U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 20-F

o REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g)
OF THE SECURITIES EXCHANGE ACT OF 1934

OR

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

OR

o SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-15184

SADIA S.A.
(Exact Name of Registrant as Specified in its Charter)

Federative Republic of Brazil
(Jurisdiction of Incorporation or Organization)

N/A
(Translation of Registrant’s name into English)

Rua Fortunato Ferraz, 659
Vila Anastácio, São Paulo, SP
05093-901, Brazil
(Address of principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class		Name of Each Exchange on which Registered
Preferred Shares, no par value per share,		New York Stock Exchange
each represented by American Depositary Shares

Securities registered pursuant to Section 12(g) of the Act:

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

The total number of issued shares of each class of stock of SADIA S.A. as of December 31, 2006, was:

257,000,000 Common Shares, no par value per share

426,000,000 Preferred Shares, no par value per share

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  x  No  o

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports

pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1034.

Yes  o  No  x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the Registrant was

required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x  No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Indicate by check mark which financial statement item the Registrant has elected to follow Item 17 o Item 18 x.

Please send copies of notices and communications from the Securities and Exchange Commission to:

Ross Kaufman, Greenberg Traurig, LLP

200 Park Avenue, New York, New York 10166

CONTENTS

GENERAL	4
PART I	4
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS	4
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE	4
ITEM 3. KEY INFORMATION	4
A. Selected Financial Data	4
B. Capitalization and Indebtedness	6
C. Reasons for the offer and use of proceeds	6
D. Risk Factors	6
ITEM 4. INFORMATION ON THE COMPANY	11
A. History and Development of the Company	11
B. Business Overview	14
C. Organizational Structure	36
D. Property, Plant and Equipment	36
ITEM 4A. UNRESOLVED SEC STAFF COMMENTS	39
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS	39
A. Operating Results	43
B. Liquidity and Capital Resources	51
C. Research and Development, patents and licenses	55
D. Trend Information	56
E. Off- balance sheet arrangements	57
F. Tabular disclosure of contractual obligations	58
G. Safe Harbor	58
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES	58
A. Directors and Senior Management	58
B. Compensation	63
D. Employees	66
E. Share Ownership	66

 

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ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS	66
A. Major Shareholders	66
B. Related Party Transactions	68
C. Interests of Experts and Counsel	68
ITEM 8. FINANCIAL INFORMATION	68
A. Consolidated Statements and Other Financial Information	68
B. Significant Changes	73
ITEM 9. THE OFFER AND LISTING	73
A. Offer and listing details	73
B. Plan of Distribution	77
C. Markets	77
D. Selling Shareholders	79
E. Dilution	79
F. Expenses of Issue	79
ITEM 10. ADDITIONAL INFORMATION	79
A. Share capital	79
B. Memorandum and Articles of Association	79
C. Material Contracts	79
D. Exchange Controls	79
E. Taxation	80
F. Dividends and Paying Agents	86
G. Statement of Experts	86
H. Documents on Display	86
I. Subsidiary Information	86
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	86
ITEM 12. DESCRIPTION OF THE SECURITIES OTHER THAN SECURITIES	89
PART II	89
ITEM 13. DEFAULTS, DIVIDENDS ARREARAGES AND DELINQUENCIES	89
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS	89
ITEM 15. CONTROL AND PROCEDURES	89

 

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Report of Independent Registered Public Accounting Firm	90
ITEM 16	91
A. Audit Committee Financial Expert	91
B. Code of Ethics	91
C. Principal Accountant Fees and Services	92
D. Exemptions from the Listing Standards and for Audit Committees	92
E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers	92
PART III	93
ITEM 17. FINANCIAL STATEMENTS	93
ITEM 18. FINANCIAL STATEMENTS	93
ITEM 19. EXHIBITS	93
BYLAWS	95
Exhibit 12.01 Certification by the Company’s CEO
Exhibit 12.02 Certification by the Company’s CFO
Exhibit 13.01 Certification pursuant to 18 U.S.C. Section 1350.
Exhibit 13.02 Certification pursuant to 18 U.S.C. Section 1350.
SADIA S.A.	F-1
CONSOLIDATED FINANCIAL STATEMENTS	F-1

 

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GENERAL

Unless otherwise indicated, all references contained herein, to the “Company”, to “Sadia”, or to “Sadia Group” are references to Sadia S.A., a corporation organized under the laws of the Federative Republic of Brazil (“Brazil”), and its consolidated subsidiaries: Sadia International Ltd.; Sadia GmbH; Rezende Marketing e Comunicação Ltda., Rezende Óleo Ltda., Sadia Overseas Ltd. and Concórdia S.A. Corretora de Valores Mobiliários, Câmbio e Commodities.

Presentation of Certain Financial Information

References to “preferred shares” and “common shares” refer to the Company’s authorized and outstanding preferred stock and common stock, designated as “ações preferenciais” and “ações ordinárias”, respectively, each without par value. All references herein to the “real,” “reais” or “R$” are to the real, the official currency of Brazil since July 1, 1994. All references to (i) “U.S. dollars”, “dollars” or “US$” refer to United States dollars, (ii) “km” to kilometers, and (iii) “tons” to metric tons.

Forward-Looking Statements

This annual report contains certain forward-looking statements as defined in Section 21E of the U.S. Securities Exchange Act of 1934 with respect to the financial condition, results of operations and business achievements/ performance of Sadia and certain of the plans and objectives of management of the Company with respect thereto. These statements may generally, but not always, be identified by the use of words such as “should”, “expects”, “estimates”, “believes” or similar expressions. Such statements include, but are not limited to, statements under the following headings: (i) Item 4. Information on the Company; and (ii) Item 5. Operating and Financial Review and Prospects. This annual report also contains forward-looking statements attributed to certain third parties relating to their estimates regarding the growth of markets and demand for products. By their nature, forward-looking statements involve risk and uncertainty because they reflect the Company’s current expectations and assumptions as to future events and circumstances that may not prove accurate: the factors discussed in Item 3. Key Information — Risk Factors, among others, could cause the Company’s actual financial condition, results of operations and business achievements/ performance to differ materially from the estimates made or implied in such forward-looking statements.

PART I

ITEM 1.  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3. KEY INFORMATION

A. Selected Financial Data

U.S. GAAP Presentation

The selected financial information for the Company included in the following table should be read in conjunction with, and is qualified in its entirety by reference to, the U.S. GAAP financial statements of the Company and “Operating and Financial Review and Prospects” appearing elsewhere herein. The consolidated financial data for the Company as of December 31, 2006, 2005, 2004, 2003 and 2002 are derived from the audited U.S. GAAP financial statements, which differ in certain respects from

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accounting practices adopted in Brazil (defined as Brazilian GAAP). Brazilian GAAP is determined by the requirements of Law No. 6,404, dated December 15, 1976, as amended (Brazilian corporate law), and the rules and regulations of the Comissão de Valores Imobiliários, or CVM, the Brazilian Securities Commission.

SADIA S.A.

SELECTED FINANCIAL DATA

Years ended December 31, 2006, 2005, 2004, 2003 and 2002 (In thousands of reais - R$, except numbers of shares and per share amounts)

		2006		2005		2004		2003		2002
Net Operating Revenue		6,830,300		7,317,842		6,109,225		5,081,717		4,139,070
Operating Income		302,223		680,903		635,029		401,009		345,322
Net income		360,560		603,268		489,501		473,268		284,262
Basic earnings per thousand shares in R$:
Preferred		531.18		885.08		742.42		717.80		431.14
Common		531.18		885.08		674.93		652.54		391.94
Diluted earnings per thousand share in R$:
Preferred		529.79		884.38		742.42		717.80		431.14
Common		529.79		884.38		674.93		652.54		391.94
Dividends paid per thousand shares in R$:
Preferred		287.12		231.96		234.68		170.08		106.89
Common		287.12		210.87		213.34		154.61		97.18
Total Current Assets		4,929,689		4,588,176		3,944,802		3,645,379		2,759,217
Total Assets		8,039,757		6,707,284		5,830,973		6,149,453		4,975,627
Total Current Liabilities		2,493,279		2,625,812		2,766,719		2,969,833		2,591,383
Total Liabilities		5,447,114		4,479,167		3,992,609		4,627,868		3,917,868
Total Shareholders’ Equity		2,592,643		2,228,117		1,838,364		1,521,585		1,057,759
Weighted average number of shares outstanding:
Preferred		421,785,712		424,595,712		425,695,712		425,695,712		425,695,712
Common		257,000,000		257,000,000		257,000,000		257,000,000		257,000,000

 

The exchange rates of real amounts into U.S. dollars for the years ended December 31, 2002, 2003, 2004, 2005, 2006 and January 2007 through May 2007 are shown in the table below:

 

 

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B. Capitalization and Indebtedness

Not applicable

C. Reasons for the offer and use of proceeds

Not applicable

D. Risk Factors

Risks Relating to Brazil

Brazilian political and economic conditions, and the Brazilian government’s economic and other policies, may negatively affect demand for Sadia´s products as well as net sales and overall financial performance.

