AN N U AL R EPO RT 2005

DISCOVER

A N N U A L R E P O RT 2 0 0 5

From Bean to your Cup

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Discover Van Houtte

C O F F E E C O N N O I S SEURS

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Something to please every connoisseur

C O F F E E C O N N O I S SEURS

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Message from the Chairman of the Board

C O M PA N Y G R OWERS

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Yes, you can have a great cup of coffee at work!

C O M PA N Y G R OWERS

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Management Report

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Anywhere, anytime

B E A N C O U NTING

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Management’s Discussion and Analysis

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Consolidated Financial Statements

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Notes to Consolidated Financial Statements

ISBN 2-9802772-9-0

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B E A N C O U NTING

Legal Deposit – Bibliothèque nationale du Québec, third quarter 2005 |

Legal Deposit – National Library of Canada, third quarter 2005

Corporate Information DIRECTORS

OFFICERS

Pierre Van Houtte Honorary Chairman of the Board Van Houtte Inc.

Jean-Yves Monette President and Chief Executive Officer

Timothy Weichel Vice-President, Operations – Central Region

KPMG LLP

Paul-André Guillotte Chairman of the Board Van Houtte Inc.

Gérard Geoffrion Executive Vice-President and Chief Financial Officer

Robert Mann Vice-President, Operations – Prairie Region

Royal Bank of Canada Scotia Bank Bank of Montreal

Christian Pouliot Vice-Chairman of the Board Van Houtte Inc.

Roger Cohen President Van Houtte USA – Filterfresh

Jamie Livingston Vice-President, Operations – Pacific Region

Jean-Yves Monette President and Chief Executive Officer Van Houtte Inc.

Roger Leblanc Vice-President, Manufacturing and Distribution

Pierre-Luc Van Houtte Corporate Secretary Van Houtte Inc. Corporate Director Michel Ouellet Corporate Director Michael Gray Corporate Director Sylvain Bernier Executive Vice-President and Chief Operating Officer Beauregard Group Robert Parizeau Chairman of the Board Aon Parizeau Inc.

Johanne Groulx Vice-President, Supply Chain and Trade Policy

AUDITORS

Coffee Services USA

BANKING INSTITUTIONS

TRANSFER AGENT

Computershare Trust Company of Canada I N V E S T O R R E L AT I O N S

Walter Prokopchuk Vice-President, Operations

Gérard Geoffrion

David Laurie Vice-President, Retail Sales – Canada

Miles Malanowich Vice-President, Operations – Western Region

AUDIT COMMITTEE

Jean-Luc Deschamps Vice-President, Finance

Ed Holloran Vice-President, Business Development

Normand De Césaré Vice-President and Corporate Controller Thierry Pejot-Charrost Director, Internal Audit Jean-Olivier Boucher General Counsel

Colleen Fleming President and CEO Career Edge

Stéphane Breault President, Cafés-bistros

Pierre Brodeur Corporate Director

Coffee Services Canada

Roger Desrosiers Corporate Director

Denis Sarrazin Vice-President, Operations – Eastern Region

Kevin Brown Controller, Treasurer and Secretary V K I Te c h n o l o g i e s

C O R P O R AT E G O V E R N A N C E COMMITTEE

Robert Parizeau, Chairman Pierre Brodeur Colleen Fleming

Angelo Mottillo Executive Vice-President and General Manager

HUMAN RESOURCES A N D C O M P E N S AT I O N COMMITTEE

Ricardo Tozzi Vice-President, Operations

Pierre Brodeur, Chairman Sylvain Bernier Colleen Fleming Robert Parizeau

HEAD OFFICE

Van Houtte Inc., 8300-19th Avenue, Montreal, Quebec H1Z 4J8 S T O C K I N F O R M AT I O N ( J U N E 3 , 2 0 0 5 )

Initial public offering: August 1987 ($2.50*) Number of shares outstanding: 5,300,000 multiple voting shares; 16,172,531 subordinate voting shares High/low for fiscal 2005: $23.48 / $14.00 Trading volume: 6,879,857 * Reflects 1997 stock-split. VAN HOUTTE’S ANNUAL MEETING OF SHAREHOLDERS

will be held on August 31, 2005 at 11:00 a.m. at the Mont-Royal Omni Hotel, Saisons A Room, 1050 Sherbrooke Street West, Montreal, Quebec The Company’s Annual Information Form for the fiscal year ended April 2, 2005 will be available at the Head Office as of June 30, 2005. Ce rapport est également disponible en français.

Robert Parizeau, Chairman Pierre Brodeur Roger Desrosiers Michel Ouellet

S T R AT E G I C O R I E N TAT I O N COMMITTEE

Jean-Yves Monette, Chairman Pierre Brodeur Paul-André Guillotte Robert Parizeau Christian Pouliot Pierre-Luc Van Houtte

AT H O M E

every connoisseur A full-flavoured coffee for breakfast? A more mellow blend for break time? An espresso at lunch? Organic or ethical coffee? Or perhaps a flavoured coffee? No matter what your taste, Van Houtte coffees are guaranteed to satisfy. Whether in whole bean or water cooled ground process, each one of our coffees is prepared according to its own recipe, combining one or more single origin coffees with a specific roasting profile and executed with precision. The final product is then packaged to maintain freshness. We are very proud of JAVANATIONTM, our most recent line of exceptional coffees featuring four single origin coffees (Guatemala, Costa Rica, Sumatra, Kenya) and three unique espresso blends (the Venetian, the Parisian and the San Francisco).

JAVANATIONTM is Van Houtte’s latest line of coffee.

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COFFEE CONNOISSEURS

Something to please

Message from the

Chairman of the Board Dear fellow shareholders, Fiscal 2005 was a good year. Under the leadership of president and CEO Jean-Yves Monette, Van Houtte’s executive team, managers and employees drove earnings up 17%, outperforming the 10% to 15% target set a year ago. This performance not only confirms that our business plan is sound but that we chose the right people to execute it. And so for 2006, we are once again projecting earnings growth of 10% to 15%. This plan seeks sustainable gains, and it is on this basis that the Board evaluates the strategy and its implementation. Still, we are pleased to see that investors have already begun to acknowledge its merits. This is excellent news for those who share my expectations for an enduring return on their investment. Your Board of Directors is not only responsible for supervising the design and execution of Van Houtte’s strategy but also for prudently assuming its fiduciary responsibility vis-à-vis your investment. In this regard, we have finished updating our corporate governance rules to reflect Canada’s new legislative and regulatory environment. Thus in 2005 we revised and formalized the mandates of each Board committee and set up the appropriate performance evaluation mechanisms. We also developed effective controls and procedures for communicating information so as to guarantee the quality and timely presentation of financial information to shareholders. During the year, we welcomed a new director to the Board. Roger Desrosiers, FCA, brings with him more than 40 years’ auditing and strategic consulting experience. I would once again like to welcome Mr. Desrosiers. Jean-Yves Monette and his colleagues on the management committee, Gérard Geoffrion and Roger Cohen, must be commended for their achievements this past year. Solidly backed by Van Houtte’s employees, Jean-Yves and his team are the skilled, enthusiastic architects of Van Houtte’s success. They can continue to rely on our full support. I would also like to thank my colleagues on the Board of Directors for their commitment to the Company’s development. In this regard, the work of the Board’s committees deserves special mention. The shareholders, including myself, are grateful for their extensive and invaluable input.

Paul-André Guillotte Chairman of the Board

Michael Gray

Paul-André Guillotte

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Roger Desrosiers

Robert Parizeau

Pierre Brodeur

Pierre-Luc Van Houtte

Pierre Van Houtte

Michel Ouellet

Jean-Yves Monette

Colleen Fleming Sylvain Bernier

COFFEE CONNOISSEURS

Christian Pouliot

COMPANY GROWERS

AT W O R K

Yes, you can have a great cup of coffee

at work!

With Van Houtte, there’s no reason to compromise on the quality of the coffee you drink at work. Our Coffee Services network offers the Total Coffee Solution, a line of unbeatable gourmet coffees, a selection of traditional and single-cup brewers, an assortment of condiments and related products, and of course, impeccable service. The Total Coffee Solution is Van Houtte coffee, service included.

Espresso café brewer

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Keurig B2003 brewer

Suprema single-cup brewer

Management Report A little more than a year and a half ago, Van Houtte’s senior management set three strategic priorities: ■ ■ ■

Accelerate growth through acquisitions and organic growth; Exercise strict cost management; Optimize capital management.

Fiscal 2005 was a success on all three fronts. It is not surprising that earnings grew 17% over 2004. While they seek sustainable results, our strategic decisions do not preclude immediate outcomes, quite the contrary. Accelerating growth Our top priority is to accelerate growth but to do so in a disciplined manner. We are not only looking to increase business volume but more importantly, to densify our operations. While this means that organic growth is pivotal to our development, it also means that our acquisitions will consolidate the markets in which we already have a footprint rather than expand our network. In fact, much of our operating costs do not vary with sales growth, provided this growth is concentrated in our existing networks. Fiscal 2005 confirmed Van Houtte’s return to growth, a process that began towards the end of last year. Adjusted for exchange rate variations and the disposal of non-strategic activities, weekly sales advanced 12.8% in 2005, slightly surpassing our objective. And consistent with our business plan, half the growth stemmed from acquisitions. Exercising strict cost management Operating income (earnings before interest, taxes, depreciation and amortization) reached $65.7 million or $6.1 million more than last year. Nearly half of this increase is attributable not to additional sales but to better overall sales profitability. In fact, our operating ratio improved from 18.0% to 18.8%. Coffee Services generated most of our improvement in operating leverage, reflecting changes made to the organization and processes implemented two years ago.

COMPANY GROWERS

Gérard Geoffrion Executive Vice-President and Chief Financial Officer

Jean-Yves Monette President and Chief Executive Officer

Optimizing capital management Last but not least is capital management. Although our growth requires significant investments in fixed assets and acquisitions, they must be made with a view to obtaining a substantive return. Our strict criteria include making an investment only if we can reasonably expect an after-tax return of at least 15%. The impact of this investment policy is not immediate on the Company’s overall return on capital, and it will take a few years before our return on equity reaches the desired levels. Other effects appear more rapidly. For example, 2005 generated $60 million in liquidities, a record in Van Houtte’s history. Up $15 million over last year, these cash resources allowed us to finance all the investments and acquisitions required for our expansion and to increase our dividend, while trimming our debt load by $15.8 million. In short, I believe that our achievements this past year were consistent with our priorities, and moreover, confirm the soundness of our strategy.

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Roger Cohen President, Van Houtte USA – Filterfresh

Deploying the brand This strategy has evolved in recent years after many years of focusing on building and expanding our two main distribution channels: one that targets home consumption, essentially through food retailers, and the other, aiming at consumption outside the home, chiefly through our Coffee Services network. Now that these two channels are in place, our focus for the immediate future will be on optimal use rather than expansion. This strategy is implemented in various ways depending on our spheres of activity and the regions in which they are exercised. However, regardless of the sphere or region, it revolves around a single goal: leverage our brand portfolio, especially the Van Houtte brand. This goal shapes almost everything we do. Thus the launch of JAVANATIONTM, a new line of Van Houtte products available in food stores, strengthens Van Houtte’s position as the coffee brand of connoisseurs. In the same vein, the opening in 2005 of several hundred Van Houtte coffee bars in as many public places (convenience stores, gas stations, cafeterias, sports centres) in Canada is boosting awareness of the Van Houtte brand which in turn stimulates sales in all our distribution channels. Moreover, the “Total Coffee Solution” concept makes our coffee services even more appealing and helps step up penetration in our target markets. On the whole, brand awareness and brand equity improved in all our markets. Fiscal 2006: continuity and convergence We will continue with this strategic focus and priorities in 2006: sales growth, strict cost management and optimal capital management. We will focus on continuity and convergence to enhance brand awareness in our distribution channels and will adapt them to our competitive position in each territory. The Keurig® coffeemakers for the home and the Van Houtte coffees for these machines should appear on store shelves during the fiscal year. Keurig technology has been immensely successful in the North-American workplace and other sites outside the home. In Canada, it can be purchased for home use on our Web site. And in the U.S., our affiliate Keurig Inc. is reporting a successful launch of its coffeemakers in retail stores. In our Coffee Services segment, we will capitalize on the success achieved in 2005 with national customers such as Lowe’s and Couche-Tard to step up development of national and continental accounts, where our network provides us with an exceptional competitive edge that will be leveraged even more next year.

