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

F1Q08 Earnings Call

June 6, 2008 9:00 am ET

Executives

Marina Kagan

Tony Maher - Chief Executive Officer

Dmitry Ivanov – Chief Financial Officer

Analysts

Victoria Grankina – Troika

[Aldi Brazi] – Merrill Lynch

Ekaterina Krasnenko – UBS

Victoria Petrova – Credit Suisse

[Gader Manodov] – Goldman Sachs

Marat Ibragimov – Citigroup

Rusty Johnson – Harding, Loevner Management

Operator

(Operator Instructions) Welcome to the Wimm-Bill-Dann First Quarter Results Conference Call. At this time I’d like to turn the conference over to Ms. Marina Kagan.

Marina Kagan

Thank you for joining us to discuss the financial results for the first 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 cautionary statements included in the press release covering any comments made during this conference call. Now I would like to hand the call over to our Chief Executive Officer, Tony Maher.

Tony Maher

I’d like to give you an overview of our first quarter 2008 results, I’ll then review the progress we’re making on our strategic initiatives, discuss our business segment results and provide an update on our outlook for 2008 now that we’ve completed the first quarter of the year. I’ll then pass the call over to Dmitry to discuss the detailed financial results.

We’re very pleased with the results in the first quarter, especially given challenging raw material and cost environment that we have discussed with your on prior call and during the road show. The first quarter saw a continued strong revenue increase of 35% year on year to $732 million US Dollars drive by higher baby food and beverage sales product mix and increased prices in dairy.

Our baby food business continued its very impressive performance increasing nearly 67% year on year. As you’ll recall at the end of ’07 we became the market leader in baby food in terms of volume. We have now just entered the dry formula market which is a unique recipe about which I will talk later. We’re very excited about this development and believe that we are now well positioned to achieve value leadership as well.

Despite the challenging cost environment affecting both segments our dairy and beverage businesses performed well in the first quarter. Group gross profit in the quarter increased over 26% to nearly $220 million US Dollars. This growth in our profitability was driven by an improved product mix and higher revenue.

Our gross margin remained solid at 30% justifying to the resilience of our business in the face of significant increases in raw material prices and our unique position in the market across the different segments in which we operate. Our EBITDA also improved in the first quarter increasing 29% on a year over year basis to $91 million US Dollars. EBITDA margin improved to 12.4% from 10.5% in the fourth quarter of 2007. This result represents only a slight decline on the year over year basis from 13% despite raw material costs as I mentioned previously.

I’d now like to turn to the progress we’re making on executing our strategy and provide insight into several items on which we have received questions recently. Firstly I want to emphasize the business continues to perform very well and as to specific items that I will cover today should be considered within the context of our broader strategy to drive growth, improve our efficiencies and organization and enhance our brand equity.

Let’s start with raw milk prices, despite some positive dynamics that we are currently seeing raw milk prices are still high. In fact, in January prices continued to climb but as of February supply started to outpace demand leading to a gradual reduction in price. However, in the first quarter we spent $103 million US Dollars more on the procurement of milk than we did the first quarter of 2007.

We continue to see reductions throughout the second quarter but prices are still substantially higher than they were in the first part of 2007. Therefore, we remain focused on improving the reliability and price of our raw milk supplies for long term contracts. We continue to execute on our plan to improve our route to market.

Our investment in marketing was lower than in prior quarters but you should not look at this as a trend. Our marketing expenditure is budgeted across the whole year and it will differ from quarter to quarter driven by strategic decisions as to when certain products and brands should be promoted and the launch of new product out to the markets.

Another important factor in enhancing our route to market is the physical delivery of our products to the final point of sale. Here I should note that wee like everyone else are seeing the effects of oil prices particularly when it comes to transportation warehousing. Despite efficiency improvements in both the dramatic increase in fuel costs is driving expense increases in these areas.

Let me now touch briefly on the latest developments around the classification of milk. In May this year the Russian Parliament adopted new technical regulations for all dairy product including drinking milk, fermented dairy products, cheese, butter, margarine, yogurt and dairy desserts. This legislation mandates that products marked milk should not contain any dry milk, vitamins or minerals and that any drinkable milk that contains these be market milk product or milk drink.

