Friesland Revenues Up, But Lower Margins Put Profit for the Period Under Pressure

Developments in the first half of 2008 confirmed the outlook expressed by Friesland Foods that pressure on margins would continue in 2008, in particular in Asia and Africa, as a consequence of the high cost of raw materials.

14/08/08 Royal Friesland Foods N.V.’s revenue was up from 2.4 billion to 2.7 billion euros in the first half of 2008. Profit for the period was down from 79 million to 29 million euros. The Industrial business group reported a good performance. The group’s volume, selling prices and result were all at higher levels than in the first half of 2007. In the Consumer Products International business group (Asia and Africa) volumes increased, while selling prices rose and market share was maintained. The group’s result declined due to the foreseen margin pressure on account of the extreme increase in the cost of raw materials in 2007. By increasing selling prices in phases, margins are gradually recovering. In the Consumer Products Europe business group, volumes decreased, selling prices increased and the result was comparable to that for the first half of 2007. During the last months of 2007 and the first months of 2008, prices on the world market shot down. Partly because of this, selling prices of, in particular, milk powder and cheese dropped fast in the Classic Dairy business group, which led to a lower result. Higher working capital and lower profit levels resulted in net cash outflows from operating activities.

Developments in the first half of 2008 confirmed the outlook expressed by Friesland Foods in its Annual Report 2007 that pressure on margins would continue in 2008, in particular in Asia and Africa, as a consequence of the high cost of raw materials. It also became evident that selling prices fluctuated more than in the past and that minor changes in supply and demand resulted in larger price fluctuations for, in particular, milk powder and whey powder, cheese and butter.

The development characterising the last months of 2007 continued in the first half of 2008. Demand on the world market stagnated somewhat owing to high price levels, resulting in dropping demand from consumers in emerging countries, in particular, and the use of alternatives for basic dairy products. In combination with gradually increasing milk supplies in Europe, this resulted in imbalance between production and demand which put prices for milk powder, whey powder, butter and cheese under pressure. In addition, the further weakening of the dollar against the euro had an effect. Because of the weak dollar, competition on the world market was difficult for eurozone countries. In the second quarter of 2008, prices for milk powder, butter and cheese stabilised, again showing a slightly upward trend, as was the case for whey powder.

In the first half of 2008, operating profit of Friesland Foods dropped to 64 million euros (first half of 2007: 145 million). The main reason was the pressure on margins in Asia, Africa and the Middle East (the Consumer Products International business group). Increasing the market share has strategic priority in these regions, and it was decided to incorporate the extreme increase in purchase prices of raw materials and basic dairy products on the world market in 2007 in selling prices of consumer products in phases. Volumes sold increased and, after a difficult first quarter, margins are recovering. In the Classic Dairy business group (cheese, milk powder, butter and fresh dairy products), margins were under pressure because selling prices in a number of product categories, such as milk powder and some cheeses, fell faster than the price of milk. For the Consumer Products Europe business group, operating profit for the first half of 2008 was comparable to that for the first half of 2007. Operating profit of the Industrial business group showed a sharp improvement. Both volume and margins were higher than in the first half of 2007.

In the first half of 2008, a total of 252 million euros was paid to member dairy farmers in milk payments in excess of the amount paid during the same period of 2007. This total included the structural increase in the market price of milk by 0.50 euro per 100 kilogrammes of milk (a total of 13 million euros) with effect from 1 January 2008. This increase was implemented to keep the paid market price of milk in line with milk price trends in the Netherlands. The price paid in advance for milk to member dairy farmers of Zuivelcoöperatie Friesland Foods was 37.20 euros including VAT per 100 kilogrammes of milk at 4.45 percent fat and 3.45 percent protein in the first half of 2008 (first half of 2007: 27.89 euros). Member dairy farmers supplied 2.72 billion kilogrammes of milk in the first half of 2008 (2007: 2.69 billion).Friesland Foods processed a total of 3.54 billion kilogrammes of milk in the first half of 2008 compared with 3.45 billion kilogrammes in 2007.

Energy costs rose by 8 million euros in the first half of 2008 on the first half of 2007. Foreign currency translation effects because of the stronger euro adversely affected operating profit by 8 million euros.

The balance of non-recurring income and expense items for the first half of 2008 totalled 7 million euros (2007: - 8 million). This includes the gain on the sale of a non-strategic dairy activity for 7 million euros and the release of restructuring provisions of 3 million euros. Non-recurring expense items pertained to, among other items, the costs of the intended merger between Friesland Foods and Campina of 4 million euros for the first half of 2008. These costs mainly related to services provided by third parties in the areas of competition, legal support, and strategic and organizational development.

Finance costs were up 6 million to 17 million euros from the first half of 2007. This rise is mainly due to higher interest expenses owing to the higher net debt as a consequence of the higher working capital, as well as being due to currency movements. The tax burden improved, going from 28 percent to 18 percent, mainly owing to the inclusion of tax losses in respect of the winding up of foreign subsidiaries.

Profit for the period attributable to minority interests decreased from 17 million to 8 million euros, owing to lower results achieved by the companies in Asia and Africa, which Friesland Foods does not fully own.

Solvency (equity as a percentage of total assets) fell from 38.9 to 36.9 percent compared with year-end 2007. This was due, on the one hand, to the lower amount in equity and, on the other, to higher total assets compared with year-end 2007. The reduction in equity was caused by dividend payments for 2007 and relatively lower profit levels. Friesland Foods more than complied with the requirements imposed by lenders as expressed in key financial figures.

Net cash flows used in operating activities in the first half of 2008 showed a sharp decline from the first half of 2007, as a consequence of the higher working capital and lower profit levels. Consequently, net debt rose from 582 billion euros at year-end 2007 to 764 million euros at the end of the first half of 2008. Working capital (excluding amounts owed to dairy farmers) rose by 85 million euros compared with year-end 2007 as a result of an increase in receivables on account of higher monthly revenues. Inventories decreased as a result of extra attention devoted to inventory management.

Friesland Foods expects margins to recover further in Asia and Africa, in particular, during the second half of 2008, as a result of continuing to gradually increase selling prices. A margin recovery is also expected in Europe, as a result of greater balance between selling prices and the price of milk. However, because of the volatility of the markets and the many uncertainties, Friesland Foods cannot make any specific forward-looking statements about the company’s financial performance in the full year of 2008.