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Wimm-Bill-Dann Foods OJSC (NYSE:WBD)

Q3 2008 Earnings Call

December 18, 2008 9:00 am ET

Executives

Tony Maher – Chief Executive Officer

Dmitry Ivanov – Chief Financial Officer

Analysts

Marat Ibragimov – Citigroup

[Gata Monda – Goldman Sachs]

Victoria Grankina – Troika

Victoria Pretova – Credit Suisse

[Odi Bruche – Merrill Lynch]

[Miss Margaret Kousier – Harving Viesner]

Operator

Welcome to the Wimm-Bill-Dann fiscal third quarter 2008 conference call. (Operator Instructions) At this time I would like to turn the conference over to Miss Marina Kagan.

Marina Kagan

Thank you for joining us today to discuss the financial results for Wimm-Bill-Dann for the nine months and third quarter of 2008. After our presentation is over, we will be happy to take your questions.

I would ask that you please refer to the questions and statements included in the press release covering any comments made during this conference call. And now I would like to hand the call over to our Chief Executive Officer, Tony Maher.

Tony Maher

Good afternoon to those of you from Russia and Europe and good morning to participants from the U.S. I would like to begin the call today by addressing a few factors that are critical to understanding our financial results for the first nine months and third quarter of 2008. I will then provide an overview of these results discussing the dynamics of the quarter as necessary.

I will also review our business segments and conclude with an update to our outlook and I will then pass the call over to Dmitry to discuss the financials.

Despite the challenging operating environment our revenue growth and profitability for the third quarter and the first nine months of 2008 were very solid. This performance testifies to the strength and resilience of the business and our focus on executing our strategy.

There is no doubt that we and others face head winds created a decline in consumer confidence in Russia and the CIS, slower GDP growth and unprecedented global financial turmoil. However, Wimm-Bill-Dann has a solid financial and operational foundation, a reflection of our work to further streamline the company, improve and enhance its positioning in the market, a process that has been ongoing as you know.

Before I get to the results I want to assure you that even taking the current environment into consideration, Wimm-Bill-Dann is very well positioned in each of our businesses and we are very optimistic about our ability to grow our brands and deliver strong, above average market growth all while ensuring the continued financial strength of our company.

Our balance sheet is very strong and our liquidity position is excellent. We have $137 million of cash on the balance sheet as of the end of the third quarter and we continue to generate significant cash flow. In the first nine months we posted $168 million in operating cash flow.

We do have a bond of approximately $185 million that we will pay down in March of next year if required. If we can get the financing at attractive rates, we may choose to refinance the debt, but as of today, we are planning to repay those obligations with internal funds.

Our group revenue for the first nine months rose 25% on a year over year basis to nearly $2.2 billion U.S. dollars. This growth has been purely organic. In the third quarter, group sales totaled $702.1 million, a 15% improvement over the prior year's quarter.

Our gross profit for the first nine months was $707 million, up 22.2% from the same period a year ago. This improvement was across our three business segments. Gross margins for the first nine months was 32.2%, down 70 basis points versus the nine months ended September 2007 due in large part to a very high price in raw material we faced this year.

Gross margins in the third quarter however, continued their recovery, up 70 basis points sequentially and up 80 basis points over the third quarter of last year reflecting our continued focus on driving efficiency, greater share of baby food and beverages in our mix and a sequential decline in raw material costs primarily raw milk.

EBITDA continues to show solid improvement as well versus the prior year. For the first nine months, EBITDA was $282.7 million, up 23.3% from the nine months of 2007. EBITDA for the quarter was $98.9 million, up 20.3% from the third quarter of 2007. EBITDA margin was 12.9% for the first nine months of 2008, down slightly from 13% in the prior year period. EBITDA margins in the third quarter was also up from 12.2% to 14.1% compared to the second quarter of this year.

As I have done in the past, I would now like to provide an update on raw milk prices. Raw milk prices continue to trend downward sequentially and this impact aided our gross margin improvement in the quarter. However, they remain at much higher levels than last year. We spent $242 million more on the procurement of raw milk in the first nine months of 2008 than we did in the same period of 2007.

We do expect milk prices to continue to grow as they usually do throughout the winter, however they are growing at a slower rate than they did last year and we have more milk, quality milk available compared to the same period last year.

