UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 20-F

 

(Mark One)

 

o

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

 

 

OR

 

 

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended
December 31, 2007

 

 

OR

 

 

o

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

 

 

OR

 

 

o

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

 

Commission file number  1-31232

 


 

WIMM-BILL-DANN FOODS OJSC

(Exact name of Registrant as specified in its charter)

 

 

(Translation of Registrant’s name into English)

 

RUSSIAN FEDERATION

(Jurisdiction of incorporation or organization)

 

16 Yauzsky Boulevard, Moscow 109028, Russian Federation

(Address of principal executive offices)

 

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

(Company Contact Person)

 

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

 

Title of each class

 

Name of each exchange on which registered

AMERICAN DEPOSITARY SHARES, EACH

REPRESENTING ONE SHARE OF COMMON STOCK

COMMON STOCK, PAR VALUE

20 RUSSIAN RUBLES PER SHARE

 

NEW YORK STOCK EXCHANGE



NEW YORK STOCK EXCHANGE(1)

 

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

 

NONE

(Title of Class)

 

NONE

(Title of Class)

 

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

 

44,000,000 shares of common stock, par value 20 Russian rubles each, as of December 31, 2007.

 

SEC 1852 (02-08)

Persons who respond to the collection of information contained in this form are not required to respond unless the form displays a currently valid OMB control number.

 



 

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

 

NONE

(Title of Class)

 

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

 

44,000,000 shares of common stock, par value 20 Russian rubles each, as of December 31, 2007

 

14,405,337 American Depositary Shares, each representing one share of common stock, as of December 31, 2007

 

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

x Yes   o No

 

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

o Yes   x No

 

Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

 

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

o Yes   x No

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer o

 

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

 

U.S. GAAP     x

 

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

 

Other o

 

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

o Item 17   o Item 18

 

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

o Yes   x No

 



 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

4

 

 

PART I

5

Item 1.    Identity of Directors, Senior Management and Advisors

5

Item 2.     Offer Statistics and Expected Timetable

5

Item 3.     Key Information

5

Item 4.     Information on Our Company

41

Item 4A.   Unresolved Staff Comments

73

Item 5.     Operating and Financial Review and Prospects

73

Item 6.     Directors, Senior Management and Employees

100

Item 7.    Major Shareholders and Related Party Transactions

109

Item 8.    Financial Information

110

Item 9.    Offer and Listing Details

111

Item 10.   Additional Information

112

Item 11.   Quantitative and Qualitative Disclosures about Market Risk

133

Item 12.   Description of Securities Other than Equity Securities

136

PART II

137

Item 13.     Defaults, Dividend Arrearages and Delinquencies

137

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

137

Item 15.   Controls and Procedures

137

Item 16A.    Audit Committee Financial Expert

141

Item 16B.    Code of Ethics

141

Item 16C.  Principal Accountant Fees and Services

141

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

142

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

142

PART III

143

Item 17.     Financial Statements

143

Item 18.     Financial Statements

143

Item 19.     Exhibits

144

 

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.

 

3



 

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

Matters discussed in this document may constitute forward-looking statements. 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” 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: strategies, outlook and growth prospects; future plans and potential for future growth; liquidity, capital resources and capital expenditures; 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, the impact of competitive pricing, the ability to obtain necessary regulatory approvals, 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 Securities and Exchange Commission.

 

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.

 

4



 

PART I

 

Item 1.    Identity of Directors, Senior Management and Advisors

 

Not applicable.

 

Item 2.    Offer Statistics and Expected Timetable

 

Not applicable.

 

Item 3.     Key Information

 

A.   Selected Financial Data

 

The selected consolidated financial data set forth below at December 31, 2007, 2006, 2005, 2004 and 2003 and for the years then ended have been derived from our audited financial statements prepared in accordance with U.S. GAAP. The selected consolidated financial data should be read in conjunction with our Consolidated Financial Statements as of December 31, 2007 and 2006 and for the years ended December 31, 2007, 2006, and 2005 included under “Item 18. Financial Statements” and “Item 5. Operating and Financial Review and Prospects.”

 

 

 

For the years ended December 31,

 

 

 

2007

 

2006

 

2005

 

2004

 

2003

 

 

 

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

 

Statement of Income Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales

 

$

2,438,328

 

$

1,762,127

 

$

1,394,590

 

$

1,183,986

 

$

938,459

 

Cost of sales

 

(1,654,879

)

(1,194,159

)

(999,006

)

(858,767

)

(665,104

)

Gross profit

 

783,449

 

567,968

 

395,584

 

325,219

 

273,355

 

Selling and distribution expenses

 

(387,853

)

(246,054

)

(191,990

)

(173,433

)

(140,746

)

General and administrative expenses

 

(180,922

)

(134,481

 

(109,642

)

(92,816

 

(75,973

 

Other operating expenses

 

(704

)

(31,812

)

(6,457

)

(6,047

)

(7,481

)

Operating income

 

213,970

 

155,621

 

87,495

 

52,923

 

49,155

 

Financial income and expenses, net

 

(16,851

)

(15,480

)

(22,868

)

(14,618

)

(15,273

)

Income before provision for income taxes and minority interest

 

197,119

 

140,141

 

64,627

 

38,305

 

33,882

 

Provision for income taxes

 

(54,302

)

(41,560

)

(30,712

)

(12,170

)

(10,717

)

Minority interest

 

(2,769

)

(3,197

)

(3,649

)

(3,161

)

(2,012

)

Net income

 

$

140,048

 

$

95,384

 

$

30,266

 

$

22,974

 

$

21,153

 

Earnings per share—basic and diluted

 

$

3.18

 

$

2.17

 

$

0.69

 

$

0.52

 

$

0.48

 

Dividends per share (1)

 

$

0.12

 

$

0.55

 

$

 

$

 

$

 

Weighted average number of shares outstanding

 

44,000,000

 

44,000,000

 

44,000,000

 

44,000,000

 

44,000,000

 

Other Data:

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

$

192,662

 

$

129,963

 

$

75,110

 

$

72,639

 

$

107,186

 

Cash provided by (used in) operating activities

 

$

96,804

 

$

169,954

 

$

113,937

 

$

71,720

 

$

29,940

 

Cash used in investing activities

 

$

(203,041

)

$

(228,158

)

$

(125,157

)

$

(73,808

)

$

(95,142

)

Cash (used in) provided by financing activities

 

$

91,429

 

$

(1,911

)

$

82,619

 

$

(16,159

)

$

73,399

 

 

5



 


(1)    Dividends paid in 2007 are attributable for 2006. Dividends paid in 2006 are attributable as follows: $0.17 per share – for years 2002-2004, $0.08 per share – for three months ended March 31, 2006, $0.30 per share - for nine months ended September 30, 2006.

 

 

 

At December 31,

 

 

 

2007

 

2006

 

2005

 

2004

 

2003

 

 

 

In thousands of U.S. Dollars

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

1,533,102

 

1,175,936

 

920,557

 

796,088

 

743,885

 

Total net assets

 

673,124

 

497,494

 

387,043

 

370,916

 

324,618

 

Total debt(1)

 

578,930

 

442,999

 

371,646

 

283,168

 

283,442

 

Total liabilities

 

846,116

 

659,465

 

508,895

 

407,845

 

398,099

 

Total liabilities and shareholders’ equity

 

$

1,533,102

 

$

1,175,936

 

$

920,557

 

$

796,088

 

$

743,885

 

 


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

 

Exchange Rates and Inflation

 

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

 

 

 

Rubles per U.S. dollar

 

 

 

High

 

Low

 

Average(1)

 

Period 
End

 

Year ended December 31,

 

 

 

 

 

 

 

 

 

2007

 

26.58

 

24.26

 

25.49

 

24.55

 

2006

 

28.48

 

26.18

 

27.09

 

26.33

 

2005

 

29.00

 

27.46

 

28.31

 

28.78

 

2004

 

29.45

 

27.75

 

28.73

 

27.75

 

2003

 

31.88

 

29.25

 

30.61

 

29.45

 

 


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

 

 

 

Rubles per U.S. dollar

 

 

 

High

 

Low

 

May 2008

 

23.88

 

23.55

 

April 2008

 

23.67

 

23.34

 

March 2008

 

24.00

 

23.51

 

February 2008

 

24.78

 

24.12

 

January 2008

 

24.89

 

24.29

 

December 2007

 

24.75

 

24.42

 

 

On June 25, 2008, the exchange rate between the ruble and the U.S. dollar was 23.62 rubles per $1.00.

 

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

 

6



 

 

 

Inflation rate

 

Year ended December 31,

 

 

 

2007

 

11.5

%

2006

 

9.7

%

2005

 

10.9

%

2004

 

11.7

%

2003

 

12.0

%

 

Source: Central Bank of Russia.

 

Effective from January 1, 2003, Russia no longer met the criteria for a highly inflationary economy. Inflation continued to decrease in Russia in 2004 through 2006

 

The inflation rate in 2007 was affected by several factors relating to increases in international energy and oil market prices, administrative decisions of the Central Bank of Russia and the economic slowdown in the United States.

 

Our results of operations are affected by the relationship between the rate of inflation and the nominal rate of devaluation/appreciation 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 2007, 2006 and 2005, the ruble appreciated in real terms against the U.S. dollar.

 

 

 

2007

 

2006

 

2005

 

Inflation(1)

 

11.5

%

9.7

%

10.9

%

Nominal appreciation/(depreciation) of the ruble relative to the U.S. dollar(1)(2)

 

6.3

%

4.0

%

1.9

%

Real appreciation of the ruble relative to the U.S. dollar(2)

 

12.8

%

10.7

%

10.8

%

 


(1)             Source: Central Bank of Russia.

 

(2)             For purposes of calculating the interest rate of our U.S. dollar-denominated notes, we used the Russian ruble/U.S. dollar exchange rates at December 31, 2007, 2006 and 2005, which appreciated/(depreciated) at the rates of 6.7%, 8.5% and (3.7)%, respectively.

 

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 are subject to greater risks than more developed markets, including significant legal, economic and political risks.

 

Investors in emerging markets such as the Russian Federation should be aware that these markets are subject to greater risks than more developed markets, including in some cases significant legal, economic and political risks. Investors should also note that emerging

 

7



 

economies, such as the economy of the Russian Federation, are subject to rapid change and that the information set out herein may become outdated relatively quickly. 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 only 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.

 

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. The willingness of consumers to purchase branded food and beverage products depends, in part, on local economic conditions. In periods of economic uncertainty, 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 the countries of the Commonwealth of Independent States, or the CIS. As with Russia, these countries are emerging markets subject to greater political, economic, social and legal risks than 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, baby food and juice sectors 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.

 

8



 

We cannot assure you of 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.

 

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 culture, management styles and systems and infrastructure and 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, which 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, in significant part, 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.

 

9



 

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

 

The material weakness in our internal control over financial reporting as identified by our management for the year ended December 31, 2007 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 ordinary Shares and ADSs. See “Item 15. Controls and procedures” for additional information.

 

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

 

Although juice consumption in Russia continues to increase, our juice product sales volume decreased in 2005 and stayed almost flat in 2006 due to vigorous market competition from other domestic producers and increased activity by foreign producers. Although our juice sales increased in 2007 by 27.8% compared to 2006, continued and/or increased competition among juice producers in Russia may cause future decline in the sales volumes of our juice products, as well as affect our juice 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 preference 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 affect on our results of operations.

 

Consumer preference for low-price juice products, primarily in the regions outside of Moscow and St. Petersburg where per capita household incomes are generally lower, put pressure on juice prices in 2005, 2006 and 2007. In addition, raw materials required for juice production, such as juice concentrate and sugar, are international commodities and are subject to international price fluctuations, and we have experienced significant increases in the cost of these commodities in 2006 and 2007. The prices for sugar and juice concentrate, particulary apple juice concentrate, have increased significantly and we expect them to continue to increase for the foreseeable future. A continuation of these trends may cause a decline in our juice product profit margins and, consequently, materially adversely affect our results of operations.

 

10



 

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

 

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 2005, 2006 and 2007. In addition, the increase in oil prices has lead to increased fuel costs and, consequently, higher 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 it 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 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. This strategy is designed to increase our market share and revenues by increasing consumer demand in our existing markets and entering into new market segments. 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 consequent 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 and services 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. 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 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 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

 

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subject to international price fluctuations, and we experienced significant increases in raw milk, sugar and concentrate prices during 2005, 2006 and 2007.

 

Our success also depends on our continued ability to be an effective advertiser in a market where media inflation on leading national television channels exceeded 50% in 2007. 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 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 growth 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 that 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. 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.

 

In 2007 we have 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 are due, in part, to droughts in Australia and New Zealand, the world’s largest suppliers of dry powder milk, and due to an increase in demand for milk products in such densely populated countries as China, Indonesia, Algeria and a number of other countries in Asia and Africa. In order to restrain the growth of prices for milk products, we and other major Russian food producers, as well as retail chains and the Russian government entered into a voluntary agreement in October 2007, according to which the prices for products of social significance (such as some milk, kefir and sour cream) were frozen at the level as of October 15, 2007. In January 2008, this agreement was extended to May 1, 2008, the prices were fixed at the January 2008 level.

 

This 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. 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.

 

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

 

In 2006 and 2007, baby food purchased from us by the Moscow City Government comprised approximately 33% and 26% respectively of the total sales revenue of our baby food segment. 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 prices or the amount of products it purchases from our baby food business, and we were unable to find alternative purchasers, then our revenues and profits from this business could be reduced, which could have a material adverse effect on our financial condition and results of operations. We discuss the sale and distribution of products produced at Wimm-Bill-Dann “B. Business—Business Overview.”

 

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 shops 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 and increased 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 as a result of this merger, we cannot guarantee that we will not experience adverse consequences in the future. A number of large Western retailers, such as German retailer Metro and French retailer Auchan, have also opened stores in our markets, which will put further pressure on prices.

 

We also compete with other brands for shelf space in retail stores. Retailers also offer other products, including their own brands that compete directly with our products. 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.

 

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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. Moreover, certain of our smaller production facilities are currently not covered by product liability insurance. 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 2006 and 2007 we did not incur material capital expenditures for environmental controls. For a more detailed discussion of our insurance coverage see “Item 4. Information on Our Company—B. Business Overview—Insurance.”

 

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

 

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

 

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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, it could materially harm our future financial results and our ability to develop our business. See “Item 4. Information on Our Company—B. Business Overview—Current Operations—Trademarks and Patents.”

 

Failure of several of our brand names and images, for which trademarks are currently being sought, to be awarded trademark protection could negatively affect our marketing plans, resulting in increased advertising expenses and a material adverse effect on our financial results.

 

As of May 15, 2008, we had 83 pending trademark applications in Russia and 15 pending trademark applications abroad. We are also in the process of contesting the rejection for registration of a number of our trademarks in countries outside of Russia. If our pending applications are not granted trademark status, 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 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, prospects and results of operations.

