Ukrproduct Regulatory News (UKR)

10 May 2005 07:00

Ukrproduct Group Ltd10 May 2005 10 May 2005 UKRPRODUCT GROUP LTD ('UPG') Ukrproduct Group is a leading Ukraine-based producer and distributor of branded dairy foods. Preliminary Results for the period ended 31 December 2004 Highlights (2003 - in brackets) • Sales: £27.1 million (£17.6 million) • Gross profit: £4.4 million (£2.4 million) • EBITDA: £2.6 million (£1.4 million) • PBT: £1.7 million (£1.2 million) • Net profit: £1.4 million (£1.1 million) • Margin growth: 16.3% (13.5%) • Earnings per share: 4.8p (3.7p) • Successful admission to AIM • First Ukrainian trading group to be listed in London • Offer oversubscribed, raising £6 million gross • Shares have consistently outperformed the placing price • Increased market leadership in core segments of processed cheese and packaged butter• Largest capacity increase in UPG's history for the production of processed cheese at Molochnik, producing 2,000 tonnes per month• Direct distribution & merchandising programmes launched in five cities each with a population of over 1 million Commenting on the FY2004 results, Sergey Evlanchik, Chief Executive ofUkrproduct Group, said: "The Group has reported significant progress in salesand profits, this growth has continued into the first quarter of 2005. Over thenext few years we shall continue to review the efficiency of our operationsbased on scale, improved logistical and sales capabilities, as well as viapenetration of more profitable business segments. Our proven business model,together with our success in a dynamically evolving environment, supports ourconfidence that we will be able to improve our performance yet further, for thelong-term benefit of our shareholders." For more information, contact: Ukrproduct Group May 10 2005Sergey Evlanchik, CEO +44 (0) 207 831 3113Dmitry Dragun, FD Thereafter +380 44 502 8014 Financial Dynamics +44 (0) 207 831 3113Benjamin FosterCharles Watenphul Notes to editors Ukrproduct Group (UPG) is one of Ukraine's leading producers of branded foods.Headquartered in Kyiv and registered in Jersey, the company's main businessfocuses is the production and distribution of branded food products, namelypackaged butter and processed cheese, to wholesale and retail outlets in Ukrainethrough its own distribution network. UPG also produces skimmed milk powder forexport to countries across Europe as well as the Far East. UPG is the marketleader in the processed cheese and packaged butter segments, with estimatedmarket shares of 33% and 23% respectively. UPG is one of Ukraine's fastestgrowing companies within its sector, with compound average sales growth of 58%between 2001-2004. On 11 February 2005,Ukrproduct Group Ltd, became the first Ukrainian tradinggroup to be admitted to AIM. The company successfully placed 27.2% of its sharecapital at 53.5p per share, giving the company an initial market capitalisationof £22.5 million. CHAIRMAN'S STATEMENT I am delighted to present the first preliminary results of Ukrproduct Groupfollowing its listing on the London Stock Exchange's Alternative InvestmentMarket (AIM). The Board and management team have worked hard to sustain theGroup's growth going forward and we are confident of our ability to delivervalue to shareholders. Overview During 2004, Ukrproduct Group has continued to demonstrate sustained growth. Weare maintaining our momentum, and despite the competitive business environment,the Group's proven business model allows us to be a step ahead of thecompetition. During the year under review, we successfully launched manyinitiatives to create a strong, integrated food and service group. Theseincluded construction of a new cheese producing facility, corporate structuringof the Group and further expansion of our distribution network. The Group successfully achieved the challenging targets set out by the Board andremains one of the most profitable and dynamic food businesses in Ukraine. Netsales have increased by 54% to £27 million, accompanied by improved profitmargins. Excellent progress has been made in our core business segments, withestimated further increases of 10 and 6 percentage points respectively to ouralready leading positions in the Ukrainian processed cheese and packaged buttermarkets. Strategy Our long-term ability to compete in the constantly changing and evolvingbusiness environment will depend crucially on developing the Group's productoffering to customers. Having grown organically to become the leader in our corebusiness segments, we now need to pick up the pace of investment in order toremain competitive in the future. On the production side, the Group continues to develop its core capabilities andaims to expand into another attractive area. The Group has for some time beenanalysing potential investment opportunities in the large, higher-margin andfast-growing hard cheese sector. We intend to secure a foothold in this areaduring 2006-2007. On the service side, the Group plans to capitalise on its existing distributionnetwork and to develop further the logistics and supply chain managementservices offered to third parties. This business activity is becomingincreasingly important for companies operating in Ukraine, where the supplychain development is in its infancy; due to high domestic economic growth,demand for these services is growing rapidly. We will keep our shareholders informed of any major developments as we continueto pursue the Group's corporate strategy. Governance The current Board was formed during the year to provide overall guidance for themanagement of the Group. The Board is committed to ensuring best practice incorporate governance, through the monitoring and development of appropriateinternal controls. 