_cover.qxd 31/05/2005 10:55 Page 1 U K R P R O D U C T G R O U P L T D A n n u a l r e p o r t a n d f i n a n c i a l s t a t e m e n t s 2 0 0 4 U K R P R O D U C T G R O U P L T D 2 6 N e w S t r e e t S t H e l i e r J e r s e y J E 2 3 R A C h a n n e l I s l a n d s w w w . u k r p r o d u c t . c o m U K R P R O D U C T G R O U P L T D A n n u a l r e p o r t a n d f i n a n c i a l s t a t e m e n t s 2 0 0 4 _cover.qxd 31/05/2005 10:55 Page 2 Ukrproduct Group Ltd Dairy Trading Corp export subsidiary CJSC Ukrproduct Group main operating subsidiary LinkStar Limited trademarks holding subsidiary With a land surface of 604,000 square kilometres, Ukraine is Europe’s second largest country. It is also the fastest growing European economy, with a GDP growth rate of 12% in 2004 (2003: 10%). In November–December 2004, Ukraine witnessed the “Orange revolution”, a now famous, peaceful climax of the popular movement which replaced the outdated political regime with a vibrant democracy taking dynamic strides westwards. In 2004 Ukraine’s population of 47 million people consumed an estimated 36,000 tonnes of processed cheese and 41,000 tonnes of packaged butter of which 12,300 tonnes (~33%) of processed cheese and 9,200 tonnes (~23%) of packaged butter were supplied by Ukrproduct Group. 01 Corporate Statement and Highlights 02 Chairman’s Statement 03 Chief Executive’s Statement 05 Financial Review 06 Board of Directors and Corporate Advisers 08 Directors’ Report 09 Corporate Governance Report 11 Corporate Social Responsibility Report 12 Remuneration Committee Report 13 Independent Auditors’ Report 14 Statement of Income 15 Balance Sheet 16 Cash Flow Statement 17 Statement of Changes in Shareholders’ Equity 18 Notes to the Financial Statements 35 Notice of Annual General Meeting designed & produced by T H E D E S I G N P O R T F O L I O a member of the flathill communications group plc www.flathillplc.com _02_UKR_arf_04.qxd 31/05/2005 10:56 Page 01 CORPORATE STATEMENT UKRPRODUCT GROUP LTD IS A UKRAINE-BASED PRODUCER AND DISTRIBUTOR OF BRANDED DAIRY FOODS. THE GROUP IS THE LEADER IN ITS TWO CORE BUSINESS SEGMENTS, ACCOUNTING FOR AN ESTIMATED 33% OF THE PROCESSED CHEESE MARKET AND 23% OF THE PACKAGED BUTTER MARKET IN UKRAINE. UKRPRODUCT IS ONE OF THE FASTEST GROWING COMPANIES IN ITS MARKETS, WITH COMPOUND ANNUAL SALES GROWTH OF 55% DURING 2001–2004. WITH A MISSION TO SUPPLY BRANDED QUALITY FOOD PRODUCTS AT AFFORDABLE PRICES TO CUSTOMERS IN UKRAINE AND ABROAD, UKRPRODUCT IS INTERNATIONAL IN ITS OUTLOOK, COMPETITIVE IN ITS ATTITUDE AND SOCIALLY RESPONSIBLE IN ITS APPROACH. UKRPRODUCT GROUP LTD BECAME A PUBLIC COMPANY ON 11 FEBRUARY 2005, PLACING 27.2% OF ITS SHARE CAPITAL ON THE ALTERNATIVE INVESTMENT MARKET OF THE LONDON STOCK EXCHANGE (“AIM”). THIS DOCUMENT IS THE FIRST ANNUAL REPORT TO BE PUBLISHED BY THE COMPANY AFTER THIS EVENT. HIGHLIGHTS Jan 2004 Ukrproduct’s UAH 10 million (GBP 1.1 million) bond issue is fully subscribed. The Group initiates the flotation process of admission to AIM. Apr 2004 The Group introduces the ISO 9001 imprint on the packaging of its products, in order to demonstrate its commitment to quality. Stockbroker WH Ireland Ltd appointed to advise the Group on the flotation process. The Antimonopoly Committee of Ukraine consents to incorporation of closed joint-stock company Ukrproduct Group Ukraine, the Group’s main operating unit. May 2004 The Group’s corporate logo and style are awarded first prize for design in the all-FSU Advertising Festival. In order to prepare the Group for flotation on AIM, a corporate structuring programme is launched. The construction of the new workshop for processed cheese production is commenced. Aug 2004 Ukrproduct Group celebrates its fifth anniversary. Sep 2004 New trading subsidiary in the northern region of Ukraine (Kharkiv) is established. Oct 2004 A variety of new flavoured cheeses are introduced to widen the product range of the Group. Nov 2004 Dr Jack Rowell is appointed as the Non-executive Chairman of the Board. Ukrproduct Logistics, a logistics and supply chain management company, is formally established to develop the service business of the Group. Dec 2004 The Group registers a 54% sales growth in FY2004, maintaining margins and increasing market share in all core business segments. UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 01 _02_UKR_arf_04.qxd 31/05/2005 10:56 Page 02 CHAIRMAN’S STATEMENT OUR PROVEN BUSINESS MODEL, TOGETHER WITH THE SUCCESS IN A DYNAMICALLY EVOLVING ENVIRONMENT, SUPPORTS OUR CONFIDENCE THAT WE WILL BE ABLE TO IMPROVE PERFORMANCE YET FURTHER, FOR THE LONG-TERM BENEFIT OF SHAREHOLDERS. develop further the logistics and supply chain management services offered to third parties. This business activity is becoming increasingly important for companies operating in Ukraine, where the supply chain development is in its infancy; due to high domestic economic growth, demand for these services is growing rapidly. CORPORATE GOVERNANCE The current Board was formed during the year to address strategic issues and to provide overall guidance for the management of the Group. The Board is committed to ensuring best practice in corporate governance, through the monitoring and development of appropriate internal controls. With regards to the Board composition going forward, Paul Williams decided not to offer himself for election as a Director in order to be able to pursue other business interests. I am grateful to Paul for his contribution to the success of the Group’s flotation on AIM this year and, on behalf of the Board, wish him every success in the future. 2004 has been an eventful year for both management and staff, and on behalf of the Board I would like to express my appreciation for their efforts, which are essential to the Group’s continuing success. Dr Jack Rowell OBE Non-executive Chairman 3 June 2005 I am delighted to present the first annual report of Ukrproduct Group following its admission to AIM. The Board and management team have worked hard to sustain the Group’s growth going forward and we are confident of our ability to deliver value to shareholders. OVERVIEW During 2004, Ukrproduct Group continued to demonstrate sustained growth. We are maintaining our momentum and are a step ahead of the competition. During the year under review, we successfully launched many initiatives to create a strong, integrated food and service group. These included construction of a new cheese production facility, corporate restructuring of the Group and further expansion of our distribution network. The Group successfully achieved the challenging targets set out by the Board and remains one of the most profitable and dynamic food businesses in Ukraine. Net sales increased by 54%, to £27 million, accompanied by improved profit margins. Excellent progress has been made in our core business segments, adding a further 10% and 5% respectively to our already leading positions in the Ukrainian processed cheese and packaged butter markets. STRATEGY Our long-term ability to compete in the constantly and evolving business environment will depend crucially on developing the Group’s product offering to customers. Having grown organically to become the leader in our core business segments, we now need to pick up the pace of investment in order to remain competitive in the future. On the production side, the Group continues to develop its core capabilities and aims to expand into another attractive area. The Group has for some time been analysing potential investment opportunities in the large, higher-margin and fast-growing hard cheese sector. We intend to secure a foothold in this area during 2006–2007. On the service side, the Group plans to capitalise on its existing distribution network and to 02 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _02_UKR_arf_04.qxd 31/05/2005 10:56 Page 03 CHIEF EXECUTIVE’S STATEMENT THE YEAR MARKED A SUBSTANTIAL STEP FORWARD IN ALL GROUP ACTIVITIES. 2004 was a breakthrough year for the Group. Continuing modernisation of the plants, expanded geographic coverage of sales, further expansion of the Group’s market share and further margin growth in the core segments are all the welcome hallmarks of a dynamically developing business. The structuring of our activities prior to our admission to AIM allowed your Board to improve the Group’s business processes and to attain significant gains in operating efficiency. In May, the Group commenced the construction of a new, state-of-the-art manufacturing facility at Molochnik, the Group’s flagship plant for processed cheese in Zhitomyr. The building programme is expected to take a year, after which production capacity will increase to 2,000 tonnes of processed cheese per month. This will be the largest ever capacity increase in the Group’s history – and it will strengthen the Group’s position as the leading processed cheese manufacturer in Ukraine. Additionally, our rapid expansion necessitated the establishment of Ukrproduct Logistics, the Group’s division dedicated both to the logistical support of other Group companies and to the provision of transport and distribution services to third parties. This service component of the Group’s business is of growing importance and we are keen to expand this area into a major profit-generating centre. distribution network and the launch of direct delivery and merchandising programmes in five big cities, each with a population of over one million – Dnepropetrovsk, Donetsk, Kyiv, Lviv and Odessa. OPERATING REVIEW Throughout the period, Molochnik performed well, producing 12,300 (FY2003: 6,700) tonnes of processed cheese and 6,100 (FY2003: 4,450) tonnes of packaged butter. Our second manufacturing facility at Starakonstantinov produced 3,500 (FY2003: 2,990) tonnes of skimmed milk powder and 3,100 (FY2003: 1,700) tonnes of packaged butter. Although Ukrproduct’s market position strengthened in all product segments, processed cheese sales did exceptionally well, and we believe our market share is now close to 33%. In September 2004, a new regional distribution centre in Kharkiv became operational – another step in the development of our pan-Ukrainian distribution network. This now comprises eight regional depots and a central warehouse in Zhitomyr. The rapid growth of the Group was supported by further development of the existing The Group continued its successful practice of the forward storage of raw milk derivatives, thereby benefiting from the differentials in protein content and prices, between summer and winter seasons. This practice ensures stability of supply of raw materials for the whole year. The total amount used in forward storage was 1,700 tonnes in the year under review. In 2005, we plan to increase this figure to 4,000 tonnes in order to satisfy growing demand. MARKET The dairy-based foods market in Ukraine continues to register accelerated growth, supported by sustained growth of consumer purchasing power, as well as by the increasing sophistication of producers’ offerings. Even after years of double-digit growth, per capita consumption of dairy-based foods remains relatively low in Ukraine in comparison with other East European countries. This indicates the potential of this market for the future. Although the competition in our principal segments is gradually increasing, the Group’s business 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 the Board and management team during the year. The growth of the hard cheese market and its relatively high level of fragmentation has 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 construction of a brand-new hard cheese plant, to become operational in 2006/2007. As part of the Group’s quality improvement plans we are also planning to install a new standardisation line for raw materials at Molochnik in summer 2005. UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 03 _02_UKR_arf_04.qxd 31/05/2005 10:56 Page 04 CHIEF EXECUTIVE’S STATEMENT continued Over the next few years we shall continue to review the efficiency of our operations based on scale, improved logistical and sales capabilities, as well as via penetration of more profitable business segments. The year marked a substantial step forward in all Group activities. This step would not have been possible without the commitment and dedication of each of our 1,200 employees. I would like to thank them as a team and each of them personally for their efforts and contribution in sustaining Ukrproduct Group’s leading position in our markets. Sergey Evlanchik Chief Executive Officer 3 June 2005 Growing volumes of the distribution of both own produce and third-party goods require that Ukrproduct constantly upgrade its warehousing facilities. The Group is now preparing a plan for building a new hub warehouse near Zhitomyr with a surface area of 20,000 square metres, three-quarters of which will be temperature- controlled. We plan to complete this project in 2007. Following the year end, the Company succeeded in raising £6 million through a placing of its shares on AIM in February 2005. We intend to use these funds to augment our working capital, to redeem our domestic high-coupon debt and to facilitate the capital expenditure programme which is essential for our expansion. OUTLOOK We have a clearly defined plan for further development and growth, which is aimed at maximising shareholder value. We will continue to serve our customers by focussing on quality, price and convenience. 