 

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 spending plans, excluding expenditures for acquisitions, we spent approximately $75.1 million in 2005, $130.0 million in 2006 and $192.7 million in 2007. We spent approximately $24.3 million in 2005, $137.3 million in 2006 and $21.8 million in 2007 for acquisitions. 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;

 

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·       slower than anticipated growth in demand for our products;

 

·       slower than anticipated revenue growth;

 

·       regulatory developments; or

 

·       a deterioration in the Russian economy.

 

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 35%. 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 35%). As a result, we are currently unable to raise additional equity financing through the issuance of depositary receipts. The Russian government or its agencies may also impose other restrictions on international securities offerings by Russian issuers. Any of the foregoing factors may limit the amount of capital available to meet our operating requirements. If we cannot obtain adequate funds to satisfy our capital requirements, we may need to limit our operations significantly, which could have a material adverse effect on our business, results of operations and prospects.

 

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

 

As of June 24, 2008, to our knowledge, approximately 44.91% 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 and will continue to be bound by this agreement to vote as a block until any member of the group elects to withdraw from the agreement. This agreement gives them control over us and the ability to elect a majority of the directors, appoint management and approve certain actions requiring the approval of a majority of our shareholders.

 

If not otherwise required by law, resolutions at a shareholders’ meeting will be adopted by a simple majority in a meeting at which shareholders holding more than half of the issued share capital are present or represented. Accordingly, as long as the group continues to hold, directly or indirectly, a controlling stake in our shares and act in concert pursuant to the Partnership and Cooperation Agreement, they will have the power to control the outcome of most matters to be decided by vote at a shareholders’ meeting and the appointment of the 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, reorganization proposal, proposed substantial sale of assets 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.

 

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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 sales 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 is likely to lead 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 expect the greatest price increases to affect television advertising, particularly during primetime.

 

The new law also imposes certain restrictions on advertising that may require us to adjust some of our advertising campaigns. We are among Russia’s top advertisers. According to Gallup, we were the third largest advertiser in 2004, the ninth largest advertiser in 2005, the twelfth largest advertiser in 2006 and the tenth largest advertiser in 2007. In 2005, 2006 and 2007 over 50% of our advertising expenditures related to television advertisements. At the same time, media inflation in Russia has been significant in recent years, exceeding 34% in 2004, 28% in 2005 and 35% in 2006 and 50% in 2007. Our advertising and marketing expenses increased in 2007 by 81.1% or $61.8 million in absolute terms, and increased by 1.4% as a percentage of sales to 5.7% in 2007 from 4.3% in 2006. The increase in expenses was due to our continued investments into major brand promotions, media inflation on Russia’s leading national television channels and general increases in marketing costs. Despite this media inflation, we were able to obtain volume discounts and endeavored to manage the cost increases more effectively. 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, may have a material adverse effect on our sales 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

 

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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 97.53% of the Lianozovsky Dairy Plant which we owned, 15% were acquired in 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 tenders for the Lianozovsky Dairy Plant, 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 these tenders were not duly held since the participants were under common control, we could lose 15% of our stakes 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 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 real estate that we have acquired and/or constructed. Russian real estate laws, particularly municipal laws in Moscow, are complicated and ambiguous. Among other things, these laws require a registrant to provide the real estate 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 real estate in Russia, and

 

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notwithstanding these efforts, there is no assurance we will be able to register all of our real estate on a timely basis.  Our failure to timely register our real estate 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.

 

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 enacted during 2001 subject juice concentrate imports to the highest level of customs duties allowed for that particular category of imports. In addition, federal customs regulations enacted during 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 us is Government Regulation No. 988, which requires food producers intending to develop and offer a new food product to the public to file an application for the product’s state registration and incorporation into the State Register of Permitted Food Products. Failure to comply with Regulation No. 988 could cause delays in introducing new food and beverage products to the public, 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 new Sanitary Rules on Children’s Food Products, which became effective on June 1, 2005, disallow certain tax benefits we formerly enjoyed in relation to some of our baby food products.

 

In May 2008, the Russian Parliament (State Duma) adopted new technical regulations for all dairy products, including drinking milk, fermented dairy products, cheese, butter, margarine, yogurts and dairy deserts. Recent legislation mandates that products marked “milk” should not contain any dry milk, vitamins, or minerals and that any drinkable milk that contains these be marked “milk product” or “milk drink”. Although these classifications are not yet being enforced and still subject to further approvals, we anticipate that should they be introduced, “milk drink” labeling may lead to a decline in sales of drinking reconstituted milk and may adversely affect 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.

 

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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, Onken and Pascuale, have been investing and continue to invest in domestic production facilities, while others, such as Coca-Cola and Pepsi, have acquired domestic producers. These investments and acquisitions reduce the competitive advantages that we have over foreign competitors without domestic production capability. 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 unwinding of such transactions, 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 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 the regulation of our prices and restriction of our commercial activities.

 

Under Russian legislation, FAS may categorize a company as a dominant force in a market. Our baby food business is categorized as a monopoly in Moscow and the Moscow region, placing restrictions on our ability to increase our profit margins for that business. Any ruling that any of our other businesses are a monopoly could result in the regulation of our prices and restrictions on our commercial activities.

 

Following sudden and, in some cases, substantial increases in food prices in 2007, FAS initiated inspections of food producers, 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 and St. Petersburg.  In Omsk, FAS ceased 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

 

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investigation was initiated which is currently pending. The investigation in St. Petersburg is still ongoing, and we are currently not able to predict its outcome. In Krasnoyarsk, the regional FAS requested us to provide information on our raw milk purchasing prices but has not yet initiated an investigation. FAS has initiated a new investigation into dairy producers connected with a decline in raw milk purchasing prices. Although we consider such a decline to be seasonal, we anticipate that we would be requested by the Federal Anti-Monopoly Service to provide our raw milk purchasing prices. We are confident that no violations in regards to the procurement of raw milk have taken place, but cannot rule out that our business could be adversely affected by pending investigation.

 

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

 

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

 

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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 20% of Moscow Baby Food Plant OJSC, a subsidiary, 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 a cash consideration of $1.1 million increasing our beneficial ownership to 87.1%. In March and April 2004, we acquired a total of an additional 6.2% of our subsidiary Tsaritsino Dairy Plant from our minority shareholders for a 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 a cash consideration of $3.1 million increasing our beneficial ownership to 96.5%.

 

We are in the process of consolidating our businesses and merging certain subsidiaries into Wimm-Bill-Dann (formerly Moscow-based Lianozovsky Dairy Plant). In this context, we are re-organizing our legal entities, which 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 a 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 a cash consideration of $3.3 million and 0.60% of ordinary shares and 1.16% of preferred shares in Nazarovo Dairy Plant for a cash consideration of approximately $0.4 million for both stakes, a 33.51% stake in Obninsk Dairy Plant for cash consideration of $11.9 million and a 13.24% stake in Angarsk Dairy Plant for cash consideration of $0.8 million. While no additional demands have been made for us to buy out minority shareholders, we may face additional buy-out demands in the future.

 

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 2007 and 2008.

 

Risks Relating to Our Financial Condition

 

Inflation could increase our costs and decrease our operating margins.

 

The Russian economy has been characterized by high rates of inflation. 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.

 

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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 year 2008 $250 million syndicated loan agreement, 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 conditions 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 a 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, inherits and ): (i) has or acquires, directly or indirectly, in aggregate more than 25 per cent 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 per cent 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 a reorganization and the merged subsidiaries would be required to notify their creditors of this reorganization. Russian law also provides that, for a period of 30 days after 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.

 

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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.

 

As of June 2008, we have outstanding indebtedness, primarily consisting of our $250 million syndicated loan agreement, our ruble bonds, bank loans and obligations under equipment financing. As of December 31, 2007, our consolidated total debt was approximately $579.6 million, of which $81.2 million was secured by equipment or inventory.

 

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 make payments on and to refinance our indebtedness, and to fund planned capital expenditures and research and development efforts, will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. If we are unable to generate sufficient cash flow or otherwise obtain funds necessary to make required payments, we may default under the terms of our indebtedness, thereby allowing the holders of our indebtedness to accelerate the maturity of such indebtedness, and potentially causing cross-defaults under and acceleration of our other indebtedness.

 

We may 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 therefrom 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.

 

Devaluation of the ruble and other currencies we trade in against the U.S. dollar and/or Euro could increase our costs and reduce our operating revenues.

 

A significant portion of our costs, expenditures and liabilities, including costs of packaging, juice concentrate and certain other raw materials, as well as capital expenditures and borrowings, are either denominated in, or closely linked to, the U.S. dollar and/or Euro, while substantially all of our operating revenues are denominated in rubles. As a result, the devaluation of the ruble against the U.S. dollar and/or Euro can adversely affect us by increasing our costs in ruble terms. Additionally, 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 ruble-denominated assets, such as ruble deposits.

 

The decline in the value of the ruble against the U.S. dollar also reduces the U.S. dollar value of tax savings arising from the depreciation of our property, plant and equipment, since their basis for tax purposes is denominated in rubles at the time of the investment. Increased tax liability would increase total expenses.

 

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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. However, the market in Russia for the conversion of rubles into foreign currencies is limited and may not continue to exist. 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 adversely affect our results of operations.

 

Russia’s inexperience with a market economy relative to more developed economies poses numerous risks that could interfere with our business. For example, the failure to satisfy liabilities is widespread among Russian businesses and the government. Furthermore, it is difficult for us to gauge the creditworthiness of some of our customers, as there are no reliable mechanisms, such as reliable credit reports or credit databases, for evaluating their financial condition. 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 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 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 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 Baby Food Plant, Trading Company Wimm-Bill-Dann, Wimm-Bill-Dann, 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,

 

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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.

 

The negligence of our suppliers in paying taxes 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. 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 lower court of the first instance for reconsideration. Although we continue to provide the results of our due diligence of 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.

 

A successful challenge by the tax authorities of our use of a past tax privilege could materially adversely affect our results of operations.

 

Our juice producing subsidiaries have benefited from small enterprise tax legislation. If we had not taken advantage of this benefit in 2003, 2004 and 2005, our tax expenses would have increased by $3.0 million, $1.2 million and $0.3 million, respectively. This tax benefit was eliminated as of January 1, 2002. However, under the amended legislation, our small enterprises that were formed prior to January 1, 2002 were able to continue and did continue to use this benefit for two years from the date on which they were formed, and in the third and fourth years after they were formed, income tax was levied at a rate of 25% and 50% of the income tax rate, respectively. Although none of our subsidiaries currently takes advantage of the small enterprise tax benefits, we cannot guarantee that the tax authorities may not retroactively challenge previous tax benefits enjoyed by our subsidiaries pursuant to small enterprise tax legislation. Such challenges, if successful, could materially adversely affect our results of operations.

 

Our use of the small enterprise tax exemption has also been subject in the past to challenge by the Russian tax authorities.

 

For example, in September 2004, our subsidiary, Fruit Rivers, was assessed approximately $12.5 million (including penalties) by the local tax authorities relating to its use of the small enterprise tax exemption in calculating its profit tax liability during 2001. Fruit Rivers challenged this tax assessment with a higher tax authority, which cancelled the assessment.

 

While we believe that our subsidiaries have in the past complied with the rules relating to the small enterprise tax exemption, the Russian tax authorities may in the future make additional claims against our subsidiaries challenging their use of this exemption. These claims could be significantly larger than the claim described above, and the resulting losses could have a material adverse effect on our financial condition and results of operations.

 

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We are only able to conduct banking transactions with a limited number of creditworthy Russian banks, as the Russian banking system remains underdeveloped, and another banking crisis could place severe liquidity constraints on our business, materially adversely affecting our business, financial position and results of operations.

 

Russia’s banking and other financial systems are not well developed or regulated, 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. Although the Central Bank of Russia has the mandate and authority to suspend banking licenses of insolvent banks, many insolvent banks still operate. Most Russian banks also do not meet international banking standards, and the transparency of the Russian banking sector still lags far behind internationally accepted norms. 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.

 

The serious deficiencies in the Russian banking sector, combined with the deterioration in the credit profile of the loan portfolios of Russian banks, may result in the banking sector being more susceptible to market downturns or economic slowdowns. In addition, the Central Bank of Russia has recently revoked the licenses of certain Russian banks, which resulted in market rumors about additional bank closures and many depositors withdrawing their savings. If a banking crisis were to occur, Russian companies would be subject to severe liquidity constraints due to the limited supply of domestic funding sources and the withdrawal of foreign funding sources that would occur during such a crisis. In addition, 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 conditions and results of operations.

 

We have also experienced problems with transmitting tax payments through certain Russian banks and, as a result, are experiencing difficulties with the Russian tax authorities. In particular, between 2004 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 settled 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.

 

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

 

Russian transfer pricing rules effective since 1999 give Russian tax authorities the right to control prices for transactions between related entities and certain other types of transactions between unrelated parties, such as foreign trade transactions or transactions with significant price fluctuations if the transaction price deviates by more than 20% from the market price. Special transfer pricing rules apply to operations with securities and derivative instruments. The Russian transfer pricing rules are vaguely drafted, and are subject of interpretation by Russian tax authorities and courts and have been used for politically motivated investigations and prosecutions. Although we believe that we comply with Russian tax law on transfer pricing, the uncertainties in interpretation of transfer pricing legislation may result in the tax authorities challenging our prices and making adjustments which could affect our tax position. If such price adjustments become effective, our results of operations could be materially adversely affected. In addition, we could face significant losses associated with the assessed amount of underpaid prior tax and related interest and penalties.

 

In addition, a number of draft amendments to the transfer pricing law have recently been introduced which, if implemented, would considerably toughen the existing law. The proposed changes, among other things, may 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. Moreover, in the event that a transfer pricing adjustment is assessed by 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.

 

Risks Relating to our Shares and ADSs and the Trading Market

 

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.

 

Because Russian law may not recognize ADS holders as beneficial owners of the underlying shares, it is possible that ADS holders could lose all their rights to those shares if the depositary’s assets in Russia are seized or arrested. In that case, ADS holders would lose all the money they have invested.

 

Russian law might treat the depositary as the beneficial owner of the shares underlying the ADSs. This is different from the way other jurisdictions treat ADSs. In the United States, although shares may be held in the depositary’s name or to its order, making it a “legal” owner of the shares, the ADS holders are the “beneficial,” or real owners. In U.S. courts, an action against the depositary, the legal owner of the shares, would not result in the beneficial owners losing their shares. Russian law may not make the same distinction between legal and beneficial ownership, and it may only recognize the rights of the depositary in whose name the shares are held, not the rights of ADS holders, to the underlying shares.