The San Luis program in Honduras is increasingly successful. Together with CARE Canada, we have forged a preferred relationship with Empresa San Luis, a cooperative made up of local coffee farmers. Since it began doing business with us, the co-op has seen the sale price of its coffee rise 30% and seasonal financing costs cut in half. They have been provided with new infrastructures and equipment. In appreciation Our return to growth is the product of a sensible and realistic business plan but most importantly of focused, disciplined execution. In so doing, we gave our field managers better tools and especially greater decision-making power. We therefore owe our performance in 2005 to these managers and to all of Van Houtte’s employees. Senior management is proud to lead this competent and passionate group of 1,887 people. On behalf of senior management, I would also like to express my appreciation to the Board of Directors for its support, effective interventions and sound advice.

Jean-Yves Monette President and Chief Executive Officer

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COMPANY GROWERS

A responsible corporate citizen Van Houtte has always made it a point of honour to be a responsible corporate citizen. To this end, our product line has included organic coffees – Coffee LoversTM – for a number of years now, some of which are also fair trade certified by Transfair. In 2006, we will expand this offering.

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ON THE GO

Anywhere,

anytime On campus, at the bank, the spa, the convenience store or renovation centre... no matter where you are, you can find a cup of gourmet coffee – a Van Houtte coffee of course! Served in a coffee bar with a café bistro ambiance, our coffee meets the strict requirements of Van Houtte’s master roaster, who in turn respects the European tradition of our founder, Albert-Louis Van Houtte.

On campus...

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...at the bank...

...or the convenience store

Management’s Discussion and Analysis Company profile Van Houtte Inc. (“Van Houtte,” the “Company,” “we”) is the most integrated gourmet coffee roaster and distributor in North America. By “integrated roaster and distributor” we mean that our business activities, carried out directly or through our subsidiaries, affiliates or franchisees cover just about the entire supply chain, starting with the purchase of green coffee, followed by roasting, retail marketing and distribution in the retail food network, to total coffee solutions that include the coffee, the brewer, condiments and other related products, designed for wherever the drink is consumed: the workplace, commercial spaces, institutions, hotels and restaurants. Our beginnings date back to 1919 when Albert-Louis Van Houtte launched an imported coffee and fine grocery store in Montreal. At the time of writing, Van Houtte and its subsidiaries employed 1,887 people, including 1,792 on a full time basis.

Additional information This MD&A was prepared on June 2, 2005. Additional information relating to the Company, including its Annual Information Form, is available on the SEDAR Web site at www.sedar.com. Unless otherwise indicated, the information contained herein is current as at June 2, 2005.

Main activities The Company groups its activities into two broad categories: Manufacturing and Marketing, and Coffee Services. Manufacturing and Marketing The Manufacturing and Marketing segment encompasses coffee roasting and distribution for home consumption through retail channels, the production and distribution of coffeemakers and related equipment as well as the franchising and operation of café bistros. Canadian and American consumers can also buy our products online at www.vanhoutte.com. Coffee roasting and distribution Van Houtte is Canada’s leading gourmet coffee roaster. We purchase our green coffee—almost exclusively Arabica—from the main producing countries located in the equatorial areas of Latin America, Africa and Asia. Because we buy gourmet coffee beans, we pay a premium over the prices published on the various coffee exchanges. And although we deal primarily with Canadian brokers, we pay for our purchases in U.S. dollars.

are state-of-the-art facilities with equipment that carefully controls the roasting process according to the specific profile required for each recipe. To ensure superior roasting worthy of the best roasting and blending traditional methods, we roast the coffee in small batches of 450 lbs. (204 kg). And thanks to our cutting-edge technology, this hand-made quality is carefully reproduced in each batch. Van Houtte uses a “cold grinding” process for its ground coffees in order to preserve bean aroma and ensure a uniform grind. Van Houtte coffees are available in some 4,300 retail points of sale across Canada and on the East Coast of the United States, compared with 4,015 a year ago. This increase is essentially the result of an agreement signed with some Canadian retail food chains that added 250 points of sale in Ontario and Western Canada. Although sold mainly under the Van Houtte brand, our coffees are also marketed under the Orient Express and other brand names. We offer more than 100 blends, roasting profiles and different packaging to suit the discriminating tastes of fine coffee lovers and connoisseurs everywhere. The Company is constantly developing new blends, profiles and packaging in response to a changing market. For example, in 2005, we launched JAVANATIONTM, a line of single origin coffees and espresso blends designed to meet the expectations of discriminating and demanding consumers. Finally, we also roast and package coffee under private labels for supermarket chains who distribute our Van Houtte branded products. TA B L E 1

Breakdown of Retail Points of Sale Offering Van Houtte Products Number of points of sale

Canada United States

3,575 725

Total

4,300

We usually negotiate directly with the supermarket chains and design, set up and stock the gourmet coffee department in a majority of their stores. Coffeemaker manufacturing Through our subsidiary VKI Technologies Inc. (“VKI”), we design, manufacture and market hopper-based, single-cup coffeemakers that brew coffee one cup at a time. At its plant in the Montreal suburb of Longueuil, VKI produces several models of single-cup coffeemakers adapted to various purposes and intensity of use. These machines can be equipped with an electronic control system, a liquid crystal display, a coffee/hot chocolate option and a paperless brewer. In addition to the hopper-based coffeemaker, VKI has designed and produces the Espresso CaféTM, which uses pre-packaged pods of coffee to prepare a consistently high-quality espresso, cappuccino, latte or americano in just 45 seconds. VKI is also a licensed manufacturer of a coffee machine that uses a pre-packaged cup-based technology, developed by Keurig, Inc., a Massachusetts-based company in which Van Houtte holds 23.5% of the diluted common shares. Marketed under the name K-Cup®, the small cups contain a hermetically sealed individual portion of coffee and an individual filter. Other VKI products include a single-cup tea brewer, produced for an American client, and ScalehammerTM, a hard water treatment system for residential and institutional use. Two Canadian hardware chains recently began selling this product. Although our Coffee Services network (see next section) is VKI’s primary market, the company also sells to other coffee service providers and vending machine manufacturers in North America, Japan and Europe.

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Kentucky. Accounting for more than 90% of our production capacity, the main plant in Montreal and the Henderson plant

M a n a g e m e n t ’s D i s c u s s i o n a n d A n a l y s i s

We operate four roasting plants: two in Montreal, Quebec, one in Vancouver, British Columbia, and one in Henderson,

Cafés bistros We operate a network of 74 franchised café bistros in Quebec and in the Ottawa region. For several years, we owned a number of these establishments. Thus a year ago, we owned seven out of 67 Van Houtte café bistros. During the 2005 fiscal year we sold all of them to franchisees. Now all café bistros are franchised. Although they represent a very small portion of our consolidated revenues, the bistros are nevertheless an integral part of our development strategy since they help maintain our brand image with consumers. Measuring from 70 to 200 square metres, the café bistros offer their clientele an extensive range of regular and specialty coffees as well as light meals and snacks. Coffee Services Our other major sphere of activity, Coffee Services focuses on the sale of coffee for consumption at work and other public places. In Canada this segment includes vending machine operations. Coffee Services offer “Total Coffee Solutions” that guarantee a fresh cup of coffee at the office and increasingly in other public locations. To this end we designed coffee bars. Coffee bars provide a bistro ambiance in a smaller space. They carry a more limited range of products and are integrated into high-traffic areas such as supermarkets, hospitals and university campuses. They are found across all Canadian regions. With this service, a company or operator typically leases the type and quantity of coffeemakers it requires and we supply the coffee and condiments. We also provide a variety of drinks and snacks. Van Houtte has a broad range of brewers priced for every budget and coffees designed to suit every taste. Our flexibility and size therefore allows us to meet the needs of all companies, large or small. As the largest Coffee Services network in North America, we have 79 branches and franchised establishments in 77 cities across most of Canada and the U.S. We wholly own our Canadian branches except for three that are joint ventures. In the U.S., our Coffee Services operations are carried out through our subsidiary Filterfresh Coffee Service, Inc. (“Filterfresh”). Headquartered in the Boston, Massachusetts region, Filterfresh has wholly-owned and franchised branches, as well as branches that are jointly owned with local partners. TA B L E 2

Breakdown of Coffee Services Branches in Canada and the U.S. by Method of Ownership and Operation Wholly- or Jointly-Owned Branches

Franchised Branches

Total

Canada United States

35 30

– 14

35 44

Total

65

14

79

We built this network primarily through acquisitions, driving most of the consolidation in the Canadian coffee services market. However, in the U.S. the market remains highly fragmented with many founder-led businesses in search of a successor and therefore presenting strong consolidation potential. Our strategy involves acquiring businesses or forming joint ventures with local entrepreneurs in regions where we already have a footprint. We integrate these acquisitions into our network or, as the case may be, integrate our own establishment into a joint venture. In both cases, we are densifying our network, enabling us to offer better service at a lower cost. In fiscal 2005, we completed 22 acquisitions and formed two new joint ventures. Between the end of the fiscal year and the time of writing, we had completed four more acquisitions.

installing Caffè MioTM coffeemakers in more than 1,000 Lowe’s stores, America’s second largest home improvement chain. Our Coffee Services branches operate vending machines that sell snacks, candies and hot and cold drinks in eight Canadian cities. We have spent the past two years streamlining this aspect of our business, selling the vending business units in nine cities where the current or projected profitability no longer justified the investment. The disposal of these nine business units represented a total of $8.6 million in annual sales.

Fiscal Year Van Houtte’s fiscal year ends on the Saturday closest to March 31 of each year. Rather than 365 days, it therefore comprises full weeks, usually 52 but sometimes 53. Thus, fiscal 2004 had 53 weeks, one week more than 2003 and 2005. Disregarding the seasonal nature of sales, this additional week alone added 1.9% to sales and EBITDA in 2004. A comparative analysis for 2005 and 2004 must therefore take this factor into account. The last fiscal year to have 53 weeks before 2004 was 1999. The additional week in fiscal 2004 was added to the fourth quarter, which therefore had 13 rather than 12 weeks. This additional week had a significant impact on the sales, coffee shipments and EBITDA in last year’s fourth quarter. To eliminate the impact of this additional week, we present the change in average weekly sales, coffee shipments and EBITDA. In this analysis, unless otherwise indicated, “2005” means the 52-week fiscal year ended April 2, 2005, “2004” means the 53-week fiscal year ended April 3, 2004, and “2003” means the 52-week fiscal year ended March 29, 2003.

Effect of currency fluctuations The high volatility of the U.S. dollar over the past two years has had a significant impact on sales and operating results. The U.S. dollar lost an average of 13% against the Canadian dollar between fiscal 2003 and 2004, and about 6% between 2004 and 2005, adversely affecting U.S. sales and operating income when converted into Canadian dollars. This MD&A indicates these impacts where possible. However, while difficult to accurately measure, the effect of currency fluctuations on the Company’s consolidated net earnings is minimal since some of the Canadian operating costs, specifically, the purchase of green coffee and a portion of the depreciation and financial expenses are incurred in U.S. dollars and are also sensitive to currency fluctuations.

Non-GAAP financial measures The Company defines EBITDA as earnings before amortization, financial expenses and income taxes. Equity in net earnings of companies subject to significant influence and non-controlling interest are not considered in the computation of EBITDA. The Company defines operating cash flows as cash flow from operating activities before changes in non-cash working capital related to operations. EBITDA and operating cash flows as defined above are not measures of results that are consistent with generally accepted accounting principles in Canada, nor are they intended to be regarded as an alternative to other financial operating performance measures or to the statement of cash flows as a measure of liquidity. They are not intended to represent funds available for debt service, dividend payments, reinvestment or other discretionary uses, and should not be considered separately or as a substitute for measures of performance prepared in accordance with generally accepted accounting principles in Canada. EBITDA and operating cash flows are used by the Company because management believes they are meaningful measures of performance. EBITDA and operating cash flows are commonly used by the investment community to analyze and compare the performance of companies in the industries in which the Company is active. The Company’s definition of EBITDA and operating cash flows may not be identical to similarly titled measures reported by other companies.

