**U.S. 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, 2005

** **

**[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15    (d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

**OR**

**[   ] SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15    (d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

Commission file number 1-15184

 

**SADIA S.A.**

(Exact Name of Registrant as Specified in its Charter)

 

Federative Republic of Brazil

(Jurisdiction of Incorporation or Organization)

 

N/A

(Translation of Registrant's name into English)

 

Rua Fortunato Ferraz, 365

Vila Anastácio, Sao Paulo, SP

05093-901, Brazil

(Address of principal executive offices)

 

Securities registered pursuant to Section 12(b) of the    Act:
| Title of Each Class

Preferred Shares, no par value per share,

each represented by American Depositary Shares | Name of Each Exchange on which Registered

New York Stock Exchange |
|----------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------|

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

None

 

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

None

 

The total number of issued shares of each    class of stock of SADIA S.A. as of December 31, 2005, was:

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

423,495,712 Preferred Shares, no par value per share

 

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

Yes  X  No  __

 

If this report is an annual or transition report,    indicate by check mark if the registrant is not required to file reports    pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1034.

Yes       No X

 

Indicate by check mark whether the Registrant (1) has    filed all reports required to be filed by Section 13 or 15(d) of the Securities    Exchange Act of 1934 during the preceding 12 months (or such shorter period    that the Registrant was required to file such reports), and (2) has been    subject to such filing requirements for the past 90 days.  

Yes   X   No

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

(X) Large accelerated filer                                   Accelerated filer                   Non-accelerated filer

 

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

 

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

Ross Kaufman, Greenberg Traurig, LLP

200 Park Avenue, New York, New York 10166

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**CONTENTS**

GENERAL..........................................................................................................................................................................................4

PART I................................................................................................................................................................................................4

ITEM 1.  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND  ADVISERS.............................................4

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE.................................................................................4

ITEM 3. KEY INFORMATION..............................................................................................................................................4

A. Selected Financial Data.............................................................................................................................................4

B. Capitalization and Indebtedness..............................................................................................................................6

C. Reasons for the offer and use of proceeds...............................................................................................................6

D. Risk Factors..................................................................................................................................................................6

ITEM 4. INFORMATION ON THE COMPANY..............................................................................................................11

A. History and Development of the Company...........................................................................................................11

B. Business Overview......................................................................................................................................................14

C. Organizational Structure..........................................................................................................................................39

D. Property, Plant and Equipment..............................................................................................................................39

ITEM 4A. UNRESOLVED SEC STAFF COMMENTS..................................................................................................42

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS..................................................................42

A. Operating Results.......................................................................................................................................................47

B. Liquidity and Capital Resources............................................................................................................................55

C. Research and Development, patents and licenses...............................................................................................59

D. Trend Information......................................................................................................................................................61

E. Off- balance sheet arrangements.............................................................................................................................62

F. Tabular disclosure of contractual obligations....................................................................................................63

G. Safe Harbor.................................................................................................................................................................63

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES....................................................................63

A. Directors and Senior Management.........................................................................................................................63

B. Compensation.............................................................................................................................................................68

C. Board Practices..........................................................................................................................................................69

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D. Employees....................................................................................................................................................................70

E. Share Ownership........................................................................................................................................................70

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.................................................71

A. Major Shareholders...................................................................................................................................................71

B. Related Party Transactions......................................................................................................................................73

C. Interests of Experts and Counsel............................................................................................................................73

ITEM 8. FINANCIAL INFORMATION.............................................................................................................................73

A. Consolidated Statements and Other Financial  Information.............................................................................73

B. Significant Changes...................................................................................................................................................78

ITEM 9. THE OFFER AND LISTING...............................................................................................................................78

A. Offer and listing details............................................................................................................................................78

B. Plan of Distribution...................................................................................................................................................83

C. Markets........................................................................................................................................................................83

D. Selling Shareholders.................................................................................................................................................85

E. Dilution........................................................................................................................................................................85

F. Expenses of Issue........................................................................................................................................................85

ITEM 10. ADDITIONAL INFORMATION.......................................................................................................................85

A. Share capital...............................................................................................................................................................85

B. Memorandum and Articles of Association...........................................................................................................85

C. Material Contracts....................................................................................................................................................85

D. Exchange Controls....................................................................................................................................................86

E. Taxation......................................................................................................................................................................86

F. Dividends and Paying Agents.................................................................................................................................93

G. Statement of Experts.................................................................................................................................................93

H. Documents on Display...............................................................................................................................................93

I. Subsidiary Information...............................................................................................................................................93

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT  MARKET RISK.............................94

ITEM 12. DESCRIPTION OF THE SECURITIES OTHER THAN  SECURITIES.................................................97

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PART II.............................................................................................................................................................................................98

ITEM 13. DEFAULTS, DIVIDENDS ARREARAGES AND DELINQUENCIES....................................................98

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS.............................................................................................................................................................................................98

ITEM 15. CONTROL AND PROCEDURES.....................................................................................................................98

ITEM 16...................................................................................................................................................................................99

A. Audit Committee Financial Expert.......................................................................................................................99

B. Code of Ethics.............................................................................................................................................................99

C. Principal Accountant Fees and Services...............................................................................................................99

D. Exemptions from the Listing  Standards and for Audit  Committees............................................................100

E. Purchases of Equity Securities by the Issuer and  Affiliated Purchasers......................................................100

PART III.........................................................................................................................................................................................101

ITEM 17. FINANCIAL STATEMENTS..........................................................................................................................101

ITEM 18. FINANCIAL STATEMENTS..........................................................................................................................101

ITEM 19. EXHIBITS...........................................................................................................................................................101

BY LAWS........................................................................................................................................................................................103

Exhibit 12.01 Certification by the Company’s CEO............................................................................................................118

Exhibit 12.02 Certification by the Company’s CFO.............................................................................................................119

Exhibit 13.01 Certification pursuant to 18 U.S.C. Section 1350.......................................................................................120

Exhibit 13.02 Certification pursuant to 18 U.S.C. Section 1350.......................................................................................121

Consolidated Financial Statements..........................................................................................................................................122

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# **GENERAL**

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

*Presentation of Certain Financial Information*

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

*Forward-Looking Statements*

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

# **PART I**

## **ITEM 1.  IDENTITY OF DIRECTORS, SENIOR  MANAGEMENT AND ADVISERS**

 

Not applicable.

## **ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE**

 

Not applicable.

## **ITEM 3. KEY INFORMATION**

 

A. Selected Financial Data

*U.S. GAAP Presentation*

The selected financial information for the  Company included in the following table should be read in conjunction with, and  is qualified in its entirety by reference to, the U.S. GAAP financial  statements of the Company and “Operating and Financial Review and Prospects”  appearing elsewhere herein. The consolidated financial data for the Company as  of December 31, 2005, 2004, 2003, 2002, and 2001 are  derived from the audited U.S. GAAP financial statements, which differ in  certain respects from accounting practices adopted in

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

** **

**SADIA S.A.**

SELECTED FINANCIAL DATA

Years ended December 31, 2005, 2004, 2003, 2002 and 2001 (In thousands of *reais*- R$, except numbers of shares and  per share amounts)

| ** **                                     | **2005**    | **2004**    | **2003**    | **2002**    | **2001**    |
|------------------------------------------------|-------------|-------------|-------------|-------------|-------------|
| ** **                                     | ** **  | ** **  | ** **  | ** **  | ** **  |
| Net        Operating Revenue                   | 7,317,842   | 6,109,225   | 5,081,717   | 4,139,070   | 3,602,470   |
| Operating        Income                        | 680,903     | 635,029     | 401,009     | 345,322     | 487,853     |
| Net        income                              | 603,268     | 489,501     | 473,268     | 284,262     | 203,484     |
|                                           |        |        |        |        |        |
| Basic earnings per thousand shares in R$:      |        |        |        |        |        |
| Preferred                                      | 885.08      | 742.42      | 717.80      | 431.14      | 308.62      |
| Common                                         | 885.08      | 674.93      | 652.54      | 391.94      | 280.56      |
|                                           |        |        |        |        |        |
| Diluted earnings per thousand share in R$:     |        |        |        |        |        |
| Preferred                                      | 884.38      | 742.42      | 717.80      | 431.14      | 308.62      |
| Common                                         | 884.38      | 674.93      | 652.54      | 391.94      | 280.56      |
|                                           |        |        |        |        |        |
| Dividends paid per thousand shares in R$:      |        |        |        |        |        |
| Preferred                                      | 231.96      | 234.68      | 170.08      | 106.89      | 69.75       |
| Common                                         | 210.87      | 213.34      | 154.61      | 97.18       | 63.41       |
|                                                |
| Total Current Assets                           | 4,588,176   | 3,944,802   | 3,645,379   | 2,759,217   | 1,562,713   |
| Total Assets                                   | 6,707,284   | 5,830,973   | 6,149,453   | 4,975,627   | 3,325,305   |
|                                           |        |        |        |        |        |
| Total        Current Liabilities               | 2,625,812   | 2,766,719   | 2,969,833   | 2,591,383   | 1,335,176   |
| Total        Liabilities                       | 4,081,472   | 3,064,254   | 3,179,620   | 2,384,244   | 1,990,129   |
| Total        Shareholders’ Equity        | 2,228,117   | 1,838,364   | 1,521,585   | 1,057,759   | 967,181     |
|                                           |        |        |        |        |        |
| Weighted average number of shares outstanding: |        |        |        |        |        |
|     Preferred                   | 424,595,712 | 425,695,712 | 425,695,712 | 425,695,712 | 425,695,712 |
|     Common                      | 257,000,000 | 257,000,000 | 257,000,000 | 257,000,000 | 257,000,000 |

 

The exchange rates of *real* amounts into U.S. dollars for the  years ended December 31, 2001, 2002, 2003, 2004, 2005 and January 2006 through  May 2006 are shown in the table below:

 

|                        | **Reais per U.S. Dollar** |
|-----------------------------|---------------------------|
|                        |                      |   |   |   |
| **Year Ended December 31,** | **High**                  | **Low** | **Average** | **End of Period** |
| 2001                        | 2.8007                    | 1.9353 | 2.3532 | 2.3204 |
| 2002                        | 3.9552                    | 2.2709 | 2.9983 | 3.5333 |
| 2003                        | 3.6623                    | 2.8219 | 3.0600 | 2.8892 |
| 2004                        | 3.2051                    | 2.6544 | 2.9171 | 2.6544 |
| 2005                        | 2.7621                    | 2.1633 | 2.4125 | 2.3407 |

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|             |   |   | **Reais per U.S. Dollar** |
|------------------|--------|--------|---------------------------|
|             |   |   |                      |   |
| **Months Ended** |   |   | **High**                  | **Low** |
| January 2006     |   |   | 2.3460                    | 2.2116 |
| February 2006    |   |   | 2.2217                    | 2.1177 |
| March 2006       |   |   | 2.2238                    | 2.1067 |
| April 2006       |   |   | 2.1542                    | 2.0892 |
| May 2006         |   |   | 2.3711                    | 2.0586 |

 

B. Capitalization and  Indebtedness

            Not applicable

 

C. Reasons for the offer and  use of proceeds

                Not  applicable

 

D. Risk Factors

**Risks Relating to Brazil**

***The Brazilian government has exercised, and continues to exercise,  significant influence over the Brazilian economy. Brazilian political and  economic conditions have a direct impact on the Company’s business and the  market price of the preferred shares.***

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

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

·      fluctuations in exchange rates;

·      interest rates;

·      inflation;

·      tax policies;

·      exchange controls;

·      energy shortages;

·      liquidity of domestic capital and lending markets; and

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

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

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

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

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

***Fluctuations in the value of Brazil’s currency against the value of the  U.S. dollar may result in uncertainty in the Brazilian economy and the  Brazilian securities market, which may adversely affect the Company’s financial  condition and results of operations and, consequently, the market value of the  preferred shares and ADSs.***

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

The *real* appreciated 22.3% in 2003,  8.9% in 2004 and 13.4% in 2005 against the dollar. On December 31, 2005, the U.S. dollar/*real* exchange rate was  US$1.00 per R$2.3407.

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

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

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

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

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

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

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

***Developments in other emerging markets may adversely affect the market price of the preferredshares and ADSs***

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

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

***Enforcement of civil liabilities may be difficult***

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

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

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

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

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

·              It is not subject to appeal;

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

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

Brazilian  counsel has also advised the Company that:

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

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

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

**Risks Relating to the Company’s Business**

***The business involves  breeding of animals and meatprocessing***

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

***Grains are the most representative isolated component of COGS and are  exposed to the volatility of the commodity markets***

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

***Environmental issues  and new regulation requirements can affect costs***

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

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***Competition in both  domestic and foreign livestock and food processing sector is very strong***

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

***Protectionist  measures could restrict Company exports***

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

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

Although the  detected Foot and Mouth Disease (FMD) cases in the northeast region of Brazil in the past have affected only cattle, hogs can also be contaminated. Cases of FMD were  identified in the states of Mato Grosso and Paraná during the second half of  2005. The Company ́s animal breeding facilities are located in the states of  Santa Catarina and Minas Gerais, internationally recognized FMD free regions.  No assurance can be given, however, that we will not be affected by FMD, either  directly or through limitations on exports imposed by importing countries.

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

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

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

Additional  preventative measures have been discussed and the Brazilian government has  proposed and approved the adoption of a National Plan for the Prevention and  Control of Newcastle Disease and the Prevention of Avian Influenza (*Plano  Nacional de Controle e Prevençao da Doenca de Newcastle e de Prevençao de  Influenza Aviária)*which will conform with OIE (World Organization for Animal  Health) standards. These measures are intended to assure international markets  that Brazil maintains sanitary barriers between states. Specific measures  include regulation of animal transportation, traceability, blood tests,  designated laboratories and other controls to monitor production conditions on  a regional basis. These measures are intended to permit the early detection of  contamination in one region and to prevent the spread

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of that contamination to  other regions within Brazil. Because the virus that causes AI is destroyed by  cooking, it is generally agreed that the consumption of contaminated poultry  does not present a threat to human health. 

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

**Risks relating to Sadia S.A.**

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

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

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

The Company ́s  ten largest customers in 2005 accounted for approximately 20% of total domestic  sales and approximately 10% of total gross sales. While the Company has been  developing new client-oriented policies to reduce the concentration of  revenues, if it loses any of its ten largest customers or if they reduce  significantly the amount they purchase from the Company, revenues and operating  income could be materially adversely affected.

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

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

##  

## **ITEM 4. INFORMATION ON THE COMPANY******

 

A. History and Development of  the Company

Sadia is a public held company, incorporated  in Brazil on June 7, 1944, and therefore is subject to the requirements of Law  No. 6,404, dated December 15, 1976, as amended by Law 9.457/97 (Brazilian  corporate law), and the rules and regulations of the *Comissao de Valores  Imobiliários*, or CVM, the Brazilian Securities Commission. 

 

Sadia is Brazil’s leading refrigerated and frozen protein products company, operating in the  processed product, poultry and pork segments. The Company believes that its  brand name and distinctive logotype are among the most widely recognized and  admired in Brazil and in the foreign markets in which it market its products,  associated with quality, tradition and value. The Company’s central  administrative headquarters are located at Rua Fortunato Ferraz, 365, Vila  Anastácio, Sao Paulo, state of Sao Paulo, Zip

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Code 05093-901, Brazil, telephone  number (55 11) 2113-3465, and the Company’s website is www.sadia.com.br or  www.sadia.com and e-mail address is ri@sadia.com.br. Materials posted on the  website are not deemed incorporated by reference into this annual report nor  made a part hereof.

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

Over the course  of its 60-year history, the Company evolved based on two key strategies: the  diversification of its portfolio of food products, and investment in quality. 

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

From 1997  forward, management has continued the reorganization of the Sadia Group and has  implemented the strategy of concentrating on higher value-added processed  products. 

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

In July 1998,  Sadia was merged with two of its subsidiaries, Sadia Frigobrás S.A. and Sadia Concórdia S.A., so that all of the activities of the Sadia Group were  concentrated in a single listed company, Sadia S.A. This resulted from a  gradual process of reorganization with a view to simplifying the Sadia Group  structure, increasing visibility to capital markets, and achieving gains in  scale through the reduction of general and administrative expenses and tax  costs.

In December  1999, Sadia acquired the capital stock of Granja Rezende S.A. (primarily a  producer and distributor of poultry and pork products) and its wholly owned  subsidiaries Rezende Alimentos Ltda., Rezende Óleo Ltda. and Rezende Marketing  Comunicaçoes Ltda.

Immediately  following the acquisition of Granja Rezende, the Company decided to sell Granja  Rezende’s soybean crushing and oil manufacturing plant and administrative  complex.

During 2000, the  subsidiary Rezende Alimentos Ltda. was converted from a limited liability  company into a corporation and the subsidiary’s name was changed to Sadia  Alimentos S.A. On December 29, 2000, the then parent was merged into Sadia  Alimentos S.A., whose name was then changed to Sadia S.A. The purpose of the  merger was to permit an operational and administrative rationalization, and the  utilization of tax loss carry forwards. In August 2002, Granja Rezende S.A. was  merged into Sadia, aiming at cost reduction both through standardization and  through rationalization of the administrative and operational activities as  well as by resulting reflections of financial and fiscal nature.

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

In the second half of 2001, Sadia and Sun Valley,   U.K. based subsidiary of Cargill Foods, formed a partnership. This  partnership gave rise to Concordia Foods Ltd., Worcester, UK. In January 2005, the partnership between Sadia and Sun Valley was discontinued, the legal entity  is being phased out. Sadia U.K. Ltd., assumed the operations once performed by  Concordia Foods Ltd.

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In August 2001, Sadia opened a distribution center (DC) in Jundiaí, Sao Paulo, to supply the Sao Paulo state region, considered the largest market in Brazil. The Jundiaí DC, is a technological milestone for the Company with 20,000 square  meters of area. The Company invested R$ 23 million in facilities and IT  structure.

In May 2002, Sadia GmbH and its subsidiary, Laxness F.C.P.A. Lda.  (Laxness) were created, aiming to leverage exports to the European market. In  February 2005, Laxness changed its name to Wellax Food Logistics C.P.A.S.U. Ltd  (Wellax).

In November  2004, the Company opened a distribution center in Ponta Grossa, state of  Paraná, giving the Company greater capacity and efficiency in its export  processes.

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

 

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

 

**Reclassification**

 

The Company reclassified the poultry and  hog breeders, reclassifying them from inventories to property, plant and equipment,  since breeders are generally accounted for as fixed assets and also because  they contribute to the cost formation of the poultry and hogs raised for  commercial purposes. The Company has not changed the breeders’ estimated useful  life.

 

The breading stock (net of depreciation) in  the amount of R$108,065 for the year ended December 31, 2004 has been  reclassified from inventories to property, plant and equipment and its related  depreciation in the amount of R$58,755 and R$50,837 for the years ended December  31, 2004 and 2003 respectively has been added to the depreciation and  amortization line item under operating activities in the statements of cash  flows for these respective years. Also, the amount of R$85,813 and R$73,594 has  been added to the purchase of property, plant and equipment line item under the  investing activities in the statements of cash flows for the years ended  December 31, 2004 and 2003, respectively. 

 

Investments

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

 

In 2005, an amount of R$ 742.4 million was  invested, of which R$ 194.6 million (26.2%) was directed towards the processed  products segment, R$ 372.8 million (50.2%) towards poultry, R$ 27.0 million (3.6%)  to pork and the remaining R$148 million (20%) mainly to information technology.  These investments were made in order to supply the growing demand in the  domestic and external markets.

 

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

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As part of the 2005  and 2006 investment plan Sadia is undertaking a sizeable expansion at the  Uberlândia Complex, which will require investments of over R$400 million  intended to increase the capacity of all of its production lines. The Company  will invest R$185 million, the integrated out growers will invest R$180  million, and R$36 million will be invested in logistics in 2006. The R$185  million investment will be distributed as follows: R$44 million to pork  production, increasing the slaughter capacity from 700,000 heads to 1.6 million  heads; chicken production will receive R$46 million to increase the slaughter  capacity from 43 million heads to 88 million heads; the turkey line will  receive R$35 million to increase its capacity of 7 million heads to 11 million  heads. Sadia will also invest R$44 million in the construction of a new feed  plant, R$7.5 million to expand the production of processed products and R$8  million in the storage of grains. The Uberlândia Complex will also house the  Company’s second margarine plant. This represents an investment of R$60 million  and is expected to become operational in the second half of 2006.

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

 

In 2003 Sadia invested R$179.3 million.

 

***Investment Plans***

 

For 2006, the total expected investment is  R$ 850 million, of which R$ 400 million will be directed towards the State of  Mato Grosso units and the remaining towards new projects in Uberlândia (MG),  Toledo and Ponta Grossa (PR), as well as expansions in units in the state of  Santa Catarina. These investments are intended to ensure better service to  Sadia’s customers, both domestic and international. The Company expects to fund  its investment plan with available cash flow generated from operations. 

 

From 2006 to 2009, Sadia plans to invest  R$1.5 billion in the state of Mato Grosso. The Company will be responsible for  R$800 million, and the remainder will be invested by its outgrowers. The amount  will be directed towards the construction of two poultry slaughter houses, one  in the city of Lucas do Rio Verde, and the other in the city of Campo Verde. Each one of them will have the slaughter capacity of 500 thousand animals per  day. As part of this investment, Sadia will also set up a slaughter and  industrialization hog unit, with slaughter capacity of 5 thousand animals per day  in the city of Lucas do Rio Verde, and a feed factory. The new units are  expected to generate 8 thousand direct jobs and 24 thousand indirect ones. 

 

Additional information on this investment  plan are as follow:

 

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

 

• From 2007 on, the poultry slaughter  houses will operate with 20% of capacity. In 2008, it is expected that these  units will operate with 85% of capacity, reaching their full capacity in 2009.

 

• The expected additional annual revenue  for poultry is R$1.2 billion by 2009, and the expected additional revenue for  the hog unit is R$400 million by 2009.

 

• The R$800 million investment does not  contemplate additional working capital, which will add up to R$140 million in  2009, for the 3 units.

 

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

 

B. Business Overview

Sadia is the leader  in all of the markets in which it operates within Brazil (see “Market Share”),  with a product portfolio of over 1,000 products. According to the Brazilian  Chicken Exports Association (ABEF),

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the Company is the largest Brazilian  slaughterer and distributor of poultry and pork products, as well as the  largest domestic exporter of poultry. Sadia is also the largest domestic  distributor of frozen and refrigerated meat-based products (according to AC  Nielsen), and leader in the Brazilian market for margarine. As of December 31, 2005, the Sadia Group had 45,537 employees, one of the largest employers in Brazil. During 2005 Sadia sold 950.7 thousand tons of poultry, 140.2 thousand tons of pork  and 738.7 thousand tons of processed products, including frozen and  refrigerated meat-based products and margarine, generating gross operating  revenues of R$8.3 billion and net income of R$603.3 million.

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

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

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

**Business Strategy**

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

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

●         **Focus  on retail sales, institutional and food service sales channels for domestic  business**. Sadia has increased, and plans to continue focusing on meeting  the needs of retail sales outlets, institutional and food service sales  channels, such as restaurants, rather than concentrating on wholesale outlets,  such as large 

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supermarkets and distributors. Between 2002 and 2005 the Company  added more than 25,000 customers to its list.

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

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

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

●             **Increase production, through organic growth,  investment in production capacity and acquisitions.**Most recently, in  January 2005, Sadia acquired 100% of Só Frango Produtos Alimentícios Ltda. (“Só  Frango”), for US$26.5 million 

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

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

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

The Company’s Operation

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

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In 2005, 44% of  total gross operating revenue was derived from the processed products segment,  poultry 41%, pork 9%, and 5% from other activities. Of the Company’s total  gross operating revenue in 2004, 47% was derived from the processed products  segment, poultry 41%, pork 8%, and 4% from other activities, such the grain and  by-products segment, hog and poultry breeding, boiled beef, beef-parts and  resale of products. In 2003 48% was derived from the processed products  segment, poultry 38%, pork 10% and 4% from other activities. 

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

The following tables present sales volumes  and gross operating revenue (prepared and presented in accordance with US GAAP)  for the years ended 2005, 2004 and 2003, as shown:

 

|                             |       | **Sales Volumes (ton)** |
|----------------------------------|------------|-------------------------|
| ** **                       | ** ** | **2005**                | **2004** | **2003** |
| ** **                       | ** ** | ** **              | ** ** | ** ** |
| **Domestic        Market**       | ** ** | **823,573**             | **736,465** | **677,842** |
|   Processed        Products |       | 647,062                 | 581,213 | 529,663 |
|   Poultry                   |       | 142,177                 | 105,826 | 100,419 |
|   Pork                      |       | 34,334                  | 49,426 | 47,760 |
|                             |       |                    |   |   |
| **External        Market**       | ** ** | **1,006,047**           | **855,303** | **668,044** |
|   Processed        Products |       | 91,593                  | 84,059 | 39,936 |
|   Poultry                   |       | 808,636                 | 692,192 | 524,419 |
|   Pork                      |       | 105,818                 | 79,052 | 103,689 |
|                             |       |                    |   |   |
| **Consolidated**                 | ** ** | **1,829,620**           | **1,591,768** | **1,345,886** |
|   Processed        Products |       | 738,655                 | 665,272 | 569,599 |
|   Poultry                   |       | 950,813                 | 798,018 | 624,838 |
|   Pork                      |       | 140,152                 | 128,478 | 151,449 |

 

|                             |       | **Gross Operating Revenue (R$ Million)** |
|----------------------------------|------------|------------------------------------------|
| ** **                       | ** ** | **2005**                                 | **2004** | **2003** |
| ** **                       | ** ** | ** **                               | ** ** | ** ** |
| **Domestic        Market**       | ** ** | **4,251.7**                              | **3,724.6** | **3,188.2** |
|   Processed        Products |       | 3,289.1                                  | 2,946.4 | 2,523.7 |
|   Poultry                   |       | 512.1                                    | 415.4 | 356.0 |
|   Pork                      |       | 148.3                                    | 154.9 | 129.8 |
|   Other                     |       | 302.2                                    | 207.9 | 178.7 |
|                             |       |                                     |   |   |
| **External        Market**       | ** ** | **4,075.7**                              | **3,392.7** | **2,529.3** |
|   Processed        Products |       | 412.3                                    | 405.6 | 284.9 |
|   Poultry                   |       | 2,937.6                                  | 2,488.7 | 1,787.4 |
|   Pork                      |       | 592.4                                    | 429.8 | 443.0 |
|   Other                     |       | 133.4                                    | 68.6 | 14.0 |
|                             |       |                                     |   |   |
| **Consolidated**                 | ** ** | **8,327.4**                              | **7,117.3** | **5,717.5** |
|   Processed        Products |       | 3,701.4                                  | 3,352.0 | 2,808.6 |
|   Poultry                   |       | 3,449.7                                  | 2,904.1 | 2,143.4 |
|   Pork                      |       | 740.7                                    | 584.7 | 572.8 |
|   Other                     |       | 435.6                                    | 276.5 | 192.7 |

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

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The following  table presents the breakdown of gross operating revenue in percentage terms by  segment, for the years ended 2005, 2004 and 2003, as shown: 

****

 

| ** **                | **Gross Operating Revenue by Segment (%)** |
|---------------------------|--------------------------------------------|
| ** **                | **2005**                                   | **2004** | **2003** |
| ** **                | ** **                                 | ** ** |   |
| Processed        Products | 44                                         | 47 | 48 |
| Poultry                   | 41                                         | 41 | 38 |
| Pork                      | 9                                          | 8 | 10 |
| Other                     | 5                                          | 4 | 4 |

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

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

|                                            | **2005**                                               | **2004**                        | **2003**                        |
|-------------------------------------------------|--------------------------------------------------------|---------------------------------|---------------------------------|
| Net operating        revenue                    |                                                   |                            |                            |
| Processed        products                       | 3,147,296                                              | 2,731,136                       | 2,386,247                       |
| Poultry                                         | 3,199,246                                              | 2,951,897                       | 2,250,189                       |
| Pork                                            |    732,710                                   |    586,595            |    554,698            |
| Other                                           |    239,186                                   |      37,845 |      41,864 |
| Adjustments for        US GAAP presentation     |          (596) |    (198,248)          |    (151,281)          |
|    Total net operating        revenue | 7,317,842                                              | 6,109,225                       | 5,081,717                       |

 

Other net  operating revenue is primarily attributable to grain and by-products and beef  products operations.

| * *                                                                           | **2005**                                     | **2004**                                                     | **2003**                                                     |
|------------------------------------------------------------------------------------|----------------------------------------------|--------------------------------------------------------------|--------------------------------------------------------------|
| **Depreciation        expense**                                                    |                                         |                                                         |                                                         |
| Processed        products                                                          |       (60,863)      |       (48,708)                      |      (54,069)                            |
| Poultry                                                                            |       (80,336)      |       (56,682)                      |      (54,653)                            |
| Pork                                                                               |       (16,853)      |       (11,003)                      |      (14,565)                            |
| Other                                                                              |        (7,294) |           (973) |           (961) |
|    Total        depreciation expense allocated to

   Segments |  

   (165,346)               |  

   (176,134)                               |  

   (169,672)                               |
| Depreciation        allocated to administrative

expenses                          |  

     (12,829)    |  

     (13,461)                    |  

     (18,227)                    |
|  Adjustments for        US GAAP presentation                                  |       (4,088)       |       31,774                        |      37,801                              |
|    Total        depreciation expense                                     |    (182,263)                       |     (157,821)                                 |    (150,098)                                       |

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| * *                                                                                      | **2005**                             | **2004**                               | **2003**                                   |
|-----------------------------------------------------------------------------------------------|--------------------------------------|----------------------------------------|--------------------------------------------|
| **Segment operating income**                                                                  | ** **                           | ** **                             | ** **                                 |
| Processed products                                                                            |    273,684                 |    274,197                   |    194,188                       |
| Poultry                                                                                       |    269,766                 |    260,393                   |    143,514                       |
| Pork                                                                                          |      94,586      |      70,902        |      26,632            |
| Other                                                                                         |       2,798 |       (3,765) |        5,548 |
| Adjustments for US GAAP presentation                                                          |      40,069      |      33,302        |      31,127            |
|     Total operating income                                                     |    680,903                 |    635,029                   |    401,009                       |
| Interest expense                                                                              |    (324,231)               |    (413,461)                 |    (449,408)                     |
| Interest income and other                                                                     |    248,203                 |    309,454                   |    481,609                       |
| Foreign currency exchange gain (loss), net                                                    |    159,602                 |      20,672        |      52,833            |
| Adjustments for US GAAP presentation                                                          |      (93,825)    |      35,428        |      (14,512)          |
| Income before income taxes, equity income or loss of          investees and minority interest |  

   670,652         |  

   587,122           |  

   471,531               |

 

| **Segment assets**                                     |                                  |                                               |                                       |
|--------------------------------------------------------|---------------------------------------|----------------------------------------------------|--------------------------------------------|
| Processed products                                     |    624,619                  |    491,982                               |    487,933                       |
| Poultry                                                |    750,504                  |    459,035                               |    377,799                       |
| Pork                                                   |    147,724                  |    137,798                               |    118,985                       |
| Other                                                  |    143,359                  |      76,910                    |      53,747            |
| Adjustments for US GAAP presentation                   |    (142,897)                |    (110,485)                             |    (128,454)                     |
|     Total property, plant and equipment | 1,523,309                             | 1,055,240                                          |    910,010                       |
|                                                   |                                  |                                               |                                       |
|  Reconciling items - corporate assets             |                                  |                                               |                                       |
|    Cash and cash equivalents                 | 2,663,689                             | 2,406,125                                          | 2,610,961                                  |
|    Accounts and notes receivable, net        |    509,615                  |    349,605                               |    453,936                       |
|    Inventories                               |    992,490                  | 1,064,671                                          |    839,557                       |
|    Other corporate assets                    |    690,825                  |    739,691                               |    616,095                       |
| Adjustments for US GAAP presentation                   |    184,459                  |    105,156                               |    661,787                       |
| Total consolidated assets                              | 6,707,284                             | 5,830,973                                          | 6,149,453                                  |
| ** **                                             |                                  |                                               |                                       |
| **Capital expenditures**                               |                                  |                                               |                                       |
| Processed products                                     |     194,587            |       93,220              |      45,056            |
| Poultry                                                |     372,761            |     146,606                         |      43,799            |
| Pork                                                   |       26,982 |        40,145        |        5,709 |
| Other                                                  |       91,662 |       52,286              |      15,656            |
| Adjustments for US GAAP presentation                   |       56,365 |         (7,340) |      69,124            |
|    Total segment capital expenditures        |    742,357                  |    324,917                               |    179,344                       |

 

*Processed Products*

As a result of  the Company’s strategy of concentrating on higher value-added, higher margin  products, the processed products segment results increased significantly as  from the second half of the 1990s. Average volumes sold increased 11.7% per  year since 1998. Sales of processed products accounted for 44% of the Company ́s  gross operating revenues in 2005.

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

The processed  products segment comprises a wide range of products, including: frozen products  (hamburgers, breaded products, ready-made dishes and pizzas), refrigerated  products (hams, sausages,

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frankfurters, bolognas, salamis, cold cuts, product  portions and refrigerated pasta) and margarine, the majority of which are sold  under the Sadia brand.

Processed  products in the domestic market, accounted for 88.9% of the total gross sales  of this segment, with the remaining 11.1% directed towards exports. The total  sales from this segment grew 10.4% as compared to 2004.  

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

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

The following table presents gross operating revenue  from sales of processed products in 2005, 2004 and 2003:

 

|                          | **Gross Operating Revenue (R$ Million)**                     |
|-------------------------------|--------------------------------------------------------------|
|                          | **2005**                                                     | **2004** | **2003** |
|                          | ** **                                                   | ** ** | ** ** |
| **Processed        Products** | **         3,701.4** | **         3,352.0** | **         2,808.6** |
| Refrigerated                  | 3,084.7                                                      | 2,778.0 | 2,326.6 |
| Frozen                        | 616.7                                                        | 574.0 | 482.0 |

 

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

 

|                                   | **Brazilian Market Share (2005)** |
|----------------------------------------|-----------------------------------|
|                                   | ** **                        | ** ** | ** ** |
|                                   | **Position**                      | **Market Share by Revenue (%)** | **Period** |
| Frozen Processed        Products       | 1st                               | 45.70 | October/November-05 |
| Refrigerated        Processed Products | 1st                               | 29.60 | November/December-05 |
| Margarine                              | 1st                               | 34.20 | October/November-05 |

Source: AC Nielsen

 

In order to  maintain market share, Sadia will continue to concentrate on launchings of  higher value-added products. In 2005, the Company launched 76 products, against  57 products in 2004 and 53 products in 2003.

*Poultry and Pork*

In 2005, sales  of non-processed products reached R$4,190.4 million, and accounted for 50.3% of  the Company ́s total gross operating revenue. In 2004, sales of non-processed  products reached R$3,488.7 million, and accounted for 41.9% of Sadia ́s total  gross operating revenue. In 2003 sales of non-processed products reached R$2,716.2  million, and accounted for 32.6% of total gross operating revenue. Sadia  exports significant amounts of fresh meat, which in 2005 accounted for  approximately 86%. In 2005, poultry and pork

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sales accounted for approximately  86.6% of total export revenue, in 2004 for approximately 86% and in 2003, 88.2%.  

Sadia owns eight chicken slaughterhouses,  three turkey slaughterhouses, and four pork slaughterhouses. In addition, the  Company has one beef slaughterhouse in the state of Mato Grosso, which became  operational as of November 2005. The table below shows slaughtering volumes of  the Company for the years ended December 31, 2005, 2004, and 2003, in millions of units: 

| ** ** | **Slaughtering Volumes (Million Heads)** |
|------------|------------------------------------------|
| ** ** | **2005**                                 | **2004** | **2003** |
| Poultry    | 650.1                                    | 573.0 | 501.0 |
| Hogs       | 3.8                                      | 3.5 | 3.9 |

The following table shows gross operating revenue from  non-processed products, for the years of 2005, 2004 and 2003:

 

|        | **Gross Operating Revenue (R$ Million)** |
|-------------|------------------------------------------|
| ** **  | **2005**                                 | **2004** | **2003** |
| ** **  | ** **                               | ** ** |   |
| **Poultry** | **3,449.7**                              | **2,904.0** | **2,143.4** |
| Whole       | 1,492.9                                  | 1,206.9 | 740.8 |
| Parts       | 1,811.0                                  | 1,583.9 | 1,298.5 |
| By-products | 145.8                                    | 113.2 | 104.1 |
| **Pork**    | **740.7**                                | **584.7** | **516.5** |
| **Total**   | **4,190.4**                              | **3,488.7** | **2,659.9** |

 

In 2005, Sadia had  a 10.3% share of domestic chicken production, in terms of tons and a 25.8%  share of the Brazilian poultry export market. This compares with results for  2004 and 2003, when the Company had a 13.6% and 12.9% share of domestic chicken  production and a 27.9% and 23.0% share of the Brazilian poultry export market,  respectively. Sadia introduced turkey production to the Brazilian market in  1973, when its consumption was virtually non-existent. Today the market is  shared with other competitors, but the Company is still in the leadership  position, with 65.6% of total sales in 2005, as compared with 66.2% of total  sales in 2004 and 66.1% for 2003. 

Approximately  70% of the Company’s pork production is used in its processed products segment.  The remainder is sold as fresh meat cuts in the domestic and international  markets. According to the Brazilian Pork Producers Association (ABIPECS), in  2005, Sadia had a 14.2 % share of domestic pork production, and a 14.2% share  of the Brazilian pork export market. This compares with results for 2004 and  2003, when the Company had a 10.4% and 11.3% share of domestic pork production  and a 19.7% and 21.3% share of the Brazilian pork export market, respectively. 

*                Beef*

 

In November 2005, Sadia decided to return  to beef because it believes that it represents a complementary business to the Company’s  activities. Sadia’s strategy in this sector is to concentrate sales towards the  external market, for the domestic market the Company will focus its efforts on  special beef cuts. In 2005, it accounted for less than 3% of total Gross  Operating Revenues.

 

***Production Process***

*Processed Products*

The Company uses  special cuts of pork, chicken and turkey, as well as selected and shaped  fragments for the production of hams, sausages, frankfurters, bologna,  hamburgers, pressed ham and related products. Seasonings and secondary raw  materials are applied to each product type or line, according to

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established  formulas, in order to ensure consistency, color, texture and flavor. The presentation  of final products is achieved by shaping, casing, cooking and freezing in  special machines. Products are then subjected to quality controls and  distributed to the consumer market after having been packaged, labeled and  boxed.

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

*Poultry*

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

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

The  “one-day-chicks” produced by parent stock are supplied to integrated outgrowers  who are responsible for raising the birds. Sadia has contracts with  approximately 6,600 outgrowers, to which the Company provides feed, technical  and veterinary assistance to allow such outgrowers the outgrowing process up to  the time the birds reach slaughtering age, which for chickens is normally 40  days (at a weight of 2.0 kg). There are no employment agreements between the Company  and the outgrowers, who generally carry out this activity in order to  supplement their income. Most outgrowers farm on a small scale and raise six  flocks per year (each flock consists of approximately 14,000 chickens). The  Company remains the owner of the birds, and at the end of each production  cycle, pays a commission fee based on a performance index that is calculated as  a function of indicators such as bird mortality, feed to meat conversion ratio  and average weight. The fee paid to the integrated farmers covers the  outgrowing costs, raw materials, labor and their net profit.

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

*Pork*

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

The hogs are  slaughtered through a process in which they are bled after being stunned  electrically. After heating to a temperature of 60/64oC, their  bristles are removed by automatic machines. The animals are

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then dried, flamed,  brushed and gutted, which process is subject to health inspection. After  cooling to a temperature of 5oC, the carcasses are cut up and  processed.

*                Beef*

* *

Differently than poultry and pork, Sadia does not  raise cattle. The Company purchases it in the spot market from one thousand  selected producers. The slaughtering process is conducted by the Company in its  facility in the state of Mato Grosso.

 

**Principal markets where the Company  competes**

In 2005, Sadia had an average of 49% of its  gross operating revenues provided from exports. This ratio was 48% and 44% for  2004 and 2003, respectively. The table set forth below presents the main  regions of the world where the company has commercial relations and the  discussion that follows describes the main trends and expectations for its markets. This information has been prepared and presented in accordance withBrazilian GAAP and is adjusted for U.S. GAAP. Refer to Note 20 of theconsolidated financial statements for details on the primary differencesbetween Brazilian GAAP and U.S. GAAP. 

 

|                                                                     | **Exports Gross Operating Revenues  (Thousand R$)** |
|--------------------------------------------------------------------------|-----------------------------------------------------|
|                                                                     |                                                |   |   |
|                                                                     | **2005**                                            | **2004** | **2003** |
|                                                                     |                                                |   |   |
| Europe                                                                   | 978,318                                             | 985,746 | 912,252 |
| Middle East                                                              | 1,047,615                                           | 802,935 | 632,991 |
| Asia                                                                     | 635,907                                             | 602,202 | 353,731 |
| South America                                                            | 542,151                                             | 387,130 | 130,322 |
| Emerging Markets  (mainly Russia and other former Soviet Union countries | 872,333                                             | 806,520 | 630,332 |
| Adjustments to  US GAAP presentation                                     | (627)                                               | (191,869) | (130,349) |
| **Total**                                                                | **4,075,697**                                       | **3,392,664** | **2,529,279** |

 

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

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

Seventy ninepercent of the Company’s exports in 2005 were to investment grade countries.

Market Overview – Domestic andInternational Markets

The growthpotential of the Brazilian market for processed food, poultry and pork, and Brazil’s low production costs are attractive to international competitors. The main barrierto such companies has nevertheless been the need to build a wide rangingrefrigerated distribution chain, and a network of integrated producers. Theprices of the sector’s principal raw materials, corn and soybeans, areinfluenced principally by climate conditions.

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The followinganalysis was prepared based on information mainly gathered from: The USDA(United States Department of Agriculture), FAO (Food and AgricultureOrganization – United Nations), CONAB (Brazilian National Supply Company), ABEF(Brazilian Poultry Exporters Association) and ABIPECS (Brazilian Pork MeatExporters Association) and AC Nielsen reports.

**Brazilian Processed Products Market**

Consumption ofprocessed products is influenced by several factors, including the increase inconsumer income, and efforts related to the development of products, with aview to meeting consumer demand for more sophisticated products. 

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

*Frozen Processed Products*

In 2005, theBrazilian market for frozen processed products accounted for sales of R$1,214.3million. Approximately 85% of this total is attributable to the two largestcompanies, Sadia S.A. and Perdigao.

| ** **                  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Sales (R$ million)          |       | 1,214.3  |       | 1,100.6  |       | 974.7    |       |
| Change %                    |       | 10.3%    |       | 12.9%    |       | -        |       |
| Volume  (thousands of tons) |       | 143.4    |       | 134.9    |       | 121.6    |       |
| Change %                    |       | 8.5%     |       | 10.9%    |       | -        |       |

 Source: ACNielsen

Due to thecharacteristics of frozen processed products with production concentrated amonga small number of companies, and supply aimed at a more restricted group ofconsumers, the Company believes that volume sales of frozen processed productswill maintain their growth trend, although at rates below the 11.6% annualaverage registered between 2003 and 2005. In any case, since the market forfrozen processed products is still far from mature in Brazil, Sadia believes that medium and long-term prospects for this segment are highlypositive based on the trend over the preceding years.

*Refrigerated ProcessedProducts*

In 2005, the Brazilian market forrefrigerated processed products accounted for sales of R$5,094.9 million. Thetwo largest companies in this market accounted for approximately 56% of thetotal share value of this market, according to AC Nielsen, with the remainingshare being split among a large number of small companies. 

 

| ** **                  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Sales (R$  million)         |       | 5,094.9  |       | 4,383.1  |       | 3,656.5  |       |
| Change %                    |       | 16.2%    |       | 19.9%    |       | -        |       |
| Volume  (thousands of tons) |       | 744.0    |       | 675.5    |       | 616.7    |       |
| Change %                    |       | 10.2%    |       | 9.5%     |       | -        |       |

Source: ACNielsen

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*Margarine*

In 2005, the Brazilian market for margarineaccounted for sales of R$1,527.5 million. The three largest producers accountedfor 85% of the market.

 

| ** **                  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Value (R$  million)         |       | 1,527.5  |       | 1,501.2  |       | 1,485.3  |       |
| Change %                    |       | 1.8%     |       | 1.1%     |       |     |       |
| Volume  (thousands of tons) |       | 302.3    |       | 285.9    |       | 294.0    |       |
| Change %                    |       | 5.8%     |       | 2.9%     |       |     |       |

Source: ACNielsen

***Poultry***

*Domestic Market*

The Brazilianpoultry market is a complex sector where a few large companies share the marketwith small producers. According to ABEF’s 2005 annual report, the four largestchicken producers in Brazil accounted for 37.1% of Brazilian production in 2005.The low concentration in the market increases competitive pressure in thesegment. Prices are subject to supply and demand imbalances. 

Many of thesesmall producers operate under low quality standards because of the large numberof producers and government difficulties to inspect them on a regular basis.Additionally, there is a widespread belief that informal practices among theseproducers reduce their costs as compared to producers that comply withapplicable regulations. 

Growth inBrazilian per capita consumption of poultry over the last four years isexpected to continue as the FAO forecast a 3.7% growth for 2005 as compared to2004. 

*e= estimate / f= forecast*

*Source: FAO (Food and Agriculture Organization)*

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In the local market, poultry export business in Brazil has grown more rapidly since the mid 1990s. This canbe explained by the shift of large Brazilian company’s exports, as well as bythe competitiveness of Brazilian poultry. Recent sanitary problems in the mainproducing countries such as the Bovine Spongiform Encephalophy (“BSE”) cases inEurope, Avian Influenza (“AI”) problems in Thailand and both BSE and AI casesin the United States have changed the world broiler trade framework. Thereduced competition from major exporting countries affected by sanitary issuesand the competitive cost of Brazilian poultry favors Brazil as the mostcompetitive exporter of quality poultry cuts and mechanically de-boned chickenmeat. Additionally, several new markets in Europe, Africa and the Middle East have opened to Brazilian chicken, and the number of markets which Brazil has access to has risen from 134 to 142 in 2005, according to ABEF’s 2005 annualreport. 

|          | **Brazilian Broiler Exports **        |
|---------------|--------------------------------------------|
|          | **Volume Destination (thousands of tons)** |
| ** **    | **2005**                                   | ** ** | **2004** | ** ** | **2005/04** |
| Middle East   | 843                                        | 31% | 750 | 31% | 12% |
| Asia          | 753                                        | 27% | 629 | 26% | 20% |
| EU            | 321                                        | 12% | 278 | 11% | 16% |
| Russia        | 254                                        | 9% | 192 | 8% | 33% |
| Africa        | 192                                        | 7% | 181 | 7% | 6% |
| South America | 113                                        | 4% | 81 | 3% | 39% |
| Others        | 286                                        | 10% | 314 | 13% | -9% |
| **Total**     | **2,762**                                  | **100%** | **2,425** | **100%** | **14%** |

*Source: ABEF*

For 2006, theUSDA has revised upwards the projected Brazilian broiler production to 10million tons, 7% from the record production level of nearly 9.4 million tonslast year. The projected increase in production reflects the firm domestic demandderived from higher employment rates and consumer purchasing power as theeconomy improves and continues to boost demand for animal proteins. Moreover,as 2006 is an election year, additional federal funding for social programs tofight hunger will help increase broiler demand. In addition to that, expansionin the export market will likely continue in view of the animal health (mostlyAvian Influenza) problems faced by other countries. 

