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Wimm Bill Dann Foods Ojsc – ‘20-F’ for 12/31/09

On:  Friday, 4/23/10, at 12:44pm ET   ·   For:  12/31/09   ·   Accession #:  1104659-10-21459   ·   File #:  1-31232

Previous ‘20-F’:  ‘20-F’ on 6/18/09 for 12/31/08   ·   Latest ‘20-F’:  This Filing

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 4/23/10  Wimm Bill Dann Foods Ojsc         20-F       12/31/09    8:5.6M                                   Merrill Corp-MD/FA

Annual Report of a Foreign Private Issuer   —   Form 20-F
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 20-F        Annual Report of a Foreign Private Issuer           HTML   2.85M 
 2: EX-4.2      Instrument Defining the Rights of Security Holders  HTML    480K 
 3: EX-4.3      Instrument Defining the Rights of Security Holders  HTML    370K 
 4: EX-8.1      Opinion re: Tax Matters                             HTML     29K 
 5: EX-12.1     Statement re: Computation of Ratios                 HTML     14K 
 6: EX-12.2     Statement re: Computation of Ratios                 HTML     14K 
 7: EX-13.1     Annual or Quarterly Report to Security Holders      HTML      9K 
 8: EX-13.2     Annual or Quarterly Report to Security Holders      HTML      8K 


20-F   —   Annual Report of a Foreign Private Issuer
Document Table of Contents

Page (sequential) | (alphabetic) Top
 
11st Page   -   Filing Submission
"Table of Contents
"Cautionary Statement Regarding Forward-Looking Statements
"Part I
"Item 1.Identity of Directors, Senior Management and Advisors
"Item 2. Offer Statistics and Expected Timetable
"Item 3. Key Information
"The Russian government has the power to regulate the prices for goods of social significance, including food products that we make
"Item 4. Information on Our Company
"Item 4A.Unresolved Staff Comments
"Item 5.Operating and Financial Review and Prospects
"Item 6.Directors, Senior Management and Employees
"Item 7. Major Shareholders and Related Party Transactions
"Item 8. Financial Information
"Item 9. Offer and Listing Details
"Item 10.Additional Information
"Item 11. Quantitative and Qualitative Disclosures about Market Risk
"Item 12. Description of Securities Other than Equity Securities
"Part Ii
"Item 13. Defaults, Dividend Arrearages and Delinquencies
"Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds
"Item 15.Controls and Procedures
"Item 16A.Audit Committee Financial Expert
"Item 16B.Code of Ethics
"Item 16C. Principal Accountant Fees and Services
"Item 16D. Exemption from the Listing Standards for Audit Committees
"Item 16E.Purchases of Equity Securities by the Issuer and Affiliated Purchasers
"Item 16F. Change in Registrant's Certifying Accountant
"Item 16G. Corporate Governance
"Part Iii
"Item 17.Financial Statements
"Item 19. Exhibits
"Index to the Consolidated Financial Statements
"Report of Independent Registered Public Accounting Firm
"Consolidated Balance Sheets as of December 31, 2009 and 2008
"Consolidated Balance Sheets
"Consolidated Statements of Income for the years ended December 31, 2009, 2008 and 2007
"Consolidated Statements of Income
"Consolidated Statements of Cash Flows for the years ended December 31, 2009, 2008 and 2007
"Consolidated Statements of Cash Flows
"Consolidated Statements of Equity and Comprehensive Income for the years ended December 31, 2009, 2008 and 2007
"Consolidated Statements of Equity and Comprehensive Income
"Notes to the Consolidated Financial Statements
"Notes to Consolidated Financial Statements
"The Company

This is an HTML Document rendered as filed.  [ Alternative Formats ]



Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 20-F

 

o

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

 

 

OR

 

 

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009

 

 

OR

 

 

o

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

 

 

OR

 

 

o

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

 

Commission file number 1-31232

 

WIMM-BILL-DANN FOODS OJSC

(Exact name of Registrant as specified in its charter)

 

RUSSIAN FEDERATION

(Jurisdiction of incorporation or organization)

 

16 Yauzsky Boulevard, Moscow 109028, Russian Federation

(Address of principal executive offices)

 

Natalya Belyavskaya, tel. +7 (495) 925-58-05, e-mail: ir@wbd.ru, address: 16 Yauzsky Boulevard, Moscow 109028, Russian Federation

(Company Contact Person)

 

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

 

Title of each class

 

Name of each exchange on which
registered

FOUR AMERICAN DEPOSITARY SHARES, EACH

 

NEW YORK STOCK EXCHANGE

REPRESENTING ONE SHARE OF COMMON STOCK

 

 

COMMON STOCK, PAR VALUE

 

NEW YORK STOCK EXCHANGE(1)

20 RUSSIAN RUBLES PER SHARE

 

 

 

Securities registered or to be registered pursuant to Section 12(g) of the Act.

 

NONE

(Title of Class)

 

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

 

NONE

(Title of Class)

 


(1) Listed, not for trading or quotation purposes, but only in connection with the registration of ADSs pursuant to the requirements of the Securities and Exchange Commission.

 



Table of Contents

 

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

 

41,846,022 shares of common stock, par value 20 Russian rubles each, as of December 31, 2009.

 

65,045,688 American Depositary Shares, each four representing one share of common stock, as of December 31, 2009

 

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

x Yes   o No

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

o Yes   x No

 

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

x Yes   o No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

x Yes   o No

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer o

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP x

 

International Financial Reporting Standards as issued
by the International Accounting Standards Board
o

 

Other o

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

o Item 17   o Item 18

 

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

o Yes   x No

 



Table of Contents

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

3

PART I

4

Item 1.Identity of Directors, Senior Management and Advisors

4

Item 2. Offer Statistics and Expected Timetable

4

Item 3. Key Information

4

Item 4. Information on Our Company

46

Item 4A.Unresolved Staff Comments

78

Item 5.Operating and Financial Review and Prospects

78

Item 6.Directors, Senior Management and Employees

115

Item 7. Major Shareholders and Related Party Transactions

124

Item 8. Financial Information

125

Item 9. Offer and Listing Details

127

Item 10.Additional Information

128

Item 11. Quantitative and Qualitative Disclosures about Market Risk

151

Item 12. Description of Securities Other than Equity Securities

154

PART II

155

Item 13. Defaults, Dividend Arrearages and Delinquencies

155

Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds

155

Item 15.Controls and Procedures

155

Item 16A.Audit Committee Financial Expert

159

Item 16B.Code of Ethics

159

Item 16C. Principal Accountant Fees and Services

159

Item 16D. Exemption from the Listing Standards for Audit Committees

160

Item 16E.Purchases of Equity Securities by the Issuer and Affiliated Purchasers

160

Item 16F. Change in Registrant’s Certifying Accountant

162

Item 16G. Corporate Governance

162

PART III

166

Item 17.Financial Statements

166

Item 18.Financial Statements

166

Item 19. Exhibits

167

 

Unless the context otherwise requires, references to “WBD,” “Company,” “we,” “us,” or “our” refer to Wimm-Bill-Dann Foods OJSC and its subsidiaries. “Lianozovsky Dairy Plant” was renamed “Wimm-Bill-Dann” in 2006. References to “Lianozovsky” and “Lianozovsky Dairy Plant” are to “Wimm-Bill-Dann”.

 


 

In this annual report, references to “U.S. dollars” or “$” are to the currency of the United States, references to “rubles” or “RUR” are to the currency of the Russian Federation, and references to “€” or “euro” are to the lawful currency of the member states of the European Union that adopted a single currency in accordance with the Treaty of Rome establishing the European Economic Community, as amended by the treaty on the European Union, signed at Maastricht on February 7, 1992.

 

2



Table of Contents

 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

Matters discussed in this document may constitute forward-looking statements within the meaning of Section 27A of the U.S. Securities Act of 1933, or the U.S. Securities Act, and Section 21E of the U.S. Securities Exchange Act of 1934, or the U.S. Exchange Act. The Private Securities Litigation Reform Act of 1995 provides safe harbor protections for forward-looking statements in order to encourage companies to provide prospective information about their businesses. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance, and underlying assumptions and other statements, which are other than statements of historical facts.

 

We desire to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and are including this cautionary statement in connection with this safe harbor legislation and other relevant laws. This document and any other written or oral statements made by us or on our behalf may include forward-looking statements, which reflect our current views with respect to future events and financial performance. The words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “forecast,” “project,” “predict,” “plan,” “may,” “should,” “will,” “could” and similar expressions identify forward-looking statements. Forward-looking statements appear in a number of places including, without limitation, “Item 3. Key Information—D. Risk Factors,” “Item 4. Information on Our Company and “Item 5.”

 

Operating and Financial Review and Prospects,” and include statements regarding: our strategies, outlook and growth prospects; future plans and potential for future growth; our liquidity, capital resources and capital expenditures; our capital structure, including our indebtedness amounts; our ability to generate sufficient cash flow to meet our debt service obligations; growth in demand for our services; economic outlook and industry trends; developments of our markets; the impact of regulatory initiatives; and the strength of our competitors.

 

The forward-looking statements in this document are based upon various assumptions, many of which are based, in turn, upon further assumptions, including without limitation, management’s examination of historical operating trends, data contained in our records and other data available from third parties. Although we believe that these assumptions were reasonable when made, because these assumptions are inherently subject to significant uncertainties and contingencies which are difficult or impossible to predict and are beyond our control, we may not achieve or accomplish these expectations, beliefs or projections. In addition to these important factors and matters discussed elsewhere herein and in the documents incorporated by reference herein, important factors that, in our view, could cause actual results to differ materially from those discussed in the forward-looking statements, including the achievement of the anticipated levels of profitability, growth, cost and synergy of our recent acquisitions, the timely development and acceptance of new products, changes in consumer preferences, the impact of competitive pricing, the ability to obtain necessary regulatory approvals, availability of external financing on commercially acceptable terms, the condition of the Russian economy, the impact of general business and global economic conditions and other important factors described from time to time in the reports filed by us with the U.S. Securities and Exchange Commission (the “SEC”).

 

Except to the extent required by law, neither we, nor any of our respective agents, employees or advisors intend or have any duty or obligation to supplement, amend, update or revise any of the forward-looking statements contained or incorporated by reference in this document.

 

3



Table of Contents

 

PART I

 

Item 1.Identity of Directors, Senior Management and Advisors

Not applicable.

 

Item 2. Offer Statistics and Expected Timetable

Not applicable.

 

Item 3. Key Information

A. Selected Financial Data

 

The selected consolidated financial data set forth below at December 31, 2009, 2008, 2007, 2006 and 2005 and for the years then ended have been derived from our audited financial statements prepared in accordance with U.S. GAAP. The selected consolidated financial data should be read in conjunction with our Consolidated Financial Statements included under “Item 18. Financial Statements” and “Item 5. Operating and Financial Review and Prospects.”

 

 

 

For the years ended December 31,

 

 

 

2009

 

2008

 

2007

 

2006

 

2005

 

 

 

In thousands of U.S. Dollars, except share and per share data

 

Statement of Income Data:

 

 

 

 

 

 

 

 

 

 

 

Sales

 

$

2,181,062

 

$

2,823,564

 

$

2,438,328

 

$

1,762,127

 

$

1,394,590

 

Cost of sales

 

(1,452,737

)

(1,910,528

)

(1,654,879

)

(1,194,159

)

(999,006

)

Gross profit

 

728,325

 

913,036

 

783,449

 

567,968

 

395,584

 

Selling and distribution expenses

 

(379,659

)

(488,110

)

(387,853

)

(246,054

)

(191,990

)

General and administrative expenses

 

(137,440

)

(171,400

)

(180,922

)

(134,481

 

(109,642

)

Other operating expenses

 

(9,552

)

(8,383

)

(704

)

(31,812

)

(6,457

)

Operating income

 

201,674

 

245,143

 

213,970

 

155,621

 

87,495

 

Financial income and expenses, net

 

(43,224

)

(101,504

)

(16,851

)

(15,480

)

(22,868

)

Income before provision for income taxes and minority interest

 

158,450

 

143,639

 

197,119

 

140,141

 

64,627

 

Provision for income taxes

 

(40,678

)

(39,898

)

(54,302

)

(41,560

)

(30,712

)

Consolidated net income

 

117,772

 

103,741

 

142,817

 

98,581

 

33,915

 

Net income attributable to noncontrolling interests

 

(1,237

)

(2,029

)

(2,769

)

(3,197

)

(3,649

)

Net income attributable to WBD Foods shareholders

 

$

116,535

 

$

101,712

 

$

140,048

 

$

95,384

 

$

30,266

 

Earnings per share - basic and diluted (1)

 

$

2.73

 

$

2.31

 

$

3.18

 

$

2.17

 

$

0.69

 

Dividends per share (2)

 

$

 

$

 

$

0.12

 

$

0.55

 

$

 

Weighted average number of shares outstanding

 

42,763,668

 

43,993,827

 

44,000,000

 

44,000,000

 

44,000,000

 

Other Data:

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

121,838

 

$

195,252

 

$

192,662

 

$

129,963

 

$

75,110

 

Cash provided by operating activities

 

$

312,296

 

$

321,190

 

$

96,804

 

$

169,954

 

$

113,937

 

Cash used in investing activities (3)

 

$

(125,262

)

$

(181,681

)

$

(183,481

)

$

(218,409

)

$

(124,107

)

Cash provided by (used in) financing activities (3)

 

$

(187,336

)

$

162,499

 

$

71,869

 

$

(11,660

)

$

81,569

 

 


(1)          Earnings per share is calculated dividing net income, attributable to WBD Foods shareholders by the weighted average number of shares outstanding over the reporting period.

 

(2)          No dividends were paid in 2009 and 2008. Dividends paid in 2007 are attributable as follows: $0.17 per share — for the years 2002, 2003 and 2004, $0.08 per share — for the three months ended March 31, 2006 and $0.30 per share for the nine months ended September 30, 2006.

 

(3)          Cash paid for acquisition from noncontrolling interests in the amount of $2,280, $3,723, $19,560, $9,749 and $1,050, was included in cash used in financing activities for the years ended December 31, 2009, 2008, 2007, 2006 and 2005, respectively.

 

4



Table of Contents

 

 

 

At December 31,

 

 

 

2009

 

2008

 

2007

 

2006

 

2005

 

 

 

In thousands of U.S. Dollars

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,488,804

 

$

1,576,965

 

$

1,533,102

 

$

1,175,936

 

$

920,557

 

Total net assets (1)

 

703,276

 

656,300

 

686,986

 

516,471

 

411,662

 

Total debt (2)

 

523,940

 

673,190

 

578,930

 

442,999

 

371,646

 

Total liabilities

 

785,528

 

920,665

 

846,116

 

659,465

 

508,895

 

Total liabilities and equity

 

$

1,488,804

 

$

1,576,965

 

$

1,533,102

 

$

1,175,936

 

$

920,557

 

 


(1)           Net assets represent net amount of total assets and total liabilities. Total net assets include equity attributable to noncontrolling interests in the amount of $9,396, $11,863, $13,862, $18,997 and $24,619 as of December 31, 2009, 2008, 2007, 2006 and 2005.

 

(2)           Total debt represents long-term and short-term loans, including the current portion of long-term loans, notes payable and vendor financing obligations.

 

Exchange Rates and Inflation

 

The following tables show, for the periods indicated, certain information regarding the exchange rate between the ruble and the U.S. dollar, based on data published by the Central Bank of Russia or the CBR. These rates may differ from the actual rates used in the preparation of our financial statements and other financial information appearing herein.

 

 

 

Rubles per U.S. dollar

 

 

 

High

 

Low

 

Average (1)

 

Period
End

 

Year ended December 31,

 

 

 

 

 

 

 

 

 

2009

 

36.43

 

28.67

 

31.93

 

30.24

 

2008

 

29.38

 

23.13

 

24.98

 

29.38

 

2007

 

26.58

 

24.26

 

25.49

 

24.55

 

2006

 

28.48

 

26.18

 

27.09

 

26.33

 

2005

 

29.00

 

27.46

 

28.31

 

28.78

 

 


(1)The average of the exchange rates on the last business day of each full month during the relevant period.

 

On April 20, 2010, the exchange rate between the ruble and the U.S. dollar was 29.17 rubles per one U.S. dollar.

 

 

 

Rubles per U.S. dollar

 

 

 

High

 

Low

 

April 2010

 

29.50

 

28.93

 

March 2010

 

29.98

 

29.19

 

February 2010

 

30.52

 

29.88

 

January 2010

 

30.43

 

29.43

 

December 2009

 

30.72

 

29.06

 

November 2009

 

29.82

 

28.67

 

 

The following table shows the rates of inflation in Russia for the years indicated:

 

 

 

Inflation rate

 

Year ended December 31,

 

 

 

2009

 

8.80

%

2008

 

13.30

%

2007

 

11.50

%

2006

 

9.70

%

2005

 

10.90

%

 


Source: Central Bank of Russia.

 

5



Table of Contents

 

Effective from January 1, 2003, Russia no longer met the criteria for a highly inflationary economy. However, the Russian economy has nonetheless been characterized by high rates of inflation.

 

Our operational results are affected by the rate of inflation and the nominal rate of appreciation/ depreciation of the ruble against the U.S. dollar (i.e., by the real appreciation or depreciation of the ruble against the U.S. dollar). In 2009, 2008 and 2007, the ruble appreciated in real terms against the U.S. dollar as follows:

 

 

 

2009

 

2008

 

2007

 

Inflation (1)

 

8.80

%

13.3

%

11.5

%

Nominal appreciation of the rubles relative to the U.S.dollar (1)

 

3.1

%

3.1

%

6.3

%

Real appreciation/ (depreciation) of the ruble relative to the U.S. dollar (1)

 

(2.9

)%

(19.9

)%

6.7

%

 


(1) Source: Central Bank of Russia.

 

B. Capitalization and Indebtedness

Not applicable.

 

C. Reasons for the Offer and Use of Proceeds

Not applicable.

 

D. Risk Factors

 

An investment in our shares and ADSs involves a high degree of risk. You should carefully consider the following information about these risks, together with the information contained in this document, before you decide to buy our shares or ADSs. If any of the following risks actually occurs, our business, financial condition, results of operations or prospects could be materially adversely affected. In that case, the value of our shares and ADSs could also decline and you could lose all or part of your investment.

 

We have described the risks and uncertainties that our management believes are material, but these risks and uncertainties may not be the only ones we face. Additional risks and uncertainties, including those we currently are not aware of or deem immaterial, may also result in decreased operating revenues, increased operating expenses or other events that could result in a decline in the value of our ADSs.

 

Risks Relating to Business Operations in Emerging Markets

 

Emerging markets such as the Russian Federation and other CIS countries are subject to greater risks than more developed markets, including significant legal, economic, tax and political risks.

 

Investors in emerging markets such as the Russian Federation and other CIS countries should be aware that these markets are subject to greater risks than in more developed markets, including in some cases significant legal, economic, tax and political risks. Investors should also note that emerging economies, such as the economy of the Russian Federation and other CIS countries, are subject to rapid change and that the information set out herein may become outdated relatively quickly. Furthermore, in doing business in various countries of the CIS, we face risks similar to (and sometimes greater than) those that we face in Russia. See also “—Risks Relating to the Russian Federation.” Accordingly, investors should exercise particular care in evaluating the risks involved and must decide for themselves whether, in light of those risks, their investment is appropriate. Generally, investment in emerging markets is suitable for sophisticated investors who

 

6



Table of Contents

 

fully appreciate the significance of the risks involved and investors are urged to consult their own legal and financial advisors before making an investment in our securities.

 

Risks Relating to Our Business and Industry

 

Economic downturns could hurt our turnover and materially adversely affect our strategy to increase our sales of premium brands.

 

Demand for dairy and certain beverage products depends primarily on demographic factors and consumer preferences, as well as factors relating to discretionary consumer spending, including the general condition of the economy and general levels of consumer confidence in the markets where we sell our products. The willingness of consumers to purchase branded food and beverage products depends, in part, on local economic conditions. In periods of economic uncertainty, such as the recent economic downturn, consumers tend to purchase more economy brands and, to the extent that our business strategy depends on the expansion of the sales of premium brands and value-added products, our results of operations could suffer. Reduced consumption of our products in any of our key markets could reduce our turnover and profitability.

 

The failure of our geographic expansion strategy could hamper our continued growth and profitability.

 

Our expansion strategy depends, in part, on funding growth in additional markets, on our ability to identify attractive opportunities in markets that will grow and on our ability to manage the operations of acquired or newly established businesses. Should growth decline in our existing markets, not increase as anticipated in markets in which we have recently acquired or established businesses, or not increase in markets into which we subsequently expand, our geographic expansion strategy may not be successful and our business and profitability may suffer.

 

In addition, we currently have production facilities in Ukraine, Georgia, Kyrgyzstan and Uzbekistan and trade operations in Kazakhstan, and our strategy contemplates the acquisition of additional operations in other countries. As with Russia, these countries are emerging markets subject to greater legal, economic, social, tax and political risks than in more developed markets. In many respects, the risks inherent in transacting business in these countries are similar to those in Russia, especially those risks set out below in “—Risks Relating to the Russian Federation.”

 

For example, in August through September 2009, our subsidiary in Uzbekistan, Vimm-Bill-Dann Toshkent, was inspected by the local authorities, who thereafter suspended the plant’s operations commencing in December 2009. The plant’s production activities remain suspended as of the date of this report. We are cooperating with the local authorities to resolve this matter. However, we cannot predict with any certainty if or when it will be resolved.

 

Our growth strategy relies on acquisitions and establishing new businesses, and our future growth, results of operations and market share would be adversely affected if we fail to identify suitable targets, outbid competing bidders or finance acquisitions on acceptable terms.

 

Our strategy depends on us being a large manufacturer in the dairy, babyfood and beverages segments so that we can benefit from economies of scale, better satisfy customer needs and compete effectively against other producers. Our growth will suffer if we are unable to implement our acquisition strategy, whether because we fail to identify suitable targets, outbid competing bidders or finance acquisitions on acceptable terms or for any other reason. Furthermore, any acquisitions or similar arrangements may harm our business if we are unsuccessful in our integration process or fail to achieve the synergies and savings we expect.

 

Our growth strategy may require additional external financing. Should the current economic downturn persist, or deteriorate further, we may be unable to secure additional financing on commercially favorable terms or at all. If we are unable to pursue additional expansion

 

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opportunities due to the lack of financing or otherwise, our future growth, results of operations and market share would be materially adversely affected.

 

We cannot guarantee the successful integration of existing or newly acquired businesses. If we fail to integrate our businesses successfully, our rate of expansion could slow and our financial condition, results of operations and prospects could be materially adversely affected.

 

We have grown through numerous acquisitions and are in the process of integrating and restructuring some of our businesses. We may make additional acquisitions in the future. Achieving the benefits of our acquisitions and our restructuring efforts will depend, in part, on integrating our businesses in an efficient manner. We cannot assure you that such integration will happen or that it will happen in a timely manner.

 

The integration of our businesses, as well as of any businesses we may acquire in the future, requires significant time and effort from our senior management, who are also responsible for managing our existing operations. The integration of new businesses may be difficult for a variety of reasons, including differing cultures, management styles, systems and infrastructure, poor records or internal controls. In addition, integrating new acquisitions may require significant initial cash investments. Furthermore, even if we are successful in integrating our existing and new businesses, expected synergies and cost savings may not materialize, resulting in lower than expected profit margins. We cannot assure you that we will be successful in realizing any of the anticipated benefits of the companies that we are now in the process of integrating or that we may acquire in the future. If we do not realize these benefits, our financial condition, results of operations and prospects could be materially adversely affected.

 

We also may acquire or establish businesses in countries that may represent new operating environments for us and which may be located a great distance from our headquarters in Moscow. We may thus have less control over the activities of these companies and may face more uncertainties with respect to the operational and financial needs of these businesses, and this may hinder our integration efforts.

 

Rapid growth and expansion may cause us difficulty in obtaining adequate managerial and operational resources, restricting our ability to successfully expand our operations.

 

We have experienced substantial growth and development in a relatively short period of time, and we believe that our businesses will continue to grow for the foreseeable future. The operating complexity of our business and the responsibilities of management have increased as a result of this growth, placing significant strain on our managerial and operational resources. Our future operating results depend, to a significant degree, upon the continued contributions of our management and technical personnel.

 

We will need to continue to improve our operational and financial systems and managerial controls and procedures to keep pace with our growth. We will also have to maintain close coordination among our logistical, technical, accounting, finance, marketing and sales personnel. Management of growth will require, among other things:

·                  the ability to integrate new acquisitions into our operations;

 

·                  continued development of financial and management controls and IT systems and their implementation in newly acquired businesses;

 

·                  increased marketing activities;

 

·                  hiring and training of new personnel; and

 

·                  the ability to adapt to changes in the markets in which we operate, including increased competition and demand for our services.

 

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Our inability to manage our growth successfully could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

There is a material weakness in our internal control over financial reporting and we may not be able to remedy this material weakness or prevent future material weaknesses. If we fail to do so there is a reasonable possibility that a material misstatement of the annual or interim statements will not be prevented or detected on a timely basis.

 

The material weakness in our internal control over financial reporting as identified by our management for the year ended December 31, 2009 is summarized below.

 

Our financial statement closing process, including the transformation of our statutory financial statements into U.S. GAAP consolidated financial statements has not reduced to an acceptably low level the risk that material errors may occur and may not be detected on a timely basis by management in the normal course of business.

 

Notwithstanding the steps we have taken and continue to take that are designed to remediate the material weakness identified above, we may not be successful in remediating this material weakness in the near or long term and we may not be able to prevent other material weaknesses in the future. Any failure to maintain or implement required new or improved internal control over financial reporting, or any difficulties we encounter in their implementation, could result in additional significant deficiencies or additional material weaknesses, failure to meet our periodic reporting obligations or result in material misstatements in our financial statements. Any such failure could also adversely affect the results of periodic management evaluations and annual auditor attestations regarding the effectiveness of our internal control over financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002.

 

The existence of a material weakness could result in errors in our financial statements that could result in a restatement of financial statements, cause us to miss our reporting deadlines and cause investors to lose confidence in our reported financial information, leading to a decline in the price of our shares and ADSs. See “Item 15. Controls and Procedures” for additional information.

 

Increased competition among juice producers in Russia may materially adversely affect our results of operations.

 

Although our beverages sales volume increased year-on-year by 10.4% in 2007, 3.7% in 2008 and 5.0% in 2009, continued and/or increased competition among juice and bottled water producers in Russia may cause future volatility or decline in the sales volumes of our beverages products, as well as affect our beverages prices and profit margins, and materially adversely affect our results of operations. “See Item 4. Information on Our Company—B. Business—Business Overview—Beverage products and brands—Market trends and competition” for additional information regarding our competitors.

 

Consumer preferences for low-price juice products and the volatility of certain raw materials required for juice production may cause our profit margins to decline and have a material adverse effect on our results of operations.

 

The juice market in Russia is very competitive, with over 20 significant brands in three fairly distinct price tiers, and various private label offerings. This competition can sometimes cause downward pressure on the prices of juice products. With the exception of price adjustments made to compensate for raw material inflation, price increases in rubles are relatively rare.

 

In terms of raw materials, most juice concentrate and sugar are international commodities that are normally denominated in U.S. dollars or euro. Over 2005, 2006, and 2007, in line with general

 

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international economic growth, prices for these commodities increased significantly year on year. Prices stabilized towards the end of 2008, and the price of juice concentrates slightly declined in 2009. However, as many national economies are showing signs of a return to economic growth, we believe that raw material prices are more likely to increase in the near term. While a return to economic growth may favorably affect revenue, it could also lead to sustained increases in raw material prices, which could put pressure on the gross profit margins of our juice products and, consequently, adversely affect our results of operations.

 

Increasing tariffs and restructuring in the transport sector could have a material adverse effect on our business and results of operations.

 

Railway and ground transportation are our principal means of transporting supplies and juice and water products to our facilities and customers. Currently, the Russian government sets rail tariffs and may further increase these tariffs as it did in 2007, 2008 and 2009. In addition, the uncertainty surrounding oil prices has lead to increased instability and unpredictable fluctuations in fuel and transportation costs.

 

The Russian government is actively considering plans to reorganize and/or privatize the nation’s railway system. Any such reorganization or privatization may result in increased charges and tariffs while failing to generate the anticipated capital investment needed to repair, maintain and improve the railway system. Any significant increases in railway transport costs may lead to a decrease in our profit margins and have a material adverse effect on our business, financial condition and results of operations.

 

Our inability to develop and maintain awareness of new brands, products and product categories could significantly inhibit our future growth and profitability.

 

Our business strategy contemplates our entry into new product categories, the development of new products and marketing new brands in existing product lines with the aim of increasing our market share and revenues. The success of this strategy depends, in part, on our ability to anticipate the tastes and dietary habits of consumers and to introduce and offer products that appeal to their preferences. Our failure to anticipate, identify or react to changes in consumer preferences or to successfully develop new brands, products and product categories could negatively affect our expansion strategy and could significantly inhibit our future growth and profitability.

 

In addition, developing and maintaining awareness of our brands in a cost effective manner is critical to informing and educating the public about our current and future product offerings and is an important element in attracting new consumers. The successful promotion of our brands will depend largely on the effectiveness of our marketing efforts and on our ability to provide reliable and useful products at competitive prices. Brand promotion activities may not yield increased operating revenues, and even if they do, such operating revenues may not offset the operating expenses we incur in building our brands. Our failure to successfully and efficiently promote and maintain our brands may limit our ability to attract new consumers and retain our existing consumers and materially adversely affect our business, financial condition, results of operations and prospects.

 

Furthermore, our ability to attract new consumers and retain existing consumers depends, in part, on our ability to maintain what we believe to be our favorable brand image. Negative publicity or rumors regarding our company, our shareholders and affiliates or our products could negatively affect this brand image, which could lead to loss of market share and revenues.

 

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If we do not continue to be an efficient producer in a highly competitive environment, particularly in relation to purchases of our packaging and raw materials, or an effective advertiser in a highly inflationary media advertising environment, our operational results will suffer.

 

Our success depends, in part, on our continued ability to be an efficient producer in a highly competitive industry. If we cannot continue to control costs through productivity gains or by eliminating redundant costs resulting from acquisitions, our results of operations will suffer. In particular, price increases or shortages of packaging and raw materials could have a material adverse effect on our results of operations. We are substantially dependent upon one supplier of packaging materials, Tetra Pak, which may make us more vulnerable to changes in global supply and demand and their effect on price and availability of these materials. Additionally, weather conditions and other factors beyond our control significantly influence the price and availability of our raw materials. A number of our raw materials, such as juice concentrate and sugar, are international commodities and are subject to international price fluctuations, and we experienced significant increases in raw milk, sugar and concentrate prices during 2006, 2007 and 2008. While raw milk prices declined for most of 2009, they increased significantly at the end of the year. Sugar prices increased in 2009 and although juice concentrate prices decreased in 2009, we cannot guarantee them not to increase in the future. A substantial amount of our packaging and raw materials are denominated in euro and/or U.S. dollars. As a vast majority of our revenues are denominated in rubles, depreciation in the ruble against the euro and/or U.S. dollar cause our packaging and raw material expenses to increase.

 

Our success also depends on our continued ability to be an effective advertiser in the Russian market. We experienced significant media inflation over several years through 2008. As a result of the economic downturn, media inflation decreased in 2009 by 14% on national television channels and by 20% on regional television channels and we do not expect any significant increase of media inflation in 2010. However, we believe that future improvement in the economic climate will lead to a general increase in advertising and a return to growth in media inflation.

 

A substantial increase in the prices of any of packaging, raw materials or advertising, which we may not be able to pass on to customers through price increases, or a protracted interruption in supply with respect to packaging or raw materials, could have a material adverse effect on our business, financial condition and results of operations. See “Item 4. Information on Our Company—B. Business—Business Overview.”

 

We may be unable to continue to add products and greater production capacity in faster growing and more profitable categories.

 

The food industry’s growth potential is constrained by population growth and changes in personal income levels. Our success depends, in part, on our ability to expand our business faster than populations are growing in the markets that we serve, or notwithstanding declines in the populations in those markets. One way to achieve such growth is to enhance our portfolio by adding products and greater production capacity in faster growing and more profitable categories. In the past, we have experienced delays in the installation of new production equipment due to internal technical integration issues as well as delays by vendors and other third-party suppliers in installing and testing new production lines.

 

Depreciation of the ruble may also hamper our ability to acquire new equipment, as this equipment is often priced in U.S. dollars or euros and, as a result, may become prohibitively expensive. Future delays in new equipment installation could inhibit our ability to add products and expand our production capacity, cause our output volume to suffer and, consequently, have a material adverse effect on our results of operations.

 

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Our inability to address the seasonal difference between the demand for dairy products and the supply of raw milk and the increasing prices of raw milk could result in a significant increase in our production costs, reducing our profitability.

 

The demand for our dairy products is significantly higher during the winter months, when Russian raw milk production is at its lowest. Conversely, during the summer months we generally experience depressed demand for dairy products in many markets, while raw milk production is at its peak. If we are unable to mitigate this inverse relationship successfully, either through the purchase of raw milk during the winter at commercially competitive prices or through the use of powder milk, our production costs will increase significantly in the winter, reducing our profitability.