Now I would like to go over the operating results for each of the businesses, which delivered strong top line growth through the first nine months of the year. Our dairy segment delivered sales of $1.6 billion in the first nine months; up nearly 23% year over year despite lower volumes for the whole dairy sector, we were able to generate sales to 11.5% to $524.6 million in the third quarter compared to the same period last year.

While gross margins in the dairy segment were down 100 basis points in the first nine months, they were up 30 basis points in the third quarter compared to the same period last year; however, we saw continued sequential recovery as gross margins grew 28% for the third quarter, 70 basis points higher than in the second quarter of this year.

We saw some slight decline in market share during the quarter in some of our second tier brands but our key brands such as [Chuda] in the [inaudible] and dessert category gained market share.

In our beverage business we achieved sales growth of nearly 20% to $372.5 million through the first nine months of the year. Sales in the third quarter of 2008 in comparison to the same period a year ago improved 15.2% to $113.5 million driven by increased volumes in a number of key product lines including our J7 Lovely Garden and Wonder Berry brands.

Gross margin for the quarter was 40%, up 40 basis points versus the third quarter of 2007 and delivering a significant recovery of 200 basis points versus the second quarter of 2008. We also believe that our juice business continues to outgrow the market.

Finally, we turn to our rapidly growing baby food business. Sales for the first nine months were $191.6 million, 61% higher than the same period in 2007. Quarterly sales in baby food improved 53.5% to $64 million. This continues to be a very profitable business for us as gross margins over the same period were 46.3%, 340 basis points higher than a year ago. We also continue to gain market share in baby food.

Let me conclude my comments with an update on our outlook for the company. Before I do so, I would like to once again put Wimm-Bill-Dann nine months 2008 numbers into context. Since we last spoke, additional factors come into play. The Ukrainian Hryvnia depreciated over 50% against the dollar and indeed in the last 24 hours even more so. The Ruble depreciated over 14% again versus the dollar. The impact of the currency re-evaluation on the third quarter's net profit has been sizable and will possibly be even more significant in the fourth quarter.

The absence of credit lines to our customers from financial institutions poses additional challenges. The market remains uncertain and there has been a continued decline in consumer confidence. Given all the above, I believe it's not prudent to provide any further guidance at this time.

We do believe we will come very close to our previously provided guidance for 2008 and we continue to do all that is possible to achieve that within the context of safeguarding the long term health of our business. I remain in the prospects for Wimm-Bill-Dann despite the difficult and uncertain environment.

Over the last few years we've put in place a strong foundation that will see us emerge even stronger from this period. As a result, we continue to post solid results, strengthen our financial position and continue to execute on our strategy.

I would now like to turn the call over to Dmitry for more a more detailed discussion on our financials.

Dmitry Ivanov

Before I get to a detailed review of our sales results and gross margins performance given the current environment, I'd like to underscore the strength of our financial position with regards to liquidity. We have a very strong cash position with $137 million on cash on the balance sheet as of the end of the third quarter. We also continue to generate a significant cash flow from operations, $168 million through the first nine months of this year.

As of today, we have no material debt maturing over the remainder of 2008. We do however have a $5 million Ruble bond which is approximately $185 million due in 2013 which is a one year auction coming up in 2009.

Back in March of this year we determined that paying down this bond might be necessary and began planning accordingly. If we can get the financing at attractive rates, we may choose to refinance the debt. We are also fully prepared to finance those obligations with internal funds.

In addition to the $185 million settled for financing in March 2009, our next bond for $2.6 billion Rubles or about $100 million is due in December 2010. These we feel will be easy to finance even in current conditions. I want to assure all of you that there is no ambiguity in our financial standing despite the current environment. Wimm-Bill-Dann is financially strong.

Moving on to the financial results for the first nine months and third quarter of 2008, total gross sales increased 24.8% for the first nine months of 2008 over the same period last year to $2.2 billion. For the third quarter of 2008 gross sales rose 15% over the same period in 2007 to $702 million.

These results versus the comparable period last year was driven by strong double digit top line across all three of our important segments, highlighted by growth of 61% for our baby food segment through the first nine months.

Sales in the dairy segment increased 22.7% for the first nine months of 2008 over the same period last year to $1.6 billion. For the third quarter of 2008, sales is the dairy segment rose 11.5% over the same period in 2007 to $525 million. The average dollar average price for dairy rose 33% to $1.4 million, for the first nine months of 2008 over the same period last year.