04 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _02_UKR_arf_04.qxd 31/05/2005 10:56 Page 05 FINANCIAL REVIEW 2004 WAS YET ANOTHER YEAR OF PROFITABLE GROWTH FOR THE GROUP. ITS FINANCIAL POSITION WAS ENHANCED, THE UNDERLYING BUSINESS CONTINUED TO DEVELOP DYNAMICALLY IN ALL SEGMENTS OF OPERATIONS, AND THE GROUP WAS CAREFUL IN CONTROLLING THE COSTS OF EXPANSION. Summary: (cid:1) Sales: £27.1 million (2003: £17.6 million) (cid:1) Gross profit: £4.4 million (2003: £2.4 million) (cid:1) EBITDA: £2.6 million (2003: £1.4 million) (cid:1) PBT: £1.8 million (2003: £1.3 million) (cid:1) Net profit: £1.5 million (2003: £1.1 million) (cid:1) Gross margin: 16.3% (2003: 13.5%) (cid:1) Earnings per share: 4.8 pence (2003: 3.7 pence) SALES Sales of £27.1 million for the period under review comprised the following product segments: Processed cheese £10.1 million Packaged butter Skimmed milk powder Other products Services £9.5 million £5.4 million £1.9 million £0.2 million Sales grew by 54% over the previous year, facilitated mainly by the Group’s expanding distribution network and well thought-out branding and promotional strategies. With regards to the sales dynamic, in the year the Group observed the continuing growth of the Ukrainian economy supported by the ongoing structural reforms, prudent monetary policies of the central bank and the rising affluence of consumers. GROSS PROFIT The Group’s gross profit of £4.4 million in 2004 has significantly increased in comparison with the previous year, both as a result of sales growth and the increase in scale of the Group’s buying power with its suppliers of raw materials. Gross profit margin has also improved significantly, following the Group’s successful implementation of the raw materials forward storage programme for the 2004–2005 season. UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 EBITDA Profit before interest, tax, depreciation and amortisation of £2.6 million was up 86% over the prior year. The growth in EBITDA was achieved through profitable expansion of the Group’s sales, timely mitigation of the seasonal (winter 2004) increase in prices of raw materials, and careful control of general and administrative expenses. PBT Profit before tax also increased markedly in 2004 albeit at a slower rate than the increase in EBITDA. The main factor behind the slower rate of increase was the higher depreciation charge in 2004 due to the Group’s ongoing modernisation programme and revaluation of fixed assets. Also, the Group incurred greater interest expense which was necessary to support the continuing growth of its borrowing requirement. NET PROFIT Net profit was recorded at £1.4 million, an increase of 27% over the previous year. There were two reasons for the slower rate of growth in the Group’s net profit compared to 2003. Firstly, an exceptional item in the form of a waiver of debt of the Group to a related party in 2003 – treated as income according to International Accounting Standards – created a higher comparative base for net income in 2003. Secondly, the Group’s effective tax rate increased in 2004 as a result of corporate restructuring and consolidation of the tax base in preparation for admission to AIM. EARNINGS PER SHARE The Group’s earnings per share in FY2004 was 4.8 pence (2003: 3.7 pence). Earnings per share has been calculated by dividing net profit attributable to ordinary shareholders (profit for the year) by the weighted average number of shares that would have been in issue if the Enlarged Group had been a legally defined Group at 31 December and had applied the merger method. In the Board’s view, such calculation is consistent with IAS/IFRS and provides a suitable basis for comparisons going forward. CASH FLOW Net cash flow from operating activities was £0.9 million and the Group was cash positive at £0.3 million as of 31 December 2004. The Group’s total debt amounted to £2.2 million, with an equity base of £5.0 million. CAPITAL EXPENDITURE During the period under review the Group purchased property, plant and equipment with a value of nearly £1.6 million. This expenditure mostly related to the construction of the new processed cheese production facility, acquisition of melting and packaging equipment and the upgrade of the production and distribution facilities. DIVIDENDS The Directors are committed to a progressive and balanced dividend policy that aims to reward shareholders adequately whilst at the same time maintaining the necessary cash position to support the Group’s continuing growth. In order to support the cash requirements of the Group, the Directors recommend that no dividend be paid for the year 2004. No dividends have been paid out during the year under review. INTERNATIONAL ACCOUNTING STANDARDS AND INTERNATIONAL FINANCIAL REPORTING STANDARDS (IAS/IFRS) The Group’s financial statements for the last four financial years, 2004 inclusive, have been prepared in accordance with IAS/IFRS. Dr Dmitry Dragun Chief Financial Officer 3 June 2005 05 _02_UKR_arf_04.qxd 31/05/2005 10:56 Page 06 BOARD OF DIRECTORS AND CORPORATE ADVISERS From left to right: Dr Dmitry Dragun, Iryna Yevets, Alexander Slipchuk, Sergey Evlanchik, Dr Jack Rowell OBE, David Lattimore and Paul Williams Dr Jack Rowell OBE Non-executive Chairman Dr Jack Rowell OBE has served as a Board member since November 2004. Dr Rowell has acted as Chairman of a number of companies in the public and private sectors and was previously a Director on the Board of Dalgety plc with responsibility for the Consumer Foods Division. Prior to this Dr Rowell was CEO of Golden Wonder, part of the Dalgety Group, and finance director and then CEO of Lucas, (also part of the Dalgety Group). In parallel to his business career he has long been involved with rugby, being England coach between 1994 and 1998. Sergey Evlanchik Chief Executive Officer Sergey Evlanchik is a founder of Ukrproduct Group. He studied at Vladivostok State University of Economics & Service in the Russian Federation and Oxford University in the UK, where he received his MBA degree. Together with Alexander Slipchuk, he established the equity trading company, Alfa-Broker in 1994. After the recess of the Russian and Ukrainian equity markets in 1998, Sergey re-focused his activities on business development in the industrial sector of Ukraine, the dairy business in particular, joining the management boards of the companies that later formed Ukrproduct Group. Iryna Yevets Chief Operating Officer Iryna Yevets is responsible for the Group’s overall performance and operational strategy in Ukraine. Iryna is a qualified accountant who started her own company, Audit Legal Services in Ukraine in 1994. In 2001 she took up a position as chief accountant at Latoritsa, a leading integrated food company based in Western Ukraine. She then joined Ukrproduct Group in 2002 as Finance Director, becoming President of the Ukrainian operating company in 2003 and Chief Operating Officer of the Group in 2004. Iryna holds Honours in Economics & Engineering from Lviv Engineering University. Dr Dmitry Dragun Finance Director Dr Dmitry Dragun is Finance Director of the Group. Dmitry worked at National (Central) Bank of Belarus in a variety of senior executive positions before going to Oxford to study for an MBA in 1997. Post-MBA, Dmitry has remained in the UK as the senior research associate in finance at Templeton College, Oxford University’s designated centre of business studies and executive development. Dmitry joined Ukrproduct Group in 2003 as its financial and investment adviser, and was appointed Finance Director of the Group in 2004. Dmitry holds the Chartered Financial Analyst (CFA®) certification. Alexander Slipchuk Executive Director Alexander Slipchuk studied at Far-Eastern High Engineering Marine School in Russia and graduated as a maritime navigator in 1989. Together with Sergey Evlanchik, Alexander established the securities house Alfa-Broker in 1994, developed the equity trading business in the far east of the Russian Federation, and acquired initial stakes in the companies that later became part of Ukrproduct Group. Alexander joined Ukrproduct in 1998, taking an executive, hands-on operating position at the Molochnik and the Starakonstantinovskiy dairy plants, the Group’s main operating assets. He serves as the Group’s Executive Director responsible for strategic oversight of the Group’s operations in Ukraine. 06 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _02_UKR_arf_04.qxd 31/05/2005 10:56 Page 07 Registered Office 26 New Street St Helier Jersey JE2 3RA Registered Number 88352 Company secretary Bedell Cristin Secretaries Limited PO Box 75 26 New Street St Helier Jersey JE2 3RA Nominated adviser and broker W H Ireland Limited 11 St James’s Square Manchester M2 6WH Registered accountants and auditors BDO Stoy Hayward 8 Baker Street London W1U 3LL Solicitors Cobbetts Ship Canal House King Street Manchester M2 4WB Principal bankers Deutsche Bank International Limited PO Box 727 St. Paul’s Gate New Street St Helier Jersey JE4 8ZB Registrars Capita Registrars The Registry 34 Beckenham Road Beckenham Kent BR3 4TU David Lattimore Non-executive Director David Lattimore is a Chartered Director with over thirty years’ experience in the UK dairy industry primarily with Unigate plc and Dairy Crest plc. He is currently a director of Forgefirst Ltd, a management services company with clients ranging from government bodies to farmers’ organisations and public limited companies. Paul Williams Non-executive Director Educated at Shrewsbury School, Paul Williams read modern languages and economics at Clare College, Cambridge. He trained with his family firm before joining Arthur Young McLelland Moores, subsequently becoming joint founder partner of his own accountancy practice, Pennington Williams, which he ran for over 22 years. Until December 2004 he was finance director and company secretary of Maelor plc, a North Wales based pharmaceutical company. Paul is a member of the London Stock Exchange’s AIM Advisory Group and the North West Regional Advisory Group, and has been a regular speaker on behalf of AIM at many UK and international seminars. UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 07 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 08 DIRECTORS’ REPORT The Directors present their report and the audited financial statements of Ukrproduct Group Ltd for the year ended 31 December 2004. PRINCIPAL ACTIVITIES AND BUSINESS REVIEW The main activity of the Company (Ukrproduct Group Ltd) is that of a holding company. The main activities of Ukrproduct Group are the production and distribution of branded dairy foods in Ukraine and the export of skimmed milk powder. The Group is one of the largest branded food producers in Ukraine with its own nationwide distribution network. More detailed commentary on the Group’s activities during the year, its financial performance and future plans and prospects are outlined in the Chairman’s and Chief Executive’s Statements and in the Financial Review. DIRECTORS The names and brief biographical details of the current Directors are provided on pages 6 and 7. Details of the Directors’ remuneration are set out in the Remuneration Committee Report. EMPLOYEES The Group is committed to ensuring provision of equal opportunities for all employees, which is reflected by its selection, recruitment and training policies. The Group considers its employees to be one of its most valuable assets and rewards high performance through competitive remuneration and incentive schemes. The Directors also consider it a priority to give employees the opportunity to communicate their ideas and opinions to all levels of management, both directly and through various surveys. SUBSTANTIAL SHAREHOLDINGS As at 15 April 2005, the Company has been notified of the following substantial interests in its issued ordinary share capital (the ten largest shareholders are reported): Shareholder Crensel Finance Limited Densim Group Management SA Fidelity European Smaller Companies Fund East Capital Osteuropafond Moore Global Fixed Income Fund Lehman Brothers International (Europe) Chase Nominees East Capital Rysslandsfond Goldman Sachs Securities Moore Macro Fund LP Main Equities Number of ordinary shares Holding % 15,000,000 15,000,000 3,300,000 900,000 837,000 800,000 727,500 600,000 500,000 418,000 36.4 36.4 8.0 2.2 2.0 1.9 1.8 1.5 1.2 1.0 PAYMENT POLICY The Group has a general set of guidelines for paying its suppliers based on specific criteria. However, it is normal practice to agree payment terms with a specific supplier when entering into a purchase contract. The Group seeks to abide by the payment terms agreed whenever it is satisfied that the goods or services have been provided in accordance with the agreed terms and conditions. AUDITORS For the financial year under review, BDO Stoy Hayward and IGK Ukraine served as auditors to the Group. STATEMENT OF DIRECTORS’ RESPONSIBILITIES