 

In 2007, we experienced significant increases in the raw-milk purchase price. The average weighted raw-milk purchase price paid by us increased in ruble terms by approximately 14% in 2005, 7% in 2006 and 64.8% in 2007. The price increases were due, in part, to droughts in Australia and New Zealand, the world’s largest suppliers of dry powder milk, and due to an increase in demand for milk products in such densely populated countries as China, Indonesia, Algeria and a number of other countries in Asia and Africa. The unprecedented increase in the price of raw and dry milk adversely affected our dairy profit margin in 2007, and continued increases in raw milk prices could further reduce our profitability. Throughout 2008, however, raw milk prices remained relatively stable. In 2009 the average raw milk price decreased by 12% compared to 2008. However, towards the end of 2009 we saw a sharp increase in the price of raw milk compared to the latter part of 2008. The shortage of high quality raw milk, coupled with raw milk price increases, may also limit our ability to expand our production of high margin value-added dairy products. See “Item 5. Operating and Financial Review and Prospects—D. Trend Information” for additional information.

 

The Russian government has the power to regulate the prices for goods of social significance, including food products that we make.

 

The Russian government has established a list of basic food products that are deemed to have “social significance,” and federal and regional authorities have the authority to regulate the prices of these products.  The list includes dairy products such as certain types of milk and kefir. Following the rapid growth of raw-milk prices during 2007, the Russian government entered into a voluntary agreement with various food producers and large retail chains in October 2007 in order to “lock-in” prices for certain types of milk, kefir and sour cream. In January 2008, this agreement was extended with prices fixed at the January 2008 level until May 1, 2008 and was not thereafter extended. In February 2010 a new trade law came into force stipulating that in cases where the price of a product of social significance increases by 30% or more within a 30 day period, the federal government has the right to set a maximum price for such product for a 90 day period. Although the voluntary agreement with the Russian government in 2007 and 2008 did not significantly impact our results of operations as we were still able to freely set the prices for the vast majority of our products, and we have not yet been affected by the new trade law any future price regulations by the Russian government of milk or food products that we produce may materially adversely affect our business, financial condition and results of operations.

 

In the event that the Moscow City Government was to reduce significantly the prices or the amount of products it purchases from our babyfood business, then our revenues and profits from this business could be reduced.

 

In 2007, 2008 and 2009, babyfood purchases by the Moscow City Government comprised approximately 26.0%, 18.3% and 17.3% of the total sales of our babyfood segment, respectively. We supply these products to the Moscow City Government pursuant to a tender held on a yearly

 

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basis. In the event that we were to lose a tender, or the Moscow City Government was to reduce significantly the purchase price or the amount of products it purchases from our babyfood business, and we were unable to find alternative purchasers, then our revenues and profits from this business would suffer, which could have a material adverse effect on our financial condition and results of operations.

 

Our substantial reliance on independent retailers and independent distributors for the distribution of our products could lower our turnover and reduce our competitiveness.

 

We sell our products either directly to retailers, including supermarkets, grocery stores and restaurants, or to independent distributors for resale to retail outlets. We expect sales to retailers and independent distributors to continue to represent a significant portion of our revenues. Our operations and distribution costs could be affected by the increasing consolidation of these entities, particularly as these customers become more sophisticated and attempt to force lower pricing levels and seek an increase in promotional programs. For example, in the spring of 2001, several Russian supermarket chains formed a loose alliance which publicly announced its intention not to purchase our products. Although these supermarket chains now purchase our products, they may not continue to do so, and they or other supermarket chains may attempt a similar consolidation of market power in the future. In addition, there has been increased merger activity among some of Russia’s supermarket chains in recent years, which further strengthens the negotiating leverage in their dealings with us. Although we have not yet experienced any material adverse effect on our business, financial condition and results of operations as a result of these mergers, we cannot guarantee that we will not experience adverse consequences in the future. A number of large Western retailers, such as German retailer Metro and French retailer Auchan, have also opened stores in our markets, which will put further pressure on prices.

 

We also compete with other brands for shelf space in retail stores. Retailers also offer other products, including their private labels that compete directly with our products. The recent economic downturn may change consumer spending patterns and lead to an increase in the consumption of private-label brands and to a decline in the consumption of higher margin national and regional brands, and this may negatively affect our revenues.

 

On February 1, 2010, the Federal Law “On the framework of state regulation of trading activities in the Russian Federation,” or the Trade Law, came into force. The Trade Law introduces a number of new requirements in respect of manufacturers, distributors and chain retailers in the sphere of food products that may significantly affect our operations. These requirements include, among other things, a prohibition on unfair competition and other discriminatory activities, requirements relating to the content and terms of supply agreements, as well as provisions regarding the regulation of prices and retail margins by Russian governmental authorities. In particular, according to the Trade Law, the federal government can, under certain circumstances, set the maximum retail prices for food products of “social significance” within the territory of one or more regions of Russia for up to 90 days.  See “—The Russian government has the power to regulate the prices for goods of social significance, including food products that we make.”

 

Provisions of the Trade Law may also necessitate the revision of our agreements with distributors and chain retailers on conditions that may be less favorable to us. For example, the Trade Law limits the remuneration paid under supply contracts by suppliers to distributors or retail chains in the form of bonuses for marketing, promotional and similar activities to a maximum 10% of the price of the acquired food products and prohibits the payment of bonuses for products of social significance altogether. These new restrictions will require us to revise our remuneration structure, although we do not expect it to affect our company significantly. The Trade Law also requires that we, retailers and distributors disclose on our websites, or make available on demand our main supply conditions, including the material terms of supply contracts. These requirements may hinder our ability to negotiate with retailers which, in turn, could lead to increased costs

 

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and/or a reduction in our turnover, competitiveness and profitability and have a material adverse effect on our business, financial condition and results of operations.

 

Although the Trade Law also contains provisions that may positively affect our relations with chain retailers, including new restrictions on retailers’ ability to charge suppliers for the opportunity to supply new store locations and modifying the range of products supplied, it is too soon to predict the overall impact of the new law.

 

Independent distributors may export our products to countries where such products do not meet the requirements of applicable legislation.

 

In exporting our products, we attempt to meet the standards and requirements of applicable legislation governing the import of food products into the importing country. However, we do not have control over independent distributors, who have, in some cases, attempted to export our products to countries where such products did not meet the requirements of applicable legislation. Any consequent recalls of our products and the associated negative publicity may adversely affect our reputation and materially adversely affect our results of operations.

 

We do not carry the types of insurance coverage customary in more economically developed countries for a business of our size and nature, and a significant event could result in substantial property loss and inability to rebuild in a timely manner or at all.

 

We maintain insurance against some, but not all, potential risks and losses affecting our operations. We cannot provide assurance that our insurance will be adequate to cover all of our losses or liabilities. We also can provide no assurance that insurance will continue to be available to us on commercially reasonable terms. Should a significant event affect one of our facilities, we could experience substantial property loss and significant disruptions in production, for which we would not be compensated. Additionally, depending on the severity of the property damage, we may not be able to rebuild damaged property in a timely manner or at all. We do not maintain separate funds or otherwise set aside reserves for these types of events. Any such loss or third-party claim for damages may have a material adverse effect on our business, results of operations and financial condition.

 

We are also exposed to product liability claims in the event that consumption of our products results in illness, injury or death, and we cannot assure you that we will not experience any material product liability losses in the future. Although we maintain insurance coverage for product liability, such coverage may be insufficient in the event of a claim. In addition, if any of the products we have produced are determined to be unsuitable for consumption, we may be required to participate in a recall involving such products.

 

Additionally, although we have made and will continue to make capital and other expenditures to comply with environmental requirements, in 2008 and 2009 we did not incur material capital expenditures for environmental controls. For a more detailed discussion of our insurance coverage see “Item 4. Information on Our Company—B. Business Overview—Insurance.”

 

If transactions of members of our group of companies and their predecessors-in-interest were to be challenged on the basis of non-compliance with applicable legal requirements, the remedies in the event of any successful challenge could include the invalidation of such transactions or the imposition of other liabilities on such group members.

 

Members of our group, or their predecessors-in-interest, at different times took a variety of actions relating to share issuances, share disposals and acquisitions, mandatory buy-out offers, valuation of property, interested party transactions, major transactions, meetings of the group members’ governing bodies, other corporate matters and anti-monopoly issues that, if successfully

 

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challenged on the basis of non-compliance with applicable legal requirements by competent state authorities, counterparties in such transactions or shareholders of the relevant group members or their predecessors-in-interest, could result in the invalidation of such transactions and our corporate decisions, restrictions on voting control or the imposition of other liabilities. Because applicable provisions of Russian law are subject to many different interpretations, we may not be able to defend successfully any challenge brought against such transactions, and the invalidation of any such transactions or imposition of any such liability may, individually or in the aggregate, have a material adverse effect on our business, financial condition and results of operations.

 

Our management information system may be inadequate to support our future growth.

 

Our management-information system is less developed in certain respects than those of food producers in more developed markets and may not provide our management with as much or as accurate information as those in more developed markets. In addition, we may encounter difficulties in the ongoing process of implementing and enhancing our management-information system.

 

Our inability to maintain an adequate management information system may have a material adverse effect on our business, financial condition and results of operations.

 

Our competitive position and future prospects depend on our senior managers and other key personnel.

 

Our ability to maintain our competitive position and to implement our business strategy is dependent to a large degree on the services of our senior management team and other key personnel. Moreover, competition in Russia for personnel with relevant expertise is intense due to the small number of qualified individuals and, as a result, we attempt to structure our compensation packages in a manner consistent with the evolving standards of the Russian labor market. We are not insured against the detrimental effects to our business resulting from the loss or dismissal of our key personnel. The loss or decline in the services of members of our senior management team or an inability to attract, retain and motivate qualified key personnel could have a material adverse effect on our business, financial condition and results of operations.

 

We may not be able to adequately protect our intellectual property rights.

 

Given the importance of brand recognition to our business, we have invested considerable effort in protecting our portfolio of intellectual property rights, including trademark registration. However, the steps we have taken may not be sufficient and third parties may infringe or misappropriate our proprietary rights. Moreover, Russia and the other countries of the CIS in which we operate generally offer less intellectual property protection than in Western Europe or North America. If we are unable to protect our proprietary rights against infringement or misappropriation, our business, financial condition and results of operations could be materially adversely affected. See “Item 4. Information on Our Company—B. Business Overview—Current Operations—Trademarks and Patents.” In addition, litigation may be necessary to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement. Any such litigation may result in substantial costs and diversion of resources, and, if decided unfavorably to us, could have a material adverse effect on our business and results of operations.

 

Failure to receive trademark protection for several of our brand names and images could negatively affect our marketing plans, resulting in increased advertising expenses and a material adverse effect on our financial results.

 

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As of April 20, 2010, we had 81 pending trademark applications in Russia and 28 pending trademark applications abroad. We are also in the process of contesting the rejection of the registration of a number of our trademarks in countries outside of Russia. If trademark status is not granted to the brands included in our pending applications, we will have limited ability to defend these brand names or images from use by others, significantly reducing the value of any advertising using these brand names or images. This will negatively affect our marketing plans for the products that utilize these brand names or images, and may require us to develop a different marketing approach for these products, resulting in increased advertising expenses and materially adversely affecting our financial results. See “Item 4. Information on Our Company—B. Business Overview—Current Operations—Trademarks and Patents.”

 

If we are unable to obtain adequate funding, we may have to limit our operations substantially, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

We continue to make significant capital expenditures, particularly in connection with the expansion of our existing operations, upgrades of existing facilities, enhancing our infrastructure, including building new warehouses and acquisitions of new companies. For the fulfillment of our capital investment plans, excluding expenditures for acquisitions, we invested approximately $192.7 million in 2007, $195.3 million in 2008 and $121.8 million in 2009. We spent approximately $21.8 million in 2007 on acquisitions and approximately $3.3 million in 2008 and $2.3 million in 2009 in order to buy out noncontrolling interests. However, we may not be able to meet our planned capital spending needs in the future in the event of the following potential developments:

·                  a lack of external financing sources;

 

·                  changes in the terms of existing financing arrangements;

 

·                  slower than anticipated growth in demand for our products;

 

·                  slower than anticipated revenue growth;

 

·                  regulatory developments; or

 

·                  a global economic slowdown and, in particular, deterioration in the Russian economy and economies of other countries we operate in, particularly Ukraine and Kazakhstan.

 

To meet our financing requirements, we may need to attract additional equity or debt financing. Russian companies are limited in their ability to issue shares in the form of ADSs or other depositary receipts due to Russian securities regulations, which, until 2005, generally provided that no more than 40% of a Russian company’s shares may be circulated abroad through depositary receipt programs. This limitation was subsequently decreased to 30% in 2008 and further decreased to between 5% and 25% (depending on the type of issuer) in 2009. Our ADS and GDS programs together account for 40% of our outstanding shares (this amount was approved by the Russian securities regulator based on the prior limit and is not required to be reduced). As a result, we are currently unable to raise additional equity financing through the issuance of depositary receipts. If we cannot obtain adequate funds to satisfy our capital requirements, we may need to limit our operations significantly, which could have a material adverse effect on our business, results of operations and prospects.

 

We are controlled by a group of shareholders whose interests could conflict with those of the holders of our securities.

 

As of April 20, 2010, to our knowledge, approximately 43.0% of our outstanding common stock was owned by our founding shareholders. This group has acted in concert since our establishment and, since 1997, pursuant to a Partnership and Cooperation Agreement, amended and

 

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restated on January 16, 2002, which requires the parties to vote the same way. This group continues to be bound by this agreement to vote as a block until any member of the group elects to withdraw from the agreement. This agreement gives them control over us and the ability to elect a majority of the directors, appoint management and approve certain actions requiring the approval of a majority of our shareholders.

 

If not otherwise required by law, resolutions at a shareholders’ meeting will be adopted by a simple majority in a meeting at which shareholders holding more than half of the issued share capital are present or represented. Accordingly, as long as the group continues to hold, directly or indirectly, a controlling stake in our shares and act in concert pursuant to the Partnership and Cooperation Agreement, they will have the power to control the outcome of most matters to be decided by vote at a shareholders’ meeting and the appointment of a majority of directors and removal of directors. The group will also be able to control or significantly influence the outcome of any vote on, among other things, any proposed amendment to our charter, proposed reorganizations and substantial asset sales or other major corporate transactions. Thus, the group may be able to take actions that may conflict with the interest of holders of our ADSs.

 

Members of our controlling group of shareholders also have interests in other companies, some of which conduct business with us. We are not aware of any related-party transactions that are being carried out on preferential terms, but cannot exclude the possibility of related-party transactions that may potentially result in the conclusion of transactions on terms less favorable than could be obtained in arm’s length transactions.

 

To the best of our knowledge, Groupe Danone, together with its subsidiaries, holds an 18.4% stake in Wimm-Bill-Dann Foods OJSC, which allows Groupe Danone to nominate its candidates to our board of directors. The election of a director nominated by Groupe Danone may present a conflict of interest between Wimm-Bill-Dann Foods OJSC and Groupe Danone, which is one of our main competitors.

 

Changes in Russian law will limit the amount of advertising time permitted on television, which could increase our advertising expenses and have a material adverse effect on our business, financial condition and results of operations.

 

The new Federal Law on Advertising which came into force on July 1, 2006, limits the amount of time that a broadcaster may devote to advertising to 15% of total broadcasting time per day and 20% in any given hour. From January 1, 2008, advertising was further limited to no more than 15% in any given hour of broadcasting time.

 

As a result of this law, the amount of available advertising time decreased. In turn, the reduction in available advertising time led to increased costs to advertisers for purchasing advertising time due to an increased demand for available time slots and a drive by media outlets to recover their losses from the decreased volume of advertising time they are permitted to sell. We are among Russia’s top advertisers.

 

According to Gallup, we were the tenth largest advertiser in 2007 and 2008, and the seventh largest in 2009. In 2007, 2008 and 2009, over 50% of our advertising expenditures related to television advertisements. At the same time, media inflation in Russia has been significant in recent years, exceeding 35% in 2006 and 50% in 2007 and 2008. Although media inflation decreased in 2009 and we do not expect significant increases in 2010 due to the recent economic downturn, any substantial increase in the future may lead us to decrease our television advertising which, consequently, could have a material adverse effect on our business, financial condition and results of operations.

 

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In the event that deficiencies or ambiguities in privatization legislation are successfully exploited to challenge our ownership in our privatized subsidiaries and we are unable to defeat these challenges, we risk losing our ownership interest in the subsidiaries or their assets, which could materially adversely affect our business, financial condition, results of operations and prospects.

 

Our business includes a number of privatized companies in Russia and other countries of the former Soviet Union, and our acquisition strategy will likely involve the acquisition of additional privatized companies. To the extent that privatization legislation is vague, inconsistent or in conflict with other legislation, including conflicts between federal and local privatization legislation, many privatizations are vulnerable to challenge, including selective challenges. For instance, a series of presidential decrees issued in 1991 and 1992, that granted to the Moscow City Government the right to adopt its own privatization procedures, were subsequently held to be invalid by the Constitutional Court of the Russian Federation, which ruled, in part, that the presidential decrees addressed issues that were the subject of federal law. While this court ruling, in theory, did not require any implementing actions, the presidential decrees were not officially annulled by another presidential decree until 2000. In the event that any title to, or our ownership stakes in, the privatized companies acquired by us, are subject to challenge as having been improperly privatized and we are unable to defeat this claim, we risk losing our ownership interest in the company or its assets, which could materially affect our business and results of operations. In particular, we own a substantial number of our other subsidiaries through Wimm-Bill-Dann (formerly Lianozovsky Dairy Plant), which was privatized in 1995. As Wimm-Bill-Dann constitutes the majority of our production capacity, its loss would materially adversely affect our, business, financial condition, results of operations and future outlook.

 

In addition, under Russian law, transactions in shares may be invalidated on many grounds, including a sale of shares by a person without the right to dispose of such shares, breach of interested-party and/or major transactions rules and failure to register the share transfer in the securities register. As a result, defects in earlier transactions in shares of our subsidiaries (where such shares were acquired from third parties) may cause our title to such shares to be subject to challenge. Additionally, of the 98.6% of Wimm-Bill-Dann which we own, 15% was acquired in a separate investment tender held by the Department of State and Municipal Property of the Moscow City Government. Under the legislation governing such tenders, a tender is not valid unless at least two participants submit bids. In the investment tender for Wimm-Bill-Dann, the only two participants were entities which were under common control, an arguable violation of this requirement. In the event that the Russian government authorities were successfully to maintain that this tender was not duly held since the participants were under common control, we could lose 15% of our stake in the Lianozovsky Dairy Plant, materially adversely affecting our results of operations.

 

Russian companies can be forced into liquidation on the basis of formal non-compliance with certain requirements of Russian law.

 

Certain provisions of Russian law may allow a court to order the liquidation of a Russian legal entity on the basis of its formal non-compliance with certain requirements during formation, reorganization or during its operation. There have been cases in the past in which formal deficiencies in the establishment process of a Russian legal entity or non-compliance with provisions of Russian law have been used by Russian courts as a basis for the liquidation of a legal entity. Weaknesses in the Russian legal system create an uncertain legal environment, which makes the decisions of a Russian court or a governmental authority difficult, if not impossible, to predict. If involuntary liquidation were to occur, such liquidation could lead to significant negative consequences for our group.

 

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For example, in Russian corporate law, if the net assets of a Russian joint stock company calculated on the basis of Russian accounting standards are lower than its charter capital as at the end of its third or any subsequent financial year, the company must either decrease its charter capital or liquidate. If the company fails to comply with these requirements, governmental or local authorities can seek the involuntary liquidation of such company in court, and the company’s creditors will have the right to accelerate their claims or demand early performance of the company’s obligations as well as compensation of any damages.

 

The existence of negative assets may not accurately reflect the actual ability of a company to pay debts as they come due. Many Russian companies have negative net assets due to very low historical asset values reflected on their Russian accounting standards balance sheets; however, their solvency, i.e., their ability to pay debts as they come due, is not otherwise adversely affected by such negative net assets. Some Russian courts, in deciding whether or not to order the liquidation of a company for having negative net assets, have looked beyond the fact that the company failed to fully comply with all applicable legal requirements and have taken into account other factors, such as the financial standing of the company and its ability to meet its tax obligations, as well as the economic and social consequences of its liquidation. Nonetheless, creditors have the right to accelerate claims, including damages claims, and governmental or local authorities may seek the liquidation of a company with negative net assets. Courts have, on rare occasions, ordered the involuntary liquidation of a company for having net assets less than the minimum charter capital required by law, even if the company had continued to fulfill its obligations and had net assets in excess of the minimum charter capital at the time of liquidation.

 

The amount of net assets of some of our subsidiaries is below the minimum legal requirements. Although we are currently taking steps to remedy this and these subsidiaries continue to meet all of their obligations to creditors, there is a minimal risk of their liquidation.

 

Our inability to register property in a timely manner may lead to fines and temporarily restrict our expansion plans.

 

We have grown both organically and through numerous acquisitions. As a result, we are routinely required to register property that we have acquired and/or constructed. Russian property laws, particularly municipal laws in Moscow, are complicated and ambiguous. Among other things, these laws require a registrant to provide the property registration authority with numerous documents from various state authorities, including from construction authorities, land register authorities, tax authorities and fire safety authorities, among others. Each of these entities exercises considerable discretion in matters of enforcement and interpretation of applicable laws, regulations and standards, the issuance and renewal of permits and in monitoring compliance with the terms thereof. Consequently, a considerable amount of effort, time and money is required to register property in Russia, and notwithstanding these efforts, there is no assurance we will be able to register all of our property on a timely basis. Our failure to timely register our property may result in our inability to properly reflect such real estate in our accounting and tax filings, which, in turn, may lead to the imposition of fines. In addition, we may be restricted on our ability to use unregistered real estate.

 

Implementation of new federal or local government policies or selective application of existing policies, affecting the food industry could substantially and negatively affect our turnover and operating margin.

 

The implementation of new federal or local government policies or selective application of existing policies, affecting the food industry could have a significant impact on our business. For example, the federal and local governments have been known to implement trade barriers, subsidies and other policies favoring certain producers. Additionally, customs regulations in Russia

 

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are unclear, subject to frequent change and are applied inconsistently. The imposition of higher customs duties on products we import would increase the costs of our products and reduce our profits, while the implementation of price controls on products we produce would reduce our operating margin. For example, federal customs regulations enacted in 2001 subjected juice concentrate imports to the highest level of customs duties allowed for that particular category of imports. In addition, federal customs regulations enacted in 2002 stipulate minimum declaration amounts for imported goods. As a result of such regulations, we may be forced to declare a higher value for imported goods than the amount actually paid and, consequently, pay a higher tariff on such goods.

 

Another example of a government regulation that has affected our business is Government Regulation No. 988, which requires food producers intending to develop and offer a new food product to the public to file an application to obtain state registration for the product and its inclusion in the State Register of Permitted Food Products. Failure to comply with Regulation No. 988 could cause delays in introducing new food and beverage products, as well as the disallowance of certain tax benefits otherwise available to producers of certain food products, such as baby food. The implementation of this regulation in June 2004 has caused delays in our introduction of certain new products and has increased production costs. We may continue to experience similar delays and increased costs in connection with Regulation No. 988 in the future.

 

In addition, the Sanitary Rules on Children’s Food Products, which became effective on June 1, 2005, disallow certain tax benefits we formerly enjoyed in relation to some of our baby food products.

 

In December, 2008, new technical regulations for all dairy products, including drinking milk, fermented dairy products, cheese, butter, margarine, yogurts and dairy desserts came into force. The legislation mandates that products labeled as “milk” should not contain any dry milk, vitamins, or minerals. Any drinking milk that contains these ingredients must be labeled as “milk product” or “milk drink”. We have sought to comply with the new rules and have changed our supply and production processes in accordance with them. For example, we included clauses in our supply contracts that the milk supplied must be in compliance with all of the requirements of these new regulations. Accordingly, we have also made changes to our packaging labels. While we believe that we are in compliance with these new requirements, we cannot guarantee that the relevant regulatory authorities will judge us to be in compliance with these new labeling requirements. In addition, as the regulation applies stricter requirements to raw milk, this may lead to price increases in our raw-milk supply costs which we may not be able to pass on to our customers and consequently have an adverse effect on our results.

 

In addition, a new federal law, “On the technical regulation of juice production from fruits and vegetables,” came into force in April 2009. The new regulations provide a definition for juices and nectars, define the level of concentration of juice in finished products, define types of juices and nectars, establish a list of food supplements that can be added into juice products and indicate the maximum permissible concentration of these supplements in juice products. The law also sets requirements for the packaging of juice products and information that is required to be disclosed on the packaging of juice products as well as other requirements for juice producers and equipment. All juice products must now be certified according to Russian standards and it is prohibited to sell juice products in Russia without such certification. While we believe that we are in compliance with these new requirements, we cannot guarantee that the relevant regulatory authorities will judge us to be in compliance with these new requirements. We also cannot predict how these new requirements will influence prices on the juice market and, consequently, any potential negative effect on our results.

 

We are also subject to the Trade Law that came into force in February 2010, which increases the regulation of manufacturers and retailers and their pricing policies.  See “—Our substantial

 

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reliance on independent retailers and independent distributors for the distribution of our products could lower our turnover and reduce our competitiveness.”

 

From February 15, 2010, food producers are no longer required to obtain certification of their food products, and can instead notify the relevant government regulators regarding their products and production process.

 

We are also subject to regional legislation and regulations. For example, in February 2007, the Moscow government enacted regulations on the voluntary labeling of foods containing genetically modified organisms, or GMO. While GMO labeling is not obligatory, it may be treated as such by the regional authorities in Moscow. In this case, we will be required to label our products as not genetically modified and incur additional expenses in relation to this requirement.

 

Increased domestic production by our foreign competitors could reduce our competitive advantages and have a material adverse effect on our market share and results of operations.

 

A number of our foreign competitors, such as Danone, Parmalat, Lactalis, Campina, Ehrmann and Onken, have been investing and continue to invest in domestic production facilities, while others, such as Coca-Cola and Pepsi, have acquired domestic producers. These investments and acquisitions reduce the competitive advantages that we have over foreign competitors without domestic production capability and could have a material adverse effect on our market share. A continuation of this trend may result in increased competition for qualified personnel and higher labor costs, and would have a material adverse effect on our business and results of operations. See “Item 4. Information on Our Company—B. Business Overview” for a further description of the recent investments by some of our foreign competitors in Russian production facilities.

 

If the Federal Antimonopoly Service were to conclude that we acquired or created a new company in contravention of antimonopoly legislation, it could impose administrative sanctions and require the divestiture of this company or other assets, which could have a material adverse effect on our business and results of operations.

 

Our business has grown substantially through the acquisition and founding of companies, many of which required the prior approval or subsequent notification of the Federal Antimonopoly Service, or FAS, or its predecessor agencies. In part, relevant legislation restricts the acquisition or founding of companies by groups of companies or individuals acting in concert without this approval or notification. While we believe that we have complied with the applicable legislation for our acquisitions and founding of new companies, this legislation is sometimes vague and subject to varying interpretations. Additionally, although the common ownership by our shareholders of a number of companies which are now our subsidiaries was generally made known to FAS and its predecessors, the existence of the shareholders’ agreement among our current shareholders was not disclosed. If FAS were to conclude that an acquisition or creation of a new company was done in contravention of applicable legislation, it could impose administrative sanctions and require the divestiture of this company or other assets, which could have a material adverse effect on our business and results of operations.

 

Further restrictions on our babyfood business which is categorized as a monopoly, the extension of monopoly status to our other businesses, or a finding that we or our distributors have violated antimonopoly laws could result in further regulation of our prices and restriction on our commercial activities.

 

Under Russian legislation, FAS may categorize a company controlling over 50% of a market, or otherwise able to control the market conditions, as a dominant force in such market. Companies controlling over 35% are listed by FAS in a special register and may become subject to monitoring

 

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and reporting requirements with respect to such markets. Current Russian legislation does not clearly define “market” in terms of the types of services or the geographic area.

 

Our babyfood business is categorized as a monopoly in Moscow and the Moscow region, placing restrictions on our ability to increase our profit margins for that business. Our Moscow-based subsidiary, Moscow Baby Food Plant was included on the list of entities holding dominant position in the Moscow region baby food market. In 2007, we merged Moscow Baby Food Plant into our Moscow-based subsidiary Wimm-Bill-Dann and received all requisite approvals from FAS for such merger. Although Moscow Baby Food Plant no longer exists, it remains on the list of entities holding dominant position in the Moscow region baby food market. Wimm-Bill-Dann, however, has not been categorized by FAS as entity holding dominant position in the Moscow region babyfood market. Any future ruling that Wimm-Bill-Dann or any of our other businesses are a monopoly could result in the regulation of our prices and restrictions on our commercial activities, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Any finding by FAS that our businesses have acted in violation of the antimonopoly laws may result in the imposition of substantial fines and the imposition of government-determined prices, restrictions on our activities or expansion, or government-mandated withdrawal from regions or markets where we currently operate, which could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Following the sudden and, in some cases, substantial increases in food prices in 2007, FAS initiated inspections of food producers, including us, as well as distributors and retail chains throughout Russia in order to determine whether these price increases were caused by price collusion among producers and retailers. While we strongly believe that we have not violated and are not currently violating any antimonopoly regulations, it is possible that FAS and its regional divisions will nonetheless determine otherwise.

 

Regional divisions of FAS have undertaken inspections of our operations in Omsk, Voronezh, St. Petersburg, Krasnoyarsk, Ufa and Moscow.

 

In Omsk, FAS ended its investigation after finding no violations. In Voronezh, the regional division of FAS found us to be in violation of antimonopoly legislation and assessed us with a fine, although no factual or legal basis was given for this finding. We successfully appealed this decision to the higher FAS body and, as a result, this decision was declared invalid and a new investigation was initiated. This new investigation resulted in a decision according to which we, along with certain other regional producers, were recognized as holding a dominant position in the Voronezh regional market. This finding did not result in any fines and/or any other sanctions.

 

The investigation in St. Petersburg resulted in a number of antimonopoly and administrative proceedings in which the St. Petersburg regional FAS alleged that we were engaging in unwarranted price increases for our finished products and purchasing raw milk at below-market levels, and we were assessed fines totaling $1.0 million. The investigation in St. Petersburg resulted in four antimonopoly litigations and four administrative litigations based on two of the abovementioned antimonopoly proceedings. One of the antimonopoly proceedings was ended by the St. Petersburg regional FAS. We successfully contested these claims and, as of the date of this document, there are no remaining FAS claims pending in St. Petersburg.

 

In Krasnoyarsk, the regional FAS requested that we provide information on the price at which we purchased raw milk. However, this request did not result in any further investigation or proceedings against us. In March 2009, the regional FAS in Ufa initiated a claim against our local branch following an investigation alleging that certain terms of our form distribution contract

 

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violated anti-competition provisions of Russian antimonopoly legislation. We successfully contested this claim.

 

In July 2009, the regional FAS in Moscow initiated two claims against us and our competitors Ehrmann, Danone and Campina alleging collusion among the producers to drive down the prices for raw milk in the Moscow region. These claims are currently pending.

 

In addition, in 2009, the Moscow Northern Administrative District commenced a social support program under which it sought to set prices for certain food products of social significance. In November 2009, Moscow FAS initiated a claim against us alleging that we acted in concert with the Moscow Northern Administrative District to establish monopoly prices. We believe these claims to be without merit, as we did not take part in the social support program, nor did we sell our products to the retail stores that took part in this program or influence the pricing policy of these stores. The litigation is currently pending.

 

We have also been subject to investigations by federal FAS.

 

In June 2008, FAS initiated an investigation into dairy producers, including us, connected with a decline in raw milk prices seeking to determine whether there was any collusion among milk producers to drive down the prices paid to suppliers. We believe this decline was due to seasonal factors and we anticipate that we will be requested by FAS to disclose detailed information regarding our raw milk purchasing prices. Although we believe that we have complied with regulations on the procurement of raw milk, FAS may find otherwise, and our business and financial condition could be adversely affected.

 

In November 2007, FAS also initiated investigations of food distributors in connection with the rise in food prices, and several distributors of our products were investigated. Six of our distributors in Voronezh were investigated, and FAS imposed a fine on one of these distributors based, among other things, on a provision in our standard distribution contracts indicating a recommended price for our products, which FAS found to be in violation of the antimonopoly laws. Distributors do not always adhere to our recommended price, and the contract provision was not intended to hamper competition, but, rather, to provide our distributors with guidelines in setting prices for our products. As a result of this ruling, in October 2007, we submitted our template distributor contract, which includes the recommended price provision, to FAS for their approval and confirmation that the contract does not violate antimonopoly laws. FAS approved the contract in March 2008, and we are hopeful that this will mitigate any risk that we or our distributors will be found in violation of the antimonopoly laws in the future based on our distribution contracts.

 

Any finding by FAS that our businesses have acted in violation of the antimonopoly laws may result in the imposition of substantial fines and the imposition of government-determined prices which could, in turn, lead to a decline in our profit margins. Additionally, restrictions on our activities or expansion, or government-mandated withdrawal from regions or markets where we currently operate, could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

In the event that our minority shareholders or minority shareholders of our subsidiaries were to challenge successfully past or future interested-party transactions, or do not approve interested-party transactions or other matters in the future, the invalidation of such transactions or failure to approve such matters could have a material adverse effect on our business, financial condition, results of operations or prospects or the value of the shares and ADSs.

