prior season. An extended discussion on cash annual increase of just over eight per cent per year. flow and cost reductions is covered on page 28 in the Taken together with the value added component of Chief Financial Officer’s review. payout each year, this adds up to a return consistent with that achieved by the better performing listed SURPLUS food companies around the world. As a co-operative, Fonterra pays out its operating surplus to shareholders as payment for the supply of Total Shareholder Return for the season is 9.6 per milk which this year amounted to a distribution of cent compared to 17.2 per cent in the prior season, $5 billion including $578 million of value add returns reflecting the more modest increase in the value of our (essentially profit). Fair Value Share. Fonterra’s average TSR since inception is 13.6 per cent, a result which demonstrates our ability FAIR VALUE SHARE AND TOTAL SHAREHOLDER RETURNS to generate value for our shareholders. In May 2006, we announced a Fair Value Share price for the 2006/07 season of $5.801, an increase of six WE’RE GROWING per cent on a like-for-like basis on the 2005/06 season’s In the season under review, we sped up the momentum share price. This is the mid-point in the valuation in growth, primarily through acquisitions, while range of $5.37 to $6.24 provided to the Board by the ensuring we are lean enough to compete in the very independent valuer, Duff & Phelps. cost competitive global market.
The price is the result of increased valuations of We’ve removed unnecessary duplication in the our Fonterra Global Trade, Fonterra Ingredients and business, increased efficiency and productivity in our Fonterra Brands businesses, reflecting good progress sites, simplified our structures so we work faster and across all our operations. smarter, and deepened our relationships with our major customers so that we progress toward our goal of The increase in the valuation takes into account some becoming their preferred supplier. We’ve taken a hard of the business improvements being delivered and look at how we can improve our service to farmers, 16 planned in our on-going drive for efficiencies across the helping those who want to grow and to improve their whole business and improved value add earnings. productivity and profitability.
This is a good result for shareholders and continues the Milk growth is always going to be important to us and trend of appreciating share values in the co-operative our goal of three per cent more milk each year is well since our formation. known to farmers. It’s not unrealistic. If all our suppliers matched the productivity of our top suppliers, we At the end of 2002 the initial fair value of supplying would achieve it easily. It is this increased productivity shareholders’ investment in Fonterra was assessed by that we seek with our growth target. We want farmers the independent valuer as being $4.89 per kilogram to improve their productivity and contribute to the of milk solids. This was calculated on the basis of the continuing low cost advantage our entire supply Fair Value Share of $3.85 plus an average investment chain enjoys. in peak notes of $1.04 per kilogram of milk solids. Based on production in 2002, this represented a total However, we recognise that farmers want clear signals investment in Fonterra of just over $5.4 billion. That about the value of their milk so that they can see clearly value today, measured on a comparable basis with the returns they are getting versus their production our post-transition share price of $6.56 stands at costs. This is an issue we are tackling now with a $7.9 billion. proposal to move to pricing signals which clearly show a milk price and a value add component of payout. We have seen some debate this year around whether the fair value method of valuation is Identifying the milk price and value add components appropriate, with a net asset backing approach put of payout will help shareholders distinguish more up as an alternative. Shareholders can be confident easily the value add returns they receive. It will provide that the methodologies applied by the independent the clear signals about milk value that are needed by farmers to make informed production decisions. valuer are best practice and recognise expected returns from Fonterra’s ongoing investments in Getting this transparency is a complex business. With manufacturing efficiency, innovation and branding. just five per cent of local milk production sold here, Analysis of stock market returns over time there is no market based price for milk at the farm gate showsvalues reflect future cash flows of companies. in New Zealand.
1 This season is unusual in that we made a transition to our new capital structure where capital previously held as peak notes converted into ordinary share capital. The post-transition share price is $6.56. Since our inception in 2001, we have used theoretical We also thank consumers who enjoy our branded calculations to determine a commodity milk price for products and have played a role in their growth. We the season based on a calculation undertaken by our think we do a great job with our consumer dairy independent valuer, Duff & Phelps, as part of their products, but it is loyal consumers who ultimately valuation of our Fair Value Share. It is fair to say most confirm that view by purchasing our products. shareholders find them difficult to understand and I thank our Directors for their commitment throughout apply to their business in any meaningful way. the year and their willingness to not only contribute However, we have had almost five years of working around the Board table, but also to get out among with these calculations and the independent valuers. our shareholders at regular meetings to discuss the Each year our understanding of the theory behind business. I want to thank Harry Bayliss for his valued them deepens and enables changes to be made to services to Fonterra as a director, and for his nearly 20 improve them. years of service to the industry in governance roles. He We have now reached the stage where we are confident has thoroughly earned his retirement. that we have a robust process which will enable us to I would like to formally welcome our new appointed achieve the milk price signals farmers have wanted for directors, John Ballard and Ralph Waters, both of some time. Our intention is to ultimately move to a whom have the breadth and depth of experience to system where we forecast payout in two components, a make a significant contribution to our governance. milk price for the season and a value-add component. Finally, my thanks to Andrew Ferrier, his leadership First and foremost, we need a system that shareholders team and all Fonterra employees for their performance. can have confidence in. Under any new system, Our results are a direct result of their efforts. the forecast milk price component of payout would represent the estimated underlying value of milk at the farm gate and be paid progressively during the year. It would provide a benchmark against which farmers can determine what margins they are making on their milk after deducting their on-farm costs.
The value add component will be designed to enable 17 farmers to see clearly how successful we are in increasing the value of milk beyond the farm gate, primarily through our consumer business of Fonterra Henry van der Heyden Brands and Fonterra Ingredients value added activities. Chairman Again, it is important for farmers to see whether the capital invested in these parts of the business is providing an economic return and such a system would deliver the transparency in value add performance that our shareholders are looking for. This is quite firmly on the Board’s agenda for the 2006/07 season.
THANKS It’s important to acknowledge the people who contribute to our strength and our success. 2006 First, I thank our shareholders for their continued 2006 loyalty. There is growing competition for supply and we appreciate the vote of confidence in us from shareholders who remain committed to the co-operative and from shareholders who have just joined us. Our ANNUAL REPORT strength begins on your farms and our growth starts ANNUAL REPORT with your growth in supply.
The co-operative thanks our customers around the FONTERRA world. We are proud of the progress we are making FONTERRA in building stronger relationships with you and the growing faith you have shown in us, our products and our experience. We look forward to adding more value to our relationships in the coming season. CEO ANDREW FERRIER -
> “A year of traction” CEO’s Review lowering costs and improving efficiencies. The change has meant some tough calls have had to be made. The 2005/06 season was a year of traction. We are here to make Fonterra the supplier of choice Savings from programmes to reduce costs and increase in the dairy market for this generation, the next productivity have gone from forecast to reality. generation and the one after that. It is critical we make Unnecessary duplications in functions and costs have all the tough decisions we need to in order to achieve been replaced with a “do it once, do it right first that. A growing, vibrant Fonterra will ultimately employ time” structure and culture. Strategic investments have more people in the long term. strengthened Fonterra Brands, increased innovation It’s been a year in which gains on the sale of investments and promotional spending has set the stage for growth, have been aggressively reinvested to position Fonterra while in Fonterra Manufacturing our people have for the growth that will create future value for boosted processing capacity and reduced costs. shareholders, particularly through Fonterra Brands and Even as we have celebrated new production records, the value add business of Fonterra Ingredients. our co-operative has continued to work hard on the Fonterra Brands acquired the Fresh ‘n Fruity™ yoghurt farm, getting a better understanding of individual business in New Zealand in a deal with New Zealand farmers’ needs and developing new service models Dairy Foods (“NZDF”), which also included the regaining which will support shareholders who want to grow of the Anchor™ brand. In all, Fonterra acquired assets their milk supply. Fonterra has also taken a leadership valued at $754 million from NZDF and sold assets role in ensuring industry investments in research and valued at $416 million including Meadow Fresh™ development are targeted to support profitable growth beverages and yoghurts, and Kiwi Meats, retaining the in productivity. Mainland, cheese and export business. What we are beginning to feel and see are the results The Kapiti™ Fine Foods ice cream and specialty cheese of hard work across the business in projects to capitalise and liquid milk business was acquired to further support on Fonterra’s true potential as one single major player. Fonterra Brands. Under the agreement Fonterra Brands This is all about being lean, productive and faster on acquired production sites at Palmerston North and our feet. It’s all about growth and it’s all about getting Paraparaumu and the rights to supply the Pam’s milk people excited about being part of a strong, competitive and cream brand in the lower-North Island. 20 and growing business. Most importantly, it’s all about Bringing the Anchor™ and Fresh ‘n Fruity™ brands into engaging with our farmers, encouraging them to the stable was a huge step up. The Kapiti™ acquisition grow and giving them the confidence to do so by augments the NZDF transaction, giving us a much demonstrating that we are utterly focused on ensuring stronger base in liquid milks through house brands in sustainable, profitable returns from their milk. the lower North Island, as well as a wonderful specialty DRIVING GROWTH cheese and ice cream brand. The 2005/06 season saw strategic investments made Overall, we are very pleased with the progress being with the emphasis on achieving value growth right made in the Winning Through Brands! strategy which across the business. has started delivering results. Sales and profits from the Investments in streamlining Fonterra’s supply chain business have exceeded targets and Fonterra Brands is are returning dividends, particularly through greater well placed for further growth. opportunities with customers. In Australia, Bonlac Foods was fully integrated into Increasingly, we are becoming a value adding supply the business enabling greater efficiencies and scale. chain for our customers’ businesses. In Australia, as Post balance date, Fonterra’s 43 per cent investment one example, we acquired Nestlé’s manufacturing in San Lu was completed, creating opportunities facilities at Dennington, redistributed production across for growth in branded product and ingredients a number of sites in Australia and now make product sales in China. for them at a lower cost while increasing our own With Bonlac on board we now have a fully integrated plant efficiency. business in Australia, right from collecting milk through On time delivery is up and we have a much greater to selling ingredients and consumer products in Australia global footprint to service customers out of multiple made from local milk and augmenting our global export geographies, all co-ordinated through our supply chain. trade with product sold from Australia. Increasingly, many of our international customers are The acquisition of 43 per cent of San Lu was the natural seeing us as their supplier of choice, giving us very next step into China and again, we see opportunities to good growth opportunities. become an integrated business in the Chinese market A year of driving relentless efficiencies in Fonterra place, collecting milk and moving it up the value chain has seen a simpler, leaner structure come together, to consumer products in hundreds of cities in China. The combination of San Lu’s distribution capabilities customer relationships. Manufacturing efficiencies, lower and our deep knowledge of all aspects of dairy make us costs to serve, simpler transactions and procurement optimistic that we have a real winner in China. savings have all created a leaner operation.
In the Fonterra Ingredients value add business a This work has resulted in a number of efficiency gains significant step forward was made with the crea- in the business, but we can never assume that all the tion of DMV Fonterra Excipients, a joint venture work is done. There will always be opportunities to between Fonterra and a major European dairy improve how we work and we will always regard the company, Campina. programme as a first and very necessary step on the road to ensuring Fonterra remains as efficient and cost In this move we have taken one of our product competitive as possible. categories and created a world class business, with the joint venture becoming one of the largest providers of Gains are also flowing through from Operations dairy based excipients to the world market with plants Journey, a five year programme to lock down Fonterra’s in New Zealand, Germany and Holland. competitiveness as a manufacturer of low cost dairy products at scale. It has delivered cost savings, through The joint venture culminates a staged growth path increased first time grading performance, reduced yield which began when Fonterra took its first steps with losses and fostered a culture of “right first time” in excipients by making the pharmaceutical grade lactose Fonterra Group Manufacturing. used as the carrier for active drug formulations in tablet form. A “One Fonterra” programme has removed duplication, lowered costs and increased efficiencies. Where before, Next we invested in plant to manufacture inhalation Fonterra Brands and Fonterra’s commodity businesses grade lactose, developing a very solid market position had their own backroom support in areas such as in Australia and Asia. That was the key to the joint human resources, communications, information venture, because with Campina’s DMV subsidiary strong services, procurement and finance, that’s all now in Europe, combining our two operations enabled us to combined as one team, reducing costs. All manufact- become a truly global supplier. uring activities worldwide are coming under one Fonterra Investments have also been made to strengthen Group Manufacturing function along with supply chain Fonterra’s manufacturing and supply chain capabilities functions and production and planning activities. including the $40 million upgrade of the Te Awamutu 21 What we are doing is getting streamlined functions site, the $37 million rebuild of the Takaka site and that are more cost effective, deliver better service, upgrades of Soprole plants in South America. enable faster responses and are having an impact on Meanwhile, service to farmers is stepping up to a new the bottom line. level with the RD1/Landmark joint venture linking 51 RD1 rural retail stores in New Zealand and Landmark’s EMPHASIS ON PEOPLE 430 stores in Australia. Having made tough calls to structure Fonterra more efficiently, the leadership team is now working hard to Through the joint venture in New Zealand, Fonterra’s push empowerment across the business to give people RD1 stores will introduce new services in finance, the ability to make decisions at the right time and at insurance, and real estate, and an expanded livestock the right level. My goal is a Fonterra culture based on sales service, drawing on Landmark’s expertise in these people getting excited about being part of a strong, areas. Products and services catering to the beef, sheep competitive and growing business. and cropping sectors will be introduced over time to complement RD1’s existing strengths in dairy. RD1 will We’re very focused on being a clear winner in the 2006 2006 also gradually expand its network of stores, particularly global dairy trade. We will do that because of the ideas to cater to Fonterra suppliers in the South Island. In of our people and their efforts. We strongly encourage Australia, Fonterra’s experience will be used to expand people to keep challenging the status quo, to think Landmark’s products and services to the dairy sector differently, and we reward them for independent and strong thinking as well as great teamwork. ANNUAL REPORT in Victoria. ANNUAL REPORT
DRIVING PRODUCTIVITY Fonterra in 2005/06 has emerged as a much leaner, FONTERRA more cost effective business. It is enjoying the first full FONTERRA year’s results from the Jedi programme with $50 million of benefits booked and more to come. Completed last season, the programme streamlined how product is ordered, supplied and paid for and touched every Andrew Ferrier part of the Ingredients business from manufacturing CEO to production forecasting inventory management and ADDING VALUE TO COMMODITIES JOHN SHASKEY
Can value add be used to describe commodities? No it In core commodities markets, primarily South East Asia, can’t, but where you sell commodities and the way you the Middle East and Latin America, the sales force sell them can add value. Broadening the appreciation has been scaled back to fit the needs of the business, that added value Ingredients is a combination of driving down the cost to serve. In value add markets, product and service offerings to customers is a such as the US, Japan, Korea and Europe, more people challenge that John Shaskey, Managing Director of with the skills and knowledge to work much closer to Fonterra Ingredients, has been dealing with over the customers are being deployed. last 12 months. “They have a very clear mandate to get on and work He has spent a good part of the past season emphasising with customers, understand the innovation support that the high value, but low volume specialty ingredients they need, work on solutions for them and then sold by Fonterra are just the tip of the value add commercialise with the appropriate customers. We iceberg. This has led to a restructuring of the business understand markets where we have to have incremental model for commodities trading, with Fonterra Global growth in infrastructure to support our value added Trade devoted to core commodities made and sold strategy. Ultimately, the game is to build commodity at the best price and Fonterra Ingredients devoted to markets into value add markets where there is a adding value. It’s a significant shift in thinking, working business case to justify that.” and culture. The value add team has made good progress in “It reflects total recognition of the fact that we cannot enhancing relationships with key global customers be a successful entity as a whole by counting on our and working with them in a collaborative way in a commodity business to deliver year after year. We number of areas such as supply chain and new product have to have the added value businesses contribute development. significantly more to payout performance and share value appreciation for Fonterra to be on a sound “This is a very different culture to that needed in core footing in the future.” commodities and it really does position us as a real Even as commodity sales values and volumes have hit competitor with other value add food ingredients 22 records in the season, John Shaskey and his team have organisations. The value add business that exists today dug deep into the business, defining what value add is the foundation to build a much more significant really means for the world’s largest dairy exporter. and profitable business in the future. It provides the platform for us to create a culture that will really “We have always thought of our value add business accelerate our growth through providing customers as being a very small part of our total business. But as with a range of value add offerings.” we have pulled the whole business apart to understand where we create value beyond the commodity value of Having a core commodities and value add split also milk we have formed a very clear view that in fact, in 40 more closely aligns a significant chunk of Fonterra’s per cent of our ingredients business we add value. capabilities to its strategic goals to be the leading global dairy product marketer, a developer of valuable “In some cases, it is selling commodities in high customer partnerships, a specialty milk components value markets where specifications, service delivery innovator and provider and the lowest cost supplier of requirements or customer relationships combine to dairy products to global markets. realise a better price. Some of the value we add is through how we sell the product and the services we The potential of the new structure has shown through offer such as distribution, technical support, working in the 2005/06 season. In key commodity sales hubs MANAGING DIRECTOR FONTERRA INGREDIENTS with customers around innovations, or creating such as South East Asia, the Middle East and Africa, ingredients with particular value for customers. There strong sales growth was achieved, especially as oil are a whole lot of ways we add value that we have exporting nations ramped up commodity imports to never fully appreciated in the past.” meet higher demand. Fonterra’s higher commodity Global Trade, says John Shaskey, is all about having no volumes included over 500,000 MT of products sourced
JOHN SHASKEY - illusions about what customers want and get. in markets such as Australia, the US and South America to meet customer demand. > “They want the right commodity at the right price. That’s all they are interested in. To deliver we need a In the value add market of the US, the business core commodities business that is as simple as it can be increased sales revenues, with improved prices with as few products as possible, long production runs achieved as sales volumes remained relatively stable in our sites and very straight forward sales processes.” year-on-year. IN CORE COMMODITIES MARKETS LIKE ASIA, we’re making the business as simple as it can be, while in the US, Japan, Korea and Europe, more people with the skills and knowledge to work much closer to customers are being deployed. That’s how you add value in commodities. US revenues include sales of US-origin product from its new Fonterra Global Trade and Fonterra produced by the Fonterra and Dairy Farmers of Americas Ingredients platform. DairiConcepts joint venture at Portales in New Mexico. “In Global Trade, it’s about having strong sales people Japan is another value add success story with Fonterra who can go in, talk to customers on their own terms increasing sales through focusing on key customers, and get the business done. In the value added side, understanding their producer and services requirements we will have people having a completely different and delivering to secure the business in a highly conversation with the customers about innovation, competitive environment. production development, speed to market. Being the John Shaskey’s goal is to transform Fonterra from best is about the right people in the right place. That’s the world’s biggest trader to the world’s best what we now have.”
EXCEEDING SALES AND PROFIT TARGETS SANJAY KHOSLA
Ask Fonterra Brands Managing Director, Sanjay Khosla, POWER BRANDS IN ACTION what his mission is and the answer is “to build great A good example of the growth in Power Brands is brands which make money”. Anlene™ “the expert in bone nutrition”. While Anlene™ was a success when it was initially launched in 1990, And his assessment of the 2005/06 season is that for the past few years the brand has been in decline. the Winning Through Brands! strategy has started This year a relaunched Anlene™ has achieved double delivering results. digit sales growth in Asia and has now been rolled out “We are delighted that we have exceeded our sales and in Australia and New Zealand. profit targets, despite paying the highest commodity The Anlene™ team has also established a ground- prices for five years. High input costs made the targets breaking partnership with leading healthcare company, more challenging, so hitting them is a real achievement. G.E., to tackle bone health issues using Anlene™ bone And we’ve done it in a year where we also restructured health products and GE Healthcare’s bone mineral the business, bedded down major brand acquisitions 24 density technology. in the Anchor™ business, Fresh ‘n Fruity™ and Kapiti™, completed negotiations for a joint venture with San Lu Foodservices has also had an excellent year with in China, and made some tough decisions about good profitable growth, despite the impact of high historically underperforming markets.” commodity prices. The Foodservices team has focused on developing strategic relationships with key global Fonterra Brands’ operating revenue, excluding accounts, laying the foundation for future growth. intersegment sales, gains on the sale of investments and other one-off items, was $192 million ahead of last The restructuring of the Fonterra Brands’ business has season at $3.7 billion, due to increased sales, improved seen improved leadership capability, more resource selling prices and benefits of brand acquisitions such as behind Power Brands and Foodservices, rationalisation Anchor™ and Fresh ‘n Fruity™ in New Zealand. of the supply chain and support services, and integration of newly acquired brands and businesses. Fonterra Brands’ operating surplus (essentially its EBIT) was $288 million, up $23 million or nine per cent from FOCUS ON BRANDS, MARKETS last year, reflecting the increased revenue and higher “We’re making tough choices and simplifying the returns from Power Brands. business to focus on markets and brands that deliver
MANAGING DIRECTOR FONTERRA BRANDS sustainable profitable growth.” This was despite investments in innovation, advertising and promotions increasing by 28 per cent over the The year’s progress follows a thorough review of the previous year. business, including markets and brands.
“Our Winning Through Brands! strategy is clearly Underperforming businesses in Russia and Egypt working and we are happy with where we are on the have been divested, and replaced with supply or
SANJAY KHOSLA - journey. We are moving the business towards sustained distributorship agreements. Meanwhile in-market
> profitable sales growth through increasing investment representation in Saudi and the United Arab Emirates is in our Power Brands and Foodservices, while reducing moving towards a more efficient business model. This our cost base”. will be an ongoing process. <
WE ARE MOVING THE BUSINESS TOWARDS sustained profitable sales growth through increasing investment in our Power Brands and Foodservices while reducing our cost base. The new leadership team has brought a new dynamic Power Brands and Foodservices, continue to clean up to Brands, and building talent and expertise continues historical underperformers (both brands and markets), to be a priority. and reduce costs by simplifying the business.
“Nurturing talent is the most important agenda across “We’ve had some great results this season and they Fonterra Brands. We have good people and the more fuel our desire to continue to perform. We have some we develop their capabilities, the more our performance ambitious goals for the next few years, but it’s all about will increase. A teams get A results while B teams get consistently pushing our Winning through Brands! D results.” strategy to meet our financial targets.”
Priorities for the next financial year are to keep building a strong talent base, drive further growth in the
LESS COMPLEXITY, MORE PRODUCTIVITY GUY COWAN
As a lean business, Fonterra is striving for less complexity, customers, controls the fixed asset register and prepares faster decision making and greater productivity. It is trial balances and general ledger reconciliations. also targeting costs, including more effective finance, IT “That move and the centralised management of Global and procurement, driven by CFO Guy Cowan. Treasury means we control cash better, we have much Fonterra achieved over $130 million in cost savings for better transparency around our cost structures and the season. Of that, $30 million came from reducing access to all the necessary financial information to unnecessary costs, eliminating duplication in Finance ensure the business can make sound decisions quickly. and centralising procurement. It also means we can focus finance staff on value adding activities supporting critical decision making “We have brought all the previously duplicated activities under one governance structure and we’ve put experts and performance tracking.” in to manage those functions. As a result, we have not “The end game is to run integrated systems across no 26 only hit our cost reduction targets for the season, but more than one or two platforms, updating data bases in have also identified savings to be delivered over the real time so that management and financial information next three years,” he says. is accessible with minimum manual interface.”
In procurement, over $100 million in savings will be “We are heading in the right direction there. Ultimately achieved over three seasons. A specialist team headed we will have one system and one financial database by an expert procurement negotiator and manager with reporting tools that deliver a higher level of currently covers New Zealand and Australia and will be information that will make us better at anticipating rolled out across Asia. where we can maximise returns. For example, using our Under their control are major contracts for packaging systems we will be able to determine which customers – Fonterra spends $400 million a year on that alone and products give us the highest contribution and tailor – energy, engineering services, consulting and more. our production to maximise that contribution.” For example savings of more than $25 million have FOREIGN EXCHANGE REVIEW been achieved by rationalising Fonterra’s tanker fleet to As well as implementing a shared services model, Guy one specification and carrying out a competitive tender Cowan keeps Fonterra’s foreign exchange management covering long-term maintenance contracts. under review as the New Zealand dollar reached CONSOLIDATION CUTS COSTS historical peaks against the US and looks likely to CFO Bringing all of Fonterra’s Information Services under trend down. one management structure supporting Fonterra’s global “We have benefited from having 15 month hedging operations provides the opportunity to standardise as the currency has appreciated and that’s given us software, infrastructure spend and applications additional revenue over the past three years. But as the
GUY - COWAN support, driving costs down without compromising currency has begun to peak, we have had to look again service levels. > at how we manage the situation so we can actively add An increasing number of financial transaction processes value. For example when currency is weak it is clearly are now consolidated under Fonterra Business Services, best to lock in positions, but as it rises we want to where costs have been reduced year on year. The team make sure we keep the door open to gain from any manages payments to suppliers, collects cash from currency depreciation. FONTERRA SPENDS AROUND $400 MILLION A YEAR ON PACKAGING ALONE – the bags, wraps and pallets you see here all come under that heading. A specialist procurement team, led by an expert negotiator, is driving down costs in this area, and others, right across the business. We use options and run the book shorter. We still slower sales programme in the middle of the 2006 manage prudently to achieve a balance between season. Higher working capital resulted in an operating certainty and added value.” cash outflow of $232 million for the year.
DEBT Cash flow is important in every business and Fonterra Guy Cowan has also reviewed Fonterra’s debt financing is no exception. “We are always looking closely costs, a move which led to the redemption of a at managing cash flows, whether it is by carefully significant number of capital notes on issue with the managing our costs, our working capital or our NZDX in July 2006. investments in fixed assets. This is an area we continue to focus on. Our balance sheet remains strong and we “The solid trading and credit history Fonterra has built intend to keep it that way.” up since it was founded means other, cheaper forms of financing are now available to us. We are able to make Cash received from the sale of the carryover inventory substantial saving on the interest expense through the along with the receipt of cash from the quarter four refinancing while still managing redemptions risk.” sales has resulted in positive operating cash flows at the beginning of the 2006/07 season. CASH FLOWS “My acid test, when it comes to cash flows, is the Fonterra is a cyclical business, as such we will always confidence lenders have in the business. Fonterra holds ensure we have enough inventory on hand to carry us a AA- rating from Standard & Poor’s with a stable through the period of low production, typically May outlook,” says Guy Cowan. – August. This year, due to commodity prices being ahead of where they were last season and higher than “In a cyclical business such as ours, short-term average production in April/May, closing inventories operating cash flow is one of the measures we track, were higher than last year. Trade receivables were also but a healthy balance sheet, constant focus on cost higher due to an unusual sales programme this year reduction and maximising return to shareholders are with high sales volumes in quarter four following a our top priorities.”