Although these classifications are not yet being enforced and are still subject to further approval by the President, we anticipate that these regulations will eventually come into effect.

For the past two years together with the Russian Dairy Union we have been campaigning for such technical regulations to be passed. The document is very positive in terms of specifying what can and cannot be used for dairy production. For instance a ban on certain types of fat and fat substitutes that some producers use to normalize fat contents or to make butter. Overall this law would protect larger responsible producers against counterfeit and openly poor quality products.

As for liquid milk we are continuing to talk to the government and remain hopeful that we will be heard. Reconstituted milk produced from high quality dry milk, observing strict technological processes is often more nutritious than full quality raw milk which often exists in Russia. Our current use of dry milk in products labeled as milk is relatively limited and is related to seasonal non-availability of raw milk in certain regions.

Should this law come into effect as is we will comply fully with it and will provide both milk and milk drinks to the market allowing consumers the choice depending on their own preferences and income. Finally I should note changes related only to drinkable and not to yogurts or any other dairy products.

Turning to the operating results of each of our businesses our dairy division delivered strong first quarter results with sales increasing 34% year over year to $555 million. The growth in dairy was driven by increases in the prices of our products and a greater share of national brands within the portfolio. The gross margin in the dairy segment remained solid decreasing only slightly to 26.4% from 26.9% in the fourth quarter of 2007. However, due to the significant change in milk prices versus prior year a decrease from 29.2% in the first quarter of ’07.

Higher milk prices for consumers are affecting volumes in the industry and they are not back to levels that we saw last year. A development that we expected as consumer adjust to higher prices. Even so our market share continues to improve versus our competitors and we gained a percentage point in the first quarter of according to latest market research.

In the beverage business we continue to make progress delivering sales growth of nearly 26% year over year to $117 million driven by continued volume growth, positive mix and favorable pricing. Gross margin in the first quarter for beverages declined to 38% from 39.9% prior year period but did stay in line fourth quarter 2007.

Sales of both of our flagship beverages brands began in 2008 as they closed last year with very solid growth. J-7 achieved impressive revenue growth of 48% over the first quarter of ’07, while Lovely Garde increased 24% year on year.

Finally as I already mentioned the main highlight of the first quarter was the performance of our baby food business. It continues to accelerate with revenue increasing 67% year over year to nearly $60 million US Dollars. These results extend our position as the market share volume leader for baby food in Russia.

Gross margin in baby food also continues to improve increasing 47.5% from 44.8% in first quarter of last year and from 46.7% last quarter. Our gross margin continues to benefit from increased volumes and selling prices, and our continued focus on improving our sales mix with high value, high margin products such as baby juice and drinkable yogurts.

As I mentioned in the beginning we have taken another important step in rounding out our baby food portfolio. With the launch of dry formula under our Agusha brand at the end of May. This formula is the result of in depth research carried out by our own R&D department together with the Russian Academy of Medical Science. It is being produced in Scandinavia and is currently being launched through several distribution channels.

To sum up the first quarter it was solid start to the year and we remain on track to fulfill the expectations that we shared with you on our last call despite some of the volume and difficult challenges that I mentioned earlier. We will be providing you with regular updates as the situation evolves in terms of changing demand patterns and raw material costs.

Before I turn the call over to Dmitry I’d like to welcome him to Wimm-Bill-Dann and his first confercne call as Chief Financial Officer of the company. Dmitry brings Wimm-Bill-Dann a unique set of experience and skills that are proving invaluable as we take this company and its finest departments to yet another level.

Dmitry Ivanov

Let me turn to the financials, Wimm-Bill-Dann group sales rose 35% in the first quarter 2008 over the same period in 2007 to $732 million. Organic growth across all three of our business segments, dairy, beverages and baby food drove these strong results. Sales in the dairy segment increase 34% to $555 million in the first quarter 2008 compared to $414 in the same period in 2007. The average dollar selling price for dairy rose 35% to $1.36 in the first quarter 2008 from $1.01 in the same period in 2007. An increase driven by growth in average rubel prices.