 

We own less than 100% of the equity interests in some of our subsidiaries. In addition, certain of our wholly owned subsidiaries have had other shareholders in the past. We and our subsidiaries

 

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in the past have carried out, and continue to carry out, transactions which may be considered to be “interested-party transactions” under Russian law, requiring approval by disinterested directors, disinterested independent directors or disinterested shareholders depending on the nature of the transaction and parties involved. See “Item 10. Additional Information—B. Charter and Certain Requirements of Russian Legislation—Interested Party Transactions.” The provisions of Russian law defining which transactions must be approved as “interested-party transactions” are subject to different interpretations. We cannot assure you that our and our subsidiaries’ applications of these concepts will not be subject to challenge by former and current shareholders. Any such challenges, if successful, could result in the invalidation of transactions, which could have a material adverse effect on our business, financial condition, results of operations or prospects and the value of the shares and ADSs.

 

In addition, Russian law requires a three-quarters majority vote of the holders of voting stock present at a shareholders’ meeting to approve certain transactions and other matters, including, for example, charter amendments, major transactions involving assets in excess of 50% of the assets of the company, repurchase by the company of shares and certain share issuances. In some cases, minority shareholders may not approve interested party transactions requiring their approval or other matters requiring approval of minority shareholders or supermajority approval. In the event that these minority shareholders were to challenge successfully past interested party transactions, or do not approve interested party transactions or other matters in the future, we could be limited in our operational flexibility and our business, financial condition, results of operations or prospects could be materially adversely affected.

 

Over the past several years, we have sought and continue to seek to acquire minority stakes in our subsidiaries with the aim of acquiring 100% interests in each of our key subsidiaries.

 

As we continue to make these acquisitions and consolidate our businesses, we may at times reach ownership thresholds triggering a legal requirement to engage in tender offers. According to the Federal Law on Joint Stock Companies a person purchasing a 30%, 50% or 75% or greater stake in an open joint-stock company is required to undertake a tender offer for the remaining shares at a price not less than the acquisition price of the respective stake. Pursuant to this requirement, in 2007 we bought a 4.71% stake in Ochakovo Dairy Plant for a cash consideration of $3.3 million and 0.60% of ordinary shares and 1.16% of preferred shares in Nazarovo Dairy Plant for a cash consideration of approximately $0.4 million for both stakes, a 33.51% stake in Obninsk Dairy Plant for a cash consideration of $11.9 million and a 13.24% stake in Angarsk Dairy Plant for cash consideration of $0.8 million.

 

Although we are and strive to be in compliance with all regulations related to consolidation, we cannot guarantee that some of our minority shareholders may not bring claims against us. See “Item 4. Information on Our Company—A. History and Development” for a description of our subsidiary mergers in 2009 and 2010.

 

Failures or alleged failures to comply with quality regulations may adversely affect our results and harm our reputation of high quality food and beverages producer

 

Product safety is an inherent risk for all food and beverage producers. We pay additional attention to safety given the short shelf life of our dairy products and given our target consumers, especially babies and infants. Our key subsidiaries are ISO certified. Nevertheless, we cannot always foresee hidden defects of our production equipment or raw materials, gross negligence, acts of violence or other occurrences beyond our control. We are also exposed to product liability claims should the consumption of our products result in illness, injury or death. Hence, we cannot guarantee that never in the future will we be the subject to material product liability losses. Although we are insured against product liability, such coverage may be insufficient at the event of the claim. In addition, should any of our products be found unsuitable for consumption, we may be required to

 

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recall them. Any problems linked to quality of our products may adversely affect our reputation and operating results.

 

Although we are doing our best to comply with all environmental regulations we can not guarantee that we may not breach any of such regulation in the future.

 

Russia has many environmental laws, however current enforcement is lax.  This is a growing area of regulation and concern in many countries based upon both governmental action and non-government organizational (NGO’s) pressure.   WBD has reduced significantly water usage in production and today generates significantly less waste water per unit produced.   We are also exposed to environmental liability claims in the event that we will not comply with environmental regulations; we cannot assure you that we will not experience any material environmental liability losses in the future. Any breach of environmental regulations may lead to fines or suspension of our activities that may lead to adverse affect on our results. Moreover breach of environmental regulations may lead to reputational risks.

 

We do not carry the types of insurance coverage customary in more economically developed countries for a business of our size and nature, and a significant event could result in substantial property loss and inability to rebuild in a timely manner or at all.

 

We maintain insurance against some, but not all, potential risks and losses affecting our operations. We cannot provide assurance that our insurance will be adequate to cover all of our losses or liabilities. We also can provide no assurance that insurance will continue to be available to us on commercially reasonable terms. Should a significant event affect one of our facilities, we could experience substantial property loss and significant disruptions in production, for which we would not be compensated. Additionally, depending on the severity of the property damage, we may not be able to rebuild damaged property in a timely manner or at all. We do not maintain separate funds or otherwise set aside reserves for these types of events. Any such loss or third-party claim for damages may have a material adverse effect on our business, results of operations and financial condition.

 

We are also exposed to product liability claims in the event that consumption of our products results in illness, injury or death, and we cannot assure you that we will not experience any material product liability losses in the future. Although we maintain insurance coverage for product liability, such coverage may be insufficient in the event of a claim. In addition, if any of the products we have produced are determined to be unsuitable for consumption, we may be required to participate in a recall involving such products.

 

We do not carry any special type of insurance coverage of such liabilities as ammonia leakage and/or explosion.  Although we maintain insurance coverage for such risks, such coverage may be insufficient in the event of a claim. For more detailed discussion of our insurance coverage see “Item 4. Information on Our Company—B. Business Overview—Insurance.”

 

Risks Relating to Our Financial Condition

 

We may be adversely affected by the current economic environment.

 

As a result of the recent economic downturn, decreased prices for major export commodities (including oil and metals) and other macro-economic challenges currently affecting many of the economies in which we operate, our consumers’ disposable incomes and our vendors’ cash flows may be adversely impacted. Consequently, customers may modify or decrease their consumption of our products and our equipment, raw material and packaging material vendors may significantly increase their prices. A decline in consumption or material changes in pricing or financing terms

 

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for our purchases of equipment, raw material and packaging may have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Continued turmoil in the credit markets could cause our business, financial condition, results of operations and the price of our shares and ADSs to suffer.

 

Over the past few years turmoil in the international credit markets, the recession in the United States and several major European economies and the collapse or near collapse of several large banks and financial services companies in the United States and United Kingdom have resulted in increased volatility in the securities markets in the United States and across Europe, including Russia. In addition, many financial market indices in Russia and other emerging markets, as well as developed markets, have declined significantly since the summer of 2008.Although these markets returned to growth in 2009 and thus far in 2010, they have not yet reached pre-crisis levels. Continued volatility in the United States, European and/or Russian securities markets stemming from these or other factors may continue to adversely affect the price of our shares and ADSs.

 

The downturn in the global financial markets has also caused some companies to experience difficulties accessing their cash equivalents, trading investment securities, drawing on revolving credit facilities, issuing debt and raising capital generally. These difficulties may negatively impact our ability to obtain financing on commercially reasonable terms and the level and volatility of the trading price of our shares and ADSs, and could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Inflation could increase our costs and decrease our operating margins.

 

The Russian economy has been characterized by high rates of inflation and the Russian Ministry for Economic Development has forecasted inflation to reach between 6.5% and 7.5% in Russia in 2010*. As we may experience inflation-driven increases in certain of our costs, including salaries and rents, which are sensitive to rises in the general price level in Russia, our costs in U.S. dollar terms will rise. In this situation, due to competitive pressures, we may not be able to raise the prices we charge for our products and services sufficiently to preserve operating margins. Accordingly, high rates of inflation in Russia could increase our costs and decrease our operating margins.

 

Covenants in our debt agreements restrict our ability to borrow, invest and engage in various activities, which could impair our ability to expand or finance our future operations.

 

Our short-term and long-term debt agreements, including our $250 million syndicated loan that we received in 2008, contain covenants that impose operating and financial restrictions on us and our subsidiaries. These restrictions significantly limit, and in some cases prohibit, among other things, our and certain of our subsidiaries’ ability to incur additional debt, provide guarantees, create liens on assets or enter into business combinations. Failure to comply with these restrictions would constitute a default under our debt agreements, including our $250 million syndicated loan agreement and any of our other senior-debt containing cross-default provisions could become immediately due and payable, which would materially adversely affect our business, financial condition and results of operations. In addition, some of our debt agreements contain provisions which permit our lenders to accelerate our debt repayment in the event of deterioration in our financial condition.

 


* According to the Russian Ministry of Economic Development updated forecast for 2010.

 

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We may not have the ability to raise the funds necessary to finance a prepayment of certain of our outstanding indebtedness in case of a change of control event.

 

The terms of our $250 million syndicated loan agreement as well as some of our other debt agreements require that we prepay the outstanding debt upon the occurrence of certain change of control events. A change of control event will generally be triggered at such time as any person acting alone or together with other persons (excluding several of our major shareholders acting individually or as a group as well as their successors, and inherits): (i) has or acquires, directly or indirectly, in aggregate more than 25% of our voting shares (whether by virtue of any issuance, sale or other disposition of such shares, any merger or other transaction having a similar effect or any voting trust or other agreement), or (ii) has or acquires the right to appoint or remove a majority of our Board of Directors or our chief executive officer, or (iii) has or acquires the power to cast or control the casting of more than 25% of our voting rights.

 

If a change in control occurs, and we are required to prepay our debt, such event could have a material adverse effect on our business, financial condition, results of operations and business prospects. It is also possible that we will not have sufficient funds at the time of the change of control to satisfy such prepayment obligations, or to refinance the debt on commercially reasonable terms.

 

Mergers of our subsidiaries may cause their indebtedness to be accelerated, and our inability to effect certain mergers within our group of companies may prevent us from optimizing our tax rate and result in increased taxes.

 

As Russian tax regulations do not allow Russian companies to pay taxes on a consolidated basis, i.e., to offset the losses of one subsidiary against the profits of another subsidiary, we are seeking to merge certain companies within each of our segments in an effort to optimize the tax rates applicable to us. Under Russian law, such mergers would be considered reorganization and the merged subsidiaries would be required to notify their creditors of this reorganization. Russian law also provides that, for a period of 30 days after the notice, these creditors would have a right to accelerate the merged subsidiaries’ indebtedness and demand reimbursement for applicable losses. In the event that all or part of certain of our subsidiaries’ indebtedness is accelerated in connection with the mergers, we and such subsidiaries may not have the ability to raise the funds necessary for repayment and our business and financial condition could be materially adversely affected. In addition, our inability or failure to consummate the mergers may prevent us from optimizing our tax rates and our effective tax rate may increase as our operations continue to expand.

 

Servicing and refinancing our indebtedness will require a significant amount of cash. Our ability to generate cash or obtain financing depends on many factors beyond our control.

 

We have outstanding indebtedness primarily consisting of our $250.0 million syndicated loan agreement, bank loans and obligations under equipment financing. As of December 31, 2009, our consolidated total debt was approximately $523.9 million, of which $21.6 million was secured by equipment. Our interest expense for the year ended December 31, 2009 was approximately $33.5 million, net of amounts capitalized.

 

Among other things, increased levels of indebtedness, and particularly increases in the level of secured indebtedness, could potentially: (1) limit our ability to obtain additional financing; (2) limit our flexibility in planning for, or reacting to, changes in the markets in which we compete; (3) place us at a competitive disadvantage relative to our competitors with superior financial resources; (4) lead to a partial or complete loss of control over our key subsidiaries or properties; (5) render us more vulnerable to general adverse economic and industry conditions, (6) require us to dedicate all or a substantial part of our cash flow to service our debt; and (7) limit or eliminate our ability to pay dividends.

 

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Our ability to service, repay and refinance our indebtedness, and to fund planned capital expenditures and research and development efforts, will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments, we may default under the terms of our indebtedness, thereby allowing the holders of our indebtedness to accelerate the maturity of such indebtedness, and potentially causing cross-defaults under and acceleration of our other indebtedness. We may also need to refinance all or a portion of our indebtedness on or before maturity, sell assets, reduce or delay capital expenditures or seek additional capital. Refinancing or additional financing may not be available on commercially reasonable terms, and we may not be able to sell our assets or, if sold, the proceeds therefrom may not be sufficient to meet our debt-service obligations. The recent global financial crisis and the highly volatile financial markets may materially adversely affect our ability to access the capital and credit markets at a time when we would like or need to do so, which could have an impact on our ability to refinance maturing debts and/or react to changing economic and business conditions. See also “—Continued turmoil in the credit markets could cause our business, financial condition, results of operations and the price of our shares and ADSs to suffer.”

 

Our inability to generate sufficient cash flow to satisfy our debt service obligations, or to refinance debt on commercially reasonable terms, would have a material adverse effect on our business, financial condition, results of operations and prospects. See “Item 5. Operating and Financial Review and Prospects—Liquidity and Capital Resources.”

 

Ruble depreciation could increase our hard-currency-denominated costs, decrease our cash reserves, or make it more difficult for us to comply with financial ratios and to repay our debts and will affect the value of dividends received by holders of ADSs.

 

Over the past 15 years, the ruble has fluctuated, at times substantially over short periods of time, against the U.S. dollar. The ruble significantly depreciated against the U.S. dollar in 2008 as a result of the global financial crisis, depreciating from 24.55 rubles per one U.S. dollar on January 1, 2008 to 29.38 rubles per one U.S. dollar as of December 31, 2008. The ruble/U.S. dollar exchange rate continued to be volatile in 2009, with a low of 36.43 rubles per one U.S. dollar on February 19, 2009 and a high of 28.67 rubles per one U.S. dollar on November 17, 2009. Although the exchange rate has been more stable in 2010, generally trading within a range of 29-30 rubles per one U.S. dollar, it may return to greater volatility in the future. The ruble has also depreciated against the euro. The euro/ruble exchange rate on January 1, 2009 was 41.43 rubles per one euro, as compared to 43.46 rubles per one euro on January 1, 2010.

 

The CBR from time to time has imposed various currency-trading restrictions in attempts to support the ruble. The ability of the government and the CBR to maintain a stable ruble will depend on many political and economic factors. These include their ability to finance the budget without recourse to monetary emissions, to control inflation and to maintain sufficient foreign currency reserves to support the ruble.

 

A majority of our capital expenditure and liabilities and borrowings are denominated in various foreign currencies. Conversely, a majority of our revenues are denominated in rubles. As a result, devaluation of the ruble against the U.S. dollar can adversely affect us by increasing our costs in rubles, both in absolute terms and relative to our revenues, and make it more difficult to comply with our financial ratios or timely fund cash payments on our indebtedness. It also reduces the U.S. dollar value of tax savings arising from tax incentives for capital investment and the depreciation of our property, plant and equipment, since their basis for tax purposes is denominated in rubles at the time of the investment.

 

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Furthermore, if the ruble declines against the U.S. dollar and/or euro and price increases cannot keep pace, we could have difficulty repaying or refinancing our U.S. dollar- and/or euro-denominated indebtedness. The devaluation of the ruble would also result in losses in the value of assets denominated in rubles, such as ruble cash deposits.

 

Russian currency control regulations could hinder our ability to conduct our business.

 

In the past, Russian currency regulations imposed various restrictions on operations involving foreign currencies in an attempt to support the ruble. Effective from January 1, 2007, most of these restrictions have been removed. However, Russian companies currently must repatriate proceeds from export sales. Moreover, the foreign currency market in Russia is still developing and we may experience difficulty in converting rubles into other currencies. A majority of our major capital expenditures and payments to vendors and a significant part of our debt are denominated and payable in various foreign currencies.

 

Russian legislation currently permits the conversion of rubles into foreign currency. Although we are not aware of any proposals from Russian authorities to impose new restrictions on ruble convertibility, we cannot guarantee that the Russian authorities will not, as a result of the global financial crisis, take future actions to restrict or otherwise hinder the free convertibility of the ruble into foreign currencies. Any delay or other difficulty in converting rubles into a foreign currency to make a payment or delay in or restriction on the transfer of foreign currency could limit our ability to meet our payment and debt obligations, which could result in the loss of suppliers, acceleration of debt obligations and cross-defaults and, consequently, have a material adverse effect on our business, financial condition and results of operations.

 

Some of our customers, debtors and suppliers may fail to pay us or to comply with the terms of their agreements with us which could materially adversely affect our business and results of operations.

 

Russia’s inexperience with a market economy relative to more developed economies poses numerous risks that could interfere with our business. For example, the failure to satisfy liabilities is widespread among Russian businesses and the government. Furthermore, it is difficult for us to gauge the creditworthiness of some of our customers, as there are no reliable mechanisms, such as reliable credit reports or credit databases, for evaluating their financial condition. As a result of the current economic downturn, we face an increased risk that our customers and/or debtors may refuse to or to be unable to comply with their payment obligations. Consequently, we face the risk that some of our customers or other debtors will fail to pay us or fail to comply with the terms of their agreements with us, which could materially adversely affect our business and results of operations.

 

In addition, we are limited in our ability to control the conduct of our raw materials and equipment suppliers, including their adherence to contract delivery terms and their compliance with applicable legislation, such as currency, tax, customs and environmental regulations and laws relating to the use of food additives and genetically modified food products. Failure of our suppliers to adhere to the terms of our contracts with them or the law may negatively affect our reputation and our business.

 

If the various initiatives we have used to reduce our tax burden are successfully challenged and/or our ability to recover VAT and take advantage of certain tax benefits are disallowed by the Russian tax authorities, we may face significant losses associated with the assessed amount of tax deemed underpaid and related interest and penalties, which would have a material adverse effect on our financial condition and results of operations.

 

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We have used various initiatives to reduce our tax burden and several of our tax initiatives have been challenged by the Russian tax authorities. There have also been press reports of instances in which the Russian tax authorities have successfully challenged methods similar to those we have used. If any of our initiatives are successfully challenged by the Russian tax authorities, we would face significant losses associated with the assessed amount of tax deemed underpaid and related interest and penalties. These losses could have a material adverse effect on our financial condition and results of operations. See also “—The Russian taxation system is underdeveloped and any imposition of significant additional tax liabilities could have a material adverse effect on our business, financial condition and results of operations.”

 

Failures or alleged failures by our suppliers to comply with their tax obligations may negatively affect our ability to recover VAT and increase our tax liabilities.

 

In 2006, the tax authorities found some suppliers dealing with certain of our subsidiaries (Moscow Babyfood Plant, Trading Company Wimm-Bill-Dann, Wimm-Bill-Dann and Ochakovo Dairy Plant) to be negligent in complying with their tax obligations. Specifically, the tax authorities claimed, among other things, that these suppliers were, in some cases, not registered as taxpayers, have not provided tax returns and/or not paid their taxes in full or at all. Although our subsidiaries perform extensive due diligence on each of their suppliers, they are not able to scrutinize thoroughly every aspect of each supplier’s business, including whether the supplier is in full compliance with respect to its tax duties. As a result of these alleged breaches by certain of our suppliers, the tax authorities have refused to reimburse VAT paid by our subsidiaries in an amount totaling approximately $1.0 million for services rendered and goods provided by such suppliers. They also refused to discount profit tax paid by our subsidiaries to the budget from the amounts under transactions with such suppliers. We challenged the tax authorities’ refusal to reimburse VAT to Ochakovo Dairy Plant and Trading Company Wimm-Bill-Dann in four separate law suits and, in each instance the court ruled in our favor.

 

Failures or alleged failures by our suppliers to comply with their tax obligations may also lead to claims against us from the tax authorities. For example in 2007, Trading Company Wimm-Bill-Dann received a demand from the tax authorities to pay taxes that were reimbursed to us in the aggregate amount of $0.5 million based on the decision by the tax authorities that our supplier was negligent in paying its tax obligations. We filed a court claim seeking to invalidate this claim. Although the court ruled against us in the first two instances, it has partially invalidated the tax claim. We further appealed the decision to the Constitutional Court of the Russian Federation, which declined consideration of the matter.

 

In 2008, the Russian tax authorities carried out an audit of Wimm-Bill-Dann OJSC for fiscal years 2004 through 2006 and found some of our suppliers negligent in paying or complying with their tax obligations. As a result, the authorities demanded that we reimburse VAT and income tax in the aggregate amount of approximately $7.8 million. In November 2008, we appealed this decision to higher tax authorities and in the court of first instance. The higher tax authorities partially invalidated these claims and reduced the total claims to approximately $2.0 million. In March 2010, the court of first instance upheld claim of tax authorities in the amount of $2.0 million. We plan to appeal this ruling.

 

The Moscow Regional service of the Russian Interior Ministry launched an investigation against us in December 2008 for alleged tax code violations. We believe that this investigation was based on the audit and assessment by the Russian tax authorities for the fiscal years 2004 through 2006, described above. As we believed that there to be no legal basis for the investigation, we lodged an appeal with the Moscow City Prosecutor’s Office and the investigation was ended in December 2009 with no charges brought. Although we continue to provide the results of due diligence carried out on our suppliers to the relevant Russian authorities, we cannot exclude the possibility that some of these suppliers will be found to have been negligent by the tax authorities.

 

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The Russian banking system remains underdeveloped, and another banking crisis could place severe liquidity constraints on our business.

 

Russia’s banking and other financial systems are less developed or regulated in comparison with other countries, and Russian legislation relating to banks and bank accounts is subject to varying interpretations and inconsistent application. The August 1998 financial crisis resulted in the bankruptcy and liquidation of many Russian banks and almost entirely eliminated the developing market for commercial bank loans at that time. Many Russian banks currently do not meet international banking standards, and the transparency of the Russian banking sector in some respects still lags far behind internationally accepted norms. Aided by inadequate supervision by the regulators, certain banks do not follow existing CBR regulations with respect to lending criteria, credit quality, loan loss reserves or diversification of exposure. Furthermore, in Russia, bank deposits made by corporate entities generally are not insured. The weak banking infrastructure in Russia also exposes us to an increased risk of unauthorized transactions or charges on our accounts due to bank error or actions by computer hackers.

 

In recent years, there has been a rapid increase in lending by Russian banks, which many believe has been accompanied by deterioration in the credit quality of the borrowers. In addition, a robust domestic corporate debt market is leading Russian banks to hold increasingly large amounts of Russian corporate ruble bonds in their portfolios, which is further deteriorating the risk profile of Russian bank assets. The serious deficiencies in the Russian banking sector, combined with the deterioration in the credit portfolios of Russian banks, may result in the banking sector being more susceptible to market downturns or economic slowdowns, including exposure to Russian corporate defaults that may occur during any such market downturn or economic slowdown. In addition, the CBR has from time to time revoked the licenses of certain Russian banks, which resulted in market rumors about additional bank closures and many depositors withdrawing their savings. Recently a number of banks and credit institutions have lost their licenses due to deficiency of capital and failure to meet the CBR requirements. If a banking crisis were to occur, Russian companies would be subject to severe liquidity constraints due to the limited supply of domestic savings and the withdrawal of foreign funding sources that would occur during such a crisis.

 

The recent disruptions in the global markets have generally led to reduced liquidity and increased cost of funding in Russia. Borrowers have generally experienced a reduction in available financing both in the inter-bank and short-term funding market, as well as in the longer term capital markets and bank finance instruments. The non-availability of funding to the banking sector in the Russian Federation has also negatively affected the anticipated growth rate of the Russian Federation. The Russian government and the CBR provided financial support only to a limited number of banks, which may result in the liquidation of other banks and financial institutions. This may result in a significant deterioration in the financial fundamentals of Russian banks, notably liquidity, asset quality and profitability.

 

There is currently a limited number of sufficiently creditworthy Russian banks and few ruble-denominated financial instruments in which we can invest our excess ruble cash. We hold the bulk of our excess ruble and foreign currency cash in Russian banks, including subsidiaries of foreign banks. Another banking crisis or the bankruptcy, or insolvency of the banks from which we receive or with which we hold our funds, could result in the loss of our deposits or affect our ability to complete banking transactions in Russia, which could have a material adverse effect on our business, financial condition and results of operations.

 

We have also experienced problems with transmitting tax payments through certain Russian banks and, as a result, are experiencing difficulties with the Russian tax authorities. In particular, between 1998 and 2007, several of our subsidiaries received tax assessments from the Russian tax authorities for tax arrears totaling approximately $8.0 million. Each of these tax assessments resulted from the failure of the subsidiaries’ banks to transfer tax payments to the state budget upon

 

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receiving the relevant payment orders. While the Russian Tax Code provides that a taxpayer is deemed to have paid a tax when the corresponding payment order is received by the taxpayer’s bank, press reports indicate that the Russian tax authorities have been actively and often successfully challenging such payments if the tax payment is not in fact received due to the failure of the bank to transfer such payment. Russian courts often rule in favor of the Russian tax authorities in such cases.

 

We challenged these assessments and, in each instance, the assessments were either declared invalid by Russian Arbitration Courts or otherwise resolved by us. There are currently no pending lawsuits in respect of our subsidiaries’ failure to transmit tax payments through certain Russian banks. However, it is likely that the Russian tax authorities will continue to appeal court rulings in our favor and issue new assessments based on the same grounds to us and/or our subsidiaries.

 

Our management believes that our subsidiaries have complied with their tax payment obligations, and we intend to challenge any further appeals by the tax authorities of the foregoing assessments or any additional similar assessments in court.  However, if a court were to rule in the Russian tax authorities’ favor, these subsidiaries and/or other of our subsidiaries that have faced similar problems would be liable for the amount of the assessments and potentially for interest and penalties on such amounts, and could potentially be liable for significant additional amounts.

 

Vaguely drafted Russian transfer pricing rules and lack of reliable pricing information may impact our business and results of operations.

 

Russian transfer pricing legislation became effective in the Russian Federation on January 1, 1999. This legislation allows the tax authorities to make transfer pricing adjustments and impose additional tax liabilities with respect to all “controlled” transactions, provided that the transaction price differs from the market price by more than 20%. “Controlled” transactions include transactions with related parties, barter transactions, foreign trade transactions and transactions with unrelated parties with significant price fluctuations (i.e., if the price with respect to such transactions differs from the prices on similar transactions conducted within a short period of time by more than 20%). Special transfer pricing provisions are established for operations with securities and derivatives. Russian transfer pricing rules are vaguely drafted, generally leaving wide scope for interpretation by Russian tax authorities and courts. There has been very little guidance (although some court practice is available) as to how these rules should be applied.

 

In 2009, a number of draft amendments to the transfer pricing legislation were announced which, if implemented, would considerably toughen the existing law and bring it more in line with international transfer pricing rules. The implementation proposed changes are expected, among other things, to effectively shift the burden of proving market prices from the tax authorities to the taxpayer, cancel the existing permitted deviation threshold and introduce specific documentation requirements for proving market prices. If the tax authorities were to impose significant additional tax liabilities as a result of transfer pricing adjustments, it could have a material adverse impact on our business, financial condition and results of operations.

 

Additionally, in the event that a transfer pricing adjustment is assessed by the Russian tax authorities, the Russian transfer pricing rules do not provide for an offsetting adjustment to the related counterparty in the transaction that is subject to adjustment. In addition to the usual tax burden imposed on Russian taxpayers, these conditions complicate tax planning and related business decisions.

 

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Risks Relating to our Shares and ADSs and the Trading Market

 

Government regulations may limit the ability of investors to deposit shares into our ADS facility.

 

The ability of investors to deposit shares into our ADS facility may be affected by current or future governmental regulations. For example, under Russian securities regulations, no more than 25% of a Russian company’s shares, and no more than 5% with respect to strategically important companies may be circulated abroad through sponsored depositary receipt programs. Prior to December 31, 2005, and at the time of our initial public offering, this threshold was 40%. Although we believe that the new lower threshold does not apply to our ADSs, in the future, we may be required to reduce the size of our ADS program or amend the depositary agreement for the ADSs.

 

Because our ADS program is regularly at or near capacity, purchasers of our shares may not be able to deposit these shares into our ADS facility, and ADS holders who withdraw the underlying shares from the facility may not be able to re-deposit their shares in the future. As a result, effective arbitrage between our ADSs and our shares may not always be possible. Our shares are listed and trade on the Russian Trading System Stock Exchange, or RTS. Due to the limited public free float of our common stock, the public market for our shares is significantly less active and liquid than for our ADSs. The cumulative effect of these factors is that our shares may from time to time, and for extended periods of time, trade at a significant discount to our ADSs.

 

Because the depositary may be considered the beneficial holder of the shares underlying the ADSs, these shares may be arrested or seized in legal proceedings in Russia against the depositary.

 

Many jurisdictions, such as the United Kingdom and the United States, recognize a distinction between legal owners of securities, such as the depositary, and the beneficial owners of securities, such as the ADS holders. In these jurisdictions, the shares held by the depositary on behalf of the ADS holders would not be subject to seizure in connection with legal proceedings against the depositary that are unconnected with the shares.

 

Russian law may not, however, recognize a distinction between legal and beneficial ownership of securities. Russian law generally treats a depositary as the owner of shares underlying the ADSs and, accordingly, may not recognize ADS holders’ beneficial ownership therein.

 

Thus, in proceedings brought against a depositary, whether or not related to shares underlying the ADSs, Russian courts may treat those underlying shares as the assets of the depositary, open to seizure or arrest. In the past, a lawsuit was filed against a depositary seeking the seizure of various Russian companies’ shares represented by ADSs issued by that depositary. In the event that this type of suit were to be successful in the future against our depositary, and the shares underlying our ADSs were to be seized or arrested, the ADS holders involved could lose their rights to such underlying shares and all of the money invested in them.

 

Voting rights with respect to the shares represented by our ADSs are limited by the terms of the deposit agreement for the ADSs and relevant requirements of Russian law.

 

ADS holders will have no direct voting rights with respect to the shares represented by the ADSs. They will be able to exercise voting rights with respect to the shares represented by ADSs only in accordance with the provisions of the deposit agreement relating to the ADSs and relevant requirements of Russian law. Therefore, there are practical limitations upon the ability of ADS holders to exercise their voting rights due to the additional procedural steps involved in communicating with them. For example, the Federal Law on Joint Stock Companies and our charter require us to notify shareholders no less than 30 days prior to the date of any meeting and at least 70 days prior to the date of an extraordinary meeting to elect our Board of Directors. Our

 

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ordinary shareholders will receive notice directly from us and will be able to exercise their voting rights by either attending the meeting in person or voting by power of attorney.

 

An ADS holder, by comparison, will not receive notice directly from us. Rather, in accordance with the deposit agreement, we will provide the notice to the depositary. The depositary has undertaken in turn, as soon as practicable thereafter, to mail to the ADS holders the notice of such meeting, voting instruction forms and a statement as to the manner in which instructions may be given by holders. To exercise its voting rights, the ADS holder must then instruct the depositary how to vote its shares. Because of this extra procedural step involving the depositary, the process for exercising voting rights may take longer for an ADS holder than for holders of shares. ADSs for which the depositary does not receive timely voting instructions will not be voted at any meeting.

 

In addition, although securities regulations expressly permit the depositary to split the votes with respect to the shares underlying the ADSs in accordance with instructions from ADS holders, there is little court or regulatory guidance on the application of such regulations, and the depositary may choose to refrain from voting at all unless it receives instructions from all ADS holders to vote the shares in the same manner. ADS holders may thus have significant difficulty in exercising voting rights with respect to the shares underlying the ADSs. There can be no assurance that holders and beneficial owners of ADSs will (i) receive notice of shareholder meetings to enable the timely return of voting instructions to the depositary, (ii) receive notice to enable the timely cancellation of ADSs in respect of shareholder actions or (iii) be given the benefit of dissenting or minority shareholders’ rights in respect of an event or action in which the holder or beneficial owner has voted against, abstained from voting or not given voting instructions.

 

The market price of our ADSs has been and may continue to be volatile.

 

The market price of our ADSs experienced, and may continue to experience, significant volatility.  The closing price of our ADSs on the New York Stock Exchange ranged from a low of $13.68 to a high of $144.40 per ADS in 2008, and a low of $24.24 to a high of $95.00 per ADS in 2009 (or $6.06 to $23.83 following the ADS split that took effect on November 17, 2009 changing our ordinary share to ADS ratio from 1:1 to 1:4).

 

Numerous factors, including many over which we have no control, may have a significant impact on the market price of our ADSs, including, among other things:

·                  periods of regional or global macroeconomic instability;

·                  variations in our operating results and those of other food and beverage companies;

·                  changes in financial estimates or other material comments by securities analysts relating to us, our competitors or our industry in general;

·                  announcements by other companies in our industry relating to their operations, strategic initiatives, financial condition or financial performance or to our industry in general;

·                  variations in national and industry growth rates;

·                  actual or anticipated announcements of technical innovations or new products or services by us or our competitors;

·                  changes in government legislation or regulatory developments in our target markets affecting us, our customers or our competitors;

·                  announcements of acquisitions or consolidations involving industry competitors or industry suppliers;

·                  general economic conditions within our business sector or in Russia; and

·                  the impact and development of any lawsuit, currently pending or threatened, or that may be instituted in the future.

 

In addition, the stock market in recent years has experienced extreme price and trading volume fluctuations that often have been unrelated or disproportionate to the operating performance of

 

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individual companies. These broad market fluctuations may adversely affect the price of our ADSs, regardless of our operating performance.

 

You may be unable to repatriate your earnings from our ADSs.