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and the U.S. For example, in 2005 we signed the largest agreement in our history in terms of the number of establishments,

M a n a g e m e n t ’s D i s c u s s i o n a n d A n a l y s i s

Thanks to our network – the only one of its kind in North America – we can serve clients with continental operations in Canada

Three-year highlights Van Houtte recorded net earnings of $21.7 million or $1.01 per share (basic and diluted) in fiscal 2005, a 52-week year ended April 2. This performance is a 16.9% increase over the $18.6 million and $0.87 ($0.86 diluted) recorded in the 53-week year ended April 3, 2004. Revenues in fiscal 2005 were $348.8 million or 5.5% more than last year. On an average weekly basis, sales growth was 7.5%. This improvement in earnings stems from the following main factors: ■

Sales growth, to which our two main segments contributed and which is partly organic and partly attributable to the net impact of acquired and divested business units in 2004 and 2005;



Improved operating efficiency: the operating ratio (EBITDA/sales), which was 18.0% in 2004, advanced to 18.8% in 2005;



A slight decrease in financial expenses, attributable to another reduction in our debt load;



Fiscal 2004 contained a non-recurring charge of $0.04 per share recorded in the first quarter related to the departure of the Company’s CEO.

TA B L E 3

Financial highlights fiscal 2003, 2004, 2005 (In thousands of dollars, except per share amounts and coffee shipments)

April 2, 2005

Revenues Earnings from continuing operations Earnings per share from continuing operations ($) Basic Diluted Net earnings Earnings per share ($) Basic Diluted Total assets Long-term liabilities Dividend per share ($) Coffee shipments (millions of lbs.) * The fiscal year ended April 3, 2004 had 53 weeks.

Fiscal years ended: April 3, 2004*

March 29, 2003

348,755 21,706

330,548 18,564

316,768 15,988

1.01 1.01

0.87 0.86

0.74 0.74

21,706

18,564

14,728

1.01 1.01

0.87 0.86

0.68 0.68

370,683 69,688 0.24 25.3

369,977 95,063 0.22 24.9

363,097 90,898 0.20 23.1



Steady growth in Canadian earnings.



Fiscal 2003 gave rise to non-recurring charges of $5.2 million or $3.6 million after taxes or $0.17 per share, related primarily to the integration of information and management systems. In 2003, Van Houtte also recorded an after-tax charge of $1.3 million or $0.06 per share as a loss from discontinued operations following the disposal of a European coffee services company.

Over the past three years, we have been managing our balance sheet more closely, limiting the growth of our total assets, and thanks to a strong operating cash flow, substantially reducing our debt load and increasing our dividend rate.

Review of operations – 2005 Van Houtte’s financial statements have been prepared in accordance with Canadian generally accepted accounting principles (“GAAP”) and in Canadian dollars. Unless expressly stated, the additional financial data appearing in this MD&A are also in Canadian dollars. Van Houtte has filed its 2005 audited consolidated financial statements with Canadian securities regulators, and these statements may be accessed through www.sedar.com or on the Van Houtte Web site at www.vanhoutte.com. This MD&A should be read in conjunction with these financial statements and related notes. In addition, once filed, Van Houtte’s Annual Information Form for the fiscal year ended April 2, 2005 will be available through www.sedar.com. Sales up 5.5% For the fiscal year ended April 2, 2005, Van Houtte recorded consolidated sales of $348.8 million, compared with $330.5 million last year, an increase of 5.5% (7.5% on an average weekly basis). This gain stems both from organic growth and the positive impact of coffee services acquisitions. It also reflects the negative impact of currency fluctuations and the disposal of certain vending business units in 2004 and 2005. Moreover, the price of green coffee increased substantially during the fiscal year and part of this increase was passed on downstream. Without the impact of these price increases, 2005 sales growth for the year would have been 3.3% (5.2% on a weekly basis). TA B L E 4

Sources of Revenue Change, Fiscal 2005 (In thousands of dollars)

Revenues, fiscal 2004 Organic growth Impact of acquisitions completed in 2004 and 2005 Impact of divestitures Impact of selling price increases Impact of currency fluctuations

330,548 12,087 12,587 (7,391) 7,500 (6,576)

Revenues, fiscal 2005

348,755

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had 53 weeks, this increase stemmed mainly from the following factors:

M a n a g e m e n t ’s D i s c u s s i o n a n d A n a l y s i s

Revenues increased 3.7% (1.7% on a weekly basis) in 2004 while net earnings advanced 26.0%. Besides the fact that 2004

Consolidated earnings before interest, taxes, depreciation and amortization (EBITDA) for the year were $65.7 million, versus $59.6 million a year ago, an increase of 10.3%. The operating ratio (EBITDA/sales) was 18.8%, against 18.0% last year. Most of this improvement is attributable to Coffee Services. TA B L E 5

Sources of EBITDA Change, Fiscal 2005 (In thousands of dollars)

EBITDA, fiscal 2004 Impact of revenue growth Impact of improved operating ratio

59,562 3,277 2,834

EBITDA, fiscal 2005

65,673

At $31.0 million, amortization and depreciation remained unchanged from last year. Financial expenses amounted to $3.9 million or $1.0 million less than the $4.9 million recorded in 2004. This decrease, the second in as many years, stems from a reduction in the Company’s debt load, made possible by disciplined balance sheet management and substantial cash flows. Taxes were $7.0 million, for an effective tax rate of 22.8%, compared with $4.7 million and 19.7%. The increase in the effective tax rate is the result of our tax planning. Although optimal, some of our deductions are fixed and their relative impact decreases as taxable income increases.

Segmented analysis TA B L E 6

Segmented information (In thousands of dollars, except for percentage change)

Fiscal year ended April 2, 2005

Fiscal year ended April 3, 2004*

Change (%)

Sales Manufacturing and Marketing Coffee Services Inter-segment

155,948 243,828 (51,021)

142,257 230,273 (41,982)

9.6 5.9 21.5

Total sales

348,755

330,548

5.5

EBITDA Manufacturing and Marketing Coffee Services General expenses

32,213 38,949 (5,489)

31,442 33,890 (5,770)

2.5 14.9 (4.9)

Total EBITDA

65,673

59,562

10.3

* 53-week year.

over the $142.3 million recorded in 2004 on the strength of the entire segment. Currency fluctuations have a minimal impact on sales in this segment. Coffee shipments were 25.3 million pounds, a 1.5% increase over 2004, which had one more week. Growth was 3.4% on an average weekly basis. TA B L E 7

Coffee Shipments by Distribution Channel and Brand, Fiscal 2004 and 2005 (In thousands of pounds)

Retail networks Van Houtte brand Other brands Sub-total Coffee Services Van Houtte brand Other brands Sub-total Total

Fiscal 2004*

(%)

7,345 9,119

29.0 36.1

7,254 9,426

29.1 37.8

91 (307)

1.3 (3.3)

3.2 (1.4)

16,464

65.1

16,679

66.9

(215)

(1.3)

0.6

6,071 2,768

24.0 10.9

5,771 2,487

23.1 10.0

300 281

5.2 11.3

7.2 13.4

(%)

Change (000 lbs)

Change (%)

Adjusted Change ** (%)

Fiscal 2005

8,838

34.9

8,257

33.1

581

7.0

9.1

25,303

100.0

24,937

100.0

366

1.5

3.4

* 53-week year. ** The adjusted growth rates are determined based on the average weekly shipments each year.

Shipments to the growing Coffee Services segment advanced 7.0% in 2005 to 581,000 pounds. On a weekly basis, growth was 9.1%. Retail shipments slipped from 16.7 to 16.5 million pounds in 2005. However, weekly shipments advanced 0.6%. Retail sales of the Van Houtte brand gained 3.2% on a weekly basis. Most of the decrease is attributable to our own brands other than Van Houtte, in particular Gold Cup and Orient Express labels, and to a lesser extent to the private labels produced for the supermarket chains that distribute our products. The sales growth in the Manufacturing and Marketing segment is explained by the following factors: ■

An increase in the weighted average selling price of coffee due to: ➤

Price adjustments following increases in the price of green coffee, which has climbed back to its year 2000 level;



A change in the product mix, namely, the relative increase in the Van Houtte brand as a proportion of sales to the detriment of our other brands and private labels;

Excluding the increase in the price of green coffee, sales in this segment would have advanced 4.3% (6.4% on a weekly basis). ■

An increase of more than 26% in VKI sales due to the execution of two major Coffee Services contracts for some 500 Suprema® coffeemakers for the Couche-Tard stores in Quebec and 1,000 Caffè MioTM brewers for the Lowe’s stores in the U.S. VKI’s other activities also contributed to this growth, i.e., sales of VKI single-cup brewers and the Keurig-licensed coffeemaker to outside accounts.

20 21

BEAN COUNTING

Sales in the Manufacturing and Marketing segment reached $155.9 million in 2005, up 9.6% (11.7% on a weekly basis)

M a n a g e m e n t ’s D i s c u s s i o n a n d A n a l y s i s

Manufacturing and Marketing

Manufacturing and Marketing EBITDA was $32.2 million, up 2.5% (4.4% on a weekly basis) over the $31.4 million recorded last year. The operating ratio was 20.7% in 2005, compared with 22.1% in 2004. For the year overall, the gross margin rate on coffee remained unchanged as the increases in the price of green coffee were passed downstream in the distribution chain. Three factors explain the decrease in operating ratio: ■

The Manufacturing and Marketing segment stepped up its promotion and marketing efforts to further increase the awareness and equity of the Van Houtte brand outside Quebec, particularly in the Greater Toronto area. Following this investment, retail coffee shipments outside Quebec improved significantly but on a smaller growth base than in Quebec. Our products still have tremendous unexploited retail potential outside Quebec, especially in Ontario, the largest market in Canada.



The corporate café bistros generated operating losses before they were sold. As well, we recorded as an operating expense a write-off of $272,425 in goodwill on the books of a number of corporate bistros.



The increase in the price of fuel affected shipping costs.

Coffee Services Coffee Services sales advanced 5.9% (7.9% on a weekly basis) in 2005 to $243.8 million, up from the $230.3 million recorded in 2004. This growth must be analyzed in light of the combined effect of the exchange rate on U.S. sales and the planned reduction in vending machine sales stemming from the disposal of certain business units in 2004 and 2005. On a constant exchange rate basis and excluding vending sales, sales advanced 13.6% (15.8% on a weekly basis). In Canada, Coffee Services sales increased 6.7% (8.8% on a weekly basis). This growth was almost entirely organic, reflecting improved account retention and recruitment, as well as selling deeper to existing accounts. In the U.S., sales climbed 16.5% after conversion to Canadian dollars and 23.7% (26.1% on a weekly basis) when expressed in U.S. dollars. Part of this growth is attributable to acquisitions made in 2004 and 2005. EBITDA was up 14.9% over last year (17.1% on a weekly basis) to $39.0 million. This strong performance was achieved despite the erosion of the U.S. dollar and losses incurred on the disposal of certain vending business units. On a constant exchange rate basis and excluding vending machine operations, EBITDA rose 19.6%. The operating ratio was 16.0% compared with 14.7% last year. Two factors explain this improvement: first, changes made to processes generated substantial operating savings, particularly in terms of selling expenses, and second, our network densification strategy produced the expected operating leverage – when our sales increase, costs increase less than proportionately. These improvements more than offset the slight decrease in gross margin following stronger sales of coffee in K-Cups® for Keurig coffeemakers where the gross margin is lower than on other coffees offered by Coffee Services. However, since the Keurig machines require less capital than the other single-cup brewers, the return on investment is comparable. TA B L E 8

Installed Base of Single-Cup Brewers in Van Houtte’s Coffee Services Network

Canada United States Total

April 3, 2004

July 24, 2004

October 16, 2004

January 8, 2005

April 2, 2005

22,730 17,681

23,173 18,997

23,274 19,275

23,545 19,410

24,057 20,082

40,411

42,170

42,549

42,955

44,139

Canada, driven in large part by the agreement signed with Lowe’s in the U.S. On April 2, the Coffee Services segment had 70,919 active accounts, an increase of 8.3% over the 65,499 accounts active on April 3, 2004. The number of active accounts is greater than the number of single-cup coffeemakers as many clients still prefer the traditional pour-over brewing systems. Intersegment sales and general corporate expenses Intersegment climbed 21.5%, outpacing consolidated sales due to three main factors: 1) strong sales by VKI to Coffee Services; 2) coffee sales resulting from the growth of our Coffee Services network; and 3) the growing importance of our own coffees in this segment’s sales. General corporate expenses declined slightly. Last year, these expenses comprised non recurring charges related to the departure of the Company’s CEO. However, certain general corporate expenses increased permanently in 2005, namely, the cost of complying with new governance and continuous disclosure rules, even if certain transitional costs in this regard will not recur, and the recording of executive stock-based compensation plans. This figure was $413,000 in 2005. In the past, this type of compensation was presented in a note to the financial statements but not included in the income statement.