Raw milk prices continue to be significantly higher on a year over year basis both in Russia and globally. In the first quarter of 2008 our raw milk costs increased 62% in rubel terms $0.76 in dollar terms compared to the same period last year. If you recall the increase was $0.65 in rubel terms $0.78 in dollar terms in the fourth quarter of 2007 in comparison to the fourth quarter of 2006 and as Tony indicated we actually saw a bit of increase in raw milk prices in January of this year and then in March.

As these statistics show our raw milk prices for the quarter as the whole are comparable to those we incurred in the fourth quarter of 2007. Gross margin in the dairy segment decreased to 20.4% in first quarter 2008 from 29.2% in the first quarter 2007. Despite continued pressure from raw milk, gross margin stayed practically unchanged compared to 26.9% in the fourth quarter of 2007. Sales in the beverage segment increased 26% to $117 million for the first quarter 2008 from $93 million in first quarter 2007.

The average selling price in the beverage segment increased 27% to $1.02 particularly in the first quarter 2008 from $0.81 in the same period last year driven primarily by product mix and growth in average rubel prices. Gross margin for the beverage segment decreased to 38% in the first quarter of 2008 compared to the first quarter 2007 where the gross margin was 39.9%.

Sales in the baby food segment increased 67% to $60 million in the first quarter 2008 compared to $36 million in the first quarter 2007. These increases were driven by healthy mix, volume and pricing growth. The average selling price rose 31% to $2.42 in the first quarter 2008 from $1.84 in the same period last year. Gross margin in the baby food segment increased to 47.5% in the first quarter 2008, from 44.8% in the first quarter 2007.

Selling and distribution expenses are essentially flat as a percentage of sales in the first quarter 2008 at 15% compared to 15.1% in the first quarter 2007. Marketing and advertising expenses for the first quarter 2008 were $27 million or 3.6% of sales compared to $30 million or 5.5% of sales in the first quarter of 2007.

We will continue to look for opportunities to drive sales growth through investments and marketing and advertising that enhance our brand equity particularly in areas where we have significant opportunities to drive growth.

Transportation and warehousing costs totaled $40 million for the first quarter 2008 increasing from $25 million in the first quarter of last year. While we incurred great transportation and warehousing expenses related to supporting our increased sales the difference in this growth in direct reflection of the inflationary pressures of increased oil prices which are a major component of these costs.

Personal expenses increased to $28 million for the first quarter 2008 compared to $18 million for the same period last year. General and administrative expenses decreased to 5.8% of sales for the first quarter 2008 compared to 7.7% in the same period last year. Financial expenses during the first quarter 2008 decreased 41% to $3.4 million compared to $5.7 million in the same period of 2007. This was mainly a result of increased foreign currency gain.

In the first quarter 2008 foreign currency gain amount to $9 million compared to $3.2 million for the same period of 2007. Our effective tax rate is a level of 28.7% in the first quarter 2008. Operating income increased 23% to $63 million for the first quarter of this year from $51 million for the same period last year reflecting a solid balance between volume and pricing and an improvement in our sales mix.

Net income increased 31% to $42 million for the first quarter of 2008 from $32 million in the same period last year. EBITDA increased 29% to almost $91 million for the first quarter of 2008 from $70 million in the same period last year. For the first quarter of 2008 our capital expenditures excluding acquisitions were about $50 million compared to $24 million in the first quarter 2007. Operating cash flow amounted to $43 million in the first quarter 2008. Net cash used in investing activities was $42 million in the first quarter 2008 and mainly comprised of the purchase of property, plant and equipment.

Net debt in the first quarter 2008 has changed from $546 million to $553 million. Debt to EBITDA covenant as of the end of the first quarter 2.76%. Increase of this pressure is pulling simple fact that we issued bonds in March and refinanced part of our debt in May. On the net debt basis the covenant would be more than one on the beginning of the year. Needless to say we pay enormous attention the efficiency of our borrowings and the best proof of it is our latest deal on capital markets. Syndicated long issued in the end of April on libor plus 1.75% interest rate.

With that I’ll turn back the floor to Marina Kagan.

Marina Kagan

We are now open for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Victoria Grankina – Troika.