For the third quarter of 2008 the average dollar selling price increased 26% to $1.41 per kilo over the same period in 2007. These increases were driven primarily by increases by average ruble prices.

Our raw milk prices continue to be higher for the first nine months of 2008 over the same period last year both in Russia and across the globe. For the first none months of 2008 our raw milk costs increased 36% in ruble terms and 46% in U.S. dollar terms compared to the same period last year. For the third quarter of 2008, our raw milk costs increased 14% in ruble terms and 20% in U.S. dollar terms compared to the same period last year.

Our raw milk costs declines [inaudible] in the third quarter 50% in ruble terms and 12% in dollar terms. However, the important point here is that they remain much higher on an absolute basis in comparison to last year.

Gross margin in the dairy segment was 29.1% for the first nine months of 2008, a decline of 100 basis points over the same period last year. Importantly, for the third quarter of 2008 gross margin in the dairy segment increased to 30.8% by 30 basis points over the same period in 2007.

Sales in the beverages segment increased 19.9% for the first nine months of 2008 over the same period last year to $373 million. For the third quarter of 2008 beverage sales rose 15.2% over the same period last year to $140 million. The average dollar selling price increased 14.8% for the first nine months of 2008 over the same period last year to $0.95 per kilo.

For the third quarter of 2008 the average selling price in the baby food segment rose 10.6% over the same period last year to $0.94 cents. This increase was driven primarily by increases in average ruble prices and improved sales mix.

Gross margins in the beverages segment was 8.6% for the first nine months of 2008, a decline of 180 basis points over the same period last year due to concentrate cost pressure. Concentrate shares in price grew 86.5% in the first nine months of 2008 compared to the same period last year. However, for the third quarter of 2008 gross margin was 40%, an improvement of 40 basis points over the same period in 2007 and a significant 200 basis point increase over the second quarter of 2008.

Sales in the baby food segment increased 61% for the first nine months of 2008 over the same period last year to $192 million. The third quarter sales rose 53.5% over the same period last year to $64 million. The average selling price in the baby food segment increased 27.4% for the first nine months of 2008 over the same period last year to $2.37 per kilo. For the third quarter of 2008 the average selling price in the baby food segment rose 19.9% over the same period last year to $2.29 per kilo. These increased were driven primarily by increases in average ruble pressure.

Gross margin in the baby food segment was 46.6% for the first nine months of 2008, an increase of 220 basis points over the same period last year. For the third quarter of 2008, gross margin in the baby food segment was 46.3%, an improvement of 340 basis points over the same period in 2007.

I will now turn to operating expenses and to other components of SP&L. Total selling and distribution expenses increased 29.8% for the first nine months of 2008 over the same period in 2007. For the third quarter of 2008 selling and distribution expenses rose 30.1% over the same period last year.

Marketing and advertising expenses for the first nine months of 2008 were $96.1 million or 4.4% of sales compared to $100.4 million or 5.7% of sales for the first nine months of 2007. For the third quarter of 2008 marketing and advertising expenses were $35.7 million up 5.1% of sales compared to $30.6 million or 5% of sales in the third quarter of 2007.

Transportation and warehousing costs for the first nine months of 2008 were $116 million compared to $89 million for the first nine months of 2007. For the third quarter of 2008 transportation and warehousing costs were $38.8 million compared to $33.3 million in the third quarter of 2007.

Personnel expenses increased 55.7% for the first nine months of 2008 over the same period last year to 93.9 million. For the third quarter of 2008 personnel expenses rose 4.6% over the same period last year to $29.8 million.

General and administrative expenses increased 5.4% for the first nine months of 2008 over the same period last year to $136.5 million. General and administrative expenses as a percentage of sales declined 120 basis points to 6.2% for the first nine months of the year in comparison to the first nine months of 2007 reflecting our focus of improving the efficiency of the business.

For the third quarter of 2008 general and administrative expenses decreased 6.2% over the same period last year to $39.6 million.

Financial expenses increased 137% for the first nine months of 2008 over the same period last year to $36.5 million. For the third quarter 2008 financial expenses were at $24.5 million, up significantly from $2.9 million over the same period last year. This is mainly as a result of the currency valuation loss of $3.9 million in the first nine months of 2008 against currency valuation gain of $14 million for the first nine months of 2007.