 

Thus, in proceedings brought against a depositary, whether or not related to shares underlying ADSs, Russian courts may treat those underlying shares as the assets of the depositary, open to seizure or arrest. In the past, a lawsuit has been filed against a depositary bank, other than our 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, and the shares were to be seized or arrested, the ADS holders involved would lose their rights to the underlying shares.

 

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

 

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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 50 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 price of our shares and ADSs may be highly volatile.

 

The trading prices of the shares and ADSs may be subject to wide fluctuations in response to many factors, including:

 

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

 

·       variations in national and industry growth rates;

 

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

 

·       changes in governmental legislation or regulation;

 

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

 

·       extreme price and volume fluctuations on the Russian stock market.

 

In addition, no more than 35% of a Russian company’s shares may be circulated abroad through depositary receipt programs, such as ADS and GDSs. Our ADS and GDS programs, however, 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 35%). As a result, we are currently unable to raise additional equity financing through the issuance of depositary receipts. This restriction may also limit the liquidity of our ADSs and their trading price.

 

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

 

We anticipate that any dividends we may pay in the future on the shares represented by the ADSs will be declared and paid to the depositary in rubles and will be converted into U.S. dollars by the depositary and distributed to holders of ADSs, net of the depositary’s fees and expenses. The ability to convert rubles into U.S. dollars is subject to the availability of U.S. dollars in Russia’s currency markets. Although there is an existing, albeit limited, market within Russia for the conversion of rubles into U.S. dollars, including the interbank currency exchange and over-the-counter and currency futures markets, the further development of this market is uncertain. At present, there is no market for the conversion of rubles into foreign currencies outside of Russia and no viable market in which to hedge ruble and ruble-denominated investments.

 

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

 

Under Russian law, dividends paid to a non-resident holder of shares generally will be subject to Russian withholding tax at a rate of 15% for legal entities and organizations as well as for individuals. Russian tax rules applicable to ADS holders are characterized by significant uncertainties and, until recently, by an absence of interpretive guidance. In 2005 and 2006, the Ministry of Finance of the Russian Federation expressed its opinion in private rulings that holders of global depositary receipts should be treated as the beneficial owners of the dividends paid on underlying shares for the purposes of double tax treaty provisions applicable to taxation of dividend income from the underlying shares, provided that the tax treaty residence of the holders of the global depositary receipts is duly confirmed. However, the Russian tax authorities have not provided official, generally applicable guidance addressing how an ADS holder should demonstrate its beneficial ownership in underlying shares. In the absence of any specific provisions in Russian tax legislation with respect to the concept of beneficial ownership and taxation of income of beneficial owners, it is unclear how the Russian tax authorities will ultimately treat the ADS holders in this regard.

 

Until the Russian tax authorities clarify whether it is permitted under Russian law to withhold Russian withholding tax in respect of dividends a company pays to the depositary at a lower rate than the domestic rate applicable to such payments (currently 15%), we intend to withhold Russian withholding tax at the domestic rate applicable to such dividends, regardless of whether the Depositary (the legal owner of the shares) or an ADS holder would be entitled to reduced rates of Russian withholding tax under the relevant income tax treaty if it were the beneficial owner of the dividends for purposes of that treaty. Although non-resident ADS holders may apply for a refund of a portion of the amount withheld by us under the relevant income tax treaty, no assurance can be given that the Russian tax authorities will grant any such refunds. See “Item  10.  Additional Information—E.  Taxation—Russian Income and Withholding Tax Considerations” for additional information.

 

In respect of our shareholders we are acting as a tax agent and shall withheld all applicable taxes from the dividends we are paying. When paying dividends for 2006 we withheld withholding tax from our shareholders – individuals. In 2007 we applied to the tax authorities and managed to reimburse it to our shareholders – individuals. Although the Russian tax authorities’ tend to recognize beneficial ownership of the ADS holders and abide by the provisions of the double tax treaties, provided that the tax residence of the holder is confirmed, we can not be sure that this practice is enshrined by law or not changed by the tax authorities.

 

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 Russian shares and securities, as well as financial instruments derived from such shares, such as the ADSs, may be subject to Russian profits tax or 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

 

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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 at foreign stock exchanges of the foregoing types of securities listed on these exchanges by foreign holders who are legal entities or organizations are not subject to taxation in Russia.

 

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 and will not be taxable in Russia. Gains arising from disposition of the foregoing types of 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.

 

Foreign judgments may not be enforceable against us.

 

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

 

There is no treaty between the United States and the Russian Federation providing for reciprocal recognition and enforcement of foreign court judgments in civil and commercial matters. These limitations may deprive you of effective legal recourse for claims related to your investment in the ADSs. The deposit agreement provides for actions brought by any party thereto against us to be settled by arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association, provided that any action under the U.S. federal securities laws or the rules or regulations promulgated thereunder 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 central and rigorously regulated 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 two or more shareholders or so elects, by licensed registrars located throughout Russia. 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

 

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a central and rigorously regulated 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.

 

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.

 

Risks Relating to the Russian Federation

 

Economic Risks

 

The Russian economy is less stable than those of most Western countries and could adversely affect our business and the value of the shares and ADSs.

 

Since the dissolution of the Soviet Union in the early 1990s, the Russian economy has experienced at various times:

 

·       significant declines in gross domestic product;

 

·       hyperinflation;

 

·       an unstable currency;

 

·       high government budget deficit and government debt relative to gross domestic product;

 

·       a weak banking system providing limited liquidity to domestic enterprises;

 

·       high levels of loss-making enterprises that continued to operate due to the lack of effective bankruptcy proceedings;

 

·       significant use of barter transactions and illiquid promissory notes to settle commercial transactions;

 

·       widespread tax evasion;

 

·       growth of a black and gray market economy;

 

·       pervasive capital flight;

 

·       high levels of corruption and the penetration of organized crime into the economy;

 

·       significant increases in unemployment and underemployment; and

 

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·       the impoverishment of a large portion of the population.

 

Although Russia has benefited recently from the increase in global commodity prices, providing an increase in disposable income and an increase in consumer spending, the Russian economy has been subject to abrupt downturns in the past. In particular, on August 17, 1998, in the face of a rapidly deteriorating economic situation, the Russian government defaulted on its ruble-denominated securities, the Central Bank of Russia stopped its support of the ruble and a temporary moratorium was imposed on certain foreign currency payments. These actions resulted in an 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 a major banking crisis in the Russian banking sector after the events of August 17, 1998, as evidenced by the termination of the banking licenses of a number of major Russian banks. This further impaired the ability of the banking sector to act as a consistent source of liquidity to Russian companies and resulted in the losses of bank deposits in some cases.

 

Recently, the Russian economy has been showing positive trends, such as the increase in the gross domestic product, a stable ruble, strong domestic demand, rising real wages and a reduced rate of inflation; however, these trends may not continue or may be abruptly reversed.

 

The infrastructure in Russia is inadequate, which could disrupt normal business activity.

 

The infrastructure in Russia largely dates back to Soviet times and has not been adequately funded and maintained over the past decade. 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 the 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.

 

The deterioration of the infrastructure in Russia harms the national economy, disrupts the transportation of goods and supplies, adds costs to doing business and can interrupt business operations. 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. These factors could have a material adverse effect on our business and results of operations.

 

Fluctuations in the global economy could materially adversely affect the Russian economy and the value of the shares and ADSs.

 

The Russian economy is vulnerable to market downturns and economic slowdowns elsewhere in the world. As has happened in the past, financial problems or an increase in the perceived risks associated with investing in emerging economies could dampen foreign investment in Russia and Russian businesses could face severe liquidity constraints, further materially adversely affecting the Russian economy. Additionally, because Russia produces and exports large amounts of oil, the Russian economy is especially vulnerable to the price of oil on the world market and a decline in the price of oil could slow or disrupt the Russian economy or undermine the value of the ruble against foreign currencies. 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 fluctuations in 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.

 

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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 itself 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.

 

Current and future changes in the 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.

 

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 often results in the enactment of conflicting legislation at various levels and may lead to further political instability. In particular, conflicting laws have been enacted in the areas of privatization, land legislation and licensing. Some of these laws and governmental and administrative decisions implementing them, as well as certain transactions consummated pursuant to them, have in the past been challenged in the courts, and such challenges may occur in the future. This lack of consensus hinders 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, such as conflict in Chechnya, which has brought normal economic activity within Chechnya to a halt and disrupted the economies of neighboring regions. Various armed groups in Chechnya have been regularly engaged in guerrilla attacks in that area. Violence and attacks relating to this conflict have spread to other parts of Russia, and several terrorist attacks have been carried out by Chechen terrorists 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. 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 press and international press have reported high levels of corruption, including the bribing of officials

 

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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 government officials or certain 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 possible 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 financial condition and 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. 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

 

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

 

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

 

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

 

·       conflicting local, regional and federal rules and regulations;

 

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

 

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

 

·       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

 

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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, 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.

 

Lack of developed 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

 

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safeguards, insider trading restrictions and fiduciary duties are rudimentary. In addition, the Russian securities market is regulated by several different authorities, which are often in competition with each other. These include:

 

·       the Federal Service for Financial Markets (FSFM);

 

·       the Ministry of Finance;

 

·       the Federal Antimonopoly Service;

 

·       the Central Bank of Russia; 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 our company. The FSFM has recently introduced a number of regulations relating to offerings of shares in and outside of Russia, including combined offerings involving closed subscription for new shares and the sale of existing shares, which remain largely untested and subject to varying interpretations. Any challenges of such regulations or transactions consummated pursuant to them could have an adverse effect on our ability to conduct equity offerings in the future. 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 can not 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. Additionally, court claims are often used in furtherance of political and commercial aims or infighting. We may be subject to such claims and may not be able to receive a fair hearing. Additionally, court orders are not always enforced or followed by law enforcement agencies. Moreover, judicial decisions in Russia can be unpredictable and may not provide effective redress.

 

These uncertainties also extend to property rights. During Russia’s transformation from a centrally planned economy to a market economy, legislation has been enacted to protect private property against expropriation and nationalization. However, these protections may not be enforced in the event of an attempted expropriation or nationalization. Expropriation or nationalization of any of our entities, their assets or portions thereof, potentially without adequate compensation, would have a material adverse effect on our business, financial condition, results of operations and prospects.

 

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

 

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

 

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

 

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

 

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

 

·       a reorganization;

 

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

 

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

 

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

 

Because there is little minority shareholder protection in Russia, your ability to bring, or recover in, an action against us will be limited.

 

In general, minority shareholder protection under Russian law derives from supermajority shareholder approval requirements for certain corporate actions, as well as from the ability of a shareholder to demand that the company purchase the shares held by that shareholder if that shareholder voted against or did not participate in voting on certain types of actions. Companies are also required by Russian law to obtain the approval of disinterested shareholders for certain transactions with interested parties.

 

The supermajority shareholder approval requirement is met by a vote of 75% of all voting shares that are present at a shareholders’ meeting. Thus, controlling shareholders owning slightly less than 75% of outstanding shares of a company may have a 75% or more voting power if certain minority shareholders are not present at the meeting. In situations where controlling shareholders effectively have 75% or more of the voting power at a shareholders’

 

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meeting, they are in a position to approve amendments to the charter of the company or significant transactions including asset transfers, which could be prejudicial to the interests of minority shareholders. It is possible that our controlling shareholders in the future may not act in the best interests of minority shareholders, and this could materially and adversely affect the value of the shares and ADSs.

 

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

 

Characteristics of and changes in the Russian tax system could materially adversely affect our business, financial condition, results of operations and prospects and the value of the shares and ADSs.

 

The tax environment in Russia historically has been complicated by the often contradictory tax legislation. This uncertainty potentially exposes us to significant fines and penalties and enforcement measures despite our best efforts at compliance, and could result in a greater than expected tax burden and the suspension or termination of our licenses. Generally, taxes payable by Russian companies are substantial and numerous. These taxes include, among others:

 

·       income taxes;

 

·       VAT;

 

·       unified social tax; and

 

·       property tax.

 

There have recently been significant changes to the Russian taxation system, including a number of changes to various chapters of the Tax Code. Among the most recent changes are significant amendments to the chapters on VAT and on the profit tax effective as of January 1, 2006, as well as the changes to Part One of the Tax Code (tax administration provisions) effective as of January 1, 2007.

 

Since tax legislation is subject to frequent change, some sections and regulations enacted under the Tax Code are comparatively new, and interpretation of these regulations is often unclear or nonexistent. Taxpayers and the Russian tax authorities often interpret tax laws differently whilst the Russian tax authorities’ interpretation of tax laws rarely favors taxpayers. In some instances, the Russian tax authorities have applied new interpretations of tax laws retroactively. There is no established precedent or consistent court practice in respect of these issues. Taxpayers often have to resort to court proceedings to defend their positions against the tax authorities. Recent events within the Russian Federation suggest that the tax authorities may be taking a more assertive position in their interpretations of the legislation and assessments.

 

In addition, differing interpretations of tax regulations exist both among and within government ministries and organizations at the federal, regional and local levels, creating uncertainties and inconsistent enforcement. Tax declarations, together with related documentation such as customs declarations, are subject to review and investigation by a number of authorities, each of which may impose fines, penalties and interest charges. Generally, in an audit taxpayers are subject to inspection with respect to the three calendar years which immediately proceeded the year in which the audit is carried out. Previous audits do not completely exclude subsequent claims relating to the audited period because Russian tax law authorizes upper-level tax inspectorates to review the results of tax audits conducted by subordinate tax inspectorates. In addition, in July 2005, the Russian Constitutional Court

 

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issued a decision that allows the statute of limitations for tax liabilities to be extended beyond the three-year term set forth in the tax laws if a court determines that a taxpayer has obstructed or hindered a 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” an audit and ultimately seek penalties beyond the three-year term.

 

In October 2006, the Supreme Arbitration Court of the Russian Federation introduced a new concept of “unjustified tax benefit” which is defined mainly by reference to specific examples of such tax benefits (e.g. absence of business purpose) and which may lead to disallowance thereof for tax purposes. There is currently no practice or guidance from the tax authorities or courts for interpreting this new concept; however, it is likely that the tax authorities will actively seek to apply this concept when challenging in courts tax positions taken by taxpayers. Although the intent of the court when introducing the concept of “unjustified tax benefit” was to combat abuse of tax law, in practice, there is no assurance that the tax authorities will not seek to apply this concept in a broader sense than may have been intended by the court. In addition, a recent pronouncement by a Russian court in December 2006 indicates a trend within the judicial system to broaden the application of criminal responsibility for tax violations.

 

Also there is no concept of a tax group in Russia, nor can a consolidated filing be made by Russian companies for tax purposes. Therefore, Russian companies and each of their Russian subsidiaries pay their own Russian taxes and may not surrender profits or losses to other group companies for tax purposes. In addition, payments of dividends between two Russian companies are currently subject to a withholding income tax of 9% at the time they are paid out of profits, although the effective rate of this tax may be lower than 9% if the company paying the dividends has received, in the same or a preceding tax period, dividends from other Russian companies. This may give rise to additional tax liabilities and inefficiencies.