Capital resources, financial position and outlook Liquidity Van Houtte’s strong operating cash flows continue to grow, ending the year at $57.0 million, compared with $46.7 million in 2004. The main elements behind this gain were the increase in net earnings and a decline in future income taxes. Cash flow per share stood at $2.65 ($2.64 diluted) compared with $2.18 ($2.17 diluted) a year ago. Changes in non-cash working capital generated $3.7 million in 2005 whereas they used $1.1 million in 2004. Van Houtte spent $28.0 million on fixed asset acquisitions during the year, against $23.1 million in 2004. These investments were made chiefly in coffeemakers, the roasting plants and in information technology. They were financed out of operating cash flows. The Company spent $9.3 million on acquisitions in 2005, compared with $13.9 million a year earlier. Most of these transactions took place in the U.S. As a result of disciplined balance sheet management and strong cash flows, Van Houtte was able to increase its dividend payout to $5.2 million in 2005 versus $4.7 million a year ago and trim its long-term debt by $15.8 million. Financial position and cash requirements Working capital (not including the short-term portion of long-term debt) stood at $38.1 million on April 2, 2005, against $43.1 million a year earlier. This decrease, the second in as many years, is in line with the Company’s strict capital management policy, developed in 2003. The increase in payables and accrued liabilities more than offset the increase in receivables and inventory.

22 23

BEAN COUNTING

at April 2, 2005. Acquisitions contributed to the good performance in the U.S. Organic growth was strong both in the U.S. and

M a n a g e m e n t ’s D i s c u s s i o n a n d A n a l y s i s

The number of single-cup coffeemakers installed in our Coffee Services network rose 9.2% during the year to 44,139 units

Long-term assets consist of investments, fixed assets, goodwill, other assets and long-term future income taxes. Fixed assets declined slightly for the second year in a row. Depreciation of Coffee Services equipment and vending machines was greater than the net additions to fixed assets due notably to the divestiture of some vending business units in Canada. Goodwill rose by $0.8 million. Although acquisitions added $5.9 million to goodwill, the decline in the U.S. dollar resulted in a devaluation of $4.8 million. The Company’s debt load (including the short-term portion of long-term debt) shrank for the third consecutive year, from $107.5 million to $88.4 million following the decrease of $15.8 million in long-term debt and the impact of exchange rate fluctuations on long-term debt. The debt/capital ratio stood at 26.8% at April 2, 2005, against 31.9% a year earlier. Non-controlling interest was $6.5 million at April 2, 2005, compared with $5.6 million at the end of fiscal 2004. The Company will continue with its disciplined investment policy. Set at approximately $28 million, the capital budget for fiscal 2006 is similar to that of fiscal 2005. TA B L E 9

Contractual Obligations by Term at April 2, 2005

Contractual Obligations

Long-term debt Net capital leases Purchasing contracts – green coffee Total

Total

Payments Due by Term (Thousands of dollars) Less than 1 year 1-2 years 3-4 years 5 and more

88,356 21,229 10,094

28,024 5,855 10,094

59,753 8,041 –

579 2,546 –

– 4,787 –

119,679

43,973

67,794

3,125

4,787

Van Houtte’s operations generate substantial cash flows. Depreciation for fiscal 2006 is projected at $32 million. As at April 2, 2005, Van Houtte had unused credit facilities of $65 million. In management’s opinion, the Company has the necessary financial resources to pursue its operations and implement its business plan. Moreover, it has the financial flexibility to seize interesting acquisition opportunities that are consistent with its business plan.

Quarterly information As is typical in our industry, particularly in the Coffee Services segment, business slows in the summer, which overlaps Van Houtte’s first and second quarters. However, this fluctuation is tempered by the fact that the first quarter has 16 weeks whereas each of the other three has 12. Consequently, we record the strongest sales of the year in the first quarter but not necessarily the highest earnings.

(In thousands of dollars, except per share amounts)

16 weeks ended: July 19, 2003

October 11, 2003

Sales 94,054 EBITDA 14,143 Net earnings 3,302 Earnings per share ($) 0.16

72,521 13,063 4,025 0.19

12 weeks ended: January 3, 2004

77,671 14,787 4,773 0.22

April 3, 2004*

16 weeks ended: July 24, 2004

October 16, 2004

86,302 17,569 6,464 0.30

102,574 18,508 5,345 0.25

77,695 15,107 4,673 0.22

12 weeks ended: January 8, 2005

82,542 16,313 5,487 0.25

April 2, 2005 *

85,943 15,745 6,201 0.29

* The quarter and fiscal year ended April 3, 2004 had 13 and 53 weeks respectively. The quarter and fiscal year ended April 2, 2005 had 12 and 52 weeks respectively.

Fiscal 2004 began on a relatively positive economic note in Canada but less so in the U.S. where the job market remained sluggish, particularly in the regions and sectors where our Coffee Services are concentrated. It was at this time that we began streamlining our vending machine operations, selectively disposing of business units whose performance fell below expectations. This streamlining continued into 2005. As well, in 2004 the U.S. dollar tumbled on the currency markets, which had a significant impact on the conversion of our U.S. sales into Canadian dollars. Moreover, the departure of the Company’s chief executive officer gave rise to non-recurring charges of approximately $0.04 per share. These factors help explain the downturn in sales and earnings in the first quarter. However, despite the impact of many exogenous factors, we promptly took measures to revitalize sales and reorganize our operations with the result that sales rebounded in the second quarter. Fiscal 2004 ended with a very strong fourth quarter, notably because it had 13 rather than the usual 12 weeks but also because of the measures implemented since the beginning of the year. These measures had a ripple effect into 2005 as both Coffee Services and the Company in general confirmed their return to growth. Still, sales growth continued to be hampered by the erosion of the U.S. dollar and the divestiture of the vending business units undertaken as part of a streamlining effort for this network. However, the operating ratio improved from quarter to quarter, reflecting greater operating efficiency and the positive impact of the growth on our operating leverage.

Fourth Quarter 2005 The last quarter of the year ended with net earnings of $6.2 million or $0.29 per share (basic and diluted), compared with $6.5 million and $0.30 per share (basic and diluted) for the same period in 2004. The fourth quarter of 2005 had 12 weeks, one week less than the comparable year-earlier quarter. The disposal of a number of vending business units had a downward impact on sales. The slight decrease in sales from $86.3 million in the fourth quarter of 2004 to $85.9 million in 2005 is largely explained by this thirteenth week and to a lesser extent by the effect of the lower U.S. dollar and the divestiture of some vending business units. On a constant exchange rate basis and excluding vending operations, sales for the quarter advanced 4.3% or 13.0% on a weekly basis. EBITDA fell by 10.4% to $15.7 million. On a constant exchange rate basis and excluding vending operations, EBITDA decreased 8.2% or 0.5% on a weekly basis.

24 25

BEAN COUNTING

Unaudited quarterly results

M a n a g e m e n t ’s D i s c u s s i o n a n d A n a l y s i s

TA B L E 1 0

TA B L E 1 1

Quarterly segmented results (In thousands of dollars, except for percentage change)

Quarter ended April 2, 2005*

Quarter ended April 3, 2004*

39,411 60,471 (13,939)

35,390 62,052 (11,140)

11.4 (2.5) 25.1

Total sales

85,943

86,302

(0.4)

EBITDA Manufacturing and Marketing Coffee Services General expenses

6,913 10,146 (1,316)

8,207 10,285 (923)

(15.8) (1.4) 42.5

Total EBITDA

15,743

17,569

(10.4)

Sales Manufacturing and Marketing Coffee Services Inter-segment

Change * (%)

* The quarter ended April 2, 2005 had 12 weeks; the quarter ended April 3, 2004 had 13 weeks.

Manufacturing and Marketing Sales reached $39.4 million during the quarter, up 11.4% or 20.6% on an average weekly basis, mainly on the strength of coffee and VKI sales. Currency fluctuations have a minimal impact on sales in this segment. Up 2.0% or 10.5% on a weekly basis over the fourth quarter in 2004, coffee shipments reached 6.1 million pounds. TA B L E 1 2

Coffee Shipments by Distribution Channel and Brand, Fourth Quarter, Fiscal 2004 and 2005 (In thousands of pounds)

Quarter ended April 2, 2005*

Quarter ended (%) April 3, 2004*

(%)

Change (000 lbs)

Change (%)

Adjusted Change ** (%)

Retail networks Van Houtte brand Other brands Sub-total

1,757 2,033 3,790

28.9 33.4 62.3

1,801 2,014 3,815

30.2 33.8 64.0

(44) 19 (25)

(2.4) 0.9 (0.7)

5.7 9.4 7.6

Coffee Services Van Houtte brand Other brands Sub-total

1,548 744 2,292

25.5 12.2 37.7

1,529 616 2,146

25.7 10.3 36.0

19 128 146

1.2 20.8 6.8

9.7 30.8 15.7

Total

6,082

100.0

5,961

100.0

121

2.0

10.5

* The quarter ended April 2, 2005 has 12 weeks; the quarter ended April 3, 2004 has 13 weeks. ** The adjusted growth rate is calculated based on the average weekly shipments in each quarter.

volume and price. Some of the increase in volume is due to inventory building by some accounts in anticipation of the announced price hikes. ■

EBITDA for the Manufacturing and Marketing segment was $6.9 million, compared with $8.2 million in the year-ago quarter. The operating ratio stood at 17.5%, against 23.2% last year. The gross margin rate on intersegment and external coffee sales decreased during the quarter due to the magnitude and suddenness of the greater-than-expected increases in the price of green coffee. The impact of this change will be gradually eliminated over the first and second quarters of fiscal 2006. The operating ratio was also adversely affected by the increase in promotional and marketing expenses outside Quebec. Higher oil prices had an effect on shipping costs.

Coffee Services Coffee Services sales were $60.5 million in the last quarter, down 2.5% over the $62.1 million recorded a year earlier. On an average weekly basis, sales advanced 5.6%. On a constant currency basis and excluding vending machine sales, sales grew 3.7% or 12.3% on an average weekly basis. In Canada, sales slipped 1.6% but advanced 6.6% on an average weekly basis on the strength of organic growth. In the U.S., sales improved 3.1% (11.7% on an average weekly basis) after conversion to Canadian dollars or 14.5% (24.1% on a weekly basis) in U.S. dollars. This performance was due in part to acquisitions made in 2004 and 2005. EBITDA for the Coffee Services segment stood at $10.1 million, down 1.4% over the year-ago period. On a constant exchange rate basis and excluding vending operations, EBITDA rose 2.7%. The operating ratio was 16.8% for the quarter, compared with 16.6% a year ago.