Currency valuation loss amounted to $15.1 million in the third quarter of 2008 compared to currency valuation gain of $8.4 million in the third quarter of 2007. Currency valuation loss was incurred in the third quarter as a result of the weakening of the ruble against the dollar impacting mainly $250 million in a loan taken out in the second quarter of 2008. Currency valuation loss is not a press item.

Our effective tax rate for the first nine months of 2008 was 28.5%, a decline of 80 basis points in comparison to the same period last year. For the third quarter of 2008 our effective tax rate was 27.8% down 60 basis points in comparison to the same period last year.

Operating income increased 15.1% for the first nine months of 2008 over the same period last year to $193.6 million. For the third quarter of 2008 operating income increased 12.9% over the same period last year to $67.6 million.

Net income increased 3.7% for the first nine months of 2008 over the same period last year to $109.6 million. For the third quarter of 2008 net income declined 22% from the same period last year to $31 million. These declines in net income are driven by the mentioned increase in financial expenses.

Underlying net income excluding foreign currency in effect and adjusted for expected tax amount increased in the third quarter of 2008 by 23.7% year over year to $41.9 million and by 17.7% year over year in the first nine months of 2008 to $112.4 million.

EBITDA increased 23.3% for the first nine months of 2008 over the same period last year to $183 million. For the third quarter of 2008 our EBITDA rose 20.3% over the same period last year to $99 million reflecting strong sales growth and continued focus on driving efficiencies in our general and administrative costs.

Our capital expenditures excluding acquisitions in the third quarter of 2008 were $47.7 million compared to $58.6 million in the third quarter of 2008. That brings our total CapEx to $158.9 million for the first nine months of 2008 up from $127,700,000 for the first nine months of last year.

Operating cash flow was a very solid $168 million for the first nine months of 2008 and net cash investments were $154 million in the first nine months of 2008 and mainly comprised of the purchase of property and equipment.

Finally the total debt EBITDA covenant as of September 30, 2008 was a very strong 1.88.

Marina Kagan

Thank you. Operator we will have questions in a minute, but we kindly ask you to limit questions to a maximum of two per caller to allow the maximum level of participation in the time available to us.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Marat Ibragimov – Citigroup.

Marat Ibragimov – Citigroup

Could you please comment on the volume in dairy segment? According to my calculations you have continued to record volume declines in the third quarter of this year compared to the third quarter of last year about 7%. What can you say?

Tony Maher

We don't give out volume information but I can confirm that the entire dairy market for the first nine months is down about 10%. We have even gone to some analysis of showing even greater decline. We have had some volume declines but it's not simple to divide one thing by another because inside our dairy numbers is also our agro business where we have some small sales of grain and so on, and they for sure are down on last year due to the price of grain as you know has come down a great deal.

So that would have bounced the numbers a bit but those details are reported inside dairy. But there has been some volume decline continuing in the quarter, pretty much in line with what we saw in the second quarter.

Marat Ibragimov – Citigroup

A question concerning your use of cash on [inaudible] You have quite significant falling off cash. Given the spend and full obligation on the bonds in March next year, it makes sense to repay, to buy out from the market some of the bonds given this cash position.

Tony Maher

There is an put option in the bond that we issued, a one year put option, should the holders want to get back the bonds then clearly we need to repay them and as I said, maybe [inaudible] and I was talking, but our plan is, and we said it on the press release today that if we cannot get refinancing at favorable rates that are appealing to us, we have to fund ourselves to repay the bond and so I think we're rather lucky compared to many other companies.

We have the cash and we don't need to refinance if it's not attractive to us. So the intent is to use those funds to repay and that's what we're going to do.

Marat Ibragimov – Citigroup

My deal was that given that the put option likely to be exercised it looks like uncertainty, I think you would need more turn on cash, we should have by acquiring the bond outstanding and that the amount of the bond that will be offered for the payment. What do you think?

Tony Maher

If some bond holders want to repay early and the discount levels are attractive to us then clearly that's an opportunity for us that we would look at. It's not a problem, but it depends on the circumstances of those bond holders and they would have individual negotiations with us should they wish to repay earlier. That's something that we are prepared to handle.

