20-F 1 d20f.htm ANNUAL REPORT ON FORM 20-F Annual Report on Form 20-F
Table of Contents

As filed with the Securities and Exchange Commission on April 2, 2007


SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 20-F

 


 

¨    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

 

OR

 

¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

¨    SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number: 1-14734

 

GROUPE DANONE

(Exact name of registrant as specified in its charter)

 

Not Applicable

(Translation of registrant’s

name into English)

 

17, Boulevard Haussman

75009 Paris

France

(Address of principal

executive offices)

 

France

(Jurisdiction of incorporation

or organization)

 

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

 

Title of each class:

  

Name of each exchange

on which registered:

American Depositary Shares, or ADSs,

each representing one-fifth of one Ordinary Share,

nominal value €0.50 per share

   New York Stock Exchange
Ordinary Shares, nominal value €0.50 per share    New York Stock Exchange

 

Securities registered or to be 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

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

 

260,864,746 ordinary shares, nominal value € 0.50 per share at December 31, 2006

 

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    ¨

 

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 1934.

 

Yes    ¨    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 for 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    ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-acccelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer    x   Accelerated filer    ¨   Non-accelerated filer    ¨

 

Indicate by check mark which financial statement item the registrant has elected to follow:

 

Item 17    ¨    Item 18    x

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes    ¨    No    x



Table of Contents

TABLE OF CONTENTS

 

          Page

Presentation of Information

   1

Cautionary Statement Regarding Forward-Looking Statements

   1
   PART I   

Item 1.

  

Identity of Directors, Senior Management and Advisors

   3

Item 2.

  

Offer Statistics and Expected Timetable

   3

Item 3.

  

Key Information

   3

Item 4.

  

Information on Groupe Danone

   11

Item 4A.

  

Unresolved Staff Comments

   34

Item 5.

  

Operating and Financial Review and Prospects

   35

Item 6.

  

Directors, Senior Management and Employees

   57

Item 7.

  

Major Shareholders and Related Party Transactions

   72

Item 8.

  

Financial Information

   76

Item 9.

  

The Offer and Listing

   78

Item 10.

  

Additional Information

   82

Item 11.

  

Quantitative and Qualitative Disclosures About Market Risk

   102

Item 12.

  

Description of Securities Other than Equity Securities

   104
   PART II   

Item 13.

  

Defaults, Dividend Arrearages and Delinquencies

   105

Item 14.

  

Material Modifications to the Rights of Security Holders and Use of Proceeds

   105
   PART III   

Item 15.

  

Controls and Procedures

   106

Item 16.

  

[Reserved]

   107

Item 16A.

  

Audit Committee Financial Expert

   107

Item 16B.

  

Code of Ethics

   107

Item 16C.

  

Principal Accountant Fees and Services

   107

Item 16D.

  

Exemptions from the Listing Standards for Audit Committees

   108

Item 16E.

  

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

   108

Item 17.

  

Financial Statements

   109

Item 18.

  

Financial Statements

   109

Item 19.

  

Exhibits

   109

 

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PRESENTATION OF INFORMATION

 

In this annual report, the “Company” refers to Groupe Danone, and “Danone” or the “Group” refers to Groupe Danone and its consolidated subsidiaries and equity affiliates. All references herein to “U.S. dollars,” “dollars,” “cents” or “$” are to the currency of the United States; references to “France” are to the Republic of France; and references to “euro” or “€” are to the currency of the European Union member states (including France) participating in the European Monetary Union.

 

The Company’s next general meeting of shareholders has been called for April 26, 2007.

 

Unless the context requires otherwise, all references herein to “markets” for particular products, or to market share, refer to markets for packaged products and exclude products which may be otherwise marketed or sold. Unless indicated otherwise, information relating to market share and position are based on volume sold. All references herein to “fresh dairy products” and the dairy products business or markets refer to processed dairy products and exclude milk, cream and butter. All references to “packaged water” refer to bottled water as well as water sold in large containers. The market share and volume data contained in this annual report have been compiled by the Company based in part upon statistics and other information obtained from several third-party sources. In addition, the Company utilizes its own surveys of competitors’ sales and customers’ purchases and inventory levels.

 

The Company maintains and publishes statistical information relating to its business in metric units, such as metric tons and thousands of liters. One metric ton equals 1,000 kilograms or 2,204 pounds, and one thousand liters equals approximately 264 gallons.

 

Various amounts and percentages in this annual report have been rounded and, accordingly, may not total 100%.

 

Since December 1990, the Company has sponsored an American Depositary Receipts, or ADRs, program in the United States with Citibank, N.A., as depositary. The American Depositary Shares, or ADSs, issued pursuant to such program have been registered with the Securities and Exchange Commission under a Registration Statement on Form F-6. Each such ADS represents one-fifth of one share. Since November 20, 1997, the ADSs have been listed on the New York Stock Exchange under the symbol “DA.” Groupe Danone has reached its current filing limit for ADRs. As a result, Citibank, N.A., as depositary, will no longer accept deposits of ordinary shares for the issuance of ADRs for Groupe Danone until further notice. The Groupe Danone ADR Program remains open for the cancellation of ADRs.

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

Certain of the statements contained in this annual report that are not historical facts, including, without limitation, certain statements made in the sections entitled “Item 3. Key Information—Risk Factors,” “Item 4. Information on Groupe Danone,” particularly the subsection “—Business Strategy,” “Item 5. Operating and Financial Review and Prospects” and “Item 11. Quantitative and Qualitative Disclosures About Market Risk,” are statements of future expectations. Forward-looking statements (within the meaning of Section 27A of the United States Securities Act of 1933 and Section 21E of the United States Securities Exchange Act of 1934, as amended) can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “is expected to,” “will,” “will continue,” “should,” “would,” “seeks” or “anticipates” or similar expressions or the negative thereof or other variations thereof, or comparable terminology, or by discussions of strategy, plans or intentions. Although the Company believes its expectations are based on reasonable assumptions, these forward-looking statements are subject to numerous risks and uncertainties. Risks that could cause actual results to differ materially from the results anticipated in the forward-looking statements include, among other things:

 

   

the risks of actual or alleged contamination or deterioration of food products;

 

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risks and uncertainties attendant to doing business in numerous countries which may be exposed to, or may have recently experienced, economic or governmental instability;

 

   

changes in economic trends and seasonality;

 

   

pricing and availability of raw materials;

 

   

changes in exchange rates, particularly the exchange rates of the euro to non-euro currencies;

 

   

customers and market concentration;

 

   

changes in laws and regulations;

 

   

increasing levels of competition in France and other international prepared food and beverage markets; and

 

   

general competitive and market factors on a global, regional and/or national basis.

 

Readers are urged to carefully review and consider the various disclosures made by the Company that attempt to advise interested parties of the factors affecting the Company’s business, including the disclosures made under the captions “Item 3. Key Information—Risk Factors,” “Item 4. Information on Groupe Danone,” particularly the subsection “—Business Strategy,” and “Item 5. Operating and Financial Review and Prospects” in this annual report, as well as in the Company’s other periodic reports on Form 6-K submitted to the Securities and Exchange Commission. The Company does not intend, and does not assume any obligation, to update any industry information or forward-looking statements set forth in this annual report to reflect subsequent events or circumstances.

 

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PART I

 

Item 1.    Identity of Directors, Senior Management and Advisors

 

Not applicable.

 

Item 2.    Offer Statistics and Expected Timetable

 

Not applicable.

 

Item 3.    Key Information

 

Selected Financial Data

 

The Company publishes its consolidated financial statements in euro. Solely for the convenience of the reader, this annual report contains translations of certain euro amounts into U.S. dollars at specified rates. These translations should not be construed as representations that the converted amounts actually represent such U.S. dollar amounts or that the original amounts could have been, or could be, converted into U.S. dollars at the rates indicated or at any other rate. Unless otherwise stated, the translations of euro into U.S. dollars have been made at the rate of $ 1.3197 per € 1.00, or € 0.7577 per $ 1.00, the noon buying rate in New York City for cable transfers in euro as certified for customs purposes by the Federal Reserve Bank of New York (the “Noon Buying Rate”) on December 29, 2006. See “—Exchange Rate Information” below for information regarding the euro/U.S. dollar exchange rates from 2002 to the present.

 

Unless otherwise indicated, the financial information contained in this annual report has been prepared in accordance with International Financial Reporting Standards (“IFRS”) as adopted by the European Union, which differ in certain significant respects from United States generally accepted accounting principles (“U.S. GAAP”). See Note 2 to the Company’s audited consolidated financial statements for the years ended December 31, 2004, 2005 and 2006 (the “Consolidated Financial Statements”) included elsewhere in this annual report for a description of the principal differences between IFRS and U.S. GAAP, as they relate to the Group, and a reconciliation to U.S. GAAP of net income and stockholders’ equity.

 

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The table below presents selected consolidated financial data for the Group for the three-year period ended December 31, 2006. Such data have been extracted or derived from the Consolidated Financial Statements of the Group, and are qualified by reference to, and should be read in conjunction with, the Consolidated Financial Statements and the Notes thereto and “Item 5. Operating and Financial Review and Prospects” included elsewhere in this annual report. The Consolidated Financial Statements have been audited by PricewaterhouseCoopers Audit, independent registered public accounting firm, as indicated in their report thereon, dated March 27, 2007, which also appears in this annual report.

 

     Year ended December 31,        
     2004     2005     2006     2006(1)  
     (in millions of €, except per share data)    

(in millions

of $, except

per share

data)

 

Amounts in accordance with IFRS:

        

Consolidated Income Statement Data

        

Net sales

   12,273     13,024     14,073     $ 18,572  

Trading operating income

     1,608       1,738       1,914       2,526  

Operating income

     1,559       1,706       1,874       2,473  

Net income from discontinued operations

     47       504       154       203  

Net income from continuing operations

     591       1,167       1,406       1,855  

Net income—attributable to the Group

     449       1,464       1,353       1,786  

Net income—attributable to minority interests

     189       207       207       273  

Earnings per share attributable to the Group(2)

     1.79       5.95       5.57       7.35  

Earnings per share from continuing operations attributable to the Group

     1.60       3.90       4.96       6.55  

Diluted earnings per share attributable to the Group(2)

     1.79       5.87       5.53       7.30  

Diluted earnings per share from continuing operations attributable to the Group(2)

     1.62       3.86       4.92       6.49  

Consolidated Balance Sheet Data

        

Current assets

   5,427     6,118     6,154     $ 8,121  

Non-current assets

     10,652       10,607       10,702       14,123  

Total assets

     16,079       16,725       16,856       22,245  

Net debt(3)

     4,538       3,572       2,902       3,830  

Stockholders’ equity attributable to the Group

     4,256       5,280       5,823       7,685  

Minority interests

     250       341       246       325  

Dividends per share(2)

     1.35       1.70       2.00       2.64  

Cash Flow Statement Data

        

Cash flow provided by operating activities, excluding changes in working capital

   1,574     1,716     1,891     $ 2,496  

Cash flow provided by operating activities

     1,694       1,847       2,169       2,862  

Cash flow provided by (used in) investing activities

     214       312       (501 )     (661 )

Cash flow used in financing activities

     (1,872 )     (2,102 )     (1,553 )     (2,049 )

(1)   Translated solely for convenience into dollars at the Noon Buying Rate on December 29, 2006 of $ 1.3197 per € 1.00.
(2)   Earnings and dividends per share have been adjusted following the June 2004 two-for-one stock split. Basic earnings per share is based on an average number of shares of 250,671,990, 246,038,406 and 242,734,094 as of December 31, 2004, 2005 and 2006, respectively. Diluted earnings per share is based on the average number of shares outstanding during the year assuming full conversion of all common stock equivalents and convertible bonds and taking into account the related reduction in interest charges, net of tax. Such average number of shares was 257,530,982, 250,280,950 and 244,688,913 for the years ended December 31, 2004, 2005 and 2006, respectively. Dividends for 2006 will be submitted for the approval of the annual shareholders’ meeting on April 26, 2007.
(3)   Net debt is defined as current and non-current financial liabilities less cash, cash equivalents and marketable securities. Danone’s management uses net debt as an internal liquidity indicator. Danone believes this information will be useful to investors since it is used as a performance measure by credit rating agencies. See “Item 5. Operating and Financial Review and Prospects—Liquidity and Capital Resources—Financial Condition” for a reconciliation of net debt to total debt.

 

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The table below presents selected consolidated financial data for the Group for the five-year period ended December 31, 2006 in accordance with U.S. GAAP.

 

     Year ended December 31,
     2002    2003    2004    2005    2006    2006(1)
     (in millions of €, except per share data)   

(in millions

of $, except
per share

data)

Approximate amounts in accordance with U.S. GAAP(2):

                 

Consolidated Income Statement Data

                 

Net sales

   12,155    11,678    12,072    12,806    13,953    $ 18,414

Operating income

     2,095      1,511      1,465      1,649      1,824      2,407

Net income

     1,420      923      399      1,335      1,326      1,750

Of which net income from continuing operations

     1,378      874      341      906      1,141      1,506

Of which net income from discontinued operations

     42      49      58      429      185      244

Earnings per share (basic)(3)

     5.38      3.63      1.59      5.43      5.46      7.21

Of which earnings per share from continuing operations

     5.23      3.43      1.36      3.68      4.70      6.20

Of which earnings per share from discontinued operations

     0.16      0.20      0.23      1.75      0.76      1.00

Earnings per share (diluted)(3)

     5.22      3.54      1.57      5.35      5.42      7.15

Of which earnings per share from continuing operations

     5.04      3.34      1.35      3.62      4.66      6.15

Of which earnings per share from discontinued operations

     0.18      0.20      0.22      1.73      0.76      1.00

Earnings per ADS (diluted)(3)(4)

     1.05      0.71      0.31      1.07      1.08      1.43

Of which earnings per ADS from continuing operations

     1.01      0.67      0.27      0.72      0.93      1.23

Of which earnings per ADS from discontinued operations

     0.04      0.04      0.04      0.35      0.15      0.20

Consolidated Balance Sheet Data

                 

Stockholders’ equity attributable to the Group

     4,836      4,671      4,472      5,434      5,973      7,883

Total assets

     15,260      14,355      13,285      13,993      14,753      19,470

(1)   Translated solely for convenience into dollars at the Noon Buying Rate on December 29, 2006 of $ 1.3197 per € 1.00.
(2)   For a description of the reconciliation to U.S. GAAP, see Note 2 to the Consolidated Financial Statements.
(3)   Earnings per share have been adjusted following the June 2004 two-for-one stock split. Basic earnings per share is based on an average number of shares of 263,700,262, 254,583,270, 250,671,990, 246,038,406 and 242,734,094 as of December 31, 2002, 2003, 2004, 2005 and 2006, respectively. Diluted earnings per share and ADS are based on the average number of shares outstanding during the year assuming full conversion of all common stock equivalents and convertible bonds and taking into account the related reduction in interest charges, net of tax. Such average number of shares was 274,482,258, 263,196,496, 257,530,982, 250,280,950 and 244,688,913 for the years ended December 31, 2002, 2003, 2004, 2005 and 2006, respectively.
(4)   Earnings per American Depositary Share, or ADS (diluted), has been calculated by dividing Earnings per share (diluted) for the applicable period as set forth in the immediately preceding line in the table, by five to reflect the ratio of one-fifth of one share per ADS.

 

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Exchange Rate Information

 

The following table sets forth, for the periods and dates indicated, certain information concerning the Noon Buying Rate in New York City for cable transfers for foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York expressed in U.S. dollars per € 1.00. These rates are provided solely for the convenience of the reader and are not the rates used by the Company in the preparation of its Consolidated Financial Statements included elsewhere in this annual report. For its general financial reporting, the Group uses the rate published by the Banque de France. No representation is made that euro could have been, or could be, converted into U.S. dollars at these rates or any other rate.

 

     U.S. dollars per € 1.00
    

Yearly/Period

end rate

  

Average

Rate(1)

   High    Low

Yearly amounts

           

2002

     1.05      0.95      1.05      0.86

2003

     1.26      1.14      1.26      1.04

2004

     1.35      1.25      1.36      1.18

2005

     1.18      1.24      1.35      1.17

2006

     1.32      1.27      1.33      1.19

Monthly amounts

           

September 2006

     1.27      1.27      1.28      1.26

October 2006

     1.28      1.26      1.28      1.25

November 2006

     1.33      1.29      1.33      1.27

December 2006

     1.32      1.32      1.33      1.31

January 2007

     1.30      1.30      1.33      1.29

February 2007

     1.32      1.31      1.32      1.29

March 2007

   $ 1.34    $ 1.32    $ 1.34    $ 1.31

(1)   The average of the Noon Buying Rates on the last business day of each month during the relevant period.

 

Fluctuations in the exchange rate between the euro and the U.S. dollar will affect the U.S. dollar equivalent of the euro-denominated prices of the shares and, as a result, will affect the market price of the ADSs in the United States. In addition, exchange rate fluctuations will affect the U.S. dollar equivalent of any cash dividends received by holders of ADSs.

 

For a discussion of the impact of exchange rate fluctuations on the Group’s results of operations, see “Item 5. Operating and Financial Review and Prospects—Impact of Changes in Exchange Rates.”

 

Risk Factors

 

In addition to the other information contained in this annual report, prospective investors should consider carefully the risks described below. The risks described below are not the only ones facing the Group. Additional risks not currently known to the Group or that the Group currently deems immaterial may also impair its business operations. The Group’s business, financial condition or results of operations could be materially adversely affected by any of these risks.

 

The actual or alleged contamination or deterioration of the Group’s products, or of similar products of other producers, could hurt the Group’s reputation and its operating results and financial condition

 

The Group’s business could be negatively affected by the actual or alleged contamination or deterioration of certain of its principal products, or of similar products sold by other producers. A substantial portion of the Group’s products, such as fresh dairy products, must be maintained within certain temperatures to retain their flavor and nutritional value and avoid contamination or deterioration. Depending on the specific type of food product, a risk of contamination or deterioration exists at each stage of the production cycle, including the

 

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purchase and delivery of food raw materials such as milk, the processing and packaging of food products, the stocking and delivery of finished products to distributors and food retailers, and the storage and shelving of finished products at the points of final sale. With respect to bottled water, the natural sources of Danone’s supply may be subject to pollution. In addition, as part of its strategy of promoting products with a strong health component, the Group is developing more and more complex products made from organic materials, especially probiotics. In the event that certain of Danone’s products are found, or are alleged, to have suffered contamination or deterioration, whether or not while such products were under Danone’s control, the Group’s net sales, results of operations and financial condition could be materially adversely affected. In addition, reports or allegations of inadequate product quality control with respect to certain products of other food manufacturers could negatively impact sales of the Group’s products. The Group believes that it has put in place measures to limit the risk of contamination, in particular through regular audits of its sites, alliances with scientific organizations of international standing and the implementation of zero-tolerance quality assurance and food safety policies.

 

Instability in markets where the Group operates could harm its business

 

The Group’s operations are subject to the risks and uncertainties attendant to doing business in numerous countries which may be exposed to, or may have recently experienced, economic or governmental instability, particularly in Latin America, Asia and the Middle East. Also, a number of countries in which the Group’s operations are conducted have less developed and less stable legal environments, maintain controls on the repatriation of profits and invested capital, impose taxes and other payments and put in place restrictions, sometimes retroactively, on the activities of multinational companies. Management believes that it has taken and continues to take appropriate measures to minimize the risks arising from the Group’s international operations. However, there can be no assurance that the financial results of the Group could not be materially affected by a downturn in economic or political conditions or by any regional crisis or significant regulatory change.

 

Seasonal consumption cycles and weather conditions may result in fluctuations in demand for some of the Group’s products and impact results of operations

 

Some of the Group’s product markets are affected by seasonal consumption cycles and weather conditions which can have a negative impact on the Group’s interim and annual results. In particular, bottled water and beverages experience peak demand during the summer months. As a result, the Group’s sales are generally higher during these months. Conversely, relatively cool summer temperatures, such as occurred in Europe in 2004, may result in substantially reduced sales of beverages, especially bottled water, and thus may have a material adverse effect on the Group’s results of operations.

 

Price increases and shortages of food and packaging raw materials could adversely affect the Group’s results of operations

 

The Group’s results of operations may be affected by the availability and pricing of raw materials, principally materials needed to produce Danone’s food and beverage products, mainly including milk, wheat, sugar and cocoa, and materials needed for packaging its products, mainly including PET and PVC plastics and light cardboard for cartons. Factors such as changes in the global or regional levels of supply and demand, weather conditions and government controls could substantially impact the price of food and packaging raw materials. A substantial increase in raw material prices (if not passed on to customers through price increases) or a continued interruption in supply could have a material adverse effect on the Group’s financial condition and results of operations.

 

The Group’s results of operations and financial condition could be harmed by changes in exchange rates

 

The Group publishes its Consolidated Financial Statements in euro. In addition, in 2006, approximately 48% of the Group’s consolidated net sales and approximately 60% of its trading operating income were in euro. However, a substantial portion of the Group’s assets, liabilities, sales, costs and earnings are denominated in

 

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currencies other than the euro, particularly in the Chinese yuan, the U.S. dollar and U.S. dollar-influenced currencies, the British pound or the Polish zloty. As a result, the Group is exposed to fluctuations in the values of such currencies against the euro with respect to the translation into euro of amounts to be reflected in its Consolidated Financial Statements. These currency fluctuations, especially with respect to these principal non-euro currencies, can have a significant impact on the Group’s results of operations. In particular, the appreciation of the euro relative to other currencies decreases the euro value of the contribution to the Group’s consolidated results and financial condition of subsidiaries which maintain their financial accounts in such other currencies. In addition, to the extent the Group incurs expenses and effects sales in different currencies in cross-border transactions, fluctuations in exchange rates can also affect the profitability of such transactions. As a result of the Group’s international strategy, the contribution by international activities to consolidated net sales, operating results and net income is expected to continue to increase over time.

 

The Group’s dependence on key customers and increased market concentration could negatively affect the Group’s ability to achieve its targeted margins and reduce its competitiveness

 

While the final consumers of Danone products are individual retail customers, Danone sells its products principally to major retail and grocery chains. The distribution market has become increasingly concentrated. In 2006, the Group’s ten largest customers worldwide accounted in the aggregate for approximately 28% of the Group’s consolidated net sales. Six of those customers are French companies and the Group’s largest client, Carrefour, represented approximately 8% of the Group’s consolidated net sales in 2006. Any increase in the Group’s dependence on key customers or market concentration generally could negatively affect the margins and competitiveness of the Group.

 

The Group depends on a limited number of suppliers for certain products and services

 

In connection with its policy of optimizing its purchasing procedures, the Group centralizes the purchase of certain materials or sub-contracted services, such as the ferments used in the fresh dairy products activities or information technology services, from a limited number of suppliers. If these suppliers are not able to supply the Group with the quantities of materials the Group needs or if the suppliers are not able to provide services in the required time period, this could have a material adverse effect on the Group’s financial condition and results of operations.

 

Changes in governmental regulations could harm the Group’s business

 

As a producer of consumer foods and beverages, the Group’s activities are subject to extensive regulation by national authorities and international organizations, including regulation with respect to the environment, hygiene, quality control and tax laws. The Group’s activities may also be subject to all kinds of barriers or sanctions imposed by countries in order to limit international trade. The activities of the Group are also subject to increasingly restrictive regulation with regard to the protection of health and human safety, especially concerning assertions about the health benefits of products marketed by the Group. The Group’s activities could be adversely affected by any significant changes in such regulation. While the Group believes that it has put in place appropriate measures to limit the risks associated with these activities through a policy of environmental management, including, in particular, the establishment of regular inspections (industrial, environmental and quality control) at all of its sites, the introduction of higher standards or more stringent regulations could necessitate additional investment and result in substantial costs for the Group.

 

The Group’s dominant position in certain markets may lead to accusations of abuse of dominance or anti-competitive practices

 

In certain of its markets, the Group is the market leader. As a consequence, the Group may be accused of the abuse of a dominant position or the use of anti-competitive practices. Such allegations could affect the reputation of the Group, result in judicial proceedings and could have a material adverse effect on the Group’s financial condition and results of operations.

 

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The Group’s results of operations and financial condition could be harmed by a failure of its information systems

 

The Group is increasingly dependent upon information technology network systems to obtain the numerical data which it uses as a basis for its operating management decisions. Any failure of these applications or communications networks may delay or taint certain decisions and result in financial losses.

 

The Group may not be able to adequately protect its intellectual property rights

 

Given the importance of brand recognition to its business, the Group has invested considerable effort in protecting its portfolio of intellectual property rights, including trademark registration, such as, for example, the trademarks Danone, Evian and LU. The Group also uses security measures to protect its patents, licenses and proprietary formulae. However, the Group cannot be certain that the steps it has taken will be sufficient to protect its intellectual property rights adequately or that third parties will not infringe upon or misappropriate its proprietary rights. Moreover, some of the countries in which the Group operates offer less protection for intellectual property rights than Europe or North America. If the Group is unable to protect its proprietary rights against infringement or misappropriation, its future financial results and its ability to develop its business could be harmed.

 

Labor disputes may cause work stoppages, strikes and disruptions

 

The Group has in the past implemented, and may in the future continue to implement, restructuring measures, including plant closings and headcount reductions, in order to lower production costs, improve efficiency of its facilities, exploit synergies and respond to the demands of a changing market. Restructurings could harm its employee relations and result in labor disputes, including work stoppages, strikes and disruptions, which in turn could have an adverse impact on the Group’s business or financial results.

 

Competition may lead to a reduction of the Group’s margins and a decline in profitability

 

The markets for each of Danone’s main business lines are highly competitive markets in which large international groups and numerous local actors are present. In Western Europe and North America, the markets served by Danone tend to be relatively mature and competition for market share is therefore particularly intense. With respect to the Group’s activities outside Western Europe and North America, certain international food and beverage groups also have important positions in certain product lines and in certain emerging markets and seek to expand such positions or enter new markets. In addition, certain retail and grocery chains have developed their own private labels and certain of Danone’s customers also offer their own competing products. As a result, the Group must continually strive to strengthen the selling power and premium image of its brand names, differentiate its products and improve the efficiency and management of its operations in order to maintain or increase its profit margins. Failure to remain competitive would have a material adverse effect on the Group’s operating results and financial condition.

 

The Group’s sales may be affected by overall economic trends in its principal geographic markets

 

As a producer principally of consumer foods and beverages, the Group’s results of operations may be affected by the overall economic trends of its principal geographic markets. In periods of economic slowdown, consumer purchase decisions may be affected by specific consumer behaviors, thus creating negative pressure on the Group’s net sales.

 

The Group’s strategy relies significantly on acquisitions, which involve risks

 

The Group’s strategy is to become the leader in each of the markets in which it operates. Within the context of continued concentration in the food and beverage industry, this strategy involves the pursuit of external growth opportunities through acquisitions and alliances. These acquisitions and alliances could have a negative

 

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impact on the Group’s business if the Group is unsuccessful in the integration process or fails to achieve the synergies and savings it expects from these acquisitions. Furthermore, the relations with partners of the Group in certain entities are governed by documents or agreements that could allow certain decisions to be made with the agreement of such partners or without the agreement of the Group. Such restrictions could make it difficult for the Group to pursue its objectives through these entities. Finally, certain agreements signed with partners could subject the Group to put options, notably in the event of a change of control of the Group.

 

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Item 4.    Information on Groupe Danone

 

History and Development

 

Groupe Danone is a société anonyme, a form of limited liability company, organized under the laws of the Republic of France. It was incorporated on February 2, 1899. Under Groupe Danone’s bylaws, revised in 1941, the Company’s existence is to last 141 years, i.e., until December 13, 2040, except in the event of earlier dissolution or extension. Its principal office is located at 17, Boulevard Haussmann, 75009 Paris, France, and its telephone number is (+33) 1.44.35.20.20. The Company’s agent in the United States is The Dannon Company Inc., located at 120 White Plains Road, Tarrytown, New York 10591-5536, USA.

 

The Company is registered with the Register of Commerce and Companies of Paris (Registre du Commerce et des Sociétés de Paris) under number 552 032 534.

 

The Company’s origins date back to 1966 when the French glass manufacturers, Glaces de Boussois and Verrerie Souchon Neuvesel, merged to form Boussois Souchon Neuvesel, or BSN. In 1967, BSN had sales of flat glass and glass containers of approximately € 150 million. In 1970, BSN began a program of diversification in the food industry and successively purchased Brasseries Kronenbourg, Société Européenne de Brasserie and Société Anonyme des Eaux Minérales d’Evian, which at the time were major customers of BSN for glass containers. As a result of these acquisitions, BSN became France’s market leader in beer and bottled water, as well as infant food, which was at that time one of Evian’s product lines. In 1973, BSN merged with Gervais Danone, a French dairy products and pasta group, thereby becoming France’s largest food and beverage group with consolidated sales in 1973 of approximately € 1.4 billion, of which 52% consisted of food and beverage sales.

 

Throughout the remainder of the 1970s and the 1980s, BSN focused on expansion in the food and beverage industry, primarily in Western Europe, after disposing of its flat glass business. This expansion included the acquisition of major breweries in Belgium, Spain and Italy; The Dannon Company, the leader in yogurt production in the United States; Générale Biscuit, a French holding company which owned LU and other major producers of biscuits in Europe; the biscuit subsidiaries of Nabisco, Inc. in France, Italy, the United Kingdom and Asia; and Galbani, Italy’s leading cheese maker. As a result, with consolidated sales of € 7.4 billion in 1989, BSN became Europe’s third largest diversified food group, ranking first in France, Italy and Spain.

 

Beginning in the early 1990s, BSN pursued a strategy of consolidating its main business lines, developing synergies in Western Europe and expanding into growing markets. Moreover, BSN paved the way for a strategy of development outside of Western Europe. As a result, BSN increased the scope of its operations and strengthened its portfolio of brands through a number of significant acquisitions and joint ventures. Within Western Europe, BSN acquired Volvic in France to strengthen its position in the bottled water sector. Outside Western Europe, BSN pursued an active acquisition strategy to expand internationally in the Asia-Pacific region, Latin America and Eastern Europe, as well as in selected markets like South Africa and the Middle East.