The Brazilian economy has been characterized by frequent and occasionally extensive intervention by the Brazilian government. The Brazilian government has often changed monetary, taxation, credit, tariff and other policies to influence the course of Brazil’s economy. The Brazilian government’s actions to control inflation and implement other policies have involved interest rate increases, wage and price controls, currency devaluations, freezing of bank accounts, capital controls and limits on imports.

Sadia’s results of operations and financial condition may be adversely affected by the following factors and governmental reaction to them:

·              fluctuations in exchange rates;

·              interest rates;

·              inflation;

·              tax policies;

·              exchange controls;

·              energy shortages;

·              liquidity of domestic capital and lending markets; and

·              other political, diplomatic, social and economic developments in or affecting Brazil.

Uncertainty over whether the Brazilian government will change policies or regulations affecting these or other factors may contribute to economic uncertainty in Brazil and to heightened volatility in the Brazilian capital markets. These and other developments in the Brazilian economy and governmental policies may adversely affect the Company and its business.

Inflation and government actions to combat inflation may contribute significantly to economic uncertainty in Brazil and could adversely affect the Company’s business.

Historically, Brazil has experienced high rates of inflation. Inflation, as well as certain government efforts to combat inflation, has had significant negative effects on the Brazilian economy. Inflation rates were 25.31% in 2002, 8.71% in 2003, 12.41% in 2004, 1.21% in 2005, 3.86% in 2006, and 1.11% in the first quarter of 2007, as measured by the Índice Geral de Preços-Mercado, or the IGP-M. The Brazilian government’s measures to control inflation have often included maintaining a tight monetary policy with high interest rates, thereby restricting availability of credit and reducing economic growth. Inflation, actions to combat inflation and public speculation about possible additional actions also contributed materially to economic uncertainty in Brazil.

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If Brazil experiences high levels of inflation in the future, the rate of growth of the Brazilian economy may be slowed, which would lead to reduced demand for the Company’s products in Brazil. Inflation also is likely to increase some of Sadia’s costs and expenses, which the Company may not be able to pass on to its customers and, as a result, may reduce profit margins and net income. In addition, high inflation generally leads to higher domestic interest rates, and, as a result, the costs of servicing its real-denominated debt may increase. Inflation may, in addition, hinder access to capital markets, which could adversely affect the Company’s ability to refinance its indebtedness. Inflationary pressures may also lead to the imposition of government policies to combat inflation that could adversely affect its business.

Foreign exchange variations between the Brazilian real and the US dollar may raise the cost of servicing our foreign currency denominated debt and adversely affect our overall financial performance.

The Company’s results of operations are affected by exchange-rate fluctuations between the Brazilian real and the U.S. dollar.

The real appreciated 8.9% in 2004, 13.4% in 2005 and 9.5% in 2006 and 4.3% in the first three months of 2007 against the dollar. On March 31, 2007, the U.S. dollar/real exchange rate was US$1.00 per R$2.0504.

Devaluation of the real relative to the U.S. dollar could result in additional inflationary pressures in Brazil by generally increasing the price of imported products and services and requiring recessionary government policies to curb demand. In addition, a devaluation of the real could weaken investor confidence in Brazil. On the other hand, appreciation of the real against the U.S. dollar may lead to a deterioration of the country’s current account and the balance of payments and may dampen export-driven growth. A significant devaluation of the real in relation to the U.S. dollar or other currencies could reduce the Company’s ability to meet debt service requirements of its foreign currency-denominated obligations.

Export revenues and the Company’s margins are also affected by the real fluctuations in relation to the U.S. dollar. Production costs are denominated in local currency but export sales are denominated in U.S. dollars or euros. Financial revenues generated by exports are reduced when translated to reais in the periods in which the Brazilian currency appreciates in relation to the U.S. currency.

In addition, fluctuations in the value of the real relative to the U.S. dollar can affect the market value of the ADSs. Devaluation of the real may reduce the U.S. dollar value of distributions and dividends on the ADSs and may also reduce the market value of the preferred shares and the ADSs.

Restrictions on the movement of capital out of Brazil may hinder investors’ ability to receive dividends and other distributions as well as the proceeds of any sale of preferred shares.

The Brazilian government may impose temporary restrictions on the conversion of Brazilian currency into foreign currencies and on the remittance to foreign investors, of proceeds from investments in Brazil. Brazilian law permits the government to impose these restrictions whenever there is a serious imbalance in Brazil’s balance of payments or reasons to foresee a serious imbalance.

Government restrictions on capital outflow may hinder or prevent the custodian in Brazil, or if investors have exchanged ADSs for the underlying preferred shares, from converting the proceeds relating to the preferred shares into U.S. dollars and remitting those proceeds abroad. Investors could be adversely affected by delays in obtaining any required governmental approval for conversion of Brazilian currency payments and remittances abroad in respect of the preferred shares underlying the ADSs. In addition, the Brazilian government may institute a more restrictive exchange control policy in the future.

Currently, in order to remit the proceeds of distributions on, and gains with respect to, the preferred shares to the U.S., the depositary must register with the Central Bank the amount invested by non-Brazilians in the preferred shares underlying the ADSs. The depositary will register its interest in the preferred shares as a foreign investment with the Central Bank. The Central Bank will issue a certificate of foreign capital registration in the name of the depositary, under which the custodian will, assuming the continued availability of foreign exchange, be able to convert dividends and other Brazilian currency-denominated distributions from the Company into U.S. dollars and remit such U.S. dollars abroad to the depositary for distribution to the foreign investor.

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Developments in other emerging markets may adversely affect the market price of the preferred shares and ADSs

The market price or the preferred shares and ADSs may be adversely affected by declines in the international financial markets and world economic conditions. The Brazilian securities market is, to varying degrees, influenced by economic and market conditions in other emerging market countries, especially those in Latin America. Although economic conditions may differ in each country, investors’ reaction to developments in one country can have an effect on the securities markets and the securities of issuers in other countries, including Brazil.

Accordingly, adverse developments in emerging market countries could lead to a reduction in both demand and the market price for the preferred shares and ADSs. These events may discourage international investment in Brazil and, more directly, may hurt the market price of the Company’s preferred shares and ADSs.

Enforcement of civil liabilities may be difficult

The Company is organized under the laws of Brazil. Most of the Company’s directors and officers and many of its advisors reside in Brazil and substantially all of the assets of these persons and of the Company are located in Brazil. As a result, it may not be possible to effect service of process upon these persons within the United States or other jurisdictions outside of Brazil. Similarly, it may not be possible to enforce, judgments of non-Brazilian courts, including judgments predicated on civil liability under the U.S. securities laws against the Company or its directors and officers.

Brazilian counsel has advised the Company that Brazilian courts will enforce judgments of U.S. courts for civil liabilities predicated on the U.S. securities laws only if the judgment satisfies certain requirements imposed by the Brazilian federal supreme court. The foreign judgment will be enforceable in Brazil if:

·              It fulfills all formalities required for its enforceability under the laws of the country that granted the foreign judgment;

·              It is for the payment of a certain sum of money;

·              It was issued by a competent court after service of process was properly made on the Company in the jurisdiction where the judgment was awarded;

·              It is not subject to appeal;

·              It is authenticated by a Brazilian consular office in the country where it was issued and is accompanied by a sworn translation into Portuguese; and

·              It is not contrary to Brazilian national sovereignty, public policy or good morals, and does not contain any provision that for any reason would not be upheld by the courts of Brazil.