 

We anticipate that any dividends we may pay in the future on the shares represented by the ADSs will be declared and paid to the depositary in rubles and will be converted into U.S. dollars by the depositary and distributed to holders of ADSs, net of the depositary’s fees and expenses. The ability to convert rubles into U.S. dollars is subject to the availability of U.S. dollars in Russia’s currency markets. Although there is an existing market within Russia for the conversion of rubles into U.S. dollars, including the interbank currency exchange and over-the-counter and currency futures markets, the further development of this market is uncertain. At present, there is a limited market for the conversion of rubles into foreign currencies outside of Russia and limited market in which to hedge ruble and ruble-denominated investments.

 

ADS holders may not be able to benefit from the United States-Russia income tax treaty.

 

Under Russian law, dividends paid to a non-resident holder of the shares generally will be subject to Russian withholding tax at a rate of 15%. The domestic tax rate applicable to dividends payable by Russian companies to non-resident individuals has been reduced from 30% to 15% effective from January 1, 2008. This tax may potentially be reduced to 5% or 10% for legal entities and organizations and to 10% for individuals under the Convention between the United States of America and the Russian Federation for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income and Capital, or the United States—Russia income tax treaty, provided a number of conditions are satisfied. However, the Russian tax rules on the application of double tax treaty benefits to individuals are unclear and there is no certainty that advance clearance would be possible. The Russian tax rules applicable to ADS holders are characterized by significant uncertainties. In a number of clarifications, the Ministry of Finance of the Russian Federation expressed a view that ADS holders (rather than the depositary) should be treated as the beneficial owners of the underlying shares for the purposes of double tax treaty provisions applicable to taxation of dividend income from the underlying shares, provided that the tax residencies of the ADS holders are duly confirmed. However, in the absence of any specific provisions in the Russian tax legislation with respect to the concept of beneficial ownership and taxation of income of beneficial owners, it is unclear how the Russian tax authorities and courts will ultimately treat the ADS holders in this regard. Thus, we may be obliged to withhold tax at standard non-treaty rates when paying out dividends and U.S. ADS holders may be unable to benefit from the United States—Russia income tax treaty. See also “Item 10. Additional Information —E. Taxation” for additional information.

 

Capital gains from the sale of ADSs may be subject to Russian income tax.

 

Under Russian tax legislation, gains realized by non-resident legal entities or organizations from the disposition of shares and securities of Russian organizations, as well as financial instruments derived from such shares, such as the ADSs, may be subject to Russian withholding income tax if immovable property located in Russia constitutes more than 50% of our assets. However, no procedural mechanism currently exists to withhold and remit this tax with respect to sales made to persons other than Russian companies and foreign companies with a registered permanent establishment in Russia. Gains arising from the disposition of the foregoing types of securities on foreign stock exchanges by non-resident holders who are legal entities or organizations are not subject to taxation in Russia.

 

The taxation of income of non-resident individuals depends on whether this income is received from Russian or non-Russian sources. The Russian tax laws do not give a definition of how the “source of income” should be determined with respect to the sale of securities, other than that

 

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income from the sale of securities “in Russia” should be considered as Russian source income. As there is no further definition of what should be considered to be a sale “in Russia,” the Russian tax authorities have a certain amount of freedom to conclude what transactions take place in or outside Russia, including looking at the place of the transaction, the place of the issuer of the shares or other similar criteria.

 

Non-residents who are individuals are taxable on Russian-source income. Provided that gains arising from the disposition of the foregoing types of securities and derivatives outside of Russia by U.S. holders who are individuals not resident in Russia for tax purposes will not be considered Russian source income, then such income should not be taxable in Russia. However, gains arising from the disposition of the same securities and derivatives “in Russia” by U.S. holders who are individuals not resident in Russia for tax purposes may be subject to tax either at the source in Russia or based on an annual tax return, which they may be required to submit with the Russian tax authorities. See also “Taxation.”

 

Foreign judgments may not be enforceable against us.

 

Our presence outside the United States may limit your legal recourse against us. We are incorporated under the laws of the Russian Federation. Substantially all of our directors and executive officers named in this document reside outside the United States, principally in Russia. All or a substantial portion of our assets and the assets of our officers and directors are located outside the United States. As a result, you may not be able to effect service of process within the United States on us or on our officers and directors. Similarly, you may not be able to obtain or enforce U.S. court judgments against us, our officers and directors, including actions based on the civil liability provisions of the federal securities laws of the United States. In addition, it may be difficult for you to enforce, in original actions brought in courts in jurisdictions outside the United States, liabilities predicated upon U.S. securities laws.

 

There is no treaty between the United States and the Russian Federation providing for reciprocal recognition and enforcement of foreign court judgments in civil and commercial matters. These limitations may deprive you of effective legal recourse for claims related to your investment in the ADSs. The deposit agreement provides for actions brought by any party thereto against us to be settled by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association, provided that any action under the U.S. federal securities laws or the rules or regulations promulgated there under may, but need not, be submitted to arbitration. The Russian Federation is a party to the United Nations (New York) Convention on the Recognition and Enforcement of Foreign Arbitral Awards, but it may be difficult to enforce arbitral awards in the Russian Federation due to a number of factors, including the inexperience of Russian courts in international commercial transactions, official and unofficial political resistance to enforcement of awards against Russian companies in favor of foreign investors and Russian courts’ inability to enforce such orders and corruption.

 

The lack of a developed share registration system in Russia may result in improper recording of the ownership of our shares, including the shares underlying the ADSs.

 

Ownership of Russian joint stock company shares (or, if the shares are held through a nominee or custodian, then the holding of such nominee or custodian) is determined by entries in a share register and is evidenced by extracts from that register. Currently, there is no central registration system in Russia. Share registers are maintained by the companies themselves or, if a company has more than 50 shareholders or so elects, by licensed registrars. Regulations have been issued regarding the licensing conditions for such registrars, as well as the procedures to be followed by both companies maintaining their own registers and licensed registrars when performing the functions of registrar. In practice, however, these regulations have not been strictly enforced, and registrars generally have relatively low levels of capitalization and inadequate insurance coverage.

 

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Moreover, registrars are not necessarily subject to effective governmental supervision. Due to the lack of a developed share registration system in Russia, transactions in respect of a company’s shares could be improperly or inaccurately recorded, and share registration could be lost through fraud, negligence, official and unofficial governmental actions or oversight by registrars incapable of compensating shareholders for their misconduct. This creates risks of loss not normally associated with investments in other securities markets. Further, the depositary, under the terms of the deposit agreement, will not be liable for the unavailability of our shares or for the failure to make any distribution of cash or property with respect thereto due to the unavailability of the shares.

 

In March 2007, the Federal Service for the Financial Markets, or the FSFM, terminated the license of three top managers of our registrar, the Central Moscow Depository. Managers of Russian depositaries and registrars are required by law to be licensed by the FSFM, and their failure to do so can result in the depository or registrar’s own license being terminated. While the FSFM reversed its decision to terminate the Central Moscow Depository managers’ licenses in April 2007, it is possible that the FSFM may take similar action seeking to terminate the managers’ or our registrar’s licenses in the future.

 

Risks Relating to the Russian Federation

 

Economic Risks

 

Economic instability in the countries where we operate could adversely affect our business.

 

Since the dissolution of the Soviet Union in 1991, the economies of Russia and other CIS countries where we operate have experienced periods of considerable instability and have been subject to abrupt downturns. Most notably, following the Russian government’s default on its ruble-denominated securities in August 1998, the CBR stopped its support of the ruble and a temporary moratorium was imposed on certain hard currency payments. These actions resulted in the immediate and severe devaluation of the ruble and a sharp increase in the rate of inflation, a substantial decline in the prices of Russian debt and equity securities, and an inability of Russian issuers to raise funds in the international capital markets. These problems were aggravated by the subsequent near collapse of the Russian banking sector, with the termination of the banking licenses of a number of major Russian banks. This crisis had a severe impact on the economies of Russia and the other CIS countries.

 

While the economies of Russia and the other CIS countries where we operate have experienced positive trends in recent years, such as increases in gross domestic product, relatively stable national currencies, strong domestic demand, rising real wages, increased disposable income, increased consumer spending and a relatively reduced rate of inflation, these positive trends have been supported, in part, by increases in global commodity prices, and may not continue or may abruptly reverse. In October 2008, Standard & Poor’s revised the outlook on its long-term sovereign credit rating for the Russian Federation from “stable” to “negative,” citing Russia’s risk of recording a deficit by 2009, but revised the credit rating to “stable” again in December 2009. The recent economic downturn, as well as any future economic downturns or slowdowns in Russia or the other CIS countries where we operate could lead to decreased demand for our products, decreased revenues and negatively affect our liquidity and ability to obtain debt financing, which would have a material adverse effect on our business, financial condition and results of operations. In particular, the recent economic crisis has led to a managed devaluation of the ruble creating a significant decline in Russia’s gold and foreign currency reserves.  In addition, the Russian economy is experiencing decreased production of goods and services, a fall in consumer demand and a decline in real wages. The decline in global prices for raw materials and commodities, especially oil and natural gas, has weakened the government’s finances and may lead to a budget deficit and a decrease in Russia’s GDP.

 

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The physical infrastructure in Russia is in poor condition, which could disrupt our normal business activities.

 

The physical infrastructure in Russia largely dates back to Soviet times and has not been adequately funded and maintained over the past two decades. Particularly affected are the rail and road networks, power generation and transmission systems, communication systems and building stock. In May 2005, a fire and explosion in a Moscow power substation, built in 1963 caused a major power outage in a large section of Moscow and some surrounding regions. The blackout disrupted electric ground transport, including the metro system, led to road traffic accidents and massive traffic congestion, disrupted electricity and water supply in office and residential buildings and affected mobile communications. The trading on exchanges and the operation of many banks, stores and markets were also halted. In addition, the road conditions throughout Russia are poor with many roads not meeting minimum quality standards, causing disruptions and delays in the transportation of goods to and within these countries. The Russian government is actively considering plans to reorganize the nation’s rail, electricity and communications systems. Any such reorganization may result in increased charges and tariffs while failing to generate the anticipated capital investment needed to repair, maintain and improve these systems.

 

The deterioration of the physical infrastructure in Russia harms the national economy, adds costs to doing business and generally disrupts normal business activities. Further deterioration of the physical infrastructure in Russia, as well as the other countries where we operate, could have a material adverse effect on our business, financial condition and results of operations.

 

Fluctuations in the global economy may materially adversely affect the economies of the countries where we operate and our business in these countries.

 

The economies of the countries where we operate are vulnerable to market downturns and economic slowdowns elsewhere in the world. As has happened in the past as well as during the recent financial crisis, financial problems or an increase in the perceived risks associated with investing in emerging economies could dampen foreign investment in Russia and elsewhere in the CIS, and businesses in these countries could face severe liquidity constraints, further adversely affecting their economies. Additionally, because Russia produces and exports large amounts of oil and gas, the Russian economy is especially vulnerable to the price of oil and gas on the world market and a decline in the price of oil and gas could slow or disrupt the Russian economy. Recent military conflicts and international terrorist activity have also significantly impacted oil and gas prices, and pose additional risks to the Russian economy. Russia is also a major producer and exporter of metal products and its economy is vulnerable to world commodity prices and the imposition of tariffs and/or antidumping measures by the United States, the European Union or by other principal export markets.

 

The disruptions recently experienced in the international and domestic capital markets have led to reduced liquidity and increased credit risk premiums for certain market participants and have resulted in a reduction of available financing. Companies located in emerging markets, including us, may be particularly susceptible to these disruptions and reductions in the availability of credit or increases in financing costs. To the extent that the current market downturn continues or worsens, it may lead to constraints on our liquidity and ability to obtain debt financing.

 

Political and Social Risks

 

Political and governmental instability could materially adversely affect our business, financial condition, results of operations and prospects and the value of the shares and ADSs.

 

Since 1991, Russia has sought to transform from a one-party state with a centrally-planned economy to a democracy with a market economy. As a result of the sweeping nature of the reforms, and the failure of some of them, the Russian political system remains vulnerable to

 

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popular dissatisfaction, including dissatisfaction with the results of privatizations in the 1990s, as well as to demands for autonomy from particular regional and ethnic groups. The other CIS countries where we operate are similarly vulnerable.

 

Current and future changes in the Russian government, major policy shifts or lack of consensus between various branches of the government and powerful economic groups could disrupt or reverse economic and regulatory reforms. Any disruption or reversal of reform policies could lead to political or governmental instability or the occurrence of conflicts among powerful economic groups, which could have a material adverse effect on our business, financial condition, results of operations and prospects and the value of the shares and ADSs.

 

Potential conflict between central and regional authorities and other conflicts could create an uncertain operating environment, hindering our long-term planning ability.

 

The Russian Federation is a federation of 83 sub-federal political units, consisting of republics, territories, regions, cities of federal importance and autonomous regions and districts. The delineation of authority and jurisdiction among the members of the Russian Federation and the federal government is, in many instances, unclear and remains contested. Lack of consensus between the federal government and local or regional authorities could result in the enactment of conflicting legislation at various levels and may lead to political instability. In particular, conflicting laws have been enacted in the areas of privatization, land legislation and licensing. Some of these laws and governmental and administrative decisions implementing them, as well as certain transactions consummated pursuant to them, have in the past been challenged in the courts, and such challenges may occur in the future. This lack of consensus may hinder our long-term planning efforts and creates uncertainties in our operating environment, both of which may prevent us from effectively and efficiently implementing our business strategy.

 

Additionally, ethnic, religious, historical and other divisions have, on occasion, given rise to tensions and, in certain cases, military conflict, which can halt normal economic activity and disrupt the economies of neighboring regions. For example, violence and attacks relating to the Chechen conflict have spread to other parts of Russia, and several terrorist attacks have been carried out in other parts of Russia, including in Moscow. The further intensification of violence, including terrorist attacks and suicide bombings, or its spread to other parts of Russia, could have significant political consequences, including the imposition of a state of emergency in some or all of Russia. Moreover, any terrorist attacks and the resulting heightened security measures are likely to cause disruptions to domestic commerce and exports from Russia. These factors could materially adversely affect our business and the value of the shares and ADSs.

 

Deterioration in relations between Russia and other former Soviet republics and/or the United States and the European Union could materially adversely affect our business, financial condition, results of operations and prospects and the value of the shares and ADSs

 

Relations between Russia and certain other former Soviet republics are or have in the past been strained. For example, in August 2008, a significant armed conflict erupted between Russia and Georgia over the separatist regions of South Ossetia and Abkhazia, culminating in Russia’s recognition of their independence from Georgia. The political and economic relationships between Ukraine and Russia have also been strained in recent years. The possible accession by Ukraine and Georgia to the North Atlantic Treaty Organization is also a significant source of tension between Russia and these countries.

 

The conflicts between Russia and these and other former Soviet republics have, in some instances, also strained Russia’s relationship with the United States and the European Union which, at times, has negatively impacted Russia’s financial markets. The emergence of new or escalated tensions between Russia and other former Soviet republics could further exacerbate tensions

 

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between Russia and the United States and the European Union, which may have a negative effect on the Russian economy and our ability to obtain financing on commercially reasonable terms. Any of the foregoing circumstances could also have a material adverse effect on our business, financial condition, results of operations and prospects and the value of the shares and ADSs.

 

Crime and corruption could disrupt our ability to conduct our business.

 

The political and economic changes in Russia in recent years have resulted in a significant dislocation of authority. Both the local and international press have reported that significant organized criminal activity has arisen, particularly in large metropolitan centers. Property crime in large cities has increased substantially. In addition, the local and international press have reported high levels of corruption, including the bribing of officials for the purpose of initiating investigations by government agencies. Press reports have also described instances in which government officials engaged in selective investigations and prosecutions to further the commercial interests of certain government officials or certain companies or individuals. Additionally, some members of the Russian media regularly publish disparaging articles in return for payment. The depredations of organized or other crime, demands of corrupt officials or claims that we have been involved in official corruption could result in negative publicity, could disrupt our ability to conduct our business effectively and could thus materially adversely affect our business, financial condition, results of operations and the value of the shares and ADSs.

 

Social instability could increase support for renewed centralized authority, nationalism or violence and thus materially adversely affect our business, financial condition, results of operations and prospects.

 

The failure of the government and many private enterprises to pay full salaries on a regular basis and the failure of salaries and benefits generally to keep pace with the rapidly increasing cost of living have led in the past, and could lead in the future, to labor and social unrest, particularly during economic downturns. Labor and social unrest may have political, social and economic consequences, such as increased support for a renewal of centralized authority, increased nationalism, including restrictions on foreign involvement in the economy of Russia, and increased violence. An occurrence of any of the foregoing events could restrict our operations and lead to the loss of operating revenues, materially adversely affecting our business, financial condition, results of operations and prospects.

 

Legal Risks and Uncertainties

 

Weaknesses relating to the legal system and legislation create an uncertain environment for investment and for business activity in Russia.

 

Russia is still developing the legal framework required to support a market economy. The following risks relating to the Russian legal system create uncertainties with respect to the legal and business decisions that we make, many of which do not exist in countries with more developed market economies:

 

·                  inconsistencies between and among the Constitution, federal and regional laws, presidential decrees and governmental, ministerial and local orders, decisions, resolutions and other acts;

·                  conflicting local, regional and federal rules and regulations;

·                  the lack of judicial and administrative guidance on interpreting legislation;

·                  the relative inexperience of judges and courts in interpreting legislation;

·                  the lack of independent judiciary;

·                  a high degree of discretion on the part of governmental authorities, which could result in arbitrary actions such as suspension or termination of our licenses; and

·                  poorly developed bankruptcy procedures that are subject to abuse.

 

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The recent nature of much of Russian legislation, the lack of consensus about the scope, content and pace of economic and political reform and the rapid evolution of the Russian legal system in ways that may not always coincide with market developments place the enforceability and underlying constitutionality of laws in doubt and results in ambiguities, inconsistencies and anomalies. In addition, Russian legislation often contemplates implementing regulations that have not yet been promulgated, leaving substantial gaps in the regulatory infrastructure. All of these weaknesses could affect our ability to enforce our rights under our permits and contracts, or to defend ourselves against claims by others. We cannot assure you that regulators, judicial authorities or third parties will not challenge our internal procedures and by-laws or our compliance with applicable laws, decrees and regulations.

 

Failure to comply with existing laws and regulations or the findings of government inspections, or increased governmental regulation of our operations, could result in substantial additional compliance costs or various sanctions which could materially adversely affect our business, financial condition, results of operations and prospects.

 

Our operations and properties are subject to regulation by various government entities and agencies, as well as to ongoing compliance with existing laws, regulations and standards. As a producer of food products, our operations are subject to quality, health and safety, production, packaging, labeling and distribution standards. The operations of our production and distribution facilities are also subject to various environmental laws and workplace regulations. Regulatory authorities exercise considerable discretion in matters of enforcement and interpretation of applicable laws, regulations and standards, the issuance and renewal of permits and in monitoring compliance with the terms thereof. Russian authorities have the right to, and frequently do, conduct periodic inspections of operations and properties of our group of companies throughout the year. Any such future inspections may conclude that we or our subsidiaries have violated laws, decrees or regulations, and we may be unable to refute such conclusions or remedy the violations.

 

Our failure to comply with existing laws and regulations or the findings of government inspections or to obtain all approvals, authorizations and permits required for our operations may result in the imposition of fines or penalties or more severe sanctions, including the suspension, amendment or termination of our permits, requirements that we cease certain of our business activities, or in criminal and administrative penalties applicable to our officers. Any such decisions, requirements or sanctions, or any increase in governmental regulation of our operations, could increase our costs and materially adversely affect our business, financial condition, results of operations and prospects.

 

We believe that our current legal and environmental compliance programs adequately address these concerns and that we are in substantial compliance with applicable laws and regulations. However, as the regulations that apply to our business are constantly changing, we are sometimes unable to immediately comply with new regulations upon their implementation. Compliance with, or any violation of, current and future laws or regulations could require material expenditures by us or otherwise have a material adverse effect on our business or financial results. See “Item 4. Information on Our Company—B. Business Overview—Regulation.”

 

Additionally, under relevant Russian legislation, Russian regulatory agencies can impose various sanctions for violations of environmental standards. These sanctions may include civil and administrative penalties applicable to a company and/or its officers. Also, in the course, or as a result, of an environmental investigation, regulatory authorities can issue an order halting part or all of the production at a plant which has violated environmental standards. We have been, at various times, subject to administrative sanctions for failure to comply with environmental regulations relating to effluent discharge and to minor administrative sanctions for violations relating to waste disposal. In the event that production at one of our facilities was partially or wholly prevented due

 

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to this type of sanction, our production capability would suffer significantly and our operating results could be materially adversely affected.

 

Developing corporate and securities laws and regulations in Russia may limit our ability to attract future investment.

 

The regulation and supervision of the securities market, financial intermediaries and issuers are considerably less developed in Russia than, for example, in the United States and Western Europe. Securities laws, including those relating to corporate governance, disclosure and reporting requirements, are relatively new, whereas other laws relating to anti-fraud safeguards, insider trading restrictions and fiduciary duties remain undeveloped. In addition, the Russian securities market is regulated by several different authorities, which are often in competition with each other. These include:

·                  FSFM;

·                  FAS;

·                  CBR; and

·                  various professional self-regulatory organizations.

 

The regulations of these various authorities are not always coordinated and may be contradictory.

 

In addition, Russian corporate and securities rules and regulations can change rapidly, which may materially adversely affect our ability to conduct capital markets transactions. While some important areas are subject to virtually no oversight, the regulatory requirements imposed on Russian issuers in other areas result in delays in conducting securities offerings and in accessing the capital markets. It is often unclear whether or how regulations, decisions and letters issued by the various regulatory authorities apply to. As a result, we may be subject to fines and/or other enforcement measures despite our best efforts at compliance, which could have a material adverse effect on our business, financial condition and results of operations.

 

The judiciary’s lack of independence, its relative inexperience and occasional abuse of discretion and the difficulty in enforcing court decisions could prevent us or you from obtaining effective redress in a court proceeding.

 

The independence of the judicial system and its immunity from economic, political and nationalistic influences in Russia cannot be guaranteed. The court system is underfunded and judges and courts are generally inexperienced in the area of business and corporate law. Judicial precedents generally have no binding effect on subsequent decisions. Not all Russian legislation and court decisions are readily available to the public or organized in a manner that facilitates understanding. In addition, the Russian judicial system can be slow or unjustifiably swift, and enforcement of court orders can in practice be very difficult in Russia. All of these factors make judicial decisions in Russia difficult to predict and effective redress uncertain. Additionally, court claims are often used in furtherance of political and commercial aims or infighting. We may be subject to such claims and may not be able to receive a fair hearing. Additionally, court orders are not always enforced or followed by law enforcement agencies and the government may attempt to invalidate court decisions by backdating or retroactively applying relevant legislative changes.

 

These uncertainties also extend to property rights. For example, during Russia’s transformation from a centrally planned economy to a market economy, legislation has been enacted to protect private property against expropriation and nationalization. However, it is possible that due to the lack of experience in enforcing these provisions and due to political factors, these protections would not be enforced in the event of an attempted expropriation or nationalization. Expropriation or nationalization of any of our entities, their assets or portions thereof, potentially without

 

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adequate compensation, would have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Selective or arbitrary government action could have a material adverse effect on our business, financial condition, results of operations and prospects and the value of the shares and ADSs.

 

Governmental authorities in Russia have a high degree of discretion and, at times, act selectively or arbitrarily, without hearing or prior notice, and sometimes in a manner that is inconsistent with legislation or influenced by political or commercial considerations. Selective or arbitrary governmental actions have reportedly included the denial or withdrawal of licenses, sudden and unexpected tax audits and claims, criminal prosecutions and civil actions. Federal and local government entities have also used ordinary defects in matters surrounding share issuances and registration as pretexts for court claims and other demands to invalidate such issuances and registrations or to void transactions. Moreover, the government also has the power in certain circumstances, by regulation or government acts, to interfere with the performance of, nullify or terminate contracts. Standard & Poor’s has expressed concerns that “Russian companies and their investors can be subjected to government pressure through selective implementation of regulations and legislation that is either politically motivated or triggered by competing business groups.” In this environment, our competitors may receive preferential treatment from the government, potentially giving them a competitive advantage over us.

 

In addition, in recent years, the Russian tax authorities have brought tax evasion claims aggressively on the basis of certain Russian companies’ use of tax-optimization schemes, and press reports have speculated that these enforcement actions have been selective and politically motivated. Selective or arbitrary government action, if directed at us, could have a material adverse effect on our business, financial condition, results of operations, prospects, and the value of the shares and ADSs.

 

Shareholder liability under Russian legislation could cause us to become liable for the obligations of our subsidiaries.

 

The Civil Code of the Russian Federation, the Federal Law on Joint Stock Companies and the Federal Law on Limited Liability Companies generally provide that shareholders in a Russian joint stock company or members of a limited liability company are not liable for the obligations of the company and bear only the risk of loss of their investment. This may not be the case, however, when one entity is capable of determining decisions made by another entity. The entity capable of determining such decisions is deemed an “effective parent.” The entity whose decisions are capable of being so determined is deemed an “effective subsidiary.” The effective parent bears joint and several responsibility for transactions concluded by the effective subsidiary in carrying out these decisions if:

 

·               this decision-making capability is provided for in the charter of the effective subsidiary or in a contract between the companies; and

 

·               the effective parent gives obligatory directions to the effective subsidiary.

 

In addition, an effective parent is secondarily liable for an effective subsidiary’s debts if an effective subsidiary becomes insolvent or bankrupt resulting from the action or inaction of an effective parent. This is the case no matter how the effective parent’s ability to determine decisions of the effective subsidiary arises. For example, this liability could arise through ownership of voting securities or by contract. In these instances, other shareholders of the effective subsidiary may claim compensation for the effective subsidiary’s losses from the effective parent which caused the effective subsidiary to take action or fail to take action knowing that such action or failure to take action would result in losses. Accordingly, we could be liable in some cases for the

 

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debts of our subsidiaries. This liability could have a material adverse effect on our business, financial condition and results of operations.

 

Shareholder rights provisions under Russian law impose significant additional obligations on us.

 

Russian law provides that shareholders that vote against or abstain from voting on certain matters have the right to sell their shares to us at market value in accordance with Russian law. The decisions that trigger this right to sell shares include:

 

·                  decisions with respect to a reorganization;

·                  the approval by shareholders of a “major transaction,” which, in general terms, is a transaction involving property worth more than 50% of the gross book value of our assets calculated according to the Russian accounting standards, regardless of whether the transaction is actually consummated; and

·                  the amendment of our charter in a manner that limits shareholder rights.

 

Our obligation to purchase shares in these circumstances, which is limited to 10% of our net assets calculated according to Russian accounting standards, at the time the matter at issue is voted upon, could have a material adverse effect on our business, financial condition, results of operations and prospects.

 

Under Russian law, if we are unable to sell the repurchased shares at a price equal to or exceeding the market price within one year after the date of repurchase, we have to reduce our charter capital accordingly.

 

There is little minority shareholder protection in Russia.

 

Minority shareholder protection under Russian law principally derives from supermajority shareholder approval requirements for certain corporate actions, as well as from the ability of a shareholder to demand that the company purchase the shares held by that shareholder if that shareholder voted against or did not participate in voting on certain types of actions. Companies are also required by Russian law to obtain the approval of disinterested shareholders for certain transactions with interested parties. In practice, enforcement of these protections has been poor. Shareholders of some companies have also suffered as a result of fraudulent bankruptcies initiated by hostile creditors.

 

The supermajority shareholder approval requirement is met by a vote of 75% of all voting shares that are present at a shareholders’ meeting. Thus, controlling shareholders owning slightly less than 75% of outstanding shares of a company may have a 75% or more voting power if certain minority shareholders are not present at the meeting. In situations where controlling shareholders effectively have 75% or more of the voting power at a shareholders’ meeting, they are in a position to approve amendments to the charter of the company or significant transactions including asset transfers, which could be prejudicial to the interests of minority shareholders. It is possible that our controlling shareholders in the future may not act in the best interests of minority shareholders, and this could materially and adversely affect the value of the shares and ADSs.

 

While the Federal Law on Joint Stock Companies provides that shareholders owning not less than 1% of the company’s stock may bring an action for damages on behalf of the company, Russian courts to date do not have much experience with such lawsuits. Russian law does not contemplate class action litigation. Accordingly, your ability to pursue legal redress against us may be limited, reducing the protections available to you as a holder of our shares and ADSs.

 

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The Russian taxation system is underdeveloped and any imposition of significant additional tax liabilities could have a material adverse effect on our business, financial condition and results of operations.

 

The discussion below provides general information regarding Russian taxes and is not intended to be inclusive of all issues. Investors should seek advice from their own tax advisors as to these tax matters before investing in the ADSs. See also “Taxation.”

 

In general, taxes payable by Russian companies are substantial and numerous. These taxes include, among others, corporate income tax, value added tax, property taxes, excise duties, payroll-related taxes and other taxes.

 

Russian tax laws, regulations and court practice are subject to frequent change, varying interpretation and inconsistent and selective enforcement. In some instances, although it may be viewed as contrary to Russian constitutional law, the Russian tax authorities have applied certain new taxes retroactively, issued tax claims for periods for which the statute of limitations had expired and reviewed the same tax period multiple times.

 

On October 12, 2006, the Plenum of the High Arbitration Court of the Russian Federation issued Resolution No. 53 formulating the concept of “unjustified tax benefit,” which is described in the Resolution by reference to circumstances, such as absence of business purpose or transactions where the form does not match the substance, and which could lead to the disallowance of tax benefits resulting from the transaction or the re-characterization of the transaction. Although there has been little further guidance on the interpretation of this concept by the tax authorities or courts, the tax authorities have actively sought to apply this concept when challenging tax positions taken by taxpayers in Russian courts. While the intention of this Resolution might have been to combat abuse of tax laws, in practice, the tax authorities may seek to apply this concept in a broader sense.

 

Generally, tax returns in Russia remain open and subject to tax audit by the tax authorities for a period of three calendar years immediately preceding the year in which the decision to conduct a tax audit is taken. The fact that a year has been reviewed by the tax authorities does not prevent further review of that year, or any tax return applicable to that year, during the eligible three-year period by a superior tax authority. In addition, on July 14, 2005, the Constitutional Court of the Russian Federation, or the Constitutional Court, issued a decision that allows the statute of limitations for tax penalties to be extended beyond the three-year term set forth in the tax laws if a court determines that the taxpayer has obstructed or hindered a tax audit. Moreover, amendments to the Tax Code of the Russian Federation, effective January 1, 2007, provide for the extension of the three-year statute of limitations if the actions of the taxpayer created insurmountable obstacles for the tax audit. Because none of the relevant terms is defined, tax authorities may have broad discretion to argue that a taxpayer has “obstructed” or “hindered” or “created insurmountable obstacles” in respect of a tax audit and to ultimately seek review and possibly apply penalties beyond the three-year term. There is no guarantee that the tax authorities will not review our compliance with applicable tax law beyond the three-year limitation period. Any such review could, if it concluded that we had significant unpaid taxes relating to such periods, have a material adverse effect on our business, financial condition, results of operations and/or prospects.

 

Moreover, the financial results of Russian companies cannot be consolidated for tax purposes. Therefore, each of our Russian subsidiaries pays its own Russian taxes and may not offset its profit or loss against the loss or profit of any of our other subsidiaries. In addition, intercompany dividends are subject to a withholding tax of 0% or 9% (depending on whether the recipient of dividends qualifies for Russian participation exemption rules), if being distributed to Russian companies, and 15% (or lower, subject to benefits provided by relevant double tax treaties), if being distributed to foreign companies. If the receiving company itself pays a dividend, it may offset tax withheld against its own withholding liability of the onward dividend although not

 

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against any withholding made on a distribution to a foreign company. These tax requirements impose additional burdens and costs on our operations, including management resources.

 

Anti-crisis tax measures were adopted in 2008 to help businesses. Such measures include, among others, the reduction of the corporate income tax rate from 24% to 20% starting from January 1, 2009, the acceleration of tax depreciation and the increase in interest expense deductibility thresholds.

 

The Russian tax authorities may take more assertive position in their interpretation of the legislation and assessments, and it is possible that transactions and activities that have not been challenged in the past may now be challenged. The foregoing factors raise the risk of the imposition of arbitrary or onerous taxes on us, which could adversely affect the value of our shares and ADSs.

 

Current Russian tax legislation is, in general, based upon the formal manner in which transactions are documented, looking to form rather than substance. However, the Russian tax authorities, in some cases, are increasingly taking a “substance over form” approach. We cannot offer prospective investors any assurance that additional tax exposures will not arise in the future. Additional tax exposures could have a material adverse effect on our business, financial condition, results of operations or prospects.

 

In addition to the usual tax burden imposed on Russian taxpayers, these conditions complicate tax planning and related business decisions. For example, tax laws are unclear with respect to deductibility of certain expenses. This uncertainty could possibly expose us to significant fines and penalties and to enforcement measures, despite our best efforts at compliance, and could result in a greater than expected tax burden.

 

Other Risks

 

We have not independently verified information we have sourced from third parties

 

We have sourced certain information contained in this document from third parties, including private companies and Russian government agencies, and we have relied on the accuracy of this information without independent verification. The official data published by Russian federal, regional and local governments may be substantially less complete or researched than those of Western countries. Official statistics may also be produced on different bases than those used in Western countries. Any discussion of matters relating to Russia in this document must, therefore, be subject to uncertainty due to concerns about the completeness or reliability of available official and public information. In addition, the veracity of some official data released by the Russian government may be questionable. In 1998, the Director of the Russian State Committee on Statistics and a number of his subordinates were arrested and subsequently sentenced by a court in 2004 in connection with their misuse of economic data.