 

In 1994, BSN changed its name to Groupe Danone, adopting the name of the Group’s best known international brand, with a view to consolidate its position as an international food and beverage group and to reinforce the marketing strength of the Danone brand name.

 

In 1997, the Group’s management decided to focus on three core activities on a worldwide basis (fresh dairy products, beverages, and biscuits and cereal products). The Group has since completed several significant divestitures in grocery, pasta, ready-to-serve meals and confectionery activities, mainly in France, Belgium, Italy, Germany and Spain. In 1999 and 2003, the Group sold 56% and 44%, respectively, of the capital of BSN Glasspack, the holding company of its glass containers business, and, in 2000, the Group sold most of its European beer activities to different companies in the industry, including Scottish & Newcastle. In 2002, the Group sold Kro Beer Brands, which held the brands Kronenbourg and 1664, among others; its Italian cheese and meat activities (Galbani); as well as its beer producing activities in China. In 2005, the Group sold its sauces

 

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activities in the United Kingdom and in the United States and, in January 2006, its sauces activities in Asia. In addition, in 2005 the Group finalized its exit from the European beer activities, selling its interest in the Spanish company Mahou. These divestitures since 1997 represented net sales of approximately € 5.9 billion in the aggregate.

 

This strategy enabled Danone to concentrate its financial and human resources on product lines with strong commercial potential and in which the Group holds leading local positions as well as to pursue its expansion outside Western Europe through internal growth, strategic acquisitions and the creation of companies.

 

Since 1998, the Group has been organized around three core activities:

 

   

fresh dairy products, including yogurts, dairy desserts and infant foods, representing approximately 56% of consolidated net sales in 2006;

 

   

beverages, representing approximately 28% of consolidated net sales in 2006; and

 

   

biscuits and cereal products, representing approximately 16% of consolidated net sales in 2006.

 

Key Events in 2006

 

The Group’s revenue in 2006 amounted to € 14,073 million, an increase of 8.1% compared to 2005. At constant exchange rates and scope of consolidation, growth in revenue was 9.7%, one of the best performances ever for the Group, in particular in the fourth quarter. Trading operating margin, which increased for the twelfth consecutive year, by 25 basis points in 2006, reached 13.60%, compared to 13.35% in 2005, in spite of a large increase in the cost of transport and the price of certain raw materials, in particular, plastics.

 

In 2006, the Group again demonstrated its ability to innovate and extend the territory of its brands and products, both in terms of geographic extent and range of products. In its fresh dairy product segment, the Group (i) successfully launched the Activia product line in the United States and Senja, a 100% vegetable specialty soy product, in France and Spain, and (ii) penetrated the organic product market in Europe, with the launch of the Les 2 Vaches des Fermiers du Bio line in France and acquired an interest in the Irish company Glenisk. In its beverages business, the Group developed new formats for its products, launched a line of flavored products in France, Germany and the United Kingdom and continued the deployment of its functional beverages V and Mizone. In its biscuits and cereal products business, the Group continued its policy of expanding its brands with the launch of its Mini Ourson product, as well as the launch of new flavors in its savory product line Tuc and its Mikado product line.

 

Finally, as part of its strategy of maintaing profitable growth of its businesses, the Group completed sales and acquisitions of equity interests in 2006 (see “Item 5. Operating and Financial Review and Prospects—Overview” and Note 3 to the Consolidated Financial Statements). In particular, the Group:

 

   

finalized its exit from the sauces business, disposing of its Asian interests in this segment, and

 

   

continued its geographic expansion, in particular in Asia in the fresh dairy products segment (see “Item 4. Information on Groupe Danone—Products and Markets”).

 

Business Overview

 

Danone is one of the world’s leading food companies, with worldwide sales and operating income of approximately € 14.1 billion and € 1.9 billion, respectively, in 2006. By volume, Danone is the world’s leading producer of fresh dairy products, the second largest producer of biscuits and cereal products and the second largest producer of packaged water. Danone’s brands include national and international market leaders such as Danone (Dannon in the United States), the world’s leading brand of fresh dairy products; Evian, the world’s leading brand of bottled still water; Volvic, the Group’s other major international brand of bottled still water; LU, Europe’s leading biscuits brand; Wahaha, the leading Chinese brand of bottled water; and Aqua, the leading

 

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brand of packaged water in Indonesia. In addition, the Group is also a leader in the infant food market in France through its subsidiary Blédina. Overall, approximately 80% of world sales were realized through leading positions in local markets.

 

The Group’s strategy of international expansion, through both internal and external growth, has led to a significant increase in net sales outside Western Europe. These sales represented 50% of total net sales in 2006 compared to less than 15% in 1995.

 

The brand name Danone (Dannon in the United States) currently represents approximately 49% of the Group’s net sales and experienced growth of close to 8% in 2006 at constant exchange rates and scope of consolidation. In addition to fresh dairy products, the brand has been extended to certain other products, such as bottled water in the United States and certain European countries as well as biscuits in certain countries in Asia. Four of the Group’s brands (Danone, LU, Evian and Wahaha) represent approximately 70% of the Group’s net sales. These four brands had a growth rate in net sales at constant exchange rates and scope of consolidation of more than 10% in 2006.

 

In addition, the Group has developed two probiotic dairy product lines known under the names Actimel on the one hand and Activia and Bio on the other, and a line of low-fat products, under the names Taillefine, Vitalinea, and Ser, as well as a “fromage frais” line designed for children known under the brands Danonino, Danimals, and Petit Gervais. These brands, which are progressively being extended to all countries in which the Group is present, represented 45% of the Group’s growth in net sales in 2006.

 

Danone’s main product for export is bottled water, mainly under the brand names Evian and Volvic. Evian was exported to approximately 150 countries in 2006 and has strong market shares in the United Kingdom, Germany and Japan. Volvic is the leading still mineral water brand in Germany and the leading imported water in Japan.

 

The Group also has a strategy of internal and external growth aimed at establishing a geographic balance between developed and emerging countries. In this context, the Group has identified new geographic regions (“Nouvelles Frontières”) which constitute areas of growth: China, Indonesia, Mexico, Russia and the United States in fresh dairy products. These new geographic regions represented 28% of the Group’s net sales in 2006.

 

Business Strategy

 

The Group’s strategy relies upon (i) a concentration on three categories of products which have substantial elements of health and well-being, (ii) strong and grouped brand names, kept dynamic by sustained advertising campaigns, (iii) a balanced geographical distribution between developed countries and emerging countries and (iv) an ambitious strategy of innovation supported by an ever-growing knowledge of consumer expectations.

 

The continued internal growth of the Group in recent years is based upon the Group’s ability to sell quality products satisfying demands of local markets by (i) improving the products sold by recently acquired companies, (ii) introducing products that are accessible to large numbers of consumers in emerging countries in order to develop mass consumption of packaged food products and ensure demand for the Group’s brands for the future and (iii) taking advantage of the Group’s marketing expertise to sell value-added products already sold in other countries, to accompany increases in purchasing power and developments in consumer trends. The Group believes that demographic trends and economic developments in Asia and Latin America will lead in the medium term, despite possible economic difficulties, to significant market expansion. The progressive improvement in the purchasing power of local populations, together with the development of a middle class, is expected to increase demand for bottled beverages and branded food products.

 

The Group will continue to follow a strategy whereby its three business lines will grow profitably as a model of development to guarantee the Group’s values and specificity.

 

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In 2007, Danone’s objective is to achieve a growth rate of 6% to 8% at constant exchange rates and scope of consolidation by (i) having a portfolio of activities concentrated on dynamic health-oriented products, especially in fresh dairy products, (ii) advertising and promoting a selected number of major brands, (iii) having a significant presence in countries which present the best prospects for long-term growth, particularly China, Mexico and Indonesia, (iv) occupying strong leading positions in local markets in each business line and (v) offering promising innovations based on satisfaction of consumers.

 

Net sales growth at constant exchange rates and scope of consolidation is expected to continue to be a leading force for improving the Group’s economic performance, due to the continuing leadership of products generating a favorable mix effect and the achievement by the Group of a critical size in several emerging markets. Concurrently, the Group will continue to promote numerous initiatives aimed at increasing its global efficiency and widespread appeal. In a difficult international economic climate and in the absence of a significant crisis, Danone’s objectives for 2007 are to increase its trading operating income by between 7% and 10%, to improve consolidated trading operating margin at constant exchange rates and scope of consolidation by more than 20 basis points and to increase current net earnings per share by more than 10%.

 

The Group will continue its policy of making acquisitions in order to consolidate current positions and to hold leading local market positions in each of its business lines. With significant free cash flow (defined as cash flows provided by operating activities less capital expenditures net of disposals) and a level of net debt (defined as current and non-current financial liabilities less cash, cash equivalents and marketable securities excluding financial liabilities linked to options granted to minority stockholders) representing less than one year of cash flow provided by operating activities, excluding changes in net working capital, the Group possesses the necessary resources to sustain its growth.

 

Products and Markets

 

The tables below show, for each of the years 2004, 2005 and 2006, consolidated net sales and trading operating income by business line and principal geographic area.

 

Business Lines

 

     Year ended December 31,  
     2004     2005     2006  
     (millions of €, except percentages)  

Net Sales(1)

             

Fresh dairy products

   6,510     53.0 %   7,184     55.1 %   7,934    56.4 %

Beverages(2)

   3,201     26.1 %   3,473     26.7 %   3,942    28.0 %

Biscuits and cereal products(3)

   2,562     20.9 %   2,367     18.2 %   2,197    15.6 %
                                   

Total

   12,273     100.0 %   13,024     100.0 %   14,073    100.0 %
                                   

Trading Operating Income(1)

             

Fresh dairy products

   917     57.0 %   1,019     58.6 %   1,109    58.0 %

Beverages(2)

   493     30.7 %   474     27.3 %   504    26.3 %

Biscuits and cereal products(3)

   278     17.3 %   343     19.7 %   301    15.7 %

Unallocated income (expense)(4)

   (80 )   (5.0 )%   (98 )   (5.6 )%   —      —    
                                   

Total

   1,608     100.0 %   1,738     100.0 %   1,914    100.0 %
                                   

(1)   Net sales or trading operating income of Danone’s subsidiaries after elimination of sales between companies belonging to the same division and elimination of intra-group sales. Intra-group sales consist of sales of products between companies that are in different divisions. Intra-group sales were € 22 million in 2006 (€ 20 million in 2005 and € 21 million in 2004).
(2)   The beverages businesses in Italy, sold in January 2005, were only consolidated in 2004.
(3)   In 2004, the biscuits businesses in the United Kingdom and Ireland, which were subsequently sold, were only consolidated during the first nine months of the year. In addition, the biscuits business in Latin America were only consolidated in 2004. The biscuits businesses in India were deconsolidated beginning July 1, 2006 (see Note 8 to the Consolidated Financial Statements).
(4)   Unallocated income (expense) represents the balance of Group income (expenses) that have not been allocated to any specific operating division. In 2006, the Group established a system of analysis allowing it to allocate all of this income and expense to business lines.

 

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Geographic Areas

 

     Year ended December 31,  
     2004     2005     2006  
     (millions of €, except percentages)  

Net Sales(1)

             

Europe(2)

   8,096     66.0 %   8,179     62.8 %   8,582    61.0 %

Asia

   1,965     16.0 %   2,235     17.2 %   2,429    17.3 %

Rest of the World

   2,212     18.0 %   2,610     20.0 %   3,062    21.7 %
                                   

Total

   12,273     100.0 %   13,024     100.0 %   14,073    100.0 %
                                   

Trading Operating Income(1)

             

Europe

   1,209     75.2 %   1,266     72.8 %   1,295    67.7 %

Asia

   259     16.1 %   256     14.7 %   244    12.7 %

Rest of the World

   220     13.7 %   314     18.1 %   375    19.6 %

Unallocated income (expense)(3)

   (80 )   (5.0 )%   (98 )   (5.6 )%   —      —    
                                   

Total

   1,608     100.0 %   1,738     100.0 %   1,914    100.0 %
                                   

(1)   Net sales or trading operating income of the Group’s subsidiaries after elimination of sales between companies belonging to the same area and elimination of inter-region sales.
(2)   France represented approximately 34% of net sales for Europe in 2006 (35.3% in 2005 and 36.8% in 2004).
(3)   Unallocated income (expense) represents the balance of Group income (expenses) that have not been allocated to any specific operating division. In 2006, the Group established a system of analysis allowing it to allocate all of this income and expense to business lines.

 

Fresh Dairy Products

 

With net sales of fresh dairy products in 2006 of over € 7.9 billion, representing approximately 4.6 million tons, Danone is the leading producer of fresh dairy products worldwide, with approximately 20% of the world’s market share and a weighted average market share of approximately 36% in the countries in which the Group is present, which is four times more than its closest competitor. Danone’s principal products in this business line are yogurts and similar products which, together, accounted for close to 95% of Danone’s total net sales of fresh dairy products in 2006, with the remainder represented by infant food sold principally in France under the Blédina brand.

 

Principal Markets.    Sales in Europe accounted for 67% of net sales of fresh dairy products and sales in the Rest of the World accounted for 33%. Danone’s principal markets for fresh dairy products in Europe are France, Spain, Germany, Italy and the Benelux countries, which together accounted for slightly more than 45% of Danone’s sales of fresh dairy products in 2006. In the Rest of the World, the Group’s principal markets are the United States, Mexico, Argentina and Brazil. This segment is undergoing a strategy of geographic expansion, with a goal of being established in five new countries per year between 2007 and 2011. This strategy is accompanied by a constant effort to make the main product lines in the segment accessible in terms of price and distribution.

 

In France, Danone is the market leader for fresh dairy products with over one-third of the total market. Danone markets yogurts and similar products and other fresh dairy products principally under the Danone brand name. The Group is also the market leader in France for infant food with its brand Blédina. After experiencing negative growth in 2004 and 2005 due primarily to difficult consumption conditions in France and competing retail and discount brands, sales for this segment in France experienced a slight positive growth in 2006.

 

In Spain, Danone has a 57.15% interest in Danone S.A., Spain’s leading producer of fresh dairy products with a share of the Spanish market of approximately 46%. Danone is also the leading producer of yogurt in Italy, with a market share of approximately 25%.

 

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In Germany, where Danone is the leader in a relatively fragmented market, sales in this segment grew by more than 11% in 2006. Danone also markets its products in Belgium and Portugal where it holds leading positions through locally established production subsidiaries and in The Netherlands, Denmark, Ireland, Austria, Switzerland, Finland, Sweden and Greece through marketing subsidiaries and franchises that sell Danone’s product lines.

 

In the United Kingdom, Danone is the second largest player in the fresh dairy product market in the United Kingdom and the third in low-fat products, due in particular to the brand Shape.

 

In 2006, the Group created Stonyfield Europe, a company specializing in organic fresh dairy products. The first initiative of Stonyfield Europe was to take a 37% interest in Glenisk, the leader in Ireland in organic fresh dairy products.

 

In Eastern Europe, Danone is the leading producer of fresh dairy products in Poland, Hungary, the Czech Republic, Bulgaria, Romania and Turkey. In each of these countries, the Danone brand name has one of the highest levels of brand awareness in the food market. The Group holds a major position in Russia, a country where the Group’s production capacity increased significantly in 2004 and 2005 and that is one of the Group’s “Nouvelles Frontières” countries due to its potential for growth. In addition, the Group has a market presence in Croatia and the Baltic countries. The Group reinforced its presence in the Ukraine in 2006 with the acquisition of JSC Molochnyi Zavod “Rodich.”

 

Danone is the leading producer of fresh dairy products in terms of both net sales and volumes in Latin America. Danone is in a leading market position in Mexico, Argentina and Brazil. In addition, the Group announced in February 2007 the formation of a joint venture with the Colombian company Alqueria to develop the fresh dairy products market in Colombia. In North America, the Group occupies the leading position in both Canada and the United States. The fresh dairy products business in the United States, which includes the Dannon Company and Stonyfield Farm, the leader in the market for organic products, is one of the “Nouvelles Frontières” countries due to its strong potential for growth. Sales in the United States in this segment experienced growth of over 11% in 2006 at constant exchange rates and scope of consolidation, due in particular to the successful launch of the Activia product line in January 2006.

 

In 2005 and 2006, the Group reinforced its presence in the North Africa/Middle East region, notably in Algeria where it gained control of Danone Djurdjura in 2006, in Egypt, where it acquired the company Olait (renamed Danone Dairy Egypt) in 2005, and in Saudi Arabia, where it gained control of the Al Safi Danone Company in 2005. Danone Djurdjura and the Al Safi Danone Company are the leaders in their respective markets. The Group also has minority interests in major producers of fresh dairy products in Morocco, Tunisia and Israel, which all have leading positions in their respective countries. In addition, the Group is present in South Africa, with a majority interest in Danone Clover.

 

The Group is currently actively extending its presence in the fresh dairy products market in the Asia-Pacific region. The Group has been present for several years in Australia through a license agreement and in Japan through the joint venture Calpis Ajinomoto Danone. The Group has recently established itself in China, India, Bangladesh and Thailand and reinforced its presence in Japan. In Japan, the Group holds a minority interest in Yakult, with which the Group entered into a partnership in the beginning of 2004 with the objective of further accelerating the growth of both companies in the functional food market and strengthening their market leadership in probiotics. In 2005 and 2006, this partnership led to the formation of joint ventures in India and Vietnam, with the goal of developing the local market in probiotics. In January 2007, the Group acquired all of the shares of the joint venture Calpis Ajinomoto Danone. The new entity, named Danone Japon, will maintain close cooperation with Ajinomoto, which will continue to be the sole distributor for fresh dairy products of Danone Japon, and with Calpis, which will continue to be the supplier for certain raw materials. In China, the Group, which holds a 20% interest in Shanghai Bright Dairy, concluded a joint venture agreement in late 2006 with China Mengniu Dairy Company Limited, for the development, production and distribution of fresh dairy products in China. The Group holds 49% of this joint venture, which benefits from Mengniu’s leading position

 

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on the Chinese market for fresh dairy products. In 2005, the Group opened a new research and development center in Shanghai with the purpose of accelerating its presence in the fresh dairy product market in Asia. In Bangladesh, the Group partnered with the Grameen group in 2006 to create Grameen Danone Foods Social Business. This initiative has the goal of offering healthy food to underprivileged populations suffering from nutritional deficiencies in Bangladesh and to contribute to the reduction of poverty by establishing a single business model of proximity. Finally, in January 2007, the Group announced the creation of a fresh dairy products company in Thailand, named Danone Dairy Thaïlande, and the formation of a strategic partnership with Dutch Mill Co.

 

Principal Brand Names.    The Group has developed two lines of probiotic dairy products known under the names Actimel on the one hand and Activia and Bio on the other, a line of low-fat products, under the names Taillefine, Vitalinea, and Ser, and a line of “fromage frais” designed for children, known as Danonino, Danimals and Petit Gervais.

 

Driven by health consciousness and numerous scientific discoveries, the probiotic market is one of the most dynamic in the fresh dairy product segment. Actimel, a probiotic dairy product that helps to strengthen natural defenses, has been produced for over ten years and continues to exhibit strong growth in sales. Net sales at constant exchange rates and scope of consolidation increased by more than 12% in 2006, reaching over € 1 billion. The growth of Actimel represented nearly 9% of the Group’s growth in net sales in 2006. Furthermore, the strong rates of growth recorded in 2006 in Argentina, Russia and Romania confirm the potential of this type of product in emerging countries. Similarly, the line of probiotic products to facilitate intestinal digestion, marketed under the name Activia, experienced very strong growth during the last years. Its net sales at constant exchange rates and scope of consolidation increased by nearly 50% in 2006, reaching nearly € 1,279 million. The growth was especially strong in the United States, where the line was launched in January 2006, Germany, the United Kingdom, Mexico and Brazil. The product line is expected to be introduced in additional countries.

 

Petit Gervais aux Fruits, the “fromage frais” designed for children, is now consumed in 43 countries. The growth has been driven by a strategy of constant innovation and local adaptation (from one country to another the product line has different names: Danonino, Danimals, Petits Gervais). Its net sales at constant exchange rates and scope of consolidation increased by more than 4% in 2006, reaching nearly € 775 million. Furthermore, in 2004, Petit Gervais aux Fruits underwent an organoleptic renovation and nutritional adaptation. A series of studies was performed on children aged five to eight in the countries where this product is sold in order to identify consumer preferences. These studies were incorporated in the development of new flavors in each of these countries.

 

New Products.    Danone is continuously involved in the introduction of new products while trying to develop, as quickly and widely as possible, a worldwide market for high-potential products. At the same time, Danone is continuously reviewing or relaunching some of its key existing products to better meet consumer demand in terms of recipes, formats or packaging. The dynamism of the segment is strongly linked to its capacity to deploy, extend and adapt global concepts very rapidly in numerous countries with its varied product lines.

 

In 2006, several launches confirmed the ability of this segment to innovate and adapt global concepts to the local market:

 

   

In the United States, the Group successfully launched the Activia product line.

 

   

In France and Spain, the Group launched Senja, a specialty soy product, 100% vegetable with no lactose or cholesterol.

 

   

In Spain, the Group launched Felices Suenos, a bed-time yogurt for children, rich in calcium and made of lemon balm, a plant with calming effects.

 

   

In Europe, the Group penetrated the market for organic products, in particular through the acquisition of an equity interest in the Irish company Glenisk and the launch in France of an organic product line under the name Les 2 Vaches des Fermiers du Bio.

 

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In addition, in the beginning of 2007, the Group launched several products including Danactive, the local version of Actimel, throughout the United States and Essensis, a new line products to hydrate and nourish skin from the inside, in France, Italy, Spain and Belgium.

 

Market Trends.    Overall, the market for fresh dairy products on a worldwide basis has grown steadily over the past several years. This market has grown continually in Western Europe, driven by the innovative and dynamic nature of health-oriented products. In the United States, the fresh dairy products market has increased over the past few years, making this product line one of the most dynamic in the country’s food industry. Emerging markets have generally enjoyed favorable conditions, particularly in Argentina, Mexico and Brazil. Management believes that the introduction of new products, particularly health-oriented products, infant foods and drinkable versions, will allow Danone to continue to improve its market position. In addition, management believes that premiums often associated with innovative products will help raise the total value of the market for fresh dairy products.

 

Danone expects to see continued growth in demand for infant food in France, driven in part by trends toward increased consumption of convenience foods under the influence of new lifestyles and the success of new and innovative product lines that combine practicality and nutritional quality.

 

Beverages

 

Danone’s beverage activities comprise natural water, “Aquadrinks” (flavored natural water and tea beverages) and functional beverages. In 2006, net sales of beverages were € 3.9 billion, of which 37% were in Europe, 51% in Asia and 12% in the Rest of the World.

 

Danone is the second leading producer of packaged water in the world based on volume, with two of the five leading brands of bottled water in the world (Evian and Volvic) as well as the leading brand of packaged water in the world (Aqua in Indonesia). With approximately 19.5 billion liters of packaged water sold in 2006, Danone has a market share of approximately 10%. Danone is also the second-leading producer of packaged water in Europe, the leading producer of packaged water in Asia-Pacific and a major actor in Latin America.

 

Principal Markets and Brand Names.    The Group maintains strong market shares in Western Europe, where there is a long tradition of consumption of still and sparkling bottled water. Danone’s principal market for bottled water is France, where Danone has more than 21% of the national market in terms of volume, mainly through its Evian, Volvic, Badoit, Salvetat and Arvie brands. Danone is also the leading producer of bottled water in Spain, with over 21% of the Spanish market through its Lanjarón, Font Vella and Fonter brands. In the United Kingdom, where the still water market continues to experience strong growth, the Group has a leadership position with a market share of close to 28%, due to its Evian and Volvic brands. In Germany, the Group is the leader in the market for still water with a market share of approximately 21%. Furthermore, with the formation of The Danone Springs of Eden BV in 2003 with Eden Springs Ltd, the Group holds the number two position in the European HOD water market. In Denmark, the Group acquired in 2006 a 49% interest in Aqua d’Or, the leader in bottled still water in Denmark.

 

In Eastern Europe, Danone is the market leader in Poland, the largest market in the region, with its subsidiary Zywiec Zdroj and Polska Woda, a joint venture entered into in 2000 with the Italian group San Benedetto. Danone is present in Turkey through its subsidiary, Danone Hayat.

 

In North Africa and the Near and Middle East, the Group is present in Morocco, where it acquired in 2001, in collaboration with the Moroccan conglomerate ONA, a 30% interest in Sotherma, a leader in the bottled water market in Morocco. In addition, in 2006, the Group acquired the Algerian bottled water company Tessala, which has a bottling factory as well as the rights to use a spring of superior quality, rich in calcium and magnesium.

 

The Group is present in the United States in the premium bottled water market through its brand Evian which has been marketed by The Coca-Cola Company since July 2002. In 2005, the Group and The Coca-Cola

 

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Company reached an agreement providing for the sale to The Coca-Cola Company of Danone’s interest in CCDA Waters, a company formed in 2002 to sell the Group’s bottled water products in the United States. After a strategic review of the prospects for the development of the local HOD market, the Group decided to disengage from this activity in the United States. In 2005, the Group sold the assets held by DS Water, LP to the Kelso investment fund.

 

In Canada, the Group occupies a strong position in the bottled water market, with its Crystal Springs, Labrador, Naya and Evian brand names. In 2006, the Group exited the HOD water market by selling its subsidiary Danone Waters of Canada.

 

In Latin America, Danone is the market leader in packaged water. The Group is the leader in the bottled water market in Mexico through its subsidiary Bonafont and holds a 50% interest in Aga Pureza, a major actor in the HOD water market. In 2004, the Group reinforced its presence in the large container water market in Mexico through the acquisition of Bonafont Garrafones y Servicios. Based on size, the Mexican bottled water market is one of the largest markets worldwide and the largest emerging market. The Group also has a leading position in the bottled water market in Argentina with the Villa del Sur and Villavicencio brands and is the market leader in Uruguay with the Salus brand.

 

In Asia, Danone is the clear leader in packaged water with a market share of approximately 20% in the region.

 

In China, the Group is the market leader with approximately 23% of the packaged water market where it sold approximately 3.6 billion liters in 2006, primarily under the Wahaha and Robust brands. The Group is also the market leader of dairy drinks in this country and is a major actor in the cola and ready-to-drink tea markets. In 2006, the Group reinforced its presence on the fruit juice market by acquiring a 22.18% interest in Hui Yuan Juice, the leader in China in fruit drinks with a market share of approximately 17%. In February 2007, the Group announced that in the context of the initial public offering of Hui Yuan Juice on the Hong Kong Stock Exchange, it would subscribe to the capital increase in order to maintain its percentage of ownership.

 

In Indonesia, the Group holds a 74% interest in Aqua, which is the clear leader in the country with more than 50% of the market. A significant part of its revenue is achieved through the sale of water in large containers. In 2006, the brand name Aqua had the leading position in the worldwide packaged water market with more than 5 billion liters of water sold.

 

In Japan, in September 2002, the Group entered an agreement with the Mitsubishi and Kirin Beverage Corp. group, one of the leaders in the Japanese beverage market, with the aim of accelerating growth of the Volvic brand in Japan and participating in the growth of the domestic segment of the market. The Group is the leader by value in the bottled water market in Japan and has a dominant position in the “premium” segment with its imported water brands Volvic and Evian.

 

New Products.    Once again, innovations contributed significantly to growth in this segment, and the Group thus confirmed its ability to respond to the development of consumption trends.

 

In the natural water segment, the Group’s objective is to make the health aspects of its products more visible to its consumers. In Mexico, the brand Bonafont focused its advertising on the elimination benefits of its spring water. Furthermore, with the goal of creating new consumption habits, new formats or packaging are introduced on a regular basis, such as the 50 cl Evian bottle launched in France in 2005, the 33 cl Evian bottle and the Evian mini-bar pack launched in France in 2006.

 

The “Aquadrinks” segment (flavored water based on natural water and tea beverages), where sales have been particularly strong in recent years, expanded its range of product types and brands. In Mexico, the Levite brand, the flavored water launched in 2002, added a sugarless version in 2006. In France, Germany and the United Kingdom, the Group launched a line of sugarless flavored water in 2006. Due to its innovations, the Group holds approximately 50% of the flavored water market in France, notably the Volvic and Taillefine brands.

 

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The functional beverage segment is another area of development for the Group. With the success of the Ser brand, which added new flavors in 2006, the Group is the leader in Argentina in diet beverages. In France, after a successful launch in 2005, the Group added new flavors and formats to the Taillefine Fiz line. This product line is now the second leading brand in the French diet beverage market. In addition, in 2006, the Group launched Taillefine Thé in France, where it occupies the second leading position in the tea beverage segment. In 2006, the Group also continued to deploy V, an energy drink containing vitamin B, as well as the Vitalinea line. In Asia, the Group continues to introduce Mizone, a functional beverage launched in Indonesia in 2005. The Group has also launched new products in this region, such as Nutri-express in China and Just Juice Bubbles in New Zealand.

 

Market Trends.    Packaged water is one of the most dynamic segments of the world’s food market due to consumption trends favoring safety and health. Despite already relatively high levels of per capita consumption, the European market, the largest in the world, continues to experience sustained growth. Outside Western Europe, the global trend in consumption of bottled water has shown a regular progression. Certain countries which already have a significant market, including China and Indonesia, are experiencing double-digit growth rates. The segment of water-based, slightly sweetened refreshment drinks is a growing market and flavored water is expected to represent a significant portion of the growth of the segment. Likewise, functional beverages are expected to be one of the areas of growth in the segment in the years to come.

 

Biscuits and Cereal Products

 

With net sales in 2006 of approximately € 2.2 billion, representing approximately 0.9 million metric tons, Danone is the world’s second-leading producer of biscuits and cereal products. Danone’s biscuit products include cookies, which represent more than half of the segment’s net sales, as well as savory snacks, crispbreads and crackers, and packaged cakes. The segment retains a strong potential with, in certain regions, rates of growth higher than the average for other food segments.