 

The foregoing conditions create tax risks in Russia that are more significant than those typically found in jurisdictions with more developed tax systems and complicate tax planning and related business decisions. They also impose additional burdens and costs on our operations, including management resources. In addition to our substantial tax burden, these risks and uncertainties complicate our tax planning and related business decisions, potentially exposing us to significant fines and penalties and enforcement measures despite our best efforts at compliance. Our exposure to additional tax liabilities could have a material adverse effect on our business, financial condition, results of operations and prospects. See also “—Risks Relating to the Russian Federation—Legal Risks and Uncertainties—Selective or arbitrary government action could have a material adverse effect on our business, financial condition, results of operations and prospects and the value of the shares and ADSs.”

 

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.

 

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Item 4.     Information on Our Company

 

A.                History and Development

 

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

 

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

 

·       In 1995, we acquired majority control of the Lianozovsky Dairy Plant (renamed as Wimm-Bill-Dann in 2006);

 

·       In 1996 and 1997, we acquired majority stakes in the Moscow Baby Food Plant, the Tsaritsino Dairy Plant and the Ramenskiy Plant (renamed as Wimm-Bill-Dann Beverages in 2007);

 

·       In 1998 and 1999, we began to expand into regions outside Moscow, acquiring dairy plants in Novosibirsk, Nizhny Novgorod and Vladivostok;

 

·       In 2000, 2001 and 2002, we acquired majority stakes in dairy plants in Ufa, Bashkortostan and the Krasnodar region in Russia, as well as dairy plants in Kiev, Ukraine and Bishkek, Kyrgyzstan;

 

·       In 2001, we acquired 100% interests in dairy plants in the Altaisky and Voronezh regions of Russia;

 

·       In 2002, we acquired control of three dairy plants in the Krasnodar, Belgorod and Samara regions of Russia;

 

·       In 2002, we acquired control of a dairy plant in Kharkov, Ukraine;

 

·       In 2002, we acquired a 100% interest in the Roska Dairy Plant (renamed Baltic Milk in 2004) in St. Petersburg;

 

·       In 2002, we acquired control of Depsona (since renamed Fruktopak) in Tula and a large warehouse complex in the Moscow region;

 

·       In 2002, we acquired control of a dried milk plant in Buryn, Ukraine;

 

·       In January 2003, we acquired a 100% interest in Siberian Cheese, a refrigeration and warehousing facility in Novosibirsk adjacent to our principal Siberian dairy production facility;

 

·       In August 2003, we acquired underground wells in the Essentuki area of Russia and a water processing and bottling factory which produces “Essentuki” brand mineral water through our purchase of 100% interests in the companies Healing Springs and Geiser;

 

·       In December 2004, we acquired Atamanskoe farm, a raw milk production company;

 

·      In April, July and September 2005, we acquired three raw milk production companies, Plemzavod Za Mir i Trud, Zavety Ilyicha and Trud Farms;

 

·                  In July 2005, we acquired 66.3% control of the Obninsk Dairy Plant in the Kaluga region which we increased to 96.45% in May 2007;

 

·       In July 2005, we acquired a 100% interest in the Kursk Baby Food Plant in the Kursk region;

 

41



 

·       In October 2005, we acquired a 100% interest in the Essentuki Mineral Water Plant at CMW (Caucasian Mineral Waters) in the town of Essentuki in the Stavropol region;

 

·       In December 2005, we acquired a controlling stake in Nazarovskoe Milk in the Krasnoyarsk region;

 

·       In December 2005, we acquired a 100% interest in the Pervouralsk City Dairy Plant in the Sverdlovsk region;

 

·       In January 2006, we increased our aggregate ownership in the Moscow Baby Food Plant to 97.3%;

 

·       In September 2006, we acquired a 100% interest in the Surgut City Dairy Plant in Western Siberia;

 

·       In November 2006, we acquired 93.74% control of the Moscow-based dairy producer Ochakovo;

 

·       In December 2006, we acquired 100% control of the Omsk-based dairy producer Manros-M; and

 

·       In December 2006, we acquired 83.36% control of Angarsky Dairy Plant (MOLKA), one of the largest dairy enterprises in Irkutsk region.

 

·                  In October 2007, we acquired 100% control of dairy producer Georgian Foods in Tbilisi, Georgia.

 

·                  In December 2007, we increased our shareholding in Obninsk Dairy Factory OJSC to 99.84% of its charter capital from the previous level of 96.45%.

 

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

 

In order to improve our corporate structure and management, as well as to reduce our expenses in 2007, we merged 14 of our subsidiaries (Tsaritsino Dairy Plant, Ufa Dairy Plant, Siberian Milk Dairy Plant, Rubtsovsk Dairy Plant, Siberian Cheese Plant, Nizhny Novgorod Dairy Plant, Baltic Milk Dairy Plant, Nazarovo Dairy Plant, PAG Rodnik, Pervouralsk Dairy Plant, Kursk Baby Food Plant, Moscow Baby Food Plant, Timashevsk Dairy Plant and Vladivostok Dairy Plant) into Wimm-Bill-Dann (formerly Lianozovsky Dairy Plant). In 2008 we have merged nine other subsidiaries into Wimm-Bill-Dann (Surgut Dairy Plant, Ochakovo Dairy Plant, Obninsk Dairy Plant, Pavlogradsky Dairy Plant, Krutinsky Dairy Plant, Angarsky Dairy Plant (MOLKA), Anna milk, SP Julia, Va-Bank-2000). We are planning to continue the consolidation process throughout 2008.

 

We completed our initial public offering on February 14, 2002 and listed our shares of common stock, represented by American Depositary Shares, or ADSs, on the New York Stock Exchange under the symbol “WBD.” Each ADS represents one underlying share of our common stock.

 

According to Standard & Poor’s global scale, our corporate credit rating is BB-, and Moody’s Investors Service ranks our Corporate Credit rating as Ba3. In 2007, Standard & Poor’s Governance Services confirmed our Corporate Governance Score (CGS) 7+, which is the highest score in Russia.

 

Our legal name is Wimm-Bill-Dann Foods OJSC, and we are incorporated as an open joint stock company under the laws of the Russian Federation and registered with the Moscow Inter-District Inspectorate No. 39 of the Russian Ministry of Taxes and Duties under the state registration number 1037700236738. We operate in the Russian Federation and the CIS under

 

42



 

a number of different trademarks and brand names, as more fully described below in “—B. Business Overview—Current Operations—Our products and brands.” Our business objectives, set forth in Article 4 of our charter, include the production and sale of food products, including milk and sour milk products, mineral water, fruit and vegetable juices and beverages and children’s food. Our head office is located at 16 Yauzsky Boulevard, Moscow 109028, Russian Federation, and our telephone number is +7 495-925-5805. We maintain a website at http://www.wbd.com. The information on our website is not a part of this report. We have appointed CT Corporation System, 111 Eighth Avenue, New York, New York 10011, as our authorized agent for service of process for any suit or proceeding arising out of or relating to our shares, ADSs, or the deposit agreement.

 

B.   Business Overview

 

We are one of Russia’s largest manufacturers of food products. Our reportable business segments in 2007 were dairy, beverage and baby food products. In 2007, the dairy segment accounted for 76.0% of our sales, the beverages segment, which includes juice and bottled mineral water, accounted for 17.0% of our sales and the baby food segment accounted for 7.0% 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 located throughout Russia, including Moscow and St. Petersburg, we were the market leader at the end of 2007 with a 33% market share in value terms. In the Russian juice market, according to a Business Analytica survey of all of Russia, we had an 18% market share in terms of value at the end of 2007. In 2007 we achieved market leadership in the baby food market with a 23% market share in volume terms (according to MEMRB), whilst our value share reached 18%.

 

We currently have 37 manufacturing facilities in Russia, Ukraine, Kyrgyzstan, Uzbekistan and Georgia as well as distribution centers in 24 cities throughout Russia and the CIS. During 2007, we employed on average 19,325 people.

 

We offer our consumers a full range of quality branded dairy, juice, water and baby food 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;

 

·                  Cheese products, including hard yellow and processed cheese.

 

Our principal beverage products include:

 

·                  Juice and nectars produced from juice concentrate;

 

·                  Enriched juice-based drinks;

 

·                  A traditional berry-juice-based drink mors made from natural berries;

 

·                  Bottled natural mineral water.

 

Our baby food products include:

 

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

 

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

 

43



 

·                  Meat, fish, poultry, fruit, vegetable and dairy purees for infants under the age of three; and

 

·                  Products for pregnant women and nursing mothers.

 

Business Goals and Strategy

 

Our strategy is driven by clearly defined business architecture. In March 2007, our senior management, after extensive consultation, approved a concise strategic approach for the company aimed at meeting our qualitative and quantitative goals over monthly, quarterly, annual and multi-year time horizons. This approach does not mark a departure from our longer-term strategic vision, rather it lends greater clarity and defines the steps to be taken following the important restructuring work implemented during 2006. The vision is that by 2010 we should be Russia’s leading fast-moving consumer goods (FMCG) company with leading key profit ratios for the industry.

 

Our strategy reflects our mission and is driven by a vision of where the company should be in the future. The mission, as articulated during 2006, is to help the entire family live healthier by enjoying our nutritious and delicious food and beverage products every day throughout their lives.

 

Business Goals

 

Our business goals for 2010 represent the key individual elements needed to achieve this vision. By this date, our goal is to be recognized by both consumers and all key Russian regulators as the leading food company in terms of health and nutrition and for our top ten brands by revenue to be among the top-50 FMCG brands in Russia. At the same time, we intend to undertake an accelerated process of innovation with the aim of increasing revenues by 2010.

 

In addition, we will seek to further strengthen our corporate image and to become one of the most desired employers of choice in Russia.  Finally, by 2010, we will aim to achieve better route-to-market execution, with greater control over how products are sold at the outlet level.

 

Business Strategies

 

In order to meet these goals, our strategy is focused on key elements that are relevant across all of our business units as well as departments serving the group as a whole, including Marketing, Human Resources, Research and Development and Corporate Communications. These key elements are as follows:

 

·                  Investing in marketing to build brand equity. We intend to increase our marketing activities and focus sponsorship on sports and active lifestyle to promote the health and wellness values of our brands.

 

·                  Investing in the sales team and route-to-market (RTM) control. We will seek to increase our sales force, with consolidated key account teams focusing on large and growing retail chain customers and an increased focus on training. We have defined our merchandizing standards and are starting to implement them in the markets where we are present.

 

·                  Driving margin improvements through optimal brand, pack and price mix. We will study changing consumer price elasticity in order to adapt the right approach to brand, packaging type and size as well as price. New, higher margin packaging will be introduced with investment focused on higher margin brands.

 

44



 

·                  Driving lowest appropriate cost and protecting quality. We will regularly audit retailers to ensure quality and provide detailed quality specifications for each stock-keeping unit (SKU). We will seek to continue to improve plant efficiency and reduce logistics costs. We also intend to continue to buy out minority shareholdings and consolidate legal entities to create a more efficient and streamlined company and tax entity.

 

·                  Accelerating innovation, new category entry and acquisitions. We will seek to continue to enter new and innovative categories and segments offering profitable growth consistent with our mission. We also intend to continue our policy of acquiring successful companies across Russia and the CIS and we will carefully study opportunities for selective acquisitions of other food companies. Finally, we will continually assess the attractiveness and potential for entry into new strategic geographic areas.

 

·                  Strengthening human resource capability. We operate in both maturing markets, such as Moscow and St Petersburg, and emerging markets, such as Russia’s regions and the CIS. We will strive to develop our human resource capability at all levels to attract and retain talented executives with experience in developed and emerging markets worldwide. At the same time, we are dedicated to developing our considerable human resource capacity within the company. This entails promoting talented people within the organization and providing them with experience in other parts of the business and other regions. We seek to provide ongoing opportunities for our employees to learn new skills through training and continued education in our Corporate University. A yearly appraisal process allows managers to understand what is expected from them, provides a forum for dialogue and an opportunity to discuss career planning. Improved corporate communications are also helping central management communicate the company’s plans and goals to employees across the business and build a more unified corporate culture. We understand that motivated and well-informed employees are directly responsible for our success.

 

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 combined data from Comcon, AC Nielsen and Russian State Statistics, that per capita consumption of packaged dairy products in Russia was 66.1, 70.9 and 75.2 liters per year in 2005, 2006 and 2007, 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.  We estimate that per capita consumption of traditional packaged dairy products in Russia increased 5.5% to 59.7 kg in 2007, from 56.6 kg in 2006. We believe that packaged dairy product consumption levels will continue to increase at a solid pace in Russia due to increasing per capita income, the growing desire and demand for sterilized milk and the greater convenience of packaged products. The spike in raw milk prices observed in 2007 caused retail price increases for dairy products and this could partially offset consumption growth in 2008.

 

Since its first widespread commercial appearance in Russia in the early 1990s, the popularity of yogurt has increased. For instance, the consumption of such products as

 

45



 

drinkable yogurt, functional foods/drinks and flavored milk is relatively high among certain groups of consumers and comparable with milk consumption levels. However, the per capita consumption of the above products remains relatively low, although we believe that this segment of the dairy market has a high growth potential as incomes in Russia grow rapidly.

 

According to our estimates, annual per capita consumption of yogurt and dairy desserts in Russia increased to about 10.2 kilograms in 2007 from 9.3 kilograms in 2006, reflecting an increase of 9.1%.

 

According to our estimates, annual cheese consumption (yellow, white and processed) in Russia increased by 7.5% to 5.4 kilograms per capita in 2007 from 5.0 kilograms per capita in 2006. We believe that cheese consumption levels will continue to grow due to increasing per capita incomes and the greater variety of cheese products available to Russian consumers.

 

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 1,600 registered producers, according to the official register of manufacturers. There is evidence, though, that the process of consolidation 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. The dessert market is growing at higher rates 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 packaging and ingredients. While Russian juice consumption

 

46



 

has recovered from the effects of the 1998 financial crisis, it is still relatively low compared to most European countries.