In the meantime of course, in U.S. dollars depending on what happens to the ruble versus the dollar, we have less dollars to repay when the time comes because they're in rubles. But nonetheless we're prepared to do that should some bond holders have some needs for early liquidity for whatever reason.

Marat Ibragimov – Citigroup

Regarding the rates, I know that you finished your negotiations on the purchase of [inaudible] for the next year in November. Could you please give some guidance on the prices? Have the prices declined or not?

Tony Maher

I think with all suppliers there is a level of confidentiality that we would like to enjoy, but what we can say is that all suppliers we have been in discussions with in relation to giving more value we'll call it, let's put it like that to us and we're obviously happy with the deal we've done for next year and we believe media still represents a very good opportunity in Russia for brand building and I think we are a branded company.

That has never changed, never will change, and we're committed to using the opportunities out there to solidify our position. Indeed I would say that was one of the things that differentiated Winn-Bill-Dann and Victor but also some other Russian companies. So the 1998 financial hiatus that was there, we're not afraid to invest to strengthen our position.

I guess the press release that Video International sent out this week which reflected an agreement that we have with them is an indication of our belief in the Russian markets and the Russian consumer and indeed in our business. So I'm not going to tell you what price we paid for GRP's but clearly we're happy that we've got a mutually beneficial agreement which Video International then with their media channels.

Marat Ibragimov – Citigroup

I've heard from other companies that TV is up to 6%, the prices compared to this year. Can you say if you mean it?

Tony Maher

We are one of the big media buyers in Russia, always have been and I guess I have a belief that we get pretty good value in our negotiations with the international and the TV channels. I can't give you our price and I'm sure if other people are happy at 30%, I'm happy for them. I'm happy with what we have also and more than that, I'm not going to say.

Operator

Your next question comes from [Gata Monda – Goldman Sachs].

[Gata Monda – Goldman Sachs]

A quick question on debt repayment schedule; as we see from your balance sheet you have $245 million on short term debt and $400 million of long term debt. You have already mentioned out of that is $185 million is classified as short term which is a bond with putable option in March of 2009 and $100 million in long term. That's bonds maturing in 2010. Would you please give us some color? What's the rest of the debt, when it's maturing and some repayment schedule on that would be great?

Dmitry Ivanov

As at September 30, we had a difference in short term debt. We refinanced from internal funds $20 million of short term loan to ING. We rolled over the short and long term department of agriculture for one year to 2010 so what we have now it's a bond which has a put option in March of 2009. And the rest is long term debt with a pay back schedule starting from 2010.

So in 2009 we expect possibly to refinance. It's the bond in the amount of approximately $108.5 million and we have all the necessary internal funds to repay it also without financing.

[Gata Monda – Goldman Sachs]

Could you break down the total debt? It's $245 million short term and $400 million long term. Could you break it down by repayment schedule? What we know at the moment is what you said about the bond that $185 million bonds are putable in March 2009. Maybe you could provide a repayment schedule for the rest of the debt.

Dmitry Uvanov

$250 million has to be paid in 2011. Approximately $150 million in 2010, part of which, $50 million in the beginning of 2010 and the remaining $100 million close to the end of 2010.

Tony Maher

I don't know if you picked up but of the $245, how much was ING?

Dmitry Uvanov

Short term was $245 million.

Tony Maher

With the ING piece in there? And that's already repaid.

Dmitry Uvanov

It's repaid from our internal cash.

Tony Maher

So the debt actually as at September 30, the one year debt is different than what it is today. Today it's $185 million. In the meantime, things changed as of September 30 to today obviously.

[Gata Monda – Goldman Sachs]

So you repaid $60 million from short term debt.

Dmitry Uvanov

$50 million and rolled over $25 million for one year. All the short term debt now is $185 million.

[Gata Monda – Goldman Sachs]

So that $25 million that you rolled over that's payable in what quarter of 2009?

Dmitry Uvanov

In 2010 third quarter.

Tony Maher

It's related to our agricultural enterprises so it's a different type of debt, subsidized debt.

Operator

Your next question comes from Victoria Grankina – Troika.

Victoria Grankina – Troika

My first question is on the dairy segment. I'm really curious to understand as to how you're managing the current shift away from the more premium product towards the more mass products taking into account the current market environment.