Brazilian counsel has also advised the Company that:

·              As a plaintiff, a holder may bring an original action predicated on the U.S. securities laws in Brazilian courts and that Brazilian courts may enforce liabilities in such actions against the Company, its directors, and certain of its officers and advisors;

·              If a holder resides outside Brazil and owns no real property in Brazil, such holder must provide a bond to guarantee court costs and legal fees in connection with litigation in Brazil; and

·              Brazilian law limits the ability of a judgment creditor of the Company to satisfy a judgment against the Company by attaching certain of its assets.

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Risks Relating to the Company’s Business

The business involves breeding of animals and meat processing subject to a variety of risks which may impact the results of our operations.

The Company’s operations involve raising animals, which is subject to a variety of risks, including disease, contamination, consumer health concerns and adverse weather conditions. Meat is subject to contamination during processing and distribution. Contamination during processing could affect a large number of the Company’s products and therefore could have a significant impact on its operations. The Company’s sales are dependent on consumer preferences, and the loss of consumer confidence in the products sold by Brazilian producers because of disease or contamination could affect the Company’s results of operations.

The prices charged for products and costs of production are subject to significant volatility which may adversely affect the Company’s results

The Brazilian foods industry, like the processed foods industry in other countries, has been characterized by cyclical periods of higher prices and profitability, followed by overproduction, leading to periods of lower prices and lower profitability. The Company believes that domestic prices and export prices for its product line are likely to remain volatile and subject to cyclical variation. There can be no assurance that the Company’s results will not be adversely affected by future downturns in market prices. The largest single component of the Company’s cost of sales is the cost of ingredients used in the preparation of feed. The price of most of the Company’s feed ingredients is subject to significant volatility resulting from weather, the size of harvests, transportation and storage costs, governmental agricultural policies, currency exchange rates and other factors. Sadia may not be successful in addressing the effects of cyclicality and volatility on costs and expenses and its overall financial performance.

Environmental issues and new regulation requirements can affect costs

Brazilian food producers, including the Company, are subject to stringent federal, state and local environmental laws and regulations concerning, among other things, human health, the handling and disposal of wastes and discharges of pollutants to the air and water. In view of the possibility of unanticipated regulatory or other developments, particularly as environmental laws become more stringent both in Brazil and worldwide, the amount and timing of future expenditures required to maintain compliance could vary substantially from their current levels and could adversely affect the availability of funds for other capital expenditures and other purposes.

Competition in both domestic and foreign livestock and food processing sector is very strong and the Company’s performance may be adversely affected by increased competition

The Company faces significant competition from other Brazilian producers in the domestic markets in which it sells its products, and from world producers in the export markets in which it sells its products. Other major vertically integrated Brazilian producers compete with the Company. To varying degrees, these companies have substantial financial resources and strengths in particular product lines and regions. The Company expects that it will continue to face strong competition in every market and that existing or new competitors are likely to broaden their product lines and to extend their geographic scope. Accordingly, there can be no assurance that the Company’s performance will not be adversely affected by increased competition.

Protectionist measures could restrict Company exports affecting thereby the Company’s sales performance

Due to the growing share of the Brazilian livestock, pork and poultry sector in the international market, companies are increasingly being affected by measures taken by importing countries in order to protect local producers. Because of the competitiveness of Brazilian companies, certain countries have raised several restrictions to prevent the entrance of Brazilian livestock products. Outcomes such as quota restrictions or import suspensions in a certain country or region, can affect substantially the sector’s export volumes and consequently the Company’s export performance as well as the results of its operations.

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FMD Cases in Brazil can indirectly affect pork and beef sales and adversely impact the results of the Company

Although the detected Foot and Mouth Disease (FMD) cases in the northeast region of Brazil in the past have affected only cattle, swine can also be contaminated. Recent cases of FMD have been identified in the states of Mato Grosso and Paraná. Sadia has animal breeding facilities located in the states of Santa Catarina and Minas Gerais, internationally recognized FMD free regions. An outbreak of FMD could have an effect on livestock owned by Sadia, the availability of livestock for purchase by Sadia, consumer perception of certain protein products or Sadia’s ability to access certain markets.

An outbreak of Avian Influenza could require the destruction of a significant portion of the Company’s flocks

Recent outbreaks of a highly pathogenic strain of avian influenza (“AI”) virus, known as H5N1, have been reported in Europe and Asia. Earlier outbreaks were reported during late 2003 and early 2004 in eight countries in Asia. At that time, more than 100 million birds in the affected countries either died from the disease or were destroyed in order to try to control the outbreak. The virus, which is believed to be spread from region to region by infected wild birds, represents a significant risk to flocks, which if infected must be destroyed to assure containment of the virus. No AI has been detected in Brazil and climatic conditions and distance from previous outbreaks reduce the likelihood of any outbreak. In 2003, through a joint effort of the Brazilian Ministries of Agriculture, Health and Environment, Brazil implemented a program to monitor and test birds with potential to carry the Avian Influenza virus from the South Pole.

In addition to the animal health requirements, which are part of the Brazilian National Poultry Health Program, Brazil has adopted a range of measures intended to limit the possibility of an outbreak of AI, including: tightened controls at ports and airports for travelers arriving from Asia; a prohibition on the importation of paddy rice from Asia; restrictions on visits to Brazilian poultry farms by travelers from Asia; and restrictions on the importation of poultry genetics.

Additional preventative measures have been discussed and the Brazilian government has proposed and approved the adoption of a National Plan for the Prevention and Control of Newcastle Disease and the Prevention of Avian Influenza (Plano Nacional de Controle e Prevenção da Doenca de Newcastle e de Prevenção de Influenza Aviária) which will conform with OIE (World Organization for Animal Health) standards. These measures are intended to assure international markets that Brazil maintains sanitary barriers between states. Specific measures include regulation of animal transportation, traceability, blood tests, designated laboratories and other controls to monitor production conditions on a regional basis. These measures are intended to permit the early detection of contamination in one region and to prevent the spread of that contamination to other regions within Brazil. Because the virus that causes AI is destroyed by cooking, it is generally agreed that the consumption of contaminated poultry does not present a threat to human health.

Despite measures adopted by the Company, the Brazilian government, and other poultry producers, no assurance can be given that the Company will not be affected by AI, either directly or through limitations on exports imposed by importing countries.

Risks relating to Sadia S.A.

The Company is controlled by a Group of Shareholders and the interests of the controlling group may conflict with those of other shareholders

The Company is controlled by a group of shareholders under the Company’s shareholders’ agreement. The preferred shares and the ADSs are not entitled to vote at shareholders’ meetings, except in limited circumstances. This means, among other things, that preferred shareholders are not entitled to vote on corporate transactions, including mergers or consolidations of the Company with other companies. In addition, the controlling shareholders have the ability to determine the outcome of any action requiring shareholder approval, including transactions such as corporate reorganizations, change of control transactions and the timing and payment of future dividends. For more information, see Item 7 — “Major shareholders and related party transactions”.

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If the Company loses any of its largest clients, or if they significantly reduce the amount they purchase from the Company, its revenue and operating income could be materially adversely affected

The Company’s ten largest customers in 2006 accounted for approximately 21% of total domestic sales and the ten largest international customers in 2006 accounted for approximately 50% of our total export sales.While the Company has been developing new client-oriented policies to reduce the concentration of revenues, if it loses any of its ten largest customers or if they reduce significantly the amount they purchase from the Company, revenues and operating income could be materially adversely affected.

The Company’s ability to export could be adversely affected by port labor disputes and disruptions and by import restrictions

The Company’s ability to export is dependent, in part, on factors beyond its control, including the lack of transport facilities due to strikes or other causes, or the enactment of Brazilian laws or regulations restricting exports in general or its products in particular. Any of these could affect the Company’s revenue and operating income.

