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

 6/18/09  Wimm Bill Dann Foods Ojsc         20-F       12/31/08   18:5.2M                                   Merrill Corp-MD/FA

Document/Exhibit                   Description                      Pages   Size 

 1: 20-F        Annual Report of a Foreign Private Issuer           HTML   2.58M 
 2: EX-1.1      Charter of Wimm-Bill-Dann Foods Ojsc Restated       HTML    248K 
                          Version, Approved September 9, 2008                    
 3: EX-4.2      Contract P81044, Dated March 1, 2008, by and        HTML     92K 
                          Between Cjsc Tetra Pak and Oao                         
                          Wimm-Bill-Dann.                                        
 4: EX-4.2.1    Annex 2 to Contract P81044, Dated March 1,2008, by  HTML     44K 
                          and Between Cjsc Tetra Pak and Oao                     
                          Wimm-Bill-Dann                                         
 5: EX-4.2.2    Annex 3 to Contract P81044, Dated March 1,2008, by  HTML     45K 
                          and Between Cjsc Tetra Pak and Oao                     
                          Wimm-Bill-Dann                                         
 6: EX-4.2.3    Annex 4 to Contract P81044, Dated March 1,2008, by  HTML     71K 
                          and Between Cjsc Tetra Pak and Oao                     
                          Wimm-Bill-Dann                                         
 7: EX-4.2.4    Annex 5 to Contract P81044, Dated March 1,2008, by  HTML     18K 
                          and Between Cjsc Tetra Pak and Oao                     
                          Wimm-Bill-Dann                                         
 8: EX-4.2.5    Annex 1.4 to Contract P81044, Dated March 1,2008,   HTML    219K 
                          by and Between Cjsc Tetra Pak and Oao                  
                          Wimmbilldann                                           
 9: EX-4.3      Contract P81055, Dated March 1, 2008, by and        HTML     88K 
                          Between Cjsc Tetra Pak and Oao                         
                          Wimm-Bill-Dann Beverages                               
10: EX-4.3.1    Amendment No.1 to the Addendum No.4 to Contract     HTML     55K 
                          P81055, Dated March 1, 2008.                           
11: EX-4.3.2    Annex 4 to Contract P81055, Dated March 1,2008, by  HTML     84K 
                          and Between Cjsc Tetra Pak and Oao                     
                          Wimm-Bill-Dann                                         
12: EX-4.3.3    Additional Agreement 8 to Contract No P81055,       HTML     16K 
                          Dated March 1,2008.                                    
13: EX-4.3.4    Annex 1.5 to Contract No P81055, Dated March        HTML     84K 
                          1,2008.                                                
14: EX-8.1      List of Subsidiaries of Wimm-Bill-Dann Foods Ojsc   HTML     40K 
15: EX-12.1     Certification by the CEO Pursuant to Section 302    HTML     18K 
                          of the Sarbanes-Oxley Act of 2002                      
16: EX-12.2     Certification by the CFO Pursuant to Section 302    HTML     18K 
                          of the Sarbanes-Oxley Act of 2002                      
17: EX-13.1     Certification of the CEO Pursuant to 18 U.S.C.      HTML     13K 
                          Section 1350, as Adopted Pursuant to                   
                          Section 906                                            
18: EX-13.2     Certification of the CFO Pursuant to 18 U.S.C.      HTML     13K 
                          Section 1350, as Adopted Pursuant to                   
                          Section 906                                            

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 20-F

 

 

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:

 

 

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

 

NONE

(Title of Class)

 

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	44
Item 4A.Unresolved Staff Comments	73
Item 5.Operating and Financial Review and Prospects	73
Item 6.Directors, Senior Management and Employees	104
Item 7. Major Shareholders and Related Party Transactions	113
Item 8. Financial Information	114
Item 9. Offer and Listing Details	117
Item 10.Additional Information	118
Item 11. Quantitative and Qualitative Disclosures about Market Risk	142
Item 12. Description of Securities Other than Equity Securities	145
PART II	146
Item 13. Defaults, Dividend Arrearages and Delinquencies	146
Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds	146
Item 15.Controls and Procedures	146
Item 16A.Audit Committee Financial Expert	150
Item 16B.Code of Ethics	150
Item 16C. Principal Accountant Fees and Services	150
Item 16D. Exemption from the Listing Standards for Audit Committees	152
Item 16E.Purchases of Equity Securities by the Issuer and Affiliated Purchasers	152
Item 16F. Change in Registrant’s Certifying Accountant	153
Item 16G. Corporate Governance	153
PART III	157
Item 17.Financial Statements	157
Item 18.Financial Statements	157
Item 19. Exhibits	158

 

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.

 

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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.

 

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The inflation rate in 2008 was affected by several factors relating to the world financial crisis, including adverse trends in pricing, certain administrative decisions of the CBR.