 

Principal Markets and Brand Names.    In 2006, sales in Europe accounted for 80% of biscuit and cereal products net sales and sales in Asia accounted for 20%.

 

Danone’s main product lines are marketed under the LU brand name, which accounts for more than 50% of the segment’s net sales and which has a dominant position in Western Europe. The Danone brand name is used in Asia, especially in China and Indonesia. The Group also has various local brands worldwide resulting from the business acquisitions carried out by the Group over the past 15 years.

 

In Western Europe, Danone is the market leader and has strong leading positions in France, the Benelux countries, Greece and Finland. In Italy and Spain, the Group is number two in the market. The Group is no longer present in the United Kingdom and Ireland following the disposal in 2004 of its biscuits businesses in these countries.

 

In Eastern Europe, Danone is the clear market leader with a strong position in Russia, Poland, Hungary, the Czech Republic and Slovakia.

 

In Latin America, in April 2004, the Group and the Arcor group signed an agreement aimed at merging their biscuits businesses in South America, thus forming the leading player in the market in that region. Bagley LatinoAmerica, the newly formed company to which the Group transferred the biscuits activities of Danone Argentine and Danone Brazil in January 2005, is 49% held by the Group.

 

In the Africa / Middle East region, the Group is present in Algeria, where in 2005 it created Danone Biscuits Algerie, in Tunisia through its 49% interest in Sotubi and in Morocco through its 50% interest in Bimo.

 

In the Asia-Pacific region, Danone is the market leader for biscuits and cereal products. One of the Group’s objectives in this segment is to develop nutritional products that are affordable to everyone. In order to achieve

 

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this objective, the Group is striving to develop product formats that are adapted to the budget of the average consumer. Danone has very strong positions in China and India, two of the top three largest biscuit and cereal product markets in the world in terms of volumes consumed. In the biscuits and cereal products segment, Danone is the leading brand in China and Britannia is the leading brand in India. Danone also has leading positions in Malaysia. In Indonesia, the Group continues to develop its activities in the biscuit market under the Danone brand name. In 2006, the Group discontinued its biscuits activities in New Zealand after the sale of Griffins Foods.

 

New Products.    Danone’s strategy for innovation tends to emphasize the nutritional qualities of biscuits, the establishment of additional eating times throughout the day and the promotion of affordable products in the segment, especially in the Asia-Pacific region. Furthermore, since 2004, the strategy for the segment in Europe mainly consisted of renewing certain existing products, with the goal of improving quality and taste in order to differentiate them from competing brands. This strategy depends mainly on enriching the cereal content of its products and reducing the amount of sugar and fat, as well as developing complete cereal products.

 

The breakfast product line (“Petit Déjeuner”), which continues to be deployed across Europe, experienced strong growth in 2006 while adding new versions. This line targets breakfast, a mealtime during which the consumption of biscuits remains minor. The biscuits of this line take advantage of the concept of “Long Lasting Energy” (“Energie à Diffusion Progressive”) developed by Danone Research, which has been validated by international experts. The research and development teams of the Group have been able to show that certain complex sugars in cereals are digested slowly and over an optimal length of time release the necessary sugars for the healthy functioning of the body and brain. This nutritional advantage, the result of an original combination and formulation of the biscuit, including preparation and cooking, has been included in the Prince Petit Déjeuner line, targeted at the youth market, as well as the LU Petit Déjeuner, its equivalent for adults. Launched successfully in France, the line has also been developed in Belgium, Holland, Italy and Spain, and for the past few years has expanded into Hungary, Russia, Poland and the Czech Republic. In 2004 and 2005, the segment expanded its Petit Déjeuner line with the launch of its first low-fat cookie product and a product line rich in cereals (Fruit & Fibres and Brut de Céréales).

 

In 2006, the segment continued its policy of expanding its product lines, in particular with the launch of Mini Ourson as well as the launch of new flavors in the savory product line Tuc and in the Mikado product line.

 

Finally, since 2004, the segment has been reinforcing its strategy of offering nutritional products accessible to everyone. After the success of Biskuat in Indonesia, the segment launched Ja Gai in China, a nutritionally enriched product, primarily in calcium, at a price of € 0.15.

 

Nutrition and Health

 

The Group’s strategy depends on the development of products with a strong nutrition and health component. The Group believes that nutrition plays an important formative role in health and well-being. This conviction has been reaffirmed year after year and inspired Danone’s Food, Health and Nutrition Charter, which was published in March 2005. This charter reaffirms the five convictions and nine commitments of the Group in nutrition and health. The nine commitments include the application of research to nutrition and health, dialogue with scientists, sharing of knowledge with the scientific world and health professionals and informing consumers, primarily through nutritional labeling of products.

 

Research and Development

 

Danone’s overall research and development objective is to contribute to the Group’s profitable growth by:

 

   

ensuring uncompromising food safety;

 

   

contributing to the development of products to better respond to consumers’ expectations in terms of health, nutritional value, taste or practicality; and

 

   

designing innovative production processes in line with the Group’s cost reduction policy.

 

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In 2000, Danone significantly revised its research and development policy to transform it into a major competitive advantage of the Group. To increase efficiency, speed and communication within the Group, the research and development teams have been grouped together in one global multidisciplinary center, Danone Vitapole Daniel Carasso (recently renamed the Danone Research Center Daniel Carasso), incorporating the three main business lines, and research has been refocused on a limited number of strategic projects. This center, located in the Paris region, has been operational since mid-2002 and employs approximately 550 researchers, engineers and technicians, supported by 250 people throughout the world. Also, as part of its strategy aimed at further accelerating growth in the functional food and beverage market, in the beginning of 2004 the Group concluded an agreement with Yakult Honsha, the world leader in the market for probiotics. As part of this agreement, a liaison office was created between the Group and Yakult for facilitating joint projects, particularly in the areas of research and development. Finally, in 2005, the Group opened a new research center in Shanghai. The purpose of this center is to develop products that deliver the nutrition and health benefits needed locally and that are adapted to the tastes of Asian consumers, in particular, Chinese, Indonesians and Indians. It will thus allow the Group to introduce its leading brands and concepts by adapting them to local specificities, in terms of ingredients as well as texture and taste. The opening of this center reflects the Group’s objective of developing its activities in Asia, and particularly to increase its position in the fresh dairy products market. The center complements the research and development activities of the Group in Asia, which already includes three entities: a center in Shanghai dedicated to the biscuits business and two centers dedicated to beverages for China.

 

In order to conduct basic research related to nutrition, flavor and food processing and preservation, Danone regularly collaborates with outside entities such as universities and specialized public research centers. The Group benefits from the expertise of external scientific committees on strategic themes, such as the committee of experts on probiotics or the Evian Center for Water. Furthermore, the Group maintains permanent relations with the scientific community in order to better understand nutrition issues and to stay informed of the latest developments in research. This permanent dialogue with scientists as well as the support of research constitute two of the commitments made by the Group in its Food, Health and Nutrition Charter.

 

Danone has also established an international prize to reward research in nutrition or major contributions to public health. Product development and improvement is the responsibility of the Group’s research and development teams, which apply the results of both internal and outside research. Furthermore, the sixteen Danone Institutes worldwide contribute to public awareness regarding nutrition through their activities for the benefit of professionals in the field of nutrition and have launched several projects for researchers and practitioners. In 2005, the Group formed a partnership to last a minimum of four years with the Pasteur Institute in order to improve understanding of the mechanism of action of probiotics. In 2005, the Group also participated in the 18th International Congress of Nutrition in South Africa. Through its participation in this event, which takes place every four years, the Group reaffirmed its willingness to build a permanent relationship with the scientific community and to participate in the progress of science by developing initiatives in the fields of nutrition and health. Finally, in 2006, the Group participated in the fourth Probiotics Convention, which took place in Paris with the objective of studying the latest scientific advances in the area of probiotics with distinguished experts from around the world.

 

In 2006, Danone spent € 126 million (€ 123 million in 2005 and € 129 million in 2004) on research and development, representing close to 1% of total net sales.

 

Purchasing

 

The Group’s principal raw material needs consist of (i) materials needed to produce Danone’s food and beverage products, primarily including milk, fruits, flour, sugar, cocoa and fats or, collectively, food raw materials and (ii) materials needed for packaging its products, primarily plastics and cardboard or, collectively, packaging raw materials. Energy supplies represent a smaller portion of the Group’s purchases. See “Item 3. Key Information—Risk Factors—Price increases and shortages of food and packaging raw materials could adversely affect the Group’s results of operations.”

 

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Food Raw Materials.    Milk represents the most important food raw material for the Group in terms of cost. In the countries where Danone requires milk for the production of its dairy products, the Company’s operating subsidiaries generally enter into contracts with individual local milk producers or dairy cooperatives. In Europe, the price of milk is essentially fixed by the European Union or supported by various national governments through quotas and customs charges such that only a small portion of purchases is directly subject to fluctuations in the worldwide market. In 2006, milk prices remained relatively stable globally. Purchasing of other food raw materials, mainly fruit mixtures, sugar, cocoa, flour and vegetable oils, is managed through global or regional purchasing programs, allowing for synergies in terms of volumes and skills. Purchases of sugar, which underwent a strong price increase in Asia in 2006, and cocoa are closely monitored because the market structure for these products is highly concentrated, with a small number of intermediaries controlling a substantial portion of total supply.

 

Packaging Raw Materials.    The Group also manages its purchases of packaging raw materials through global or regional programs in order to optimize shared knowledge and volume effects. Factors that influence the pricing of packaging materials include international and regional supply and demand, economic cycles, installed production capacities and oil prices. The price of PET and plastics, which are among the most significant packaging raw materials purchased by the Group, varied widely in Europe and Asia between 2004 and 2006, mainly due to the fluctuation in the price of oil. The other significant raw materials used for packaging (such as cardboard) did not experience significant change in prices at the Group level during the last few years.

 

Organizational Systems and Information Technology

 

In 2004, the Group established an information systems organization which allows the optimization and rationalization of information technology investments while taking advantage of global synergies.

 

Project Themis

 

For several years, the Group has been in the process of implementing an integrated information system (Themis) through an SAP framework. The years 2005 and 2006 were marked by significant deployments in the beverages segment, primarily in England, France and Spain, as well as in the fresh dairy products segment in Portugal, England, Ireland, Hungary and Mexico. In 2006, 64% of worldwide sales are from subsidiaries that have implemented Themis.

 

With the continued deployment of Themis, new projects are being studied in other operational areas, such as the management of warehouses and inventories or the management of industrial maintenance. These extensions are expected to be implemented in pilot sites in 2006 and 2007 (the United States for warehouse management, France and Germany for industrial maintenance) and will subsequently be deployed in the other subsidiaries of the Group. In addition, in 2006, functional extensions were completed for the processes of managing proximity orders and production planning, in particular, scheduling under production line constraints. These two significant extensions were successfully implemented in the context of the deployment of Themis in Mexico and will be implemented in future deployments, in particular in Russia.

 

Finally, after a pilot phase in three plants (Biscuits in the Czech Republic, Beverages in France and Fresh Dairy Products in Poland), the ISIS project of managing industrial performance has entered the deployment phase at various industrial sites of the Group, in particular in France, Russia, Poland and the United States.

 

Research and Development

 

In research and development, speed of conception and bringing a product to market as well as ensuring its launch are important factors of success. The establishment of the Artemis system allows research teams to accelerate the phases of conception and to ensure product launches, offering in one device all of the nutritional and food safety information related to the ingredients used by Danone, as well as a tool to aid in product

 

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formulation. Its deployment began in 2005, continued in 2006 in the European subsidiaries in the fresh dairy products and biscuits segments and will continue in 2007 in North America, Mexico, Russia and in Southern Europe.

 

Supply Chain

 

For several years, the Group has been optimizing its purchases and supply chain, with the goal of improving upstream efficiency as well as collaboration with its suppliers. This effort was made concurrently with the formation of CPG Market in 2000 with Nestlé, Henkel and SAP. CPG Market was sold to Accenture at the end of 2004. It offers to suppliers and purchasers a range of technological solutions, such as electronic quotes and online bids (eSourcing) as well as a transactional platform for exchanging EDI messages for online transfer of documents, from ordering to invoicing (eSupply Chain). At the end of 2006, more than 270 supplier-purchaser links were established. This program will be extended in 2007 and 2008 to all of the Group’s subsidiaries in Europe and North America, over 50 industrials sites.

 

Sales and Marketing

 

In sales and marketing, various projects achieved in 2005 allowed the Group to develop its knowledge in order to ensure improved performance for its customers, in particular:

 

   

the creation of Internet sites allowing the sharing of information about the Group’s products—www.danonefoodservice.com;

 

   

the creation of a marketing database allowing collaborative work among the agencies, the creators of the product and the marketing teams; and

 

   

the deployment of a business control system at points of sale in several major markets.

 

Intellectual Property

 

The Group owns rights to trademarks, brand names, models and copyrights throughout the world. The territorial extent of protection depends on the significance of the product concerned. The Group has established a chart of its intellectual property and regularly updates and revises its portfolio of products and corresponding rights for each of its subsidiaries in order to monitor the protection of its brand names.

 

The Group is also the owner of patents, licenses and proprietary recipes, as well as substantial know-how and technologies related to its products and the processes for their production, the packages used for its products and the design and exploitation of various processes and equipment used in its business.

 

Such trademarks, brand names, models, copyrights, licenses, patents, proprietary recipes and know-how, which are held by the Company and several entities throughout the Group, represent major assets for Danone. The Group is committed to taking appropriate legal steps to protect and exploit such intellectual and industrial property. See “Item 3. Key Information—Risk Factors—The Group may not be able to adequately protect its intellectual property rights.”

 

Risk Management Policy

 

The Group maintains an active risk management policy to preserve the investment of shareholders and the interests of employees, consumers and the environment. The policy is based upon identification and control of risks in conjunction with a global policy of insuring goods and potential liabilities.

 

Since 2002, the Group has had in place a global risk identification policy (with a specific application called “Vestalis”) that charts major operational risks and allows the classification of problems in terms of the risks’ frequency of occurrence and their financial impact on the Group. Vestalis has been deployed or is in the process

 

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of being deployed in 75 of the Group’s subsidiaries, which represents approximately 92% of the Group’s net sales in 2006. This chart allows the identification of risks and weaknesses in the entire process, to group or prioritize them by country or business segment and to define preventive and corrective actions, which may be local or global, as applicable.

 

The most significant risks are reviewed once a year by the management of the three business segments and a general review is performed by the Group’s management and the Audit Committee.

 

The Group has a global insurance policy based on stringent technical evaluations using worldwide available insurance products based on their availability and local regulations. The insurance policy for risk is uniform for all of the subsidiaries over which the Company has direct or indirect operational control.

 

In addition, in order to optimize its insurance expenses and maintain a strong level of control over its risks, the Group self-insures through its reinsurance subsidiary Danone Ré, a company consolidated in the Group’s financial statements. The self-insurance policy covers certain risks whose costs can be accurately estimated as the Group is aware of their frequency and their financial impact. Such risks relate essentially to (i) coverage for damage to goods, transport, operating losses and civil liability for the majority of the Group’s companies and (ii) payments for disabilities, training and death for the French subsidiaries. These self-insurance programs are limited to accidents under € 7.5 million per accident. Moreover, “stop-loss” insurance protects Danone Ré against an increased frequency of accidents and loss. These self-insurance programs are managed by professional insurers and the provisions recorded in the financial statements are determined by independent actuaries.

 

Customers, Distribution and Marketing

 

Customers

 

While end consumers of Danone products are individual retail customers, the principal portion of Danone’s sales are to major retail and grocery chains. The retail industry has become increasingly concentrated over the past several years. In many markets, the Group’s three largest clients represent a significant portion of net sales. This concentration, particularly advanced in Europe, is expected to increase in North America and in emerging countries. In 2006, the Group’s 10 largest customers worldwide, of which six are French retail groups, accounted in the aggregate for approximately 28% of total consolidated net sales. Danone’s largest client alone, Carrefour, accounted for approximately 8% of consolidated net sales in 2006.

 

The Group has global partnership agreements with major retailers. These partnership agreements contain, in particular, provisions concerning geographic expansion policy, logistical collaboration or management of food safety. However, they typically exclude pricing terms, which remain within the responsibility of the Group’s subsidiaries.

 

In recent years, certain European retail chains have rapidly expanded internationally. The Group has benefited from this expansion by using existing commercial relationships to introduce its products in certain international markets and therefore accelerate its own geographic expansion as well as the international development of its brands. In these new areas, most large retail chains seek to develop the marketing of brand name quality products as their means of growth and profitability.

 

Distribution

 

Although distribution policies vary among different countries due to local characteristics, the Group has two major distribution policies: on the one hand, the flow of products towards major retailers, and on the other hand, the flow designated for traditional market outlets.

 

In emerging countries, particularly in Asia and Latin America, a large portion of Danone’s sales is made through traditional market outlets or through smaller distribution networks that are most often controlled by the

 

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Group. A strong distribution structure is a competitive factor in those countries in which traditional businesses and independent supermarkets still represent a significant share of food sales. In Latin America, a significant amount of sales of fresh dairy products are made through local networks. In Argentina for example, the Group benefits from a distribution network which enables delivery to over 75,000 sales points through a fleet of 1,000 trucks. Similarly, in Indonesia, the beverages subsidiary Aqua has built a distribution network by signing agreements with 70 exclusive distributors, who account for 80% of deliveries. This amounts to a total of 10,000 trucks stamped with the Aqua name, circulating in Indonesia every day to supply 1.3 million points of sale.

 

In recent years, the Group has built leadership positions in the market for water in large containers in Latin America, Asia and, more recently, in Europe. This business requires a direct relationship with the consumers (for example, Home and Office Delivery (“HOD”) in Europe) or through franchised retail shops (for example, Robust in China).

 

The Group follows an active policy of streamlining its logistics flows in order to increase quality of service while reducing costs. This policy is based on an ongoing assessment of the Group’s organizational models, especially outsourcing its distribution in collaboration with specialized distributors.

 

The Group has undertaken several initiatives, working closely with its mass retailers to accelerate the development of its product categories, to optimize the flow of products and the inventory levels of its customers. These include efficient consumer response, or ECR, which, in addition to achieving stock management, automatic stock replenishments and just-in-time delivery, is used to coordinate stock levels between the stores, the client’s warehouses and Danone’s warehouses. ECR is also used to work with distributors to better manage consumer demand and expectations. Danone also works with its customers to develop marketing concepts to enhance its customers’ sales, such as joint promotions for specific events.

 

Marketing

 

The Group’s advertising and promotional policies constitutes a key element in the success of its overall strategy based on innovation, brand recognition and market leadership. The Group engages significant resources to ensure the success of its advertising and promotional strategy, and management expects advertising costs, in relation to net sales, to remain at least at the same level in the future.

 

For several years, the Group has been following a policy of resource optimization by focusing on a few brands in order to maximize efficiency. Accordingly, more and more products have been introduced under leading brand names such as Danone or Taillefine/Vitalinea, currently used for fresh dairy products, beverages and biscuits and cereal products. In addition, the fresh dairy products segment has developed four blockbuster product lines, the Actimel, Activia, Danonino and Vitalinea lines, which are progressively being marketed in all of the countries where the Group is present. Finally, each subsidiary annually conducts a segmentation study of its brand portfolio using internal methods in order to optimize the allocation of advertising budgets.

 

Danone’s operating companies in each business line and geographic market are responsible for developing their own advertising, promotional and sales strategies adapted to local consumer patterns. The Group maintains a decentralized marketing and sales structure in order to provide its operating companies with the proximity and flexibility necessary to respond and adapt to a broad and changing variety of market conditions. In order to ensure (i) coherence of retailing strategies within the Group, (ii) an optimal sharing of marketing know-how and (iii) an optimization of promotional costs, the Group has a director in charge of coordinating commercial retail strategies and initiatives as well as a policy of ensuring that strategic principles and initiatives extend across product lines and geographic areas.

 

The Group believes that direct marketing, which aims at creating direct contact with consumers, will continue to develop rapidly. This strategy, in France, is oriented around a centralized database, which contains approximately four million French households and which allows the Group to regularly communicate with its consumers through personalized mailing campaigns that are adapted to consumer profiles. In January 2006, this

 

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marketing initiative was renewed with the launch of “Danone et vous.” This new communication method aims to supply consumers with more information, advice and transparence on their food products. This program includes, notably, an annual guide devoted to nutrition and health and a Danone et vous magazine focused on families with children, as well as a dedicated Internet site.

 

Food Safety and Quality Management

 

Food Safety

 

Food safety is a paramount consideration for Danone. Over the last several years, the Group has implemented a voluntary policy of risk identification and control. The implementation of this policy involves the Group’s Quality Department, the Food Safety Center (CSA), the Divisional Quality Departments and the subsidiaries. In 2004, the food safety policy was redefined in internal documents, called directives. These directives govern fundamental aspects of food safety, in particular, traceability, risk analysis, allergens and biosafety. Risk management is the responsibility of the CSA. In cooperation with the business segments, the CSA works on the identification and classification of risks according to their magnitude and frequency of occurrence. Risks are classified in four categories: microbiological, chemical, physical or allergenic. The goal is to control the risks in the Group as well as in suppliers. The Group strives to continually improve control over its supply chain by (i) gaining complete knowledge of the raw materials it purchases, (ii) rigorously monitoring the chain of distribution, (iii) developing a more efficient upstream tracing system and (iv) controlling the production processes (by defining and implementing rules relating to hygiene and production, methods based on international standards and control of critical points). For certain risks, such as pesticides and heavy metals, the Group has implemented monitoring programs, while for others, such as risks of allergies, the Group imposes preventive measures for all its subsidiaries that go beyond regulatory requirements. Danone’s policy also includes the implementation of rigorous procedures for crisis management, in particular, the creation of a dedicated crisis management center with connections to the subsidiaries’ centers, in order to guarantee consumer safety while maintaining the reputation of its brands. In addition, the Group uses tracing tools in order to enable the Group to identify for a given lot of products, the origin of raw materials used, the procedures followed, the controls carried out and the customers to whom the products were sold. Furthermore, the Group periodically evaluates the level of control over all the risks to which the Group’s businesses are exposed.

 

Beyond risks that are scientifically established, the Group remains particularly committed to keeping up-to-date on risks perceived by the consumer, such as genetically modified organisms and the risks of obesity. To this end, the Group has developed a network of privileged advisors, including consumer associations that discuss and attempt to clarify topics that are of common concern through various formal and informal forums.

 

Quality Management

 

The Group considers quality to be a managerial responsibility that is rooted in understanding consumers and customers as well as in the pursuit of performance. The Group has made quality a determining factor for all of its processes, businesses and activities. The quality management policy has three main components: (i) the identification, evaluation and control of food safety risks at each stage from the procurement of raw materials through the consumption of products, (ii) the improvement of all processes and (iii) monitoring the quality perceived by consumers. This quality policy is based on monitoring product performance through internal and consumer testing. In addition, external audits are performed to assess the manufacturing process and hygiene. In the water segment, for example, this process of verification goes from the original water supply all the way to the actual dispatch of the products for sale.

 

Quality management teams oversee quality systems and their implementation at each of Danone’s operating subsidiaries. They are specifically dedicated to: (i) the development of new products through organoleptic tests performed internally and by consumers, allowing a clear vision of the products on the market as well as how the Group responds to consumers’ needs; (ii) teaching skills to employees in quality control departments through

 

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specific training programs allowing for experience sharing and transfer of best practices between different subsidiaries; and (iii) developing quality control systems in each subsidiary. The Group is accordingly engaged in a process of evolution of the certification of its industrial sites toward Danone’s reference system, built on the ISO 22000 standard. This reference system will allow the Group to have a single instrument of quality management and will also facilitate the alignment of all of its action plans towards achieving the objectives defined by the Group.

 

Industrial Risk Management

 

The safety of the Group’s industrial sites, its employees and people living at the sites’ boundaries is a key priority for the industrial policy of the Group. The Group’s critical industrial sites are relatively little exposed to major natural disasters (floods, earthquakes and cyclones). These risks are evaluated in advance of each major installation, and new industrial installations are designed with all applicable safety standards. However, the Group’s international development makes it necessary for the Group to set up businesses in areas that are occasionally exposed to earthquakes (Japan, Indonesia, Turkey, Mexico and Algeria).

 

The Group’s industrial activities do not intrinsically expose it to particular risks compared to other industries. The management of fire and explosion risk remains a major concern of the Group’s three segments.

 

In order to reinforce its risk management, the Group has put in place procedures to evaluate the level of safety at its industrial sites. These evaluations are made by independent auditors and enable operational units to define and implement customized prevention and protection policies. These procedures are based on international standards that most often go beyond local standards. Furthermore, they allow an exhaustive inventory of the various potential industrial risks and are also applicable to partnerships with the Group’s most significant suppliers.

 

In 2006, 130 of these safety audits were conducted by independent entities, which assigned a rating from 1 to 5 for each audited site. The average rating for the sites was 4.19 in 2006, compared to 4.00 in 2005, 3.94 in 2004 and 1.74 in 1994, marking a strong improvement in safety conditions since the establishment of this preventative system. In addition, 54 sites had a rating of 5, authorizing them to obtain the RHP certificate (Highly Protected Risks).

 

Regulatory and Environmental Matters

 

Regulatory Matters

 

The Group’s activities are subject to numerous laws and regulations, which are becoming more and more stringent and are constantly evolving. These laws and regulations relate principally to water, air, noise, the use of natural resources and waste. These activities are subject to obtaining authorizations and making filings under French legislation with respect to the protection of the environment and equivalent regulations in other countries. Packaging is subject to specific regulations, in particular European Directive 94/62, amended in 2004, relating to packaging and packaging waste, reduction at the source, reduction of the toxicity of hazardous substances and recycling and recovery. In addition, the Group’s activities are subject to the European Directive of 2003 establishing an exchange system and quotas for greenhouse gas emissions, and, since 2005, the transpositions of the National Allocation Plans for quotas in the European Union. Four of the Group’s 67 sites in the European Union are subject to quotas, while the other sites are below the minimum eligibility threshold.

 

The principal potential risks relating to the environment are (i) water pollution (essentially organic and biodegradable pollution), (ii) risks related to refrigerating installations (ammonia and other refrigerating liquids), and (iii) risks related to the storage of raw materials (flour and sugar silos) or products for the cleaning and disinfection of the Group’s plants (acid or alkaline products), especially when these installations are located in inhabited areas. Nevertheless, the Group believes that, in light of its activities, its direct negative impact on the environment is limited.

 

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Environmental Policy

 

The Group’s environmental policy aims to respond to the growing concerns of many different parties, especially consumers, about the environmental impact of industrial sites and products. In 1996, the Company’s management established the basic principles of the Group’s commitment to environmental protection through the adoption of an environmental charter which applies to each of Danone’s facilities and divisions (research and development, purchasing, marketing, production, logistics and headquarters) in all the countries where the Group operates. The charter aims to create a system of systematic accountability and protection of the environment at every step of production, from design to delivery of the final product, and encourages the participation of all employees. In addition, since 1991, the Group has had an environmental department to define and coordinate the application of its environmental policy in collaboration with a network of more than 70 correspondents throughout the world. This policy focuses on four principal areas: industrial activity, packaging, water conservation and agriculture issues.

 

Industrial Activity

 

The application of the Group’s environmental policy in its facilities involves three areas: ensuring compliance with regulations, which is linked with control of environmental risks, reduction of water and energy consumption and of waste production through its “Green Plants” (“usines sobres”) program and, finally, ISO 14001 certification of the Company’s sites.

 

Regulatory Compliance and Risk Management

 

To ensure regulatory compliance and reinforce risk management, the Group implemented in 2000 a program for the audit of its production facilities by a specialized company. At the end of 2006, most of the facilities had been audited, with the exception of recently acquired facilities. The analysis covers multiple criteria such as operating licenses, water supplies, outflow, atmospheric emissions, storage of raw materials, refrigerating installations, energy, noise and environment, soil and waste management. The conclusions of the analysis lead to recommendations for the development of quantified and prioritized plans. Since 2006, the facilities have been audited and evaluated on the basis of a common reference, “Green,” which was developed for Danone by a specialized firm and goes beyond regulatory requirements to incorporate the Group’s own priorities. The Group believes that these audit results and the actions taken indicate that no major risks are present that would have a serious detrimental effect on the environment.

 

Decrease in the Consumption of Natural Resources

 

Since 1995, the Group’s “Green Plants” program has aimed at reducing the consumption of water and energy and reducing the production of waste material. This program corresponds to the Group’s desire to promote an economic and sustainable business model, limiting plants to using only the resources absolutely necessary for the plant’s activities. Targets were fixed in September 2001 by the Group’s executive committee for the reduction of the ratios for the consumption of water and energy between 2000 and 2010: 30% for the consumption of water and thermal energy and 20% for total energy (thermal and electric). These reductions constitute a significant response from the Group to the necessity of reducing the emission of gases causing the greenhouse effect. Between 2000 and 2006, the average ratios of the Group decreased by 19% for total water used per ton produced, 31% for thermal energy per ton produced and 26% for total energy per ton produced. Furthermore, in 2006, the rate of waste recycling was approximately 81%.

 

Environmental Management

 

The Group has implemented an environmental management program enabling it to ensure that all of its sites integrate environmental consciousness into plant activities. At December 31, 2006, 90 sites (industrial sites, corporate headquarters and research centers) had ISO 14001 certifications, amounting to approximately 48% of

 

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the Group’s sites. In the event of an environmental accident, there are procedures in place in each of the plants and sites to manage the situation and minimize the consequences of such an accident. A guide to the management of environmental emergencies was distributed to each plant at the beginning of 2001 and is updated annually.