The Directors of Ukrproduct Group Ltd have accepted responsibility to prepare the combined financial information for the year ended 31 December 2004 on the basis set out in note 2 to the combined financial information. In preparing this combined financial information, the Directors have: (cid:1) selected suitable accounting policies and applied them consistently; (cid:1) made judgements and estimates that are reasonable and prudent; (cid:1) stated whether applicable accounting standards have been followed; and (cid:1) prepared the combined financial information on the going concern basis as they believe that the Group will continue in business. The Directors have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the entity and to prevent and detect fraud and other irregularities. Approved by and signed by order of the Board Authorised Signatory Bedell Cristin Secretaries Limited Secretary 3 June 2005 08 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 09 CORPORATE GOVERNANCE REPORT INTRODUCTION The Group’s Board has considered the guidance published by the Institute of Chartered Accountants in England and Wales concerning the internal control requirements of the Combined Code of Corporate Governance and has established an ongoing process for identifying, evaluating and managing the significant risks faced by the Group. In general terms, the Group’s corporate governance principles aim to secure adherence to prudent business practice, to prevent the executive excesses harmful to enterprise and to align the managers’ interests with those of shareholders. Driving shareholder value is key and an underlying motive of corporate governance. The Group is well aware of the heightened requirements for corporate transparency and the shareholder responsibility advocated by the international business community and regulatory bodies in the UK, Ukraine, Jersey and internationally. Consequently, the Group has evolved its composition along the lines of clearer responsibility for Directors and a more transparent holding structure for shareholders. As the Group grows, these policies and procedures will be developed to reflect the requirements of the Combined Code appropriate to a company of the Group’s size. THE BOARD The Group Board consists of three Non-executive and four Executive Directors. The biographical details of the Directors are shown on pages 6 and 7. The roles of the Chairman of the Board and the Chief Executive of the Group are held separately with a clear division of responsibility between them. The Chairman of the Board is an Independent Non-executive Director. All Non-executive Directors are considered to be independent, under generally available guidelines, and together bring a wide range of skills and international experience to bear on issues under consideration. Within the scope of the corporate governance procedures, the Group Board meets regularly to consider the financial results, budgets, and major items of capital expenditure of all companies of the Group. This body is also responsible for formulating, reviewing and approving the Group’s strategy and the phases of its development. The meetings of the Board of Directors take place in Ukraine or Jersey, or any other suitable jurisdiction as decided upon from time to time by the Board. Teleconference discussions are also a possibility, when Directors are present in either (or both) Jersey or Ukraine. The Board has established two committees: Audit and Remuneration. AUDIT COMMITTEE Chairman, Paul Williams The Audit Committee consists of three Non-executive Directors. All members of the Audit Committee have relevant financial experience and some are qualified chartered accountants. This Committee, inter alia, is responsible for reviewing the annual and interim financial statements, in addition to the systems of internal control and risk management, and also for ensuring the integrity of the financial information reported to shareholders. The Audit Committee is scheduled to meet at least three times per annum. REMUNERATION COMMITTEE Chairman, David Lattimore The Remuneration Committee comprises three Non-executive Directors. This Committee is scheduled to meet at least twice per annum to advise the Board on the Group’s remuneration strategy and to determine the terms of employment and total remuneration of the Executive Directors and senior employees, including the granting of share options. Among others, the objective of this Committee is to attract, retain and motivate Executives capable of delivering the Group’s objectives. The Remuneration Committee is also responsible for the evaluation of the performance of Executive Directors. INVESTOR RELATIONS The Group meets and encourages communication with its institutional and private shareholders, fund managers, financial analysts and brokers. In communicating to the above-mentioned parties the Group uses various means such as the annual report, interim statements, annual general meetings and the Company website (www.ukrproduct.com) as necessary. The Group recognises that the increased transparency is an integral part of being a listed company. As such it has set up procedures to ensure that it discloses price sensitive information to the market in a timely fashion, regularly consults with its nominated adviser and ensures timely publication of its interim and annual financial statements within the deadlines imposed by the AIM Rules and the corresponding requirements of the jurisdictions in which the Group is present or operates. UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 09 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 10 CORPORATE GOVERNANCE REPORT continued FINANCIAL PROCEDURES AND INTERNAL CONTROL The Group adheres to comprehensive and strictly regulated budgeting and reporting procedures that are aimed at more efficient internal control and risk management. The Board is responsible for the Group’s system of internal control and for reviewing its effectiveness, however, it is recognised that any control system can only provide reasonable and not absolute assurance against material misstatement or loss. The main constituents of the internal control system are: (cid:1) documented policies, procedures and authorisation levels; (cid:1) clearly defined lines of responsibility in the organisational structure of the Group; (cid:1) a management structure which facilitates ease of communication both vertically and horizontally; (cid:1) annual budgeting and monthly reporting procedures. The annual budgets are updated each month once actual figures become available. Due to the dynamic development of the macroeconomic environment of the country the Group operates in, variances in actual figures for sales, prices and other underlying assumptions from those forecast may occur. Hence, the budget is flexed to better reflect the future of the Group. Such variances by each company within the Group are discovered and recommendations for further actions are formulated. The internal control system is further enforced by the Group’s internal audit department. The main objectives of the internal audit function are to ensure the safety of the Company’s assets and the reliability of accounting records. The internal audit department is responsible for auditing the financial statements and accounting procedures of the companies within the Group, as well as for disclosing and reducing various types of risks related to Group operations. Each company within the Group has a designated auditor, who systematically performs the audits. 10 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 11 CORPORATE SOCIAL RESPONSIBILITY REPORT The Group is committed to the principles of corporate social responsibility (“CSR”) and believes that these are in the long-term interests of its shareholders. Accordingly, the Board is committed to developing and implementing CSR policies which are aimed at: (cid:1) promoting equality and fairness among employees, partners and suppliers; (cid:1) ensuring safe and healthy working conditions; (cid:1) maintaining corporate reputation and dedication to business ethics; (cid:1) supporting the communities in which the Group operates; and (cid:1) establishing long-term and healthy relationships with the Group’s partners, customers and other affiliated parties. The main elements of the Group’s approach towards fulfiling the objectives outlined above comprise the following: EMPLOYEES The Group is committed to ensuring equal opportunities to all its employees, both current and prospective. Each employee’s efforts are highly valued and the Board believes that a diverse mix of the workforce facilitates innovation, efficiency and teamwork. As a matter of corporate policy, regular training and development workshops are conducted for the staff. These are aimed at all employee groups, including management, technical as well as production personnel. The training programmes encourage the staff to move up the career ladder and are central to the Group’s continuing growth and success. HEALTH AND SAFETY Management at business units within the Group are responsible for developing and maintaining the underlying practices that provide for a healthy and safe working environment. Special attention is given to the production facilities, where the equipment, lighting, air conditioning, work space and other constituents undergo constant review and optimisation. Regular monitoring is carried out to ensure that required standards are met and that employees use the provided communication channels to further develop their surrounding working conditions. CUSTOMERS Customer satisfaction is at the core of the Group’s business model. Accordingly, the Board is keen to continue supplying the customers with high quality, affordable products as required by the current market demand. The Group’s segmentation practices are aimed at segregating various customer groups in order to meet their needs with maximum efficiency. In addition, regular marketing surveys are conducted to ensure consistent maximum value is offered to the customers. ENVIRONMENT AND COMMUNITY Even though the dairy-based food manufacturing industry generally has a low environmental impact, the Group recognises the importance of good environmental practices and seeks to minimise a negative impact that its operations or products may have on the surrounding areas. The Group complies with the environmental laws and regulations in Ukraine and strives to promote the effective resource management, energy conservation and waste efficiency. The Group is also anxious to develop and maintain partnership relationships with the communities it operates in, by means of supporting local initiatives and charitable events. The Group participates in such initiatives by contributing cash donations and gifts, as well as employee time, by encouraging staff to participate as volunteers. UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 11 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 12 REMUNERATION COMMITTEE REPORT This report is prepared by the Remuneration Committee of the Board and sets out the Company’s policy on the remuneration of the Directors, with a description of service agreements and remuneration packages for each Director. THE REMUNERATION COMMITTEE (THE “COMMITTEE”) The Committee comprises three Non-executive Directors and is chaired by David Lattimore. This Committee is scheduled to meet at least twice per annum. The objective of the Committee is to advise the Board on the Group’s overall remuneration policy and to determine the terms of employment and total remuneration of the Executive Directors and certain senior employees, including the granting of share options. The Remuneration Committee is also responsible for the evaluation of the performance of Executive Directors. REMUNERATION POLICY The Company’s remuneration policy is to provide remuneration packages which: (cid:1) are designed to attract, motivate and retain high calibre Executives; (cid:1) are competitive and in line with comparable businesses; (cid:1) are based on practices exercised in countries where the Group operates; (cid:1) intend to align the interests of the Executives with those of the shareholders, by means of providing fixed and performance related remuneration; and (cid:1) set challenging performance targets and motivate Executives to achieve those targets both in the short and long-term. BASE SALARY The Committee reviews base salaries of the Executive Directors each year taking into account job responsibilities, competitive market rates and the performance of the Executive concerned. Consideration is also given to the cost of living and the Director’s experience. While determining the base salaries, the Committee also considers general aspects of the employment terms and conditions of employees elsewhere in the Group. INCENTIVE BONUS PLANS AND EQUITY ARRANGEMENTS Taking into account that the Remuneration Committee was formed late in the year under review, no bonus plans have been set during this period. The Committee plans to consider developing long-term equity incentive arrangements to make the overall Executive Remuneration structure more performance-related, more