 

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 2008, 2007 and 2006, the ruble appreciated in real terms against the U.S. dollar as follows:

 

		2008		2007		2006
Inflation (1)		13.3	%	11.5	%	9.7	%
Nominal appreciation of the ruble relative to the U.S. dollar (1)		3.1	%	6.3	%	4.0	%
Real appreciation/ (depreciation) of the ruble relative to the U.S. dollar (1)		(19.9	)%	6.7	%	8.5	%

 

(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 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.

 

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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 turmoil in the financial markets, 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.”

 

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 current market conditions 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 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 results of operations and financial condition could be materially adversely affected.

 

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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.

 

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

 

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

 

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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, 2008 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 beverages consumption in Russia continues to increase, our beverages product sales volume decreased in 2005 and stayed almost flat in 2006 due to market competition from other domestic producers and increased activity by foreign producers. Although our beverages sales volume increased year-on-year by 10.4% in 2007 and 3.7% in 2008, continued and/or increased competition among juice and bottled water producers in Russia may cause future decline in the sales volumes of our beverages products, as well as affect our beverages prices and profit margins and, consequently, may 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 is very competitive, with more than 20 significant brands in 3 fairly distinct price tiers, and also with noticeable private label offerings. As a result, prices are under pressure, and with the exception of increases for raw materials inflation, price increases in rubles are relatively rare. In terms of raw materials, most juice concentrate, and even sugar, are international commodities and are normally denominated in U.S. dollars or euro. Over 2005, 2006, and 2007, following the international growth trend experienced in general, prices for these commodities were increasing significantly year on year. Towards the end of 2008 prices seemed to be stabilizing, and we believe that in the near term raw material prices are more likely to fall than increase. Nonetheless, while a return to economic growth may be good for revenue, it could also signal increases in raw material prices, which could put pressure on our juice products gross profit margins and, consequently, adversely affect our results of operations.

 

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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 2006, 2007 and 2008. In addition, the uncertainty surrounding oil prices has lead to increased instability and unpredictable fluctuations in fuel and transportation costs.

 

In 2003, legislation was enacted which sets out the framework for the reorganization of the Russian Railways Ministry into OAO Russian Railroads, a joint-stock company, to be followed by the eventual privatization of certain of its functions. This reorganization and privatization have not been completed in accordance with the timetable contemplated in the legislation and it is not clear whether they will be completed at all. However, if the privatization of Russian Railroads or other factors result in increased railway transport costs, thereby decreasing our profit margins, our business and results of operations could be materially adversely affected.

 

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, and ultimately our failure 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. 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 services could negatively affect this brand image, which could lead to loss of market share and revenues. In addition, 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.

 

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 and shortages of packaging and raw materials could have a material

 

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adverse effect on our results of operations. For example, our results of operations may be affected by the availability and pricing of packaging materials, principally cardboard and plastic containers, and raw materials, principally raw milk and juice concentrate. 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. Moreover the substantial amount of packaging materials we are buying, as well as other raw materials, for example juice concentrates are denominated in euro and/or U.S. dollars. Exchange rate changes have made packaging materials and other raw materials more expensive for us as the vast majority of our revenues are denominated in rubles.

 

Our success also depends on our continued ability to be an effective advertiser in a market where media inflation on the leading national television channels exceeded 31% in 2008. A substantial increase in the prices of any of the foregoing, 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. The devaluation 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.

 

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 during this time period.

 

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

 

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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. Although raw milk prices were stable during 2008, we cannot guarantee that they will not increase further in the future. 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.

 

Russian federal and regional governments may regulate the prices of certain goods that are considered to have “social significance.”  There is an established list of basic food products that are deemed to have “social significance,” including dairy products such as certain types of milk and kefir. For example, 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 to May 1, 2008 with prices fixed at the January 2008 level it was not extended and at the moment it is expired. Although this arrangement with the Russian government 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, any future price regulations by the Russian government of raw 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 and 2008, babyfood purchases by the Moscow City Government comprised approximately 26% and 18% 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 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, two of Russia’s largest supermarket chains, Perekryostok and Pyatyorochka, merged in April 2006, 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 this merger, we cannot guarantee that we will not experience adverse consequences in the future. A number of large

 

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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. In addition, retailers in Russia typically charge food and beverage producers, including us and our competitors, for shelf space. If retailers give higher priority to other brands, purchase less of, or even refuse to buy, our products, seek substantial discounts, charge unreasonable prices for shelf space, fail to offer sufficient shelf space, or devote inadequate promotional support to our brands, it could lower our turnover and reduce our competitiveness and profitability.

 

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 2007 and 2008 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

 

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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 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. See “Item 5. Operating and Financial Review and Prospects —A. Operating Results— Corporate and Operational Highlights for 2008” for a description of the new Enterprise Resource Planning, or ERP system we are currently implementing.

 

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

 

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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.