 

Packaging

 

Management believes that environmental consciousness in the packaging of the Group’s products can play a large role in the protection of the environment. Since 1992, Danone has been involved in “Eco-Emballages,” an organization targeted at developing the collection and recycling of packaging in France. In 23 countries, Danone has actively participated in reducing packaging waste through “Point Vert”-type organizations. Danone also strives to reduce packaging waste at the source by slightly lightening its packaging materials. The Group has set a target of reducing the weight of its packaging by 10% over ten years. In 2006, 25 subsidiaries tracked the packaging/product weight ratio for their ten most significant products. Danone established a network of contact people who are dedicated to educate and train various interested parties in product development and marketing, in particular through the publication of a manual on ecological packaging and a tool to assess the impact of activities on the environment.

 

Protection of Water Resources

 

In 1998, the Group and in particular the beverages division joined the 1971 Ramsar Convention on Wetlands to implement awareness campaigns, training and information relating to the preservation and use of wetlands. The Ramsar Convention signed in 1971 consists of 138 countries that agreed to policies favoring wetlands, marshes, peatland and other natural water retention sites in the plains or highlands, which filter rainwater and supply the water tables. These zones are fundamental for the conservation of water and water quality. In 2002, following a Group initiative, the Danone–Evian Fund was created to support projects for the protection and sustainable management of water and water quality. The fund, which has a budget of € 1 million, is managed by the Ramsar Convention with the help of a local French not-for-profit organization for the defense of coastlines.

 

For example, the Evian spring has special protection. The recognized catchment area where Evian natural spring water begins covers over 34 square kilometers at an average altitude of 850 meters. Eighty-five percent of this pristine catchment area is covered by forests, natural meadows and marshes. Human presence is limited to a few villages and family farms principally making cheese. Société des Eaux Minérales d’Evian joined with the French government in 1992 to found the Association pour la Protection de l’Impluvium des Eaux Minérales d’Evian (APIEME). This organization seeks to protect the Evian natural spring water catchment area by expanding the sewer system, experimenting with more environmentally friendly farming practices and bringing livestock housing into regulatory compliance.

 

In 2004, the Group performed a complete inventory of the 78 springs that it uses, their risks and their level of protection. In 2005, the Group deployed a tool allowing it to more precisely identify the actions required to ensure the long-term preservation of these springs and their environment. In addition, the Group promotes sharing best practices among those responsible for the management of these springs.

 

Agriculture

 

Most of the Group’s raw materials are agricultural products. In order to protect the environment without diminishing the quality of its products, the Group encourages farmers to adopt farming methods that are more environmentally friendly than traditional methods. The Group has also developed a business based on organic agriculture, through its U.S. subsidiary Stonyfield Farm and, since 2006, its subsidiary Stonyfield Europe. The Group implemented pilot operations for its cereal, dairy farm and fresh produce suppliers to develop methods for limiting the use of fertilizer and phyto-sanitary products to a strict minimum, without negatively affecting competitiveness of its operations.

 

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The Group is progressively expanding this method through the farms that supply its plants. Since 2002, the Group has been participating with Nestlé and Unilever in a program called the “Sustainable Agriculture Initiative” (“SAI”). This initiative comprises sharing experiences in sustainable agriculture with other industrial businesses in cooperation with farmers and consumers, first in Europe and then throughout the world. Sustainable agriculture, as defined in SAI, is a broader concept than integrated agriculture, as it includes the consumption of natural resources (such as energy sources) and the economic and social impact of operations on local communities. In 2003, the SAI established sustainable agriculture practices for the production of cereal and milk in Europe. In 2004, all of the Group’s milk producers were audited according to internal standards regarding food quality, traceability and security. Since 2005, these audits have also covered environmental aspects.

 

Training and Employee Information

 

The Group attempts to increase the environmental awareness of its employees through various informational tools. Each year, approximately 15,000 employees attend environmental awareness sessions. In addition, a specific training program for the protection of the environment and plant assets is offered to all industrial engineers. Since 2000, an Intranet site has enabled the dissemination of information relating to the environment, the Group’s environmental policy and sharing experience. The environmental department also has tools for the dissemination of such information and in 2006 established a worldwide network of 72 environmental coordinators in Europe, South America and China.

 

Environmental Expense and Investment

 

Investments for the protection of the environment amounted to approximately € 25 million (approximately 3.6% of the Group’s total industrial investments) in 2006 of which 28% were for air (reduction of greenhouse gases, treatment of odors, smoke and noise), 24% were for water (water treatment, purification stations, economies of consumption), 21% were for waste (improving collection, storage, sorting) and 13% were for energy (economies of consumption, conversion to cleaner energy sources).

 

Expenses related to the environment amounted to approximately € 103 million in 2006. They included expenses of € 39 million for the management of water, energy and waste and taxes other than packaging charges. The latter amounted to € 64 million in 2006. In addition, the fines, penalties and damages paid to third parties in connection with environmental issues were less than € 0.2 million in 2006. No significant provision for risks or expenses related to the environment is included in the Consolidated Financial Statements as of December 31, 2006.

 

Competition

 

Competitors in Danone’s core businesses include other large international food and beverage groups, such as Nestlé, Kraft, PepsiCo. and The Coca-Cola Company, as well as smaller companies with focused markets or product lines and food retailing chains offering generic or private label products. The food and beverage sector is highly competitive due to the large number of national and international competitors. Management believes that Danone’s strategy to maintain and improve its profitability is based on the quality, convenience and innovative aspects of Danone’s products and the strong image associated with its brands in the important areas of health, nutrition and food safety. Management believes that success in this industry is achieved through strong local market positions, and therefore the Group seeks to be the market leader in each country where it operates. This strategy allows for a long-lasting, balanced and constructive relationship with major distribution networks, by marketing key products yielding growth and profitability.

 

Because Danone’s markets in Western Europe tend to be relatively mature, competition for market share is particularly intense. Danone’s strategy, complemented by a strong advertising component focusing on certain brands, is to differentiate itself from its competitors by marketing innovative, value-added products that respond to a growing consumer demand for health-oriented/well-being food products. This effort is reinforced by significant advertising based on a portfolio of concentrated brands.

 

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In North America, the food and beverage markets are relatively mature and competition is intense. In competition with other large food and beverage groups, Danone has based its strategy on its experience of the management of value-added, health-oriented products and its ability to market locally its diverse global product lines.

 

In the Rest of the World, essentially in emerging countries, competition in the Group’s three business lines is high. This is due to the presence of local competitors who usually market products at very low prices, and also due to the efforts of international competitors to penetrate or increase their activities in these high potential markets. Danone’s strategy consists of targeting these areas by marketing quality products that emphasize health and safety and are accessible to the greatest number of consumers.

 

Organizational Structure

 

The table below presents a list of the Company’s principal operational subsidiaries by business line, including name, country of incorporation or residence and proportion of Danone’s direct and indirect ownership interest at December 31, 2006.

 

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FRESH DAIRY PRODUCTS

 

BEVERAGES

 

BISCUITS AND CEREAL PRODUCTS

EUROPE

 

AUSTRIA

Danone Ges.mbH 100%

BELGIUM

N.V. Danone S.A. 100%

BULGARIA

Danone Serdika 100%

CZECH REPUBLIC

Danone a.s. 98.30%

DENMARK

Danone A/S 100%

FINLAND

Danone Finlande Oy 100%

FRANCE

Blédina 100%

Danone 100%

GERMANY

Danone GmbH 100%

GREECE

Danone Grèce 100%

HUNGARY

Danone Kft 100%

IRELAND

Danone Ltd 100%

Glenisk 35.72%

ITALY

Danone SpA 100%

POLAND

Danone Sp zoo 100%

PORTUGAL

Danone Portugal S.A. 55.17%

ROMANIA

Danone SRL 100%

RUSSIA

Danone Industria 70%

Danone Volga 63.54%

SLOVAKIA

Danone Spol s.r.o. 100%

SLOVENIA

Danone 100%

SPAIN

Danone S.A. 57.15%

Danone Canaries (Iltesa) 44.87%

SWEDEN

Danone AB 100%

THE NETHERLANDS

Danone Nederland B.V. 100%

TURKEY

Danone Tikvesli 100%

 

UKRAINE

Danone 100%

Rodich 100%

UNITED KINGDOM

Danone Ltd 100%

 

AMERICAS

 

ARGENTINA

Danone Argentina S.A. 99.45%

BRAZIL

Danone Ltda. 100%

CANADA

Danone Canada Delisle Inc. 100%

MEXICO

Danone de Mexico 100%

UNITED STATES

The Dannon Co. 100%

Stonyfield Farm 83.99%

 

AFRICA AND THE MIDDLE EAST

 

ALGERIA

Danone Djurdjura 100%

EGYPT

Danone Dairy Egypt 100%

ISRAEL

Strauss Dairy 20%

MOROCCO

Centrale Laitière 29.22%

SAUDI ARABIA

Al Safi Danone Company 50.10%

SOUTH AFRICA

Danone Clover 55%

Clover Danone Beverages 39.46%

TUNISIA

Stial-Socoges 50%

 

ASIA-PACIFIC

 

BANGLADESH

Grameen Danone Foods 50%

INDIA

Yakult Danone India 50%

INDONESIA

PT Danone Dairy Indonesia 70.30%

JAPAN

Calpis Ajinomoto Danone(1) 50%

Yakult Honsha 20.02%

VIETNAM

Yakult Vietnam 20%

 

EUROPE

 

BELGIUM

Danone Waters Beverage Benelux 100%

DENMARK

Aqua d’Or 49%

FRANCE

Evian (SAEME) 100%

Mont Roucous 100%

Seat 99.86%

Smda 100%

Volvic (SEV) 100%

Drinkco 100%

GERMANY

Danone Waters Deutschland 100%

POLAND

Polska Woda 50%

Zywiec Zdroj 100%

SPAIN

Aguas Font Vella y Lanjarón 78.46%

Dasanbe Agua Mineral Natural 50%

SWITZERLAND

Evian Volvic Suisse 100%

THE NETHERLANDS

The Danone Springs of Eden BV(2) 66.65%

TURKEY

Danone Hayat 100%

UNITED KINGDOM

Danone Waters UK &

Ireland 100%

 

AMERICAS

 

ARGENTINA

Aguas Danone de Argentina 100%

CANADA

Danone Naya 100%

MEXICO

Bonafont 100%

Pureza Aga 50%

UNITED STATES

Great Brands of Europe 100%

URUGUAY

Salus 58.46%

 

AFRICA AND THE

MIDDLE EAST

 

ALGERIA

Tessala 100%

MOROCCO

Sotherma 30%

 

ASIA

 

AUSTRALIA

Frucor Beverages 100%

CHINA

Aquarius 50%

Wahaha group 51%

Robust group 92%

Shenzhen Health Drinks 100%

China Hui Yuan Juice 22.18%

INDONESIA

Aqua 74%

JAPAN

Kirin MC Danone Waters 25%

NEW ZEALAND

Frucor 100%

 

EUROPE

 

BELGIUM

LU Belgie 100%

CZECH REPUBLIC

Opavia LU 100%

FINLAND

LU Suomi 100%

FRANCE

LU France 100%

GERMANY

LU snack Foods 100%

Griesson De Beukelaer 40%(3)

GREECE

Papadopoulos 60%

HUNGARY

Györi Keksz 100%

ITALY

Saiwa 100%

POLAND

LU Polska 75%

SPAIN

LU Biscuits S.A. 100%

RUSSIA

Bolshevik 76.42%

Chock and Rolls 76.42%

THE NETHERLANDS

LU Nederland 100%

 

AMERICAS

 

ARGENTINA/BRAZIL

Bagley LatinoAmerica 49%

 

AFRICA AND THE

MIDDLE EAST

 

ALGERIA

Danone Biscuits 51%

EGYPT

Danone Mashreq 100%

MOROCCO

Bimo 50%

TUNISIA

Société Tunisienne de Biscuiterie 49%

 

ASIA

 

CHINA

Jiangmen Danone Biscuits 100%

Shanghai Danone Biscuits Foods

Co. Ltd 90%

INDIA

Britannia Industries Ltd. 25.50%(4)

INDONESIA

Danone Biscuits Indonesia 100%

MALAYSIA

Danone Biscuits Manufacturing

(M) Sdn Bhd 100%

Danone Snacks Manufacturing

(M) Sdn Bhd 100%

PAKISTAN

Continental Biscuits Ltd 49.49%


(1)

 

In January 2007, the Group acquired all of the shares of Calpis Ajinomoto Danone, which was renamed Danone Japon.

(2)

 

By virtue of an agreement among shareholders, the effective voting rights are 50%.

(3)

 

The Group is in the process of selling its interest in Griesson de Beukelaer.

(4)

 

Britannia Industries was deconsolidated beginning July 1, 2006 (see Note 8 to the Consolidated Financial Statements).

 

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Property, Plants and Equipment

 

Danone operates production facilities located around the world in its principal markets. At December 31, 2006, Danone had 186 production sites, out of which approximately 43.5% were located in Europe (14.5% in France, 6.5% in Spain and 22.5% elsewhere in the European Union), 47% in the Asia-Pacific region (31% in China and 16% in New Zealand, India, Indonesia and elsewhere in southeastern and southwestern Asia) and 9.5% in the Rest of the World (3% in the United States and Canada and 4% in Argentina, Brazil, Mexico and countries in Central America and 2.5% in Africa and the Middle East). The table below sets forth the total number of Danone’s facilities at December 31, 2006 and total production by main business line in 2006 for the fully consolidated companies.

 

Business Line

  

Number

of Plants

  

Total Production

(thousands of tons or

millions of liters)

Fresh dairy products

   45    4,675

Beverages

   103    12,957

Biscuits and cereal products

   38    634

 

The Group’s general policy is to own its production facilities. Although the production facilities are numerous and widely dispersed, certain facilities are particularly important centers of production. In 2006, the Group’s five largest fresh dairy products facilities were located in Argentina, Mexico, Saudi Arabia, the United States and Brazil, and accounted for approximately 29% of the Group’s production for fresh dairy products. The Group’s two largest sources of bottled water, both located in France, accounted for 24% of the Group’s total production capacity for packaged water in 2006, and the two most important sources of production of water in large containers, both located in Indonesia, accounted for close to 14% of the Group’s total water production capacity. The Group’s five largest biscuit and cereal product facilities are located in Belgium, France, Indonesia and Italy and accounted for approximately 34% of the Group’s total production capacity for biscuits and cereal products in 2006.

 

The Group’s central management conducts periodic reviews of its production sites to consider possibilities for improving efficiency, quality, protection of the environment and safety. On the basis of such reviews, management establishes plans for the expansion, specialization, upgrading and modernization or closing of specific sites.

 

Item 4A.    Unresolved Staff Comments

 

Not applicable

 

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Item 5.    Operating and Financial Review and Prospects

 

The following discussion is based upon, and should be read in conjunction with, the Consolidated Financial Statements and the Notes thereto, included elsewhere in this annual report. The figures referred to in the following discussion are, unless otherwise noted, determined in accordance with IFRS.

 

U.S. GAAP Reconciliation

 

The Consolidated Financial Statements of Groupe Danone have been prepared in accordance with International Financial Reporting Standards as adopted by the European Union, or IFRS. The application of these principles gives rise to certain differences compared with U.S. generally accepted accounting principles, or U.S. GAAP. The application of U.S. GAAP would result in a decrease in 2006 consolidated net income of € 27 million (€ 129 million in 2005 and € 50 million in 2004) to € 1,326 million, a decrease in net sales of € 120 million (€ 143 million in 2005 and € 143 million in 2004) to € 13,953 million and an increase in stockholders’ equity of € 150 million (€ 154 million at December 31, 2005 and € 216 million at December 31, 2004) to € 5,973 million at December 31, 2006. See Note 2 to the Consolidated Financial Statements for a discussion of the material differences between IFRS as applied by the Group in its Consolidated Financial Statements and U.S. GAAP.

 

Effects of Changes in the Scope of Consolidation and Exchange Rates

 

Variations in the scope of consolidation, such as acquisitions and divestitures, may increase or decrease the Group’s consolidated sales and results of operations in comparison to prior years and thus make it difficult to discern the performance of its underlying business. Similarly, as a global business operating in numerous currencies, changes in exchange rates of the euro, which is the Group’s reporting currency, may result in an increase or decrease in the consolidated sales and results of operations as reported in the Consolidated Financial Statements. In order to enable investors to follow the year-to-year changes in the Group’s operations, as required by the French securities regulator, the Group has provided details of the impact on its net sales and operating income of changes in the scope of consolidation and in exchange rates and have isolated the changes related solely to the underlying business.

 

The Group calculates the impact of currency variances by converting the figures from the previous year as reported in their local currencies by the companies within the scope of consolidation using the exchange rates for the current year. For further detail on the impacts of these currency variations, see the discussion below in “—Overview—Exchange Rates.”

 

The Group calculates the impact of changes in the scope of consolidation for the current year by taking into account the changes in the scope of consolidation that occurred in the current year and assuming these changes had occurred in the prior year for the same period. In order to calculate the effect of changes in the scope of consolidation with respect to acquired entities, the Group uses financial information provided by such entities for periods prior to their acquisition. For details on the principal changes in the scope of consolidation in 2004, 2005 and 2006, see “—Overview—Changes in Scope of Consolidation.”

 

Critical Accounting Policies

 

For a complete description of the Group’s significant accounting policies, please see Notes 1 and 2 to the Consolidated Financial Statements. The Group’s critical accounting policies are those that have meaningful impact on the reporting of its financial condition and results and require significant management judgment and estimates. These policies include the Group’s accounting for (a) asset impairment, (b) put options granted to minority stockholders, (c) trade and consumer promotion activities and (d) income taxes and deferred taxes.

 

Asset Impairment.    Evaluating the impairment of long-lived assets, including goodwill, indefinite-lived brands and investments in affiliates, involves management judgment in estimating the fair values and future cash

 

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flows related to these assets. The predictability of future cash flows involves considerable management judgment and is notably based upon assumptions on expected future operating performance. In 2006, the Group recorded provisions and impairment charges of € 170 million, of which € 130 million related to its interests in the HOD water business in Europe and € 40 million related to goodwill in Robust (Beverages in China). In 2005, the Group recorded impairment charges of € 104 million, including € 53 million in relation to the goodwill of Danone Waters of Canada (HOD water in Canada) and € 51 million in relation to Bakoma (Fresh Dairy Products in Poland). In 2004, the Group recorded provision and impairment charges of € 608 million relating to the Group’s activities in the HOD water business in the United States and in Europe. See Notes 5 and 7 to the Consolidated Financial Statements for a more detailed description of impairment charges.

 

Put Options Granted to Minority Stockholders.    The Group is committed to acquiring the minority shareholdings owned by third parties in some of the less than 100% owned subsidiaries, should these third parties wish to exercise their put options. The exercise prices of these put options, which are reflected as financial liabilities in the consolidated balance sheet, are usually based on the profitability and the financial position of the entity as of the exercise date. Evaluating the exercise price of these put options requires management judgment in estimating the future profitability and financial performance of the related subsidiaries. See Note 2 to the Consolidated Financial Statements for a more detailed description of these put options.

 

Trade and Customer/Consumer Promotion Activities.    Danone offers various sales incentive programs to customers and consumers. The amount and timing of expense recognition for these trade and consumer activities involve significant management judgment based on estimated participation and performance levels. Actual expenses may differ if the levels of participation and performance vary from these estimates. However, the vast majority of the Group’s incentive programs do not exceed one year and therefore do not require highly uncertain long-term estimates.

 

Income Taxes and Deferred Taxes.    Determining income tax expense and establishing reserves involves management judgment as to the ultimate resolution of any tax issues, and the number of years with open tax audits varies depending on the tax jurisdiction. Historically, the Group’s assessments in respect of the ultimate resolution of tax issues have been reasonably accurate. While it is often difficult to predict the final outcome or timing of resolution of any particular tax matter, the Group expects the resolution of current open tax issues not to be dissimilar from the historical trend. In addition, in certain countries where it operates, the Group has tax losses that can be carried forward. They mainly result from the tax deductibility of goodwill and operating losses in certain countries as well as from the loss incurred in 2005 on the disposal of the HOD water activities in the United States. Determining the amount of these tax losses that the Group will be able to use in the future and the corresponding deferred tax assets to be recognized in the consolidated financial statements, requires management judgment, especially in estimating the future performance of the subsidiaries and the tax groups that generated those tax losses.

 

Overview

 

Refocusing Strategy

 

In line with the Group’s strategy of focusing on its three core business lines, between 1997 and 2006, the Group sold nearly all of its grocery activities, its glass containers business, its cheese and cured meat activities (Galbani), its beer activities in Europe and its sauce activities.

 

At the same time, the Group has continued to strengthen its position in its strategic segments while following a policy of increasing the profitability of its businesses. In this context, between 2002 and 2006, the Group concluded various partnerships and sold certain of its equity interests:

 

   

In 2002, the Group entered into a cooperation agreement with The Coca-Cola Company for the distribution of the Group’s bottled water products in North America. In 2005, a new agreement was signed providing for an increase of approximately 20% in expenditures for advertising and promoting Evian products, as well as the sale to The Coca-Cola Company of Danone’s interest in CCDA Waters, a

 

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company formed in 2002 to sell the Group’s bottled water products in the United States (notably the Dannon Water and Sparkletts brands).

 

   

In 2003 and 2004, the Group significantly reinforced its presence in Japan, with the acquisition of an additional equity interest in Yakult, the leader in probiotics, in which the Group now holds an equity interest of 20%, and with the conclusion of a partnership with Yakult particularly focused on the development of joint research and development projects and of probiotic products. This partnership resulted in the formation of two joint ventures in 2005 and 2006, in India and Vietnam, with the aim of developing the local market in probiotics.

 

   

In April 2004, the Group and ARCOR, the leader in the Argentinean food industry, signed an agreement aimed at merging their biscuits businesses in South America in 2005, thus forming the leading player in the market in that region. The newly formed entity, Bagley LatinoAmerica, is 49% owned by Groupe Danone and 51% owned by the ARCOR group, which has assumed operational management as of January 2005.

 

   

In 2005, the Group sold its sauces businesses in the United Kingdom and in the United States and announced the sale, effective January 2006, of its sauces businesses in Asia.

 

   

In 2005, the Group sold its minority interest in the Spanish company Mahou, finalizing its exit from the beer business.

 

   

In 2006, the Group concluded a joint venture agreement with China Mengniu Dairy Company Limited, for the development, production and distribution of fresh dairy products in China. The Group holds 49% of this joint venture, which benefits from Mengniu’s leading position on the Chinese market for fresh dairy products.

 

Acquisitions and Investments

 

As part of the Group’s development strategy, Danone is continuously considering potential acquisitions. Danone may acquire an initial equity interest of less than 100% in a target company, including, as the case may be, a minority interest, and concurrently enter into agreements with other shareholders allowing Danone to increase its interest over time to obtain effective control, a majority interest or sole ownership.

 

Financial investments were € 575 million in 2006, compared to € 636 million in 2005 and € 98 million in 2004. The principal financial investments in 2006 related to:

 

   

the acquisition of an additional 3.22% interest in Danone Asia, a holding company that holds the Group’s interests in the Asia-Pacific region. Following this acquisition, the Group holds 100% of Danone Asia;

 

   

the acquisition of an additional interest in Danone Djurdjura (Fresh Dairy Products in Algeria), raising the Group’s holdings from 51% to 100%. This company, which was previously accounted for by the equity method, has been fully consolidated beginning in the second semester of 2006;

 

   

the acquisition of an additional interest in Danone Romania (Fresh Dairy Products in Romania), raising the Group’s holdings from 65% to 100%;

 

   

the acquisition of a 22.18% interest in Hui Yuan Juice Holdings Co (Beverages in China), which is accounted for by the equity method;

 

   

the acquisition of 100% of the company Rodich (Fresh Dairy Products in the Ukraine), which is fully consolidated;

 

   

the acquisition of a 49% interest in the Danish company Aqua d’Or (Beverages in Denmark), which is accounted for by the equity method;

 

   

the acquisition of an additional 10.3% interest in Shanghai Bright Dairy (Fresh Dairy Products in China), which is non-consolidated; and

 

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the acquisition of an additional 3.8% interest in Wimm Bill Dann (Fresh Dairy Products in Russia), which is non-consolidated.

 

Financial investments in 2005 were principally related to the acquisition of the interest held by the Suntory group in DS Waters, LP (which was sold to the Kelso investment fund in November 2005), the acquisition of an additional interest in Danone Asia, raising the Group’s interest from 93.56% to 96.78%, the acquisition of an additional 29% interest in Sotubi (Biscuits in Tunisia) and the acquisition of the Egyptian fresh dairy products company Olait (renamed Danone Dairy Egypt).

 

Financial investments in 2004 were principally related to the acquisition of an additional interest in Zywiec Zdroj (Beverages in Poland), bringing the Group’s holdings from 88% to 100%, the acquisition of assets of Chock & Rolls (Biscuits in Russia) and the acquisition of an interest in Bonafont Garrafones y Servicios (HOD Water in Mexico).

 

In addition, the Company and its subsidiaries concluded various agreements providing for the repurchase by the Group of interests held by third parties in certain companies in the event these third parties wish to sell their interests (see Notes 5 and 25 to the Consolidated Financial Statements). No significant financial investment is currently considered probable regarding these options, with the exception of the potential partial exercise of the option relating to Danone Russia.

 

Finally, repurchases of the Company’s shares made through the programs authorized by the general shareholders’ meetings for the years 2003 to 2005 represented expenditures of € 731 million in 2006, compared to € 685 million in 2005 and € 226 million in 2004. The Group anticipates that it will actively complete share repurchases in 2007.

 

Capital Investments.    Capital investments amounted to € 692 million in 2006, compared to € 607 million in 2005 and € 520 million in 2004 (representing, respectively, 4.9%, 4.7% and 4.2% of consolidated net sales). The steady increase in investment since 2004 reflects the need for production capacity required for the strong growth in the Group’s revenues. In 2006, approximately 38% of capital investments were investments in capacity in the “Nouvelles Frontières” countries, those with strong growth in net sales (Russia, Mexico, China, Indonesia and the United States in the fresh dairy products segment), notably:

 

   

an increase in production capacity in the United States to ensure the development of the Activia (launched in January 2006) and Danactive (launched in January 2007) product lines; and

 

   

an increase in production capacity for the fresh dairy products and beverages activities in Latin America, which have experienced very strong growth.

 

Investments in 2006 also include the construction of a new biscuit production plant in Algeria and increased production capacity for the Volvic aromatisé product line in France.

 

Amounts expended during 2005 included primarily investments in capacity in the “Nouvelles Frontières” countries.

 

In 2004, capital investments included (i) investments in capacity in Europe to meet the growth in sales of Actimel and (ii) investments in capacity in the “Nouvelles Frontières” countries. One of the main investments for 2004 related to a production plant for fresh dairy products in Tchekov, Russia.

 

The main capital investments currently underway are related to increasing capacity in the “Nouvelles Frontières” countries as well as increasing European capacity for the Actimel, Danacol and Essensis product lines.

 

As in 2006, the Group anticipates the continuation in 2007 of its investment efforts in the “Nouvelles Frontières” countries. The Group anticipates that its capital investments should represent between 4.5% and 5% of its net sales in 2007.

 

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Changes in Scope of Consolidation

 

Changes in the scope of consolidation are described in Note 3 to the Consolidated Financial Statements. The principal acquisitions in 2006 included:

 

   

the acquisition of an additional 3.22% interest in Danone Asia, a holding company that holds the Group’s interests in the Asia-Pacific region. Following this acquisition, the Group holds 100% of Danone Asia;

 

   

the acquisition of an additional interest in Danone Djurdjura (Fresh Dairy Products in Algeria), raising the Group’s holdings from 51% to 100%. This company, which was previously accounted for by the equity method, has been fully consolidated beginning in the second semester of 2006;

 

   

the acquisition of an additional interest in Danone Romania (Fresh Dairy Products in Romania), raising the Group’s holdings from 65% to 100%;

 

   

the acquisition of a 22.18% interest in Hui Yuan Juice Holdings Co (Beverages in China), which is accounted for by the equity method;

 

   

the acquisition of 100% of the company Rodich (Fresh Dairy Products in the Ukraine), which is fully consolidated; and

 

   

the acquisition of a 49% interest in the Danish company Aqua d’Or (Beverages in Denmark), which is accounted for by the equity method.

 

The main acquisitions in 2005 concerned the purchase of an additional 3.22% interest in Danone Asia as well as the acquisition of an additional 29% interest in Sotubi (Biscuits in Tunisia), raising the Group’s holdings in this company from 20% to 49%.

 

The acquisitions in 2004 were essentially related to the acquisition of an additional interest in Zywiec Zdroj (Beverages in Poland), the acquisition of the assets of Chock and Rolls (Biscuits in Russia) and the acquisition of an interest in Bonafont Garrafones y Servicios (HOD Water in Mexico).

 

The principal divestments in 2006 included:

 

   

Sauces in Asia: The sale of these activities in January 2006 generated a capital gain of approximately € 154 million (before minority interests). As the Group has completely exited its sauces activities, this capital gain is reflected in the item “Net income from discontinued operations” in the consolidated income statement.

 

   

Griffins (Biscuits in New Zealand): The sale of this company, finalized in May 2006, generated a non-taxable capital gain of € 43 million, which is reflected in the item “Other operating (expense) income” in the consolidated income statement.

 

   

Danone Waters of Canada (HOD Water in Canada): The sale of this company in June 2006 generated a net loss of approximately € 11 million. This loss before tax, in an amount of € 38 million, is reflected in the item “Other operating (expense) income” in the consolidated income statement.

 

   

Bakoma (Fresh Dairy Products in Poland): The sale of the minority interest held by the Group in this company was finalized in December 2006 and generated a capital gain of approximately € 6 million. This gain is reflected in the item “Net income (loss) of affiliates” in the consolidated income statement.

 

The principal divestments in 2005 were related to beverages activities in Italy, minority interests held by the Group in biscuits activities in Colombia, fresh dairy products business in Greece, beer activities in Spain, packaged water in the United States and sauces activities held by the Group in the United Kingdom and the United States.