ITEM 4. INFORMATION ON THE COMPANY

A. History and Development of the Company

Sadia S.A. is a publicly held company, incorporated in Brazil on June 7th, 1944, and therefore is subject to the requirements of Law No. 6,404, dated December 15th, 1976, as amended by Law 9,457/97 (Brazilian Corporate Law), and the rules and regulations of the Comissão de Valores Imobiliários — CVM, the Brazilian Securities Commission.

Sadia is Brazil’s leading refrigerated and frozen protein products company, operating in the processed product, poultry, pork and beef segments. The Company believes that its brand name and distinctive logotype are among the most widely recognized and admired in Brazil and in the foreign markets in which it sells its products, associated with quality, tradition and value. The Company’s central administrative headquarters are located at Rua Fortunato Ferraz, 659, Vila Anastácio, São Paulo, state of São Paulo, Zip Code 05093-901, Brazil, telephone number (55 11) 2113-3302, and the Company’s website is www.sadia.com.br or www.sadia.com and e-mail address is ri@sadia.com.br. Materials posted on the website are not deemed incorporated by reference into this annual report nor made a part hereof.

Sadia S.A. began in 1944, with the acquisition by Attilio Fontana of the meatpacker Concórdia Ltda., located in the municipality of the same name, in the Western part of the state of Santa Catarina, Brazil. At the time, the Company consisted of a wheat mill and an unfinished slaughterhouse for hogs.

At the end of the 1980s and early 1990s, the Company’s policy of expansion gave way to rationalization of management and cost structures through reduction by merging a number of companies in the Sadia Group. Sadia began the 1990s having controlling ownership in 21 companies, and began to concentrate its operations in the production of processed meat products.

In 1997, the Company sold its cattle slaughterhouse in Barra do Garças, state of Mato Grosso, four soybean processing facilities (crushing and refining), 12 grain purchasing and warehousing centers, and also transformed its Várzea Grande slaughterhouse, state of Mato Grosso, into a plant for the production of processed meat products. In addition, product transportation, which had been made by a fleet of owned vehicles, was outsourced to specialized transportation companies.

In July 1998 Sadia was created by the merger of Sadia Concórdia S.A. into Sadia Frigobrás S.A., consolidating its operations in a single public company, simplifying its corporate structure, emphasizing the Company´s brand, and reducing administrative expenses.

In December 1999, Sadia acquired the capital stock of Granja Rezende S.A. (primarily a producer and distributor of poultry and pork products) and its wholly owned subsidiaries Rezende Alimentos Ltda., Rezende Óleo Ltda. and Rezende Marketing Comunicações Ltda. Immediately following the acquisition of Granja Rezende, the Company decided to sell Granja Rezende’s soybean crushing and oil manufacturing plant and administrative complex.

During 2000, the subsidiary Rezende Alimentos Ltda. was converted from a limited liability company into a corporation and the subsidiary’s name was changed to Sadia Alimentos S.A. On December 29, 2000, the then parent was merged into Sadia Alimentos S.A., whose name was then

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changed to Sadia S.A. The purpose of the merger was to permit an operational and administrative rationalization, and the utilization of tax loss carry forwards. In August 2002, Granja Rezende S.A. was merged into Sadia, aiming at cost reduction both through standardization and through rationalization of the administrative and operational activities as well as by resulting reflections of financial and fiscal nature.

In April 2001, the Company listed its American Depositary Receipts (ADRs) program on the New York Stock Exchange, providing investors an alternate channel to buy its stocks. In June 2001, the Company adhered to Bovespa’s Level One of corporate governance, certifying its commitment to transparency and fair disclosure of information.

In August 2001, Sadia opened a distribution center (DC) in Jundiaí, São Paulo, to supply the São Paulo state region, considered the largest market in Brazil. The Jundiaí DC, is a technological milestone for the Company with 20,000 square meters of area. The Company invested R$ 30 million in facilities and IT structure.

Sadia GmbH was created in December 2001, and its subsidiary, Laxness F.C.P.A. Lda. (Laxness), was incorporated in April 2002, with the aim of leveraging exports to the European market. In February 2005, Laxness changed its name to Wellax Food Logistics C.P.A.S.U. Ltd (Wellax).

In 2004 Sadia began the expansion of the Uberlândia unit in order to improve the facility and make it one of the Company’s most modern facilities in Brazil. In November 2004, the Company opened a distribution center in Ponta Grossa, state of Paraná, giving Sadia greater capacity and efficiency in its export processes.

Also in November 2004, Sadia’s preferred shares were authorized to be traded on the Madrid Stock Exchange, by the International Latin American Market, Latibex, ender the symbol “XSDI”.

In January 2005, Sadia acquired 100% of Só Frango Produtos Alimenticios Ltda. (Só Frango), a company based in Brasilia with a total slaughtering capacity of 150,000 chickens per day (at the time of the acquisition). In March 2005, Só Frango was merged into Sadia.

The increase in liquidity of Sadia’s shares throughout 2005 led to the listing of its preferred shares at the Bovespa Index, known as Ibovespa, starting in September 2005.

In November 2005, Sadia decided to return to the beef segment due to the belief that it represents a complementary business to the Company’s activities. Sadia’s strategy in this segment is to concentrate sales towards the export market; for the domestic market the Company will focus its efforts on premium beef cuts.

In order to improve corporate governance levels and to more closely align interests among its shareholders, in 2005 Sadia granted 80% tag-along rights to the holders of non-voting preferred shares, satisfying market expectations.

In 2006 Sadia invested approximately R$970 million. The investments in 2006 were directed towards poultry, processed products , beef and some facilities expansion.

Reclassification

There have been no reclassifications made in the financial statements.

Investments

In the last years Sadia has continually increased its level of capital expenditures.

Sadia maintained its investments in 2006 with a firm commitment to growth and focus on its core business and the potential for international growth. Sadia ended 2006 with investments of R$969,6 million, including R$85.0 million for the Jundiaí and Uberlândia distribution centers and R$60.0 million for the Uberlândia margarine plant. The investments in 2006 were directed towards poultry (38%), processed products (31%), pork (15%), beef (1%) and our projects at Lucas do Rio Verde and Russia (15%).

From 2006 to 2009, Sadia plans to invest R$1.5 billion in the state of Mato Grosso. The Company will be responsible for R$800 million, and the remainder will be invested by its outgrowers. The amount will be directed towards the construction of a poultry slaughter house, with a slaughter

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capacity of 500,000 animals per day; a slaughter and industrialization hog unit, with slaughter capacity of 5,000 animals per day, one processing unit and a feed factory.

Additional information on this investment plan are as follow:

·  Sadia’s R$800 million investment will be distributed as follows: 25% in 2006; 50% in 2007 and the remainder 25%, in 2008;

·  For the first semester of 2008, the poultry slaughter houses will operate with 20% of capacity. In 2009, it is expected that these units will operate with 100% of capacity. • For the second semester of 2008, the pork slaughter houses will operate with 40% of capacity. In 2009, it is expected that these units will operate with 100% of capacity;

·  The expected additional annual revenue for poultry is R$600 million by 2009, and the expected additional revenue for the hog unit is R$400 million by 2009;

·  The R$800 million investment does not contemplate additional working capital, which will add up to R$80 million in 2009;

·  The tax incentives will be similar to those obtained in other states in the Midwest and better than those obtained in the southern states of Brazil.

In 2005, an amount of R$ 742.4 million was invested, of which R$ 194.6 million (26.2%) was directed towards the processed products segment, R$ 372.8 million (50.2%) towards poultry, R$ 27.0 million (3.6%) to pork and the remaining R$148.0 million (20%) to other projects, mainly to information technology. These investments were made in order to supply the growing demand in the domestic and export markets.