 

The following table shows annual per capita juice and water product per capita consumption in liters in Russia and selected European countries in 2007 according to Canadean:

 

Country

 

Juices, Nectars
& Still drinks

 

Packaged Water

 

Germany

 

51

 

156

 

Netherlands

 

49

 

22

 

Poland

 

42

 

62

 

United Kingdom

 

38

 

26

 

Hungary

 

35

 

110

 

France

 

33

 

120

 

Bulgaria

 

28

 

70

 

Russia

 

22

 

24

 

Italy

 

16

 

198

 

 

Source: Canadean, 2007

 

We estimate that the annual per capita juice product consumption in Russia in 2007, 2006 and 2005 was approximately 21.5 liters, 19 liters and 16 liters, respectively, based on Business Analytica market estimates. Consumption of bottled water in Russia is now on par with juice consumption. Still, we believe that Russia has strong growth potential in this sector in comparison with consumption per capita 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 2007, according to a Business Analytica survey of ‘Total Urban Russia’ (cities with a population of over 100,000 people), the four largest Russian producers had an 85% share of the juice market. Russian producers often use cheaper domestic inputs and modern packaging technologies, and they increasingly promote their brands on a national scale. The industry is now experiencing consolidation, as demonstrated by the increase in acquisition activity. According to the Business Analytica survey, during 2007, there were more than 200 brands of juice products in the Russian juice market, although 10 of them accounted for 77% 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 2007, the top-ten bottled water producers in Russia had jointly a 71% market share in Moscow and a 66% market share in the ten largest cities of Russia in value terms. This difference is largely due to the prominence of local or regional producers in certain regions outside of Moscow whose water products have traditionally benefited from consumer loyalty in those regions.

 

47



 

Baby Food Industry

 

Consumption.   The baby food market in Russia is comprised of four main segments:

 

·       powdered formula and cereals;

 

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

 

·       supplemental infant food products (early solid foods, including juices, purees);

 

·       other products (baby water, puddings, soups, biscuits, tea).

 

According to our estimates, from 2003 to 2007, the baby food market in Russia grew by 77% in terms of volume, mainly due to growing category penetration. We estimate that over 80% of nationwide baby food 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 could have a positive impact on the baby food market over the next five years. Within the framework of the program, mothers get additional compensation for 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 baby food.

 

Production. The baby food market emerged in Russia in the early 1990s with a government plan to build approximately 110 production sites throughout the country to develop baby food 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 baby food started to acquire production facilities in Russia in the second half of the 1990s. Since 2000, the baby food 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 baby food products accounted for 76.0%, 17.0% and 7.0% of our net sales in 2007, 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:

 

 

 

2007

 

2006

 

2005

 

 

 

 

 

 

 

 

 

Dairy products

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales (in million USD)

 

1,853

 

1,321

 

1,004

 

 

 

 

 

 

 

 

 

Annual sales growth (% year on year)

 

40.2

%

31.6

%

22.6

%

 

 

 

 

 

 

 

 

Percent of total sales

 

76.0

%

75.0

%

72.0

%

 

 

 

 

 

 

 

 

Sales volume (in th. tons)

 

1,599

 

1,354

 

1,195

 

 

 

 

 

 

 

 

 

Annual volume growth (% year on year)

 

18.2

%

13.2

%

8.7

%

 

 

 

 

 

 

 

 

Beverage products

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales (in million USD)

 

414

 

324

 

303

 

 

 

 

 

 

 

 

 

Annual sales growth (% year on year)

 

27.8

%

6.9

%

0.7

%

 

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Percent of total sales

 

17.0

%

18.4

%

21.7

%

 

 

 

 

 

 

 

 

Sales volume (in million liters)

 

491

 

445

 

436

 

 

 

 

 

 

 

 

 

Annual volume growth (% year on year)

 

10.3

%

2.1

%

-5.7

%

 

 

 

 

 

 

 

 

Baby food products

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales (in million USD)

 

172

 

117

 

88

 

 

 

 

 

 

 

 

 

Annual sales growth (% year on year)

 

46.6

%

33.5

%

35.9

%

 

 

 

 

 

 

 

 

Percent of total sales

 

7.0

%

6.6

%

6.3

%

 

 

 

 

 

 

 

 

Sales volume (in th. tons)

 

87

 

66

 

58

 

 

 

 

 

 

 

 

 

Annual volume growth (% year on year)

 

31.9

%

14.7

%

15.5

%

 

 

 

 

 

 

 

 

Total net sales (in million USD)

 

2,438

 

1,762

 

1,395

 

 

Dairy Products and Brands

 

Our principal dairy product lines, types of products, principal brands, and their approximate percentage of our total dairy revenue in 2007, 2006 and 2005 are as follows:

 

Product line

 

Main brands

 

Approximate
percentage of
total dairy
revenue in
2007

 

Approximate
percentage of
total dairy
revenue in
2006

 

Approximate
percentage of
total dairy
revenue in
2005

 

Essential Dairy

 

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

 

41

%

39

%

46

%

 

 

 

 

 

 

 

 

 

 

Value-Added Dairy

 

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

 

59

%(1)

61

%

54

%

 

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 low 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:

 


(1) Slight downshift was caused by the acquisition and portfolio integration of Ochakovo and Manros.

 

49



 

Segment

 

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”

 

 

 

“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” and “M”

 

“Chudo”, “Frugurt”, “Lada”

 

 

 

“Vesely Molochnik”

 

 

 

 

 

 

 

 

 

 

 

Econom

 

Enough money for food only

 

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

 

 

 

 

 

 

 

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 2003 we launched the premium “NEO” brand and the mass-market “Zavetny Bidonchik”. 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.   The Russian dairy market has been growing in the last three years. According to our estimates, the total market for packaged dairy products in Russia was 8.8 billion liters in 2005, 9.3 billion liters in 2006 and 9.9 billion liters in 2007. We believe that consumption may continue to increase, as rising household incomes in Russia may tend to bring about higher protein consumption and preferences for dairy products. In particular, Russian households have proven receptive to yogurt, enriched dairy products and dessert dairy products. Given the existing low per capita consumption, we see this market segment as providing an opportunity for growth. We also expect continued growth in the consumption of products with long shelf life, including sterilized milk.

 

Though some measure of consolidation is occurring in the Russian dairy industry, the milk processing sector in Russia remains fragmented and includes more than 1,600 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 offerings as consumer spending is growing 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 helped us expand our business. We have also increased our production of value-added products 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 2007 with a 34% market share in volume terms*. In the traditional dairy market, we lead the market with a 33.5% market share in volume terms. In the enriched dairy market, our share was 29% in volume

 


* The dairy market shares stated for our company and all the competitors exclude in each case cheese and butter

 

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terms at the end of 2007. In yogurts and desserts, we were the market leader with 45.1% 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 yogurts and desserts and, to some extent, in products for children, 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 2007, Danone had a 12.9% market share in yogurts and desserts in volume terms and a 6.7% 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 2007, Unimilk had a 12.9% market share in traditional dairy, a 6.5% market share in yogurts and desserts and 13.1% 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 5.7% market share in yogurts and desserts in 2007 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 4.3% market share in traditional dairy and a 3.8% share of the total Russian dairy market in volume terms in 2007.

 

·                  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 diary co-operative, signed a merger agreement, which is subject to the approval of European regulators. According to the AC Nielsen study of 24 cities, Campina had a 7.7% market share in yogurts and desserts in 2007 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.

 

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 generally tended in the past to focus on niche markets, usually in the premium segment, they are now increasingly offering products to an 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

 

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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 beverage products consist of juice and bottled mineral and drinking water products. In 2007, juice products made up 92.5% of beverages sales with bottled mineral water accounting for 7.5%.

 

Our juices are produced primarily at the Ramenskiy Plant in Moscow (renamed Wimm-Bill-Dann Beverages in 2007) and at Fruktopak in Tula, and we have also retained juice lines at our dairy production facilities in Vladivostok, Novosibirsk and at the Tsaritsino Dairy Plant in Moscow. Our mineral water is produced at our two plants in the Essentuki area.

 

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

 

·        “J-7,” 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

 

·        “J-7 Exotic,” an exotic fruit juice and nectar range

 

 

 

Traditional berry-juice-based drinks

 

·        “Wonder Berry,” covering 4 kinds of berry-juice based drinks. Compote was moved out of range in the beginning of 2007.

 

 

 

Mineral water

 

·        “Essentuki,” covering 3 kinds of therapeutic mineral water (Essentuki #4, #17 and #20)

 

 

·        “Novoessentukskaya,” covering 1 kind of therapeutic mineral table water

 

The juice market consists of three basic segments, and WBD juice products are presented in all of them. We have positioned our portfolio of juice and nectar brands against three major volume segments, so that our three brands are placed in key competitive price segments. Investments into J-7 and Essentuki marketing and distribution in 2007 have been very successful.

 

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For example, in 2007, we introduced new packaging design and marketing approaches for “J-7” brand products. The main packaging for the brand remains Tetra Prizma 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, 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 “J-7” and “Lovely Garden”. A new pack design in new Tetra Prizma packaging was launched for “100% Gold” juices and nectars in the 1-liter format.

 

 In 2007, J-7 was repositioned to the premium segment and showed strong business results. 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:

 

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

 

“J-7”

 

“Wonder Berry”

 

“J-7 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”

 

 

 

 

 

 

 

Econom

 

· Aged 25-45

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

 

“Lovely Garden”

 

“Lovely Garden”

 

 

 

“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 both premium and econom 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.

 

Our aim in entering the bottled water sector is to satisfy the growing demand among Russian consumers for quality mineral and drinking water using ecologically pure Russian

 

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sources. We believe that consumers will eventually distinguish and value the superior quality spring and natural water that we offer them as opposed to purified water.

 

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

 

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 total market for juice products, defined as the total consumption of domestically produced and imported products, increased to 3,062 million liters in 2007, according to Business Analytica, from 2,700 million liters in 2006. We believe that rising household incomes in Russia and the increasing preference for juice over fresh fruit, which generally accompanies increased incomes, will encourage the consumption of vitamin-rich, value-added products with different tastes and nutritional characteristics. For example, according to Business Analytica, in Moscow, which enjoys 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 Canadean study). 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 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 them juice is still a novelty and we believe that with rising household incomes there will be a growing demand for lower-middle juice offerings. 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 having 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 at acceptable prices.

 

In the Russian juice market, according to a Business Analytica survey of all of Russia, we had an 18% market share in value terms at the end of 2007.

 

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 2007. Dobry, Rich and Nico are key brands of the company. Multon 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 28% market share in Russia. Tonus, Ya, Fruktovy Sad and other brands have become well-known among Russian consumers. In 2007 Lebedyansky acquired Troya

 

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Ultra juice producer based in St. Petersburg and complete purchase of Progress juice plant. In March 2008 PepsiCo announced acquisition of 76% of Lebedyansky.

 

·       Nidan is a Novosibirsk-based Russian company that accounted for 16% of the market in value terms in 2007. Moya Semya is a major brand of the company. Other key brands are Caprise and Champion. In August 2007 Lion Capital, a British investment fund, agreed to acquire 75% of Nidan’s shares.

 

The market shares of our principal competitors mentioned above are indicated in each case as of the end of 2007, in value terms.

 

The market for mineral water is characterized by rising consumption, as well as many local brands that are strong in their respective home regions. According to Business Analytica, the total market for bottled water in Russia increased to 3,349 million liters in 2007 from 2,965 million liters in 2006. Russian bottled-water producers dominated the market, with a 67% market share in terms of value, while the share of the two market leaders, PepsiCo and Coca-Cola, accounted for 33%, according to a Business Analytica survey of Russia’s 10 largest cities in 2007. According to the same survey, we were among the top-ten water producers in Russia, with a 2.9% market share by value. The market growth in recent years has been driven mainly by the increased consumption of bottled water sold in large packaging, which is consumed for drinking, as well as cooking purposes. We believe that this market will continue to expand in the coming years due to the growing per capita income in Russia and increasing concern among the population over food and water quality.

 

Baby food products and brands

 

Our baby food products, sold under the “Agusha” brand, include liquid dairy baby food, juice, purees and products for pregnant and nursing women. These products are mainly produced at the Moscow Dairy Baby Food Plant and at the Kursk Baby Food Plant, with production launched at Manros-M in Omsk in March 2008. In 2007, baby food products comprised 7% of our total sales.

 

As of 2005, baby food is a stand alone business for operational and reporting purposes. Prior to 2005, baby food was part of our dairy segment.

 

We are currently developing our baby food division by focusing on geographical expansion, full range of products and increased production. We also plan to launch new products, as well as expand the range of the existing ones.

 

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

 

Market trends and competition.   The baby food market in Russia has been experiencing dynamic growth in recent years, supported by improved market conditions, including rising average incomes, more stringent government regulation of baby food production and the introduction of various state-supported social programs aimed at improving domestic birth rates and providing maternity assistance. As a result of these improved conditions and increased consumer demand, domestic production of baby food products has increased over the last few years, with certain of Russia’s major juice and dairy producers increasing their production capacity and introducing new baby food brands. Foreign producers are also active in the market and, similar to the dairy and juice markets, several such producers have begun to focus on establishing local production capacity in Russia. The baby food market is already consolidated, with top six players accounting for approximately 78% of the total baby food market, according to MEMRB. Given the existing low per capita consumption and growing incomes this market segment has a strong growth potential. Another factor driving the growth of the Russian baby food market is the increase in the number of infants aged four and under

 

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by 3.5% in 2005, by 2.5% in 2006 and by 2.6% in 2007, according to the Federal State Statistics Service (former GosKomStat).

 

According to MEMRB, we were the market leader in dairy products for babies and infants in Russia in 2007, with 75% value share, followed by Petmol (part of Unimilk, Tyoma brand) with 25% value share. Nestlé and Nutricia were the market leaders for powdered formula and cereals, with 50% and 31% value shares in powdered formula and 21% and 29% value shares in cereals, respectively.  Local producers of baby food products are also active in regional markets, the largest of which are the Zelenodolsk Baby Food Dairy Plant, Ekaterinburg Dairy No. 1, Novosibirsk Dairy and Ratmir Tver Dairy.

 

Among the leading producers of baby food in Russia are foreign companies such as Nestlé, Nutricia, Heinz and Hipp, which generally operate in all of the main baby food categories, as well as domestic producers such as us, Nutritek, MK Tikhoretsky and Lebedyansky, which generally operate in select baby food product categories.

 

New Product Development

 

For a leading consumer goods company operating in an ever more competitive marketplace, we rely on the process of innovation in order to strengthen our market position and win market share in other segments. A high-technology research and development capability is a crucial competitive advantage for us and a key to our long-term profitability growth.

 

Our Research and Development (R&D) base, employing more than 40 people, is located at Lianozovsky Dairy Plant in Moscow, the company’s flagship enterprise and one of the largest and one of the best technically equipped dairy production facilities in Europe including its own testing platform.  R&D creates and tests new products for the company’s dairy, beverages and baby food units, working closely with production across the company. Since 2006, with the creation of the new post of Head of Marketing and Innovation, R&D is working even more closely with Marketing to combine intelligence and research about changing consumer habits and patterns to develop new products across all three main business units.

 

Innovations can include enriched versions of existing products, new formats and packaging for popular products – changing how they are consumed – and wholly new products for the Russian market. New packaging technology can turn a product into a convenient snack or meal, such as “Vesely Molochnik” kasha with a spoon. All of these innovations are aimed at providing higher margin goods for the company and nutritious, convenient and tasty foods for the consumer.