According to the USDA’s GAIN Report wholebroiler exports in 2005 reached nearly 1.1 million  tons, with an increase of7% over 2004. The average export price for whole broilers in 2005 increased26.6% over the previous year. Exports of broiler parts reached 1.7 milliontons, up 18% over 2004. The average export price for broiler parts in 2005increased 11.8% from the previous year. This confirms Brazilian broilerexporters’ strategy to increase profitability by focusing on higher valueproducts, such as broiler parts and further processed products which increasedsignificantly in 2005 by 86% in volume, reaching 84,000 tons, valued at US$ 184million, up 82% from 2004.

 

In 2005, Japan became the largest marketfor Brazil’s broiler exports, mostly broiler parts. Exports to Japan increased by 24% in volume, and by 34% in value.  

 

The European Union was the second largestmarket for Brazilian broiler exports, mostly broiler parts, with an increase of24.9% in volume, and 34% in value. The increase in broiler exports to theEuropean Union also reflects a significant increase in exports of processedbroilers. The European Union market accounted for nearly 80% of all processedbroiler exports from Brazil. 

 

Saudi Arabia, traditionally Brazil’s largest single export marketfor poultry, now ranks third. In 2005, Saudi Arabia increased imports ofBrazilian broilers, mostly for whole broilers, 14% in volume and 38% in value. Saudi Arabia also accounted for nearly 45% of all Brazilian broiler exports to the Middle East.

 

Russia remained as the 4th largest market for Brazilian broiler exports in2005 despite quota restrictions. Shipments to Russia totaled 258,000 tons, up34% from 2004. The value of broiler exports to Russia was significantly up in2005 by 65%, reflecting a larger increase in broiler parts.

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*International Poultry Market*

The prevalenceof highly pathogenic avian influenza (“HPAI”), which is reportedly spreadingfrom Asia to other countries, may impact the world broiler trade outlook in2006. Despite the possible impacts on poultry consumption raised by concerns ofHPAI, the USDA forecasts a 3.5% increase in the world poultry consumption in2006. 

According to theFAO, properly cooked poultry is safe to consume as conventional cooking(temperatures at or above 70°C in all parts of a food item) will inactivate theH5N1 virus. Moreover, there is no epidemiological evidence to indicate thatpeople have been infected with the H5N1 virus following consumption of properlycooked poultry or eggs. It is expected, thus, that as consumers become moreaware of the true dangers of HPAI, the level of poultry consumption will not beaffected.

According to theUSDA, world economic growth is expected to remain strong throughout 2006,although not at the same level of 2005. The forecasted positive economicenvironment will promote investment in meat production and processing capacityin many major livestock and poultry producing countries. 

Moreover,increases in worldwide real per capita GDP in 2006 will continue to fuel risinglivestock and poultry consumption and hence production. Asian economiesparticularly China, Hong Kong, Taiwan, and Thailand are forecast to experiencestrong growth, likely fostering meat consumption as consumers will have moredisposable income. 

According to theFAO, from 1999 to 2004 per capita consumption of poultry in developingcountries grew at an annual rate of 2.8% compared with a 2.5% growth rate indeveloped countries. Many observers believe that the consumption of animalprotein in developing countries will continue to grow at a faster rate than indeveloped countries, in part due to the rapid economic growth of manydeveloping countries, such as China and India. Economic growth and increases inper capita income is tied to growth in meat demand as less expensive vegetableprotein is substituted for animal protein sources. From 1999 to 2004, percapita poultry consumption in India grew at an annual rate of 12.7%, contrastedwith a 0.3% decline in Japan for the same period.

According to theUSDA, macroeconomic stability and growth in low and some middle-income countriesresults in higher consumption of red meat and poultry, providing new growthopportunities for domestic producers and world suppliers. 

According to theFAO, per capita consumption of poultry in developed countries is more thanthree times that of developing countries. This difference is even moreaccentuated for certain countries. In 2005, for instance, while India isforecasted to consume 1.6kg poultry per capita, Japan will consume, 10 timesthat amount, with 16kg. 

Page 27 

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*e= estimate / f= forecast*

*Source: FAO (Food and Agriculture Organization)*

* *

According to theUSDA, broiler meat exports by major traders are forecasted to reach a recordbreaking 7.5 million tons in 2006. Poultry demand is expected to be strong dueto the absence of the United States in major beef markets and constraints ongrowth in Brazilian beef exports. The 2006 increase of nearly 7% is the resultof increased trade by a number of countries including Argentina, Brazil, China, Thailand, and the United States.

Thai broilermeat exports in 2006 are estimated to grow further by 30% over the 2005 level,mainly because of the market value of Thai cooked products and because of theability of Thai producers to increase cooked product supplies quickly. It isexpected that total exports will continue to be cooked products as importprohibitions on Thai uncooked chicken continue.  

Thai domesticconsumption in 2006 is forecasted to grow further by 7% due to increasingconsumer confidence in the safety of cooked chicken meat among Thai consumersand relatively competitive prices of chicken meat against other meats. Broilermeat consumption in 2005 recovered from the 2004 level to 750,000 tons after asharp drop in domestic consumption in 2004, and it is just bellow the 2003record consumption of 775,000 tons. Improved disease controls have rebuiltconsumer confidence in the safety of chicken meat.

According to theUSDA, in 2005, Russian poultry production grew by 15% and is expected toincrease by an additional 15% in 2006 as the sector continues to benefit fromheavy investment. Despite these investments Russia will continue to be theworldwide leader in poultry imports with a forecasted 1.1 million tons for2006. Poultry accounts for 35% of the total Russian meat market, of which 35%are whole birds, 37% are chicken leg quarters and 28% is deeply processedproduct.  

Japan’s total broiler consumption in 2006 isprojected to stay flat from the level achieved last year at 1.8 million tons.The USDA also expects a slight decrease of 2.1% in the Japanese poultryimports, as a consequence of the weaker outlook for food service demand,coupled with high year beginning stocks. 

Saudi Arabia poultry imports for 2006 are expected toreach about 447,000 tons a 2.5% increase compared to the 2005. As stated in theUSDA’s GAIN Report, according to local importers, Brazilian frozen broiler meatexports this year are expected to increase by at least 10% compared to the 2004export level of 333,000 tons. France, the second largest broiler meat exporterto the Kingdom, is expected to lose significant market share to Brazil this year compared to last year.

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The USDAprojects that the European Union broiler meat consumption will have just aslight increase of 0.5%, reaching 7.3 million tons. Imports on the other hand, areexpected to increase by 4.5%, to 460,000 tons in 2006. 

In 2006, Chinesebroiler meat imports are projected to reach 300,000 tons, a 20% increase fromthe previous year. 

|          | **World Broiler Balance (thousands of tons)** |
|---------------|-----------------------------------------------|
|          | **2005 (p)**                                  |   | **2006 (f)** |
| ** **    | **Production**                                | **Consumption** | **Exports** | ** ** | **Production** | **Consumption** | **Exports** |
| United States | 15,792                                        | 13,363 | 2,464 |   | 16,300 | 13,769 | 2,538 |
| China         | 10,200                                        | 10,150 | 300 |   | 10,500 | 10,440 | 360 |
| Brazil        | 9,400                                         | 6,240 | 2,800 |   | 10,000 | 6,490 | 3,040 |
| EU            | 7,670                                         | 7,330 | 780 |   | 7,690 | 7,370 | 780 |
| Japan         | 1,130                                         | 1,820 | - |   | 1,125 | 1,810 | - |
| Argentina     | 1,080                                         | 973 | 110 |   | 1,180 | 1,034 | 150 |
| Canada        | 1,000                                         | 984 | 100 |   | 1,020 | 995 | 105 |
| Thailand      | 950                                           | 750 | 300 |   | 1,120 | 803 | 400 |
| Others        | 11,325                                        | 14,253 | 85 |   | 12,111 | 15,091 | 93 |
| **Total**     | **58,227**                                    | **55,863** | **6,979** | ** ** | **60,576** | **57,801** | **7,466** |

*Source: USDA*

*(p) preliminary (f) forecast*

* *

|                 | **World Broiler Imports   (thousands of tons)** |
|----------------------|-------------------------------------------------|
| ** **           | **2005 (p)**                                    | **2006 (f)** |
| Russia               | 1,040                                           | 23% | 1,075 | 23% |
| Japan                | 695                                             | 15% | 680 | 15% |
| EU                   | 440                                             | 10% | 460 | 10% |
| Saudi Arabia         | 436                                             | 10% | 447 | 10% |
| Mexico               | 360                                             | 8% | 378 | 8% |
| China                | 250                                             | 6% | 300 | 6% |
| Hong Kong            | 230                                             | 5% | 246 | 5% |
| South Africa         | 175                                             | 4% | 190 | 4% |
| United Arab Emirates | 160                                             | 4% | 160 | 3% |
| Kuwait               | 130                                             | 3% | 138 | 3% |
| United States        | 17                                              | 0% | 16 | 0% |
| Others               | 580                                             | 13% | 564 | 12% |
| **Total**            | **4,513**                                       | **100%** | **4,654** | **100%** |

*Source: USDA*

* (p) preliminary (f) forecast*

***Pork***

*Brazilian Pork Market*

Processingcompanies are subject to the same problems as those in the poultry market,unfair competition with small and low quality producers. Although theseproblems influence product quality, there is still very low perception by partof the population of the risks involved and price dumping is widely practiced.According to ABIPECS 2005 annual report, the four largest pork producers in Brazil were responsible for 35.8% of Brazilian production in 2005. 

Page 29 

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*e= estimate / f= forecast*

*Source: FAO (Food and Agriculture Organization)*

 

Brazilian porkbreeding and slaughtering continues to increase its productivity efficiency.Measured by the average birth rate of piglets, productivity doubled since the1970s, the birth rate reached 24 animals per female and at 160 days old,animals weigh 100 kg in average, ready to be slaughtered. Research has alsocontributed to reduce fat by 31%, cholesterol by 10% and calories by 14% inpork produced in Brazil. This enhancement allows for a better productivity ofprime cuts, more meat per carcass as well as more nutritious and healthiermeat. 

Brazilian pork exports had an impressiveexpansion in 2005 increasing 22.5% in volume to 761,000 tons in 2005 from 510,000tons in 2004. It had an even better performance in terms of market value, whichgrew to US$ 1.2 billion in 2005 from US$ 740 million in 2004 for an increase of57.7%. 

 

|         | **Brazilian Pork Exports** |
|--------------|----------------------------|
| ** **   | **Thousand Tons**          | ** ** | **Million US$** |
| ** **   | **2005**                   | **%** | **2004** | **%** | ** ** | **2005** | **%** | **2004** | **%** |
| Russia       | 405                        | 65% | 288 | 57% |   | 805 | 69% | 449 | 58% |
| Hong Kong    | 61                         | 10% | 58 | 11% |   | 84 | 7% | 73 | 9% |
| Ukraine      | 22                         | 4% | 36 | 7% |   | 34 | 3% | 52 | 7% |
| South Africa | 18                         | 3% | 12 | 2% |   | 31 | 3% | 18 | 2% |
| Argentina    | 17                         | 3% | 28 | 6% |   | 33 | 3% | 46 | 6% |
| Cingapore    | 17                         | 3% | 16 | 3% |   | 34 | 3% | 27 | 3% |
| Moldavia     | 8                          | 1% | 2 | 0% |   | 15 | 1% | 3 | 0% |
| Albania      | 8                          | 1% | 5 | 1% |   | 14 | 1% | 8 | 1% |
| Uruguay      | 7                          | 1% | 10 | 2% |   | 12 | 1% | 13 | 2% |
| Kasakistan   | 7                          | 1% | 2 | 0% |   | 13 | 1% | 3 | 0% |
| Others       | 55                         | 9% | 52 | 10% |   | 93 | 8% | 86 | 11% |
| **Total**    | **625**                    | **100%** | **510** | **100%** | ** ** | **1,168** | **100%** | **777** | **100%** |

*Source: ABIPECS*

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In 2005, Brazilian pork exporters increasedtheir shipments of pork cuts, which now account for more than 75% of all porkexports. This increase reflects the strategy of Brazilian exporters to increaseprofitability by exporting higher value products. 

 

Russia remains the principal market for Brazilian pork exports. Russianmarket share of Brazilian pork imports in terms of volume increased from 57% in2004 to 65% in 2005. Hong Kong is the second largest Brazilian market for porkexports with a 10% market share, followed by Ukraine, which is now the thirdlargest market for Brazilian pork exports.

 

Pork productionis expected to decline by 3.2% to 2.7 million tons in 2006. The decline in porkproduction is mostly attributed to lower expected exports to Russia. However, foreign and Brazilian companies estimate production to increase in thecenter-west region of Brazil as a result of maturing investments. Most of thisproduction increase from the center-west will be absorbed by domestic demand,which is likely to be firm in 2006 due to lower consumer prices.

*International Pork Market*

Pork consumptioncontinues to benefit from beef and poultry supply disruptions due to AI andBSE. Increases in pork production are substituting for reduced demand for beefand poultry in many countries. According to the USDA, global pork exports areforecasted to increase 2.5% in 2005 reaching a record high of 4.6 million tons.

Nevertheless, there is an increasing awareness thatmeat trade flows are becoming largely dictated by sanitary conditions andregulations. Exporters worry that market access, driven by trade policy, aswell as veterinary and food safety controls, could become easily susceptible tonon-tariff trade barriers, especially when those controls are not based ontechnical criteria. In this very uncertain environment, exporting countries aretrying to maintain a competitive position in lucrative markets. At the sametime, importing countries are seeking to ensure fairness for their domesticproducers, while also safeguarding the health and economic needs of theirconsumers. 

Pork consumption in the major consuming countries isexpected to grow about 3% in 2006 and again China accounts for the largestportion (76%) of this forecasted growth. 

Similar topoultry, in the next years, most of the growth in pork consumption will derivefrom the emerging economies. Not only are low and middle-income countriesincreasing their per capita consumption, but they are also gradually accountingfor a greater share of world consumption. According to the USDA, China’s pork consumption accounted for 50% of pork consumption in major pork consumingcountries in 2001 and is forecast to account for 53% in 2006. On the otherhand, the EU’s share of pork consumption is forecast to decrease from 24% to22% from 2001 to 2006.

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*e= estimate / f= forecast*

*Source: FAO (Food and Agriculture Organization)*

* *

EU pork production is expected tomarginally increase in 2006 while exports will have a slight increase of 1% in2006 to nearly 1.5 million tons. The European Union easily retains its positionas the world's leading pork exporter and is forecast to account for 28% of porkexports by major traders.

 

The United States market is currentlysignaling producers to expand production. Production in recent years has beenexport driven. While only 8% of U.S. pork production was exported in 2001, 13%of American pork production is expected to be exported in both 2005 and 2006.In 2006, U.S. pork exports are forecast to reach 1.3 million tons.

 

In 2003, the Russian government publishedthe resolutions that established poultry quota and beef and pork tariff ratequotas (“TRQ”). The Russian TRQ establishes country specific quotas for the EU,  Paraguay, United States and a general quota for all other countries. Asprocessed pork is not under the TRQ, imports of this kind of meat pork haveincreased. 

                

                Meat bans introduced by Russia at the end of 2005 (affecting Brazil and Poland) and in the beginning of 2006(affecting Ukraine) created a state of uncertainty for importers looking tofill their TRQ allocations. According to the USDA, if the bans are not removedin the near future, it will be very difficult for importers to find adequatesubstitution. Brazilian meat imports entered Russia for only half a year in2005. If the ban on Brazilian meat is lifted from two of Brazil’s most important meat-producing regions, then it is expected that importers will beable to fill their quotas.

 

One of the few countries in which a decline inconsumption is anticipated in 2006 is Japan. While the decline in Japanese porkconsumption is minor, less than 2%, it demonstrates the market is readjusting.In 2004, mainly due to import bans on U.S. beef due to BSE and Asian poultrydue to AI, Japan experienced unusually high levels of demand for pork. As Japan adjusts to supply shocks to the beef and poultry sectors, pork consumption isforecast to return to more historic levels.

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|  

  | **World Pork Balance (thousands of tons)** |
|----------------|--------------------------------------------|
|           | **2005 (p)**                               | ** ** | **2006 (f)** |
| ** **     | **Production**                             | **Consumption** | **Exports** | ** ** | **Production** | **Consumption** | **Exports** |
| China          | 48,900                                     | 48,570 | 400 |   | 50,900 | 50,535 | 415 |
| EU             | 20,720                                     | 19,310 | 1,430 |   | 20,900 | 19,470 | 1,450 |
| United States  | 9,402                                      | 8,619 | 1,229 |   | 9,591 | 8,763 | 1,263 |
| Brazil         | 2,730                                      | 1,985 | 745 |   | 2,656 | 2,100 | 725 |
| Canada         | 1,960                                      | 1,012 | 1,075 |   | 1,975 | 1,033 | 1,100 |
| Russia         | 1,785                                      | 2,434 | 1 |   | 1,900 | 2,574 | 1 |
| Japan          | 1,260                                      | 2,531 | 0 |   | 1,240 | 2,485 | 0 |
| Mexico         | 1,175                                      | 1,615 | 55 |   | 1,200 | 1,640 | 65 |
| Philippines    | 1,100                                      | 1,130 | 0 |   | 1,122 | 1,152 | 0 |
| Korea South    | 1,050                                      | 1,328 | 5 |   | 1,010 | 1,351 | 10 |
| Taiwan         | 910                                        | 950 | 0 |   | 935 | 965 | 0 |
| Others         | 1,545                                      | 2,121 | 63 |   | 1,569 | 2,139 | 71 |
| **Total**      | **92,537**                                 | **91,605** | **5,003** | ** ** | **95,167** | **94,207** | **5,100** |

*Source: USDA*

*(p) preliminary (f) forecast*

According to theUSDA, Japan is expected to remain the world’s largest pork importer in 2006,importing over 1,235 thousand tons, slightly below the previous year. In 2004,mainly due to the import ban on U.S. beef and broiler meat from key suppliersdue to animal diseases, the Japanese pork market enjoyed an unusually highdemand with record level imports, high levels of domestic pork production andhigh prices. In 2005, this heated situation started to cool, reflecting overallslow down in consumption, reduced imports and lower stocks compared to 2004. 

|          | **World Pork Imports   (thousands of tons)** |
|---------------|----------------------------------------------|
| ** **    | **2005 (p)**                                 | **2006 (f)** |
|          | **Volume**                                   | **%** | **Volume** | **%** |
| Japan         | 1,243                                        | 31% | 1,235 | 30% |
| Russia        | 650                                          | 16% | 675 | 16% |
| Mexico        | 495                                          | 12% | 505 | 12% |
| Korea South   | 300                                          | 7% | 351 | 9% |
| Hong Kong     | 250                                          | 6% | 270 | 7% |
| Romania       | 185                                          | 5% | 180 | 4% |
| Canada        | 135                                          | 3% | 155 | 4% |
| Australia     | 90                                           | 2% | 95 | 2% |
| Ukraine       | 75                                           | 2% | 60 | 1% |
| China         | 70                                           | 2% | 50 | 1% |
| Others        | 127                                          | 3% | 118 | 3% |
| Total Foreign | 3,620                                        | 89% | 3,694 | 89% |
| United States | 447                                          | 11% | 435 | 11% |
| **Total**     | **4,067**                                    | 100% | **4,129** | 100% |

*Source: USDA*

*(p) preliminary (f) forecast*

 

As a result ofthe substitution effect arising from the ban on chicken products from China and the U.S. in 2004, Hong Kong pork imports were higher than normal. When thesubstitution effect dissipated in

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2005, Hong Kong pork imports dropped 24.7% . The  USDA forecasts for 2006 a modest increase of 8% given the sporadic avian  influenza cases in China. China is the largest supplier to Hong Kong followed  by Brazil. According to the USDA, Brazilian pork are very price competitive and  product specifications are good for Hong Kong’s retail. 

***Seasonal Nature ofBusiness***

*Chicken and Pork*

Not seasonal innature.

*Turkeys*

Turkey production activities are seasonal innature with respect to “whole turkeys”, whose production is concentrated in thesecond half of the year, with a higher volume of sales in the fourth quarterbecause of Christmas holidays.

*Processed products*

Processedproducts are seasonal only in the celebration products, with a higher volume ofsales in the fourth quarter.

***Raw Materials***

Sadia owns nineanimal feed plants with an installed capacity of 5.5 million tons per year, avolume sufficient to supply all the animal feed requirements of its breedingoperations. The basic raw materials used in animal feed production are corn andsoybeans, in a mix that contains preservatives and micronutrients. The Company suppliesthe basic animal feed to its outgrowers and sell the remainder on the spotmarket.

The Companypurchases corn and soybeans from rural producers, small merchants,cooperatives, large scale traders and through auctions organized by theBrazilian government, as well as occasionally from Argentina. Most of theproduction of these raw materials is concentrated in the States of SantaCatarina, Paraná, Rio Grande do Sul, Goiás and Mato Grosso. Grains are receivedin sacks or in bulk, and are then weighed. A sample is taken to measurehumidity and impurities in the grain. After approval, the grain is unloadedinto a hopper for cleaning and drying. Grain is then sieved in order toeliminate the residues that accompany it. After selection and cleaning, thegrain is milled and mixed with the other ingredients of the feed.

Sadia acquiresbeef for the production of frozen and refrigerated processed products, andboiled beef parts. Other inputs, such as prepared animal intestines (forcasing), seasonings and other ingredients, cardboard boxes, plastic bags (forpackaging and labels), and veterinary medicines (for poultry and hog breeding),are acquired from many different sources, both at home and abroad.

*Costs and OperatingExpenses*

Sadia ́s principalcosts of production are incurred in *reais* and consist of grains, cornand soybeans, packaging, and labor. While input costs are *reais*denominated, the international commodity prices (grains and packaging) tend tofollow international prices and are influenced by exchange rate fluctuations. TheCompany operates with an average idle capacity of 20% in processed productlines but can be at full capacity dependingon the market demand. Due to the flexibility inproduction lines and to the diversity of the equipmentpresent in its thirteen plants, production can be adapted and reformulated,depending on the Company ́s needs to face a determined segment demand, night andweekend shifts as well as supply partnerships are broadly used to reducebottlenecks during the production process.

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*Corn*

Brazil's corn prices used to be determined onlyby domestic supply. Production was mainly on relatively small properties andhad a low level of mechanization. However, during 2002, due to the *real*currency depreciation and the improvement of several local producers, part oftheir crop was shifted to the international market. Therefore, Brazilian cornprices went up to adjust to international prices.

In Brazil, there are some 20 different regions where buyers can bid for the product. Cornprices tend to be influenced by local supply, but international prices alsoinfluence local quotes, according to crop expectations among the main worldproducers (U.S.A., China and Argentina) and the level of international storagein the main consuming countries (Europe and Japan). 

The followingchart sets forth the Company’s average monthly buying price of corn for theperiod between January, 1995 and December 31, 2005:

  According to CONAB’s May 2006 Report, it is expectedthat the 2005/06 Brazilian corn crop production will increase 16.6% compared tolast year’s production, reaching approximately 40.8 million tons. This increaseis mainly due to the need of crop rotation between corn and soy, thedisappointing soybean prices and the better productivity in corn.

*Soybean*

Soybean producers in Brazil have beenincreasing their productivity duringthe last several years and Brazil has become the second largest producer in the world. Soybeanproduction is substantially mechanized and grains are cultivated on large properties. Producers are well organized andproduction is oriented to the

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export market. Production  is also spread over several regions among the southern,  southeastern and central region of the country, and prices are regionally given  by local supply. However, international prices tend to influence local prices  when foreign demand and supply are unbalanced.

CONAB expects the Braziliansoybean planted area for 2005/06 to decrease around 4.7% in comparison to thelast crop. This reduction is a result of the historicallow soybean prices in the domestic and foreign markets, which leads to areduction of soybean’s profitability when compared to other agriculturalproducts such as sugar cane and corn. In addition to that, there is a negativeprofit margin projection for the central states in Brazil. 

Despitethe reduction in planted area, CONAB forecasts that the production for 2005/06crop will be equivalent to 55.2 million tons, a 7.3% increase as compared tothe 2004/05 crop. This is due to an increase in productivity, especially in thesouthern region of Brazil

The followingchart sets forth the Company’s average monthly buying price of soybeans for theperiod between January 1995 and December 31, 2005.

***Marketing***

Sadia’s brandname is considered one of the Company's most valuable assets. The Companymaintains an active marketing program using both electronic and printed media.

The Companyincurred advertising expenses of R$116.6 million, R$121.4 million, and R$96.8million during the years ended December 31, 2005, 2004 and 2003, respectively.

Marketingexpenses are related to investments in advertising of specific campaigns forthe launch of higher value-added products and for the reinforcement of Sadia’sbrand name. 

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***Logistics***

The Company’s logisticssystem and distribution channels are two of its principal competitiveadvantages. Sadia has taken many initiatives to sustain its leadership, whichincludes partnerships, information technology investments and the developmentof new processes for optimization of logistics, both domestic andexport-related.

***Distribution***

Within theBrazilian market, Sadia sells its finished products to wholesale and retailoutlets, as well as to institutional clients. For the year ended December 31, 2005, the Company sold to approximately 94 thousand customers throughout Brazil. Sadia ́s distribution strategy is based on the importance of direct sales tocustomers, thereby avoiding concentration among a few large customers.  

Sadia maintainssales representation offices in Germany, England, Russia, Japan, China, the United Arab Emirates, Argentina, Uruguay, Chile, Panama and Turkey. In 2005, it sold to approximately 426 foreign clients.

In 2005, 60% of exports were sold to approximately 10long-standing customers. All of these customers have imported increasingquantities of the Company ́s products over the last ten years. 

***Transport***

*Transport*

Sadia usestrucks as the primary method of distributing its products in Brazil. The Company’s distribution system is handled by a network of approximately 1,800refrigerated hired vehicles for both long and short range deliveries, whichservice customers directly throughout Brazil. 

Distribution bytruck is made by refrigerated vehicles, given the perishable nature of the foodproducts, whose shelf life varies from 12 days, refrigerated chicken to 540days, frozen turkey . In the case of stoppage of transport by virtue of ageneral strike, the result would be a complete loss of the products in transitand lack of supply for the points of sale if the period of interruption isgreater than 30 days, an outcome the Company considers remote. As analternative to highway transport, supply could be effected by air, althoughthis would increase the freight cost by more than 20 times. In the case of asector strike, the impact would be minimized because the Company hasmanufacturing units producing the same products located in different regions ofthe country.

*Shipment of Exports*

 

The Company ships 45% of its exportsthrough the port of Paranaguá, 15% through Antonina, both in the State of Paraná, 38% through the ports of Sao Francisco do Sul and Itajaí, in the state of SantaCatarina and the remaining 2% from other ports.

 

In the port of Paranaguá, the Company hastwo refrigerated warehouses, capable of receiving and expediting one thousandtons per day. These warehouses have a "drive in" storage system andonly operate with palleted cargoes. Since one of the warehouses is located inthe wharf area, the Company has priority in the mooring of ships arriving atthe port of Paranaguá, thereby avoiding possible cost increases due to delaysin loading its cargo.

 

The Company also has a warehouse in Ponta Grossa, in the state of Paraná, with storage capacity of 11 thousand tons, and isable to receive and expedite one thousand tons per day.

 

The Company ships its cargoes in "fullcontainer" or conventional "reefer" vessels for palleted cargo.

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***Sales***

Sadia hasadapted its sales structure and commercial policies to include the large chain,wholesale (cash and carry), regional mid-size clients, traditional retail(small retail), institutional and distributor channels. The Company sales forcehas been unified in a single management group, making it possible for the bigretail chains to be serviced by an account manager, with the support ofcoordinators, promoters and re-stockers. For medium and small retailers, Sadia hasinstituted a telemarketing service, which complements the market work of thesales force and also relies to a limited extent on local distributors. 

**Brazilian Food Sector Regulation**

The BrazilianMinistry of Agriculture, through the *Secretaria de Defesa Agropecuária*(SDA), Agricultural and Cattle Breeding Defense Secretary, under the AnimalProducts Inspection Department (DIPOA), regulates Sadia ́s activities. The latterdepartment is responsible for the issuance of regulations, conduct ofinspections and legal support in respect to the livestock, animal breeding,food processing and any other activity involving animal related affairs in theBrazilian territory.

***Sustainability andEnvironment***

Brazilianenvironmental regulations have their principles established in the FederalConstitution, with concurrent jurisdiction among the Brazilian federalgovernment, the states and the municipalities to regulate the subject. The publicadministration at each such level of government is responsible for thesupervision and control of pollution in any form, as well as for thepreservation of forests, hydraulic resources and the fauna and flora. Theintegration of all of the federal, state and municipal agencies responsible forthe protection and improvement of environmental quality is undertaken by theNational Environmental System (SISNAMA).

As a producer offoodstuffs using a wide range of industrial processes, especially its meat productlines which require slaughter of animals, Sadia is subject to compliance withall of the legal requirements, covering environmental risks that are customaryin these processes, such as rules governing treatment of liquid effluents,solid organic waste, particle suspension and odors. The Company is careful torespect the environment at all stages of the production chain, including its activitiesin the field, the design of packaging (developed with a view to reducing thequantity of raw materials used) and adapting the same to recycling processes.In addition to simplify treating residues, Sadia invests in minimizing thegeneration of such residues by optimizing processes and adopting stringentprocedures for controlling the emission of wastes and effluents. The Company’s expendituresrelated to meeting environmental requirements and in process optimizationamounted to approximately R$10.1 million in 2005, R$13.3 million in 2004 andR$15.8 million in 2003.

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C. Organizational Structure

 

 

The Sadia Groupis currently composed of seventeen companies, as shown in the chart above.

The Companyconcentrates all production, slaughtering, distribution and product salesactivities within Brazil. Sadia International Ltd. is one of the company’ssmaller vehicles for sales outside Brazil, and is a shareholder of theChurrascaria Beijing steakhouse, which was established in Beijing inpartnership with Sky Dragon, a company linked to the Chinese Ministry ofAgriculture. Rezende Óleo and RezendeMkt. e Comunicaçoes Ltda. are non-operational. Sadia GmbH. is a holding that controls Wellax FoodLogistics C.P.A.S.U. Lda., an offshore company responsible for the largest partof Sadia ́s export operations. Sadia Alimentos is a subsidiary of Sadia International,established in 2003 aiming to develop commercial operations in the Argentinemarket. Sadia Uruguay and Sadia Chile are each responsible for the distributionand sales of the Company ́s products in their respective countries. NordfinHolding Limited owns 40% of Sadia Chile. Concórdia CVMCC is a brokerage firmauthorized to operate in accordance with current Brazilian legislation. Theassets of Empresa Matogrossense de Alimentos were acquired in September 2005,as part of the company's investment strategy in the state of Mato Grosso. Thecompanies not mentioned above are representative offices.

 

D. Property, Plant andEquipment

In 2005, Sadia ownsthirteen plants, including eight units for poultry production, four units forpork, one for beef, ten units for animal feed, two units for the crushing ofsoybeans and nine units for processed products. Some plants aremulti-operational, including several integrated activities. Sadia owns seventeendistribution and commercial centers and eleven representative offices anddistribution centers abroad.

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**Operating Units**

The table below lists Sadia’s operating units andtheir principal activities:

 

| **State**  | ** ** | **City**                | ** ** | ** ** | **Principal activity**                                                                       |
|------------|------------|-------------------------|------------|------------|----------------------------------------------------------------------------------------------|
| **MG**     | ** ** | Uberlândia        |       |       | Raising and slaughtering chickens, turkeys and hogs,  processed products and animal feed     |
| ** ** |       |                    |
| **MT**     | ** ** | Várzea Grande    |       |       | Raising and slaughtering chickens, processed  products and animal feed. Beef slaughterhouse. |
| **PR**     | ** ** | Dois Vizinhos           |       |       | Raising and slaughtering chickens; animal feed and  crushing of soybean.                     |
| **PR**     | ** ** | Francisco Beltrao       |       |       | Raising and slaughtering chickens and turkeys and  animal feed                               |
| **PR**     | ** ** | Toledo                  |       |       | Raising and slaughtering chickens and hogs;  processed products; animal feed and soy oil     |
| **PR**     | ** ** | Ponta Grossa            |       |       | Pizzas and pasta, Miss Daisy, processed products                                             |
| **PR**     | ** ** | Paranáguá |       |       | Margarine                                                                                    |
| **RJ**     | ** ** | Duque de Caxias         |       |       | Processed products                                                                           |
| **RS**     | ** ** | Tres Passos             |       |       | Raising and slaughtering hogs and animal feed                                                |
| **SC**     | ** ** | Chapecó          |       |       | Raising and slaughtering chickens and turkeys,  animal feed and processed products           |
| **SC**     | ** ** | Concórdia        |       |       | Raising and slaughtering chickens and hogs,  processed products and animal feed              |
| **MT**     | ** ** | Campo Verde             |       |       | Animal feed                                                                                  |
| **DF**     | ** ** | Brasília         |       |       | Raising and slaughtering chicken, processed products  and animal feed.                       |

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LeasedOperating Units

The table below listsSadia’s leased operating units and their principal activities

 

| **State** | ** ** | City      |   |   | Principal activity                               |
|-----------|------------|-----------|--------|--------|--------------------------------------------------|
| **RS**    | ** ** | Lajeado   |   |   | Raising and slaughtering poultry and animal feed |
| **RS**    | ** ** | Garibaldi |   |   | Raising and slaughtering poultry and animal feed |

**Distribution and Commercial Centers**

The table below lists Sadia’s distributionand commercial centers and the corresponding region of activity:

 

| **State** | ** ** | **City**             | ** ** | ** ** | **Region of Activity**                            |
|-----------|------------|----------------------|------------|------------|---------------------------------------------------|
| **AM**    | ** ** | Manaus               |       |       |  North  Region                               |
| **BA**    | ** ** | Salvador             |       |       |  Northeast  Region                           |
| **CE**    | ** ** | Fortaleza            |       |       |  Northeast  Region                           |
| **DF**    | ** ** | Brasília      |       |       |  Federal   District                          |
| **MG**    | ** ** | Belo Horizonte       |       |       |  Southeast  Region                           |
| **MS**    | ** ** | Campo Grande         |       |       |  Central region                              |
| **MT**    | ** ** | Várzea Grande |       |       |  Central Region                              |
| **PA**    | ** ** | Belém         |       |       |  North  Region                               |
| **PE**    | ** ** | Recife               |       |       |  Northeast  Region                           |
| **PR**    | ** ** | Colombo              |       |       |  South  Region                               |
| **PR**    | ** ** | Ponta Grossa         |       |       |  South  Region                               |
| **RJ**    | ** ** | Rio de Janeiro       |       |       |  Southeast  Region                           |
| **RS**    | ** ** | Porto Alegre         |       |       |  South  Region                               |
| **SC**    | ** ** | Itajaí        |       |       |  South  Region                               |
| **SP**    | ** ** | Sao Paulo            |       |       |  Southeast  Region                           |
| **SP**    | ** ** | Jundiaí       |       |       |  Southeast Region and Sao Paulo State Region |
| **ES**    | ** ** | Vitória       |       |       |  Southeast  Region                           |

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**ProductionCapacity**

 

Sadia’sconsolidated production capacity is as follow

** **

|                                         |       | **Production Capacity** |
|----------------------------------------------|------------|-------------------------|
|                                         |       | ** **              |   | ** ** |
|                                         |       | **2005**                |   | **2004** |
| ** **                                   | ** ** | **Capacity**            | ** ** | **Production** | ** ** | **Production** |
|                                         |       |                    |   |   |   |   |
| Poultry  Slaughtering (Million heads/year)   |       | 740.1                   |   | 650.1 |   | 572.9 |
| Hog Slaughtering  (Million heads/year)       |       | 3.9                     |   | 3.8 |   | 3.5 |
| Processed  Products (thousands of tons/year) |       | 1,040.0                 |   | 695.4 |   | 666.7 |
| Animal Feed  (thousands of tons/year)        |       | **5,515.44**            |   | 4,647 |   | 4,169.1 |
|                                         |       |                    |   |   |   |   |

** **

** **

**Environmental issues affecting the Company’sactivities**

 

As a poultry and hog livestock andslaughtering company, Sadia’s activity impacts on environmental issues,especially related to water resources pollution, animal treatment anddeforestation. However, the Company takes all measures to comply with theBrazilian environmental regulations.

 

As a way of ensuring the sustainability ofits activities, Sadia has strict policies for reducing consumption of water anduses biomass to substitute fuel oil and gas to generate thermal energy. All itsunits have water resources treatment facilities to avoid the contamination ofwater tables and rivers near the units. The Company also strictly supervisesthe activities taken by the poultry and hog outgrowers. 

 

The Company utilizes firewood in itsproductive process under the Brazilian environmental legal requirements andauthorized by the IBAMA (Instituto Brasileiro do Meio Ambiente e dos RecursosNaturais Renovaveis), the Brazilian Environmental and Renewable NaturalResources Institute. This firewood comes from the Company’s owned forest landand from third parties, and is used as fuel to warm up the boilers.

 

The only environmental requirement forSadia related to its owned forest land is to maintain at least 20% of theCompany’s forest land as native forest. Sadia is in compliance with suchrequirement.

 

Moreover, the Company has a program forbeing self sufficient in firewood, maintaining forest land for all of itsmanufacturing units. These areas total 17 thousand hectares and supply 65% ofthe Company’s current firewood requirements.

 

## **ITEM 4A. UNRESOLVED****SEC****STAFF COMMENTS**

 

The Company has no unresolved comments from the staffof the U.S. Securities and Exchange Commission in respect of its periodicreports under the Exchange Act.

 

## **ITEM 5. OPERATING AND FINANCIAL REVIEW ANDPROSPECTS**

 

The following discussion should be read inconjunction with the Company’s consolidated financial statements and notesthereto, and other financial information included elsewhere in this annualreport.

 

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**Discussion on Critical Accounting Policies**

Critical accounting policiesare those that are considered important, complex or subjective by the Company'smanagement to the understanding of the Company's financial condition andresults, as well as estimates about the effect of matters that are uncertain.

 

*Allowance for DoubtfulAccounts*

The collectibility of accountsreceivable is based on a combination of factors. In circumstances wheremanagement is aware of a specific customer’s inability to meet its financialobligations, a specific allowance against amounts due is recorded to reduce thenet recognized receivable to an amount that is likely to be collected. Inaddition, an allowance is recorded based on the length of time receivables arepast due and historical experiences.  In addition, Sadia records a provision inlight of past collection and write-off experience, as well as when significantpayment delays occur and the Company believes that it may not receive paymentin full.

 

Given the assumptions involved,such as the financial situation of the Company’s debtors, commercial andeconomic trends, allowances for doubtful accounts are subject to uncertaintyand may be revised upward or downward depending on the actual performance of anaccount receivable.

 

*Depreciation and Amortization*

Sadia recognizes expensesrelated to the depreciation and amortization of its property, plant andequipment and breeding stock based on the straight-line and estimatedproduction cost methods, respectively. The useful life of assets and estimatesfor production is reviewed periodically based on existing facts andcircumstances. The determination of useful lives and estimates for productionrequires considerable judgment and is inherently uncertain, due to changes intechnology and industry competition, which could cause early obsolescence ofthe property, plant and equipment.  If Sadia is required to materially changethe assumptions used, its depreciation and amortization expense, obsolescencewrite-off and the net book value of property, plant and equipment could bematerially different.

 

*Impairment of Long-LivedAssets*

Sadia periodically assessesthe need to perform impairment tests of long-lived assets (or asset groups)based on various indicators such as the level of business profitability and technologicaldevelopments.  When necessary, upon the occurrence of any negative triggeringevent such as a significant loss in market value of a property, plant andequipment or significant adverse change in the extent or manner in which along-lived asset is being used, cash flow studies are prepared to determine ifthe accounting value of the property, plant and equipment is recoverablethrough the profitability resulting from its business.  In order to estimatefuture cash flows, Sadia makes various assumptions and estimates.  Theseassumptions and estimates can be influenced by different external and internalfactors, such as economic and industry trends, interest rates, foreign exchangerates, changes in the business strategies and in the type of products offeredto the market.

*Contingencies*

Sadia establishesprovision for contingencies on its balance sheet when it determines, takinginto consideration the opinion of its legal advisors, that a loss is probable,in one of the labor, tax or civil cases to which the Company is party. Sadiacontinuously evaluates the estimates and assumptions used to establish theprovision for contingencies based on relevant facts and circumstances that mayhave a material effect on the result of operations and stockholders’ equity.Even though management believes that the provisions are presently adequate, theestablishment of provisions for judicial proceedings involves estimates thatcan result in the final amount being different than the provisions as a resultof uncertainties that are inherent to the establishment of the provision. Incase the amount of provisions for contingencies is lower than the amountactually due, an increase in provisions would be necessary.

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Deferred Tax Assets

Sadia recognizes deferred taxassets and liabilities which do not expire, arising from tax losscarry-forwards, temporary add-backs and other procedures. Sadia periodicallyreviews the deferred tax assets for recoverability and establishes a valuationallowance, as required, based on historical taxable income, projected futuretaxable income, and the expected timing of the reversals of existing temporarydifferences. In the event the Company or one of its subsidiaries operates at aloss or are unable to generate sufficient future taxable income, or if there isa material change in the actual effective tax rates or time period within whichthe underlying temporary differences become taxable or deductible, Sadiaevaluates the need to establish a valuation allowance against all or asignificant portion of the Company’s deferred tax assets, resulting in anincrease in the effective tax rate, thereby decreasing net income. If Sadiadetermines that it can realize a deferred tax in excess of its net recordedamount, it decreases the valuation allowance, thereby increasing net income.Significant management judgment is required in determining any valuationallowance. The principal uncertainty relates to the likelihood of futuretaxable income from the subsidiary that generated the deferred tax asset. A changein the Company’s projections of profitability could result in the need torecord a valuation allowance against deferred tax assets, resulting in anegative impact of future results. 

*Pension Benefits*

Sadia accounts for its defined pension planusing actuarial models. These models use an attribution approach, which assumesemployees render services over their service lives on a relatively smooth basisand also presumes that the income statement effects of pension benefit plansshould follow the same pattern. Sadia accounts for its retirement plan based onactuarial recommendations following the applicable laws, income taxregulations, as well as in accordance with the plan’s rules.

 

Net pension income or expense is determinedusing assumptions as of the beginning of each year. These assumptions areestablished at the end of the prior fiscal year and include expected long term returnrates of the plan assets, discount rates and compensation rate increases. Theactual future amounts and experience related to these assumptions willdetermine whether Sadia has created sufficient reserves for accrued pensioncosts.

 

***Recently Issued Accounting Standards***

 

In December 2004, the FASB issued FASBStatement No.151, Inventory Costs, which clarifies the accounting for abnormalamounts of idle facility expense, freight, handling costs, and wasted material(spoilage). Under this Statement, such items will be recognized ascurrent-period charges. In addition, the Statement requires that allocation offixed production overheads to the costs of conversion be based on the normalcapacity of the production facilities. The application of this Statement isrequired after January 1, 2006. The Company anticipates no significant impacton its financial statements by applying Statement 151.

 

In December 2004, the FASB issued FASBStatement No. 153, Exchanges of Nonmonetary Assets, which eliminates anexception in APB 29 for nonmonetary exchanges of similar productive assets andreplaces it with a general exception for exchanges of nonmonetary assets thatdo not have commercial substance. The application of this Statement is requiredafter January 1, 2006. The Company anticipates no significant impact on itsfinancial statements by applying Statement 153.

 

In May 2005, the FASB issued SFAS No.154,"Accounting Changes and Error Corrections" ("SFAS 154")which replaces Accounting Principles Board Opinions No. 20 "AccountingChanges" and SFAS No. 3, "Reporting Accounting Changes in InterimFinancial Statements—An Amendment of APB Opinion No. 28." SFAS 154provides guidance on the accounting for and reporting of accounting changes anderror corrections. It establishes retrospective application, or the latestpracticable date, as the required method for reporting a change in accountingprinciple and the reporting of a correction of an error. SFAS 154 is effectivefor accounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005. 

 

In February 2006, the FASB issued SFASNo.155, “Accounting for Certain Hybrid Financial Instruments,” an amendment toSFAS No.133 and No.140. The primary objectives of this Statement with

Page 44 

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respect  to SFAS No.133 are to simplify accounting for certain hybrid financial  instruments by permitting fair value remeasurement for any hybrid financial  instrument that contains an embedded derivative that otherwise would require  bifurcation and eliminate the interim guidance in Statement No.133  Implementation Issue No D1, “Application of FAS No.133 to beneficial Interests  in Securitized Financial Assets,” which provides that beneficial interests in  securitized financial assets are not subject to the provisions of SFAS No.133.  The primary objective of this Statement with respect to SFAS No.140 is to  eliminate a restriction on the passive derivative instruments that a qualifying  special-purpose entity (SPE) may hold. This Statement is effective for all  financial instruments acquired or issued after the beginning of an entity’s  first fiscal year that begins after September 15, 2006. Management does not expect the adoption of this Statement to have an impact on the Company’s  consolidated financial statements.

*** ***

***Recently Adopted Accounting Standards***

 

In December 2004, FASB issued the FASBStatement No.123 (revised 2004), Share-Based Payment, which addresses theaccounting for transactions in which an entity exchanges its equity instrumentsfor goods or services, with a primary focus on transactions in which an entityobtains employee services in share-based payment transactions. This Statementis a revision of the Statement 123 and supersedes APB Opinion No. 25,Accounting for Stock Issued to Employees, and it is related to theimplementation guidance. This Statement was early adopted by the Company in2005. (See note 15)

 

In March 2005, the FASB issued FIN 47,"Accounting for Conditional Asset Retirement Obligations, aninterpretation of FASB Statement No.143" ("FIN 47"), whichrequires an entity to recognize a liability for the fair value of a conditionalasset retirement obligation when incurred if the liability's fair value can bereasonably estimated. FIN 47 is effective for fiscal years ending after December 15, 2005. The Company did not have any impact on applying FIN 47.

 

**Brazilian Economic Environment**

The Company’s resultsof operations and financial condition are dependent on Brazil's general economic condition and particularly on (i) economic growth and inflationand their impact on people’s purchasing power, (ii) financing costs and theavailability of financing, and (iii) exchange rates between Brazilian andforeign currencies. The following table sets forth Brazilian Gross DomesticProduct (GDP) growth, inflation and the devaluation of Brazilian currencyagainst the U.S. dollar and interest rate changes for the periods shown.

|                    | **Brazilian Selected Economic Indicators** |
|-------------------------|--------------------------------------------|
|                    |                                       |   |   |   |
|                    | **2005**                                   | **2004** | **2003** | **2002** |
|                    | ** **                                 | ** ** | ** ** | ** ** |
| Real GDP  Growth(%)a    | 2.28                                       | 4.94 | 0.54 | 1.93 |
| Inflation(%)?           | 1.21                                       | 12.41 | 8.71 | 25.31 |
| US$ / R$ Exchange Ratel | 2.3407                                     | 2.6544 | 2.8892 | 3.5333 |
| TJLP(%)l                | 9.8                                        | 9.8 | 11.0 | 10.0 |

* (1) Source:Ipeadata*

*(2) IGPM, source: Economática*

*(3)*Long-TermInterest Rate 

* *

The Brazilianeconomy has been affected by interventions on the part of the government, whichhas made repeated changes in its monetary, credit, tariff and other policies,in order to influence the direction of the national economy. The changes inpolicies involving foreign exchange and tax rates could have a significantimpact on the Company ́s business and operating results, in the same way asinflation, currency devaluation, social instability and other political,economic and diplomatic issues, and the reaction of the Brazilian government tothese issues.