Victoria Grankina – Troika

My first question really stems from the raw milk price inflation. Can you please comment on the current situation with raw milk prices now that we have finished two months of the second quarter of 2008? Can you also please comment on the situation of the prices of concentrate, how is that developing in terms of current trading?

Tony Maher

The milk prices did start coming down from about the middle of February slowly but nonetheless week after week. The prices in May for the month are lower than they were in January. They would normally be lower also but the difference is it was bigger than would normally be the case. Nonetheless, significantly higher than last year. I think there’s more good news in the second quarter in the case of raw milk prices to the first quarter because we know January was quite a negative month for milk prices.

We’ve always said that we will be sinking for the first six, seven months of the year significantly lower prices last year on milk. In world market terms dry milk has bottomed out, it fell from $5,000 a ton down to $3,000 a ton. There’s a slight creeping up but it’s up one week, down another week over the last couple weeks. Pretty much it’s holding where it was.

What I would say is April, May, better than the first quarter as March was better than February, but still a lot higher than year ago. Of course also so are our prices a lot higher in terms of finished goods. In terms of concentrate some good news there. I think the first half year because we buy concentrate in advance there was a lot of inflation in apple concentrate in particular I guess driven by demand globally the Chinese apple is starting to come down in price, I think it’s dropping about $300 a ton. There is some still higher than a year ago but nonetheless lower than it was in the first quarter.

I think it’s driven by global demand quite simply. Still, commodity prices generally cultural type products the general trend is up, or higher than it was a year ago. With some things peaking and coming down like milk but still higher and now like apple juice which is a big part of our juice business peaking and coming down also but still higher.

Victoria Grankina – Troika

Is it fair for us to assume that the gross margin evolution in the second quarter was quite similar to what it was in the first quarter of 2008?

Tony Maher

I hate to give too much guidance for the second quarter given that we’re just announcing the first quarter but I think it would be fair to assume, I would say my expectations are that the second quarter gross profit numbers should be a little bit better than the first quarter gross profit numbers, it would be my expectation.

Operator

Your next question comes from [Aldi Brazi] – Merrill Lynch.

[Aldi Brazi] – Merrill Lynch

Could you please help us understand the structure of your milk production especially the contracts that you have an you have long term contracts and is that preventing you from benefiting from a faster decline in raw milk prices that exist of spot rates that’s coming through more slowly because you’ve got these long term contracts?

Tony Maher

Milk is very complicated thing, not like most other things that you buy in so far as it depends on fat content, protein content and quality of a whole bunch of other things. The long term contracts are not necessarily locked in at a given price. We do have the ability to take our prices down as we have been doing to those. They do come down faster to contracts which are effectively week to week, i.e. where we have back spot because liquid milk is never bought on spot because the farmer has to big or small has to find a daily output for his produce otherwise it spoils.

I wouldn’t say it’s preventing us from doing anything that is in our interest. A farmer doing well is also in our interest. These big farmers are typically some of the biggest in Russia and Ukraine and so on they typically have the best quality, they typically have year round supply and they need some certainty in the business also. Its not because the contracts that we would be taking the prices down at a sharper pace it would be really making sure we have the right balance between what’s in our interest in point price and our interest in guaranteeing supply.

I wouldn’t say its negative at all the more volatile part of our buying milk which represents approximately 40% of our milk buying there’s some benefits when prices are on the way down but there’s also some non-benefits there because you’re typically dealing with quality levels of milk which are not as good and also some cost elements that are higher because you’ve got collections costs are higher and so on. I don’t see this as negative.

[Aldi Brazi] – Merrill Lynch

You mentioned earlier that your market share had grown in terms of sales in the dairy, what about in volume?

Tony Maher

Involume and value, yes absolutely. More than a share pint actually and in key accounts which we just got yesterday for the first time our market share there is even bigger than our market share nationally in Russia and growing even faster. There’s no share question.

[Aldi Brazi] – Merrill Lynch

In terms of your price increases in dairy in April and May can you shed some light?