 

The principal divestments in 2004 were related to the sale in July of subsidiaries in the biscuits segment in the United Kingdom (Jacob’s) and in Ireland (Irish Biscuits).

 

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Exchange Rates

 

A significant part of the Group’s assets is located outside France and is denominated in currencies other than the euro. In 2006, 48% of the Group’s net sales were booked in euro and the remaining 52% were in other currencies, primarily the Chinese yuan, the U.S. dollar, the British pound and the Mexican peso. In addition, approximately 40% of the Group’s trading operating income was denominated in currencies other than the euro. As a result, foreign exchange rate fluctuations against the euro could have a significant effect on the Group’s income statement. These fluctuations also have an effect on the value on the Group’s consolidated balance sheet of assets and liabilities recorded in currencies other than the euro.

 

Seasonality

 

Seasonal consumption cycles affect certain of Danone’s product markets, which can have an impact on Danone’s quarterly and annual results. In particular, the demand for water is at its peak during the second and third quarters of the year, and demand for biscuits is generally strongest during the fourth quarter of each year. As a result, Danone typically records its lowest quarterly net sales during the first quarter of each year. In addition, rainy summers, such as those in Europe in 2004, may negatively impact sales of packaged water and, as a result, total net sales. Conversely, warmer temperatures, such as those experienced in Europe in the summer of 2003, can stimulate demand and thus favorably impact net sales.

 

Other Factors

 

Inflation has not had a material impact on the Group’s consolidated results of operations in the last three years, since the rate of inflation in the Group’s principal markets during such period has, on an overall basis, been relatively low. Other factors affecting Danone’s business activities and results of operations include raw material prices, fluctuations in exchange rates, competition, economic conditions and consumer spending power in countries where the Group operates, fluctuations in interest rates, nutritional trends and certain government actions. For more information on how these particular factors may affect Danone’s business and results of operations, see “Item 3. Key Information—Risk Factors.”

 

Valuation of Assets

 

The Group performs a review of long-lived assets (including goodwill) for impairment at least once a year. As described in Notes 1.4 and 1.5 to the Consolidated Financial Statements, this review consists of comparing the recoverable value of the assets to their net carrying value. The recoverable value corresponds to the higher of value in use and market value. In 2006, the Group recorded non-current charges of € 130 million related to its interests in the HOD water business in Europe and € 40 million in relation to goodwill in Robust (Beverages in China).

 

In 2005, as a result of this review, the Group recorded a non-current charge of € 53 million relating to its investment in the HOD water business in Canada and a non-current charge of € 51 million relating to its minority interest in Bakoma (Fresh Dairy Products in Poland).

 

In 2004, the Group recorded a non-current charge of € 608 million relating to investments in the HOD water business in the United States and in Europe. This non-current charge consisted of (i) a depreciation of the carrying value of the Group’s investment in DS Waters LP and a provision for the put option granted to Suntory Ltd, for a total amount of € 455 million and (ii) a depreciation in the carrying value of the Group’s investment in The Danone Springs of Eden BV in the amount of € 153 million.

 

See Notes 5 and 7 to the Consolidated Financial Statements for a more detailed description of impairment charges.

 

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Recent Events

 

In January 2007, the Group announced the formation of a fresh dairy products company in Thailand, named Danone Dairy Thaïlande, and the formation of a strategic partnership with Dutch Mill Co.

 

In January 2007, the Group acquired all of the shares of the joint venture Calpis Ajinomoto Danone, which was renamed Danone Japon.

 

In February 2007, the Group announced the formation of a joint venture with the Colombian company Alqueria to develop, produce and distribute fresh dairy products in Colombia.

 

In February 2007, the Group announced that in the context of the initial public offering of Hui Yuan Juice on the Hong Kong Stock Exchange, it would subscribe to the capital increase in order to maintain its percentage of ownership.

 

Consolidated Results of Operations

 

The tables below present (i) the principal components of the consolidated income statement in euro and as a percentage of net sales and (ii) the Group’s net sales, trading operating income and trading operating margin by main business line and geographic area for each of the years ended December 31, 2004, 2005 and 2006. The information below should be read in conjunction with the Consolidated Financial Statements and the Notes thereto, included elsewhere in this annual report.

 

     Year ended December 31,  
     2004     2005     2006  
     (millions of €, except percentages)  

Net sales(1)

   12,273     100.0 %   13,024     100.0 %   14,073     100.0 %

Cost of goods sold

   (6,223 )   50.7 %   (6,644 )   51.0 %   (7,214 )   51.3 %

Selling expenses

   (3,108 )   25.3 %   (3,331 )   25.6 %   (3,605 )   25.6 %

General and administrative expenses

   (976 )   8.0 %   (1,017 )   7.8 %   (1,047 )   7.4 %

Research and development expenses

   (129 )   1.0 %   (123 )   1.0 %   (126 )   0.9 %

Other (expense) income

   (229 )   1.9 %   (171 )   1.3 %   (167 )   1.2 %
                        

Trading operating income

   1,608     13.1 %   1,738     13.3 %   1,914     13.6 %

Other operating (expense) income

   (49 )   0.4 %   (32 )   0.2 %   (40 )   0.3 %

Operating income

   1,559     12.7 %   1,706     13.1 %   1,874     13.3 %

Cost of net debt

   (94 )   0.8 %   (101 )   0.8 %   (37 )   0.3 %

Other financial (expense) income

   104     0.9 %   (9 )   —       (31 )   0.2 %

Income before income tax

   1,569     12.8 %   1,596     12.3 %   1,806     12.8 %

Income taxes

   (428 )   3.5 %   (473 )   3.7 %   (360 )   2.6 %

Income from consolidated companies

   1,141     9.3 %   1,123     8.6 %   1,446     10.2 %

Net income (loss) of affiliates

   (550 )   4.5 %   44     0.3 %   (40 )   0.2 %

Net income from continuing operations

   591     4.8 %   1,167     8.9 %   1,406     10.0 %

Net income from discontinued operations

   47     0.4 %   504     3.9 %   154     1.1 %
                        

Net income

   638     5.2 %   1,671     12.8 %   1,560     11.1 %

Attributable to the Group

   449     3.7 %   1,464     11.2 %   1,353     9.6 %

Attributable to minority interests

   189     1.5 %   207     1.6 %   207     1.5 %
                                    

(1)   Net sales are stated net of rebates and discounts, as well as trade support actions that are generally invoiced by customers.

 

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    Net Sales  

Trading Operating

Income

 

Trading Operating

Margin(1)

 
    2004   2005   2006   2004     2005     2006   2004     2005     2006  
    (millions of €, except percentages)  

By Business Line

                 

Fresh dairy products

  6,510   7,184   7,934   917     1,019     1,109   14.1 %   14.2 %   14.0 %

Beverages

  3,201   3,473   3,942   493     474     504   15.4 %   13.7 %   12.8 %

Biscuits and cereal products

  2,562   2,367   2,197   278     343     301   10.9 %   14.5 %   13.7 %

Unallocated expenses

  —     —     —     (80 )   (98 )   —     —       —       —    
                                             

Total

  12,273   13,024   14,073   1,608     1,738     1,914   13.10 %   13.35 %   13.60 %
                                             

By Geographic Area

                 

Europe(2)

  8,096   8,179   8,582   1,209     1,266     1,295   14.9 %   15.5 %   15.1 %

Asia

  1,965   2,235   2,429   259     256     244   13.2 %   11.5 %   10.0 %

Rest of the World

  2,212   2,610   3,062   220     314     375   10.0 %   12.0 %   12.2 %

Unallocated expenses(3)

  —     —     —     (80 )   (98 )   —     —       —       —    
                                             

Total

  12,273   13,024   14,073   1,608     1,738     1,914   13.10 %   13.35 %   13.60 %
                                             

(1)   Trading operating income as a percentage of net sales.
(2)   France represented approximately 34% of the net sales of Europe in 2006 (35.3% in 2005 and 36.8% in 2004).
(3)   Unallocated income (expense) represents the balance of Group income (expenses) that have not been allocated to any specific operating division. In 2006, the Group established a system of analysis allowing it to allocate all of this income and expense to business lines.

 

Results of Operations for the Years Ended December 31, 2005 and 2006

 

Net Sales.    Net sales for the Group increased by 8.1% from € 13,024 million in 2005 to € 14,073 million in 2006. This increase in net sales resulted from a 9.7% increase in net sales at constant exchange rates and scope of consolidation, partially offset by a net negative effect (-1.4%) of changes in the scope of consolidation of the Group’s operations and currency exchange rates (-0.2%). The 9.7% increase in net sales at constant exchange rates and scope of consolidation achieved in 2006 resulted from an increase in sales volumes (approximately 7.1%) and an increase in price per unit of goods sold (2.6%).

 

The effect of changes in the scope of consolidation primarily resulted from the deconsolidation of the biscuits activities in India as of July 1, 2006 (see Note 8 to the Consolidated Financial Statements) and from the sale of the biscuits activities in New Zealand in June 2006.

 

Geographically, growth in net sales in 2006 was driven by the Rest of the World and by Asia, which achieved growth rates of 17.3% and 8.7%, respectively, at constant exchange rates and scope of consolidation. Growth in Europe, which is a more mature market, was 4.9% at constant exchange rates and scope of consolidation.

 

Cost of Goods Sold.    Cost of goods sold corresponds to production costs, including costs of raw materials (food and packaging), labor costs and depreciation of production machinery. In absolute terms, the cost of goods sold increased by 8.6% from € 6,644 million in 2005 to € 7,214 million in 2006. As a percentage of net sales, cost of goods sold increased from 51.0% in 2005 to 51.3% in 2006, representing an increase of approximately 30 basis points. This increase was mainly due to the increase in cost of certain raw materials, particularly plastics and sugar in Asia. These unfavorable factors were partially compensated by the Group’s policy of optimizing its use of ingredients and packaging, rationalizing raw materials flows in collaboration with suppliers and increasing productivity.

 

Selling Expenses.    Selling expenses correspond to advertising and promotional expenses, distribution costs and costs relating to the sales force. In absolute terms, selling expenses increased from € 3,331 million in 2005 to € 3,605 million in 2006, representing 25.6% of net sales in 2005 and 2006. This stability resulted from the

 

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Group’s policy of optimizing its advertising and promotional campaigns and reinforcing the accessibility of the Group’s products in terms of price, especially in emerging countries. In 2006, marketing expenses remained stable as a percentage of net sales.

 

General and Administrative Expenses.    General and administrative expenses increased slightly in 2006 to € 1,047 million from € 1,017 million in 2005, representing 7.4% of net sales in 2006 compared to 7.8% in 2005. This slight decrease in percentage of net sales was mainly due to the Group’s active policy over the last several years of reducing structural costs.

 

Research and Development Expenses.    Research and development expenses, which represent approximately 1% of net sales, increased slightly in 2006, to € 126 million from € 123 million in 2005.

 

Other Income and Expense.    Other expense amounted to € 167 million in 2006 compared to € 171 million in 2005. Other expense is composed of the following items:

 

     Year ended December 31,
         2005            2006    
     (€ in millions)

Employee profit sharing

   116    121

Stock options granted to employees of the Group

   23    14

Other

   32    32
         

Total

   171    167

 

The item “Other” includes mainly restructuring costs and the gain or loss on the sale of assets.

 

Trading Operating Income.    Trading operating income increased by € 176 million, from € 1,738 million in 2005 to € 1,914 million in 2006.

 

Trading operating margin increased by 25 basis points, from 13.35% in 2005 to 13.60% in 2006. This increase, supported by innovations in added value, increases in productivity and optimization of fixed costs, occurred in spite of significant increases in raw materials costs, mainly plastics, and the negative impact of changes in the mix of countries.

 

The Group’s trading operating income and margin under IFRS are calculated before certain items such as capital gains and losses on disposals of consolidated activities and impairment charges in relation to long-lived assets of subsidiaries. For a discussion of the differences in presentation between IFRS and U.S. GAAP, see Note 2 to the Consolidated Financial Statements.

 

Other Operating (Expense) Income.    In 2006, other operating expense totaled € 40 million, consisting essentially of the € 38 million loss related to the sale of Danone Waters of Canada (HOD Water in Canada) as well as the € 40 million impairment charge relating to the goodwill of Robust (Beverages in China), partially offset by the € 43 million gain realized on the sale of Griffins (Biscuits in New Zealand).

 

In 2005, other operating expense totaled € 32 million, consisting essentially of the € 53 million impairment charge on the Group’s HOD water activities in Canada, partially offset by the € 19 million gain related to the sale of Italaquae.

 

Operating Income.    Operating income increased by € 168 million, from € 1,706 million in 2005 to € 1,874 million in 2006. Operating margin increased by 20 basis points, from 13.1% in 2005 to 13.3% in 2006.

 

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Cost of Net Debt.    Cost of net debt decreased from € 101 million in 2005 to € 37 million in 2006. Cost of net debt is composed of the following items:

 

     Year ended December 31,  
         2005             2006      
     (€ in millions)  

Interest expense

   (189 )   (219 )

Interest income

   88     182  
            

Cost of net debt

   (101 )   (37 )

 

In 2006, the increase in interest expense resulted mainly from the higher interest expense on financial liabilities denominated in foreign currencies that are entered into to hedge certain foreign investments. The increase in interest income resulted mainly from an increase in the average amount of cash equivalents.

 

Other Financial Income and Expenses.    Other financial expenses amounted to € 31 million in 2006 compared to € 9 million in 2005. The increase in financial expenses results primarily from the decrease in interest received on the loan made to the investment funds in connection with the sale of Galbani, the loan having been repaid in May 2006.

 

Income Taxes.    The Group’s income taxes decreased from € 473 million in 2005 to € 360 million in 2006. The effective tax rate decreased from 29.6% in 2005 to 19.9% in 2006, due to the application of specific tax rates to capital gains and losses and impairment charges as well as the recognition of a deferred tax asset in 2006 for the full amount of the tax losses generated by the sale of the HOD water activities in the United States (see Note 24 to the Consolidated Financial Statements). After adjusting for non-current items, the effective tax rate was 28.1% in 2006 compared to 29.1% in 2005. See Note 24 to the Consolidated Financial Statements for a reconciliation of the French tax rate and the Group’s effective tax rate.

 

Net Income of Affiliates.    Net income of affiliates is detailed as follows:

 

     Year ended December 31,  
         2005             2006      
     (€ in millions)  

Group’s share in net income

   69     62  

Impairment charge

   (51 )   (130 )

Gain on disposal and others

   26     28  
            

Total

   44     (40 )

 

For 2006, the item “Impairment charge” includes impairment charges related to the Group’s interest in The Danone Springs of Eden BV (HOD Water in Europe). The item “Gain on disposal and others” includes the capital gain from the sale of the minority interest in Bakoma (Fresh Dairy Products in Poland).

 

For 2005, the item “Impairment charge” includes the loss in value of the minority interest in Bakoma. The item “Gain on disposal and other” includes primarily (i) the net capital loss of € 313 million from the disposal of the HOD water activities in the United States, (ii) the net capital gain of € 292 million from the disposal of Mahou (Beer in Spain) and (iii) the net capital gain of € 22 million from the disposal of Galletas Noël (Biscuits in Colombia).

 

Net Income from Discontinued Operations.    For 2006, this item includes the gain on the sale of the sauces activities in Asia. For 2005, this item includes net income from the sauces activities and the capital gain of € 473 million from the disposal of the sauces activities in the United Kingdom and the United States.

 

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Net Income Attributable to the Group.    In 2006, net income attributable to the Group amounted to € 1,353 million compared to € 1,464 million in 2005. The reconciliation of Group share in net income to Group share in current net income is presented in the table below:

 

     Year ended December 31,  
         2005             2006      
     (€ in millions)  

Net income attributable to the Group

   1,464     1,353  

Non-current net income from continuing operations

   71     (11 )

Net income from discontinued operations

   (504 )   (148 )
            

Current net income attributable to the Group from continuing operations

   1,031     1,194  

 

Non-current net income from continuing operations primarily consists of elements reflected in the item “Other operating (expense) income” (see above) and impairment charges and gains and losses from disposals relating to entities accounted for under the equity method (see above), as well as the effect of the recognition of deferered tax assets for the full amount of the tax losses generated by the HOD water activities in the United States.

 

Net Income per Share.    The diluted net income per share attributable to the Group decreased from € 5.87 in 2005 to € 5.53 in 2006. Excluding non-current items recorded in 2005 and 2006, diluted net income per share attributable to the Group would have increased by approximately 17.9%, from € 4.14 in 2005 to € 4.88 in 2006.

 

Net Sales, Trading Operating Income and Trading Operating Margin by Main Business Line

 

Fresh Dairy Products.    Net sales of fresh dairy products increased from € 7,184 million in 2005 to € 7,934 million in 2006, a 10.4% increase. At constant exchange rates and scope of consolidation, net sales increased by 9.2%. This internal growth, which was mainly driven by four blockbuster product lines (Actimel, Activia, Danonino and Vitalinea), was reinforced by positive effects of changes in the scope of consolidation, primarily related to the consolidation of Al Safi Danone Company (Saudi Arabia) and Danone Djurdjura (Algeria), companies in which the Group obtained control in July 2005 and July 2006, respectively. Variations in exchange rates had a slightly negative impact on growth of net sales in 2006, in the amount of 0.1%. Sales of yogurt and similar products, which represent close to 95% of the segment’s sales, showed an increase in net sales of close to 11% in 2006.

 

The 2006 performance once again reflects the segment’s ability to innovate and expand the scope of its brands and key products, whether geographically or through the introduction of new products. The probiotic line Activia continued to show growth rates in sales of close to 50% at constant exchange rates and scope of consolidation and represented net sales of € 1,279 million. Similarly, sales of Actimel recorded growth of 12% at constant exchange rates and scope of consolidation and represented net sales of more than € 1 billion in 2006.

 

Trading operating income improved from € 1,019 million in 2005 to € 1,109 million in 2006, and trading operating margin decreased from 14.2% to 14.0%. If corporate expenses had been reallocated to the business segments in 2005, trading operating income would have been € 965 million in 2005 and trading operating margin would have increased from 13.4% in 2005 to 14.0% in 2006. This increase of 68 basis points, which is primarily due to the stability in the price of milk and favorable market conditions for the other raw materials, demonstrates the continued success of innovation and the higher margin blockbusters.

 

Beverages.    Net sales of beverages increased from € 3,473 million in 2005 to € 3,942 million in 2006, an increase of 13.5%. At constant exchange rates and scope of consolidation, net sales of beverages increased 14.8% in 2006. This increase was partially offset by a 1.1% negative impact from changes in the scope of consolidation.

 

Trading operating income for beverages increased by more than 6% from € 474 million in 2005 to € 504 million in 2006 and trading operating margin decreased from 13.7% in 2005 to 12.8% in 2006. If corporate

 

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expenses had been reallocated to the business segments in 2005, trading operating income would have been € 448 million in 2005 and trading operating margin would have decreased from 12.9% in 2005 to 12.8% in 2006. The decrease in trading operating margin resulted primarily from (i) negative effects related to the increase in the price of plastics and sugar, particularly in Asia, and (ii) stronger growth in countries with lower margins, particularly in China in the fourth quarter of 2006.

 

Biscuits and Cereal Products.    Net sales of biscuits and cereal products decreased from € 2,367 million in 2005 to € 2,197 million in 2006, a decrease of 7.1%. This decrease is primarily due to a negative impact from changes in the scope of consolidation of 9.9% related to the disposal of Griffins (New Zealand) and the deconsolidation of the Indian company Britannia Industries (see Note 8 to the Consolidated Financial Statements). At constant exchange rates and scope of consolidation, net sales of biscuits and cereal products increased by 3.1% in 2006. This increase was mainly driven by Europe.

 

Trading operating income for biscuits and cereal products decreased from € 343 million in 2005 to € 301 million in 2006. Trading operating margin decreased from 14.5% in 2005 to 13.7% in 2006. If corporate expenses had been reallocated to the business segments in 2005, trading operating income would have been € 325 million in 2005 and trading operating margin would have remained stable at 13.7%. This stability primarily results from the neutral impact of the cost of raw materials and strong productivity, which compensated for an unfavorable geographic mix.

 

Net Sales, Trading Operating Income and Trading Operating Margin by Geographic Area

 

Europe.    Net sales in Europe increased from € 8,179 million in 2005 to € 8,582 million in 2006, an increase of 4.9%. At constant exchange rates and scope of consolidation, net sales increased by 5.1%, despite a slight increase in France, which represented € 2,916 million, or 34% of the region. The growth in Europe was primarily driven by the strong performances of Russia, Spain and Germany.

 

Trading operating income for Europe increased from € 1,266 million in 2005 to € 1,295 million in 2006 and trading operating margin decreased from 15.5% in 2005 to 15.1% in 2006. If corporate expenses had been reallocated to the business segments in 2005, trading operating income would have been € 1,204 million in 2005 and trading operating margin would have increased from 14.7% in 2005 to 15.1% in 2006.

 

Asia.    Net sales in Asia increased from € 2,235 million in 2005 to € 2,429 million in 2006, an increase of 8.7%. At constant exchange rates and scope of consolidation, net sales increased by 20.6% in 2006, with a large contribution from China.

 

Trading operating income for Asia decreased from € 256 million in 2005 to € 244 million in 2006 and trading operating margin decreased from 11.5% in 2005 to 10.0% in 2006. If corporate expenses had been reallocated to the business segments in 2005, trading operating income would have been € 239 million in 2005 and trading operating margin would have decreased from 10.7% in 2005 to 10.0% in 2006. This decrease is primarily due to the negative impact of the increase in the price of plastics and sugar.

 

Rest of the World.    Net sales in this region, which primarily includes the activities of the Group in the Americas and South Africa, increased from € 2,610 million in 2005 to € 3,062 million in 2006, an increase of 17.3%. At constant exchange rates and scope of consolidation, net sales increased by 16% in 2006, with high levels of growth in every country in the region.

 

Trading operating income for the Rest of the World increased from € 314 million in 2005 to € 375 million in 2006 and trading operating margin increased from 12% in 2005 to 12.2% in 2006. If corporate expenses had been reallocated to the business segments in 2005, trading operating income would have been € 295 million in 2005 and trading operating margin would have increased from 11.3% in 2005 to 12.2% in 2006, due to the growth of the business in the entire region.

 

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Results of Operations for the Years Ended December 31, 2004 and 2005

 

Net Sales.    Net sales for the Group increased by 6.1% from € 12,273 million in 2004 to € 13,024 million in 2005. This increase in net sales resulted from a 6.7% increase in net sales at constant exchange rates and scope of consolidation and a positive impact of currency exchange rates (1.6%), partially offset by a net negative effect (-2.2%) of changes in the scope of consolidation of the Group’s operations. The 6.7% increase in net sales at constant exchange rates and scope of consolidation achieved in 2005 resulted from an increase in sales volumes (5.2%) and an increase in price per unit of goods sold (1.5%).

 

The effect of changes in the scope of consolidation primarily resulted from the sale in 2004 of the Group’s biscuits activities in the United Kingdom (Jacob’s) and in Ireland (Irish Biscuits), by the deconsolidation of the biscuits activities in Latin America as of January 1, 2005 and by the sale of the bottled water activities in Italy in January 2005. These negative effects were partially offset by the first-time consolidation of Al Safi Danone Company, after the Group obtained control of this company on July 1, 2005. The currency conversion effect was mainly due to the depreciation of the euro against the U.S. dollar and currencies related to it, particularly the Chinese yuan.

 

Geographically, at constant exchange rates and scope of consolidation, growth in net sales in 2005 was driven by Asia and the Rest of the World, which achieved growth rates of 12.9% and 15.6%, respectively. Growth in Europe, which is a more mature market, was 2.8% at constant exchange rates and scope of consolidation.

 

Cost of Goods Sold.    Cost of goods sold corresponds to production costs, including costs of raw materials (food and packaging), labor costs and depreciation of production machinery. In absolute terms, the cost of goods sold increased by 6.8% from € 6,223 million in 2004 to € 6,644 million in 2005. As a percentage of net sales, cost of goods sold increased from 50.7% in 2004 to 51.0% in 2005, representing an approximately 30 basis point increase. This increase was mainly due to the increase in cost of certain raw materials, particularly plastics. These unfavorable factors were partially compensated by the Group’s policy of optimizing its use of ingredients and packaging, rationalizing raw materials flows in collaboration with suppliers and increasing productivity.

 

Selling Expenses.    Selling expenses correspond to advertising and promotional expenses, distribution costs and costs relating to the sales force. In absolute terms, selling expenses increased from € 3,108 million in 2004 to € 3,331 million in 2005, representing 25.3% and 25.6% of net sales, respectively. This increase in percentage of net sales resulted mainly from a significant increase in distribution costs following the increase in oil prices. This was partially offset by the Group’s policy of optimizing its advertising and promotional campaigns and reinforcing the accessibility of the Group’s products in terms of price, especially in emerging countries. In 2005, marketing expenses remained stable as a percentage of net sales.

 

General and Administrative Expenses.    General and administrative expenses increased slightly in 2005 to € 1,017 million from € 976 million in 2004, representing 7.8% of net sales in 2005 compared to 8.0% in 2004. This slight decrease in percentage of net sales was mainly due to the Group’s active policy over the last several years of reducing structural costs.

 

Research and Development Expenses.    Research and development expenses, which represent approximately 1% of net sales, decreased slightly in 2005, to € 123 million from € 129 million in 2004.

 

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Other Income and Expense.    Other expense amounted to € 171 million in 2005 compared to € 229 million in 2004. Other expense is composed of the following items:

 

     Year ended December 31,
         2004            2005    
     (€ in millions)

Employee profit sharing

   115    116

Stock options granted to employees of the Group

   28    23

Other

   86    32
         

Total

   229    171

 

The item “Other” includes mainly restructuring costs and the gain or loss on the sale of assets.

 

Trading Operating Income.    Trading operating income increased by € 130 million, from € 1,608 million in 2004 to € 1,738 million in 2005.

 

Trading operating margin increased by 25 basis points, from 13.10% in 2004 to 13.35% in 2005. This increase, which included approximately 51 basis points from the Group’s operating performance and approximately 44 basis points from changes in the scope of consolidation, occurred in spite of significant increases in transport costs and raw materials costs, mainly plastics, and the negative impact of changes in the mix of countries.

 

The Group’s trading operating income and margin under IFRS are calculated before certain items such as capital gains and losses on disposals of consolidated activities and impairment charges in relation to long-lived assets of subsidiaries. For a discussion of the differences in presentation between IFRS and U.S. GAAP, see Note 2 to the Consolidated Financial Statements.

 

Other Operating (Expense) Income.    In 2005, other operating expense totaled € 32 million, consisting essentially of the € 53 million impairment charge on the Group’s HOD water activities in Canada, partially offset by the € 19 million gain related to the sale of Italaquae (Beverages in Italy).

 

In 2004, other operating expense totaled € 49 million, consisting essentially of the capital loss on the disposal of the Group’s biscuits subsidiaries in the United Kingdom (Jacob’s) and Ireland (Irish Biscuits).

 

Operating Income.    Operating income increased by € 147 million, from € 1,559 million in 2004 to € 1,706 million in 2005. Operating margin increased by 40 basis points, from 12.7% in 2004 to 13.1% in 2005.

 

Cost of Net Debt.    Cost of net debt increased from € 94 million in 2004 to € 101 million in 2005. Cost of net debt is composed of the following items:

 

     Year ended December 31,  
     2004     2005  
     (€ in millions)  

Interest expense

   (149 )   (189 )

Interest income

   55     88  
            

Cost of net debt

   (94 )   (101 )

 

In 2005, the increase in interest expense resulted mainly from the € 13 million charge related to the early redemption of convertible bonds and an increase in the average cost of debt. The increase in interest income resulted mainly from an increase in the average amount of cash equivalents.

 

Other Financial Income and Expenses.    Other financial expenses amounted to € 9 million in 2005. In 2004, other financial income amounted to € 104 million and included primarily capital gains on the sale of

 

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non-consolidated investments for € 47 million and an earn-out received on the disposal of BSN Glasspack in the amount of € 71 million.

 

Income Taxes.    The Group’s income taxes increased from € 428 million in 2004 to € 473 million in 2005. The effective tax rate increased from 27.3% in 2004 to 29.6% in 2005, due to the application of specific tax rates to capital gains and losses and impairment charges. See Note 24 to the Consolidated Financial Statements for a reconciliation of the French tax rate and the Group’s effective tax rate.

 

Net Income of Affiliates.    Net income of affiliates is detailed as follows:

 

     Year ended December 31,  
         2004             2005      
     (€ in millions)  

Group’s share in net income

   58     69  

Impairment charge

   (608 )   (51 )

Gain on disposal

   —       26  
            

Total

   (550 )   44  

 

In 2005, the item “Impairment charge” includes impairment charges related to the minority interest in Bakoma (Fresh Dairy Products in Poland). The item “Gain on disposal” includes primarily (i) the net capital loss of € 313 million from the disposal of the HOD water activities in the United States, (ii) the net capital gain of € 292 million from the disposal of Mahou (Beer in Spain) and (iii) the net capital gain of € 22 million from the disposal of Galletas Noël (Biscuits in Colombia).

 

In 2004, the item “Impairment charge” includes provision and impairment charges related to the Group’s investments in DS Waters LP and The Danone Springs of Eden BV.

 

Net Income from Discontinued Operations.    This item includes net income from the sauces activities and the capital gain of € 473 million from the disposal of the sauces activities in the United Kingdom and the United States.

 

Net Income Attributable to the Group.    In 2005, net income attributable to the Group amounted to € 1,464 million compared to € 449 million in 2004. The reconciliation of Group share in net income to Group share in current net income is presented in the table below:

 

     Year ended December 31,  
         2004             2005      
     (€ in millions)  

Net income attributable to the Group

   449     1,464  

Non-current net income from continuing operations

   508     71  

Net income from discontinued operations

   (47 )   (504 )
            

Current net income attributable to the Group from continuing operations

   910     1,031  

 

Non-current net income from continuing operations primarily consists of elements reflected in the item “Other operating (expense) income,” as well as impairment charges and gains and losses from disposals relating to entities accounted for under the equity method (see above).