28 GLOBAL MANUFACTURING VIEW LEVERAGES EXPERTISE GARY ROMANO
A map of the world shows Fonterra Group In New Zealand, for example, Fonterra’s four cheese Manufacturing’s scale. There’s barely a country without cutting, grating and shredding operations are being a dot representing some form of manufacturing or consolidated into one modern plant in Taranaki. On processing. New Zealand has 24 primary sites, Australia completion, the new plant will produce more than is dotted with 10. Another 50 sites are scattered 80,000 tonnes of consumer packaged cheese a year around the globe in South East Asia, Africa, the for the New Zealand, Australian and Asian markets, Americas and Europe. marketed under the Mainland™, Chesdale™ and Anchor™ brands. The plant has the capacity to increase The scale is vast to process nearly 20 billion litres of processing by up to 30 per cent. milk each year – 14 billion in New Zealand. But Gary Romano, Director of Fonterra Group Manufacturing, Similar consolidation is being undertaken with secondary says the power of the assets doesn’t lie in the stainless powder processing, carefully managing which products steel, but the people who run them. are to be packed in New Zealand and which offshore. “It’s all about expertise. We are here to make our LOCKED, ALIGNED, COMPLEX
DIRECTOR OF FONTERRA GROUP MANUFACTURING ingredients and consumer businesses successful, A priority for Gary Romano and his team has been to whatever market they want to be in. We’re here ramp up the efficiency and lock down the costs of the to build new plant, make the best use of old plant New Zealand processing sites responsible for the vast and to leverage our capability right across the group bulk of Fonterra’s production. Today’s sites are now and around the world. If you want it made, we described as “locked”, “aligned” or “complex”. will make it better than you expected at the lowest GARY ROMANO - possible price.” A locked site makes just one specification of product > – whole milk powder for example – enabling very long Fonterra’s processing assets were gathered into a production runs which reduce energy and cleaning global group a year ago so that one view of our costs, and minimise yield losses and grading failures. entire capabilities could be formed, a culture of global excellence created and the assets used more effectively. Aligned plants make a limited range of specifications, Since then, progress has been steady. again reducing manufacturing changeover times and WE ARE HERE TO BUILD NEW PLANT, make the best use of old plant and to leverage our capability across the group and around the world. If you want it made, we will make it better than you expected at the lowest possible price. downtime, while promoting higher yields and better have enabled substantial transportation savings and grading performance. Complex plants manage technically environmental benefits, by reducing the number challenging specifications or multiple short runs, with of tanker trips needed to deliver our milk from the capability to change from one product specification Marlborough to Clandeboye by about 3,000 trips a to another in a matter of hours or even minutes. year. Further technological advances are being targeted with the creation of the Manufacturing Innovation “It is a simple concept, but it has involved marketing, Group. This group was formed recently with the former sales and operations planning and manufacturing Fonterra Innovation function being moved out into the working together to make the right decisions for the respective parts of the business where value is created. business. The results have been significantly lower costs with similar levels of customer servicing maintained.” BETTER, FASTER, SMARTER Having locked and aligned plants also ensures capital is Gary Romano says Group Manufacturing is also invested to maximum effect. In April 2006, for example, continually achieving returns from its Operations two new dryers were commissioned at Te Awamutu, Journey programme with its “better, faster, smarter” a plant aligned to powder specifications. The new focus. Its aim is to optimise performance, leverage dryers replace three old ones and boast a combined Fonterra’s manufacturing scale and achieve operational processing capacity of 13.5 tonnes of powder per hour. excellence to support Fonterra’s strategy of being They are considerably more energy efficient than the a low cost supplier and its value add push. The ones they are replacing, which will enable Fonterra to Manufacturing Excellence programme running in realise significant savings in operational costs. New Zealand challenges staff at sites to continuously find better ways of working. The programme is rolling BETTER GRADES, YIELDS out in Australia. With plants no longer all things to all people, first time “There are fantastic stories coming out of that grading performance has increased to 94.2 per cent programme. At Clandeboye, for example, we have from 93 per cent in the prior season. Losses are down brought coal costs down significantly because our 16 per cent to three per cent. Uptime, the time our guys worked out how to balance the loads on the manufacturing plants are actually producing product boilers that provide energy to the site. We have a and not in maintenance or cleaning mode, has increased nationwide project on compressed air use, matching by three per cent. Energy consumption has come down loads, eliminating unnecessary use and tracking leaks by 10 per cent which has partially mitigated soaring 30 in lines. That looks like it will deliver significant savings prices, a feat recognised with Fonterra’s winning the over the next two years.” Energywise Award for the second time in the past three years from the Energy Efficiency and Conservation Despite Fonterra’s manufacturing being grouped Authority (EECA). With energy Fonterra’s third largest globally for less than a year, Gary Romano is pleased manufacturing cost, behind only labour and plant with progress to date and energised by the potential depreciation, the savings make a significant contribution for bigger gains. to Fonterra’s international competitiveness. “Our focus has been in New Zealand and to a lesser Fonterra Group Manufacturing is adopting new extent Australia, so there’s a lot more that can be done. technologies to drive efficiency gains and slash costs. We have some priorities around driving best practice in “Lights out packaging” – automated packing of our consumer manufacturing sites, and others around product, has been trialled at one locked plant and increasing uptimes, building on our yield gains and will be rolled out at others. Technology to increase improving our delivered in full, on time performance. In solids concentration in evaporators, developed by energy, we’re looking to trim another five per cent off Fonterra, is also under trial. Leading-edge concentration our consumption. It’s going to be a full on year.” and automation technologies at our Tuamarina site DIRECTOR FONTERRA MILK SUPPLY
ENCOURAGING SUSTAINABLE AND PROFITABLE GROWTH BARRY HARRIS
As Director of Fonterra Milk Supply, Barry Harris has a products in the international markets looking good, our good feel for farmer sentiment. Right now, he says, it’s farmers are expressing confidence in the industry. BARRY HARRIS - pretty positive. “That’s reflected in a good season and the clear > “We have just completed a very good season with the potential for ongoing milk growth.” highest milk flows ever. We are seeing new conversions Encouraging that growth and ensuring it is sustainable to dairy. Dairy is still the most profitable use of are two of his main responsibilities. Good progress has agricultural land and we’re seeing significant increases been made in the season towards aligning Fonterra in cow numbers. Clearly, with the prospects for our Milk Supply’s services to supporting farmers who want WE HAVE A NEW SERVICE MODEL FOR SUPPLIER RELATIONSHIPS. It’s about better understanding the needs of individual farmers and targeting our services to their needs. We’re moving from a “one size fits all” approach to treating farmers as individuals. to grow. It’s a shift in thinking, from Fonterra taking In March 2006, the dairy industry agreed a sustainable a “one size fits all” approach to a new service model environmental management strategy to change dairy’s which treats them as individuals. environmental impact while maintaining productivity. The strategy is based on the whole industry “One of our key achievements is developing a new co-operating to develop, trial and communicate service model for supplier relationships which is about methods that improve farmers’ ability to address better understanding the needs of individual farmers environmental issues. It covers the leadership needed and targeting our services to their needs. to encourage change and demonstrate its benefits, the “We’ve recognised that there are people who want actions needed to get farmers understanding and using to grow and there are others who are ticking over tools to improve their environmental performance and comfortably. As a result, their expectations of us are the targeted research needed to develop ways to help different and we will be much more targeted in the way farmers meet environmental objectives. we help them.” “This is a big step forward. It’s a strategy that SERVICE MODEL REVAMPED co-ordinates industry investment and activities in a way Fonterra Milk Supply is rolling out a new service model, that targets the priorities of the dairy sector. There’s including regional service centres where farmers can a lot to be gained in a very targeted approach which connect with a consistent team of experienced people says ‘here are our priorities’ and puts actions plans who know the area, the individuals who farm there behind them.” and any climatic and environmental challenges they face. At the same time, the former Field Representative ENVIRONMENTAL STEWARDSHIP network is being freed up to provide more detailed Barry Harris, a former CEO of Environment Waikato, farming, business and environmental advice to farmers says there’s been a sea change in attitudes towards on a growth path, with their roles being renamed farming sustainability and the need to balance growth Area Managers. with stewardship of the environment.
The model responds directly to feedback from farmers “The shift in attitude and commitment to do something who have stressed the need for service that adds value is considerable and very encouraging.” as well as being value for money and working with He points to the very positive results coming out of 32 Fonterra-based representatives who have the strong the Clean Streams Accord as evidence of progress. The industry knowledge needed to work with farmers to Accord, signed by Fonterra, regional councils and the resolve issues and respond to their needs. Ministers of the Environment and Agriculture in 2003, Fonterra is a major partner in the drive to increase aims to achieve clean healthy streams, rivers, lakes and profitable on-farm productivity being led by Pastoral 21, wetlands in dairying areas. a collaboration of industry organisations. One of its aims Already 75 per cent of farmers have excluded dairy is increased funding for research; another more targeted cattle from streams, rivers and lakes versus a 2007 research that directly supports productivity goals. target of 50 per cent; 93 per cent of race crossing “As an industry we are working more effectively and points have bridges or culverts against a 2007 target collaboratively to agree on where we put our investment of 50 per cent. to get the best result for farmers. Resources are not The results are less spectacular in the area of nutrient unlimited, so it’s vital that what we have is invested in budgeting where 33 per cent of farms had management the right programmes in a very targeted way.” systems in place against a target of 100 per cent by 2007, although recent data suggests this has improved SUSTAINABLE MILK GROWTH to 57 per cent. Fonterra is targeting growth of three per cent in milk supply each year, but it isn’t growth at any price “We’ve been putting a great deal of emphasis on with the co-operative’s foundation theme reinforcing nutrient budgeting and that’s starting to shift the profitability and sustainability. numbers. We ran nutrient management workshops with Dexcel that were attended by more than 2,000 “We want to encourage growth through improvements farmers and rural professionals and saw the number in productivity. That helps enhance farmers’ profitability of suppliers with nutrient management programmes in and over the long term helps solidify our global place double.” competitiveness. One of our big challenges is dealing with issues around the environment and Also rolled out in the year is the Milk Collection sustainability. We are making good progress on the Programme of Work through which a significant sustainability front, working with a whole range of investment has been made in upgrading the technology farming stakeholders to ensure we have profitable and of the tanker fleet. Radio frequency identification sustainable dairy farming.” tags are being fitted on milk vats which allow automatic identification of the farm and the vat. New is improving service levels for farmers while ensuring milk sampling technology allows the volume and a level of healthy competition in the rural supply temperature of the milk collected to be stored on field so that farmers get the best value for another tag, providing very accurate traceability. their money.
In-cab technology is enabling the more efficient “We strongly support the idea of a competitive, low scheduling of tanker movements, which over time will cost rural supply sector and the joint venture will have enable more milk to be collected by fewer movements, a valuable role to play here.” driving down fuel use and road user charges as well as Barry Harris’ priorities for the coming season total fleet costs. include bedding in the new, more targeted service The joint venture between RD1 and Landmark, also delivery model, supporting increased growth in completed in the past year, means RD1’s 51 rural retail milk supply and engaging strongly with stakeholders stores will introduce new services in finance, insurance around profitable sustainable dairy farming. He and real estate, as well as an expanded livestock sales starts from a good position, with farmers surveys service drawing on Landmark’s expertise, built up with showing 80 per cent of them regard Fonterra Milk its 430 stores in Australia. Again, the motivating force Supply’s performance as very good to excellent.
33 2006 2006 ANNUAL REPORT ANNUAL REPORT FONTERRA FONTERRA PERFORMANCE MEASURES
The lack of competitors of a similar size and scale The 2005/06 Milk Price Gap is the same as the reported within New Zealand, and the absence of a market 2004/05 Milk Price Gap of 23 cents but in 2005/06 determined price for milk requires Fonterra to adopt certain methodology refinements were made to the a set of theoretical performance measures to assist calculation of the Historical CMP and Fonterra CMP to shareholders in assessing performance on a basis better determine a more representative price of milk. consistent with traditional businesses operating in a Had the previous methodology been applied to the competitive market. 2005/06 season the Milk Price Gap would have reduced to 19 cents, a reduction of four cents. Correspondingly, FAIR VALUE SHARE a restatement of the 2004/05 Historical CMP and The Fair Value Share essentially reflects the value ascribed Fonterra CMP on the basis adopted for 2005/06 would to the expected future returns to shareholders from our have resulted in a Milk Price Gap of 27 cents, similarly value added activities. It represents the additional return implying a reduction in the gap between the two Fonterra is able to earn in excess of a business selling seasons of four cents. only basic commodity products from New Zealand. As There are a large number of components in the such, it captures the value associated with Fonterra’s Historical CMP and Fonterra CMP that can affect sale of consumer and foodservice products within the gap including differences in installed plant, plant Brands, and value add sales within the Ingredients utilisation, product mix, working capital and operating business, as well as from future opportunities to increase expenses. Further there are inherent limitations in the value add returns through product innovation and measurement of the Historical CMP and Fonterra CMP, manufacturing efficiency. It also reflects the expected both of which involve a significant number of subjective future earnings of Fonterra’s investments and joint judgements and assumptions. It is therefore doubtful ventures. The Fair Value Share is set by the Board based whether either measure can be reliably determined on a valuation range determined by an independent within a margin of error of less than one per cent. valuer appointed by the Shareholder’s Council. Accordingly, it is not appropriate to place too much Our Fair Value Share rose from $5.44 in the 2005/06 reliance on small movements in the Milk Price Gap, season to $5.80 for the 2006/07 season. After making which is the product of both the Historical CMP and appropriate adjustments for the impact of the capital the Fonterra CMP. 34 restructuring this represents a six per cent increase. This Notwithstanding these issues, Fonterra continues to is the fifth annual increase in the Fair Value Share. analyse the component parts of the Milk Price Gap to Duff & Phelps, LLC (Duff & Phelps)1 independently identify areas where improvements within its control valued each share at between $5.37 and $6.24 (prior can be achieved. Fonterra is also developing alternative to the consolidation of the share standard to be measures of long-term efficiency including internal and undertaken in November 2006), compared with a range external benchmarking. of $5.03 to $5.85 for the 2005/06 season. The increase TOTAL SHAREHOLDER RETURN reflected Duff & Phelps’ recognition of the anticipated Total Shareholder Return (TSR) is a common measure for benefits of the cost saving initiatives undertaken during evaluating a shareholder’s total return on investment. the 2005/06 season and the ongoing improvement in For a conventional listed company TSR is calculated value add earnings anticipated in the Ingredients and as the total return comprising dividends paid and any Brands businesses. change in share price over the year, divided by the shareholder’s investment at the start of the year. MILK PRICE GAP Since its formation Fonterra has calculated the Milk As a co-operative Fonterra does not pay dividends but Price Gap as one of its key performance indicators. distributes virtually all its income to shareholders in the The Milk Price Gap is a performance measure form of payout. For the purposes of determining a TSR aimed at comparing the performance of Fonterra’s for Fonterra, total return is defined as payout less the notional commodities only business with that of the Historical CMP plus the appreciation in the Fair Value hypothetical efficient competitor. The gap represents Share over the year. The Historical CMP is applied to the difference between the Historical Commodity Milk the TSR as it is consistent with the milk price applied Price (Historical CMP) and the Fonterra Commodity in the Fair Value Share. The investment is defined as Milk Price (Fonterra CMP). a shareholder’s investment at the start of the year comprising both the Fair Value Share and Peak Notes. The 2005/06 Historical CMP is assessed at $3.85 per kilogram of milksolids and the Fonterra CMP is assessed Total returns for 2005/06 were 61 cents per kilogram at $3.62 per kilogram of milksolids. Accordingly the of milksolids. This included a TSR Value Add component current season Milk Price Gap is calculated at 23 cents. of 25 cents.
1 During 05/06 the company’s previous valuer Standard & Poor’s Corporate Value Consulting (S&P CVC) was sold to international valuation firm Duff & Phelps, LLC (Duff & Phelps). Almost all the staff from S&P CVC including the entire team that work on the Fonterra valuation transferred to Duff & Phelps. The Shareholders’ Council assigned the S&P CVC valuation contract to Duff & Phelps. PERFORMANCE MEASURES – continued
Dividing the total return earned by the opening QUOTA investment results in a TSR for the current season of The return that we earn from selling into quota markets 9.6 per cent. This compares to a TSR of 17.2 per cent at a price over and above the market price (known as for the 2004/05 season and 11.0 per cent for the the Quota Rent) is treated as a value add activity. The 2003/04 season. level of quota rent earned has decreased significantly from 14 cents per kg/MS in the 2002/03 season to four Fonterra’s annual compound average TSR for the last cents per kg/MS in the current season. This decrease is four years is 12.7 per cent. despite the volume of quota sales remaining relatively constant over the last four seasons. The decrease in VALUE ADD CONTRIBUTION TO PAYOUT value add quota returns is driven by the increase in Another key performance metric applied in assessing market prices relative to quota prices together with the Fonterra’s results is the Value Add Contribution to appreciation in the NZD. Payout. This represents the returns earned by Fonterra in excess of those that would be earned by selling In the table below we have converted Fonterra’s the shareholder supplied milk as undifferentiated historical value add earnings at the 2005/06 conversion commodity only products. The Value Add Contribution rate and normalised the historical results to the level of to Payout for a particular season is calculated as total quota rents earned in 2005/06. The table shows that payout less the Fonterra CMP. on this basis the value add earnings have increased by 71 per cent over the last four seasons. For 2005/06 the Value Add Contribution to Payout is assessed at 48 cents per kilogram of milksolids compared to 45 cents per kilogram of milksolids HISTORICAL VALUE ADD RETURNS in 2004/05. The table below summarises the key 2005/06 2004/05 2003/04 2002/03 components of Payout in recent years. Value add returns (NZD/kg/MS) 0.48 0.45 0.48 0.47 PAYOUT SUMMARY Average Annual Conversion Rate 0.66 0.61 0.52 0.48 NZD per kg/MS Value add returns 2005/06* 2004/05 2003/04 2002/03 – Normalised for FX 35 Payout 4.10 4.59 4.25 3.63 at 05/06 Rate 0.48 0.42 0.38 0.34 Historical CMP 3.85 4.37 3.97 3.34 Quota Rent Differential Milk Price Gap (0.23) (0.23) (0.20) (0.18) – Normalised at Fonterra CMP 3.62 4.14 3.77 3.16 05/06 levels 0.00 (0.02) (0.06) (0.06) Value Add Value add returns Contribution to Payout 0.48 0.45 0.48 0.47 – Normalised for FX and Quota 0.48 0.40 0.32 0.28 *Methodology changes were made in the 2006/07 season which do not make the result comparable with prior years.
The table above shows a relatively consistent level COMMODITY PRICES of Value Add Contribution to Payout throughout Value add earnings, particularly in the Ingredients the period with the 2005/06 result being at the top business, also tend to be impacted inversely by of a fairly narrow range. The apparent consistency commodity prices. In periods of increasing prices value of value add earnings does not reflect a number of add margins tend to be compressed as it takes time season specific events and macroeconomic variables to push through the increasing commodity prices to which have a significant impact on the assessed level the value add selling price. Conversely in periods of 2006 2006 of Value Add Contribution to Payout including the declining commodity prices, value add margins increase impact of changing FX rates, changes in commodity as selling prices decrease at a slower rate than the prices and quota rents. These three key factors are underlying commodity price. Over the last four seasons discussed below. commodity prices have increased to record highs which
has impacted on all of Fonterra’s value add businesses. ANNUAL REPORT FOREIGN EXCHANGE ANNUAL REPORT Fonterra’s value add earnings are predominately based in US Dollars and converted back to NZ dollars. Over the last four seasons Fonterra’s average conversion rate FONTERRA FONTERRA has increased from 0.48 in the 2002/03 season to 0.66 for the current season. PERFORMANCE MEASURES – continued
MILK PRICE HISTORICAL CMP As a co-operative, Fonterra distributes virtually all its As discussed above the CMP is based upon the cost of income to shareholders in the form of payout. This milk applied by Duff & Phelps in assessing the earnings payout is paid in proportion to the supply of milksolids of the Ingredients business for the purpose of the received from the shareholders. Fair Value Share. The Historical CMP simply takes that forward looking model used for the valuation and For performance purposes it is important to divide this applies the actual milk volumes, base commodity prices single payout figure between the payment for the milk and exchange rates achieved by Fonterra during the and the return on the co-operative’s value add activities season (hence it is the Historical CMP). and investments. Fonterra processes approximately 95 per cent of all FONTERRA CMP New Zealand milk and accordingly there is not a valid The Fonterra CMP is calculated in a similar manner market based price for liquid milk acquired within to the Historical CMP. However rather than applying New Zealand. Further, at this time, it is not appropriate the efficient competitor sales mix and operating costs to use prices paid for milk outside New Zealand due to as applied in the Historical CMP, the Fonterra CMP the significant variances in cost structures between the uses Fonterra’s commoditised product mix and costs. New Zealand dairy industry and that in other countries It is based upon the actual volume of milksolids and the relatively small proportion of New Zealand received during the year however it assumes that milk that is sold fresh in New Zealand. Accordingly the only commodity products are manufactured. All milk milk price is assessed by a calculation known as the volumes actually applied by Fonterra to manufacture Commodity Milk Price (CMP). This is based upon the non-commodity and value add products are assumed cost of milk determined by Duff & Phelps as part of to be applied to the manufacture of the most similar their Fair Value Share assessment. The CMP is the price commodity products and are assumed to be sold at a hypothetical efficient competitor could afford to pay a base commodity product price. Accordingly the for milk and is assessed as: Fonterra CMP excludes any returns earned by Fonterra from value add activities. Annual revenue that could reasonably be achieved 36 from the sale of a balanced portfolio of dairy commodity products, derived from milk, of the quality and quantity supplied to Fonterra in New Zealand. Less: The assessed operating costs and capital costs (including a fair return on capital) incurred in deriving commodity milk revenue.