As part of the 2005 investment plan, in January 2005 Sadia acquired 100% of Só Frango Produtos Alimentícios Ltda. (“Só Frango”), for R$70.3 million. Só Frango was active in poultry slaughtering and processing as well as in the production of animal feed meal. Its product line ranges from whole chicken, special frozen and chilled cuts to sausages and cold cut meats. With 1,700 employees, Só Frango generated R$220 million in gross revenues in 2004 and had a slaughtering capacity of 150,000 chickens per day. In April 2005, Só Frango was merged into Sadia S.A.. Sadia intends to expand this capacity over the next five years to 400,000 chickens per day, which should generate 2,000 new direct jobs and around 12,000 indirect jobs. All operations with out growers and suppliers, as well as Só Frango’s job positions, have been maintained. Through this acquisition, the Company strengthened its presence in the central region of Brazil, close to raw material producers and to main centers of consumption.

In 2004, the amount invested was R$324.9 million, of which R$93.2 million (28.7%) was directed towards the processed products segment, R$146.6 million (45.1%) towards poultry, R$40.1 (12.3%) to pork. The remaining  R$44.9 million (13.8%) was directed towards the Ponta Grossa distribution center located in the state of Paraná, and towards the upgrade of the management software, SAP.

Investment Plans

Plans for 2007 contemplate investments of R$800 million, which will be destined to the Lucas do Rio Verde unit, the Russia plant, enlargement of our processed products capacity and to modernize manufacturing processes with an additional R$150 million to be invested in breeding stock.

The most significant investment, of about R$1.5 billion in the period from 2006 to 2009, is destined to the agroindustrial complex of Lucas do Rio Verde, in Mato Grosso. An amount of R$440 million is destined for 2007. This project contemplates the construction of a poultry slaughtering unit, one swine slaughtering and one processing unit. The works started in the second half of 2006 and the plant startup is scheduled for the first half of 2008. Out of the total estimated amount, R$ 800 million shall come from the company and the remaining R$700 million shall come from the group of integrated farmers. They will be financed by the National Economic and Social Development Bank (BNDES) to build the aviaries and poultry farms that will feed the agroindustrial complex.

The works for the expansion of the Uberlândia unit, which will become one of the most modern units among the 13 operated by the group in Brazil, are at the final stage and should be completed in 2007. The investment in this project totals R$ 400 million, distributed during the years of 2004/2007, R$30 million is expected to be invested in the Uberlândia unit in 2007.

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The investment in the Russia plant comprises a meat processing unit, developed in partnership with a Sadia distributor in that country. This is an investment of R$ 92 million and has already consumed R$ 13 million, will consume another R$ 60 million in 2007 and R$ 19 million in 2008. The works of this unit begun late in 2006 and startup is scheduled for the second half of 2007. The Russian market, which has become increasingly western, is compatible with Sadia’s business strategy abroad. For instance, the Company has already closed a pre-agreement to supply processed poultry to the McDonald’s fast food chain in that country.

A portion of the resources contemplated for 2007 will be used to expand the Brasília unit, to modernize the Concórdia and Chapecó (SC) units and to improve internal technological processes. Another portion will be allocated aiming to increase the Company´s beef slaughtering capacity, currently around 1,000 animals per day, to 2,000 heads per day by the end of 2007.

B. Business Overview

Sadia is the leader in all of the markets in which it operates within Brazil (see “Market Share”), with a product portfolio of over 1,000 products. According to the Brazilian Chicken Exports Association (ABEF), the Company is the largest Brazilian slaughterer and distributor of poultry and pork products, as well as the largest domestic exporter of poultry. Sadia is also the largest domestic distributor of frozen and refrigerated meat-based products (according to AC Nielsen), and leader in the Brazilian market for margarine. As of December 31, 2006, the Sadia Group had 47,490 employees, one of the largest employers in Brazil. During 2006 Sadia sold 918.0 thousand tons of poultry, 122.4 thousand tons of pork and 799.6 thousand tons of processed products, including frozen and refrigerated meat-based products and margarine, generating gross operating revenues of R$7.9 billion and net income of R$360.6 million.

The Company’s high degree of vertical integration ensures control at all stages of production and distribution of products. Sadia’s operations include breeding farms for poultry and hog grandparent and parent stock, hatcheries, pork breeding centers, slaughterhouses, processing units, animal feed production plants, representative offices and distribution centers. The Company pioneered the vertical integration of poultry and hog breeding in Brazil, initially in the state of Santa Catarina. Today, with the exception of beef, all operations employ a system of vertical integration, consisting of a partnership with rural producers, with a view to obtaining animals for slaughter, raised in highly productive breeding conditions and controlled hygienic-sanitary conditions. Sadia produces one-day chicks and piglets and supplies them to outgrowers, along with feed, transport, technical and veterinary assistance.

Sadia exports around 1,000 different products to approximately 100 countries. It currently produces a range of products that includes: frozen, refrigerated, salted and smoked pork cuts, lard, bacon, ingredients for “feijoada” (a Brazilian pork and bean stew); frozen and refrigerated pork and chicken giblets; whole frozen and seasoned chickens; frozen and refrigerated poultry cuts and parts; marinated and partially cooked chicken parts; whole frozen and seasoned turkeys; frozen and seasoned turkey cuts and parts; breaded chicken parts; raw, cooked and smoked hams; “tender” gammons, hams, cold cuts and related products; “Parma-type” hams; smoked chickens and turkeys; cooked and smoked turkey hams and turkey-based cold cuts; partially cooked and frozen products, such as beef, turkey and chicken meatballs; beef, turkey and chicken-based hamburgers; pork, turkey and chicken based frankfurters; sausages; bolognas; salamis; coppa; turkey-based hams; cold cuts in general; chicken, meat and pork-based patés; beef, poultry and fish-based frozen ready-made dishes and pasta; frozen ready-made foods for heating and serving as meals and snacks, such as breaded poultry, fish and appetizers, frozen pizzas and refrigerated fresh pasta; margarine and refrigerated desserts.

Sadia owns 13 plants within 7 different states in Brazil, and distributes its product line of over 1,000 items through distribution and sales centers located throughout Brazil, Latin America, the Middle East, Asia and Europe.

Business Strategy

Sadia’s business strategy is designed to give continuity to the Company’s growth and increase its profitability. The Company believes that with the recognition of its brand name as a symbol of quality, tradition and value—Sadia means “healthy” in Portuguese — an unequaled domestic distribution network supported by excellent logistics, attention to customer needs across the product line and in all distribution channels and highly favorable production economics in Brazil, the Company will be able to achieve both increased growth and increased profitability, while maintaining its commitment to its employees,

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outgrowers, suppliers and residents of the communities in which it does business. The principal elements of this strategy are as follows:

·              Increase domestic market penetration through expanded distribution. Sadia has an extensive distribution network, supported by an outsourced transportation fleet, superior knowledge of wholesale, retail and institutional sales channels, integrated logistics planning and strategically located distribution centers, trans-shipment points and facilities. The Company plans to continue to develop and improve its distribution network and systems in every product category.

·              Focus on retail sales, institutional and food service sales channels for domestic business. Sadia has increased, and plans to continue focusing on meeting the needs of retail sales outlets, institutional and food service sales channels, such as restaurants, rather than concentrating on wholesale outlets, such as large supermarkets and distributors. Between 2002 and 2006 the Company added more than 25,000 customers to its list.

·              Continue to increase service and market responsiveness. Sadia intends to remain the leader in Brazil in the markets that it serves by maintaining high standards of customer service and continuing to be responsive to the changing needs of varying market segments. As part of this strategy, it has structured its operations,distribution and logistics so that it can fill orders of varying sizes depending on the particular demands of the market segment. In export markets, the Company seeks to provide raw and processed products. It intends to remain close to its customer base, providing decentralized and rapid order fulfillment and personalized service, including attention to refrigeration quality in customers’ facilities.

·              Maintain low-cost product and operating efficiency. The natural advantages of operating in Brazil—grains, labor, weather, out-grower and related costs—added to the Company’s operating efficiency, permit it to compete in international markets. Sadia intends to continue to be amongst the lowest cost producers and distributors of protein products in the Brazilian and international markets. The Company’s vertically integrated operations and attention to operating efficiencies, permit quality and cost control throughout the entire production process.