 

Item 4. Information on Our Company

 

A.            History and Development

 

We trace our history back to 1992, when a group of individuals formed an enterprise which began leasing a production line at the Lianozovsky Dairy Plant in Moscow and purchasing juice concentrates and packaging materials. On November 25, 1992, we produced the first carton of juice carrying the Wimm-Bill-Dann brand name. We selected this brand name to attract consumers who preferred products with foreign-sounding names due to their perceived higher quality and novelty and, since its introduction; the “Wimm-Bill-Dann” name has become a brand name recognized in the majority of Russian households.

 

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In order to take advantage of the opportunities arising from the privatization of Russian state-owned assets, our founding shareholders began acquiring shares in the Lianozovsky Dairy Plant in Moscow, and continued to expand their juice production business. Following their acquisition of a majority stake in the Lianozovsky Dairy Plant in 1995, they added dairy products to the portfolio, thus becoming a dairy and juice producer. Our growth has been accomplished, in part, through significant acquisitions, including the following:

 

·                  From 1995 through 1999, we acquired majority control of the Lianozovsky Dairy Plant (renamed as Wimm-Bill-Dann in 2006) and majority stakes in the Moscow Babyfood Plant, the Tsaritsino Dairy Plant and the Ramenskiy Plant (renamed as Wimm-Bill-Dann Beverages in 2007).  We also began to expand into regions outside Moscow, acquiring dairy plants in Novosibirsk, Nizhny Novgorod and Vladivostok.

 

·                  From 2000 through 2002, we acquired controlling stakes in dairy plants in Ufa, Samara, Belgorod, and the Krasnodar region in Russia, as well as dairy plants in the cities of Kiev and Kharkov in Ukraine and in Bishkek, Kyrgyzstan. We also acquired controlling stakes in a production site in Tula, Russia, a large warehouse complex in the Moscow region and a dried milk plant in Buryn, Ukraine. In addition, we acquired 100% interests in dairy plants in the Altaisky and Voronezh regions of Russia and in the Roska Dairy Plant (renamed Baltic Milk in 2004) in St. Petersburg.

 

·                  From 2003 through 2005, we acquired a 100% interest in Siberian Cheese, a refrigeration and warehousing facility in Novosibirsk adjacent to our principal Siberian dairy production facility. We also expanded into the water business with our acquisition of companies controlling underground wells in the Essentuki area of Russia and a water processing and bottling factory that produces “Essentuki” brand mineral water, as well as our purchase of the Essentuki Mineral Water Plant at CMW (Caucasian Mineral Waters) in the town of Essentuki in the Stavropol region. We also acquired several raw milk production companies, including Atamanskoe farm, Plemzavod Za Mir i Trud, Zavety Ilyicha and Trud Farms. In addition, we acquired the Obninsk Dairy Plant in the Kaluga region, the Kursk Babyfood Plant in the Kursk region, Nazarovskoe Milk in the Krasnoyarsk region and Pervouralsk City Dairy Plant in the Sverdlovsk region.

 

·                  From 2006 through 2008, we acquired the Surgut City Dairy Plant in Western Siberia; the Omsk-based dairy producer Manros-M; and Georgian Foods based in Tbilisi, Georgia. We also acquired controlling stakes in Moscow-based dairy producer Ochakovo and Angarsky Dairy Plant (MOLKA), one of the largest dairy enterprises in Irkutsk region.  In addition, we increased our aggregate ownership in the Moscow Babyfood Plant to 97.3% and our aggregate ownership in WBD Beverages to 100%.

 

We continue to incur capital expenditures in order to improve our production facilities and office infrastructure. We incurred capital expenditures in the amount of $121.8 million, $195.3 and $192.7 million in 2009, 2008 and 2007, respectively.  We also incurred $2.6 million, $3.3 million and $21.8 million in 2009, 2008 and 2007, respectively for acquisitions of stakes from non-controlling interests.

 

Our operations are currently organized into three separately reported segments: dairy, beverages and babyfood, all operating under the umbrella of our holding company, Wimm-Bill-Dann Foods OJSC, which was incorporated on May 31, 2001. In addition, at the end of 2004, we created a separately managed non-core business unit called “Agro” for the purpose of buying and managing a select number of dairy farms in certain Russian regions. Agro is currently reported as part of our dairy division.

 

In order to improve our corporate structure and management, as well as to reduce our expenses, we merged 14 of our subsidiaries (Tsaritsino Dairy Plant, Ufa Dairy Plant, Siberian Milk Dairy

 

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Plant, Rubtsovsk Dairy Plant, Siberian Cheese Plant, Nizhny Novgorod Dairy Plant, Baltic Milk Dairy Plant, Nazarovo Dairy Plant, PAG Rodnik, Pervouralsk Dairy Plant, Kursk Baby Food Plant, Moscow Baby Food Plant, Timashevsk Dairy Plant and Vladivostok Dairy Plant) in 2007 into Wimm-Bill-Dann (formerly Lianozovsky Dairy Plant). In 2008 we merged nine additional subsidiaries into Wimm-Bill-Dann (Surgut Dairy Plant, Ochakovo Dairy Plant, Obninsk Dairy Plant, Pavlogradsky Dairy Plant, Krutinsky Dairy Plant, Angarsky Dairy Plant (MOLKA), Anna milk, SP Julia and Va-Bank-2000).

 

We completed our initial public offering on February 14, 2002 and listed our shares of common stock, represented by American Depositary Shares, or ADSs, on the New York Stock Exchange under the symbol “WBD.” Until November 17, 2009 each ADS represented one underlying share of our common stock. On November 17, 2009, a ratio change took effect whereby the ratio of ADSs to common stock was changed to four ADSs per one underlying share of common stock.

 

According to Standard & Poor’s global scale, our corporate credit rating is BB-, and Moody’s Investors Service ranks our Corporate Credit rating as Ba3. In 2009 Standard & Poor’s Governance Services reconfirmed our Governance, Accountability, Management Metrics and Analysis (GAMMA) score 7+, which is the highest score in Russia.

 

Our legal name is Wimm-Bill-Dann Foods OJSC, and we are incorporated as an open joint stock company under the laws of the Russian Federation and registered with the Moscow Inter-District Inspectorate No. 39 of the Russian Ministry of Taxes and Duties under the state registration number 1037700236738. We operate in the Russian Federation and the CIS under a number of different trademarks and brand names, as more fully described below in “—B. Business Overview—Current Operations—Our products and brands.” Our business objectives, set forth in Article 4 of our charter, include the production and sale of food products, including milk and sour milk products, mineral water, fruit and vegetable juices and beverages and children’s food. Our head office is located at 16 Yauzsky Boulevard, Moscow 109028, Russian Federation, and our telephone number is +7 495-925-5805. We maintain a website at http://www.wbd.com. The information on our website is not a part of this report. We have appointed CT Corporation System, 111 Eighth Avenue, New York, New York 10011, as our authorized agent for service of process for any suit or proceeding arising out of or relating to our shares, ADSs, or the deposit agreement.

 

B. Business Overview

 

We are one of Russia’s largest manufacturers of food and beverage products. Our reportable business segments in 2009 were dairy, beverages and babyfood. In 2009, the dairy segment accounted for 70.2% of our sales, the beverages segment, which includes juice and bottled mineral water, accounted for 18.6% of our sales and the babyfood segment accounted for 11.2% of our sales.

 

Since our founding in 1992, we have become the market leader in Russia in the dairy and babyfood markets as well as one of the market leaders in the juice market. In the dairy market, according to an AC Nielsen Dairy Study of 24 major cities, including Moscow and St. Petersburg, or the AC Nielsen Dairy Study we were the market leader at the end of 2009 with a 29.6% market share in value terms. In the Russian juice market, according to a Business Analytica survey of Russia as a whole, we had a 20.5% market share in value terms at the end of 2009 and we are currently among the top-three Russian producers of juice and nectars. In the babyfood market, according to Middle East Marketing Research Bureau (MEMRB), we had an 18.1% in value terms at the end of 2009. In 2009 we successfully entered the children’s segment with product offerings for children aged between four and nine years old.

 

We currently have 37 manufacturing facilities in Russia, Ukraine, Kyrgyzstan, Uzbekistan and Georgia as well as distribution centers in 40 cities throughout Russia and the CIS. During 2009, we employed, on average, 16,299 people.

 

We offer our consumers a full range of quality branded dairy, juice, water and babyfood products, using carefully selected raw materials, modern production technology and strict quality

 

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controls. All of our products are made according to our own recipes and reflect our understanding of consumer demands and tastes.

 

Our principal dairy products include:

 

·                  Traditional products, such as sterilized and pasteurized milk, butter and cream, as well as traditional sour-milk products such as kefir, cottage cheese, soft cottage cheese and sour cream;

 

·                  Yogurts and dairy desserts, such as traditional and drinkable yogurt, curd desserts, fruit-flavored milk, puddings and flavored cottage cheese; and

 

·                  Cheese products, including hard yellow and processed cheese.

 

Our principal beverage products include:

 

·                  Juice and nectars produced from juice concentrate;

 

·                  Enriched juice-based drinks;

 

·                  Mors, a traditional berry-juice-based drink made from natural berries;

 

·                  Bottled natural mineral water; and

 

·                  Drinking water.

 

Our babyfood products include:

 

·                  Liquid dairy products for infants under the age of three;

 

·                  Juices and water for infants under the age of three;

 

·                  Meat, fish, poultry, fruit, vegetable and dairy purees for children aged three and under;

 

·                  Dry formula for feeding babies, developed in close co-operation with the Research Institute of the Russian Medical Academy;

 

·                  Products for pregnant women and nursing mothers; and

 

·                  Other food products for children.

 

Business Goals and Strategy

 

Our strategy for the period 2010-2015 is to build upon our strong existing brands (“brand equity”), established market position, cost leadership, strong management team and scale within Russia and the CIS in order to increase sales and profitability, realize long-term efficiency gains, strengthen our market position and increase shareholder value over the long term. We will also seek to maintain our position as one of Russia’s leading fast-moving consumer goods (FMCG) companies with key profit ratios attributable to our industry.

 

Our approach takes into account both the challenges and opportunities presented by the global financial downturn and its impact on the economies of Russia and CIS. We are making use of our experience gained during the 1998 and 2009 financial crises to make short and medium-term adjustments to our product mix and marketing efforts, as well as endeavoring to maintain sustainable debt ratios. We believe that the continued implementation of our long-term strategy, with its emphasis on building upon existing brand equity, cost leadership and continuous innovations will better position us to weather the economic downturn as well as benefit from a future recovery in consumption.

 

Business Goals

 

Our business goals for 2015 are aimed at achieving qualitative and quantitative results that increase shareholder value and establish a foundation for sustainable growth over a five to ten-year time horizon. As Russia’s leading manufacturer of food and beverage products, it is both our core

 

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mission and a vital component of our individual and corporate brand image to be acknowledged by both consumers and regulators as one of the country’s top food and beverage producers in terms of health and nutrition.

 

Among the goals we will endeavor to achieve by 2015 are:

 

·                  to be leaders in all major categories in which we compete or have a clear path to leadership;

 

·                  to extend our portfolio to include at least one other food and beverage category;

 

·                  to enhance the market positions of our top existing dairy, beverages and babyfood brands and have our top-10 brands by revenue be among the top-50 FMCG brands in Russia;

 

·                  focus on continuous innovations, with newly launched and innovative products making a substantial contribution to our revenue;

 

·                  to strengthen our route-to-market execution so that we have greater control over how our products are sold at the outlet level to ensure the integrity and quality of our products and brands; and

 

·                  to be widely recognized as one of Russia’s employers of choice, offering top opportunities for personal and career growth, in order to attract and retain the most talented personnel.

 

Business Strategy

 

Our business strategy relies upon two fundamental building blocks: (i) people and capabilities and (ii) cost leadership:

 

People and capabilities. We aim to build an agile, fast learning team with superior execution:

 

·                  attracting, developing and retaining top talent within the FMCG industry

 

·                  developing potential — providing continuous opportunities for training and further education while developing career plans and identifying key skills

 

·                  rewarding performanceestablishing clear incentives for success and space for innovation

 

·                  creating the right environment — maintaining a strong corporate culture based on values and creativity, establishing clear lines of responsibility and reporting while reducing both the institutions and mindset of bureaucracy wherever possible

 

Cost leadership. We seek to optimize the supply chain, increase the efficiency of our assets and reduce working capital by:

 

·                  cost optimization — reducing supply-chain and procurement costs, cutting the unit cost of manufacturing and optimizing production lines while making the best use of existing assets

 

·                  strict management of working capital — managing inventories and increasing the effectiveness of expenditure

 

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·                  driving margins and profitability — intelligently managing pricing and volume mix, optimizing input costs (recipes, raw materials and packaging) and better managing discounts and bonuses

 

Our business strategy is focused on the following four core principles, which are relevant across all of our business units:

 

Innovation. We are continuously seeking to develop innovative products and processes, with a focus on healthy and nutritious food and beverage products.

 

Growth. We aim to grow both organically and through M&A activity by:

 

·                  having clearly articulated brand, pack, price strategies for all of our products and markets

 

·                  improving route-to-market strategy — further developing an efficient and effective distribution model with multi-year planned roll outs for each region/market

 

·                  improving current and developing new sales channels, in particular hotels, restaurants and cafes (HoReCa)

 

·                  pursuing carefully selected M&A opportunities — as part of our growth strategy, we are continuously evaluating potential M&A opportunities in order to further industry consolidation as well as to penetrate new markets

 

Preferred brands and products. Our product strategy is centered on developing food and beverage products meeting consumer preferences and demand that have substantial health and nutrition benefits. We seek to do so by:

 

·                  optimizing our product portfolio

 

·                  investing in marketing to grow the equity of our brands and allow for accelerated innovation and further quality improvements

 

·                  making our strategic brands truly national

 

·                  channeling investment and other resources to core brands which will serve as a base for innovation and entry into new categories and segments

 

Winning customer relationships. We aim to be the best supplier for our customers and provide superior sales execution in key cities and channels by:

 

·                  centralizing our commercial function at our head office

 

·                  reducing the number of distributors we work with while building stronger relationships with distributors possessing direct distribution capabilities

 

·                  increasing our sales to national and local key accounts

 

·                  implementing a world-class Key Accounts Management model and new trading terms, including a new pricing policy

 

·                  developing category management

 

·                  focusing on improving service level

 

·                  controlled route-to-market

 

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Current Operations

 

Dairy Industry

 

Consumption. Russian dairy consumption is relatively low compared to most European countries and is characterized by two primary trends—the comparatively solid development of the market for traditional dairy products and a more rapidly developing market for yogurts and desserts.

 

We estimate, based on a combined data from Comcon, AC Nielsen, USDA, Euromonitor, Canadean Dairy and Russian State Statistics, that per capita consumption of packaged dairy products in Russia was approximately67.4, 65.6 and 66.9 kg per year in 2007, 2008 and 2009, respectively, levels that are relatively low compared to the majority of European countries. The demand for dairy products remained relatively stable in the aftermath of the 1998 Russian financial crisis and the ensuing decline in per capita income, as dairy products are generally considered to be staple consumer goods. In addition, increasing per capita income following 1998 has positively affected dairy consumption, particularly of higher-priced and higher-margin products such as yogurt and dessert dairy products. The spike in raw milk prices observed in 2007 caused retail price increases for dairy products and this partially offset consumption growth in 2008. In 2009 due to relatively stable raw milk prices, consumption of traditional packaged products recovered, and returned to 2007 levels, despite the economic crisis. However a renewed spike in raw milk prices at the end of 2009 and reduced disposable income may negatively affect consumption in 2010. We estimate that per capita consumption of traditional packaged dairy products in Russia increased by 3% to approximately 53.7 kg in 2009, from approximately 52.3 kg in 2008.

 

Since its first widespread commercial appearance in Russia in the early 1990s, the popularity of yogurt has increased. For instance, the consumption of such products as drinkable yogurt, functional foods/drinks and flavored milk is relatively high among certain groups of consumers and comparable with milk consumption levels. While, the per capita consumption of these products remains relatively low, we believe that this segment of the dairy market has a high long-term growth potential as household incomes increase in Russia over time, especially in the regional markets.

 

Consumption of yogurts and dairy desserts in Russia was also affected by the inflation in late 2007 through 2008, and the downward trend continued in 2009 due to the general downturn in the economy.

 

According to our estimates, annual per capita consumption of yogurts and dairy desserts was about 8.7 kg, 8.4 kg and 8.1 kg in 2007, 2008 and 2009 respectively.

 

According to our estimates, annual cheese consumption (yellow, white and processed) in Russia stayed almost flat at approximately 5.0 kg per capita in 2009.

 

Production. Milk production and processing in Russia declined dramatically during the 1990s due to the general state of the Russian economy, a lack of raw materials due, in part, to the slaughter of dairy cows necessitated by a shortage of feed, and a sharp increase in energy prices. Additionally, the majority of Russian milk producers, comprising individual farmers and collective agricultural enterprises, operate with inefficient and outdated facilities and equipment, and function under outdated management practices. Yields per cow are still less than half of those in Western Europe.

 

The result of this decline was a drop in processing volumes and an increased reliance upon imported dairy products. While the financial crisis of 1998 aided Russian producers to some extent, as it pushed imported foods out of the Russian market, it also caused difficulties for Russian companies that depended on imported materials for production. In general, producers that were able to limit their exposure to fluctuations in the value of the ruble and to establish links with Russian suppliers survived the crisis and took leading positions in the marketplace. Although the milk processing sector continues to consolidate, with smaller and less efficient producers going out of business or merging with larger companies, the market remains fragmented. According to an AC

 

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Nielsen Dairy Study, there were more than 820 active dairy producers at the end of 2009, compared to 850 at the beginning of 2007.

 

In addition, foreign, particularly European, producers have recognized the potential for growth in the demand in Russia for milk, yogurt and dairy desserts and are investing in the Russian market. A number of European producers, such as Danone, Parmalat, Campina, Lactalis and Ehrmann, produce dairy products in Russia, principally in the Moscow region, and comprise our principal competition in the yogurt and dairy dessert segment of the dairy market. Until the recent economic downturn, the market for dairy desserts was growing more rapidly than the traditional dairy market. Foreign producers have also been developing new products catering to changing consumer tastes with a focus on fresh health and wellness products.

 

We have made significant investments in developing our own farms and establishing long-term relationships with third-party raw milk suppliers. These steps help us to address the seasonal imbalances in raw milk availability and prices while also increasing quality of the raw milk we purchase. The government has continued a large scale program aimed at the revival of the agricultural sector in Russia, which we see as an important and helpful development.

 

Juice and Mineral Water industries

 

Consumption. Before the early 1990s, consumption of juice products in Russia was limited. Juice products manufactured in the Soviet Union included only vegetable juices and fruit juices made of locally grown fruit such as apples and pears. Most Russian households tried orange, pineapple, grapefruit and other exotic fruit juices for the first time in 1991 and 1992, following the dissolution of the Soviet Union. Russian juice consumption grew each year until 1998, when it fell following the 1998 financial crisis, which led to a reduction in Russian incomes and a significant increase in the cost of juice products due to the increase in the ruble cost of imported juice packaging and ingredients. Juice consumption began to recover after 1998, rapidly increasing until it reached its peak in 2007. In the midst of the recent economic downturn, juice consumption remained relatively flat in 2008 as compared to 2007 and decreased by 16% in 2009, according to our estimates. Unlike certain basic dairy products, juice is not considered by the average Russian consumer to be part of the core, essential food basket, which is why juice consumption is more affected by fluctuations in the economy.

 

According to research carried out by the Russian Union of Juice Producers, Business Analytica and Canadean, annual per capita juice product consumption in Russia in 2009, 2008 and 2007 was approximately 17.7 liters, 21.1 liters and 21.3 liters, respectively.

 

Consumption of bottled water in Russia was also significantly affected by the economic downturn in 2009 decreasing, to 19.7 liters per capita in 2009, from 22.9 liters in 2008 according to estimates based on Canadean and Business Analytica data.

 

Production. Following the dissolution of the Soviet Union and the economic reforms that liberalized import procedures, foreign producers were able to capture a significant share of the Russian juice market by importing their products. However, the 1998 financial crisis caused the majority of the foreign companies to leave the market, while forcing a majority of Russian producers to decrease or discontinue juice production.

 

The juice product market began recovering in 1999, and since then, has experienced significant increases in sales volume, stimulated by rising Russian incomes and an increased interest in health issues, as well as by the advertising efforts of juice-producing companies.

 

In addition, a number of Russian producers that survived the 1998 financial crisis managed to restructure their production facilities using Western technologies and to strengthen their market positions. In 2009, according to a Business Analytica survey of ‘Total Urban Russia’ (cities with a population of over 100,000 people), the four largest producers in Russia had an 87% share of the juice market. The industry has been experiencing consolidation, as demonstrated by the increase in

 

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acquisition activity. According to the Business Analytica survey, during 2009, there were more than 200 brands of juice products in the Russian juice market, although 10 of them accounted for 75% of the market in value terms.

 

The bottled-water market in Russia is characterized by a large number of brands, including local brands that are strong in the regions where they are produced. In addition, the leading brands in Moscow differ from those with leading market shares in many of the regions outside of Moscow. According to Business Analytica, in 2009, the top-ten bottled water producers in Russia together had a 71% market share in Moscow and a 66% market share in the ten largest cities of Russia in value terms. This difference is largely due to the prominence of local or regional producers in certain regions outside of Moscow whose water products have traditionally benefited from consumer loyalty in those regions.

 

Babyfood Industry

 

Consumption. The babyfood market in Russia is comprised of five main segments:

 

·                  liquid dairy products (milk, kefir, cottage cheese and curd desserts, yogurts, liquid formula);

 

·                  juice and water;

 

·                  purees (including fruit, vegetable and meat);

 

·                  powdered formula; and

 

·                  other products (cereals, puddings, soups, biscuits, tea).

 

According to our estimates, from 2003 to 2008, the babyfood market in Russia grew by 99% in volume terms, mainly due to growing category penetration. The market continued to grow in 2009, despite the economic downturn, with 9% growth in volume terms. We estimate that over 80% of nationwide babyfood product sales are in the European part of Russia.

 

In 2006, the Russian government launched a nationwide program aimed at improving the health of the nation and increasing the birth rate, which we believe has had a positive impact on the babyfood market. Within the framework of the program, mothers get additional compensation for the birth of their second and following children. In addition, as more and more Russian women go back to work shortly after giving birth, consumption of and reliance on ready-to-eat babyfood has increased.

 

Production. The babyfood market emerged in Russia in the early 1990s with a government plan to build approximately 110 production sites throughout the country to develop babyfood products such as meat, fruit, vegetable, grain and fish purees and various dairy products. Although only a small number of these government-sponsored production sites have since been built, domestic and foreign producers of babyfood started to acquire production facilities in Russia in the second half of the 1990s. Since 2000, the babyfood market has grown substantially in terms of product variety, production volumes and consumption.

 

In the individual product categories, foreign producers currently dominate the powdered formula and cereals market, while domestic producers hold leading positions in the liquid dairy products and supplemental infant food market.

 

Our Products and Brands

 

Our dairy, beverage and babyfood products accounted for 70.2%, 18.6% and 11.2% of our net sales in 2009, respectively. Our principal geographic market is Russia, and Moscow is our most significant market within Russia. The following table sets forth our annual consolidated net sales, the proportion of consolidated net sales attributable to each of our main business lines, our reported annual sales volumes and their growth rates:

 

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2009

 

2008

 

2007

 

Dairy products

 

 

 

 

 

 

 

Sales (in million USD)

 

1,530.2

 

2,095.9

 

1,852.5

 

Annual sales growth, % year on year

 

(27.0

)%

13.1

%

40.2

%

Percent of total sales

 

70.2

%

74.2

%

76.0

%

Sales volume (in th. tons)

 

1,337

 

1,453

 

1,599

 

Annual volume growth (decline), % year on year

 

(8.0

)%

(9.2

)%

18.2

%

Beverage products

 

 

 

 

 

 

 

Sales (in million USD)

 

406.6

 

473.2

 

414.1

 

Annual sales growth, % year on year

 

(14.1

)%

14.3

%

27.8

%

Percent of total sales

 

18.6

%

16.8

%

17.0

%

Sales volume (in million liters)

 

534

 

509

 

491

 

Annual volume growth, % year on year

 

5.0

%

3.7

%

10.3

%

Baby food products

 

 

 

 

 

 

 

Sales (in million USD)

 

244.2

 

254.5

 

171.8

 

Annual sales growth, % year on year

 

(4.0

)%

48.2

%

46.6

%

Percent of total sales

 

11.2

%

9.0

%

7.0

%

Sales volume (in th. tons)

 

135

 

111

 

87

 

Annual volume growth, % year on year

 

21.6

%

27.5

%

31.9

%

Total net sales (in million USD)

 

2,181.1

 

2,823.6

 

2,438.3

 

 

Dairy Products and Brands

 

We divide our dairy products by type and by price segment. We have two diary product categories, including “essential dairy”, which are related to economy segment and presented by the following brands: “Vesely Molochnik”, “M”, “Kubanskaya Burenka”, “33 Cows” and “Pastushok”, and “value-added dairy,” which are related to high price segment and presented by the following brands: “Little House in the Village”, “Zdraivery”, “Imunele”, “Chudo”, “Bio-Max” and other.  In addition, our products fall within three defined price segments, as further described below.

 

In 2007, 2008 and 2009, dairy products comprised 76.0%, 74.2% and 70.2% of our total sales, respectively. Our principal dairy product categories, principal brands, and their approximate percentage of our total dairy revenue in 2009, 2008 and 2007 are as follows:

 

Product line

 

Main brands

 

Approximate
percentage of total
dairy in 2009

 

Approximate
percentage of
total dairy in
2008

 

Approximate
percentage of
total dairy in
2007

 

Essential Dairy

 

“Vesely Molochnik”, “M”, “Kubanskaya Burenka”, “33 Cows”, “Pastushok”

 

39

%

41

%

41

%

Value-Added Dairy

 

“Little House in the Village”, “Zdraivery”, “Imunele”, “Chudo”, “Bio-Max”, “Lamber”, “Mazhitel”

 

61

%

59

%

59

%

 

The Russian market for packaged dairy products has several defined market segments. It can also be divided into non-branded and branded products, although non-branded products generally cover only the lower segment of the market. Our branding policy is designed to ensure we reach customers in most of the segments with the right mix of brands, products and packaging formats. We support strong national brands, as well as a few key local brands which are well established in their respective regions. The following chart illustrates our estimates of the current market segment positioning for our major brands, as well as a general description of the purchasers within each market segment:

 

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Product line

 

Purchaser material well-
being scale

 

Traditional products

 

Yogurts and
dairy desserts

 

Health-
oriented
enriched
 products

 

Cheese
Products

 

Premium

 

Enough money to buy major household appliances, monthly income above $500 per family member

 

“Little House in the Village”

 

Bio-Max, Zdraivery

 

“Imunele”, “Bio-Max”, “Mazhitel”

 

“Lamber”

 

Value for Money

 

Enough money to buy food and clothing, but not enough to buy major household appliances

 

“33 Cows”, “Na Zdorovye”, “Vesely Molochnik”, “Slavyanochka”, “Kubanskaya Burenka” and “M”

 

“Chudo”

 

 

 

“Vesely Molochnik”

 

Econom

 

Enough money for food only

 

“Zavetny Bidonchik”, “Pastushok”, “Nash Doctor”

 

“Frugurt”, "Lada"

 

 

 

 

 

 

In general, we seek to maintain at least one brand within most dairy market segments, and we intend to develop new brands to expand our coverage of attractive segments. In 2009, we launched the new “Zdraivery” brand, specifically for children aged between four and nine years old. A variety of products are marketed under the Zdraivery brand, including traditional dairy products, yogurt, dairy desserts, juice and smoothies.

 

Market trends and competition. According to our estimates, the total market for packaged dairy products in Russia was 9.6 billion liters in 2007 and 9.3 billion liters in 2008. The decline in 2008 was due to significant price increases in retail product prices caused by the growth of global raw milk prices at the end of 2007. Despite the economic downturn in 2009, the market for packaged dairy products increased to 9.5 billion liters which was driven by increased consumption of traditional dairy products. At the same time, given existing low per capita consumption, we believe that the Russian dairy market continues to provide a long-term opportunity for growth. In particular, Russian households have proven receptive to yogurt, enriched dairy products and dairy-dessert products. We also expect continued growth in the consumption of products with extended shelf life, including sterilized milk.

 

From 2000 to the present, we have expanded our distribution capacity, reduced our sales to wholesalers, increased our sales to retailers and increased advertising. We also remain committed to our regional expansion strategy and are constantly expanding our regional product offerings as consumer spending has grown steadily in the regions. Cutting costs and improving the quality of our products remain our main focus areas. We believe that these strategies, along with our marketing efforts have increased public awareness and customer loyalty and will continue to help us mitigate the negative effects of the current economic downturn. We have also increased our production of value-added products that are available in attractive and convenient packaging.

 

In the dairy market, according to the AC Nielsen Dairy Study we were the market leader at the end of 2009 with a 30.5% market share in volume terms*.

 

In traditional dairy, we compete primarily with local producers, such as Unimilk, Molvest (Voronezhsky M.K.), as well as with a number of smaller regional producers. In enriched dairy, we compete primarily with Danone. In the market for yogurts and desserts and, to some extent, for children’s foods products, we compete with foreign producers such as Danone, Campina and Ehrmann who continue to invest in their businesses in Russia. We view the following producers as our primary competitors:

 


* Dairy market shares stated for our company and its competitors exclude cheese and butter

 

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·                              Groupe Danone, a French company and the most active foreign producer in Russia. It has a dairy plant in the Volga region where it produces yogurts, as well as a dairy plant in the Moscow region. Both domestically produced and imported products are sold under the Danone brand name across Russia through its own distribution network. Key brands are Activia, Actimel, Rastishka and Danissimo, which Danone aggressively promotes. According to the AC Nielsen Dairy Study, at the end of 2009, Danone had an 11.6% market share in yogurts and desserts in volume terms and a 6.8% share of the total Russian dairy market in volume terms.

 

·                              Unimilk, the second largest dairy holding company in Russia. Unimilk has over 25 dairy production facilities in Russia and two in Ukraine. Its largest production facility, the St. Petersburg-based Petmol, produces a wide range of dairy products. According to the AC Nielsen Dairy Study, at the end of 2009, Unimilk had a 19.1% market share in traditional dairy, a 9.9% market share in yogurts and desserts and 18.4% share of the total Russian dairy market in volume terms.

 

·                              Ehrmann, a German company producing yogurts at its plant located in the Moscow region. Its brand names Ehrmigurt, Yogurtovich, Fruktovich and Uslada were developed specifically for Russian consumers. According to the AC Nielsen Dairy Study, Ehrmann had a 3.1% market share in yogurts and desserts at the end of 2009 in volume terms.

 

·                              Molvest, a Russian company producing a wide range of dairy products. Its main brand names are Vkusnoteevo and Ivan Poddubniy. According to the AC Nielsen Dairy Study, Molvest had a 3.4% market share in traditional dairy and a 3.0% share of the total Russian dairy market in volume terms at the end of 2009.

 

·                              Campina, an international co-operative dairy company that specializes in production of milk, yogurt and desserts. Its main brand names are Campina, Fruttis, Nezhniy, Stupinskoe and Yogho!. Campina merged with Friesland Foods, another large international dairy co-operative, in 2009. According to the AC Nielsen Dairy Study, Campina had a 7.3% market share in yogurts and desserts at the end of 2009 and a 1.0% share of the total Russian dairy market in volume terms.

 

Recent trends also indicate that industry consolidation may lead to the emergence of larger domestic producers, which would likely increase competition.

 

Foreign dairy manufacturers generally have large promotional budgets and advanced production know-how, allowing them to offer quality and innovative products, and strong distribution networks. While foreign manufacturers in the past generally tended to focus on niche markets, usually in the premium segment, they are now increasingly offering products to the average Russian consumer with an average income. For example, Danone owns two plants in Russia and has introduced several of its yogurt brands into the Russian market, some of which were developed specifically for Russian consumers. Dutch company Campina also owns a dairy plant in Russia that produces fresh yogurts and yogurts with a long shelf life. In addition, the German companies Ehrmann and Onken produce yogurt at Russian plants. Foreign cheese producers have also launched production facilities, including French company Lactalis and German company Hochland. Lactalis also owns seven dairy factories in Kazakhstan, Moldova and Ukraine that produce milk, kefir, sour cream, yogurt and cheese. In Russia, Lactalis owns Lactalis Istra, a factory located near Moscow with capacity to produce up to 6,000 metric tons of cheese annually, and in Ukraine it owns a dairy plant in Nikolaev that produces various dairy products. Due to their increased domestic production of yogurt and dairy desserts, foreign producers have become our main competitors in these sectors, whereas we mainly compete with domestic producers in the traditional dairy sector.

 

We believe that we have several important competitive advantages that will allow us to maintain a leading position in the Russian dairy market, including strong and diversified brands across all price segments, stable access to raw milk, a broad distribution network, our focus on new product development, a substantial in-house R&D department, modern production assets and

 

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technology, access to external capital and a strong management team. We also benefit from our strong regional production base, while our foreign competitors must generally transport their yogurts and premium segment desserts from Moscow to the regions, which is costly and logistically complex.