ADDITIONAL PERFORMANCE MEASURES
The performance measurements discussed above are The consistency between the milk price determined consistent with those provided in previous years. by the independent valuer for the Fair Value Discussed below are additional performance measures Share and the milk price for financial reporting that Fonterra will report on going forward. is particularly important to ensure comparability between the value add earnings inherent in the Fair SEPARATION OF MILK COMPONENT AND VALUE ADD Value Share and those distributed by way of payout. COMPONENT OF PAYOUT To the extent there is a significant disconnect, issues Over the last year management has been reviewing around adequate return on investment will arise. Fonterra’s performance measures and in particular the calculation of the price of raw milk. The existing Historical Based upon the work undertaken, the existing CMP CMP and Fonterra CMP models were examined along model (or a derivative of the model) is still considered with alternative approaches. The analysis identified the the most appropriate basis for determining the raw milk following key issues: price to be used for all purposes. Accordingly, under the new approach the Valuer will assess the CMP as they There should ideally be one methodology for currently do. However, in determining the optimal calculating the milk price for all purposes including long term product mix the Valuer will apply Fonterra’s the Fair Value Share, management performance forecast base commodity product prices rather than the measurement and statutory financial reporting. Valuer’s modelled mean-reverting forecast prices. PERFORMANCE MEASURES – continued
Having assessed this optimal product mix the Valuer will continue to deduct the hypothetical efficient FONTERRA BRANDS SEGMENTAL PROFORMA STATEMENT OF FINANCIAL POSITION competitors costs (including a capital charge on the AS AT 31 MAY optimal asset base) as it currently does. The residual will be the amount available to pay for raw milk. NZD Millions 2006 2005 Accounts Receivable 560 448 To avoid confusion, the new basis of calculation will be Inventory 772 699 known as the “Milk Price Methodology”. At year end rather than having a Historical CMP we will simply have Other Current Assets 75 455 a Historical Milk Price. Total Current Assets 1,407 1,602 Investments 271 240 At year end suppliers have traditionally been provided Intangibles 1,9751,340 with an analysis of the value add, Historical CMP and Fonterra CMP components of the payout. The Board Fixed Assets 552 515 has determined that going forward all forecast payout Total Non-Current Assets 2,798 2,095 announcements will also identify separately the milk Trade Creditors and Payables (707) (697) price component and value add component of the Total Funds Employed 3,498 3,000 season’s payout. Total Interest Bearing Debt 1,210 966 Identifying a separate milk price component of payout Equity 2,2882,034 will provide a clear signal to shareholders regarding Total Capital Employed 3,498 3,000 the value of milk at the farm gate which will assist RONA(1) 6.8%7.2% in making on-farm decisions. The increased visibility Total Return on Enterprise Value(2) 9.3%7.2% around the value add returns will enable shareholders Normalised Return on Enterprise Value(3) 9.3% 4.6% to better monitor the performance of Fonterra’s value add operations. (1) Segment Operating Surplus after tax excluding Amortisation and non-recurring items as a percentage of Average Net Assets (Total While Fonterra’s total payout will remain unchanged, Funds Employed) the two components of payout will be paid separately. (2) Increase in Enterprise Value (as determined by independent valuer) plus Free Cash Flow, excluding interest, as a percentage of Opening The milk price component of payout will continue to 37 Enterprise Value be paid pursuant to an advance rate schedule while (3) Total Return on Enterprise Value as defined above less the increase the value add component will be paid twice a year in in value of the National Foods Investment in the 2004/05 season February and August. The key change in Fonterra Brands proforma statement FONTERRA BRANDS of financial position relates to divestments, acquisitions As discussed in the Chairman’s Review, detailed below and the receipt of proceeds from 2004/05 sale of its is additional segmental information regarding the investment in National Foods. During the 2005/06 performance of the Fonterra Brands business. season Fonterra Brands acquired the NZDF, Kapiti and Pastryhouse businesses and divested certain operations FONTERRA BRANDS SEGMENTAL OPERATING RESULTS of its Mainland business. These aquisitions were funded YEAR ENDED 31 MAY by the proceeds received from the sale of Fonterra NZD Millions 2006 2005 Brands 19 per cent investment in National Foods, Sales to customers outside the group 3,790 3,775 (included in other current assets as at 31 May 2005) Inter-segmental sales 71 59 and interest bearing debt. 2006
Total Revenue 3,861 3,834 2006 As the table above shows Fonterra Brands’ Return on Total cost of sales 2,608 2,544 average Net Assets (RONA) for the 2005/06 year has Gross margin 1,253 1,290 decreased slightly from the return for the 2004/05 Operating expenses 939 832 year, primarily as a result of the substantial acquisitions Segment operating result including undertaken in the 2005/06 season. These acquisitions ANNUAL REPORT non-recurring items 314 458 ANNUAL REPORT are expected to improve Fonterra Brands’ return in Non-recurring income/(expenses) 26 193 future years. Segment operating surplus 288 265 However the Total Return on Enterprise Value which FONTERRA The preceding table illustrates that Fonterra Brands includes the increase in Fonterra Brands’ value (as FONTERRA segment operating surplus for 2005/06 was ahead of assessed by the Valuer) improved between the 2004/05 the result achieved for 2004/05. Discussion of Fonterra and 2005/06 years. Excluding the increase in value of Brands operating result is included in the Chairman’s the National Foods investment from the 2004/05 Total Review on page 15 and the commentary from Fonterra Return on Enterprise Value calculation shows an even Brands’ Managing Director on page 24. greater improvement on a normalised basis. Governance
Fonterra is New Zealand’s largest co-operative as well During the year the director election process for Elected as being a significant company in the context of the Directors was reviewed and the timing of elections New Zealand economy and the global dairy industry. was changed so that at the time of the elections the The Company has approximately 11,000 New Zealand most up-to-date financial results are available. This change also ensures that the Director elections coincide dairy farmer suppliers who are shareholders, and with the Annual Meeting. The structure of the Board has issued Capital Notes which are listed on the will continue to be reviewed in consultation with New Zealand Debt Market of New Zealand Exchange shareholders to ensure that it best meets the demands Limited (“NZX”). of the co-operative. The Board and Management are committed to a system of corporate governance that meets the “INDEPENDENT DIRECTORS” unique requirements of Fonterra’s shareholders and The Fonterra Constitution specifies the composition of the Board and does not distinguish between 38 best practice appropriate to a co-operative and, as New Zealand’s biggest company, also takes into account “independent” and “non-independent” directors. The recommendations by the New Zealand Securities Appointed Directors are “independent” and free of Commission and NZX. any supplier relationship with the Company. However, the co-operative nature of the Company means that Elected Directors, who must be shareholders, will have The Board of Fonterra a supplier relationship with the Company. While none of the Elected Directors are material shareholders, they COMPOSITION are not classified as “independent” under the NZX The composition of the Fonterra Board is a significant definitions because their supplier relationship with element in the governance of the co-operative. The Fonterra is material to their business activity. Board is comprised of up to 13 directors. Under the The Board considers that the mix of Elected and Fonterra Constitution, nine of the directors are elected Appointed Directors, as mandated in the Constitution, from the shareholder base (“Elected Directors”), and provides an appropriate balance so that the Board four are appointed by the Board and approved by operates in the best interests of the Co-operative’s shareholders at the Annual Meeting (“Appointed shareholders. Directors”). There are no executive directors. All Directors comply with the legislative requirements for During the financial year two of the Appointed Directors disclosing interests, and Fonterra has a Securities Code retired. They were replaced by Mr John Ballard and of Conduct, which guides and regulates both Directors Mr Ralph Waters. and Management in their personal dealings with Fonterra securities and those of related companies. Appointed Directors have a significant role to play in providing a balance of independence, skills and BOARD ROLE & CHARTER experience to the Board, complementing the deep The Board has the responsibility to direct and supervise understanding of the dairy industry provided by the the management of the business and affairs of the Elected Directors. Consequently, appointments are only Co-operative. Key activities in discharging this made after a process involving an extensive search responsibility are: determination of payout; setting of based on detailed criteria. Appointed Directors are the Fair Value Share price after determination of the appointed for a term specified by the Board, subject to Fair Value range by the Valuer; review and approval of shareholder approval. Elected Directors are appointed the budget and corporate plan; the appointment and for a three-year period through a postal ballot. review of the performance of the CEO; engagement in the strategic planning process and in the setting of required to have an accounting or financial background. the strategy for the Company and the major business The Chairman of the Committee (who must not be the units; approval of significant acquisitions and disposals Board Chairman) is Graeme Hawkins. Both he and outside management’s delegated authorities; oversight Roger France, who also sits on the Committee, have of the Board Committees and the areas covered by accounting and financial backgrounds and both are each of those Committees. Appointed Directors. The Board has issued a written delegation of authority The AFRC has significant roles in (i) assisting the to Management, which it regularly reviews, and has Board to ensure the quality and integrity of financial reporting and review processes in place to monitor reports, (ii) reviewing the risk and assurance processes, performance of Management in the conduct of the and (iii) overseeing Treasury operations and policies. operations of the Company. Principal activities of the AFRC include establishing The Board has adopted a Charter, which defines its and reviewing internal audit and global assurance manner of operation and relationship with Management. processes; reviewing the internal control framework, The Board Charter is posted on the Fonterra website, significant risks, exposures and mitigation strategies; www.fonterra.com. A process exists to regularly review reviewing financial reports to shareholders and offering documents; reviewing and overseeing financial risk the Charter to ensure that it reflects the role of the strategies, hedging policies and other treasury functions; Board as it develops. ensuring the timeliness and balance of disclosures on the affairs of the Company; and overseeing the Board Meetings appointment of external auditors and the external audit process. The Board meets formally at least eight times each year to conduct business. The business at those meetings APPOINTMENTS REMUNERATION AND DEVELOPMENT COMMITTEE (“ARD COMMITTEE”) includes consideration of the ongoing operations of the Fonterra business, long term and annual plans The ARD Committee is comprised of up to five and budgets, and major strategic proposals and Directors, two of whom are Appointed Directors. governance matters (including statutory responsibilities The Chairman of the Committee is the Chairman of and continuous disclosure issues). the Board, Henry van der Heyden. Principal activities of the ARD Committee include obtaining assurance The Board also holds a number of workshops each year that the Company’s human resources policies and 39 to consider matters of significance such as the Fonterra practices support achievement of the Company’s goals; Strategy and Fonterra’s capital structure. In addition, overseeing appointments of the CEO, roles reporting to Directors visit significant global markets to enhance the CEO, and key professional legal and public relations their understanding of the business of the Company advisors; reviewing remuneration strategies and plans; and its strategies. These market visits include briefings and overseeing the development of key employees. from management and meetings with joint venture The Committee is also developing processes for the partners, major customers and local political leaders. evaluation of individual Directors and the Board as a whole. Board Committees SHAREHOLDER RELATIONS COMMITTEE (“SRC”) The Board uses Committees or Working Groups to The SRC is comprised of four Directors. Up to four facilitate more effective and efficient decision-making. Shareholder Councillors also attend SRC meetings as Committees and Working Groups have written terms of observers. The Chairman of the Committee is Greg reference, and report on their activities to the Board. Gent. Principal activities of the SRC include monitoring 2006 Committees are made up of Directors only, although the interface between Fonterra and shareholders; 2006 other people may be present as observers, whereas reviewing the delivery of services to shareholders and the terms and conditions of supply and; acting as an Working Groups may have employees, shareholders, or intermediary for shareholders with complaints against others as members in addition to Directors. the Company and liaising with the Milk Commissioner ANNUAL REPORT The Terms of Reference and membership of each ANNUAL REPORT in relation to complaints that cannot be resolved. Committee or Working Group are reviewed annually The SRC also provides a significant interface with the by the Board. There are currently five permanent Shareholders’ Council on shareholder / supplier issues. Committees of the Board and one Working Group, as FONTERRA identified below. Other committees may be formed as FAIR VALUE SHARE REVIEW COMMITTEE (“FVS FONTERRA COMMITTEE”) required – for example, in the event of major merger and acquisition activity. The Fair Value Share Review Committee is comprised of four directors. The Board Chairman and CEO AUDIT, FINANCE & RISK COMMITTEE (“AFRC”) may also attend ex-officio. The Chairmen of the The AFRC is comprised of up to five Directors, and must Shareholders’ Council and the Performance Committee include an Appointed Director and the Chairman of the of the Shareholders’ Council are entitled to attend Company. At least one member of the Committee is as observers. The Chairman of the FVS Committee is Roger France. Shareholder Relations and The principal activity of the FVS Committee is providing advice to the Board on the setting of the Fair Value Stakeholder Interests from within the Fair Value range determined by The Board continues to promote the co-operative the Valuer, which the Board is required to do under nature of the Company and reflects this in its dealings the Constitution. In order to fulfil this role the FVS Com- with its supplying shareholders. This year has seen a mittee reviews information provided by management continuation of the Board’s programmes for fostering to the Valuer, and interacts with the Valuer to the and enhancing relationships with its supplying extent required to enable the Committee to obtain a shareholders. high level understanding of the process used in the The Board and management have maintained regular determination of the Fair Value Range. direct contact through a significant number of meetings held throughout New Zealand. These meetings have EXTERNAL RELATIONS COMMITTEE also been supported by the Shareholders’ Council, Field The External Relations Committee is comprised of Representatives and the Fonterra Farmer Network. three Directors. The Chairman of the Committee is They provide an important forum for shareholders to the Chairman of the Board, Henry van der Heyden. engage with Directors and management and gain a The purpose of the Committee is to assist the Board better understanding of the Fonterra business. in building relationships with political contacts and The Fonterra Milk Supply Service Centre also international trade policy contacts as well as with continues to provide an important service through selected joint venture partners. which shareholders can contact the Company to make MILK PRICING WORKING GROUP (“MPWG”) comments, or to raise questions or complaints, and The MPWG is comprised of four Directors, up to two ensures that shareholders’ concerns are addressed. external appointees, and a Management representative, Fonterra also maintains the Fencepost website which being the Director Fonterra Milk Supply. The current provides a wide range of information and other Chairman of the Working Group is Mark Townshend. services to shareholders, as well as a corporate Fonterra The purpose of the MPWG is to assist the Board with website (www.fonterra.com) which contains general the development of milk pricing signals in co-ordination information on the Company and is accessible to the with the development of the capital structure. general public. 40 CANDIDATE ASSESSMENT PANEL AND GOVERNANCE DEVELOPMENT COMMITTEE Information Disclosure In addition to the Board Committees, the Board and Shareholders’ Council agreed to establish The Board is committed to providing information to its the Candidate Assessment Panel and Governance shareholders and other investors in a timely manner. The Board regularly reviews the expected payout Development Committee as joint initiatives to aid the to suppliers, and communicates its best estimate. development and assessment of future candidates The Board also uses shareholder meetings to update for the Elected Director positions on the Board and shareholders on the Company’s performance, and provide shareholders better information on the electoral strategic issues. process. The Panel is independently chaired by John Palmer and has two Directors and two Shareholders’ Shareholders also receive information relating to the Fair Councillors as members. The Committee comprises two Value Share, annual and half-year financial results, and Board members and three Shareholders’ Councillors. elections of Directors and Shareholders’ Councillors. As a listed issuer of debt securities, Fonterra also keeps the market informed of material information through Remuneration of Directors announcements to the NZX. The Directors’ Remuneration Committee (“DRC”), is independent of the Board and the Shareholders’ Council, Shareholders’ Council being separately elected by Fonterra Shareholders. Under the constitution, the DRC considers and The Board has a significant and unique relationship with the Shareholders’ Council, which is established under recommends for shareholder approval, the form and the Constitution. The Council is independent of the amount of remuneration for Elected Directors. Board and comprises 46 shareholders, representing 25 The Board is responsible for setting remuneration different wards, who are elected by the shareholders. of Appointed Directors, but generally follows the The Council’s functions include reviewing the Board’s remuneration levels approved for Elected Directors. statement of intentions for the performance and The Board is authorised to approve special remuneration operations of the Company, and commenting on for a Director who is engaged to carry out work other reports from the Board on the Company. The Board than as a Director of Fonterra or where a Director is and Council share common interests in shareholder called upon to exercise special skills for the benefit of issues, which are generally addressed through the SRC, the Company. MPWG, or similar mechanisms. The Board receives regular feedback from the Council, Within Management, the Ethics programme is the both at its regular meetings, and through regular responsibility of the Fonterra Leadership Team and meetings between the Chairs of the Board and the is administered by the Director of Human Resources, Council and the Chairs of their respective Committees. who reports to the ARD Committee in relation to To assist the working relationship, the Board and ethical matters. The Director of Human Resources Council have approved a written protocol detailing the reports at least annually on Ethics issues and is assisted working interface between the Board, executive and in administering the Ethics programme by an Ethics Shareholders’ Council. Committee comprised of members of management including the General Counsel, the Director of Global Assurance and members of offshore businesses and Ethics Framework and major business units of the Company. Stakeholder Interests During the reporting period Fonterra did not encounter any material breaches of policy or its Code Fonterra’s Board is committed to the ethical conduct of Conduct. of the Company’s business around the world. The Company has published The Way We Work – Fonterra’s Code of Business Conduct, which reinforces this Audit Independence Policy commitment. The Way We Work is based on Fonterra’s Values and Principles. The Board, primarily through the AFRC, ensures that the external Auditors appointed by the Company are The Way We Work covers matters such as: independent. Fonterra operates a rigorous selection Moral courage and leadership process to appoint its auditors and has a policy of Dignity and respect rotating its lead external audit partner in accordance with best practice. AFRC approval is required for any Work environment and hours of work activities the Auditor undertakes for the Company Fair treatment and diversity other than those specified in their engagement as Harassment Auditor. In general, the AFRC will not approve the Health and safety Auditor performing any potentially conflicting tasks unless exceptional circumstances exist and appropriate Alcohol abuse safeguards to ensure independence are put in place. 41 Child labour Privacy Product safety, sales, marketing and advertising Governance Standards Children as customers The Board recognises the need to continually review its Governance Standards to ensure they are in line Infant formula with developing best practice. In so doing, the Board Business records, recording information, protect- considers material published by a range of parties ing Fonterra’s assets, name and confidential in New Zealand and internationally. The objective of information the Board is to continue to structure and develop External business practices, relationships with the governance systems and disclosures to provide vendors, conflicts of interest, inside information meaningful and effective governance that is appropriate and securities trading, competition and antitrust, in the particular context of Fonterra as a major anti-corruption laws, competitive information, co-operative based in New Zealand. gifts and entertainment, external relations and 2006 communications 2006 Legislation, environment, agricultural raw materials, ethical standards in research, individual political activities, corporate political activities, export control and compliance. ANNUAL REPORT ANNUAL REPORT The Way We Work also provides very clear policies governing the relationships that Fonterra has with significant stakeholders such as employees, customers, FONTERRA shareholders, business partners and suppliers, and FONTERRA communities. The Code has a global reach and is not limited to any particular country or community. The Way We Work is not a substitute for the corporate policies of Fonterra. Rather, it refers employees to the relevant policies and encourages communication of compliance with those policies. The Board of Fonterra
He has nine years experience as a member of the Technology NZ Reference Group analysing research and development projects, and has served on the Animal Remedies and Pesticides Boards. He is a director of Embryo Technologies Ltd and Hawkes
HENRY VAN DER HEYDEN Bay Dairies. BE (HONS) (LINCOLN) Mr Bailey farms 205 hectares near Feilding and has other dairy farming interests in the lower North Henry van der Heyden became Chairman of Fonterra Island. He holds a Bachelor of Agricultural Economics Co-operative Group in September 2002 and is a from Massey University and is a member of the founding Director of the co-operative. Institute of Directors. He has contributed to industry governance for 14 years, as both a director and chairman, and played a considerable role in the industry rationalisation that led to Fonterra’s establishment. He pioneered the establishment of shareholder committees having a role in co-operative governance, a move which led to the establishment of Fonterra’s Shareholders’ Council. Mr van der Heyden currently serves on Fonterra’s JOHN BALLARD Audit, Finance and Risk Committee, and is Chairman MBA of the Appointments, Remuneration and Development Committee and External Relations Group. He is also John Ballard was appointed as an independent a director of the NZX, Innovation Waikato Ltd, King director in May 2006, effective from July 2006. St Advertising and Independent Egg Producers, and Mr Ballard has a Master of Business Administration serves on Waikato University’s School of Management from the Columbia University Graduate School of Advisory Board. He is a Trustee of Asia:New Zealand. 42 Business, majoring in Marketing and International He holds a Bachelor of Agricultural Engineering Business. He has served on the boards of several with Honours from Lincoln University and began his prominent listed companies including Woolworths farming career sharemilking in the Putaruru/Tokoroa Ltd, CSR Ltd, Rinker Ltd, and Email Ltd. He is a area, where he purchased a farm in 1985. Mr van der former Chairman of Wattyl Ltd. and is a Trustee of Heyden owns three dairy farms in partnership with the Sydney Opera House. his wife Jocelyn and has an equity partnership in two In addition to his extensive governance experience, other properties. The van der Heydens have two sons Mr Ballard has a strong track record in consumer goods, and two daughters. marketing brands and distribution management as a result of leadership roles in international companies including Coca-Cola Amatil Ltd (Australia), United Biscuits Asia Ltd, and Southcorp, where he was CEO prior to the company’s acquisition by Fosters Ltd. His farming interests extend to a property producing milk-fed veal in New South Wales. Mr Ballard is married with two children.
MALCOLM BAILEY B Ag Econ MASSEY
Malcolm Bailey was elected to the Fonterra Board of Directors in May 2004. He is a member of the Shareholder Relations Committee and the External Relations Committee. He is Fonterra’s representative on the International Food and Agriculture Trade Policy Council. Mr Bailey is a former National President of Federated Farmers, a former Fonterra Shareholders’ Councillor, and has been a Special Agricultural Trade Envoy for the New Zealand Governmentand an External Monetary Policy Adviser to the Reserve Bank. HARRY BAYLISS ROGER FRANCE B AGR SC (MASSEY) BCOM, CA
Harry Bayliss has been a dairy company director Roger France joined the Board of Fonterra in January for 17 years. He has served as Chairman of the 2003. The first 11 years of his professional career New Zealand Dairy Research Institute and as a were with a PricewaterhouseCoopers predecessor director of Bonlac Foods, ViaLactia Biosciences, firm, and included five years in audit supervisory and Dairy Meats, and LIC. He is currently a member of management positions in Sydney and London. Fonterra’s Audit, Finance and Risk Committee and He spent 10 years as Chief Financial Officer with two Fair Value Share Committee. New Zealand publicly listed companies, Allied Farmers His farming interests have centred on coastal Taranaki Co-operative Limited and Freightways Holdings for more than 20 years, starting with the purchase of Limited, before returning to what was then Coopers a dairy farm in Otakeho in 1981 after five years of & Lybrand as a partner in the Corporate Finance sharemilking. Expansion of this holding has continued division, subsequently serving as the Managing ever since and he now also has farming interests in Partner in Auckland. South Waikato. He has a Bachelor of Agricultural Following the merger with Price Waterhouse, he sat on Science from Massey University. Mr Bayliss retired as the Management Board of PricewaterhouseCoopers a director at the end of the financial year. and led its Corporate Value Consulting practice in the Asia Pacific region for three years before retiring from the firm in June 2001.
He joined Air New Zealand’s Board in October 2001, 43 acting as Executive Director until February 2002 and is currently the airline’s Deputy Chairman and Chairman of its Audit Committee. Mr France has been Chairman of the private investment company Tappenden Holdings since 1997, and is a GREG GENT member of the University of Auckland Council. He serves on Fonterra’s Audit, Finance and Risk Greg Gent has served the dairy industry as a Committee and is Chairman of the Fair Value director since 1993. He is Chairman of Fonterra’s Share Committee. Shareholder Relations Committee and serves on the Appointments, Remuneration and Development Committee, the Trade Strategy Committee and the Milk Price Working Group. He is also a director of FMG Insurance. He began his 2006 career working for the Bank of New Zealand in 1972. 2006 After five years he made the move into dairying, with 700 cows on his farm at Ruawai, Northland. In 2002 Mr Gent completed the Advanced ANNUAL REPORT Management Programme at INSEAD, France. ANNUAL REPORT FONTERRA FONTERRA The Board of Fonterra – continued
GRAEME HAWKINS EARL RATTRAY BSC, BCOM, ACA B Ag Econ MASSEY
Graeme Hawkins is Chairman of Watercare Services Earl Rattray has been a dairy company director for Ltd and a director of a number of other companies 11 years. He is Chairman of the Dairy Companies including Ballance Agri-Nutrients Co-operative Ltd, Association of New Zealand and currently serves on Horizon Energy and Cavalier Corporation Ltd. He Fonterra’s Audit, Finance and Risk Committee and its is a former director of Bay Milk Products Ltd and External Relations Committee. Northland Co-operative Dairy Company Ltd. Mr Rattray farms 180 hectares in partnership with His business experience includes 14 years with the his wife Joanne at Honikiwi, near Otorohanga, and Fletcher Group in a variety of strategic planning and has an interest in two other farming properties. Prior financial roles, including an 18 month secondment to to dairy farming, he worked as an economist for the Prime Minister’s Advisory Group. He then worked the New Zealand Meat and Wool Board’s Economic for Dominion Breweries for eight years, becoming Service in Wellington. He holds a Bachelor’s degree CEO in 1987. He has been a professional director for in Agricultural Economics and is a member of the the past 13 years. Institute of Directors and the Institute of Primary Mr Hawkins has Bachelor of Science and Commerce Industry Management. degrees and is an Associate Chartered Accountant. He is Chairman of Fonterra’s Audit, Finance and Risk Committee and serves on the Appointments, Remuneration and Development Committee and the 44 Fair Value Share Committee.
MARK TOWNSHEND
Mark Townshend has been a Director of Fonterra since its formation. He is Chairman of the Milk Pricing STUART NATTRASS Working Group and serves on the Appointments, B AG SC (HONS) (LINCOLN) Remuneration and Development Committee. He is the chairman of eight farming companies and a Stuart Nattrass was elected to the Fonterra Board director of Liberty Genetics Ltd. of Directors in June 2003. He is a member of the Mr Townshend has been farming for more than 30 Audit, Finance and Risk Committee, Appointments, years and is involved in four dairy farms in each of Remuneration and Development Committee. the North and South Islands. He also has farming Mr Nattrass was involved in international financial interests in both North and South America. markets, principally foreign exchange risk Mr Townshend and wife Diane have four adult, management, for 16 years. He was initially employed tertiary-educated children who are all connected at the National Bank in Wellington and left the with agriculture. In 1997 the Townshends were the industry having held the position of Global Head of inaugural national winners of the FMG AC Cameron Foreign Exchange Risk for Westpac, based in Sydney. Excellence in Farming Award. He has been involved in farming all his life, and his interests now include ownership of a 420 hectare pastoral property near Geraldine. He also has a share in a 1,200 cow, spray-irrigated dairy farm near Ashburton. Mr Nattrass has a Bachelor of Agricultural Science with Honours from Lincoln University. JOHN WILSON JIM VAN DER POEL B AG SC (MASSEY)
Jim van der Poel has been a dairy company director John Wilson was elected to the Fonterra Board since 1999 and was elected to the Fonterra Board of Directors in June 2003. He is currently serving in 2002. on the Shareholder Relations Committee, the Milk He presently serves on the Audit, Finance and Risk Pricing Working Group and the Fair Value Share Committee, the Shareholder Relations Committee Committee. and the Milk Price Working Group. He is Chairman of He was the first Chairman of the Fonterra Shareholders’ Dexcel and a director and chairman of a number of Council and is the chairman of SAITL. private companies in which he is a shareholder. Mr Wilson is also a member of the Institute of Directors He and his family live and farm at Ohaupo in the and holds a certificate in Company Direction. Waikato but also have farming interests in the Mr Wilson was awarded a Nuffield Scholarship in South Island. Mr van der Poel has won a number of 2000. In 2003 he was selected for the Fonterra farming awards including Sharemilker of the Year, Advanced Development Programme. the A.C. Cameron Award, the Dairy Exporter Primary He lives near Te Awamutu with his wife Belinda Performer Award and a 2002 Nuffield Scholarship to and their four children, and has built a dairy study the capital structures of co-operatives. farming business that includes their farm in Te Awamutu and part ownership of farms in Geraldine, South Canterbury. Mr Wilson has a Bachelor of Agricultural Science 45 from Massey University.
RALPH WATERS CP ENG, FIE AUST, M BUS
Ralph Waters was appointed to the Board as an independent director in July 2006. Mr Waters retired as Chief Executive of Fletcher Building in August 2006, having doubled its revenue and increased its share price more than four fold during his stewardship. 2006 Before joining Fletcher Building, Mr Waters was 2006 Managing Director of the Australian publicly listed company Email Limited, after having previously held management positions in the organisation. He has also held a number of engineering and managerial ANNUAL REPORT positions. He will continue as a director of Fletcher ANNUAL REPORT Building and is also a director of Fisher & Paykel Appliances. FONTERRA FONTERRA Fonterra Leadership Team
ANDREW FERRIER – Favourite Fonterra Brand: Tip Top™ Chief Executive Officer – “Dairy is the life blood of New Zealand’s economy – Bachelor of Business Administration from the and prosperity, today and into the future.” University of New Brunswick SANJAY KHOSLA – Master of Business Administration from Managing Director Fonterra Brands Concordia University – Bachelor of Electrical Engineering (Hons) Indian – 21 years experience at senior executive level Institute of Technology – 20 years experience in international agribusiness – Harvard University’s Advanced Management both in commodities and consumer products Programme – Heads Fonterra’s $13 billion business. The world’s – Joined Fonterra (August 2004) after 27 years with fifth largest dairy company with $13 billion in Unilever in Europe and India - most recently as assets. Is implementing a “people, lean and grow” Chairman of Unilever Global Beverages Category strategy to drive growth through the talent of 46 Board based in Holland Fonterra’s international workforce, an effective, efficient cost structure, and investments which will – Is implementing Fonterra Brands Winning Through increase Fonterra’s revenues, market share and Brands! strategy which has seen the business long-term returns to shareholders exceed sales and profit targets this year – Favourite Fonterra Brand: Mainland™ Cheddar – Favourite Fonterra Brand: All Power Brands Master’s Vintage Cheddar – “Dairy is Life.” – “Dairy is for life!” GUY COWAN Chief Financial Officer JOHN SHASKEY Managing Director Fonterra Ingredients – Bachelor of Engineering (Hons), University of Sussex – 30 years experience in the dairy industry – Qualified Chartered Accountant (UK), Certified – 25 years experience in international dairy markets Public Accountant (US) – 15 years experience in senior management – 34 years experience in international commercial – Led the teams that delivered the merger benefits and financial roles promised to Fonterra shareholders on the creation – 23 years of experience in international oil and of Fonterra gas industry – Led Programme Jedi, the programme of work – Led Fonterra’s move to shared services which that designed and implemented the integrated delivered $30 million in cost reductions business model for Fonterra Ingredients, following the formation of Fonterra – Favourite Fonterra Brand: Kapiti™ Cheese – Led the global sales team, which achieved a – “Dairy is the essence of life.” nine per cent increase in sales volumes this year, BARRY HARRIS including a record of over 300,000 MT in one Director Fonterra Milk Supply month, to deliver $9.2 billion in revenue – Bachelor of Agricultural Sciences, Massey University – Has restructured Fonterra’s Ingredients business to provide increased focus on value add – Master of Natural Resource Economics, Stanford opportunities that will lead to an increased University Management Programme contribution to Fonterra’s performance from the – Prior roles as Chief Executive of Greater Ingredients business Wellington District Council and Environment FROM LEFT TO RIGHT: ANDREW FERRIER, JOHN SHASKEY, SANJAY KHOSLA, GUY COWAN, JERRY SAVILLE, GRAHAM STUART, BARRY HARRIS, GARY ROMANO, AND GRAEME MCMILLAN.