Outlook For the past two years, Van Houtte has been executing a three-pronged strategy: 1) accelerate sales growth in the retail and Coffee Services networks in order to improve profitability; 2) exercise disciplined cost management; and 3) optimize capital management. This strategy, however, poses different challenges depending on the region. ■

In Eastern Canada, where the Van Houtte brands are well established, we have successfully improved our operating efficiency in order to enhance both the service quality in the Coffee Services segment and our profitability. We must continue to be proactive and vigilant to maintain our market share and leadership in the retail sector, particularly in Quebec.



In the West, we have established ourselves as the market leader in coffee services. Our challenge in this region is to use this segment as a springboard to accelerate the penetration of the Van Houtte brand across all the distribution channels, especially retail. We have made great strides in terms of brand awareness, and retail sales have grown significantly in the last two years.



In absolute terms, Ontario offers the best potential for growth, both in retail and coffee services. The fact that per capita sales in Ontario are lower than in the other regions of Canada bespeaks untapped growth potential. However, because it is also the most competitive market in Canada, we will continue to invest heavily to boost penetration both in the retail and Coffee Services networks.



The job market has strengthened in the U.S. where we will continue implementing our organic and acquisition growth strategy in our current territories with a view to increasing the network’s density.

26 27

BEAN COUNTING

Sales growth in the Manufacturing and Marketing segment reflect higher VKI and coffee sales, which increased in both

M a n a g e m e n t ’s D i s c u s s i o n a n d A n a l y s i s



We do not expect uniform quarterly growth in 2006. More specifically, the adjustments to our sourcing and pricing strategy that we made in the last quarter of 2005 in response to the recent increases in green coffee prices will only be fully effective from the second half of the first quarter of 2006. Consequently, this quarter will not perform up to potential. Nevertheless, Van Houtte expects net earnings for fiscal 2006 to increase between 10% and 15%, which will be fuelled equally by organic growth and acquisitions.

Dividend policy The dividend policy established by the Board of Directors calls for deciding at mid-year whether dividends should be paid, and if so, the payout amount based on the Company’s financial position and investment plans. Thus, a dividend of $0.24 per share was paid in fiscal 2005 for a total payout of $5.2 million, corresponding to approximately 10% of the previous year’s cash flow.

Risks and uncertainties Van Houtte’s main product is coffee, a commodity subject to considerable price fluctuations. An increase in the price of coffee can adversely affect sales, profit margins or both. Van Houtte specializes in gourmet coffee, and past experience has shown that price sensitivity is less pronounced in the gourmet coffee segment since consumers are already prepared to pay more for a superior product. However, there is no assurance that this behaviour will continue. Coffee destined for the retail sector represents nearly 25% of Van Houtte’s total sales. Our access to this market depends on agreements signed with retailers, mostly supermarket chains. In most of their stores, we design, set up and stock the gourmet coffee department. However, some of these agreements allow the retailers to vary the number of Van Houtte products they carry, or even to decide whether or not they offer our products at all. As well, some chains have Van Houtte roast and package their coffee under private label. There is no assurance that these agreements and the related coffee volumes will be renewed. Coffee Services account for more than 70% of sales and almost 60% of EBITDA. Because these services are offered mainly to workplaces, particularly offices, demand varies with the general economic and employment situation. A large portion of our Coffee Services costs are fixed in the near term, thereby creating significant operating leverage. When sales decrease, the corresponding decrease in EBITDA will be higher. Conversely, when sales increase, the corresponding decrease in EBITDA will be higher. Our subsidiary VKI and affiliate Keurig have both developed cutting-edge brewing technology, providing us with a strategic edge in the coffee services market. Should equally advanced technologies be developed and offered on the market, our strategic position and development capacity would be weakened. Finally, most of our loans are at variable interest rates determined according to the bankers’ acceptance rates or the prime rate. Since our loans are both in Canadian and U.S. dollars, the interest rates could fluctuate based on the monetary policies of the Bank of Canada and the U.S. Federal Reserve. A sudden major increase in interest rates would reduce our profitability.

Changes in accounting policies In fiscal 2005, Van Houtte began recording the cost of executive compensation in the form of stock options. Previously, this compensation was disclosed in a note to the financial statements but was not included in the computation of the Company’s results, and therefore had no impact on earnings calculation.

anticipated events. Goodwill Goodwill is the difference between the acquisition cost of an enterprise over the fair value of its tangible and intangible net assets at the time of acquisition. Goodwill is revised downward if the fair value of an operating unit is less than its book value. This fair value is estimated annually. In 2005, Van Houtte recorded a write-off of $272,425 related to some corporate café bistros. Others Management uses other estimates when preparing financial statements but these have no material impact on the Company’s earnings or value and consequently are not relevant.

Related party transactions There were no material related party transactions in 2005.

Disclosure controls and procedures We have evaluated the effectiveness of the disclosure controls and procedures as of the end of the period covered by the annual filings and concluded about its effectiveness.

Forward-looking information This analysis contains forward-looking statements reflecting Van Houtte’s objectives, estimates and expectations. Such statements may be marked by the use of verbs such as “believe,” “anticipate,” “estimate” and “expect” as well as the use of the future or conditional tense. By their very nature, such statements involve risks and uncertainty. Consequently, results could differ materially from the Company’s projections or expectations.

28 29

BEAN COUNTING

Some amounts in the financial statements or in this MD&A are estimates by management based on knowledge of current or

M a n a g e m e n t ’s D i s c u s s i o n a n d A n a l y s i s

Significant estimates

Management’s Responsibility for Financial Statements These financial statements have been prepared by management in conformity with Canadian generally accepted accounting principles and include amounts that are based on best estimates and judgments. Management of the Company and of its subsidiaries, in furtherance of the integrity and objectivity of the data in the financial statements, has developed and maintains systems of internal accounting controls and supports a program of internal audit. Management believes that these systems of internal accounting controls provide reasonable assurance that financial records are reliable and form a proper basis for the preparation of the financial statements and that assets are properly accounted for and safeguarded, and that the preparation and presentation of other financial information are consistent with the financial statements. The Board of Directors carries out its responsibility for the financial statements principally through its Audit Committee, consisting solely of outside directors. The Audit Committee reviews the Company’s annual consolidated financial statements, and management’s discussion and analysis and recommends them to the Board of Directors for approval. The Audit Committee meets with the Company’s management, internal and external auditors to discuss internal controls over the financial reporting process, auditing matters and financial reporting issues and formulates the appropriate recommendations to the Board of Directors. The auditors appointed by the shareholders have full access to the Audit Committee, with and without management being present. These financial statements have been examined by the auditors appointed by the shareholders, KPMG LLP, chartered accountants, and their report is presented hereafter.

Jean-Yves Monette President and Chief Executive Officer

Gérard Geoffrion Executive Vice-President and Chief Financial Officer

May 20, 2005

Auditors’ Report to the Shareholders We have audited the consolidated balance sheets of Van Houtte Inc. as at April 2, 2005 and April 3, 2004 and the consolidated statements of earnings, retained earnings and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at April 2, 2005 and April 3, 2004 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.

Chartered Accountants

Montreal, Canada May 20, 2005

Revenues Cost of goods sold and operating expenses

2005

2004

$348,755 283,082 65,673

$ 330,548 270,986 59,562

31,016 3,886 30,771

31,030 4,860 23,672

7,012

4,671

23,759

19,001

72

39

Depreciation and amortization Financial expenses (note 3) Operating profit before the undernoted Income taxes (note 4) Earnings before the undernoted Share in net earnings of companies subject to significant influence Share of non-controlling interest in subsidiary companies Net earnings

(2,125)

(476)

$ 21,706

$ 18,564

Basic: Net earnings

$

1.01

$

Diluted: Net earnings

$

1.01

$

E A R N I N G S P E R S H A R E (note 5) :

0.87 0.86

Weighted average number of shares outstanding (in thousands)

21,519

21,428

Diluted weighted average number of shares (in thousands)

21,598

21,532

2005

2004

$ 99,757

$ 86,184

See accompanying notes to consolidated financial statements.

Consolidated Statements of Retained Earnings Years ended April 2, 2005 and April 3, 2004 (In thousands of dollars)

Retained earnings, as stated, beginning of year Change in accounting policy – stock-based compensation (note 1 c)) Restated retained earnings, beginning of year

(1,630) 98,127

– 86,184

Net earnings

21,706

18,564

Dividends

(5,176)

(4,719)

(54)

(272)

Premium paid on redemption of subordinate voting shares (note 12) Retained earnings, end of year See accompanying notes to consolidated financial statements.

30 31

$114,603

$ 99,757

BEAN COUNTING

(In thousands of dollars, except for earnings per share data)

Consolidated Financial Statements

Consolidated Statements of Earnings Years ended April 2, 2005 and April 3, 2004

Consolidated Balance Sheets April 2, 2005 and April 3, 2004 (In thousands of dollars)

2005

2004

ASSETS

Current assets: Cash Accounts receivable Income taxes receivable Inventories (note 6) Prepaid expenses Future income taxes (note 4)

$

5,338 41,298 – 28,045 3,310 1,681 79,672

$

7,341 36,396 576 26,775 3,301 1,859 76,248

Investments (note 7)

18,939

18,128

Fixed assets (note 8)

115,805

116,963

Goodwill (note 9)

141,631

140,781

Other assets (note 10)

7,526

7,315

Future income taxes (note 4)

7,110

10,542

$ 370,683

$ 369,977

38,937 1,965 692 28,024 69,618

32,541 – 576 22,710 55,827

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities: Accounts payable and accrued liabilities Income taxes payable Deferred income Current portion of long-term debt (note 11) Long-term debt (note 11)

60,332

84,796

Employee future benefits

1,764

1,562

Future income taxes (note 4)

1,075

3,083

Non-controlling interest

6,517

5,622

Shareholders’ equity: Capital stock (note 12) Contributed surplus (notes 1 c) and 12)) Retained earnings Currency translation adjustment (note 13)

128,250 2,043 114,603 (13,519) 231,377

127,076 – 99,757 (7,746) 219,087

Commitments and guarantees (note 14) Contingencies (note 15) $ 370,683 See accompanying notes to consolidated financial statements.

On behalf of the Board:

Jean-Yves Monette Director

Robert Parizeau Director

$ 369,977

(In thousands of dollars)

2005

2004

$ 21,706

$ 18,564

C A S H F L O W S F R O M O P E R AT I N G A C T I V I T I E S

Net earnings from continuing operations: Adjustments for: Depreciation of fixed assets Amortization of other assets Amortization of financial expenses (note 3) Future income taxes Non-controlling interest Equity in net earnings of companies subject to significant influence Stock-based compensation (note 12) Loss on write-off of other assets Gain on disposal of fixed assets Loss (gain) on disposal of businesses Gain on foreign exchange

28,536 2,480 271 1,308 2,125 (72) 413 272 (254) 304 (103) 56,986

28,881 2,149 478 (3,194) 476 (39) – – (91) (393) (126) 46,705

3,698 60,684

(1,141) 45,564

(9,330) (27,986) 1,043 (944) (2,187) (39,404)

(13,884) (23,116) 1,503 (1,139) (2,801) (39,437)

1,214 (94) (15,804) (5,176) (1,817) (21,677)

285 (710) 51 (4,719) (830) (5,923)

Effect of exchange rate changes on cash denominated in foreign currency

(1,606)

(2,011)

Net decrease in cash

(2,003)

(1,807)

7,341

9,148

Net change in non-cash balances related to working capital items (note 16)

CASH FLOWS FROM INVESTING ACTIVITIES

Business acquisitions (note 17) Additions to fixed assets Proceeds from disposal of fixed assets Disposal of investments Increase in other assets

CASH FLOWS FROM FINANCING ACTIVITIES

Issue of subordinate voting shares (note 12) Redemption of subordinate voting shares for cancellation (note 12) (Decrease) increase in long-term debt Dividends Dividends paid to non-controlling shareholders of subsidiaries

Cash, beginning of year Cash, end of year See accompanying notes to consolidated financial statements.

32 33

$

5,338

$

7,341

BEAN COUNTING

Years ended April 2, 2005 and April 3, 2004

Consolidated Financial Statements

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements Years ended April 2, 2005 and April 3, 2004 (Tabular amounts are expressed in thousands of dollars)

Van Houtte Inc. is incorporated under the Canada Business Corporations Act. The Company is an important gourmet coffee roaster, marketer and distributor. It markets its gourmet coffees across Canada and the US through distribution channels that include coffee services, retail stores, cafés-bistros, on-line shopping and food service networks.