competitive and aligned with shareholders’ interests. SERVICE CONTRACTS All Executive Directors were appointed on 1 November 2004. These appointments are valid for an indefinite period and may be terminated with three months notice given by either party at any time starting from 11 August 2005. The Company’s provision for compensation for loss of office is to provide compensation which reflects the Company’s contractual obligations. NON-EXECUTIVE DIRECTORS All Non-executive Directors were appointed on 1 November 2004. These appointments are valid for an indefinite period and may be terminated with three months notice given by either party at any time starting from 11 August 2005. The decision to re-appoint, as well as the determination of the fees of the Non-executive Directors, rests with the Board. The Non-executive Directors may accept appointments with other companies, although any such appointment is subject to the Board’s approval and terms and conditions of Service Agreements. DIRECTORS’ REMUNERATION Details of the Directors’ remuneration are outlined below: Executive Sergey Evlanchik Alexander Slipchuk Iryna Yevets Dr Dmitry Dragun Non-executive Dr Jack Rowell Paul Williams David Lattimore Annual salary/fee £ Salary/fees 2004 £ Benefits in kind 2004 £ Total salary and benefits in kind 2004 £ 50,000 45,000 40,000 35,000 30,000 25,000 25,000 8,333 7,500 6,667 5,833 5,000 4,167 4,167 — — — — — 249 249 8,333 7,500 6,667 5,833 5,000 4,416 4,416 12 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 13 INDEPENDENT AUDITORS’ REPORT To the members of Ukrproduct Group Ltd We have audited the accompanying combined special purpose financial information, which has been prepared for the reasons and on the basis set out in note 2. The combined special purpose financial information (“combined financial information” hereafter) on pages 14 to 34 has been prepared by combining, on the basis more fully explained in note 2, the accounts of the companies under common control (hereafter collectively referred to as the “Enlarged Group”), which were the subject of an acquisition on 11 February 2005 following the Company’s listing on the Alternative Investment Market of the London Stock Exchange. As explained in note 2 of the combined financial information, these are not the statutory accounts of the Enlarged Group and have been prepared solely for the purpose of presenting the combined financial information relating to the Enlarged Group. RESPECTIVE RESPONSIBILITIES OF DIRECTORS AND AUDITORS As described on page 8, the Directors of the Company have accepted responsibility for the preparation of this combined financial information in accordance with the basis of preparation set out in note 2 of the combined financial information. Our responsibilities, as independent auditors, are established in the United Kingdom by the Auditing Practices Board, by our profession’s ethical guidance and by the terms of our engagement letter dated 30 March 2005. Under the terms of our engagement we are required to report to you our opinion as to whether the combined financial information has been properly prepared in accordance with the basis of preparation set out in note 2 of the combined financial information. We will also report to you, if in our opinion, we have not received all the information and explanations we require for our audit. Our report has been prepared solely in connection with the combination of the new Enlarged Group. It has been released to the Company on the basis that our report shall not be copied, referred to or disclosed, in whole (save for the Company’s own internal purposes) or in part, without our prior written consent. Our report was designed to meet the agreed requirements of the Company determined by the Company’s needs at the time. Our report should not therefore be regarded as suitable to be used and relied on by any party other than the Company for any purpose or in any context. Any party other than the Company who obtains access to our report and chooses to rely on our report (or any part of it) will do so at their own risk. To the fullest extent permitted by law, BDO Stoy Hayward LLP will accept no responsibility or liability in respect of our report to any other person or organisation. BASIS OF AUDIT OPINION We conducted our audit having regard to Auditing Standards issued by the UK Auditing Practices Board. An audit includes an examination, on a test basis, of evidence relevant to the amounts and disclosures in the combined financial information. It also includes an assessment of the significant estimates and judgements made by the Directors in the preparation of the combined financial information, and whether the accounting policies are appropriate to the Enlarged Group’s circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all of the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the combined financial information are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion, we have also evaluated the overall adequacy of the presentation of the information in the combined financial information. OPINION In our opinion, the combined financial information for the year ended 31 December 2004 have been properly prepared in accordance with the basis of preparation set out in note 2. BDO Stoy Hayward LLP Chartered Accountants London 3 June 2005 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 13 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 14 STATEMENT OF INCOME Revenues Costs of sales Gross profit Other operating income General and administrative expenses Selling and distribution expenses Other expenses Income from waiver of debt Profit before interest and taxation Finance costs – interest payable and similar charges Profit before taxation Income tax expense Profit after taxation Attributable to: Owners Minority interest Basic earnings per share (pence) Diluted earnings per share (pence) The notes on pages 18 to 34 form part of this combined financial information. Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 17,597 (15,222) 2,375 — (690) (399) (180) 250 1,356 (94) 1,262 (146) 1,116 1,111 5 1,116 3.7 3.7 27,115 (22,698) 4,417 63 (1,045) (1,070) (296) — 2,069 (312) 1,757 (301) 1,456 1,436 20 1,456 4.8 4.8 Notes 4 25 5 8 8 8 14 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 15 BALANCE SHEET Non-current assets Property, plant and equipment Intangible assets Investments Deferred tax Total non-current assets Current assets Inventories Loans issued Receivables and prepayments Cash and cash at bank Total current assets Current liabilities Bank loans and overdrafts Trade and other payables Promissory notes Current income tax liabilities Net current assets Total assets less current liabilities Non-current liabilities Long-term loans Bonds Promissory note Deferred income tax liabilities Net assets Capital and reserves attributable to equity holders Invested capital Merger reserve Revaluation reserve Retained earnings Minority interest Total shareholders’ equity The notes on pages 18 to 34 form part of this combined financial information. As at 31 December 2003 £ 000 As at 31 December 2004 £ 000 Notes 9 10 11 7 13 14 15 12 16 17 18 19 19 18 7 20 22 9 22 1,017 5,023 — 89 — 3 83 36 1,106 5,145 1,607 15 2,143 132 3,897 (1,008) (1,938) (3) (119) (3,068) 829 1,935 — (302) (22) — 2,328 212 2,029 300 4,869 (1,077) (1,671) — (253) (3,001) 1,868 7,013 (221) (933) (5) (703) 1,611 5,151 3,000 (1,866) — 409 1,543 68 1,611 3,000 (1,866) 2,020 1,865 5,019 132 5,151 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 15 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 16 CASH FLOW STATEMENT Cash flow from operating activities Net profit before taxation Adjustments for: Depreciation Interest expense Income from waiver of debt Increase in inventories (Increase)/decrease in trade and other receivables (Increase)/decrease in trade and other payables Cash (used by)/generated from operations Interest paid Income tax paid/(refunded) Net cash (used in)/generated by operating activities Cash flows from investing activities Purchase of property, plant and equipment Purchase of investments Proceeds from sale of property, plant and equipment Proceeds from sale of investment Loans (advanced)/repaid Net cash used in investing activities Cash flows from financing activities Net proceeds from long-term borrowing Proceeds from issue of bonds Proceeds from issue of shares/additional capital Distribution of profit Net proceeds from issue of promissory notes Net proceeds from short-term borrowing Net cash generated by/(used in) financing activities Effect of exchange rate changes and restatements on cash and cash equivalents Net increase/(decrease) in cash and cash equivalents Cash and cash equivalents at the beginning of the year Cash and cash equivalents at the end of the period The notes on pages 18 to 34 form part of this combined financial information. Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 Notes 1,262 1,757 62 94 (250) 1,168 (1,039) (1,070) 839 (102) (94) (32) (228) 520 305 — 2,582 (872) (71) (349) 1,290 (305) (66) 919 (733) (1,566) — 31 — 104 1 3 (7) (207) (598) (1,776) — 303 1,075 — (20) 602 996 (86) 84 48 132 232 680 — 147 1,039 (14) 168 132 300 23 23 23 (914) (70) 23 12 16 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 17 STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY Merger reserve £ 000 Revaluation reserve £ 000 Retained earnings £ 000 Shareholders’ equity £ 000 Minority interest £ 000 Balance at 1 January 2003 Issue of shares Purchase of treasury shares Net profit for the year Reduction in minority interest on issue of new shares Issue of share capital in the Company (note 20) Elimination of share capital in subsidiaries Distribution of profit Exchange differences on translation to the presentation currency (note 3c) Share capital £ 000 309 845 (20) — — 3,000 (1,134) — — — — — — — (3,000) 1,134 — — Balance at 1 January 2004 3,000 (1,866) Gain on revaluation of fixed assets Deferred income tax on gain on revaluation Issue of shares — — 15 Issued on acquisition of Operating Group 15,273 — — — — Merger reserve arising on an acquisition of Operating Group Net profit for the period Depreciation on revaluation of fixed assets Elimination of shares issued and merger reserve on acquisition of Operating Group Exchange differences on translation to the presentation currency (note 3c) Balance at 31 December 2004 — — — (15,288) — — (15,288) 15,288 — 3,000 — (1,866) The notes on pages 18 to 34 form part of this combined financial information. — — — — — — — — — — 3,073 (674) — — — — (154) — (225) 2,020 256 — — 1,111 42 — — (913) (87) 409 — — — — — 1,436 158 — (138) 1,865 565 845 (20) 1,111 42 — — (913) (87) 1,543 3,073 (674) 15 15,273 (15,288) 1,436 4 — (363) 5,019 118 — — 5 (42) — — — (13) 68 75 (17) — — — 20 (4) — (11) 132 Total equity £ 000 683 845 (20) 1,116 — — — (913) (100) 1,611 3,148 (690) 15 15,273 (15,288) 1,456 — — (374) 5,151 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 17 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 18 NOTES TO THE FINANCIAL STATEMENTS 1. GROUP AND PRINCIPAL ACTIVITIES For the purposes of this financial information the terms “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 common management and control for a number of years although they did not comprise a statutory group as they had not been linked by a common parent. Following the establishment of a new holding company Ukrproduct Group Ltd (the “Company”) on 18 May 2004, the companies comprising the Operating Group were brought together on 11 February 2005 following the Company’s listing on the Alternative Investment Market of the London Stock Exchange to create a formal group under the 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 produces and exports skimmed milk powder to the markets of Denmark, Russia, Bulgaria, Holland and other countries. The Group is not involved in the retailing of its products. The Operating Group’s production facilities and management are based in Ukraine. The head office is located in Kyiv. The Enlarged Group has its own distribution network in Ukraine. The average number of employees of the Enlarged Group during the 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 combined financial information are set out below: a) Basis of preparation This financial information is based on the audited non statutory special purpose combined financial information of the Enlarged Group which has been prepared by combining the historical financial information for each of the companies that comprise the Enlarged Group from the accounting records of those companies. The financial information has been prepared in accordance with International Financial Reporting Standards (“IFRS”), including International Accounting Standards (“IAS”) and Interpretations issued by the International Accounting Standards Board. The majority of companies making up the Enlarged Group maintain their accounting records in accordance with the Ukrainian regulations. The financial information has been prepared from those accounting records and adjusted as we consider necessary in order to comply with IFRS. Accounting records of the Enlarged Group are maintained in Ukrainian Hryvnas (“UAH” or “Hryvna” hence), the national currency of Ukraine. The Hryvna has also been adopted as the measurement currency for the purpose of the special purpose combined financial information (see note 2(c)). The financial information has been translated into British Pounds Sterling at the rates given in note 2(p). The combined financial information has been prepared under the historical cost convention, as modified by the revaluation of property, plant and equipment at fair value in the year ended 31 December 2004. The preparation of the financial statements in conformity with IFRS requires the use of certain critical accounting estimates. It also requires management to exercise its judgement in the process of applying the Enlarged Group’s accounting policies. Early adoption of standards In 2003, the Enlarged Group adopted early the IFRS below, which are relevant to its operations. The financial information has been amended as required, in accordance with the relevant requirements. IAS Presentation of Financial Statements (revised 2003) 1 IAS IAS 2 8 (revised 2003) Inventories (revised 2003) Accounting Policies, Changes in Accounting Estimates and Errors IAS 10 (revised 2003) Events after the Balance Sheet Date IAS 16 (revised 2003) Property, Plant and Equipment IAS 17 (revised 2003) Leases IAS 21 (revised 2003) The Effects of Changes in Foreign Exchange Rates IAS 24 (revised 2003) Related Party Disclosures IAS 27 (revised 2003) Consolidated and Separate Financial Statements IAS 28 (revised 2003) Investments in Associates IAS 32 (revised 2003) Financial Instruments: Disclosure and Presentation IAS 33 (revised 2003) Earnings per Share IAS 39 (revised 2004) Financial Instruments: Recognition and Measurement IFRS 3 (issued 2004) Business Combinations IAS 36 (revised 2004) Impairment of Assets IAS 38 (revised 2004) Intangible Assets 18 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 19 2. SIGNIFICANT ACCOUNTING POLICIES continued a) Basis of preparation continued Early adoption of standards continued The early adoption of IAS 1, 2, 8, 10, 16, 17, 21, 24, 27, 28, 32 and 33 (all revised 2003) did not result in substantial changes to the Enlarged Group’s accounting policies. In summary: (cid:1) IAS 1 (revised 2003) has affected the presentation of minority interest and other disclosures; (cid:1) IAS 2, 8, 10, 16, 17, 27, 28, 32 and 33 had no material effect on the Enlarged Group’s policies; (cid:1) IAS 21 (revised 2003) had no material effect on the Enlarged Group’s policy. The functional currency of each of the consolidated entities has been re-evaluated based on the guidance to the revised standard. The majority of the Enlarged Group entities have the same functional currency as their measurement currency; and (cid:1) IAS 24 (revised 2003) has affected the identification of related parties and some other related party disclosures. The early adoption of IAS 39 (revised 2004) has resulted in a change to the accounting policy relating to the classification of financial assets at fair value through profit or loss. The Enlarged Group has applied the exemptions afforded by IFRS 1 from the requirement to re-state comparative information for 2001 and 2002 for IAS 39 and IAS 32, and has applied previously applicable generally 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 has been no goodwill arising as subsidiaries accounted for as acquisitions were so acquired on incorporation. In accordance with the provisions of IFRS 3: (cid:1) the Enlarged Group ceased amortisation of goodwill from 1 January 2003; and (cid:1) from the year ended 31 December 2003 onwards, goodwill is tested annually for impairment, as well as when there are indications of impairment. The Enlarged Group has reassessed the useful lives of its intangible assets in accordance with the provisions of IAS 38. No adjustments resulted from this reassessment. All changes in the accounting policies have been made in accordance with the transition provisions in the respective standards. All standards adopted by the Enlarged Group require retrospective application other than: (cid:1) IAS 16 – the exchange of property, plant and equipment is accounted at fair value prospectively; (cid:1) IAS 21 – prospective accounting for goodwill and fair value adjustments as part of foreign operations; (cid:1) IFRS 3 – prospectively after 31 March 2004; (cid:1) IAS 39 requires simultaneous adoption with IAS 32; and (cid:1) 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 out in the table on page 20. As described in note 1 the Enlarged Group is comprised of a number of companies under common management and ultimate ownership but was not linked by a formal ownership structure or a single common parent until 11 February 2005. The Operating Group, which sits within the Enlarged Group, was not linked by a formal ownership structure or a single common parent until 18 May 2004. The special purpose combined financial information has been prepared in order to present the combined results and balances that would have been shown had the Enlarged Group been under the control of a single common parent. Where Group companies are formally owned by another Group company, they have been consolidated to the highest possible level using the acquisition method, in which share capital of the entity is eliminated against the investment recorded in the parent. As such, the Enlarged Group companies have been treated as if they had been owned from the date of their formation and consideration issued for the investment equalled share capital, goodwill does not arise on acquisition other than incidentally. The combination of companies under common ownership but not linked by a formal ownership structure has been based on the pooling of interests (“merger method”). In applying this method, financial statement items for each Group company are combined as if they had been combined from the earliest period, the result being a combination of all Group companies’ assets, liabilities and reserves. All intra-Enlarged Group transactions and balances are eliminated on combination. Business combinations of entities under common control are outside the scope of IFRS 3 and so the early adoption of that standard does not affect this treatment. Following the formal acquisition of the Enlarged Group companies in May 2004, a combined balance sheet has been prepared as at 31 December 2004. The business combination comprising a number of businesses under common control is outside the scope of IFRS 3 and the balance sheet has been prepared using the pooling of interests method. UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 19 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 20 NOTES TO THE FINANCIAL STATEMENTS continued 2. SIGNIFICANT ACCOUNTING POLICIES continued b) Principles of combination and consolidation continued The results and balances of the following organisations have been combined: Country of incorporation Deemed Group holding Method of combination 2004 2003 Operating Group Molochnik OJSC Ukrprodexpo SC Starokonstantinovskiy Molochniy Zavod SC Agrospetsresursy LLC Togoviy Dim Maslayana SC* Togoviy Dim Milko SC* Agrospetsresursy Dnipro SC* Agrospetsresursy Lviv SC* Starkon-Moloko LLC Dairy Trading Corporation Alfa-Broker Ltd Intermilk SC Ukrevroprodukt SC* Agrospetsresursy Zhytomyr SC* Ukrproduct-Kharkov SC* Nash Molochnik Private Enterprise SC* Ukrproduct-Logistics Private Enterprise Ukrproduct CJSC Enlarged Group All entities within the Operating Group above plus: LinkStar Limited Dairy Trading Corporation Ukrproduct Group plc Ukraine Ukraine Ukraine Ukraine Ukraine Ukraine Ukraine Ukraine Ukraine USA UK Ukraine Ukraine Ukraine Ukraine Ukraine Ukraine Ukraine Cyprus BVI UK 95.2% Acquisition method 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Acquisition method Acquisition method Acquisition method Acquisition method Acquisition method Acquisition method Acquisition method Acquisition method Merger method Merger method Acquisition method Acquisition method Acquisition method Acquisition method Acquisition method Acquisition method Merger method Acquisition method Merger method Acquisition method Merger method Merger method Acquisition method Merger method Acquisition method Acquisition method Acquisition method Acquisition method Merger method Merger method Merger method Merger method Merger method n/a n/a n/a n/a n/a n/a Merger method n/a * Subsidiaries of Agrospetsresursy LLC, the Operating Group’s specialised distribution companies. Intermilk SC, Alfa-Broker Ltd and Dairy Trading Corporation (USA) are in the process of solvent liquidation. Between 30 June 2004 and 11 February 2005 Alfa-Broker Ltd transferred its principal business and assets to LinkStar Limited, a company registered in Cyprus. Subsequently, Alfa-Broker Ltd is not to be included as part of the Group going forward. It has therefore been necessary to include the results of Alfa-broker Limited in the combined financial information in order to provide the combined results for the full period under review. LinkStar Limited was acquired by the Company on 11 February 2005 following the Company’s listing on the Alternative Investment Market of the London Stock Exchange. c) Translation from measurement to presentation currency and adoption of SIC 30 Management has considered what would be the most appropriate measurement and presentation currencies for this financial information. As a result of this review management has concluded that: (i) Hryvna is the currency of the primary economic environment in which the Enlarged Group operates. Consequently, Hryvna is the most appropriate measurement currency for the Group; and (ii) the Enlarged Group should use British Pounds Sterling as the presentation currency for its IFRS financial statements. Thus management has decided to use the following basis for the translation of Hryvna figures to British Pounds for presentation purposes: (i) for current year figures all assets and liabilities are translated at the closing rate existing at the balance sheet date. Income and expense items are translated at an average rate for the period. Equity items other than the net profit or loss for the period that is included in the balance of accumulated profit or loss are translated at the closing rate existing at the balance sheet date; (ii) for comparative figures all assets and liabilities are translated at the closing rate existing at the relevant balance sheet date. Income and expense items are translated at an average rate for the period. Equity items other than the net profit or loss for the period that is included in the balance of accumulated profit or loss are translated at the closing rate existing at the previous balance sheet date; and (iii) all exchange differences resulting from the application of the translation methods described above are recognised directly in equity. Actual exchange rates applied in the translation are detailed in note 2(p) on page 22. 20 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 21 2. SIGNIFICANT ACCOUNTING POLICIES continued (d) Segment reporting A business segment is a group of assets and operations engaged in providing products or services that are subject to risks and returns that are different from those of other business segments. A geographical segment is engaged in providing products or services within a particular economic environment that are subject to risks and returns that are different from those of segments operating in other economic environments. (e) Property, plant and equipment Figures calculated using the Ukrainian statutory accounting rules, have been adopted as deemed depreciated historical cost for property, plant and equipment as at 1 January 2004. Subsequent additions have been recorded at cost. With effect from 1 January 2004, the Enlarged Group adopted the revaluation model (as defined in IAS 16: Property, Plant and Equipment) for all classes of assets. This change of accounting policy was made on the grounds that management believe that this policy provides more reliable and relevant financial information because it better reflects the value in use of such assets to the Enlarged Group. In accordance with the provisions of that standard, the revaluation model has not been applied retrospectively. All classes of assets as at 1 January 2004 were revalued as at that date by an independent valuer BGS Asset on a depreciated replacement cost basis. Management believes that the carrying value of all additions since 1 January 2004 is not materially different to fair value. Depreciation is applied to all items of property, plant and equipment with the exception of land. Depreciation is calculated on the reducing balance method using the following annual rates: Buildings Plant and machinery Equipment and motor vehicles 5% 15% 25% Gains and losses on disposals are determined by comparing proceeds with the carrying amount and are included in operating profit. (f) Assets under construction Assets under construction are reported at their cost of construction including costs charged by third parties and the capitalisation of the Enlarged Group’s directly attributable costs. No depreciation is charged on assets during