 

We intend to take advantage of these strengths through our strategy of promoting brand awareness and loyalty with an emphasis on product quality, as well as by continuing our efforts to focus on developing new products equal to or better in quality than those offered by Western producers.

 

Beverage Products and Brands

 

In 2007, 2008 and 2009, beverage products comprised 17.0%, 16.8% and 18.6% of our total sales, respectively.  Our principal beverage product lines and types of products and brands are as follows:

 

Product Line

 

Brands and Types of Products

Juice, nectars and juice containing drinks produced from juice concentrate

 

· “J7,” covering 14 kinds of fruit and berry juices and nectars
·  “100% Gold Premium” and “100% Gold Classic”, covering 15 kinds of fruit juices, nectars and juice containing drinks

· “Lovely Garden,” covering 19 kinds of fruit and berry juices and nectars, 5 kinds of juices and nectars enriched with vitamins and 3 kinds of traditional Russian berry drinks

 

 

 

Enriched juice-based drinks

 

·“J7 Exotic,” an exotic fruit juice and nectar range and “J7 Imunno”, an enriched variety;
·“Zdraivery,” covering 6 kinds of enriched fruit juice and nectars;

 

 

 

Traditional berry-juice-based drinks

 

· “Wonder Berry,” covering 4 kinds of berry-juice based drinks;

 

 

 

Mineral water

 

· “Essentuki,” covering 3 kinds of therapeutic mineral water (Essentuki #4, #17 and #20)
 · “Novoessentukskaya,” covering 1 kind of therapeutic mineral table water
· “Rodniki Rossii,” covering drinking table water in gas and still varieties

 

The juice market consists of three basic price segments, and our juice products are present in all of them.  In 2009 we also launched new premium juice products under “Zdraivery” brand and relaunched “100% Gold Classic”. We also launched “Rodniki Rossii”, a new brand of mineral water, at the end of 2008.

 

The following chart illustrates our estimates of the current market-segment positioning for our major brands, as well as a general description of the purchasers within each market segment:

 

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Segment

 

General Purchaser
Characteristics

 

Juice and nectars
produced from
juice concentrate

 

Traditional
berry-juice-
based drinks

 

Other juice-
based drinks

 

Mineral
water

Premium

 

Aged 20-45

 

 

 

 

 

“J7 Exotic”

 

“Essentuki”

 

 

Men and women in the middle to upper-middle income bracket

 

“J7”

 

“Wonder Berry”

 

“J7 Imunno”

“Zdraivery”

 

 

 

 

 

 

 

 

 

 

 

 

 

Value for Money

 

Aged 20-45

 

 

 

 

 

 

 

“Rodniki Rossii”

 

 

· Men and women in the middle to upper-middle income bracket

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

· Active, optimistic and open-minded

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Aged 25-45

 

 

 

 

 

 

 

 

 

· Primarily married men and women with children in the middle income bracket

 

“100% Gold Premium”
 “Lovely Garden”

 

“Lovely Garden”

 

 

 

 

 

· Self-confident, rational, but not trend setters

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Econom

 

Aged 25-45

 

 

 

 

 

 

 

“Novoessentukskaya”

 

 

Men and women typically with children and below average incomes; family oriented

 

“100% Gold Classic”

 

 

 

 

 

 

Our main water brand is produced at factories from underground wells in the Essentuki area of Russia. Our mineral water products are positioned in each of the three segments of the market and cater to consumers who prefer bottled natural mineral water to purified or ordinary tap water. We remain committed to expanding our Essentuki production capacity. We also introduced the “Rodniki Rossii” natural drinking water brand at the end of 2008, which delivered a strong performance in 2009 and demonstrated its potential for its strong development in the future.

 

Our aim in the bottled water sector is to satisfy the growing demand among Russian consumers for quality mineral and drinking water using ecologically pure Russian sources. We believe that consumers will eventually distinguish and value the superior quality spring and natural water products from competing purified water brands.

 

We believe that our primary competitors in this area are Pepsi’s “Aqua Minerale” and Coca-Cola’s “BonAqua,” as well as “Saint Springs”, “Shishkin Les” and “Arkhyz”. We have positioned our brand in a more up-to-date style, accentuating the fact that it is naturally produced mineral water, and offer both still and carbonated waters in a variety of sizes.

 

Market trends and competition. The Russian juice market grew steadily from the time of the dissolution of the Soviet Union until the 1998 financial crisis, following which there was a significant decrease in consumption from which the market had substantially recovered by 2000.

 

The longer term growth of household incomes in Russia and the increasing preference for juice over fresh fruit has driven the consumption of vitamin-rich, value-added products with different tastes and nutritional characteristics. For example, according to Business Analytica, in Moscow, which had higher average per-capita incomes than most other parts of Russia, the average consumption of juice in 2009 was approximately 48 liters per capita, as opposed to national per

 

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capita consumption of approximately 17.7 liters per capita according to our estimates based on Russian Union of Juice Producers, Business Analytica and Canadean surveys.

 

The economic downturn had a significant effect on the juice market in 2009. According to our estimates, the total market for juice products, defined as the total consumption of domestically produced and imported products, declined to 2,514 million liters in 2009 from 3,003 million liters in 2008. This decline can be attributed to a combination of weakened consumer spending power and an increase in the average price. We believe that we will see stabilization in the juice market in 2010 and that it will potentially return to growth in 2011.The markets for juice products in Moscow, the Moscow region and St. Petersburg are relatively mature compared to other regions of Russia, and are expected to exhibit relatively modest growth rates in the future, with particular growth expected in the upper-middle product segment. We believe that significant growth opportunities lie in the regions of Russia. Juice remains a novelty in many regions, and we believe that with rising household incomes there will be a growing demand for juice offerings in the lower-middle price segment. The Russian juice market is highly competitive largely due to strong rivalry among top 4 players with several brands covering all price segments.

 

In the Russian juice market, according to the Business Analytica survey, we had a 20.5% market share in value terms at the end of 2009.

 

Our principal competitors in the Russian juice market include the following companies:

 

·                  Multon is a Russian juice producer acquired by Coca-Cola in 2005. According to Business Analytica, had a 20.3% market share in value terms in Russia at the end of 2009. Its key brands include Dobry, Rich and Nico. Multon has gained significant market share since 1998 primarily through aggressive pricing policies and advertising.

 

·                  Lebedyansky is based in the Lipetsk region. Lebedyansky acquired local juice producer Troya Ultra in 2006. In 2008, PepsiCo acquired 100% stake in Lebedyansky. According to Business Analytica, PepsiCo had a 32.3% market share in Russia at the end of 2009 in value terms. Its key brands include Tonus, Ya, Fruktovy Sad, Privet and other brands.

 

·                  Nidan is a Novosibirsk-based Russian company that, according to Business Analitica, had a 13.2% market share in Russia at the end of 2009 in value terms. Its key brands include Moya Semya, Caprise and Da!. In 2007 Lion Capital, a British investment fund, acquired 75% of Nidan’s shares.

 

According to our estimates, which are based on data from Business Analytica and Canadean data, the total market for bottled water in Russia decreased to 2,794 million liters in 2009 from 3,256 million liters in 2008. Russian bottled-water producers dominated the market, with a 60% market share in value terms, while the combined share of the two market leaders, PepsiCo and Coca-Cola, amounted to 35%, according to a Business Analytica survey of Russia’s 10 largest cities in 2009. According to the same survey, we were among the top-ten water producers in Russia, with a 3.9% market share by value in 2009. Market growth in recent years has been driven mainly by the increased consumption of bottled water sold in large format packaging and which is consumed for drinking and used for cooking. Despite the short-term negative impact on the market due to the economic downturn, we believe that this market will continue to expand over the longer term due to increasing awareness of the importance of food and water quality.

 

Babyfood Products and Brands

 

Our babyfood products, sold under the “Agusha” brand, include liquid dairy babyfood, juice, purees and products for pregnant and nursing women. These products are mainly produced at the Moscow Dairy Babyfood Plant and at the Kursk Babyfood Plant, with production launched at Manros-M in Omsk in March 2008. In 2007, 2008 and 2009, babyfood products comprised 7.0%, 9.0% and 11.2% of our total sales, respectively.

 

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We are currently developing our babyfood sales by focusing on geographical expansion, developing a full range of products and increasing production. In addition, we plan to continue to launch of new products and expand the range of the existing products.

 

To further expand our geographical reach and widen our portfolio, we acquired the Kursk Babyfood Plant in July 2005 and re-launched it after an extensive modernization in April 2007. The plant sources certain of its raw materials from its own fruit orchards, and our acquisition of the plant allowed us to expand our babyfood product range to include fruit and vegetable purees.

 

Agusha is the leading brand on the Russian babyfood market in terms of spontaneous brand and advertising awareness in 2009 according to the Comcon Brand Health study, as well as the leading brand in terms of volume share according to the MEMRB retail audit.

 

Market trends and competition. The babyfood market in Russia has experienced dynamic growth in recent years, supported by improved market conditions, including rising average incomes, more stringent government regulation of babyfood production and the introduction of various state-supported social programs aimed at improving domestic birth rates and providing maternity assistance. As a result of these improved conditions and increased consumer demand, domestic production of babyfood products has increased over the last few years, with certain of Russia’s major juice and dairy producers increasing their production capacity and introducing new babyfood brands. Foreign producers are also active in the market and, similar to the dairy and juice markets, several have begun to focus on establishing local production capacity in Russia. The babyfood market is already consolidated, with the top five players accounting for approximately 74% of the total value in 2009, according to MEMRB. Given the present low per capita consumption and the long-term trend of increasing household incomes, we believe this market segment continues to have strong growth potential. Another factor driving the growth of the Russian babyfood market is the increase in the number of infants aged four and under by 2.5% in 2006, 2.6% in 2007, 3.1% in 2008 and 3.3% in 2009, according to the Federal State Statistics Service.

 

We are the leader in the babyfood market with the overall volume share of 25.9% as of the end of 2009, according to MEMRB.

 

New Product Development

 

For a leading consumer-goods company operating in an ever more competitive marketplace, we rely on the process of innovation in order to strengthen our market position. We believe that having high-technology research and development capabilities is a crucial competitive advantage for us and a key to our long-term growth.

 

Our Research and Development (R&D) department, employing more than 20 people, is located at Wimm-Bill-Dann in Moscow, the company’s flagship enterprise and one of the largest and best technically equipped dairy production facilities in Europe. The factory has its own testing platform, and the R&D department creates and tests new products for each of our dairy, beverages and babyfood units. The department works closely with production units across the company and with our marketing division to combine intelligence and research about changing consumer habits and patterns to develop new products.

 

Innovations include enriched versions of existing products, new formats and packaging for popular products (i.e. changing how they are consumed), and developing products that are entirely new for the Russian market.

 

Much of our new product development effort over the past three years has focused on higher-margin, value-added yogurt and dessert products.

 

In 2009, we re-designed the entire line of “Chudo” products in order to improve brand visibility and consumer recognition. In addition, following the successful launch of a cottage cheese product under the “Chudo” brand in the family pack format in 2008, we have built upon our

 

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initial success by launching spoonable yogurts and mixed curds with chocolate sauce in family pack format in 2009.

 

We also extended our “BioMax” brand with the launch of new curd and spoonable and drinkable yogurt products under the “BioMax Effective” line to strengthen our competitive advantage over Danone’s “Activia” products.

 

In order to expand our target audience, we launched the “Zdraivery” brand in 2009. “Zdraivery” is a brand for children, aged between four and nine years with a wide product portfolio, including traditional dairy products, yogurt and dairy desserts, juice and smoothies. They are positioned as healthy products made only from natural ingredients, and which help children to grow and develop.

 

In the babyfood segment, we have re-launched the “Total Care” line within the “Agusha” brand in 2009. We redesigned the brand for better visibility on the store shelf and increase its attractiveness to shoppers. We also launched compote and mors under the “Agusha” brand in the 500ml packaging. In 2010, we plan to launch the production of compotes for children in the 200ml package format.

 

Advertising and Marketing

 

Brand building and marketing have always been at the core of our business. Since the early 1990’s, we have built brands into household names in Russia and the CIS, from the “J7” brand of juice to one of Russia’s first yogurts under the “Chudo” brand to leading babyfood brand “Agusha”.

 

Our marketing strategy is directed at leveraging our leading portfolio of brands by accelerating brand building based on our deep understanding of consumers and react quickly to new trends in the marketplace. As the cost of advertising on Russian television continues to rise, we will continue to concentrate on more focused and efficient campaigns to reach target consumer audiences.

 

Our investment in some 10 power brands in recent years is aimed at increasing their average selling price and market share, while achieving the right product mix. We believe our most successful brands still have considerable untapped potential.

 

In juice, the “J7” brand saw radical changes in 2007, with a new advertising campaign, new packaging, improved taste profile and new pricing structure. We will continue to expand the brand and enhance its brand equity.

 

Instead of viewing products within the context of a single market niche, we have positioned all of our power brands on the basis of health and wellness, reflecting our mission and the emerging trend toward healthier lifestyles visible today in Russia. We see each brand as a reflection of our broader corporate identity, with our label on every product aimed at conveying a consistent message of quality, taste and health.

 

Our advertising and marketing expenditures of $138.0 million in 2007, $142.3 million in 2008 and $139.5 million in 2009 constituted 5.7%, 5.0% and 6.4% of net sales, respectively. Though we are, in some instances, able to obtain volume discounts, we expect these expenditures, as a percent of net sales, to increase significantly due to market competition and annual media inflation. According to Gallup, in Russia, we were the tenth largest advertiser both in 2007 and 2008 and the seventh largest advertiser in 2009.

 

In 2007, we began systematic testing of the quality of our advertising which continued in 2008 and 2009. We saw positive results with several key brands, including “J7,” “Little House in the Village,” “Chudo” and “Agusha”. In 2009 we developed strong commercial campaigns for the

 

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“J7,” “Chudo” and “Agusha” brands. We launched a new brand “Zdraivery”, which we supported with strong advertizing campaigns targeted specifically to children and their parents.

 

We plan to continue to allocate the bulk of our advertising budget to a limited group of strategic brands which are highly ranked in their respective markets. We also plan to continue our aggressive advertising and marketing of selected new products.

 

We have also built brand awareness through charitable work and sponsored events. For example, we sponsor International Charity Foundation events benefiting orphans through the “Hope around the World” program, as well as several other charitable organizations. We also serve as a trustee of the Charity Foundation for Special Grants, which was headed by the late Mstislav Rostropovich, a prominent Russian cellist.

 

Sales and Distribution

 

According to the Russian Federal Statistics Agency, total retail sales in Russia decreased by 5.5% year-on-year in 2009 due to the general economic downturn.

 

Seven Russian regions (Moscow, St. Petersburg, Moscow region, Sverdlovsk region, the Republic of Bashkortostan, Tyumen region and Krasnodar region) accounted for 42.1% of total retail turnover in 2009, with Moscow alone accounting for 17.1%, according to the Russian Federal Statistics Agency.

 

In recent years, individuals in Russia have been spending an increasing percentage of their incomes on consumer goods. According to the Russian Federal Statistics Agency in 2009, the cash income of the population grew 1.9% compared to 2008, however due to the increase of savings share in the disposable income by 1.7%, the consumer purchase power decreased in comparison with 2008.

 

Notably, the share of products being sold in open markets continued to decline in 2009. According to Business Analytica, the juice sales by volume at open markets in 2009 comprised 10.7% of total juice sales in Russia as compared to 11.6% in 2008. The portion of dairy product sales by volume at open markets in 2009 remained flat at 7% in 2009 as compared to 2008, according to the AC Nielsen Dairy Study. In the babyfood segment the share of open market sales is insignificant.

 

The absolute size of the retail market has continued to grow every year, with Russia’s regional markets growing at a faster pace as compared to the more mature Moscow and St. Petersburg markets. According to Business Analytica and AC Nielsen data, the share of sales via modern formats, such as supermarkets, hypermarkets and discounters, in the overall volume of retail sales continued to increase in 2009. According to Business Analytica, the share of juice sold in modern format outlets grew from 21.7% of total juice sales in 2008 to 23.5% in 2009. The corresponding share of all dairy products grew by volume from 73.6% in 2008 to 74.0% in 2009, according to an AC Nielsen.

 

In Moscow, the country’s largest single market, this ratio is considerably higher.

 

Over the last several years, foreign and domestic retail chains have focused on expanding into large regional cities throughout Russia, in particular targeting fast-growing but under-served regions such as the Urals and Siberia. We believe that the expansion of retail chains creates additional opportunities for market expansion and has a generally positive effect. In particular, retail chains generally operate with increased business transparency and new technologies that enhance sales and marketing efforts, as well as provide manufacturers with new opportunities to increase the volume and geography of sales.

 

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Sales

 

In 2009, we continued the reorganization of our sales and distribution functions in order to increase their efficiency. In 2007, as a part of this long term plan, we merged our dairy and babyfood sales forces widen distribution in the babyfood segment. In 2009, we focused our efforts on the re-engineering of processes for key account management processes and retained Bain & Company, an independent consultant, to provide the necessary support. In addition, in 2009, WBD Foods’ management team was strengthened with the addition of a new vice president to our management team who has joined us as an expert in key account management, increased the number of key account managers by 25%, and modified the functional specialization scheme of key account managers.

 

In addition, as part of our strategy to expand the geography of our distribution network, we opened four new distribution centers in Tyumen, Saratov, Pyatigorsk and Novorossiysk in 2009. We also hired a team of regional field managers in order to improve the control procedures over trade marketing activities carried out by the distribution centers.  In addition to sales made through our distribution centers, we also continued to sell our products directly from production sites and through independent distributors.

 

Distribution

 

Due to differing consumption patterns and product characteristics, our dairy, babyfood and beverage businesses require different distribution strategies. We have therefore built two distribution systems: one for our dairy and babyfood, and the other one for beverage products. At the same time, we use the same marketing approach in each business and take advantage of synergies between the systems to the extent possible.

 

We sell our products through various sales channels, including independent distributors and wholesalers, supermarket chains, small- and medium-sized grocery stores, open air markets, pavilions, kiosks, and hotels, restaurant and cafes (HoReCa)

 

In an effort to mitigate the effects of the global economic downturn and related decline in sales as well as to generally fortify our sales strategy, we launched a route-to-market strategy in 2009. In this connection, we undertook an analysis of the cities and towns where our products are sold in order to identify the most promising markets and develop customized plans for their development.

 

We also increased the share of our direct store delivery, strengthened our partnerships with distributors, unified our trade terms in order to provide more transparency and insight to our customers and implemented a sales force information system that enables us to control and manage the direct sales of each of our independent distributors.

 

Independent distributors

 

One of the challenges we faced in 2009 was preventing a sharp decline in sales in the context of the global economic downturn and its negative impact on the Russian marketplace. With this objective in mind, and with the goal of creating a foundation for strong sales growth in the future, we launched a route-to-market strategy. We made a cluster analysis of the cities/towns in order to identify the most promising markets and develop customized programs for their development. In addition, we increased the share of DSD (Direct Store Delivery), strengthened our partnerships with distributors, and unified our trade terms in order to inject more transparency. All of these actions helped us avoid a sharp drop in sales in 2009.

 

As a percentage of total sales during 2009, in value terms, we sold 48% of our dairy products, 66% of beverages and 40% of babyfood products through independent distributors and this process is supervised by our sales teams.

 

During 2009, our dairy and babyfood products distribution network consisted of 35 regional sales offices throughout Russia and the CIS. All of our dairy distributors in Moscow are exclusive

 

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to us and do not distribute the dairy products of our competitors. We have also implemented a segmentation program among the Moscow distributors whereby each distributor controls the distribution of a particular segment or segments of the dairy market. A number of independent distributors, with which we have established relationships, purchase dairy, beverage and babyfood products from us. In order to incentivize these distributors, in 2009 we introduced a new type of discounts — discount for cooperation. These discounts are given to distributors who deliver great results across all our categories.

 

During 2009, our beverage-product distribution network consisted of 16 regional sales offices throughout Russia. In Moscow, our independent distributors act principally as logistical coordinators. Our sales representatives work directly with retail outlets and other customers in making sales, while relying on the distributors to execute the orders, carry out deliveries and collect payments. Outside of Moscow, we rely more heavily on our independent distributors. Some of our beverage distributors have teams devoted exclusively to the sale and distribution of our products.

 

All of our dairy distributors in Moscow are exclusive to us and do not distribute the dairy products of our competitors. We have also implemented a segmentation program among the Moscow distributors whereby each distributor controls the distribution of a particular segment or segments of the dairy market. A number of independent distributors, with which we established relationships, purchase dairy, beverage and babyfood products from us. In 2008 we started to consolidate our base of distributors and decreased the total number of distributors from 240 to 173, which has increased our ability to manage the distribution system more effectively while, at the same time, enhancing the profitability of our partners by providing them with greater economies of scale. Independent distributors purchase directly from us and then resell our products through their own distribution centers. Given the importance of these customers, we process orders from independent distributors relatively quickly. We launched our Internet-based ordering system in Moscow in January 2000, and all orders by our dairy product distributors in Moscow and the Moscow region are now placed through the Internet. In 2001, we started to use an automated order system with all of our independent distributors who purchase our products in large volumes, and in 2002, we began using this automated order system with our smaller independent distributors as well

 

In 2004, we worked with and invested in our independent distributors in Moscow to establish warehouses and transportation infrastructure capable of fully supporting a “cold supply chain” in order to maintain our products’ integrity, freshness and nutritional value.

 

In 2009, we started a program for product portfolio optimization aimed at increasing level of service, reducing the write-offs of finished goods, and improving production efficiency.

 

Direct sales

 

As the share of chain retailers grows, our intention is to increase the share of our own direct sales to them.

 

As a percentage of our total sales during 2009, in terms of value, we sold 40% of our dairy products, 27% of beverages and 33% of babyfood products directly through our national and local key accounts. We believe that the importance of these customers to our business will continue to grow in the coming years. We want to become and remain the supplier of choice for these customers by further developing key supplier relationships and improving customer service standards. Over the past several years we have been selling products directly to several retail chains, including Seventh Continent, Auchan, Metro, Perekryostok, Lenta, and other. In addition, in 2009, we began direct distribution to the SPAR, Billa, and Magnolia retail chains. See also “—Sales” above for a description of the steps we took in 2009 to improve key account management.

 

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While we increased national and local key-account relationships and sales in 2009, the economic downturn has had an impact on the business of these clients. Liquidity problems and large debts led to some retail chains experiencing problems with solvency.

 

In connection with this, we toughened our credit policy and are carefully tracking the financial condition of our partners. We have also increased our efforts to reduce receivables.

 

Export program

 

We began exporting our juice products, in particular our “Wonder Berry” traditional berry-juice drinks, to Western markets in 1999, mainly focusing on Russian communities abroad. We selected this product because of its distinctiveness and the opportunity it presented to take advantage of the expansion of the red-berry juice market in Europe.

 

We currently export our juice products to the United States, Canada, certain CIS countries, Latvia, Estonia and Lithuania, Mongolia and Vietnam. Our juice products are distributed in these countries through independent distributors and are sold in various national and multinational retail chains. Our products are also exported and sold through various sales channels in CIS countries such as Ukraine, Kyrgyzstan, Kazakhstan, Turkmenistan, Georgia, Armenia, Azerbaijan, Moldova and Belarus,. We also export our “Essentuki” mineral water, principally to the United States, Canada. Our production facilities were certified in 2007 to export “Essentuki” to Ukraine. Our beverage export sales totaled $4.6 million in 2007, $8.3 million in 2008 and $6.0 million in 2009.

 

The Lianozovsky Dairy Plan (2004), Tsaritsino Dairy Plant (2005) and the Rubtsovsk dairy plant (2007) have received licenses to export dairy products to the European Union (EU). During the licensing process, all of the equipment and production, technological and control processes at the plants were inspected to ensure compliance with international norms and standards based on the principles of Hazard Analysis and Critical Control Points (HACCP). The EU license is accepted by a majority of CIS countries as an indicator of high quality and safety.

 

We routinely participate in trade shows in foreign countries and work with foreign distributors on promotional campaigns and product tastings (e.g., “Green Week”, “ANUGA” and “SIA”). We also engage in market testing and market research in, as well as one-off deliveries to, foreign countries in order to determine the attractiveness of potential future markets. We are a six-time recipient, most recently in 2009, of “The Best Industry Sector Exporter” award from the Trade and Economic Council of the Russian Ministry of Economic Development and Trade.

 

When we export our products to any other country, we seek to ensure that we are compliant with the applicable legislation governing the import of food products into that country. Independent distributors have, in a few cases, attempted to export our products to other countries that did not meet applicable legislation.

 

Production and Raw Materials

 

Production Efficiency and Quality

 

Our Quality Management System (QMS) is a clearly defined set of procedures that aimed at ensuring control of the quality process control and quality assurance.

 

In accordance with the QMS, we undertake supplier assessment audits to ensure that our suppliers provide materials that meet our exacting quality standards. This includes raw materials for making our products, packaging and equipment. Our experts work with existing and prospective suppliers to ensure their goods comply with our quality, safety and performance standards. Suppliers are graded and assigned Key Production Indicators (KPIs) based on criteria that measure product quality, delivery, cost and responsiveness. This work not only ensures suppliers meet our standards but helps make them more efficient, lowering our input costs.

 

The QMS plays a critical role in the ongoing technological integration across all of our factories and trading groups. In the dairy business unit, where we have made substantial investments since 2003 in modernizing acquired production facilities, quality control experts have

 

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led a “unification project,” aimed at establishing the tight coordination of the manufacturing process at a number of our geographically dispersed plants. The consistent application of manufacturing procedures and technology ensures that plants operating thousands of kilometers apart can make products with consistently high and uniform taste and quality.

 

We have continued the deployment of the program designed to improve production conditions, work practices and the professional level of our employees, which was initially launched in 2007 in order to enhance the performance of our production plants. Each plant is audited at regular intervals, assigned a score (using a 100-point scale) and rated accordingly.  Following these audits, and together with local specialists, we produce action plans for the improvement of each plant. Plants compete to achieve the highest ratings.

 

We have our own accredited research test center laboratory with a team of scientists and experts. Samples of all our primary ingredients and samples of our final products undergo microbiological analysis and in-depth testing. In addition, we have ISO/IEC 17025 certified laboratories at all of our plants that perform quality checks on our products at all stages, including quality checks on the raw milk supplied by farms to us, the materials at our production facilities and the finished products in our warehouses.

 

We also measure the quality of the product and packaging once our products enter the market place. The product samples that are purchased in various cities are delivered to our Quality Department in Moscow by a courier to be tested for specification compliance. Under a system launched in 2007, trade sampling and laboratory analysis compare products against our specifications and provide a Quality Index calculation determining whether a product meets the standards set by us.

 

In developing new types of products, we cooperate closely with the Institute of Nutrition of the Russian Academy of Medical Sciences, Moscow State University of Food Production, Moscow State University of Applied Biotechnology and All-Russian Institute of the Dairy Industry. This collaboration has provided our employees with scientific support, solutions to technical problems and on-site training. We also work closely with several multinational raw material and additive suppliers in order to benefit from their collective technical expertise as we develop new products and evolving quality standards.

 

In addition, our researchers and quality control experts work closely with Russian federal bodies and their regional and local departments, such as the Sanitary and Epidemiological Inspectorate and the country’s main consumer safety agency, known as Rospotrebnadzor. We also actively work with lawmakers and government experts to develop new regulations and procedures for the food industry aimed at making sure rules are clear for all participants.

 

In addition to compliance with the relevant Russian quality standards, we strive to ensure that our products conform to the quality standards of organizations such as the World Health Organization, l’Association Francaise de Normalisation and the Food and Agricultural Organization, as well as EU regulations. We are also a member of the International Federation of Fruit Juice Producers, the Russian Union of Juice Manufacturers and the Russian Dairy Union. Additionally, we assist relevant Russian government agencies in initiating and developing regulations for the Russian market.

 

To improve the feedback and answer questions from our consumers, we have established a nation-wide toll-free hot-line in Russia and Ukraine. The number is printed on our packaging used for all of our products.

 

In 2008, the standard production reporting system was deployed at all of our production sites to report on the key production indicators. A system performance reviews for production staff was developed and implemented, allowing us to explain fully the incentive plans and training programs available to production personnel.

 

We installed 19 production lines in 2009, including cottage cheese production line, sterile milk production line, family format yogurts production line and other. We believe that the new lines will

 

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enhance our production efficiency in making high-quality and complex products. For example, our Babyfood plant already manufactures products to very high quality standards.

 

We have continued to extend the Company’s Quality and Safety Management System. By the end of 2009, 19 of our dairy and beverage plants were granted ISO 9001 Certificates, and 14 were granted ISO 22000 Certificates. During 2010, we plan to develop and certify the Quality and Safety Management System for a number of other plants.

 

Food Raw Materials

 

The main raw materials we use in our production include the following:

 

·                  raw milk, which we obtain from domestic farmers;

 

·                  powdered milk, which we generally obtain from our own production, domestic producers or import;

 

·                  bacteria cultures, which we generally import;

 

·                  flavorings, which we generally import;

 

·                  sugar, which we generally buy locally;

 

·                  juice concentrate and juice puree, which we primarily import, but also purchase domestically; and

 

·                  other ingredients such as frozen fruits, aromas and stabilizers.

 

The prices of each of these raw materials are generally volatile.

 

Our purchasing policy is to build long-term strategic relationships with our partner suppliers. We have focused on developing partnerships with established leaders in the field of local and global food production, including the leading Russian and international producers of sugar, fruit concentrates and purees, powder milk, frozen fruits and ingredients.

 

We purchase almost all of our raw materials from producers. We purchase certain raw materials such as bacteria cultures, juice concentrates and flavors from foreign manufacturers when products of appropriate quality are not available locally.

 

With the aim of ensuring a stable supply of raw milk at reasonable and forecasted prices, ensuring consistent quality of milk and balancing out seasonality, we are moving towards long-term milk supply contracts, leasing milking and refrigeration equipment to local producers, providing selected local milk producers with working capital loans, assisting with long-term subsidized bank financing arrangements, contracting directly with farmers and avoiding middlemen and working with the state authorities that regulate this sector.

 

“Milk Rivers” program. We have strengthened our position in the dairy market by developing our own network of raw-material suppliers, in significant part through investments that support agricultural producers.

 

In the summer of 1999, we merged and formalized these programs under our “Milk Rivers” program, through which we provide local farms with trade loans, feed, and leased combine-harvesters and milking and refrigeration equipment. In selecting farms to participate in this program, we choose only those that seek to increase the quality of their products and raise the productivity of their herds. We also look for producers that can help balance out the seasonality in raw milk production volumes.

 

Under the Milk Rivers program, we have leased milking and refrigeration equipment for terms, which typically vary from one to five years to agricultural enterprises located in the Moscow and other regions, including Voronezh, Nizhny Novgorod, Ufa, Novosibirsk, Krasnodar and Altai. The lease receivables are primarily denominated in U.S. dollars, euros and rubles. Equipment leased out to farms includes milking and refrigeration equipment for accelerated milk cooling and the

 

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temporary storage of milk at farms and other technical devices that increase the productivity of farms. The type of equipment provided depends on the needs of each particular farm.

 

We have also offered seminars and lectures to our Milk Rivers program participants to help them improve the quality of the milk they produce.

 

Other initiatives. A key factor for enhancing the milk productivity of a herd and increasing its milk quality is the availability of a good feed base. This particular problem is one of the most acute issues in recent years and is due to harvesting problems linked to a lack of modern harvesting machinery on Russian farms. For this reason, the second stage of the Milk Rivers program has entailed providing new fodder-harvesting machines to a number of the participating agricultural enterprises. German company Doppstadt, through its joint-venture in St. Petersburg, is our partner in this project.

 

Seasonality

 

In general, our business is quite balanced and is not subject to significant seasonal fluctuations.

 

The demand for our dairy products is higher during the winter months, when Russian raw milk production is at its lowest. Conversely, during the summer months, we generally experience lower demand for dairy products, while raw milk production is at its peak. To address these seasonal demands, we built strong relationships with raw milk suppliers and continue investment in “Milk rivers” program.

 

The demand for our juice products traditionally peaks during the April/May period and again in December. We believe that the high demand during April through May is related to the public’s heightened desire for vitamin-rich food and drink products during the transition from winter to spring, and the high demand in December is related to increased juice consumption during the holidays.

 

The demand for both dairy and juice products in southern Russia rises in the summer due to an increase in the number of tourists.

 

Mineral water is the part of our products portfolio most subject to seasonal fluctuations, although our “Essentuki” brand is a therapeutic water product and has relatively low seasonality in comparison with drinking waters, such as our recently launched “Rodniki Rossii” brand. The share of water is relatively low in our product portfolio, so the seasonal peaks and troughs are more or less compensated by the opposite seasonality of our dairy products.

 

Sales of certain babyfood products are affected by seasonal factors. In particular, sales of juice and purees for babies are typically 10-15% higher during the summer months, while sales of liquid dairy baby products are typically 5-8% lower in the summer due, in part, to the fact that many Russians travel to the countryside for vacations in the summer and are unable to transport such products, which have a short shelf life.