Note 1 Changes in accounting policies The Company has made certain changes in accounting policies to conform to the new accounting standards issued and applicable to the Company. a) Long-lived assets Effective April 4, 2004, the Company adopted the CICA Handbook Section 3063, “Impairment of Long-Lived Assets”. Long-lived assets, including fixed assets and intangible assets with finite useful lives, are amortized over their useful lives. The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of a group of assets may not be recoverable. If the sum of undiscounted net cash flows expected to result from the use and eventual disposition of a group of assets is less than its carrying amount, it is considered to be impaired. An impairment loss is measured as the amount by which the carrying amount of the group of assets exceeds its fair value. At April 2, 2005, no such impairment had occurred. b) Asset retirement obligations Effective April 4, 2004, the Company retroactively adopted CICA Handbook Section 3110 “Asset Retirement Obligations”. The standard provides guidance for the recognition, measurement and disclosure of liabilities for asset retirement obligations and the associated asset retirement costs. The standard applies to legal obligations associated with the retirement of a tangible long-lived asset that result from acquisition, construction, development or normal operations. The standard requires the Company to record the fair value of a liability for an asset retirement obligation in the year in which it is incurred and when a reasonable estimate of fair value can be made. The asset retirement cost is capitalized as part of the related asset and is amortized to earnings over time. The standard describes the fair value of a liability for an asset retirement obligation as the amount at which that liability could be settled in a current transaction between willing parties, that is, other than in forced or liquidation transaction and is adjusted for any changes resulting from passage of time and any changes to the timing or the amount of the original estimate or undiscounted cash flows. The Company is subsequently required to allocate the asset retirement cost to expense using a systematic and rational method over the assets’ useful life. The adoption of this standard had no impact on the Company’s financial position, results of operations or cash flows. c) Stock-based compensation and other stock-based payments In 2003, The Canadian Institute of Chartered Accountants (“CICA”) amended its pronouncement relating to stock-based compensation requiring companies to measure and expense all equity instruments awarded to employees and directors starting in the fiscal year beginning on or after January 1, 2004 in accordance with the fair value method. The fair value of stock options to employees and directors is determined at the date of grant using the Black-Scholes option pricing model, and the

treatment to this change in accounting policy for those companies who adopt this new pronouncement for fiscal years commencing before January 1, 2004, and a retroactive treatment for those companies adopting this new pronouncement after January 1, 2004. Effective April 4, 2004, the Company applied the retroactive treatment without restatement, for options granted since March 31, 2002. The adoption by the Company of this standard did not have any effect on its results, financial position or cash flows, except for the following reclassifications included in shareholders’ equity, an increase in contributed surplus of $1,630,000 and a decrease in retained earnings of $1,630,000. For the year ended April 2, 2005, the compensation expense of $413,000 was recorded in the statement of earnings and credited to contributed surplus. Prior to April 4, 2004, no compensation expense was recognized when stock options were granted to employees and directors. However, the Company provided pro forma information as if the fair value method had been applied. d) Hedging relationships Effective April 4, 2004, the Company applied Accounting Guideline (“AcG”) AcG-13, “Hedging Relationships”, that presents its view on the identification, designation, documentation and effectiveness of hedging relationships, for the purpose of applying hedge accounting, as well as on the discontinuance of hedge accounting. The adoption of this new standard had no material impact on the Company’s consolidated financial statements.

Note 2 Significant accounting policies The consolidated financial statements are prepared in accordance with Canadian generally accepted accounting principles. a) Consolidation and long-term investments The consolidated financial statements include the accounts of Van Houtte Inc. and all its subsidiaries (the “Company”). The major subsidiaries are Red Carpet Food Systems Inc., Selena Coffee Inc., Filterfresh Coffee Service, Inc., including its principal subsidiaries (Corporate Coffee Services, LLC and Potomac Coffee, LLC), VKI Technologies Inc. and Les Cafés Orient Express Ltée. Investments in joint ventures are accounted for using the proportionate consolidation method. Joint ventures represent a negligible portion of the Company’s operations. Investments in companies subject to significant influence are accounted for by the equity method. Portfolio investments are recorded at cost and would be written down in the case of a permanent impairment. Investments in companies in which the Company believes it does not exercise a significant influence are classified as portfolio investments. b) Inventories Raw materials are stated at the lower of cost, based on the first-in, first-out method, and replacement value. Finished goods and work-in-process are stated at the lower of average cost and net realizable value. Raw materials purchased using commodity contracts are accounted for at the purchase price set out under the terms and conditions of these contracts. c) Fixed assets Fixed assets are stated at cost, net of any investment tax credits which are accounted for when qualified expenditures are incurred. Interest expense and other direct costs relating to major capital projects are capitalized to the cost of fixed assets until the commercial production stage.

34 35

BEAN COUNTING

compensation charge is expensed over the vesting period of the options. The transitional provisions provide for a prospective

Notes to Consolidated Financial Statements

Note 1: Changes in accounting policies (continued)

Note 2: Significant accounting policies (continued) Depreciation is calculated using the straight-line method over the following periods: Asset

Buildings Coffee service equipment Vending equipment Machinery and equipment Furniture Computer equipment Rolling stock Leasehold improvements

Period

20 to 30 years 7 years 12 years 5 to 15 years 10 years 3 years 3 to 15 years Term of lease

d) Goodwill and other intangible assets Goodwill and intangible assets with indefinite useful lives are not amortized. Goodwill is tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test is carried out in two steps. In the first step, the carrying amount of the reporting unit is compared with its fair value. When the fair value of a reporting unit exceeds its carrying amount, then goodwill of the reporting unit is considered not to be impaired and the second step of the impairment test is not required. The second step is carried out when the carrying amount of a reporting unit exceeds its fair value, in which case the implied fair value of the reporting unit’s goodwill is compared with its carrying amount to measure the amount of the impairment loss, if any. When the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized in an amount equal to the excess and is presented as a separate line item in the statement of earnings before extraordinary items and discontinued operations. Intangible assets acquired in business combinations which have an indefinite useful life, are also tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test compares the carrying amount of the intangible asset with its fair value, and an impairment loss is recognized in the statement of earnings for the excess of the carrying value over the fair value. Intangible assets with finite useful lives such as non-compete agreements, are amortized using the straight-line method over the term of the agreement. e) Other assets Deferred development costs, net of applicable research and development tax credits, represent costs incurred to develop new coffee brewing equipment, brewers and other. Deferred costs are amortized on a straight-line basis over three years. Patents and rights are recorded at cost and are amortized using the straight-line method over 17 years. The deferred financing costs related to long-term financing are amortized using the straight-line method over the term of the related long-term debt. Other assets, which include start-up costs, are primarily amortized over a period of 3 years. Management reviews periodically the value and amortization period of other assets. A permanent decline, if such be the case, will be determined based on future undiscounted cash flows. f) Income taxes The Company follows the asset and liability method of accounting for income taxes. Under this method, future income tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases. Future income tax assets and

the liabilities settled. Future income tax assets are recognized and, if realization is not considered “more likely than not” a valuation allowance is provided. The effect on future income tax assets and liabilities of a change in tax rates is recognized in income in the period that substantive enactment or enactment occurs. g) Employee future benefits The Company accrues the estimated cost of the contractual termination benefits, when it is probable that employees will be entitled to benefits and the amount can be reasonably estimated. h) Foreign currency translation Net assets of self-sustaining foreign operations are translated using the current rate method. Adjustments arising from this translation are deferred and recorded as a separate item under shareholders’ equity and are included in income only when a reduction in the net investment in these foreign operations is realized. Gains or losses on foreign currency balances or transactions that are designated as hedges of a net investment in self-sustaining foreign operations are offset against exchange losses or gains included in the currency translation adjustment account included in shareholders’ equity. Other foreign currency transactions entered into by the Company are translated using the temporal method. Translation gains and losses are included in the statement of earnings. i) Derivative financial instruments The Company uses various derivative financial instruments to manage its exposure to fluctuations in interest rates, foreign currency exchange rates and commodity pricing. The Company does not hold or use any derivative instruments for speculative trading purposes. The Company documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives to specific assets and liabilities or to specific firm commitments or forecasted transactions. The Company enters into interest rate swaps in order to manage the impact of fluctuating interest rates on its long-term debt. These swap agreements require the periodic exchange of payments without the exchange of the notional principal amount on which the payments are based. The Company designates its interest rate swap agreements as hedges of the underlying debt. Interest expense on the debt is adjusted to include the payments made or received under the interest rate swaps. Realized and unrealized gains or losses associated with derivative instruments, which have been terminated or cease to be effective prior to maturity, are deferred under other current or non-current assets or liabilities on the balance sheet and recognized in earnings in the period in which the underlying hedged transaction is recognized. In the event a designated hedged item is sold, extinguished or matures prior to the termination of the related derivative instrument, any realized or unrealized gain or loss on such derivative instrument is recognized in earnings. j) Revenue recognition Revenue is recognized when goods are delivered or when services are provided. Rental fees are billed on a periodic or a monthly basis and recognized when services are provided. When clients are invoiced, the portion of unearned revenues is recorded under deferred revenues. k) Use of estimates The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, related amounts of revenues and expenses and disclosure of contingent assets and liabilities. Significant areas requiring the use of management estimates relate to the determination of the useful life of assets for amortization and evaluation of net recoverable amounts, the determination of the fair value of portfolio investments, the determination of the fair value of assets acquired and liabilities assumed in business combinations, implied fair value of goodwill, provisions for income taxes and determination of future income tax assets and liabilities and the determination of the fair value of financial instruments. Actual results could differ from those estimates. 36 37

BEAN COUNTING

liabilities are measured using enacted or substantively enacted tax rates expected to apply when the assets are realized or

Notes to Consolidated Financial Statements

Note 2: Significant accounting policies (continued)

Note 3 Financial expenses 2005

Interest on long-term debt Amortization of financial expenses

2004

$

3,615 271

$

4,382 478

$

3,886

$

4,860

Note 4 Income taxes Income tax expense is detailed as follows: 2005

Current Future

2004

$

5,704 1,308

$

7,865 (3,194)

$

7,012

$

4,671

The following table reconciles the statutory tax rate with the effective tax rate: 2005

2004

Combined statutory tax rate Earnings taxed (losses recovered) at a different rate than the statutory rate Manufacturing and processing deduction Adjustment to future income tax assets and liabilities for enacted changes in tax laws and rates Other items

31.9%

33.2%

(5.8) –

(9.5) 0.2

(0.1) (3.2)

(1.1) (3.1)

Effective tax rate

22.8%

19.7%

The tax effects of temporary differences that give rise to significant portion of the future tax assets and future tax liabilities are as follows: 2005

Future income tax assets – current: Employee future benefits Reserve deductible next year

$

574 1,107 1,681

2004

$

624 1,235 1,859

Future income tax assets – non-current: Tax losses carried forward Differences between book and tax bases of fixed assets Differences between book and tax bases of other assets Valuation allowance Total future income tax assets – non-current

17,393 2,438 177 (1,622) 18,386

16,954 1,676 135 – 18,765

Future income tax liabilities – non-current: Differences between book and tax bases of fixed assets Differences between book and tax bases of other assets Total future income tax liabilities

4,069 8,282 12,351

4,301 7,005 11,306

Net future income tax assets

$

7,716

$

9,318

2005

Future income tax assets: Current Long-term

$

Future income tax liabilities

1,681 7,110 8,791

2004

$

1,075

Net future income tax assets

$

7,716

1,859 10,542 12,401 3,083

$

9,318

The Company has not recognized a future tax liability for the undistributed earnings of its subsidiaries in 2005 and in prior years because the Company does not expect those unremitted earnings to reverse and become taxable to the Company in the foreseeable future. A future tax liability will be recognized when the Company expects that it will recover these undistributed earnings in a taxable manner. As at April 2, 2005, the Company had net operating loss carryforwards for income tax purposes available to reduce future federal, provincial and US federal taxable income of approximately $14,895,000, $15,726,000 and $30,877,000, respectively. These losses will expire as follows: Federal

2008 2009 2010 2014 2015 2018 to 2024

$

255 1,311 5,837 6,168 1,324 –

$ 14,895

Provincial

$

294 1,308 8,012 4,439 1,673 –

$ 15,726

US Federal

$

85 – 246 1,051 377 29,118

$ 30,877

As at April 2, 2005, the Company also had capital losses to carry forward of $1,514,000 without expiry dates. The future tax asset related to these operating losses is recorded in the financial statements.