Tony Maher

Russia is a big place as indeed is Ukraine and Central Asia, we might have taken some SKUs in some regions but on a national basis we didn’t take any price increase in April and May for dairy. As I said, that doesn’t mean we didn’t take some pricing but by and large it would an SKU or two which would be local more than national. We did take some juice pricing in May which is what our competitors did also. In dairy I think our prices are already more or less what they should be, we didn’t previously driving to and there was no need for doing it at some of our key cost items were coming down.

Operator

Your next question comes from Ekaterina Krasnenko – UBS.

Ekaterina Krasnenko – UBS

My first question about your G&A costs which as a percentage of sales are down, could you please provide more detail on the costs and for example the stock option costs on the quarterly wages and if so credit effect on the financials and how you were able to reduce the costs?

Tony Maher

G&A costs have been coming down for some time. If you look this quarter after quarter I think versus prior year quarters stock options are expensed on quarterly basis so they have pluses and minuses in quarters depending on where the closing price ends up and obviously has some impact but we have committed to and we have delivered on the notion that G&A costs which will be reduced in fixed terms we fight hard to make sure they don’t decrease as we increase revenue clearly you don’t need to increase G&A.

It’s an area we’ve been working on part of the benefit on consolidation of the legal entities which occurred after the first quarter last year is a reason also. There are a lot of factors in there that drive that. Without saying that that’s going to be the same percentage quarter after quarter but I think our expectation is seeing the G&A will continue to reduce as a percentage of our revenue.

Ekaterina Krasnenko – UBS

Could you probably say which [inaudible]?

Tony Maher

I don’t know if we’re going to get into that level of detail on the call to be honest. I think as I said to you it’s a mixture of things from fees to legal fees to a whole host of things we have not in this quarter but we’ve been working on it the last couple of years to reduce. Telephone calls, everything. We’ve done national deals which telecoms providers that dramatically reducing our communications costs. Stock options are a piece of it.

Whatever you can imagine going into G&A there’s no number that I would like to see less. We continue to push back on that. What I believe you’ll see in subsequent quarters continued progress in the area.

Ekaterina Krasnenko – UBS

The second question, in your press release you provided percents of income would you please explain what does this mean, what is this item? It’s going after net income and currency translation adjustment.

Dmitry Ivanov

The other comprehensive income reflects the shareholders wealth increase calculated with international accounting principles. Its net income adjusted on currency exchange and change in etiquette.

Operator

Your next question comes from Victoria Petrova – Credit Suisse.

Victoria Petrova – Credit Suisse

We see some slight gross margin decline even quarter on quarter which was to a large extent more than compensated on EBITDA line, part of which is of course the GNV which have declined as percent of sales, sales in part is also relative selling in distribution expenses and I know Tony commented briefly that it probably would not be sustainable quarter on quarter.

My question would be do I understand it correctly that should a marketing expenses were not as large in the first quarter as they for example might be going forward. This is just for me to understand the potential dynamics for the second quarter as well. Also, we see some improvements in net margin on the quarter on quarter basis as well is it basically flat from EBITDA margin or was there something else in tax rate it was sustainable so it’s basically coming from EBITDA margin.

Tony Maher

The tax rate is pretty much where it has been for some time. I think marketing first of all we don’t give marketing guidance by quarter nor do we have marketing percentages by quarter, the programs are not even year programs they are gross marketing initiatives or 12, 18 month plus initiates so that’s where spend varies quarter to quarter.

What I would say is that marketing on an ongoing basis would be higher than what you saw in Q1 that doesn’t necessarily mean anything for Q2 it’s just that as an ongoing basis. On an annual basis you should expect a higher number.

Victoria Petrova – Credit Suisse

Would it mean that SG&A would be higher as a percent of sales in comparison? Basically selling and distribution expenses as a percent of sales would be most probably be higher than in the first quarter 2008?

Tony Maher

That depends on a whole bunch of factors which again we don’t give guidance of that kind of detail but it depends on a whole bunch of things. Inside that is distribution costs which typically can be higher in the winter time especially for trains and heated wagons and so on than it is in the summer time. Summer wagons are cheaper than winter wagon. Especially in Russia given distance and so on it’s a very complex and long answer which I’m not so sure it would be helpful to go into because I think there wouldn’t be enough time to even do it.