Waikato with emphasis on sustainable agriculture, service and environmental performance across all environmental management and biosecurity. of Fonterra manufacturing sites – Key responsibilities include Fonterra’s relationship – Favourite Fonterra Brand: Tip Top™ with shareholders, the efficient collection of some – “Dairy is Pride.” 14 billion litres of milk and ensuring Fonterra’s goals in milk growth are achieved in a way that GRAHAM STUART is profitable for farmers and sustainable for the Group Director Strategy and Growth environment – Bachelor of Commerce (1st Class Hons), – Favourite Fonterra Brand: Tip Top™ University of Otago – “Dairy is New Zealand’s future, it will underpin the – Master of Science, Massachusetts Institute wealth and wellbeing of our society.” of Technology – Led almost $1 billion in merger and acquisition JERRY SAVILLE achievements this year including the 43 per Group Director of Human Resources 47 cent investment in San Lu, the move to 100 – Master of Arts, Oxford University per cent ownership of Bonlac in Australia, the – Diploma in Industrial Relations acquisition of the Anchor™, Fresh ‘n Fruity™ and ™ – Completed London Business School’s Sloan Kapiti brands in New Zealand, the formation of programme with distinction DMV Fonterra Excipients and the RD1/Landmark joint venture – 30 years experience in human resources, change management, strategic planning and leadership – Over 20 years senior management experience, development including 15 years in the dairy industry in finance and management roles – Professional highlight for the year has been preparing Fonterra for future challenges by – Five years in corporate strategy roles restructuring and establishing clear performance – Favourite Fonterra Brand: Mainland™ milestones – “Dairy is and always should be an integral part of – Favourite Fonterra Brand: Kapiti™ Cheese a healthy diet.” – “Dairy is a great natural product.” 2006 GRAEME MCMILLAN 2006 GARY ROMANO Group Director Corporate Communications Director Group Manufacturing – 20 years of communications experience including – Bachelor of Chemical Engineering (Hons), senior international postings in South East Asia ANNUAL REPORT Queensland University – 10 years experience in dairy industry communications ANNUAL REPORT – MBA, University of Western Australia – Leads a team responsible for the development – First joined the Dairy Industry in 1997 and implementation of all Fonterra’s shareholder, employee and stakeholder communications FONTERRA – Previously worked for Alcoa of Australia, The FONTERRA strategies both in New Zealand and internationally Boston Consulting Group and Dairy Partners ™ of America – Favourite Fonterra Brand: Fresh ‘n Fruity (especially apricot) – Focus on supporting the business to create value – “One day everyone in New Zealand will recognise – Heads team that is responsible for leading just how important dairy is to this country.” the drive to achieve world class standards of productivity, quality, safety, cost effectiveness, 48 THE FINANCIALSTATEMENTS COMPRISE: Statements ofFinancialPerformance Statement ofSignificantAccounting Policies Statements ofCashFlows Statements ofFinancialPosition Statements ofMovementsinEquity Financial Statements ER A E EDNGRAEMEHAWKINS HENRY VAN DERHEYDEN ietr 4Jl 06Director, 24July2006 Director, 24July2006 For andonbehalfoftheBoard ofDirectors whoauthorised the issueofthesefinancialstatementson24July2006. The Directors hereby approve thefinancialstatements FONTERRA CO-OPERATIVE GROUPLIMITED for theyearended31May2006. 54 53 52 51 50 Contact Information Statutory Information Auditors’ Report Notes totheFinancialStatements 103 89 88 60
FONTERRA ANNUAL REPORT 2006 Statement of Financial Performance FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M PARENT $M
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED NOTES 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
Operating revenue 1 13,001 12,323 5,027 5,342
Payout to suppliers (4,959) (5,329) (4,959) (5,329) Inventory increase 55 384 – – Other costs of goods sold 2 (5,907) (5,217) (35) (13) Total costs of goods sold (10,811) (10,162) (4,994) (5,342)
Operating expenses 2 (1,774) (1,648) 219 227 Interest expense 2 (364) (269) (321) (247) Other expenses (2,138) (1,917) (102) (20)
Operating surplus/(deficit) before taxation 52 244 (69) (20) Taxation (expense)/credit 3 (40) (25) 164 175 Net surplus 12 219 95 155
Net surplus attributable to: Parent interests – 191 95 155 Minority interests 12 28 – – Net surplus 12 219 95 155
50
THE ACCOMPANYING NOTES FORM PART OF THESE FINANCIAL STATEMENTS Statements of Movements in Equity FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M PARENT $M
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED NOTES 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
Net surplus attributable to: Parent interests 5a – 191 95 155 Minority interests 5c 12 28 – – Foreign currency translation reserve movement: Parent interests 5b 90 (36) – – Minority interests 5c 21 (12) – – Other movements in retained earnings 5a 5 – – – Total recognised revenues and expenses 128 171 95 155
Co-operative shares issued 4 473 200 473 200 Peak notes issued 4 42 51 42 51 Supply redemption rights issued 4 119 244 119 244 Total contributions from owners 634 495 634 495
Co-operative shares surrendered 4 (238) (404) (238) (404) Peak notes surrendered 4 (30) (74) (30) (74) Supply redemption rights surrendered 4 (172) (57) (172) (57) Total distributions to owners (440) (535) (440) (535)
Other movements in minority interests 5c (88) (15) – – 51
Movements in equity for the year 234 116 289 115
Equity at the beginning of the year 4,911 4,795 4,728 4,613
Equity at the end of the year 5,145 4,911 5,017 4,728
Equity at the end of the year comprises: Parent interests 5,017 4,728 5,017 4,728 Minority interests 5c 128 183 – – Equity at the end of the year 5,145 4,911 5,017 4,728
THE ACCOMPANYING NOTES FORM PART OF THESE FINANCIAL STATEMENTS Statement of Financial Position FONTERRA CO-OPERATIVE GROUP LIMITED AS AT 31 MAY 2006
CONSOLIDATED $M PARENT $M
AS AT AS AT AS AT AS AT NOTES 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
Cash balances 137 116 10 1 Receivables and prepayments 6 2,558 2,271 6,009 7,057 Inventories 7 3,300 3,245 – – Taxation receivables 63 38 239 195 Other current assets 30 34 – 1 Total current assets 6,088 5,704 6,258 7,254
Property, plant and equipment 8 4,366 4,297 63 41 Investments 9 484 331 7,839 7,309 Intangibles 11 2,101 1,469 – – Deferred taxation 16 7 – 62 81 Other non-current assets 34 11 21 – Total non-current assets 6,992 6,108 7,985 7,431 Total assets 13,080 11,812 14,243 14,685
Bank overdrafts 115 79 12 8 Owing to suppliers 692 982 692 1,015 Capital notes 17 576 – 576 – Payables and accruals 12 1,194 983 3,832 4,630 Provisions 13 103 88 41 23 52 Current borrowings 14 1,793 1,480 1,710 1,374 Taxation payable 40 29 – – Other current liabilities 33 52 27 51 Total current liabilities 4,546 3,693 6,890 7,101
Provisions 13 50 62 36 53 Term borrowings 15 3,263 2,418 2,245 2,090 Deferred taxation 16 – 7 – – Capital notes 17 23 483 23 483 Other non-current liabilities 53 238 32 230 Total non-current liabilities 3,389 3,208 2,336 2,856
Total liabilities 7,935 6,901 9,226 9,957
Net assets 5,145 4,911 5,017 4,728
Co-operative shares 4 3,569 3,334 3,569 3,334 Peak notes 4 1,149 1,137 1,149 1,137 Supply redemption rights 4 285 338 285 338 Retained earnings 5a 170 166 14 (81) Foreign currency translation reserve 5b (156) (247) – – Minority interests 5c 128 183 – – Equity 5,145 4,911 5,017 4,728
THE ACCOMPANYING NOTES FORM PART OF THESE FINANCIAL STATEMENTS Statements of Cash Flows FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M PARENT $M
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED NOTES 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
Cash flows from operating activities Cash was provided from: Receipts from customers 12,207 12,044 4,681 5,291 Interest received 12 9 32 20 Dividends received 35 30 31 – Taxation received 1 5 – 4 Cash was applied to: Payments to creditors and employees (6,252) (5,776) (288) (262) Payments for milk supplied (5,813) (5,714) (5,081) (5,180) Taxation paid (80) (108) – – Interest paid (342) (262) (329) (221) Net cash flows from operating activities 18 (232) 228 (954) (348)
Cash flows from investing activities Cash was provided from: Proceeds from disposal of property, plant and equipment 34 59 1 8 Proceeds from sale of subsidiaries 19 9 64 – – Proceeds from sale of associates 1 5 – – Proceeds from sale of investments 389 40 – – Net loans from subsidiaries – – 262 – Cash was applied to: Acquisition of property, plant and equipment (515) (620) (40) (27) Acquisition of other intangibles (5) (6) – – Net loans to subsidiaries – – – (131) 53 Purchase of minority interests – (105) – – Acquisition of associates/investments (1) (78) – (8) Acquisition of subsidiaries 19 (540) (5) – – Acquisition of other investments (9) – (6) – Advances secured against inventory (76) – – – Net cash flows from investing activities (713) (646) 217 (158)
Cash flows from financing activities Cash was provided from: Increase in borrowings 5,638 6,033 5,202 6,236 Issue of co-operative shares 145 265 145 265 Issue of peak notes 33 24 33 24 Repayment of deferred share receivable 1 – 1 – Cash was applied to: Repayment of borrowings (4,790) (5,856) (4,547) (5,958) Repurchase of capital notes (92) (83) (92) (83) Dividends paid to minority interests (23) (17) – – Net cash flows from financing activities 912 366 742 484
Net (decrease)/increase in cash held (33) (52) 5 (22) Opening cash balances 37 94 (7) 15 Effect of exchange rate changes on cash flows 18 (5) – – Closing cash balances 22 37 (2) (7)
Reconciliation of closing cash balances to the statement of financial position: Cash balances 137 116 10 1 Bank overdrafts (115) (79) (12) (8) Closing cash balances 22 37 (2) (7)
THE ACCOMPANYING NOTES FORM PART OF THESE FINANCIAL STATEMENTS Statement of Significant Accounting Policies FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
(a) Basis of preparation Fonterra Co-operative Group Limited (the “Company” or “Parent” or “Fonterra”) is a co-operative company domiciled in New Zealand, registered under the Companies Act 1993, the Co-operatives Companies Act 1996, and the Dairy Industry Restructuring Act 2001. Fonterra is an issuer for the purpose of the Financial Reporting Act 1993 and its financial statements comply with that Act. The reporting currency used in the preparation of these financial statements is New Zealand dollars.
Financial statements for Fonterra and consolidated Group financial statements are presented. The financial statements comprise statements of the following: financial performance; movements in equity; financial position; cash flows; significant accounting policies; as well as the notes to these statements contained on pages 60 to 87.
The financial statements have been prepared in accordance with generally accepted accounting practice (“GAAP”) in New Zealand. Where no financial reporting standard or statement of standard accounting practice exists in New Zealand in relation to a particular issue, the accounting policies and disclosures adopted have been determined having regard to sources of Authoritative Support.
The financial statements are prepared on the basis of historical cost except that derivative financial instruments that are not designated as hedges are stated at market value and investments in subsidiaries are stated at Fonterra’s share of net assets. The cost of certain assets and liabilities is based on their fair value at the date of the formation of the Company.
(b) Basis of consolidation The consolidated financial statements comprise the Company, its subsidiaries (the “Group”) and the Group’s interest in associates, joint ventures and partnerships. Intra-Group transactions are eliminated in preparing the consolidated financial statements.
54 Subsidiaries Subsidiaries are entities that are controlled, either directly or indirectly, by the Parent. Subsidiaries are included in the consolidated financial statements using the purchase method of consolidation.
Associates Associates are entities in which the Parent, either directly or indirectly, has a significant but not controlling interest. The consolidated financial statements include the Group’s share of the net surplus/(deficit) of associates on an equity accounted basis.
Acquisition or disposal during the year Where an entity becomes or ceases to be a part of the Group during the year, the results of the entity are included in the consolidated results from the effective date that the entity became a subsidiary or an associate or until the date it ceased to be a subsidiary or associate.
Goodwill and discount arising on acquisition Fair values are assigned to the identifiable assets and liabilities of subsidiaries and associates of the Group at the date they are acquired. Where the fair value of the identifiable net assets acquired in the purchase of a subsidiary or an associate is less than the purchase price paid, the difference is treated as goodwill and is written off on a straight line basis, over the period of expected benefit, for up to 20 years following the date of acquisition.
Where the fair value of the identifiable net assets acquired in the purchase of a subsidiary or an associate exceeds the purchase price paid, the difference is treated as discount on acquisition and is applied to reduce the fair value of acquired non-monetary assets. Statement of Significant Accounting Policies (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
(c) Foreign currency Exchange differences Short-term transactions covered by forward exchange contracts are translated at the exchange rates specified in those contracts. Other foreign currency transactions are translated to New Zealand currency at the exchange rates ruling at the dates of the transactions.
Monetary assets and liabilities in foreign currencies at balance date covered by forward exchange contracts are translated at the exchange rates specified in those contracts. Monetary assets and liabilities in foreign currencies at balance date not covered by forward exchange contracts are translated at the exchange rates ruling at that date. Exchange differences arising on the translation of monetary assets and liabilities in foreign currencies are recognised in the statement of financial performance except as detailed below.
If a foreign currency liability is designated as a hedge of a foreign non-monetary asset (or vice versa), both the asset and the liability are translated at the exchange rate ruling at balance date. Exchange movements are taken to the foreign currency translation reserve except where the exchange movements on the liability exceed that of the asset.
Translation of the financial statements of foreign operations The assets and liabilities of overseas operations, being independent foreign operations, are translated at the exchange rates ruling at balance date. The revenues and expenses of these operations are translated at rates approximating the exchange rates ruling at the dates of the transactions. Exchange differences arising on the translation of the financial statements of independent foreign operations are recognised directly in the foreign currency translation reserve.
Derivative financial instruments that are designated as hedges of the net investment in independent foreign operations are translated at the exchange rates ruling at balance date. Exchange differences arising on the translation of such derivative
financial instruments are recognised directly in the foreign currency translation reserve to the extent that they offset the 55 exchange differences arising on the translation of the financial statements of the independent foreign operations to which the designated hedge relates.
(d) Derivative financial instruments The Group uses derivative financial instruments within predetermined policies and limits in order to manage exposure to fluctuations in foreign currency exchange rates and interest rates.
Derivative financial instruments that are designated as hedges of specific foreign exchange, interest rate risks or economic exposures are recognised on the same basis as the underlying hedged items. Where a hedge of an anticipated purchase or sale transaction is undertaken, the exchange difference on the hedging transaction up to the date of the purchase or sale transaction, and any costs associated with the hedge transaction to that date, are deferred and included in the measurement of the purchase or sale transaction. Derivative financial instruments that do not constitute hedges are stated at market value and any resultant gain or loss is recognised in the statement of financial performance.
Where a derivative financial instrument, which is a hedge of an anticipated transaction, is terminated early but the anticipated transaction is still expected to occur, the deferred gain or loss that arose prior to termination continues to be deferred and is recognised as part of the transaction when it occurs. If the transaction is no longer expected to occur, the deferred gain or loss is recognised in the statement of financial performance immediately.
The Group does not engage in speculative transactions or hold derivative financial instruments for trading purposes.
(e) Investments Investments other than investments in associates and investments in subsidiaries are stated at cost.
In the Parent’s financial statements investments in subsidiaries are stated at Fonterra’s share of net assets and associates are stated at cost. Changes in net assets are recognised in the statement of financial performance. Statement of Significant Accounting Policies (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
(f) Identifiable intangible assets Brands and other identifiable intangible assets purchased The fair value of brands and other identifiable intangible assets purchased by the Group are recognised where the intangible asset is controlled through custody or legal rights and could be sold separately from the rest of the business. Where such intangible assets are regarded as having limited useful lives their value is amortised over those estimated useful lives. Where such intangible assets are regarded as having indefinite useful lives, they are not amortised. However, impairment reviews are carried out on an annual basis to ensure that such intangible assets are not carried at amounts above their recoverable amounts. Any amortisation or impairment write-downs are recognised in the statement of financial performance.
Research and development expenditure All research expenditure is recognised in the statement of financial performance as incurred. Significant development expenditure is recognised as an asset when it can be demonstrated that the commercial production of the material or product, or use of the process, will commence.
Development expenditure recognised as an asset is stated at cost and amortised in the statement of financial performance over the period of expected benefits on a straight-line basis, not exceeding five years. Amortisation begins at the time that commercial production or use of the process commences. All other development expenditure is recognised in the statement of financial performance as incurred.
(g) Property, plant and equipment Owned assets Property, plant and equipment is stated at cost and depreciated in accordance with its estimated useful life as outlined below. Cost includes the purchase consideration and those costs directly attributable to bringing the asset to the location
56 and condition necessary for its intended use. Costs cease to be capitalised when substantially all the activities necessary to bring an asset to the location and condition for its intended use are complete.
Depreciation Depreciation is calculated on a straight-line basis to allocate the cost of the asset, less any residual value, over its estimated useful life. The range of estimated useful lives for each class of property, plant and equipment is as follows:
Land Indefinite Buildings 25 – 50 years Plant, vehicles and equipment 3 – 30 years
Finance leases Assets under finance leases are recognised as non-current assets in the statement of financial position. Leased assets are recognised initially at their fair value, or if lower, at the present value of the minimum lease payments. A corresponding liability is established and each lease payment allocated between the liability and interest expense. Leased assets are depreciated on the same basis as equivalent property, plant and equipment.
Operating leases Leases that are not finance leases are classified as operating leases. Operating lease payments are recognised as an expense on a basis representative of the pattern of benefits.
(h) Inventories Inventories are stated at the lower of cost and net realisable value.
The cost of dairy product manufactured from milk suppliers in New Zealand is established by estimating an arm’s length cost for raw milk, being the price that could be paid by a hypothetical efficient competitor based on forecasted hedged selling prices while still making an adequate return on capital. In the case of manufactured inventories and work in progress, cost includes all direct costs plus that portion of the fixed and variable production overhead incurred in putting inventories into their present location and condition. Statement of Significant Accounting Policies (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
(i) Receivables Receivables are stated at estimated net realisable value.
(j) Impairment If the estimated recoverable amount of an asset is less than its carrying amount, the asset is written down to its estimated recoverable amount and an impairment loss is recognised in the statement of financial performance.
Where an impairment is subsequently recovered the reinstatement of the previous impairment is recognised through the statement of financial performance.
(k) Provisions Provisions are recognised only in those circumstances where the Group has a present obligation as a result of a past event.
(l) Revenue recognition Sales revenue includes revenue earned net of returns, discounts and allowances from the sale of inventory items. Sales revenue is recognised when the significant risks and rewards of ownership of the inventory items have passed to the buyer.
(m) Payout to Suppliers Payout to Suppliers is the total available after retentions for payout to supplier shareholders for the milk they supply to the Group. Premiums for speciality milks, such as winter milk and colostrum, are included within other cost of goods sold.
(n) Taxation Income tax expense is recognised on the operating surplus/(deficit) before taxation, adjusted for permanent differences 57 between taxable and accounting income. Deferred taxation is calculated using the comprehensive basis under the liability method. This method involves recognising the tax effect of all timing differences between accounting and taxable income as a deferred taxation asset or liability in the statement of financial position. The deferred taxation asset or liability is stated at the income tax rates prevailing at balance date.
Deferred taxation assets are not recognised unless realisation of the asset is virtually certain.
Deferred taxation assets and liabilities are not offset if they arise in different tax jurisdictions.
(o) Cash and cash equivalents For the purpose of the statement of cash flows, cash comprises cash balances (net of bank overdrafts) and demand deposits. Cash excludes borrowings at call that are not used as part of the Group’s day-to-day cash management.
(p) Comparative figures Where a change in the presentational format of the financial statements has been made during the period, comparative figures have been restated accordingly.
(q) Changes in accounting policy There have been no changes in accounting policies. Uniform accounting policies have been applied throughout the Group and on a basis consistent with the prior period. Statement of Significant Accounting Policies (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
(r) Adoption of New Zealand Equivalents to International Financial Reporting Standards (“NZ IFRS”) The New Zealand Accounting Standards Review Board (“ASRB”) requires the adoption of NZ IFRS for application to reporting periods beginning on or after 1 January 2007, with early adoption permitted for reporting periods beginning on or after 1 January 2005.
Fonterra has elected to apply NZ IFRS for the year ending 31 May 2008. A discussion on how Fonterra is managing the transition to NZ IFRS is set out below.
In preparation for the adoption of NZ IFRS, Fonterra has formed a project team and sought independent external advice. The project team is led by senior finance personnel and reports on a regular basis to the Audit, Finance and Risk Committee a sub-committee of the Board.
An assessment has been performed to determine the differences between the current key accounting policies of Fonterra and current NZ IFRS with material differences set out below. It should not be regarded as a complete list of changes in accounting policies that will result from the transition to NZ IFRS, as NZ IFRS and related interpretations may change between the issue date of these financial statements and the Group’s first balance date reported under NZ IFRS being 31 May 2008. The regulatory bodies that promulgate IFRS and NZ IFRS have some significant ongoing projects that could affect the differences set out below and the impact of these variances may be material.
The purpose of the following disclosure is to highlight major impacts the Group expects as a result of transitioning to NZ IFRS. The expected material adjustments arising from differences between the current key accounting policies of Fonterra and NZ IFRS identified to date are outlined in the appropriate paragraphs. Where a reliable estimate of the impact is possible it has been quantified. Where decisions have not yet been made pending amendments to International Financial Reporting Standards that are currently expected, no impact is considered to be reliably estimable. All adjustments noted below will be
58 recognised through an adjustment to opening retained earnings or another component of equity as appropriate.
Reporting of Equity NZ IAS 32: Financial Instruments: Presentation; NZ IFRS-7 Financial Instruments: Disclosures and NZ IAS 39: Financial Instruments: Recognition and Measurement (“NZ IAS 39”) require, inter alia, Fonterra’s shares to be classified as liabilities and carried at fair value with changes in fair value recognised in the statement of financial performance. Application of these standards in this manner would clearly produce an anomalous result in the presentation of the Group’s statements of financial position and financial performance and accordingly the matter has been referred to the International Financial Reporting Interpretations Committee, which in turn referred it to the International Accounting Standards Board (“IASB”). Members of the IASB have noted that current NZ IFRS produces an unsatisfactory result in circumstances such as Fonterra’s. The IASB has issued an exposure draft, which if approved will mean that Fonterra will be able to continue to treat its co-operative shares as equity and without remeasurement to fair value. On the assumption that this exposure draft will ultimately be incorporated in the applicable NZ IFRS standard at the date of conversion, no adjustment is now expected.
Financial Instruments and Hedge Accounting NZ IAS 39 requires all derivative instruments to be recorded at fair value in the statement of financial position with the related changes in fair value being recognised in income unless the instruments qualify for hedge accounting and the strict NZ IAS 39 hedging criteria are met. Fonterra currently uses both foreign exchange contracts (options and forwards) to hedge forecast foreign cash flows, and foreign exchange swaps as well as cross currency and interest rate swaps to hedge borrowings. Fonterra intends to adopt hedge accounting for these instruments wherever practicable. Where such instruments qualify as cash flow hedges the effective portion of changes in fair value of those instruments will be recorded directly in equity until the hedged transaction occurs. Where such instruments qualify as fair value hedges, changes in the fair value of the instruments along with changes in the fair value of the debt will be recorded in the statement of financial performance. Statement of Significant Accounting Policies (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
If the instruments do not qualify for hedge accounting, the entire change in the fair value of the instrument will be recorded in the statement of financial performance. The estimated impact of adoption is the recognition of all derivative instruments at their fair value by adjusting total derivative instrument values by $84 million credit and the restatement of debt instruments in hedge relationships (representing debt instruments totalling $3,309 million of the total borrowing included in note 20) to their fair values by increasing the currently recorded value by $168 million. Debt instruments not in hedge relationships will continue to be carried at amortised cost. These adjustments will impact on equity with the recognition of a cash flow hedge reserve and an adjustment to opening retained earnings.
Income Tax NZ IAS 12: Income Taxes, requires an entity to calculate deferred tax using a balance sheet approach by comparing the tax bases of assets and liabilities to their carrying values in the statement of financial position. Differences between the two values are temporary differences on which deferred tax must be recognised (with some limited exceptions). This is different to current New Zealand accounting standards and is expected to result in a deferred tax liability larger than that currently recorded in the statement of financial position of the Group (primarily as a result of the recognition of deferred tax on brands and the revaluation of certain tangible assets on formation). Guidance to be issued over the ensuing twelve months is expected to clarify the application of the current standard – particularly with respect to the calculation of deferred tax on brands. Accordingly, Fonterra is not yet able to finalise the opening balance sheet adjustment arising from the application of this standard.
Business Combinations NZ IFRS 3: Business Combinations is required to be followed for all business combinations entered into from the date of the opening balance sheet at 1 June 2006. Under this standard all business combinations must be recognised using purchase accounting and goodwill will no longer be amortised (instead goodwill will be subject to an annual impairment test within the constraints of NZ IAS 36: Impairment of Assets). Because of the available exemptions under NZ IFRS 1: First-time Adoption 59 of New Zealand Equivalents to International Financial Reporting Standards, Fonterra will have the option not to restate past business combinations in accordance with these new requirements. Fonterra has yet to decide whether it will restate past business combinations.
Foreign Currency Translation Reserve NZ IAS 21: The Effects of Changes in Foreign Exchange Rates, requires certain exchange differences arising on translation of a foreign operation to be disclosed as a separate component of equity, in the foreign currency translation reserve. On disposal of a foreign operation the related balance in the cumulative translation reserve is transferred to the statement of financial performance. An available exemption under NZ IFRS 1 is to deem the cumulative translation reserve to be zero at the date of transition, and not account for any cumulative differences that arose before the date of transition on subsequent disposal. Fonterra has elected to take this exemption and therefore reset the foreign currency translation reserve to zero by transferring the balance to opening retained earnings. At 31 May 2006, the balance of the foreign currency translation reserve that will be transferred to retained earnings amounted to $156 million debit. This has no net impact on opening equity.