construction. Upon completion, all accumulated costs of the asset are transferred to the relevant fixed asset category and subsequently subjected to the applicable depreciation rates from the time the asset is completed and ready for use. (g) Intangible assets – computer software Acquired computer software licenses are capitalised on the basis of the costs incurred to acquire and bring to use the specialised software. These costs are amortised over their estimated useful lives (three years). (h) Investments The Enlarged Group has investments in the equity of Ukrainian companies including investments representing more than 50% of the share capital of the investee company. Other than as referred to under (b) on page 20, where such companies are not expected to become subsidiaries of the proposed holding company, they have been excluded from the combination and are treated as investments. Investments are carried at cost, which management believe is not significantly different from fair value. (i) Inventories Inventories are stated at the lower of cost and net realisable value. Cost is determined using the first-in, first-out method. The cost of finished goods and work in progress comprises raw materials, direct labour, other direct costs and related production overheads (based on normal operating capacity) but excludes borrowing costs. (j) Trade receivables Trade receivables are carried at the original invoice amount less provision made for impairment of these receivables. A provision for impairment of trade receivables is established when there is objective evidence that the Enlarged Group will not be able to collect all amounts due according to the original terms of receivables. (k) Cash and cash equivalents Cash and cash equivalents are carried in the balance sheet at cost. Cash and cash equivalents comprise cash in hand, deposits held at call with banks and other short-term highly liquid investments with original maturities of three months or less. Bank overdrafts are included within borrowings in current liabilities on the balance sheet. (l) Provisions Provisions for environment restoration, restructuring costs and legal claims are recognised when: the Enlarged Group has a present legal or constructive obligation as a result of past events; it is more likely than not that an outflow of resources will be required to settle the obligation; and the amounts have been reliably estimated. Restructuring provisions are not recognised for the future operating losses. Where there are a number of similar obligations, the likelihood that an outflow will be required in settlement is determined by considering the class of obligations as a whole. A provision is recognised even if the likelihood of an outflow with respect to any one item included in the same class of obligation may be small. UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 21 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 22 NOTES TO THE FINANCIAL STATEMENTS continued 2. SIGNIFICANT ACCOUNTING POLICIES continued (m) Revenue recognition Revenue recognition for the fair value for the sale of goods and services, net of value added tax, rebates and discounts and after eliminated intra-group sales with the Enlarged Group, is as follows: (i) Sales of goods – own production. Sales of goods are recognised when an Enlarged Group entity has delivered products to the customer, the customer has accepted the products and collectability of the related receivables is reasonably assured. (ii) Sales of goods – third parties. Sales of goods are recognised when an Enlarged Group entity has delivered products to the customer, the customer has accepted the products, and collectability of the related receivables is reasonably assured. (iii) Sales of services. Sales of services are recognised in the accounting period in which the services are rendered, by reference to completion of the specific transaction assessed on the basis of the actual service provided as a proportion of the total services to be provided. (iv) Interest income. Interest income is recognised on a time-proportion basis using the effective interest method. When a receivable is impaired, the Enlarged Group reduces the carrying amount to its recoverable amount, being the estimated future cash flow discounted at the original effective interest-rate of the instrument, and continues unwinding the discount as interest income. Interest income on impaired loans is recognised either as cash collected or on a cost-recovery basis as conditions warrant. (n) Leases Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases (net of any incentives received from the lessor) are charged to the 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 with relevant legislation currently in force. The charge for taxation in the statement of income for the year comprises current tax and changes in deferred tax. 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 on income, are recorded within operating expenses. Deferred income tax is provided, using the balance sheet liability method, for all temporary differences arising between the tax basis of assets and liabilities and their carrying values for financial reporting purposes except for those differences permanently disallowed. A deferred tax asset is recorded only to the extent that it is probable that taxable profit will be available against which the deductible temporary differences can be utilised. Deferred tax assets and liabilities are measured at tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates that have been enacted or substantively enacted at the balance sheet date. (p) Foreign currency translation Transactions denominated in currencies other than Hryvna (“foreign currencies”) are recorded in Hryvna at the exchange rate ruling on the transaction date. Exchange differences resulting from the settlement of transactions denominated in foreign currency are included in the statement of income using the exchange rate ruling on that date. Monetary assets and liabilities denominated in foreign currency are translated into Hryvna at the official exchange rate at the balance sheet date. Foreign currency gains and losses arising from the translation of assets and liabilities are reflected in the statement of income as foreign exchange translation gains less losses. Income and expense figures have been converted to British Pounds for presentation purposes at an average rate of £1 = UAH 9.74 for the year ended 31 December 2004 and £1 = UAH 8.76 for the year ended 31 December 2003. Assets, liabilities and equity items have been converted to pounds for presentation purposes at a closing rate of £1 = UAH 10.18 for the year ended 31 December 2004 and £1 = UAH 9.47 for the year ended 31 December 2003. Exchange differences resulting from conversion to presentational currency are included in retained earnings. (q) Pension costs The Enlarged Group contributed to the Ukrainian state pension scheme, social insurance and employment funds in respect of its employees. The Enlarged Group’s pension scheme contributions are expensed as incurred. The contributions are included in staff costs. The Enlarged Group has no other liabilities in respect of 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, trade and other creditors and short and long-term borrowings) approximate to their fair values at the date of the transaction. Where the fair value of a financial asset is materially below the carrying amount, the carrying amount is written down to fair value. (s) Borrowing costs Borrowing costs are recognised as an expense in the period in which they are incurred. (t) Reclassification of 2003 comparative information An amount of £1,866,000 has been reclassified between share capital and merger reserve in the comparative figures. This ensures that the basis of preparation is consistent with the 2004 combined financial information, with Ukrproduct Group Ltd being the holding company of the Enlarged Group as opposed to the summation of the share capital of the Group’s subsidiaries which was originally reported upon. The net assets and shareholders’ funds of the Enlarged Group are not affected by this reclassification. 22 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 23 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 overall risk management programme focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the Enlarged Group’s financial performance. Risk management is carried out by the Enlarged Group Treasurer under policies approved by the Board of Directors. The Enlarged Group Treasurer identifies and evaluates financial risks in close co-operation with the Enlarged Group’s operating units. The management Board provides broad guidance and operating principles for overall risk management, as well as written policies covering specific areas, such as foreign exchange risk, interest-rate risk, credit risk, use of derivative financial instruments and non-derivative financial instruments, and investing excess liquidity. Foreign exchange risk Although the Enlarged Group is an international operator, management believes that the foreign exchange risk is minimal at present and is likely to remain so in the future. The Enlarged Group’s international operations consist primarily of 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 2004 the principal rate of exchange used for translating foreign currency balances was US$1 = UAH 5.31. As at 31 December 2003 the principal rate of exchange used for translating foreign currency balances was US$1 = UAH 5.48. The Enlarged Group’s established corporate policy towards hedging the potential foreign exchange risk is to require customers to pay for the export shipments of the skimmed milk powder in full and in advance (from one to two months). The Group’s export operations have never employed any other payment methods as a matter of corporate principle, and this is expected to continue in the future. Similarly, the Enlarged Group has never been engaged in forward transactions and does not expect to conduct these transactions in the future. The Directors believe that these policies effectively eliminate the foreign exchange risk. The Enlarged Group’s export-related obligations in Ukraine, such as payments for raw milk and packaging materials, are all entirely Hryvna-denominated. The UAH/US Dollar exchange rate has been reasonably stable in recent years, and the Directors have no reason to believe that this is likely to 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 and the activities of large international trading companies in this market. There is always a risk that the prevailing world marketing price may be insufficient to cover the production costs for skimmed milk powder. Against such a risk, the Group recognises that there is no effective financial hedge, thus the major instrument employed in the management of the price risk is the tight control of the operating costs. Credit risk The Enlarged Group has no significant concentrations of credit risk. It has policies in place to ensure that wholesale sales of products both in Ukraine and abroad are made to customers with an appropriate credit history. Liquidity risk Prudent liquidity risk management implies maintaining sufficient cash and the availability of funding through an adequate amount of committed credit facilities. Due to the dynamic nature of the underlying businesses, the Enlarged Group’s Treasurer aims to maintain flexibility in funding by keeping committed credit lines available. Cash flow and fair value interest-rate risk As the Enlarged Group has no significant interest-bearing assets, the Enlarged Group’s income and operating cash flows are substantially independent of changes in market interest-rates. The Enlarged Group’s interest-rate risk arises from medium to long-term borrowings. Potentially, borrowings issued at variable rates expose the Enlarged Group to cash flow interest-rate risk. Borrowings issued at fixed rates expose the Enlarged Group to fair value interest-rate risk. Enlarged Group policy is to maintain at least 80% of its borrowings in fixed rate instruments. At 31 December 2004, almost all of borrowings were at fixed rates. UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 23 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 24 NOTES TO THE FINANCIAL STATEMENTS continued 4. SEGMENTAL ANALYSIS The shareholders of the Enlarged Group put a particular emphasis on enhancing the vertical integration of the Enlarged Group. This emphasis necessitated separation of the product lines into distinguishable and analysable segments, in order to be able to identify the individual profitability of each segment. Therefore, from 2003, the Enlarged Group has gradually transformed its management reporting and control systems to reflect the segmental information to the extent required by its operating activities and the requirements of IFRS. Ukrainian Accounting Standards do not require the production of the segmental information to the same level as that required by IFRS. Sales to external customers Butter Cheese Skimmed milk powder Total dairy Services Other Profit before depreciation, interest and taxation Butter Cheese Skimmed milk powder Total dairy Services Other Unallocated corporate expenses Unallocated income from waiver of debt Depreciation Butter Cheese Skimmed milk Total dairy Services Other Profit before interest and taxation Butter Cheese Skimmed milk Total dairy Services Other Unallocated corporate expenses Unallocated income from waiver of debt Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 7,743 5,807 3,167 16,717 64 816 17,597 501 933 466 1,900 — (7) 1,893 (725) 250 1,418 22 31 9 62 — — 62 479 902 457 1,838 — (7) 1,831 (725) 250 1,356 9,512 10,064 5,453 25,029 188 1,898 27,115 840 2,187 565 3,592 16 27 3,635 (1,042) — 2,594 159 286 46 491 4 25 520 683 1,904 519 3,106 11 2 3,119 (1,049) — 2,070 24 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 25 4. SEGMENTAL ANALYSIS continued Other information – Segment Assets Butter Cheese Skimmed milk powder Total dairy Services Other Unallocated corporate assets Unallocated deferred tax Consolidated total assets Other information – Segment Liabilities Butter Cheese Skimmed milk powder Total dairy Services Other Unallocated corporate liabilities Unallocated deferred tax Consolidated total liabilities Capital expenditure Butter Cheese Skimmed milk Total dairy Services Other Unallocated capital expenditure UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 1,225 1,996 170 3,391 — 401 3,792 1,211 — 5,003 931 571 452 1,954 — 51 2,005 1,387 — 3,392 184 520 60 764 — 3 767 — 767 2,529 4,603 989 8,121 50 1,145 9,316 662 36 10,014 380 1,423 243 2,046 22 177 2,245 1,915 703 4,863 301 1,198 82 1,581 2 36 1,619 19 1,638 25 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 26 NOTES TO THE FINANCIAL STATEMENTS continued 4. SEGMENTAL ANALYSIS continued Sales by market Ukraine Denmark Russia Bulgaria Holland Japan Other countries The majority of the Enlarged Group’s recognised assets and liabilities are in Ukraine. 