 

Looking forward, new product development is being conducted in line with the company’s mission to provide healthy, high-quality and safe foods for the entire family. Functional foods, products aimed at women and convenience products for busy lifestyles are key areas of focus. The department is working to develop new, enriched products that deliver added nutrition through the use of biologically active ingredients that help deliver essential nutrients. The successful launch in the second half of 2007 of the “Beauty” brand, which contains aloe extract and is formulated to rejuvenate the skin, nails and hair, is an example of such a functional product. In baby food, R&D is focused on filling out our range and enhancing product quality.

 

Much of our new product development effort over the past three years has focused on higher-margin, value-added yogurt and dessert products. At present, we are focused on the development of value-added dairy products oriented towards Russian consumers, taking into consideration the general deficit of micro- and macro-nutrients in the diets of the average Russian consumer, and leveraging our superior understanding of Russian taste preferences.

 

Throughout 2005 and 2006 we actively develop our cheese and enriched dairy products. We expanded our cheese production, introducing new brands and varieties. For example, we

 

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introduced a wide selection of processed cheese products under our “Vesely Molochnik” brand, as well as hard cheese sold under “Lamber” brand. In addition, in 2005, we launched a new line of “5 Grain” yogurts and cottage cheese products and low lactose milk under the “Bio-Max” brand.

 

In 2006, we launched a new kefir called “Effective” under the Bio-Max brand. In addition, in 2006, we launched rice pudding under the “Vesely Molochnik’’ brand.

 

In the beverages segment, we launched a new product under our “Lovely Garden” brand called “Lovely Garden—10 Vitamins” during 2005. In the same year, we introduced new PET bottle packaging for this brand.

 

In 2006 we launched a new production line at the Kursk Baby Food Plant for juices and fruit purees. In the first quarter of 2007 we launched new Agusha product ranges, including meat and fish purees containing essential vitamins and minerals and made from GM-free ingredients. The Chudo assortment reached 200 SKUs (stock-keeping units) by the end of 2007, offering wider range of flavors in every category it operates.

 

During 2007 a significant number of innovative products were introduced to Russian consumers. The launch of “Beauty” was considered one of the most important launches across the portfolio. A number of packaging ideas were implemented in 2007, such as multipacks for Chudo, Imunele and Beauty to stimulate consumer off-take. J-7 core orange flavor upgrade, new packaging and advertising campaign stimulated J-7 sales growth in 2007. In addition, a number of new flavors were launched in the Juice segment, including two versions of tomato juice under the “Lovely Garden” brand and “Mango Cinnamon” under J-7.

 

Advertising and Marketing

 

Brand building and marketing have always been at the core of our business. Since the early 1990’s, we have built brands into household names in Russia and the CIS,  from the J-7 brand of juice to one of Russia’s first yogurts under the Chudo brand to Agusha, the most popular baby food brand.

 

Our marketing strategy is aimed at turning our leading portfolio of brands into even stronger competitive advantage. We will aim to accelerate brand building based on a deeper understanding of consumers and faster reaction to new trends in the marketplace. As the cost of advertising on Russian television continues to rise, we will concentrate on more focused and more efficient campaigns to reach target consumer audiences.

 

Our investment in some 10 power brands in 2007 is aimed at increasing their average selling price and market share, while achieving the right product mix. We believe, our most successful brands still have considerable untapped potential.

 

In juice, the J-7 brand saw radical changes in 2007, with a new, breakthrough advertising campaign, new packaging, improved taste profile and new pricing structure.

 

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

 

In addition, the scientific potential of the R&D division and consumer knowledge have been brought together, with R&D reporting to marketing. The innovation process has been accelerated with a focus on value-added, functional foods.

 

Our advertising and marketing expenditures of $57.9 million in 2005, $76.2 million in 2006 and $138.0 million in 2007 constituted 4.1%, 4.3%, and 5.7% of net sales, respectively. Though we are, in some instances, able to obtain volume discounts, we expect these expenditures, as a percent of net sales, to increase significantly due to market competition and annual media inflation. According to Gallup, in Russia, we were the ninth largest advertiser in 2005, the twelfth largest advertiser in 2006 and the tenth largest advertiser in 2007. In 2007,

 

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we began systematic testing of the quality of our advertising, and saw positive results on several key brands, including J-7, Little House in the Village and Agusha.

 

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

 

We have also built brand awareness through charitable work and sponsored events. For example, in 2004, 2005 and 2006, we sponsored the “Tefi” National Television Awards program. For several years, we have sponsored International Charity Foundation events benefiting orphans through its “Hope Around the World” program. We also support several other charitable organizations and serve as a trustee of the Charity Foundation for Special Grants, which was headed by the late Mstislav Rostropovich, a prominent Russian musician.

 

Sales and Distribution

 

According to Russia’s Federal Statistics Agency, total retail sales in 2007 in Russia as a whole grew 15.2% year-on-year.

 

 Seven Russian regions (Moscow, Saint-Petersburg, Moscow region, Sverdlovsk region, Rostov region, Tyumen region and Krasnodar region) accounted for 43.2% of total retail turnover, including 19% in Moscow alone.

 

In recent years, individuals in Russia have been spending an increasing percentage of their incomes on consumer goods. In 2007, the cash income of the population grew 22.4% compared to 2006, and purchase of goods and services grew by 23.5%. The growth in the income of the population led to growth in demand as well as a change in its structure, as consumers began to buy more expensive and higher quality goods.

 

Today, Russia’s retail landscape is in the midst of a transformation. International and domestic food retail chains, the familiar retail model in Western countries, have expanded, replacing more traditional outlets such as open markets and kiosks.

 

A notable feature of 2007 was a decrease in sales at open markets. Retail volumes at open markets in 2007 were 10% below 2006 levels. The decline of open markets reflects the fact that modern stores provide a wide range of products across a wide range of price categories and that consumers are increasingly dissatisfied with the quality of products as well as environment and lack of convenience inherent in shopping at open markets. At the same time, the current share of modern retail formats among total retail turnover in Russia as a whole remains low compared to developed markets, at around 25% compared to 75% in most of Europe.

 

The absolute size of the retail market continues to grow every year, with Russia’s regional markets seeing the fastest growth. According to Business Analytica and Nielsen data, the share of sales via modern formats, such as supermarkets, hypermarkets and discounters, in general volume of retail sales is seeing rapid growth. According to Business Analytica, the share of juice sold in modern format outlets grew from 13.4% of all juice sales in 2006 to 15.7% in 2007, while the share of all dairy products grew from 57% in 2006 to 63% in 2007 (according to AC Nielsen).

 

In Moscow, the country’s largest single market, this ratio is considerably higher and in the last few years, foreign and domestic retail chains have focused on expanding in large regional cities, in particular targeting fast-growing but under-served regions such as the Urals and Siberia. We believe that growth in retail chains creates additional opportunity for market expansion and has a generally positive effect. In particular, retail chains provide increased business transparency and new technologies for sales and marketing, and offer manufacturers new opportunities to increase sales volumes, and expand sales geographically.

 

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Sales

 

In 2007, we made substantial investments in our Sales and Distribution (S&D) function as part of a long-term commitment to improve our “route-to-market” and better control our in-store execution.

 

We plan to meet the changing and increasing demands of our customers by delivering appropriate stock levels and reasonable delivery times consistent with achieving the optimal economics of distribution. In order to achieve these objectives, we have developed a network of distribution centers and trade offices throughout Russia and other countries of the CIS. At the end of 2006 we had 14 distribution centers for dairy products, whereas in the fourth quarter of 2007 this number grew to 25. On the basis of distribution centers, teams of field managers were created that allow us to control sales, including controlling trade marketing actions by these centers. We also sell our products directly from production sites.

 

A key part of our strategy is to enhance control over the “route-to-market” and collaborate successfully with retailers to ensure key brands are well positioned in retail outlets, priced correctly and maintained at the same high quality as when they left the factory. Investment in our own fleet of cold-chain delivery vehicles represents a substantial upfront cost, but ensures better control and flexibility over deliveries of perishable dairy products. Across the company, improvements are being made to the supply chain to reduce costs, maintain quality and tightly track products from the factory to the consumer.

 

Another key strategic direction is development and increasing efficiency of our field sales force.

 

We are also developing our merchandising standards and setting up pilot stores for our sales personnel and distributors to showcase our brands and provide a template for merchandizing strategies.

 

Distribution

 

Due to different consumption patterns and product characteristics, our dairy, baby food and beverage businesses require different distribution strategies. We have therefore built two distribution systems: one for our dairy and baby food, and the other one for beverage products, although we use the same marketing approach in each business and take advantage of synergies between the systems to the extent possible. We also develop our sales through exclusive distributors, for which our products sales is a 100% of their business.

 

We sell our products through various sales channels, including independent distributors and wholesalers, supermarket chains, small- and medium-sized grocery stores, open air markets, pavilions and restaurants.

 

Independent distributors

 

As a percentage of total sales during 2007, in terms of products value, we sold 60% of our dairy products, 67% of beverages and 40% of baby food products through large chains of independent distributors. The process is controlled by our sales personnel.

 

All of our dairy distributors in Moscow are exclusive to us and do not distribute dairy products of our competitors. We also implemented a segmentation program among the Moscow distributors whereby each distributor controls the distribution of a particular segment or segments of the dairy product market. In St. Petersburg and the surrounding areas, we also have large independent distributors who purchase products from us in accordance with the segmentation program. We believe that this strategy increases the quality and efficiency of distribution while allowing distributors a larger financial stake and incentive to operate high-quality distribution channels.

 

A number of independent distributors with whom we work purchase dairy, beverage and baby food products from us.

 

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Our beverage product distribution network consisted of 15 regional sales offices throughout Russia in 2007. We have reduced the number of distributors we work with and broadened the scope of sales made through the distributors to include sales to sub-distributors, wholesalers and small retailers. In Moscow, our independent distributors act principally as logistical coordinators, as our sales representatives work directly with retail outlets and other customers in making sales but rely on the distributors to execute the orders through delivery and payment collection. Outside of Moscow, we rely more heavily on our independent distributors. Some of our beverage distributors have teams devoted exclusively to the sale and distribution of our products.

 

Independent distributors purchase directly from us and then resell our products through their own distribution centers. Given the importance of these customers, we process orders from independent distributors relatively quickly. We launched our Internet order system in Moscow in January 2000, and all orders by our dairy product distributors in Moscow and the Moscow region are now placed through the Internet. In 2001, we started to use an automated order system with all of our independent distributors who purchase our products in large volumes, and in 2002, we began using this automated order system with our smaller independent distributors as well

 

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

 

Direct sales

 

We sell our products through all the available sales channels, including independent distributors and wholesalers, supermarket chains, small- and medium-sized grocery stores, open air markets, pavilions and restaurants. However, as the share of chain retailers grows, our strategy is to increase the share of our own direct sales to them.

 

As a percentage of our total sales during 2007, in terms of product value, we sold 36% of our dairy products, 30% of beverages and 25% of baby food products directly through our national and local key accounts. We believe that the importance of these customers will continue to grow in the coming years. In 2007, our share of sales via the sector grew 6.1% compared 2006. We want to become the supplier of choice for these customers by developing key supplier relationships and improving customer service standards. We also sell our products to wholesaler Metro, whose customers are mainly small- and medium-sized businesses that purchase our products in bulk for resale or everyday business use.

 

While relationships with supermarket chains are currently beneficial for us, we expect that the growth of certain chains and consolidation of market power may increase the bargaining power of some of these customers. For example, some Russian supermarket chains have, from time to time, created informal alliances in an attempt to obtain greater price discounts from manufacturers. We do not intend to seek or sustain inefficient sales volumes and may withdraw from unprofitable business relationships.

 

Other sales

 

Our infant dairy products are also purchased by the Moscow City Government, which, in turn, distributes them through specialized milk kitchens located around Moscow and the Moscow region. In 2005 and 2006, the Moscow City Government purchased 36% and 33% respectively of our total baby food sales in terms of product value. In 2007, our baby food sales through milk kitchens decreased to 26%, while, the value of commercial sales increased.

 

We sell our juice products directly to certain airlines, restaurants, schools, hotels and other establishments. As a percentage of total sales during 2007 we sold 2.9% of our dairy products and 2.6% of our juices products through these customers.

 

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Export program

 

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

 

We currently export our juice products to the United States, Canada, Australia, Germany, France, Israel, Latvia, Estonia and Lithuania, Mongolia and China. Our juice products are distributed in these countries through independent distributors and are sold in various national and multinational retail chains. Our products are also exported and sold through various sales channels in CIS countries such as Kazakhstan, Georgia, Armenia and Moldova, and we further developed our distribution channels, marketing efforts and sales in Belarus during 2007. We also export our “Essentuki” mineral water, principally to the United States, Canada and Moldova. Our production facilities were certified in 2007 to export “Essentuki” to Ukraine. Our beverages export sales totaled $2.6 million in 2004, $3.0 million in 2005, $3.3 million in 2006 and $4.6 million in 2007.

 

The Tsaritsino Dairy Plant (at the end of 2005) and the Rubtsovsk dairy plant (at the beginning of 2007) received a license to export dairy products to the EU. During the licensing process, all of the plants’ equipment and production, technological and control processes were inspected to ensure compliance with international norms and standards. The Lianozovsky Dairy Plant received a similar license in 2004 and currently exports dairy products to the Baltic States and Germany.

 

We routinely participate in trade shows in foreign countries and work with foreign distributors on promotional campaigns and product tastings (e.g., “Green Week”, “ANUGA” and “SIA”). We also engage in market tests and market research in, as well as one-off deliveries to, foreign countries in order to determine future potential markets. We are a three-time recipient, most recently in 2005, of “The Best Industry Sector Exporter” award from the Trade and Economic Council of the Russian Ministry of Economic Development.

 

In exporting our products to a country, we strive to meet the applicable legislation governing the import of food products into the country. Independent distributors have, in some cases, attempted to export products to other countries that did not meet applicable legislation.

 

Production and raw materials

 

Production efficiency and quality

 

Our Quality System (QS) is a clearly defined set of procedures that work together to ensure quality process control and quality assurance.

 

Our QS undertakes Supplier Assessment audits to ensure suppliers provide materials that meet our exacting quality standards. This includes raw materials for making our products, packaging and equipment. Our experts work with existing and prospective suppliers to ensure their goods can demonstrate compliance with our quality, safety and performance standards. Suppliers are graded and assigned Key Production Indicators (KPIs) based on the criteria of product quality, delivery, cost and responsiveness. This work not only ensures suppliers meet our standards but helps make them more efficient, lowering our input costs.

 

The QS plays a critical role in ongoing technological integration across all of our factories and trading groups. In the dairy business unit, where we have invested substantially since 2003 in modernizing acquired production facilities, quality control experts have led the Unification Project, aimed at establishing tight coordination of the manufacturing process at many of our geographically distant plants. Consistent manufacturing procedures and technology mean plants operating thousands of kilometers apart can make products with consistently high and uniform taste and quality.