Page 45 

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*Inflation and Real PlanEffects*

Inflation hastraditionally had a negative effect on the Brazilian economy in general in pastyears, and on the Company ́s profitability and operating results in particular.In an attempt to control inflation, the government has at times imposed wageand price controls, and reduced its spending. Inflation and the measuresadopted by the government, combined with public speculation about its futuredecisions, have also contributed to periods of uncertainty in the economy, aswell as to increased volatility in the Brazilian securities markets. Inaddition, the government’s desire to control inflation and reduce budgetdeficits may cause it to take actions that slow Brazilian economic growth. 

After theimplementation of the *Real* Plan, which was based on an exchange rateanchor (*reais* x U.S. dollar), inflation rates declined and stabilized atlow levels. This new economic environment increased the purchasing power ofpart of the population, which was accustomed to high inflation levels and didnot have access to financial instruments to reduce their monetary losses due tohigh inflation. Incomes rose, credit availability increased and consumption ofconsumer goods grew. According to the IGP-M Brazilian inflation amounted to868.30% in 1994, 15.25% in 1995, 9.20% in 1996, 7.74% in 1997, 1.78% in 1998,20.1% in 1999, 9.95% in 2000, 10.38% in 2001, 25.31% in 2002 8.71% in 2003,12.41% in 2004 and 1.21% in 2005.

*Exchange Rate Effects*

From March 1995until January 1999, the Brazilian Central Bank managed a semi-fixed exchangerate policy based on the establishment of an annual exchange rate fluctuationtarget at the beginning of each year, setting both a wide limit or “band”, anda much narrower band, in order to effect a gradual devaluation by means of thisexchange rate band system. The Central Bank bought or sold U.S. dollars in themarket in order to ensure that the exchange rate remained within establishedlimits.

In an attempt tostem the increasing capital outflows and concerns about the commitment ofcertain state governments to the fiscal austerity proposal, on January 13,1999, Brazilian monetary authorities halted their intervention, abandoning thesystem of exchange rate bands, and allowed the *real*’s value to bedetermined by the foreign exchange markets, intervening only to limit wideswings in the value of the currency. 

Since then, theexchange rate market has been operating under a floating rate regime and theCentral Bank has implemented an inflation target policy, using local interestrates to adjust demand. A negative side-effect of this policy has been highinterest rate levels, increasing cost of capital to the company and raisinguncertainty in the financial markets about the capacity of Brazil to pay its debts, increasing the sovereign risk. 

AlthoughSadia uses *reais* as its functional currency, a relevant portion of itsassets, liabilities and revenues are dollar denominated. In December 2005,49.5% of the Company ́s gross revenues were mainly collected in foreigncurrency, coming from export proceeds, corresponding to R$4,076 million.

Considering thatSadia has subsidiaries abroad, the volatility of the *real* createsforeign exchange gains and losses, which are included in the Company’s foreigncurrency exchange gain (loss), net account in results of operations. In 2005,on a consolidated basis, the Company recorded foreign exchange gains (includinggains from foreign currency swaps) of R$290.7 million compared to R$72.7million in 2004.

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A. Operating Results

The following table summarizes certainselected financial data derived from the Company ́s statements of income,expressed as percentages of net operating revenue, for the periods indicated,as shown.

 

|                                                                          | **Consolidated Income Statement**                |
|-------------------------------------------------------------------------------|--------------------------------------------------|
|                                                                          | **Years Ended December 31, 2005, 2004 and 2003** |
|                                                                          | **(%)**                                          |
|                                                                          |                                             |   |   |
| ** **                                                                    | **2005**                                         | **2004** | **2003** |
|                                                                          | ** **                                       | ** ** | ** ** |
| Net operating  revenue                                                        | **100.0**                                        | **100.0** | **100.0** |
| Cost of goods  sold                                                           | (72.8)                                           | (70.3) | (72.3) |
| Gross profit                                                                  | **27.2**                                         | **29.7** | **27.7** |
|                                                                          | ** **                                       | ** ** | ** ** |
| Operating  expenses:                                                          |                                             |   |   |
|   Selling                                                                | (17.0)                                           | (18.7) | (18.0) |
|   General and  administrative                                            | (1.1)                                            | (0.9) | (1.1) |
|   Other  operating income (expenses), net                                | 0.2                                              | 0.3 | (0.7) |
| Total operating  expenses                                                     | (17.9)                                           | (19.3) | (19.8) |
|                                                                          |                                             |   |   |
| Operating income                                                              | **9.3**                                          | **10.4** | **7.9** |
|                                                                          | ** **                                       | ** ** | ** ** |
| Interest expense                                                              | (4.3)                                            | (5.5) | (8.9) |
| Interest income  and other, net                                               | 3.4                                              | 4.1 | 9.0 |
| Foreign currency  exchange gain, net                                          | 0.7                                              | 0.6 | 1.2 |
| Income before  income taxes, equity income of investees and minority interest |                                             |   |   |
| **9.2**                                                                       | **9.6**                                          | **9.3** |
|                                                                          | ** **                                       | ** ** | ** ** |
| Income tax  benefit (expense)                                                 | ** **                                       | ** ** | ** ** |
|   Current  benefit (expense)                                             | (0.7)                                            | (0.5) | (0.8) |
|   Deferred tax  benefit (expense)                                        | (0.2)                                            | (1.0) | 0.8 |
|   Total income  tax                                                      | **(0.9)**                                        | **(1.6)** | **0.0** |
| Income before  equity income of investees and minority interest               |                                             |   |   |
| 8.2                                                                           | 8.0                                              | 9.3 |
|                                                                          |                                             |   |   |
| **Net income**                                                                | **8.2**                                          | **8.0** | **9.3** |

 

The following table sets forth componentsof Sadia ́s cost of goods sold, expressed as a percentage of total cost of goodssold for 2005, 2004 and 2003:

 

| ** **                   | **Composition of Cost of**

**Goods Sold (%)** |
|------------------------------|------------------------------------------------|
| ** **                   | **December 31,**                               |
| ** **                   | **2005**                                       | **2004** | **2003** |
|                         |                                           |   |   |
| Raw Materials                | 76                                             | 78 | 78 |
| Labor                        | 12                                             | 12 | 11 |
| Depreciation                 | 3                                              | 2 | 3 |
| Other                        | 9                                              | 9 | 9 |
| **Total cost of goods sold** | **100**                                        | **100** | **100** |

Page 47 

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|                                                                          | **Consolidated Income Statement**                            |
|-------------------------------------------------------------------------------|--------------------------------------------------------------|
|                                                                          | **Years Ended December 31, 2005, 2004, 2003, 2002 and 2001** |
|                                                                          | **(R$ Million)**                                             |
|                                                                          |                                                         |   |   |   |   |
| ** **                                                                    | **2005**                                                     | **2004** | **2003** | **2002** | **2001** |
|                                                                          | ** **                                                   | ** ** | ** ** | ** ** | ** ** |
| Gross operating  revenue                                                      | **8,327.4**                                                  | **7,117.3** | **5,717.5** | **4,654.8** | **3,977.1** |
|                                                                          | ** **                                                   | ** ** | ** ** | ** ** | ** ** |
| Value-added tax  on sales                                                     | (914.2)                                                      | (880.0) | (535.3) | (0.4) | (0.3) |
| Sales deductions                                                              | (95.3)                                                       | (128.1) | (100.5) | (98.4) | (81.4) |
| Net operating  revenue                                                        | **7,317.8**                                                  | **6,109.2** | **5,081.7** | **4,139.1** | **3,602.5** |
| Cost of goods  sold                                                           | (5,324.4)                                                    | (4,292.7) | (3,673.0) | (2,903.2) | (2,322.7) |
| Gross profit                                                                  | **1,993.5**                                                  | **1,816.6** | **1,408.7** | **1,235.9** | **1,279.8** |
|                                                                          | ** **                                                   | ** ** | ** ** | ** ** | ** ** |
| Operating  expenses:                                                          |                                                         |   |   |   |   |
|   Selling                                                                | (1,245.9)                                                    | (1,144.5) | (916.7) | (828.7) | (720.8) |
|   General and  administrative                                            | (81.0)                                                       | (52.5) | (54.2) | (49.1) | (54.0) |
|   Other  operating income (expenses), net                                | 14.3                                                         | 15.4 | (36.8) | (12.8) | (17.1) |
| Total operating  expenses                                                     | (1,312.6)                                                    | (1,181.5) | (1,007.7) | (890.6) | (791.9) |
|                                                                          |                                                         |   |   |   |   |
| Operating income                                                              | **680.9**                                                    | **635.0** | **401.0** | **345.3** | **487.9** |
|                                                                          | ** **                                                   | ** ** | ** ** | ** ** | ** ** |
| Interest expense                                                              | (311.6)                                                      | (336.8) | (450.2) | (317.8) | (201.2) |
| Interest income  and other, net                                               | 248.0                                                        | 249.8 | 459.8 | 266.5 | 144.6 |
| Foreign currency  exchange gain, net                                          | 53.4                                                         | 39.1 | 61.0 | 2.7 | (171.4) |
| Income before  income taxes, equity income of investees and minority interest |                                                         |   |   |   |   |
| **670.7**                                                                     | **587.1**                                                    | **471.5** | **296.7** | **259.9** |
|                                                                          | ** **                                                   | ** ** | ** ** | ** ** | ** ** |
| Income tax  benefit (expense)                                                 | ** **                                                   | ** ** | ** ** | ** ** | ** ** |
|   Current  benefit (expense)                                             | (52.0)                                                       | (33.0) | (39.1) | 34.6 | (38.9) |
|   Deferred tax  benefit (expense)                                        | (16.4)                                                       | (63.1) | 40.1 | (46.8) | (12.2) |
|   Total income  tax                                                      | **(68.4)**                                                   | **(96.1)** | **1.0** | **(12.2)** | **(51.1)** |
| Income before  equity income of investees and minority interest               |                                                         |   |   |   |   |
| 602.2                                                                         | 491.0                                                        | 472.6 | 284.6 | 208.8 |
|                                                                          |                                                         |   |   |   |   |
| Equity income  (loss) of investees                                            | 1.2                                                          | (1.4) | 0.4 | (0.7) | 0.0 |
| Minority  interest                                                            | (0.2)                                                        | (0.1) | 0.3 | 0.3 | 0.4 |
| Income (loss) before cumulative effect of accounting  change                  | 603.3                                                        | 489.5 | 473.3 | 284.3 | 209.3 |
| Cumulative effect of accounting change, net of tax                            | -                                                            | - | - | - | (5.8) |
| **Net income**                                                                | **603.3**                                                    | **489.5** | **473.3** | **284.3** | **203.5** |
|                                                                          |                                                         |   |   |   |   |

 

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****

**SADIA S.A.**

CONSOLIDATED BALANCE SHEET

Years ended December 31,2005, 2004, 2003, 2002, and 2001

(In thousands of *reais* - R$)

 

| ** **                                                                         | **2005**      | **2004**      | **2003**      | **2002**      | **2001**      |
|------------------------------------------------------------------------------------|---------------|---------------|---------------|---------------|---------------|
| ** **                                                                         | ** **    | ** **    | ** **    | ** **    | ** **    |
| Cash and cash equivalents and investments in debt  and held-to-maturity securities | 2,574,996     | 1,917,192     | 1,957,753     | 1,249,783     | 346,354       |
| Total  Current Assets                                                              | 4,588,176     | 3,944,802     | 3,645.379     | 2,759,217     | 1,562,713     |
| Investments in debt and held-to-maturity securities                                | 65,057        | 436,782       | 1,158,586     | 760,857       | 609,767       |
| Property, plant and equipment, net                                                 | 1,523,309     | 1,055,240     | 910,010       | 918,320       | 893,068       |
| **Total  Assets**                                                                  | **6,707,284** | **5,830,973** | **6,149,453** | **4,975,627** | **3,325,305** |
| ** **                                                                         | ** **    | ** **    | ** **    | ** **    | ** **    |
| Total  Current Liabilities                                                         | 2,625,812     | 2,766,719     | 2,969,833     | 2,591,383     | 1,335,176     |
| Short-term debt and current portion of long-term  debt                             | 1,484,342     | 1,738,835     | 2,026,752     | 2,052,068     | 910,386       |
| Long-term  debt                                                                    | 1,704,184     | 1,031,375     | 1,366,836     | 1,205,160     | 889,767       |
| **Total  Shareholders’ Equity**                                              | **2,228,117** | **1,838,364** | **1,521,585** | **1,057,759** | **967,181**   |

 

 

Structure andProfitability of the Company’s Operations

***Period ended December 31, 2005 compared with period ended December 31, 2004***

 

The following discussion presents acomparison of results of operations for the twelve-month period ended December 31, 2005 and 2004. 

 

*Gross Operating Revenue*

The R$8,327.4million gross operating revenues represented an increase of 17% over 2004.Sales volumes reached 1.8 million tons, a 14.9% increase as compared to thesame period last year.

This resultreflects growth in revenues of 20.1% in the international market and 14.2% inthe domestic market, despite the problems presented by foot and mouth diseasein Brazil, the concerns over avian flu in Europe and Asia and the Braziliansanitary inspectors’ strike in the fourth quarter of 2005.

*Domestic Market*

In the domesticmarket, sales volume reached 823,573 tons, an 11.8% increase over the prioryear. Continuing the trend seen in 2004, processed products led domestic marketsales, in line with the Company ́s strategy of focusing on more value addedproducts. 

Gross operatingrevenue added up to R$4.3 billion in 2005, which represented a 14.2% increaseover 2004. 

The significantincrease in revenues and volumes resulted mainly from a strategy based on thediversification of the sales channels, the release of new products bettersuited to the consumer’s purchasing power and improvement in managing the Company’sbrands. The strategy of reviewing the processed products portfolio and focusingon products with better margins compensated, in part, for the slackening ofdomestic demand.

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*Export Market*

Strong exportdemand for Sadia products in 2005 resulted in a 20.1% increase in revenues, toR$4.1 billion. Sales volumes reached record levels, surpassing the 1.0 millionton mark for the year, representing a 17.6% increase over 2004 shipments.  

Sadia ́s performancewas due to its ability to increase international prices, optimize logistics andimprove product mix. In dollar terms, these factors effectively offset the11.8% devaluation of the average dollar for the twelve months ended December 31, 2005 against the twelve months ended December 31, 2004.

In the Middle East, Sadia maintains its traditional presence in the principal areas of the region,with market leadership and brand recognition. Middle Eastern countriesprimarily consume whole birds of low weight (up to 1.4 kg) and processedproducts. Exports to Middle Eastern countries accounted for 25.7% of revenuesin the export market. Europe, which received 24% of exports, is a largepurchaser of poultry cuts and processed products. With respect to Eurasia, which comprises the Caucasus region and Russia, Sadia exports were mainly pork andpoultry cuts. This region represented 21.4% of all exports. The main exports to Asia, which accounted for 15.6% of all revenues from exports, are specialpoultry cuts, pork carcasses and cuts. In the Americas, sales are concentratedmainly on processed products, poultry parts and whole birds. The Americas accounted for 13.3% of export revenues. 

*ProcessedProducts*

Sales ofprocessed products were the principal driver in domestic revenue growth,representing 78.6% of revenues in the domestic market. This result reflects theCompany ́s efforts to adapt its product portfolio, aiming to capture the demandfor differentiated products and leadership in several segments. This strategyallowed an increase of 11.3% in volumes and 11.6% in gross operating revenue.Despite the difficulty of passing on costs in the domestic market, Sadiamanaged to keep its average prices at the same levels as 2004.

With sales ofprocessed products in the export market, Sadia obtained R$412.3 million, a 1.7%increase as compared to 2004. This is equivalent to shipments of 91,600 tons, an9% increase over 2004 volumes. The 7.4% increase in dollar term pricespartially offset the 11.8% devaluation of the dollar against the *real*for the year.

*Poultry*

The poultrysegment in the domestic market registered a 34.3% increase in volumes sold,leading to a 23.3% increase in gross operating revenue. The acquisition of SóFrango, in January 2005, contributed to this growth and to an increase in wholepoultry sales. As whole poultry has lower prices per ton compared to poultrycuts, average prices in this segment fell 8.2% for the year. 

In the externalmarket, the highlight in gross operating revenues was achieved by the poultrysegment, which registered R$2.9 billion, an increase of 18% over 2004. Exportsales volumes amounted to 808,636 tons, a 16.8% increase over 2004. The greaterparticipation of whole poultry in the portfolio of products sold, due to anincrease in sales to the Middle East and South America, resulted in a 1%increase in *real* average prices in this segment. Dollar prices increased12.9% over 2004.

*Pork*

Limited suppliesof pork products resulted in a 30.5% reduction in domestic volumes, and a 4.3%reduction in gross operating revenue, in order to supply export markets. Theshortage permitted a 37.8% increase in prices, partially offsetting the revenuedecline.

Export volumesconsiderably increased with the recovery of shipments to the Russian market,since Russia allowed unused import quotas to be filled in open market auctions,which permitted the Company to ship volumes in excess of the applicable quotas.In addition, throughout 2005, Sadia resumed previous levels

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of pork production,  which had been reduced in 2004 as a consequence of the import quotas  established by the Russian government. Annual sales of 105,800 tons,  represented a 33.9% increase as compared to 2004 and generated R$592.4 million  in revenues, 37.8% more than domestic revenues. Average prices increased almost3% in local currency terms, a 15.2% increase in dollar terms. 

*Sales Deductions and Taxon Sales*

Value-added taxon sales consist of  ICMS, the Social Contribution on Sales (Cofins) and thecontribution to the Social Integration Program (PIS), which amounted to R$914.2million, a 3.9% increase over 2004. In 2005, total sales deductions were R$95million compared to R$128 million in 2004. The ratio of value-added tax onsales as a percentage of gross operating revenues was at 11% in 2005 and 12.4%in 2004. This improvement was due to, among other factors, the optimization ofvalue-added taxes which has allowed the growth in net revenues to be greaterthan that in gross revenues.

*Cost of Goods Sold*

Cost of goodssold increased 24% over 2004. Cost of goods sold as a percentage of netoperating revenues increased to 72.8% in 2005 from 70.3% in 2004. This increasewas principally due to purchases in the first half of 2005 of higher-cost porkon the spot market as a result of a supply shortage. 

*Selling Expenses*

The ratio ofselling expenses over net income showed a significant reduction in 2005,reaching 17% as compared to 18.7% for 2004. This reduction reflects theaggressive cost containment efforts of management in 2005, with theimplementation of several measures, such as the renegotiation of contracts andgreater efficiency of logistics.

*Administrative and GeneralExpenses*

Theadministrative and general expenses over net operating revenues reached 1.1% in2005, as compared to 0.9% in 2004. 

*Other Operating Income(Expenses), Net*

Otheroperational net results accounted for a R$14.3 million income in 2005 ascompared to a R$15.4 million gain in 2004. There were no significant changes in2005 in comparison to 2004.

*Interest Expense*

Interest expensein 2005 amounted to R$311.6 million, 7.5% below the R$336.8 million accountedfor in 2004. The ratio interest expense to total debt fell from 11.2% in 2004to 9.3% in 2005. This decrease is primarily due to the one time loss of R$110million on the sales of Brazilian bonds in 2004. 

*Interest Income and Other,Net*

Interest incomein 2005 amounted to R$248 million, 1% below the R$249.8 million accounted forin 2004. 

*Foreign Currency ExchangeGain (Loss), Net*

Foreign exchangecurrency gain of R$ 53.4 million reported in 2005 was primarily attributable togains from hedges of sales of exports, resulting from the 17.3% average appreciationof Brazilian currency against the U.S. dollar for 2005 against 2004. Theforeign exchange currency gain of 2004 was R$ 39.1 million.

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*Income Tax*

Sadia reportedan income tax expense of R$ 68.4 million in 2005, against R$ 96.1 million in2004. This is mainly because a larger portion of taxable income in 2004 wasgenerated in Brazil while in 2005 the earnings were primarily generated abroad.Earnings generated abroad are non-taxable. Since achieving record net income in2005, and thus, were able to make a large distribution of interest on capitaland dividends, it was possible to deduct part of the amount distributed fromthe income tax payable and contain tax expenses.

*Net Income*

Sadia’s netincome reached a record R$ 603.3 million in 2005 surpassing by almost 23.2% the2004 result. This performance is in line with the company’s strategy of revenuegrowth, cost control and efficiency of results.

***Period ended December 31, 2004 compared with December 31, 2003***

The followingdiscussion presents comparisons of results of operations for the twelve-monthperiod ended December 31, 2004 and 2003. 

*Gross Operating Revenue*

The year of 2004was characterized by great volatility of costs and exchange rates, whichfrustrated hopes of achieving higher results in terms of profitability.However, Sadia knew how to take advantage of the slow, but consistent recoveryof consumption on the domestic scenario and volatility in the global poultrymarket due to the AI crisis in Asia. Gross operating revenues at R$7.1 billion,increased 24.5% over 2003, despite the devaluation of the dollar havingaffected their value in Brazilian *reais.* The Company broke new salesrecords with total sales volumes 18.3% over those registered in 2003. Whatdrove revenues was, above all, a robust rise in sales volumes, which requiredstrong, mobilized efforts, and improved operating results.

In the domesticmarket, even though the recovery of employment levels was slow to affect theconsumption of non-durable goods, Sadia recorded constant growth in terms ofrevenues throughout 2004. The launching of products that are increasinglybetter suited to consumers’ needs, the exploration of the Sadia brand name, andthe enhancement of services related to various distribution channels guaranteedsales performance above the country’s average rate of growth.

*DomesticMarket*

Domesticsales grew 8.6% over 2003, and gross revenues increased 16.8%. Considering thedifficulties in passing increasing costs to sales prices, the growth inrevenues is directly related to an improved mix and the stepping up of sales tonew channels. In the processed foods segment, sales were 9.7% greater than in2003, and revenues grew 16.7%. The mix of traditional product items deservesspecial attention, with a recovery in the consumption of convenience productsin the second half of 2004. In the poultry segment, sales volumes increased5.4% and revenues grew 16.7%. The greatest portion of production continued tobe directed to the export market. The pork line of products, whose salesincreased 3.5%, generated revenues 19.3% higher than in 2003. The segment wasbenefited by the recovery of prices, in an environment of reduced supply.

*Export Market*

In terms ofexports, even with the 8.1% appreciation of the Brazilian *real* comparedto the U.S. dollar in 2004, export revenues increased 34.1% and accounted for a49% share of total revenues. Export volumes were 28% higher than those in 2003.

With the AIepidemic in Asia, which reduced the world supply of poultry, internationalprices rose substantially in the first quarter of 2004. With the gradualreestablishment of supply, the entrance of new

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players in the market, and the  trend in consumption to replace poultry with other kinds of meat, the high point of the cycle was interrupted in the region. 

In Europe, competition conditions remained stable, since no restrictions were placed onprocessed products from countries affected by AI. Sadia took advantage ofopportunities that opened up for Brazilian products, expanding its presence inthe Asian region. During the year, gross revenues for the export marketincreased 34.1% over 2003. Regarding the processed products line, the 42.4%growth in revenues reflects the Company’s efforts to increase its share ofhigher value-added products in the export market, as well. The growth inrevenues is also the result of the stepping up of business activities in newmarkets in South America, which made it possible to increase sales of productsthat were previously under represented in the export mix, such as bolognas,salamis and margarines. The pork segment, negatively affected by the Russiangovernment’s establishment of quotas, represented a 3% decrease in revenues.The distribution of Sadia’s exports has remained well balanced among theprincipal regions of the world. The more than 1,000 items exported aredeveloped according to the features of each market.

Europe, which received 23% of exports, is a largepurchaser of poultry cuts and processed products. In the Middle East, theCompany maintains its traditional presence in the principal areas of theregion, with market leadership and brand recognition. Arabic countriesprimarily consume whole birds of low weight (up to 1.4 kg) and processedproducts. With respect to Eurasia, which comprises the Caucasus region and Russia, Sadia exports mainly pork and poultry cuts. The main exports to Asia are specialpoultry cuts, pork carcasses and cuts. In the Americas, sales are concentratedprincipally on processed products, poultry parts and whole birds. Secondarymarkets include regions with great potential for growth in the medium term.

*Processed Products*

In the domesticmarket the Company increased its sales volumes in 9.7% reaching 581 thousandtons. Revenues reached R$ 2,946.4 million an increase of 16.7% compared to2003. Processed products comprised 79% of revenues in the domestic market in2004, in line with the Company’s focus on higher added value products.

Export revenueshad an impressive rise of 42.4% and 110.5% in volumes in 2004. They reached R$405.6 million and 84 thousand tons accounting for 12% of exports revenues.

*Poultry*

In 2004,domestic revenues of poultry were up 16.7%, generating R$ 415.4 million. Volumesalso saw an increase this year, reaching 106 thousand tons.

In foreignmarkets, Sadia increased its poultry revenues by 39.2%, to R$ 2,488.7 million.This number comprised 73.4% of all exports. Poultry volumes in the foreignmarkets were also up, reaching 692 thousand tons, an increase of 32% ascompared to 2003.

*Pork*

Volumes had aslight increase in the domestic market in 2004. From 47.7 thousand tons in2003, volumes reached 49.4 thousand tons in 2004. Revenues had a betterdevelopment, with an increase of 19.3% as compared to 2003 reaching R$ 154.9million.

Exports had a different development.Revenues and volumes, both suffered with the Russian bans on meat imports andthe quota regime, decreasing 3% and 23.8%, respectively.

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*Sales Deductions and ValueAdded Tax on Sales*

Value-added taxon sales consist of  ICMS, the Social Contribution on Sales (Cofins) and thecontribution to the Social Integration Program (PIS), and amounted to R$ 880.0million, 64.4% above the R$ 535.3 million reached in 2003. Total salesdeductions increased by 27.% from December 31, 2003 to December 31, 2004, from R$ 100.5 million to R$ 128 million. Sales deductions and VAT ratioas a percentage of gross operating revenues were at 14.2% in 2004 and 11.1% in2003.

*Cost of Goods Sold*

Costs increased16.9% over 2003, reaching R$ 4,292.7 million. Grain prices showed a fallingtrend throughout the year, but cost items related to packaging remainedpressured. Grain inventory management, better mix of products sold andoperational process controls guaranteed gross profits of R$ 1.8 billion,corresponding to a gross margin of 29.3% in 2004, as compared to 27.3% in 2003.

*Selling Expenses*

Sadia’s sellingexpenses were R$ 1,144 million in 2004, 24.9% higher than in 2003. As apercentage of net revenues in 2004 this represented 18.7% and 18.0% in 2003.This growth can be explained by the additional efforts in advertising becausein 2004 Sadia launched its campaign celebrating its 60 year anniversary.

*General and AdministrativeExpenses*

Administrativeexpenses remained at reduced levels, less than 0.9% of net revenues.

*Other Operating Expenses,Net*

Otheroperational net results accounted for a revenue of R$15.4 million in 2004 ascompared to an expense of R$36.8 million in 2003. This change is represented byreversals of civil and fiscal provisions in the net amount of R$ 3 million in2004 as compared to civil and fiscal contingencies provided and provisions madefor losses in assets of R$46 million in 2003.

*Interest Expense*

Interest expensein 2004 amounted to R$336.8million, 25.2% below the R$450.2 million accountedfor in 2003. This decrease of R$113.4 million was mainly due to losses of R$110million on the sales of Brazilian bonds, higher interest rates in U.S. dollardenominated debt and a larger total debt for the year of 2003 as compared to 2004.The increase in expense is also due to higher losses in swap contracts ascompared to 2003.

*Interest Income and Other,Net*

Interest incomein 2004 amounted to R$249.8 million, 45.7% below the R$ 459.8 million accountedfor in 2003. This decrease is mainly due to a total reduction in financialassets of 23.5% in 2004.

*Foreign Currency ExchangeGain (Loss), Net*

Foreign exchangecurrency gain of R$ 39.1 million reported in 2004 was primarily attributable tothe 8.1% appreciation of Brazilian currency against the U.S. dollar, which isnet of a R$ 50.7 million exchange rate loss resulted from the translation ofinvestments denominated in foreign currencies.

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*Income Tax*

The Company reported an income tax expenseof R$ 96.1 million in 2004, against a benefit of R$ 1.0 million in the previousyear. This is mainly because a significant portion of taxable income in 2004was generated in Brazil while in 2003 the earnings were primarily generatedabroad which are non-taxable. 

 

*Net Income*

Net income of R$489.5 million in 2004 was 3.4% higher than that posted in 2003 and representeda return on equity of 26.6%.

 

B. Liquidity and CapitalResources

**Liquidity and Sources of Funding**

The Company'sprincipal cash requirements include: (i) debt repayment, (ii) investments inproperty, plant and equipment, raising efficiency levels and optimization ofprocesses; and (iii) payment of dividends and interest on equity toshareholders. The Company's primary sources of liquidity have traditionallyconsisted of cash generated from operations and short and long-term debt. Sadiabelieves that these sources of funds, together with its cash and cashequivalents will continue to be adequate to meet the Company’s currentlyanticipated capital requirements.

The net cashgenerated by operating activities totaled R$842.2 million, R$307.2 million andR$975.8 million for the years ended December 31, 2005, 2004, 2003, respectively. Net cash used in investing activities amounted to R$1,236.2 million, R$ 639.4million, and R$92.9 million for the years ended December 31, 2005, 2004, 2003, respectively. Net cash provided by financing activities was R$313.1 million in2005, while an amount of R$721.7 million was used in 2004. In 2003, net cash providedby financing activities was R$479.5 million. Cash and cash equivalents at theend of the year was R$683.3 million in 2005, R$764.2 million in 2004 andR$1,818.1 million in 2003.

|                                                 | **Consolidated Cash Flow** |
|------------------------------------------------------|----------------------------|
|                                                 | **(R$ Million)**           |
|                                                 |                       |   |   |
|                                                 | **2005**                   | **2004** | **2003** |
| Net  cash provided by operating activities           | 842.2                      | 307.2 | 975.8 |
| Net  cash provided by (used in) investing activities | (1,236.2)                  | (639.4) | (92.9) |
| Net  cash provided by (used in) financing activities | 313.1                      | (721.7) | 479.5 |
| Cash  and cash equivalents at end of year            | **683.3**                  | **764.2** | **1,818.1** |

 

The changes thatoccurred in the net cash in 2004 in relation to 2003 and 2005 were due to thefollowing:

***Changes in2005 relative to 2004****:*

*Net CashProvided by Operating Activities*

Changes inForeign currency exchange gain, net were due to the Company’s hedge resultsthat are aimed to compensate for losses in Sadia’s export revenues and wereinfluenced by the 17.3% average devaluation of the dollar against the real for2005 against 2004.

Changes inInventories were due to more efficient inventory management, which led to adecrease of the average inventory turnover from 90 days in 2004 to 66 days in2005.

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Changes inAccrued interest, net were due to a greater amount paid in interest, as Sadiaincreased its financing as a result of greater investments in 2005. 

Changes inSocial Charges, Taxes Payable, Other Liabilities’ account were due toprovisions on the acquisition of Só Frango and marketing expenses. 

*Net CashProvided or Used in Investing Activities*

Changes inPurchase of property, plant and equipment were due to the greater capitalinvestitures the Company incurred in 2005. In 2004 R$324.9 million wereinvested, while in 2005 Sadia invested R$742.4 million.

*Net CashProvide or Used in Financing Activities*

Changes inLong-term debt issuances were due to greater financing incurred as the Companyincreased its investments in 2005.

***Changes in2004 relative to 2003***

*Net CashProvided by Operating Activities*

Changes inRecoverable Taxes and Other Assets were higher than 2003 due to changes in theCOFINS legislation in 2004. The new legislation allowed companies to net thesum of the COFINS tax obligations generated from sales and the COFINS taxcredits generated in the purchase of raw materials. Moreover, as sales fromexported goods do not generate COFINS tax obligations, the Company, as anexporter, had a positive net sum in the Recoverable Taxes and Other Assetsaccount. 

Inventories werehigher in 2004 that 2003, such increase being attributable to lower thanexpected demand in the domestic market during 2003. Additionally, the Companywas stimulated to stock up on grains during the end of 2004 as their priceswere lower than their 2003 value.

Changes inAccrued Interest, Net were less than its 2003 value due to changes in theCompany’s finance strategy in 2004, which started focusing on less volatilesecurities associated therefore with lower interest rates. 

Changes inSocial Charges, Taxes Payable, Other Liabilities’ account were larger than its2003 value due to payment of the Employee Bonus.

*Net CashProvided or Used in Investing Activities*

Changes inPurchase of property, plant and equipment were due to the greater capitalinvestitures the Company incurred in 2004. In 2003 R$179.3 million wereinvested, while in 2004 Sadia invested R$324.9 million.

Changes inHeld-to-maturity investments were due to the creation of two offshore funds inDecember 2003, and new purchases during 2004 were classified asavailable-for-sale debt securities.

Changes inAvailable-for-sale debt securities were due to the reason mentioned above.

*Net CashProvided or Used in Financing Activities*

Changes inLong-term debt issuances were due to a lesser amount of financing contracted bythe Company as most of the capital investitures were done with its own resources.

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Indebtedness and Financial Strategy

The loans incurredby the Company are basically intended to finance exports, investments in fixedassets, and working capital. 

Atthe end of 2005, the Company’s total interest-bearing debt stood at R$3,357.5 million,representing a 21.6% increase as compared to the total debt of R$2,761.4 million on December 31, 2004. There was a significant improvementin terms of the total debt maturity distribution, in 2004, 63.5% was accountedas short-term, as compared to only 48.9% in 2005. It is worth mentioning thatthe total debt takes into consideration the values of the foreign currency andinterest rate swaps.

Atthe end of 2005, Sadia’s total investment amounted to R$2,695.7 thousand, a8.5% increase as compared to R$2,485.4 on December 31, 2004. There was also a significant improvement in terms of the total investment maturitydistribution, in 2004, 81.3% was accounted as short-term, as compared to 97.6%in 2005. 

The Company’s debt profile at December 31, 2005 and 2004 was as follows:

 

| **R$ Million**         | **2005**   | **2004**   |
|------------------------|------------|------------|
| ** **             | ** ** | ** ** |
| Short-tem debt         | 1,643.0    | 1,911.6    |
| Long-term debt         | 1,714.5    | 1,099.6    |
| Total Debt             | 3,357.5    | 3,011.2    |
|                   |       |       |
| Short-tem  investments | 2,630.7    | 2,020.3    |
| Long-term  investments | 65.1       | 465.1      |
| Total  Investments     | 2,695.7    | 2,485.4    |

 

On May 12, 2003, the Company entered into an agreement to sell, from time to time, up toR$150 million of its domestic receivables to a special purpose entity,organized as an investment fund. The receivables sold are subject to a discountrate that should not be lower than 95% of the average rate of Brazilianinterbank certificate deposits (17.9% p.a. at December 31, 2005). Through December 31, 2005, the Company received cash proceeds of R$2.6 billion (R$2.2 billionin 2004) from the sales of domestic receivables under this agreement andincurred in interest expenses of R$27 million for the year ended December 31, 2005 (R$23 million in 2004). Based on the structure of this transaction, theagreement has been accounted for as a financing by the Company. As of December 31 , 2005, the accounts receivable for this debt, pledged as collateral was R$190.4million.

**Short-Term Debt**

 

Following the normal course of operations,the amounts maturing in the short run can be settled or re-negotiated for thenext period. The Company uses trade finance for its working capital needsbecause it is available at a lower cost, since lenders perceive that theexchange risk is mitigated by the link to U.S. dollar exports. 

 

Working capitalfrom commercial banks primarily relates to export financing and pre-exportadvances, of which R$432.1 million in 2005 (R$744.4 million in 2004) weredollar denominated with a coupon at Libor (4,39% p.a. at December 31, 2005)plus a spread at the rate of 0.10% p.a. and fixed rate coupons from 4.2% to5.76% p.a. in 2005.

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| **R$ Million**                                            | **2005** | **2004** |
|-----------------------------------------------------------|----------|----------|
|                                                      |     |     |
|   Working capital from commercial banks              | 545.4    | 761.1    |
|   Trade accounts receivable domestic credit facility | 190.4    | 162.1    |
|   Trade accounts receivable export credit facility   | -        | 120.8    |
|   Bank borrowings, secured by accounts receivable    | 54.4     | 17.8     |
| ** **                                                | 790.2    | 1,061.9  |

 

On December 31, 2005 and 2004, the weighted average interest rates for U.S. dollar and localcurrency on short-term debt were 6.90% and 7.06% p.a., respectively.

**Long-Term Debt**

| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | **Long-Term Debt - R$ thousand**                                                      |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | ** **                                                                            | ** ** |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | **2005**                                                                              | **2004** |
| **Foreign debt  (denominated in U.S. dollars):**                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |                                                                                  |   |
| IFC- International Finance  Corporation funding in foreign currency for investment in property, plant and  equipment, which R$23,325 is subject to interest at fixed rate of 9.05% p.a.,  guaranteed by promissory real estate mortgages                                                                                                                                                                                                                                                                                     |  

 

 

    23,325                                     |  

 

 

   129,222 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                  |   |
| Export financing, composed  of prepayment, payable in amount of R$372,780 in installments up to 2010,  subject to LIBOR variation for 6 month deposits (4.7% in December 2005 plus  annual interest of 8.2% p.a, and a line focused on the incentive for foreign  trade in amount of R$1,212,113, subject to LIBOR variation for 6 month plus  interest of 5.69% p.a., guaranteed by promissory notes or sureties.                                                                                                           |  

 

 

 

 

  1,584,893                         |  

 

 

 

 

    924,965 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                  |   |
| Financing subject to LIBOR  variation for 1 month deposits (4.39% in December 2005) plus interest of  0.10% p.a., guaranteed by its own titles                                                                                                                                                                                                                                                                                                                                                                               |  

 

   145,719                                                  |  

 

            - |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |                                                                                  |   |
| BNDES (National Bank for Economic and Social Development),  payable from 2006 to 2013, composed as follows: FINEM in the amount of  R$29,046  subject to the weighted average of the exchange variation of  currencies traded by BNDES - UMBNDES and fixed interest of 3.50% p.a. and  FINAME in the amount of R$40,704 subject to the weighted average of the  exchange variation of currencies traded by BNDES - UMBNDES and fixed annual  interest of 3% p.a. guaranteed by mortgage bonds and real estate mortgages |  

 

 

 

 

 

      69,750 |  

 

 

 

 

 

     66,677 |

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| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | **2005**                                                | **2004**                                                |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------|---------------------------------------------------------|
| **Local debt (denominated in reais):**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |                                                    |                                                    |
| BNDES (National  Bank for Economic and Social Development), credit lines for investments and  exports, payable from 2006 to 2012, composed as follows: FINAME in the amount  of R$225,684  subject to the Long-Term Interest Rate -TJLP (9.75% p.a. in  December 2005) and interest of 4.45% p.a.,  FINAME-EXIM in the amount of  R$139,321 subject to TJLP and interest of 3.97% p.a. and FINEM in the amount  of R$37,654 subject to TJLP and interest of 3.50% p.a., guaranteed by  mortgage bonds and real estate mortgages |  

 

 

 

 

 

402,659 |  

 

 

 

 

 

436,309 |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |                                                    |                                                    |
| PESA - Special Aid Program  for Agribusiness payable in installments from 2005 to 2020, subject to the –  General Price Index –Market – IGP-M plus interest rate of 9.89% p.a., secured  by investments in debt securities with a carrying value of R$25,710 and  sureties.                                                                                                                                                                                                                                             |  

 

 

131,831                         |  

 

 

129,310                         |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |                                                    |                                                    |
| Other subject to interest  rate from 4% to 14% p.a.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       | 40,187                                                  | 21,846                                                  |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |                                                    |                                                    |
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | 2,398,364                                               | 1,708,329                                               |
| Less current portion of  long- term debt                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |    (694,180)                                  |    (676,954)                                  |
| **Long- term portion**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | **1,704,184**                                           | **1,031,375**                                           |

 

On December 29, 2005, the Company made early settlement in the amount of US$27.5 million referring to the financing agreementwith the International Finance Corporation (IFC). The Company has stated itsintention to settle the remaining balance of R$23.3 million in the short term,and, accordingly, there will be no restrictions with respect to thedistribution of dividends in addition to the mandatory minimum dividendrequired by law, if one of the consolidated financial indexes (currentliquidity, long-term indebtedness and total indebtedness) does not meet theagreed ratio levels. 

 

 

At December 31, 2005, long-term debt maturities were as follows:

 

| **Long Term Debt** | **R$ million** |
|--------------------|----------------|
|               |                |
| 2007               |   190.7   |
| 2008               |   131.2   |
| 2009               |   116.8   |
| 2010               |   977.0   |
| Thereafter         |   288.5   |
| ** **         | **1,704.2**    |

 

C. Research and Development,patents and licenses

Sadia investedR$10.9 million, R$10.1 million and R$6.5 million for the years ended December 31, 2005, 2004 and 2003, respectively, in research and development activities.During the past five years, the R&D department has developed seven newproduct families (refrigerated pasta, pizzas, fish-based products, ready-madedishes, sweet pies, frozen desserts and breaded products), as well as improvingexisting products.

Page 59 

----

During 2005, Sadialaunched 76 products mainly in the lines of ready to eat dishes, margarines,breaded chicken, hams and Miss Daisy Desserts.

Investments in R&D have also brought benefits tothe area of animal breeding, achieving improvements in the quality of meat, theproduction process, and reducing feed conversion rates. Between 1975 and 2005,the duration of the chicken production cycle was reduced from 59.3 days to 36days for each 1.7 kg bird. During the same period, chicken weight increasedfrom 1.7 kg to 2.0 kg for slaughtering. Similarly, the feed conversion ratedecreased from 2.4 kg to 1.8 kg per kg of chicken. 

 

Between 1975 and2005, the duration of the hog production cycle was reduced from 179 days to 146days for each 100 kg animal. During the same period, slaughtered hog weightincreased from 94 kg to 119 kg. In a similar way, the feed conversion ratedecreased from 3.6 kg to 2.6 kg of feed per kg of pork. During the same period,the percentage of pork meat per carcass increased from 46% to 59%. 

Page 60

----

D. Trend Information

This section discusses the main concerns and trends that drove the Company’s strategic  planning in 2005 and those expected for 2006.

**Avian Flu**

Outbreaks of a strain of virus, H5N1, known    as Avian Influenza A (AI), during the first quarter of 2006, have been reported    in Europe. The virus, which is communicated by infected wild birds, represents    a significant risk to flocks of fowl, which if infected must be slaughtered to  assure containment of the virus.

According to the Food and AgricultureOrganization (FAO) Transboundary Animal Diseases Bulletin of 2004, HighlyPathogenic Avian Influenza (HPAI) has been recognized for well over one hundredyears, and it seems clear that for the first third of the twentieth century thevirulent disease was endemic in some countries and occurred fairly regularly inothers. Since the first report of an HPAI outbreak caused by a virus of H5subtype, in 1959, primary outbreaks of HPAI in poultry have been reportedseveral times.

Even though the World Health Organization (WHO) statistics show that from the end of 2003 until May 2006, there were 4,265 outbreaks of AI with the H5N1 string, there were only 218 cases of confirmed poultry-to-human contamination and 124 human deaths. According to FAO the adaptation for human-to-human transmission has not yet occurred. Moreover, the WHO states that until today there is no epidemiological data suggesting that the disease can be transmitted to humans through properly cooked food (even if contaminated with the virus prior to cooking).

According to United States Department ofAgriculture, vaccines to protect humans against H5N1 viruses currently areunder development. In addition, research is underway on methods to make largequantities of vaccine more quickly. So far, research suggests that twoantiviral medicines, oseltamavir (Tamiflu®) and zanamavir (Relenza®), may beuseful treatments for H5N1 avian influenza. However, H5N1 viruses are generallyresistant to two other available antiviral medications, amantadine andrimantadine, so they cannot be used to treat avian flu. 

Even though there has never been a case ofH5N1 or any other highly pathogenic cases of poultry diseases of AI in Brazil, Sadia is aware of the risk, and is closely monitoring its developments. The Companyis working on this issue with the utmost priority, at the highest level of itscorporate governance structure and adopting several preventive measures.

Sadia's poultry plants are spreadthroughout the country with 8 industrial units across 5 different states. Inaddition to that, Brazil's vast territorial extension reduces substantially therisk of countrywide contamination.

In order to avoid AI reaching its plants,Sadia has implemented a strict control on the access to the animal producingfarms. Visits to farms and poultry establishments are strictly prohibited untilfurther notice. In the event of visits from certifying companiesrepresentatives and genetic material suppliers, access must be limited to the Company’soffice after a 7-day quarantine in Brazil, without any kind of contact withother birds.

As there is a serious threat ofintroduction of avian influenza through the exposure of the Company’scommercial flock to wild birds, especially waterfowl, all of Sadia’s integratedoutgrowers have protected their farms water springs and most of them have put tightermesh screens in order to block the entry of smaller wild birds in their farms.

The Company is also equipping its plants tocook, grill and bread the poultry meat, as according to FAO, the virus isdestroyed in temperatures above 70°C, allowing these products to be exportedregardless of any sanitary related embargos. Sadia is also constantlyincreasing the volumes of processed products in its product portfolio, whichcreates a natural hedge for the Company.

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Besides that, the Company is aware of allthe procedures that have to be implemented in the event of an outbreak, and isspreading this knowledge to all of its integrated outgrowers. 

Moreover, the Brazilian government hasestablished the National Plan for the Prevention and Control of NewcastleDisease and the Prevention of Avian Influenza (Plano Nacional de Controle ePrevençao da Doenca de Newcastle e de Prevençao de Influenza Aviária) whichconforms with OIE (World Organization for Animal Health) standards for zoning.These measures which are intended to assure international markets that Brazil maintains sanitary barriers between states will allow the country to petition forcertain Brazilian states to be considered as autonomous regions, avoiding,thus, a generalized ban on exports. 

It is important to mention that Sadia isalready in full compliance with the National Plan for the Prevention of theAvian Flu and the Prevention and Control of the Newcastle Disease.