Tony Maher

Actually I think today there's a report out from Neilson, a news release which talks about Russian consumer prices and they've just done some research. And their research, and indeed our experience would not substantiate what their hypothesis is, that Russians are moving down to lower brands.

That hasn't happened. Indeed in the diary segment where we've lost about less than a share point on a 12 months basis and it's the lower end tier brands that we actually lost. Our main brands have not lost anything, in fact, they've gained. Our [inaudible] market share in fresh yogurt is up and our desserts are up about five share points and so on.

So that hasn't been the experience. I think what's happened and the Neilson research is just out today and I'm sure it's available to everybody on the call, it's basically saying what Russians are doing is that they're typically buying a little bit less often where they have constraints on their budgets rather than not buying at all, not buying their normal products.

So we haven't actually seen that. We have seen some buying soften and that's actually proved also from some other research from a company called Comcon that they're doing research on one million people to get about 800,000 respondents every month for the past couple of months, and they're a pretty reputable firm.

Now in our case, and this has always been the case because Russian consumers were never all of the same financial strengths. It's a very diverse country as we know and we've had, and we've always had a tiered approach to consumer demographics.

We've got in juice we've got three tiers of price segments that we market against. In dairy in milk we've actually got about four. If you go from Bio-max at the top end down to [inaudible] for example there are different price segments. And so we've got a portfolio which is really targeted across a wide consumer group. But we really see very little cannibalization at this point at least from one sector to another.

Victoria Grankina – Troika

Would it be fair to say that you haven't seen much significant product mix evolution there in the recent period?

Tony Maher

We haven't seen a huge amount of change in mix in dairy. Actually more so in juice where J7 continues to outperform our other brands. But that's also from a position where we're pretty much re-launching the last couple of years.

But in dairy I would say if there's any mix shift it's towards our stronger brands and where we had a little bit of a loss but nothing that worrying us too much. It's really from peripheral second tier brands, some lower level yogurt brands like we've had from some other areas, but if you look at our main brands, no shift whatsoever.

Victoria Grankina – Troika

On the credit situation in the market, the new legislation that requires you to separate milk and milk products will have some difficult scenarios for the smaller players which haven't had time to register their packaging. I saw your products in the supermarkets yesterday so you've obviously done a good job. From your sense do you think this will have a major impact on your competitors?

Tony Maher

Like all legislation and in particular in Russia when some new stuff comes in, you saw what happened in the days of alcohol changes and stamps and so on a couple of years ago, so the start is always a little bit uncertain.

I think the big question for us is around how the government intends to police the compliance with this legislation across our competitors. We've been who we are, we're always in compliance so we had a team of people working full time on this and with the governments so we had some senior people working on the project with the government and the department of agriculture and other bodies to make sure that we were ready and also that they were ready.

We've got the various certificates and in Russia you need certificates for everything. We've got all of those and that was quite a big job. We got our packaging in order and so on. I'm sure that with everything we know that's not true for almost any of our competitors. But how compliant they will need to be in the short term is another question.

This legislation came in yesterday and whether it means that some suppliers will not be able to supply stores next week and the stores become more diligent about ensuring that their suppliers are compliant is a question we can't answer. We worked on the thing to make sure we were and we are, and I think our people did a great job because it's not a small thing.

For our non Russian listeners it meant that every single sku we had, had to have new packaging, had to have new certificates, product certificates legally done by the government and so on, so it was a huge thing. But we've done it.

But I can't tell you what will happen with our competitors. I know they were complaining to the government that they weren't ready.

Victoria Grankina – Troika

Was it a very costly process?

Tony Maher

A cost in time. I can't say that it's cost us any specific money but of course we had some senior people pretty much full time on making sure that we were ready and there's always a cost to that at one level, but there was no write offs for packaging and so on. We did get an agreement from government that we could, any product that was produced before the 17th could be sold until that product was used.

We also got agreement that we could use existing packaging by putting stickers and other forms of communication on them. So to fair, government were very supportive in trying to one, achieve their objectives, and two, understand that there were some real issues about changing so many things on a single day.

So no real cost in terms of – I can't tell you that we wrote off anything, we didn't actually. But of course it took a lot of time.

Victoria Grankina – Troika

I'm hearing that the supermarkets are holding back payments from other industry brands and not particularly dairy. Are you seeing that perhaps this can evolve into an issue?