·              Continued brand differentiation. Sadia has developed its brand across the entire product line both in the domestic and international markets, and that is amongst its most valuable assets. The Company intends to continue to invest in the development of  branded products, through shipping, packaging, advertising campaigns, with a view to continue to develop brand loyalty and the perception of premium quality that is associated with the Sadia products.

·              Increase production, through organic growth, investment in production capacity and acquisitions. Sadia’s goal is to expand production capacity at its existing facilities and to build new plants, while also continuing to focus on its core business. The Company estimates that investments in its facilities will total R$950 million for 2007, including R$150 million to be invested in breeding stock, R$440 million to expand the complex at Lucas do Rio Verde, R$150 million for construction of new distribution centers, R$60 million for construction at the Russia unit and R$150 million for general expansion of facilities, including expansion and modernization of Brasilia, Concórdia, Chapecó and Uberlândia and of the beef slaughtering capacity at the Várzea Grande unit.

Sadia is working on the expansion of the Uberlândia unit, which will become one of the most modern units among the 13 operated by the group in Brazil. The Company is at the final stages of completion and the expansion should be completed in 2007. The expansion is intended to increase production capacity and Sadia estimates that once the expansion is completed, chicken production will increase by 110% (from 41,875 to 88,000), pork production will increase by 146% (from 614 to 1,512) and turkey production will increase by 98% (from 6,379 to 12,614), measured by slaughtering heads per year, and production of industrialized products will increase by 62% (from 75,166 to 121,912), measured by tons per year. The investment in this project totals R$400 million over the years of 2004 through 2007, R$30 million is expected to be invested in the Uberlândia unit in 2007.

Sadia’s largest new investment is the agroindustrial complex of Lucas do Rio Verde, in Mato Grosso. Over the period from 2006 to 2009 the project will involve a total of approximately R$800 million in direct investment by Sadia and approximately an additional R$700 million in investments expected to be made by a group of approximately 130 integrated outgrowers. The investment involves the construction of a poultry slaughtering unit a swine slaughtering and a processing unit. The investment of the integrated outgrowers involves the construction of infrastructure for breeding and raising of poultry and swine to be processed in Sadia’s new facilities. In 2007, Sadia expects to invest approximately R$440 million. Construction started in the second half of 2006 and the complex is scheduled to begin operations in the first half of 2008. The Brazilian National Economic and Social Development Bank (BNDES) and

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Fundo Constitucional do Centro-Oeste, a government program managed by Banco do Brasil, are expected to finance the portion of the project costs to be borne by the integrated outgrowers. To date the BNDES has committed R$250 million to the outgrowers. Sadia has assisted the outgrowers to obtain the BNDES financing and intends to grant a guarantee to the BNDES in support of the outgrowers’ obligations to repay the BNDES financing to be drawn upon only in case BNDES’ security interest in the outgrowers’ assets, such as land and equipment, is not sufficient to cover their obligations In the past Sadia has granted financial guarantees to its outgrowers only on a very limited basis (as of December 2006, only R$20.2 million in such guarantees were granted). The remaining R$450 million in investments to be contributed by the outgrowers is expected to be financed by the Banco do Brasil program and possibly by additional BNDES commitments. Up to R$600 in commitments have been made available through the Banco do Brasil program to finance the outgrowers and, to the extent of any excess, Sadia’s investment in other projects. Sadia does not expect to offer a guarantee for any such additional amounts and the BNDES has made no additional commitment to finance it. Neither Sadia nor any other person has guaranteed that these additional investments will be made, the amount and timing of which will depend entirely on the ability of the outgrowers to obtain financing on terms acceptable to them. This venture is expected to create 8,000 direct and 24,000 indirect jobs.

The investment in the Russia plant comprises a meat processing unit, developed in partnership with a Sadia distributor in that country.  This is an investment of R$92 million approved in October 2006 and has already consumed R$13 million and will require another R$60 million in 2007 and R$19 million in 2008. The construction of this unit began late in 2006 and startup is scheduled for the second half of 2007. The Russian market, which has become increasingly westernized, is compatible with Sadia’s business strategy abroad. For instance, the Company already closed a pre-agreement to supply processed poultry to the McDonald’s fast food chain in that country.

·              Maintain exports and domestic sales volumes approximately equal. The competitiveness of the production of poultry and pork gives the Company access to international markets, economies of scale and low-cost export financing. Sadia has had success in increasing sales in foreign markets, such as Russia, where it previously did not have a presence, and increasing the number of markets in which the Company is present and the products that it sells. Sales to international markets and domestic markets, in substantially equal amounts, provides an important hedge against volatility in any particular market.

·              Invest in environmentally sound projects and initiatives. Sadia has been increasingly active in seeking to assure that its business is environmentally sound, beyond mere compliance with regulations, and it intends to invest significantly in this aspect of  the business. Recently, Sadia concluded a borrowing of R$60 million from the Brazilian development bank, BNDES, in order to develop the “3S Program” - Sadia Sustainable Swine Production Program, which will consist in selling carbon certified emission reductions under the Clean Development Mechanism signed at the Kyoto Treaty to finance social initiatives in the outgrowers area.

·              Expand product portfolio, with emphasis on higher value-added processed products. Sadia believes that continuous product innovation is essential to meet the needs of customers and consumers. As the market for frozen ready to eat products has grown, both domestically and internationally, Sadia has sought to meet the challenge by increasing emphasis from poultry and pork production to production of processed food products, including a product portfolio that now numbers over 700 products. During the last three years, Sadia has introduced an average of 60 new products per year, after extensive product development and test marketing.

The Company’s Operation

The Company’s operations are organized into four segments: “processed products” (frozen and refrigerated products and margarines), “poultry” (chickens and turkeys), “pork” and “beef”.

In 2006, 49.0% of total gross operating revenue was derived from the processed products segment, poultry 36.3%, pork 6.7%, beef 3.7% and 4.2% from other activities. Of the Company’s total gross operating revenue in 2005, 44.5% was derived from the processed products segment, poultry 41.4%, pork 8.9%, and 5.2% from other activities, such the grain and by-products segment, hog and poultry breeding, boiled beef, beef-parts and resale of products. In 2004 47.1% was derived from the processed products segment, poultry 40.8%, pork 8.2% and 3.9% from other activities.

Activities related to the grains and by-products currently consist of the crushing of soy to obtain the meal used as a raw material in the production of feed for the company’s stock and that of the integrated producers.

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The following tables present sales volumes and gross operating revenue (prepared and presented in accordance with US GAAP) for the years ended 2006, 2005 and 2004, as shown:

 

		Sales Volumes (ton)
		2006		2005		2004
Domestic Market		928,626		823,573		736,465
Processed Products		723,086		647,062		581,213
Poultry		155,485		142,177		105,826
Pork		41,022		34,334		49,426
Beef		9,033		—		—
Export Market		963,959		1,006,047		855,303
Processed Products		76,470		91,593		84,059
Poultry		762,479		808,636		692,192
Pork		81,382		105,818		79,052
Beef		43,628		—		—
Consolidated		1,892,585		1,829,620		1,591,768
Processed Products		799,556		738,655		665,272
Poultry		917,964		950,813		798,018
Pork		122,404		140,152		128,478
Beef		52,661		—		—

 

		Gross Operating Revenue (R$ Million)
		2006		2005		2004
Domestic Market		4,482.0		4,251.7		3,724.6
Processed Products		3,513.5		3,289.1		2,946.4
Poultry		492.3		512.1		415.4
Pork		154.5		148.3		154.9
Beef		40.6		—		—
Other		281.1		302.2		207.9
Export Market		3,412.0		4,075.7		3,392.7
Processed Products		361.6		412.3		405.6
Poultry		2,373.0		2,937.6		2,488.7
Pork		371.1		592.4		429.8
Beef		254.7		—		—
Other		51.6		133.4		68.6
Consolidated		7,894.0		8,327.4		7,117.3
Processed Products		3,875.1		3,701.4		3,352.0
Poultry		2,865.3		3,449.7		2,904.1
Pork		525.6		740.7		584.7
Beef		295.3		—		—
Other		332.7		435.6		276.5

(*)          Other: Grains and by-products, pig and chicken beeding and products resale

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The following table presents the breakdown of gross operating revenue in percentage terms by segment, for the years ended 2006, 2005 and 2004, as shown:

		Gross Operating Revenue by Segment (%)
		2006		2005		2004
Processed Products		49		44		47
Poultry		36		41		41
Pork		7		9		8
Beef		4		—		—
Other		4		5		4

(*)          Other: Grains and by-products, boiled beef parts, pig and chicken breeding and resale of products

The following information about segments is based upon information used by the Company’s management to assess the performance of operating segments and decide on the allocation of resources and has been prepared and presented in accordance with Brazilian GAAP that is adjusted for US GAAP presentation. The Company has four identifiable reportable segments: Processed Products, Poultry, Pork and Beef.