2004 has been an eventful year for both management and staff, and on behalf ofthe Board I would like to express my appreciation for their efforts, which areessential to the Group's continuing success. Jack RowellNon-Executive Chairman CHIEF EXECUTIVE'S STATEMENT 2004 was a breakthrough year for the Group. Continuing modernisation of theplants, expanded geographic coverage of sales, further expansion of the Group'smarket share and further growth of margins in the core segments are all thewelcome hallmarks of a dynamically developing business. The structuring of our activities prior to our admission to AIM allowed yourBoard to improve the Group's business processes and to attain significant gainsin operating efficiency. In May, the Group commenced the construction of a new,state-of-the-art manufacturing facility at Molochnik, the Group's flagship plantfor processed cheese in Zhitomyr. The building programme is expected to take ayear, after which production capacity will increase to 2,000 tonnes of processedcheese per month. This will be the largest ever capacity increase in the Group'shistory - and it will strengthen the Group's position as the leading processedcheese manufacturer in Ukraine. Additionally, our rapid expansion necessitatedthe establishment of Ukrproduct Logistics, the Group's division dedicated bothto the logistical support of other Group companies and to the provision oftransport and distribution services to third parties. This service component ofthe Group's business is of growing importance and we are keen to expand thisarea into a significant profit-generating centre. Operating review Throughout the period, Molochnik performed well, producing 12,300 (2003: 6,700)tonnes of processed cheese and 6,100 (2003: 4,450) tonnes of packaged butter.Our second manufacturing facility at Starakonstaninov produced 3,500 (2003:2,990) tonnes of skimmed milk powder and 3,100 (2003: 1,700) tonnes of packagedbutter. Although Ukrproduct's market position strengthened in all productsegments, processed cheese sales did exceptionally well, and we believe ourmarket share is now around 33%. In September 2004, a new regional distribution centre in Kharkiv becameoperational - another step in the development of our pan-Ukrainian distributionnetwork, which now comprises eight regional depots and a central warehouse inZhitomyr. The rapid growth of the Group was supported by further development ofthe existing distribution network and the launch of direct delivery andmerchandising programmes in five big cities, each with a population of over 1million - Dnepropetrovsk, Donetsk, Kyiv, Lviv and Odessa. The Group continued its successful practice of the forward storage of raw milkmaterials, thereby benefiting from the differentials in protein content andprices, between summer and winter seasons. This practice ensures stability ofsupply of the raw materials for the whole year. The total amount used in forwardstorage was 1,700 tonnes in the year under review. In 2005, we plan to increasethis figure to 4,000 tonnes in order to satisfy the growing demand. Market The dairy-based foods market in Ukraine continues to register acceleratedgrowth, supported by the sustained growth of consumer purchasing power, as wellas by the increasing sophistication of the producers' offerings. Even afteryears of double-digit growth, per capita consumption of dairy-based foodsremains relatively low in Ukraine in comparison with other East Europeancountries. This indicates the potential of this market in the future. Althoughthe competition in our principal segments is gradually increasing, the Group'sbusiness model provides a platform for the maintenance of its leading position. Prospects Development of new business opportunities has been a key point of focus for theBoard and management team during the year. The growth of the hard cheese market and its relatively high level offragmentation have created an opportunity for the Group to enter this segment,based on using our traditional strengths in production, quality control,branding and distribution. We are currently assessing options for constructionof a brand-new hard cheese plant, to become operational in 2006/2007. As part of the Group's quality improvement plans, we are planning to install anew standardisation line for raw materials at Molochnik in summer 2005. Growing volumes of the distribution throughput (both own produce and third-partygoods) require that Ukrproduct constantly upgrade its warehousing facilities.The Group is now preparing a plan for building a new smart hub warehouse nearZhitomyr with a surface area of 20,000 square metres, three quarters of whichwill be temperature-controlled. We plan to complete this project in 2007. Since the year end, the Company succeeded in raising £6 million gross through aplacing of its shares on the London Stock Exchange's Alternative InvestmentMarket (AIM). We intend to use these funds to augment our working capital, toredeem our domestic high-coupon debt and to facilitate the capital expenditureprogramme, which is essential for our expansion. Outlook We have a clearly defined plan for further development and growth, which isaimed at maximising shareholder value. We will continue to serve our customersby focussing on quality, price, convenience and innovation. The Group has reported significant progress in sales and profits, this growthhas continued into the first quarter of 2005. Over the next few years we shallcontinue to review the efficiency of our operations based on scale, improvedlogistical and sales capabilities, as well as via penetration of more profitablebusiness segments. Our proven business model, together with our success in adynamically evolving environment, supports our confidence that we will be ableto improve our performance yet further, for the long-term benefit of ourshareholders. The year marked a substantial step forward in all Group activities. This stepwould not have been possible without the commitment and dedication of each ofour 1,200 employees. I would like to thank them as a team and each of thempersonally for their efforts and contribution into sustaining Ukrproduct Group'sleading position in our markets. Sergey EvlanchikChief Executive Officer FINANCIAL REVIEW The year 2004 was yet another period of profitable growth for the Group. Thefinancial position was robust, the underlying business continued to developdynamically in all segments of operations, and the Group was careful incontrolling the costs of expansion. Sales Sales of £27.1 million for the period comprised the following product segments: Processed cheese £10.1 million (£5.8 million)Packaged butter £9.5 million (£7.7 million)Skimmed milk powder £5.4 million (£3.2 million)Other products £1.9 million (£0.8 