Tony Maher

I mentioned that a little bit on what I was saying earlier. We've actually seen our receivables come down, but I've made no secret that I felt that our balance sheet needed to get better. I still believe that. Our inventory levels, I think you will see them coming down when we issue our full year results. I alluded to this on the last conference call that our inventory levels were higher than they should be.

But we've had a, we changed a little bit. We centralized credit management. We appointed a credit controller for the entire country of Russia, it was separate from the Ukraine, primarily this year, and so we're tightly managing it.

Having said all of that, I guess there's a couple of things; one is that we are products that you pretty much have to have on the shelves, otherwise as a retailer you have a problem. That gives us some leverage in making sure that we're at the head of queue getting paid. But one cannot underestimate the difficulty that retailers have from small to large and as a result of that, distributors have in terms of refinancing.

As a result of that, we can't – I have to say too that at any one day we do have some customers on stock might take the entire country stock supply, if I take the entire country view. No large customers, but nonetheless it's a challenge.

As I said, we can only hope and believe, and I think this is true that retailers do need to pay people who supply fresh products because they're out of stock if they don't get a daily delivery. That wouldn't be true for other types of products and that gives us an advantage I think to being up at the front of the queue rather than at the back.

Operator

Your next question comes from Victoria Pretova – Credit Suisse.

Victoria Pretova – Credit Suisse

I know you are not willing to give additional guidance, but are you keeping your 2010 guidance as it was before? Could you give us some more color on your split between dollar based and ruble based cost?

Tony Maher

I think clearly with what's happening in the world around us, the guidance for 2008 is difficult. Guidance for 2010 is certainly I would say at this point is almost impossible because the world has changed dramatically the last three or four months. Obviously we follow, I have in my office unfortunately the Bloomberg Streak and if I look at the dollar a couple of weeks ago to the Euro, it was $1.24 and I just before I came out about an hour ago, it was $1.46.

And if I look at, we get lots of advice and we've got I guess a lot of the banks who are on the line, your banking side are all advising us, some of the biggest banks in the world and none of them predicted anything about the ruble to the euro to the dollar. I don't have other than they'd like from some sources, we don't really have a line of sight of what happens there.

In relation to your second part of the question, if I look at dairy, if I look at cost of goods for example, certainly more than half of our cost of goods, well over half our cost of goods is in rubles, so that's quite strong. Baby food, more or less the same.

In relation to the rest of cost of goods, most of the content there would be in euro's, packaging mainly. So I guess if I was to split it, maybe 70/30, 70 rubles and 30 in packaging and pretty much all euro's.

In relation to below the line and this applies to all our businesses, almost every piece of our overhead below gross margin is in rubles. There's almost no, there's obviously some, but there almost no overhead which anything other than rubles.

In relation to beverages, that is much more exposed to our currency. All the juices clearly with very little exception come from abroad mainly denominated in U.S. dollars and have been packaging again which makes up the rest is in the area of euros. So other than labor costs which is above the line, production costs, practically everything there is in foreign currency.

Victoria Pretova – Credit Suisse

Would this mean that actually for dairy and for baby food in nine months and also third quarter results, we haven't seen the impact of ruble evaluation because the euro was still relatively weak, right?

Tony Maher

Ruble devaluation really didn't happen until about September when things started to slip so there's obviously some effect in the PAL in Q3. Clearly there will be more in Q4 when you consider what's happening to the ruble.

We have taken a little bit in pricing but not too much, but I would say in other areas of course, there's also some things that have been positive because the price the concentrate has actually started coming down and hard currency also.

So if I can give you examples, apple juice, and this is a world wide thing, apple juice is about half of what it was at the start of the year in hard currency. So there's also some backs and forwards going on there. But clearly, directionally, you're right.

Operator

Your next question comes from [Odi Bruche – Merrill Lynch]

[Odi Bruche – Merrill Lynch]

I had a question about the prices. You gave us a bit of an update which I interpreted to be more of fourth quarter outlook but I wanted to ask about 2009 and the balance between what you expect the impact of more on milk will be but also on the other hand the fact that input price that the farmers have come down significantly and the grain prices down by almost half now. I thought that was really good.

Tony Maher

Firstly, milk prices in Q4 will be lower than Q4 last year, but you need to remember that Q4 last year was really out of any proportion in Russia. But milk prices for the first nine months of this year was nearly $250 million higher than a year ago. So if you take the full year number, I guess it would be somewhere in the order of $200 million prior year, probably be more than that even.