 

As of June 16, 2009, we had 89 pending trademark applications in Russia and 24 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 investing plans, excluding expenditures for acquisitions, we invested approximately $130.0 million in 2006, $192.7 million in 2007 and $195.3 million in 2008. We spent approximately $137.3 million in 2006 and $21.8 million in 2007 on acquisitions and approximately $3.3 million in 2008 for the buy out of minority shareholders. 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, especially 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. 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 to 30%). 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.

 

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

 

As of June 16, 2009, to our knowledge, approximately 44.20% 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 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 as long as they hold, either directly or indirectly, a majority of our shares, they will control 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 can 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.

 

Recently adopted 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 new 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 twelfth largest advertiser in 2006 and the tenth largest advertiser in 2007 and 2008. In 2006, 2007 and 2008 over 50% of our advertising expenditures related to television advertisements. At the same time, media inflation in Russia has been

 

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significant in recent years, exceeding 35% in 2006 and 50% in 2007 and 2008. Imposition of the new law, coupled with overall media inflation in Russia, is likely to continue to increase our advertising expenses. The increased cost of advertising, along with the decreased availability of advertising time slots, may also lead to a decrease in our television advertising which, consequently, could have a material adverse effect on our business, financial condition and results of operations.

 

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, as we own a substantial number of our other subsidiaries through Wimm-Bill-Dann, (formerly Lianozovsky Dairy Plant) and as Wimm-Bill-Dann constitutes the majority of our production capacity, its loss would materially adversely affect our prospects, business and results of operations.

 

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 98.2% of the 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 the 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 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 liquidation of a legal

 

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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.

 

For example, in Russian corporate law, negative net assets calculated on the basis of Russian Accounting Standards as at the end of the second or any subsequent year of a company’s operation can serve as a basis for a court to order the liquidation of the company upon a claim by governmental authorities. 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. 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.

 

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 possible 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 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 which were enacted in 2001 subjected in a 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

 

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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.

 

On December 19, 2008, the new technical regulations for all dairy products, including drinking milk, fermented dairy products, cheese, butter, margarine, yogurts and dairy deserts came into force. Recent 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.

 

On October 27, 2008, a new federal law, “On the technical regulation for juice production from fruits and vegetables,” was adopted and came into force on April 27, 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 and 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. These regulations also contain 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 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 against them, which would 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

 

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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 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 was 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 respective approvals from FAS for such merger. Although Moscow Baby Food Plant no longer exists it is still on the list of entities holding dominant position in the Moscow region baby food market. Wimm-Bill-Dann was not categorized by FAS as entity holding dominant position in the Moscow region baby food market, but any 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.

 

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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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.

 

To date, the regional divisions of FAS have undertaken inspections of our operations in Omsk, Voronezh, St. Petersburg and Ufa.

 

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 proceedings and administrative proceedings in which the St. Petersburg regional FAS alleged that we were engaging in unwarranted price increases for our finished products, as well as purchasing raw milk at below-market levels and assessed fines against us totaling $1.0 million. The investigation in St. Petersburg resulted in 4 antimonopoly litigations and 4 administrative litigations based on two of the abovementioned antimonopoly litigations. One of the antimonopoly proceedings was ceased by St. Petersburg regional FAS. The other antimonopoly proceeding was successfully appealed by us and was found invalid as well as one administrative proceeding based on it and we are waiting that the other administrative proceeding based on this antimonopoly proceeding will also be found invalid. We appealed the other two antimonopoly proceedings which are currently pending as well as administrative proceeding based on one of them. In Krasnoyarsk, the regional FAS has requested that we provide information on the price at which we purchased raw milk this request did not result in any investigation or proceeding against us. In March 2009, the regional FAS in Ufa conducted an investigation against our branch there trying to find some provisions of our distribution contract violating antimonopoly legislation that resulted in proceedings against us for competition-blocking. The proceeding is currently pending.

 

In June 2008, FAS initiated a new investigation into dairy producers, including us, connected with a decline in raw milk purchasing prices trying to investigate whether there was any collusion among milk producers to drive down the prices paid to suppliers. Although we believe this decline is due to seasonal factors, 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

 

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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 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. For example, in January 2006, we acquired a 20% stake in our subsidiary Moscow Babyfood Plant OJSC, from minority shareholders for cash consideration of $7.0 million increasing our beneficial ownership to 97.34%. In January 2005, we acquired a 10% stake in our subsidiary Siberian Dairy Plant from minority shareholders for cash consideration of $1.1 million increasing our beneficial ownership to 87.1%. In March and April 2004, we acquired a total additional 6.2% of our subsidiary Tsaritsino Dairy Plant from our minority shareholders for cash consideration of $3.4 million increasing our beneficial ownership to 97.6%. In addition, we acquired a 47.7% interest in our subsidiary Ufa Dairy Plant in September 2003 from minority shareholders for cash consideration of $3.1 million increasing our beneficial ownership to 96.5%.