As Fonterra progresses toward 31 May 2008, the Group will continue to provide users of the financial statements with updated information about the likely impacts of NZ IFRS on the Group’s earnings, cash flows and financial position. Notes to the Financial Statements FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M PARENT $M
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED NOTES 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
1. Operating revenue
Operating revenue comprises: Sales 12,774 11,952 4,715 5,103 Dividends received – 21 31 1 Interest received 14 9 279 227 Share of total recognised revenue and expenses of associates, after taxation 10 28 22 – – Gain on disposal of investments 19 82 243 – – Gain on disposal of property, plant & equipment 2 18 – 7 Other operating revenue 101 58 2 4 Total Operating revenue 13,001 12,323 5,027 5,342
2. Other cost of goods sold and operating expenses
Other cost of goods sold and operating expenses include: Amortisation of goodwill on consolidation 11 28 14 – – Amortisation of brands 11 1 1 – – Amortisation of other intangible assets 11 4 7 – – 60 Audit fees – Principal auditor 4 4 2 2 Other assurance fees – Principal auditor 2 2 1 1 Other services – Principal auditor 1 1 – – Bad and doubtful debts: Written off 1 5 – – Increase in provision for doubtful debts 1 – – – Brand impairment 11 2 32 – – Brand impairment reinstatement 11 (4) (15) – – Loss on disposal of investments 19 2 – – – Loss on disposal of property, plant & equipment 3 4 – – Impairment – property, plant & equipment 8 6 – – Depreciation: Buildings 53 50 – 1 Plant, vehicles and equipment 409 398 16 19 Directors’ remuneration: Fees 1 1 1 1 Donation and grants 1 1 – – Operating lease expense 68 61 5 5 Research costs 99 78 1 1 Capital notes premium on redemption 17 26 – 26 – Restructuring costs 13 57 2 24 – Revaluation of investments in subsidiaries to net asset backing – – (514) (528) Interest Expense includes: Finance leases 14 14 – – Borrowings 350 255 321 247 Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M PARENT $M
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED NOTES 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
3. Taxation Operating surplus/(deficit) before taxation 52 244 (69) (20)
Prima facie taxation expense/(credit) at 33% 17 80 (23) (7) Add/(deduct) taxation effect of: Non-deductible/(non-assessable) items: Dividends received – (7) (10) – Capital gains (26) (79) – – Amortisation of intangible assets 11 7 – – Brand impairment – 11 – – Brand impairment reinstatement (1) (5) – – Share of total recognised revenue and expenses of associates, after taxation (9) (7) – – Non-claimable tax credits 6 3 – – Other (9) 19 (6) (18) Losses of overseas subsidiaries not recognised 3 6 – – Revaluation of investments in subsidiaries to net asset backing – – (170) (174) Controlled Foreign Company and Foreign Investment Fund regime adjustments 13 12 – – Recognition of tax losses 51 (3) 46 12 Under/(over) provision prior year (9) 8 (1) 12 Less tax on foreign income due to different tax rate (7) (20) – – Taxation expense/(credit) 40 25 (164) (175) 61
Taxation expense/(credit) comprises: Current taxation 62 71 (183) (184) Deferred taxation 16 (22) (46) 19 9 40 25 (164) (175)
Imputation credits: Opening balance 27 31 Tax payments net of refund – (4) Closing balance 27 27
The imputation credits are available to the shareholders of the Parent company: Through the Parent company 27 27 Through subsidiaries 11 11 38 38
Dividend withholding payment credits: The dividend withholding payment credits are available to the shareholders of the Parent company: Through the Parent company – – Through subsidiaries 1 1 1 1
Tax Losses Unrecognised tax losses available for set off against future assessable income: Tax losses 329 156 Tax saving thereon 103 47
The ability to utilise these tax losses depends on the generation of sufficient assessable income in the respective tax jurisdictions. Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED AND PARENT
YEAR ENDED 31 MAY 06 YEAR ENDED 31 MAY 05
NUMBER VALUE NUMBER VALUE 000’S $M 000’S $M
4. Capital
Co-operative shares: Opening balance 1,158,434 3,334 1,199,859 3,538 End of season issues/(surrenders) prior year ––(146) (1) Issued 6,618 36 4,858 23 Surrendered (21,939) (119) (25,907) (122) End of season issues current year 86,879 473 39,729 186 End of season surrenders current year (21,907) (119) (59,959) (281) Supply redemption rights price differential – (36) – (9) Closing balance 1,208,085 3,569 1,158,434 3,334
Peak notes: Opening balance 37,888 1,137 38,684 1,160 End of season issues/(surrenders) prior year ––(6) – Issued 184 5 136 4 Surrendered (1,009) (30) (1,485) (44) End of season issues current year 1,244 37 1,574 47 End of season surrenders current year ––(1,015) (30) 62 Closing balance (fully paid) 38,307 1,149 37,888 1,137
Supply redemption rights: Opening balance 75,842 338 38,306 151 End of season issues/(surrenders) prior year ––(34) – Issued 44 – 289 1 Surrendered (2,272) (10) (2,682) (10) End of season issues current year 21,907 119 51,719 243 End of season surrenders current year (36,377) (162) (11,756) (47) Closing balance (fully paid) 59,144 285 75,842 338
Capital structure changes On 1 June 2006 the Group transitioned to a new capital structure. The impact of the transition is disclosed in note 26 – Subsequent events. The information set out in this note relates to the existing capital structure.
Co-operative shares Each shareholder supplying milk to the Company in a season is required to hold one co-operative share (“share”) for each kilogram of milksolids obtainable from milk supplied to the Company by that shareholder in that season.
Shares are issued and surrendered at fair value. Fair value is determined on an annual basis for each season by the Board with the advice of an independent valuer. Fair value for the 2006/07 season has been set by the Board, after receiving Duff & Phelps estimated fair value range, at $5.80 per share (2005/06 season: $5.44 per share).
If a shareholder increases supply during a season and they do not hold sufficient shares to cover that increased production, they are required to purchase additional shares. Additional shares are paid for by:
• the automatic surrender of supply redemption rights that are held; • cash; • redeeming any excess peak notes held; or • any combination of the above. Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
4. Capital (continued) The Company also has the option (not exercised to date) to allow additional shares to be paid for by redeeming any capital notes held by the shareholder.
If a shareholder decreases supply and therefore holds more shares than they are required to hold they must surrender those excess shares. The Company pays the surrender value:
• at the option of the shareholder, by the issue of supply redemption rights; and/or • by the issue of capital notes (not offered at 31 May 2006 due to transition, refer note 26).
The Company also has the option (not exercised to date) to pay the surrender value by the payment of cash or, in special circumstances, by the issue of redeemable preference shares.
Share changes required by shareholder increases/decreases in supply for the 2005/06 season are reflected in the capital set out above as at 31 May 2006.
Rights attaching to the shares include:
• voting rights on a poll or postal ballot of one vote per 1,000 kilograms of milksolids obtainable from milk supplied to the Company by a dairy farm during the season preceding that in which a poll or postal ballot is taken; • rights to a share in any dividends; and • rights to share in any surplus on liquidation of the Company.
Peak notes Each shareholder supplying milk to the Company in a season is required to hold a number of peak notes for the season as determined by the Board at the commencement of the season. Peak notes are issued based on each shareholder’s milk supply profile during the season. Peak notes are issued at $30 each. Due to transition to the new structure (refer note 26) peak notes
were not physically issued at 31 May 2006 as all peak notes were surrendered as part of the transition. 63
Peak notes are paid for by:
• cash; • redeeming any capital notes held; or • a combination of the above.
If a shareholder holds more peak notes than they are required to hold, that shareholder may choose to either:
• hold the excess peak notes to use in the future; or • surrender the peak notes by giving notice to the Company. Due to the capital transition (refer note 26) shareholders were not offered the option at 31 May 2006 to surrender excess peak notes.
Where the peak notes are surrendered the Company pays the surrender value:
• by the issue of capital notes; or • by the payment of cash.
Peak notes have no voting rights, no dividend rights, and no rights to share in any surplus on liquidation of the Company.
Supply redemption rights Where a shareholder holds more shares than required in a season (based on actual supply of milk by that shareholder) the Company shall require that shareholder to surrender those excess shares. Supply redemption rights are issued to shareholders who elect to be issued with them in exchange for shares that are being surrendered. Due to the capital transition all excess shares as at 31 May 2006 were automatically converted to supply redemption rights (refer note 26). A supply redemption right gives its holder the right to either:
• exchange each supply redemption right held for one co-operative share at no cost when further shares are required due to increased production (irrespective of the value of the supply redemption right); or • at any time surrender the supply redemption right at issue price.
Supply redemption rights have no voting rights and no dividend rights. On liquidation each supply redemption right becomes due to be redeemed for an amount equal to its issue price, which will be paid after all other obligations of the Company have been met, but before distribution of any surplus to holders of shares. Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M PARENT $M
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED NOTES 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
5a. Retained earnings
Opening balance 166 74 (81) (236) Current year net surplus – 191 95 155 Transfer from foreign currency translation reserve (1) (99) – – Other movements 5 – – – Closing balance 170 166 14 (81)
5b. Foreign currency translation reserve
Opening balance (247) (310) – – Difference arising on translation of financial statements of independent foreign operations 90 (36) – – Transfer to retained earnings 1 99 – – Closing balance (156) (247) – –
5c. Minority interest
Balance at beginning of year 183 182 – – Acquisition of subsidiaries 3 1 – –
64 Disposal of subsidiaries (1) – – – Buy-out of minority interests (68) – – – Foreign currency translation 21 (12) – – Share of surplus in subsidiaries 12 28 – – Dividends paid and provided to minority interests (22) (16) – – Closing balance 128 183 – –
6. Receivables and prepayments
Trade receivables 2,215 1,640 37 67 Prepayments 84 135 59 109 Due from subsidiaries 25 – – 5,946 6,612 Due from associates 25 32 38 5 – Future hedging of receivables (loss)/gain – – (60) 241 Other receivables 227 458 22 28 Total receivables and prepayments 2,558 2,271 6,009 7,057
At 31 May 2006, unrealised gains and losses associated with currency hedging contracts held other than for an on balance sheet trade receivables have been recognised in the Parent and then transferred to a subsidiary company. The effect of this is to recognise the future hedging of receivables loss of $60 million (31 May 2005: Gain $241 million) and an equivalent increase in amounts receivable from subsidiaries in the Parent. There is no impact on the earnings of the Parent or Group. Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M PARENT $M
AS AT AS AT AS AT AS AT NOTES 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
7. Inventories
Raw materials 259 250 – – Finished goods 3,041 2,995 – – Total inventories 3,300 3,245 – –
8. Property, plant and equipment
At cost Land 218 140 1 2 Buildings 1,246 1,181 9 8 Plant, vehicles and equipment 4,154 3,651 97 79 Capital work in progress 248 460 20 3 Total cost 5,866 5,432 127 92
Accumulated depreciation Buildings 206 165 1 1 Plant, vehicles and equipment 1,294 970 63 50 Total accumulated depreciation 1,500 1,135 64 51
Net book value 65 Land 218 140 1 2 Buildings 1,040 1,016 8 7 Plant, vehicles and equipment 2,860 2,681 34 29 Capital work in progress 248 460 20 3 Total property, plant and equipment 4,366 4,297 63 41
9. Investments
Associates 10,24 463 319 58 58 Subsidiaries 24 – – 7,766 7,245 Other investments 21 12 15 6 Total investments 484 331 7,839 7,309
The investment in associates held by the Parent entity represents part of the Group’s investment in the Dairy Partners Americas entities, which are included within the consolidated analysis provided in Note 10. Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M
AS AT AS AT NOTES 31 MAY 06 31 MAY 05
10. Investment in associates
At cost 487 375 Impairment of investment (2) (2) Post-acquisition share of reserves 48 (19) Dividends received (70) (35) Total investment in associates 463 319
Goodwill included in investment in associates balance: Opening balance 124 107 Goodwill arising on acquisition 94 24 Amortisation of goodwill (7) (7) Closing balance 211 124
Comprising: Goodwill arising on acquisition of associates 233 139 Accumulated amortisation (22) (15) 211 124
Total investment in associates comprises:
66 Corporation Inlaca, CA 27 24 DPA Manufacturing Holdings Limited 48 45 Dairy Partners Americas Brasil Limitada 114 100 DPA del Ecuador S.A. 26 22 AFF P/S 73 65 Britannia New Zealand Foods PVTE Limited 17 18 DairiConcepts Management, LLC 27 27 Dairy Industries (Jamaica) Limited 8 7 DMV Fonterra Excipients GmbH and Co KG 115 – Other 8 11 Total investment in associates 463 319
Movement in investment in associates: Opening balance 319 274 Acquired during the year 116 45 Disposed of during the year – (4) Transferred from investment in subsidiaries 1 – Transferred to investment in subsidiaries (5) (1) Share of total recognised revenues and expenses, after taxation 28 22 Foreign currency translation 39 (9) Dividends received (35) (8) Closing balance 463 319
Share of total recognised revenues and expenses, after taxation of associates: Operating surplus before taxation 36 30 Goodwill amortisation (7) (7) Taxation expense (1) (1) Share of total recognised revenues and expenses, after taxation 1 28 22 Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M
AS AT AS AT NOTES 31 MAY 06 31 MAY 05
11. Intangibles
Goodwill on amalgamation and acquisition of subsidiaries: Cost 711 254 Accumulated amortisation (62) (34) 649 220 Brands: Cost 1,570 1,368 Accumulated amortisation (11) (10) Impairment (114) (116) 1,445 1,242 Other: Cost 80 76 Accumulated amortisation (30) (26) Impairment (43) (43) 7 7 Total intangibles 2,101 1,469
Goodwill: Opening balance 220 236 Arising on acquisition of subsidiaries 493 4 67 Arising on acquisition of minority interest – (6) Cancellation of minority interest shares 20 – Disposal of subsidiary (55) – Foreign currency translation (1) – Amortisation 2 (28) (14) Closing balance 649 220
Brands: Opening balance 1,242 1,293 Impairment during the year 2 (2) (32) Impairment reinstatement 2 4 15 Acquisition of subsidiaries 273 – Disposal of subsidiary (93) (11) Foreign currency translation 22 (22) Amortisation 2 (1) (1) Closing balance 1,445 1,242
Other: Opening balance 7 17 Research & development 4 3 Transferred to property, plant and equipment – (6) Amortisation 2 (4) (7) Closing balance 7 7 Total intangibles 2,101 1,469 Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M PARENT $M
AS AT AS AT AS AT AS AT NOTES 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
12. Payables and accruals
Trade payables 418 373 – – Accruals 363 355 32 70 Employee entitlements 159 151 19 12 Due to subsidiaries 25 – – 3,722 4,499 Due to associates 25 26 – 25 – Other 228 104 34 49 Total payables and accruals 1,194 983 3,832 4,630
13. Provisions
Provision for restructuring and rationalisation: Opening balance 15 29 – 1 Raised during the year 57 2 24 – Utilised during the year (28) (15) (3) – Reclassifications within note 13 – (1) – (1) Closing balance 44 15 21 –
Legal claims provisions:
68 Opening balance 74 63 59 55 Raised during the year 27 9 13 9 Released during the year (36) – (33) – Utilised during the year (26) (7) (1) – Reclassifications within note 13 – 9 – 9 Reclassifications from parent to other group entities – – – (14) Closing balance 39 74 38 59
Other provisions: Opening balance 61 82 17 38 Transferred from other group entities – – – 13 Raised during the year 23 35 5 12 Utilised during the year (14) (56) (4) (44) Reclassifications within note 13 – (8) – (8) Reclassifications from other balance sheet categories – 8 – 6 Closing balance 70 61 18 17 Total provisions 153 150 77 76
Provisions are included within the statement of financial position as follows: Current liabilities 103 88 41 23 Non-current liabilities 50 62 36 53 Total provisions 153 150 77 76 Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
13. Provisions (continued)
The nature of the above provisions is as follows:
• The provision for restructuring and rationalisation includes obligations relating to restructuring and other rationalisation costs.
• The legal claims provision includes global estimates for legal matters. The timing and amount of the future obligations are uncertain, as they are contingent on the outcome of a number of judicial proceedings.
• Other provisions arise globally in a number of subsidiaries in the normal course of business.
More specific information has not been given on some provisions as the Directors believe this disclosure would prejudice the position of the Company and the Group.
CONSOLIDATED $M PARENT $M
AS AT AS AT AS AT AS AT 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
14. Current borrowings
Commercial paper 550 939 550 939 Unsecured bank loans 139 234 81 168 Finance lease liabilities 25 23 – – Medium term notes 1,079 284 1,079 267 Total current borrowings 1,793 1,480 1,710 1,374
69 Finance lease liabilities are secured over the related item of property, plant and equipment. The associated minimum lease payments included in current finance lease liabilities is $37 million (31 May 2005: $35 million). Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M PARENT $M
AS AT AS AT AS AT AS AT 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
15. Term borrowings
Secured bank loans 1 2 – – Unsecured bank loans 790 20 – – Finance lease liabilities 139 159 – – Medium term notes 2,333 2,147 2,245 2,090 Perpetual notes – 90 – – Total term borrowings 3,263 2,418 2,245 2,090
Term borrowings are repayable on the following terms: One to two years 359 1,076 299 949 Two to five years 1,879 740 1,020 550 Greater than five years 1,025 602 926 591 Total term borrowings 3,263 2,418 2,245 2,090
Secured bank loans are secured by a floating charge over the assets of the borrowing subsidiary. Finance lease liabilities are secured over the related item of property, plant and equipment.
Non-current finance lease liabilities include the following amounts: Minimum lease payments 161 185 – – 70 Future interest cost (22) (26) – – Total non-current finance lease liabilities 139 159 – –
Non-current finance lease liabilities are repayable on the following terms: One to two years 54 23 – – Two to five years 85 129 – – Greater than five years – 7 – – Total non-current finance lease liabilities 139 159 – –
The perpetual notes issued by Bonlac Foods Limited were redeemed in November 2005. Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M PARENT $M
AS AT AS AT AS AT AS AT NOTES 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
16. Deferred taxation
Opening balance (7) (53) 81 90 Realised on disposal of subsidiary (8) – – – Deferred taxation included in taxation expense 3 22 46 (19) (9) Closing balance 7 (7) 62 81
The deferred taxation asset/(liability) is represented by: Property, plant and equipment (257) (225) (2) (1) Employee entitlements 48 45 6 6 Inventories 61 22 – – Financial arrangements (1) (35) (4) (1) Receivables, payables and provisions 42 51 14 6 Other 40 37 – (2) Deferred tax asset/(liability) (67) (105) 14 8 Tax losses recognised New Zealand 48 73 48 73 Tax losses recognised offshore 26 25 – – Total deferred taxation asset/(liability) 7 (7) 62 81
17. Capital notes 71 The capital notes are unsecured subordinated interest bearing obligations. Interest is payable on a quarterly basis at a rate of 7.90% per annum (31 May 2005: 7.73%). This rate is reset on 10 July each year.
The capital notes have no fixed maturity date and continue in existence until redeemed by the Company on an election date, or otherwise purchased by the Company through the secondary market, or off market after allotment with agreement from the holder, or are redeemed or purchased by the Company from its shareholders in accordance with the Company’s constitution. The capital notes have an election date of 10 July in each year. The Company has the option to redeem all or part of the capital notes for cash on each election date.
On 26 April 2006, Fonterra issued a notice of election to redeem for cash certain of the capital notes. The capital notes to be redeemed have been included in current liabilities and include the premium on redemption of $26 million (note 2). The record date for the redemption was 30 June 2006, with the redemption occurring on 10 July 2006. The redemption amount for each capital note redeemed was $1.04833. Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M PARENT $M
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED NOTES 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
18. Cash flows
18. (a) Reconciliation of net surplus to net cash flows from operating activities Net surplus 12 219 95 155 Non-cash items: Amortisation of intangibles 2 33 22 – – Depreciation 2 462 448 16 20 Brand impairment 2 2 32 – – Brand impairment reinstatement 2 (4) (15) – – Movement in deferred taxation 16 (22) (46) 19 9 Gain on disposal of investments 1 (82) (243) – – (Gain)/loss on disposal of property plant and equipment 1,2 1 (14) – (7) Share of total recognised revenue and expenses of associates after taxation 1,10 (28) (22) – – Impairment of property, plant and equipment 2 8 6 – – Revaluation of investments in subsidiaries to net asset backing 2 – – (514) (528) Other non-cash items 2 5 – (1)
72 372 173 (479) (507) Movement in working capital decrease/(increase): Movement in receivables and prepayments 6 (293) (439) 387 124 Movement in inventories 7 (55) (384) – – Movement in current taxation balances (14) (21) (44) 4 Movement in other current assets 4 48 1 2 Movement in owing to suppliers (290) 275 (323) 279 Movement in payables, accruals and other current liabilities 166 (36) (69) 21 Movement in amounts due to and from associates 6,12 32 (20) 20 – Movement in provisions 13 15 (24) 18 (18) (435) (601) (10) 412 Items classified as investing and financing activities (181) 437 (560) (408)
Net cash flows from operating activities (232) 228 (954) (348)
18. (b) Non-cash investing and financing transactions For the Group, there were two material non-cash transactions for the year ended 31 May 2006. The acquisition of the New Zealand Dairy Foods’ business, as disclosed in note 19(a), included a $373 million non-cash component of consideration being the fair value of Mainland Products Limited.
On 1 September 2005 Bonlac Foods Limited (BFL), a partially owned subsidiary of Fonterra, completed a selective share cancellation of the remaining shares held by the minority shareholder, Bonlac Supply Company, issuing them with unsecured capital notes. As a result of this transaction Fonterra now owns 100% of BFL.
There were no material non-cash transactions for the year ended 31 May 2005. Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
19. Business combinations
19. (a) Acquisition of New Zealand Dairy Foods (“NZDF”) On 31 August 2005 the Group entered into an agreement to purchase the business of NZDF (a subsidiary of Rank Group Limited) in return for the Group’s 100% investment in Mainland Products Limited (“MPL”) and a net cash payment for the difference between the fair values of MPL and NZDF business acquired. The net cash consideration including transaction costs, working capital adjustments and an incentive payment totalled $356 million.
The disposal of MPL gave rise to a net gain of $57 million to the Group.
The transaction had the following net impact on the assets and liabilities of the Group:
CONSOLIDATED $M
ACQUISITION OF DISPOSAL NET NZDF BUSINESS OF MPL IMPACT
Other current assets 55 (78) (23) Property, plant & equipment 70 (115) (45) Intangibles 260 (148) 112 Other non-current assets – (11) (11) Current liabilities (34) 49 15 Net assets 351 (303) 48
Net consideration (343) (13) (356) Fair value of Mainland Products Limited (373) 373 – Total consideration (716) 360 (356) 73
Net assets 351 (303) 48 Gain on disposal – (57) (57) Total consideration (716) 360 (356) Goodwill arising on acquisition (365) – (365)
Net cash paid (345) Amounts owing to Rank Group (11) Total net consideration (356) Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
19. Business combinations (continued)
19. (b) Other acquisitions In addition to the acquisition of a portion of the NZDF business the Group also made other acquisitions including the purchase of: (a) 100% of the shares in Kapiti Fine Foods Limited and United Milk Limited (“Kapiti”); (b) the remaining 50% of Civil Whey Limited; (c) the business of the Pastryhouse Limited; and (d) the business relating to the Dennington processing plant.
Of these, the only material acquisition was the purchase of Kapiti, which was acquired on 31 March 2006 for $169 million, including transaction costs, from Foodstuffs (Wellington) Co-operative Society Limited. This transaction resulted in goodwill arising on acquisition of $124 million.
There were no material acquisitions for the year ended 31 May 2005.
Total other acquisitions (including the acquisition of Kapiti, the remaining 50% of Civil Whey Limited, the assets of the Pastryhouse Limited and the assets relating to the Dennington processing plant) had the following net impact on the assets and liabilities of the Group:
CONSOLIDATED $M
ON ACQUISITION ON ACQUISITION 31 MAY 06 31 MAY 05
74 Total assets 93 – Total liabilities (22) – Net assets 71 – Transfer investment in associate to investments in subsidiaries (4) – Group share of uplift in fair value of assets 5 – Total consideration (187) – Net Goodwill arising on acquisition (115) –
Goodwill arising on acquisition (128) – Discount arising on acquisition 13 – Net Goodwill arising on acquisition (115) –
The discount on acquisition arising has been allocated to non monetary assets as follows:
Property, plant and equipment 11 – Inventory 2 – 13 –
The discount on acquisition recognised in income in the current year totals $3 million (31 May 2005: $1 million).
Reconciliation to statement of cash flows Cash paid (195) – Deferred settlement (3) – Performance guarantee recoverable 11 – Total (187) – Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
19. Business combinations (continued)
19. (c) Other disposals In addition to the disposal of MPL the Group also disposed of the following businesses: (a) the Group’s Inhalation Grade Lactose business; (b) 50% of the Group’s interest in RD1 Limited; (c) 100% of NDS Fuel Limited; (d) 100% of New Zealand Milk (Egypt) SAE; (e) 100% of New Zealand Milk Enterprises (Russia) Limited; and (f) 100% of Fonterra (CIS) Closed Stock Company (Russia).
This had the following impact on the assets and liabilities of the Group:
CONSOLIDATED $M
ON DISPOSAL ON DISPOSAL 31 MAY 06 31 MAY 05
Total assets 67 51 Total liabilities (20) (47) Net assets 47 4
Net proceeds 78 37 Gain on disposal 31 33 Less elimination of 50% gain against investment in associate (8) – 75 Net Gain on disposal 23 33
Reconciliation to statement of cash flows Net proceeds 78 37 Less receivables from acquirer (69) – Plus settlement of intercompany loans – 27 Total cash received 9 64
The only material disposals during the year ended 31 May 2006 were the disposal of the Group’s Inhalation Grade Lactose business and 50% of Fonterra’s interest in RD1 Limited. On 31 May 2006 Fonterra had entered into an agreement to dispose 100% of its Inhalation Grade Lactose business (DMV-Fonterra Excipients (NZ) Limited) to DMV-Fonterra Excipients GmbH & Co KG, and then purchase 50% of DMV-Fonterra Excipients GmbH & Co KG. Total proceeds from this disposal were $52 million (including transaction costs and working capital adjustments) with net assets disposed of $36 million, resulting in a gain on sale of $16 million. As Fonterra still owns 50% of the Inhalation Grade Lactose business through its purchase of 50% of DMV-Fonterra Excipients GmbH & Co KG, 50% of the $16 million gain was offset against the investment in associate, giving a total gain recognised of $8 million for the year. Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
19. (c) Other disposals (continued) On 31 May 2006, the Group had entered into an agreement to divest 50% of its ownership of RD1 Limited for $18 million (including transaction costs and net asset adjustment). The net assets disposed were $1 million resulting in a gain on disposal of $17 million. The investment in RD1 Limited will now be accounted for as an associate.