 

Net Income per Share.    The diluted net income per share attributable to the Group increased significantly from € 1.79 in 2004 to € 5.87 in 2005. Excluding non-current items recorded in 2004 and 2005, net income per share attributable to the Group would have increased by approximately 16%, from € 3.57 in 2004 to € 4.14 in 2005.

 

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Net Sales, Trading Operating Income and Trading Operating Margin by Main Business Line

 

Fresh Dairy Products.    Net sales of fresh dairy products increased from € 6,510 million in 2004 to € 7,184 million in 2005, a 10.4% increase. At constant exchange rates and scope of consolidation, net sales increased by 7%. This internal growth was reinforced by positive effects of changes in the scope of consolidation, primarily related to the consolidation of Al Safi Danone Company (Saudi Arabia), of which the Group obtained control in July 2005. Variations in exchange rates also had a positive impact on growth of net sales, in the amount of 2.3%. Sales of yogurt and similar products, which represent close to 95% of the segment’s sales, showed an increase in net sales of 11% in 2005.

 

The 2005 results once again reflect the segment’s ability to innovate and expand the scope of its brands and key products, whether geographically or through the introduction of new products. The probiotic line Activia continued to show growth rates in sales of close to 36% at constant exchange rates and scope of consolidation and represented net sales of approximately € 845 million. Similarly, sales of Actimel recorded growth of close to 20% at constant exchange rates and scope of consolidation and represented net sales of approximately € 890 million in 2005. Sales of the low-fat product line Taillefine/Vitalinea, which totaled approximately € 900 million in 2005, had a growth rate of approximately 2% at constant exchange rates and scope of consolidation.

 

Trading operating income improved 11.1% from € 917 million in 2004 to € 1,019 million in 2005, and trading operating margin increased from 14.1% to 14.2%. In addition to the negative effect related to the increase in the cost of plastics and transport, trading operating margin was impacted by the difficulties encountered in markets with higher margins, such as France, as well as strong growth in countries with lower margins.

 

Beverages.    Net sales of beverages increased from € 3,201 million in 2004 to € 3,473 million in 2005, an increase of 8.5%. At constant exchange rates and scope of consolidation, net sales of beverages increased by 10% in 2005. This increase was partially offset by a 2.6% negative impact from changes in the scope of consolidation related in particular to the disposal of the bottled water activities in Italy. Innovation was again a key factor in the growth of this segment, in particular with the launch of new flavored and functional beverages, such as Taillefine Fiz in France and Smakolyk in Poland.

 

Trading operating income for beverages decreased by approximately 4% from € 493 million in 2004 to € 474 million in 2005 and trading operating margin decreased from 15.4% in 2004 to 13.7% in 2005. The decrease in trading operating margin resulted primarily from (i) negative effects related to the increase in the cost of transport and the cost of raw materials, in particular plastics, and (ii) stronger growth in countries with lower margins. On the other hand, the disposal of the water activities in Italy had a positive impact on trading operating margin.

 

Biscuits and Cereal Products.    Net sales of biscuits and cereal products decreased from € 2,562 million in 2004 to € 2,367 million in 2005, a decrease of 7.6%. This decrease is primarily due to a negative impact from changes in the scope of consolidation of 10.1% related to the disposal of the biscuits activities in the United Kingdom and Ireland, as well as the deconsolidation of the biscuits activities in Latin America. At constant exchange rates and scope of consolidation, net sales of biscuits and cereal products increased 1.5% in 2005. In 2005, this increase was again driven by Asia (particularly India and Indonesia). In Europe, sales decreased slightly, due to strong competitive pressure from local actors.

 

Trading operating income for biscuits and cereal products increased from € 278 million in 2004 to € 343 million in 2005. Trading operating margin increased significantly, from 10.9% in 2004 to 14.5% in 2005. This increase reflects the Group’s efforts to improve profitability in the biscuits segment. Margin was also positively impacted by changes in the scope of consolidation, notably the disposal of Jacobs and Irish Biscuits in 2004 and the deconsolidation of the activities in Latin America as of January 1, 2005.

 

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Net Sales, Trading Operating Income and Trading Operating Margin by Geographic Area

 

Europe.    Net sales in Europe increased from € 8,096 million in 2004 to € 8,179 million in 2005, an increase of 1.0%. At constant exchange rates and scope of consolidation, net sales increased by 2.8%, despite a slight decrease in France, which represented € 2,833 million, or 35.3% of the region. The growth in Europe was primarily driven by the strong performances of Russia, Turkey, the United Kingdom and Germany.

 

Trading operating income for Europe increased from € 1,209 million in 2004 to € 1,266 million in 2005 and trading operating margin increased from 14.9% in 2004 to 15.5% in 2005. This increase was mainly the result of an improvement in operational performance as well as changes in the scope of consolidation (disposals of the water businesses in Italy as well as the biscuits businesses in the United Kingdom and Ireland). It was partially offset by the increase in the price of certain raw materials, particularly plastics, as well as a decrease in profitability in France.

 

Asia.    Net sales in Asia increased from € 1,965 million in 2004 to € 2,235 million in 2005, an increase of 13.8%. At constant exchange rates and scope of consolidation, net sales increased by 12.9% in 2005, with a large contribution from Indonesia and China.

 

Trading operating income for Asia decreased from € 259 million in 2004 to € 256 million in 2005 and trading operating margin decreased from 13.2% in 2004 to 11.5% in 2005, principally due to the large negative impact of the increase in the cost of transport and the price of plastics.

 

Rest of the World.    Net sales in this region, which primarily includes the activities of the Group in the Americas and South Africa, increased from € 2,212 million in 2004 to € 2,610 million in 2005, an increase of 18%. At constant exchange rates and scope of consolidation, net sales increased by 15.6% in 2005, with high levels of growth in every country in the region.

 

Trading operating income for the Rest of the World increased from € 220 million in 2004 to € 314 million in 2005 and trading operating margin increased from 10.0% in 2004 to 12.0% in 2005, due to the growth of the business and the deconsolidation of the biscuits activities in Latin America.

 

Liquidity and Capital Resources

 

Net Debt

 

Danone’s consolidated net debt is defined as current and non-current financial liabilities less cash, cash equivalents and marketable securities. Danone’s management uses net debt and total equity as an internal liquidity indicator. Danone believes this information will be useful to investors since it is used as a performance measure by credit rating agencies. A table of changes in net debt with a reconciliation of net debt to total debt is provided below.

 

     At December 31,
    

At December 31,

2005

  

Change for

the year

   

Transfer to

current portion

   

Translation

adjustments

    Other    

At December 31,

2006

     (€ in millions)

Cash and cash equivalents

   576    115     —       (36 )   —       655

Marketable securities

   2,413    201     —       (11 )   (39 )   2,564
                                 

Total cash and cash equivalents

   2,989    316     —       (47 )   (39 )   3,219

Current financial liabilities

   869    (235 )   23     (13 )   (228 )   416

Non-current financial liabilities

   5,692    28     (23 )   (12 )   20     5,705
                                 

Total financial liabilities

   6,561    (207 )   —       (25 )   (208 )   6,121
                                 

Net debt

   3,572    (523 )   —       22     (169 )   2,902
                                 

 

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Other changes in net debt correspond primarily to changes in financial liabilities related to the put options granted to minority stockholders (see note 16 to the Consolidated Financial Statements).

 

Cash, Cash Equivalents and Marketable Securities

 

Marketable securities, which are treated as trading securities, include mainly negotiable debt instruments (€ 1,292 million at December 31, 2006, € 670 million at December 31, 2005 and € 765 million at December 31, 2004) and money market funds (€ 1,272 million at December 31, 2006, € 1,743 million at December 31, 2005 and € 1,435 million at December 31, 2004).

 

Marketable securities are usually purchased from major financial institutions.

 

Financial Debt

 

Financial debt is composed of the following:

 

     At December 31,
         2004            2005            2006    
     (€ in millions)

Convertible bonds

   605    70    —  

Bank loans, other debt and employee profit-sharing debt

   3,456    3,465    3,617

Financial liabilities linked to options granted to minority stockholders

   2,440    2,626    2,504

Financial liabilities linked to securitized receivables

   703    400    —  
              

Total debt

   7,204    6,561    6,121
              

Including short-term portion

   527    869    416

Including long-term portion

   6,677    5,692    5,705

 

The line item “Bank loans, other debt and employee profit-sharing debt” mainly comprises (i) Euro Medium-Term Notes (EMTN) denominated in euro or in foreign currencies, which were issued as part of the annual program established by the Company and its subsidiary Danone Finance to issue EMTNs in a principal amount of up to € 7 billion, and (ii) treasury notes in a principal amount of up to € 2.5 billion.

 

The line item “Financial liabilities linked to options granted to minority stockholders” corresponds to the exercise price of the put options granted to minority stockholders in certain consolidated companies. The main commitment relates to Danone Spain for € 2,020 million. The majority of these options are exercisable at any time and no significant financial investment is currently considered probable regarding these options, with the exception of the potential partial exercise of the option relating to Danone Russia.

 

The decrease in financial debt between December 31, 2005 and December 31, 2006 resulted primarily from the early redemption of the balance of the convertible bonds as well as the expiration in June 2006 of the receivables securitization program.

 

Consolidated Cash Flows

 

The Group believes that the liquidity from its operations, cash, cash equivalents and marketable securities and the amounts available through its credit lines will be sufficient to finance its operating expenses, capital investment needs, debt service and dividend payments.

 

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The table below presents information related to the consolidated cash flows for the years ended December 31, 2004, 2005 and 2006.

 

     Year ended December 31,  
         2004             2005             2006      
     (€ in millions)  

Cash flows provided by operating activities

   1,694     1,847     2,169  

Capital expenditures

   (520 )   (607 )   (692 )

Proceeds from the sale of fixed assets(1)

   30     63     39  

Free cash flow(2)

   1,204     1,303     1,516  

Purchase of businesses and other investments, net of cash and cash equivalents acquired

   (98 )   (636 )   (575 )

Proceeds from the sale of businesses and other financial investments, net of cash and cash equivalents disposed of(1)

   620     1,596     391  

(Increase) decrease in long-term loans and other assets

   130     (134 )   336  

Changes in cash and cash equivalents of discontinued operations

   52     30     —    

Dividends

   (456 )   (489 )   (610 )

Purchases of treasury stock (net of disposals)

   (213 )   (558 )   (587 )

Increase in capital and additional paid-in capital

   38     61     52  
                  

Net financing surplus (requirements)(3)

   1,277     1,173     523  

(1)   The sum of these two line items corresponds to the line item “Proceeds from the sale of businesses and other investments net of cash and cash equivalents disposed of” in the statements of cash flows presented on page F-6.
(2)   Free cash flow equals cash flows from operating activities minus capital expenditures net of disposals. Groupe Danone management uses free cash flow as an internal liquidity indicator. Groupe Danone believes this information will be useful to investors since it is used as a performance measure by credit rating agencies. Free cash flow does not represent the residual cash flow available for discretionary expenditures, as other commitments have not been deducted. Free cash flow is a non-IFRS measure and should not be considered a substitute for IFRS measures of cash flow from operating, investing, and financing activities.
(3)   Net financing surplus (requirements) is an internal indicator that reflects changes in cash and cash equivalents, net of changes in current and non-current financial liabilities. The Group believes this measure to be useful to investors as it reflects changes in the Group’s financial structure, including its liquidity and solvency. Net financing surplus (requirements) is a non-IFRS measure and should not be considered a substitute for IFRS measures of cash flow from operating, investing, and financing activities. Net financing surplus (requirements) can also be derived from the statements of cash flows as follows:

 

     Year ended December 31,  
     2004     2005    

2006

 
     (€ in millions)  

Cash flows provided by operating activities

   1,694     1,847     2,169  

Cash flows provided by investing activities

   214     312     (501 )

Increase in capital and additional paid-in capital

   38     61     52  

Purchases of treasury stock (net of disposals)

   (213 )   (558 )   (587 )

Dividends

   (456 )   (489 )   (610 )

Net financing surplus (requirements)

   1,277     1,173     523  

 

Cash Flows Provided by Operating Activities

 

Cash flows provided by operating activities reflects the difference between cash generated by operating activities, excluding changes in net working capital and net changes in current working capital. In general, cash flow is lower in the first half of any given year compared to the second half of that year because of higher working capital needs in the beginning of the year due to (i) increased production in preparation for reduced plant activity and temporary plant closures during the summer vacation months, (ii) the build-up of beverages inventory for stronger consumption in the summer and (iii) outstanding accounts receivable from sales realized in May and June as a result of seasonal variations.

 

The increase in cash flows provided by operating activities resulted from (i) a 10.2% increase in cash provided by operating activities before net changes in working capital, which increased from € 1,716 million in

 

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2005 to € 1,891 million in 2006 and (ii) the optimization of net changes in working capital, which amounted to € 278 million in 2006 compared to € 131 million in 2005.

 

Capital Expenditures.    Capital expenditures amounted to € 692 million in 2006 compared to € 607 million in 2005 and € 520 million in 2004, representing 4.9%, 4.7% and 4.2% of net sales, respectively. See “—Overview—Acquisitions and Investments.” Disposals of industrial assets amounted to € 39 million in 2006, compared to € 63 million in 2005 and € 30 million in 2004.

 

Financial Investments.    Financial investments totaled € 575 million in 2006 compared to € 636 million in 2005 and € 98 million in 2004. For additional information on the Group’s acquisitions and divestitures, see above “—Overview—Acquisitions and Investments” and “—Recent Events.”

 

Proceeds from the sale of assets amounted to € 391 million in 2006 compared to € 1,596 million in 2005 and € 620 million in 2004. In 2006, proceeds from the sale of assets primarily related to the disposals of the sauces business in Asia (approximately € 180 million), the HOD water business in Canada (approximately € 47 million) and the biscuits business in New Zealand (approximately € 138 million).

 

Share Repurchase.    In 2006, the Company repurchased 7,073,266 of its own shares, for a total amount of € 731 million compared to 9,125,430 shares for a total amount of € 685 million in 2005 and 3,396,387 shares, for a total amount of € 226 million in 2004. In addition, the income received upon the exercise of share purchase options by employees amounted to € 144 million in 2006 compared to € 127 million in 2005 and € 13 million in 2004.

 

Other Financing

 

At December 31, 2006, the Group’s non-consolidated investments included investments in listed companies with a market value of € 757 million, as is reflected in the balance sheet. These non-consolidated investments mainly consist of investments in Wimm Bill Dann, ONA, Shanghai Bright Dairy and Britannia Industries (see Note 8 to the Consolidated Financial Statements).

 

Marketable securities include mainly negotiable debt instruments and money market funds with major financial institutions, with respect to which the Group’s exposure is limited. In addition, other financial assets include marketable securities in the amount of € 84 million held as security for the Group’s damage and healthcare provisions.

 

The Group’s pension fund had a market value of € 339 million at December 31, 2006, of which approximately 26% was invested in equity securities, pursuant to the policy adopted by the managers of these funds. See Note 17 to the Consolidated Financial Statements.

 

Financial Condition

 

Danone’s consolidated net debt (defined as current and non-current financial liabilities less cash, cash equivalents and marketable securities) decreased to € 2,902 million at December 31, 2006 compared to € 3,572 million at December 31, 2005 and € 4,538 million at December 31, 2004, corresponding to ratios of net debt to total equity of 47.8% in 2006 (6.6% excluding financial liabilities related to the put options granted to minority stockholders), 63.5% in 2005 (16.8% excluding financial liabilities related to the put options granted to minority stockholders) and 100.7% in 2004 (46.6% excluding financial liabilities related to the put options granted to minority stockholders). The Group’s management uses the net debt to total equity ratio as an internal liquidity indicator. The Group believes this information will be useful to investors since it is used as a performance measure by credit rating agencies.

 

The Company’s long-term debt is rated A1 stable by Moody’s and A+ stable by Standard & Poor’s, and its commercial paper is rated A-1 by Standard & Poor’s. The Group’s financial objective includes the use of debt financing to lower the average cost of capital, while maintaining reasonable levels of indebtedness to protect its financial flexibility.

 

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Danone maintains (at the parent company level and at the level of its finance subsidiaries, in particular Alfabanque, a wholly-owned subsidiary of the Company approved by the Comité des Etablissements de Crédit et des Entreprises d’Investissement and subject to all regulations applicable to credit institutions) credit lines with banks and other financial institutions to ensure the availability on an as-needed basis of medium-term credit lines. At December 31, 2006, Danone had credit lines totaling € 2,800 million (€ 2,875 million at December 31, 2005 and € 3,050 million at December 31, 2004). Operating subsidiaries had credit lines of € 294 million at December 31, 2006. Moreover, at December 31, 2006, the Group had cash and cash equivalents and marketable securities of € 3,219 million (compared to € 2,989 million at December 31, 2005 and € 2,666 million at December 31, 2004) to meet working capital needs and to take advantage of expansion opportunities.

 

Off-balance Sheet Arrangements and Aggregate Contractual Obligations

 

Aggregate Contractual Obligations

 

The following table sets forth the contractual obligations of the Group at December 31, 2006:

 

     Payment due by period  
     Total    2007    2008    2009    2010    2011    2012 and
after
 
     (€ in millions)  

Financial liabilities(1)(2)

   6,328    517    1,610    225    143    128    3,705 (3)

Capital lease commitments

   19    3    2    2    2    2    8  

Operating lease commitments

   295    97    61    44    24    20    49  

Commitments to purchase goods, services and investments

   652    512    58    44    23    12    3  

Commitments related to financial investments

   47    47    —      —      —      —      —    

(1)   Excluding financial liabilities linked to capital leases.
(2)   Including financial interest.
(3)   Consists primarily of the financial liabilities related to options granted to minority stockholders, which can be exercised at any time. The options granted to the minority shareholders of Danone Spain were granted for an initial contractual period of 25 years (expiring between November 2016 and February 2017) and may be automatically renewed for successive 5-year periods.

 

Other Commitments

 

     Amount of obligation by date of expiration
     Total    2007    2008    2009    2010    2011    2012 and
after
     (€ in millions)

Commitments granted

                    

Guarantees and pledges given

   98    78    1    —      1    —      18

Other commitments given

   99    57    8    9    4    3    18

Commitments received

                    

Credit lines

   3,094    539    —      1,152    1,400    —      3

Guarantees and pledges received

   61    52    1    —      —      —      8

Other commitments received

   61    56    2    1    —      —      2

 

In connection with the formation of The Danone Springs of Eden BV, the Group granted a put option and was granted a call option on the 33.1% interest in the company it does not already own, directly or indirectly. These options can be unconditionally exercised in 2008 and, when certain conditions are met, before 2008. The exercise price of these options depends on the valuation of the company taking into account its economic performance and its results. At December 31, 2006, taking into account the performance of the company during the year 2006, the obligation of the Group in relation to these options was reviewed and assessed at approximately € 120 million (€ 150 million at December 31, 2005).

 

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In addition, the Group granted a put option to its Indian partner in Britannia Industries (see Note 8 to the Consolidated Financial Statements).

 

Finally the Company and its subsidiaries are parties to a variety of legal proceedings arising out of the normal course of business. Liabilities are accrued for when a loss is probable and can be reasonably estimated.

 

Impact of Changes in Exchange Rates

 

The Group publishes its consolidated financial statements in euro. In 2006, approximately 48% of the Group’s net sales and 60% of its trading operating income were realized in euro. However, a substantial portion of the Group’s assets, liabilities, sales and earnings are denominated in currencies other than the euro, particularly the Chinese yuan, the U.S. dollar and U.S. dollar-influenced currencies, the British pound or the Polish zloty. As a result, the Group is exposed to fluctuations in the values of such currencies against the euro with respect to the translation into euro of amounts to be reflected in its consolidated financial statements. In particular, the appreciation of the euro in relation to other currencies decreases the euro value of the contribution to the Group’s consolidated results and to the financial condition of the Group’s subsidiaries that maintain their financial accounts in such other currencies.

 

Both the sales and operating expenses of the Group’s subsidiaries are denominated principally in the currencies of their home countries, except for imports, exports and financial transactions, which are generally hedged. As a result, the Group believes that its exposure to currency fluctuations has been, and will continue to be, limited locally. As a result of the Group’s strategy of geographic expansion, however, the proportion of the Group’s consolidated net sales, operating income and net income represented by international operations is expected to continue to increase.

 

For the purpose of preparing its consolidated financial statements, the Group uses the exchange rate applicable at the end of the year for the conversion of balance sheets (except if high local inflation rates call for a different method) and the average exchange rate for the year (calculated by averaging the applicable rate at the end of each month during the year) for conversion of income statements and cash flow changes.

 

In accordance with the Group’s accounting policies, differences resulting from translation into euro of the financial statements of foreign subsidiaries are accounted for under stockholders’ equity until such time as the foreign investments to which such differences relate are sold or liquidated. See “Item 3: Key Information—Risk Factors—The Group’s results of operations and financial condition could be harmed by changes in exchange rates.”

 

In 2006, approximately 52% of the Group’s net sales (49% in 2005) and 40% of the Group’s trading operating income (40% in 2005) were outside the euro zone and therefore subject to exchange rate risk.

 

     2005     2006  
    

In millions of

euro

  

As a % of

Group figures

   

In millions

of euro

  

As a % of

Group figures

 

Net sales:

          

of subsidiaries located in euro zone

   6,642    51 %   6,755    48 %

of subsidiaries located outside euro zone

   6,382    49 %   7,318    52 %
                      

Group total net sales

   13,024    100 %   14,073    100 %
                      

Trading operating income:

          

of subsidiaries located in euro zone

   1,043    60 %   1,148    60 %

of subsidiaries located outside euro zone

   695    40 %   766    40 %
                      

Group total trading operating income

   1,738    100 %   1,914    100 %
                      

 

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Item 6.    Directors, Senior Management and Employees

 

Directors and Senior Management

 

In accordance with French law governing a société anonyme, a form of limited liability company, the Company’s activities are managed by its board of directors, or conseil d’administration, and by its Chairman and Chief Executive Officer, who has full executive authority to manage the activities of the Company, subject to the prior authorization of the board of directors or of the Company’s shareholders for certain decisions specified by law or by the charter of the board of directors.

 

Under French company law, the board of directors may elect one person to assume the position of Chairman and Chief Executive Officer or split these functions between two different persons (either the Chairman of the Board or another natural person bearing the title of Chief Executive Officer or Directeur Général). The Company’s bylaws were modified at the extraordinary shareholders’ meeting of April 25, 2002 to provide for such a choice. According to the Company’s bylaws, the choice is made by the board of directors deciding with a majority of all its members. On April 25, 2002, the board of directors decided not to split these two functions, which are currently performed by the same person.

 

French law and the Company’s bylaws permit the board of directors to delegate general or specific powers to up to five people (Directeurs Généraux Délégués or Assistant Managing Directors). The Chief Executive Officer proposes the appointment of the Directeurs Généraux Délégués or Assistant Managing Directors to the board of directors and the board of directors determines their specific management powers and responsibilities. Under French law, an Assistant Managing Director, like the Chief Executive Officer, has broad powers to represent and bind the Company in dealings with third parties. An Assistant Managing Director may be removed by the board of directors at any time upon proposal by the Chief Executive Officer. An Assistant Managing Director may be held individually responsible for his/her actions if they are deemed contrary to the Company’s interests.

 

Pursuant to the Company’s bylaws, in addition to the appointment of Directeurs Généraux Délégués, the board of directors can appoint one or more Vice-Chairmen. The Vice-Chairman’s seat comprises no particular powers other than chairing board meetings and general meetings if either the Chairman or the director temporarily acting for the latter, in compliance with law, is absent.

 

In consideration for their services on the board, directors are entitled to receive jetons de présence (“directors’ fees”). The total annual amount of jetons de présence is fixed at the shareholders’ meeting, but the board determines their allocation among the directors. In addition, remuneration may be granted to directors on a case-by-case basis for special assignments. Subject to one exception below, a director may not vote for his or her own remuneration. If he or she does vote, the decision is void. The board may also authorize the reimbursement of travel and accommodation expenses as well as other expenses incurred by directors in the corporate interest. The Chairman of the Board, Chief Executive Officer and Assistant Managing Directors are entitled to receive remuneration or other amounts in addition to jetons de présence under certain circumstances. Any additional remuneration is determined by the board of directors and therefore, in this case only, the Chairman of the Board, Chief Executive Officer and Assistant Managing Directors may vote on resolutions concerning their remuneration.

 

Board of Directors

 

Under French law, the board of directors prepares and presents yearly financial statements to the shareholders and calls the shareholders’ meeting. In addition, the board of directors determines the direction of the Company’s activities and oversees the implementation of its decisions.

 

Meetings of the board of directors, which are held as often as required by the corporate interest, are normally convened and presided over by the Chairman. According to French company law, if the board of

 

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directors has not met for over two months, at least one-third of the members of the board may request that the Chairman convene the board regarding matters listed in the agenda for the meeting. A quorum is at least one-half of the members of the board, and decisions are taken by a vote of the majority of the members present, deemed to be present, or represented by other members of the board of directors. The Company’s bylaws permit that certain decisions be taken by the board of directors by means of a conference call or video communication. A director may give a proxy to another director by any written or electronic means, but a director cannot represent more than one other member at any particular meeting. Members of the board of directors represented by another member at meetings do not count for purposes of determining the existence of a quorum. A director may not vote for an arrangement or contract in which he or she is interested. If he or she does vote, the decision will be void.

 

Under French law, the board of directors must give prior authorization for any security, pledge or guarantee granted by the Company to secure obligations of third parties. This authorization is generally granted for a period of one year. If the security, pledge or guarantee has not been previously authorized by the board of directors, it shall have no effect with regard to the Company.

 

Pursuant to French law and the Company’s bylaws, the board of directors may consist of 3 to 18 directors. The Company’s bylaws provide that each director is elected by the shareholders at an ordinary general meeting of shareholders for a three-year term and is eligible for reelection upon expiration of such term. The shareholders’ meeting of April 11, 2003 passed a resolution increasing the aggregate amount of directors’ fees to € 500,000. Pursuant to the Group’s code of business conduct (Principes de Conduite des Affaires du Groupe), directors who are also members of the executive committee do not receive directors’ fees. In 2006, directors were paid a total of approximately € 278,000 in directors’ fees for their attendance at board meetings. A director who attended all five meetings of the board of directors in 2006 received € 20,000 in director’s fees, with a fixed portion of € 10,000 per year and a variable portion of € 2,000 per meeting attended. In addition, the members of the three committees of the board of directors received compensation of € 4,000 per meeting. The compensation of the chairmen of these committees is double these amounts. Each director must own at least 2,000 shares of the Company throughout his term of office. In 2006, the board of directors of the Company held five meetings and the attendance rate was approximately 85%.

 

The Company’s bylaws provide for the retirement age of the directors. Directors cannot be appointed if they are over 70 years old. The term of such director will automatically terminate at the end of the ordinary general meeting of shareholders held in the year during which the director has reached the age of 70. However, according to the Company’s bylaws, the general shareholders’ meeting may resolve that this age limit shall not apply to one or more directors who remain in office or may be re-appointed, provided the number of directors concerned by this provision does not exceed one-quarter of the directors in office.

 

In addition, according to the Company’s bylaws, the Chairman of the Board, the Chief Executive Officer (if applicable) and Assistant Managing Directors may not be more than 65 years old.

 

The French Commercial Code (Code de Commerce) strictly forbids loans by the Company to its directors. In addition, no Group company may provide loans to directors or guarantee any director’s obligations. This prohibition also applies to specified executive officers, Assistant Managing Directors, permanent representatives of companies on the board of directors, spouses or heirs of such persons, and other intermediaries.

 

The French Commercial Code and the Company’s bylaws require any director, the Chief Executive Officer, any Assistant Managing Directors and any of the Company’s shareholders holding voting rights greater than 10%, or if a shareholder company, the company controlling it, that are considering, either directly or indirectly, personally or through an intermediary, entering into an agreement with the Company, to inform the Company’s board of directors as well as its auditors before the transaction is consummated. French law also requires such an agreement to be authorized by the board of directors, and the director in question or person concerned may not vote on the issue. French law further requires such an agreement to be submitted to an ordinary general meeting of shareholders for approval once entered into, upon presentation of a special report from the Company’s auditors. Any agreement entered into in violation of these requirements may be declared void by the Commercial

 

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Court at the request of the Company or of any shareholder, if such agreement is contrary to the interests of the Company. However, French law also states that such agreements, if they are entered into in the ordinary course of business and with terms and conditions which are not out of the ordinary, are not subject to the prior authorization of the board of directors. Nevertheless, such agreements must be disclosed by the interested party to the Chairman of the board of directors unless they are not significant for any party in terms of purpose or financial impact. The list and purpose of such agreements must be communicated by the Chairman of the board to the board of directors and to the statutory auditors.

 

Under French law, directors are liable for violations of French legal or regulatory requirements applicable to sociétés anonymes, violation of the bylaws or mismanagement. A director may be held liable for such actions both individually and jointly with other directors.

 

The following table sets forth the names and ages of the directors of the Company, their principal occupation or employment, the dates of their initial election as directors and the years of expiration of their terms:

 

Name

   Age   

Principal Occupation or Employment

   Director
Since
   Term
Expires
 

Franck Riboud

   51   

Chairman and Chief Executive Officer (“Président Directeur Général”) of Groupe Danone.

Director of L’Oreal SA, Renault, ONA; Member of Supervisory Board of Accor.

   1992    2010 (1)

Jacques Vincent

   61   

Vice-Chairman, Directeur Général Délégué of Groupe Danone.

Chairman of the Board of Directors of Ecole Normale Supérieure de Lyon; Director of Syngenta.

   1997    2008  

Bruno Bonnell(2)

   48    Chairman and Chief Executive Officer of the Board of Directors of Infogrames Entertainment; Member of the Supervisory Board of Pathe, Eurazeo.    2002    2008  

Michel David-Weill

   74    President of Supervisory Board of Eurazeo; Member of Supervisory Board of Publicis Groupe.    1970    2008  

Emmanuel Faber

   43   

Executive Vice-President—Asia-Pacific of Groupe Danone.