million)Services £0.2 million (£0.1 million) Sales grew by 54% over the previous year, facilitated mainly by the Group'sexpanding distribution network, well thought-out branding and promotionalstrategies. With regards to the sales dynamic, in the year the Group observedthe continuing growth of the Ukrainian economy supported by the ongoingstructural reforms, prudent monetary policies of the central bank and risingaffluence of the consumers. Gross profit Group's gross profit of £4.4 million in 2004 (2003: £2.4 million) hassignificantly increased in comparison with the previous year, in particular asthe result of the increase in the Group's buying power vis-a-vis the suppliersof raw materials. Gross profit margin has also improved significantly, followingthe Group's successful implementation of the raw materials forward storageprogramme for season 2004-2005. EBITDA Profit before interest, taxes, depreciation and amortisation of £2.6 million wasup nearly 86% over the prior year. The growth in EBITDA was achieved viaprofitable expansion of the Group's sales, timely mitigation of the seasonal(winter 2004) increase in prices of raw materials, and careful control of thegeneral administrative expenses. PBT Profit before taxes has increased significantly in 2004 to £1.7 million (2003:£1.2 million) albeit at a slower rate than the increase in EBITDA. The mainreason for this was the higher depreciation charge in 2004, due to the Group'songoing modernisation programme and revaluation of fixed assets. Also, the Groupincurred greater interest expense, which was necessary to support the continuinggrowth in the borrowing requirement. Net profit Net profit was recorded at £1.4 million, an increase of 27% over the previousyear. There were two reasons for the slower growth in Group's net profit incomparison to Sales and EBITDA. First, an exceptional item in the form of awaiver of debt of the Group to a related party in 2003 - treated as incomeaccording to International Accounting Standards - created the higher comparativebase for net income in 2003. Second, the Group's effective tax rate hasincreased in 2004 as a result of corporate structuring and consolidation of taxbase in preparation to listing on London Stock Exchange. Earnings per share The Group's earnings per share in FY2004 have been 4.8 pence (2003: 3.7 pence).Earnings per share has been calculated by dividing net profit attributable tothe ordinary shareholders (profit for the year) by the weighted average numberof shares that would have been in issue if the Enlarged Group had been a legallydefined Group at 31 December and had applied the merger method. In the Board'sview, such calculation is consistent with IAS/IFRS and provides a suitable basisfor comparisons going forward. Cash flow Net cash flow from operating activities was £0.9 million and the Group was cashpositive at £0.3 million as of 31 December 2004. The Group's total debt amountedto £2.2 million, with an equity book value of £5.1 million. Capital expenditure During the period under review, the Group purchased property, plant andequipment with a value of nearly £1.6 million (2003: £0.8 million). Thisexpenditure mostly related to the construction of the new processed cheeseproduction facility, acquisition of melting and packaging equipment, upgrade ofthe production and distribution facilities and various other uses. Dividends The directors are committed to a progressive and balanced dividend policy thataims to reward shareholders adequately whilst at the same time maintaining theGroup's cash position necessary to support the continuing growth. In order tosupport the cash requirements of the Group, the Directors recommend that nodividend be paid for the year 2004. No dividends have been paid out during theyear under review. International Accounting Standards and International Financial ReportingStandards (IAS/IFRS) The Group's financial statements for the last four financial years, 2004inclusive have been prepared in accordance with IAS/IFRS. Dmitry DragunChief Financial Officer BALANCE SHEET As at 31 December, £ 000 Notes 2003 2004Non-current assetsProperty, plant and equipment 8 1,017 5,023Intangible assets - 3Investments 89 83Deferred tax 6 - 36 Total non-current assets 1,106 5,145 Current assetsInventories 1,607 2,328Loans issued 9 15 212Receivables and prepayments 10 2,143 2,029Cash and cash at bank 132 300 Total current assets 3,897 4,869 Current LiabilitiesBank loans and overdrafts 11 (1,008) (1,077)Trade and other payables 12 (1,938) (1,671)Promissory Notes 13 (3) -Current income tax liabilities (119) (253) (3,068) (3,001) Net current assets 829 1,868 Total assets less current liabilities 1,935 7,013Non-Current LiabilitiesLong-term loans 14 - (221)Bonds 14 (302) (933)Promissory Note 13 (22) (5)Deferred income tax liabilities 6 - (703)Net assets 1,611 5,151 Capital and reserves attributable to equityholdersShare capital 15 3,000 3,000Merger reserve (1,866) (1,866)Revaluation reserve - 2,020Retained earnings 409 1,865 1,543 5,019 Minority interest 16 68 132 Total shareholders' equity 1,611 5,151 STATEMENT OF INCOME Year ended 31 December, £ 000 Notes 2003 2004 Revenues 4 17,597 27,115Costs of sales (15,222) (22,698) Gross profit 2,375 4,417 Other operating income 63General and administrative expenses (690) (1,045)Selling and distribution expenses (399) (1,070)Other expenses (180) (296)Income from waiver of debt 4 250 - Profit before interest and taxation 4 1,356 2,069 Finance costs - interest payable and similar (94) (312)charges Profit before taxation 1,262 1,757Income tax expense 6 (146) (301) Profit after taxation 1,116 1,456 Attributable to:Owners 1,111 1,436Minority interest 5 20 1,116 1,456 Earnings per share basic, pence 7 3.7 4.8Earnings per share diluted, pence 7 3.7 4.8 CASH FLOW STATEMENT As at 31 December, £ 000 Notes 2003 2004Cash flow from operating activitiesNet profit before taxation 1,262 1,757Adjustments for: Depreciation 62 520 Interest expense 94 305Income from waiver of debt (250) - 1,168 2,582 Increase in inventories (1,039) (872) Increase in trade and other receivables (1,070) (71) Increase / (decrease) in trade and other payables 839 (349) Cash (used by) /generated from operations (102) 1,290Interest paid (94) (305)Income