Financial results for the Second quarter and Six Months Ended 30 June 2011

September 14, 2011

Cherkizovo Group (LSE: CHE), one of Russia’s leading integrated and diversified meat producers, today announces second quarter and first half unaudited financial results for the period ended 30 June 2011.

Highlights

Business Developments

Sergey Mikhailov, Chief Executive Officer of Cherkizovo Group, said:

«Despite the challenging operating environment at the beginning of this year, we have delivered a strong set of results across all segments in the first half of 2011, significantly improving our performance in the second quarter driven by an improving pricing environment, rising demand and continued cost efficiencies. Accordingly, we showed Group revenues of $689.1 million, adjusted EBITDA of $105.7 million and a robust adjusted EBITDA margin of 15%. Moreover, we have confirmed our status as the most active player on the Russian meat market through the acquisition of Mosselprom, one of Russia’s best known poultry producers. Furthermore, we have started construction of the country’s largest poultry production complex in the Lipetsk region.

We are now in the process of integrating Mosselprom within the Group’s production structure. Achieving synergies will help us to increase operational efficiency in our poultry segment, where we continue to deliver against our large scale capacity increase projects. Already this year we opened two large poultry production facilities in our Bryansk and Penza clusters and an incubation site in Bryansk, while we plan to launch a processing facility and another incubation facility in Penza which will be amongst the largest not just in Russia, but across Europe.

Our production results in the pork segment were affected by the extreme weather conditions that we witnessed last summer, however now we see this segment begin to stabilise. We have also begun integrating our new asset „Orelselprom“, which was acquired through the Mosselprom transaction.

In the meat processing segment we see a steady increase in demand for our meat products and we continue to work on increasing the efficiency and improving the resource base of this segment. In May we announced the launch of the meat processing plant in Kaliningrad that we bought last year.

We also welcome the Government’s recent decision to offer direct subsidies to offset sharp cost increases, and allow domestic producers to continue developing quality local products, despite the difficult trading conditions. Moreover, the current grain harvest is turning out to be favourable for Russia, which, we expect, is set to further stabilise input costs.

Overall, we expect that in the second half of the year we will return to normalised profitability levels, which we already demonstrated in the second quarter, and this will offset the negative impact of the performance in the first quarter. Accordingly, management is optimistic that we are on track to meet expectations for the full year.»

Chief Executive’s Review

Financial Overview

The table below summarizes the Group’s strong performance on a rouble currency basis for the second quarter and the first half of 2011:

1H2011

1H2010

Change

2Q2011

2Q2010

Change

Sales

19 723,6

17 222,6

15%

10 703,3

9 303,2

15%

Gross Profit

4 858,0

4 919,3

-1%

2 968,4

2 721,1

9%

Gross margin, %

25%

29%

 

28%

29%

 

Operating expenses

(2 699,6)

(2 270,5)

19%

(1 434,9)

(1 199,5)

20%

Operating Income

2 158,4

2 648,8

-19%

1 533,5

1 521,6

1%

Operating Income margin, %

11%

15%

 

14%

16%

 

Net Income

1 888,5

2 226,8

-15%

1 351,1

1 274,5

6%

Adjusted EBITDA

3 025,9

3 398,1

-11%

  2 004,2

1 918,9

4%

EBITDA margin, %

15%

20%

 

19%

21%

 

 

 

 

 

 

 

 

On a reported currency basis sales increased for the first half of 2011 by 20% to US$689.1 million (1H2010: US$572.8 million); and for the second quarter by 24% due to healthy organic growth across all segments. Gross profit increased 4% to US$169.7 million (1H2010: US$163.6 million). Operating expenses as a percentage of sales were largely flat at 14% compared to 13% in the first half of 2010. Net income decreased 11% to $66.0 million (1H2010: US$74.1 million).

Adjusted EBITDA* decreased 6% to US$105.7 million (1H2010: US$113.0 million) and adjusted EBITDA* margin was 15% for the 1H2011, and 19% for the second quarter of 2011, reflecting a significant improvement in profitability and a robust operating performance by the Group.

USD, mln (unaudited)

1H2011

1H2010

Change

2Q2011

2Q2010

Change

Sales

689,1

572,8

20%

382,5

307,6

24%

Gross Profit

169,7

163,6

4%

106,1

90,0

18%

Gross margin, %

25%

29%

 

28%

29%

 

Operating expenses

(94,3)

(75,5)

25%

(51,3)

(39,7)

29%

Operating Income

75,4

88,1

-14%

54,8

50,3

9%

Operating Income margin, %

11%

15%

 

14%

16%

 

Net Income

66,0

74,1

-11%

48,3

42,1

15%

Adjusted EBITDA

105,7

113,0

-6%

71,6

63,4

13%

EBITDA margin, %

15%

20%

 

19%

21%

 

Poultry Division

Sales volumes in the Poultry division in the first half of 2011 increased by a robust 18% to approximately 117,990 tonnes of sellable weight compared to approximately 99,860 tonnes for the first half of 2010.