Director of Ryanair Holdings Plc; Member of the Supervisory Board of Legris Industries.

   2002    2010 (1)

Richard Goblet d’Alviella(2)

   58    Chief Executive Officer (“Administrateur Délégué”) of Sofina S.A.; Director of Delhaize Groupe, Suez, Suez-Tractebel, Caledonia Investements, Finasucre SA, Glaces de Moustier sur Sambre, Henex S.A., Société de Participations Industrielles SA; Member of the Supervisory Board of Eurazeo.    2003    2009  

Naomasa Tsuritani(3)

   63    Senior Managing Director of Yakult Honsha, Co Ltd.    2007    2008  

Bernard Hours

   50   

Executive Vice-President—Fresh Dairy Products of Groupe Danone.

Director of Colombus Café, Flam’s.

   2005    2008  

Christian Laubie(2)

   68    Member of the Haut Conseil du Commissariat aux Comptes.    1985    2009  

Jean Laurent(2)

   62    Chairman of the Board of Directors of Calyon S.A., Institut Europlace de Finance; Director of M6; Member of the Supervisory Board of Eurazeo.    2005    2009  

Hakan Mogren(2)

   62    Deputy Chairman of AstraZeneca Plc; Vice-Chairman of Gambro AB; Board Member of Remy Cointreau, Investor AB.    2003    2009  

 

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Name

   Age   

Principal Occupation or Employment

   Director
Since
   Term
Expires

Jacques Nahmias(2)

   59    Chairman and Chief Executive Officer of Pétrofrance Chimie SA, Terminales Portuarias S. L., Vice-Chairman of Mercury Oil & Shipping Corporation, Petrofrance Inc.    1981    2008

Benoît Potier(2)

   49    Chairman and Chief Executive Officer of Air Liquide SA; Chairman and Chief Executive Officer of Air Liquide International; Member of the Supervisory Board of Michelin.    2003    2009

(1)   Subject to the approval of the shareholders’ meeting of April 26, 2007.
(2)   Independent director as determined by the board of directors.
(3)   Naomasa Tsuritani was co-opted by the board of directors on February 14, 2007 to replace the resigned director Hirokatsu Hirano for the remainder of his term, i.e., until the shareholders’ meeting called to approve the financial statements for the year 2007.

 

The Company’s board also includes three honorary directors who serve in an advisory role: Daniel Carasso (Honorary Chairman), Yves Boël and Jean-Claude Haas.

 

The Company has implemented a charter, which outlines the rights and responsibilities of directors and the principles governing the conduct of its executive officers. These guidelines were adopted at the directors’ meeting held on April 25, 2002. In 2003, further to the recommendations of the Nomination Committee and following the Bouton Report, a report issued in France to promote better corporate governance practices for listed companies, the board of directors evaluated its operating practices and decided to modify the charter of the board of directors. Following its evaluation in 2006, a new charter was adopted by the board of directors at its meeting on December 15, 2006.

 

The board of directors applied the recommendations of the Bouton Report to evaluate the independence of the directors according to criteria that are different from those adopted by the New York Stock Exchange. However, the board of directors decided to progressively implement the recommendation of the Bouton Report relating to directors who have served as such for over 12 years and provide for the development of the board accordingly. The board of directors also noted that the roles as directors that Mr. Goblet d’Alviella occupies in two companies in which Mr. Franck Riboud was also a director until June 2006 did not affect his independence. As a result of these decisions, the board reviewed the position of each of its directors and qualified seven of the thirteen directors as independent. The Company believes that seven of the thirteen directors are also independent under the independence criteria adopted by the New York Stock Exchange.

 

Significant Differences from NYSE Corporate Governance Requirements

 

Although Groupe Danone, as a foreign private issuer, is exempt from most of the corporate governance requirements of the New York Stock Exchange applicable to U.S. companies, Groupe Danone currently complies with substantially all such corporate governance requirements except that Groupe Danone’s non-management directors do not currently meet without management and Groupe Danone’s Nomination and Compensation Committee is not composed wholly of independent directors.

 

Executive Committee

 

Under the authority of Mr. Franck Riboud, the executive officers comprising the executive committee ensure the operational management of the Group. The executive officers implement the strategy defined by the board of directors, approve the budgets, coordinate the planning and execution of the missions of each of the subsidiaries and business lines and, depending on the results achieved, determine action plans to be implemented. The executive officers meet in committee at least once a month.

 

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The following table sets forth the names and ages of the executive officers of the Company and their current positions with the Company:

 

Name

   Age   

Position

   Executive Officer Since

Franck Riboud

   51    Chairman and Chief Executive Officer (Président Directeur Général)    1996

Jacques Vincent

   61    Vice-Chairman and Directeur Général Délégué    1996

Georges Casala

   65    Executive Vice-President—Biscuits and Cereal Products    2000

Emmanuel Faber

   43    Executive Vice-President—Asia-Pacific    2000

Antoine Giscard d’Estaing

   46    Executive Vice-President—Finance, Strategy and Information Systems (Chief Financial Officer)    2005

Bernard Hours

   50    Executive Vice-President—Fresh Dairy Products    2001

Philippe Loïc Jacob

   42    Secretary General    2005

Thomas Kunz

   49    Executive Vice-President—Beverages    2004

Franck Mougin

   49    Executive Vice-President—Human Resources    2002

Sven Thormahlen

   50    Executive Vice-President—Research and Development    2005

 

Franck Riboud, 51, has been Chairman and Chief Executive Officer (Président Directeur Général) since 1996. Mr. Riboud joined the Group in 1981 and has held several positions, including General Manager of Evian in 1990 and General Manager of Corporate Business Development in 1994 when he was responsible particularly for the internationalization of the Group. Prior to being appointed to his current position, he was Vice-President and General Manager and Member of the board of directors from 1994. Mr. Riboud holds a degree in engineering from Ecole Polytechnique in Lausanne.

 

Jacques Vincent, 61, was appointed Vice-Chairman and Directeur Général Délégué in 1998. Prior to this, he was Vice-President—Fresh Dairy Products. Having spent most of his career with the Group, he occupied various positions as general manager of certain of its subsidiaries in France, Germany, Italy and the United States in the water and dairy businesses. Mr. Vincent holds a Master of Science degree from Stanford University, an engineering degree from the Ecole Centrale de Paris and a degree in economics.

 

Georges Casala, 65, is Executive Vice-President—Biscuits and Cereal Products Worldwide. He began his career in General Foods and joined Danone in 1973. Since then, he has held such positions as President and Chief Executive Office of the Dannon Company in the United States from 1982 to 1989, Vice-President of Danone France since 1989 and Executive Vice-President—Northern Europe since 1995. Mr. Casala is a graduate of the Ecole Supérieure de Commerce de Paris and holds a degree in economics.

 

Emmanuel Faber, 43, is Executive Vice-President—Asia-Pacific. He joined the Group in 1997 as Director of Development and Strategy, held the position of Executive Vice-President—Finance, Strategy and Information Systems from 2000 to 2005 and has held his current position since 2005. He began his career as a consultant with Bain & Co. then worked for Banque Baring Brothers in 1988. Subsequently, he became financial director and head of strategy of the Legris Industries Group in 1993 and later a member of the board of directors in 1994 and Managing Director of the Group in 1997. Mr. Faber is a graduate of the Ecole des Hautes Etudes Commerciales (HEC).

 

Antoine Giscard d’Estaing, 46, is Executive Vice-President—Finance, Strategy and Information Systems (Chief Financial Officer). He began his career as a finance inspector in the French civil service. He then joined Lyonnaise des Eaux, where he held a number of positions within the Finance Department and at subsidiary Elyo.

 

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From October 1995 to May 1999, Mr. Giscard d’Estaing served as Senior Vice President, Finance for Lyonnaise des Eaux, which merged with Suez to become Suez Lyonnaise des Eaux in 1997. In June 1999, he joined Schneider Electric as Executive Vice-President, Finance and Control and a member of the Executive Committee. Antoine Giscard d’Estaing is a member of the Board of the French stock market authority, Autorité des Marchés Financiers (AMF). He is a graduate of the Ecole des Hautes Etudes Commerciales (HEC) and the Ecole Nationale d’Administration (ENA).

 

Bernard Hours, 50, is Executive Vice-President—Fresh Dairy Products Worldwide. He joined the Group in 1987 following a career at Unilever. Since then, he held various positions within the Group, including several marketing positions at Kronenbourg, Evian and Danone France. He was also General Manager of subsidiaries in the fresh dairy products division (Hungary and Germany) and in the biscuits division (France). Mr. Hours is a graduate of the Ecole des Hautes Etudes Commerciales.

 

Philippe Loïc Jacob, 42, is Secretary General of Groupe Danone (covering the Legal Department, Public Affairs Department, Quality Department and Risk Management Department). He started his career in 1986 in various marketing positions for Evian and for Brasseries Kronenbourg. In 1993 he was appointed Director of Acquisitions within the Corporate M&A Department. In 1996 he moved to Argentina as General Manager of Villa del Sur before being appointed General Manager of the Mercosur Water Business. In 2000 he was appointed Director of Strategy and Acquisitions for the Water Worldwide Business Unit. Philippe-Loïc Jacob is a French and Canadian citizen and holds a diploma from the Lyon School of Management (EM Lyon).

 

Thomas Kunz, 49, is Executive Vice-President—Beverages. He joined the Group in 1990 as Marketing Director of Gervais Danone AG, Germany. In 1995, he was appointed General Manager of Danone de Mexico, and in 1998, he was appointed General Manager of Bagley, Argentina. In 1999, he was appointed General Manager of the Dairy North America business. Mr. Kunz graduated from the Saint Gall University in Switzerland with a degree in economics.

 

Franck Mougin, 49, is Executive Vice-President—Human Resources. He has spent his entire career working in human resources, for several industrial groups. Mr. Mougin began his career with CGEE-Alsthom in 1981, before joining the Luchaire group. In 1983, he joined Matra Electronique as Human Resources Manager. From 1989 to 1995, he held the position of Human Resources Manager with Fruehauf France, and then with the Fruehauf-Trailor Group. Since 1995, he held successive positions as Human Resources Manager for Placoplatre, and then for the British Plaster Board Group (BPB) in London. Mr. Mougin holds a Master’s degree in social law.

 

Dr. Sven Thormahlen, 50, is Executive Vice-President—Research and Development. He received his doctorate in organic synthetic chemistry from the University of Hamburg and held different positions in the research and development organizations of leading healthcare and consumer goods companies. He has worked in Germany, in the United States and in France. His experience covers product research, product development, clinical studies and quality assurance.

 

Directors’ and Executive Officers’ Compensation

 

In 2006, the aggregate amount of compensation paid by Danone to its executive officers and directors as a group (19 persons in all) for services in all capacities was € 11.4 million, including € 11.1 million to executive officers of which € 6 million was variable compensation. The aggregate amount paid by Danone for pension, retirement or similar benefits for the same executive officers and directors as a group in respect of the 2006 fiscal year was € 0.6 million.

 

Executive officers’ compensation amounts include a fixed element and a variable element representing between 40% and 60% of total compensation. The variable element is based on economic, social and individual objectives. For all executive officers, the variable element is based on economic objectives, to which is added a qualitative evaluation of the strategy developed over the course of the year. For the Chairman and Vice-

 

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Chairman, the variable economic element is calculated with reference to Group objectives, in terms of net sales, trading operating margin, free cash flow and current net earnings per share, as communicated to the financial markets. For executive officers who manage a business line, the variable economic element is based on objectives set in the budget of the business line in terms of net sales, trading operating income, free cash flow and trading operating margin. For the other executive officers, the variable economic element is calculated based on the Group’s objectives set in the budget in terms of trading operating margin, current net earnings per share and operating costs. The compensation of the Chairman and Vice-Chairman are determined by the board of directors on the basis of recommendations made by the Nomination and Compensation Committee. The compensation policy for the other members of the executive committee is presented annually to the Nomination and Compensation Committee.

 

In 2005 and 2006, the aggregate amount of compensation for services awarded to the directors was:

 

     Compensation and Other
Benefits(1)

Name

   2005    2006
     (in euro)

Franck Riboud

   2,485,540    2,579,100

Jacques Vincent

   1,544,620    1,592,980

Bruno Bonnell

   20,000    16,000

Michel David-Weill

   32,000    24,000

Emmanuel Faber

   966,058    998,084

Richard Goblet d’Alviella

   54,000    44,000

Hirokatsu Hirano

   20,000    16,000

Bernard Hours

   941,408    1,364,170

Christian Laubie

   54,000    44,000

Jean Laurent

   20,000    24,000

Hakan Mogren

   16,000    22,000

Jacques Nahmias

   22,000    20,000

Benoît Potier

   66,000    68,000

(1)   Compensation includes gross salary, bonuses, indemnities and directors’ fees granted by the Company and its subsidiaries for the financial period. In 2006, the variable portion of compensation was € 1,583,560 for Franck Riboud, € 828,360 for Jacques Vincent, € 508,464 for Emmanuel Faber and € 809,550 for Bernard Hours. In addition, benefits in kind were granted to each director member of the executive committee in the amount of € 4,620.

 

Employees at Groupe Danone benefit from the Groupe Danone standard employment contracts. However, while Franck Riboud and Jacques Vincent hold their positions as Président Directeur Général and Directeur Général Délégué, respectively, their service contracts with the Company are suspended. In the event that either of these two individuals no longer holds his position, his service contract with the Company will be reinstated, (i) taking into account the length of his terms as Président Directeur Général or Directeur Général Délégué, respectively, for purposes of seniority and benefits, (ii) at a position comparable to that currently held in the executive committee and (iii) at an annual level of compensation no less than the average for all the members of the executive committee during the twelve months prior to such reinstatement. Emmanuel Faber and Bernard Hours continue to benefit from their service contracts without interruption. In addition, if Messrs. Riboud and Vincent are removed from their current positions in certain specific circumstances, they will be entitled to a severance payment of two times the compensation (including bonus compensation and benefits) received during the preceding twelve months. A similar provision also applies to Mr. Faber and all members of the executive committee who hold a service contract under French law.

 

Senior managers of the Group who were under the French pension system at December 31, 2003 benefit from a defined benefit pension plan. This plan pays a pension based on years of service and the amount of the last salaries, under the condition that the employee is still with the Group at the time of retirement. The pension is paid after deducting pensions paid by other mandatory plans and may reach a maximum of 65% of the last salary. In the event of retirement before the age of 55 or in the event of death before retirement, the employee loses all

 

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benefits under this plan. This pension plan was closed to new participants on December 31, 2003. The amount provisioned for this plan represents the obligation of the Group at December 31, 2006 for the payment of annuities calculated on the basis of life expectancies based on mortality tables.

 

At December 31, 2006, the total amount of the Group’s pension obligations for directors was € 38 million.

 

Committees of the Board of Directors

 

The board of directors has established three committees: the Audit Committee, the Nomination and Compensation Committee and the Social Responsibility Committee, as described below. The administrative organization of the Audit Committee and the Nomination and Compensation Committee differs from that required of U.S. companies listed on the New York Stock Exchange.

 

Audit Committee

 

In its meeting on December 15, 2006, the board of directors gave the Audit Committee a new charter which outlines its responsibilities.

 

The Audit Committee is responsible for:

 

   

reviewing and commenting on the Company’s statutory and consolidated financial statements prior to their approval by the board of directors and in particular, (i) ensuring that management has ensured the reliability and integrity of the Company’s accounting policies, (ii) reviewing the accounting treatment of complex or unusual transactions, (iii) reviewing the scope of consolidation, (iv) verifying that the internal control procedures are sufficient to assure the quality of financial information and (v) reviewing the principal financial information documents of the Group;

 

   

conducting the selection process for the independent auditors of the Company, making all proposals for their appointment, renewal and compensation, reviewing their audit plan as well as reviewing specific projects that may be assigned to them, and ensuring their independence; and

 

   

ensuring the existence of the internal control and risk management procedures established by the Company, reviewing the report of the Chairman of the board of directors on internal control, approving the internal audit plan, following its execution and ensuring the level of quality and adequacy of resources allocated to internal controls.

 

In 2006, the Audit Committee met six times and in particular examined:

 

   

the procedures put in place for the valuation of long-term assets, in particular, those related to the HOD water activities in Europe,

 

   

the status of the work on internal control procedures required to comply with the Sarbanes-Oxley Act of 2002,

 

   

the procedures for risk assessment,

 

   

the approval of internal and external audit plans, and

 

   

the pre-approval policy for services of the independent auditors (excluding audit work),

 

The written minutes of the Audit Committee meetings were circulated to the directors and commented on during the meetings of the board of directors.

 

As of February 28, 2007, the members of the Audit Committee were Benoît Potier (Chairman), Richard Goblet d’Alviella and Christian Laubie, who are all independent.

 

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Mr. Christian Laubie is the “financial expert” of the Audit Committee, due to his knowledge of accounting principles, procedures of internal control and the roles of the Audit Committee. Mr. Laubie was the Chief Financial Officer of Danone from 1980 to 2000, and he participates in the organization that regulates statutory audit professionals in France.

 

Nomination and Compensation Committee

 

In 2005, the board of directors decided to merge the Compensation Committee and the Nomination Committee into a single committee called the Nomination and Compensation Committee.

 

In its meeting on December 15, 2006, the board of directors gave the Nomination and Compensation Committee a new charter which outlines its responsibilities.

 

The Nomination and Compensation Committee is responsible for:

 

   

making proposals to the board of directors for nominations of directors;

 

   

preparing the review by the board of directors of questions relating to management of the Company;

 

   

conducting an evaluation of the board of directors and the Audit Committee, upon request;

 

   

proposing criteria for the compensation of the executive officers of the Company;

 

   

making proposals related to the grant of share purchase options or shares free of charge to the executive officers and directors;

 

   

proposing the allocation of attendance fees among directors; and

 

   

more generally, making recommendations related to the Group’s compensation policy upon the request of the board of directors.

 

In 2006, the committee met once and in particular reviewed in detail all of the compensation programs and benefits for the members of the Executive Committee. After the adoption of its charter by the board of directors in December 2006, the committee met for the first time on January 23, 2007.

 

As of February 28, 2007, the members of the Nomination and Compensation Committee were Mr. Michel David-Weill (Chairman), Mr. Jean Laurent (independent director) and Mr. Hakan Mogren (independent director).

 

Social Responsibility Committee

 

In its meeting on December 15, 2006, the board of directors decided to create a third governance body, the Social Responsibility Committee. In its meeting on February 14, 2007, the board of directors gave this committee a charter which outlines its responsibilities and procedures.

 

The Social Responsibility Committee is responsible for:

 

   

reviewing the principal risks and opportunities for the Group in environmental matters in relation to its objectives and activities and with respect to market trends and developing practices in the industry;

 

   

reviewing the social policies of the Group, its objectives and the results obtained;

 

   

reviewing reporting, evaluation and control systems in order to allow the Group to produce reliable information in non-financial matters;

 

   

reviewing the non-financial information published by the Group, in particular relating to social and environmental matters;

 

   

reviewing once a year the ratings received by the Company and its subsidiaries by non-financial rating agencies; and

 

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ensuring the application of the ethical codes established by the Group.

 

In addition, in the field of socially responsible investments, the committee is responsible for:

 

   

evaluating the impact of these actions for the Company and the Group;

 

   

reviewing the application of the rules established by the Group concerning investments and social programs in areas related to the Group’s activities; and

 

   

ensuring that the Company’s interests are preserved, in particular preventing any conflict of interest between these activities and the rest of the activities of the Group.

 

As of February 28, 2007, the members of the Social Responsibility Committee are Mr. Jean Laurent (Chairman and independent director), Mr. Bruno Bonnell (independent director) and Mr. Emmanuel Faber.

 

Share Ownership

 

As of December 31, 2006, the total number of shares owned by the Company’s directors and executive officers as a group (19 persons) was 177,780 or 0.07% of the outstanding shares of the Company, not including 13,975,995 shares held by Eurazeo, in which Mr. Michel David-Weill, a director of the Company, has direct and/or indirect interests. None of the Company’s directors or executive officers owns more than 1% of the Company’s outstanding shares.

 

Options

 

As of December 31, 2006, a total of 6,719,034 options to purchase existing shares was outstanding, of which 1,718,401 were held by the executive officers. During 2006, the grants and exercise of options by directors were as follows:

 

     Options Granted(1)    Options Exercised

Board Directors

  

Number of

Options

  

Expiration

Date

  

Exercise

Price

  

Number of

Options

  

Exercise

Price

Franck Riboud

   100,000    04/26/2014    99.48    60,000    58.09
            65,000    73.57
            28,000    69.40

Jacques Vincent

   66,500    04/26/2014    99.48    60,000    73.57
            60,000    69.40

Emmanuel Faber

   26,500    04/26/2014    99.48    60,000    73.57
            26,500    69.40

Bernard Hours

   26,500    04/26/2014    99.48    4,000    61.98
            3,200    58.09
            12,000    51.53

(1)   Option Plan of April 22, 2005.

 

These options were granted by the board of directors pursuant to employee stock option plans adopted at general shareholders’ meetings. Pursuant to each option plan, the board was authorized to issue options exercisable in the aggregate for up to 1.0% of the Company’s outstanding share capital at the date of issuance (plan adopted in May 1997), up to four million shares at the date of issuance (plans adopted in May 1999, May 2001 and April 2003) or up to three million shares at the date of issuance (plan adopted in April 2005), including all options already outstanding under the current and previous plans. Since March 1999, the exercise price for the options should be at least equal to the average price quoted for the shares on Euronext Paris during a period of 20 business days prior to the date of granting by the board. The options may only be exercised two or four years after their grant, unless an exception is available.

 

In 2006, a total of 151,500 options to purchase existing shares issued under the April 22, 2005 plan were granted at a weighted average exercise price of € 99.48 to the ten employees of the Group, excluding directors,

 

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who received the largest number of options, of which 132,500 were granted to six members of the Company’s executive committee.

 

During the same period, a total of 335,700 options were exercised at a weighted average exercise price of € 63.26 by the ten employees of the Group, excluding directors, who subscribed or purchased the largest number of shares, of which 50,000 options were exercised by two members of the executive committee.

 

The following table sets out certain information relating to the various option plans as of December 31, 2006. Numbers have been restated to give effect to the 2-for-1 stock splits effected by the Company in June 2000 and June 2004.

 

Options Plan

  Options
Issuable
   

Date

of

Board
Meeting

Granting
Options

    Options
Granted
  Expiration
Date
  Exercise
Price of
Options
per
Ordinary
Share
 

Number

of

Options
Cancelled

at
December 31,
2006

 

Number

of

Options
Exercised at
December 31,
2006

 

Number

of
Exercisable
Options

  Of which:
Options
Exercisable
by
Members
of the
Executive
Committee
  Of which:
Number of
Members
of the
Executive
Committee
who can
Exercise
the
Options

May 14, 1997

  3,098,340 (1)   09/09/1997     640,000   09/09/2005   33.38   103,600   536,400   —     —    
    01/28/1998     160,000   01/28/2006   38.99   —     160,000   —     —    
    03/18/1998     778,000   03/18/2006   44.25   73,200   704,800   —     —    
    05/19/1998     10,000   05/19/2006   51.07   6,000   4,000   —     —    
    09/15/1998     274,000   09/15/2006   58.08   28,000   246,000   —     —    
    01/26/1999     279,200   01/26/2007   55.75   30,000   201,165   48,035   —    
    03/17/1999     160,800   03/17/2007   56.75   20,000   122,800   18,000   —    
    05/19/1999     378,040   05/19/2007   61.98   41,200   239,615   97,225   —    
      2,680,040       302,000   2,214,780   163,260   —     0

May 19, 1999

  4,000,000 (2)   06/15/1999     414,000   06/15/2007   64.19   49,800   263,267   100,933   —    
    09/14/1999     39,400   09/14/2007   60.15   —     34,200   5,200   —    
    01/26/2000     666,680   01/26/2008   58.09   17,600   531,080   118,000   —    
    03/15/2000     449,600   03/15/2008   51.53   44,000   316,880   88,720   15,600  
    05/22/2000     83,200   05/22/2008   63.50   41,600   27,199   14,401   —    
    09/13/2000     241,400   09/13/2008   77.91   40,000   109,100   92,300   —    
    10/17/2000     4,800   10/17/2008   76.90   —     2,400   2,400   —    
    03/14/2001     1,488,500   03/14/2009   73.57   236,400   711,569   540,531   75,000  
      3,387,580       429,400   1,995,695   962,485   90,600   2

May 29, 2001

  4,000,000 (3)   10/08/2001     311,300   10/08/2009   70.81   44,500   127,180   139,620   —    
    04/25/2002     1,313,600   04/25/2010   69.40   91,100   560,195   662,305   130,700  
    10/17/2002     234,600   10/17/2010   60.76   36,000   112,682   85,918   18,000  
    04/11/2003     1,843,650   04/11/2011   59.07   206,500   484,876   1,152,274   364,300  
      3,703,150       378,100   1,284,933   2,040,117   513,000   9

April 11, 2003

  4,000,000 (4)   10/15/2003     61,200   10/15/2011   65.79   17,200   17,600   26,400   —    
    04/15/2004     1,875,680   04/15/2012   67.41   206,400   231,711   1,437,569   431,300  
    10/13/2004     44,300   10/13/2012   64.05   4,000   1,600   38,700   20,000  
    04/22/2005     1,137,728   04/22/2013   75.11   74,300   4,000   1,059,428   297,501  
      3,118,908       301,900   254,911   2,562,097   748,801   9

April 22, 2005

  3,000,000     08/08/2005 (5)   14,000   08/08/2013   82.57   —     —     14,000   14,000  
    10/18/2005     12,800   10/18/2013   90.15   800   —     12,000   —    
    04/27/2006     965,025   04/26/2014   99.48   16,850   —     948,175   352,000  
    10/16/2006     17,000   10/15/2014   111.08   100   —     16,900   —    
      1,008,825       17,750   —     991,075   366,000   10

Total

      13,898,503       1,429,150   5,750,319   6,719,034   1,718,401  

(1)   Of a total of 3,098,340 options issuable under the May 1997 Option Plan, 418,300 options were not granted and ceased to be issuable on May 19, 1999.
(2)   Of a total of 4,000,000 options issuable under the May 1999 Option Plan, 612,420 options were not granted and ceased to be issuable on May 29, 2001.
(3)   Of a total of 4,000,000 options issuable under the May 2001 Option Plan, 296,850 options were not granted and ceased to be issuable on April 11, 2003.
(4)   Of a total of 4,000,000 options issuable under the April 2003 Option Plan, 881,092 options were not granted and ceased to be issuable on April 22, 2005.
(5)   On July 20, 2005, the board of directors authorized the grant of 14,000 options and this grant was made by delegation on August 5, 2005.

 

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Employees

 

At December 31, 2006, Danone had a total of 88,124 employees worldwide. The table below shows the total number of employees at year-end and the percentage of such employees by geographic area and business line at December 31, 2006, 2005 and 2004.

 

     2004     2005     2006  

Total number of employees

   89,449     88,184     88,124  

By Geographic Area:

      

France

   13.8 %   13.7 %   13.3 %

Rest of Europe

   23.6 %   22.9 %   23.5 %

China

   27.2 %   26.8 %   23.6 %

Rest of Asia-Pacific

   18.7 %   19.8 %   15.0 %

North and South America

   16.3 %   13.8 %   20.3 %

Africa and Middle East

   0.4 %   3.0 %   4.3 %
                  

Total

   100.0 %   100.0 %   100.0 %
                  

By Business Line:

      

Fresh dairy products

   26.7 %   30.0 %   32.6 %

Beverages

   43.7 %   44.4 %   49.1 %

Biscuits and cereal products

   24.4 %   21.3 %   16.7 %

Other food businesses(1)

   2.8 %   2.6 %   —    

Corporate functions

   2.4 %   1.7 %   1.6 %
                  

Total

   100.0 %   100.0 %   100.0 %
                  

(1)   Corresponds to the employees of Amoy Foods Ltd and Shanghai Amoy Foods, sold in January 2006.

 

Employee Profit Sharing

 

The Company’s employees benefit from a triennial profit sharing plan, renewed in 2006, based on the Group’s results. In addition, the subsidiaries generally have in place profit sharing plans for their employees based on their own results. In 2006, recorded charges relating to profit sharing plans amounted to € 121 million (€ 116 million in 2005 and € 115 million in 2004).

 

Group Performance Units

 

In 2005, the Group put in place a new system of variable compensation, in the form of Group Danone Performance Units (“GPU”), for which members of the executive committee and certain managers are eligible, totaling approximately 1,000 people worldwide.

 

The value of the GPUs, which can vary between € 0 and € 30, is calculated over a sliding period of three years based on the Group’s performance measured based on objectives communicated to the financial markets. Each year, the board of directors of the Company, considering the recommendations of the Nomination and Compensation Committee, sets the performance objectives for the next year and evaluates the achievement of the previous year’s objective for each GPU plan. In the event of a successful tender offer for shares of the Company, the performance objectives of the GPU plans will be considered to have been met and the GPUs will be paid in the month following the completion of the offer.

 

This three-year variable compensation program, based on performance objectives announced to the financial markets, increases the unity and commitment of managers with the objective of strengthening the Group’s positions in its markets and improving its operational performance.

 

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General Policy

 

Danone’s corporate culture is based on two goals: economic and social. As a result, the Group’s human resources policy is founded on two principles: a full and complete involvement in operating decisions and the determination to meet demanding social commitments. The Direction du Développement Durable et de la Responsabilité Sociale (Management of Sustainable Development and Social Responsibility) coordinates and implements the sustainable development policy, in connection with the various functional departments of the Group and its subsidiaries.