tax paid/(refunded) (32) (66) Net cash (used in)/generated by operating activities (228) 919 Cash flows from investing activities Purchase of property, plant and equipment (733) (1,566)Purchase of investments - 1Proceeds from sale of property, plant and equipment 31 3Proceeds from sale of investment - (7)Loans (advanced)/repaid 104 (207) Net cash used investing activities (598) (1,776) Cash flows from financing activitiesNet proceeds from long term borrowing 17 - 232Proceeds from issue of bonds 17 303 680Proceeds from issue of shares/additional capital 1,075 -Distribution of profit (914) -Net proceeds from issue of promissory Notes 17 (70) (20)Net proceeds from short term borrowing 17 602 147 Net cash generated by financing activities 996 1,039 Effect of exchanges rate changes and restatements on cash and (86) (14)cash equivalents Net increase in cash and cash equivalents 84 168 Cash and cash equivalents at the beginning of the year 48 132 Cash and cash equivalents at the end of the period 132 300 STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY Share Merger Re- Retained Share-holders ' Minority Total capital reserve earnings equity interest equity Valuation £ 000 £ 000 £ 000 £ 000 £ 000 £ 000 reserve £ 000Balance at 1 January 2003 309 - - 256 565 118 683Issue of shares 845 - - - 845 - 845Purchase of treasury shares (20) - - - (20) - (20)Net profit for the year - - - 1,111 1,111 5 1,116Reduction in minority - - - 42 42 (42) -interest on issue of newsharesIssue of share capital in 3,000 (3,000) - - - - -the Company (Note 15)Elimination of share (1,134) 1,134 - - - - -capital in subsidiariesDistribution of profit - - - (913) (913) - (913)Exchange differences on - - - (87) (87) (13) (100)translation to thepresentation currency Balance at 1 January 2004 3,000 (1,866) - 409 1,543 68 1,611Gain on revaluation of - - 3,073 - 3,073 75 3,148fixed assetsDeferred income tax on gain - - (674) - (674) (17) (690)on revaluationIssue of shares 15 - - - 15 - 15Issued on acquisition of 15,273 - - - 15,273 - 15,273Operating GroupMerger reserve arising on - (15,288) - - (15,288) - (15,288)an acquisition of OperatingGroupNet profit for the period - - - 1,436 1,436 20 1,456Depreciation on revaluation - - (154) 158 4 (4) -of fixed assetsElimination of share issued (15,288) 15,288 - - - - -and merger reserve onacquisition of OperatingGroupExchange differences on - - (225) (138) (363) (11) (374)translation to thepresentation currency Balance at 31 December 2004 3,000 (1,866) 2,020 1,865 5,019 132 5,151 NOTES 1. Group and Principal Activities For the purposes of this financial information the terms the "Operating Group"and "Enlarged Group" have been taken to indicate the companies listed in Note 2(b). All of these companies have effectively operated as a group under commonmanagement and control for a number of years although they did not comprise astatutory group as they had not been linked by a common parent. Following theestablishment of a new holding company, Ukrproduct Group Ltd (the 'Company') on18 May 2004, the companies comprising the Operating Group were brought togetheron 11 February 2005 following the Company's admission to the AlternativeInvestment Market of the London Stock Exchange to create a formal group underthe ultimate control of this new holding company. The Enlarged Group's main activity is to produce and supply dairy products(butter and cheese) to wholesale and retail outlets in Ukraine. It also producesand exports skimmed milk powder to the markets of Denmark, Russia, Bulgaria,Holland and other countries. The Group is not involved in the retailing of itsproducts. The Enlarged Group's production facilities and management are based in Ukraine.The head office is located in Kyiv. The Enlarged Group has its own distributionnetwork in Ukraine. The average number of employees of the Enlarged Group duringthe year ended 31 December 2004 was 1,194 people (2003 - 783 people). 2. Significant Accounting Policies The principal accounting policies adopted in the preparation of the combinedfinancial information are set out below: a) Basis of Preparation This financial information is based on the audited non statutory special purposecombined financial information of the Enlarged Group which have been prepared bycombining the historical financial information for each of the companies thatcomprise the Enlarged Group from the accounting records of those companies. Thefinancial information has been prepared in accordance with InternationalFinancial Reporting Standards ('IFRS'), including International AccountingStandards ('IAS') and Interpretations issued by the International AccountingStandards Board. The majority of companies making up the Enlarged Group maintain their accountingrecords in accordance with the Ukrainian regulations. The financial informationhas been prepared from those accounting records and adjusted as we considernecessary in order to comply with IFRS. Accounting records of the Enlarged Groupare maintained in Ukrainian Hryvnas ('UAH' or 'Hryvna' hence), the nationalcurrency of Ukraine. The Hryvna has also been adopted as the measurementcurrency for the purpose of the special purpose combined financial information(see Note 2c). The financial information has been translated into British pounds sterling atthe rates given in Note 2(p). The combined financial information has been prepared under the historical costconvention, as modified by the revaluation of property, plant and equipment atfair value in the year ended 31 December 2004. The preparation of financial statements in conformity with IFRS requires the useof certain critical accounting estimates. It also requires management toexercise its judgement in the process of applying the Enlarged Group'saccounting policies. Early adoption of standards In 2003, the Enlarged Group early adopted the IFRS below, which are relevant toits operations. The financial information has been amended as required, inaccordance with the relevant requirements. IAS 1 (revised 2003) Presentation of Financial StatementsIAS 2 (revised 2003) InventoriesIAS 8 (revised 2003) Accounting Policies, Changes in Accounting Estimates and ErrorsIAS 10 (revised 2003) Events after the Balance Sheet DateIAS 16 (revised 2003) Property, Plant