Despite these measures, no assurance can begiven that Sadia will not be affected by AI, directly, or through limitationson exports imposed by importing countries. 
**Foreign Market Protectionist Measures**
New regulationswill continue to be issued by foreign importer countries to protect their localproducers. Since a relevant part of Sadia ́s revenues comes from exportoperations, the raising of protectionist barriers can affect its operations.
In July 2002,the EU Sanitary Commission issued a new regulation increasing the duties forimported fresh chicken. During the second semester of 2002, 100% of Brazilianchicken exported to Europe was required to be tested for the forbiddenantibiotic Nitrofuran, increasing export sales costs.
In November2003, a panel was established in the World Trade Organization (WTO) on requestof Brazil and Thailand against the change in classification of salted poultrymade by the EU. With this change, Brazilian salted poultry was classified asfrozen and, thus, had an increase of 15.4% ad valorem in its duty rate. InAugust 2005, the final WTO decision favored Brazil and Thailand in the panel. However, the WTO decision is characterized as only a recommendationto the European Union, and there will not be an immediate application of theruling.
The Russiangovernment also introduced a quota regime for pork and poultry imports that isto remain in effect through 2006. The quotas for 2006 have not yet beenestablished.These initiativescan reduce competitiveness of the Company ́s products in such markets; however,the Brazilian government, associated with local and international entities,normally negotiates the terms of such measures in order to mitigate theirnegative effects.
**E. Off- balance sheetarrangements**

The Company does not have anyoff-balance sheet arrangements that have or are reasonably likely to have acurrent or future effect on its financial condition, changes in financialcondition, revenues or expenses, results of operations, liquidity, capitalexpenditures or capital resources other than the one described below.
Sadia hasoff-balance sheet arrangements consisting of guarantees granted in the amountof R$11.5 million to banks under loans obtained by certain out growers as partof a special development program in the central region of Brazil. As of December 31, 2005, the outstanding debt related to those out growers was US$11.8million, fully guaranteed by Sadia. The Company also has off-balance sheetarrangements related to the export receivables sold under the Insured ReceivablesPurchase Agreement in the amount of R$ 22.9 million.

Page 62 

F. Tabular disclosure of contractual obligations
The Company has long term purchase contracts with suppliers that are oriented for production purposes (packing and industrial units). At December 31, 2005, the balance of contractual obligations were as follows:

****

*** ***

*** ***

**Contractual Obligations – Payments Due By Period (Thousand R$)**

*** ***

*** ***

*** ***

*** ***

*** ***

*** ***

*** ***

*** ***

*** ***

*** ***

*** ***

*** ***

*** ***

***Less than 1 year***

*** ***

***1 - 3 years***

*** ***

***3 - 5 years***

*** ***

***More than 5 years***

*** ***

***Total***

Long-Term Debt Obligations

 

694,180

 

321,982

 

1,093,714

 

288,488

 

2,398,364

 

 

 

 

 

 

 

 

 

 

 

Capital (Finance) Lease Obligations

 

-

 

-

 

-

 

-

 

-

 

 

 

 

 

 

 

 

 

 

 

Operating Lease Obligations

 

65,200

 

99,400

 

-

 

-

 

164,600

 

 

 

 

 

 

 

 

 

 

 

Purchase Obligations

 

42,000

 

159,000

 

159,000

 

 

 

360,000

 

 

 

 

 

 

 

 

 

 

 

Other Long-Term Liabilities Reflected on the Company's Balance Sheet under the GAAP of the primary financial statements

 

-

 

-

 

-

 

-

 

-

**Total**

** **

**801,380**

** **

**580,382**

** **

**1,252,714**

** **

**288,488**

** **

**2,922,964**

Sadia does not have any contractual purchase  obligations associated with its animal feed requirements.

The long-term debt obligations incurred by the Companyare basically intended to finance exports, investments in fixed assets andworking capital. Purchase Obligations relates to future acquisition of rawmaterials. Operating Lease Obligations are related to Sadia’s non-cancelableleasing agreements for industrial units that expire over the next three years.

G. Safe Harbor

** **

See “Forward-LookingStatements” in “General” on page 2 of this Annual Report.
**ITEM 6. DIRECTORS, SENIOR MANAGEMENT ANDEMPLOYEES**
** **

A. Directors and SeniorManagement

Executive Officers and Members of the Boardof Directors

The Company ismanaged by a Board of Directors and a Board of Executive Officers, formed byBrazilian citizens or a majority of Brazilian citizens domiciled in thecountry, whose powers shall prevail in the decision-making.

The term ofoffice of the members of the Board of Directors and of the Executive Officersshall be for one year and shall be unified, extending up to the entry uponoffice of the new administrators, reelection being permitted.

Page 63 

In 2005 Sadia acquired a directors and officers liability insurance (D&O), in order toprotect all its executives against legal actions that may arise from financialloss caused to third parties.

There are nopending legal proceedings, involving either board members or executive officersthat could prevent any of these from carrying out their duties.

**Board of Directors**

Pursuant to Sadia's By-laws, the board of directors is composed of aminimum of seven to a maximum of eleven members, all of them necessarily beingshareholders and shall adopt an Internal Regulation to govern its ownactivities. 

In the annual shareholder’smeeting, held on April 26, 2006 the new board members were elected. The boardof directors is composed of four members who represent the controllingshareholder group, and seven independent members.

Certain members of the board are related.Mr Osório Henrique Furlan is the uncle of Mr. Walter Fontana, and Mr. RomanoAncelmo Fontana Filho, Mr. Eduardo Fontana d’Ávila and Mr. Walter Fontana arecousins.

 

**Name**

**Birth Date**

**Position**

Walter Fontana Filho

12/07/1953

Chairman

Eduardo Fontana d’Ávila

02/28/1954

Vice Chairman

Osório  Henrique Furlan

07/31/1922

Vice Chairman

Alcides Lopes Tápias

09/16/1942

Member

Everaldo Nigro dos Santos

07/12/1939

Member

Francisco  Silverio Morales Cespede

06/21/1947

Member

José  Marcos Konder Comparato

09/27/1932

Member

Luiza  Helena Trajano Inácio Rodrigues

10/09/1948

Member

Norberto Fatio 

04/07/1944

Member

Romano  Ancelmo Fontana Filho 

08/25/1941

Member

Vicente Falconi Campos

09/30/1940

Member

 

*WalterFontana Filho. *Mr.Fontana Filho has been the Chairman of the board of directors since April 2005. He was Chief ExecutiveOfficer of the Company from 1994 to 2005, with previous experience asCommercial Vice President Director and Domestic Commercial Director. Mr.Fontana holds an undergraduate and graduate degree in Economics from PontificiaUniversidade Católica, and a specialization in Business Marketing from FundaçaoGetúlio Vargas.

*Eduardo Fontana d’Ávila.*** **Mr. Fontana d’Ávila is Vice Chairman of the board of directors and a member ofthe board since 2005. He was Industrial Director until 2005. He has been withthe Company since 1977 always directed towards industrial production. Mr. D ́Ávilaholds undergraduate degree in Engineering from Mackenzie University and agraduate degree in Business Administration from Fundaçao Getúlio Vargas.

*OsórioHenrique Furlan.*  Mr.Furlan is Vice Chairman of theboard of directors and member of the board since 2002. He served as thecompany’s first executive president. He is a member of the Sao Paulo CommercialAssociation and former vice president of Transbrasil Airlines from 1964 to1975. Mr. Furlan received his undergraduate degree in law from Faculdade deDireito Bragança Paulista.

*Alcides LopesTápias.* Mr. Tapias hasbeen a member of the board ofdirectors since 2002. Mr. Tapias served as Banco Bradesco’s ExecutiveVice-President, President of FEBRABAN (Brazilian Bank Federation) and was amember of the National Monetary Council. He also served as former Industry,Trade and Development Minister (July, 2001). Mr. Tapias holds an undergraduatedegree in Business

Page 64 

Administration from Universidade Mackenzie and a graduate  degree in law from Faculdades Metropolitanas Unidas.

*EveraldoNigro dos Santos.*  Mr.Santos has been a member ofthe board of directors since 2004. He also served as former CEO of Alcan LatinAmerica from 1997 to 1999. Mr. Santos holds an undergraduate degree inengineering from Universidade Mackenzie and an MBA from the Centre d ́ÉtudesIndustrielles.

*FranciscoSilverio Morales Cespede. *Mr.Cespede has been a member ofthe board of directors since 2004. He is also the Chief Financial Officer ofSao Paulo Alpargatas S.A., a member of the board of Santista Textil S.A. andformer Chief Financial Officer and member of the board of directors of Monsantodo Brasil. Mr. Cespede holds an undergraduate and graduate degree in BusinessAdministration from Fundaçao Getúlio Vargas. 

*Jose MarcosKonder Comparato.*Mr.Comparato has been a member of the board of directors since 2006. He is Presidentof the Fiscal Council of Itaúsa - Investimentos Itaú S.A., former executivedirector of Banco Itaú S.A. and former CEO of Itaúsa Empreendimentos S.A. Mr. Comparato holds an undergraduate degreein Civil Engineering from Escola Politecnica - Universidade de Sao Paulo. 

*Luiza Helena TrajanoInácio Rodrigues.*Mrs.Rodrigues has been a member of the board of directors since 2006. She is CEO ofMagazine Luiza and member of the board of Grupo Algar. She holds anundergraduate degree inBusiness Administration and Law from Faculdade de Direito de Franca.

*NorbertoFatio. *Mr. Fatio has beena member of the board of directorssince 2004. He has commercial and marketing executive experience at Unilever,Danone, Bunge Alimentos, Kibon, Fleischmann Royal Nabisco and Sé Supermercados.Mr. Fatio received his undergraduate degree in Business Administration fromFundaçao Getúlio Vargas.

*RomanoAncelmo Fontana Filho.*** **Mr. Fontana is a member of the board of directors since 1994.He previously served as Chairman of the board and former IT and Human ResourcesDirector from 1976 to 1994. Mr. Fontana holds an undergraduate degree inBusiness Administration from Universidade Mackenzie.

*VicenteFalconi Campos.*  Mr.Falconi Campos has been a memberof the board of directors since 2002. He is a Brazilian Government consultanton the energy crisis management committee and a member of the board ofdirectors of AMBEV. Mr. Falconi Campos holds an undergraduate degree inengineering from Universidade Federal de Minas Gerais and a PhD from ColoradoSchool of Mines. 

 

**ExecutiveOfficers**

The Company's management team consists ofprofessionals with extensive experience in the Brazilian food sector. There arecurrently no members of the founding family serving in executive capacities.The executive officers are responsible for the execution of decisions of theboard of directors and day-to-day management of the Company. Below is a shortrésumé of the key members of Sadia's executive management team for the year of2005: 

Page 65

**Name**

**Birth Date**

**Position**

Gilberto Tomazoni

08/28/1958

Chief Executive Officer

Adílson Serrano Silva

10/14/1948

Human Resources and Management Director

Alexandre de Campos

09/22/1970

International Sales Director

Alfredo  Felipe da Luz Sobrinho

08/31/1945

Corporate Relations and Legal Affairs Director

Antonio Paulo Lazzaretti

07/24/1947

Production and Products Technology

Claudio  Lemos Pinheiro

08/04/1951

Controller, Administrative and Information  Technology Director

Ernest Sícoli Petty

07/04/1968

Purchasing Director

Flávio Luis Fávero

12/11/1963

Processed Products Director

Flávio Riffel Schmidt

03/23/1953

Investment Projects

Gilberto Meirelles Xandó Baptista

08/24/1965

Commercial Director – Domestic Market

Guillermo Henderson Larrobla

03/11/1956

International Sales Director

José  Augusto Lima de Sá

06/14/1953

Commercial Director – Exports

Luiz Gonzaga Murat Júnior

10/17/1953

Chief Financial Officer, and Investor Relations  Director

Paulo Francisco Alexandre Striker

10/23/1954

Logistics Director

Ricardo  Fernando Thomas Fernandez

10/25/1963

Grain Purchase Director

Roberto Banfi

02/21/1947

International Sales Director

Ronaldo Kobarg Müller

11/11/1959

Poultry Production Director

Sérgio Carvalho Mandin Fonseca

09/12/1957

Domestic Sales Director

Valmor Savoldi

01/28/1954

Planning, Logistic and Suppies Director

 

*GilbertoTomazoni.*Mr. Tomazoni isthe Chief Executive Officer.His previous experience within the Company includes industrial, sales (localand foreign markets) and marketing areas. Mr. Tomazoni holds an undergraduatedegree in Engineering from Universidade Federal de Santa Catarina and agraduate degree in Management Development from Fundaçao de Ensino doDesenvolvimento.

*AdílsonSerrano Silva.* Mr. SerranoSilva is the Human Resources and Management Director. He has previousexperience with human resources at Cofap, Eletroradiobrás, VASP and LinhasCorrente. Mr. Serrano Silva holds an undergraduate degree in BusinessAdministration from Faculdade Senador Flaquer and a graduate degree in BusinessAdministration from Fundaçao Getúlio Vargas.

*Alexandre deCampos.* Mr. Campos is the International Sales Director. He has previousexperience with foreign trade at General Electric and Perdigao. Mr. Camposholds an undergraduate degree in Business Administration from FaculdadesTibiriçá and a graduate degree in Marketing from Escola Superior de Propagandae Marketing.

*Alfredo Felipe da LuzSobrinho.*Mr. da LuzSobrinho is the CorporateRelations and Legal Affairs Director. He previously was a member of the boardof directors and was Vice President of Marketing, Sales and Services ofTransbrasil. Mr. da Luz Sobrinho was former President of ABIPECS and Presidentof the Attílio Francisco Xavier Fontana Foundation. He holds an undergraduatedegree in Law from Centro de Ensino Universidade Brasília.

*Antonio PauloLazzaretti.*  Mr.Lazzaretti is the Productionand Products Technology Director. He was the former industrial director andmanager for the Company. He previously worked for Renner Hermann. Mr.Lazzaretti holds an undergraduate degree in Chemical Engineering from theUniversidade Federal do Rio Grande do Sul, with a specialization in BusinessAdministration from Fundaçao Candido Mendes.

Page 66 

*Claudio LemosPinheiro.*  Mr. LemosPinheiro is the Company’s Controller, Administrative and Technology Director. His experience within the Companyincludes the financial, IT and controlling areas. He holds an undergraduatedegree in Business Administration from Universidade Católica de Pelotas, anextension in Business Administration from Universidade de Sao Paulo and an MBAfrom J. L. Kellogg Graduate School of Management.

*Ernest SícoliPetty.*  Mr. Sícoli Pettyis the Purchasing Director. Hehas previous experience in the food and agribusiness sectors at Pepsico,Cargill and Seara. Mr. Sícoli Petty holds an undergraduate degree inAgriculture Engineering from Universidade de Sao Paulo and an Executive MBA inBusiness Administration from BSP/University of Toronto. 

*Flávio LuisFávero.*  Mr. Fávero is theProcessed Productcs ProductionDirector – Processed Products. He has previous experience within the Company asTotal Quality Coordinator and Production Manager.  Mr. Fávero holds anundergraduate degree in Chemical Engineering from the Universidade do Sul and agraduate degree in Management Development from Universidade de Santa Catarina. 

*Flávio RiffelSchmidt.*  Mr. RiffelSchmidt is the InvestmentProjects Director.  He has previous experience in the finance, planning andcontrol departments at the Company. Mr. Riffel Schmidt holds an undergraduatedegree in Business Administration and Accounting from Universidade do Vale dosSinos. 

*GilbertoMeirelles Xandó Baptista.* Mr. Xandó Baptista is the Commercial– Domestic Market Director. He is the former Marketing Director with experiencein the controlling, sales and marketing areas. Mr. Xandó Baptista holds an undergraduatedegree in Business Administration from Getúlio Vargas Foundation, with aspecialization in Business Administration from CEAG-FGV and Universidade de SaoPaulo.

*GuillermoHenderson Larrobla.*  Mr.Henderson Larrobla is the InternationalSales Director. He has previous experience with Seara Alimentos (Bunge Group). Mr. Henderson Larrobla  holds an undergraduate degree in Mechanical Engineeringfrom Universidade Federal do Rio Grande do Sul and a Marketing Managementspecialization from Universidade de Blumenau. 

*José Augusto Lima de Sá.*  Mr.Lima de Sá is the Commercial – Export Director. He has experience of more than 20 years in foreigntrade. He is the former Chief Executive Officer and Chairman of Frangosul. Mr. Limade Sá holds an undergraduate degree in Business Administration from FundaçaoGetúlio Vargas with extension courses at Harvard and Wharton business schools.

*Luiz GonzagaMurat Júnior*.  Mr. Muratis the Chief Financial Officer and Director of Investor Relations. He was theChief Financial Officer, Controller and Market Relations Director at PerdigaoS.A., Chief Financial Officer, Controller and Director of Market Relations atBahia Sul Celulose S.A., General Manager of Finance and Administration andController at Suzano Feffer. He is a member of the Board of Directors ofBrasilAgro. He is also a member of the board of directors of Santher Fábrica dePapel, and of ABRASCA – the Brazilian Association of Publicly-held Companies,in addition to being an alternate director of the industrial area of IBEF – theBrazilian Institute of Financial Executives. He was a member of the Board ofDirectors of Laboratórios Fleury. Mr. Murat has a degree in BusinessAdministration from Fundaçao Getúlio Vargas and a post-graduate degree inAgricultural Economics from Stanford University. 

*PauloFrancisco Alexandre Striker.* Mr Striker is the LogisticsDirector. He is the former trade marketing manager and brand management/strategic planning manager. Mr. Striker holds an undergraduate degree inBusiness Administration and Civil Engineering from Universidade Mackenzie and aspecialization in Business Administration from JUSE Institute (Japan) and Fundaçao Dom Cabral.

*RicardoFernando Thomas Fernandez.* Mr. Thomas Fernandez is the GrainPurchasing Director. He has experience in grains and supply areas. Mr. ThomasFernandez holds an undergraduate degree in business administration fromUniversidade do Oeste de Santa Catarina and specialization in enterprisemanagement at Fundaçao Dom Cabral.

Page 67 

*RobertoBanfi.*  Mr. Banfi is the International Sales Director. He hasprevious experience includes working for Bonfiglioli - Cica, Cicatrade andSwift Armour as Director and served as Marketing Manager and Coordinator forMercosur in the sales area of RMB-Refinaçoes de Milho do Brasil. Mr. Banfiholds an undergraduate degree in Accounting from H.E.C. Lausanne and an MBAfrom Stanford Business School.

*RonaldoKobarg Müller.*  Mr. Mülleris the Poultry ProductionDirector. He has experience within the Company as Total Quality Coordinator andProduction Manager.  Mr. Müller holds an undergraduate degree in Chemical Engineeringfrom Fundaçao Educacional da Regiao de Blumenau and a graduate degree in ManagementDevelopment from Universidade Federal de Santa Catarina.

*SérgioCarvalho Mandin Fonseca.* Mr. Mandin Fonseca is the DomesticSales Director. He was the former retail director at the Martins Distributioncompany and has experience at La Fonte Metalurgy and Souza Cruz Cigarettecompany. Mr. Mandin Fonseca holds an undergraduate degree in Production Engineeringfrom Universidade de Sao Paulo and an MBA from the University of California.

*Valmor Savoldi. *Mr Savoldi is the Planning, Logistic and Supplies Director. He has former experiencewithin the Company including the areas of agriculture, production, poultry andpork processing, total quality and sales.  Mr. Savoldi holds an undergraduatedegree in Agricultural Engineering and a specialization in Management Developmentfrom Universidade Federal de Santa Catarina.

 

B. Compensation

For the yearended December 31, 2005, the aggregate compensation paid by Sadia to allmembers of the board of directors and executive officers for services in allareas was R$ 13.7 million, not including related taxes or social securitycontributions. For the years ended December 31, 2004 and 2003 the amount paid was approximately R$ 12.9 million and R$ 11.1 million, respectively.

The Company hasalso granted health assistance and life insurance as benefits to its executiveofficers.

For the year 2003, the Company developed a variable compensationprogram for officers and management  aiming to consolidate several challengingtargets. This program, called GVS (Sadia Value Generation), uses valuegeneration metrics considering, among other things, cost reduction, expensecontainment and revenue growth. The amount paid to each participant depends onthe extent to which his performance indicators have been achieved. In the eventof the termination of the mandate of a director or an executive officer, theyare entitled only to statutory employment benefits under applicable law,without any special severance.

The Companysponsors a defined benefit pension plan that offers supplementary retirementbenefits to the employees, through Attílio Francisco Xavier Fontana Foundation.The pension benefit is generally defined as the difference between (i) 80% ofthe retiree’s average salary during the last 36 months indexed to the date ofretirement and (ii) the value of the retirement pension paid by the Braziliansocial security system. For retired employees the initial pension payment issubsequently adjusted upwards to recognize cost of living increases andproductivity awards granted to active employees. The Company provides for thecosts of pension benefits based on a fixed percentage of compensation, asrecommended annually by independent actuaries. The accumulated benefitobligation related to this pension plan were R$645.8 million and R$537.4million at December 31, 2005 and 2004, respectively. The Company expects tocontribute approximately R$6 million to the plan during fiscal year 2006.

As of January 1, 2001, the Company began sponsoring two new defined benefit plans to itsemployees and certain employee executives. Such benefit plans generally providebenefits payable as a single lump sum to eligible employees upon retirement.The Company intends to fund these benefits from its operations. The aggregateprojected benefit obligation and the aggregate accumulated benefit obligationrelated to those benefit plans were R$57.2 million and R$47.6 million,respectively, at December 31, 2005 and R$59.5 million and R$54.7 million,respectively, at December 31, 2004.

Page 68 

During 2003, theCompany terminated the stock award plan for its directors, who received aportion of their annual bonus in shares of preferred stock that were purchasedin the market by the Company in the director’s name, which totaled 711,000preferred shares at the termination date.

*Stock OptionPlan*

In April 2005,the shareholders’ meeting approved the Executive Stock Option Plan. The plan isintended to grant to Company executives options to buy preferred, nominativeshares issued by the Company, available in the treasury, in accordance with CVMInstructions 10/1980 and 390/2003. 

The objective ofsuch initiative is to motivate plan participants, directing their behavior andlong-term vision, stimulating their sense of ownership and commitment to theorganization, in keeping with the interests of company shareholders. 

The price forexercising the options does not include any discount and will be based on theaverage price of the shares in the last three trading days on the Sao PauloStock Exchange prior to the grant date, updated by the accumulated NationalConsumer Price Index (INPC) between the grant date and the date of exercise.There is a three year vesting period as from the option grant date. Theparticipants will be able to fully or partially exercise their right up to 2years after the vesting period. 

Under the planregulations, the preferred shares will be acquired and earmarked in treasuryfor this sole purpose.

The compositionof the options granted is presented as follows:

 

** **

**Date**

**Number of shares**

**Price of shares**

** **

**Grant date**

** **

**Start**

** **

**Final**

**Price on the Grant date**

**Updated – INPC**

**12/31/05**

**Market**

**Price 12/31/05**

 

 

 

 

 

 

 

06/24/05

06/23/08

06/23/10

2,200,000

4.55

4.63

6.43

 

Considering theprovisions of SFAS 123R, which was early adopted by the Company, a compensationexpense in the amount of R$ 0.7 million has been classified as compensationexpense under general and administration expense. As of December 31, 2005, the amount of R$ 3.4 million related to the unrecognized compensation cost relatedto stock options is expected to be recognized in 2.5 years. The Companycurrently has shares in treasury, which are sufficient to cover future stockoption exercises.

C. Board Practices

Sadia has five standing committees: a tax planningcommittee, an audit committee, a financial committee, a human resources and compensationcommittee, and an ethics committee. The committees are composed of members ofthe board who dedicate themselves to the development of the long run strategyof specific areas of the Company.

**Tax Planning Committee**

* *

This committee is responsible to identifycost reduction opportunities through the evaluation of the tax regulations, itschanges and impacts on the Company’s operations. This committee is composed ofthree effective members: Roberto Romano Ancelmo Fontana Filho (coordinator),Francisco Silverio Morales Cespede and Osório Henrique Furlan.

Page 69 

**AuditCommittee**

In compliancewith the requirements of the Sarbanes-Oxley Act and the rules of the New YorkStock Exchange, this committee oversees financial reporting processes andcompliance with corporate law, as well as supervising external and in-houseauditors to guarantee independence. The committee is made up of members of theBoard of Directors, one of which is necessarily a financial expert. The currentmembers of the audit committee are Francisco Silverio Morales Cespede(coordinator), Alcides Lopes Tápias and José Marcos Konder Comparato. Allmembers of the audit committee satisfy the audit committee membershipindependence requirements set forth by the SEC and the NYSE. Francisco SilverioMorales Cespede has been determined by the board to be the audit committee“financial expert” within the meaning of the rules adopted by the SEC relatingto the disclosure of financial experts on audit committees in periodic filingspursuant to the U.S. Securities Exchange Act of 1934.

**FinancialCommittee**

This committeeis responsible for managing the Company's long-term financial strategy. Thecommittee is also in charge of developing hedging policies, project finance,capital market deals, capital structure and guidelines on the Company's cashflow management. It is composed of three members: Alcides Lopes Tápias(coordinator), Everaldo Nigro dos Santos and Walter Fontana Filho.

**HumanResources and Compensation Committee**

This committeeis responsible for overseeing Sadia's human resources planning and strategy.The committee has three basic functions: executive performance evaluation;establish training, hiring and compensation/bonus policies; and design uppermanagement succession programs. It is composed of three members: Eduardo Fontana d'Ávila (coordinator), Everaldo Nigro dos Santos, Vicente Falconi Campos andNorberto Fatio.

**EthicsCommittee**

The Ethics Committee is comprised of members of theBoard of Directors and Company managers, and is in charge of periodicallyreviewing the Company's Code of Ethics; analyzing reports on violations of theCode of Ethics forwarded to it by the Ethics and Conduct Commission; examiningmost serious cases of violations of the Code of Ethics, and submitting it tothe Board of Directors for decision; and deliberating on questions regardingthe interpretation of the Code of Ethics text, as well as potential ethicaldilemmas. It is made up of three full-time members, Norberto Fatio(coordinator), Eduardo Fontana d ́Ávila and Francisco Silverio Morales Cespede.

D. Employees

At December 31, 2005, 2004 and 2003 the Company had, respectively, 45,381, 40,637 and 34,432 employees.

Sadia possessesan employee Profit-Sharing Program which benefited more than 26,000 employeesin 2005. The total distributed under the program was R$ 24.8 million, or R$ 923per year/employee. The Profit-Sharing Program was established throughnegotiations with the employee commission, in accordance with applicablelegislation. 

Of the benefits offered toemployees, some of the most noteworthy include part-time and, at some plants,full-time daycare through a network of accredited, private providers; familyhealth plan; funeral assistance; dental and medical care; loans; privatepension plan; and discounts on Company products. 

E. Share Ownership

On March 31, 2006 the board members and executive directors of the Company (excluding thosethat are part of the shareholders’ agreement) held, as a group, 20,439,218common shares and 12,325,867

Page 70

preferred shares, corresponding to 7.95% and 4.80%of the amount of outstanding shares of each class, respectively. 

For more detailson ownership and any relationship among major shareholders, see “Item 7. MajorShareholders.”
** ****ITEM 7. MAJOR SHAREHOLDERS AND RELATEDPARTY TRANSACTIONS**
 

A. Major Shareholders

 

**Share Position**

Sadia has two types of shares, common andpreferred, of which only the common shares carry voting rights. The Company’smajor shareholders do not have different voting rights.

 

The following tables contain certaininformation as of March 31, 2006 with respect to (i) any person known to theCompany to be the beneficial owner of more than 5% of the Company’s outstandingshares of voting common shares, (ii) any person known to the Company to be thebeneficial owner of more than 5% of the Company’s outstanding shares ofpreferred shares and (iii) the total number of the Company’s voting commonshares and preferred shares owned by the executive officers and directors ofthe Company as a group.

 

 

**Shareholders**

**Common Shares**

**%**

**Preferred Shares**

**%**

**Total**

**%**

 

 

 

 

 

 

 

Fundaçao Attilio F. X. Fontana

 24,998,558

    9.73%

                 -

      -

  24,998,558

    3.66%

Osório Henrique Furlan

  14,948,969

    5.82%

                 -

      -

  14,948,969

    2.19%

Sunflower Participaçoes S.A. (*)

  32,018,789

  12.46%

                 -

      -

  32,018,789

    4.69%

Other Shareholders (*)

104,713,344

  40.73%

  29,617,709

  6.95%

134,331,053

  19.66%

PREVI – Caixa Prev. Bco. Brasil

    1,996,511

   0.78%

  59,359,870

 13.93%

  61,356,381

   8.98%

Oppenheimer Funds Inc.

                  -

       -

   46,238,940

 10.85%

 46,238,940

    6.77%

Other Shareholders

  78,323,829

  30.48%

288,279,193

  67.68%

 366,603,022

  53.68%

Stock in Treasury

                 -

     -

   2, 504,288

    0.59%

  2,504,288

    0.37%

**Total**

**257,000,000**

**100.00%**

**426,000,000**

**100.00%**

**683,000,000**

**100.00%**

(*) Part of the shareholders’ agreement

Page 71 

 

Oppenheimer Funds Inc. is an investmentadvisor, and its holdings were as follows:

 

**Shareholders**

**Common Shares**

**%**

** Preferred Shares**

**%**

** Total**

**%**

Oppenheimer Developing Markets Fund

-

0.00%

36,392,000

78.70%

36,392,000

78.70%

Pacific Select Fund

-

0.00%

  5,892,290

12.74%

  5,892,290

12.74%

TA Index Oppenheimer Emerging Markets

-

0.00%

  1,284,000

  2.78%

  1,284,000

 2.78%

OFI Trust Company

-

0.00%

     805,400

 1.74%

     805,400

 1.74%

OppenheimerFunds PLC

-

0.00%

     451,380

 0.98%

     451,380

 0.98%

OFI Institutional Emerging Markets Eq.  Fund LP

-

0.00%

     405,870

 0.88%

     405,870

 0.88%

Stichting Pensionenfonds Hoogovens

-

0.00%

     366,000

 0.79%

     366,000

 0.79%

Raytheon Company Master Trust

-

0.00%

     268,000

 0.58%

     268,000

 0.58%

Altria Corp Serv Master Retirement Trust

-

0.00%

     241,000

 0.52%

     241,000

 0.52%

Pacific Funds PF Oppenheimer Emerging  Markets Fund

-

0.00%

     133,000

 0.29%

     133,000

 0.29%

**TOTAL**

**-**

**0.00%**

**46,238,940**

**100.00%**

**46,238,940**

**100.00%**

*Sunflower Participações* is a holding company composed of severalfamily members and is part of the shareholders agreement. The breakdown is asfollows:

**Shareholders**

**Common Shares**

**%**

**Preferred Shares**

**%**

**Total**

**%**

 

 

 

 

 

 

 

Maria Aparecida Cunha Fontana

14,084,143

  43.99%

-

-

14,084,143

  43.99%

Walter Fontana Filho

  6,739,660

  21.05%

-

-

  6,739,660

  21.05%

Attilio Fontana Neto

  5,716,562

  17.85%

-

-

  5,716,562

  17.85%

Vânia Cunha Fontana

  5,478,424

  17.11%

-

-

  5,478,424

  17.11%

**TOTAL**

**32,018,789**

**100.00%**

**-**

**-**

**32,018,789**

**100.00%**

 

****

**Significantchanges in percentage of ownership held by major shareholders**

In conformity with paragraph 1 of thearticle 12 of the CVM instruction 358/02, which attends to the obligation ofdisclosure of information about a relevant position of an individual, or groupof persons, jointly acting or representing a common interest, reaching aparticipation that corresponds to 5% of one type or a class of shares, Sadia informedthat in accordance with the letter sent to the Company by Hedging-Griffo AssetManagement Ltda., Hedging-Griffo Corretora de Valores S.A. and the institutionsthey represent held 6.64% of Sadia ́s preferred shares in November 2004 and sold5.06% of the respective preferred shares in December 2004. The change in participationof the shareholders did not affect the Company’s control. 

 

During January 2005 the same institutionsmentioned in the paragraph above reached a 5.27% ownership and in February,2005, the same institutions sold 5.54% of Sadia’s preferred shares. The changein participation of the shareholders did not affect the Company’s control. 

 

As of closing day of February 15, 2006 OppenheimerFunds, Inc. and its clients possessed, 10.85% of the Company’s preferred shares.This participation did not affect the Company’s control.

 

Shareholders Agreement

Members of thefamily of the founder, Mr. Attilio Fontana, established a shareholders’agreement in May 1977, amended in May 2005, when it was extended until May2010. The agreement strives to regulate the relationship between the familygroups regarding the purchase and sale of shares between themselves and withthird parties as well as to establish principles and rules for the exercise ofblock voting rights, investment

Page 72 

policy and remuneration of capital. The  agreement is reviewed every five years. Any family member who wishes to dispose  of his or her shareholding must provide a right of first refusal to all parties  to the shareholders’ agreement.

In December 2005, the Company'sshareholders’ agreement was composed of 47 participants and controlled 53.2% ofSadia’s voting shares. 

B. Related Party Transactions

The Company hasoperating transactions with Sadia International and Wellax, which are both theCompany’s vehicles for sales outside Brazil. Wellax is also acting as a financingentity of the Company by obtaining export-financing loans from internationalbanks and investing the proceeds in debt securities.

Concórdia CVMCCis a brokerage firm that is responsible for identifying the optimalalternatives of investments for the cash surplus generated by the Company andits subsidiaries. 

C. Interests of Experts andCounsel

*Not Applicable.*
**ITEM 8. FINANCIAL INFORMATION**
 

A. Consolidated Statements andOther Financial Information  

See “Item 18. FinancialStatements”

Legal Proceedings 

The Company isparty to certain legal proceedings arising in the normal course of business,and has made provisions based on its best estimate of the probable losses thatwill ultimately be incurred. The Company believes that the provisions made aresufficient to cover probable losses. In connection with certain legalproceedings, the Company has made judicial deposits, which will only bereleased upon a favorable legal judgment. 

The Company’slabor force is represented by collective bargaining agreements. All collectivebargaining agreements are re-negotiated annually.

Contingenciesclassified as having a probable risk of loss, for which provisions are recordedunder liabilities, have the following balances:

**R$ million**

**2005**

**2004**

 

 

 

**Tax**

42.2

33.6

**Civil**

13.3

11.7

**Labor**

16.4

13.6

Total

71.9

59.0

 

***Taxlitigation***

The main taxcontingencies involve the following cases:

a)             Income and social contribution taxes onnet income

Page 73 

Provision forincome and social contribution taxes on net income amounting to R$9.2 million,of which R$6.1 million recorded on the acquisition of the subsidiary GranjaRezende (incorporated in 2002), R$2.2 million on withholding income tax oninvestments of Granja Rezende and R$0.8 million for other provisions.

b)             State VAT (ICMS)

The Company is adefendant in several administrative cases involving ICMS, mainly in the Statesof Sao Paulo, Rio de Janeiro and Amazonas (SUFRAMA), totaling a probablecontingency estimated at R$20.2 million.

c)             Other tax contingencies

Several casesrelated to payment of IOF (Tax on Financial Operations), PIS (SocialIntegration Program Tax), COFINS (Tax for Social Security Financing) and otherstotaling a probable loss of R$12.8 million.

The Company hasother tax contingencies where the claimed amount is R$479.9 million, that wereassessed as possible losses by the Company’s legal counsel and management andtherefore no provision was recorded. 

On November 9, 2005, the Supreme Court declared by a majority of votes that Law 9718/98 wasunconstitutional, which changed the calculation basis of PIS and COFINS,including operating and financial income. This decision affects only thetaxpayers whose actions have been judged, however, this decision indicates thatthe court suits that have the same objective will also be successful. TheCompany has a court suit questioning the increase in the basis, however, it hasbeen calculating and paying these taxes in accordance with the law. If the Companyhad already received a final decision, the credit to be recognized in thefinancial statements would be approximately R$60 million.

***Civillitigation***

The amountprovided represents principally proceedings involving claims forindemnification for losses and damages, including pain and suffering, arisingfrom work-related accidents and consumer relations.

The Company hasother civil contingencies where the claimed amount is R$50.2 million, that wereassessed as possible losses by the Company’s legal counsel and management andtherefore no provision was recorded.

***Laborclaims***

There areapproximately 1,780 labor claims against the Company. These claims are mainlyrelated to overtime, and health exposure or hazard premiums, none of theamounts provided involve a significant amount on an individual basis. The totalamount of such labor claims amount to R$35.9 million and a provision of R$16.4million has been provided in the accompanying financial statements based onhistorical information and represents the Company’s best estimate of theultimate loss that will be incurred.

Dividends and Dividend Policy 

***Payment of Dividends***

In accordancewith Brazilian corporate law, the Company is required to hold an annualshareholders’ meeting by April 30 of each year, during which an annual dividendwill be declared In addition, interim dividends may be declared by the board ofdirectors. According to Brazilian corporate law, dividends must generally bepaid to the holders of the relevant shares within 60 days of the date ofdeclaration of the same dividend, unless a resolution of shareholdersestablishes another date of payment, which in both cases, must

Page 74 

 

occur before the  end of the fiscal year in which the dividend was declared. The Company’s  by-laws require that an annual general shareholders’ meeting be held within  four months of the end of each fiscal year. At this meeting, among other  things, an annual dividend may be declared by decision of the shareholders and  at the recommendation of the executive officers, as approved by the board of  directors. The payment of annual dividends is based on the financial Statements  relating to the fiscal year ending December 31. According to the Company’s  by-laws, dividends will be paid to shareholders within 60 days of the date of  declaration of the dividend, which must be effected before the end of the  fiscal year in which the same dividend was declared. The requirement for  mandatory dividends may be met through payments either in the form of dividends  or of interest on shareholders’ equity. The Company is not required to adjust  the amount of the dividend for inflation for the period from the end of the  last fiscal year to the date of declaration of the same dividend. It is  therefore possible that the amount, expressed in r*eais*, of the dividends  paid to holders of preferred shares or common shares will be reduced due to  inflation. Shareholders have up to three years from the date of payment of the  dividend to demand payment of these as they relate to shares held by the same  party, after which time the Company will be free from any obligation to make  such payments.

Payments of cashdistributions by the Company relating to the preferred shares underlying thepreferred ADRs will be made in Brazilian currency to the custodian, in itscapacity as representative of the depositary, which will then convert suchproceeds into U.S. dollars and will then remit the same U.S. dollars to thedepositary for distribution to holders of the related ADRs (See “Description ofAmerican Depositary Receipts”). Dividends paid toshareholders that are not Brazilian residents, including holders of preferredADRs, are exempt from withholding of Brazilian income tax at source, exceptwith regard to income provisioned before 1996, which is subject to retention of15% in lieu of Brazilian taxation.

Shareholdersthat are not resident within Brazil must register with the Brazilian CentralBank so that the dividends resulting from sales, or other amounts, may beremitted in foreign currency outside Brazil. The preferred shares underlyingthe ADRs are maintained within Brazil by the custodian, which acts as agent forthe depositary, which appears in the Company’s register as the beneficial ownerof the shares.

***Notional InterestCharge Attributed to Shareholders’ Equity***

Braziliancompanies are permitted to pay limited additional amounts to holders of equitysecurities and treat such payments as an expense for Brazilian income taxpurposes. The amount of any such interest payment to holders of equitysecurities is generally limited in respect of any particular year to (i)retained earnings for such year plus 50% of the pre-tax profits for such yearmultiplied by (ii) the *Taxa de Juros de Longo Prazo*interest rate(Long-Term Interest Rate -TJLP), which is the official rate for governmentallong-term loans. The additional payment may take the form of supplementaldividends to shareholders. A 15% withholding tax is payable by the Company upondistribution of the notional interest amount. In 1996, the withholding tax waspayable by the Company and was accrued and charged to income. In 1997, thewithholding tax was paid by the Company on behalf of the shareholders. Suchpayments are also deductible for social contribution purposes.

Under Brazilianlaw, the Company is obliged to distribute to shareholders an amount sufficientto ensure that the net amount received by shareholders after payment by theCompany of Brazilian withholding taxes in respect of the distribution ofnotional interest, is at least equal to the mandatory distribution.

***Mandatory Dividends***

As establishedin its by-laws, Sadia is required to distribute to shareholders in lieu ofdividends relative to each fiscal year ended December 31, an amount of no lessthan 28% of the distributable amount (the mandatory dividend) in any givenfiscal year (an amount of which shall include any interest on shareholders’equity paid). In addition to the mandatory dividend, the board of directors mayrecommend the payment of dividends to shareholders from other legally availableresources, according to the terms of such law. Any payment of interim dividendsor interest on shareholders’ equity will be deducted from the amount of themandatory dividend for the same fiscal year. In accordance with Braziliancorporate law, if the board of directors decides, prior to the annualshareholders’ meeting, that the payment of the mandatory dividends for thepreceding fiscal year is not advisable, due to the financial condition of theCompany, then there will be no 

Page 75 

 

requirement to pay such mandatory dividends.  Such a decision must be reviewed by an audit committee, and reported to  shareholders and to the CVM. If a mandatory dividend is not paid, any retained  earnings must be allocated to a special reserve account. If the Company does  not incur the expected losses that led to the withholding of the mandatory  dividend, then the Company will be required to pay the proper mandatory  dividend.

***Dividend Policy***

The Companycurrently plans to pay dividends or interest on shareholders’ equity on itspreferred and common shares to the amount of the distributions required in anyfiscal year, subject to the determination by the board of directors that suchdistributions are inadvisable due to the financial condition of the Company. Inaccordance with its policy, the Company pays dividends twice a year, althoughthe law does not require it to do so.

***Dividends Distributed***

The following table sets out the grossamount of dividends paid to the Company’s shareholders since 2001 in Braziliancurrency and converted into U.S. dollars at the commercial exchange rate on thedate of payment of the same dividends. 

 

** **

**Gross Historical Dividend Payments**

** **

** **

** **

** **

** **

** **

** **

** **

**Period**

**Description**

**Payment Date**

**R$ per 1,000**

**R$ per 1,000**

**US$ per 1,000**

**US$ per 1,000**

**US$ per 100 ADRs**

**Preferred Shares**

**Common Shares**

**Preferred Shares**

**Common Shares**

**2001**

Interests on  Equity

8/22/2001

32.40

29.40

12.84

11.65

11.00

Interests on  Equity

2/14/2002

89.29

81.18

36.82

33.48

31.33

**2002**

Dividends

8/16/2002

17.60

16.00

5.57

5.06

5.67

Interests on  Equity

2/14/2003

74.71

67.92

20.42

18.57

17.24

Interests on  Equity

2/21/2003

23.97

21.79

6.64

6.03

5.60

**2003**

Interests on  Equity

8/15/2003

71.40

64.90

23.85

21.68

20.14

Interests on  Equity

2/16/2004

156.80

142.54

53.95

49.04

45.16

**2004**

Interests on  Equity

8/17/2004

77.88

70.80

25.97

23.61

21.92

Interests on  Equity

2/16/2005

133.93

121.75

51.66

46.96

43.61

Interests on  Equity

3/14/2005

13.13

11.94

4.77

4.34

4.01

**2005**

Interests on  Equity

8/17/2005

84.90

77.18

36.14

32.85

30.53

Interests on  Equity

2/16/2006

174.52

174.52

82.41

82.41

69.54

Dividends

3/16/2006

39.12

39.12

18.57

18.57

18.39

 

***Calculation ofDistributable Amount***

At each annualgeneral shareholder’s meeting, the board of directors must recommend the mannerof allocation of the Company’s income from the preceding fiscal year. Accordingto Brazilian corporate law, the net income of a company after deduction ofincome tax and social contributions relative to the same fiscal year, and netof any losses accumulated in prior fiscal years, and amounts allocated toemployee and management profit-shares, will represent the net income of theCompany, following (i) the deduction of amounts allocated to the constitutionof the legal reserve, (ii) the deduction of amounts allocated to theconstitution of other reserves, following the principles established by theCompany and in accordance with the applicable legislation (as hereinafterdiscussed), and (iii) the increase by the reversion of reserves constituted inprevious fiscal years. This net income will be available for distribution toshareholders (thus constituting the adjusted net profit, designated here as thedistributable amount) in any fiscal year.

Page 76 

*Legal Reserve*

According toBrazilian corporate law, the Company is required to maintain a legal reserve towhich it must allocate 5% of its net income in each fiscal year, until theamount of this reserve is equal to 20% of the paid-in share capital, or untilthe sum of this reserve and all other capital reserves reaches 30% of thepaid-in share capital. Net losses, if any, may be debited against the legalreserve.

*Discretionary Reserve*

According toBrazilian corporate law, the Company may decide to assign on a discretionarybasis a portion of the net income to the limit established in its by-laws (withsuch reserves collectively designated as discretionary reserves). The Company’sby-laws established a special fund for research and development to which it mayallocate up to 15% of its net income per year, until the amount of this fund isequivalent to 10% of its paid-in share capital.

*Contingency Reserve*

According toBrazilian corporate law, the Company may also decide to assign a portion of thenet income to a contingency reserve against likely losses in future fiscalyears. Any amount thus assigned in a previous year must be (i) reversed in thefiscal year in which the loss was envisaged, if this loss does not effectivelyoccur, or (ii) debited, if the foreseen event actually materializes. At thepresent time, Sadia has no contingency reserve. There are no clearly definedrules on the extension of the future period for which a loss may be foreseenfor the purposes of constituting a contingency reserve. Its determination thusdepends on circumstances and the nature of each particular event, and will bedecided at the discretion of the board of directors.

*Investment Project Reserve*

According toBrazilian corporate law, a portion of the net income may also be assigned forany discretionary appropriations for plant expansions or any other investmentprojects, the amount of which is based on the capital budget previouslypresented by management and approved by shareholders. Following the conclusionof the corresponding investment projects, the Company may withhold the relevantappropriation until the shareholders vote to transfer all or part of thecapital reserve or retained earnings. The Company’s by-laws effective as ofMarch 31, 2000, contains provisions for a special expansion reserve, to whichat least 15% and at most 60% of the net income (formerly 5% and 15%,respectively) must be allocated each year, until the amount of this reserve isequivalent to 70% of its paid-in share capital (from former 30%).

*Unrealized Income Reserve*

According toBrazilian corporate law, if the amount of unrealized income (according to thedefinition below) in any fiscal year exceeds the allocated amount (i) of thelegal reserve, (ii) of the discretionary reserves, (iii) of the contingencyreserve and (iv) of the investment project reserve, the excess amount may beallocated to an unrealized income reserve. Unrealized income in any fiscal yearwill represent the sum (i) of monetary correction of the balance sheet (until1995) during the fiscal year, (ii) income from subsidiaries or associatedcompanies for the fiscal year in question, (iii) income from installment salesto be received after the end of the subsequent fiscal year.

*Fiscal IncentiveInvestment Reserve*

According to theterms of Brazilian tax legislation, a portion of net income may also beassigned to a fiscal incentive investment reserve for amounts corresponding tothe Company’s income tax deductions generated by credits for certaininvestments that are approved by the government. The reserve may only be usedto acquire shares in companies that are developing specific projects that areapproved by the government.

Page 77 

Braziliancorporate law states that all discretionary allocations of net income includingdiscretionary reserves, the contingency reserve, the unrealized income reserveand the investment project reserve, will be subject to approval by shareholdersat the annual meeting, and may be transferred to the Company’s capital or usedto pay dividends in subsequent fiscal years. The fiscal incentive investmentreserve and the legal reserve are also subject to approval by shareholders atthe annual meeting and may be transferred to the Company’s capital, but may notbe used to pay dividends in subsequent fiscal years.

The calculationof the net income of the Company, and the allocations to reserves in any fiscalyear, are determined on the basis of financial statements prepared inaccordance with Brazilian corporate law and Brazilian GAAP, which differs fromthe financial statements prepared in accordance with United States generallyaccepted accounting principles. The financial statements presented herein wereprepared in accordance with U.S. GAAP, and while the allocations to reservesand the dividends are reflected in these consolidated financial statements,investors will not be able to calculate the amounts of these allocations, or ofdividends due, on the basis of the same consolidated financial statements.

B.Significant Changes

No significant change has occurred sincethe date of the annual financial statements included in this annual report.