 

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Should we proceed to consolidate our businesses, we may trigger a legal requirement that we redeem shares on shareholders’ demand. According to amendments to the Federal Law on Joint-Stock Companies, which came into effect on July 1, 2006, a holder of more than 95% of shares in an open joint-stock company has the right to buy out the remaining shares from the minority shareholders for cash consideration equal to the amount determined by an independent appraiser. The new amendments also require a person purchasing 30%, 50%, 75% or more shares in an open joint-stock company to offer to other shareholders of this entity to sell their 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 cash consideration of $3.3 million and 0.60% of ordinary shares and 1.16% of preferred shares in Nazarovo Dairy Plant for cash consideration of approximately $0.4 million for both stakes, a 33.51% stake in Obninsk Dairy Plant for cash consideration of $11.9 million and a 13.24% stake in Angarsk Dairy Plant for cash consideration of $0.8 million.

 

In 2008, we acquired an additional 2.6% interest in WBD Beverages for cash consideration of $3.3 million. As a result of this transaction, we obtained 100% control in WBD Beverages.

 

Although we are and strive to be in compliance with all regulations related to consolidation, we can not guarantee that some of our minority shareholders may bring claims against us. See “Item 4. Information on Our Company—A.History and Development” for a description of our subsidiary mergers in 2008 and 2009.

 

Risks Relating to Our Financial Condition

 

We may be adversely affected by the current economic environment.

 

As a result of the credit market crisis (including uncertainties with respect to financial institutions and the global capital markets), 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 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.

 

Since the summer of 2007, 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, and continue to be depressed as of the date of this annual report. 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 current downturn in the global financial markets has also caused some companies to experience difficulties accessing their cash equivalents, trading investment securities, drawing on revolvers, issuing debt and raising capital generally. A continuation of this downturn 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.

 

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Inflation could increase our costs and decrease our operating margins.

 

The Russian economy has been characterized by high rates of inflation, and the World Bank forecasted inflation to reach between 11%-13% in Russia in 2009. As we tend to 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 require us to repay our debt to them in the event of deterioration in our financial condition.

 

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

 

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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 million syndicated loan agreement, bank loans and obligations under equipment financing. As of December 31, 2008, our consolidated total debt was approximately $673.2 million, of which $75.5 million was secured by equipment. Our interest expense for the year ended December 31, 2008 was $44.5 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.

 

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. 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.”

 

We may not be able to generate sufficient cash flow or access international capital markets or incur additional indebtedness to enable us to service or repay our indebtedness or to fund our other liquidity needs. We may 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 there from may not be sufficient to meet our debt-service obligations. 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 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.

 

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Over the past 15 years, the ruble has fluctuated, at times substantially over short periods of time, against the U.S. dollar and, in particular, it has significantly depreciated against the U.S. dollar in 2008 as a result of the ongoing global financial crisis. For example, on December 31, 2008, the official exchange rate published by the CBR was 29.38 rubles per one U.S. dollar, as compared to 24.55 rubles per one U.S. dollar on January 1, 2008. Furthermore, various press reports suggest that the ruble will continue to depreciate against the U.S. dollar through 2009, and as of June 16, 2009, the exchange rate was 31.15 rubles per one U.S. dollar. The ruble has also depreciated against the euro. On June 16, 2009, the official exchange rate was 43.30 rubles per one euro, as compared to 41.44 rubles per one euro on January 1, 2008.

 

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 either 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.

 

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 results of operations.

 

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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 financial crisis, we face an increased risk that our customers and/or debtors may refuse to or 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 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.

 

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.

 

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 have claimed, among other things, that these suppliers are, 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 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.

 

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Although the court ruled against us in the first two instances, the court of the third instance ruled in our favor and remanded the case back to the court of first instance for consideration. After being reconsidered in the court of first instance, we appealed the decisions of the courts that partially upheld our claims to the Constitutional Court of the Russian Federation, claiming that the existing tax practice is inconsistent with the Russian Constitution. The case is currently pending.

 

In addition, in 2008 the Russian tax authorities carried out an audit of Wimm-Bill-Dann for fiscal years 2004 through 2006 and found some of our suppliers negligent in paying or complying with their tax obligations and 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. The court proceeding is still pending.

 

To the best of our knowledge, in December 2008, the Moscow Regional service of the Russian Interior Ministry launched an investigation against us for alleged tax code violations. We believe that this investigation is based on an assessment by the Russian tax authorities for the fiscal years 2004 through 2006. We believe that there is no legal basis for this investigation, and we have lodged an appeal with the Moscow City Prosecutor’s Office. The investigation is currently pending. 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.

 

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 due 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.

 

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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. According to Standard & Poor’s, which in October 2008 revised the outlook on its long-term sovereign credit rating for the Russian Federation from “stable” to “negative,” Russia is at risk of recording a deficit by 2009. In addition to anticipated slower asset growth on the Russian banking market, the Russian Federation is facing significant inflation, a significant decline in stock prices and a substantial outflow of capital from the country. The Russian government and the CBR provide financial support only to a limited number of banks, which may result in the liquidation of other banks and financial institutions. A combination of these factors 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.