and EquipmentIAS 17 (revised 2003) LeasesIAS 21 (revised 2003) The Effects of Changes in Foreign Exchange RatesIAS 24 (revised 2003) Related Party DisclosuresIAS 27 (revised 2003) Consolidated and Separate Financial StatementsIAS 28 (revised 2003) Investments in AssociatesIAS 32 (revised 2003) Financial Instruments: Disclosure and PresentationIAS 33 (revised 2003) Earnings per ShareIAS 39 (revised 2004) Financial Instruments: Recognition and MeasurementIFRS 3 (issued 2004) Business CombinationsIAS 36 (revised 2004) Impairment of AssetsIAS 38 (revised 2004) Intangible Assets The early adoption of IAS 1, 2, 8, 10, 16, 17, 21, 24, 27, 28, 32 and 33 (allrevised 2003) did not result in substantial changes to the Enlarged Group'saccounting policies. In summary: - IAS 1 (revised 2003) has affected the presentation of minorityinterest and other disclosures. - IAS 2, 8, 10, 16, 17, 27, 28, 32 and 33 had no material effect onthe Enlarged Group's policies. - IAS 21 (revised 2003) had no material effect on the EnlargedGroup's policy. The functional currency of each of the consolidated entities hasbeen re-evaluated based on the guidance to the revised standard. The majority ofthe Enlarged Group entities have the same functional currency as theirmeasurement currency. - IAS 24 (revised 2003) has affected the identification of relatedparties and some other related party disclosures. The early adoption of IAS 39 (revised 2004) has resulted in a change to theaccounting policy relating to the classification of financial assets at fairvalue through profit or loss. The Enlarged Group has applied the exemptionsafforded by IFRS 1 from the requirement to re-state comparative information for2001 and 2002 for IAS 39 and IAS 32, and has applied previously applicablegenerally accepted accounting principles to those years. The early adoption of IFRS 3, IAS 36 (revised 2004) and IAS 38 (revised 2004)resulted in a change in the accounting policy for goodwill. However, there hasbeen no goodwill arising as subsidiaries accounted for as acquisitions were soacquired on incorporation. In accordance with the provisions of IFRS 3: - The Enlarged Group ceased amortisation of goodwill from 1 January2003 - From the year ended 31 December 2003 onwards, goodwill is testedannually for impairment, as well as when there are indications of impairment. The Enlarged Group has reassessed the useful lives of its intangible assets inaccordance with the provisions of IAS 38. No adjustments resulted from thisreassessment. All changes in the accounting policies have been made in accordance with thetransition provisions in the respective standards. All standards adopted by theEnlarged Group require retrospective application other than: - IAS 16 - the exchange of property, plant and equipment is accountedat fair value prospectively - IAS 21 - prospective accounting for goodwill and fair valueadjustments as part of foreignoperations. - IFRS 3 - prospectively after 31 March 2004. - IAS 39 requires simultaneous adoption with IAS 32. - IFRS 3 requires simultaneous adoption with IAS 36 and IAS 38. b) Principles of combination and consolidation The combined financial information includes the results of the companies set outin the table below. As described in Note 1 the Enlarged Group is comprised of anumber of companies under common management and ultimate ownership but was notlinked by a formal ownership structure or a single common parent until 11February 2005. The Operating Group, which sits within the Enlarged Group, wasnot linked by a formal ownership structure or a single common parent until 18May 2004. The special purpose combined financial information has been preparedin order to present the combined results and balances that would have been shownhad the Enlarged Group been under the control of a single common parent. Where group companies are formally owned by another group company, they havebeen consolidated to the highest possible level using the acquisition method, inwhich share capital of the entity is eliminated against the investment recordedin the parent. As such, the Enlarged Group companies have been treated as ifthey had been owned from the date of their formation and consideration issuedfor the investment equaled share capital, goodwill does not arise on acquisitionother than incidentally. The combination of companies under common ownership but not linked by a formalownership structure has been based on the pooling of interests ('mergermethod'). In applying this method, financial statement items for each groupcompany are combined as if they had been combined from the earliest period, theresult being a combination of all group companies' assets, liabilities andreserves. All intra-Enlarged Group transactions and balances are eliminated oncombination. Business combinations of entities under common control are outsidethe scope of IFRS 3 and so the early adoption of that standard does not affectthis treatment. Following the formal acquisition of the Enlarged Group companies in May 2004, acombined balance sheet has been prepared as at 31 December 2004. The businesscombination comprising a number of businesses under common control is outsidethe scope of IFRS 3 and the balance sheet has been prepared using the pooling ofinterests method. The results and balances of the following organisations have been combined: Operating Group Country of Deemed Method of combination incorporation group holding 2004 2003 Molochnik OJSC Ukraine 95.2% Acquisition method Merger methodUkrprodexpo SC Ukraine 100% Acquisition method Merger methodStarokonstantinovskiy Molochniy Ukraine 100% Acquisition method Acquisition methodZavod SCAgrospetsresursy LLC Ukraine 100% Acquisition method Merger methodTogoviy Dim Maslayana SC * Ukraine 100% Acquisition method Acquisition methodTogoviy Dim Milko SC * Ukraine 100% Acquisition method Acquisition methodAgrospetsresursy Dnipro SC* Ukraine 100% Acquisition method Acquisition methodAgrospetsresursy Lviv SC* Ukraine 100% Acquisition method Acquisition methodStarkon-Moloko LLC Ukraine 100% Acquisition method Merger methodDairy Trading Corporation USA 100% Merger method Merger method Alfa-Broker Ltd UK 100% Merger method Merger methodIntermilk SC Ukraine 100% Acquisition