There were two material disposals during the year ending 31 May 2005 being the disposal of the Group’s Fonterra Brands’ interests in Mexico and Bangladesh as follows:
On 1 February 2005, the Group divested its ownership in New Zealand Milk Products (Bangladesh) Limited, with a net nil impact on the Group result.
On 2 March 2005, the Group divested 100% of its Fonterra Brands Mexican group of companies which includes: Milk Products Holding (Mexico) Limited (MPHM) and its subsidiaries: Servilac SA de CV; New Zealand Milk (Mexico) Holdings SA de CV; New Zealand Milk (Mexico) SA de CV; Lácteos Finos Mexicanos SA de CV. and an associated brand holding company Xemlet Global Limited.
The Mexican disposal gave rise to a gain on disposal of $33 million. In addition the transaction also triggered a brand reinstatement of $9 million and the recognition of tax losses not previously recognised, totalling $8 million. Therefore the total gains to the Group forming part of the prior year result arising from this transaction amounted to $50 million.
20. Financial instruments 76 The Group is subject to a number of financial risks, which arise as a result of its operational activities.
To manage and limit the effect of those financial risks, the Board of Directors has approved a Treasury Policy that covers defined limits and delegated authority levels, and authorised use of various financial instruments. The policies and financial instruments being utilised at balance date are reported below.
Commodity price risk Fluctuations in world dairy commodity prices can have a significant impact on the Group’s sales revenue and inventory sales. The Group is currently unable to hedge its exposure to commodity price risk due to the absence of any effective commodity price hedging markets.
Foreign exchange risk Foreign exchange risk is the risk of cash flow uncertainty that may arise from a movement in foreign exchange rates to which the Group may be exposed.
The main impacts of foreign exchange movements on the Group arise from:
• Transaction risk - variations in the New Zealand dollar value of the Group’s net foreign cash flows.
• Translation risk - the value of the Group’s investment in foreign subsidiaries and associates and the Group’s foreign currency debt.
Approximately three quarters of the Group’s net foreign exchange exposure is against the United States dollar. The Group’s objective is to manage foreign exchange risk and to provide greater certainty to the forecast payout.
The Parent company operates a centralised Group Treasury that uses forward exchange contracts, currency options and cross currency interest rate swaps to manage these risks in accordance with the Board approved Treasury Policy and delegated authorities. Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
20. Financial instruments (continued)
Notional and principal balances The notional or principal contract amounts of foreign exchange instruments outstanding at balance date are:
CONSOLIDATED AND PARENT $M
AS AT AS AT 31 MAY 06 31 MAY 05
In relation to receivables and future sales: Sold forward foreign exchange contracts (4,033) (2,085) Purchased forward foreign exchange contracts 8,908 6,316 Net forward foreign exchange contracts 4,875 4,231
Sold currency option contracts (2,629) (670) Purchased currency option contracts 4,244 4,300 Net currency options 1,615 3,630 Net contracts in relation to receivables and future sales 6,490 7,861
In relation to borrowings: Sold forward foreign exchange contracts (1,248) (853) Purchased forward foreign exchange contracts 1,650 1,735 Net forward foreign exchange contracts 402 882 Cross currency interest rate swaps 2,607 1,735 Net contracts in relation to borrowing 3,009 2,617 77
The Parent company has a further $3 million (31 May 2005: $31 million) of net foreign exchange contracts outstanding with subsidiary companies as at 31 May 2006.
Interest rate risk Interest rate risk is the risk that the Group’s cost of funds changes as a result of changes in interest rates that the Group pays on its outstanding debt.
The Group’s objective in interest rate risk management is to minimise the cost of debt. In accordance with the Treasury Policy, the Group uses interest rate swaps (including cross-currency interest rate swaps) to manage its interest rate risk within Board approved limits.
Notional and principal balances The notional or principal contract amounts of interest rate instruments outstanding at balance date are:
CONSOLIDATED AND PARENT $M
AS AT AS AT 31 MAY 06 31 MAY 05
Interest rate swaps 6,654 4,909 Cross currency interest rate swaps 2,607 1,735 9,261 6,644 Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
20. Financial instruments (continued)
Repricing analysis The following tables identify the periods in which interest rates are subject to review on financial assets and liabilities.
31 MAY 06 CONSOLIDATED $M
EFFECTIVE 6 MONTHS 6-12 1-2 2-5 >5 INTEREST RATE TOTAL OR LESS MONTHS YEARS YEARS YEARS
Assets Cash balances 7% 137 137 – – – – Receivables and prepayments – 2,558 2,558 – – – – Total 2,695 2,695 – – – –
Liabilities Payables and accruals/owing to suppliers – 1,886 1,886 – – – – Bank overdraft 7% 115 115 – – – – Borrowings (excluding perpetual notes) 7% 5,056 2,667 1,004 – 459 926 Capital notes 8% 599 599 – – – – Total 7,656 5,267 1,004 – 459 926
Off balance sheet instruments Interest rate swaps – 198 320 (114) (830) 426 78 Cross currency interest rate swaps – (479) 400 – 79 – Repricing gap (4,961) (2,853) (284) (114) (1,210) (500)
31 MAY 05 CONSOLIDATED $M
EFFECTIVE 6 MONTHS 6-12 1-2 2-5 >5 INTEREST RATE TOTAL OR LESS MONTHS YEARS YEARS YEARS
Assets Cash balances 7% 116 116 – – – – Receivables and prepayments – 2,271 2,271 – – – – Total 2,387 2,387 – – – –
Liabilities Payables and accruals/owing to suppliers – 1,965 1,965 – – – – Bank overdraft 7% 79 79 – – – – Borrowings (excluding perpetual notes) 7% 3,808 1,817 72 978 343 598 Perpetual notes 9% 90 90 – – – – Capital notes 8% 483 483 – – – – Total 6,425 4,434 72 978 343 598
Off balance sheet instruments Interest rate swaps – 94 (202) 56 (500) 552 Cross currency interest rate swaps – (428) – 350 39 39 Repricing gap (4,038) (2,381) (274) (572) (804) (7) Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
20. Financial instruments (continued)
31 MAY 06 PARENT $M
EFFECTIVE 6 MONTHS 6-12 1-2 2-5 >5 INTEREST RATE TOTAL OR LESS MONTHS YEARS YEARS YEARS
Assets Cash balances 7% 10 10 – – – – Receivables and prepayments – 6,009 6,009 – – – – Total 6,019 6,019 – – – –
Liabilities Payables and accruals/owing to suppliers – 4,524 4,524 – – – – Bank overdraft 7% 12 12 – – – – Borrowings 7% 3,955 1,647 1,004 – 378 926 Capital notes 8% 599 599 – – – – Total 9,090 6,782 1,004 – 378 926
Off balance sheet instruments Interest rate swaps – 198 320 (114) (830) 426 Cross currency interest rate swaps – (479) 400 – 79 – Repricing gap (3,071) (1,044) (284) (114) (1,129) (500)
79
31 MAY 05 PARENT $M
EFFECTIVE 6 MONTHS 6-12 1-2 2-5 >5 INTEREST RATE TOTAL OR LESS MONTHS YEARS YEARS YEARS
Assets Cash balances 7% 1 1 – – – – Receivables and prepayments – 7,057 7,057 – – – – Total 7,058 7,058 – – – –
Liabilities Payables and accruals/owing to suppliers – 5,645 5,645 – – – – Bank overdraft 7% 8 8 – – – – Borrowings 7% 3,464 1,650 60 949 214 591 Capital notes 8% 483 483 – – – – Total 9,600 7,786 60 949 214 591
Off balance sheet instruments Interest rate swaps – 94 (202) 56 (500) 552 Cross currency interest rate swaps – (428) – 350 39 39 Repricing gap (2,542) (1,062) (262) (543) (675) – Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
20. Financial instruments (continued) Liquidity risk Liquidity risk is the risk that the Group is unable to meet its obligations as and when the amounts fall due.
In accordance with the Treasury Policy, the Group has policies and limits in place to manage liquidity risk. The Group has undrawn funding under two committed bank facilities of $1.66 billion in total as at 31 May 2006 (31 May 2005: $1.26 billion).
Credit risk Credit risk is the risk of loss arising from the failure of a debtor or trading counterparty to honour fully any financial or contractual obligation.
The Group incurs credit risk as a result of transactions with customers from its normal sales activities and transactions with financial institutions.
Contracts for sale are only entered into with customers whose credit limits are in accordance with the Group’s delegated authorities approved by the Board.
The maximum credit risk on cash, receivables and other investments is best represented by their carrying value. The maximum credit risk on off-balance sheet financial instruments is equivalent to the values reported in the Fair Value Summary table.
Group Treasury has policy covering exposures to financial institutions, and these are monitored against approved limits on a daily basis. The Group does not hold collateral or security in relation to credit risk, and has no undue concentrations of credit risk.
Fair value The carrying value of financial instruments is equivalent to their fair value, unless where summarised below:
80 CONSOLIDATED $M
AS AT 31 MAY 06 AS AT 31 MAY 05
CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE
Liabilities Borrowings (5,056) (5,073) (3,808) (3,895) Perpetual notes ––(90) (100) Capital notes (599) (606) (483) (523) Derivative instruments Forward foreign exchange contracts (14) (45) 54 274 Currency options 57 29 106 130 Cross currency interest rate swaps (34) (37) (267) (257) Interest rate swaps 9 (13) 10 42
PARENT $M
AS AT 31 MAY 06 AS AT 31 MAY 05
CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE
Liabilities Borrowings (3,955) (3,971) (3,464) (3,551) Capital notes (599) (606) (483) (523) Derivative instruments Forward foreign exchange contracts (50) (48) 274 274 Currency options 29 29 130 130 Cross currency interest rate swaps (34) (37) (267) (257) Interest rate swaps 11 (11) 10 42 Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
CONSOLIDATED $M PARENT $M
AS AT AS AT AS AT AS AT 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
21. Contingent liabilities
Contingent liabilities comprise: Customs and excise bonds 20 17 – – Underwriting commitments, performance bonds and other 31 38 3 11 Aggregate amount of associates liabilities for which the group is jointly and severally liable 34 16 34 16 Total contingent liabilities 85 71 37 27
In the normal course of its business Fonterra, its subsidiaries and associates are exposed to claims, legal proceedings and arbitrations that may in some cases result in costs to the Group. The Directors believe that these have been adequately provided for by the Group and there are no additional legal proceedings or arbitrations that are pending at the date of these financial statements that require provision or disclosure.
22. Commitments
Capital commitments Buildings 33 6 – – Plant, vehicles and equipment 87 171 3 7 Total capital commitments 120 177 3 7 81
Operating lease commitments Non-cancellable operating lease commitments per annum: Less than one year 57 42 6 4 One to two years 36 27 6 4 Two to five years 64 43 13 10 Greater than five years 22 16 1 5 Share of associates’ operating lease commitments 35 32 – – Total operating lease commitments 214 160 26 23
The Group leases premises, plant and equipment.
23. Segmental analysis
The Group operates predominantly in two industrial segments – Ingredients and Consumer Products (predominantly Fonterra Brands) and two geographical segments - New Zealand and other. Ingredients’ operations comprise the manufacture and global marketing of dairy commodity and value-added ingredients products, including trading dairy products on other manufacturers’ behalf. Consumer products operations comprise the production, marketing and sale of value-added milk powders, liquid milks and yoghurts, packaged natural cheese, processed cheese, butter, spreads and cream to retailers and foodservice businesses in more than 30 countries.
In the absence of a market based price for milk and in order to present the results of the Group in its two principal segments, the analysis set out below is based on the cost of milk for the Ingredients segment as being Fonterra’s Commodity Milk Price. This is the estimated payout for milk that Fonterra would have been able to make to enable it to recover all its costs, including a fair return on capital, based on its actual volume of supply but assuming that non-commodity products had been manufactured as commodity products and taking account of Fonterra’s actual plant configuration and the location of milk. Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
23. Segmental analysis (continued)
CONSOLIDATED $M
YEAR YEAR YEAR YEAR YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED ENDED ENDED ENDED ENDED ALL VALUES IN $ MILLIONS 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
INDUSTRY SEGMENTS INGREDIENTS CONSUMER ELIMINATIONS CONSOLIDATED
Sales to customers outside the group 9,211 8,548 3,790 3,775 – – 13,001 12,323 Inter-segment sales1 1,404 1,377 71 59 (1,475) (1,436) – – Total revenue 10,615 9,925 3,861 3,834 (1,475) (1,436) 13,001 12,323
Segment operating surplus2 725 601 288 265 (28) (43) 985 823 Non-recurring income/(expense)3 (31) 13 26 193 – – (5) 206 Segment operating surplus including non-recurring items 694 614 314 458 (28) (43) 980 1,029
Unallocated net interest expense (350) (260) Unallocated tax expense (40) (25) Value add payout component (578) (525) Group net surplus before minority interest 12 219
Segment assets4 9,094 8,372 4,672 3,849 (686) (409) 13,080 11,812
82 Capital employed5 7,295 6,265 3,498 3,000 (48) (20) 10,745 9,245
1 Inter-segment sales are on an arms length basis. 2 Represents earnings before interest and taxation calculated on the basis of cost of milk to the Ingredients business being the Fonterra Commodity Milk Price and adjusted for non-recurring items. 3 The non-recurring income/(expense) items represent brand (impairment)/reinstatements, the gain on disposal of investments, one off restructuring costs and other. The prior year represents brand (impairment)/reinstatements and gain on disposal of investment including National Foods. 4 A right of set off has been established for intercompany advances and funding. 5 Capital employed includes equity and the net interest bearing debt, including capital notes, of a segment. Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
23. Segmental analysis (continued)
CONSOLIDATED $M
YEAR YEAR YEAR YEAR YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED ENDED ENDED ENDED ENDED ALL VALUES IN $ MILLIONS 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05 31 MAY 06 31 MAY 05
GEOGRAPHICAL SEGMENTS NEW ZEALAND OTHER ELIMINATIONS CONSOLIDATED
Sales to customers outside the group 10,130 9,656 2,871 2,667 – – 13,001 12,323 Inter-segment sales1 1,200 1,180 53 32 (1,253) (1,212) – – Total revenue 11,330 10,836 2,924 2,699 (1,253) (1,212) 13,001 12,323
Segment operating surplus2 874 720 115 100 (4) 3 985 823 Non-recurring income/(expense)3 15 198 (20) 8 – – (5) 206 Segment operating surplus including non-recurring items 889 918 95 108 (4) 3 980 1,029
Unallocated net interest expense (350) (260) Unallocated tax expense (40) (25) Value add payout component (578) (525) Group net surplus before minority interest 12 219
Segment assets4 11,504 10,365 1,993 1,732 (417) (285) 13,080 11,812
1 Inter-segment sales are on an arms length basis. 83 2 Represents earnings before interest and taxation calculated on the basis of cost of milk to the Ingredients business being the Fonterra Commodity Milk Price and adjusted for non-recurring items. 3 The non-recurring income/(expense) items represent brand (impairment)/reinstatements, the gain on disposal of investments, one off restructuring costs and other. The prior year represents brand (impairment)/reinstatements and gain on disposal of investment including National Foods. 4 A right of set off has been established for intercompany advances and funding.
The following is supplementary information providing details of the operating revenues by country of domicile of the customer.
CONSOLIDATED $M
YEAR ENDED YEAR ENDED 31 MAY 06 31 MAY 05
Ingredients Americas 2,711 2,332 Asia 2,869 2,565 Australia & New Zealand 1,467 1,877 Europe, Africa & the Middle East 2,164 1,774 Total Ingredients’ Revenues 9,211 8,548
Consumer Americas 615 673 Asia 1,151 963 Australia & New Zealand 1,782 1,769 Europe, Africa & the Middle East 242 370 Total Consumer Revenues 3,790 3,775
Total Group Revenues 13,001 12,323 Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
24. Group entities
All subsidiaries (consolidated), associates and joint ventures (equity accounted) are involved in either marketing, distribution, processing, technology or financing dairy products. All Group entities have a balance date of 31 May unless otherwise indicated. The significant subsidiaries, associates and joint ventures of the Group are listed below.
OWNERSHIP OWNERSHIP INTERESTS (%) INTERESTS (%) COUNTRY OF AS AT AS AT OVERSEAS SUBSIDIARIES INCORPORATION 31 MAY 06 31 MAY 05
New Zealand Milk (Australasia) Pty Limited Australia 100 100 NZMP (UK) Ltd United Kingdom 100 100 Fonterra (Europe) GmbH Germany 100 100 Fonterra (Logistics) Ltd United Kingdom 100 100 Sociedad Productores de Leche S.A., Soprole1 Chile 57 57 Fonterra (Mexico) S.A. de C.V.1 Mexico 100 100 Fonterra (USA) Inc USA 100 100 Fonterra Brands Lanka (Private) Ltd2 Sri Lanka 100 100 Fonterra (Middle East) EC Bahrain 100 100 PT Fonterra Brands Indonesia2 Indonesia 100 100 New Zealand Milk (Malaysia) Sdn Bhd Malaysia 100 100 Fonterra Brands Phils. Inc.2 Philippines 100 100 Fonterra Brands (Hong Kong) Ltd2 Hong Kong 100 100 2 84 Fonterra Brands (Singapore) Pte Ltd Singapore 100 100 Fonterra Brands (New Young) Pte Ltd Singapore 51 – New Young Dairy Products Co. Ltd Taiwan 51 51 New Tai Milk Products Co. Ltd Taiwan 51 51 Fonterra (China) Ltd Hong Kong 100 100 Fonterra (SEA) Pte Ltd Singapore 100 100 Peters & Brownes Foods Pty Ltd Australia 100 100 Fonterra Brands (Thailand) Ltd2 Thailand 100 100 Fonterra Brands (Australia) Pty Ltd2 Australia 100 100 Fonterra (Australia) Pty Ltd3 Australia 100 100 Australasian Food Holdings Pty Limited Australia 100 100 Fonterra Brands (China) Ltd Hong Kong 100 100 Bonlac Foods Limited and subsidiary companies3, 4 Australia 100 50
1 Balance Date 31 December (comparative ownership interest % consistent at 31 December 2005). 2 During 2005 and 2006 selected New Zealand Milk companies were renamed to Fonterra Brands. 3 On 1 June 2006 Bonlac Foods Limited was renamed Fonterra Australia Ltd and Fonterra (Australia) Pty Ltd was renamed Fonterra Ingredients Australia Pty Ltd. 4 The balance date of Bonlac Foods Limited was changed during the year to 31 May from 30 June (comparative ownership interest % consistent at 30 June 2005). Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
24. Group entities (continued)
OWNERSHIP OWNERSHIP INTERESTS (%) INTERESTS (%) COUNTRY OF AS AT AS AT NEW ZEALAND SUBSIDIARIES INCORPORATION 31 MAY 06 31 MAY 05
Canpac International Limited New Zealand 100 100 Fencepost.com Limited New Zealand 100 100 Fonterra Insurance Limited New Zealand 100 100 Fonterra Research Centre Limited New Zealand 100 100 Mainland Products Limited1 New Zealand – 100 New Zealand Dairy Board New Zealand 100 100 Fonterra Brands Limited3 New Zealand 100 100 Fonterra (New Zealand) Limited New Zealand 100 100 Fonterra Limited New Zealand 100 100 RD1 Limited4 New Zealand – 100 The Lactose Company of NZ Limited New Zealand 100 100 Fonterra Brands (Tip Top) Limited3 New Zealand 100 100 ViaLactia Biosciences (NZ) Limited New Zealand 100 100 Fonterra Brands (New Zealand) Ltd New Zealand 100 – Kapiti Fine Foods Ltd2 New Zealand 100 –
1 The Group’s 100% interest in this entity was sold on 31 August 2005 (refer note 19). 2 Balance date 31 March. 85 3 During 2005 and 2006 selected New Zealand Milk companies were renamed to Fonterra Brands. 4 The Group disposed of 50% of this entity on 31 May 2006 and is now accounted for as associate.
The ownership interest of the entities in the following table is less than or equal to 50%. However, they have been consolidated on the basis that the Group controls them based on its capacity to determine the financing and operating policies that guide the activities of these entities and has an entitlement to a significant level of ownership benefits.
OWNERSHIP OWNERSHIP INTERESTS (%) INTERESTS (%) COUNTRY OF AS AT AS AT OVERSEAS SUBSIDIARIES 50% OR LESS OWNERSHIP INCORPORATION 31 MAY 06 31 MAY 05
Fonterra Brands (Mauritius) Ltd Mauritius 49 49 Fonterra Brands (Middle East) L.L.C. UAE 49 49 Saudi New Zealand Milk Products Company Ltd Saudi Arabia 49 49 Fonterra (Japan) Ltd Japan 50 50 Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
24. Group entities (continued)
The ownership interest of the following entities is 50% or less and the Group is not considered to exercise a controlling interest. These entities are therefore accounted for as associates.
OWNERSHIP OWNERSHIP INTERESTS (%) INTERESTS (%) COUNTRY OF AS AT AS AT OVERSEAS ASSOCIATES NOT CONSOLIDATED INCORPORATION 31 MAY 06 31 MAY 05
DairiConcepts Management L.L.C.1 USA 50 50 Corporacion Inlaca, C.A.1 Venezuela 25 25 DPA Manufacturing Holdings Limited1 Bermuda 50 50 Dairy Partners Americas Brasil Limitada1 Brazil 50 50 Dairy Partners Americas Argentina S.A.1 Argentina 50 50 Dairy Partners Americas del Ecuador S.A.1 Ecuador 50 50 Dairy Industries (Jamaica) Limited1 Jamaica 50 50 AFF P/S3 Denmark 25 25 Britannia New Zealand Foods PVTE Limited4 India 49 49 DMV Fonterra Excipients GmbH & Co KG2 Germany 50 –
1 Balance Date 31 December (comparative ownership interest % consistent at 31 December 2005). 2 A 50% interest in this entity was acquired on 31 May 2006. 3 Balance Date 30 September (comparative ownership interest % consistent at 30 September 2005). 4 Balance Date 31 March (comparative ownership interest % consistent at 31 March 2006).
86
OWNERSHIP OWNERSHIP INTERESTS (%) INTERESTS (%) COUNTRY OF AS AT AS AT NEW ZEALAND ASSOCIATES NOT CONSOLIDATED INCORPORATION 31 MAY 06 31 MAY 05
RD1 Limited1 New Zealand 50 –
1 The Group disposed of 50% of this entity on 31 May 2006 and is now accounted for as an associate.
25. Related party transactions
Note 24 identifies all significant Group entities, including subsidiaries, associates and joint ventures. All of these entities, together with the non-significant subsidiaries, associates and joint ventures, are related parties of the Parent. There are no additional related parties with whom material transactions have taken place.
The Parent has entered into the following material related party transactions:
• Loans and advances to/from related parties (refer to notes 6 and 12);
• Interest income and expense on loans and advances (the majority of parent interest income disclosed in note 1 is from related parties);
• Sale of inventories (the majority of Parent sales disclosed in note 1 is to related parties);
• Group tax loss offsets (refer to note 3); and
• The Parent acts as a central treasury function for the Group.
The Parent bears the cost of the following on behalf of certain subsidiaries:
• Audit fees;
• Rental expense;
• Employee remuneration; and
• Guarantees of borrowings/debt instruments. Notes to the Financial Statements (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
25. Related party transactions (continued)
Directors and executives conduct business with the Parent and its subsidiaries in the normal course of their business activities as supplying shareholders. All of these transactions are conducted on commercial terms and conditions. Approximately 1% of payments to suppliers are paid to Directors and executives.
26. Subsequent events note
On 15 June 2006 Fonterra purchased 43% of Shijiazhuang San Lu Group, a Chinese dairy company for RMB 864 million, $174 million.
On 1 June 2006 the Group transitioned to a new capital structure. The new structure resulted in the following: (a) Peak notes, redeemed and replaced with a capacity adjustment applied to payout; (b) Supply redemption rights (“SRR”), redeemed and replaced with excess shares; (c) The introduction of a new share standard (transition share standard) for the transition period requiring the injection of further capital, as the transition share standard requires shareholders to hold more than one share per kilogram of milksolids; and (d) After the above steps, shareholders had two options: (i) Surrender some or all of any shares held that were in excess of the required minimum number; or (ii) Purchase additional shares so that the number of excess shares held after transition was completed equalled the number of SRRs held immediately prior to transition. However, the total number of excess shares held by a shareholder cannot exceed 20% of the required minimum shares.
A summary of the movements resulting from the capital restructure are summarised below. 87
CO-OPERATIVE PEAK TOTAL ALL VALUES IN $ MILLIONS SHARES SRR NOTES EQUITY
Value as at 31 May 2006 3,569 285 1,149 5,003 Adjustment for 2006/07 season supplier movements (130) (15) (23) (168) Reverse end of season peak note accrual – – (37) (37) Value of equity prior to transition 3,439 270 1,089 4,798 (a) Redemption of peak notes – – (1,089) (1,089) (b) Redemption of supply redemption rights 325 (270) – 55 Supply redemption rights price differential (55) – – (55) (c) Additional investment required due to increased Share Standard 897 – – 897 (d) Net surrender of excess shares (63) – – (63) Value of equity after transition 4,543 – – 4,543
Value of equity prior to transition 4,798 Value of equity after transition 4,543 Net cash paid 255
Net cash paid resulting from the transition is $255 million.
Later in the 2006/07 season, once all adjustments for transition are complete, shares will be consolidated back to one share per kilogram of milksolids. This will result in shareholders holding a fewer number of shares than they held during the transition period, at a higher value per share. Consolidation will be completed by December 2006. Auditor’s Report TO THE SHAREHOLDERS OF FONTERRA CO-OPERATIVE GROUP LIMITED
We have audited the financial statements on pages 50 to 87. The financial statements provide information about the past financial performance and cash flows of the Company and Group for the year ended 31 May 2006 and their financial position as at that date. This information is stated in accordance with the accounting policies set out on pages 54 to 59.
Directors’ Responsibilities The Company’s Directors are responsible for the preparation and presentation of the financial statements which give a true and fair view of the financial position of the Company and Group as at 31 May 2006 and their financial performance and cash flows for the year ended on that date.