5. EXPENSES BY NATURE Depreciation Changes in inventories of finished goods and work in progress Raw materials and consumables used Employee benefit costs Other expenses Total cost of goods sold, marketing and distribution costs and administrative expenses 6. EMPLOYEE BENEFIT EXPENSE Wages and salaries Social security costs Remuneration of key personnel Directors – Salaries Other key personnel – Salaries Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 14,565 938 412 245 684 91 662 17,597 22,669 1,921 680 228 205 — 1,412 27,115 Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 62 1,039 13,750 585 1,055 16,491 523 (873) 21,298 1,373 2,788 25,109 Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 435 150 585 995 378 1,373 Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 15 27 20 44 The Directors are those persons remunerated by the Enlarged Group who are to become Directors of Ukrproduct Group Ltd. Other than salaries, no benefits in kind were paid to the Directors or key management personnel. 26 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 27 7. TAXATION Income tax comprised the following: Current tax charge – Ukraine Current tax charge – non-Ukraine Deferred tax relating to the origination and reversal of temporary differences Income tax charge for the year Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 104 42 — 146 250 76 (25) 301 Differences between IFRS and Ukrainian statutory taxation regulations give rise to certain temporary differences between the carrying value of certain assets and liabilities for financial reporting purposes and for profit tax purposes. The tax effect of the movement on these temporary differences is recorded at the rate of 25% (2003: 25%). Reconciliation of tax charge Profit before tax – Ukraine Profit before tax – non-Ukraine Tax calculated at domestic tax rates applicable to profits in the relevant countries Net income not subject to tax and expenses not deductible for tax purposes Tax charge Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 384 878 1,262 325 (179) 146 520 1,237 1,757 430 (129) 301 The weighted average applicable tax rate was 24.5% (2003: 25.7%). The charge is due to the changes in profitability of the companies comprising the Enlarged Group in the respective countries. Deferred tax liability at beginning of the period Deferred tax recognised in statement of income during the year Deferred income tax arising on the revaluation of property, plant and equipment Exchange differences on translation to the presentation currency Deferred tax asset at end of the period Deferred tax liability at end of the period Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 — — — — — — — (25) 690 2 36 703 Ukraine currently has a system of taxation broadly similar in scope to those of the developed market economies. There are a number of laws related to various taxes imposed by both central and regional governmental authorities. Although laws related to these taxes have not been in force for significant periods, the practice of taxation and implementation of regulations are well established, documented with a sufficient degree of clarity and adhered to by the taxpayers. Nevertheless, there remain certain risks in relation to the Ukrainian tax system: few court precedents with regard to tax related issues exist; different opinions regarding legal interpretation may arise both among and within government ministries and regulatory agencies; and tax compliance practice is subject to review and investigation by a number of authorities with overlapping responsibilities. Generally, tax declarations remain subject to inspection for an indefinite period. In practice, however, the risk of retroactive tax assessments and penalty charges decreases significantly after three years. The fact that a year has been reviewed does not preclude the Ukrainian tax service performing a subsequent inspection of that year. The Enlarged Group’s management believes that it has adequately provided for tax liabilities in the accompanying financial information; however, the risk remains those relevant authorities could take different positions with regard to interpretive issues. UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 27 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 28 NOTES TO THE FINANCIAL STATEMENTS continued 8. EARNINGS PER SHARE Basic earnings per share Basic earnings per share has been calculated by dividing net profit attributable to the ordinary shareholders (profit for the year) by the weighted average number of shares that would have been in issue if the Enlarged Group had been a legally defined Group at 31 December and had applied the merger method (note 2(b)). Net profit attributable to ordinary shareholders, £ 000 Weighted number of ordinary shares in issue Basic earnings per share, pence Year ended 31 December 2003 Year ended 31 December 2004 1,111 1,436 30,000,000 30,000,000 3.7 4.8 Diluted earnings per share There are no potentially dilutive shares in existence at the year end, hence diluted earnings per share has been calculated by dividing the net profit attributable to ordinary shareholders (profit for the year) by the weighted average number of shares that would have been in issue if the Enlarged Group had been a legally defined Group at 31 December and had applied the merger method (note 2(b)). 9. PROPERTY, PLANT AND EQUIPMENT Cost or valuation Opening balance Revaluation Additions/transfers from assets under construction Disposals Exchange differences on translation to the presentation currency Closing balance Accumulated depreciation Opening balance Revaluation Depreciation charge for the year Disposals Exchange differences on translation to the presentation currency Closing balance Net book amount at 31 December 2004 Prior year amounts Depreciated cost at 1 January 2003 Additions in 2003 Disposal in 2003 Depreciation in 2003 Currency exchange differences Depreciated cost at 31 December 2003 Assets under construction Land and buildings Plant and machinery Vehicles and equipment 40 289 3,110 (2,393) (54) 992 — — — — — — 992 52 (7) (5) 40 412 4,130 155 (450) (306) 3,941 136 1,471 132 (115) (177) 1,447 2,494 260 73 (14) (19) (23) 277 439 573 488 (45) (90) 347 187 881 (427) 150 1,365 1,138 50 474 90 (23) (39) 552 813 42 355 (1) (11) 4 389 36 146 298 (41) (25) 414 724 28 311 (16) (32) 20 311 Total 1,238 5,179 4,634 (3,315) (300) 7,436 222 2,091 520 (179) (241) 2,413 5,023 382 732 (31) (62) (4) 1,017 Fixed assets with a net book value of £2,339,288 as at 31 December 2004 (£44,000 at 31 December 2003) were pledged as collateral for loans. The Enlarged Group obtained an estimated market value of all assets as at 1 January 2004 from an independent professional valuer BGS Asset on a depreciated replacement cost basis. The market valuation of the fixed assets of the Group was £4.2 million and the revaluation surplus net of applicable deferred income tax was credited to other reserves in shareholders’ equity. 28 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 29 10. INTANGIBLE ASSETS Cost or valuation At 1 January 2004 Additions At 31 December 2004 Accumulated amortisation At 1 January 2004 Amortisation charge for the year At 31 December 2004 Net book amount at 31 December 2004 11. INVESTMENTS Details of investments, including the percentage of the share capital owned by the Enlarged Group, are as follows: Vash Molochnik (100%) Balakonenko (50%) Other listed and non-listed investments (less than 5% holding) Computer software £ 000 — 7 7 — 4 4 3 Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 — — 89 89 — — 83 83 Vash Molochnik SC was a subsidiary of Agrospetresursy LLC. Vash Molochnik SC has been inactive since November 2002 and has not been combined in this financial information as this company is in the process of solvent liquidation. Details of transactions and balances between the Group and this company are set out in note 24. Balakonenko LLC has not been combined in these accounts on the grounds of materiality. Due to the lack of a developed market all investments have been valued at cost. The Enlarged Group’s management believes that the carrying value of investments is not significantly different from fair value. 12. CASH AND CASH EQUIVALENTS Cash – in UAH Bank – in UAH Bank – in foreign currency 13. INVENTORIES Raw materials Finished goods Other inventories Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 20 92 20 132 2 209 89 300 Year ended 31 December 2003 £’000 Year ended 31 December 2004 £ 000 497 900 210 1,607 817 1,441 70 2,328 The cost of inventories, which is recognised as an expense and included in ‘cost of sales’, amounted to £20,425,000. UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 29 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 30 NOTES TO THE FINANCIAL STATEMENTS continued 14. LOANS ISSUED Related parties Other Loans issued are denominated in US Dollars and Hryvna, short-term in nature, unsecured and interest free. 15. RECEIVABLES AND PREPAYMENTS Trade debtors Other debtors Prepayments VAT receivable Prepaid profit tax Other prepaid taxes Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 15 — 15 201 11 212 Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 1,283 1,505 144 485 210 1 20 297 221 5 1 — 2,143 2,029 There is no concentration of credit risk with respect to trade receivables as the Enlarged Group has a large number of customers, primarily in Ukraine. The carrying value of receivables and prepayments approximates to fair value. 16. BANK LOANS AND OVERDRAFTS Bank loans and overdrafts comprise a series of unsecured loans and overdrafts received from Ukrainian banks and denominated in Hryvna and Euro. The weighted average interest-rate for the loans outstanding at 31 December 2004 was 18.0% (31 December 2003: 19.25%). The carrying value of bank loans and overdrafts approximates to fair value. 17. TRADE AND OTHER PAYABLES Trade creditors Other creditors Deferred income Accruals VAT and other taxation payable The carrying value of bank loans and overdrafts approximates to fair value. All balances are repayable on demand. 18. PROMISSORY NOTES Promissory notes are denominated in Hryvna and are interest free (see note 24 for related party disclosure). Payable within 1 year Payable in 1–2 years Payable in 2–5 years Payable in over 5 years The carrying value of promissory notes approximates to fair value. Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 168 178 — 44 36 1,427 46 82 105 11 1,938 1,671 Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 3 22 — — 25 — 5 — — 5 30 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 31 19. LONG-TERM LOANS AND BONDS Long-term loans are repayable in 2006 and, these balances with a face value of UAH 2,163,000, are interest free. The fair values of the interest free loans are based on cash flows discounted using a rate based on a borrowing rate of 18%. The carrying value of the remainder approximates to fair value. In 2003 the Operating Group company Agrospetsresursy LLC issued bonds denominated in Hryvna with a face value of UAH 2,863,000. During the year ended 31 December 2004, this company issued further bonds with a face value of UAH 7,137,000. The bonds bear interest at 18% and mature on 8 November 2006. The carrying amounts approximate fair value. 