Generally I think you should think marketing on a 12 month basis would be higher than Q1 but that’s neither here nor there because as I said its happening in the quarter is the ongoing basis but then as I said I think to Victoria’s question earlier we certainly expect the gross margin there was a lot of pressure on gross margin in Q1 given the price of milk but as that has come down clearly gross margin one would expect to get even stronger. It’s all relative.

Victoria Petrova – Credit Suisse

Coming back to gross margin I would have one more question, basically this legislation related to use of formula prices would probably partially be used to encourage demand for raw milk maybe protect farmers I assume that. Can you maybe estimate the expense of the additional supply potentially coming from that or maybe your additional supply as a percent?

If I understand it correctly your dry milk consumption is between 15% and 25% of overall milk you are using depending on the season and correct me if I’m wrong should we expect that it would go to 5% to 15% or something like that just also to estimate the extent of your raw milk purchases locally?

Tony Maher

Not all dry milk do we use for final drinking milk or liquid milk. It goes into some yogurt, some of the recipes into some kippers and some other products. There’s quite a bit of the dry milk we buy that has nothing at all to do with this legislation. One has to say that in winter; especially as you go east the seasonality is very high.

In the summer time we’ve got more than we need and so do the farmers and in the winter time we have less than we need and typically in those markets we supplement fresh milk or raw milk with adding high quality dry powder milk so its not 100% of the product the final product so it’s a blend. You end up with very high quality milk but you end up with milk because there isn’t enough of the raw milk to do it.

That leaves us with some options we’re looking to see how we’re going to manage this, it leaves us with some options either to just supply liquid milk at 100% liquid milk, raw milk or we do what, we put on the label as the governments are requiring us to do call it milk drink if its mixed. Then it’s up to consumers to buy one or the other.

There’s also other things for example in our first quarter as indeed to our second quarter some of the products that we were selling before in the case of converting 100% liquid milk into cheaper brands or cheaper packs of fresh milk is something that we’re not doing. Private label, for example we have cut back to practically zero. This is new legislation which is only last week come to the fore.

We’re looking to work through how we deal with the challenging aspects as I said on my speech earlier there are lot of aspects of this are very positive because legislation around what constituted butter or fat or sour cream and so on was extremely vague and was abused not by our main competitors I have to say but certainly by our less developed regional competitors.

Still the government polices this; this is a very good thing for consumers and for us. The challenging aspect of it is around the use of dry milk in winter time which in all of the circumstances is fine but in Russia as there’s a deficit of milk for about four months of the year that doesn’t mean there’s no milk its just not enough of it, we face cost challenges and we’re working through and we will be over this couple months working through plans to mitigate that.

Will it lead to increased prices of raw milk, honestly, too early to say and I think also it depends on when the legislation comes in. The current best estimate is that it comes in towards the end of the year or early next year but I’m not an expert on Russian government law in terms of when these things get enacted. The best estimates we have it comes to law six months after it gets published. We have to work our way through this and see where it brings us.

Marina Kagan

To your question on whether there will be more raw milk on the market just to make it clear Russia has lots of raw milk its just that a lot of it cannot be used for industrial purposes and the one that can be is in short supply as Tony said in winter months and this legislation will not really change the supply part of raw milk.

Operator

Your next question comes from [Gader Manodov] – Goldman Sachs.

[Gader Manodov] – Goldman Sachs

My question is actually regarding CapEx and on the back of upcoming changes on legislation you’d probably need to introduce new packaging. If I understand it properly and especially that might concern local brands and will that require additional CapEx on introducing the packaging lines so that you have to make some changes.

Tony Maher

No, not at all. The only thing that would change is not CapEx but we literally have to get a print run done with change the label on the pack. We buy packaging every day. We don’t carry one year of stock of packaging. No, no CapEx whatsoever. We don’t buy cartons, we buy rolls of paper and our lines make all the packaging so on and so forth. In some packaging cases we actually make it from the most base raw materially into the final package. There’s no issue there.