 
**ITEM 9. THE OFFER AND LISTING**
 

A.Offer and listing details

On December 31, 2005, the Company’s share capital consisted of 257,000,000 common shares and 426,000,000 preferred shares. 

 

Both types of the Company’s shares areregistered shares and are publicly traded in Brazil on the Sao Paulo StockExchange since 1971, under the ticker symbols SDIA3 and SDIA4.

 

In June 2001,the Company adhered to the “Level 1 of Corporate Governance Requirements” inBovespa, certifying its commitment to transparency and fair disclosure ofinformation.  

To become a Level 1 company, anissuer must agree to:

·              ensurethat shares of the issuer representing 25% of its total capital are effectivelyavailable for trading;

·              adoptoffering procedures that favor widespread ownership of shares whenever making apublic offering;

·              complywith minimum quarterly disclosure standards;

·              complywith the disclosure of shareholders agreement and stock options programs;

·              providean annual calendar with corporate events

·              providecash flow statements

·              followstricter disclosure policies with respect to transactions made by controllingshareholders, directors and officers involving securities issued by the issuer;

In April 2001,the Company listed its American Depositary Receipts (ADRs) program on the NewYork Stock Exchange, providing investors an alternate channel to buy itsstocks. Currently, one Sadia ADR [SDA] is equivalent to 10 preferred shares.

Page 78 

The Company’spreferred shares are also traded on the LATIBEX, under the ticker symbol XSDIsince November 2004. The LATIBEX is an electronic market created in 1999 by the  Madrid stock exchange in order to enable trading of Latin American equitysecurities in euro denomination. 

In September2005, due to the improved liquidity of its preferred shares, Sadia became the firstcompany in its segment to be part of the theoretical portfolio of the Sao PauloStock Exchange Index (IBOVESPA). 

In December,2005, with the aim of improving Corporate Governance practices and allow abetter alignment of the interests of shareholders of common and preferredshares, was approved the right, for the preferred shares to be included in apublic offering resulting from the disposal, if any, of the Company’s control(tag along rights), and thus entitle their holders to receive a price equal to80% of the amount paid per common share which is an integral part of thecontrol block.

In 2005, the Company’s preferred shares represented59.5% of the total volume traded among the food sector stocks in Bovespa, witha daily average financial volume of R$12.1 million, which represented a 98%increase as compared to the 2004 financial volume. During the first quarter of2006, Sadia’s preferred shares continued to increase its daily averagefinancial volume, reaching R$20 million.

 

In 2005, Sadia’s ADRs had a daily averagefinancial volume of US$686.9 thousand. The number of shares traded in NYSErepresented 11.5% of the total number of Sadia’s preferred shares traded.During the first quarter of 2006, Sadia’s ADRs also continued to increase itsdaily average financial volume, reaching US$1.6 million, representing 14.5% ofthe total number of Sadia’s preferred shares traded.

 

Price Information

The tables below present, for the indicatedperiods, the minimum and maximum prices for the preferred shares on Bovespa inBrazilian *reais*. 

 

 

 

**Preferred Share Price (R$ per Share)**

 

 

 

 

 

 

**High**

**Low**

**2001**

 

1.43

0.94

**2002**

 

1.36

1.01

**2003**

 

3.98

1.13

**2004**

 

5.98

3.56

**2005**

 

6.90

3.56

 

*Source: Economática*

Page 79 

 

 

 

**Preferred Share Price (R$ per Share)**

 

 

 

 

 

** **

**High**

**Low**

**2004**

 

 

 

First Quarter

 

4.74

3.98

Second Quarter

 

4.33

3.56

Third Quarter

 

5.69

4.05

Fourth Quarter

 

5.98

4.89

**2005**

 

 

 

First Quarter

 

5.95

4.30

Second Quarter

 

4.62

3.56

Third Quarter

 

6.70

4.46

Fourth Quarter

 

6.90

5.02

**2006**

 

 

 

First Quarter

 

7.60

5.64

 

*Source: Economática*

 

 

 

 

**Preferred Share Price (R$ per Share)**

 

 

 

 

 

 

**High**

**Low**

**Dec-05**

 

6.60

5.81

**Jan-06**

 

7.60

6.42

**Feb-06**

 

7.60

6.19

**Mar-06**

 

6.65

5.64

**Apr-06**

 

6.52

5.60

**May-06**

 

6.15

5.40

 

*Source: Economática*

 

 

The tables below present, for the indicatedperiods, the minimum and maximum prices for the Sadia’s ADR on the New YorkStock Exchange in dollars. 

 

 

 

**ADR Share Price (US$ per Share)**

 

 

 

 

** **

 

**High**

**Low**

**2001**

 

5.73

3.58

**2002**

 

5.67

2.66

**2003**

 

13.92

3.18

**2004**

 

22.41

11.35

**2005**

 

30.50

14.45

 

 

 

 

 

*Source: Economática*

Page 80 

 

 

 

**ADR Share Price (US$ per Share)**

 

 

 

 

 

** **

**High**

**Low**

**2004**

 

 

 

First Quarter

 

16.55

13.50

Second Quarter

 

14.40

11.35

Third Quarter

 

19.87

13.20

Fourth Quarter

 

22.41

17.12

**2005**

 

 

 

First Quarter

 

22.02

15.94

Second Quarter

 

19.36

14.45

Third Quarter

 

29.69

18.75

Fourth Quarter

 

30.50

22.11

**2006**

 

 

 

First Quarter

 

34.70

25.42

 

*Source: Economática*

 

 

 

 

**ADR Share Price (US$ per Share)**

 

 

 

 

 

 

**High**

**Low**

**Dec-05**

 

29.25

26.09

**Jan-06**

 

33.60

28.81

**Feb-06**

 

34.70

28.53

**Mar-06**

 

31.64

25.42

**Apr-06**

 

31.20

27.72

**May-06**

 

30.14

23.45

 

**Share Rights**

Sadia’s sharesare entitled to a compulsory minimum dividend of 28% of the net income for theyear, They shall participate equally in capital increases derived from netincome and reserves, revaluation of assets and yearly capital restatement. 

Only common sharesare entitled to vote the resolutions of the General Shareholders Meeting.

Preferred sharesdo not have voting rights, but enjoy the following advantages:

·                priority in theproportional, noncumulative receipt of 28% of the net income for the year, asminimum dividend, competing in equal terms with common shares in any dividendallocated above that percentage;

·            right to be included inthe public offering for the disposal of the shareholding control under theconditions set forth in art. 254-A, with the wording given by Law 10303, dated October31, 2001, which guarantees a price at least equal to 80% of the amount paid percommon share of the integral part of the control block; 

·            priority in capital reimbursementin case of liquidation of the Company.

81

Preferred sharesmay acquire voting rights if the Company fails to pay, for at least threeconsecutive years, the minimum dividend to which they are entitled and suchright shall continue up to the payment of the first next dividend.

Restrictions on Foreign Investment

According toSadia’s Bylaws, 51% of the voting capital of the Company must be held byBrazilian citizens. The right to convert dividend payments and proceeds fromthe sale of preferred shares into foreign currency and to remit such amountsoutside Brazil is subject to exchange control restrictions and foreigninvestment legislation which generally are subject to several mechanisms thatpermits a foreign investor to trade directly in Bovespa. 

Until March2000, this mechanism was known as the Annex IV Regulations, in a reference toAnnex IV of Resolution No. 1,289 of the National Monetary Council (the"Annex IV Regulations"). Currently, this mechanism is regulated byResolution No. 2,689, of January 26, 2000, of the National Monetary Council andby Instruction No. 325, of January 27, 2000, of the CVM, as amended (the"2,689 Regulation"). The 2,689 Regulation, which became effective on March 31, 2000, sets forth new rules concerning foreign portfolio investments in Brazil. 

Foreigninvestments registered under Annex IV Regulations had to be conformed to the2,689 Regulation by September 30, 2000. Such rules allow foreign investors toinvest in almost all of the financial assets and to engage in almost alltransactions available in the Brazilian financial and capital markets, if somerequirements are fulfilled.

In accordancewith the 2,689 Regulation, foreign investors are individuals, legal entities,mutual funds and other collective investments resident, domiciled orheadquartered abroad. The 2,689 Regulation prohibits the offshore transfer orassignment of the title of the securities, except in the cases of (i) corporatereorganization effected abroad by a foreign investor or (ii) inheritance. 

Pursuant to the2,689 Regulation, foreign investors must: (i) appoint at least onerepresentative in Brazil with powers to perform actions relating to the foreigninvestment; (ii) fill in the appropriate foreign investor registration form;(iii) obtain registration as a foreign investor with CVM; and (iv) register theforeign investment with the Central Bank.

The securitiesand other financial assets held by the foreign investor pursuant to the 2,689Regulation must be registered or maintained in deposit accounts or under thecustody of an entity duly licensed by the Central Bank or by the CVM or beregistered in register, clearing and custody systems authorized by the CentralBank or by the CVM. In addition, securities trading is restricted totransactions carried out in exchanges or organized over-the-counter marketslicensed by the CVM.

All investmentsmade by a foreign investor under the 2,689 Regulation will be subject to anelectronic registration with the Central Bank. Resolution No. 1,927 of theNational Monetary Council, which is the Amended and Restated Annex V toResolution No. 1,289 (the "Annex V Regulations"), provides for theissuance of depositary receipts in foreign markets in respect of shares ofBrazilian issuers. The ADSs have been approved under the Annex V Regulations bythe Central Bank and the CVM. Accordingly, the proceeds from the sale of theADSs by ADR holders outside Brazil are free of Brazilian foreign investmentcontrols and holders of the ADSs will be entitled to favorable tax treatment.According to the 2,689 Regulation, foreign investments registered under Annex VRegulations may be transferred to the new investment system created byResolution No. 2,689 and vice-versa, with due regard to the conditions setforth by the Central Bank and by the CVM.

Payments ofdividends and other cash distributions by the Company relating to the preferredshares underlying the Preferred ADRs will be made in Brazilian currency to thecustodian, in its capacity as representative of the depositary, which will thenconvert such proceeds into U.S. dollars and will then remit such U.S. dollarsto the depositary for distribution to holders of the related preferred ADSs. Ifthe custodian is not immediately able to convert the dividends in Braziliancurrency to U.S. dollars, then the holders of the
82

 preferred ADSs may beadversely affected by devaluation or other fluctuations in exchange rates,before it is possible to convert and remit these dividends. Fluctuations in theexchange rate between the *real* and the U.S. dollar may also affect thevalue in U.S. dollars, equivalent to the price in *reais*, of thepreferred shares traded on Brazilian stock exchanges.

** **

As of December 31, 2005 there were approximately 6 U.S. beneficial owners of the ADSs (based ontheir addresses only), representing approximately 4.1 % of the total preferredshares**.**

B. Plan of Distribution

**NotApplicable.**

C. Markets 

Trading on the Brazilian Stock Exchanges

Of Brazil's stock exchanges, *Bovespa* has beenthe most significant in recent years. During 2005, the Bovespa accounted foralmost the total of the trading value negotiated in Brazil. 

Bovespa is a non-profit entity owned by its memberbrokerage firms. Trading on Bovespa is limited to member brokerage firms and alimited number of authorized non-members. Trading is conducted between 10:00 a.m. and 5:00 p.m. on the automated system. There is also trading in the so-calledafter-market from 5:45 p.m. to 7:00 p.m. Only shares that were traded duringthe regular trading session of the day may be traded in the after-market of thesame day. 

There are no specialists or market makers for theCompany's shares on Bovespa. The CVM and Bovespa have discretionary authorityto suspend trading in shares of a particular issuer under certaincircumstances. Trading in securities listed on Bovespa may be effected off theexchange under certain circumstances, although such trading is very limited.

In December 2005, the aggregate market capitalizationof the companies listed on Bovespa Index was approximately US$ 359.4 billion.Although any of the outstanding shares of a listed company may trade onBovespa, in most cases less than half of the listed shares are actuallyavailable for trading by the public, the remainder being held by small groupsof controlling persons that rarely trade their shares. For this reason, datashowing the total market capitalization of Bovespa tend to overstate theliquidity of the Brazilian equity securities market. The Brazilian equitysecurities market is relatively small and illiquid compared to major worldmarkets.

Settlement of transactions is effected three businessdays after the trade date without adjustment of the purchase price forinflation. Payment for shares is made through the facilities of a separateclearinghouse, named *Companhia Brasileira de Liquidaçao e Custódia*(CBLC),which maintains accounts for member brokerage firms. The seller is ordinarilyrequired to deliver the shares to the exchange on the second business dayfollowing the trade date. The CBLC is controlled by clearing agents, such asmember brokerage firms and banks, and Bovespa.

According to Bovespa, international investorsare allowed to hold any asset class available to domestic investors in Brazil. 

According to the CMN(Brazilian Monetary Council) Resolution 2,689, since international investorsare not established or resident in the country, it is necessary to hire aninstitution to act as: 

·                Legal Representative,who will responsible to present all the registration information of theinvestor to the Brazilian authorities. When the representative is an individualor a non-financial
83

corporation, the investor must indicate a financialinstitution duly authorized by the Central Bank that will be jointly andseverally responsible for the representative's obligation. 

·                Fiscal Representative,who will be responsible for taxes and fiscal issues on behalf of the investorbefore the Brazilian Authorities. 

·                Custodian, who will beresponsible to hold updated reports and control all the assets of theinternational investor in segregated accounts, and provide this informationanytime it is required, to the Authorities and to the investor. 

The financial assets andsecurities traded as well as other forms of financial applications must beregistered, held in custody or maintained in deposit accounts at anappropriated authorized institution authorized by the CVM or Central Bank. 

International investments inequity instruments are tax exempt on capital gains and on CPMF. Investmentsfrom countries that do not tax income or where tax rates are lower than 20% aretaxed as domestic investors. There is no minimum permanence period requirementfor the investments in Brazil.

More information can be foundon the Bovespa website: http://www.bovespa.com.br.

***Regulation of BrazilianSecurities Markets*********The Brazilian securities markets are regulated by theCVM, which has authority over stock exchanges and the securities markets ingeneral, and by the Brazilian Central Bank, which has, among other powers, licensingauthority over brokerage firms and regulates foreign investment and foreignexchange transactions. The Brazilian securities market is governed by Law no.6,385 dated December 7, 1976, as amended (Brazilian securities law) and theBrazilian corporate law (Law no. 6,404 dated December 15, 1976, as amended)(Brazilian corporate law).

Law 10,303 of October 31, 2001, amended Law ns 6,385/76 and Law ns 6,404/76. The most important changes were (i) the conversion of CVMinto an autonomous governmental agency linked to the Ministry of Finance, withlegal independence and separate assets and liabilities; (ii) the requirement ofgreater disclosure by listed companies; (iii) the tag-along right to minoritycommon shareholders in the event of change in control of a listed company; (iv)the right of preferred shareholders with non-voting rights or restricted votingrights representing at least 10% of the total stock of a listed company toelect one board member and his alternate; (v) the right of the minority commonshareholders to also elect one board member; and (vi) the preferred shares willonly be traded in the stock market if they have at least one of the rightsmentioned below: (a) priority in the receipt of dividends corresponding to atleast 3% of the shares’ net worth based on the last approved balance sheet ofthe company; (b) the right to receive dividends at least 10% higher than thedividend assigned to each common share; or (c) the tag-along right in the eventof change in the control of the company. 

Under the Brazilian corporatelaw, a company is either listed, a *companhia aberta*, such as theCompany, or private, a *companhia fechada*. All listed companies areregistered with the CVM and are subject to reporting requirements. A companyregistered with the CVM may have its securities traded either on Bovespa or inthe Brazilian over-the-counter markets (Brazilian OTC). The shares of a listedcompany, including the Company, may also be traded privately subject to certainlimitations.

There are certain cases in which the disclosure ofinformation to the CVM, Bovespa, or even to the public is required. Theseinclude (i) the direct or indirect acquisition by an investor of at least 5%(five percent) of any class or type of shares representing the capital stock ofa listed company, (ii) the sale of shares which represents the transfer ofcontrol of a listed company and (iii) the occurrence of a material event to thecorporation.

CVM issued Instruction Ns 361, of March 5, 2002, whichregulates tender offers mainly when the following events occur: (i) delistingof public companies; (ii) increase in the equity interest by the controllingshareholder; and (iii) transfer of control of a public company.

84

To be listed on Bovespa, a company must apply forregistration with the CVM and Bovespa. Once this exchange has admitted acompany to listing and the CVM has accepted its registration as a listedcompany, its securities may be traded in Bovespa, as long as the companycomplies with the minimum requirements of this exchange.

The Brazilian OTC consists of direct trades betweenindividuals in which a financial institution registered with the CVM serves asintermediary. No special application, other than registration with the CVM, isnecessary for securities of a listed company to be traded in the Brazilian OTC.The CVM requires that it be given notice of all trades carried out in theBrazilian OTC by the respective intermediaries.

Trading in securities on Bovespa may be suspended atthe request of a company in anticipation of the announcement of a materialevent. Trading may also be suspended on the initiative of the exchange or theCVM, among other reasons, based on or due to a belief that a company hasprovided inadequate information regarding a material event or has providedinadequate responses to the inquiries by the CVM or the exchange.

The Brazilian securitiesmarkets are governed principally by Brazilian securities law, by Braziliancorporate law and by regulations issued by the CVM and the *ConselhoMonetário Nacional* (National Monetary Council). These laws and regulations,among others, provide for disclosure requirements, restrictions on insidertrading and price manipulation, and protection of minority shareholders.Although many changes and improvements have been introduced, the Braziliansecurities markets are not as highly regulated and supervised as the U.S. securities markets or markets in certain other jurisdictions.

D. Selling Shareholders

Not Applicable.

E. Dilution

Not Applicable.

F. Expenses of Issue

Not Applicable.
**ITEM 10. additionalINFORMATION**
 

A. Share capital

Not applicable.

** **

B. Memorandum and Articles ofAssociation

The information required forthis item was included in the Registration Statement on Form 20-F filed onMarch 17, 2001 (Commission file number 0-31072).

                

C. Material Contracts

Not applicable.

85

D. Exchange Controls

 

Before March 2005, there were two legalforeign exchange markets in Brazil, the Commercial Market and the FloatingMarket. The Commercial Market was reserved primarily for foreign tradetransactions and transactions that generally require previous approval fromBrazilian monetary authorities, such as the purchase and sale of registeredinvestments by foreign individuals and related remittances of funds overseas.The Commercial Rate was the commercial exchange rate for Brazilian currencyinto U.S. dollars as reported by the Central Bank. The Floating Rate was theprevailing exchange rate for Brazilian currency into U.S. dollars, and wasapplicable to transactions to which the Commercial Rate did not apply. 

 

Through  Resolution 3,265 of March 4, 2005(which took effect on March 14, 2005), the National Monetary Council introduceda single foreign exchange market and abolished the legal differences betweenthe referred Commercial and Floating Markets. Among the modifications toforeign exchange market rules is a greater freedom to remit funds abroadthrough the foreign exchange market. On the other hand, the so-called“CC5-Accounts”, which are bank accounts in *reais* held in Brazil by foreign entities, may no longer be used to transfer funds on behalf of thirdparties.

 

The Company will make all cashdistributions on Preferred Shares in *reais* and consequently exchangerate fluctuations may affect the U.S. dollar amounts received by the holders ofPreferred ADRs on conversion by the Depositary. Fluctuations in the U.S.dollar/*real*exchange rate may also affect the U.S. dollar equivalent ofthe Preferred Share price in *reais* on the Brazilian stock exchanges.

 

E. Taxation

 

The following summary contains adescription of the principal Brazilian and U.S. federal income tax consequencesof the ownership and disposition of a preferred share and a preferred ADR. Itdoes not purport to be a comprehensive description of all the taxconsiderations that may be relevant to a decision to purchase those securities.In particular, this summary deals only with holders that will hold preferredshares or preferred ADRs as capital assets and does not address the taxtreatment of a holder that may be subject to special tax rules, like a bank, aninsurance company, a dealer in securities, a person that will hold preferredshares or preferred ADRs in a hedging transaction or as a position in astraddle or conversion transaction for tax purposes, a person that has afunctional currency other than the U.S. dollar, a person liable for alternativeminimum tax, a partnership (or other entity treated as a partnership for U.S.federal income tax purposes) or a person that owns or is treated as owning 10%or more of the voting shares of the company. Each prospective purchaser of apreferred share or preferred ADR should consult his own tax advisers as to thepersonal tax consequences of his investment, which may vary for investors indifferent tax situations.

 

The summary is based upon tax laws of Brazil and the United States and applicable regulations, judicial decisions andadministrative pronouncements as in effect on the date hereof. Thoseauthorities are subject to change or new interpretations, possibly withretroactive effect. Although there is no income tax treaty between Brazil and the United States at this time, the tax authorities of the two countries havehad discussions that may culminate in a treaty. No assurance can be given,however, as to whether or when a treaty will enter into force or how it willaffect the U.S. holders of preferred shares or preferred ADRs. This summary isalso based upon the representations of the depositary and on the assumptionthat each obligation in the deposit agreement relating to the preferred ADRsand any related documents will be performed in accordance with its terms.

 

** **

**Brazilian Tax Considerations**

 

The following discussionsummarizes the material Brazilian tax consequences of the acquisition,ownership and disposition of preferred shares or preferred ADSs by a holderthat is not domiciled in Brazil for purposes of Brazilian taxation and, in thecase of a holder of preferred shares which has registered its investment insuch securities with the Central Bank as a U.S. dollar investment (in eachcase, a non-Brazilian holder). The following discussion does not specificallyaddress all of the Brazilian tax considerations applicable to any particularnon-Brazilian
86

holder, and each non-Brazilian holder should consult his or herown tax advisor concerning the Brazilian tax consequences of an investment inany of such securities.

 

***Taxation of Dividend***

 

Dividends paid with respect to incomeearned since January 1, 1996, including dividends paid in kind (i) to thedepositary in respect of the preferred shares underlying the preferred ADSs or(ii) to a non-Brazilian holder in respect of preferred shares, are not subjectto any withholding tax in Brazil. The current tax legislation eliminated thethen existing 15% withholding tax on dividends paid to companies, residentindividuals or non-residents in Brazil. Accordingly, dividends with respect toprofits generated on or after January 1, 1996 are not subject to withholdingtax in Brazil. Dividends related to profits generated until December 31, 1993 will be subject to Brazilian withholding tax of 25%. Dividends related to profitsgenerated between January 1, 1994 and December 31, 1995 will be subject toBrazilian withholding tax of 15%, ifdistributed expenses on dividends paid as interest on equity, are neitherdeductible from the calculation basis of corporate income tax nor from thesocial contribution on income.

 

***Taxation of Gains***

 

Gains realized outside Brazil, until December 31st, 2003, by a non-Brazilian holder on the dispositionof Preferred ADSs to another non-Brazilian holder are not subject to Braziliantax. From January 1st, 2004 on, investments made in permanent assetsby non resident are subject to the payment of income tax over capital gains.The gain will be charged at a 15% or 25% rate if the beneficiary is a tax havencountry resident or from on any jurisdiction where taxing rates are below 20%.The taxable capital gain is calculated on the difference from the selling valueof the asset and the declared value to Brazilian Central Bank (in foreigncurrency) by the time of registration. As of January 1, 2005 operations of stock, mercantile and future exchange are subjected to a withholding tax at arate of 0,005% according to Law nr. 11,033 of December 21, 2004. This value is deductible from withholding tax paid upon capital gains. Pursuant the sameact stock operations held by an individual with a monthly value up to R$ 20,000will be exempt of the withholding tax.

 

The withdrawal of preferred shares inexchange for Preferred ADSs is not subject to Brazilian tax. The deposit ofpreferred shares in exchange for Preferred ADSs is not subject to Brazilian taxif the preferred shares are registered by the investor or its agent under the2,689 Regulation. In the event the preferred shares are not so registered, thedeposit of preferred shares in exchange for Preferred ADSs may be subject toBrazilian tax at the rate of 15% or 25%. On receipt of the underlying preferredshares, a non-Brazilian holder who qualifies under the 2,689 Regulation will beentitled to register the U.S. dollar value of such shares with the Central Bankas described below.

 

Non-Brazilian holders are subject to tax in  Brazil on gains realized on sales of preferred shares that occur abroad or onthe proceeds of a redemption of, or a liquidating distribution with respect to,preferred shares. When the preferred shares are registered under the 2,689Regulation, the non-Brazilian holder cannot transfer or assign them abroad. Asa general rule, non-Brazilian holders are subject to a withholding tax imposedat a rate of 15% or 25% on gains realized on sales or exchanges of preferredshares that occur in Brazil to or with a resident of Brazil, outside ofBovespa. From January 2004, on this taxation is also applicable to gains accruedin transactions conducted by non-Brazilian holders. Non-Brazilian holders aresubject to withholding tax at the rate of 20% on gains realized on sales orexchanges in Brazil of preferred shares that occur on Bovespa unless such saleis made under the 2,689 Regulation. Gains realized arising from transactions onBovespa by an investor under the 2,689 Regulation are not subject to tax(except as described below). The gain realized as a result of a transaction onBovespa is the difference between the amount in Brazilian currency realized onthe sale or exchange and the acquisition cost measured in Brazilian currency,without any correction for inflation, of the shares sold. The gain realized asa result of a transaction that occurs other than on Bovespa will be thepositive difference between the amount realized on the sale or exchange and theacquisition cost of the preferred shares, both such values to be taken intoaccount in *reais.*There are grounds, however, to hold that the gainrealized should be calculated based on the foreign currency amount registeredwith the Central Bank. There can be no assurance that the current preferentialtreatment for holders of preferred ADSs and for certain non-Brazilian holdersof preferred shares under the 2,689
87

Regulation will continue in the future orthat such treatment will not be changed in the future. As of January 1, 2000,the preferential treatment under the 2,689 Regulation is no longer applicableif the non-Brazilian holder of the preferred ADSs or preferred shares isresident of a tax haven, *i.e*., countries which do not impose income taxor where such tax is imposed at a rate lower than 20% in accordance with LawNo. 9,959, of January 27, 2000. In other words, gains realized by such holderon the sale or exchange in Brazil that occur in the spot market of sharestraded on a Brazilian stock exchange will be taxed at a rate of 20%. Anyexercise of preemptive rights relating to the preferred shares will not besubject to Brazilian taxation. Any gain on the sale or assignment of preemptiverights relating to the preferred shares by the depositary on behalf of holdersof preferred ADSs will be subject to Brazilian income taxation at the rate of15% or 25%, unless such sale or assignment is performed within Bovespa, andwith the investments registered under 2,689 Resolution or Annex V from CentralBank, in which the gains are exempt from withholding income tax. Any gain onthe sale or assignment of preemptive rights relating to preferred shares, willbe subject to Brazilian income tax at the same rate applicable to the sale ordisposition of preferred shares. The maximum rate of such tax is currently 15%,except for non-resident holders domiciled in tax haven countries, where ratesare 25%.

 

***Notional Interest Charge Attributedto Shareholder's Equity***

Distributions of interest onequity in respect of the preferred shares as an alternative form of payment toshareholders who are either Brazilian residents or non-Brazilian residents,including holders of ADSs, are subject to Brazilian withholding tax at the rateof 15%. In case the non-Brazilian resident is a tax haven country resident oris under the jurisdiction of a region where tax rate is below 20%, he will beentitled to pay a rate of 25%. Since 1996, such payments have been taxdeductible by the Company. Since 1997, the payments have also been deductiblein determining social contributions and income tax by the Company as long asthe payment of a distribution of interest is approved at the Company’s generalmeeting. The board of directors of the Company alone may determine thedistribution of interest on shareholders’ equity. No assurance can be giventhat the board of directors of the Company will not determine that futuredistributions of profits be made by means of interest on shareholders’ equityinstead of by means of dividends.

***Other Brazilian Taxes***

There are no Brazilianinheritance, gift or succession taxes applicable to the ownership, transfer ordisposition of preferred shares or preferred ADSs by a non-Brazilian holderexcept for gift and inheritance taxes which are levied by some States of Brazilon gifts made or inheritances bestowed by individuals or entities not residentor domiciled in Brazil or domiciled within the state to individuals or entitiesresident or domiciled within such state in Brazil. There are no Brazilianstamps, issue, registration or similar taxes or duties payable by holders ofpreferred shares or preferred ADSs.

Pursuant to Decree number,2,219 of May 2, 1997, and Ordinance no. 5 of January 21, 1999, issued by theMinistry of Finance, the amount in *reais* resulting from the conversionof the proceeds received by a Brazilian entity from a foreign investment in theBrazilian securities market (including those in connection with the investmentin the preferred shares or preferred ADSs and those made under Regulation nr.2,689, which substituted Annex IV Regulations) is subject to a financialtransaction tax (IOF), although at present the rate of such tax is 0%. TheMinister of Finance is empowered to establish the applicable IOF tax rate.Under Law nr 8,894 of June 21, 1994, such IOF tax rate may be increased at anytime to a maximum of 25%, but any such increase will only be applicable totransactions occurring after such increase becomes effective.

Pursuant to Law number, 9,311of October 24, 1996, the *Contribuiçao Provisória sobre MovimentaçaoFinanceira* (CPMF) was levied at a rate of 0.2% on fund transfers inconnection with financial transactions in Brazil. Pursuant to Law 9,539, theCPMF tax was payable until February 1999. Pursuant to Constitutional Amendment21, of March 18, 1999, the collection of the CPMF was extended for anadditional period of 36 months. Thispayment of the CPMF tax was required as of June 17, 1999. The CPMF tax rate was 0.38% during the first 12 months, and would be 0.30% for the remainingperiod. But in December 2000, Constitutional Amendment number 31 increased therate to 0.38% as of March 2001. By May 28, 2002, Constitutional Amendment number 37 determined that CPMF must be charged until December 31, 2004. Finally, the Constitutional Amendment number 42, approved in 2003, extended the CPMF taxuntil December 31, 2007. 

88

 

The responsibility for the collection ofthe CPMF tax is borne by the financial institution that carries out therelevant financial transaction. Additionally, when the non-Brazilian holderremitted the proceeds from the sale or assignment of preferred shares by meansof foreign exchange transactions, the CPMF tax was levied on the amount to be remittedabroad in Brazilian r*eais*. However, since April, 2002 this tax has notbeen charged on stock transactions. If it is necessary to perform any exchangetransaction in connection with Preferred ADSs or preferred shares, it will bearthe CPMF tax.

***Registered Capital***

The amount of an investment inpreferred shares held by a non-Brazilian holder who qualifies and registeredwith the CVM under the Annex IV Regulations which was converted into Annex of2,689 Resolution as of June 2000, or in ADSs held by the depositaryrepresenting such holder, as the case may be, is eligible for registration withthe Central Bank; such registration (the amount so registered is referred to asRegistered Capital) allows the remittance abroad of foreign currency, convertedat the commercial exchange rate, acquired with the proceeds of distributionson, and amounts realized with respect to disposition of, such preferred shares.The registered capital for preferred shares purchased in the form of apreferred ADSs, or purchased in Brazil and deposited with the depositary inexchange for a preferred ADS, will be equal to their purchase price (in U.S.dollars) paid by the purchaser. The Registered Capital for preferred sharesthat are withdrawn upon surrender of preferred ADSs, will be the U.S. dollarequivalent of (i) the average price of the preferred shares on the Brazilianstock exchange on which the greatest number of such preferred shares was soldon the day of withdrawal, or (ii) if no preferred shares were sold on such day,the average price of preferred shares that were sold in the fifteen tradingsessions immediately preceding such withdrawal. The U.S. dollar value of thepreferred shares is determined on the basis of the average commercial exchangerate quoted by the Central Bank on such date (or, if the average price ofpreferred shares is determined under clause (ii) of the preceding sentence, theaverage of such average quoted rates on the same fifteen dates used todetermine the average price of the preferred shares).

A non-Brazilian holder ofpreferred shares may experience delays in effecting the registration ofregistered capital, which may delay remittances abroad. Such a delay mayadversely affect the amount, in U.S. dollars, received by the non-Brazilianholder. 

**United States****Tax Considerations**

**                *USFederal Income Tax Considerations***

As used below, a“U.S. holder” is a beneficial owner of a Preferred Share or Preferred ADR thatis, for U.S. federal income tax purposes, (i) a citizen or resident alienindividual of the United States, (ii) a corporation (or an entity treated as acorporation) organized under the law of the United States, any State thereof orthe District of Columbia, (iii) an estate, the income of which is subject toU.S. federal income tax without regard to its source, or (iv) a trust if (1) acourt within the United States is able to exercise primary supervision over theadministration of the trust, and one or more United States persons have theauthority to control all substantial decisions of the trust, or (2) the trustwas in existence on August 20, 1996 and properly elected to continue to betreated as a United States person. For purposes of this discussion, a “non-USholder” is a beneficial owner of a Preferred Share or Preferred ADR that is (i)a nonresident alien individual, (ii) a corporation (or an entity treated as acorporation) created or organized in or under the law of a country other thanthe United States or a political subdivision thereof or (iii) an estate ortrust that is not a U.S. holder. If a partnership (including for this purposeany entity treated as a partnership for U.S. federal tax purposes) is abeneficial owner of a Preferred Share or Preferred ADR, the U.S. federal tax treatment of a partner in the partnership generally will depend on thestatus of the partner and the activities of the partnership. A holder of aPreferred Share or Preferred ADR that is a partnership and partners in thatpartnership should consult their own tax advisers regarding the U.S. federal income tax consequences of holding and disposing of Preferred Shares orPreferred ADRs.

89

***Nature of Preferred ADRs for U.S. Federal Income Tax Purposes***

In general, for U.S. federal income tax purposes, a holder of a Preferred ADR will be treated as the ownerof the underlying Preferred Shares. Accordingly, except as specifically notedbelow, the tax consequences discussed below with respect to Preferred ADRs willbe the same for Preferred Shares in the Company, and exchanges of PreferredShares for Preferred ADRs, and Preferred ADRs for Preferred Shares, generallywill not be subject to U.S. federal income tax.

***Taxation of Dividends***

U.S. holders: In general, subject to the passiveforeign investment company rules discussed below, a distribution on a PreferredADR (including for this purpose a distribution of interest on shareholders’equity) will constitute a dividend for U.S. federal income tax purposes to theextent that it is made from the Company’s current or accumulated earnings andprofits as determined under U.S. federal income tax principles. If adistribution exceeds the Company’s current and accumulated earnings andprofits, it will be treated as a non-taxable reduction of basis to the extentof the U.S. holder's tax basis in the Preferred ADR on which it is paid, and tothe extent it exceeds that basis it will be treated as a capital gain. Forpurposes of this discussion, the term “dividend” means a distribution thatconstitutes a dividend for U.S. federal income tax purposes.

The gross amountof any dividend on a Preferred ADR (which will include the amount of anyBrazilian taxes withheld) will be subject to U.S. federal income tax as foreignsource dividend income. The amount of a dividend paid in Brazilian currencywill be its value in U.S. dollars based on the prevailing spot market exchangerate in effect on the day that the U.S. holder receives the dividend or, in thecase of a dividend received in respect of a Preferred ADR, on the date theDepositary receives it, whether or not the dividend is converted into U.S.dollars. Any gain or loss realized on a conversion or other disposition of theBrazilian currency generally will be treated as U.S. source ordinary income orloss. Any Brazilian withholding tax will be treated as a foreign income taxeligible for credit against a U.S. holder’s U.S. federal income tax liability,subject to generally applicable limitations under U.S. federal income tax law.For purposes of computing those limitations separately under current law forspecific categories of income, a dividend generally will constitute foreignsource “passive income” or, in the case of certain holders, “financial servicesincome” for purposes of the current foreign tax credit limitation rules. Fortaxable years beginning after December 31, 2006, “passive income” generallywill be treated as “passive category income,” and “financial services income”generally will be treated as “general category income.” A U.S. holder will bedenied a foreign tax credit with respect to Brazilian income tax withheld fromdividends received with respect to the underlying Preferred Shares representedby the Preferred ADRs to the extent the U.S. holder has not held the PreferredADRs for at least 16 days of the 30-day period beginning on the date which is15 days before the ex-dividend date or to the extent the U.S. holder is underan obligation to make related payments with respect to substantially similar orrelated property. Any days during which a U.S. holder has substantiallydiminished its risk of loss on the Preferred ADRs are not counted towardmeeting the 16-day holding period required by the statute. The rules relatingto the determination of the foreign tax credit are complex, and you shouldconsult with your own tax advisers to determine whether and to what extent youwould be entitled to this credit. You should consult your tax adviser withrespect to the determination of the foreign tax credit limitation, as therelevant rules are complex and are scheduled to change in future years.Alternatively, any Brazilian withholding tax may be taken as a deductionagainst taxable income, provided the U.S. holder takes a deduction and not acredit for all foreign incme taxes paid or accrued in the same taxable year. Adividend will not be eligible for the corporate dividends received deduction.

Subject tocertain exceptions for short-term and hedged positions, any dividend that anindividual receives on a Preferred ADR in a taxable year beginning before January 1, 2011 will be subject to a maximum tax rate of 15% if the dividend is a “qualifieddividend.” A dividend on a Preferred ADR will be a qualified dividend if (i)the Preferred ADRs are readily tradable on an established securities market inthe United States, and (ii) the Company was not, in the year prior to the yearthe dividend was paid, and is not, in the year the dividend is paid, a passiveforeign investment company (“PFIC”). The Preferred ADRs are listed on the NewYork Stock Exchange and will qualify as readily tradable on an establishedsecurities market in the United States so long as they are so listed. Based onexisting guidance, it is not entirely clear whether a
90

dividend on a PreferredShare will be treated as a qualified dividend, because the Preferred Sharesthemselves are not listed on a U.S. exchange. Based on the Company's auditedfinancial statements and relevant market and shareholder data, the Company doesnot believe that it was a PFIC for U.S. federal income tax purposes for its2004 or 2005 taxable year. The U.S. Treasury has announced its intention topromulgate rules pursuant to which holders of stock of non-U.S. corporations,and intermediaries through whom the stock is held, will be permitted to rely oncertifications from issuers to establish that dividends are treated asqualified dividends. Because those procedures have not yet been issued, it isnot clear whether the Company will be able to comply with them. Speciallimitations on foreign tax credits apply to dividends subject to the reducedrate of tax.  Holders of Preferred ADRs should consult their own tax advisersregarding the availability of the reduced dividend tax rate in the light oftheir own particular circumstances.

Non-U.S.holders: A dividend paidto a non-U.S. holder on a Preferred ADR will not be subject to U.S. federalincome tax unless the dividend is effectively connected with the conduct oftrade or business by the non-U.S. holder within the United States (and isattributable to a permanent establishment or fixed base the non-U.S. holdermaintains in the United States if an applicable income tax treaty so requiresas a condition for the non-U.S. holder to be subject to U.S. taxation on a netincome basis on income from the Preferred ADR). A non-U.S. holder generallywill be subject to tax on an effectively connected dividend in the same manneras a U.S. holder. A corporate non-U.S. holder may also be subject under certaincircumstances to an additional “branch profits tax,” the rate of which may bereduced pursuant to an applicable income tax treaty. 

***Taxation of Capital Gains***

U.S. holders. Subject to the passive foreign investment companyrules discussed below, on a sale or other taxable disposition of a PreferredADR, a U.S. holder will recognize capital gain or loss in an amount equal tothe difference between the U.S. holder's adjusted basis in the Preferred ADRand the amount realized on the sale or other disposition, each determined inU.S. dollars. Any gain a U.S. holder recognizes generally will be U.S. source income for U.S. foreign tax credit purposes, and, subject to certain exceptions,any loss will generally be a U.S. source loss. If a Brazilian tax is withheldon a sale or other disposition of a Preferred Share, the amount realized willinclude the gross amount of the proceeds of that sale or disposition beforededuction of the Brazilian tax. The generally applicable limitations under U.S. federal income tax law on crediting foreign income taxes may preclude a U.S. holder from obtaining a foreign tax credit for any Brazilian tax withheld on a sale ofa Preferred Share.

In general, anyadjusted net capital gain of an individual in a taxable year beginning before January 1, 2011 is subject to a maximum tax rate of 15%. In subsequent years, the maximumtax rate on the net capital gain of an individual will be 20%. The deductibilityof capital losses is subject to limitations.

Non-U.S.holders. A non-U.S. holderwill not be subject to U.S. federal income tax on a gain recognized on a saleor other disposition of a Preferred ADR unless (i) the gain is effectivelyconnected with the conduct of trade or business by the non-U.S. holder withinthe United States (and is attributable to a permanent establishment or fixedbase that the non-U.S. holder maintains in the United States if an applicableincome tax treaty so requires as a condition for the non-U.S. holder to besubject to U.S. taxation on a net income basis on income from the PreferredADR), or (ii) in the case of a non-U.S. holder who is an individual, the holderis present in the United States for 183 or more days in the taxable year of thesale or other disposition and certain other conditions apply. Any effectivelyconnected gain of a corporate non-U.S. holder may also be subject under certaincircumstances to an additional “branch profits tax”, the rate of which may bereduced pursuant to an applicable income tax treaty.

***Passive Foreign Investment Company Rules***

A special set of  U.S. federal income tax rules applies to a foreign corporation that is a PFICfor U.S. federal income tax purposes. As noted above, based on the Company'saudited financial statements and relevant market and shareholder data, theCompany believes it was not a PFIC for U.S. federal income tax purposes for its2004 or 2005 taxable year. However, because the determination of whether theCompany is a PFIC is based upon the composition of its income and assets fromtime to time, it is possible that the Company will become a PFIC for any futuretaxable year. 

91

The PFIC rulesare designed generally to eliminate any benefits of deferral of U.S. federal income tax that a U.S. holder could derive from investing in a corporationthat is organized outside the United States (a “foreign corporation”). Ingeneral, a foreign corporation is a PFIC if at least 75% of its gross incomefor the taxable year is passive income or if at least 50% of its assets for thetaxable year produce passive income or are held for the production of passiveincome. In general, passive income for this purpose means, with certaindesignated exceptions, dividends, interest, rents, royalties (other thancertain rents and royalties derived in the active conduct of trade orbusiness), annuities, net gains from dispositions of certain assets, netforeign currency gains, income equivalent to interest, income from notionalprincipal contracts and payments in lieu of dividends. The determination ofwhether a foreign corporation is a PFIC is a factual determination madeannually and is therefore subject to change. Subject to certain exceptionspursuant to certain elections that generally require the payment of tax, oncestock in a foreign corporation is stock in a PFIC in the hands of a particularshareholder that is a United States person, it remains stock in a PFIC in thehands of that shareholder. 

If the Companyis treated as a PFIC, contrary to the tax consequences described in “U.S.Federal Income Tax Considerations - Taxation of Dividends” and “U.S. FederalIncome Tax Considerations - Taxation of Capital Gains” above, a U.S. holderthat does not make an election described in the next two paragraphs would besubject to special rules with respect to (i) any gain realized on a sale orother disposition of a Preferred ADR and (ii) any “excess distribution” by theCompany to the U.S. holder (generally, any distribution during a taxable yearin which distributions to the U.S. holder on the Preferred ADR exceed 125% ofthe average annual taxable distributions that the U.S. holder received on thePreferred ADR during the preceding three taxable years or, if shorter, the U.S.holder’s holding period for the Preferred ADR). Under those rules, (i) the gainor excess distribution would be allocated ratably over the U.S. holder'sholding period for the Preferred ADR, (ii) the amount allocated to the taxableyear in which the gain or excess distribution is realized would be taxable asordinary income and (iii) the amount allocated to each of those years, withcertain exceptions, would be subject to tax at the highest tax rate in effectfor that year, and the interest charge generally applicable to underpayments oftax would be imposed in respect of the tax attributable to each of those years.A U.S. holder who owns a Preferred ADR during any year that the Company is aPFIC must file Internal Revenue Service Form 8621. 

The special PFICrules described above will not apply to a U.S. holder if the U.S. holder makesa timely election to treat the Company as a “qualified electing fund” (“QEF”)in the first taxable year in which the U.S. holder owns a Preferred ADR and theCompany is a PFIC and if the Company complies with certain reportingrequirements. Instead, a shareholder of a QEF generally is currently taxed on apro-rata share of the Company’s ordinary earnings and net capital gain treatedas ordinary income and long-term capital gain, respectively. Neither thatordinary income nor any actual dividend from the Company would qualify for the15% maximum tax rate on dividends described above if the Company is a PFIC inthe taxable year that the ordinary income is realized or the dividend is paidor in the preceding taxable year. The Company has not yet determined whether,if it were a PFIC, it would make the computations necessary to supply U.S. holders with the information needed to report income and gain pursuant to a QEFelection. It is, therefore, possible that U.S. holders would not be able tomake or retain that election in any year that the Company is a PFIC. Although aQEF election generally cannot be revoked, if a U.S. holder makes a timely QEFelection for the first taxable year that it owns a Preferred ADR and the Companyis a PFIC (or is treated as having done so pursuant to any of certainelections), the QEF election will not apply during any later taxable year inwhich the Company does not satisfy the tests to be a PFIC. If a QEF election isnot made in that first taxable year, an election in a later year will generallyrequire the payment of tax and interest, and in certain circumstances theelection may cease to be available at a later date.

Instead of a QEFelection, a U.S. holder of stock in a PFIC that is considered marketable stockcould elect to mark the stock to market annually, recognizing as ordinaryincome or loss each year an amount equal to the difference as of the close ofthe taxable year between the fair market value of the stock and the U.S. holder’sadjusted basis in the stock. Losses would be allowed only to the extent of thenet mark-to-market gain previously included in income by the U.S. holder under the election for prior taxable years. A U.S. holder’s adjusted basis inthe Preferred ADRs will be adjusted to reflect the amounts included or deductedwith respect to the mark-to-market election. If the mark-to-market electionwere made, the rules stated in the second preceding paragraph would not applyfor periods covered by the election. A mark-to-market election
92

 will not applyduring any later taxable year in which the Company does not satisfy the teststo be a PFIC. In general, the Preferred ADRs will be considered to bemarketable stock, as should be the case at this time, if the Preferred ADRs trade,other than in *de minimis* quantities, on at least 15 days during eachcalendar quarter. There is no certainty, however, that the Preferred Shareswill be considered to be “marketable stock” for these purposes unless and untilthe Internal Revenue Service designates the Bovespa as having rules adequate tocarry out the purposes of the PFIC rules. There can be no assurance that theInternal Revenue Service will make that designation.

***Information Reporting and Backup Withholding***

Dividends paidon, and proceeds from the sale or other disposition of, a Preferred ADR to a U.S. holder, generally may be subject to information reporting requirements and may besubject to backup withholding at the rate of 28% unless the U.S. holder provides an accurate taxpayer identification number or otherwise demonstratesthat they are exempt.  The amount of any backup withholding collected from apayment to a U.S. holder will be allowed as a credit against the U.S. holder’s U.S. federal income tax liability and may entitle the U.S. holder to a refund, provided that certain required information is submitted to theInternal Revenue Service.  A non-U.S. holder generally will be exempt fromthese information reporting requirements and backup withholding tax but may berequired to comply with certain certification and identification procedures inorder to establish its eligibility for exemption.

F. Dividends and Paying Agents

 

Not Applicable.

 

G. Statement of Experts

 

Not Applicable.