Prices for poultry sales in dollar terms increased by 9% from $2.30 per kg in the first half of 2010 to $2.51 per kg in the first half of 2011 (excluding VAT)*. Compared to the first quarter of 2011, the price in the second quarter increased by 7% to $2.59 per kg.

Prices in rouble terms increased by almost 4% from 69.11 roubles per kg in the first half of 2010 to 71.79 roubles per kg in the first half of 2011 (excluding VAT). Compared to the first quarter of 2011, the price in the second quarter increased by 2% from 71.07 to 72.39 roubles per kg.

Total sales in the Poultry division increased in the first half 27% to US$321.8 million (1H2010: US$253.3 million). Gross Profit slightly decreased to US$75.3 million (1H2010: US$76.6 million), divisional Gross Margin decreased to 23% (1H2010: 30%) mostly due to increasing input and labour costs. The segment also accounted for approximately 382 million RUR or US$13.3 million of direct subsidies which offset the cost of sales.

Operating expenses as a percentage of sales remained flat at 13%. Operating income of the division decreased by 22% to US$35.0 million (1H2010: US$44.9 million), and operating margin was 11%. Profit in the Poultry division decreased by 23% to US$31.1 million (1H2010: US$40.4 million).

Adjusted EBITDA* decreased 14% to US$48.7 million (1H2010: US$56.7 million), while Adjusted EBITDA* margin in the Poultry division was 15% in the first half of 2011.

Pork Division

Sales volumes in the Pork division in the first half of 2011 were almost flat at 41,070 tonnes of live weight, compared to 40,936 tonnes in the first half of 2010.

In dollar terms, prices for pork sales increased by 14% from $2.36 per kg of live weight in the first half of 2010 to $2.70 per kg of live weight in the first half of 2011 (excluding VAT)*. Compared to the first quarter of 2011, the price in the second quarter increased by 11% from $2.57 to $2.84 per kg.

Prices in rouble terms increased by 9% from 71.09 roubles per kg in the first half of 2010 to 77.41 roubles per kg in the first half of 2011 (excluding VAT). Compared to the price in the first quarter of 2011 of 75.27 roubles per kg, the price in the second quarter increased by 6%.

Total sales in the Pork division increased by 16% to US$123.4 million (1H2010: US$106.0 million). Gross Profit increased 3% to US$46.1 million (1H2010: US$44.8 million) while Gross Margin decreased to 37% due to input cost increases and amortization and labour costs increases resulting from launch of new assets into operation. The segment also accounted for approximately 168 million RUR or US$5.9 million of direct subsidies which offset the cost of sales.

Operating Expenses as a percentage of sales were flat at 7%. The division generated Operating Income of US$37.0 million (1H2010: US$37.6 million), while Operating Margin was 30% (1H2010: 35%). Profit in the Pork division increased by 4% to US$35.5 million (1H2010: US$34.3 million).

Adjusted EBITDA* generated by the division increased 3% to US$46.3 million (1H2010: US$44.9 million), and Adjusted EBITDA* Margin was 38% (1H2010: 42%).

Meat Processing Division

Sales volumes increased by 6% to 70,097 tonnes from 66,200 tonnes for the first half of 2010.

Prices in dollar terms increased by 17% from $3.81 per kg in the first half of 2010 to $4.47 per kg in the first half of 2011 (excluding VAT)*. Compared to the first quarter of 2011, the price in the second quarter increased by 8% from $4.30 to $4.64 per kg.

Prices in rouble terms increased by 12% from 114.66 roubles in the first half of 2010 to 127.98 roubles per kg in the first half of 2011 (excluding VAT). Compared to the price in the first quarter of 125.75 roubles per kg, the price in the second quarter of 2011 increased by 3%.

Total sales in the Meat Processing division increased 24% to US$303.0 million (1H2010: US$243.4 million). Divisional Gross Profit increased 14% to US$48.5 million (1H2010: US$42.4 million), while Gross Margin slightly decreased to 16% (1H2010: 17%) due to meat price increase, and an increase in labour costs and social tax. Operating expenses as a percentage of sales were flat at 12%. Division profit decreased to US$7.4 million (1H2010: 9.1 million).

Adjusted EBITDA* for the division was flat at US$18.3 million, and Adjusted EBITDA* margin decreased to 6% (1H2010: 8%).

Financial Position

The Group’s Capital Expenditure on property, plant and equipment and maintenance amounted to US$106.0 million in the first half of 2011. Of that, US$42.2 million was invested into the Poultry division, mainly into the breeding and incubation sites, as well as slaughter and processing sites within the capacity increase projects at the Bryansk and Penza clusters; US$58.2 million was invested into the Pork division, mainly into the construction of three pork complexes, and US$5.6 million was invested into the Meat Processing division.