method Merger methodUkrevroprodukt SC* Ukraine 100% Acquisition method Merger methodAgrospetsresursy Zhytomyr SC* Ukraine 100% Acquisition method n/aUkrproduct- Kharkov SC* Ukraine 100% Acquisition method n/aNash Molochnik Private Enterprise Ukraine 100% Acquisition method n/aSC*Ukrproduct-Logistics Private Ukraine 100% Acquisition method n/aEnterpriseUkrproduct CJSC Ukraine 100% Merger method n/aEnlarged Group All entities within the Operating Group above plus: LinkStar Limited Cyprus 100% Acquisition method n/aDairy Trading Corporation BVI 100% Merger method Merger methodUkrproduct Group plc UK 100% Acquisition method n/a * Subsidiaries of Agrospetsresursy LLC, the Operating Group's specialiseddistribution companies. Intermilk SC, Alfa-Broker Ltd and Dairy Trading Corporation (USA) are in theprocess of solvent liquidation. Between 30 June 2004 and 11 February 2005 Alfa-Broker Ltd transferred itsprincipal business and assets to LinkStar Limited, a company registered inCyprus. Subsequently, Alfa-Broker Ltd is not to be included as part of the Groupgoing forward. It has therefore been necessary to include the results ofAlfa-broker Limited in the combined financial information in order to providethe combined results for the full period under review. LinkStar Limited wasacquired by the Company on 11 February 2005 following the Company's listing onthe Alternative Investment Market of the London Stock Exchange. c) Translation from measurement to presentation currency and adoptionof SIC 30 Management has considered what would be the most appropriate measurement andpresentation currencies for this financial information. As a result of thisreview management has concluded that: (i) Hryvna is the currency of the primary economic environment in whichthe Enlarged Group operates. Consequently, Hryvna is the most appropriatemeasurement currency for the Group; (ii) The Enlarged Group should use British pounds sterling as thepresentation currency for its IFRS financial statements. Thus management has determined to use the following basis for the translation ofHryvna figures to British pounds for presentation purposes: (i) for current year figures all assets and liabilities are translatedat the closing rate existing at the balance sheet date. Income and expense itemsare translated at an average rate for the period. Equity items other than thenet profit or loss for the period that is included in the balance of accumulatedprofit or loss are translated at the closing rate existing at the balance sheetdate. (ii) for comparative figures all assets and liabilities are translated atthe closing rate existing at the relevant balance sheet date. Income and expenseitems are translated at an average rate for the period. Equity items other thanthe net profit or loss for the period that is included in the balance ofaccumulated profit or loss are translated at the closing rate existing at theprevious balance sheet date. (iii) all exchange differences resulting from the application of thetranslation methods described above are recognised directly in equity. Actual exchange rates applied in the translation are detailed in Note 2(p)below. (d) Segment reporting A business segment is a group of assets and operations engaged in providingproducts or services that are subject to risks and returns that are differentfrom those of other business segments. A geographical segment is engaged inproviding products or services within a particular economic environment that aresubject to risks and returns that are different from those of segments operatingin other economic environments. (e) Property, plant and equipment Figures calculated using the Ukrainian statutory accounting rules, have beenadopted as deemed depreciated historical cost for property, plant and equipmentas at 1 January 2004. Subsequent additions have been recorded at cost. With effect from 1 January 2004, the Enlarged Group adopted the revaluationmodel (as defined in IAS 16: Property, Plant and Equipment) for all classes ofassets. This change of accounting policy was made on the grounds that managementbelieve that this policy provides more reliable and relevant financialinformation because it better reflects the value in use of such assets to theEnlarged Group. In accordance with the provisions of that standard, therevaluation model has not been applied retrospectively. All classes of assets as at 1 January 2004 were revalued as at that date by anindependent valuer BGS Asset on a depreciated replacement cost basis. Managementbelieves that the carrying value of all additions since 1 January 2004 is notmaterially different to fair value. Depreciation is applied to all items of property, plant and equipment with theexception of land. Depreciation is calculated on the reducing balance methodusing the following annual rates: Buildings 5%Plant and machinery 15%Equipment and motor vehicles 25% Gains and losses on disposals are determined by comparing proceeds with thecarrying amount and are included in operating profit. (f) Assets under construction Assets under construction are reported at their cost of construction includingcosts charged by third parties and the capitalisation of the Enlarged Group'sdirectly attributable costs. No depreciation is charged on assets duringconstruction. Upon completion, all accumulated costs of the asset aretransferred to the relevant fixed asset category and subsequently subjected tothe applicable depreciation rates from the time the asset is completed and readyfor use. (g) Intangible assets - computer software Acquired computer software licenses are capitalised on the basis of the costsincurred to acquire and bring to use the specialised software. These costs areamortised over their estimated useful lives (3 years). (h) Investments The Enlarged Group has investments in the equity of Ukrainian companiesincluding investments representing more than 50% of the share capital of theinvestee company. Other than as referred to under (b) above, where suchcompanies are not expected to become subsidiaries of the proposed holdingcompany, they have been excluded from the combination and are treated asinvestments. Investments are carried at cost, which management believe is not significantlydifferent from fair