 

H. Documents on Display

The Company makes its filings inelectronic form under the EDGAR filing system of the U.S. Securities andExchange Commission. Its filings are available through the EDGAR system at http://www.sec.gov. Sadia’s SEC filings,including this annual report andthe exhibits thereto, are also available for inspection and copying at thepublic reference facilities maintained by the Securities and ExchangeCommission. Information can be obtained either on the SEC website (www.sec.gov)or by phone 1-800-SEC-0330. Company documents and statutory information arealso available at Sadia’s website (www.sadia.com.br).Information regarding legal issues can be obtained from the Company’s U.S. legal counsel, Greenberg, Traurig LLP, at 1-212-801-9380. 

The Company has, in compliance with NewYork Stock Exchange Corporate Governance Rule 303A.11, provided on its websitea summary of how its corporate governance practices differ from those followedby U.S. domestic companies under the New York Stock Exchange listing standards.

I. Subsidiary Information

Not Applicable.
 
93
**ITEM 11. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**
 

Quantitative information about market risk

The main marketrisks the Company faces are interest rate, exchange rate and commodity pricerisks which arise from adverse changes in market conditions and could representa potential loss. Sadia mitigates some of these risks through the use ofderivatives instruments. 

In the beginningof 2004, Sadia implemented a department to control overall exposure offinancial assets and liabilities; counterparty and credit risk; legal risk; anddisseminate risk culture within the Company. The financial department hasincorporated a Hedging and Investment Policy which was reviewed and approved bythe Financial Committee. These policies prohibit speculative trading and obligethe Company to diversify its counterparties. Sadia periodically providesreports to senior management about potential risks and actions taken tomitigate them. 

***Foreign Currency Risk***

The Company’sexposure to foreign currency are mainly due to Sadia’s external revenues, thatin 2005 accounted for 49% of  the Company’s total gross operating revenues, andits debt denominated in U.S. dollars, that on December 31, 2005 accounted for 2,236.6million.

The percentage of the Company’s dollar andreais denominated debt on December 31, 2005 were as follows:

 

** **

**Debt Breakdown (%)**

**Short-term  debt**

 

Denominated in  reais

11.2%

Denominated in  U.S. dollars

13.6%

**Long term  debt:**

 

Denominated in  reais

18.0%

Denominated in  U.S. dollars

57.2%

**Total**

**100.0%**

 

The foreigncurrency swap contracts that are entered by the Company are aimed to mitigatepotential losses on the Company’s external revenues derived from thedevaluation of the dollar. The Company does not use these swap contracts fortrading or speculative purposes. See note 3 of the consolidated financialStatements for discussion of the accounting policies for derivatives and otherfinancial instruments.

94

The table below provides information onCompany’s foreign currency as of December 31, 2005.

 

**Instruments  Denominated in U.S. Dollars**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

** **

 

 

** **

**2006**

**2007**

**2008**

**2009**

**2010**

**After 2011**

**Total**

**Fair Value**

**Average Rate**

**Assets**

** **

** **

** **

** **

** **

** **

** **

** **

** **

**Cash and cash  equivalents**

131,922

 

 

 

 

 

131,922

131,922

1.80 

**Investments  in debt securities**

1,613,682

0

0

0

0

0

1,613,682

1,613,682

9.25 

**Total**

**1,745,604**

**0**

**0**

**0**

**0**

**0**

**1,745,604**

**1,745,604**

** **

 

 

 

 

 

 

 

 

 

**Liabilities**

 

 

 

 

 

 

 

 

 

**Short term  debt**

412,958

0

0

0

0

0

412,958

412,904

1.39 

**Long term  debt**

516,449

145,164

76,503

70,343

935,353

79,875

1,823,687

1,810,250

4.67 

**Total**

**929,407**

**145,164**

**76,503**

**70,343**

**935,353**

**79,875**

**2,236,645**

**2,223,155**

** **

 

 

 

 

 

 

 

 

 

 

Foreign currency  and interest rate swap contracts notional amount - reais to US dollars

2,055,028

12,908

9,376

0

304,291

0

2,381,603

113,286

 

 

 

Average Paying Rate in r*eais* 98% CDI

Average Receiving Rate inU.S. dollars 5.35% p.a.

 

***Interest Rate Risk***

The Company’sexposure to interest rate is basically due to the Company’s floating rate debt,that amounted to R$2,677.3 million on December 31, 2005.

 

The percentage of the Company’s debtsubject to fixed and floating interest rates on December 31, 2005 were as follows:

 

** **

**Debt Breakdown (%)**

**Fixed rate**

 

Denominated in  reais

10.7%

Denominated in  U.S. dollars

5.4%

**Floating rate**

 

Denominated in  reais

18.6%

Denominated in  U.S. dollars

65.4%

**Total**

**100.0%**

 

 

Sadia’s floatinginterest rate exposure is primarily subject to the variations of Libor as itrelates to U.S. dollar denominated debt and to the variations of the TJLP, anannual long-term interest rate that includes an inflation factor and isdetermined quarterly by the Central Bank and other exchange variation. On December 31, 2005, the TJLP was equivalent to 9.75% per year. 

95

The table below provides information aboutSadia’s significant interest rate sensitive instruments. For variable interestrate debt, the rate presented is the weighted average rate calculated as of December 31, 2005.

 

**Rate Sensitive Instruments**

**R$ Thousand**

 

 

 

 

 

** **

 

 

** **

 

**2006**

**2007**

**2008**

**2009**

**2010**

**After 2011**

**Total**

**Fair Value**

**Average Rate**

**Assets**

** **

** **

** **

** **

** **

** **

** **

** **

** **

**Cash and cash  equivalents**

 

 

 

 

 

 

 

 

 

   Denominated  in reais

149,323

0

0

0

0

0

149,323

149,323

0.00 

   Denominated  in reais

402,028

0

0

0

0

0

402,028

402,028

18.12 

   Denominated  in U.S. dollars

43,963

0

0

0

0

0

43,963

43,963

0.00 

   Denominated  in U.S. dollars

87,959

0

0

0

0

0

87,959

87,959

1.80 

 

 

 

 

 

 

 

 

 

 

**Investments  in debt securities**

 

 

 

 

 

 

 

 

 

   Denominated  in reais

278,040

0

39,347

0

0

25,710

343,097

343,097

16.19 

   Denominated  in U.S. dollars

1,613,682

0

0

0

0

0

1,613,682

1,613,682

9.25 

 

 

 

 

 

 

 

 

 

 

**Total**

**2,574,995**

**0**

**39,347**

**0**

**0**

**25,710**

**2,640,052**

**2,640,052**

** **

**Liabilities**

** **

** **

** **

** **

** **

** **

** **

** **

** **

**Short-term  debt**

 

 

 

 

 

 

 

 

 

***  Fixed  rate***

 

 

 

 

 

 

 

 

 

   Denominated  in reais

167,751

0

0

0

0

0

167,751

167,751

8.75 

   Denominated  in U.S. dollars

78,349

0

0

0

0

0

78,349

78,349

1.39 

***  Floating  rate***

 

 

 

 

 

 

 

 

 

   Denominated  in reais

190,351

0

0

0

0

0

190,351

190,351

17.04 

   Denominated  in U.S. dollars

353,711

0

0

0

0

0

353,711

353,657

0.42 

**Total**

**790,162**

**0**

**0**

**0**

**0**

**0**

**790,162**

**790,162**

** **

**Long term  debt:**

 

 

 

 

 

 

 

 

 

***  Fixed  rate***

 

 

 

 

 

 

 

 

 

   Denominated  in reais

12,506

7,567

7,567

7,567

2,759

134,052

172,018

172,018

9.68 

   Denominated  in U.S. dollars

34,281

15,688

13,249

7,089

7,089

15,679

93,075

93,075

4.67 

***  Floating  rate***

 

 

 

 

 

 

 

 

 

   Denominated  in reais

165,225

38,030

47,151

38,846

38,846

74,561

402,659

402,659

4.20 

   Denomineted  in U.S. dollars

482,168

129,476

63,254

63,254

928,264

64,196

1,730,612

1,717,175

6.50 

**Total**

**694,180**

**190,761**

**131,221**

**116,756**

**976,958**

**288,488**

**2,398,364**

**2,384,927**

** **

 

 

 

 

 

 

 

 

 

 

**Total debt**

**1,484,342**

**190,761**

**131,221**

**116,756**

**976,958**

**288,488**

**3,188,526**

**3,155,934**

** **

 

***Credit risks***

The Company is subject tocredit risks related to customer accounts receivable, financial investments andderivative contracts. Credit risks from accounts receivable are minimized bythe pulverization of the customer portfolio, in which no group is responsiblefor more than 10% of the Company’s consolidated
96

revenues. Risks associated withfinancial instruments are lessened by hiring first-line financial institutions,subject to the limitations pre-established by the Credit and FinancialCommittees.

***Grain purchase pricerisk***

The Company’s operations areexposed to the volatility of grain prices (corn and soybean) used in thepreparation of feed for its breeding stock and slaughter destinated animals.These commodities price results from factors beyond the control of management,such as climate, the size of the harvest, transport and storage costs andgovernment agricultural policies, among others.

The Company does not enter into future oroptions contracts to protect itself against changes in the commodities price;however it maintains a risk management strategy based on its inventory policythrough physical control, which includes acquisition of grains with fixed andnon-fixed prices.

 
**ITEM 12. DESCRIPTION OF THE SECURITIESOTHER THAN SECURITIES**
** **

Not Applicable.

** **

97
**PART II****ITEM 13. DEFAULTS, DIVIDENDS ARREARAGES ANDDELINQUENCIES**
** **

Not Applicable.

** **
**ITEM 14. materialmodifications to the rights of security holders and use of proceeds**
** **

In December 2005, Sadia, with the aim ofimproving Corporate Governance practices and allow a better alignment of theinterests of shareholders of common and preferred shares the Company proposedand its shareholders approved at the Extraordinary Shareholders Meeting andratified in the Special Preferred Shareholders Meeting, the exclusion of theright to a dividend, per preferred share to be 10% higher than that of eachcommon share, from the Company’s By-laws, and also to grant preferred sharesthe right to be included in any possible public offering for the disposal ofthe Company’s control, with the guarantee of a minimum price equal to eightypercent (80%) of the amount paid for each voting share which is an integralpart of the controlling block to title holders of preferred shares.

 

For further information, please consultFile/Film Number 001-15184/051275163 and 001-15184/051275160, both filed withSEC on 12/20/2005.
**ITEM 15. CONTROL AND PROCEDURES**
 

TheCompany has carried out an evaluation under the supervision of its management,including its Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of its disclosure controls andprocedures. There are inherent limitations to the effectiveness of any systemof disclosure controls and procedures, including the possibility of human errorand the circumvention or overriding of the controls and procedures. Accordingly, even effectivedisclosure controls and procedures can only provide reasonable assurance thatthey will achieve their control objectives. Based on that evaluation, theCompany’s Chief Executive Officer and Chief Financial Officer concluded thatthe design and operation of the Company’s disclosure controls and proceduresare effective to ensure that information required to be disclosed in thereports that the Company files and submits under the Exchange Act is (i) recorded,processed, summarized and reported within the time periods specified inSecurities and Exchange Commission rules and forms, and (ii) accumulated andcommunicated to management, including the Chief Executive Officer and ChiefFinancial Officer, to allow timely decisions regarding required disclosure asof the end of the Company’s most recent fiscal year.

The Company has created a Disclosure Policy Committee composed of theChairman of the Board of Directors, Walter Fontana, the Chief ExecutiveOfficer, Geraldo Tomazoni, and the Chief Financial Officer and InvestorRelations Executive Officer, Luiz Murat. This Committee oversees and reviewsall materials for which there is a legal disclosure requirement, together withall data required to support the documents mentioned above. This committeemeets at regular intervals in order to review all data.

In preparation for the adoption of Section 404 of the Sarbannes-OxleyAct of 2002 by all Foreign Private Issuers by June 30, 2007 the Company'smanagement has initiated a detailed evaluation of existing internal controlsagainst Section 404 requirements. Management will allocate the necessaryresources and initiate required actions to redesign or address any possibleSection 404 weaknesses prior to that date. No changes in the Company’s internalcontrols over financial reporting occurred during the period covered by thisreport that materially affected, or are reasonably likely to materially affect,the Company’s internal controls over financial reporting.

98

 

The certifications requiredby this Item have been filed as Exhibits 12.01 and 12.02.

A.            Management’s annual report on internalcontrol over financial reporting

Not applicable.

B.             Attestation report of the registeredpublic accounting firm

Not applicable.

C.             Changes in internal control over financialreporting.

Not applicable.

** **
**ITEM 16.******
 

A. Audit Committee FinancialExpert

The Board of Directors of theCompany has determined that Francisco Silverio Morales Cespede is the auditcommittee financial expert within the meaning of Sarbanes-Oxley and relatedregulations. The audit committee is already fully in compliance with therequirements of Sarbanes-Oxley. See Item 6.C. Board Practices-Audit Committee.The Company has, in compliance with New York Stock Exchange CorporateGovernance Rule 303A.11, provided on its website a summary of how its corporategovernance practices differ from those followed by U.S. domestic companiesunder the New York Stock Exchange listing standards, at www.sadia.com.br.

B. Code of Ethics

The Company has recently adopted a Code ofEthics (called "Código de Ética") that applies to all of theCompany's employees, including our principal executive officer, principalfinancial officer, principal accounting officer or controller. The englishversion of the Code can be downloaded at the Company’s website (www.sadia.com.br).Additionally, any person, upon request, can ask for a hard copy or electronicfile of such Code.  style='color:black'>If the Company makes anysubstantive amendment to the Code of Ethics or grants any waivers, includingany implicit waiver, from a provision of the Code of Ethics, it will disclosethe nature of such amendment or waiver on its website. 

 

C. Principal Accountant Feesand Services

**Audit and Non-AuditFees**

The following table sets forth the feesbilled to the Company by its independent auditors, during the fiscal yearsended December 31, 2005 and 2004: 

** **

 

**Audit Fees (Thousand R$)**

 

** **

** **

 

**2005**

**2004**

Audit fees             

693

502

Audit-related fees                

105

280

Tax-fees 

-

 

**Total fees             **

**798**

**782**

Auditfees in the above table are the aggregate fees billed by KPMG *AuditoresIndependentes* for 2005 and 2004, in connection with the audit of theCompany’s annual financial statements and review of the Company’s quarterlyfinancial information.

99

 

Audit-relatedfees in the above table are the aggregate fees billed by KPMG for providing duediligence services. Tax fees in the above table are fees billed for taxcompliance and tax advice.

**Audit CommitteePre-Approval Policies and Procedures**

The Company’s Audit Committeehas established pre-approval and procedures for the engagement of itsindependent auditors for audit and non-audit services. 

The Audit Committee reviewsthe scope of the services to be provided, before their commencement, in orderto ensure that there are no independence issues and the services are notprohibited services as defined by Sarbanes-Oxley Act of 2002. 

**D. Exemptions from theListing  Standards and for Audit Committees**

Not Applicable

**E. Purchases of EquitySecurities by the Issuer and Affiliated Purchasers**

Not Applicable

100

** **
**PART III****ITEM 17. FINANCIAL STATEMENTS**
 

The Company has responded to Item 18 in lieu of responding to this item.
**ITEM 18. FINANCIAL STATEMENTS**
 

 Reference is made to Item 19for a list of all financial Statements filed as part of this Annual Report.
**ITEM 19. EXHIBITS**
 

Financial Statements

Report of Independent Auditors................................................................................................................... F2

Consolidated Balance Sheets as of December 31, 2005and 2004............................................................. F 4

Consolidated Statements of Income for Years EndedDecember 31, 2005, 2004 and  2003................... F 6

Consolidated Statements of Changes in Shareholders’Equity for the Years Ended December 31, 2005, 2004 and 2003    F 8

Consolidated Statements of Cash Flows for the YearsEnded December 31, 2004, 2003 and 2002..... F 9

Notes to Consolidated Financial Statements............................................................................................... F10

All schedules for which provision is made in theapplicable accounting regulation of the Securities and Exchange Commission arenot required under the related instructions or are inapplicable and thereforehave been omitted.

**List of Exhibits**

1.01 Sadia By laws

2.01 Deposit Agreement datedas of December 30, 2002, by and among Sadia S.A., The Bank of New York asDepositary and the Owners and Holders of American Depositary Receipts (suchagreement is incorporated by reference to the Registration Statement on FormF-6 relating to the ADSs (File No. 333-102013) filed with the Commission onDecember 19, 2002.

101

2.02 The total amount oflong-term debt of the Company authorized under any instrument does not exceed10% of the total assets of the Company and its subsidiaries, on a consolidatedbasis.  The Company undertakes to furnish to the SEC all other instrumentsrelating to long-term debt of the Company and its subsidiaries upon request ofthe SEC. 

12.01Certification by the Company’s Chief Executive Officer required by Item 15

12.02Certification by the Company’s Chief Financial Officer required by Item 15

13.01Certification pursuant to 18 U.S.C. Section 1350.

13.02Certification pursuant to 18 U.S.C. Section 1350.

ConsolidatedFinancial Statements

 

**SIGNATURES**

The Company hereby certifiesthat it meets all of the requirements for filing on Form 20-F and that it hasduly caused and authorized the undersigned to sign this Annual Report on itsbehalf.

**SADIA S.A.**

 

Date: June 29, 2006

                

 

 

By: /s/ Gilberto Tomazoni

Name: Gilberto Tomazoni

Title: Chief Executive Officer

By: /s/ Luiz Gonzaga Murat Jr.

Name: Luiz Gonzaga Murat Jr.

Title: Chief Financial Officer

102

**Exhibit 1.01Sadia By Laws**

 

**                 SADIA S.A.**
**BY LAWS**
** **

**CONSOLIDATED AT THE EXTRAORDINARY GENERALMEETING HELD ON 04.29.2005**

 

**CHAPTER I**

**THE COMPANY,  ITS HEADQUARTERS AND PURPOSE**

 

**ARTICLE 1**

**SADIA S. A.**is a company governed by these By laws, by the JointStock Company Act and by all other Laws and Regulations applicable to theCompany and its business purpose.

 

**ARTICLE 2**

The Company’s headquarters is located at Rua Senador AttilioFontana ns 86, Centro, in the County of Concórdia, State of Santa Catarina,with jurisdiction in the same county. 

** **

**ARTICLE 3**

The duration of this Company is indefinite.

** **

**ARTICLE 4**

The purpose of this Company is to engagein:

 

a)                   Agricultural,  industrial and commercial activities related to food products, generally;

 

b)                   The operation ofslaughterhouses, tanneries, meat packing plants, factories producing preserves,whether or not canned, meats, fats and dairy products, processing of vegetableoils, as well as the operation of large-scale cold storage depots includingmeat warehousing, preservation, storage and classification;

 

c)                   Meats, generally,byproducts and selected cuts;

 

d)                   Processing and sale ofwheat, other grains and their by-products;

 

 

e)                   Livestock framing(cattle, swine, sheep, goat and poultry);

 

f)                    Lumber mills;

 

g)                   Road transportation ofown and third party goods and rental of cold stores, silos and warehouses; 

 

h)                   All activities relatedagriculture and agribusiness and the sale of grains and other primary productsand/or processed products on the domestic and foreign market;

 

i)                     Processing and sale ofsubstances and products, generally, for human food and animal feed;

 

j)                     Processing and sale ofchemical, sanitary and veterinary products for use in agriculture, poultry,cattle and swine raising, i.e. livestock, generally);

 

k)                   Forestry andreforestation activities;

 

l)                     Any other agricultural,industrial and commercial activities correlated to the purposes of the Company;

103

 

m)                  Planning and developmentof agricultural and engineering projects, under the responsibility ofprofessionals duly qualified by the appropriate bodies.

 

**Sole clause** -       Leasing cold storage chambers, silos anddepots, as described in letter "g" of this Article, does not fallunder general warehouse activities as set out in Executive Order No. 1102, of 21/11/1903.

 

 

**CHAPTER II**

**CAPITAL STOCK**

** **

**SECTION I**

**SUBSCRIBED CAPITAL**

 

**ARTICLE 5**

Capital Stock isone billion and five hundred million reais (R$ 1,500,000,000.00, fully paid-in,divided into six hundred and eighty-three million (683,000,000) no par value,of which two hundred and fifty-seven million (257,000,000) are common sharesand four hundred and twenty-six million (426,000.000) are preferred shares withno voting rights.

.

 

**SECTION II**

**CAPITAL INCREASE**

**ARTICLE 6**

The Company may increase the capital stockupon a resolution by the General Meeting, proposed by the Board of Directors,and after hearing the Audit Committee, using:

 

a)    The reserves, retainedor suspended earnings, surplus capital or special reserves resulting frommonetary correction;

 

b)   Annual restatement ofthe monetary expression of the capital stock, observing the provision inArticle 7 of the Bylaws;

 

c)    Issuance and placementof shares by subscription.

 

**Paragraph 1**-     The capital increases described in items"a" and "b" will observe the provision in Article 17,clause 4, of Law No. 6404/76.

 

**Paragraph 2**-     Resolutions relating to capital stock increaseshall state indicate the number and type of shares to be issued and shall betranscribed in the minutes of the Meeting.

 

**Paragraph 3**-     Within 30 (thirty) days from capital increase,the Board of Executive Officers shall submit the corresponding minutes of theGeneral Meeting to the Commercial Registry for annotation and filing.

 

**ARTICLE 7**

Regardless of having reached the limitcontemplated in item I of Article 297 of Law No. 6404/76, the General Meetingshall make a resolution in the year following that of its calling about thetransfer of the capital reserve to the capital stock referred to in Article 167of the same Law.

 

**ARTICLE 8**

The following conditions for subscriptionand payment shall be observed in the issuance and placement of capital shares:

 

I.      In increases by subscription, theGeneral Meeting shall indicate: 

 

a)   Whether the payment shall be made incash or in kind, on demand or by installments;

104

 

b) The deadline for placing or subscribingthe issuance;

 

c)  The period of time for subscribing theshares;

 

d)  The price of issuance of the shares.

 

II. Whenever the issuance of shares permitsa term subscription or subscription by installments, the Subscription Bulletinshall specify the down amount, the number and amount of the installments andthe respective payment dates as follows:

 

a)           A minimum payment of10% (ten per cent) of the subscribed amount must be paid at the time ofsubscription; this amount may be received by the Company independent of a bankdeposit;

 

b)                   If the shareholderfails to make any payment of the subscription installment on the due date, thisshall imply, regardless of any notice: 

 

b.1)          Accelerated maturity of allsubsequent installments which shall become due by the shareholder;

 

b.2)          That the shareholder is indefault and consequently, subject to interest on arrears at the rate of onepercent (1%) of the amount of the overdue and unpaid installments plusrestatement based on the nominal variation of the National Treasury Bonds(OTNs) or any other official index, at the discretion of the AdministrativeBoard of Directors;

 

  b.3)        The Company shall be entitledto file, against the shareholder and joint debtors, an execution action tocollect the amounts due or to sell the shares at the Stock Exchange, at theShareholders’ account and risk, as permitted by Law..

 

III. Whenever capital is increased bysubscription, the COMPANY shall establish a period no shorter than thirty (30)days for the shareholders to exercise their preemptive rights.

 

**ARTICLE 9**

Upon a resolution of the Administrative Board of Directorsand observing the provisions of Article 30 of Law 6404/76, the COMPANY maynegotiate its own shares.

 

**CHAPTER III**

**SHARES**

** **

**SECTION I**

**PROVISIONS APPLYING TO ALL SHARES**

 

**ARTICLE 10**

The following provisions apply to allCompany shares:

I. All company shares shall be book-entryshares and remain in deposit accounts with BANCO BRADESCO S.A., on behalf oftheir holders, no certificate being issued, pursuant to Articles 34 and 35 ofLaw No.  6404/76,  of 12/15/1976.

 

II. Preferred and common shares areentitled to the compulsory minimum dividend of twenty-eight percent (28%) ofthe net income for the year, established in accordance with Article 202, itemsI to III, Law No. 6404/76, also observing the provisions of letter “b” ofArticle 12 of these Bylaws. 

 

III. Ordinaryand preferred shares shall participate equally in capital increases derivedfrom net income and reserves, revaluation of assets and yearly capitalrestatement.

105

 

IV. In capitalincreases, classes of shares may be created or shares may be issued withoutobserving the previous proportional relation between classes and kinds ofshares.

 

V. Provided thatthe maximum limits established by the Brazilian Securities Exchange Committeeare observed, the maintenance agreement relating to book-entry share servicesmay authorize the financial institution to charge the shareholder for the costof transferring the title to the shares.

 

**SECTION II**

**COMMON SHARES**

 

**ARTICLE 11**

Only COMMON shares are entitled to vote theresolutions of the General Meeting.

 

**Sole Paragraph** – Fifty-one percent (51%) of the capital with votingrights shall be owned by Brazilian citizens.

 

 

**SECTION III**

**PREFERRED SHARES**

 

**ARTICLE 12**

 PREFERRED shares are not entitled to voteand shall enjoy the following advantages:

 

a)   priority in the proportional,noncumulative receipt of twenty-eight percent (28%) of the net income for theyear, as minimum dividend, competing in equal terms with common shares in anydividend allocated above that percentage;

 

b)   right to be included in the publicoffering for the disposal of the shareholding control under the conditions setforth in art. 254-A, with the wording given by Law 10303, dated 10.31.2001,with a guaranteed price at least equal to eighty percent (80%) of the amountpaid per share with voting right and an  integral part of the control block ; 

 

c)   priority in capital reimbursement incase of liquidation of the Company.

 

**Sole Paragraph**–**              **Nonvoting preferred shares mayacquire this right if the Company fails to pay, for at least three (3)consecutive years, the minimum dividend to which they are entitled and suchright shall continue up to the payment of the first next dividend.

** **

**ARTICLE 13**

The shareholders agreements on purchase andsale or preemptive rights on the acquisition of shares or on exercising votingrights shall be valid, before the Company, only after being filed in theCompany’s headquarters.

** **

**CHAPTER IV**

**THE MANAGEMENT**

 

**ARTICLE 14**

The Company shall be managed by aAdministrative Board of Directors and a Board of Executive Board ofDirectorsOfficers, formed by Brazilian citizens or a majority of Braziliancitizens domiciled in the country, whose powers shall prevail indecision-making.

 

**Paragraph 1**– The term of office of the members of theAdministrative Board of Directors and of the Executive Director Officers shallbe for one year and shall be unified, extending up to the entry upon office ofthe new administrators, reelection being permitted.

106

**Paragraph 2**-     The members of the Administrative Board ofDirectors and the Executive Director Officers shall enter upon office bysigning the corresponding installation certificate or by subscribing theminutes of the meeting of election in the corresponding books of minutes ofmeetings at which time a Declaration of Principles shall also be signed.

 

**SECTION I**

**BOARD OF DIRECTORS**

** **

**ARTICLE 15**

The Administrative Board of Directors shallcomprise a minimum of seven (7) to a maximum of eleven (11) members, all ofthem necessarily being shareholders and shall adopt an Internal Regulation togovern its own activities as well as those of the Committees reporting to it,the rights and duties of other Administrative Board of Directors members andits relationship with the Executive Board of Board of Directors ExecutiveOfficers and other corporate bodies as well as any other matters deemedconvenient.

 

**Paragraph 1** –The General Meeting shall elect the members of theAdministrative Board of Directors and, among them, the Chairperson.

 

**Paragraph 2** -  The Administrative Board of Directors shall elect,among its members, one or more Vice Chairpersons who, following the electionorder, shall substitute for the Chairperson in cases of absence, incapacitationor vacancy.

** **

**Paragraph 3**-  If a vacancy occurs whereby the number of membersof the Administrative Board of Directors is reduced below the number fixed inthese Bylaws, a General Meeting shall be called within thirty (30) days to fillthe vacant positions. The term of office of the new members of theAdministrative Board of Directors elected to fill the vacancies shall coincidewith that of the other members. 

** **

**ARTICLE 16**

The Ordinary Meetings of the Board of Directors shall beheld at least once a month, on the dates scheduled in advance in the annualcalendar prepared by the Chairperson of the Board of Directors, and theextraordinary meetings whenever necessary, upon a call sent to the members atleast twenty-four (24) hours in advance, informing the place, date and time ofthe meeting, with a brief explanation about the day’s agenda.

** **

**Paragraph 1**-     Notices shall be given by the Chairperson of theAdministrative Board of Directors or at the request of three (3) of its membersand, should the Chairperson fail to comply with it within five (5) days, thosemembers may call the meeting directly, however, to be held at the same addressof the Company’s Executive Management.

 

** **

**Paragraph 2 -    **The quorum for the meetings of theAdministrative Board of Directors shall be a minimum of six (6) of its memberspresent in person.

 

**Paragraph 3** –**  **Each member of the Administrative Boardof Directors shall be entitled to one (1) vote in its meetings.

 

**Paragraph 4** -**   **Except for the Sole Paragraph to Article17, the decisions of the Administrative Board of Directors shall be adopted, inany case, by the majority voting of the members present and the Chairperson isentitled to the casting vote, without prejudice of his/her own vote.

** **

** **

**Paragraph 5** -     The meetings of the Administrative Board ofDirectors shall be entered in the Book of Minutes of Meetings of theAdministrative Board of Directors and the resolutions destined to be effectivebefore third parties shall be transcribed as determined by the Administrative Boardof Directors.

107

**ARTICLE 17**

It is incumbent upon the Administrative Boardof Directors:

 

I -        Establish and enforce compliancewith the general direction of the Company’s business and of other companiesunder its control, if any.

 

**II –      Establish and enforcecompliance with all regulations for the operation and administration of theCompany, particularly those related to:**

 

a)             Hiring and management ofpersonnel, personnel allocation, careers, levels, salaries and wages as well asfringe benefits of the employees of the Company;

 

b)             Controls, audit, accountingand statistics;

 

c)             Acquisition, administrationand disposal of permanent assets.

 

**III –     Elect and remove the ViceChairpersons of the Administrative Board of Directors and Executive Director Officersand define their duties and individual fees, in case an aggregate amount isestablished by the General Meeting.**

 

IV –         Make a resolution, at any time, about thedistribution of interim dividends from interim balance sheet accounts, orRetained Earnings or Profit Reserve.

 

V.    Approve:

 

a)             The administrative structureof the Company and respective positions, duties and salaries;

 

b)             The Strategic Plan;

 

c)             The Yearly Operational Planand the corresponding capital, investment and financial budgets as well asdivestitures;

 

d)             Interim balance sheetsprepared by the Company;

 

e)             The balance sheet,statements of income and annual report to be submitted to the General Meeting;

 

f)              The acquisition of assetsunder property, plant and equipment whenever, due to their nature and/or cost,the amount exceeds that contemplated in a specific project which is an integralpart of the Yearly Operational Plan;

 

g)             The disposal of assets fromproperty, plant and equipment when, due to its nature and/or amount, they havenot been contemplated in the Yearly Operational Plan;

 

h)             Interest in other Companiesof any nature, as a shareholder or quota holder;

 

i)              Nomination ofadministrators for the controlled, affiliate or associated companies; and

 

j)              Any operation exceeding thescope of the Board of Executive Board of Director Officers or which does notobserve the approved budgets, policies and rules of the Administrative Board ofDirectors.

108

 

 

VI –         Call the General Meetings whenrequired by Law and these Bylaws or whenever deemed convenient.

 

VII -         Approve proposals to besubmitted to the General Meetings and relating to:

 

a)  Amendment of the Bylaws;

 

b)  Modification of Capital Stock;

 

c) Merger with another Company,amalgamation into or of other Company;

 

d)  Creation of other statutory reserves;

 

e)  Distribution of the profits determinedin the annual balance sheet.

 

VIII -  Authorize the Board of Directors ExecutiveOfficers to:

 

a)  Waive Corporate rights, unless thoserights are derived from the normal course of corporate businesses, and in thecase of donations aiming to provide support to social, philanthropic andsimilar projects and programs, provided that in this case the limit establishedin the Yearly Operational Plan, letters “g”  and “h” to Article 23 of theseBylaws, is observed;

 

b)             Acquire and dispose ofshares or quotas and encumber them, always observing the provisions of Article35 of these Bylaws

 

c)  Offer collaterals, except in the caseof financial operations contemplated in the Annual Operating Plan;

 

d)             Assign, by means of anagreement with a commercial purpose, and for a definite period of time, whetheror not renewable, the use of the trademark **"SADIA"**, logos,emblems, symbols and other distinct signs which identify the Company, as wellas other trade marks, know-how, intellectual property works and patents whichare, or may come to be, its property, except in the case of its use in relationto products which, even though processed by third parties, are destined to beexclusively marketed by the Company, provided that observing Article 23, letter“f” of these Bylaws; and

 

e)             Dispose of, by means of adefinitive assignment, trade marks, patents, know-how, characters or any otherintellectual work owned by the Company.

 

IX –         Require, at any time, theexamination of specific corporate matters or business and issue general rulesor instructions about them to be observed by the Board of Executive Director Officers.

 

X -           Follow up the management andthe performance of the Board of Executive Board of Director Officers.

 

XI – Create, at any time, on a temporary orpermanent basis, committees or work groups, always presided by a member of theAdministrative Board of Directors and formed by administrators, employees orhired professionals, for the specific purpose of preparing projects, carryingout analysis and making recommendations on certain matters or following upactivities in any Corporate area.

 

XII -    Prepare and approve the InternalRegulation of the Administrative Board of Directors and the Code of Conduct ofthe Company.

 

XIII -   Evaluate formally the resultsachieved by the Company.

109

 

**Sole Paragraph -** The matters referred to under numbers I,III, IV, letters "a", "b", "c", "f" and“g”  of number V; under number VII, letters "a"  and  "c" of number VIII and under number XII may only be approved by the vote of atleast half plus one of the acting members of the Administrative Board ofDirectors.

 

XIV – Appoint and remove independentauditors for the Company.

 

**ARTICLE 18**

It is incumbent upon the Chairperson of theAdministrative Board of Directors:

 

I  -            Comply with and enforcecompliance with these Bylaws, the Internal Regulation of the Administrative Boardof Directors, the Code of Conduct of the Company, the resolutions of theGeneral Meeting and of the Administrative Board of Directors and keep abreastof the corporate operations.

 

II  -      Safeguard, within the scope ofits duties, the effectiveness of the shareholders agreement filed in its mainheadquarters.

 

III -      Formally convene the GeneralMeetings and chair them.

 

IV -      Call and chair the meetings ofthe Administrative Board of Directors.

 

V –           Provide guidance to the Boardof Executive Board of Director Officers on resolutions approved by theAdministrative Board of Directors.

 

**SECTION II**

**AUDIT COMMITTEE**

** **

**ARTICLE 19**

The Audit Committee is a technicalpermanent body whose duty is to assist the Board of Directors. It is formed bythree (3) to five (5) members of the Board of Directors, elected by the Boardof Directors for an annual term of office. Three (3) of them should becompulsorily independent members as defined in its Internal Regulation. Atleast one (1) of the independent members shall have proven experience andknowledge of finance and controls, including some understanding ofinternational accounting standards.     

 

**Paragraph 1 -**     The Audit Committee shall have, among itsmembers, a Coordinator appointed by the Board of Directors at the same meetingthat formed it. 

 

**Paragraph 2 -**     The Internal Regulation of the Audit Committeeshall establish how it shall be called, the frequency of meetings and any otherformalities regarding the participation of guests and the resolutions to bemade by this body. 

** **

**Paragraph 3 -    **The non-independent members of the AuditCommittee shall not be entitled to vote the collegiate resolutions of thisbody.
 
**ARTICLE 20**

** **

It is specifically incumbent upon the AuditCommittee, without prejudice of a better detailing of its duties in its InternalRegulation:

 

        I.           Monitor theeffectiveness of the procedures relating to the annual and other regularfinancial reports of this Company;

 

      II.           Verify the maintenanceof efficient accounting systems and internal controls, overseeing them on anongoing basis;

 

    III.           Monitor the riskmanagement system relating to the internal control environment of this Company;

110

 

    IV.           Analyze in advance thereports to be submitted to the Brazilian and to the U.S. Securities andExchange Commission  (CVM and SEC); 

 

      V.           Select and refer externalauditors to be engaged, including their respective proposals and fees, to theBoard of Directors, for approval;

 

    VI.           Approve in advance theengagement, by the Company, of all other services to be rendered by externalauditors, particularly consulting services, ensuring compliance with theapplicable legislation;

 

  VII.           Establish proceduresfor investigating and taking action in cases of misconduct as well as inrelation to receiving, handling and responding to accusations relating toaccounting practices, internal controls in the issuance of financial reportsand internal audit;

 

 VIII.           Analyze, prior tosubmitting to the Board of Directors, transactions with Related Parties, asreferred to in the current legislation; 

 

   IX.           Propose to theChairperson of the Board of Directors, when preparing the operational plan, anamount to be included in the annual budget of the Board of Directors andrequired to fund the activities of the Audit Committee; and

 

     X.           Supervise the servicesand prepare a formal evaluation of the performance of the internal audit ofthis Company.

** **

**SECTION III**

**THE BOARD OF DIRECTORSBOARD OF EXECUTIVEOFFICERS**

 

**ARTICLE 21**

The Board of Executive Board of Director Officersshall comprise a minimum of seven (07) and a maximum of twenty-five (25)members, whether or not shareholders, being one of them appointed ManagingDirector Officer and the remaining designated Director Officers, all of themelected by the Administrative Board of Directors. The Board of Directors shallalso designate their titles and respective fees in the election act.

 

**ARTICLE 22**

The Board of Executive Board of Directors Officersshall be convened at least once a month, called by the Managing Director Officeror, in his/her absence, by at least three (3) Director Officers jointly,whatever their titles, and the minutes of such meetings shall be transcribed inthe pertinent book.

 

**Paragraph 1** –The meetings of the Board of Board of Directors ExecutiveOfficers shall be presided by the Managing Director Officer or, in his/herabsence, by any Director Officer, as provided for in Article 23, letter"l".

 

**Paragraph 2** – The quorum for meetings of the Board of Board ofDirectors Executive Officers shall be at least seven (7) Director Officers andresolutions shall be approved by majority voting.

** **

**ARTICLE 23**

With the observance of the scope of dutiesof the Administrative Board of Directors, it shall be incumbent upon the Boardof Executive Board of Directors Officers:

 

a)     Manage the corporate businessseeking to safeguard the interests of the Company, carrying out and enforcingcompliance with the laws, these Bylaws and the resolutions approved by theGeneral Meeting and by the Administrative Board of Directors.

 

b)    Submit to the Administrative Board ofDirectors the matters referred to under Article 17, item IV and V, letters"b",  "c",  "d"  and  "e"  of item VIIIand item IX of these Bylaws.

111

 

c)     Approve or validate loans, fundingand leases;

 

d)    Approve the acquisition, disposal erenting of property, plant and equipment, observing the provisions of letters“f” and “g” of item V of Article 17 of these Bylaws;

 

e)     Approve the offer of collaterals infinancial operations contemplated in the Annual Operating Plan as well asprovide guarantees and/or collaterals to its subsidiaries in loan, funding andlease operations;

 

f)     Approve the assignment for temporaryuse of trade marks, know-how, patents and intellectual property works, owned bythe Company, provided that (1) in connection with industrial processing ofproducts by third parties, to be marketed by the Company on an exclusive basis;or (ii) authorization be granted for the use of trademarks and intellectualproperty works solely for the purposes of dissemination, not intended forcommercial use;

 

g)    Waive Corporate rights, observing theprovisions in Article 17, item VIII, letter “a” of these Bylaws;

 

h)    Approve donations aiming to providesupport to social, philanthropic and similar projects and programs, providedthat the limit established in the Yearly Operational Plan is observed;

 

i)      import machines, equipment piecesand products for own use, transformation or resale;

 

j)      Appoint proxies orattorneys-in-fact, representatives or agents in the Brazilian territory andabroad, observing the provisions in Article 24, item I, letter “e” of theseBylaws;

 

k)     Approve the setting up and windup ofindustrial, commercial and service units as well as branches and deposits;

 

l)     Designate to any of its member theduties of a Director Officer in his/her absences or incapacitation.

** **

**Sole Paragraph** - Notwithstanding the provisions in Paragraph 1 ofArticle 22, the meetings of the Board of Board of Directors Executive Officersfor resolution on the matters referred to under letter “d” shall necessarily bepresided by the Managing Director Officer. 

** **

**ARTICLE 24**

Except for the acts within the exclusivescope of the Board of Executive Board of Directors Officers, as a collectivebody, it shall be incumbent upon the Executive Director Officers:

 

 

**I -    SEVERALLY**

 

a)    Carry out and enforce compliance with these Bylaws andthe resolutions approved by the General Meeting and by the Administrative Boardof Directors.

 

b)  Represent the Company before Courts orthird parties and Governmental, State and Municipal Authorities.

 

c)    Hire and dismiss technicians oremployees in any category, in accordance with letter "a" of item IIof Article 17;

 

d)   Receive, release, issue, endorse,discount and accept trade bills, pay and redeem notes, promote collections,open accounts in banking establishments, endorse checks for deposits and makeinteraccount transfers of money on behalf of the Company;       

 

e)    Signinstruments relating to the actions authorized by the Administrative Board ofDirectors, as referred to in item VIII of Article 17, and those approved by theBoard of Directors, as per letters “c” to “l” of Article 23 of these Bylaws;

112

 

 

f)   Practiceall other acts required for the development of corporate businesses which,according to law and these Bylaws, are not dependent upon a prior authorizationby the General Meeting or a decision by the Board of Executive Board ofDirectors Officers.

** **

**II –           JOINTLY, UPON THE SIGNATURE OF TWODIRECTORSDIRECTOR**

 

  a)  Issue and endorse Promissory Notesand accept Bills of Exchange;

 

  b) Issue checks or Rural PromissoryNotes;

 

**Paragraph 1**-     The powers under item I and letter "b"of item II may be granted through a power-of-attorney.

 

**Paragraph 2**-     Exceptionally, whenever issuing checks forpayment of raw materials at individual purchasing stations, these powers may,at the discretion of the Board of Board of Directors Executive Officers, beexercised by one Director Officer or by an attorney-in-fact.

 

**Paragraph 3** –    In the companies in which the Company is ashareholder, the Company may be represented by any of the Director Officers,previously appointed by the Executive Board of Board of Directors ExecutiveOfficers for this purpose or by an attorney-in-fact with special powers, asprovided for in Paragraph 1 of article 126 of Law No. 6404/76.

** **

**SECTION IV**

**ADVISORY COUNCIL**

** **

**ARTICLE 25**

The Advisory Council shall comprise aminimum of seven (7) to a maximum of fifteen (15) members, whether or notshareholders, one of them being appointed Chairperson and another ViceChairperson, elected and removed at any time by the Administrative Board ofDirectors, for a term of office of one (1) year, reelection being permitted.

** **

**Paragraph 1**– When electing the members of the Advisory Council,the Administrative Board of Directors shall appoint its Chairperson and ViceChairperson.

 

**Paragraph 2** -     Except for the Chairperson and Vice Chairpersonof the Administrative Board of Directors – who shall be native members of theAdvisory Board – no other Management member is permitted to be a member of thisbody.

 

**Paragraph 3**-     The members of the Advisory Council shall entertheir respective offices by signing the Installation Certificate, to betranscribed on the book of minutes of meetings of this body.

** **

**ARTICLE 26**

The Advisory Council shall convene ordinarymeetings on a quarterly basis and, extraordinary meetings whenever requested bythe Administrative Board of Directors through its Chairperson.

 

**Paragraph 1**–    It is incumbent upon the Chairperson of theAdvisory Board or, in his/her absence, to the Vice Chairperson, to call,convene and chair the meetings of this body.

** **

**Paragraph 2**-     The quorum for the meetings of the AdvisoryCouncil shall be a minimum of half plus one of its acting members.

** **

**ARTICLE 27**

It is incumbent upon the Advisory Councilto issue its opinion on matters of relevant interest to the Company and,irrespective of any request, to keep the Administrative Board of Directors,informed about relevant matters which may come to the knowledge of its members.

113

 

 

**CHAPTER V**

**GENERAL MEETING**

**SECTION I**

**CONVENING MEETINGS AND MAKING RESOLUTIONS**

 

**ARTICLE 28**

A lawfully called and convened GeneralMeeting is the highest body of the Company, capable of resolving all mattersand making any resolutions, including those relating to amendments to theseBylaws.

** **

**ARTICLE 29**

General Meetings are held, on an ordinarybasis, within the four (4) months  following the closing of the fiscal year,for the purposes contemplated in the Law and, on an extraordinary basis,whenever corporate interests so require.

** **

**ARTICLE 30**

Save for the exceptions contemplated in theLaw, a General Meetings is constituted whenever, on a first call, shareholdersrepresenting a minimum of twenty-five percent (25%)  of the Capital Stock withvoting rights are present and, on a second call, any number of the shareholderspresent.

** **

**ARTICLE 31**

Regularly made resolutions of the GeneralMeetings shall bind all shareholders, in spite of those absent or dissenting,as provided for by the Law and these Bylaws. 

** **

**ARTICLE 32**

General Meetings convened in accordancewith Law shall be chaired by the Chairperson of the Administrative Board ofDirectors who will appoint one or more secretaries from among the shareholderspresent.

**Sole Paragraph -** In the absence of the Chairperson, theGeneral Meeting shall be chaired by one of the Vice Chairpersons of theAdministrative Board of Directors, observing the order of election and, in theabsence of both, by a member of the Administrative Board of Directors appointedby the shareholders.

** **

**ARTICLE 33**

In the event that the General Meetingcannot be held on the scheduled date, due to lack of legal quorum, a secondcall shall be made in the same manner of the first, spaced by a minimum ofeight (8) days between the first publication of the advertisement and the dateof the General Meeting which, in this case, shall be convened with any numberof attendees. 

** **

**SECTION II**

**ORDINARY SHAREHOLDERS MEETING**

** **

**ARTICLE 34**

Ordinary General Meetings shall be held to:

 

I –            Receive the Managementaccounts and examine, discuss and vote the financial statements;

 

II –           Make a resolution about theappropriation of net income for the year and the distribution of dividends.

 

III -  Elect the members of theAdministrative Board of Directors and of the Fiscal Council, as the case maybe.

 

IV – Approve the restatement of the CapitalStock in the cases contemplated by Law No. 6404/76 and these Bylaws.

114

V – Fixthe compensation of the administrators and of the members of the FiscalCouncil, when called.

** **

**SECTION III**

**EXTRAORDINARY GENERAL MEETING**

** **

**ARTICLE 35**

Whenever held on an extraordinary basis, aGeneral Meeting shall make resolutions only about the matters for which it wascalled.

 

**ARTICLE 36**

It is incumbent upon the General Meeting toauthorize the disposal or pledge of quotas or shares with voting rights of alegal entity whose control of the voting capital is directly or indirectlyowned by the Company whenever the disposal or pledge implies the risk of losingthat control.

 

**CHAPTER VI**

**AUDIT COMMITTEE**

** **

**ARTICLE 37**

The Audit Committee shall be permanent andhave the powers  established in the Law, being formed by a minimum of three (3)and a maximum of five (5) permanent members and an equal number of substitutes,whether or not shareholders, elected by the General Meeting for a one-yearmandate.

 

**Sole Paragraph**–****The permanent members of the Audit Committeeshall receive monthly fees, observing the minimum amount established by Law, tobe fixed by the General Meeting that elected them.