Auditors’ Responsibilities We are responsible for expressing an independent opinion on the financial statements presented by the Directors and reporting our opinion to you.
Basis of Opinion An audit includes examining, on a test basis, evidence relevant to the amounts and disclosures in the financial statements. It also includes assessing: (a) the significant estimates and judgements made by the Directors in the preparation of the financial statements; and (b) whether the accounting policies are appropriate to the circumstances of the Company and Group, consistently applied and adequately disclosed.
We conducted our audit in accordance with generally accepted auditing standards in New Zealand. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary to provide us with sufficient evidence to give reasonable assurance that the financial statements are free from material misstatements, whether caused by fraud or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information 88 in the financial statements.
We carry out other assignments on behalf of the Company and Group in the areas of taxation compliance, transaction services, financial assurance, and international accounting standard advisory services. Partners and employees of our firm may deal with the Company and Group on normal terms within the ordinary course of trading activities of the Company and Group. The firm has no other relationship with, or interest in, the Company and Group.
Unqualified Opinion We have obtained all the information and explanations we have required.
In our opinion: (a) proper accounting records have been kept by the Company as far as appears from our examination of those records; and (b) the financial statements on pages 50 to 87: (i) comply with generally accepted accounting practice in New Zealand; and (ii) give a true and fair view of the financial position of the Company and Group as at 31 May 2006 and their financial performance and cash flows for the year ended on that date.
Our audit was completed on 24 July 2006 and our unqualified opinion is expressed as at that date.
Chartered Accountants Auckland Statutory Information FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
Equity securities held at balance date In accordance with New Zealand Exchange Ltd Listing Rule 10.5.3(c), the following table identifies the Equity Securities in which each Director and their Associated Persons have a relevant interest as at 31 May 2006. The figure alongside each Director includes beneficially held securities, holdings by Associated Persons and joint holdings with Associated Persons.
EQUITY SECURITIES HELD AS AT 31 MAY 2006 SHARES SRRs
Malcolm Bailey 1,426,054 15,239 Harry Bayliss 217,562 6,505 Greg Gent 336,544 5,313 Stuart Nattrass 4,248,760 13,930 Earl Rattray 243,721 21,560 Mark Townshend 1,483,640 71,744 Henry van der Heyden 352,666 52,436 Jim van der Poel 3,824,921 100,253 John Wilson 2,083,164 100,036
Co-operative status In accordance with Section 10 of the Co-operative Companies Act 1996, the Directors of Fonterra Co-operative Group Limited unanimously resolved on July 24, 2006 that the Company was, for the year ended 31 May 2006, a co-operative dairy company. The opinion was based upon the fact that:
• Throughout that period the principal activities of the Company have been the activities stated in clause 1.2 of the Company’s constitution: – the manufacture and sale of butter, cheese, dried milk, or casein, or any other product derived from milk or milksolids supplied to the Company by its shareholders 89 – the sale to any person of milk or milksolids supplied to the Company by its shareholders – the collection, treatment, and distribution for human consumption of milk or cream supplied to the Company by its shareholders
• Each of the Company’s principal activities are co-operative activities (as defined in section 3 of the Co-operative Companies Act 1996)
• Throughout that period not less than 60 per cent of the voting rights attaching to shares in the Company have been held by transacting shareholders (as defined in section 4 of the Co-operative Companies Act 1996).
Remuneration of Directors The fees paid to each Director of Fonterra Co-operative Group Limited are scheduled below.
FEES $
M G Bailey 105,097 H G Bayliss 105,097 G R W France 128,282 G W Gent 114,653 G S Hawkins 118,282 D M Hoare 36,290 I R Johnson 44,197 S J Nattrass 105,097 E S Rattray 105,097 M G Townshend 114,653 H W van der Heyden 217,742 J W van der Poel 105,097 J S Wilson 105,097 Statutory Information (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
Subsidiary company Directors The following companies were subsidiaries of Fonterra Co-operative Group Limited as at 31 May 2006. Directors as at that date are listed; those who resigned during the year are denoted with an “R”. Alternate Directors are denoted with an “A”. Where an amount is given this represents the total Director’s remuneration and the value of other Director’s benefits received from the specific company during the year ended 31 May 2006.
236752 Limited (formerly Anchor Fonterra Brands (The Pastryhouse) Limited: Superannuation Investments Ltd): G M Cowan, P J Kilgour G M Cowan, P J Kilgour, C L Gandell (R), K J Hampton (R), Fonterra Brands (Tip Top Investments) Limited D Patterson (R), E S Rattray (R), D W C Scott (R), (formerly Tip Top Investments Ltd): J Stronach (R), A R Whatmough (R), A G Wilding (R) G M Cowan, D A Matthews 616059 Limited: Fonterra Brands (Tip Top) Limited G M Cowan, J C Dale (formerly Tip Top Ice Cream Company Ltd): Anchor Ethanol Limited: G M Cowan, D A Matthews G M Cowan, J C Dale Fonterra Brands Investments Canpac International Limited: (NZ) Limited (formerly Knoll Holdings NZ Ltd): G M Cowan, J C Dale G M Cowan, D A Matthews
Dairy Industry Superannuation Scheme Fonterra Brands Limited Trustee Limited: (formerly New Zealand Milk Ltd): M A Apiata-Wade, P J Robertson, G Roper, D W C Scott, A G M Cowan, P J Kilgour, J C Dale (R) D Steele, N W Walker, A G Wilding Fonterra Corporate Research DMV - Fonterra Excipients (NZ) Limited: and Development Limited: 90 G M Cowan, P J Kilgour G M Cowan, J C Dale
Fencepost.com Limited: Fonterra Enterprises International Limited: G M Cowan, P J Kilgour, J C Dale (R) G M Cowan, P J Kilgour, J C Dale (R)
Fonterra (APV) Limited: Fonterra Enterprises Limited: G M Cowan, D A Matthews G M Cowan, P J Kilgour, J C Dale (R)
Fonterra (Asia) Limited: Fonterra Equities Limited: G M Cowan, J C Dale G M Cowan, P J Kilgour, J C Dale (R)
Fonterra (International) Limited: Fonterra Finance (N.Z.) Limited: G M Cowan, J C Dale G M Cowan, P J Kilgour, J C Dale (R)
Fonterra (Iran) Limited: Fonterra Finance Corporation Limited: G M Cowan, J C Dale G M Cowan, P J Kilgour, J C Dale (R)
Fonterra (Middle East) Limited: Fonterra Holdings (Americas) Limited: G M Cowan, J C Dale G M Cowan, J C Dale
Fonterra (New Zealand) Limited: Fonterra Holdings (Argentina) Limited: G M Cowan, J C Dale G M Cowan, J C Dale
Fonterra (Number One) Limited: Fonterra Holdings (Brazil) Limited: G M Cowan, J C Dale G M Cowan, J C Dale
Fonterra Brands (China Holdings) Limited Fonterra Holdings (Ecuador) Limited: (formerly New Zealand Milk (China) Ltd): G M Cowan, J C Dale G M Cowan, P J Kilgour, J C Dale (R) Fonterra Holdings (Venezuela) Limited: Fonterra Brands (New Zealand) Limited: G M Cowan, J C Dale G M Cowan, P J Kilgour Fonterra Holdings Limited: G M Cowan, J C Dale Statutory Information (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
Subsidiary company Directors (continued)
Fonterra Insurance Limited: Naturalac Nutrition Limited: G M Cowan, P J Kilgour, J C Dale (R) G M Cowan, D A Matthews
Fonterra IP Limited: New Zealand Dairy Board: G M Cowan, D A Matthews G M Cowan, J C Dale
Fonterra Limited: New Zealand Dairy Exporter Limited: G M Cowan, J C Dale G M Cowan, P J Kilgour, J C Dale (R)
Fonterra Manufacturing (Americas) Limited: New Zealand Milk (Australasian Holdings) Limited: G M Cowan, J C Dale G M Cowan, P J Kilgour, J C Dale (R)
Fonterra PGGRC Limited: New Zealand Milk (CIS Holdings) Limited: G M Cowan, P J Kilgour, J C Dale (R) G M Cowan, P J Kilgour, J C Dale (R)
Fonterra Projects Limited: New Zealand Milk (Denmark) Limited: G M Cowan, P J Kilgour, J C Dale (R) G M Cowan, P J Kilgour, J C Dale (R)
Fonterra Research Centre Limited: New Zealand Milk (International) Limited: G M Cowan, J C Dale G M Cowan, P J Kilgour, J C Dale (R)
Fonterra TM Limited: New Zealand Milk (Mauritius Investments) Limited: G M Cowan, J C Dale D A Matthews
Food Solutions Group 2000 Limited: New Zealand Milk Brands Limited: G M Cowan, J C Dale G M Cowan, P J Kilgour, J C Dale (R)
General Foods Corporation (N.Z.) Limited: New Zealand Milk Products Limited: 91 G M Cowan, D A Matthews G M Cowan, J C Dale
Glencoal Energy Limited: Nzagbiz Limited: G M Cowan, J C Dale G M Cowan, D A Matthews
Kapiti Cheeses Limited: NZM (Dairy Holdings) Limited: G M Cowan, P J Kilgour G M Cowan, P J Kilgour, J C Dale (R)
Kapiti Dairy Foods Limited: On-Farm Productivity Services Limited: G M Cowan, P J Kilgour G M Cowan, P J Kilgour
Kapiti Dairy Holdings Limited: Peters Ice Cream Company (N.Z.) Limited: G M Cowan, P J Kilgour G M Cowan, D A Matthews
Kapiti Fine Foods Limited: Pinnacle Holdings NZ Limited: G M Cowan, P J Kilgour, B J Drake (R), S W Irons (R), G M Cowan, P J Kilgour, G L Beatty (R), R G O’Connor (R) G C Malcolmson (R), A S McNeil (R) Promak No. 2 Limited: Kapiti Gourmet Limited: G M Cowan, P J Kilgour, J C Dale (R) G M Cowan, P J Kilgour Promak Technology (NZ) Limited: Kapiti Icecream Limited: G M Cowan, P J Kilgour, J C Dale (R) G M Cowan, P J Kilgour RD1 Limited: Key Ingredients New Zealand Limited: B S Harris, G R Stuart, G M Cowan (R), J C Dale (R), G M Cowan, J C Dale P J Kilgour (R)
Milk Products Finance Limited: SAITL Technologies Limited: G M Cowan, J C Dale R R Soar, P J Spooner, P J van Boheemen, J S Wilson
Milk Products International Limited: South Auckland Independent Testing Society Limited: G M Cowan, J C Dale R R Soar, P J Spooner, P J van Boheemen, J S Wilson, R Andela (A), A Gane (A), M E Matthews (A) Statutory Information (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
Subsidiary company Directors (continued)
Sovenz Limited: Bonland Cheese Trading Pty Ltd [Australia]: G M Cowan, P J Kilgour, J C Dale (R) G M Cowan, K J Murray, A M Coleman (A), D K Mallinson (A), G L Beatty (R), D K Mallinson (R), D A Matthews (R) Te Roto Cheeses Limited: G M Cowan, P J Kilgour Comercial Dos Alamos S.A. [Chile]: A Alarcón Araya, H Covarrubias Lalanne, M F Gana The Lactose Company of New Zealand Limited: Eguiguren, J F Silva Barroilhet, J M Ugarte Undurraga G M Cowan, J C Dale Comercial Santa Elena S.A. [Chile]: United Milk Limited: A Alarcón Araya, H Covarrubias Lalanne, M F Gana G M Cowan, P J Kilgour Eguiguren, J F Silva Barroilhet, J M Ugarte Undurraga ViaLactia Biosciences (NZ) Limited: Cottee Nutriceuticals Pty. Ltd [Australia]: G M Cowan D K Mallinson, G R Stuart ViaLactia Bovine Limited: Cottee Nutritionals Pty Ltd [Australia]: G M Cowan D K Mallinson, G R Stuart ViaLactia Clover Limited: Dairy Enterprises (Chile) S.A. [Chile]: G M Cowan M P Campbell, G M Cowan, J C Dale, A J Duncan, Whareroa Co-Generation Limited: M D Wynne, S Diez (A), J P Egaña (A), C Herrera (A), G M Cowan, P J Kilgour, J C Dale (R) L O Herrera (A), S Obach (A)
Whareroa Farm Limited: Dairy Enterprises International (Chile) Limited G M Cowan, P J Kilgour, J C Dale (R) [Cayman Islands]:
92 S R Armstrong, R D Castro Urdiales Whareroa Power Limited: G M Cowan, P J Kilgour, J C Dale (R) Dairy Fresh Pty. Ltd. [Australia]: G M Cowan, K J Murray, A M Coleman (A), D K Mallinson A.C.N. 111 834 489 Pty Ltd [Australia]: (A), G L Beatty (R), D K Mallinson (R), D A Matthews (R) G M Cowan, K J Murray, A M Coleman (A), D K Mallinson (A), G L Beatty (R), D K Mallinson (R) Dairymas (Malaysia) Sdn Bhd [Malaysia]: G P Gomez Lackington, W I A B W Ismail, W I B W Nik, A.C.N. 113 345 430 Pty Ltd [Australia]: P Pant, A R Sarker, M D Wynne (R) B S Donnison, P L Thorn Fonterra (Brasil) Ltda [Brazil]: Anchor Foods (Malaysia) Sdn Bhd [Malaysia]: D H Broad, B T Willis Chan T Y, Lee W N Fonterra (Central America) S.A. [Panama]: Anchor Foods Limited [United Kingdom]: M D Foster, M d R García de Pullin, B T Willis G M Cowan, G R Sharma, D A Pilkington (R) Fonterra (Centro America) S.A. [Guatemala]: Anmum (Malaysia) Sdn. Bhd. [Malaysia]: M D Foster, M d R García de Pullin, R O’Neill, B T Willis G P Gomez Lackington, Lee W N, A R Sarker Fonterra (China) Limited [Hong Kong]: Arctic Foods Pty Ltd [Australia]: G M Cowan, J C Dale, M B N Dewdney, M J Newell G M Cowan, K J Murray, A M Coleman (A), D K Mallinson (A), G L Beatty (R), D K Mallinson (R), D A Pilkington (R), Fonterra (CIS) Limited Liability Company (formerly B S Pummell (R), N A Thomas (R) New Zealand Milk (CIS) LLC) [Russian Federation]: A Eremin, M K N Oldham (R) Australasian Food Holdings Pty Limited [Australia]: G M Cowan, K J Murray, A M Coleman (A), D K Mallinson Fonterra (Europe) GmbH [Germany]: (A), G L Beatty (R), D K Mallinson (R), D A Matthews (R) P H Landon-Lane, K A Wickham (R)
Bonlac Finance Ltd [Australia]: Fonterra (Ing.) Limited [Mauritius]: B S Donnison, S G Nelson, P L Thorn J C Dale, M B N Dewdney Statutory Information (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
Subsidiary company Directors (continued)
Fonterra (Italy) S.P.A. [Italy]: Fonterra Brands (Far East) Limited (formerly P H Landon-Lane, P Pennati, G L Waterhouse, K A New Zealand Milk (Far East) Ltd) [Hong Kong]: Wickham (R) P Pant, A R Sarker, M D Wynne (R)
Fonterra (Japan) Limited [Japan]: Fonterra Brands (Guangzhou) Ltd (formerly Anchia J C Dale, M B N Dewdney, H Fukaii, Y Fukuoka, Milk Products (Guangzhou) Ltd) [China]: K Kumagai, T Morii, R Quin, M J Newell (R), J P Shaskey (R) A R Sarker, M D Wynne, A Zhi Yu, Ng L S (R)
Fonterra (Latam) Ltd [Bermuda]: Fonterra Brands (Guatemala), S.A. (formerly New G M Cowan, J C Dale Zealand Milk (Guatemala), S.A.) [Guatemala]: J J Caceres Donis, R D Castro Urdiales, Z Looknanan-Clarke Fonterra (Logistics) Ltd [United Kingdom]: G L Waterhouse Fonterra Brands (Hong Kong) Limited (formerly New Zealand Milk (Hong Kong) Ltd) [Hong Kong]: Fonterra (Mexico) S.A. de C.V. [Mexico]: W C W Chao, P Pant, A R Sarker, Ng L S (R), D A Matthews, R O’Neill, B T Willis, L Barona Mariscal (A), M D Wynne (R) J R López Cortés (A), J A Monroy Adame (A) Fonterra Brands (Malaysia) Sdn Bhd (formerly New Fonterra (Middle East) E.C. [Bahrain]: Zealand Milk (Malaysia) Sdn Bhd) [Malaysia]: M P J Bates, G M Cowan, J C Dale, M G Patel Chan T Y, G P Gomez Lackington, Lee W N, P Pant, Fonterra (Netherlands) B.V. [Netherlands]: A R Sarker, M D Wynne (R) G R Stuart Fonterra Brands (Mauritius Holdings) Limited Fonterra (SEA) Pte. Ltd. [Singapore]: (formerly New Zealand Milk Holdings (Mauritius) Ltd) G M Cowan, J C Dale, M J Newell, C J Wilson [Mauritius]: 93 J Jingree, S K Jogoo, P Pant, A R Sarker, M D Wynne (R) Fonterra (Thailand) Limited [Thailand]: M J Newell, K Vunthanadit, C J Wilson Fonterra Brands (Mauritius) Ltd (formerly New Zealand Milk (Mauritius) Ltd) [Mauritius]: Fonterra (USA) Inc [United States]: P Ah Lim, G H Liu Man Hin, H M Liu Man Hin, A R Sarker, J C Dale, G Hills, D B Learmonth M D Wynne Fonterra Australia Ltd (formerly Bonlac Foods Ltd) Fonterra Brands (Middle East) LLC (formerly [Australia]: New Zealand Milk (UAE) LLC) [United Arab Emirates]: J C Dale, B S Donnison, R M Kennerley, M F Parkin, J A Stephenson, E C Mulligan (R) G R Stuart, P L Thorn, N R Campbell (R), R J Campbell (R), K D Jackson (R), J Waldvogel (R), G R Stuart (R) (A) Fonterra Brands (New Young) Pte. Ltd. [Singapore]: P Pant, A R Sarker, M D Wynne (R) Fonterra Brands (Americas), Inc. (formerly New Zealand Milk (Caribbean), Inc) [United States]: Fonterra Brands (Singapore) Pte. Ltd (formerly R D Castro Urdiales New Zealand Milk (Singapore) Pte Ltd) [Singapore]: P Pant, A R Sarker, M D Wynne (R) Fonterra Brands (Asia Holdings) Pte. Ltd (formerly Milk Products Holdings (SEA) Pte Ltd) [Singapore]: Fonterra Brands (Thailand) Ltd (formerly N.Z. P Pant, A R Sarker, M D Wynne (R) Milk Products (Thailand) Co., Ltd) [Thailand]: B Duangratana, A M Fitzsimmons, P Pant, C Fonterra Brands (Australia) Pty Ltd (formerly Phaonimmongkol, A R Sarker, D M W Kennedy (R), Bonland Dairies Pty Ltd) [Australia]: S Prarusudamkerng (R), M D Wynne (R) G M Cowan, K J Murray, A M Coleman (A), D K Mallinson (A), G L Beatty (R), D K Mallinson (R), D A Matthews (R) Fonterra Brands (Trading Singapore) Pte. Ltd (formerly New Zealand Milk (Trading Singapore) Fonterra Brands (Centram), S.A. (formerly Pte Ltd) [Singapore]: New Zealand Milk (Centram) S.A.) [Panama]: P Pant, A R Sarker, M D Wynne (R) J J Caceres Donis, R D Castro Urdiales, Z Looknanan-Clarke
Fonterra Brands (China) Ltd [Hong Kong]: G M Cowan, A R Sarker Statutory Information (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
Subsidiary company Directors (continued)
Fonterra Brands Australia (P&B) Pty Ltd Inversiones Dairy Enterprises S.A. [Chile]: (formerly PB Foods Ltd) [Australia]: M P Campbell, G M Cowan, J C Dale, A J Duncan, G M Cowan, K J Murray, A M Coleman (R) (A), M D Wynne, S Diez (A), J P Egaña (A), C Herrera (A), D K Mallinson (R) (A), G L Beatty (R), D A Pilkington (R), L O Herrera (A), S Obach (A) B S Pummell (R), N A Thomas (R) Key Ingredients, Inc. [United States]: Fonterra Brands Lanka (Private) Limited (formerly J C Dale, G Hills, D B Learmonth New Zealand Milk Lanka (Private) Ltd) [Sri Lanka]: La Pradera Milk Products, C.A. [Venezuela]: A D I De Raadt, P Pant, A R Sarker, S M G M Cowan, J L Iranzo, M M Perez Ortiz, O N de Massiani Abeyagunawardena (A), M D Wynne (R), C Sri-Nammuni (A), R Chaw (R), G R Stuart (R) (R) (A) Mainland Dairies Pty. Ltd. [Australia]: Fonterra Brands Phils. Inc (formerly New Zealand G M Cowan, K J Murray, A M Coleman (A), D K Mallinson Milk Philippines, Inc) [Philippines]: (R) (A), G L Beatty (R), D A Matthews (R) A M Fitzsimmons, C M Mendoza, R A Mendoza, P Pant, R Pulido, A R Sarker, M V Del Rosario (R), C Wee (R), Mainland Foodservice Pty Limited [Australia]: M D Wynne (R) G M Cowan, K J Murray, A M Coleman (A), D K Mallinson (R) (A), G L Beatty (R), D A Matthews (R) Fonterra Commercial Trading (Shanghai) Company Limited [China]: Milk Products (New Zealand) Limited [Thailand]: G M Cowan, J C Dale, M B N Dewdney, Kwok H Y, J C Dale, A M Fitzsimmons, L Pakiam, G R Stuart, M J Newell M D Wynne
Fonterra Foods Pty Ltd [Australia]: Milk Products Holdings (Investments) Ltd [United 94 G M Cowan, K J Murray, A M Coleman (R) (A), Kingdom]: D K Mallinson (R) (A), G R Stuart (R) G L Waterhouse
Fonterra Holdings (Mexico), S.A. de C.V. [Mexico]: Milk Products Holdings (Middle East) EC [Bahrain]: D A Matthews, B T Willis, L Barona Mariscal (A), G M Cowan, D K Knowlton, M D Wynne, G Glover (R), J R López Cortés (A) J R Manikkam (R)
Fonterra Holdings (Thailand) Limited [Thailand]: Milk Products Holdings (North America) Inc. M J Newell, K Vunthanadit, C J Wilson [United States]: J C Dale, G Hills, D B Learmonth Fonterra Ingredients Australia Pty Ltd (formerly Fonterra (Australia) Pty Ltd) [Australia]: Milk Products Japan Ltd [Japan]: J C Dale, B M Ryan, G R Stuart J C Dale, T Inagaki, R Quin, M B N Dewdney (R), M J Newell (R), J P Shaskey (R) Fonterra Investments Netherlands Coöperatie U.A. [Netherlands]: Murrumbidgee Dairy Products Pty Ltd [Australia]: J C Dale, R M Major, K I McInteer, G L Waterhouse G M Cowan, K J Murray, A M Coleman (R) (A), D K Mallinson (A), G L Beatty (R), B S Donnison (R), Fonterra Investments Pty Limited [Australia]: P L Thorn (R) G M Cowan, K J Murray, A M Coleman (R) (A), D K Mallinson (R) (A), G R Stuart (R) New Tai Milk Products Co Ltd [Taiwan]: M B N Dewdney, Kwok H Y, J Lee, C Lee, G Lee, M Lee, Fonterra Milk Australia Pty Ltd [Australia]: M J Newell, J P Shaskey G M Cowan, J C Dale, R M Kennerley, B M Ryan New Young Dairy Products Co., Ltd [Taiwan]: Fonterra Servicios, S.A. de C.V. [Mexico]: S Y Lin, K M Lin, C C Lin, Ng L S, A R Sarker, M D Wynne G M Cowan, J C Dale, R O’Neill, B T Willis, L Barona Mariscal (A), J R López Cortés (A), J A Monroy Adame (A) New Zealand Dairy Services (Latin America) Inc. [United States]: Fonterra Venezuela, S.A. (formerly NZMP Venezuela, R D Castro Urdiales S.A.) [Venezuela]: M D Foster, M M Perez Ortiz, B T Willis, M P de Alexandre (A), O N de Massiani (A), S Guevara Camacho (A) Statutory Information (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
Subsidiary company Directors (continued)
New Zealand Milk (Australasia) Pty Ltd [Australia]: Sociedad Procesadora de Leche Del Sur S.A. [Chile]: G M Cowan, K J Murray, A M Coleman (A), D K Mallinson M P Campbell, R D Castro Urdiales, A Cussen Mackenna, (A), G L Beatty (R), D K Mallinson (R), D A Matthews (R) J L Letelier Azzari, E A Teisaire, S Diez (A), J P Matus (A), C Perez-Cotapos (A), J R Valente Vias (A), New Zealand Milk (Barbados) Ltd [Barbados]: G Varela Alfonso (A), L A J Kavanagh (R), J C Dale (R) (A), R D Castro Urdiales, G R Stuart D K Knowlton (R) (A), S D O’Connor (R) (A) New Zealand Milk (LATAM) Ltd [Bermuda]: Sociedad Productores de Leche S.A., Soprole [Chile]: G M Cowan, J C Dale E Alcalde Irarrázaval, J J Besa de Cárcer, R D Castro New Zealand Milk Products (UK) Ltd [United Urdiales, J L Letelier Azzari, W Riesco Salvo, E A Teisaire, Kingdom]: J R Valente Vias, E Alcalde Undurraga (A), O Ferrari (A), G R Sharma, G L Waterhouse J P Matus (A), S Oddo Gómez (A), C Perez-Cotapos (A), G Varela Alfonso (A), A Vergara del Río (A), M P Campbell Newdale Dairies (Pvt) Ltd [Sri Lanka]: (R), L A J Kavanagh (R), J C Dale (R) (A), A J Duncan (R) (A), A D I De Raadt, P Pant, A R Sarker, D K Knowlton (R) (A) S M Abeyagunawardena (A), M D Wynne (R), C Sri-Nammuni (R) (A) Solid Fresh Food & Beverage (M) Sdn. Bhd. [Malaysia]: G P Gomez Lackington, Lee S S, Lee S C, P Pant, NZMP (AEM) Ltd [United Kingdom]: A R Sarker, M D Wynne (R) K I McInteer, G L Waterhouse Solid Milk Industries Sdn. Bhd [Malaysia]: NZMP (UK) Ltd [United Kingdom]: G P Gomez Lackington, P Pant, A R Sarker, Lee S S (A), G R Sharma, G L Waterhouse Lee S C (A), M D Wynne (R) NZX Ltd [United Kingdom]: Susumas Sdn Bhd [Malaysia]: 95 G L Waterhouse Chan T Y, G P Gomez Lackington, Lee W N, P Pant, Peters & Brownes Foods Pty Ltd [Australia]: A R Sarker, M D Wynne (R) G M Cowan, K J Murray, A M Coleman (A), D K Mallinson TransContinental Distributors Ltd [Canada]: (A) (R), G L Beatty (R), A M Coleman (R), D A Pilkington B Kipping, D B Learmonth, D Tyers (R), B S Pummell (R), N A Thomas (R) Unilac Australia Pty Ltd [Australia]: Peters Foods (WA) Pty Ltd [Australia]: B S Donnison, P L Thorn G M Cowan, K J Murray, A M Coleman (A), D K Mallinson (A) (R), G L Beatty (R), A M Coleman (R), United Milk Tasmania Limited [Australia]: D A Pilkington (R), B S Pummell (R), N A Thomas (R) B S Donnison, S G Nelson, P L Thorn
PT Fonterra Brands Indonesia (formerly PT New Zealand Milk Indonesia) [Indonesia]: D A Ross, A R Sarker
PT. Fonterra Indonesia [Indonesia]: G M Cowan, J C Dale, U Marzukoh, C J Wilson, R A Suria (R)
Recombined Dairy Systems A/S [Denmark]: K I McInteer, G R Sharma, G L Waterhouse
Saudi New Zealand Milk Products Company Limited [Saudi Arabia]: H Al Arnout, A M H Al Marzouki, B Greaney, P Thomsen, G Glover (R), J R Manikkam (R)
Sociedad Agrícola y Lechera Praderas Australes S.A. (“Pradesur”) [Chile]: M F Gana Eguiguren, E F Rojas Bravo, J F Silva Barroilhet Statutory Information (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
Employee remuneration Fonterra’s frameworks and process for managing performance and remuneration have been continuously improved over the past year, building on the global review and work undertaken in 2005. We have focused on a global implementation of the new remuneration framework supporting Fonterra’s competitiveness in the markets in which we operate.