 

During the banking crisis in 1998 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 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

 

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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. Moreover, the Ministry of Finance of the Russian Federation is in the process of drafting amendments to the transfer pricing legislation, which may come into force in the near future. The implementation of these amendments are expected to considerably toughen the existing law, as the 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.

 

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 30% of a Russian company’s shares and no more than 25% 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 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.

 

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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 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. For the period from January 1, 2008 to December 31, 2008, the closing price of our ADSs on the New York Stock Exchange has ranged from a low of $13.68 per ADS to a high of $144.40 per ADS.

 

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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 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

 

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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 record 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. 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.

 

Russian thin-capitalization rules could affect our ability to deduct interest on certain borrowings.

 

Russian thin-capitalization rules limit the amount of interest that can be deducted by a Russian company on debt payable to non-resident shareholders. Until January 1, 2006, these rules applied only to loans issued to a Russian company by a foreign company owning directly or indirectly more than 20% of the share capital of the Russian company. However, thin-capitalization rules that came into effect on January 1, 2006 extend the rules’ application to debt issued to a Russian company by another Russian company that is affiliated with such foreign company, as well as to debt issued to a Russian company which is secured by such foreign company or such affiliated Russian company. It is not yet fully clear how these new rules will be applied in practice by the Russian tax authorities.

 

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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 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. For example, the current financial crisis, as well as any future economic downturns or slowturns 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 financial 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 and an increase in the inflation rate. The decline in global prices for raw materials, especially for oil and natural gas, has weakened the government’s finances and may lead to a budget deficit and a decrease in Russia’s GDP in 2009 and beyond.

 

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 one of the Moscow power substations built in 1963 caused a major power outage in a large section of Moscow and some surrounding regions. The blackout disrupted ground electric 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.

 

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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 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

 

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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.

 

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 presses 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 the current financial crisis. 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

 

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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;

·                  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.

 

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, or in 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,

 

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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 criminal and administrative penalties applicable to 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 to this type of sanction, our production capability would suffer significantly and our operating results would suffer.

 

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 securities-related 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. 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

 

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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.

 

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 recharacterization of the transaction. There has been very little further guidance on the interpretation of this concept by the tax authorities or courts, but it is likely that the tax authorities will actively seek 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, there is no assurance that the tax authorities will not 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, recent 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

 

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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 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 recently adopted 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.

 

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B. Business Overview

 

We are one of Russia’s largest manufacturers of food products. Our reportable business segments in 2008 were dairy, beverage and babyfood. In 2008, the dairy segment accounted for 74.2% of our sales, the beverages segment, which includes juice and bottled mineral water, accounted for 16.8% of our sales and the babyfood segment accounted for 9.0% of our sales.

 

Since our founding in 1992, we have become the market leader in Russia in the dairy market and one of the market leaders in the juice market. In the dairy market, according to an AC Nielsen study of 24 major cities, including Moscow and St. Petersburg, we were the market leader at the end of 2008 with a 31.0% market share in value. In the Russian juice market, according to a Business Analytica survey of Russia as a whole, we had a 17.9% market share in value at the end of 2008. In 2008 we strengthened our market leadership in the babyfood market with a 25.0% market share in volume terms (according to MEMRB), while our value share reached 18.3%.

 

We currently have 37 manufacturing facilities in Russia, Ukraine, Kyrgyzstan, Uzbekistan and Georgia as well as distribution centers in 30 cities throughout Russia and the CIS. During 2008, we employed, on average, 18,485 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 control. 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 drinking yogurt, fruit-flavored milk and kefir, 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 2009-2012 is to build upon our strong existing brands (‘brand equity’), established market position, strong management team and organizational resources and

 

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scale within Russia and the CIS in order to increase sales and profitability, realize long-term efficiency gains, strengthen 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 for our industry.

 

Our approach takes into account both the challenges and opportunities presented by global financial downturn and its impact on the economies of Russia and CIS. We are making use of our experience gained during the 1998 financial crisis 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 controls and innovation 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 2012 are aimed at achieving qualitative and quantitative results which increase the shareholder value of the Company and establishing foundation for sustainable growth over a five to ten-year time horizon. As Russia’s leading manufacturer of food products, it is both our core 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 companies in terms of health and nutrition.

 

Among the goals we will endeavor to achieve by 2012 are:

 

·                  our top-10 brands by revenue should be among the top-50 FMCG brands in Russia.

 

·                  newly launched and innovative products should be making a substantial contribution to our revenue, while we should have enhanced the market positions of our top existing brands in dairy, beverages and babyfood.

 

·                  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.