 

Packaging

 

Our principal packaging raw materials include materials needed for packaging our dairy, babyfood and juice products, consisting mainly of aseptic paper, none-aseptic paper, plastics (PP, PE, Polysterene and others), foils and corrugated board. Our main supplier of composed material for the production of milk and juice carton containers is Tetra Pak, the world leader in manufacturing equipment and materials for aseptic packaging of liquid food products.

 

OJSC Tetra Pak AO (“Tetra Pak”) supplied approximately 67.2%, 65.0% and 63.1% of our total packaging materials in value terms in 2007, 2008 and 2009 (including carton, plastic, foil and other materials), and we are substantially dependent upon this packaging supplier to meet our requirements.

 

As a major Russian consumer of Tetra Pak products, we have annual contracts with Tetra Pak, which supplies us from its Russian plants as well as from its other European plants.

 

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We have established similar relationships with companies such as SIG Combibloc (aseptic paper for juice and milk) and Elopak (none-aseptic paper for dairy products).

 

As part of our strategy to increase locally produced raw materials, we are developing relationships with Russian manufacturers of packaging materials, in particular with companies such as Gofra, Gotek, Stirolplast, FormalineGrainer, Interpak, Polex, Formaplast, Eximpack, Lukoil-Neftekhim and Planet Thermoforming.

 

We are focused on two main areas in building our procurement strategy:

 

·               standardization of specifications for raw materials and packaging allowing group purchasing; and

 

·               strategic relationships with key group-wide suppliers

 

These two factors are directed at allowing us to benefit from economies of scale, which we believe will lead to enhanced effectiveness and cost optimization.

 

Trademarks and Patents

 

We have registered brand names and trademarks throughout Russia and in other countries. We keep track of our intellectual property and monitor the protection of our brand names and instances of copyright infringement in Russia and the CIS. The extent to which we seek protection of our trademarks outside of Russia and the CIS depends on the significance of the brand and jurisdiction concerned. The brand names listed above under “— Our products and brands—Dairy products and brands” and “—Our products and brands—Beverage products and brands,” which we have registered in Russia, are material to us. We also own several licenses, patents and proprietary recipes, know-how and technologies related to our products and processes. See “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business and Industry—We may not be able to protect our intellectual property rights adequately, resulting in material harm to our financial results and ability to develop our business” for a description of the risks related to the protection of our trademarks.

 

In 2008, we obtained recognition of our “J7” trademark (combined mark) as a well-known trademark from Rospatent, the Russian patent office. Such recognition protects this trademark for an unlimited duration of time and provides us with certain additional benefits with respect to our use of these trademarks.

 

Insurance

 

We maintain property insurance coverage for our production facilities and our warehousing facility in Tomilino. The insurance coverage has been taken out on an “All Risks” basis covering buildings and equipment at our production facilities for the total sum of $1.0 billion. We have insurance for business interruption at production facilities with the total coverage of $0.9 billion.

 

We have product liability insurance for our production and distribution operations Russia with $2.5 million liability coverage per insurance claim within the territory of Russia, the CIS countries and Mongolia, and $5.0 million liability coverage per insurance claim worldwide except for the claims made on territory of Russia, the CIS countries and Mongolia, with a cumulative coverage limit of $5.0 million.

 

We have general liability insurance covering production and distribution operations with $5.0 million liability coverage per claim and in the annual aggregate within the territory of Russia and Ukraine, and $1.0 million liability coverage per claim and in the annual aggregate within the territory of Uzbekistan and Kyrgyzstan.

 

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See “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business and Industry—We do not carry the types of insurance coverage customary in other more economically developed countries for a business of our size and nature, and a significant event could result in substantial property loss and inability to rebuild in a timely manner or at all.”

 

Environmental and Product Liability

 

We are subject to the requirements of environmental laws and regulations. While we devote resources designed to maintain compliance with these requirements, we cannot assure you that we operate at all times in complete compliance with all such requirements. We could be subject to potentially significant fines and penalties for any noncompliance that may occur. See “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business and Industry—Failure to comply with existing laws and regulations or the findings of government inspections, or increased governmental regulation of our operations, could result in substantial additional compliance costs or various sanctions which could materially adversely affect our business, financial condition, results of operations and prospects.”

 

We also face an inherent business risk of exposure to product liability claims in the event that consumption of our products results in personal illness or death, and we cannot assure you that we will not experience any material product liability losses in the future. In addition, if any of the products we have produced are determined to be unsuitable for consumption, we may be required to participate in a recall involving such products. We have not had any significant historical experience of such claims and are unaware of any potential unasserted claims. See “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business and Industry—Failure to comply with existing laws and regulations or the findings of government inspections, or increased governmental regulation of our operations, could result in substantial additional compliance costs or various sanctions which could materially adversely affect our business, financial condition, results of operations and prospects” and “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business and Industry—Independent distributors may export our products to countries where such products do not meet the requirements of applicable legislation. The consequent recalls of our products and the associated negative publicity may adversely affect our reputation in the Russian Federation, the CIS and abroad and adversely affect our results of operations.”

 

Regulation

 

The production, sale and distribution of food and beverages in the Russian Federation are regulated by general civil legislation and by special legislation that includes quality standards and various safety and sanitary rules.

 

Government Entities Involved

 

In addition to the federal executive bodies and their structural subdivisions that have authority over general issues, such as defense, internal affairs, security, border service, justice, tax enforcement and rail transport, there are a large number of government agencies directly involved in regulating and supervising the quality and safety of food in the Russian Federation.

 

The Ministry of Health Protection and Social Development. This Ministry is authorized to issue regulations in various areas, including with respect to sanitary and epidemiological safety and consumer rights protection. The Ministry supervises and coordinates its subordinate bodies, including, among others, the Federal Service for Supervision in the Area of Protection of Consumer Rights and Human Welfare.

 

The Federal Service for Supervision in the Area of Protection of Consumer Rights and Human Welfare. This Service is the principal federal body authorized to supervise sanitary and epidemiological issues in the Russian Federation. The Service enforces sanitary-epidemiological rules (which include sanitary rules, sanitary standards and hygienic requirements) and monitors the sanitary conditions of production sites and equipment, compliance with sanitary standards for raw

 

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material and finished product storage at manufacturing plants, compliance with sanitary standards for the storage and sale of food products and safety at wholesale and retail outlets and businesses catering to the public. The Service also carries out inspections of sellers’ premises.

 

The Federal Agency for Technical Regulation and Metrology. This Agency manages government property in the sphere of technical regulation and metrology. On a temporary basis, until such functions are transferred to other federal authorities, the Agency oversees compliance with obligatory general and industrial standards. This Agency is subordinated to the Ministry of Industry and Energy.

 

The Federal Service for Veterinary and Phyto-Sanitary Supervision. This Service supervises the sanitary safety of raw food materials used in the production of food products and beverages where such raw food materials are derived from animals. This Service is subordinated to the Ministry of Agriculture.

 

Applicable Food and Health Legislation

 

The principal Russian legislation regulating the quality and safety of food and beverages includes the following:

 

The Federal Law on Quality and Safety of Food Products establishes a general framework for ensuring that food products and materials used in their production conform to certain quality, safety and sanitary requirements and provides for the state registration and certification of food products once they so conform. It also establishes general requirements for the manufacturing, packaging, storage, transportation and sale of food products and beverages, and for the destruction of poor-quality and unsafe products.

 

The Federal Law on the Sanitary Epidemiological Well Being of People requires food products and beverages, and the raw materials used in their production, to meet certain sanitary standards and health requirements and to have no harmful effects. Products that do not conform to sanitary rules and health requirements and represent a danger to consumers must be withdrawn immediately from production or sale. As a result, the fulfillment of sanitary standards and health requirements is an obligatory condition for the production, import and sale of food and beverage products in the Russian Federation.

 

The Federal Law on Technical Regulation provides for the development, enactment, application and enforcement of obligatory technical requirements and the development of voluntarily standards relating to manufacturing processes, operations, storage, transportation, selling and utilization. Amendments to this law, dated May 1, 2007, provide for the adoption of obligatory technical requirements on the safety of food products by January 1, 2010. Until such technical requirements are developed and adopted, the existing standards are mandatory to the extent they are necessary to secure the protection of safety and health, environmental protection and consumers’ rights. See also “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business and Industry—Possible implementation of new federal or local government policies, or selective application of existing policies, affecting the food industry could substantially and negatively affect our turnover and operating margin.”

 

The Governmental Regulation on Monitoring of Quality and Safety of Food Products and Health of People establishes a procedure for supervising and monitoring the quality and safety of food products.

 

The Government Regulation on State Registration of New Food Products, Materials and Goods provides for the obligatory state registration of certain food products, including mineral water, babyfood and dairy products enriched with vitamins and/or other microelements. Food producers intending to develop and offer a new food product to the public are required to file an application for the product’s state registration and incorporation into the State Register of Permitted Food Products. Such applications are reviewed by the Federal Service for Supervision in the Area of Protection of Consumer Rights and Human Welfare (together with the Federal Service

 

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for Veterinary and Phyto-Sanitary Supervision with respect to products derived from animals) within 40 days of their filing.

 

The Regulation for the Conduct of Sanitary-Epidemiological Examinations of Products establishes procedures for the sanitary-epidemiological examination of products. Government bodies which monitor sanitary and health issues conduct sanitary-epidemiological examinations of samples of each product and issue a conclusion as to whether such product satisfies the prescribed requirements. Products that have not undergone a hygienic evaluation may not be produced, shipped, used, sold or certified.

 

A number of other regulations also apply to food products, including babyfood products. For example, requirements for the storage, production, labeling, transportation and sale of food and beverages are established by state standards, sanitary rules, hygienic requirements and other regulations.

 

In addition, food products may be subject to regulation by regional authorities. For instance, the Moscow Government approved a series of regulations relating to the use of genetically modified organisms (GMO) in food products aimed at informing customers about such use and providing preferences to manufacturers who do not use GMO. In particular, in February 2007, the Moscow Government issued a decree recommending that manufacturers refrain from marketing GMO products in Moscow and establishing a voluntary GMO labeling system.

 

Registration Requirements

 

Certain food and beverage products (such as children’s products, dietary foods, milk products enriched by vitamins and/or other microelements, additives to food and food products manufactured using technologies that have never been applied in the Russian Federation) must be registered with the Russian government if they are either manufactured in Russia or imported into Russia for the first time. The regulation makes it illegal to manufacture, import or circulate products that are subject to state registration but have not been registered.

 

The product registration process includes:

 

·               An examination of documents provided by the manufacturer or supplier of the product describing the product, its safety and evidencing its conformity with applicable rules;

 

·               Toxicological, hygienic, veterinary and other types of tests of products and, with respect to products manufactured in Russia, an examination of the manufacturing conditions of such products;

 

·               Registration of the product, its manufacturer and supplier with the State Register of Food Products maintained by the Federal Service for Health Protection and Social Development; and

 

·               Issuance of a certificate of state registration permitting the product to be manufactured, imported or distributed in the Russian Federation.

 

The state registration of products is carried out by the Federal Service for Supervision in the Area of Protection of Consumer Rights and Human Welfare (together with the Federal Service for Veterinary and Phyto-Sanitary Supervision with respect to products derived from animals).

 

Certification

 

The certification of products and services is currently regulated by the Federal Law on Technical Regulation. Product certification is a procedure whereby an agency authorized by the government confirms that a product complies with technical regulations, standards and requirements. Milk products, babyfood, juice, certain water products and other beverages are subject to mandatory certification. Conformity symbols evidencing that the manufacturer has undergone certification procedures are required to be printed on a product’s packaging. Failure to mark a product with a required conformity symbol carries possible administrative sanctions.

 

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Bulk Purchase of Raw Milk

 

A supplier of raw milk must provide a certificate stating that the farm from which it originated has passed a health inspection. Milk bought in bulk must also conform to requirements with respect to temperature, color, sedimentation, content of neutralizers, heavy metals, density, protein content, fat content, alcohol content and other characteristics.

 

Production and Transportation

 

Laboratory employees and technical specialists must verify that the condition of equipment, implements, raw materials and packaging conform to sanitary requirements. For example, in the course of manufacturing, microbiological tests must be conducted of samples of raw materials, packaging and products. Products are tested for their content of chemical pollutants, toxins, medicinal and hormonal preparations, radionuclides and pathogenic microorganisms. They are also tested to identify bacteria, yeast and mold content, and to determine their sterility and the effectiveness of the pasteurization process. Products are also examined to determine the amounts of certain nutrients they contain, including protein, fat, vitamins and carbohydrates. In addition, the cleanliness of the factory, storage conditions and employees must be monitored.

 

Food products and beverages must be transported in specially equipped vehicles, for which sanitary registration documents must have been issued. Adherence to transportation and storage requirements is a very important component of securing delivery of a quality product from producer to consumer’s table, especially during the summer months.

 

Packaging Material and Labeling Requirements

 

Manufacturers and suppliers of all types of packaging materials used in the production of dairy and juice products must provide certificates of conformity and sanitary-epidemiological certificates for packaging materials showing that the packaging materials are permitted and safe for contact with the food products.

 

The Law on the Protection of Consumers’ Rights and the Law on Quality and Safety of Food Products determine the scope and format of the information that should be made available to consumers. According to these laws and other applicable national standards, the packaging of finished products must contain the following information: the name of the product, information regarding its certification, conditions of use (if necessary), contraindications (if any), preservatives and food additives, net mass or volume, ingredients, nutritional value, conditions of storage, shelf life, name and address of the manufacturer and other information. The law also authorizes a wide range of government and public agencies to monitor producers’ compliance with the requirements of the law and imposes sanctions and penalties if such requirements are not met.

 

Special Requirements for Children’s Dairy Products

 

The Law on the Quality and Safety of Food Products defines children’s food products as food products specially designed for children under 14 that meet certain nutritional requirements. Such products are subject to more stringent sanitary-epidemiological standards. For example, certain ingredients and components are prohibited for use in children’s food products, and the procedures for monitoring raw materials and ingredients used in manufacturing, technological processes and sanitary conditions of production are stricter for children’s dairy products than for other dairy products. Laboratory analyses and tests must be conducted for a broader list of microbiological indicators. Packaging materials for children’s dairy products must be certified for use with children’s products. Children’s dairy products are also subject to special labeling requirements. For example, packaging of children’s dairy products must bear information on the purpose and conditions of use of such products.

 

Under the Sanitary Rules on Children’s Food Products, which became effective on June 1, 2005, the volume of liquid food product packaging for children under three years old cannot

 

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exceed 0.35 liters. In addition, such products may be produced only by separate specialized factories or manufacturing lines that are subject to special certification.

 

Competition and Pricing

 

The Federal Antimonopoly Service is the governmental agency that regulates the prevention and limitation of monopolistic activity and the support of competition in the market. The Federal Law on the Protection of Competition prohibits the abuse of a dominant market position to limit competition. Following the sudden and, in some cases, substantial increases in food prices in 2007, FAS initiated inspections of food producers, including us, as well as distributors and retail chains throughout Russia in order to determine whether these price increases were caused by price collusion among producers and retailers. Regional divisions of FAS have undertaken inspections of our operations in Omsk, Voronezh, St. Petersburg, Krasnoyarsk, Ufa and Moscow. Although said inspections have been resolved positively for us, we cannot guarantee that the analogous proceedings will not be instituted in the future and as a result we will not be held liable.

 

In addition, FAS may categorize a company controlling over 50% of a market or otherwise able to control the market conditions as a dominant force in such market. Companies controlling over 35% are listed by FAS in a special register and may become subject to monitoring and reporting requirements with respect to such markets. Current Russian legislation does not clearly define “market” in terms of the types of services or the geographic area.

 

Our babyfood business is categorized as a monopoly in Moscow and the Moscow region, placing restrictions on our ability to increase our profit margins for that business. Our Moscow-based subsidiary, Moscow Baby Food Plant was included on the list of entities holding dominant position in the Moscow region baby food market. In 2007, we merged Moscow Baby Food Plant into our Moscow-based subsidiary Wimm-Bill-Dann and received all requisite approvals from FAS for such merger. Although Moscow Baby Food Plant no longer exists, it remains on the list of entities holding dominant position in the Moscow region baby food market. Wimm-Bill-Dann, however, has not been categorized by FAS as an entity holding dominant position in the Moscow region babyfood market. Any future ruling that Wimm-Bill-Dann or any of our other businesses are a monopoly could result in the regulation of our prices and restrictions on our commercial activities. Although the Company is not currently included in the local or national FAS registry we cannot guaranty that we will not be included in such registry in the future.

 

Because of our significant market position, the Federal Antimonopoly Service monitors our activities and our subsidiaries are required to notify the Federal Antimonopoly Service on the monthly basis on our milk products prices and raw milk prices. We are also required to notify the Federal Antimonopoly Service and/or apply for its prior approval for the acquisition of other companies.

 

See “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business and Industry—Further restrictions on our babyfood business which is categorized as a monopoly, the extension of monopoly status to our other businesses, or a finding that we or our distributors have violated antimonopoly laws could result in further regulation of our prices and restriction on our commercial activities”  and “—Any finding by FAS that our businesses have acted in violation of the antimonopoly laws may result in the imposition of substantial fines and the imposition of government-determined prices, restrictions on our activities or expansion, or government-mandated withdrawal from regions or markets where we currently operate, which could have a material adverse effect on our business, financial condition, results of operations and prospects.”

 

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Trade Law

 

On February 1, 2010, the Federal Law “On framework of state regulation of trading activities in the Russian Federation,” or the Trade Law, came into force. The Trade Law introduces a number of new requirements in respect of manufacturers, distributors and chain retailers in the sphere of food products that may significantly affect our operations. These requirements include, among other things, a prohibition on unfair competition and other discriminatory activities, requirements relating to the content and terms of supply agreements, as well as provisions on the regulation of prices and retail margins by Russian governmental authorities. In particular, according to the Trade Law, the federal government can, under certain circumstances, set the maximum retail prices for food products of “social significance” within the territory of one or more regions of Russia for up to 90 days.

 

The Trade Law also limits the remuneration paid under supply contracts by suppliers to distributors or retail chains in the form of bonuses for marketing, promotional and similar activities to a maximum 10% of the price of the acquired food products and prohibits the payment of bonuses for products of social significance altogether. Additionally, the Trade Law requires that we, retailers and distributors disclose on our websites or make available on demand our main supply conditions, including the material terms of supply contracts.

 

Although the Trade Law also contains provisions that may positively affect our relations with chain retailers, including new restrictions on retailers’ ability to charge suppliers for the opportunity to supply new store locations and modifying the range of products supplied, it is too soon to predict the overall impact of the new law.

 

See “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Business and Industry— The Russian government has the power to regulate the prices for goods of social significance, including food products that we make.”

 

C. Organizational Structure

 

The following table sets out our primary production subsidiaries, their countries of incorporation and our aggregate beneficial ownership interest and voting interest in each subsidiary as of April 20, 2010.

 

Plant

 

Ownership
Interest

 

Country of
Incorporation

Wimm-Bill-Dann Plant (1)

 

98.68

%

Russian Federation

Karasuk Dairy Plant

 

93.80

%

Russian Federation

Wimm-Bill-Dann Ukraine (2)

 

98.53

%

Ukraine

Moloko Veidelevki

 

100.00

%

Russian Federation

Tuymazinskiy Dairy Plant

 

85.00

%

Russian Federation

Bishkek Dairy Plant

 

96.10

%

Kyrgyz Republic

Gulkevichy Dairy Plant

 

52.27

%

Russian Federation

WBD Toshkent

 

100.00

%

Republic of Uzbekistan

Bolsherechensk Dairy Plant

 

79.78

%

Russian Federation

Beverage plants

 

 

 

 

Wimm-Bill-Dann Beverages (3)

 

100.00

%

Russian Federation

Essentuki Mineral Water Plant at CMW

 

100.00

%

Russian Federation

Farms

 

 

 

 

Trud

 

96.55

%

Russian Federation

Atamanskoe Farm

 

99.54

%

Russian Federation

Plemzavod Za Mir and Trud

 

100.00

%

Russian Federation

Zavety Ilyicha

 

99.59

%

Russian Federation

Niva

 

94.62

%

Russian Federation

 

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(1) Formerly Lianozovsky Dairy Plant. During 2007 and 2008, the following subsidiaries were merged into Wimm-Bill-Dann: Tsaritsino Dairy Plant, Ufa Dairy Plant, Siberian Milk Dairy Plant, Rubtsovsk Dairy Plant, Siberian Cheese Plant, Nizhny Novgorod Dairy Plant, Baltic Milk Dairy Plant, Nazarovo Dairy Plant, PAG Rodnik, Pervouralsk Dairy Plant, Kursk Babyfood Plant, Moscow Babyfood Plant, Timashevsk Dairy Plant, Vladivostok Dairy Plant, Surgut Dairy Plant, Ochakovo Dairy Plant, Obninsk Dairy Plant, Pavlogradsky Dairy Plant, Krutinsky Dairy Plant, Angarsky Dairy Plant (MOLKA), Anna milk, SP Julia and Va-Bank-2000.

 

(2) Formerly Kiev Dairy Plant No. 3. In 2007 we merged Buryn Powder Milk Plant and Kharkov Dairy Plant into Wimm-Bill-Dann Ukraine.

 

(3) Formerly Ramenskiy Dairy Plant

 

D. Property, Plants and Equipment Production facilities

 

We currently manufacture our products at 37 production facilities, including 31 production sites that produce dairy products, two babyfood production sites, two water production subsidiaries and two plants that produce exclusively juices. We have made substantial investments to maintain and enhance quality, lower costs and increase productivity. Over 2007, 2008 and 2009 we invested approximately $512.9 million in the modernization of our existing production facilities and $27.7 million in the purchase of minority stakes in our existing production subsidiaries.

 

Our main production plants are capable of managing the production of a diverse and evolving product range, enabling us to adapt quickly to changes in consumer demand on a seasonal basis or otherwise. We continue to implement cost-cutting programs at all of our plants and introduce innovative products and packaging formats.

 

We are also reviewing our production staff numbers with the aim of enhancing productivity. Sales per production employee, calculated on the basis of our total headcount, which is a common measure of productivity used in the food industry, was $220,145 per employee in 2007, $287,473 per employee in 2008 and $247,062 per employee in 2009.

 

The following table contains data regarding our main production facilities.

 

Moscow and Moscow region

 

Year of
Acquisition (1)

 

Year of
Building

 

Number of
Production
Lines

 

Wimm-Bill-Dann + Babyfood (2)

 

1995

 

1989

 

198

 

Wimm-Bill-Dann Beverages (3)

 

1997

 

1982

 

14

 

Central Russia (excluding Moscow)

 

 

 

 

 

 

 

(Caucasian Mineral Waters)

 

2005

 

2001

 

3

 

Ural

 

 

 

 

 

 

 

Tuimazy Dairy Plant

 

2002

 

1958

 

9

 

Other CIS countries

 

 

 

 

 

 

 

Wimm-Bill-Dann Ukraine (4)

 

2001

 

1973

 

43

 

Bishkek Dairy Plant

 

2000

 

1990

 

16

 

Tashkent Dairy Plant

 

2004

 

1970

 

9

 

 


(1)          “Acquisition” means the purchase of more than 50% of the issued share capital. Only plants acquired by us as of April 20, 2010 are included in this table.

 

(2)          Formerly Lianozovsky Dairy Plant. In April and May 2007, the following subsidiaries were merged into Wimm-Bill-Dann: Tsaritsino Dairy Plant, Ufa Dairy Plant, Siberian Milk Dairy Plant, Rubtsovsk Dairy Plant, Siberian Cheese Plant, Nizhny Novgorod Dairy Plant, Baltic Milk Dairy Plant, Nazarovo Dairy Plant, PAG Rodnik, Pervouralsk Dairy Plant, Kursk Babyfood Plant, Moscow Babyfood Plant, Timashevsk Dairy Plant, Vladivostok Dairy Plant, Obninsk Dairy Plant, Annino Dairy Plant, Angarsky Dairy Plant (MOLKA), Surgut Dairy Plant and Manros-M. On March 5, 2007, we sold Novokuibyshevskmoloko — our Samara region-based subsidiary.

 

(3)          Formerly Ramenskiy Dairy Plant

 

(4)          Formerly Kiev Dairy Plant 3. In December 2007 Buryn Powder Milk Plant and Kharkov Dairy Plant were merged into Wimm-Bill-Dann Ukraine.

 

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As of December 31, 2009 and 2008 the assets that served as collateral for certain of our short- and long-term loans consisted of the property, plant and equipment with a net book value of $21.6 million and $75.5 million, respectively.

 

Item 4A. Unresolved Staff Comments

 

None.

 

Item 5. Operating and Financial Review and Prospects

 

The following discussion of our financial condition and results of operations is intended to help the reader understand our company, our operations and our present business environment and should be read in conjunction with our consolidated financial statements, related notes and other information included elsewhere in this document. In particular, we refer you to the risks discussed in “Item 3. Key Information—D. Risk Factors” for information regarding governmental, economic, fiscal, monetary or political policies or factors that could materially adversely affect our operations or your investment in our shares and ADSs. In addition, this section contains forward looking statements that involve risk and uncertainties. Our actual results may differ materially from those discussed in forward looking statements as a result of various factors, including those described under “Item 3. Key Information—D. Risk Factors” and “Cautionary Statement Regarding Forward Looking Statements.” Our reporting currency is the U.S. dollar and our consolidated financial statements have been prepared in accordance with U.S. GAAP.

 

Russian Business Environment

 

The Russian economy is vulnerable to market downturns and economic slowdowns elsewhere in the world. The recent global financial crisis has resulted in capital markets instability, significant deterioration of liquidity in the banking sector, and tighter credit conditions within Russia in 2008 and the following economic downturn adversely affected our financial condition in 2009.

 

The current economic environment is challenging and we believe that the outlook for the next several years presents significant challenges in terms of sales volume and pricing as well as input costs. Specifically, the current economic conditions create uncertainty about (1) the level of demand for our products; (2) the pricing of major commodities manufactured by us; (3) the exchange rate between the ruble and the U.S. dollar and its impact on our financial condition.

 

We believe we have taken measures to deal with the uncertainties in our operating environment and that our operating cash flows in 2010 will be sufficient to allow us continue to operate in the normal course of business including routine working capital and priority capital projects, assuming the successful managing of our debt.

 

Business Structure

 

We have organized our business into three segments:

 

·                  the dairy segment, comprising the production and sale of milk, yogurts, desserts and other dairy products, it also provides processing services to our beverage segment. The dairy segment also includes our agricultural subsidiaries;

·                  the beverages segment, comprising the production and sale of juice, nectars, traditional berry-juice-based drinks, mineral water and other beverage products;

·                  the babyfood segment, comprising the production of liquid dairy babyfood, juice, purees and products for pregnant and nursing women.

 

The table below sets forth by segment our key dairy, beverage and babyfood subsidiaries:

 

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Plant

 

Voting
Interest

 

Country of
Incorporation

 

Dairy plants

 

 

 

 

 

Wimm-Bill-Dann Plant (including merged Moscow Babyfood Plant, relating to Babyfood segment)

 

98.68

%

Russian Federation

 

Karasuk Dairy Plant

 

93.80

%

Russian Federation

 

Wimm-Bill-Dann Ukraine

 

98.53

%

Ukraine

 

Moloko Veidelevki

 

100.00

%

Russian Federation

 

Tuymazinskiy Dairy Plant

 

85.00

%

Russian Federation

 

Bishkek Dairy Plant

 

96.10

%

Kyrgyz Republic

 

Gulkevichy Dairy Plant

 

52.27

%

Russian Federation

 

WBD Toshkent

 

100.00

%

Republic of Uzbekistan

 

Bolsherechensk Dairy Plant

 

79.78

%

Russian Federation

 

Farms

 

 

 

 

 

Trud

 

96.55

%

Russian Federation

 

Atamanskoe Farm

 

99.54

%

Russian Federation

 

Plemzavod Za Mir and Trud

 

100.00

%

Russian Federation

 

Zavety Ilyicha

 

99.59

%

Russian Federation

 

Niva

 

94.62

%

Russian Federation

 

Beverage plants

 

 

 

 

 

Wimm-Bill-Dann Beverages

 

100.00

%

Russian Federation

 

Essentuki Mineral Water Plant at CMW

 

100.00

%

Russian Federation

 

 

Exchange Rates

 

The appreciation in real terms of the ruble against the U.S. dollar tends to result in an increase in our reportable costs and revenues, while depreciation of the ruble against the U.S. dollar in real terms tends to result in a decrease in our reportable costs and revenues. Following the general economic downturn, the ruble depreciated against the U.S. dollar in 2009 by 2.9%, based on the exchange rate as of December 31, 2009 as compared to the exchange rate as of December 31, 2008. This generally resulted in a decrease in the reported U.S. dollar value of our ruble-denominated assets and liabilities. The ruble depreciated by 27.8% against the U.S. dollar based on the average exchange rate in the year ended December 31, 2009 as compared to the average exchange rate in the year ended December 31, 2008. This generally results in a decrease in the reported U.S. dollar value of our ruble-denominated sales and operating expenses. Additionally, nominal depreciation of the ruble against the U.S. dollar has a similar effect when income statements of our non-U.S. dollar-denominated subsidiaries are translated into U.S. dollars while preparing our consolidated financial statements. As a result of ruble depreciation, we recognized a translation loss of $15.5 million in 2009, compared to a loss of $129.7 million in 2008 and gain of $41.0 million in 2007. See also “Item 3. Key Information—D. Risk Factors—Risks Relating to Our Financial Condition— Ruble depreciation could increase our hard-currency-denominated costs, decrease our cash reserves, or make it more difficult for us to comply with financial ratios and to repay our debts and will affect the value of dividends received by holders of ADSs” and Note 2 to our Consolidated Financial Statements included elsewhere herein for a description of our currency translation methodology.

 

A. Operating Results

 

Overview

 

We are one of the largest Russian manufacturers of dairy, beverage and babyfood products, with sales of $2,181.1 million, $2,823.6 million and $2,438.3 million in 2009, 2008 and 2007, respectively. Our reportable business segments in 2009 were dairy products, beverage products and babyfood products, which comprised 70.2%, 18.6% and 11.2% of our sales, respectively. Our principal geographic market is Russia, which accounted approximately for 92.0%, 93.0% and 93.0% of our sales in each of 2009, 2008 and 2007. We also have production facilities and

 

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distribution chains in the CIS countries of Ukraine, Kyrgyzstan, Uzbekistan and Georgia, as well as a distribution center in Kazakhstan.

 

Our products are typically priced in rubles for Russian sales and in local currencies for our sales in other CIS countries. Our direct costs, including personnel, utility and transportation expenses are incurred primarily in rubles, while direct materials costs are incurred primarily in rubles and U.S. dollars.

 

In 2009, our net income, attributable to WBD Foods shareholders increased by 14.6% to $116.5 million from $101.7 million in 2008 primarily due to a combination of favorable factors, such as raw milk purchase prices decline in the first through the third quarter of 2009 and decrease of juice concentrates prices in 2009, and selling prices growth in the beverages and babyfood segments.

 

 Our sales decreased by 22.8% in 2009, including year-on-year sales decreases of 27.0%, 14.1% and 4.0% in the dairy, beverage and babyfood segments, respectively. Ruble selling prices increased by 1.4% in the dairy segment, 4.6% in the beverages segment and 0.9% in the babyfood segment.  However, the average dollar selling price declined by from $1.44 to $1.11, or 22.9% per 1 kilogram in the dairy segment, from $0.93 to $0.76, or 18.2% per liter in the beverages segment and from $2.30 to $1.82, or 20.5% per 1 kilogram in the babyfood segment in the full year 2009 compared to 2008. By volume, dairy segment sales decreased by 8.0%, beverage segment sales increased by 5.0% and babyfood segment sales increased by 21.5% in the year ended December 31, 2009 as compared to the year ended December 31, 2008.

 

Our selling and distribution expenses decreased in 2009 as compared to 2008 and slightly increased as a percentage of sales, from 17.3% to 17.4%. In particular, transportation tariffs tended to decline in 2009 whereas in 2008 we experienced transportation tariffs growth. This factor allowed us to decrease our transportation costs in 2009.

 

Over the past three years, we have been constructing new capacity, modernizing existing capacity. Our capital expenditures (excluding acquisitions) in 2009, 2008 and 2007 were $121.8, $195.3 and $192.7 million, respectively. Expenditures for acquisitions of noncontrolling stakes in certain of our subsidiaries, in 2009, 2008 and 2007 totaled $2.6, $3.3 and $21.8 million, respectively.

 

As of December 31, 2009, we had a total of $523.9 million in outstanding debt (consisting of loans, notes payable and vendor financing obligations). The short-term portion of our debt comprised 42.1% of our total indebtedness as of December 31, 2009. Additionally, of our total indebtedness as of December 31, 2009, 52.2% was denominated in foreign currency and 47.8% was denominated in rubles.

 

Below is a summary of our operational highlights for 2009 and the beginning of 2010.

 

Corporate and Operational Highlights for 2009

 

January

 

·

We changed our supply and production processes for all dairy products in accordance with new technical regulations in Russia, which came into force on December 31, 2008.

 

 

 

 

 

 

·

We launched the new brand “Zdraivery” targeting children aged 4-9 years old with a wide portfolio of products, including traditional dairy products, yogurt, and dairy desserts, juice and smoothies.

 

 

 

 

 

 

·

We launched the production of “Rodniki Rossii” brand mineral water sourced from the Essentuki region of Russia.