Note 5 Earnings per share Basic earnings per share is calculated by dividing the net earnings attributable to the common shareholders by the weighted average daily number of common shares outstanding during the year. Diluted earnings per share is calculated by dividing the net earnings attributable to the common shareholders by the weighted average number of common shares outstanding restated to take into account the potential dilutive impact of the exercise of the stock options under the treasury stock method. 2005 (in thousands)

2004 (in thousands)

Weighted average number of outstanding common shares Potential dilutive impact

21,519 79

21,428 104

Weighted average number of common and dilutive shares

21,598

21,532

38 39

BEAN COUNTING

These future tax assets and liabilities are presented as follows in the consolidated balance sheet:

Notes to Consolidated Financial Statements

Note 4: Income taxes (continued)

Note 6 Inventories Raw materials Work-in-process Finished goods

2005

2004

$ 11,008 564 16,473

$ 10,685 657 15,433

$ 28,045

$ 26,775

2005

2004

Note 7 Investments Shares in companies subject to significant influence, voting and participating, at equity value Advances to companies subject to significant influence and to minority shareholders, with various interest rates and payment terms Portfolio investment

$

427

$

383

3,092 15,420

2,325 15,420

$ 18,939

$ 18,128

Accumulated depreciation

Net book value

Note 8 Fixed assets 2005 Cost

Land Buildings Coffee service equipment and vending equipment Machinery and equipment Furniture, computer equipment and leasehold improvements Rolling stock

$

1,571 15,229 153,020 41,107 25,844 18,164

$

– 5,098 84,644 22,394 16,412 10,582

$

1,571 10,131 68,376 18,713 9,432 7,582

$ 254,935

$ 139,130

$ 115,805

Cost

Accumulated depreciation

Net book value

2004

Land Buildings Coffee service equipment and vending equipment Machinery and equipment Furniture, computer equipment and leasehold improvements Rolling stock

$

1,571 14,893 145,138 40,269 26,839 17,247

$ 245,957

$

– 4,628 74,300 22,907 17,170 9,989

$ 128,994

$

1,571 10,265 70,838 17,362 9,669 7,258

$ 116,963

segments: Manufacturing and marketing

Coffee services

Total

Balance as at April 3, 2004 Purchases (disposals) of businesses Write-off following discontinuance of several bistro operations Translation adjustments

$ 29,414 – (273) –

$ 111,367 5,922 – (4,799)

$ 140,781 5,922 (273) (4,799)

Balance as at April 2, 2005

$ 29,141

$ 112,490

$ 141,631

Cost

Accumulated amortization

Net book value

Note 10 Other assets 2005

Patents and rights Start-up costs Deferred development costs Deferred financing costs Other assets

$

914 1,163 7,785 1,453 5,048

$

615 687 4,611 1,153 1,771

$

299 476 3,174 300 3,277

$ 16,363

$

8,837

$

7,526

2004 Cost

Patents and rights Start-up costs Deferred development costs Deferred financing costs Other assets

$

Accumulated amortization

Net book value

918 1,163 6,318 1,889 4,010

$

515 440 3,260 1,562 1,206

$

403 723 3,058 327 2,804

$ 14,298

$

6,983

$

7,315

Note 11 Long-term debt Revolving bank credit facility (i) Other Less current portion

40 41

2005

2004

$ 85,928 2,428 88,356

$ 104,681 2,825 107,506

28,024

22,710

$ 60,332

$ 84,796

BEAN COUNTING

For the year ended April 2, 2005, the changes in the carrying amounts of goodwill are as follows for each of the two business

Notes to Consolidated Financial Statements

Note 9 Goodwill

Note 11: Long-term debt (continued) (i) As at April 2, 2005, these borrowings were drawn on a bank credit facility of $150 million. The bank credit facility is composed of two tranches. The first tranche of $60 million is a 364-day revolving facility that can be extended on a yearly basis, and the second tranche of $90 million is a three-year revolving facility maturing in October 2005. As at April 2, 2005, Cdn$18,900,000 was borrowed under the first tranche, and $67,028,400 (Cdn$33,000,000 and US$28,000,000) under the second tranche. The borrowed amounts of the first tranche are to be reimbursed in full in October 2007 at the latest or if the facility is not extended, while the borrowed amounts of the second tranche will be converted, in October 2005, into a two-year term loan repayable in eight quarterly installments beginning three months following the effective date of the term loan. The credit agreement governing this bank credit facility contains certain covenants, among which is the obligation to maintain certain financial ratios. During the year, the Company satisfied the covenants pertaining to these ratios. The borrowed amounts bear interest at floating rates based on Bankers’ Acceptances or the bank prime rate. The bank credit facility is unsecured by the assets of Van Houtte Inc. In accordance with the terms of various borrowing agreements and excluding any refinancing options, the Company will make the following repayments over the next five years: 2006 2007 2008 2009 2010

$ 28,024 34,163 25,590 200 379

Note 12 Capital stock 2005

2004

Authorized Unlimited number of multiple voting shares with voting rights of five votes per share, participating and without par value Unlimited number of subordinate voting shares with voting rights of one vote per share, participating and without par value Unlimited number of Classes A and B preferred shares, issuable only in series, non-voting and without par value Issued and paid 5,300,000 multiple voting shares 16,303,331 subordinate voting shares (16,130,481 shares in 2004)

$

353 127,897

$ 128,250

$

353 126,723

$ 127,076

a) Share issue and repurchase – 2005 During the year, 5,000 subordinate voting shares were redeemed for a cash consideration of $94,000. The excess of the price paid over the average cost of these shares as well as the redemption expenses of $54,000 were recorded as a reduction of retained earnings. During the year, 177,850 subordinate voting shares were issued upon the exercise of stock options, for a cash consideration of $1,213,613.

During the year, 55,700 subordinate voting shares were redeemed for a cash consideration of $710,000. The excess of the price paid over the average cost of these shares as well as the redemption expenses of $272,000 were recorded as a reduction of retained earnings. During the year, 46,500 subordinate voting shares were issued upon the exercise of stock options, for a cash consideration of $284,675. c) Stock option plan Under a stock option plan, 1,650,000 subordinate voting shares are reserved for certain management employees of the Company. The exercise price of each option is determined based on the average of the daily high and low board lot trading prices of the Company’s shares on the TSX stock exchange for the last five trading days for which there have been transactions immediately preceding the date on which the option is granted. Each option may be exercised during a period not exceeding ten years from the date it was granted. The following table provides details regarding changes to outstanding options for the years ended April 2, 2005 and April 3, 2004.

Options

Balance at beginning Granted Cancelled Exercised

2005

2004

Weighted average exercise price

Weighted average exercise price

Options

1,033,023 42,000 (52,486) (177,850)

$

18.11 16.15 16.49 6.82

1,181,674 243,921 (346,072) (46,500)

$

20.26 14.22 24.32 6.12

Balance at end of year

844,687

$

20.49

1,033,023

$

18.11

Vested options at end of year

593,033

$

21.81

714,515

$

18.08

The following table provides summary information regarding outstanding options as at April 2, 2005: Options outstanding Number of outstanding options as at April 2, 2005

Weighted average years to maturity

15 20 25 30

206,201 322,390 133,000 183,096

7.3 5.4 4.3 3.3

$ 10 to 30

844,687

5.2

Range of exercise prices

$ 10 15 20 25

to to to to

Options exercisable Weighted average exercise price

Number exercisable as at April 2, 2005

Weighted average exercise price

$

14.19 18.31 23.17 29.48

133,500 153,500 133,000 173,033

$

14.17 18.48 23.17 29.61

$

20.49

593,033

$

21.81

During the year 2005, the Company granted 42,000 stock options to senior executives and management at a weighted average exercise price of $16.15 and cancelled 52,486 options, of which 38,019 were granted after March 31, 2002 at a weighted average exercise price of $14.11. The weighted average fair value of stock options granted was $4.99 while that of cancelled options was $3.95. The fair value of each option granted was determined using the Black-Scholes option pricing model and the following weighted average assumptions: Risk-free interest rate Expected life Expected volatility Expected dividend yield 42 43

3.93% 7.1 years 27% 1.5%

BEAN COUNTING

b) Share issue and repurchase – 2004

Notes to Consolidated Financial Statements

Note 12: Capital stock (continued)

Note 12: Capital stock (continued) The compensation expense for the year ended April 2, 2005 was $413,000. The total consideration was recorded under contributed surplus. If the stock options had been accounted for based on the fair value based method, pro forma net earnings and pro forma net earnings per share would have been as follows for the year ended April 3, 2004: As reported

Pro forma

Net earnings

$ 18,564

$ 17,841

Earnings per share: Basic Diluted

$ $

$ $

0.87 0.86

0.83 0.83

The pro forma figures omit the effect of stock options granted prior to March 31, 2002.

Note 13 Currency translation adjustment 2005

Balance at beginning Effect of exchange rate variation on translation of net assets of U.S. self-sustaining subsidiaries Balance at end

2004

$ (7,746)

$

(1,172)

(5,773) $ (13,519)

$

(6,574) (7,746)

Furthermore, gain (loss) on foreign exchange transactions recorded in the consolidated statement of earnings amounted to ($667,000) in 2005 and ($1,563,000) in 2004.

Note 14 Commitments and guarantees a) Commitments The Company rents premises and equipment under operating leases which expire at various dates up to 2017 and for which gross rents total $26,411,000. Of this amount, a portion of $5,182,000 is assumed by the franchisees of the Company. Annual payments under these leases for the next five years are as follows:

2006 2007 2008 2009 2010 and thereafter

$

Gross

Franchisees

6,953 5,500 4,149 3,142 6,667

$

1,098 861 747 596 1,880

Net

$

5,855 4,639 3,402 2,546 4,787

b) Disclosure of guarantees Capital leases A subsidiary of the Company, VKI Technologies Inc., has guaranteed lease obligations to third parties by franchisees of its Filterfresh Coffee Service, Inc. subsidiary. As security for the guarantees provided, the Company has a lien on the franchisees’ licenses and assets. As at April 2, 2005, the Company guarantees a total of US$13,030 for lease obligations to third parties. The Company also guarantees lease obligations to third parties for a total of US$59,472. In the opinion of management, the security for the guarantees provided is adequate.

The Company indemnifies its directors and officers, former directors and officers and individuals who act or who have acted at the Company’s request as a director or officer of an entity in which the Company is a shareholder or creditor, to the extent permitted by law, against any and all charges, costs, expenses, amounts paid in settlement or investigative damages incurred by the directors and officers as a result of any lawsuit, or any judicial, administrative or investigating proceeding in which the directors and officers are sued as a result of their service. These indemnification claims are subject to any statutory or other legal limitation period. The nature of the indemnification agreements prevents the Company from making a reasonable estimate of the maximum potential amount it could be required to pay to counterparties. The Company has purchased directors’ and officers’ liability insurance coverage in the amount of $30,000,000 which carries a $250,000 deductible. No amount has been accrued in the consolidated balance sheet with respect to these indemnifications. To the knowledge of the Company, there is no such claim against directors and officers. Operating leases The Company has guaranteed lease obligations for its franchisees expiring between 2006 and 2007. If a franchisee defaults under its contractual obligation, the Company must, under certain conditions, compensate the lessor for the default. The maximum exposure in respect of these guarantees is $542,497 (2004 - $737,651). As at April 2, 2005, the Company has not recorded a liability associated with these guarantees, since it is not probable that a franchisee will default under the agreement.