 

Operational decisions are effected by a human resources organization that is simple and close to the needs of the business. Human resources are organized by division and rely on group-wide structures in key areas such as compensation, organization and know-how, integration of acquisitions, recruitment and senior management. As a result, to attract talent from all over the world, the Group has developed an institutional communication campaign presented on the Internet by the website “danonepeople.com.” The development of human resources is ensured by training and quality management, for example, through tools such as “360°” personal assessments and coaching. Furthermore, human resources promotes the Group’s international development through (i) a global recruitment policy, (ii) encouraging the movement of managers around the world through a dedicated team that manages the administrative, financial and personal aspects of transfers and rotations and (iii) the integration of newly acquired companies.

 

Social Policy

 

The Group’s core principles are based on International Labor Organization conventions relating to the prohibition of child labor, forced labor, discriminatory practices, safety and working conditions, working hours, the application of national laws to the minimum wage, freedom of association and expression of employees and the right to collective bargaining. These principles are minimum requirements to be met by all Group companies, related companies, partners and suppliers. The implementation of a human resource and social policy is only valid insofar as the basic requirements are fulfilled by the employees of the Group and its partners.

 

Safety and Working Conditions.    Group policies regarding safety and working conditions apply to all employees, including temporary staff, interns and apprentices, who are all included in statistics, and to all Group companies, whether recently acquired or not.

 

Welfare.    The Group has developed a welfare policy in accordance with the economic situation of the environment in which the subsidiaries operate. Welfare takes into account the fundamental needs for social protection of employees and their families. It covers areas as diverse as pensions, workplace accidents, access to medical care and insurance for business travel.

 

Wages.    The Group’s objective is to be attractive in the countries in which it is present. Wages are a key factor in the Group’s human resource policies which offer the continued acquisition of skills and career opportunities. The Group’s objective is to better attract and motivate employees, and the Group seeks to be competitive with comparable leading international companies in each country where it operates. Each subsidiary is encouraged to develop a formal compensation policy and to communicate it to managers and management committees.

 

In 2001, the Group introduced a worldwide classification system for all managers, enabling them to identify their precise ranking and related responsibilities. The individual contribution of each manager is evaluated in an annual interview or Development and Performance Review (RDP).

 

In 2006, the Group’s personnel expenses, including social expenses, amounted to € 1,807 million compared with € 1,793 million in 2005 and € 1,729 million in 2004. In addition, € 121 million was paid to the employees of the Group in 2006 as part of the incentive and profit sharing schemes, compared with € 116 million in 2005 and € 115 million in 2004.

 

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Dialogue with Unions.    The topics most often covered in collective bargaining agreements as negotiated with unions or workers’ representatives are compensation, work hours and conditions and work safety. Since 1996, the Group’s Information and Consultation Committee has met once a year and is composed of Group union members and permanent national unions on the one hand and Danone human resources and operational managers on the other. It also has observer members from the International Union of Food Workers (IUF). Regular dialogue has existed since 1985 with the IUF, which has led to the implementation of six common programs since 1988 relating to equal opportunities in the workplace, the availability of economic and social information, the recognition of union rights and informing representatives of the personnel in the event of a modification of the business which may affect jobs and working conditions and the restructuring of the biscuits segment, programs that have been concluded since 1988 by six agreements which were revised in 2005 to facilitate worldwide application. These agreements are widely distributed within the Group’s subsidiaries and published in 20 languages in order to be more easily understood and put in place.

 

Training.    More than ten years ago, the Company put in place a series of training programs in areas such as purchasing, marketing, human resources and financing that are run by professionals from various companies within the Group with the assistance of outside specialists, in the form of educational partnerships with universities.

 

Leading Social and Environmental Responsibility.    In conducting business, the “Danone Way” is both a business conduct policy and a tool designed to assist the Group’s subsidiaries in addressing a number of areas, such as social policy, environmental, food safety and nutrition issues. These guidelines reflect the perspectives and particular concerns of key categories of stakeholders such as employees, consumers and clients, suppliers, stockholders, the community in general and the environment. Management has assigned specific objectives to the “Danone Way”: to spread, share and enrich the values and culture of the Group in each country where it operates, to allow subsidiaries to perform self-evaluations with respect to observable and measurable criteria and to have available at the Group level a collection of effective practices.

 

For each stakeholder, each of the subsidiaries’ teams performs self-evaluations on the basis of a set of practices as defined by the Group. Working groups bringing together individuals from different backgrounds are asked to contribute to the evaluation process. At the end of the process, the results are approved and endorsed by executives of each responsible subsidiary. Thus, the “Danone Way” has enabled each subsidiary to identify strong and weak points in different areas. It has also allowed them to prioritize and implement plans for improvement.

 

For example, in the context of its social policies, evaluation of management and of the Group’s human resource policy is based on 26 criteria set out in several themes: compliance with the law, respect for individuals, progress for organizations and employees, implementing values, and open communication with employees and their representatives, conditions for social dialogue and respect for rules of ethics.

 

The “Danone Way” was first introduced in 2000, tested in 2001 in approximately 10 subsidiaries and is being deployed worldwide. As of today, 94% of the Group’s subsidiaries have implemented the “Danone Way” and independent reviews have been carried out in 31 subsidiaries by PricewaterhouseCoopers and Mazars to validate their self-evaluations. The audit results show that there are no significant anomalies in the self-evaluations with respect to the procedures defined by the Group. These results are the subject of a report that covers the published consolidated results, which is available on the Internet site of the Group under the heading “Sustainable Development.”

 

The results of the self-evaluations show high-level practices in areas relating to employees, shareholders, customers and suppliers. The results in areas relating to the environment and local communities are weaker because they are less directly related to the business and correspond to less established practices in certain countries where the Group operates. The implementation of the “Danone Way” shows its effectiveness in maintaining and promoting the Groupe Danone culture in a context of strong geographic expansion. Over 750 improvement measures are underway in all subsidiaries covering all areas.

 

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Local economic impact on emerging economies.    The Group has set up operations in many emerging countries, with local production to meet domestic demand. The subsidiaries in developing countries benefit from training programs, technology transfer and modern industrial equipment. Knowledge transfer is facilitated by the Danone Research Center, which works in collaboration with local teams. The effort is aimed at products, quality control and production processes.

 

The Group’s activities in a country bring work to numerous local producers and suppliers of goods and services, with which the Group seeks to form long-term relationships to ensure supplies that meet its standards in quantity and quality. In addition, the Group’s industrial activities cause suppliers of specialized equipment (packaging machines, etc.) to establish a permanent presence in the countries where the Group operates and facilitate the formation of teams that work, for example, with milk producers on the feeding of livestock, cultivation methods, etc.

 

Corporate citizenship.    Involvement in the community is both a necessity and a founding principle of the Group’s corporate culture. Generally speaking, the Group is involved in offering support for public bodies, NGOs and local non-profit associations and communities.

 

Publications.    Between 1998 and 2005, the Group had published a Social and Environmental Responsibility Report, which presented the social and environmental impacts of the Group’s activities. In 2006, the Group decided to combine the Social and Environmental Responsibility Report with the Business Report. In addition, the information corresponding to the reporting for Sustainable Development (Global Reporting Initiative, launched in 1997 in conjunction with CERES and the United Nations Environment Program) as well as the indicators required by law under the Nouvelles Régulations Economiques (NRE) are available on the Internet site of the Group, under the heading Sustainable Development.

 

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Item 7.    Major Shareholders and Related Party Transactions

 

Major Shareholders

 

The following table sets forth certain information with respect to the beneficial share ownership and voting rights of principal shareholders, as of December 31, 2006.

 

Name

   Number of
Shares
Beneficially
Owned
   Percentage
of Shares
Owned
    Number of
Voting Rights
   Percentage
of Voting
Rights(1)
 

Eurazeo

   13,975,995    5.4 %   23,692,481    9.1 %

Caisse des Dépôts et Consignations

   9,297,592    3.6 %   9,297,592    3.6 %

Sofina and Glaces de Moustier

   5,200,000    2.0 %   6,700,000    2.5 %

Predica

   4,570,106    1.7 %   4,570,106    1.7 %

FCPE “GROUPE DANONE”

   3,885,071    1.5 %   7,311,794    2.9 %

Public

   203,480,811    78.0 %   209,378,669    80.2 %

The Company and its subsidiaries(2)

   20,455,171    7.8 %   —      —    
                      

Total

   260,864,746    100.00 %   260,950,642    100.00 %
                      

(1)   Double voting rights have been granted for each share fully subscribed, paid for, and beneficially owned by the same individual or entity for at least two years. This percentage excludes the shares held by the Company and its subsidiaries, which have no right to vote.
(2)   Including 2,882,060 shares (i.e., 1.1% of the capital) held by the Spanish subsidiary of the Company, Danone S.A.

 

To the best of the Company’s knowledge only Eurazeo holds more than 5% of the share capital of the Company and to the best of the Company’s knowledge there are no shareholders’ agreements. However, certain financial institutions, mutual funds, may manage funds that collectively hold more than 5% of the capital of the Company. There is no clause in the Company’s bylaws giving preferential rights for the acquisition or sale of shares. Furthermore, at December 31, 2006, existing pledges on shares of the Company in registered form on the books of the Company (nominatif pur) and in registered form on the books of a financial intermediary (nominatif administré), respectively, amounted to 788 shares held by two shareholders and 38,716 shares held by eleven shareholders.

 

As of December 31, 2006, pursuant to authorizations granted by the general shareholders’ meeting of April 27, 2006 or prior authorizations, the Group owned, directly and through its Spanish subsidiary, Danone SA, 20,455,171 shares of Groupe Danone, representing 7.8% of its share capital.

 

For a description of the Company’s share repurchase program, see “Item 10. Additional Information—Purchase by the Company of its Own Shares.”

 

Significant Changes

 

Shareholdings

 

On April 4, 2006, Eurazeo reported having exceeded 5% of the Company’s voting rights on that date and that it held 5.1% of the capital and 8.71% of the Company’s voting rights. On February 9, 2007, Eurazeo reported that it held 5.36% of the share capital and 8.4% of the Company’s voting rights.

 

To the Company’s knowledge, there were no other significant shareholding changes during the past three years.

 

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On December 31, 2006, the Company conducted a survey of its nominative shares, which revealed the following distribution of the Company’s shareholders:

 

Institutional investors

  

–    France

   27 %

–    United States

   17 %

–    United Kingdom

   10 %

–    Other

   18 %

Individual shareholders

   11 %

Shareholders represented at the Board of Directors

   7 %

Treasury shares and FCPE “GROUPE DANONE”

   10 %
      

Total

   100 %

 

At December 31, 2006, the Company estimates that there were approximately 1,000 institutional investors and approximately 200,000 individual shareholders.

 

Stock purchase plans

 

Stock options are granted annually to the Company’s senior management.

 

The general meeting of shareholders, by successive authorizations, authorized the board of directors to grant, once or multiple times, over a maximum period of 26 months, options to subscribe for or purchase shares of the Company subject to a limit of 1% of the Company’s share capital for the 1997 plan, a limit of four million shares for the May 1999, May 2001 and April 2003 plans (after taking into account the two-for-one stock split on June 15, 2004) and a limit of three million shares for the April 2005 plan.

 

Pursuant to these authorizations, the board of directors granted to the Company’s senior management stock options to acquire a total of 13,898,503 shares. At December 31, 2006, 6,719,034 of these options could still be exercised by their beneficiaries. In addition, the board of directors had authority to grant 1,991,175 stock purchase options at December 31, 2006 under the April 2005 plan. See “Item 6. Directors, Senior Management and Employees—Directors and Senior Management—Options.”

 

The duration of these plans is eight years. The exercise price for the options must amount to at least the average price for the 20 trading days preceding the board of directors’ meeting which grants the options and generally may not be exercised for two or four years after the grant date.

 

However, the plan rules for the options granted by the board of directors as of April 11, 2003 provide that the beneficiaries may exercise all or part of the options before the two to four-year period has elapsed in the event of a successful tender offer for the shares of the Company.

 

At the annual shareholders’ meeting of April 26, 2007, the board of directors will submit for approval resolutions for a new authorization of 26 months to grant options to purchase shares of the Company, on one or more occasions, subject to a limit of three million shares, which would annul and replace the previous authorization granted to the board of directors on April 22, 2005.

 

In addition, the annual shareholders’ meeting of April 22, 2005 authorized the board of directors to grant, once or multiple times, over a maximum period of 26 months, existing or newly issued shares of the Company free of charge in an amount of up to 0.4% of the Company’s share capital, i.e., one million shares. At the annual shareholders’ meeting of April 26, 2007, the board of directors will submit for approval resolutions for a new authorization of 26 months to grant existing or newly issued shares of the Company free of charge, on one or more occasions, subject to a limit of one million shares.

 

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Shareholders’ Agreements

 

To the Company’s knowledge, there is no shareholder other than Eurazeo holding more than 5% of the capital or voting rights of the Company and there are no shareholders’ agreements.

 

Shares Held in the United States

 

For information on shares held in the United States, see “Item 9. The Offer and Listing—Price History of Shares.”

 

Related Party Transactions

 

In June 1998, the Company, Sofina, its wholly owned subsidiary Interamerican Finance and Danasia Participations, an affiliate of Sofina, entered into a memorandum of understanding regarding their respective ownership interests in Danone Asia Pte Ltd, a holding company for Groupe Danone’s investments in the Asia-Pacific region. Under the terms of the memorandum of understanding, Sofina, Interamerican and Danasia had an option to sell to the Company, and the Company had an option to buy from them, their entire ownership interest in Danone Asia Pte Ltd. These options were exercisable in thirds, beginning, respectively, on January 1, 2003, January 1, 2005 and July 1, 2006, at a price to be determined based on an agreed upon formula, taking into account the then current market value of the shares. At the end of 2002, Danone confirmed its intention to exercise these three purchase options. The interest of the Group in Danone Asia increased from 90.34% at December 31, 2002 to 93.56% at December 31, 2003, to 96.78% in January 2005 and to 100% on July 1, 2006. In addition, in December 2001, the Company granted to Union Financière Boël preemptive acquisition rights exercisable at market value with respect to Sofina shares held by a subsidiary of the Company. In December 2004, the Group sold its interests in Sofina. Mr. Yves Boël, one of the Company’s directors until April 2002 and currently an honorary director, was the Chairman of Sofina and the delegated Chairman (“administrateur délégué”) of Union Financière Boël, and Mr. Richard Goblet d’Alviella, one of the Company’s current directors, is a delegated director of these two companies. In addition, Mr. Franck Riboud was a director of Sofina until June 2006. See “Item 6. Directors, Senior Management and Employees—Directors and Senior Management—Board of Directors.”

 

Each of the above-referenced transactions was entered into on an arm’s-length basis according to the Company’s normal business practices.

 

No loans or guarantees were granted or made by the Company or its subsidiaries to any member of the executive committee.

 

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Transactions by Directors and members of the Executive Committee (“mandataires sociaux”) of the Company’s shares

 

Name

   Type of transaction    Date of
transaction
   Unit
price
(in
euros)
    Number
of
shares
   Total
amount (in
euros)

Frank Riboud(1)

   Exercise of purchase options    02/27/2006    58.09     60,000    3,485,400
   Sale    02/27/2006    97.00     60,000    5,820,000
   Exercise of purchase options    08/03/2006    73.57     65,000    4,782,050
   Sale    08/03/2006    104.36 (2)   65,000    6,783,229
   Exercise of purchase options    12/01/2006    69.40     28,000    1,943,200
   Sale    12/14/2006    119.90     1,528    183,270

Jacques Vincent

   Exercise of purchase options    02/21/2006    73.57     60,000    4,414,200
   Sale    02/21/2006    94.25     47,630    4,489,127
   Sale    04/04/2006    101.50     2,300    233,450
   Exercise of purchase options    09/14/2006    69.40     60,000    4,164,000
   Sale    09/14/2006    108.80     21,000    2,284,800
   Sale    10/20/2006    115.70     9,150    1,058,655
   Sale    10/20/2006    115.70     8,970    1,037,829

Emmanuel Faber

   Exercise of purchase options    08/03/2006    69.40     26,500    1,839,100
   Sale    08/03/2006    104.55 (2)   26,500    2,770,575
   Exercise of purchase options    08/03/2006    73.57     60,000    4,414,200
   Sale    08/03/2006    104.35 (2)   60,000    6,261,000

Bernard Hours

   Exercise of purchase options    03/08/2006    58.09     2,000    116,180
   Exercise of purchase options    03/08/2006    61.98     4,000    247,920
   Sale    03/09/2006    96.09     4,000    384,360
   Exercise of purchase options    06/05/2006    58.09     1,200    69,708
   Exercise of purchase options    09/04/2006    51.53     12,000    618,360
   Sale    09/04/2006    107.14 (2)   12,000    1,285,680

Christian Laubie

   Sale    08/03/2006    105.54     3,000    316,614
   Sale    08/31/2006    107.90     2,000    215,800
   Sale    09/12/2006    108.90     3,000    326,700

Benoît Potier

   Purchase    05/19/2006    91.45     500    45,725

Georges Casala

   Exercise of purchase options    02/22/2006    44.25     30,000    1,327,500
   Sale    09/04/2006    107.90     1,500    161,850
   Sale    09/15/2006    109.90     1,500    164,850

Thomas Kunz(3)

   Exercise of purchase options    9/20/2006    69.40     12,000    832,800
   Sale    9/20/2006    108.80     20,000    2,176,000
   Exercise of purchase options    9/20/2006    61.98     4,000    247,920
   Exercise of purchase options    9/20/2006    73.57     4,000    294,280

Philippe-Loïc Jacob

   Exercise of purchase options    11/21/2006    69.40     3,200    222,080
   Sale    11/21/2006    119.18     3,200    381,376
   Exercise of purchase options    12/13/2006    64.19     1,400    89,866
   Exercise of purchase options    12/13/2006    61.98     800    49,584

(1)

 

Three persons related to Mr. Riboud each completed a sale of 3,765 shares of the Company on December 14, 2006 at a price per share of 119.90 euros.

(2)

 

Net amount.

(3)

 

On November 7, 2006, Mr. Kunz purchased 12,000 put options and sold 12,000 call options at a unit price of 3.78 euros.

 

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Item 8.    Financial Information

 

Consolidated Statements and Other Financial Information

 

See “Item 18. Financial Statements,” for a list of the financial statements filed with this annual report.

 

Dividend Policy

 

The declaration and amount of dividends to be paid on the shares in respect of any period are subject to the decision by the Company’s shareholders at an ordinary general meeting of shareholders. Pursuant to French law, payment of dividends must be made within nine months following the end of the fiscal year to which they relate.

 

Under French law and the Company’s bylaws, the Company’s unconsolidated statutory net income in each fiscal year, as increased or reduced, as the case may be, by any profit or loss of the Company carried forward from prior years, less any contributions to legal reserves, is available for distribution to the shareholders of the Company as dividends, subject to other applicable requirements of French law and the Company’s bylaws.

 

Pursuant to the Company’s bylaws, the Company’s shareholders may determine at an ordinary meeting the portion, if any, of dividends that each shareholder may elect to receive in shares. For dividends distributed in respect of the years 1989 through 1995, each of the Company’s shareholders was given the option of receiving dividends in the form of cash or shares. Applications for dividend payments in the form of shares shall be submitted no later than three months after the date on which the general shareholders’ meeting is held. The board of directors does not intend to recommend a stock dividend in the near future.

 

Dividends paid to holders of shares or ADSs who are not residents of France generally will be subject to French withholding tax at a rate of 25%. Under certain tax treaties entered into between France and other countries, such withholding tax may be reduced to 15% for holders of shares who qualify for the benefits of these treaties, subject to certain procedures and exceptions. Under the Treaty between France and the United States for Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and Capital signed on August 31, 1994 (the “Treaty”), such reduced withholding tax may apply to holders of shares and also to holders of ADSs, who are residents of the United States as defined by the provisions of the Treaty, subject to certain procedures and exceptions.

 

French individual residents are entitled to a tax credit with respect to dividends paid to them since January 1, 2005, which is equal to 50% of the distributed dividends, capped at € 230 or € 115 depending on the marital status of the recipient. Under certain tax treaties entered into between France and other countries this French tax credit attached to dividends may, in certain circumstances, be paid, net of withholding tax, to non-French resident individual shareholders. In addition, under the Treaty, such payment of French tax credit, net of withholding tax, may have been available not only to certain individual holders of shares but also to certain individual holders of ADSs, qualifying as U.S. residents under the Treaty, subject to certain exceptions and procedures. See “Item 10. Additional Information—Taxation—French Taxation—Taxation of Dividends” and “Item 10. Additional Information—Taxation—Taxation of U.S. Investors—Taxation of Dividends.”

 

Dividends paid to holders of ADSs are converted from euro to dollars and subjected to a charge by the depositary for any expenses incurred by the depositary in such conversion.

 

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The following table sets forth the total dividends paid per share and per ADS for each year indicated, with and without the French tax credits attached to dividends and before deduction of any French withholding tax, taking into account the two-for-one stock split effected by the Company in June 2004.

 

     Dividends
Per Share
   Dividends Per
Share Including
French Tax Credit
Calculated at the
Rate of 50%(2)
   Dividends
Per ADS
   Dividends Per
ADS Including
French Tax Credit
Calculated at
the Rate of 50%(2)

Year to Which Dividend Relates(1)

   (€)    (€)    ($)(3)(4)    ($)(3)(4)

2002

   1.15    1.73    0.26    0.39

2003

   1.23    1.84    0.29    0.43

2004

   1.35    1.35    0.34    0.34

2005

   1.70    1.70    0.44    0.44

2006(5)

   2.00    2.00    0.53    0.53

(1)   Pursuant to French law, payment of dividends must be made within nine months following the end of the fiscal year to which they relate.
(2)   A French tax credit (known as the avoir fiscal) was attached to distributions of dividends made before December 31, 2004. Its amount ranged from 10% to 50% of the dividends depending on the nature of the recipient. For simplification purposes, the avoir fiscal included in the dividend per share in the chart above were calculated at the rate of 50%. From 2005 on, the avoir fiscal has been abolished and partially replaced by a French tax credit benefiting only individuals. Such French tax credit is equal to 50% of the dividends distributed, but capped at €230 or €115 per year depending on the marital status of the recipient. Any payment equivalent to French tax credits, less applicable French withholding tax, is made only following receipt by the French Tax Administration of a claim for such payment filed by shareholders entitled to such payment, and is generally not expected to be paid before 12 months after the filing of such claim, and after the close of the calendar year in which the respective dividends are paid. See “Item 10. Additional Information—Taxation—French Taxation” and “Item 10. Additional Information—Taxation—Taxation of U.S. Investors.”
(3)   Periods prior to 2006 translated solely for convenience from euro into dollars at the Noon Buying Rates on the respective dividend payment dates, or on the following business day if such date was not a business day in France or the United States. For convenience only, avoir fiscal amounts have been translated into dollars at the Noon Buying Rates on such dates although such amounts are paid subsequent to such payment dates. The Noon Buying Rates may differ from the rate that may be used by the Depositary to convert euro to dollars for purposes of making payments to holders of ADSs. Figures for 2005 translated solely for convenience at the Noon Buying Rate on December 29, 2006 of $ 1.3197 per € 1.00.
(4)   As each ADS represents one-fifth of one share, the amount of dividends per share has been divided by five to obtain the historical dividends declared per ADS.
(5)   Dividends to be proposed at the shareholders’ meeting to be held on April 26, 2007.

 

Legal Proceedings

 

On December 5, 2001, the European Commission concluded that anti-competitive practices in the beer market in Belgium had occurred and imposed a fine of € 44.6 million on the Company. The entire amount was provisioned in the Group’s accounts at December 31, 2001 and was paid in 2002. In February 2002, the Company launched a procedure seeking to recover the amount paid. In October 2005, the Court of First Instance confirmed the decision of the European Commission. However, the Court decided to slightly reduce the amount of the fine imposed, from € 44.04 to € 42.41 million, finding that the Commission had incorrectly determined that an aggravating circumstance existed. The Company has appealed this decision to the European Court of Justice. This appeal was rejected by the European Court of Justice in February 2007.

 

The Group is not presently party to litigation or arbitration that could have or has had, in the recent past, a significant effect on its financial condition, activities or results.

 

The Company and its subsidiaries are parties to a variety of legal proceedings arising out of the normal course of business. Liabilities are accrued for when a loss is probable and can be reasonably estimated. See Note 18 to the Consolidated Financial Statements.

 

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Item 9.    The Offer and Listing

 

Price History of Shares

 

The principal trading market for the Company’s shares is the Euronext Paris SA, or Euronext Paris, the French integrated national dealing system through which trading in all French listed securities occurs. The Company’s shares are traded on Eurolist by Euronext (ISIN Code: FR0000120644) and are included in the CAC 40 Index, the principal stock exchange index published by Euronext Paris, the market enterprise which manages and operates the French stock exchange markets and are included in the Dow Jones Eurostoxx and Dow Jones Stoxx. Since September 25, 2000, the Company’s shares are eligible for deferred settlement service. The Company’s shares have been included in the Eurostoxx 50 index and Dow Jones Sustainability World Index since September 2000.

 

In the first half of 2004, the Company delisted its shares from the London Stock Exchange and the Brussels Stock Exchange, due to the low liquidity of the shares on these exchanges. The delisting from the London Stock Exchange occurred on March 24, 2004 and the delisting from the Brussels Stock Exchange occurred on May 11, 2004.

 

Since December 1990, the Company has sponsored an American Depositary Receipts, or ADRs, program in the United States with Citibank, N.A., as depositary. The American Depositary Shares, or ADSs, issued pursuant to such program have been registered with the Securities and Exchange Commission under a Registration Statement on Form F-6. Each such ADS represents one-fifth of one share. Since November 20, 1997, the ADSs have been listed on the New York Stock Exchange under the symbol “DA.” Groupe Danone has reached its current filing limit for ADRs. As a result, Citibank, N.A., as depositary, will no longer accept deposits of ordinary shares for the issuance of ADRs for Groupe Danone until further notice. The Groupe Danone ADR Program remains open for the cancellation of ADRs.

 

As of December 31, 2005, 24,243,025 ADSs were outstanding, representing approximately 1.86% of the Company’s outstanding shares, and there were 164 holders of record of ADSs, 3 of which had addresses outside the United States.

 

The table below sets forth the reported high and low sales prices for the Company’s shares reported by Euronext Paris and for the ADSs on the New York Stock Exchange for the periods indicated.

 

     Euronext Paris    New York
Stock Exchange

Calendar Period

   High    Low    High    Low
     (in €)    (in $)

Monthly

           

March 2007

   123.45    115.11    35.75    32.52

February 2007

   128.34    115.70    35.72    32.10

January 2007

   120.00    112.50    33.35    31.66

December 2006

   120.10    113.10    33.74    32.26

November 2006

   121.10    113.70    33.50    31.02

October 2006

   117.60    108.60    31.39    29.02

September 2006

   112.20    105.40    29.92    28.27

Quarterly

           

2006

   121.10    85.20    33.74    20.89

First quarter

   101.80    85.20    26.40    20.89

Second quarter

   102.30    88.40    27.50    23.51

Third quarter

   112.20    95.00    29.92    25.75

Fourth quarter

   121.1    108.6    33.74    29.02

 

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     Euronext Paris    New York
Stock Exchange

Calendar Period

   High    Low    High    Low
     (in €)    (in $)

2005

   96.30    67.75    23.17    17.21

First quarter

   77.00    67.75    20.44    17.72

Second quarter

   77.10    71.20    19.97    17.29

Third quarter

   96.25    72.00    23.17    17.21

Fourth quarter

   91.35    81.40    21.86    19.48

Yearly

           

2004

   63.30    62.20    18.58    15.30

2003

   68.50    52.10    16.32    11.48

2002

   75.20    54.70    13.94    10.94

Sources: Euronext Paris S.A. and Bloomberg.

 

On March 30, 2007, the last reported listed price of the Company’s shares on Euronext Paris was € 123.19 per share and the last reported listed price of the Company’s ADSs on the New York Stock Exchange was $35.72 per ADS.

 

Plan of Distribution

 

Not applicable.

 

Nature of Trading Market

 

Generals

 

On September 22, 2001 upon successful completion of an exchange offer, the Paris-BourseSBF SA, or the SBF, the Amsterdam Stock Exchange and the Brussels Stock Exchange merged to create Euronext, the first pan-European exchange. Through the exchange offer, all the shareholders of the SBF, the Amsterdam Stock Exchange and the Brussels Stock Exchange contributed their shares to Euronext N.V., a Dutch holding company. The Portugal Exchange was integrated into Euronext in February 2002.

 

In January 2002, Euronext N.V. acquired the London International Financial Futures and Options Exchange (LIFFE), London’s derivative market, and created Euronext.liffe. Euronext.liffe is the international derivatives business of Euronext, comprising the Amsterdam, Brussels, Lisbon, London and Paris derivatives markets. Euronext.liffe creates a single market for derivatives, by bringing all of its derivatives products together on one electronic platform, LIFFE CONNECT®.

 

Euronext N.V. is listed on Eurolist by EuronextTM.

 

Securities quoted on exchanges participating in Euronext cash markets are traded and cleared over common Euronext platforms. NSC is the common platform for trading, Clearing 21 is the platform for clearing. In addition, Euronext Paris anticipates the implementation of central clearinghouse (but not before 2008), settlement and custody structures over a common system. However, these securities will remain listed on their local exchanges. As part of Euronext, Euronext Paris retains responsibility for the admission of shares to Euronext Paris’ trading markets as well as the regulation of those markets.

 

Euronext Paris

 

As from February 21, 2005, all securities currently traded on the Premier, Second and Nouveau Marchés are listed and traded on a single market, Eurolist by Euronext, which is operated by Euronext Paris. In accordance with Euronext Paris rules, the shares issued by domestic and other companies are classified in capitalization

 

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compartments. The shares of listed companies are distributed between three capitalization compartments, according to the criteria set by Euronext Paris:

 

   

Compartment A comprises the companies with market capitalizations above € 1 billion;

 

   

Compartment B comprises the companies with market capitalizations from € 150 million and up to and including € 1 billion;

 

   

Compartment C comprises the companies with capitalizations below € 150 million.