The prices are high. Russia has always had a deficit of quality raw milk and of course that doesn't help, but as of today we have and we believe our competitors have more milk than is required. So as we go forward into 2009, there's I guess two things.

Our perspective is that the inflation on raw milk next year should be quite modest because the levels of milk in Russia are relatively speaking by comparative to western Europe, high. Now what the uncertainty is, the uncertainty is in relation to this new milk regulation, what that's going to mean, what it might mean if borders close and so on.

We haven't used dry milk this year but of course other people use dry milk in the confection industry and so on and so forth and that may change. So it's not only dairy producers that use milk. We're obviously the main users, but confectionary and biscuits and so on also use it in their production.

So it's a little bit uncertain. I think the best estimate and the best belief that we have is that we don't see more than a couple of percent in dollar terms milk price increase next year if any actually. That would be our view for 2009 and we're seeing that pretty much in Q4. While there's been a slight increase versus Q3, it's modest and would be below 2007 levels.

[Odi Bruche – Merrill Lynch]

In 2009, what would you see? I think there's a break in consumer behavior in 2009 but would you as your prospects of increasing pricing and varying leverages essentially?

Tony Maher

2009, I guess we'll talk about in more detail when we do the full year results and maybe we'll have more clarity. But directionally it very much depends on what happens with the ruble as well. When I talked about we want to deliver shareholder value over the long term not over a quarter and certainly if the ruble devalues significantly against the dollar and you all follow many of the reports that I get from financial institutions also and you've got varying people giving rates that it can go to 32. There's others at 35. There's some others at 40. Who knows?

Certainly we would be playing stakes on pricing in rubles but then it very much depends on what happens to the dollar/ruble basis. So it's very hard to know what that percentage might look like.

In relation to juices it's a little bit different in that so far as all the players have the same issue and that is that almost all the costs and direct costs are hard currency and simply while there might be some lagging effect as there usually is if currency devalues. I think in the medium term, certainly people would be looking to maintain dollar revenues because the alternative is you just cancel the product.

That's not true with milk. If the ruble devalues there's so much of our overhead and costs in milk which are ruble denominated that it's not all negative news.

Operator

Your last question comes from [Miss Margaret Kousier – Harving Viesner]

[Miss Margaret Kousier – Harving Viesner]

I just wanted to ask what your future thoughts are on the baby food business, particularly with the changes that are occurring at [Libidyanski]. Do you see any likelihood of your growing your asset base significantly in baby food or perhaps buying a portion or all of their assets or what is your thinking along this? It's such a strong market domestically.

Tony Maher

Obviously [Lebadan] has a nice business and they've done a good job. I think they're at a slight discount to our brand in the marketplace, so slightly different positioning. They also push very much on juice which I guess is the foundation of that company also.

I think for us, Agusha has really been going from strength to strength. I can tell you that October has been the biggest month in our history for baby food in volume terms and it looks like November and December are heading in the same direction.

I think obviously having one brand is a big strength. I think in relation to [Lebadan], I'm not sure they're for sale. I think the shareholders of that business, if it's no longer [Lebadan], I'm not so sure what they call it these days, but whatever they call it, the shareholders who I know, I don't think they're short on money given the price they got from our friends in New York.

I don't think they're in any, at least to my knowledge, in any hurry to part with that. If that ever was to come to pass, I guess it would be something we would certainly look at. They know where we are and we know where they are. I have to say we don't rely on buying anybody's business in terms of baby food to grow our own.

The Agusha has been an extraordinary success over the last couple of years and there's even financial crises or otherwise, there's no indication on the recent horizon that would suggest that there's anything changing there. But we're very committed to that business. It's a great business and we've come to understand it well and I think we've also, I can't say about the Russian consumer, but the parents of the Russian consumer for Agusha have a huge trust in that brand and it's something we are very appreciative of and very glad of.

Operator

This will conclude today's question and answer session. I'd like to turn the call over for any closing or additional remarks.

Marina Kagan

Thank you once again for joining us today. Should you have any further questions, please do not hesitate to contact us. The replay of this call will be available for the next week. All the information can be found on the communication that was sent to you or on our web site. But for now, goodbye.

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