Note 15 Contingencies The Company is involved in various lawsuits and claims. Management is of the opinion that the resolution of these claims would have no material impact on the Company’s financial position or results of operations.

Note 16 Additional information on cash flows 2005

Operating activities Changes in non-cash operating working capital items: (Increase) decrease in the undernoted items: Accounts receivable Income taxes payable Inventories Prepaid expenses (Decrease) increase in the undernoted items: Accounts payable and accrued liabilities Employee future benefits

$ (4,850) 2,542 (1,270) (9)

2004

$

6,058 (173)

Working capital acquired

(2,744) 1,655 (2,372) 384 2,865 (1,212)

1,400

283

$

3,698

$

(1,141)

Cash payments of interest and income taxes were as follows Cash interest payments Cash payments for income taxes

$ $

3,786 3,163

$ $

4,765 6,211

Purchase of fixed assets financed by accounts payable Purchase of fixed assets financed by capital lease

$ $

1,147 236

$ $

1,644 –

44 45

BEAN COUNTING

Directors’ and officers’ indemnification agreements

Notes to Consolidated Financial Statements

Note 14: Commitments and guarantees (continued)

Note 17 Business acquisitions and disposals The business combinations are accounted for using the purchase method. Results of the businesses acquired are included from the date of the acquisition in the consolidated financial statements of the Company. a) 2005 During the year, the Company acquired twenty-two coffee service businesses, seventeen in the United States and five in Canada, and sold three of its vending branches in Canada for a total net cash consideration of $9,330,000. The principal acquisitions of the year are: United States On June 26, 2004, concurrent with a partnership agreement of which the Company holds a 67.5% interest, the Company purchased the business of Potomac Coffee LLC. On December 21, 2004, the Company purchased the business of North America Coffee (Manteno). Canada On October 22, 2004, the Company purchased the business of Café de Marc inc. b) 2004 During the year, the Company acquired fifteen coffee service businesses, twelve in the United States and three in Canada, and sold six of its vending branches in Canada for a total net cash consideration of $13,884,000. The principal acquisitions of the year are: United States On March 30, 2003, concurrent with a partnership agreement of which the Company holds a 74% interest, the Company purchased the businesses of Coffee Time Inc. and Mocha Men West Inc. On December 15, 2003, concurrent with a partnership agreement of which the Company holds a 56% interest, the Company purchased the business of Corporate Coffee Systems, Inc. On June 26, 2003, the Company acquired the remaining 75% ownership of Caffe Satisfaction LLC. The acquisitions and disposals are summarized as follows: 2005

Assets acquired and disposed Non-cash operating working capital Fixed assets Other assets Goodwill (1)

$

Liabilities assumed Long-term debt Non-controlling interest (Loss) gain on disposal

1,400 2,642 917 5,922 10,881

2004

$

283 4,183 1,831 14,737 21,034



549

1,088

4,070

(304)

393

Net assets acquired at fair value

$ 10,097

$ 16,022

Consideration Cash Portion of purchase price paid in a prior year

$

9,330 767

$ 13,884 2,138

$ 10,097

$ 16,022

$

$ 13,796

(1)

Tax base of goodwill acquired

4,854

The carrying value of cash, accounts receivable, accounts payable and accrued liabilities approximates their fair value because of the near-term maturity of these instruments. The carrying value of the revolving term loan and other debt approximates its fair value, as the interest rates vary based on market rate. b) Management of interest risk The Company has entered into interest rate swaps to manage its interest rate exposure on a portion of the revolving bank credit. The Company is committed to exchange, at specific intervals, the difference between the fixed and floating interest rates calculated by reference to the notional amounts. As at April 2, 2005 and April 3, 2004, the Company pays a fixed interest rate of 4.86% on a notional amount of $30,000,000 and receives a floating interest based on Bankers’ Acceptance having a three-month maturity. The swap will expire in July 2007. The negative fair value of the interest rate swap is $1,070,316 (2004 - $1,884,907). The Company does not foresee any failure by the counterparties to these contracts as they are financially-sound Canadian banks. c) Foreign exchange risk The Company makes several purchases in US dollars and enters into various types of foreign exchange forward contracts in order to manage its foreign exchange risk. The Company does not hold nor issue such financial instruments for trading purposes. As at April 2, 2005, there were forward exchange contracts outstanding for a notional amount of US$32,500,000 (2004 - US$4,500,000). The positive fair value of the forward exchange contracts is $151,439 as at April 2, 2005 and there was a negative fair value of $61,000 as at April 3, 2004. d) Credit risk The Company does not have a significant exposure to any individual customer nor counter-party. The Company reviews a new customer’s credit history before extending credit and conducts regular reviews of its existing customers’ credit performance. An allowance for doubtful accounts is established based upon factors such as the credit risk for specific customers, historical trends and other information. e) Other risk The Company also has a significant exposure toward the fluctuation of the price of green coffee. The Company purchases, from time to time, coffee contracts on a public commodities market in order to manage its price risk. As at April 2, 2005, the Company had contracts for 6.3 million pounds of green coffee having a negative fair value of $358,141 and as at April 3, 2004, the Company had contracts for 2.4 million pounds of green coffee having a positive fair value of $309,094.

Note 19 Segmented information In order to better distinguish the unique dynamics of the coffee services market from the Company’s other activities, the segmented information is now presented as follows: a) The “Manufacturing and Marketing” segment encompasses coffee roasting and distribution for home consumption through retail channels such as supermarkets. It also includes café-bistros and the manufacture of coffeemakers. b) The “Coffee Services” segment focuses on the sale of coffee for consumption in the workplace and other public locations. Van Houtte’s coffee services network also distributes complementary products such as condiments, snacks, drinks, water and point-of-use water systems. Moreover, this segment includes vending machine operations.

46 47

BEAN COUNTING

a) Fair value

Notes to Consolidated Financial Statements

Note 18 Financial instruments

Note 19: Segmented information (continued) These segments are managed separately, since they require different marketing strategies and are assessed individually based on operating income before depreciation, amortization and financial expenses. The accounting policies of each segment are identical to those policies used for the consolidated financial statements. Segment income includes income from sales to third parties and inter-segment sales. These sales are accounted for at prevailing market prices.

Business segments Revenues: Manufacturing and Marketing Coffee Services Intersegment

Operating earnings before depreciation and amortization, financial expenses: Manufacturing and Marketing Coffee Services General corporate expenses

Fixed assets and goodwill: Manufacturing and Marketing Coffee Services

Additions to fixed assets and other assets: Manufacturing and Marketing Coffee Services General corporate

Depreciation and amortization of fixed assets and other assets: Manufacturing and Marketing Coffee Services General corporate

2005

2004

$155,948 243,828 399,776

$ 142,257 230,273 372,530

(51,021) $348,755

(41,982) $ 330,548

$ 32,213 38,949 71,162

$ 31,442 33,890 65,332

(5,489) $ 65,673

(5,770) $ 59,562

$ 63,360 194,076 $257,436

$ 62,565 195,179 $ 257,744

$

$

9,537 20,370 29,907

6,926 19,704 26,630

5 $ 29,912

300 $ 26,930

$

$

8,165 22,697 30,862

8,007 22,920 30,927

154

103

$ 31,016

$ 31,030

Note 20 Comparative figures Certain comparative figures have been reclassified to conform with the financial statement presentation adopted in the current year.

8

1

Discover Van Houtte

C O F F E E C O N N O I S SEURS

2

3

Something to please every connoisseur

C O F F E E C O N N O I S SEURS

4

5

Message from the Chairman of the Board

C O M PA N Y G R OWERS

6

7

Yes, you can have a great cup of coffee at work!

C O M PA N Y G R OWERS

8

...

Management Report

12 13

Anywhere, anytime

B E A N C O U NTING

14 ...

Management’s Discussion and Analysis

B E A N C O U NTING

30 ...

Consolidated Financial Statements

B E A N C O U NTING

34 ...

Notes to Consolidated Financial Statements

ISBN 2-9802772-9-0

|

B E A N C O U NTING

Legal Deposit – Bibliothèque nationale du Québec, third quarter 2005 |

Legal Deposit – National Library of Canada, third quarter 2005

Corporate Information DIRECTORS

OFFICERS

Pierre Van Houtte Honorary Chairman of the Board Van Houtte Inc.

Jean-Yves Monette President and Chief Executive Officer

Timothy Weichel Vice-President, Operations – Central Region

KPMG LLP

Paul-André Guillotte Chairman of the Board Van Houtte Inc.

Gérard Geoffrion Executive Vice-President and Chief Financial Officer

Robert Mann Vice-President, Operations – Prairie Region

Royal Bank of Canada Scotia Bank Bank of Montreal

Christian Pouliot Vice-Chairman of the Board Van Houtte Inc.

Roger Cohen President Van Houtte USA – Filterfresh

Jamie Livingston Vice-President, Operations – Pacific Region

Jean-Yves Monette President and Chief Executive Officer Van Houtte Inc.

Roger Leblanc Vice-President, Manufacturing and Distribution

Pierre-Luc Van Houtte Corporate Secretary Van Houtte Inc. Corporate Director Michel Ouellet Corporate Director Michael Gray Corporate Director Sylvain Bernier Executive Vice-President and Chief Operating Officer Beauregard Group Robert Parizeau Chairman of the Board Aon Parizeau Inc.

Johanne Groulx Vice-President, Supply Chain and Trade Policy

AUDITORS

Coffee Services USA

BANKING INSTITUTIONS

TRANSFER AGENT

Computershare Trust Company of Canada I N V E S T O R R E L AT I O N S

Walter Prokopchuk Vice-President, Operations

Gérard Geoffrion

David Laurie Vice-President, Retail Sales – Canada

Miles Malanowich Vice-President, Operations – Western Region

AUDIT COMMITTEE

Jean-Luc Deschamps Vice-President, Finance

Ed Holloran Vice-President, Business Development

Normand De Césaré Vice-President and Corporate Controller Thierry Pejot-Charrost Director, Internal Audit Jean-Olivier Boucher General Counsel

Colleen Fleming President and CEO Career Edge

Stéphane Breault President, Cafés-bistros

Pierre Brodeur Corporate Director

Coffee Services Canada

Roger Desrosiers Corporate Director

Denis Sarrazin Vice-President, Operations – Eastern Region

Kevin Brown Controller, Treasurer and Secretary V K I Te c h n o l o g i e s

C O R P O R AT E G O V E R N A N C E COMMITTEE

Robert Parizeau, Chairman Pierre Brodeur Colleen Fleming

Angelo Mottillo Executive Vice-President and General Manager

HUMAN RESOURCES A N D C O M P E N S AT I O N COMMITTEE

Ricardo Tozzi Vice-President, Operations

Pierre Brodeur, Chairman Sylvain Bernier Colleen Fleming Robert Parizeau

HEAD OFFICE

Van Houtte Inc., 8300-19th Avenue, Montreal, Quebec H1Z 4J8 S T O C K I N F O R M AT I O N ( J U N E 3 , 2 0 0 5 )

Initial public offering: August 1987 ($2.50*) Number of shares outstanding: 5,300,000 multiple voting shares; 16,172,531 subordinate voting shares High/low for fiscal 2005: $23.48 / $14.00 Trading volume: 6,879,857 * Reflects 1997 stock-split. VAN HOUTTE’S ANNUAL MEETING OF SHAREHOLDERS

will be held on August 31, 2005 at 11:00 a.m. at the Mont-Royal Omni Hotel, Saisons A Room, 1050 Sherbrooke Street West, Montreal, Quebec The Company’s Annual Information Form for the fiscal year ended April 2, 2005 will be available at the Head Office as of June 30, 2005. Ce rapport est également disponible en français.

Robert Parizeau, Chairman Pierre Brodeur Roger Desrosiers Michel Ouellet

S T R AT E G I C O R I E N TAT I O N COMMITTEE

Jean-Yves Monette, Chairman Pierre Brodeur Paul-André Guillotte Robert Parizeau Christian Pouliot Pierre-Luc Van Houtte

AN N U AL R EPO RT 2005

DISCOVER

A N N U A L R E P O RT 2 0 0 5

From Bean to your Cup