		2006		2005		2004
Net operating revenue
Processed products		3,102,397		3,147,296		2,731,136
Poultry		2,872,845		3,199,246		2,951,897
Pork		494,571		732,710		586,595
Beef		309,353		—		—
Other		97,535		239,186		37,845
Adjustments for US GAAP presentation		(46,401	)	(596	)	(198,248	)
Total net operating revenue		6,830,300		7,317,842		6,109,225

 

Other net operating revenue is primarily attributable to grains and by-products.

		2006		2005		2004
Depreciation expense
Processed products		(92,214	)	(60,863	)	(76,648	)
Poultry		(100,080	)	(80,336	)	(77,476	)
Pork		(15,223	)	(16,853	)	(20,647	)
Beef		(11,660	)	—		—
Other		(4,072	)	(7,294	)	(1,363	)
Total depreciation expense allocated to Segments		(223,249	)	(165,346	)	(176,134	)
Depreciation allocated to administrative expenses		(17,320	)	(12,829	)	(13,461	)
Adjustments for US GAAP presentation		35,185		(4,088	)	31,774
Total depreciation expense		(205,384	)	(182,263	)	(157,821	)

 

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		2006		2005		2004
Segment operating income
Processed products		194,494		273,684		274,197
Poultry		100,204		269,766		260,393
Pork		35,489		94,586		70,902
Beef		11,482		—		—
Other		2,087		2,798		(3,765	)
Adjustments for US GAAP presentation		(41,533	)	40,069		33,302
Total operating income		302,223		680,903		635,029
Interest expense		(310,442	)	(324,231	)	(413,461	)
Interest income and other		282,904		248,203		309,454
Foreign currency exchange gain (loss), net		104,219		159,602		20,672
Adjustments for US GAAP presentation		9,812		(93,825	)	35,428
Income before income taxes, equity income or loss of investees and minority interest		388,716		670,652		587,122

 

Segment assets
Processed products		715,248		624,619		491,982
Poultry		1,018,005		750,504		459,035
Pork		275,533		147,724		137,798
Beef		104,340		—		—
Other		220,312		143,359		76,910
Adjustments for US GAAP presentation		(178,458	)	(142,897	)	(110,485	)
Total property, plant and equipment		2,145,980		1,523,309		1,055,240
Reconciling items - corporate assets
Cash and cash equivalents		2,550,602		2,663,689		2,406,125
Accounts and notes receivable, net		678,598		509,615		349,605
Inventories		1,084,454		992,490		1,064,671
Other corporate assets		929,259		690,825		739,691
Adjustments for US GAAP presentation		463,406		184,459		105,156
Total consolidated assets		8,039,757		6,707,284		5,830,973
Capital expenditures
Processed products		302,648		194,587		93,220
Poultry		367,581		372,761		146,606
Pork		143,032		26,982		40,145
Beef		7,786		—		—
Other		234,331		91,662		52,286
Adjustments for US GAAP presentation		(85,776	)	56,365		(7,340	)
Total segment capital expenditures		969,602		742,357		324,917

Processed Products

As a result of the Company’s strategy of concentrating on higher value-added, higher margin products, the processed products segment results increased significantly as from the second half of the 1990s. Average volumes sold increased 11.2% per year since 1998. Sales of processed products accounted for 49.1% of the Company’s gross operating revenues in 2006.

Sadia owns nine plants that manufacture processed products, eight of which are dedicated to meat processing and one to margarine production. These plants are located close to their suppliers of raw materials or to the main domestic centers of consumption.

The processed products segment comprises a wide range of products, including: frozen products (hamburgers, breaded products, ready-to-eat dishes and pizzas), refrigerated products (hams, sausages, frankfurters, bolognas, salamis, cold cuts, product portions and refrigerated pasta) and margarine, the majority of which are sold under the Sadia brand.

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Processed products in the domestic market, accounted for 90.7% of the total gross sales of this segment, with the remaining 9.3% directed towards exports. The total sales from this segment grew 4.7% as compared to 2005.

Most of the raw materials used derive from poultry and pork produced by the company. By contrast, selected suppliers, who are subject to inspection by the Federal Agriculture Ministry, produce all beef that is processed by the Company.

The Company believes that the use of chicken meat as a raw material for processed products should grow substantially for two reasons: (i) the increase in the range of chicken-based products such as breaded products, and (ii) an increasing share for this kind of meat in the composition of other processed products, such as sausages, frankfurters and bolognas. Moreover, the development of specialized products (boiled and roasted products) for the institutional and foreign markets should also contribute to the increase in chicken production.

The following table presents gross operating revenue from sales of processed products in 2006, 2005 and 2004:

		Gross Operating Revenue (R$ Million)
		2006		2005		2004
Processed Products		3,875.1		3,701.4		3,352.0
Refrigerated		3,224.7		3,084.7		2,778.0
Frozen		650.4		616.7		574.0

 

Sadia is the Brazilian leader in frozen and refrigerated processed products according to AC Nielsen’s surveys. The Company’s market position is supported by significant investments in its brand, distribution channels and in quality control.

		Brazilian Market Share (2006)
		Position		Market Share by Revenue (%)		Period
Frozen Processed Products		1st		43.2		October/November-06
Refrigerated Processed Products		1st		30.2		November/December-06
Margarine		1st		38.1		October/November-06

 

Source: AC Nielsen

 

In order to maintain market share, Sadia will continue to concentrate on launchings of higher value-added products. In 2006, the Company launched 41 products, against 76 products in 2005 and 57 products in 2004.

Poultry, Pork and  Beef

In 2006, sales of non-processed products reached R$3,686.3 million, and accounted for 46.7% of the Company’s total gross operating revenue. In 2005, sales of non-processed products reached R$4,190.4 million, and accounted for 50.3% of Sadia’s total gross operating revenue. In 2004 sales of non-processed products reached R$3,488.7 million, and accounted for 41.9% of total gross operating revenue. In 2006, poultry, pork and beef sales accounted for approximately 87.9% of total export revenue, in 2005 for approximately 86.6% and in 2004, 86.0%.

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Sadia owns eight chicken slaughterhouses, three turkey slaughterhouses, and four pork slaughterhouses. In addition, the Company has one beef slaughterhouse in the state of Mato Grosso, which became operational as of November 2005. The table below shows slaughtering volumes of the Company for the years ended December 31, 2006, 2005, and 2004, in millions of units:

		Slaughtering Volumes (Million Heads)
		2006		2005		2004
Poultry		666.9		650.1		573.0
Hogs		4.0		3.8		3.5
Beef		0.25		0.07		—

 

The following table shows gross operating revenue from non-processed products, for the years of 2006, 2005 and 2004:

		Gross Operating Revenue (R$ Million)
		2006		2005		2004
Poultry		2,865.3		3,449.7		2,904.0
Whole		1,239.8		1,492.9		1,206.9
Parts		1,491.2		1,811.0		1,583.9
By-products		134.3		145.8		113.2
Pork		525.6		740.7		584.7
Beef		295.3		—		—
Total		3,686.2		4,190.4		3,488.7

 

In 2006, Sadia had a 14.7% share of chicken production in Brazil, in terms of tons and a 25.9% share of the Brazilian poultry export market. This compares with results for 2005 and 2004, when the Company had a 10.3% and 13.6% share of domestic chicken production and a 25.8% and 27.9% share of the Brazilian poultry export market, respectively. Sadia introduced turkey production to the Brazilian market in 1973, when its consumption was virtually non-existent. Today the market is shared with other competitors, but the Company is still in the leadership position, with 63.2% of total slaughter in 2006, as compared with 65.6% of total slaughter in 2005 and 66.2% for 2004.