 

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

 

The Trade QS measures the quality of the product and packaging in the marketplace itself. Under a system launched in 2007, trade sampling and laboratory analysis match products against our specifications and provide a Quality Index calculation determining whether a product meets the high standards set by us for our consumers.

 

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

 

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

 

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

 

To improve the feedback and receive queries from our consumers a nation-wide toll-free hot-line was developed and implemented. The number is printed on our packaging for all of our products.

 

We have been upgrading and expanding our facilities with advanced technological engineering. Our significant investments in manufacturing have helped enable our products to compete with those of leading domestic and international manufacturers. For example, at the Lianozovsky and Tsaritsino Dairy Plants, we installed new equipment improving the quality of raw milk used in production; at the Timashevsk Dairy Plant, we installed an automatic system controlling production processes; and at the Vladivostok Dairy Plant, we modernized the water purification system. Additionally, the reconstruction of the Moscow Baby Food Plant and installation of new production lines there have allowed us to improve the quality of the products produced at this plant. All the lines at the Moscow Baby Food Plant are now equipped with aseptic technology. The method of ultrafiltration we use at this plant also allows us to produce children’s cheese paste which retains its most beneficial nutrient, serum protein, giving it a higher nutritional value than similar products manufactured at other plants.

 

During 2005, we continued to modernize the Lianozovsky and Tsaritsino Dairy Plants by upgrading acceptance workshops, broadened our cheese production capacity at the Rubtsovsk Dairy Plant in order to satisfy the growing demand for our hard cheese products and added a new production line for porridges and processed cheese at the Timashevsk Dairy Plant. At the Vladivostok Dairy Plant, we installed a juice production line to produce “Lovely Garden” and “J-7” juice products.

 

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During 2006, we installed a new innovative line of fruit preparation that allows us to improve the quality of jams used in our products. A unique technology for aseptic dairy-based sauce production was developed and implemented at Lianozovsky Dairy Plant. A new filling line with tunnel autoclave was installed at the Kursk Baby Food Plant. New technologies for purification of raw juice were implemented at Ramenskoye.

 

In 2007 we completely overhauled our newly acquired plants, Manros and Angarsky Dairy Plant (MOLKA). They are now fully operational. We are also in the process of closing down Ochakovsky Dairy Plant for a major overhaul and moving the production to our other facilities.

 

Food raw materials

 

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

 

·                         raw milk, which we generally obtain from domestic farmers;

 

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

 

·                         bacteria cultures, which we generally import;

 

·                         flavorings, which we generally import;

 

·                         sugar, which we generally import;

 

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

 

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

 

The prices of each of the foregoing raw materials are generally volatile.

 

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

 

We purchase almost all of our raw materials from the producers and do not engage in a significant amount of barter transactions. We purchase certain raw materials such as bacteria cultures, juice concentrates and flavors from foreign manufacturers when products of appropriate quality are not available locally.

 

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

 

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

 

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

 

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Under the Milk Rivers program, we have rented milking and refrigeration equipment for periods from three to eight years for agricultural enterprises located in the Moscow and other regions, including Voronezh, Nizhny Novgorod, Ufa, Novosibirsk, Krasnodar and Altai. The lease receivables are offset with milk supplies based on a predetermined schedule during the lease term. The lease receivables are denominated in U.S. dollars and Russian rubles. Equipment leased out to farms includes milking and refrigeration equipment for accelerated milk cooling and the temporary storage of milk at farms and other technical devices that increase the productivity of farms. The type of equipment provided depends on the needs of each particular farm.

 

Under the Milk Rivers program, we also provide loans to Milk Rivers dairy producers for the purchase of dairy cattle. We have also offered seminars and lectures to our Milk Rivers program participants to help them improve the quality of the milk they produce.

 

We plan to eventually expand the scope of this program to other regions of Russia.

 

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

 

We believe that providing dairies with wholesome, well-balanced compound animal fodder is essential for increasing the productivity of dairy herds, especially in the winter. We have been working with select farms and fodder producers since 1999. As with the Milk Rivers program, payment for the fodder is made with milk supplies.

 

In February 2008, we opened a new mega-farm complex in Volosovsk District near St Petersburg, built in place of the Trud collective farm, which we had acquired in 2005. The state-of-the-art farm is designed for 1,200 Holstein milking cows.

 

Seasonality

 

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 lower demand for dairy products, while raw milk production is at its peak. To address these seasonal demands, we have commenced and expanded the production of powder milk at some of our dairy production facilities for use in production during the winter months.

 

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

 

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

 

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

 

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Packaging

 

Our principal packaging raw materials include materials needed for packaging our dairy, baby food and juice products, consisting mainly of five groups:

 

·                  aseptic paper

 

·                  nonaseptic paper

 

·                  plastics (PP, PE, Polysterene and others)

 

·                  foils

 

·                  corrugated board

 

Our main supplier of composed material for the production of milk and juice carton containers is Tetra Pak, the world leader in manufacturing equipment and materials for aseptic packaging of liquid food products.

 

Tetra Pak supplied approximately 71% of our total packaging materials in value terms in 2007 (including carton, plastic, foil and other materials), and we are substantially dependent upon this packaging supplier to meet our requirements.

 

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

 

We have established similar relationships with companies such as SIG Combibloc (aseptic paper for juice and milk) and Elopak (nonaseptic paper).

 

As part of our strategy to increase locally produced raw materials, we are developing relationships with Russian manufacturers of packaging materials, in particular with companies such as Gofra, Polimer, Formoline, Formaplast, Eximpack, Lukoil-Neftekhim and Planet Thermoforning.

 

We focus on two main areas building our procurement strategy:

 

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

 

·                  strategic relationships with key group-wide suppliers

 

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

 

Trademarks and Patents

 

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

 

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In 2007, we obtained recognition of two of our trademarks (“Wimm-Bill-Dann” as a word mark (literal) and combined trade mark “Wimm-Bill-Dann, that’s what you want” as a combined mark) as well-known trademarks of high renown from Rospatent, the Russian patent bodytrademark office. Such recognition protects these trademarks for an unlimited duration of time and provides us with certain additional benefits with respect to our use of these trademarks.

 

Insurance

 

We maintain property insurance coverage for our 19 major facilities, including Wimm-Bill-Dann Foods, Wimm-Bill-Dann, Tsaritsino Dairy Plant, Moscow Baby Food Plant, Ochakovo Dairy Plant, Ramenskiy Plant, Timashevsk Dairy Plant, Obninsk Dairy Plant, Annino Dairy Plant, Ufa Dairy Plant, Siberian Dairy Plant, Vladivostok Dairy Plant, Nizhny Novgorod Dairy Plant, Rubtsovsk Dairy Plant, Pervouralsk Dairy Plant, Healing Springs, Baltic Milk, Kiev Dairy Plant, Kharkov Dairy Plant, Buryn Dairy Plant, Bishkeksut, Toshkent Dairy Plant and our warehousing facility at Tomilino distribution center. Insurance coverage is on “All Risks” basis covering buildings of 15 plants and Tomilino distribution center, equipment at 18 facilities for the total sum of $485.2 million. We have insurance for business interruption at 14 major manufacturing facilities with the total coverage of $421.7 million.

 

We have product liability insurance with $1 million liability coverage per insurance case within the territory of Russia, the CIS countries and Mongolia, $2.5 million liability coverage per insurance case worldwide except for the territory of Russia, the CIS countries and Mongolia with the cumulative coverage of $5 million for production and distribution operations of diary, soft drinks, juices and baby foods in Russia.

 

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

 

Environmental and Product Liability

 

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

 

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

 

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associated negative publicity may adversely affect our reputation in the Russian Federation, the CIS and abroad, and adversely affect our results of operations.”

 

Regulation

 

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

 

Government Entities Involved

 

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

 

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

 

The Federal Service for Supervision in the Area of Protection of Consumer Rights and Human Welfare.   This Service is the principal federal body authorized to supervise sanitary and epidemiological issues in the Russian Federation. The Service enforces sanitary-epidemiological rules (which include sanitary rules, sanitary standards and hygienic requirements), monitors the sanitary conditions of production sites and equipment, fulfillment of sanitary standards for raw material and finished product storage at manufacturing plants, compliance with sanitary standards for the storage and sale of food products, their quality and safety at wholesale and retail outlets and businesses catering to the public. The Service also carries out inspections of sellers’ premises.

 

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

 

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

 

Applicable Food and Health Legislation

 

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

 

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

 

The Federal Law on the Sanitary Epidemiological Well Being of People requires food products and beverages, and the raw materials used in their production, to meet certain sanitary standards and health requirements and to have no harmful effects. Products that do not conform to sanitary rules and health requirements and represent a danger to consumers

 

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must be withdrawn immediately from production or sale. As a result, the fulfillment of sanitary standards and health requirements is an obligatory condition for the production, import and sale of food and beverage products in the Russian Federation.

 

The Federal Law on Technical Regulation provides for the development, enactment, application and enforcement of obligatory technical requirements and the development of voluntarily standards relating to manufacturing processes, operations, storage, transportation, selling and utilization. Amendments to this law, dated May 1, 2007, provide for the adoption of obligatory technical requirements on the safety of food products by January 1, 2010. Until such technical requirements are developed and adopted, the existing standards are mandatory to the extent they are necessary to secure the protection of safety and health, environmental protection and consumers’ rights.

 

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

 

The Government Regulation on State Registration of New Food Products, Materials and Goods provides for the obligatory state registration of certain food products, including mineral water, baby food and dairy products enriched with vitamins and/or other microelements. Food producers intending to develop and offer a new food product to the public are required to file an application for the product’s state registration and incorporation into the State Register of Permitted Food Products. Such applications are reviewed by the Federal Service for Supervision in the Area of Protection of Consumer Rights and Human Welfare (together with the Federal Service for Veterinary and Fito-Sanitary Supervision with respect to products derived from animals) within 40 days of their filing.

 

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

 

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

 

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

 

Registration Requirements

 

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

 

The product registration process includes:

 

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

 

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

 

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

 

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

 

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

 

Certification

 

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

 

Bulk Purchase of Raw Milk

 

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

 

Production and Transportation

 

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

 

Food products and beverages must be transported in specially equipped vehicles, for which sanitary registration documents must have been issued.

 

Packaging Material and Labeling Requirements

 

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

 

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

 

Special Requirements for Children’s Dairy Products

 

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

 

Under the Sanitary Rules on Children’s Food Products, which became effective on June 1, 2005, the volume of liquid food product packaging for children under three years old cannot exceed 0.35 liter. In addition, such products may be produced only by separate specialized factories or manufacturing lines that are subject to special certification.

 

Competition and Pricing

 

The Federal Antimonopoly Service is the governmental agency that regulates the prevention and limitation of monopolistic activity and the support of competition in the market. The Federal Law on the Protection of Competition prohibits the abuse of a dominant position to limit competition. Our subsidiary, the Moscow Baby Food Plant, has been included in the register of entities holding a significant share of the market. Inclusion in this register does not impose additional reporting or other requirements on us; however, because of our significant position, the Federal Antimonopoly Service monitors our activities and we are required to notify the Federal Antimonopoly Service and/or apply for its prior approval for the acquisition of other companies.

 

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C.   Organizational Structure

 

The following table sets out our primary production subsidiaries, their countries of incorporation and our aggregate beneficial ownership interest and voting interest in each subsidiary as of June 24, 2008.

 

Plant

 

Ownership
Interest

 

Country of
Incorporation

 

Wimm-Bill-Dann Plant (1)

 

97.54

%

Russian Federation

 

Karasuk Dairy Plant

 

93.80

%

Russian Federation

 

Wimm-Bill-Dann Ukraine (2)

 

98.35

%

Ukraine

 

Moloko Veidelevki

 

100

%

Russian Federation

 

Tuymazinskiy Dairy Plant

 

85.00

%

Russian Federation

 

Bishkek Dairy Plant

 

96.10

%

Kyrgyz Republic

 

Gulkevichy Dairy Plant

 

52.27

%

Russian Federation

 

WBD Toshkent

 

100

%

Republic of Uzbekistan

 

Manros-M

 

100

%

Russian Federation

 

Bolsherechensk Dairy Plant

 

79.78

%

Russian Federation

 

Beverage plants

 

 

 

 

 

Wimm-Bill-Dann Beverages (3)

 

97.00

%

Russian Federation

 

Valdai Springs Water Plant

 

100

%

Russian Federation

 

Essentuki Mineral Water Plant at CMW (Caucasian Mineral Waters)

 

100

%

Russian Federation

 

Farms

 

 

 

 

 

Trud

 

96.48

%

Russian Federation

 

Atamanskoe Farm

 

99.53

%

Russian Federation

 

Plemzavod Za Mir and Trud

 

100.00

%

Russian Federation

 

Zavety Ilyicha

 

99.59

%

Russian Federation

 

Niva

 

94.62

%

Russian Federation

 

 


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

 

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

 

(3) Formerly Ramensky Dairy Plant

 

D.   Property, Plants and Equipment Production facilities

 

We currently manufacture our products at 37 production facilities, including 31 production sites that produce dairy products, four baby food production sites and two plants that produce exclusively juices. We have made substantial investments to maintain and enhance quality, lower costs and increase productivity. Over 2005, 2006 and 2007 we invested approximately $397.5 million in the modernization of our existing production facilities and $153.0 million in the acquisitions of new production assets.

 

 Our main production plants are capable of managing the production of a diverse and evolving product range, enabling us to adapt quickly to changes in consumer demand on a seasonal basis or otherwise. We have completed the main phase of our extensive modernization program and have begun efficiency, waste reduction and cost cutting programs at all of our plants.

 

We also review our production headcount with the aim of enhancing productivity. Sales per production employee, calculated on the basis of our total headcount, which is a common

 

71



 

measure of productivity used in the food industry was $142,815 per employee in 2005, $162,994 per employee in 2006 and $220,145 per employee in 2007.

 

In 2006 we started working with an international management consulting firm on a training and business-process optimization program at the Lianozovsky Dairy Plant and Moscow Baby Food Plant in an effort to increase asset utilization, to cut costs, and to raise labor productivity. As a result, we were able to reduce our employee headcount during 2007, excluding the plants we acquired during the second half of 2006, where the reduction of headcount is still in process.

 

The following table contains data regarding our main production facilities.