[Gader Manodov] – Goldman Sachs

If you look at cost of goods sold of dairy and baby segments the most significant line in there, the most significant component is milk and could you just specify the share of raw milk in this milk line and the share of dry milk and on the back of this upcoming changes in legislation are you expecting an increase of the share of raw milk in the milk line of cost of goods sold?

Tony Maher

We won’t break out the share of dry versus liquid. Actually in the first quarter I have to tell you that there was almost no dry milk whatsoever used because we had more milk than we needed post February. That’s the best answer I can give you in relation to that. If you remember I said on the call and road show and other calls that we from the middle of February on we had more milk than we needed and that means that we would typically using very little dry milk because unless its required for a recipe in yogurts or pro-biotics or whatever.

I just answered the question for Victoria in relation to what this legislation means for liquid milk it’s a bit uncertain. In this year it’s uncertain because it very much depends on demand for the final product, it depends on what we can do to mitigate what we can do in terms of mix of cheaper milk versus more expensive milk and so on. It’s a bit difficult to give more guidance than we’ve already given. Legislation is a week old.

By and large the majority of our national brands in milk are always 100% liquid milk, they are always 100% to raw milk so this legislation if anything it affects more regional brands. Siberia is a particular challenge because there is simply not enough raw milk there in the winter time for obvious reasons. I think we all understand Siberia gets pretty cold in the winter time. The herds are far more in the summer.

[Gader Manodov] – Goldman Sachs

Looking back at the revenue increase you specified that improved product mix in the dairy segment and if I’m not wrong by the end of 2007 there was some move towards in product mix towards increased share of traditional dairy products rather than value added dairy products. Do you expect some change in product mix in future or is it going keep as it is now share of value adding products in total portfolio of your products.

Tony Maher

There were positive mix implications for baby food and positive mix for beverages, our J-7 brand which is obviously higher priced than any of our other brands grew faster than any of our other businesses. In the case of dairy we didn’t actually saw there was positive value added we said there was positive mix in relation to the share of national brands which by definition and that’s not just traditional dairy that’s across the national brands we have in traditional as well as what would be strategy and desserts.

Typically national brands are clearly higher margin so what you saw here was we look at our business really in terms of essential dairy like commodity dairy and effectively where the value added is many times not just yogurt and desserts although they are obviously receiving part of it but also our national brands like Domik v Derevne and so on which are extremely high priced and relative to the market.

It’s the share of national brands grew significantly in the first three months of last year in dairy and that’s where the deposit of mix was. Contrary to that some of our cheaper brands traditionally are cheaper products and things like private label and so on declined quite a bit and some to zero.

[Gader Manodov] – Goldman Sachs

Do you expect further increase, continuing increase of the share of national brands in total sales portfolio?

Tony Maher

Its always part of our objective to have that possible that all national brands because they’re much easier to manage and much easier to support. We’re a long way away from that, we’ve got some very strong regional brands but we have been gradually moving over the last couple years to where possible moving some regional brands over across to national brands because clearly advertising expense is getting more expensive and so on it becomes a challenge. Brands by definition aren’t just products they’ve got to be fuel to which media and other form of support and that becomes expensive.

By and large it’s our aspiration over a long period of time to move the mix of our business to more and more national and less and less regional.

Operator

Your next question comes from Marat Ibragimov – Citigroup.

Marat Ibragimov – Citigroup

As it relates to income in the profit and loss statement in the amount of $4 million how does that relate to income and expenses?

Marina Kagan

We can get back to you on that.

Marat Ibragimov – Citigroup

Could you please comment on the cash flow statement, I saw quite a significant deduction in the inventory area, is it a seasonal factor or that your inventory?

Tony Maher

Your looking at our inventory versus Q4 is it? If you remember I said at the conference call and then indeed when you and I met that our inventory levels in Q4 were high. Typically a lot of that has to do with carrying dry milk and so on so our inventory levels were too high in Q4 somewhat deliberately but also we’ve been working on, I’ve also made no secrets that are working happily to improve and need to improve even further. We would expect we have teams of people working on reducing holding packaging stocks and a number of other things.

It’s an area where we still have work to do on. Some progress being made but it continues to be, especially with the cost of inventory getting higher and higher it’s something we’re working on to reduce.