Approximately 70.0% of the Company’s pork production is used in its processed products segment. The remainder is sold as fresh meat cuts in the domestic and international markets. According to the Brazilian Pork Producers Association (ABIPECS), in 2006, Sadia had a 12.1% share of Brazilian pork production, and a 14.5% share of the Brazilian pork export market. This compares with results for 2005 and 2004, when the Company had a 14.2% and 10.4% share of Brazilian pork production and a 14.2% and 19.7% share of the Brazilian pork export market, respectively.

In November 2005, Sadia decided to resume its beef operations because it believes that it represents a complementary business to the Company’s activities. Sadia’s strategy in this sector is to concentrate sales towards the export market; for the domestic market the Company will focus its efforts on premium beef cuts. In 2006, it accounted for 3.7% of total Gross Operating Revenues.

Production Process

Processed Products

The Company uses special cuts of pork, chicken and turkey, as well as selected and shaped fragments for the production of hams, sausages, frankfurters, bologna, hamburgers, pressed ham and related products. Seasonings and secondary raw materials are applied to each product type or line, according to established formulas, in order to ensure consistency, color, texture and flavor. The presentation of final products is achieved by shaping, casing, cooking and freezing in special machines. Products are then subjected to quality controls and distributed to the consumer market after having been packaged, labeled and boxed.

The raw material for margarine is crude soybean oil, which is subjected to refining and bleaching processes. Fats are obtained by hydrogenating bleached oil. Both of these materials are deodorized in order to prepare the “blend”. The process is completed by the preparation of an emulsion, the cooling and crystallization of the product, placing into containers, and the packing of these into boxes.

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Poultry

The production process for poultry consists of four stages. The first two entail direct investment by the Company in grandparent and parent stock. The third relates to the commercial stock of birds, and involves the direct participation of integrated outgrower farmers, and the last is the slaughtering process.

The Company imports grandparent stock from the United States in the form of eggs that are hatched in its hatcheries and then raised on company-owned farms. These birds produce parent stock that are also raised on Company-owned farms, and that in turn produce eggs. The operation involves eleven hatchery centers, eight of which produce “one-day-chicks” and three “one-day-turkeys”. The “one-day-chicks” are supplied to third-party outgrowers. Sadia operates a similar system for turkeys, importing eggs to produce grandparent stock that in turn produces parent stock that are raised on company-owned farms. The Company is not dependent on any foreign supplier for its genetic resources, nor does it face any barriers to their development.

The “one-day-chicks” produced by parent stock are supplied to integrated outgrowers who are responsible for raising the birds. Sadia has contracts with approximately 6,600 outgrowers, to which the Company provides feed, technical and veterinary assistance to allow such outgrowers the outgrowing process up to the time the birds reach slaughtering age, which for chickens is normally 36 days (at a weight of 2.0 kg). There are no employment agreements between the Company and the outgrowers, who generally carry out this activity in order to supplement their income. Most outgrowers farm on a small scale and raise six flocks per year (each flock consists of approximately 14,000 chickens). The Company remains the owner of the birds, and at the end of each production cycle, pays a commission fee based on a performance index that is calculated as a function of indicators such as bird mortality, feed to meat conversion ratio and average weight. The fee paid to the integrated farmers covers the outgrowing costs, raw materials, labor and their net profit.

Poultry are slaughtered through a process by which they are electrically stunned. They are then bled by puncturing of major blood vessels. After heating to a temperature of 55/60oC, they are plucked and gutted by automatic machines. The gutting process is subject to health control and inspection. The carcasses are then moved for cooling or freezing at respective temperatures of 6oC and -12/-18oC, and are then packaged according to the required standards of the Serviço de Inspeção de Produtos Animais (SIPA — Animal based Product Inspection Agency). At this stage, the whole birds are either distributed to the consumer market as fresh meat or used as raw material in processed products.

Pork

The Company produces grandparent, parent and piglet stock on its own farms, 90% of the parent stock produced by the Company is supplied to integrated outgrowers who receive feed, medicine and technical assistance by way of support. These parent animals produce hogs that are sold to the Company for slaughter, after the fattening process is completed. The remainder of the parent stock produced by Sadia is sold to piglet producers, who also receive feed, medicine and technical assistance. The Company repurchases the piglets at market prices and distributes them to integrated outgrowers, who after the fattening process sell such pigs to Sadia for slaughtering.

The hogs are slaughtered through a process in which they are bled after being stunned electrically. After heating to a temperature of 60/64oC, their bristles are removed by automatic machines. The animals are then dried, flamed, brushed and gutted, which process is subject to health inspection. After cooling to a temperature of 5oC, the carcasses are cut up and processed.

Beef

Sadia acquires cattle for slaughter at our Várzea Grande unit from producers in the state of Mato Grosso, within a limited radius of our facility, whose cattle have been branded at birth and therefore are of verifiable origin. Currently the Company is able to slaughter 1,000 heads of cattle per day on average.

Principal markets where the Company competes

In 2006, Sadia had an average of 43.2% of its gross operating revenues provided from exports. This ratio was 48.9% for 2005 and 47.7% 2004. The table set forth below presents the main regions of the world where the company has commercial relations and the discussion that follows describes the main trends and expectations for its markets. This information has been prepared and presented in accordance

 

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with Brazilian GAAP and is adjusted for U.S. GAAP. Refer to Note 23 of the consolidated financial statements for details on the primary differences between Brazilian GAAP and U.S. GAAP.

		Exports Gross Operating Revenues (Thousand R$)
		2006		2005		2004
Europe		889,171		978,318		985,746
Middle East		787,838		1,047,615		802,935
Asia		533,295		635,907		602,202
South America		528,453		542,151		387,130
Emerging Markets (mainly Russia and other former Soviet Union countries)		719,706		872,333		806,520
Adjustments to US GAAP presentation		(46,426	)	(627	)	(191,869	)
Total		3,412,037		4,075,697		3,392,664

Revenues are attributed to regions based upon where the products are shipped. All long-lived operational assets are located in Brazil and assets located outside of Brazil consist of sales offices located in various countries.

Europe is a large purchaser of poultry cuts and processed products. Sadia maintains a traditional presence in the Middle East, with market leadership and strong brand recognition. Middle Eastern countries primarily consume whole birds of low weight (up to 1.4 kilograms) and processed products. With respect to Eurasia, which comprises the Caucasus region and Russia, the Company exports mainly pork and poultry cuts. The main exports to Asia are special poultry cuts, pork carcasses and cuts. In the Americas, sales are concentrated primarily in processed products, poultry parts and whole birds. Secondary markets include regions with great potential for growth in the medium term.

Seventy nine percent of the Company’s exports in 2006 were to investment grade countries.

Market Overview — Domestic and International Markets

The growth potential of the Brazilian market for processed food, poultry, pork and beef, and Brazil’s low production costs are attractive to international competitors. The main barrier to such companies has nevertheless been the need to build a wide ranging refrigerated distribution chain, and a network of integrated producers.

The following analysis was prepared based on information mainly gathered from: The USDA (United States Department of Agriculture), CONAB (Brazilian National Supply Company), ABEF (Brazilian Poultry Exporters Association) and ABIPECS (Brazilian Pork Meat Exporters Association) and AC Nielsen reports.

Brazilian Processed Products Market

Consumption of processed products is influenced by several factors, including the increase in consumer income, and efforts related to the development of products, with a view to meeting consumer demand for more sophisticated products.

The processed products segment is divided into three categories: frozen products, refrigerated products and margarines.

Frozen Processed Products

In 2006, the Brazilian market for frozen processed products accounted for sales of R$1,286.3 million. Approximately 80.1% of this total is attributable to the two largest companies, Sadia and Perdigão.

 

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