20. SHARE CAPITAL At 31 December 2004 the Company issued 30,000,000 shares of £0.10 per share at a par value conditional upon admission of the Company to the Alternative Investment Market of the London Stock Exchange. Issued share capital 21. MINORITY INTEREST Opening balance Share of profit/(loss) Gain on revaluation Deferred income tax on gain on revaluation Reduction in minority interest on issue of new shares Depreciation on revaluation of fixed assets Exchange difference on translation to presentation currency Closing balance Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 3,000 3,000 Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 118 5 — — (42) — (13) 68 68 20 75 (17) — (4) (11) 132 As at 31 December 2004 a minority interest of 4.8% (2003: 4.8%) was held in Molochnik OJSC. 22. MERGER RESERVE The merger reserve arises on the application of the pooling of interests method of consolidation used to account for the combination of Ukrproduct and its subsidiaries. 23. CASH FLOWS FROM FINANCING ACTIVITIES Long-term loans Gross amount of new loans received Repayment of loans Net cash flows from long-term borrowings Bonds Gross amount of new bonds issued Repayment of bonds Net cash flows from bonds Promissory notes Gross amount of new promissory notes issued Repayment of promissory notes Net cash flows from issue of promissory notes UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 — — — 303 — 303 156 (86) (70) 295 (64) 232 783 (103) 680 120 (140) (20) 31 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 32 NOTES TO THE FINANCIAL STATEMENTS continued 23. CASH FLOWS FROM FINANCING ACTIVITIES continued Short-term borrowings Gross amount of new short-term borrowings Repayment of short-term borrowings Net cash flows from short-term borrowings Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 315 (917) 602 2,858 2,711 147 24. RELATED PARTY TRANSACTIONS For the purposes of this financial information, parties are considered to be related if one party has the ability to control the other party or exercise significant influence over the other party in making financial or operational decisions as defined by IAS 24 “Related Party Disclosures”. In considering each possible related party relationship, attention is directed to the substance of the relationship, not merely the legal form. At 31 December 2004 related parties of the Group included the following: Vash Molochnik SC Teilhard Securities Inc Ukrmolexpo East European Venture Capital Inc International Fund for Reconstruction and Development Inc Advanced Dairy Technology Ltd Densim Group Management SA Global Dairy Corporation Dairy Investment Group Inc Burinsky Zavod of Dry Milk Burinsky Zavod Sukhogo Obezhirennogo Moloka Buhnmolprom Krasilevsky Moloko Zavod Krolevetsky Maslozavod Starokonstantinovsky Zavod of Dry Milk Starokonstantinovsky Zavod Sukhogo Obezhirennogo Moloka Terebovlya Zavod of Dry Non-fat Milk Terebovlya Zavod of Dry Milk Nature of relationship An uncombined 100% subsidiary Common control Common control Common control Shareholder of Group company Shareholder of Group company Shareholder of Group company Shareholder of Group company Shareholder of Group company Shareholder of Group company Common control Common control Common control Common control Common control Common control Common control Common control Transactions and balances between the Enlarged Group and related parties are set out below. Sales to related parties were as follows. Sales were primarily of finished goods and were made at or near nil mark-up. Sales Krasilevsky Moloko Zavod Krolevetsky Maslozavod Terebovlya Zavod of Dry Non-fat Milk Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 950 137 12 1,099 214 64 — 278 32 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 33 24. RELATED PARTY TRANSACTIONS continued Purchases from related parties are summarised below. Purchases International Fund for Reconstruction and Development Inc Krasilevsky Moloko Zavod Krolevetsky Maslozavod Starokonstantinovsky Zavod Sukhogo Obezhirennogo Moloka Terebovlya Zavod of Dry Non-fat Milk Terebovlya Zavod of Dry Milk Burinsky Zavod Sukhogo Obezhirennogo Moloka Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 — 857 101 26 21 — 26 1,031 116 330 44 — — 2 — 492 During the year ended 31 December 2003 Ukrmolexpo SC, a related party waived loan balances owed by Molochnik OJSC and Agrospetresursy LLC amounting to £250,000. This amount has been treated as income. Debt forgiven Ukrmolexpo Balances due from/(to) related parties at each period end are shown below. Outstanding balances at the year end Teilhard Securities Inc Ukrmolexpo International Fund for Reconstruction and Development Inc Krasilevsky Moloko Zavod Krolevetsky Maslozavod Starokonstantinovsky Zavod Sukhogo Obezhirennogo Moloka Terebovlya Zavod of Dry Non-fat Milk Terebovlya Zavod of Dry Milk Burinmolprom Net amounts due from related parties Loans issued outstanding at the year end (note 14) Teilhard Securities Inc Promissory notes outstanding at the year end (note 18) Ukrmolexpo On 18 May 2004, CJSC Ukrproduct Group acquired the Operating Group for a consideration of £15.3 million satisfied by the issue of new shares. The acquisitions were all made from related parties by virtue of common control, namely Global Dairy Corporation, Densim Group Management, Advanced Dairy Technology Ltd, International Fund for Reconstruction and Development, East Europe Venture Capital Inc., Alfa-Broker Ltd and Dairy Investment Group Inc. UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 250 — Year ended 31 December 2003 £ 000 Year ended 31 December 2004 £ 000 — (149) — 206 (5) 32 (15) — (1) 68 15 (25) (3) (7) (111) 182 (4) 23 7 (4) (1) 82 201 (5) 33 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 34 NOTES TO THE FINANCIAL STATEMENTS continued 25. CURRENCY ANALYSIS Assets Non-current assets Property, plant and equipment Intangible assets Investments Deferred tax Current assets Cash and cash at bank Inventories Loans issued Receivables and prepayments Total assets Liabilities Current liabilities Bank loans and overdrafts Trade and other payables Promissory notes Current income tax liabilities Non-current liabilities Long-term loans Bonds Promissory notes Deferred tax Total liabilities UAH £ 000 US$ £ 000 Other currencies £ 000 5,012 3 83 36 211 2,328 11 1,892 9,576 845 1,430 — 150 221 933 5 703 11 — — — 62 — 201 137 411 — 54 — 96 — — — — 4,287 150 — — — — 27 — — — 27 232 187 — 7 — — — — 426 Total £ 000 5,023 3 83 36 300 2,328 212 2,029 10,014 1,077 1,671 — 253 221 933 5 703 4,863 This note was prepared for the period ended 31 December 2004. 26. BRANDS The Group owns the brand “Nash Molochnik”, which translates into English as “Our Dairyman” “Narodny product” (“People’s Product”) and “Vershcova Doliyna” (“Creamy Valley”). These brands have been generated internally by the Enlarged Group and as such IFRS does not permit them to be recognised as an intangible asset. Therefore the brands have not been capitalised in this financial information. 27. EVENTS AFTER THE BALANCE SHEET DATE On 11 February 2005 the Company was successfully admitted to the Alternative Investment Market of the London Stock Exchange. On this date, the Company issued 11,214,953 ordinary shares for cash consideration of £6 million before share issue costs and completed the legal acquisition of 100% of the share capital of CJSC Ukrproduct Group (Ukraine), Dairy Trading Corporation (BVI) and LinkStar Limited (Cyprus). On the same date, the Company issued 912,028 share options to Directors and 1,302,896 share warrants to the Company’s brokers at an exercise price of 53.5 pence each. 34 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 35 NOTICE OF ANNUAL GENERAL MEETING Notice is hereby given that the annual general meeting (“AGM”) of Ukrproduct Group Ltd will be held on Wednesday 29 June 2005 at 10.00am at the offices of CJSC Ukrproduct Group, 16th Floor, 39–41 Shota Rustaveli Street, 01033 Kyiv, Ukraine for the purposes of considering and, if thought fit, passing the following ordinary resolutions. 1. To receive and approve the Directors’ Report and Financial Statements for the period ended 31 December 2004. 2. To elect Dr Jack Rowell as a Director of the Board in accordance with Articles 16 and 17 of the Company’s Articles of Association. 3. To elect Sergey Evlanchik as a Director of the Board in accordance with Articles 16 and 17 of the Company’s Articles of Association. 4. To elect Iryna Yevets as a Director of the Board in accordance with Articles 16 and 17 of the Company’s Articles of Association. 5. To elect Dr Dmitry Dragun as a Director of the Board in accordance with Articles 16 and 17 of the Company’s Articles of Association. 6. To elect Alexander Slipchuk as a Director of the Board in accordance with Articles 16 and 17 of the Company’s Articles of Association. 7. To elect David Lattimore as a Director of the Board in accordance with Articles 16 and 17 of the Company’s Articles of Association. 8. To appoint BDO Stoy Hayward and IGK Ukraine to serve, either jointly or severally at the discretion of the Directors, as auditors of the Company for the financial year 2005 and to authorise the Board to determine their remuneration. 9. To receive and approve the Remuneration Committee Report. Approved by and signed by order of the Board Authorised Signatory Bedell Cristin Secretaries Limited Secretary 26 New Street St. Helier Jersey JE2 3RA Channel Islands 3 June 2005 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 35 _0_UKR_arb_04.qxd 31/05/2005 10:59 Page 36 NOTICE OF ANNUAL GENERAL MEETING NOTES 1. Any member entitled to attend and vote at the AGM is entitled to appoint one or more proxies (who need not be a member of the Company) to attend and, on a poll, vote instead of the member. Completion and return of a form of proxy will not preclude a member from attending and voting at the meeting in person, should he subsequently decide to do so. 2. In order to be valid, any form of proxy, power of attorney or other authority under which it is signed, or a notarially certified or office copy of such power or authority, must reach the Company’s Registrars, Capita Registrars, Proxy Department, The Registry, 34 Beckenham Road, Beckenham, Kent BR3 4TU, not less than 48 hours before the time of the meeting or of any adjournment of the meeting. 3. As permitted by Regulation 41 of the Uncertificated Securities Regulations 2001, shareholders must be entered on the Company’s share register at 6.00 pm on Monday 27 June 2005 in order to be entitled to attend and vote at the AGM. Such shareholders may only cast votes in respect of shares held at such time. Changes to entries on the relevant register after that time shall be disregarded in determining the rights of any person to attend or vote at the meeting. 4. Copies of the service contracts of each of the Directors, and the register of Directors’ interests in shares of the Company kept pursuant to section 325 of the Act will be available for inspection at the registered office of the Company during usual business hours on any weekday (Saturdays and public holidays excluded) from the date of this notice until the date of the AGM and at the place of the AGM from at least 15 minutes prior to and until the conclusion of the AGM. 36 UKRPRODUCT GROUP LTD Annual Report and Financial Statements 2004 _cover.qxd 31/05/2005 10:55 Page 2 Ukrproduct Group Ltd Dairy Trading Corp export subsidiary CJSC Ukrproduct Group main operating subsidiary LinkStar Limited trademarks holding subsidiary With a land surface of 604,000 square kilometres, Ukraine is Europe’s second largest country. It is also the fastest growing European economy, with a GDP growth rate of 12% in 2004 (2003: 10%). In November–December 2004, Ukraine witnessed the “Orange revolution”, a now famous, peaceful climax of the popular movement which replaced the outdated political regime with a vibrant democracy taking dynamic strides westwards. In 2004 Ukraine’s population of 47 million people consumed an estimated 36,000 tonnes of processed cheese and 41,000 tonnes of packaged butter of which 12,300 tonnes (~33%) of processed cheese and 9,200 tonnes (~23%) of packaged butter were supplied by Ukrproduct Group. 01 Corporate Statement and Highlights 02 Chairman’s Statement 03 Chief Executive’s Statement 05 Financial Review 06 Board of Directors and Corporate Advisers 08 Directors’ Report 09 Corporate Governance Report 11 Corporate Social Responsibility Report 12 Remuneration Committee Report 13 Independent Auditors’ Report 14 Statement of Income 15 Balance Sheet 16 Cash Flow Statement 17 Statement of Changes in Shareholders’ Equity 18 Notes to the Financial Statements 35 Notice of Annual General Meeting designed & produced by T H E D E S I G N P O R T F O L I O a member of the flathill communications group plc www.flathillplc.com _cover.qxd 31/05/2005 10:55 Page 1 U K R P R O D U C T G R O U P L T D A n n u a l r e p o r t a n d f i n a n c i a l s t a t e m e n t s 2 0 0 4 U K R P R O D U C T G R O U P L T D 2 6 N e w S t r e e t S t H e l i e r J e r s e y J E 2 3 R A C h a n n e l I s l a n d s w w w . u k r p r o d u c t . c o m U K R P R O D U C T G R O U P L T D A n n u a l r e p o r t a n d f i n a n c i a l s t a t e m e n t s 2 0 0 4