Net Debt** at the end of the first half of 2011 was US$835.6 million or RUR23,459.8 million. Total Debt was at US$874.7 million or RUR24,558.3 million. Of Total Debt, long-term debt was approximately US$587.4 million, or 67% of the debt portfolio. Short-term debt was US$287.3 million, or 33% of the portfolio. Cost of Debt for the first half of 2011 decreased to 2%. The portion of subsidized debt in the portfolio was 88%, improving from 86% as of 31 March 2011. Cash and cash equivalents totalled US$39.1 million at 30 June 2011.

Subsidies

For the first half of 2011 under Government decree № 1247-p, agro-industrial companies have received direct government support for pork, poultry and egg production due to extraordinary weather conditions in the second and third quarter of 2010 that resulted in sharp cost increases. Cherkizovo Group has applied for these subsidies on the basis of its actual production volumes. This corresponds to 382 million roubles in poultry segment, or US$13.3 million and 168 million roubles, or US$5.9 million in pork segment. The total of 550 million roubles or US$19.2 million in subsidies has offset the cost of sales.

The Group received interest reimbursement of US$25.9 million for the first half of 2011 which offset interest expense. For the first half of 2010 the interest reimbursement was US$18.5 million.

Outlook

We have delivered a strong set of results across all segments in the first half of 2011 and were able to significantly improve profitability in the second quarter driven by efficiency gains and an improved pricing environment. We have completed an acquisition of Mosselprom, one of Russia’s best known meat producers, which enables us to further enhance our market position in high margin businesses. Furthermore, we have started construction of the country’s largest poultry production complex in the Lipetsk region.

Our capacity increase projects in poultry are well under way, with two large poultry production facilities and an incubation site opening in our Bryansk and Penza clusters, while we plan to launch a processing facility and another incubation facility in Penza this year. At the same time we are actively integrating the acquired facilities into our structure.

Results in the pork segment were affected by the extreme weather conditions of last summer, however now we see this segment begin to stabilise, and we have also begun integrating our new asset, which was acquired through the Mosselprom transaction.

In the meat processing segment we see a steady increase in demand for our meat products, and to further capitalize on this, we have launched the meat processing plant in Kaliningrad that we bought last year.

For the remainder of the year we see our primary drivers to be the increasing demand for our products, a positive pricing environment and stabilising input costs structure. We see that the current grain harvest is turning out to be favourable for Russia, though grain prices in Russia will likely depend on global grain pricing trends, as Russia has returned to export markets. We also welcome the Government’s recent decision to offer direct subsidies to offset sharp cost increases, and allow domestic producers to continue developing quality local products, despite the difficult trading conditions.

We are already returning to normalised profitability levels, and this will offset the negative impact of the performance in the beginning of the year. Accordingly, management is optimistic that we are on track to meet expectations for the full year and confirm our status as the leader of the industry.

*Non-GAAP financial measures. This press release includes financial information prepared in accordance with accounting principles generally accepted in the United States of America, or US GAAP, as well as other financial measures referred to as non-GAAP. The non-GAAP financial measures should be considered in addition to, but not as a substitute for, the information prepared in accordance with US GAAP.

Adjusted Earnings before Interest, Income Tax, Depreciation and Amortization («Adjusted EBITDA»). Adjusted EBITDA represents income before income tax and non-controlling interests adjusted for interest, depreciation and amortization and certain other items as shown in the reconciliation in Appendix 1. Adjusted EBITDA margin is defined as Adjusted EBITDA as a percentage of our net revenues. Our adjusted EBITDA may not be similar to adjusted EBITDA measures of other companies; is not a measurement under accounting principles generally accepted in the United States and should be considered in addition to, but not as a substitute for, the information contained in our consolidated statement of operations. We believe that adjusted EBITDA provides useful information to investors because it is an indicator of the strength and performance of our ongoing business operations, including our ability to fund discretionary spending such as capital expenditures, acquisitions and other investments and our ability to incur and service debt. While depreciation and amortization are considered operating costs under generally accepted accounting principles, these expenses primarily represent the non-cash current period allocation of costs associated with long-lived assets acquired or constructed in prior periods. Our adjusted EBITDA calculation is commonly used as one of the bases for investors, analysts and credit rating agencies to evaluate and compare the periodic and future operating performance and value of companies within our industry. Adjusted EBITDA is reconciled to our consolidated statements of operations in Appendix 1.

**Net debt is calculated as total debt minus cash and cash equivalents

Some of the information in this press release may contain projections or other forward-looking statements regarding future events or the future financial performance of the Group. You can identify forward looking statements by terms such as «expect," «believe," «anticipate," «estimate," «intend," «will," «could," «may» or «might» the negative of such terms or other similar expressions. We wish to caution you that these statements are only predictions and that actual events or results may differ materially. We do not intend to update these statements to reflect events and circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events. Many factors could cause the actual results to differ materially from those contained in our projections or forward-looking statements, including, among others, general economic conditions, our competitive environment, risks associated with operating in Russia, rapid market change in our industry, as well as many other risks specifically related to the Group and its operations.