 

**CHAPTER VII**

**THE FISCAL YEAR, THE BALANCE SHEET AND THERESULTS**

** **

**SECTION I**

**THE FISCAL YEAR AND THE BALANCE SHEET**

** **

**ARTICLE 38**

The fiscal year shall end at December 31 ofevery year, when the Executive Board of Board of Directors Executive Officersshall prepare the Company ́s financial statements, based on the commercialaccounting of the Company and expressing clearly its situation and the changesoccurred in the year:

 

I –       Balance Sheet;

 

II–       Statement of Year-to-Date netincome and losses or changes in shareholders equity;

 

III -      Statement of income for theyear;

 

IV –     Statement of changes in financialposition.

** **

**ARTICLE 39**

The books and records of the Company shall be examined by anindependent audit firm selected by the Administrative Board of Directors.

** **

**SECTION II**

**DISTRIBUTION OF NET INCOME**

** **

**ARTICLE 40**

The General Meeting shall make a resolutionabout the distribution of net income for the year as determined by the balancesheet and proposed by the Administrative Board of Directors, accompanied by theopinion of the Fiscal Council, if active, observing the following criteria:

115

 

I –              Five percent (5%) of thenet income for the Legal Reserve Fund, up to the amount established by the Lawon Capital Stock.

 

II –           An amount equivalent totwenty–eight percent (28%)  of Net Income for the year as a portion requiredfor the payment of the minimum dividend of preferred and common shares, suchnet income being reduced or increased by the amounts contemplated in items I,II and III, Article 202 of Law No. 6404/76, also observing the provisions ofitem “b” of Article 12 of these Bylaws.

 

III –          Up to ten percent (10%),after deducting any accumulated losses and the provision for income tax, as theparticipation of the administrators.

 

IV –          A minimum of fifteen percent(15%) and a maximum of sixty percent (60%) on net income, as Special ExpansionReserve, destined to fund the expansion plans of the Company, up to reachingseventy percent (70%) of the capital.

 

V –            Up to five percent (5%) toset up a Special Fund for Research and Development, up to reaching ten percent(10%) of the capital.

 

VI –         The remainder shall bedestined as proposed by the administration bodies to the General Meeting.

 

**Paragraph 1**  –    The amount corresponding to the participationof the administrators shall be distributed solely if the minimum dividend tothe shareholders contemplated in these Bylaws has been guaranteed.

 

**Paragraph 2**  –      The distribution of dividends and bonuses shallobserve the periods of time defined in the Law.

 

**Paragraph 3**  –     Whenever the subscribed capital is increased,the dividends corresponding to that period may be distributed on a "prorata tempore" basis from the paid-up capital.

 

**Paragraph 4 **  –    The amounts paid from pre-existing RetainedEarnings and/or Profit Reserves accounts are an integral part of the minimumdividend established in item II of this article.

 

**Paragraph 5 **  –    If the minimum dividend is paid from thepre-existing Retained Earnings and/or Profit Reserves accounts, a portion ofthe Net Income for the year, corresponding to the amount of the   paid dividend,may be appropriated to reestablish the reserves used. 

 

**Paragraph 6**  –     The Company may pay interest on theshareholders’ own capital as dividends. 
 
**CHAPTER VIII**

**COMPANY WINDUP**

** **

**ARTICLE 41**

The Company may be liquidated in the casescontemplated in the Law or upon a resolution of the General Meeting.

 

**Sole Paragraph -** It is incumbent upon the General Meetingto establish the liquidation mode and to elect the liquidators and the membersof the Fiscal Council who will be active during the liquidation period.

** **

**CHAPTER IX**

**MISCELLANEOUS**

** **

**ARTICLE 42**

In addition to the official gazette *Diário Oficial doEstado de Santa Catarina,* the publications required by the Law and by theseBylaws shall be made**on the same press institution where the minutes orthe abstract of the

116

minutes of the Shareholders approving these Bylaws havebeen published until any change is advised to the shareholders for annotationin the minutes of the Ordinary General Meeting.

** **

**I certify that these Bylaws are a faithfulcopy of the text approved by the Extraordinary General Meeting held on12.15.2005, entered in the Book of Minutes of the General Meetings 01 of thisCompany and duly signed.**

** **

**MAURO E. GUIZELINE**

**SECRETARY**

** **

** **

REGISTRY OF COMMERCE OF THE STATE OF SANTA CATARINA

Docket: 05/315620-0

Company No.: 42 3 0002574 7

 SADIA S/A

/s/ Fabiana Everling de Freitas 

General Secretary

** **

117

**Exhibit 12.01 Certification by the Company’s CEO**

CERTIFICATION

I, Gilberto Tomazoni, Chief ExecutiveOfficer, certify that:

 

1.             I have reviewed this annual report on Form 20-F of Sadia S.A.;

2.         Based on my knowledge, this report does not contain anyuntrue statement of a material fact or omit to state a material fact necessaryto make the statements made, in light of the circumstances under which suchstatements were made, not misleading with respect to the period covered by thisreport;

3.         Based on my knowledge, the financial statements, andother financial information included in this report, fairly present in allmaterial respects the financial condition, results of operations and cash flowsof the company as of, and for, the periods presented in this report;

4.         The company’s other certifying officers and I areresponsible for establishing and maintaining disclosure controls and procedures(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the company andhave:

(a)   Designed such disclosure controls and procedures, or caused suchdisclosure controls and procedures to be designed under our supervision, toensure that material information relating to the company, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;

(b)   Evaluated the effectiveness of the company's disclosure controlsand procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of theperiod covered by this report based on such evaluation; and

(c)   Disclosed in this report any change in the company’s internalcontrol over financial reporting that occurred during the period covered by theannual report that has materially affected, or is reasonably likely tomaterially affect the company’s internal control over financial reporting; and

 

5.             The company’s other certifying officer(s) and I havedisclosed, based on our most recent evaluation of internal control overfinancial reporting, to the company’s auditors and the audit committee of thecompany’s board of directors (or persons performing the equivalent functions):

(a)  All significant deficiencies and material weaknesses in the designor operation of internal control over financial reporting which are reasonablylikely to adversely affect the company’s ability to record, process, summarizeand report financial information; and

(b)  Any fraud, whether or not material, that involves management orother employees who have a significant role in the company’s internal controlover financial reporting.

Date: June 29,2006

/s/ GilbertoTomazoni  

GilbertoTomazoniChief Executive Officer

 

A signed original of this written statement required by Section 302 has been provided to Sadia S.A. and will be retained by Sadia S.A. and furnished to the Securities and Exchange Commission or its staff upon request.

118
**Exhibit 12.02 Certification by the Company’s CFO**CERTIFICATION
 

I, Luiz Gonzaga Murat Junior, Chief Financial Officer,certify that:

 

1.             Ihave reviewed this annual report on Form 20-F of Sadia S.A.;

2.             Basedon my knowledge, this report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this report;

3.             Basedon my knowledge, the financial statements, and other financial informationincluded in this report, fairly present in all material respects the financialcondition, results of operations and cash flows of the company as of, and for,the periods presented in this report;

4.             Thecompany’s other certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-15(e) and 15d-15(e)) for the company and have:

(a)   Designed such disclosure controls andprocedures, or caused such disclosure controls and procedures to be designedunder our supervision, to ensure that material information relating to thecompany, including its consolidated subsidiaries, is made known to us by otherswithin those entities, particularly during the period in which this report isbeing prepared;

(b)   Evaluated the effectiveness of thecompany's disclosure controls and procedures and presented in this report ourconclusions about the effectiveness of the disclosure controls and procedures,as of the end of the period covered by this report based on such evaluation;and

(c)   Disclosed in this report any changein the company’s internal control over financial reporting that occurred duringthe period covered by the annual report that has materially affected, or isreasonably likely to materially affect the company’s internal control overfinancial reporting; and

 

5.             The company’s other certifying officer(s)and I have disclosed, based on our most recent evaluation of internal controlover financial reporting, to the company’s auditors and the audit committee ofthe company’s board of directors (or persons performing the equivalentfunctions):

 

(a)  All significant deficiencies andmaterial weaknesses in the design or operation of internal control overfinancial reporting which are reasonably likely to adversely affect thecompany’s ability to record, process, summarize and report financialinformation; and

(b)  Any fraud, whether or not material,that involves management or other employees who have a significant role in thecompany’s internal control over financial reporting.

Date: June 29,2006

s/ Luiz Gonzaga Murat Junior

Luiz GonzagaMurat JuniorChief Financial Officer

 

A signed original of this written statement requiredby Section 302 has been provided to Sadia S.A. and will be retained by Sadia S.A. and furnished to the Securities and Exchange Commission or its staff upon request.

119
**Exhibit 13.01 Certification pursuant to 18 U.S.C.Section 1350.**
 

CERTIFICATIONPURSUANT TO 18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE U.S. SARBANES-OXLEY ACT OF 2002

 

In connection with the Annual Report of Sadia S.A.(the “Company”) on Form 20-F for the fiscal year ended December 31, 2005, asfiled with the U.S. Securities and Exchange Commission on the date hereof (the“Report”), I, GilbertoTomazoni, Chief ExecutiveOfficer, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant tosection 906 of the U.S. Sarbanes-Oxley Act of 2002, that to the best of myknowledge:

(i)      the Reportfully complies with the requirements of Section 13(a) or 15(d) of the U.S.Securities Exchange Act of 1934; and

(ii)    theinformation contained in the Report fairly presents, in all material respects,the financial condition and results of operations of the Company.

 

 

 

** **

/s/Gilberto Tomazoni 

Name:Gilberto Tomazoni

Title: Chief Executive Officer

 June 29, 2006

 

A signed original of this written statement requiredby Section 906 has been provided to Sadia S.A. and will be retained by Sadia S.A. and furnished to the Securities and Exchange Commission or its staff upon request.

120
**Exhibit 13.02 Certification pursuant to 18 U.S.C.Section 1350.**
 

CERTIFICATIONPURSUANT TO 18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE U.S. SARBANES-OXLEY ACT OF 2002 

In connection with the Annual Report of Sadia S.A.(the “Company”) on Form 20-F for the fiscal year ended December 31, 2005, asfiled with the U.S. Securities and Exchange Commission on the date hereof (the“Report”), I, Luiz Gonzaga Murat Junior, Chief Financial Officer, certify,pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of theU.S. Sarbanes-Oxley Act of 2002, that to the best of my knowledge: 

(i)       the Reportfully complies with the requirements of Section 13(a) or 15(d) of the U.S.Securities Exchange Act of 1934; and

(ii)     theinformation contained in the Report fairly presents, in all material respects,the financial condition and results of operations of the Company.

 

 

** **

/s/ LuizGonzaga Murat Junior

Name: Luiz GonzagaMurat JuniorTitle: Chief Financial OfficerJune 29, 2006

 

A signed original of this written statement requiredby Section 906 has been provided to Sadia S.A. and will be retained by Sadia S.A. and furnished to the Securities and Exchange Commission or its staff upon request.

121

 
***Consolidated  Financial Statements***
*** ***

***Sadia S.A.***

*** ***

*** ***

***Years  ended December 31, 2005, 2004 and 2003***

 

 

122
 
**SADIA S.A.**
*** ***
***CONSOLIDATED FINANCIAL STATEMENTS***

 

 

 

** **

**Contents**

 

 

Report ofIndependent Registered Public Accounting Firm 

(KPMG AuditoresIndependentes)........................................................................................ 1

 

Report ofIndependent Registered Public Accounting Firm 

(Ernst &Young Auditores Independentes S.S.)..................................................................... 2

 

ConsolidatedBalance Sheets as of December 31, 2005 and 2004......................................... 3

 

ConsolidatedStatements of Income for Years Ended December 31, 2005, 2004

and 2003.............................................................................................................................. 5

 

ConsolidatedStatements of Changes in Shareholders’ Equity for the Years Ended

December 31, 2005, 2004 and 2003..................................................................................... 7

 

ConsolidatedStatements of Cash Flows for the Years Ended December 31, 2005,

2004 and 2003..................................................................................................................... 8

 

Notes toConsolidated Financial Statements........................................................................... 9

 

F-1

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

The Board ofDirectors and Shareholders ofSadia S.A.

 

We have audited the accompanying consolidated balance sheet of Sadia  S.A.****and subsidiaries (the “Company”) as of December 31, 2005 and 2004 and the related consolidated statements of income, changes inshareholders’ equity, and cash flows for the years then ended. Theseconsolidated financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audit. 

 

We conducted our audits in accordance with the standards of thePublic Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believe thatour audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred toabove present fairly, in all material respects, the financial position of SadiaS.A. and subsidiaries as of December 31, 2005 and 2004, and the results oftheir operations and cash flows for the years then ended, in conformity withgenerally accepted accounting principles in the United States.

 

KPMG Auditores Independentes

 

Sao Paulo, Brazil

June 29, 2006

F-2

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

The Board ofDirectors and Shareholders ofSadia S.A.

 

We have audited the consolidated balance sheet of Sadia S.A.****as of December 31, 2003, and the related consolidated statements of income,changes in shareholders’ equity, and cash flows for the year then ended. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conducted our audit in accordance with the standards of thePublic Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above presentfairly, in all material respects, the consolidated financial position of SadiaS.A. at December 31, 2003, and the consolidated results of its operations andits cash flows for the year then ended, in conformity with U.S. generallyaccepted accounting principles.

** **

 

ERNST & YOUNG 

Auditores Independentes S.S.

 

 

 

/s/ Sergio Ricardo Romani

Sergio Ricardo Romani

Partner

 

São Paulo, BrazilFebruary 3, 2004

F-3

**SADIA S.A.**

CONSOLIDATEDBALANCE SHEETSDecember 31, 2005 and 2004(Inthousands of Reais – R$, except share amounts)

 

 

** **

**2005**

**2004**

Assets

Current assets:

  Cash and cash equivalents

683,274

764,178

  Available-for-sale securities

1,891,722

1,153,014

  Foreign currency and interest rate swap contracts

55,656

103,100

  Accounts and notes receivable, net

718,132

612,169

  Inventories 

981,941

1,068,431

  Recoverable taxes 

146,562

155,891

  Deferred income taxes

22,039

20,372

  Other current assets

88,850

67,647

Total current assets

4,588,176

3,944,802

Property, plant and equipment, net

1,523,309

1,055,240

Other assets:

  Equity investees

4,135

5,330

  Available-for-sale securities

65,057

436,782

  Foreign currency and interest rate swap contracts

-

28,362

  Judicial deposits 

78,396

77,204

  Recoverable taxes 

120,024

87,186

  Deferred income taxes 

27,054

56,554

  Intangible assets other benefit

15,311

26,508

  Prepaid pension plan

95,027

49,316

  Other intangible assets

29,440

-

  Goodwill

32,728

-

  Other

128,627

63,689

Total other assets

595,799

830,931

Total assets

6,707,284

5,830,973

F-4

 

 

** **

**2005**

**2004**

Liabilities and  Shareholders’ equity

** **

** **

Current  liabilities:

 

 

  Short -term  debt

790,162

1,061,881

  Current  portion of long-term debt

694,180

676,954

  Foreign currency and interest rate swap  contracts 

158,692

172,802

  Suppliers

495,330

483,566

  Salaries and  social charges payable

24,132

22,181

  Taxes payable 

38,648

38,055

  Dividends  payable

128,210

82,797

  Accrued  vacation payable

75,093

65,959

  Accrued employee bonus

59,304

51,048

  Accrued marketing

43,999

27,745

  Other

118,062

83,731

Total current  liabilities

2,625,812

2,766,719

 

Long-term  liabilities

  Long-term debt

1,704,184

1,031,375

  Foreign  currency and interest rate swap contracts 

10,331

68,183

  Provision for  legal proceedings and labor claims

71,947

58,984

  Accrued  employee benefit liability

47,575

48,388

  Stock options

678

-

  Other

16,824

18,800

Total long-term  liabilities

1,851,539

1,225,730

 

Minority  interest 

1,816

160

 

Shareholders’  equity:

  Preferred shares, no par  value, 426,000,000 shares

    authorized, issued and  outstanding in 2005 and 2004

 

938,914

 

627,055

  Common shares, no par  value, 257,000,000 shares

    authorized, issued and  outstanding in 2005 and 2004

 

561,086

 

372,945

  Preferred  shares in treasury, at cost

(10,377)

(198)

  Appropriated  retained earnings

738,417

767,441

  Unappropriated  retained earnings

2,055

71,121

  Accumulated  other comprehensive income (loss)

(1,978)

-

Total  shareholders’ equity

2,228,117

1,838,364

Total  liabilities and shareholders’ equity

6,707,284

5,830,973

See notes to the Consolidated Financial Statements.

F-5

**SADIA S.A**

 

CONSOLIDATEDSTATEMENTS OF INCOMEYearsended December 31, 2005, 2004 and 2003(Inthousands of Reais - R$, except numbers of shares and per share amounts)

 

** **

**2005**

**2004**

**2003**

 

 

 

 

Gross operating revenue 

8,327,372

7,117,318

5,717,525

 

 

 

 

Value-added tax on sales

  (914,219)

  (880,010)

  (535,337)

Sales deductions

    (95,311)

  (128,083)

  (100,471)

Net operating revenue

7,317,842

6,109,225

5,081,717

Cost of goods sold

(5,324,359)

(4,292,650)

(3,673,011)

Gross profit

1,993,483

1,816,575

1,408,706

 

 

 

 

Operating expenses:

 

 

 

  Selling 

(1,245,892)

(1,144,482)

   (916,671)

  General and administrative 

     (80,959)

     (52,462)

     (54,207)

  Other operating income (expenses), net 

     14,271

     15,398

     (36,819)

Total operating expenses

(1,312,580)

(1,181,546)

(1,007,697)

 

 

 

 

Operating income 

   680,903

   635,029

   401,009

 

 

 

 

Interest expense

   (311,626)

   (336,825)

   (450,198)

Interest income and other, net

   247,998

   249,784

   459,750

Foreign currency exchange gain, net

     53,377

     39,134

     60,970

Income before income taxes, equity income  of investees and minority interest

 

   670,652

 

   587,122

 

   471,531

 

 

 

 

Income tax benefit (expense) 

 

 

 

  Current benefit (expense)

     (52,028)

     (32,969)

     (39,072)

  Deferred tax benefit (expense)

     (16,411)

     (63,130)

      40,099

  Total income tax

     (68,439)

     (96,099)

        1,027

Income before equity income of investees  and minority interest

 

   602,213

 

   491,023

 

   472,558

 

 

 

 

Equity income (loss) of investees

      1,219

       (1,385)

          361

Minority interest

        (164)

          (137)

          349

 

 

 

 

Net income

  603,268

   489,501

   473,268

 

 

 

 

Net income applicable to  preferred shares 

  375,802

   316,045

   305,564

Net income applicable to  common shares

  227,466

   173,456

   167,704

Net income

  603,268

   489,501

   473,268

F-6

**SADIA S.A**

CONSOLIDATEDSTATEMENTS OF INCOMEYearsended December 31, 2005, 2004 and 2003(Inthousands of Reais - R$, except numbers of shares and per share amounts)

 

 

** **

**2005**

**2004**

**2003**

 

 

 

 

Basic earnings per thousands  shares in R$:

 

 

 

  Preferred

885.08

742.42

717.80

  Common

885.08

674.93

652.54

 

 

 

 

Weighted average number of shares outstanding:

 

 

 

    Preferred

424,595,712

425,695,712

425,695,712

    Common

257,000,000

257,000,000

257,000,000

 

 

 

 

Diluted earning per thousands shares in  R$

 

 

 

    Preferred

884.38

742.42

717.80

    Common

884.38

674.93

652.54

 

 

 

 

Weighted average shares and diluted  potential number of shares

 

 

 

    Preferred

425,137,363

425,695,712

425,695,712

    Common

257,000,000

257,000,000

257,000,000

See notes to the Consolidated Financial Statements.

F-7

**SADIA S.A.**

CONSOLIDATEDSTATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITYYearsended December 31, 2005, 2004 and 2003(Inthousands of Reais -R$)

 

 

**2005**

**2004**

**2003**

Preferred  shares 

    At the beginning of the year (426,000,000 shares)

   627,055

   627,055

  439,939

    Capital increase without issue of shares 

   311,859

              -

  187,116

    At the end of the year (426,000,000 shares)

   938,914

   627,055

  627,055

Common  shares

    At the beginning of the year (257,000,000 shares)

   372,945

   372,945

  260,061

    Capital increase without issue of shares

   188,141

              -

  112,884

    At the end of the year (257,000,000 shares)

   561,086

   372,945

  372,945

Treasury  shares

    At the beginning of the year (304 shares)

         (198)

         (198)

        (198)

    Purchase of shares (2,200,000 shares)

    (10,179)

    At the end of the year (2,200,304 shares)

    (10,377)

         (198)

        (198)

Retained  earnings

    Appropriated retained earnings

      At the beginning of the year

   767,441

   470,450

  468,413

     Used to increase capital

   (475,068)

              -

  (300,000)

     Transfer from  unappropriated retained earnings

   446,044

   296,991

  302,037

      At the end of the year

   738,417

   767,441

  470,450

    Unappropriated retained earnings 

      At the beginning of the year

     71,121

     26,922

      6,145

      Used to increase capital

     (24,932)

      Net income

   603,268

   489,501

  473,268

      Transfer to appropriated retained earnings

   (446,044)

   (296,991)

  (302,037)

      Dividends / interest on capital

          Preferred  

   (126,617)

   (95,756)

    (97,143)

          Common

     (74,741)

   (52,553)

    (53,311)

      At the end of the year

      2,055

     71,121

    26,922

    Accumulated other comprehensive income (loss)

      At the beginning of the year

             -

     24,411

   (116,601)

     Adjustment to unrealized  gain (loss) on available-for sale securities

 

             -

 

     (36,989)

 

   213,656

     Excess of additional  liability on retirement indemnity

      (2,996)

              -

              -

     Income tax benefit  (expense)

       1,018

    12,578

    (72,644)

      At the end of the year

       (1,978)

               -

     24,411

Total  shareholders’ equity

2,228,117

1,838,364

1,521,585

 

Comprehensive  income:

 

 

 

    Net income

   603,268

   489,501

   473,268

    Unrealized  gain (loss) on available-for-sale securities, net of taxes (R$12,577 and  R$72,644 for 2004 and 2003, respectively)

 

 

             -

 

 

     (24,411)

  

 

   141,012

    Excess of  additional liability on retirement indemnity, net of taxes (R$1,018 in  2005)

 

      (1,978)

 

              -

 

            -

    Reclassification adjustment for loss  (gain) included in net income, net of tax (R$23,681 in 2003)

 

              -

 

    110,000

 

    (45,969)

Comprehensive  income

   601,290

   537,690

  568,311

 

See notes to the Consolidated FinancialStatements.

F-8

**SADIA S.A.**

 

CONSOLIDATED  STATEMENTS OF CASH FLOWS  Yearsended December 31, 2005, 2004 and 2003(Inthousands of Reais -R$)

 

** **

**2005**

**2004**

**2003**

**Cash flows from operating  activities:**

** **

** **

** **

  Net income

   603,268

   489,501

   473,268

 Adjustments to reconcile net  income to net cash provided by operating activities:

 

 

 

     Minority interest 

          164

          137

          (349)

     Loss (gain) on sale of  securities 

              -

   110,000

     (69,650)

     Foreign currency  exchange (gains), net

    (53,377)

     (39,134)

     (60,970)

     Equity income or loss of  investees 

        1,219

       1,385

          (361)

     Depreciation and  amortization

   182,263

   157,821

   150,098

     Deferred income taxes

     16,411

     63,130

     (40,099)

     Pension plan

     (45,711)

     (23,062)

       (7,295)

     Provision for (reversal  of) contingencies

       (2,611)

       (9,021)

     10,732

    Loss from sale of  property, plant and equipment

     51,897

     21,777

     38,517

  Changes in operating assets  and liabilities: 

 

 

 

   Accounts and notes  receivable

     (89,012)

     (35,266)

   (107,949)

   Inventories

   100,221

   (249,600)

     (16,487)

   Recoverable taxes and  other assets

     (71,041)

     (68,029)

     15,789

   Judicial deposits

       (1,192)

       (2,126)

      (6,034)

   Suppliers

       (3,407)

   125,597

   110,793

    Accrued interest, net

   130,546

     (58,984)

   297,974

    Social charges, taxes payable, other liabilities 

     22,529

   (176,895)

   187,829

**Net cash provided by  operating activities**

   842,167

   307,231

   975,806

**Cash flows from investing  activities:**

 

 

 

   Proceeds from sale of  property, plant and equipment

       3,400

       2,857

       8,728

   Purchase of property,  plant and equipment

   (673,098)

   (324,917)

   (179,344)

   Acquisition, net of cash  acquired of Só Frango

     (69,259)

             -

              -

   Investment in equity investees

              -

       (1,088)

       (2,942)

   Held-to-maturity investments:

        Purchases

              -

         (2,747)

     (61,027)

        Maturities 

              -

       36,447

   722,669

   Available-for-sale debt securities:

        Purchases

(1,512,809)

(1,893,844)

(1,388,487)

        Maturities and sales

1,015,558

1,543,873

   807,533

**Net cash provided by (used  in) investing activities**

(1,236,208)

   (639,419)

     (92,870)

**Cash flows from financing  activities:**

   Short-term debt

      Issuances

   863,702

   801,112

2,119,594

      Repayments

   (994,557)

(1,119,073)

(1,997,073)

   Long-term debt

      Issuances

1,490,109

   675,703

1,574,677

      Repayments

   (916,382)

   (948,196)

(1,122,088)

   Dividends/interest on  capital paid

   (129,735)

   (131,234)

     (95,588)

**Net cash provided by (used  in) financing activities**

   313,137

   (721,688)

   479,522

Net change in cash and cash  equivalents

    (80,904)

(1,053,876)

1,362,458

Cash and cash equivalents at  beginning of year

   764,178

1,818,054

   455,596

Cash and cash equivalents at  end of year

   683,274

   764,178

1,818,054

See notes to Consolidated Financial Statements.

F-9

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

**  1.  Operations**

 

       Sadia S.A. (together with its consolidatedsubsidiaries, “Sadia” or “the Company”) is incorporated under the laws of theFederative Republic of Brazil. Sadia S.A.’s shares are traded on the Sao PauloStock Exchange (Bovespa) and on the Madrid Stock Exchange (Latibex) and itsADRs on the New York Stock Exchange (NYSE).

 

       The Company’s principal business is theproduction and distribution of poultry and pork products. The Company’soperations include feed facilities, hatcheries, poultry farms for grandparentand parent stock, pork breeding centers, poultry and pork processing units,sales offices and distribution centers. Presently Sadia’s operations areorganized into three main business segments: “Processed Products” (sausage,ham, chicken nuggets, margarine, frozen meals, pizza and pasta among othersimilar products), “Poultry” (chickens and turkeys) and “Pork”.

 

       The exchange rate of the Brazilian real (“R$”)to the U.S. dollar was R$2.8892=US$1.00 at December 31, 2003, R$2.6544=US$1.00 at December 31, 2004 and R$2.3407=US$1.00 at December 31, 2005.

 

**  2.  Presentation of the Consolidated Financial Statements**

 

       a)  Basisof presentation

 

         Theconsolidated financial statements have been prepared in accordance with style='font-size:12.0pt'>generally accepted accounting principles in theUnited States of America (“US GAAP”), which differs in certain respects fromaccounting principles generally accepted in Brazil (“Brazilian GAAP”), whichthe Company uses to prepare its statutory consolidated financial statements asfiled with the Brazilian Securities Commission – CVM (“Comissao de ValoresMobiliários”).

 

          b)  Consolidation procedures

 

The consolidated financial statements include the accounts of Sadiaand its controlled subsidiaries (ownership interest greater than 50%). Theportion of equity and net income attributable to shareholders other than Sadiais reflected as minority interest in the consolidated financial statements.Investments in entities in which the Company does not control but hassignificant influence over, are accounted for on the equity method. Allsignificant intercompany accounts and transactions are eliminated inconsolidation.

F-10

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

**  2.  Presentation of the Consolidated Financial Statements** (Continued)

 

              b)  Consolidation procedures (Continued)

 

The following subsidiaries were included in the consolidatedfinancial statements for the years ending December 31:

 

 

 

**Ownership %**

** **

** **

**2005**

**2004**

 

 

 

 

**Sadia  International Ltd.**

**100,00%**

**100,00%**

Sadia Uruguay  S.A.

100,00%

100,00%

   Sadia  Alimentos S.A.

    1,00

    1,00%

Sadia Chile  S.A.

  60,00%

  60,00%

Sadia Alimentos  S.A.

  99,00%

  99,00%

Sadia UK. Ltd. 

100,00%

100,00%

**Concórdia  S.A. C.V.M.C.C.**

**  99,99%**

**  99,99%**

**Empresa  Matogrossense de Alimentos Ltda.**

**100,00%**

**     -**

**Rezende Óleo  Ltda.**

**100,00%**

**100,00%**

** **

Rezende  Marketing e Comunicaçoes Ltda.

    0,09%

    0,09%

**Rezende  Marketing e Comunicaçoes Ltda.**

**  99,91%**

**  99,91%**

**Sadia  G.m.b.H.**

**100,00%**

**100,00%**

** **

Wellax  Food Logistics C. P. A. S. U. Lda.

100,00%

100,00%

** **

Sadia  Foods G.m.b.H.

100,00%

100,00%

** **

Qualy  B. V.

100,00%

100,00%

** **

Sadia  Japan Ltd.

100,00%

100,00%

 

c) Só Frango acquisition

 

On January 3, 2005 Sadia acquired the all capital stock of Só Frango Produtos Alimentícios Ltda. (primarily a  producer and distributor of poultry) for R$69,259 in cash, (net of cash  acquired of R$1,083). The operations of Só Frango Produtos Alimentícios Ltda.  are included in the consolidated financial statements from the date of  acquisition. Through this acquisition, Sadia  strengthens its presence in the central region of Brazil close to raw materialproducers and to Brazil’s main centers of consumption.

 

The acquisition was recorded by  allocating the cost of the assets acquired, including intangible assets and  liabilities assumed, based on their estimated fair value at the acquisition  date and determined goodwill in accordance with the purchase method of  accounting prescribed by Statement of Financial Accounting Standards (“SFAS”)  141, *“Business Combinations”*. The excess of the cost of the acquisition  over the net of amounts assigned to the fair value of the assets acquired and  the liabilities assumed is recorded as goodwill. The valuation of assets and  liabilities was determined and the purchase price was allocated as follows: 

F-11

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

**  2.  Presentation of the Consolidated Financial Statements** (Continued)

c) Só Frango acquisition(Continued)

 

**Assets:**

 

  Accounts receivable

16,951

  Inventory

13,731

  Recoverable taxes

16,558

  Other current assets

  2,382

  Property, plant and equipment

32,531

  Amortizable intangible assets

32,148

  Others noncurrent assets 

  5,764

**Liabilities:**

 

  Short-term and long-term debt

(32,837)

  Accounts payable and accrued liabilities

(38,257)

  Deferred income taxes liability

(14,354)

**Net assets**

**34,617**

 

 

Purchase price, net of cash acquired

(69,259)

 

 

Total Goodwill

34,642

 

The difference between the goodwill initially recorded and theamount reported as of December 31, 2005 refers to the tax benefit generated inaccordance with SFAS 109. The Company estimates the entire goodwill balancerelated to this acquisition will be deductible for tax purpose.

 

As of December 31, 2005 the Company has the following amounts related to intangible assets:

 

** **

**Amortizable Cost**

** **

**Amortization**

** **

**Net Amount**

 

 

 

 

Amortized  intangible assets:

 

 

 

  Brand

  8,471

(1,129)

  7,342

  Client  portfolio

23,677

(1,579)

22,098

** **

**32,148**

**(2,708)**

**29,440**

 

F-12

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated) 

 

**  2.  Presentation of the Consolidated Financial Statements** (Continued)

 

c) Só Frango acquisition(Continued)

 

No significant residual value is estimated for these intangibleassets. The following table represents the total estimated amortization ofintangible assets for the next five succeeding years:

 

 

**Estimated  Amortization Expenses**

 

 

2006

  4,062

2007

  4,062

2008

  4,062

2009

  4,062

2010

  2,932

Thereafter

10,260

29,440

 

d) Empresa Matogrossense de Alimentos 

 

OnSeptember, 2005 Sadia acquired all the capital stock of Empresa Matogrossensede Alimentos Ltda. by R$1.350. As this Company does not have operations, activecustomers, but only land, the excess amount paid over the net assets acquiredwas allocated to property, plant and equipment.

 

e) Pro forma results 

 

The following unaudited pro forma financial information presents thecombined results of operations of the Company and Só Frango ProdutosAlimentícios Ltda. (“Só Frango”) and Empresa Matogrossense de Alimentos Ltda.as if the acquisitions had occurred at January 1, 2004. The historical results of the Company for 2005 include the results of Só Frango. The pro forma resultsfor 2004 combine the historical results of the Company for 2004 with thehistorical results for 2004 of Só Frango. The unaudited pro forma financialinformation is not intended to represent or be indicative of the Company’sconsolidated results of operations or financial condition that would have beenreported had the acquisition been completed as of the beginning of the periodspresented and should not be taken as indicative of the Company’s futureconsolidated results of operations or financial condition. Pro formaadjustments are tax-effected at the Company’s statutory tax rate.

F-13

**SADIA S.A.**

** **

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**  2.   Presentation of the Consolidated Financial Statements** (Continued)

 e) Pro forma results (Continued)

 

**Unaudited**

**2004**

 

 

Net operating revenue

6,301,452

Net income

   467,704

Basic earnings per thousand shares in R$:

 

 Preferred

709.36

   Common

644.87

 

       The pro forma effects in 2005 for net operating revenue, netincome, basic earngins per share would not be materially different from theactual results. The pro forma net earnings for 2004 include R$3,564, of whichR$2,708 relates to the intangibles amortization and R$856 relates to thetangibles amortization.

 

 

**  3.  Significant Accounting Policies**

 

       a)  Useof estimates

 

       The preparation of financial statements in accordance with U.S. generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the amounts reportedin the financial statements and accompanying notes. Significant items subjectto such estimates and assumptions include the carrying amount andrecoverability of property, plant and equipment, valuation allowances forreceivables, recoverability of deferred income tax assets, provisions forcontingencies, the determination of the fair value of derivatives and financialinstruments and stock option valuation. Actual results could differ from thoseestimates.

 

b) Cashand cash equivalents

 

           Cash equivalents are highly liquid investments withmaturity of three months or less when purchased. For purpose of theconsolidated statements of cash flow, the Company considers all highly liquiddebt instruments with original maturities of three months or less to be cashequivalents.

F-14

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**  3.   Significant Accounting Policies**(Continued)

 

c)Available-for-sale securities

 

           Management determines the appropriate classification of thedebt securities at the time of purchase and reevaluates such designation as ofeach balance sheet date. Available-for-sale securities are carried at fairvalue, with the unrealized gains and losses reported in other comprehensiveincome. Interest on securities classified as available-for-sale is included ininterest income and other, net. The specific identification method is used todetermine the cost of securities sold, with realized gains and losses includedin interest income and other, net.

In determining if andwhen a decline in market value below amortized cost is other-than-temporary,management evaluates the market conditions, offering prices and other keymeasures for the investments in debt securities. When such a decline in valueis deemed to be other-than-temporary, an impairment loss is recognized in theoperating results to the extent of the decline.

  d) Accounts and notes receivable

 

Trade accounts receivable are recorded at the invoiced amount and donot bear interest. The allowance for doubtful accounts is the Company’s bestestimate of the amount of probable credit losses in the Company’s existingaccounts receivable. Account balances are charged off against the allowanceafter all means of collection have been exhausted and the potential forrecovery is considered remote.

 

e)  Inventories 

Processed products, livestock (excluding breeders),work-in-progress, raw materials and supplies and other are valued at the lowerof cost (average method) or market. Cost for finished goods andwork-in-progress includes purchased raw materials, labor and manufacturing andproduction overhead, which are related to the purchase and production ofinventories. Normal losses in hog stock and poultry are inventoried andabnormal losses in stock are expensed immediately as cost of goods sold.

F-15

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

**  3.  Significant Accounting Policies**(Continued)

 

       f)   Property, plant and equipment 

            Property, plant and equipment are recorded at cost of acquisition,  formation or construction, including the interest incurred on financing, during  the period of construction, modernization and expansion of the industrial  units. Expenditures that materially extent the useful lives of existing  facilities and equipment are capitalized. Depreciation is calculated using the  straight-line method at rates that take into account the estimated useful life  of the assets, adjusted in keeping with the work shifts, being 25 years for  buildings, 5 to 10 years for machinery and equipment, 10 years for  installations and 4 years for vehicles. Depletion of forestry resources is  calculated based on the extraction of timber and the average costs of the  forests.

  Breeding stock is recorded at the cost of formation which includesthe appropriation of costs of the breeding hens, animal feed, medication andlabor. These costs are accumulated for approximately six months until thebreeding stock initiates the breeding cycle. From then on, the costs of thebreeding stock begin to be amortized by the estimated number of offsprings. TheCompany periodically reviews the estimated number of offspring to be producedby the batch and revises its estimate accordingly. The amortization isallocated to poultry and hog production costs. The productive cycle ranges fromfifteen to thirty months.

 

       g)  Accounting for the Impairment of Long-Lived Assets

 

The Company reviews its property, plant and equipmentfor possible impairment whenever events or changes in circumstances indicatethat the carrying value of an asset or group of assets may not be recoverableon the basis of undiscounted future cash flows. The reviews are carried out atthe lowest level of groups of assets to which the Company is able to attributeidentifiable future cash flows. If the carrying amount of an asset exceeds itsestimated future cash flows, an impairment charge is recognized by the amountby which the carrying amount of the asset exceeds the fair value of the asset.These reviews to date have not indicated the need to recognize any impairmentlosses. 

F-16

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**  3.  Significant Accounting Policies**(Continued)

 

h)  Goodwilland Other Intangible Assets 

  

Goodwill relates to the excess of the purchase price over the fairvalue of tangible and identifiable intangible net assets acquired in a businessescombination. Goodwill acquired in a business combination has an indefiniteuseful life and consequently is not amortized, but instead tested forimpairment at least annually in accordance with the provisions of SFAS No.142, *Goodwilland Other Intangible Assets.* Intangible assets with estimable useful livesare amortized over their respective estimated useful lives to their estimatedresidual values, and reviewed for impairment in accordance with SFAS No.144, *Accountingfor Impairment or Disposal of Long-Lived Assets*. 

  

i)  Environmental matters 

  

Our production facilities and also our forestry activities are bothsubject to Government environmental regulations. We diminish the risksassociated with environmental matters, through operating procedures andcontrols and investments in pollution control equipment and systems. We believethat no provision for losses related to environmental matters is currentlyrequired, based on existing Brazilian laws and regulations. 

  

j)  Interest attributed to shareholders’ equity

 

            Brazilian corporations are permitted to attributeinterest on shareholders’ equity, which is deductible for statutory income taxpurposes. The Company elected to pay such interest to its shareholders on December 31, 2005, 2004 and 2003 and accrued the amount due with a direct charge toshareholders’ equity in a manner similar to a dividend. The distribution to theshareholders is subject to withholding income tax at the rate of 15%, and theamount of interest on shareholders’ equity attributable to dividends must benet of such withholding income tax.

F-17

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**  3.  Significant Accounting Policies**(Continued)

 

       k)  Revenuesand expenses

 

The Company recognizes revenue when products are shipped and thecustomer takes ownership and assumes risk of loss, collection of the relevantreceivable is probable, persuasive evidence of an arrangement exists and thesales price is fixed or determinable.

Shipping and handling costs are classified as selling expenses andtotaled R$544,364, R$495,870 and R$394,820 for the years ended December 31, 2005, 2004 and 2003, respectively.

Research and development costs are charged to expense as incurredand totaled R$10,873, R$10,130 and R$6,510 for the years ended December 31, 2005, 2004 and 2003, respectively.

The cost of advertising is expensed as incurred. The Companyincurred advertising expenses of R$116,559, R$121,435 and R$96,845 during theyears ended December 31, 2005, 2004 and 2003, respectively. 

  

       l)   Foreigncurrency transactions

 

Transactions in foreigncurrency are recorded at the prevailing exchange rate at the time of therelated transactions. Foreign currency denominated monetary assets andliabilities are translated using the exchange rate at the balance sheet date.Exchange differences are recognized in the statements of income as they occur. 

  

       m) Income taxes

 

Income taxes are accounted for under the asset and liability method.Deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases and operating loss and tax credit carryforwards. Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to berecovered or settled. The effect on deferred tax assets and liabilities of achange in tax rates is recognized in income in the period that includes theenactment date.

F-18

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**  3.  Significant Accounting Policies**(Continued)

 

n)  Earnings per share

 

            Basic earnings per share were calculatedin accordance with FASB Statement No. 128, *Earnings per Share.* Thecomputation has been made as if the net income for each year would be fullydistributed. Earnings may be used to increase capital or otherwiseappropriated; consequently such earnings would no longer be available asdividends. The unit of one thousand shares is used because this is the basisfor quotation and trading on the Sao Paulo Stock Exchange.

 

            Until December 31, 2004, preferred and common shareholders had different dividend and liquidation rights, thus basicearnings per share were calculated using “two-class” method taking into accountthat the preferred shares were entitled to a dividend 10% greater than thecommon shares. The “two-class” method is an earning allocation formula thatdetermines earnings per share for preferred and common shares according to thedividends to be paid as required by the Company’s by-law and participation rightsin undistributed earning.

 

As described in note 14, it was approved in a general extraordinary shareholder’smeeting and ratified in a special meeting of preferred shareholders that thecommon and preferred are entitled to the same dividends distribution, thereforeamending the Company’s by laws the payments of 10% greater to preferred thanthe common shareholders. As described in note 14, the common and preferredshareholders have agreed that, effective in 2005, the preferred shareholderswould no longer be entitled to a 10% dividend premium. Accordingly, the “twoclass” method of computing earnings per share is no longer required for theyear ended December 31, 2005.

 

o)  Accounting for DerivativeInstruments and Hedging Activities 

  

In accordance with SFAS No. 133, *“Accounting for DerivativeInstruments and Hedging Activities,”* as amended by SFAS No. 137, *“Accountingfor Derivative Instruments and Hedging Activities – Deferral of the EffectiveDate of FASB Statement No. 133,”* and SFAS No. 138, *“Accounting forCertain Derivative Instruments and Certain Hedging Activitie*s*,”* theCompany records all foreign currency in the balance sheet as either assets orliabilities measured at fair value.  Adjustments to fair value for foreigncurrency derivatives are included in foreign currency exchange gain (loss), neton the statement of income. Adjustments to the fair value of non-fixed grainpurchase derivatives are include in interest income and other, net on thestatement of income. The Company has not designated any derivative as held forhedging purposes for any periods presented.

F-19

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

**  3.  Significant Accounting Policies**(Continued)

 

p) Reclassifications

 

The Company reclassified the poultry and hog breeders reclassifyingthem from inventories to property, plant and equipment, since breeders aregenerally accounted for as fixed assets and also because they contribute to thecost formation of the poultry and hogs raised for commercial purposes. TheCompany has not changed the breeder’s estimated useful life.

 

The breading stock (net of depreciation) in the amount of R$108,065for the year ended December 31, 2004 has been reclassified from inventories toproperty, plant and equipment and its related depreciation in the amount ofR$58,755 and R$50,837 for the years ended December 31, 2004 and 2003respectively has been added to the depreciation and amortization line itemunder operating activities in the statements of cash flows for these respectiveyears. Also, the amount of R$85,813 and R$73,594 has been added to the purchaseof property, plant and equipment line item under the investing activities inthe statements of cash flows for the years ended December 31, 2004 and 2003,respectively.

Certain other reclassifications have been made to prior years toconform to current presentations. The effects of these reclassifications arenot material to the Company’s consolidated financial statements.

 

q) RecentlyIssued Accounting Standards

 

In December 2004, the FASB issued FASB Statement No.151, *InventoryCosts*, which clarifies the accounting for abnormal amounts of idle facilityexpense, freight, handling costs, and wasted material (spoilage). Under thisStatement, such items will be recognized as current-period charges. Inaddition, the Statement requires that allocation of fixed production overheadsto the costs of conversion be based on the normal capacity of the productionfacilities. The application of this Statement is required after January 1, 2006. The Company anticipates no significant impact on its financial statementsby applying Statement 151.

F-20

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**  3.   Significant Accounting Policies**(Continued)

 

q) RecentlyIssued Accounting Standards (Continued) 

  

In December 2004, the FASB issued FASB Statement No. 153, *Exchangesof Nonmonetary Assets*, which eliminates an exception in APB 29 fornonmonetary exchanges of similar productive assets and replaces it with ageneral exception for exchanges of nonmonetary assets that do not havecommercial substance. The application of this Statement is required after January 1, 2006. The Company anticipates no significant impact on its financial statementsby applying Statement 153.

 

In May 2005, the FASB issued SFAS No.154, "Accounting Changesand Error Corrections" ("SFAS 154") which replaces AccountingPrinciples Board Opinions No. 20 "Accounting Changes" and SFAS No. 3,"Reporting Accounting Changes in Interim Financial Statements—An Amendmentof APB Opinion No. 28." SFAS 154 provides guidance on the accounting forand reporting of accounting changes and error corrections. It establishesretrospective application, or the latest practicable date, as the requiredmethod for reporting a change in accounting principle and the reporting of acorrection of an error. SFAS 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 15, 2005.

 

In February 2006, the FASB issued SFAS No.155,“Accounting for Certain Hybrid Financial Instruments,” an amendment to SFAS No.133and No.140. The primary objectives of this Statement with respect toSFAS No.133 are to simplify accounting for certain hybrid financialinstruments by permitting fair value remeasurement for any hybrid financialinstrument that contains an embedded derivative that otherwise would requirebifurcation and eliminate the interim guidance in Statement No.133Implementation Issue No D1, “Application of FAS No.133 tobeneficial Interests in Securitized Financial Assets,” which provides thatbeneficial interests in securitized financial assets are not subject to theprovisions of SFAS No.133. The primary objective of this Statementwith respect to SFAS No.140 is to eliminate a restriction on thepassive derivative instruments that a qualifying special-purpose entity (SPE)may hold. This Statement is effective for all financial instruments acquired orissued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. Management does not expect the adoption of this Statement to have animpact on the Company’s consolidated financial statements.

F-21

  

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**  3.  Significant Accounting Policies**(Continued)

 

r) RecentlyAdopted Accounting Standards

 

In December 2004, FASB issued the FASB Statement No.123 (revised2004), *Share-Based Payment*, which addresses the accounting fortransactions in which an entity exchanges its equity instruments for goods orservices, with a primary focus on transactions in which an entity obtainsemployee services in share-based payment transactions. This Statement is arevision of the Statement 123 and supersedes APB Opinion No. 25, *Accountingfor Stock Issued to Employees,* and it is related to the implementationguidance. This Statement was early adopted by the Company in 2005. (See note15)

In March 2005, the FASB issued FIN 47, "Accounting forConditional Asset Retirement Obligations, an interpretation of FASB StatementNo.143" ("FIN 47"), which requires an entity to recognize aliability for the fair value of a conditional asset retirement obligation whenincurred if the liability's fair value can be reasonably estimated. FIN 47 iseffective for fiscal years ending after December 15, 2005. The Company did not have any impact on applying FIN 47. 