 

 

 

Year of
Acquisition 
(1)

 

Year of 
Building

 

Number of
Production
Lines

 

Moscow and Moscow region

 

 

 

 

 

 

 

Wimm-Bill-Dann + BF (2)

 

1995

 

1989

 

58

 

Wimm-Bill-Dann Beverages (3)

 

1997

 

1982

 

14

 

Obninsk Dairy Plant OJSC

 

2005

 

1982

 

9

 

Ochakovskiy Dairy Plant

 

2006

 

1962

 

18

 

Central Russia (excluding Moscow)

 

 

 

 

 

 

 

Annino Dairy Plant

 

2001

 

1978

 

8

 

Timashevsk Dairy

 

2001

 

1985

 

18

 

Essentuki Mineral water Plant at the CMW (Caucasian Mineral Waters)

 

2005

 

2001

 

3

 

Siberia and Far East Russia

 

 

 

 

 

 

 

Karasuk Dairy Plant

 

1999

 

1952

 

5

 

Angarsky Dairy Plant (MOLKA)

 

2006

 

1956

 

8

 

Surgut Dairy Plant

 

2006

 

1974

 

5

 

Manros-M

 

2006

 

1970

 

8

 

Tuimazy Dairy Plant

 

2002

 

1958

 

9

 

Other CIS countries

 

 

 

 

 

 

 

Wimm-Bill-Dann Ukraine (4)

 

2001

 

1973

 

21

 

Kharkov Dairy Plant

 

2002

 

1974

 

16

 

Buryn Powder Milk Plant

 

2002

 

1974

 

4

 

Bishkek Dairy Plant

 

2000

 

1990

 

14

 

 


(1) “Acquisition” means the purchase of more than 50% of the issued share capital. Only plants acquired by us as of June 24, 2008 are included in this table.

 

(2) Formerly Lianozovsky Dairy Plant. In April and May 2007, the following subsidiaries were merged into Wimm-Bill-Dann: Tsaritsyno Dairy Plant, Ufa Dairy Plant, Siberian Milk Dairy Plant, Rubtsovsk Dairy Plant, Siberian Cheese Plant, Nizhny Novgorod Dairy Plant, Baltic Milk Dairy Plant, Nazarovo Dairy Plant, PAG Rodnik, Pervouralsk Dairy Plant, Kursk Baby Food Plant, Moscow Baby Food Plant, Timashevsk Dairy Plant and Vladivostok Dairy Plant. On March 5, 2007, we sold Novokuibyshevskmoloko – our Samara region-based subsidiary.

 

(3) Formerly Ramensky Dairy Plant

 

(4) Formerly Kiev Dairy Plant No 3

 

As of December 31, 2007 and 2006 the assets that served as collateral consisted of the following:

 

·                  Inventory in the amounts of $3.2 million and $12.1 million, respectively;

·                  Property, plant and equipment with a net book value of $78.0 million and $95.6 million, respectively.

 

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Item 4A.    Unresolved Staff Comments

 

None.

 

Item 5.      Operating and Financial Review and Prospects

 

The following discussion of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and the related notes included under “Item 18. Financial Statements” and other information in this document. This Item 5 contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in forward-looking statements as a result of various factors, including the risks described in “Item 3. Key Information—D. Risk Factors” and under the caption “Cautionary Statement Regarding Forward-Looking Statements.” Our Consolidated Financial Statements are expressed in U.S. dollars and prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”).

 

A.   Operating Results

 

Overview

 

We are one of the largest Russian manufacturers of dairy and juice products, with sales of $2,438.3 million, $1,762.1 million and $1,394.6 million in 2007, 2006 and 2005, respectively. Our reportable business segments in 2007 were dairy products, beverage products and baby food products. In 2007, the dairy segment accounted for 76.0% of our sales, the beverages segment, which includes juice and bottled mineral water products, accounted for 17.0% of our sales and the baby food segment accounted for 7.0% of our sales. In 2006, the dairy segment accounted for 75.0% of our sales, the beverages segment accounted for 18.4% of our sales and the baby food segment accounted for 6.6% of our sales. Our principal geographic market is Russia, which accounted approximately for 93%, 93% and 92% of our sales in 2007, 2006 and 2005, respectively. However, we also have production facilities in Ukraine, Kyrgyzstan and Uzbekistan and acquired a dairy production facility in Georgia in the fourth quarter of 2007.

 

In 2007, our net income increased by 46.8% to $140.0 million from $95.4 million in 2006. Our sales increased by 38.4% in 2007, including year-on-year sales increases of 40.2%, 27.8% and 46.6% in the dairy, beverage and baby food segments, respectively. By volume, dairy segment sales were higher by 18.2%, beverage segment sales increased by 9.8% and baby food sales increased by 31.9% in 2007.

 

The gross margin in the dairy segment decreased slightly to 29.2% in 2007 from 30.5% in 2006 due to a sharp rise in the price of raw milk of 35.7% which was partially offset by selling price increases and a more favorable product mix. The gross margin in the beverage segment increased to 39.8% in 2007 from 35.3% in 2006 despite raw materials cost pressure, driven by continued efficiency improvements and better pricing and discount management in all regions. The gross margin in the baby food Segment increased to 45.1% in 2007 from 43.1% in 2006, driven by a growing share of non-dairy baby food and a decreased share of baby food produced by co-packing in our sales.

 

Our selling and distribution expenses increased in 2007 as compared to 2006 in absolute terms and also as a percentage of sales, from 14.0% to 15.9%. In particular, our marketing, advertising and transportation costs were higher in 2007 in line with our strategy of supporting strong national brands, improving our route-to-market and expanding our geography.

 

Our net income increased 46.8% to $140.0 million for the full year of 2007 from $95.4 million in 2006.

 

Over the past three years, we have been constructing new capacity, modernizing existing capacity and making strategic acquisitions. Our capital expenditures (excluding acquisitions)

 

73



 

in 2007, 2006 and 2005 were $192.7 million, $130.0 million and $75.1 million, respectively. Expenditures for acquisitions of subsidiaries in 2007, 2006 and 2005 totaled $21.8, $137.3 million (exclusive of advances made in 2006 for acquisitions completed in 2007) and $24.3 million (exclusive of advances made in 2005 for acquisitions completed in 2006 but including advances made in 2004 for acquisitions made in 2005), respectively.

 

As of December 31, 2007, we had a total of $579.6 million in outstanding debt (consisting of long-term loans, notes payable, vendor financing obligations and $0.7 million of third parties guarantees). Of our total indebtedness as of December 31, 2007, 58.3% was denominated in foreign currency and 41.7% was denominated in rubles.

 

Below is a summary of our operational highlights for 2007 and the beginning of 2008.

 

Corporate and Operational Highlights for 2007

 

February

 

On February 8, 2007 our executives, directors and shareholders marked the fifth anniversary of the company’s initial public offering on the New York Stock Exchange by ringing the opening bell of the NYSE trading session. At the close of trading that day, our share price was US$66.0 and market capitalization was US$2.73bn.

 

 

 

February

 

UBS (Luxembourg) S.A. issued 7.5% Loan Participation Notes due 2008 for the sole purpose of funding a $150 million loan (the “Loan”). The Loan will mature on May 14, 2008 and bears interest at an annual rate of 7.5%, payable in arrears on November 14, 2007 and May 14, 2008, and matured on May 14, 2008.

 

 

 

March

 

We sold our 87.13% stake in Novokuibyshevsk Dairy Plant, which was impaired in the third quarter of 2006.

 

 

 

April

 

New Head of the Baby Food Business Unit, Gary Sobel, was appointed. Mr. Sobel began his career at Procter and Gamble, where over 13 years he worked in various positions in Canada, the US, the UK and Russia. From 2005, Mr. Sobel headed Dirol Cadbury (a division of Cadbury Schweppes) in Russia.

 

 

 

April

 

On April 25, 2007, the following subsidiaries were merged into Wimm-Bill-Dann (formerly Lianozovsky Dairy Plant): Tsaritsyno Dairy Plant, Ufa Dairy Plant, Siberian Milk Dairy Plant, Rubtsovsk Dairy Plant, Siberian Cheese Plant, Nizhny Novgorod Dairy Plant, Baltic Milk Dairy Plant, PAG Rodnik, Nazarovo Dairy Plant, Pervouralsk Dairy Plant.

 

 

 

April

 

We announced the launch of baby food production at the Kursk baby food plant. Acquired in 2005, the plant underwent extensive renovation, and 90% of the equipment was replaced. Today, it is the most modern plant of its type in Russia, making use of cutting edge global technology and the latest scientific research in the industry.

 

 

 

May

 

On May 29, 2007, we acquired an additional 30.12% stake in the founding capital of Obninsk Dairy Plant OJSC from 66.33%, increasing our share to 96.45% of its charter capital.

 

 

 

May

 

On May 31, 2007, the following subsidiaries were merged into Wimm-Bill-Dann: Kursk Baby Food Plant, Moscow Baby Food Plant, Timashevsk Dairy Plant and Vladivostok Dairy Plant.

 

 

 

September

 

We launched Neo Beauty, an innovative dairy drink, and the first functional food product of its kind on the Russian market with a proven impact on the overall health and particularly the state of skin,

 

74



 

 

 

nails and hair

 

 

 

October

 

On October 16, 2007, we announced the acquisition of 100% of dairy production plant Georgian Foods Ltd, which is based in Tbilisi, Georgia.

 

 

 

November

 

We announced the launch of mors production in Canada in partnership with Canadian juice company Wonder Berry.

 

 

 

December

 

On December 12, 2007, we increased our shareholding in Obninsk Dairy Factory OJSC to 99.84% of its charter capital from the previous level of 96.45%.

 

Corporate and Operational Highlights for 2008

 

January

 

On January 31, 2008, the following subsidiaries were merged into Wimm-Bill-Dann (formerly Lianozovsky Dairy Plant): Surgut City Dairy Plant OJSC, Ochakovo Dairy Plant OJSC, Anna milk CJSC, Angarsky Dairy Plant OJSC, Obninsk Dairy Plant OJSC.

 

 

 

February

 

We opened a new mega-farm complex in Volosovsk District near St Petersburg, built in place of the Trud collective farm, which we had acquired in 2005. The state-of-the-art farm is designed for 1,200 Holstein milking cows.

 

 

 

February

 

We launched a major project to implement a new Enterprise Resource Planning (ERP) information system that will cover finance, production, supply, logistics and distribution and will be based on Oracle E-Business Suite software. We plan to complete the main stage of the ERP system implementation by the end of 2010.

 

 

 

March

 

A new corporate structure and management positions went into effect from March 1, 2008. As part of the restructuring, the existing dairy and baby food business units, along with the Holding company, were combined into a single structure: Wimm-Bill-Dann Foods.

 

 

 

March

 

In March and April 2008, WBD Foods issued five-year ruble-denominated bonds for a total value of 5 billion rubles. The interest rate of the first coupon was established at an auction at an annual rate of 9.30% and the bond yield to the annual offer amounted to 9.52% annually.

 

 

 

March

 

We launched the production of Agusha baby food and Imunele functional products at our Manros-M production facility in the Omsk Region, Siberia.

 

 

 

April

 

On April 25, 2008, we entered into a syndicate loan agreement with ING Bank N.V., ABN Amro N.V. and CALYON as mandated lead arrangers, pursuant to which mandated lead arrangers and syndicate lent to us a principal amount of $250 million on May 8, 2008. The loan matures on April 25, 2011, and interest is payable by us quarterly in arrears at an annual rate of LIBOR+1.75%.

 

 

 

May

 

On May 15, 2008 and on May 7, 2008, we repaid our 2003 and 2007 Eurobond loans with the accrued interest, respectively.

 

75



 

Results of Operations

 

The following table summarizes the results of our operations for the years ended December 31, 2007, 2006 and 2005:

 

 

 

2007

 

% of
sales

 

2006

 

% of
sales

 

2005

 

% of
sales

 

 

 

(in thousands)

 

 

 

(in thousands)

 

 

 

(in thousands)

 

 

 

Sales

 

$

2,438,328

 

100.0

 

$

1,762,127

 

100.0

 

$

1,394,590

 

100.0

 

including:

 

 

 

 

 

 

 

 

 

 

 

 

 

Dairy

 

1,852,458

 

76.0

 

1,320,901

 

75.0

 

1,003,601

 

72.0

 

Beverages

 

414,117

 

17.0

 

324,074

 

18.4

 

303,147

 

21.7

 

Baby Food

 

171,753

 

7.0

 

117,152

 

6.6

 

87,839

 

6.3

 

Cost of sales

 

(1,654,879

)

67.9

 

(1,194,159

)

67.8

 

(999,006

)

71.6

 

Gross profit

 

783,449

 

32.1

 

567,968

 

32.2

 

395,584

 

28.4

 

Selling and distribution expenses

 

(387,853

)

15.9

 

(246,054

)

14.0

 

(191,990

)

13.8

 

General and administrative expenses

 

(180,922

)

7.4

 

(134,481

)

7.6

 

(109,642

)

7.9

 

Other operating expenses

 

(704

)

0.0

 

(31,812

)

1.8

 

(6,457

)

0.5

 

Operating income

 

213,970

 

8.8

 

155,621

 

8.8

 

87,495

 

6.3

 

Financial income and expenses, net

 

(16,851

)

0.7

 

(15,480

)

0.9

 

(22,868

)

1.6

 

Provision for income taxes

 

(54,302

)

2.2

 

(41,560

)

2.4

 

(30,712

)

2.2

 

Minority interest

 

(2,769

)

0.1

 

(3,197

)

0.2

 

(3,649

)

0.3

 

Net Income

 

$

140,048

 

5.7

 

$

95,384

 

5.4

 

$

30,266

 

2.2

 

Volume

 

 

 

 

 

 

 

 

 

 

 

 

 

Dairy (th. tons)

 

1,599

 

 

 

1,354

 

 

 

1,195

 

 

 

Beverages (th. liters)

 

491

 

 

 

445

 

 

 

436

 

 

 

Baby Food (th. tons)

 

87

 

 

 

66

 

 

 

58

 

 

 

 

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

 

Sales

 

Sales increased by 38.4% to $2,438.3 million in 2007 from $1,762.1 million in 2006. The dairy business was our largest segment, representing 76.0% of sales in 2007 compared to 75.0% in 2006.

 

 

 

Year ended December 31,

 

 

 

2007

 

% of
sales

 

2006

 

% of
sales

 

 

 

(in thousands)

 

 

 

(in thousands)

 

 

 

Dairy products

 

$

1,852,458

 

76.0

 

$

1,320,901

 

75.0

 

Beverage products

 

414,117

 

17.0

 

324,074

 

18.4

 

Baby food

 

171,753

 

7.0

 

117,152

 

6.6

 

 

 

$

2,438, 328

 

100.0

 

$

1,762,127

 

100.0

 

 

76



 

Sales in our dairy segment increased by 40.2% to $1,852.5 million in 2007 from $1,320.9 million in 2006. We sold 1,599.5 thousand tons of dairy products in 2007 and 1,353.5 thousand tons of dairy products in 2006. The average selling price increased by 18.7% from $0.976 per kilogram in 2006 to $1.158 per kilogram in 2007 driven by a favorable sales mix, ruble price increases and ruble appreciation. Our improved dairy sales were driven by our increased presence in the regions of Russia and the CIS, es