Specifically we have focused on:
• Improving the alignment of our remuneration framework with our performance and other management processes;
• Ensuring a globally consistent approach is implemented to establish competitive remuneration ranges in our key markets; and
• Refreshing and updating our incentive plans to improve the alignment with our key business objectives and measures.
Fonterra’s remuneration philosophy focuses on providing Fonterra’s managers with clear accountability for managing the performance and the resulting reward and recognition of their employees, as well as the ability to differentiate reward and recognition based on performance. Fonterra also provides its employees with the information required to know what is expected of them in Fonterra, and to manage their performance against this.
Finally, given Fonterra’s geographical spread, a balance has been established between the requirements of the local markets (including the legal frameworks) and the need to create value by applying Fonterra’s frameworks in a consistent manner.
Base remuneration In the case of salaried staff, Fonterra operates a framework based on “total remuneration”. Fonterra pays both fixed and variable remuneration, which is consistent with the relevant local market, whilst recognising and rewarding exceptional performance. Fonterra also considers other factors in its framework, including internal equity to ensure the desired behaviours of one Fonterra, flexibility and change are supported. 96 Each year, remuneration surveys are conducted by independent remuneration consultants to measure Fonterra’s market position and advise on the setting of remuneration ranges and merit increase guidelines to maintain Fonterra’s market position consistent with the agreed policy.
Annual incentive plans Variable remuneration drives Fonterra’s performance by: 1. Aligning the objectives of the company to ensure collaboration and the one team approach to achieve Fonterra’s goals 2. The establishment of targets which are stretch yet achievable 3. Linking the levels of reward to the performance of the company, teams, and individuals.
Our incentive programs act as an important communication device, signalling to employees what is most important to Fonterra and how success in Fonterra is measured and rewarded.
At the commencement of each operating year, a series of Key Performance Indicators (KPIs) are identified and agreed. These KPIs are a series of financial, operational, and qualitative measures drawn from the three-year strategic plan and the annual operating budget. Statutory Information (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
Annual incentive plans (continued) The actual KPIs used in the annual incentive plan include (but are not limited to): Net Profit after Tax, Available for Payout, Return on Net Assets, Working Capital Efficiency, Compliance to Operating Plans, New Product Development and People Development.
For each KPI, a range of performances for payment purposes is determined, with the range defined by:
• Threshold – performance less than the threshold results in no payment
• Target – performance to the targeted level results in an ‘On Target’ payment
• Maximum – performance to/beyond this level will result in a maximum available payment.
In addition to the above business measures, Fonterra’s remuneration framework takes into account an element of individual performance. A link with our performance management system “PERFORM” and the short-term incentive plan has been implemented. This link seeks to drive the right level of individual focus whilst ensuring the overall business targets are met. The primary driver of any resulting payment is therefore the business results.
At the end of each operating year, performance against the KPIs is determined and independently reviewed. Any payments made in the Short Term Incentive (STI) Plan are adopted and approved by the Appointments Remuneration and Development Committee.
Long term incentive plan For certain key executives, Fonterra operates a Long Term Incentive (LTI) Plan. This plan is designed to motivate, reward and retain key executives.
The plan has the following features: 97 • The plan compares Fonterra’s Total Shareholder Return (TSR) with that of 25 other external “comparator” companies, over a three year period. The comparator companies are selected on criteria for geographical spread, food and beverage companies, and, ingredients and consumer companies
• No amount is earned if Fonterra’s ranking is less than the 50th percentile of the comparator group
• Once payments have vested (after a minimum of three years), participants have the option to exercise or defer a percentage of the amount earned
• A new three year cycle commences each year.
Any payments made in the LTI Plan are recommended by the Appointments Remuneration and Development Sub-Committee and subsequently adopted and approved by the full Board of Fonterra. Statutory Information (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
Employee remuneration analysis – amounts paid for the financial year ended 31 May 2006
YEAR ENDED 31 MAY 06
REMUNERATION RANGE NEW ZEALAND1 OFFSHORE2 CESSATIONS3 TOTAL
100,000 110,000 158 26 13 197 110,001 120,000 115 56 23 194 120,001 130,000 86 56 11 153 130,001 140,000 49 35 13 97 140,001 150,000 46 26 11 83 150,001 160,000 41 37 10 88 160,001 170,000 26 23 11 60 170,001 180,000 19 19 5 43 180,001 190,000 23 20 7 50 190,001 200,000 5 13 3 21 200,001 210,000 8 16 7 31 210,001 220,000 13 13 8 34 220,001 230,000 10 12 4 26 230,001 240,000 10 7 1 18 240,001 250,000 11 4 1 16 250,001 260,000 9 11 3 23 260,001 270,000 2 5 3 10 270,001 280,000 8 4 2 14 98 280,001 290,000 4 6 0 10 290,001 300,000 5 5 2 12 300,001 310,000 4 3 1 8 310,001 320,000 3 7 2 12 320,001 330,000 3 3 1 7 330,001 340,000 0 4 1 5 340,001 350,000 0 7 1 8 350,001 360,000 3 5 2 10 360,001 370,000 5 4 1 10 370,001 380,000 2 2 2 6 380,001 390,000 1 3 1 5 390,001 400,000 1 1 1 3 400,001 410,000 2 4 1 7 410,001 420,000 2 3 1 6 420,001 430,000 3 1 0 4 430,001 440,000 0 1 1 2 440,001 450,000 2 4 1 7 450,001 460,000 1 2 1 4 460,001 470,000 2 5 0 7 470,001 480,000 1 1 3 5 480,001 490,000 1 2 0 3 490,001 500,000 1 1 2 4 500,001 510,000 0 2 0 2 510,001 520,000 0 1 0 1 520,001 530,000 0 1 1 2 530,001 540,000 0 2 1 3 Statutory Information (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
Employee remuneration analysis – amounts paid for the financial year ended 31 May 2006 (continued)
YEAR ENDED 31 MAY 06
REMUNERATION RANGE NEW ZEALAND1 OFFSHORE2 CESSATIONS3 TOTAL
540,001 550,000 1 1 0 2 550,001 560,000 1 0 0 1 560,001 570,000 1 0 1 2 570,001 580,000 2 0 0 2 580,001 590,000 1 3 0 4 590,001 600,000 0 2 1 3 600,001 610,000 0 2 2 4 610,001 620,000 0 2 0 2 620,001 630,000 0 2 0 2 630,001 640,000 0 2 1 3 670,001 680,000 0 0 1 1 690,001 700,000 1 1 0 2 700,001 710,000 1 1 1 3 720,001 730,000 0 0 1 1 740,001 750,000 0 0 1 1 750,001 760,000 0 1 0 1 820,001 830,000 0 1 0 1 850,001 860,000 1 0 0 1 860,001 870,000 1 2 0 3 99 870,001 880,000 1 0 0 1 880,001 890,000 1 0 1 2 890,001 900,000 1 0 0 1 900,001 910,000 0 0 1 1 950,001 960,000 1 0 0 1 990,001 1,000,000 0 1 0 1 1,000,001 1,010,000 0 0 1 1 1,010,001 1,020,000 0 0 1 1 1,020,001 1,030,000 0 1 0 1 1,080,001 1,090,000 1 0 0 1 1,100,001 1,110,000 2 0 0 2 1,190,001 1,200,000 0 0 1 1 1,310,001 1,320,000 1 0 0 1 1,440,001 1,450,000 1 0 0 1 1,480,001 1,490,000 0 1 0 1 1,720,001 1,730,000 0 0 1 1 1,780,001 1,790,000 0 0 1 1 2,110,001 2,120,000 0 0 1 1 2,920,001 2,930,000 1 0 0 1 Total 705 486 180 1,371
1 Includes employees employed in New Zealand solely during the current financial year. 2 Includes employees that were employed in an overseas operation during the current financial year. Amounts paid in foreign currency have been translated at an average conversion rate for the financial year. 3 Cessations include employees that have been terminated or retired during the financial year. The amounts paid to former employees include salary and bonuses for the current year, prior year bonuses that have been paid in the current year (which were accrued at 31 May 2005) and termination entitlements including those arising from employment arrangements entered into by legacy companies prior to the formation of Fonterra. Statutory Information (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
Current credit rating status Standard and Poor’s Rating Services and Fitch Ratings have rated the Company AA- with a rating outlook of stable. Capital Notes which are subordinate to other Fonterra debt issued are rated A+ by Standard and Poor’s.
Exchange rulings and waivers The New Zealand Exchange Limited (NZX) has ruled that the Capital Notes do not constitute “equity securities” under its Listing Rules. This means that where Capital Notes are quoted on NZX, the Company is not required to comply with the Rules which apply to an issuer of quoted equity securities.
NZX has also determined that a “Minimum Holding” for Fonterra Capital Notes is Capital Notes having a face value of $5,000 (rather than the $1,000 as currently provided for in Appendix 2 of the Listing Rules).
ANALYSIS OF FONTERRA CO-OPERATIVE GROUP LIMITED’S CAPITAL NOTE HOLDING AS AT 14 JULY 2006
HOLDER HOLDING FROM/TO COUNT % QUANTITY %
1 – 999 9 1% 4,258 0% 1,000 – 4,999 23 2% 64,693 0% 5,000 – 9,999 572 48% 3,887,572 4% 10,000 – 99,999 530 45% 11,604,374 11% 100,000 and over 52 4% 86,958,357 85% 1,186 100% 102,519,254 100%
100,000 and over – includes the holding of Fonterra Co-operative Group Ltd for the amount of 67,435,575. 100 Fonterra Co-operative Group Limited’s Capital Notes where assigned a long term credit rating of “A+” by Standard and Poors a Division of The McGraw-Hill Companies, Inc. on 6 March 2006.
Entries in the interests register (A) Directors’ Interests in Transactions (1) General Disclosures of Interest The following general disclosures of interest were made during the year: M G Bailey Shareholder of Grand Bend Ltd, The Taonui Land Co Ltd; Director and shareholder of Hawkes Bay Dairies (2002) Ltd; Cessation of directorship of Process Solutions Group Ltd G R W France Member of the Governance Board of the National Research Centre for Growth & Development G W Gent Director and shareholder of Six-O-Farms Ltd, Delamm Ltd G S Hawkins Director and shareholder of Link International Group Limited; Chairman of the Liggins Institute Advisory Board (from 1 Jan 2006, replacing prior disclosure in respect of Liggins Institute) S J Nattrass Shareholder and Chairman of Global Horticulture Ltd M G Townshend Director and shareholder of White Pine Dairies Ltd, Crescent Genetics Ltd; Trustee of Haurakian Charitable Trust H W van der Heyden Director of Innovation Waikato Ltd, King St Advertising Ltd, New Zealand Exchange Ltd, Independent Egg Producers Co-op Ltd; Member of University of Waikato Management School Advisory Board; Trustee of Asia:NZ J W van der Poel Director and shareholder of Tirnanog Farm Ltd, Singletree Dairies Ltd, Dairy Desk Ltd, Castle Hill Station Ltd; Director of Focal Consultants, LLC; Partner in Focal Dairies, LP J S Wilson Director and shareholder of Milktech Ltd
(2) Specific Disclosures Nil Statutory Information (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
(B) Securities Dealings of Directors The following entries were made in the Interests Register during the year.
CO-OPERATIVE SHARES
JOINTLY HELD HELD BY WITH ASSOCIATED ASSOCIATED PERSONS PERSONS
(1) New disclosures Directors disclosed the following holdings of Co-operative Shares during the year: Malcolm Bailey 1,314,226 – Earl Rattray 43,105 – John Wilson – 890,399
(2) End of Season Changes Directors disclosed the following transactions associated with end of season adjustments: Malcolm Bailey (SRR conversion) 3,943 – Harry Bayliss – 4,376 Harry Bayliss (SRR conversion) (6,505) – Greg Gent 7,917 – Greg Gent (SRR conversion) 12,878 – Stuart Nattrass 274,002 – Stuart Nattrass (142,895) – Stuart Nattrass (SRR conversion) 7,654 – 101 Earl Rattray (SRR conversion) (6,479) 5,151 Mark Townshend 2,347 – Mark Townshend (SRR conversion) 42,315 – Mark Townshend (SRR conversion) (52,976) – Henry van der Heyden 473 – Henry van der Heyden (SRR conversion) (42,532) (9,904) Jim van der Poel 197,489 35,925 Jim van der Poel (SRR conversion) 11,107 1,385 Jim van der Poel (SRR conversion) (64,363) – John Wilson – 10,646 John Wilson (SRR conversion) (31,679) –
In all cases the allocations or surrenders relate to the 2004/05 end of season adjustments and were made on 5 July 2005 in accordance with the Constitution. The value upon allocation or surrender of these securities was $4.69 per co-operative share. Where indicated above, conversions to or from SRRs were at a value of $4.69. Statutory Information (continued) FONTERRA CO-OPERATIVE GROUP LIMITED FOR THE YEAR ENDED 31 MAY 2006
Entries in the interests register (continued)
(3) Other Trading Activities G W Gent: Mr Gent acquired Jointly with Associated Persons 85,484 Co-operative Shares as at 1 June 2005 as part of a farm purchase. J W van der Poel: On 1 July 2005, 163,011 Co-operative Shares jointly held with an Associated Person were transferred to another Associated Person. On 1 March 2006 an Associated Person of Mr van der Poel acquired 356,002 Co-operative Shares as part of a farm purchase.
(C) Loans to Directors There have been no loans to Directors.
(D) Directors’ Remuneration The Directors’ Remuneration Committee, comprising six shareholders appointed under the constitution, makes recommendations for shareholder approval as to the level of Directors’ fees.
At the Annual Meeting of Shareholders held on 11 October 2005, shareholders approved, on the recommendation of the Directors’ Remuneration Committee, the following amounts of remuneration effective until the next Annual Meeting of Shareholders.
Chairman $225,000 p.a. Directors $108,000 p.a. Discretionary additional payments to the Chairmen of the Audit Finance & Risk Committee, Shareholder Relations Committee, Fair Value Share Review Committee and Milk Pricing Working 102 Group (except if the Chairman is the Fonterra Chairman) $15,000 p.a.
The Board subsequently approved the payment of the discretionary additional payment, at the prevailing approved rate, to the Chairmen of the Audit Finance and Risk Committee, Shareholder Relations Committee, Fair Value Share Review Committee and Milk Pricing Working Group.
The Board has a policy of applying the same remuneration levels to directors appointed under clause 12.4 of the Constitution.
In general, fees paid by subsidiary or associate companies in respect of Fonterra directors or employees serving as directors of those companies are payable directly to Fonterra.
(E) Directors’ Indemnity and Insurance Fonterra has given indemnities to, and has effected insurance for, Directors and executives of the company and its related companies, in accordance with section 162 of the Companies Act 1993, and Fonterra’s constitution, which, except for specific matters that are expressly excluded, indemnify and insure Directors and executives against monetary losses as a result of actions undertaken by them in the course of their duties. Among the matters specifically excluded are penalties and fines that may be imposed for breaches of law.
Separate Deeds of Indemnity have been entered into between the Company and its appointees to the Bonlac Foods Limited board and the boards of its Chilean subsidiaries, in respect of their roles as directors of those companies. Contacts
Fonterra Corporate Centre Fonterra Group Manufacturing Private Bag 92032 P O Box 459 Auckland Hamilton NEW ZEALAND NEW ZEALAND 64 9 374 9000 (phone) 64 7 839 8398 (phone) 64 9 379 8284 (fax) 64 7 839 8118 (fax)
Wellington Office Fonterra Milk Supply P O Box 417 Private Bag 92032 Wellington Auckland NEW ZEALAND NEW ZEALAND 64 4 471 8999 (phone) 64 9 374 9000 (phone) 64 4 471 8600 (fax) 64 9 379 8284 (fax)
Fonterra Global Trade Fonterra Milk Supply Private Bag 92032 Contact Centre Auckland 0800 65 65 68 NEW ZEALAND 64 9 374 9000 (phone) Fencepost.com 64 9 379 8284 (fax) Private Bag 92032 Auckland Fonterra Ingredients NEW ZEALAND Private Bag 92032 64 9 374 9000 (phone) 103 Auckland 64 9 300 3414 (fax) NEW ZEALAND 64 9 374 9000 (phone) RD1 64 9 379 8284 (fax) P O Box 9045 Hamilton Fonterra Brands NEW ZEALAND Private Bag 92032 64 7 858 0600 (phone) Auckland 64 7 858 0601 (fax) NEW ZEALAND 64 9 374 9000 (phone) www.fonterra.com 64 9 379 8284 (fax)
Fonterra Foodservices New Zealand freephone 0800 650 670 Australia freephone 1300 724 844 104 Total number of shareholders (supply numbers) at 31 May 31 at numbers) Total(supply shareholders of number TotalReturn Shareholder Payout to Contribution ValueAdd Price Milk Commodity Fonterra Gap Price Milk Price Milk Commodity Historical kg/ MS) per (NZD Payout Shareholder Overseas (000’s)Overseas (000’s)Zealand New Ingredients and other revenue from outside of the Group the of outside fromrevenue other and Ingredients rate Fonterra’sconversion NZD/USD average year the throughout Ingredients Group the of outside fromrevenue Consumer Net Interest Bearing Debt (NZD millions) (NZD Debt Bearing Interest Net Shareholders’Funds,including minority interests millions)(NZD millions) Total(NZD Employed Assets surplus operating Segment Inter-GroupEliminations Consumer T Sta Fair A O millions) (N ZD Revenue millions) (NZ D surplus operating Segment T millions) (NZD minorities after Surplus/( Deficit) Net ebt to debt plus equity ratio equity plus debt to Debt C 5 4 3 2 1 7 6
otal Staff otal otal apital apital verage perating perating Initial Fair Value Share price was a nominal value set by the Fonterra Board; subsequent valuations determined from within the range set by the independent valuer. independent the by set range the within from determined valuations subsequent Board; Fonterra the by set value nominal a was price Share Value Fair Initial been not have Comparatives price. 34. milk page refer commodity methodology, Fonterra refined and the price using milk restated commodity Historical of calculation the to made were refinements methodology 2005/06 In 2005/06. and 2004/05 2003/04, 2002/03, in used that to methodology different Applying and over operations, its of all from Fonterra by milk suppliers’ supplied. to milk of capital) of value the cost the above (including added value the of year.measure a is formation Fonterra’s Payout in to systems Contribution reporting Add Group’s Value the The of structure the to due available not is season 2001/02 the for information comparative Certain Represents earnings before interest and tax calculated on the basis of the historical CMP and adjusted for non recurring items. recurring non for adjusted and CMP historical the of basis the on calculated tax and interest before earnings Represents currency foreign net converted has place. in Fonterra cover that hedge rate the the on is based rate Dollars conversion NZ into average The receipts season. the for rates spot daily the of average the is rate exchange Average ff V Revenue alue Share alue
E mployed Spot NZD/US E mployed (000’s)Employed mployed P er ) set for the next season next the for set (NZD) Price R f eturn ormance 6 Exchange s Fo NTERRA 2 ate applying Rate 6 7
– S – EA S ON 2005/06 2005/06 in review in 2005/06 11,286 13,001 13,080 52.1%
4 3,790 9,211 5,600 5,145 9.6% (0.23) 5.80 0.48 3.62 3.85 4.10 0.66 11.0 17.4 0.68 985 (28) 288 725 6.4 – 2004/05 11,680 12,323 11,812 17.2% 46.9% 3,775 8,548 4,334 4,911 (0.23)
5.44 0.45 4.14 4.37 4.59 11.6 18.6 0.61 0.69 191 823 (43) 265 601 7.0 2003/04 12,144 11,830 11,112 11.0% 45.7%
3,636 8,194 4,041 4,795 (0.20) 4.69 0.48 3.77 3.97 4.25 11.1 19.6 0.52 0.62 839 280 563 8.5 (4)
7 2002/03 12,562 12,474 10,746 16.7% 48.5% 4,587 7,887 4,388 4,665 (0.18) 4.38 0.47 3.16 3.34 3.63 10.8 19.8 0.48 0.51 257 817 404 407 9.0
6 2001/02 13,057 13,924 11,800 51.3% 3 5,583 8,341 4,718 4,485 5 (0.39)
3.85 0.22 5.06 5.45 5.33 20.0 0.44 0.43 (50) 599 N/a N/a N/a N/a N/a N/a
1 For more information see www.fonterra.com see information more For
USD per MT FOB Litres (million) USD per MT FOB 12,60 12,80 13,000 13,20 13,40 13,60 13,80 14,000 14,20 $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 $6.00 1,00 1,50 2,00 2,50 3,00 Percent 1,00 1,50 2,00 2,50 3,00 50 10 12 14 16 18 20 50 40 60 80 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 MILK COLLECTION MILK PA *Oceania Export Series, Series, Export *Oceania AV FONTERRA THE ON RETURN Agriculture. of Department US Service, Marketing Agricultural Series, Export *Oceania AV YOUT 2001/0 2001/02 2001/0 2001/0 2001/0 ERAGE COMMODITY PRICES PRICES COMMODITY ERAGE PRICES COMMODITY ERAGE – NZD per kg/MS per NZD – 2 2 2 2 2002/0 2002/0 2002/03 2002/0 2002/0 – kg/MS and Litres collected Litres and kg/MS – A g ricultural Marketin ricultural 3 3 3 3 FA 2003/0 2003/04 2003/0 2003/0 2003/0 IR IR – USD per MT FOB* MT per USD – FOB* MT per USD – VA LUE SHAR LUE 4 4 4 4 g Service, US Department of of Department US Service, 2004/0 2004/05 2004/0 2004/0 2004/0 E – vs the NZX 50 Capital Inde Capital 50 NZX the vs – 5 5 5 5 2005/0 2005/06 2005/0 2005/0 2005/0 A g riculture. 6 6 6 6 RE 1,06 1,08 1,10 1,12 1,14 1,16 1,18 1,20 1,22
0 0 0 0 0 0 0 0 0 FONTERRA SHARE FONTERRA NZX 50 CAPI 50 NZX S x VA INDEX RETURN INDEX
Kg/MS (millions) ULT LUE RETURN LUE (MILLION CHEESE CHEESE BUTTER BUTTER LITRES kg/MS WM WM SM SM TA S S P P P P L ) AT
A
MT 000’s Average Kg/MS GLANCE 100,000 105,00 110,00 70,000 75,000 80,000 85,000 90,000 95,000 $1,000 $1,100 1,50 1,75 2,00 2,25 2,50 2,75 3,00 $500 $600 $700 $800 $900 0.30 0.35 0.40 0.45 0.50 0.55 0.60 0.65 0.70 0 0 0 0 0 0 0 0 0 Rate that Fonterra converts net foreign currency receipts into NZD based on hedge cover in place. in cover hedge on based NZD into receipts currency foreign net converts Fonterra that Rate FONTERRA INGREDIENTS INGREDIENTS A AND SHAREHOLDERS OPERA SEGMENT 2001/02 2001/0 2001/0 2001/0 0.44 2 2 2 ’S A ’S – Manufactured in NZ 000’ NZ in Manufactured – VERAGE NZD/USD CONVERSION RA CONVERSION NZD/USD VERAGE 2002/0 2002/0 2002/03 2002/0 TING SURPLU TING 0.48 3 3 3 VERAGE kg/M VERAGE 2003/04 2003/0 2003/0 2003/0 S 0.52 – NZD millions NZD – 4 4 4 S – NZ only NZ – s MT and T and MT s 2004/05 2004/0 2004/0 2004/0 0.61 TE 5 5 5 otal Ingredients sales 000’ sales Ingredients otal 2005/06 2005/0 2005/0 2005/0 0.66 6 6 6 9,50 10,000 10,500 11,000 11,500 12,000 12,500 13,000 13,500 DAIR 0 IN NEW ZEALAN NEW IN MANUF SALES VOLUME SALES Y INGREDIENT Y s MT s
INGREDIENT Number of Suppliers SUPPLIERS ACTURE AV ERAG TO kg/MS TA D D S E S L
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Insight Creative Limited. Auckland. New Zealand. 09/06 FOOP004. Primary Photography – John Crawford.
New Zealand Dollars (million) 10,500 11,00 11,50 12,000 12,500 13,000 13,500 14,000 14,500 0 0 TO 2001/0 TA 13,924 L REVENUE REVENUE L 2 2002/0 – NZD millions NZD – 12,474 3 2003/0 11,83 0 4 2004/0 12,323 5 2005/0 13,001 6 TO NZD MILLION NZD TA L REVENU L E S
a r r e t n o F 6 0 0 2 t r o p e r l a u n n A
F o n t e r r a A nnual report 2 0 0 6