  

**  4.    Cashand Cash Equivalents**

 

 

**2005**

**2004**

 

 

 

**Local currency**

** **

** **

  Cash and bank accounts

149,323

  84,536

  Investment funds of variable earnings

401,931

258,345

  Others

       98

        89

 

551,352

342,970

**Foreign currency**

 

 

  Cash and bank accounts

  43,963

  70,412

  Interest-bearing current account 

  87,959

350,796

 

131,922

421,208

 

683,274

764,178

 

F-22

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

 

**  5.   Available-for-SaleSecurities**

 

On May 14, 2004, the Company ultimately sold all of its holdings ofBrazil Brady Bonds, including those securities held by third party investmentfunds. The Company received gross proceeds of approximately R$935,000 andrecorded a loss of approximately R$110,000.

 

During 2004, the Company started to invest in Credit Linked Notes(CLN), which are debt securities issued by highly rated American and Europeanbanks indexed in Reais with Inter Deposit Rates. These securities arecollaterized by highly rated Brazilian banks and companies’ debt securities.Such CLN securities, as well as the other debt securities held by the foreigninvestment funds are classified as available-for-sale at December 31, 2005 and 2004.

 

In 2005, the Company also made dual currency investments, which havedifferentiated profitability according to the strike negotiated. It alsomaintained the structured notes investments.

The following is a summary of available-for-sale debt securities at December 31, 2005 and 2004:

 

**Available-for-sale debt securities**

 

** **

**Amortized**

**Cost**

**Gross**

**Unrealized**

**Gains**

**Gross**

**Unrealized**

**Losses**

**Estimated**

**Fair**

**Value**

December 31, 2005

 

 

 

 

  Investment funds (1)

1,613,682

-

-

1,613,682

  National treasury notes

    65,057

-

-

     65,057

  Austrian Bonds

  278,040

-

-

  278,040

Total

1,956,779

-

-

1,956,779

 

 

 

 

 

December 31, 2004

 

 

 

 

  Investment funds (1)

1,153,014

-

-

1,153,014

  National treasury notes

  199,034

-

-

   199,034

  Austrian Bonds

  237,748

-

-

   237,748

Total

1,589,796

-

-

1,589,796

 

(1) Largely represented  by Credit Linked Notes and dual currency investments (Credit Linked notes in  2004)

F-23

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**  5.     Available-for-SaleSecurities** (Continued)

 

         The amortized cost and estimatedfair value of available for sale securities at December 31, 2005, bycontractual maturity, are shown below:

 

 

**Available for-sale-debt securities**

** **

**Maturity  periods**

**Amortized**

**Cost**

**Estimated**

**Fair Value**

** **

 

 

Due in less than one year

1,891,722

1,891,722

Due in one to three years

39,347

39,347

Due after five years

25,710

25,710

Total

1,956,779

1,956,779

 

**  6.    Accounts and Notes Receivable, Net**

 

**2005**

**2004**

Customer

 

 

  Domestic

469,150

363,279

  Export, mainly denominated in U. S.  dollars

259,573

258,050

Allowance for doubtful accounts

  (10,591)

   (9,160)

 

718,132

612,169

 

**      **The changes in the allowance fordoubtful accounts are as follows:

 

* *

**2005**

**2004**

**2003**

 

 

 

 

Balance at the beginning of the year

  (9,160)

(33,628)

(40,480)

Amounts charged to expense 

  (4,234)

  (1,285)

  (4,966)

Write offs 

  2,803

25,753

11,818

Balance at the end of the year

(10,591)

  (9,160)

(33,628)

During 2005, the Company and its subsidiaries abroad (SadiaInternational Ltd. and Wellax Food Comércio de Produtos Alimentares Lta.)renewed and amended the Insured Receivables Purchase Agreement selling itsexport receivables up to a limit of US$130 million, with interest rate of0.375% + LIBOR. Credit Insurance covering 90% of the value of the receivableswas taken out with third parties and the beneficiaries in the event of Defaultare the contracting financial institutions. 

 

F-24

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

 

**  6.  Accounts and Notes Receivable, Net** (Continued)

 

Under this agreement, the Company retained servicingresponsibilities, such as collection. At December 31, 2005, the receivables sold under this agreement amounted to R$228,813.

 

As of December 31, 2004, the previous Insured Purchased Agreement hada limit of US$100 million and, with an interest rate of 0.7% + LIBOR. Thereceivable assigned in the amount of R$120,810 has been accounted for assecured financing with such debt outstanding included in short term debt in theamount of R$120,810.

 

During the year ended December 31, 2005, the Company received cash proceeds of approximately R$1,840 million (R$1,500 million in 2004) andincurred expenses of R$8 million (R$ 4 million in 2004 and R$2 million in 2003)with respect to this agreement. The Company had no credit losses on the sale ofthe receivables under this agreement for December 31, 2005, 2004 and 2003.

 

During 2005, 2004 and 2003, no single customer or group representedmore than 10% of consolidated sales.

 

**  7.  Inventories**

 

 

**2005**

**2004**

 

 

 

Finished goods 

   352,117

   389,765

Live stock and poultry

   386,561

   351,980

Raw materials

   129,229

   189,144

Work  in process

     38,646

     72,076

Packing material

     36,702

     35,206

Stock  in transit

       9,341

       7,791

Supplies in warehouse and other

     29,344

     22,469

 

   981,941

1,068,431

 

F-25

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**  8.   Recoverable Taxes**

 

 

**2005**

**2004**

 

 

 

Value-added state sales tax- ICMS

162,058

  81,067

Federal excise tax – IPI

  48,853

  53,626

Income tax withheld at source and advanced income  tax

  36,165

  26,393

COFINS

    3,748

  61,932

Other  (principally PIS tax credits on raw material)

  15,762

  20,059

Total

266,586

243,077

Current portion

(146,562)

(155,891)

Non current portion

120,024

  87,186

 

Value-added state sales tax- ICMS

 

Composed of credits generated by the commercial operations and bythe acquisition of property, plant and equipment, of a number of the Company’sunits and can be offset with taxes of the same nature.

 

PIS and COFINS

 

Composed of credits arising from non-cumulative collection of PISand COFINS, which can be compensated with other federal taxes.

 

Federal excise tax - IPI

 

Federal excise tax - IPI credits includes the tax credit on packingand other material and the presumed IPI incentive on exports. IPI credits arerecognized as a reduction of cost of raw materials used in the productionprocess of goods produced for export and are available to be utilized againstother federal taxes payable. 

 

Income tax withheld at source

 

Income tax withheld at source represents income tax paid uponredemption of certain investments and is available to be utilized against otherfederal income taxes payable.

 

F-26

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**  9.     Property, Plant and Equipment**

 

 

**2005**

**2004**

 

** **

** **

Land

    50,974

   32,990

Buildings

  554,962

  493,700

Machinery and equipment

  952,984

  778,343

Installations

  220,704

  189,042

Breeding stock

  219,159

  162,490

Vehicles

    12,896

    14,042

Timber and reforestation

    19,659

    16,414

Other

    71,318

    48,305

Construction in progress

  417,319

  167,057

 

2,519,975

1,902,383

Accumulated depreciation 

  (996,666)

  (847,143)

Total

1,523,309

1,055,240

Interest capitalized aspart of property, plant and equipment was R$16,852, R$11,206 and R$4,903 forthe years ended December 31, 2005, 2004 and 2003, respectively.

 

**10.    Short-term Debt**

 

 

**2005**

**2004**

 

 

 

  Working capital from commercial banks

  545,435

  761,103

  Trade accounts receivable domestic credit facility

  190,351

  162,138

  Trade accounts receivable export credit facility

            -

  120,810

  Bank borrowings, secured by accounts receivable 

    54,376

    17,830

** **

  790,162

1,061,881

 

Working capital from commercial banks primarily relates to exportfinancing and pre-export advances, of which R$432,060 in 2005 (R$744,423 in2004) are denominated in U.S. dollars with interest at Libor (4,39% p.a. atDecember 31, 2005) plus interest at the rate from 0.10% p.a. to 5.76% p.a. in 2005(interest at the rate from 0.10% p.a. to 4.48% p.a. in 2004).

F-27

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**10.  Short-term Debt**(continued)

 

On May 12, 2003, the Company entered into an agreement to sell, fromtime to time, up to R$150,000 of its domestic receivables to a special purposeentity, organized as an investment fund. The receivables sold are subject to adiscount rate that should not be lower than 95% of the average rate ofBrazilian interbank certificate deposits (17.9% p.a. at December 31, 2005). Through December 31, 2005, the Company received cash proceeds of R$2,626,000(R$2,249,000 in 2004) from the sales of domestic receivables under thisagreement and incurred in interest expenses of R$27,000 for the year ended December 31, 2005 (R$23,000 in 2004). Based on the structure of this transaction, theagreement has been accounted for as a financing by the Company. As of December 31, 2005, the accounts receivable for this finance pledged as collateral wereR$190,351.

 

At December 31, 2005 and 2004, the weighted average interest rateson short-term debt were 6.90% p.a. and 7.06% p.a., respectively.

 

F-28

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

**11.  Long-term Debt**

 

 

**2005**

**2004**

 

 

 

**Foreign debt  (denominated in U.S. dollars):**

 

 

IFC- International Finance  Corporation funding in foreign currency for investment in property, plant and  equipment, which R$23,325 is subject to interest at fixed rate of 9.05% p.a.,  guaranteed by promissory real estate mortgages

 

 

 

 

   23,325

 

 

 

 

   129,222

 

 

 

Export financing, composed  of prepayment, payable in amount of R$372,780 in installments up to 2010,  subject to LIBOR variation for 6 month deposits (4.7% in December 2005 plus  annual interest of 8.2% p.a, and a line focused on the incentive for foreign  trade in amount of R$1,212,113, subject to LIBOR variation for 6 month plus  interest of 5.69% p.a., guaranteed by promissory notes or sureties.

 

 

 

 

 

 

 

1,584,893

 

 

 

 

 

 

 

   924,965

 

 

 

Financing subject to LIBOR  variation for 1 month deposits (4.39% in December 2005) plus interest of  0.10% p.a., guaranteed by its own titles

 

 

   145,719

 

 

            -

 

 

 

BNDES (National Bank for Economic  and Social Development), payable from 2006 to 2013, composed as follows:  FINEM in the amount of R$29,046  subject to the weighted average of the  exchange variation of currencies traded by BNDES - UMBNDES and fixed interest  of 3.50% p.a. and FINAME in the amount of R$40,704 subject to the weighted  average of the exchange variation of currencies traded by BNDES - UMBNDES and  fixed annual interest of 3% p.a. guaranteed by mortgage bonds and real estate  mortgages

 

 

 

 

 

 

 

 

 

     69,750

 

 

 

 

 

 

 

 

 

     66,677

F-29

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

**11.  Long-term Debt**(Continued)

 

** **

**2005**

**2004**

**Local debt (denominated in reais):**

 

 

BNDES (National  Bank for Economic and Social Development), credit lines for investments and  exports, payable from 2006 to 2012, composed as follows: FINAME in the amount  of R$225,684  subject to the Long-Term Interest Rate -TJLP (9.75% p.a. in  December 2005) and interest of 4.45% p.a.,  FINAME-EXIM in the amount of  R$139,321 subject to TJLP and interest of 3.97% p.a. and FINEM in the amount  of R$37,654 subject to TJLP and interest of 3.50% p.a., guaranteed by  mortgage bonds and real estate mortgages

 

 

 

 

 

 

 

 

 

   402,659

 

 

 

 

 

 

 

 

 

   436,309

 

 

 

PESA - Special Aid Program  for Agribusiness payable in installments from 2005 to 2020, subject to the –  General Price Index –Market – IGP-M plus interest rate of 9.89% p.a., secured  by investments in debt securities with a carrying value of R$25,710 and  sureties.

 

 

 

 

 

   131,831

 

 

 

 

 

   129,310

 

 

 

Other subject to interest  rate from 4% to 14% p.a.

     40,187

     21,846

** **

 

 

** **

2,398,364

1,708,329

Less current portion of  long- term debt

   (694,180)

   (676,954)

Long- term portion

1,704,184

1,031,375

 

On December 29, 2005, the Company made early settlement in the amount of US$27,500 thousandreferring to the financing agreement with the International Finance Corporation(IFC). The Company has revealed its intention to settle the remaining balanceof R$23,325 in the short term, and, accordingly, there will be no restrictionswith respect to the distribution of dividends in addition to the mandatoryminimum dividend required by law, when one of the consolidated financialindexes (current liquidity, long-term indebtedness and total indebtedness) doesnot meet the agreed ratio levels.

 

At December 31, 2005, long-term debt maturities were as follows:

2007

  190,761

2008

  131,221

2009

  116,756

2010

  976,958

Thereafter

  288,488

 

1,704,184

F-30

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

**12.  Judicial Deposits**

 

Judicial deposits are restricted assets of the Company placed ondeposit with the court and held in judicial escrow relating to certain legalproceedings pending of legal resolution.

 

**13.  Commitments, Contingencies and Guarantees**

 

**Commitments**

 

The Company has enteredinto purchase commitments for production purpose (packing) amounting toapproximately R$360,000 at December 31, 2005 and is payable until 2010.

 

*Leasing* 

The Companyhas non-cancelable leasing agreements for industrial units that expire over thenext three years. These leasing are subject to renewal for 4 more years and donot require any penalty if the Company does not renew them. The Company doesnot pay execution costs, such as maintenance and insurance. The rental expensestotaled R$33,110 in 2005 (R$27,512 in 2004).  

The tablebelow shows the future payments related to the leasing agreement at December 31, 2005: 

 

2006

  65,200

2007

  65,200

2008

  34,200

Total

   164,600

F-31

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

**13.  Commitments, Contingencies and Guarantees** (continued)

 

**Contingencies**

 

The Company is party to certain legal proceedings arising in thenormal course of business, and has made provisions based on its best estimateof the probable losses that will ultimately be incurred. The Company believesthat the provisions made are sufficient to cover probable losses. In connectionwith certain legal proceedings, the Company has made judicial deposits, whichwill only be released upon a favorable legal judgment (see Note 12). 

 

The Company’s labor force is represented by collective bargainingagreements. All collective bargaining agreements are re-negotiated annually.

 

Contingenciesclassified as having a probable risk of loss, for which provisions are recordedunder liabilities, have the following balances:

 

 

**2005**

**2004**

 

 

 

Tax

42,217

33,618

Civil

13,281

11,746

Labor

16,449

13,620

 

71,947

58,984

*Tax litigation*

*** ***

The main taxcontingencies involve the following cases:

 

a)Income and socialcontribution taxes on net income 

Provision forincome and social contribution taxes on net income amounting to R$9,159, ofwhich R$6,120 recorded on the acquisition of the subsidiary Granja Rezende(incorporated in 2002), R$2,222 on withholding income tax on investments ofGranja Rezende and R$817 for other provisions. 

 

b)State VAT (ICMS) 

The Companyis a defendant in several administrative cases involving ICMS, mainly in theStates of Sao Paulo, Rio de Janeiro and Amazonas (SUFRAMA), totaling a probablecontingency estimated at R$20,223.

F-32

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**13.  Commitments, Contingencies and Guarantees**(continued)

 

*Tax litigation* (Continued)

 

c)Other tax contingencies

 

Several cases  related to payment of IOF (Tax on Financial Operations), PIS (Social  Integration Program Tax), COFINS (Tax for Social Security Financing) and others  totaling a probable loss of R$12,835.

The Company has other tax contingencies where the claimed amount isR$479,891, that were assessed as possible losses by the Company’s legal counseland management and therefore no provision was recorded.

 On November 9, 2005, the Supreme Court declared by a majority of votes that Law 9718/98 wasunconstitutional, which changed the calculation basis of PIS and COFINS,including operating income other than sales and financial income. This decisionaffects only the taxpayers whose actions have been judged, however, thisdecision indicates that the court suits that have the same objective would alsobe successful. The Company has a court suit questioning the increase in thebasis, however, it has been calculating and paying these taxes in accordancewith the law. If the Company had already received a final favorable decision,the credit to be recognized in the financial statements would be approximatelyR$60,000.

 

*Civil litigation* 

  The amountprovided represents principally proceedings involving claims forindemnification for losses and damages, including pain and suffering, arisingfrom work-related accidents and consumer relations. 

 The Company has other civil contingencies wherethe claimed amount is R$50,242, that were assessed as possible losses by theCompany’s legal counsel and management and therefore no provision was recorded.

 

*Labor claims* 

 

 There are approximately 1,780 labor claimsagainst the Company. These claims are mainly related to overtime, and healthexposure or hazard premiums, none of the amounts provided involve a significantamount on an individual basis. The total amount of  such labor claims amount toR$35,920 and a provision of R$16,449 has been provided in the accompanyingfinancial statements based on historical information and represents theCompany’s best estimate of the ultimate loss that will be incurred.

F-33

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

**13.  Commitments, Contingencies and Guarantees**(continued)

 

**Guarantees**

 

The Company provides guarantees to loans obtained by certain outgrowers located in the central region of the country as part of a specialdevelopment program for that region. Such loans are used to improve the outgrowers farms installations and will be repaid in 10 years. The loansguaranteed by the Company amounts to R$11,796 and based upon the provisions ofFIN 45 the fair value of the non-contingent obligation of such guarantees inthe amount of R$324 has been provided for.

 

**14.  Shareholders’ Equity**

 

Brazilian Corporate Law permits the use of appropriated andunappropriated retained earnings to increase capital. Such a capital increasemust be approved by the Company’s Board of Directors. The allocation of thecapital increase between preferred and common shares is proportional to thenumber of shares outstanding. 

 

The preferred shareholders may not vote at shareholders’ meetings  but have the right to receive priority in repayment of their capital, in thecase of liquidation.

 

The Company’s by-laws provide to pay a mandatory dividend to common    and preferred shareholders of at least 28% of annual net distributable income    determined in accordance with Brazilian Corporate Law. From 1997 to 2004,    preferred shareholders were entitled to receive a dividend per share 10% higherthan common shareholders.

 

On December  15, 2005, in an extraordinary general shareholder’s meeting, the right for  preferred shares to be included in a potential public offering for sale of the  Company’s control (Tag along) was approved, and the shareholders holding  preferred shares were guaranteed a minimum price equal to 80% of the amount  paid for a share with voting rights, which is part of the controlling block,  substituting/excluding item b) of article 12 of the by-laws that granted an  advantage for receipt of dividends by holders of preferred shares at least 10%  higher than those attributed to the holders of common shares, therefore making  equal the remunerations attributed to the common and preferred shares in terms  of dividends. This approval was ratified in a Special Meeting of Preferred  Shareholders by 57.12% of the total number of preferred shares holders. 

F-34

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**14.   Shareholders’ Equity**(Continued)

 

Brazilian Corporate Law permits the payment of dividends only in *reais*,limited to the amounts of research and development and expansion reserves ofappropriated retained earnings and unappropriated retained earnings in thefinancial statements prepared in accordance with Brazilian Corporate Law. At December 31, 2005 and 2004 the Company had in its statutory books the following amounts:

 

 

**2005**

**2004**

Appropriated retained earnings:

 

 

    Research and development reserve

55,447

65,833

    Expansion reserve

627,128

644,881

Unappropriated retained earnings

-

24,932

 

Dividends paid per thousand shares in**R$ were as follows:

 

** **

**2005**

**2004**

**2003**

 

 

 

 

    Preferred 

231.96

234.68

170.08

    Common 

210.87

213.34

154.61

The Company elected to characterize a portion of the 2005, 2004 and2003 dividends as interest on capital (or interest attributable toshareholders’ equity) as discussed in note 3 j).

 

Brazilian Corporate Law and the Company’s by-laws require thatannual appropriations be made to certain reserves (appropriated retainedearnings). These comprise mainly (a) 5% of net income (statutory accounts) mustbe transferred to a legal reserve until such reserve reaches 20% of capitalstock under Brazilian GAAP; (b) appropriation of 15% to a research anddevelopment reserve which is general reserve for support development of theCompany’s operations; (c) appropriation from 15% to 60% to a expansion reserve.The legal reserve cannot be used to distribute dividends to shareholders.

 

The components of appropriated retained earnings at December 31, 2005 and 2004 were as follows:

 

 

**2005**

**2004**

 

 

 

Legal reserve

55,842

56,727

Research and development reserve

55,447

65,833

Expansion reserve

627,128

644,881

 

738,417

767,441

F-35

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**15.   Stock Option Plan**

 

In the Ordinary and Extraordinary General Meeting of April 29, 2005 the stock option plan was approved in its first phase for the Company’sofficers. The plan comprises nominative preferred shares issued by the Company.

 

The price for exercising the options does not include any discountand will be based on the average value of the quotation for the share in thelast three days of trading on the Sao Paulo Stock Exchange prior to the grantdate, updated by the accumulated National Consumer Price Index (INPC) betweenthe grant date and the exercise date of the option. The vesting period, duringwhich the participant cannot exercise their rights to purchase the shares, willbe three years as from the option granting date. The participants will be ableto fully or partially exercise their purchase rights after the vesting periodwithin a maximum period of 2 years, and only after this period has expired theywill lose the right to the options not exercised.

 

Under the plan regulations, the preferred shares will be reacquiredand earmarked in treasury for this sole purpose.

 

The  composition of the options granted is presented as follows:

 

** **

**Vesting period**

** **

** **

** **

**Number of shares**

**Price of shares**

** **

** **

** **

**Grant date**

** **

** **

** **

**Start**

** **

** **

** **

**Final**

**Weighted average fair value at grant date**

** **

** **

**Updated – INPC**

** **

** **

**Market 12/31/05**

 

 

 

 

 

 

 

06/24/05

06/23/08

06/23/10

2,200,000

4.55

4.63

6.43

 

On December 31, 2005, the Company early adopted the provisions ofStatement of Financial Accounting Standards (“SFAS”) No.123(R) (revised 2004),“Share-Based Payments”, or SFAS 123(R), requiring it to recognize expenserelated to the fair value of its share-based compensation awards. Shared based compensation expense for all share-based compensationawards granted in 2005 was based on the grant-date fair value estimated inaccordance with the provisions of SFAS 123(R) and the expense has beenrecognized for stock option awards on a straight-line basis over the requisiteservice period of the award.

 

Considering the provisions of SFAS 123R, as the option pricecontains an inflation index (INPC) that is considered an *other condition*,the fair value of the option in the amount of R$678 has been classified instock option, non-current liability and the compensation expense as general andadministration expense.

F-36

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**15.   Stock Option Plan**--(continued)

 

The fair valueof stock-based awards was estimated based on the following assumptions for theyear ended December 31, 2005:

 

** **

**December, 31 2005**

 

 

Expected life  (in years)

3

Interest rate

18%

Volatility

37.06%

Dividend yield

4.8%

Expected  inflation

12,12%

Weighted-average  fair value at grant date

R$4.55

 

Expected Term - The Company’s expectedterm represents the period that the Company’s stock-based awards are expectedto be outstanding and was determined based on the assumption that the officerswill exercise their options upon the vesting period is over. We do not expectany forfeiture as those options are for officers, which the turnover issignificantly low.

 

Expected Volatility – The Company usesthe trading history and implied volatility of its preferred stock indetermining an estimated volatility factor when using the Black-Scholesoption-pricing formula to determine the fair value of options granted.

 

Expected Dividend – The Company uses thepayments history per stock dividends for the expected dividend value factorwhen using the Black-Scholes option-pricing formula to determine the fair valueof options granted.

 

Risk-Free Interest Rate - The Companybases the risk-free interest rate used in the Black-Scholes valuation method onthe implied yield currently available on Interbank Bank Certificated rate –CDI.

 

Inflation – Expected inflationdetermined based on the information available with BACEN (Brazilian CentralBank). 

 

As of December 31, 2005 the amount of R$3,388 related to the unrecognizedcompensation cost related to stock options is expected to be recognized in 2.5years. The Company currently has shares in treasury, which are sufficient tocover future stock option exercises. 

F-37

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**15.   Stock Option Plan**--(continued)

 

Stock option activity for the year ended December 31, 2005, is as follows:

 

** **

** **

**Shares in**

**thousands**

**Weighted-average expected exercise price**

 

 

 

Outstanding as of December 31,2005 

      -

    -

  Grants of options 

2,200

5.19

  Exercises 

      -

    -

  Forfeitures or expirations

      -

    -

  Outstanding as of December 31, 2005

2,200

5.30

** **

** **

**16.    Net Income per share**

 

         There were no adjustments to net income in calculating diluted netincome per share. The table below reconciles basic weighted average outstandingto diluted weighted average shares outstanding.

 

** **

**Year ended December 31, 2005**

** **

**Common**

**Preferred**

 

 

 

Basic weighted average shares outstanding

257,000,000

424,595,712

Effect of dilutive securities – stock  options

               -

      541,651

Diluted weighted average shares  outstanding

257,000,000

425,137,363

 

 

**17.    Income Taxes**

 

         Incomebefore provision for income taxes was as follows: 

 

 

**2005**

**2004**

**2003**

 

 

 

 

Domestic

288,056

410,134

  61,376

Foreign 

382,596

176,988

410,155

 

670,652

587,122

471,531

F-38

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**17.   Income Taxes**(Continued)

        A break-down between domestic and foreignincome and social contribution tax (expense) benefit for the year is asfollows: 

 

**2005**

**2004**

**2003**

Domestic:

 

 

 

   Current 

(51,956)

(32,057)

(38,653)

   Deferred 

(14,691)

(57,469)

40,099

 

(66,647)

(89,526)

 1,446

Foreign:

 

 

 

   Current

      (72)

    (912)

    (419)

  Deferred

  (1,720)

  (5,661)

        -

 

  (1,792)

  (6,573)

    (419)

 

(68,439)

(96,099)

 1,027

 

Brazilian income taxes consist of federal income tax and socialcontribution. The 2005, 2004 and 2003 statutory rates for these taxes were asfollows:

 

 

** **

Federal income tax

25.00%

Social  contribution tax

  9.00%

Combined statutory rate

34.00%

 

Because the Company is engaged in rural activities, certain relatedinvestments can be depreciated for tax purposes on an accelerated basis and theresulting tax losses may be offset against profits generated in otheractivities.

 

The reconciliation of income tax at the Brazilian statutory rates toincome tax expense follows:

 

 

**2005**

**2004**

**2003**

 

 

 

 

Income before  income taxes

670,652

587,122

471,531

Income tax  expense, at Brazilian statutory taxes rates 

 

(228,022)

 

(199,621)

 

(160,321)

   Tax-exempt  income in foreign subsidiary

128,291

  65,277

132,992

   Non-taxable  (nondeductible) foreign currency exchange (loss)

 

  (51,816)

 

  (17,231)

 

  (21,651)

   Benefit from  deductibility of interest attributed to shareholders’ equity (Note 3 h))

 

  59,411

 

  49,883

 

  50,772

   Exempted  financial results 

  13,699

          -

         -

   Other  permanent differences

    9,998

    5,593

      (765)

Income tax  expense

  (68,439)

  (96,099)

    1,027

F-39

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**17.  Income Taxes**(Continued)

During 2002, the Company established a new foreign subsidiary. Dueto a current tax treaty, earnings generated by such subsidiary are taxed whenactually distributed. As the Company intends to permanently reinvest theearnings of this foreign subsidiary, no income tax payment is required. At December 31, 2005, this subsidiary had cumulative earnings of R$902 million that are nottax effected (R$619 million in 2004). If such cumulative earnings were to bedistributed to the Company, approximately R$135 million of taxes would be paid.

 

       Deferred tax assets and liabilities are comprised of thefollowing:

 

 

**2005**

**2004**

Deferred tax assets:

 

 

   Employee bonus accrual

  20,163

  16,928

   Accrued contingencies

  24,462

  20,055

   Accrued employee benefit  liability

  10,152

    8,268

   Tax loss carryforwards

    9,861

  19,079

   Property, plant and  equipment

  51,801

  56,535

   Deferred charges

  15,608

    6,631

   Other (mainly timing  differences for tax purposes)

 

  18,578

 

  18,029

Total deferred income tax assets 

150,625

145,525

 

 

 

Deferred tax liabilities:

 

 

   Property, plant and  equipment

  (56,677)

  (34,063)

   Pension plan

  (32,309)

  (16,767)

   Unrealized gains from foreign  currency and 

      interest rate swap contracts

 

      (572)

 

  (16,484)

   Intangible assets

   (10,010)

          -

   Other

    (1,964)

    (1,285)

Total deferred tax liabilities

(101,532)

  (68,599)

Net deferred tax assets

  49,093

  76,926

Current portion

  (22,039)

  (20,372)

Non current portion

  27,054

  56,554

F-40

 

**SADIA S.A.**

** **

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**17.  Income Taxes**(Continued)

 

In assessing the realizability of deferred tax assets, managementconsiders whether it is more likely than not that some portion or all of thedeferred tax assets will not be realized. The ultimaterealization of deferred tax assets is dependent upon the generation of futuretaxable income during the periods in which those temporary differences becomedeductible and tax loss carryforwards utilizable. Management considers thescheduled reversal of deferred tax liabilities, projected future taxableincome, and tax planning strategies in making this assessment. Based upon thelevel of historical taxable income and projections for future taxable incomeover the periods in which the deferred tax assets are deductible, managementbelieves it is more likely than not that the Company will realize the benefitsof these deductible differences and tax loss carryforwards at December 31,2005.

 

The Company has notprovided a valuation allowance against the net deferred tax asset as ofDecember 31, 2005 arising out of temporary differences based upon management’sbelief that it is more likely than not that such deferred tax asset will berealized in the future through reversal of the differences and the generationof taxable income by the Company.

 

The total amount of R$29,002 related to loss carryforwards have noexpiration date and are available to offset up to 30% of future taxable incomein any given year. 

 

**18.  Risk Management and Financial Instruments**

 

The Company’s operationsare exposed to market risks, principally in relation to exchange ratevariations, credit risk and grain purchase prices. These risks are monitored bythe Risk Management Area that uses a specific system to calculate the “VAR-Value at Risk”, and permanently monitored by the finance committee, composedof members of the Board of Directors and other finance executives of theCompany, who are responsible for defining the Board’s risk management strategyby determining the position and exposure limits.

F-41

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**18.  Risk Management and Financial Instruments** (Continued)

 

a) Exchange rate risk

 

Since much of Sadia’s debt is denominated in U.S. dollars, theCompany minimizes in part the effects of unfavorable exchange movements byholding cash, cash equivalents and available-for-sale instruments denominatedin U.S. dollars. Accordingly, if the *real* devalues against the U.S.dollar and it results in a foreign exchange loss, the Company records anoffsetting gain from these dollar denominated contracts. Additionally toprotect against further possible devaluation of the *real,*the Company entersinto foreign currency and interest rate swap contracts. The Company does notenter into derivatives contracts for speculative purposes.

 

b) Credit risk

 

The Company is potentially exposed to credit risk in relation to itstrade accounts receivable, long and short-term investments and derivativeinstruments. The Company limits the risk associated with these financialinstruments by subjecting them to the control of highly rated financialinstitutions that operate within the limits pre-established by the credit andfinancing committees.

 

The concentration of credit risk with respect to accounts receivableis minimized due to the spread of its client base, since the Company does nothave any customer or group representing 10% or more of its consolidated revenues,as well as granting credits for customers with solid financial and operationalratios. Generally, the Company does not require a guarantee for domesticaccounts receivable. 

 

c) Grain purchaseprice

 

The Company’s operations are exposed to the volatility in prices ofgrain (corn and soybean) used in the preparation of fodder for its breedingstock, where the price variation results from factors beyond the control ofmanagement, such as climate, the size of the harvest, transport and storagecosts and government agricultural policies, among others. The Company does not enter into future or options contracts toprotect itself against changes in the commodities price; however it maintains arisk management strategy based on its inventory policy through physicalcontrol, which includes acquisition of grains with fixed and non-fixed prices.

F-42

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**18.  Risk Management and Financial Instruments** (Continued)

 

d) Estimated marketvalues

 

The Company used the following methods and assumptions in estimatingthe fair value disclosures of its financial instruments at December 31, 2005 and 2004:

 

*Cash and cash equivalents:* The carryingamounts reported in the balance sheet for cash and cash equivalents approximatetheir fair values.

 

*Investments in debt securities:* Themarket values of investments in debt securities were calculated based on themarket quotations of these securities when such information is not availablebased on their present value calculated through the future cash flows and usinginterest rates applicable to instruments of similar nature, terms and risk, orbased on the market quotations of these securities.

 

*Accounts and notes receivable and accounts payable:* The carrying amounts reported in the balance sheet for accounts andnotes receivable and accounts payable approximate their fair values.

 

*Long and short-term debt:* The marketvalues of loans and financing were calculated based on their present valuecalculated through the future cash flows and using interest rates applicable toinstruments of similar nature, terms and risks or based on the market quotationof these securities. The market value of BNDES financing are similar to thebook values, since there are no similar instruments with comparable maturitiesand interest rates.

 

*Foreign currency and interest rate swap contracts:* The fair values of foreign currency and interest rate swap contractswere estimated based on quoted market prices of comparable contracts. At December 31, 2005 and 2004 the notional amounts of the outstanding contracts wereR$2,381,603****and R$1,358,855****and the measurement of thesecontracts at fair values resulted in a loss of R$93,659 and R$109,523,respectively. The Company recognizes these contracts on the balance sheet atfair value and adjustments to fair value were recorded through income. Theactual cash settlements on the contracts occur at times specified in each agreement.The Company does not intends to terminate any of these contracts prior tomaturity.**

F-43

  

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**18.  Risk Management and Financial Instruments** (Continued)

 

The following tablepresents the carrying amounts and estimated fair values of the Company’sfinancial instruments at December 31, 2005. The fair value of a financialinstrument is the amount at which the instrument could be exchanged in acurrent transaction between willing parties.

 

** **

**2005**

 

**Carrying**

**amount**

**Fair**

**value**

 

 

 

Financial  assets:

 

 

   Cash and cash equivalents

  683,274

  683,274

   Investments in debt securities

1,956,779

1,956,779

   Accounts and notes receivable, net

  718,132

  718,132

Financial  liabilities:

 

 

   Short-term debt

  790,162

   789,859

   Suppliers

  495,330

   495,330

   Long –term debt

1,704,184

1,690,747

 

 

**19.  Supplementary Retirement Plan**

 

The Company sponsors a defined benefit pension plan that offerssupplementary retirement benefits to the employees, through Attílio FranciscoXavier Fontana Foundation. The pension benefit is generally defined as thedifference between (i) 80% of the retiree’s average salary during the last 36months indexed to the date of retirement and (ii) the value of the retirementpension paid by the Brazilian social security system. For retired employees theinitial pension payment is subsequently adjusted upwards to recognize cost ofliving increases and productivity awards granted to active employees. TheCompany provides for the costs of pension benefits based on a fixed percentageof remuneration, as recommended annually by independent actuaries. Theaccumulated benefit obligation related to this pension plan were R$645,838 andR$537,420 at December 31, 2005 and 2004, respectively. The Company expects tocontribute approximately R$6,000 to the plan during fiscal year 2006.

F-44

  

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**19.  SupplementaryRetirement Plan**(Continued)

 

       The Company also provides for otherretirement benefits to its employees and certain employee executives. Such benefitplans generally provide benefits payable as a single lump sum to eligibleemployees upon retirement. The Company intends to fund these benefits from itsoperations. The aggregate projected benefit obligation and the aggregateaccumulated benefit obligation related to those other retirement benefit wereR$57,244 and R$47,575, respectively, at December 31, 2005 and R$59,487 and R$54,719, respectively, at December 31, 2004.

 

Information regarding the plans follows:

 

** **

**Pension benefits**

**Other benefits**

** **

**2005**

**2004**

**2005**

**2004**

**Change in benefit  obligation**

 

 

 

 

     Benefit obligation at  beginning of year

   580,504

561,366

59,487

53,686

     Net service cost

     13,018

  16,515

  4,912

  4,295

     Interest cost

     64,139

  62,004

  6,495

  5,734

     Participants contributions  (service cost)

       5,424

    6,194

        -

         -

     Actuarial loss

     49,397

  (38,654)

  (2,419)

  1,818

     Benefits paid 

     (30,468)

  (26,921)

  (4,141)

  (6,046)

     Plan changes

     22,515

           -

        -

          -

     Curtailment

             -

           -

  (7,090)

          -

     Benefit obligation at  end of year

   704,529

580,504

57,244

59,487

**Change in plan assets**

 

 

 

 

     Fair value of plan  assets at beginning of year

   904,695

756,642

        -

        -

     Actual return on plan  assets

   152,442

166,792

        -

        -

     Company contributions

      6,295

    8,295

        -

        -

     Participant  contributions

      6,177

    5,933

        -

        -

     Benefits paid

     (34,609)

  (32,967)

        -

        -

     Fair value of plan  assets at end of year

1,035,000

904,695

        -

        -

**Funded status**

 

 

 

 

     Funded status at end  of year

   330,471

324,191

(57,244)

(59,487)

     Unrecognized  transition asset

      (3,766)

    (5,649)

       -

         -

     Unamortized prior  service cost

     22,515

           -

22,464

  27,318

     Unrecognized net  actuarial gain

   (254,193)

(269,226)

  5,511

  10,289

     Excess of additional liability

             -

           -

  (2,995)

          -

     Net amount recognized

     95,027

  49,316

(32,264)

  (21,880)

 

**Amounts recognized in  the statement of financial position**

** **

**2005**

** **

**2004**

** **

**2005**

** **

**2004**

 

 

 

 

 

     Intangible asset

             -

            -

15,311

  26,508

     Prepaid pension plan

     95,027

  49,316

         -

           -

     Accrued benefit  liability 

             -

          -

(47,575)

  (48,388)

     Net amount recognized

     95,027

49,316

(32,264)

  21,880

 

F-45

  

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**19.  SupplementaryRetirement Plan**(Continued)

 

The following projected benefit payments, which reflect expectedfuture service, as appropriate, are expected to be paid:

 

 

**Pension benefits**

**Other benefits**

 

 

 

2006

  31,534

  2,537

2007

  33,120

  3,129

2008

  34,877

  2,808

2009

  36,680

  4,203

2010

  38,618

  7,833

2011 -2015

222,427

31,337

 

The pension planweighted-average asset allocation at December 31, 2005 and 2004, by asset category, is as follows:

 

 

**2005**

**2004**

 

 

 

Debt securities

  57%

  53%

Equity securities

  34%

  36%

Real estate

    8%

  10%

Others assets

    1%

    1%

 

100%

100%

The investment strategy adopted by AttilioFrancisco Xavier Fontana Foundation for the pension plans sponsored by theCompany is to maximize the rates of return on plan assets within an acceptablelevel of risk aiming to minimize the cost of providing pension benefits whilemaintaining adequate funding levels. Such investment strategy is revised on anannual basis. The current strategic targets are to have a pension assetportfolio comprising of 34% equity securities, 57% debts securities(substantially comprised of fixed and variable income investment funds) and 8%real estate. The plan asset portfolio does not include any hedging, futures orderivative instruments.

 

Equity securities at December 31, 2005, are entirely represented by 24,998,558 common shares of the Company (24,998,558 common shares and5,400,000 preferred shares at December 31, 2004) with an aggregate fair valueof R$160,741 at December 31, 2005. During 2005, the plan sold 5,400,000preferred shares of the Company. Dividends paid by the Company on shares heldby the plan were R$7,571 for the year ended December 31, 2005 (R$7,042 in 2004).

F-46

  

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**19.  SupplementaryRetirement Plan**(Continued)

 

The pension plan is one of the investors in the special purposeentity organized as an investment fund for which the Company is sellingdomestic receivables as disclosed in Note 10. During 2003, the pension planinvested approximately R$20 million (2,000 quotas) in the investment fund. Inreturn for the amount invested, the pension plan received shares from theinvestment fund. As of December 31, 2005 such investment amounted to approximatelyR$32 million.

 

** **

**2005**

**2004**

**Weighted-average  assumptions**

 

 

    Discount rate

11.3%

11.3%

    Expected return on plan  assets

12.4%

12.4%

    Rate of compensation  increase

  7.1%

  7.1%

       The Company uses a December 31 measurementdate for its plans. In developing the expected rate of return on plan assets,the Company considered the actuarial assumptions recommended by its independentactuaries, which basically reflect expectations of future returns.

 

** **

**Pension benefits**

**Other benefits**

** **

**2005**

**2004**

**2003**

**2005**

**2004**

**2003**

**Components of net  periodic benefit cost**

 

 

 

 

 

 

Service cost

  13,018

16,515

11,324

  4,912

4,295

3,285

Interest cost

  64,139

62,004

51,855

  6,495

5,734

4,381

Expected return on plan assets

(110,592)

(92,401)

(66,521)

        -

       -

      -

Amortization of transition  asset

    (1,882)

  (1,882)

  (1,882)

        -

       -

      -

Amortization of prior  service cost

          -

        -

        -

    2,397

  2,397

  2,397

Recognized net actuarial  gain

   (8,238)

  (5,049)

         -

    558

         -

         -

Net periodic pension cost  (credit)

  (43,555)

(20,813)

  (5,224)

14,362

12,426

10,063

 

 

**20. Segment and Related Information**

 

The following information about segments is based upon informationused by the Company’s management to assess the performance of operatingsegments and decides on the allocation of resources. This approach is required  by FASB Statement No. 131 *Disclosure about Segments of an Enterprise andRelated Information*, and has been applied for all periods presented. 

 

The Company has three identifiable reportable segments: Processedproducts, Poultry and Pork. 

F-47

  

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**20.  Segment and Related Information**(Continued)

 

The Company evaluates segment performance based on informationgenerated from its statutory accounting records prepared in accordance withaccounting principles generally accepted in Brazil, which has been adjusted forUS GAAP in the following presentation:

 

a) Segment information

 

* *

**2005**

**2004**

**2003**

**Net operating revenue**

 

 

 

Processed products

3,147,296

2,731,136

2,386,247

Poultry

3,199,246

2,951,897

2,250,189

Pork

   732,710

   586,595

   554,698

Other 

   239,186

     37,845

     41,864

Adjustments for US GAAP presentation

         (596)

   (198,248)

   (151,281)

   Total net operating revenue

7,317,842

6,109,225

5,081,717

Other net operating revenue is primarilyattributable to grain and by-products and beef products operations.

 

* *

**2005**

**2004**

**2003**

**Depreciation expense**

 

 

 

Processed products 

      (60,863)

      (76,648)

     (73,844)

Poultry

      (80,336)

      (77,476)

     (74,596)

Pork

      (16,853)

      (20,647)

     (19,917)

Other

       (7,294)

        (1,363)

       (1,315)

   Total depreciation expense allocated to

   Segments

 

   (165,346)

 

   (176,134)

 

   (169,672)

Depreciation allocated to administrative

expenses 

 

     (12,829)

 

     (13,461)

 

     (18,227)

 Adjustments for US GAAP presentation

      (4,088)

      31,774

     37,801

   Total depreciation expense

   (182,263)

    (157,821)

   (150,098)

 

F-48

  

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**20.  Segment and Related Information**(Continued)

 

a) Segment information (Continued)

 

* *

**2005**

**2004**

**2003**

**Segment operating income**

 

 

 

Processed products

   273,684

   274,197

   194,188

Poultry

   269,766

   260,393

   143,514

Pork

     94,586

     70,902

     26,632

Other

      2,798

      (3,765)

       5,548

Adjustments for US GAAP presentation

     40,069

     33,302

     31,127

    Total operating income

   680,903

   635,029

   401,009

Interest expense

   (324,231)

   (413,461)

   (449,408)

Interest income and other

   248,203

   309,454

   481,609

Foreign currency exchange gain (loss), net

   159,602

     20,672

     52,833

Adjustments for US GAAP presentation

     (93,825)

     35,428

     (14,512)

Income before income taxes, equity income or loss of  investees and minority interest

 

   670,652

 

   587,122

 

   471,531

**Segment assets**

 

 

 

Processed products

   624,619

   491,982

   487,933

Poultry

   750,504

   459,035

   377,799

Pork

   147,724

   137,798

   118,985

Other

   143,359

     76,910

     53,747

Adjustments for US GAAP presentation

   (142,897)

   (110,485)

   (128,454)

    Total property, plant and equipment

1,523,309

1,055,240

   910,010

 

 

 

 

 Reconciling items - corporate assets

 

 

 

   Cash and cash equivalents

2,663,689

2,406,125

2,610,961

   Accounts and notes receivable, net

   509,615

   349,605

   453,936

   Inventories

   992,490

1,064,671

   839,557

   Other corporate assets

   690,825

   739,691

   616,095

Adjustments for US GAAP presentation

   184,459

   105,156

   661,787

Total consolidated assets 

6,707,284

5,830,973

6,149,453

** **

 

 

 

**Capital expenditures**

 

 

 

Processed products

    194,587

      93,220

     45,056

Poultry

    372,761

    146,606

     43,799

Pork

      26,982

       40,145

       5,709

Other

      91,662

      52,286

     15,656

Adjustments for US GAAP presentation

      56,365

        (7,340)

     69,124

   Total segment capital expenditures

   742,357

   324,917

   179,344

F-49

  

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**20.  Segment and Related Information**(Continued)

 

b) Exportsales by region/market

 

** **

**2005**

**2004**

**2003**

 

 

 

 

Europe

    978,318

    985,746

    912,252

Middle East

1,047,615

    802,935

    632,991

Asia

    635,907

    602,202

    353,731

South America

    542,151

    387,130

    130,322

Emerging markets (mainly Russia and other former  Soviet Union countries)

 

    872,333

 

    806,520

 

    630,332

Adjustments for US GAAP presentation

         (627)

    (191,869)

    (130,349)

 

4,075,697

3,392,664

2,529,279

 

Revenues are attributed to regions based upon wherethe products are shipped.

 

All long-lived operational assets are located in Brazil and assets  located outside of Brazil consist of sales offices located in various  countries.

 

The adjustments for US GAAP presentation asdemonstrated above comprise differences between the Company’s statutoryaccounting records prepared in accordance with Brazilian GAAP and theconsolidated financial statements prepared in accordance with U.S. GAAP. Theprimary differences relate to:

 

a)  Elimination of assets, liabilities, revenues,costs and expenses of equity method accounted investees that are accounted forusing the proportional consolidation method under Brazilian GAAP;

 

b) Reclassifications of certain assets, liabilitiesand income statement lines reported under Brazilian GAAP for the presentationof accompanying consolidated financial statements in accordance with US GAAP;

 

c) Accounting for the transfer of receivables (asdisclosed in Note 6) as a financing in the accompanying consolidated financialstatements rather than as a sale as accounted for under Brazilian GAAP.

 

F-50

  

**SADIA S.A.**

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2005, 2004 and 2003

(In thousands of Reais - R$, unless otherwise indicated)

 

 

**21. Supplemental Disclosures of Cash Flow Information**

 

* *

**2005**

**2004**

**2003**

 

 

 

 

Income taxes paid

    1,881

    3,070

3,321

Interest paid (including exchange variation)

227,389

228,922

204,871

**22.Supplemental Interest Expense and Interest Income and Other**

** **

**2005**

**2004**

**2003**

 

 

 

 

Interest expenses

 

 

 

   Interest and charges on *real* debt

  (57,679)

(124,565)

(293,904)

   Interest and charges on U.S. dollar debt

(185,269)

  (52,271)

(101,070)

   Loss on sale of securities

          -

(110,000)

         -

   Other

  (68,678)

  (49,989)

  (55,224)

 

(311,626)

(336,825)

(450,198)

 

 

 

 

Interest income and other, net

 

 

 

   Interest income on cash equivalents  and investments in debt securities

 

218,685

 

219,163

 

357,280

   Gain on sale of securities

          -

          -

  69,650

   Other

  29,313

  30,621

  32,820

 

247,998

249,784

459,750

F-51