 

·                  we will 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 Strategies

 

Our strategy is focused on the core principles of Growth, Efficiency and Winning Organization. These principles are relevant across all of our business units as well as departments serving the group as a whole, including Marketing, Sales, Operations, Finance, Human Resources, Research and Development and Corporate Communications. These key elements are as follows:

 

·                  Growth: growing brands to increase market share in all segments, grow margins and profit and increase our future potential in the marketplace via:

 

·          Focused marketing: make our strategic brands truly national, optimizing our portfolio and channeling investment and other resources to core brands which will serve as a base for innovation and entry into new categories and segments;

 

·          Increased market share: seek to have the best product offering in leading product categories as well as making the requisite investments in marketing to grow the

 

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equity of our brands and allow for accelerated innovation and further quality improvements;

 

·          M&A: enter new product categories and geographic markets through carefully selected acquisitions;

 

·          Driving margins and profitability: intelligently manage pricing and volume mix, optimize input costs (recipes, raw materials and packaging) and better manage discounts and bonuses;

 

·          Improved route-to-market: further develop a winning distribution model while aiming to achieve status as best supplier for our partners and superior sales execution in key cities and channels.

 

·                  Efficiency: optimizing the supply chain, increasing the efficiency of our assets and reducing working capital via:

 

·          Cost optimization: reduce supply-chain and procurement costs, cut the unit cost of manufacturing and optimize production lines while making the best use of existing assets;

 

·          Strict management of working capital: reduce inventories and increase the effectiveness of expenditure through tight controls over capital investments as well as marketing and sales costs.

 

·                  Winning organization: build an agile, fast learning team capable of executing well and fast via:

 

·          Developing human potential: provide continuous opportunities for training and further education while developing career plans and identifying key skills;

 

·          Rewarding performance: establish clear incentives for success and space for innovation;

 

·          Creating the right environment: maintain strong corporate culture based on values and creativity, establish clear lines of responsibility and reporting while reducing both the institutions and mindset of bureaucracy wherever possible.

 

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, Canadian dairy and Russian State Statistics, that per capita consumption of packaged dairy products in Russia was approximately 65.3, 67.4 and 65.5 kg per year in 2006, 2007 and 2008, 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. We estimate that per capita consumption of traditional packaged dairy products in Russia decreased by 3% to approximately 52.2 kg in 2008, from approximately 53.8 kg in 2007. The per capita decrease was driven by strong inflation observed in Q4 2007.

 

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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.

 

According to our estimates, annual per capita consumption of yogurts and dairy desserts in Russia was also affected by the inflation in late 2007 and decreased by at least 3% to about 8.4 kg in 2008.

 

According to our estimates, annual cheese consumption (yellow, white and processed) in Russia stayed flat at approximately 4.9 kg per capita in 2008.

 

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. The milk processing sector, however, still remains fragmented, and currently includes over 1,400 registered producers compared to 1,600 in 2006, according to the official register of manufacturers. The process of consolidation in the sector is under way, with the less efficient producers going out of business or being acquired by larger companies.

 

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 desserts was growing at a higher rate than the traditional dairy market. It is also developing to cater to changing consumer tastes with more attention being paid to fresh health and wellness products.

 

We have made significant investments in the development of our own farms and also establishing long-term relationships with third-party raw milk suppliers. These steps help us to address the seasonal problem of raw milk deficits and increase the quality of the raw milk we purchase. The government has also started 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

 

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packaging and ingredients. While Russian juice consumption levels have recovered from the effects of the 1998 financial crisis, it is still relatively low compared to most European countries.

 

We estimate that annual per capita juice and mineral water product consumption in Russia in 2008, 2007 and 2006 was approximately 21.0 liters, 21.1 liters and 18.7 liters, respectively, based on data of Business Analytica and Canadean.

 

Consumption of bottled water in Russia is now on par with juice consumption. We believe that Russia has strong growth potential in this sector in comparison with per capita consumption in developed markets.

 

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 a majority of the foreign companies to leave the market, and also forced 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 2008, 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 84% share of the juice market. The industry has been experiencing consolidation, as demonstrated by the increase in acquisition activity. According to the Business Analytica survey, during 2008, there were more than 200 brands of juice products in the Russian juice market, although 10 of them accounted for 72% of the market. 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 2008, the top-ten bottled water producers in Russia had jointly a 67% market share in Moscow and a 61% 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;

 

·                  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. 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

 

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the birth of their second and following children. More and more Russian women go back to work shortly after giving birth. Many of them rely on ready-to-eat babyfood.

 

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 with additional types of products being introduced and increased consumption due to the increasing birth rate in Russia.