Marat Ibragimov – Citigroup

You’ve mentioned that the raw milk purchase price grew by 62% in rubel terms in the first quarter could you give some indication on the price performance in the first two months of the second quarter, in April and May so we can have some understanding how this indication of raw milk price is moving now.

Tony Maher

It’s lower. It’s still higher than a year ago. Obviously for competitive reasons we’re reluctant in giving the price we pay for milk. It is where it’s a good 30% plus higher than it was a year ago still.

Marat Ibragimov – Citigroup

Does the growth year on year basis is much slower but still it’s…

Tony Maher

It’s lower for sure. It’s been coming down gradually week after week it’s about the second or third week of February. Gradually but still a lot higher than a year ago. The good news is that of course our pricing is also up which is a positive side of that.

Operator

Your last question comes from Rusty Johnson – Harding, Loevner Management.

Rusty Johnson – Harding, Loevner Management

One question regarding your baby food in the mix could you help me understand what’s going on, is it from effectively a dry power formula you’re selling that’s mixed at home to more sort of ready to eat liquid I think you said drinkable yogurts. Is it just sort of a big shift in terms of what you’re actually selling and how far do you have to go there, can you talk about that.

Tony Maher

First there’s the dry formula we just launched in May so that was one of the opportunities we had. Whichever way you want to look at it we didn’t have dry formula we just launched it. Already the distribution levels are very encouraging I have to say. In Q1 there’s no dry formula. Our baby food business up to a couple years ago was really in ready to consume dairy baby food and we had a very strong position in that area.

We were by far the market leader in that area about 60% market share but we were only about number six player in baby food. If you take the entire portfolio for what baby’s consume we weren’t in there at all. We weren’t in juices, we weren’t in purees, we weren’t in meat and vegetables, all the other stuff that baby’s get. What’s we’ve been doing the last couple years is extending our range and extending our geography in Russia.

What you’re seeing really, on the strength of one brand our brand called Agusha. What’s you’re seeing is really a lot of portfolio expansion which we just build now with dry formula. We have very healthy babies in Russia and this is where they’re used to consuming liquid yogurt and curds and so on which is a bit like [inaudible]. These are products that we traditionally had a very strong position on.

We’ve now gone into meat, vegetable and fruit and juices which have been taken by mothers and parents for their children with the same enthusiasm as the original dairy products.

Rusty Johnson – Harding, Loevner Management

In regards to raw milk could you go back and emphasize what’s really important here in terms of your connection with these long term contracts and quality people. Is it a supply issue and you need to get more, is it a quality issue whether there’s milk but the issues is quality milk and to what degree are you increasing your competitive advantage by backing into the contracts own production. I’m struggling with what’s really important here and what will be important in the future?

Tony Maher

What’s really important is supply and policy. Price is nice too, so its not that we ignore that but, that’s important for the farmer too. I had a meeting early yesterday morning with one of our big suppliers and while the price we’re paying him is less today than it was three or four months ago the relationship is actually perfect because the guy knows that we’re around when he has lots of milk and we’re around in the winter when maybe the power it the other way.

That is good for him because he’s investing in larger farms; this particular gentleman has cow herds of over 4,000 cows. This is a big business with lots of employees and so on an so forth. These are the kind of farmers that there’s a mutual dependency on, we to them and them to us. Which is why actually during the high rate of growth last year we didn’t lose any of these because there’s a long term, not only about a contract, contracts in effect in Russia can be more easily be broken but this is really about a long term relationship that does have a contract attached to it but the relationship is far stronger than the contract.

Rusty Johnson – Harding, Loevner Management

Are most of these exclusive?

Tony Maher

Almost all are exclusive, yes.

Marina Kagan

Its also in terms of quality and supply usually they are linked because also the new legislation said that liquid milk cannot be milk with protein lower than 2.8% and pricing also depends on the amount of protein in the milk. In a way supply of that milk is in shorter supply of other quality milk.

Ladies and gentlemen thank you once again for joining us today. Should you have any further questions please do not hesitate to contact us. Good bye from all of us here in Moscow.

Operator

That will conclude today’s conference call. Thank you for your participation ladies and gentlemen you may now disconnect.

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