value. (i) Inventories Inventories are stated at the lower of cost and net realisable value. Cost isdetermined using the first-in, first-out method. The cost of finished goods andwork in progress comprises raw materials, direct labour, other direct costs andrelated production overheads (based on normal operating capacity) but excludesborrowing costs. (j) Trade receivables Trade receivables are carried at original invoice amount less provision made forimpairment of these receivables. A provision for impairment of trade receivablesis established when there is objective evidence that the Enlarged Group will notbe able to collect all amounts due according to the original terms ofreceivables. (k) Cash and cash equivalents Cash and cash equivalents are carried in the balance sheet at cost. Cash andcash equivalents comprise cash on hand, deposits held at call with banks andother short-term highly liquid investments with original maturities of threemonths or less. Bank overdrafts are included within borrowings in currentliabilities on the balance sheet. (l) Provisions Provisions for environment restoration, restructuring costs and legal claims arerecognised when: the Enlarged Group has a present legal or constructiveobligation as a result of past events; it is more likely than not that anoutflow of resources will be required to settle the obligation; and the amountshave been reliably estimated. Restructuring provisions are not recognised forthe future operating losses. Where there are a number of similar obligations, the likelihood that an outflowwill be required in settlement is determined by considering the class ofobligations as a whole. A provision is recognised even if the likelihood of anoutflow with respect to any one item included in the same class of obligationmay be small. (m) Revenue recognition Revenue recognition for the fair value for the sale of goods and services, netof value added tax, rebates and discounts and after eliminated intra-group saleswith the Enlarged Group, is as follows: (i) Sales of goods - own production. Sales of goods are recognised when anEnlarged Group entity has delivered products to the customer, the customer hasaccepted the products and collectability of the related receivables isreasonably assured. (ii) Sales of goods - third parties. Sales of goods arerecognised when an Enlarged Group entity has delivered products to the customer,the customer has accepted the products, and collectability of the relatedreceivables is reasonably assured. (iii) Sales of services. Sales of servicesare recognised in the accounting period in which the services are rendered, byreference to completion of the specific transaction assessed on the basis of theactual service provided as a proportion of the total services to be provided.(iv) Interest income. Interest income is recognised on a time-proportion basisusing the effective interest method. When a receivable is impaired, the EnlargedGroup reduces the carrying amount to its recoverable amount, being the estimatedfuture cashflow discounted at original effective interest rate of theinstrument, and continues unwinding the discount as interest income. Interestincome on impaired loans is recognised either as cash collected or on acost-recovery basis as conditions warrant. (n) Leases Leases in which a significant portion of the risks and rewards of ownership areretained by the lessor are classified as operating leases. Payments made underoperating leases (net of any incentives received from the lessor) are charged tothe statement of income on a straight line basis over the period of the lease. (o) Income taxes Taxation has been provided for in the financial information in accordance withrelevant legislation currently in force. The charge for taxation in thestatement of income for the year comprises current tax and changes in deferredtax. Current tax is calculated on the basis of the taxable profit for the year,using the tax rates in force at the balance sheet date. Taxes, other than onincome, are recorded within operating expenses. Deferred income tax is provided, using the balance sheet liability method, forall temporary differences arising between the tax basis of assets andliabilities and their carrying values for financial reporting purposes exceptfor those difference permanently disallowed. A deferred tax asset is recordedonly to the extent that it is probable that taxable profit will be availableagainst which the deductible temporary differences can be utilised. Deferred taxassets and liabilities are measured at tax rates that are expected to apply tothe period when the asset is realised or the liability is settled, based on taxrates that have been enacted or substantively enacted at the balance sheet date. (p) Foreign currency translation Transactions denominated in currencies other than Hrvvna ("foreign currencies")are recorded in Hryvna at the exchange rate ruling on the transaction date.Exchange differences resulting from the settlement of transactions denominatedin foreign currency are included in the statement of income using the exchangerate ruling on that date. Monetary assets and liabilities denominated in foreign currency are translatedinto Hryvna at the official exchange rate at the balance sheet date. Foreigncurrency gains and losses arising from the translation of assets and liabilitiesare reflected in the statement of income as foreign exchange translation gainsless losses. Income and expense figures have been converted to British pounds forpresentation purposes at an average rate of £1 = UAH 9.74 for the year ended 31December 2004 and £1 = UAH 8.76 for the year ended 31 December 2003. Assets,liabilities and equity items have been converted to pounds for presentationpurposes at a closing rate of £1 = UAH 10.18 for the year ended 31 December 2004and £1 = UAH 9.47 for the year ended 31 December 2003. Exchange differencesresulting from conversion to presentational currency are included in retainedearnings. (q) Pension costs The Enlarged Group contributed to the Ukrainian state pension scheme, socialinsurance and employment funds in respect of its employees. The Enlarged Group'spension scheme contributions are expensed as incurred. The contributions areincluded in staff costs. The