 

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 74.2%, 16.8% and 9.0% of our net sales in 2008, respectively. Our principal geographic market is Russia, with Moscow being the most significant one. The following table sets forth our annual consolidated net sales, the proportion of consolidated net sales accounted for by our main business lines, our reported annual production volumes and their growth rates:

 

		2008		2007		2006
Dairy products
Sales (in million USD)		2,095.9		1,852.5		1,320.9
Annual sales growth (% year on year)		13.1	%	40.2	%	31.6	%
Percent of total sales		74.2	%	76.0	%	75.0	%
Sales volume (in th. tons)		1,453		1,599		1,354
Annual volume growth (% year on year)		(9.2	)%	18.2	%	13.2	%
Beverage products
Sales (in million USD)		473.2		414.1		324.1
Annual sales growth (% year on year).		14.3	%	27.8	%	6.9	%
Percent of total sales		16.8	%	17.0	%	18.4	%
Sales volume (in million liters)		509		491		445
Annual volume growth (% year on year)		3.7	%	10.3	%	2.1	%
Baby food products
Sales (in million USD)		254.5		171.8		117.2
Annual sales growth (% year on year)		48.2	%	46.6	%	33.5	%
Percent of total sales		9.0	%	7.0	%	6.6	%
Sales volume (in th. tons)		111		87		66
Annual volume growth (% year on year)		27.5	%	31.9	%	14.7	%
Total net sales (in million USD)		2,823.6		2,438.3		1,762.1

 

Dairy Products and Brands

 

Our principal dairy product lines, types of products, principal brands, and their approximate percentage of our total dairy revenue in 2008, 2007 and 2006 are as follows:

 

Product line		Main brands		Approximate percentage of total dairy in 2008		Approximate percentage of total dairy in 2007		Approximate percentage of total dairy in 2006
Essential Dairy		“Vesely Molochnik”, “M”, “Kubanskaya Burenka”, “33 Cows”, “Pastushok”		41	%	41	%	39	%
Value-Added Dairy		“Little House in the Village”, “Beauty”, “Imunele”, “Chudo”, “Bio-Max”, “Lamber”, “Mazhitel”		59	%	59	%	61	%

 

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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 which each market segment covers:

 

Production 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”		“Beauty”, “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”		“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 the premium segment of the market we launched a broad selection of products throughout 2004 and 2005, including our flagship functional product Imunele. In 2007, we extended our functional range to include Beauty with aloe vera, the first product of its kind on the Russian dairy market.

 

Market trends and competition. According to our estimates, the total market for packaged dairy products in Russia was 9.3 billion liters in 2006, 9.6 billion liters in 2007. In 2008, the market declined to 9.3 billion liters due to significant price increases, caused by the growth of global raw milk prices at the end of 2007. Over the short-term, we believe that consumption may stay flat or even decline due to the current economic downturn and the potential reduction of household incomes in Russia. At the same time, given existing low per capita consumption, we see this market segment as providing 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.

 

While a certain degree of consolidation is taking place in the Russian dairy industry, the milk processing sector in Russia remains fragmented and includes more than 1,400 large, medium and small enterprises. Due to the high degree of fragmentation, the market is very competitive in pricing terms. 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

 

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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 and strengthening marketing investment have increased public awareness and loyalty to our products and will 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 an AC Nielsen study of 24 major cities, including Moscow and St. Petersburg, we were the market leader at the end of 2008 with a 31.0% market share in volume terms*. In the traditional dairy market, we lead the market with a 30.3% market share in volume terms. In the enriched dairy market, our share was 25.0% in volume terms at the end of 2008. In yogurts and desserts, we were the market leader with 44.2% in volume terms.

 

In traditional dairy, we compete primarily with local producers, such as Unimilk, Voronezhsky M.K. (Molvest), as well as with a number of smaller regional producers. In enriched dairy, we compete primarily with Groupe Danone. In the segment 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:

 

·          Groupe Danone, a French company which is the most active foreign producer in Russia and aggressively promotes its products. It has a dairy plant in the Volga region where it produces yogurts, as well as a dairy plant in the Moscow region. We understand that Danone may have plans to build a new plant in Siberia. 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. According to the AC Nielsen study of 24 cities, in 2008, Danone had a 12.3% market share in yogurts and desserts in volume terms and a 7.2% 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 study of 24 cities, in 2008, Unimilk had a 14.9% market share in traditional dairy, a 7.9% market share in yogurts and desserts and 14.7% 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 study of 24 cities, Ehrmann had a 4.1% market share in yogurts and desserts in 2008 in volume terms.

 

·          Voronezhsky M.K., a Russian company producing a wide range of dairy products. Its main brand names are Vkusnoteevo and Ivan Poddubniy. According to the AC Nielsen study of 24 cities, Voronezhsky M.K had a 4.1% market share in traditional dairy and a 3.7% share of the total Russian dairy market in volume terms in 2008.

 

·          Campina is 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!. In May 2008, Campina and Friesland Foods, another large international dairy co-operative, signed a merger agreement. According to the AC Nielsen study of 24 cities, Campina had an 8.0% market share in yogurts and desserts in 2008 and a 1.2% 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 could become our significant competitors.