 

 

 

 

February-

 

·

We re-designed the entire line of “Chudo” products significantly improving

 

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December

 

shelf visibility.

 

 

 

 

·

We successfully installed and put into operation 19 production lines at our production sites, including: ERMI, ARSIL, A3 Speed and Trepko. The new lines will enhance production efficiency of high-quality and complex products.

 

 

 

March

·

We carried out the re-branding of “Agusha”, one of the most popular babyfood brands in Russia with the aim of enhancing the brand awareness. We have improved the design for better visibility on shelf and improved its attractiveness.

 

 

 

 

·

We launched a new line of yogurts and desserts under “BioMax” brand.

 

 

 

 

·

We repaid our ruble-denominated bonds in the amount of 4,660.3 million rubles ($158.6 million or $129.9 million at the exchange rate as of December 31, 2008 or March 6, 2009, the date of repayment, respectively).

 

 

 

May-June

·

We issued bonds on MICEX, raising cash of 3 billion rubles, ($96.9 million at the exchange rates at the dates of the transactions). The bonds are due in February 2013, and bondholders have a put option exercisable in September 2010 at 100% of the nominal value plus accrued interest.

 

 

 

May

·

We were ranked among the Top-40 companies globally for corporate reputation. WBD was ranked 37th globally by Forbes magazine and the Reputation Institution in their 2009 survey of the World’s Most Reputable Companies survey.

 

 

 

June

·

We received a strong corporate governance score from Standard & Poor’s. Standard & Poor’s Governance Services affirmed its governance, accountability, management, metrics and analysis (GAMMA) score of ‘GAMMA-7+’ on a 10-point scale.

 

 

 

October

·

We opened a dairy factory in Tbilisi, Georgia

 

 

 

 

·

We installed and put into operation a warehouse management system in Nizhny Novgorod and Kazan.

 

 

 

 

·

As part of the ongoing process of reorganizing our Sales and Distribution function we formed a Local Key Accounts Department to better serve our local customers.

 

 

 

November

·

We carried out a split of our ADSs, whereby the ratio was changed from 1 common share per 1 ADS to 1 common share per 4 ADSs. The split did not affect the number of common shares outstanding.

 

 

 

November-December

·

We implemented new terms and conditions for our distributors in Central Region, including a reduction in mark-ups for distributors when on-selling to sub-distributors and retailers.

 

 

 

December

·

We finished reconstruction of the Moscow Baby Food plant.

 

 

 

 

·

We launched compote and mors beverages under the “Agusha” brand

 

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Corporate and Operational Highlights for 2010

 

January

·

We launched sales of packed sliced cheese under our Lamber brand

February

·

We launched production of pasteurized milk in PET bottles under the “Domik v Derevne” brand.

February-March

·

We implemented new terms and conditions for our distributors in the South, Urals, Siberia and Far East regions.

April

·

Standard & Poor’s Governance Services affirmed governance, accountability, management, metrics and analysis (GAMMA) score of ‘GAMMA-7+’, noting positive developments in the on-going deployment of the Company’s risk management system and increase in the activity of the board-level corporate governance committee.

 

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Results of Operations

 

The following table summarizes the results of our operations for the years ended December 31, 2009, 2008 and 2007:

 

 

 

2009
(in thousands)

 

% of
sales

 

2008
(in thousands)

 

% of
sales

 

2007
(in thousands)

 

% of
sales

 

Sales

 

$

2,181,062

 

100.0

 

$

2,823,564

 

100.0

 

$

2,438,328

 

100.0

 

including:

 

 

 

 

 

 

 

 

 

 

 

 

 

Dairy

 

1,530,247

 

70.2

 

2,095,900

 

74.2

 

1,852,458

 

76.0

 

Beverages

 

406,609

 

18.6

 

473,196

 

16.8

 

414,117

 

17.0

 

Baby Food

 

244,206

 

11.2

 

254,468

 

9.0

 

171,753

 

7.0

 

Cost of sales

 

(1,452,737

)

66.6

 

(1,910,528

)

67.7

 

(1,654,879

)

67.9

 

Gross profit

 

728,325

 

33.4

 

913,036

 

32.3

 

783,449

 

32.1

 

Selling and distribution expenses

 

(379,659

)

17.4

 

(488,110

)

17.3

 

(387,853

)

15.9

 

General and administrative expenses

 

(137,440

)

6.3

 

(171,400

)

6.1

 

(180,922

)

7.4

 

Other operating expenses

 

(9,552

)

0.4

 

(8,383

)

0.3

 

(704

)

0.0

 

Operating income

 

201,674

 

9.2

 

245,143

 

8.7

 

213,970

 

8.8

 

Financial income and expenses, net

 

(43,224

)

2.0

 

(101,504

)

3.6

 

(16,851

)

0.7

 

Provision for income taxes

 

(40,678

)

1.9

 

(39,898

)

1.4

 

(54,302

)

2.2

 

Consolidated net income

 

117,772

 

5.4

 

103,741

 

3.7

 

142,817

 

5.9

 

Noncontrolling interests

 

(1,237

)

0.1

 

(2,029

)

0.1

 

(2,769

)

0.1

 

Net income attributable to WBD Foods shareholders

 

$

116,535

 

5.3

 

$

101,712

 

3.6

 

$

140,048

 

5.7

 

 

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

 

In evaluating our operating results, we exclude the impact of currency translation as our primary statement of income accounts are denominated in Russian rubles so it is more meaningful to evaluate these figures without the impact of currency.  In order to exclude currency translation effects, we compare the current year results to the prior year using a fixed average exchange rate.

 

Sales

 

Sales decreased by 22.8% to $2,181.1 million in 2009 from $2,823.6 million in 2008. The dairy business is our largest segment, representing 70.2% of sales in 2009 compared to 74.2% in 2008.

 

 

 

Year ended December 31,

 

 

 

2009

 

% of
 sales

 

2008

 

% of
sales

 

 

 

(in thousands)

 

(in thousands)

 

Dairy products

 

$

1,530,247

 

70.2

 

$

2,095,900

 

74.2

 

Beverage products

 

406,609

 

18.6

 

473,196

 

16.8

 

Babyfood

 

244,206

 

11.2

 

254,468

 

9.0

 

Total sales

 

$

2,181,062

 

100.0

 

$

2,823,564

 

100.0

 

 

Decline in customers’ personal income and overall stagnation in the national economy as a result of general economic downturn adversely affected our sales.

 

The majority of our sales prices are stated in rubles. As a result, ruble depreciation against the U.S. dollar adversely affected our revenues when reported in U.S. dollars. Ruble depreciation in 2009 caused a decrease in our dairy segment sales by approximately $424.2 million, beverages segment sales by approximately $111.2 million and babyfood segment sales by approximately $67.8 million. The general economic downturn materially adversely affected both our sales volume and selling price as a result of changes in consumers’ preferences and switched demand to low-margin, economy-class products primarily in our dairy segment.

 

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Sales in our dairy segment decreased by 27.0% to $1,530.2 million in 2009 compared to $2,095.9 million in 2008. Our sales volume decreased by 116 thousand tons or 8.0% to 1,337 thousand tons in 2009 from 1,453 thousand tons in 2008 primarily due to a raw milk shortage on the Russian market in the fourth quarter of 2009. The average dollar selling price decreased by 21.8% from $1.44 per kilogram in 2008 to $1.11 per kilogram in 2009, driven mainly by adverse effect of the ruble depreciation against the U.S. dollar. However, our average ruble prices per kilogram increased in 2009 in comparison with 2008 by 0.49 ruble per kilogram, or 1.4% from 35.8 ruble per kilogram to 36.3 ruble per kilogram, as a result of raw milk prices growth in the fourth quarter of 2009, driven by a shortage of raw milk on the Russian market.

 

Sales in our beverages segment decreased by $66.6 million, or 14.1% to $406.6 million in 2009 compared to $473.2 million in 2008.Our beverages segment sales volume increased by 25 thousand liters or 5.0% to 534 million liters in 2009 compared to 509 million liters in 2008. The average dollar selling price decreased by 18.1% from $0.930 per liter in 2008 to $0.761 per liter in 2009, driven primarily by the adverse effect of ruble depreciation against the U.S. dollar, which was partly off-set by the combination of favorable factors, including a 4.6% increase in ruble selling prices for our beverages segment products, 5.0% increase in sales volume and the improvements in our product mix.

 

Sales in our babyfood segment decreased by $10.3 million, or 4.0% to $244.2 million in 2009 from $254.5 million in 2008. Babyfood sales volume increased by 24 thousand tons, or 21.5% to 135 thousand tons in 2009 compared to 111 thousand tons in 2008 as a result of re-branding of “Agusha” brand and our leading positions on the babyfood market. The average selling price decreased by 20.5% from $2.30 per kilogram in 2008 to $1.82 per kilogram in 2009.

 

In 2009, 55.9% of our sales came from regions other than Moscow, compared to 56.0% in 2008. Regional sales represented 57.7%, 63.7% and 31.5% of dairy, beverages and babyfood segment revenues in 2009, respectively. We have focused for several years on sales growth in the regions through the expansion of our distribution and production capabilities in various regions, as well as certain CIS countries.

 

Cost of Sales

 

Cost of sales primarily consists of expenses relating to raw materials (raw milk for dairy and babyfood products, concentrates for juices and packaging materials for all products), which accounted for 80.0% and 83.9% of our total cost of sales in 2009 and 2008, respectively. The table below sets forth these costs for both 2009 and 2008:

 

 

 

Year ended December 31,

 

 

 

2009

 

%

 

2008

 

%

 

 

 

(in thousands)

 

(in thousands)

 

Raw materials

 

$

1,162,897

 

80.0

 

$

1,602,540

 

83.9

 

Personnel

 

88,392

 

6.1

 

111,789

 

5.9

 

Depreciation and amortization

 

75,491

 

5.2

 

82,459

 

4.3

 

Utilities

 

39,541

 

2.7

 

53,177

 

2.8

 

Goods for resale

 

38,687

 

2.7

 

4,529

 

0.2

 

Other

 

47,729

 

3.3

 

56,034

 

2.9

 

Total cost of sales

 

$

1,452,737

 

100.0

 

$

1,910,528

 

100.0

 

 

Raw-material costs decreased by 27.4% in 2009. Raw materials also decreased as a percentage of sales to 53.3% in 2009 from 56.8% in 2008. Raw-material costs accounted for 55.9% of dairy sales in 2009 compared to 59.2% in 2008. This decline was primarily caused by significant ruble depreciation against the U.S. dollar, which favorably affected our raw-material costs by approximately $213.9 million, and the continued decrease in raw milk prices which began at the end of 2008 and continued through the third quarter of 2009. However, it was off-set by a sharp increase in raw milk prices in the fourth quarter of 2009 driven by a shortage of raw milk on the

 

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Russian market. Raw-material costs accounted for 41.0% of babyfood sales in 2009 compared to 44.4% in 2008, primarily as a result of raw materials prices decrease in 2009. Raw-material costs decreased to 51.2% of beverage sales in 2009, compared to 52.7% in 2008 due to the decrease in the price of juice concentrates.

 

Our dairy and babyfood segments purchases of package materials and fruit concentrates, which are primarily denominated in hard-currencies, grew in 2009 in comparison with 2008, which resulted in an increase of share of hard-currency-denominated raw materials costs. In particular, 78.3% of our raw material costs were ruble-denominated and 21.7% were hard-currency-denominated in 2009, whereas 87.7% of these costs were ruble-denominated and 12.3% were hard-currency denominated in 2008. In the beverages segment, 16.7% of our raw material costs were ruble-denominated and 83.3% were hard-currency-denominated in 2009, and 21.6% of our raw material costs were ruble-denominated and 78.4% were hard-currency denominated in 2008.

 

Personnel expenses decreased by 20.9% in 2009 compared to 2008 due to our decreased employee headcount and the depreciation of the ruble against the U.S. dollar, which decreased our ruble-denominated personnel costs in U.S. dollar terms. The average number of production personnel decreased in 2009 by 10.1% to 8,828 compared to 9,822 in 2008 due to the staff optimization process which continued in 2009.

 

Depreciation and amortization decreased by 8.5% from $82.5 million in 2008 to $75.5 million in 2009 as a result of ruble depreciation against the U.S. dollar (favorable effect $21.0 million), which was partly off-set by depreciation charge of the capital expenditures we made in the fourth quarter of 2008 and in 2009 in order to increase our production capacity by improving our facilities and overall infrastructure.

 

Utility costs decreased by 25.6% in 2009 primarily due to significant depreciation of the ruble against the U.S. dollar in 2009, as our utility costs are incurred primarily in rubles.

 

Goods for resale increased to $38.7 million in 2009 compared to $4.5 million in 2008 due to a significant growth in the volume of co-packing products we sold as a result of the shortage of raw milk supplies in the fourth quarter of 2009.

 

Selling and Distribution Expenses

 

Selling and distribution expenses decreased by 22.3% in 2009 compared to 2008. As a percentage of sales, selling and distribution expenses increased to 17.4% in 2009 from 17.3% in 2008. Our selling and distribution expenses in 2009 and 2008 were as follows:

 

 

 

Year ended

 

 

 

December 31,

 

 

 

2009

 

2008

 

 

 

(in thousands)

 

Advertising and marketing

 

$

139,532

 

$

142,312

 

Personnel

 

92,223

 

120,183

 

Shipping and handling

 

89,086

 

135,598

 

Warehouse

 

14,787

 

13,285

 

Materials and supplies

 

458

 

13,124

 

Bad debt expense

 

4,511

 

8,156

 

Other

 

39,062

 

55,452

 

Total selling and distribution expenses

 

$

379,659

 

$

488,110

 

 

Advertising and marketing expenses decreased in 2009 by 2.0% or $2.8 million in absolute terms, and increased by 1.4% as a percentage of sales to 6.4% in 2009 from 5.0% in 2008. The decrease in expenses was caused by significant depreciation of the ruble against the U.S. dollar and decrease in the media inflation rates in 2009. However, our ruble-denominated marketing and advertisement expenses increased mainly due to our continued investments in major and new brand promotions. The increase was primarily attributable to TV advertising expenses due to the

 

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increased volume of TV advertisements placed on Russia’s leading national television channels in 2009.

 

Personnel expenses decreased by 23.3% in 2009 compared to 2008. The average number of employees in our selling and distribution department decreased to 5,224 in 2009 from 6,005 in 2008 mainly due to the headcount optimization process that continued into 2009. As majority of our personnel expenses are denominated in rubles, significant depreciation of the ruble against the U.S. dollar favorably affected our personnel costs. Our payroll cost per employee per annum in our selling and distribution department decreased by 11.8% to $17,654 in 2009 from $20,014 in 2008, mainly due to reduction of personnel headcount and depreciation of the ruble against the U.S. dollar in 2009. Our personnel costs as a percentage of sales decreased to 4.2% in 2009 from 4.3% in 2008.

 

Shipping and handling costs, which primarily consist of external transportation costs, decreased by 34.3% in 2009, compared to 2008. Our transportation expenses as a percentage of sales slightly decreased to 4.1% in 2009 from 4.8% in 2008. The decrease in transportation costs was mainly caused by depreciation of the ruble against the U.S. dollar, and by slight decrease in shipping rates in 2009.

 

Our bad debt expenses slightly decreased to 0.2% as a percentage of sales in 2009 from 0.3% in 2008 primarily due to improved debt collectability in 2009. See also “B. Liquidity and Capital Resources—Critical Accounting Policies and Estimates—Allowance for Doubtful Accounts” below.

 

General and Administrative Expenses

 

General and administrative expenses decreased by 19.8% in 2009 compared to 2008, and increased as a percentage of sales to 6.3% in 2009 from 6.0% in 2008. Our general and administrative expenses in 2009 and 2008 were as follows:

 

 

 

Year ended

 

 

 

December 31,

 

 

 

2009

 

2008

 

 

 

(in thousands)

 

Personnel

 

$

76,710

 

$

81,972

 

Taxes other than income tax

 

13,916

 

17,127

 

Depreciation

 

11,869

 

17,700

 

Audit, consulting and legal fees

 

5,653

 

11,985

 

Materials and supplies

 

709

 

4,570

 

Communication costs

 

3,835

 

4,489

 

Rent

 

1,209

 

3,695

 

Other

 

23,539

 

29,862

 

Total general and administrative expenses

 

$

137,440

 

$

171,400

 

 

Personnel expenses decreased by 6.4%, primarily as a result of the depreciation of the ruble against the U.S. dollar and decrease in the average number of employees, which was partly off-set by severance payments. The average number of employees decreased to 2,247 in 2009 compared to 2,658 in 2008 due to our continued employee headcount optimization efforts, which resulted in the severance payments in accordance with labor agreements.

 

Depreciation expense decreased by 32.9% from $17.7 million in 2008 to $11.8 million in 2009, as a result of ruble depreciation against the U.S. dollar (by approximately $3.3 million), and a one-off transaction related to office facility upgrades, incurred in 2008 as part of our capital investments program budget. We completed our office assets renovation program in 2008 and no significant upgrades were undertaken in 2009.

 

Our expenses for audit, consulting and legal services decreased by 52.8% in 2009 compared to 2008, as result of the cost optimization scheme.

 

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Other Operating Expenses

 

Other operating expenses increased to $9.6 million in 2009 from $8.4 million in 2008, mainly as a result of intangible assets, previously treated as indefinite-lives trademarks, impairment loss recognized as part of amortization expense.

 

Operating Income

 

Operating income decreased by 17.7% to $201.7 million in 2009 from $245.1 million in 2008, as a result of ruble depreciation against the U.S. dollar. In particular, the ruble depreciation against the U.S. dollar by 27.8% adversely affected our operating results in 2009 in comparison with those in 2008. The general economic downturn materially adversely affected both our sales volume and selling price as a result of changes in consumers’ preferences and switched demand to low-margin, economy-class products primarily in our dairy segment. As a percentage of sales, operating income increased from 8.7% in 2008 to 9.2% in 2009, primarily as a result of gross profit margin growth.

 

Earnings before Interest, Taxation, Depreciation and Amortization (EBITDA)

 

We present EBITDA because we consider it an important supplemental measure of our operating performance. EBITDA represents net income before interest, income taxes and depreciation and amortization, adjusted for interest income, foreign currency exchange gain and losses, bank charges and other financial expenses and noncontrolling interest. EBITDA margin is EBITDA expressed as a percentage of sales.

 

Our consolidated EBITDA decreased by $54.4 million or 15.1% from $361.0 million in 2008 to $306.6 million in 2009 because of ruble depreciation against the U.S. dollar, which adversely affected our EBITDA by $85.1 million, which was partly off-set by combination of favorable factors, such as raw milk purchase prices decline in the first through the third quarter of 2009 and stable decrease of juice concentrates prices in 2009, ruble-denominated selling prices growth by 1.4%, 4.6% and 0.9% in the dairy, beverages and babyfood segments, respectively, and volume growth by 21.5% and 5.0% in the babyfood and beverages segments, respectively.

 

Our consolidated EBITDA margin increased by 1.3% from 12.8% in 2008 to 14.1% in 2009 as a result of selling prices growth and decrease of cost of sales.

 

EBITDA is a non-U.S. GAAP financial measure. The following table reconciles EBITDA to net income attributable to WBD Foods shareholders and EBITDA margin to net income attributable to WBD Foods shareholders as a percentage of sales.

 

 

 

Year ended December 31,

 

 

 

2009

 

% of
sales

 

2008

 

% of
 sales

 

 

 

(in thousands)

 

(in thousands)

 

Net income, attributable to WBD Foods shareholders

 

$

116,535

 

5.3

 

$

101,712

 

3.6

 

Add: Depreciation and amortisation

 

104,883

 

4.8

 

115,823

 

4.1

 

Add: Income tax expenses

 

40,678

 

2.0

 

39,898

 

1.4

 

Add: Interest expenses

 

33,467

 

1.5

 

44,544

 

1.6

 

Less: Interest income

 

(4,595

)

(0.2

)

(6,648

)

(0.2

)

Add: Foreign exchnage losses, net

 

11,616

 

0.5

 

61,357

 

2.2

 

Add: Bank charges

 

2,687

 

0.1

 

2,868

 

0.1

 

Add: Noncontrolling interest

 

1,237

 

0.1

 

2,029

 

0.1

 

Add:Loss (gain) on other financial income/expenses

 

43

 

0.01

 

(617

)

(0.02

)

EBITDA

 

$

306,551

 

14.1

 

$

360,966

 

12.8

 

 

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Financial Income and Expenses

 

Financial income and expenses comprised the following:

 

 

 

Year ended

 

 

 

December 31,

 

 

 

2009

 

2008

 

 

 

(in thousands)

 

Interest expense

 

$

33,467

 

$

44,544

 

Interest income

 

(4,595

)

(6,648

)

Foreign currency losses (gains), net

 

11,616

 

61,357

 

Bank charges

 

2,687

 

2,868

 

Other financial expenses (income), net

 

49

 

(617

)

Total financial income and expense, net

 

$

43,224

 

$

101,504

 

 

Interest expense decreased by 24.9% in 2009 compared to 2008. This was mainly due to ruble depreciation against the U.S. dollar and a reduction in our average debt, which primarily consists of $250 million syndicated loan, received in April 2008, whereas our debt in 2008 additionally included notes payable that we repaid in 2009.

 

We received interest income of $4.6 million in 2009 compared to $6.6 million in 2008. Income was received from short-term investing of free cash accumulated for repayment of our ruble-denominated bonds, commencing in 2010.

 

In 2009 and 2008 our net income, attributable to WBD Foods shareholders was negatively affected by currency exchange rate fluctuations resulting in an $11.6 million and $61.4 million, respectively. The net foreign exchange loss primarily arose from our U.S. dollars denominated debt. In 2009 the average U.S. dollar rate appreciated by 27.8% against the ruble, and the average euro rate appreciated by 21.4% against the ruble in 2009, while the average U.S. dollar rate appreciated by 19.9% against the ruble, and the average euro rate appreciated by 15.3% against the ruble in 2008.

 

Provision for Income Taxes

 

Our provision for income taxes for the years ended December 31, 2009 and 2008 was as follows:

 

 

 

Year ended

 

 

 

December 31,

 

 

 

2009

 

2008

 

 

 

(in thousands)

 

Current provision

 

$

44,058

 

$

39,844

 

Deferred income tax charge/(benefit)

 

(3,380

)

54

 

Total provision for income taxes

 

$

40,678

 

$

39,898

 

 

Provision for income taxes amounted to $40.7 million in 2009 and $39.9 million in 2008. These provisions comprise current income tax charges of $44.1 million in 2009 and $39.8 million in 2008, and a deferred tax benefit of $3.4 million in 2009 and expense of $0.1 million in 2008. Deferred tax benefits and charges arise on temporary differences between the bases of computing income under domestic tax principles and U.S. GAAP.

 

Effective January 1, 2009 the statutory income tax rate in Russia was reduced down to 20% from 24%. In the view of this change, we evaluated our deferred income tax assets and liabilities at the 20% income tax rate as of December 31, 2008. Resulting from that change in rate, the net deferred income tax expense decreased by $3.4 million in 2008.

 

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The relationship between pretax earnings for financial reporting purposes and taxable income for income tax purposes, for the years ended December 31, 2009 and 2008 was as follows:

 

 

 

Year ended
December 31,

 

 

 

2009

 

2008

 

 

 

(in thousands)

 

Income before provision for income taxes

 

$

158,450

 

$

143,639

 

Russian statutory tax rate

 

20

%

24

%

Income tax provision at Russian statutory rate

 

31,690

 

34,473

 

Tax effect of expenses not deductible for national statutory taxation purposes

 

10,695

 

13,238

 

Tax effect of income not taxable for national statutory taxation purposes

 

(668

)

(3,193

)

Tax effect of income tax at different rates

 

1,517

 

(1,290

)

Increase (decrease) in valuation allowance

 

464

 

(1,594

)

Tax effect of income tax rate change

 

 

(3,446

)

Tax effect of other permanent differences

 

(3,020

)

1,710

 

Provision for income taxes

 

$

40,678

 

$

39,898

 

 

For Russian income tax purposes, certain of our subsidiaries have accumulated tax losses incurred in 2004-2009, which may be carried forward for use against their future income within 10 years. There are no restrictions for use of accumulated tax losses. As of December 31, 2009, for statutory income tax purposes, we had $47.0 million in tax losses available to carry forward expiring as follows:

 

 

 

(in thousands)

 

December 31, 2010

 

$

20,712

 

December 31, 2011

 

1,696

 

December 31, 2012

 

2,256

 

December 31, 2013

 

1,710

 

December 31, 2014 and thereafter

 

20,658

 

Total loss carryforward

 

$

47,032

 

 

Noncontrolling Interest

 

The noncontrolling interest reflects the net income and losses of our subsidiaries that are attributable to the noncontrolling interests in those subsidiaries. In 2009, net income attributable to noncontrolling interests in our subsidiaries decreased to $1.2 million from $2.0 million in 2008. Of these amounts, net income attributable to the noncontrolling interests in the dairy segment was $1.0 million in 2009 and $1.5 million in 2008, respectively. The decrease in noncontrolling interest was generally due to our acquisition of shares from minority shareholders.

 

Net Income Attributable to WBD Foods Shareholders

 

Net income attributable to WBD Foods shareholders increased in 2009 to $116.5 million (5.3% of sales) from $101.7 million (3.6% of sales) in 2008, primarily due to a reduction of foreign currency exchange losses by $49.7 million in 2009 and combination of favorable factors which off-set adverse effect of ruble depreciation against the U.S. dollar, such as raw milk purchase price decline in the first through the third quarter of 2009 and decrease of juice concentrates prices in 2009, ruble-denominated selling prices growth by 1.4%, 4.6% and 0.9% in the dairy, beverages and

 

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babyfood segments, respectively, and volume growth by 21.5% and 5.0% in the babyfood and beverages segments, respectively.

 

Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

 

Sales

 

Sales increased by 15.8% to $2,823.6 million in 2008 from $2,438.3 million in 2007. The dairy business was our largest segment, representing 74.2% of sales in 2008 compared to 76.0% in 2007.

 

 

 

Year ended December 31,

 

 

 

2008

 

% of
 sales

 

2007

 

% of
 sales

 

 

 

(in thousands)

 

(in thousands)

 

Dairy products

 

$

2,095,900

 

74.2

 

$

1,852,458

 

76.0

 

Beverage products

 

473,196

 

16.8

 

414,117

 

17.0

 

Babyfood

 

254,468

 

9.0

 

171,753

 

7.0

 

Total sales

 

$

2,823,564

 

100.0

 

$

2,438,328

 

100.0

 

 

The majority of our sales prices are stated in rubles. Following this fact, ruble depreciation against the U.S. dollar adversely affected our revenues when reported in U.S. dollars. As a result, the effect of this factor on our 2008 reportable sales was a decrease of our dairy segment sales by approximately $49.2 million, beverages segment sales by approximately $11.1 million and babyfood segment sales by approximately $6.0 million.

 

Sales in our dairy segment increased by 13.1% to $2,095.9 million in 2008 compared to $1,852.5 million in 2007. We sold 1,453 thousand tons of dairy products in 2008 and 1,599 thousand tons of dairy products in 2007. The average selling price increased by 24.6% from $1.158 per kilogram in 2007 to $1.443 per kilogram in 2008 driven mainly by average ruble price growth — a result of launching new high-margin products.

 

Sales in our beverages segment increased by 14.3% to $473.2 million in 2008 compared to $414.1 million in 2007. We sold 509 million liters of juice and water in 2008 and 491 million liters of juice and water in 2007. The average selling price increased by 10.2% from $0.844 per liter in 2007 to $0.930 per liter in 2008, driven primarily by a combination of favorable factors, such as price, volume and mix.

 

Sales in our babyfood segment increased by 48.2% to $254.5 million in 2008 from $171.8 million in 2007 and this was driven by both favorable volume and price factors. We sold 110.9 thousand tons of babyfood products in 2008 and 87.4 thousand tons in 2007. The average selling price increased by 16.7% from $1.966 per kilogram in 2007 to $2.295 per kilogram in 2008.

 

In 2008, 56% of our sales revenues came from regions other than Moscow. Regional sales represented 56%, 67% and 28% of dairy, beverages and babyfood segment revenues in 2008, respectively. We have focused for several years on sales growth in the regions through the expansion of our distribution and production capabilities in various regions, as well as certain CIS countries.

 

Cost of Sales

 

Cost of sales primarily consists of expenses relating to raw materials (raw milk for dairy and babyfood products, concentrates for juices and packaging materials for all products), which accounted for 83.9% and 84.9% of our total cost of sales in 2008 and 2007, respectively. The table below sets forth these costs for both 2008 and 2007:

 

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Year ended December 31,

 

 

 

2008

 

%

 

2007

 

%

 

 

 

(in thousands)

 

(in thousands)

 

Raw materials

 

$

1,602,540

 

83.9

 

$

1,405,801

 

84.9

 

Personnel

 

111,789

 

5.9

 

90,207

 

5.5

 

Depreciation and amortization

 

82,459

 

4.3

 

65,879

 

4.0

 

Utilities

 

53,177

 

2.8

 

42,554

 

2.6

 

Goods for resale

 

4,529

 

0.2

 

7,341

 

0.4

 

Other

 

56,034

 

2.9

 

43,097

 

2.6

 

Total cost of sales

 

$

1,910,528

 

100.0

 

$

1,654,879

 

100.0

 

 

 

Raw-material costs increased by 14.0% in 2008. Raw materials decreased as a percentage of sales to 56.8% in 2008 from 57.7% in 2007. Raw-material costs accounted for 59.2% of dairy sales in 2008 compared to 60.3% in 2007. This was primarily caused by a reduction in raw-milk prices in 2008 in comparison with the fourth quarter of 2007. Raw-material costs accounted for 44.4% of babyfood sales in 2008 compared to 44.3% in 2007. Raw-material costs increased to 52.7% of beverage sales in 2008, compared to 51.4% in 2007 due to the growth in prices for juice concentrates.

 

In the dairy and babyfood segments, 87.7% of our raw material costs were ruble-denominated and 12.3% were hard-currency-denominated in 2008, whereas 85.0% of these costs were ruble-denominated and 15.0% were hard-currency denominated in 2007. In the beverages segment, 21.6% of our raw material costs were ruble-denominated and 78.4% were hard-currency-denominated in 2008, and 21.2% of our raw material costs were ruble-denominated and 78.8% were hard-currency denominated in 2007.

 

Personnel expenses increased by 23.9% in 2008 compared to 2007. The average number of production personnel decreased in 2008 by 11.3% to 9,822 compared to 11,076 in 2007 due to continuing staff departures within costs optimization process in 2008.

 

Depreciation and amortization increased by 25.2% from $65.9 million in 2007 to $82.5 million in 2008, reflecting the significant capital expenditures we have been making to increase our production capacity by improving our facilities and overall infrastructure.

 

Utility costs increased by 25.0% in 2008 due to larger production and warehousing facilities, as well as an increase in electricity and gas tariffs.

 

Selling and Distribution Expenses

 

Selling and distribution expenses increased by 25.8% in 2008 compared to 2007. As a percentage of sales, selling and distribution expenses increased to 17.3% in 2008 from 15.9% in 2007. Our selling and distribution expenses in 2008 and 2007 were as follows:

 

 

 

Year ended

 

 

 

December 31,

 

 

 

2008

 

2007

 

 

 

(in thousands)

 

Advertising and marketing

 

$

142,312

 

$

137,965

 

Personnel

 

120,183

 

83,901

 

Shipping and handling

 

135,598

 

111,228

 

Bad debt expense

 

13,285

 

11,534

 

Materials and supplies

 

13,124

 

11,249

 

Warehouse

 

8,156

 

1,650

 

Other

 

55,452

 

30,326

 

Total selling and distribution expenses

 

$

488,110

 

$

387,853

 

 

Advertising and marketing expenses increased in 2008 by 3.2% or $4.3 million in absolute terms, and decreased by 0.7% as a percentage of sales to 5.0% in 2008 from 5.7% in 2007. The

 

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increase in expenses was due our continued investments into major brand promotions and a launch of a range of new products. The increase was primarily attributable to TV advertising expenses due to the increased volume of TV advertisements placed as well as growth in advertising prices on Russia’s leading national television channels, which, in 2008, exceeded 50%. Despite this media advertising price inflation, we were able to obtain volume discounts and manage the cost increases more effectively.

 

Personnel expenses increased by 43.2% in 2008 compared to 2007. The average number of employees in our selling and distribution department increased to 6,005 in 2008 from 5,712 in 2007 mainly due to the development of our sales network in 2008. Our payroll cost per employee increased by 36.3% to $20,014 in 2008 from $14,689 in 2007, mainly due to implementation of a performance based reward system, increase of salaries as well as continually enhancing the quality and developing our regional sales force in 2008. Our personnel costs as a percentage of sales increased to 4.3% in 2008 from 3.4% in 2007.

 

Shipping and handling costs, which primarily consist of external transportation costs, increased by 21.9% in 2008, compared to 2007. Our transportation expenses as a percentage of sales slightly increased to 4.8% in 2008 from 4.6% in 2007. The increase in transportation costs was mainly due to the expansion of our sales volumes in the regions and increased transportation tariffs (in particular, for motor transportation - by 12-15%, railway — by 20%, air — by 30%).

 

Our bad debt expenses increased to 0.3% as a percentage of sales in 2008 from 0.1% in 2007 primarily due to the fact that we used more co