Enlarged Group has no other liabilities in respectof pensions or employee retirement benefits. (r) Financial instruments The carrying amounts of the Enlarged Group's financial assets and liabilities(comprising investments, bank and cash balances, trade and other debtors, tradeand other creditors and short and long-term borrowings) approximate to theirfair values at the date of the transaction. Where the fair value of a financialasset is materially below the carrying amount, the carrying amount is writtendown to fair value. (s) Borrowing Costs Borrowing costs are recognised as an expense in the period in which they areincurred. (t) Reclassification of 2003 comparative information An amount of £1,866,000 has been reclassified between share capital and mergerreserve in the comparative figures. This ensures that the basis of preparationis consistent with the 2004 combined financial information, with UkrproductGroup Ltd being the holding company of the Enlarged Group as opposed to thesummation of the share capital of the Group's subsidiaries which was originallyreported upon. The net assets and shareholders' funds of the Enlarged Group arenot affected by this reclassification. 3. Financial risk factors The Enlarged Group's activities expose it to a variety of financial risks:market risk (including foreign exchange risk, and price risk), credit risk,liquidity risk and cash flow interest-rate risk. The Enlarged Group's overallrisk management programme focuses on the unpredictability of financial marketsand seeks to minimise potential adverse effects on the Enlarged Group'sfinancial performance. Risk management is carried out by the Enlarged Group Treasurer under policiesapproved by the Board of Directors. The Enlarged Group Treasurer identifies andevaluates financial risks in close co-operation with the Enlarged Group'soperating units. The management board provides broad guidance and operatingprinciples for overall risk management, as well as written policies coveringspecific areas, such as foreign exchange risk, interest-rate risk, credit risk,use of derivative financial instruments and non-derivative financialinstruments, and investing excess liquidity. Foreign exchange risk Although the Enlarged Group is an international operator, the management believethat the foreign exchange risk is minimal at present and is likely to remain soin the future. The Enlarged Group's international operations consist primarilyof the export of skimmed milk powder to the various markets around the world.The primary currency for export sales is the US Dollar. As at 31 December 2004the principal rate of exchange used for translating foreign currency balanceswas US$1 = UAH 5.31. As at 31 December 2003 the principal rate of exchange usedfor translating foreign currency balances was US$1 = UAH 5.48. The Enlarged Group's established corporate policy towards hedging the potentialforeign exchange risk is to require the customers to pay for the exportshipments of the skimmed milk powder in full and in advance (from one to twomonths). The Group's export operations have never employed any other paymentmethods as a matter of corporate principle, and this is expected to continue inthe future. Similarly, the Enlarged Group has never been engaged in forwardtransactions and does not expect to conduct these transactions in the future.The Directors believe that these policies effectively eliminate the foreignexchange risk. The Enlarged Group's export-related obligations in Ukraine, suchas payments for raw milk and packaging materials, are all entirelyHryvna-denominated. The UAH/US Dollar exchange rate has been reasonably stablein recent years, and the Directors have no reason to believe that this is likelyto change in the future. Price risk The Enlarged Group is exposed to commodity price risk for skimmed milk powder.The price for this product is predominately determined by the world market andthe activities of large international trading companies in this market. There isalways a risk that the prevailing world marketing price may be insufficient tocover the production costs for skimmed milk powder. Against such a risk, theGroup recognises that there is no effective financial hedge, thus the majorinstrument employed in management of the price risk is the tight control of theoperating costs. Credit risk The Enlarged Group has no significant concentrations of credit risk. It haspolicies in place to ensure that wholesale sales of products both in Ukraine andabroad are made to customers with an appropriate credit history. Liquidity risk Prudent liquidity risk management implies maintaining sufficient cash and theavailability of funding through an adequate amount of committed creditfacilities. Due to the dynamic nature of the underlying businesses, the EnlargedGroup's Treasurer aims to maintain flexibility in funding by keeping committedcredit lines available. Cash flow and fair value interest-rate risk As the Enlarged Group has no significant interest-bearing assets, the EnlargedGroup's income and operating cash flows are substantially independent of changesin market interest rates. The Enlarged Group's interest-rate risk arises from medium to long-termborrowings. Potentially, borrowings issued at variable rates expose the EnlargedGroup to cash flow interest-rate risk. Borrowings issued at fixed rates exposethe Enlarged Group to fair value interest-rate risk. Enlarged Group policy is tomaintain at least 80% of its borrowings in fixed rate instruments. At 31December 2004, almost all of borrowings were at fixed rates. 4. Segmental analysis The shareholders of the Enlarged Group put a particular emphasis on enhancingthe vertical integration of the Enlarged Group. This emphasis necessitatedseparation of the product lines into the distinguishable and analysablesegments, in order to be able to identify the individual profitability of eachsegment. Therefore, from 2003, the Enlarged Group has gradually transformed itsmanagement reporting and control systems to reflect the segmental information tothe extent required by its operating activities and the requirements of IFRS.Ukrainian Accounting Standards do not require the production of the SegmentalInformation to the same level as that required by IFRS.