 

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

 

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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, and Onken launched its own dairy production factory in Russia in 2003. Foreign cheese producers also launched production facilities in 2003, including French company Lactalis and German company Hochland. In 2004, Lactalis acquired Foodmaster International, a company owning 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: strong and diversified brands, stable access to raw milk, a broad distribution network, new product development focus, a substantial in-house R&D department, modern production assets and 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

 

Our principal beverage product lines and types of products and brands are as follows:

 

Product Line		Brands and Types of Products
Juice and nectars produced from juice concentrate		·      “J7,” covering 14 kinds of fruit and berry juices and nectars ·      “100% Gold,” covering 9 kinds of fruit juices and nectars ·      “Lovely Garden,” covering 17 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
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 segments, and WBD juice products are presented in all of them.  We have benefited from investments into “J7” and Essentuki marketing and distribution during 2007 and 2008.

 

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For example, in 2007, we introduced new packaging design and marketing approaches for “J7” branded products. The main packaging for the brand remains Tetra Prisma and PET packaging. The portfolio of “Lovely Garden” was improved and strengthened via additional introductions of ‘Future Consumption’ packs and smaller format 0.5 liter packs, which had not been used previously for “Lovely Garden”. In addition, the use of 2-liter packaging was extended to other flavors and 1.5-liter packs were launched along with the 0.5 liter format in three flavors. “Wonder Berry” remained in 1-liter and 0.33 liter packs. At the end of 2007, we moved from 0.425 liter PET bottles to 0.39-liter formats for “J7” and “Lovely Garden”. A new pack design in new Tetra Prisma packaging was launched for “100% Gold” juices and nectars in the 1-liter format. In 2008, we launched “J7 Imuno” enriched line, “Lovely Garden” line was extended with “Iced Grapefruit” and “Winter Story” seasonal flavors.

 

In 2007, “J7” was repositioned to the premium segment. 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:

 

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 Men and women in the middle to upper-middle income bracket		“J7”		“Wonder Berry”		“J7 Exotic”		“Essentuki”
Value for Money		Aged 20-45 · 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 · Self-confident, rational, but not trend setters		“100% Gold Premium”  “Lovely Garden”		“Lovely Garden”				“Rodniki Rossii”
Econom		Aged 25-45 Men and women typically with children and below average incomes; family oriented		“100% Gold Classic”						“Novoessentukskaya”

 

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. At the end of 2008 we introduced the “Rodniki Rossii” natural drinking water brand.

 

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

 

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water, and offer both still and carbonated waters in a variety of sizes, providing consumers with an enhanced choice.

 

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 2007 was approximately 51 liters per capita, as opposed to national per capita consumption of approximately 21.5 liters per capita (according to a Canadean survey). The most dynamic growth in recent years has been in the lower-middle price bracket, which we expect will continue to drive market growth in the foreseeable future.

 

The total market for juice products, defined as the total consumption of domestically produced and imported products, accounted for 3,007 million liters in 2008, according to Business Analytica, from 3,030 million liters in 2007. The market declined in 2008 due to a significant price increases in the juice market. We believe that the present economic downturn may result in a slight decline in volumes in 2009.

 

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. In many of these regions juice is still a novelty and we believe that with rising household incomes there will be a growing demand for juice offerings in the lower-middle price segment. The operating environment has been challenging since the 1998 financial crisis. Competitive pressures have intensified because of the low purchasing power of households outside of Moscow and St. Petersburg and the rising number of domestic producers. We initially responded to this competitive challenge by introducing two new brands, one targeted at the middle-market price segment and the other at the mass-market price segment. In addition, we have been revising our juice distribution network, reducing the number of distributors we work with and building stronger relationships with distributors possessing direct distribution capabilities. We believe that, together with the launch of new products, the increased share of higher-priced products in our product mix, increased advertising, new packaging and increased production capacity, these strategies will increase public awareness of our products and our sales, which will allow us to expand our market share.

 

In the Russian juice market, according to a Business Analytica survey of Russia as a whole, we had an 18% market share in value terms at the end of 2008.

 

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

 

·                  Multon is based in St. Petersburg and, according to Business Analytica, had a 22% market share in Russia in 2008. Dobry, Rich and Nico are key brands of the company. Multon has gained significant market share since 1998 primarily through aggressive pricing policies and advertising. In 2007 it launched the Rich Fruit drinkable puree. Multon was acquired by Coca-Cola in April 2005.

 

·                  Lebedyansky is based in the Lipetsk region and, according to Business Analytica, had a 26% market share in Russia in 2008. Tonus, Ya, Fruktovy Sad and other brands have become well-known among Russian consumers. In March 2008, PepsiCo announced the acquisition of 100% of Lebedyansky juice business.

 

·                  Nidan is a Novosibirsk-based Russian company that had a 15.0% market share in Russia in 2008. Moya Semya is a major brand of the company. Other key brands are Caprise and Champion. In 2007 Lion Capital, a British investment fund, acquired 75% of Nidan’s shares.

 

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